Healthcare Realty Trust Incorporated
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good morning, and welcome to the Healthcare Realty Trust Third Quarter Analyst Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to David Emery, Chairman and CEO. Please go ahead.

[David Emery:]

Thank you. Good morning everyone. Joining us on the call today are Scott Holmes, Doug Whitman, Todd Meredith, Carla Baca and Bethany Mancini. Ms. Baca will now read the disclaimer.

[Carla Baca:]

Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the Form 10-K filed with the SEC for the year-ended December 31, 2014. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operations, FFO or FFO per share. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30, 2015. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.

[David Emery:]

Thank you. We’re again pleased to report a solid quarter. Strong revenue and FFO growth continue to highlight the company's positive operating metrics and quality portfolio. We expect the company's progress to build throughout the months ahead and in the years to come. Healthcare Realty's investment strategy remain centered on low risk, high value real estate within an expanding outpatient medical office sector. Healthcare Realty's model for growth will continue to benefit from multiple balanced sources and a foundation of robust internal growth. We continue our efforts to better capitalize on the inherent value of our portfolio. As insurance reform policies laid out [ph] inefficiency and non-performing healthcare systems. Merely affiliated all campus properties can quickly become orphan assets. It is the own campus locations with one of the top 100 health systems in the country that will ensure positive renewal rates and EUs and consistent performance overtime, enhancing Healthcare Realty's portfolio value. To put this in context, the top 100 systems operate over 1700 hospitals with each system generating revenues greater than $1.9 billion. The top 25 generating $5.3 billion or more. In addition, the company's balanced investment approach is prime to benefit from health systems having a more positive outlook on the expansion of their clinical missions. Ready-to-move beyond the uncertainty in earlier years of health insurance reform. We're moving forward with several development projects and markets where we already have a presence. Own campus facilities with significant leasing from hospital driven services and better long-term returns at a lower risk relative to most acquisition offerings. The MOB market is very stable, without cycles of overbuilding, setting the stage for robust growth. Recurrent tenants, higher rent coverages and low fungible characteristics determine the company's resilience. Its ability to compound NAV overtime and allow the company to be selective and avoid the variable effects of just spread investing. Healthcare Realty has a well-defined and home strategy and is poised to extend this distinctive position to prosper in a highly desirable asset class. Now, I'd like to ask Ms. Mancini to summarize our current views on current events and trends related to healthcare industry. Bethany?

[Bethany Mancini:]

Earlier this week, the President signed into law the Bipartisan Budget Act of 2016 providing for a two year $80 billion federal budget, with minimal cut in Medicare payments to healthcare providers. One item in the budget affects Medicare payment rates across outpatient setting to lower the rate for services performed in new hospital outpatient departments located in facilities off the hospital campus. Long anticipated but largely unexpected in this year's budget, payments will be brought in line with those for the same procedures performed in physician offices. We expect this adjustment in rates will dis-incentivize the development of off-campus hospital anchored facility. And conversely benefit to Healthcare Realty's on-campus medical office building. That can continue to initiate leases with the hospital at higher Medicare rate. In regards to our current off-campus outpatient facilities existing hospital leases should have a higher propensity to renew since they are grandfathered in by the new law. And overall, site neutral Medicare policy shouldn't no way impact the general logic of health systems moving care to outpatient settings to lower costs. Efforts to repeal the Affordable Care Act remain ongoing, however constrained by a probable veto up to the next selection. The center for Medicare and Medicaid services recently finalized 2016 Medicare rate for the various care setting and physician fee schedule rates on average will remain stable within expectations. On the regulatory side of health insurance reforms, we are beginning to see the several ACA initiatives at the Federal level are faltering. Insurance cost supported by federal loans are collapsing, Medicare accountable care organizations are performing poorly. The growth in the adoption of electronic health record is weighing, basic system upgrades and tougher federal requirements. And two-thirds of providers that enrolled in Medicare's voluntary bundled payments program have dropped out. However independent of these issues healthcare providers and insurers alike are making positive stride to pull profit margins by expanding the use of outpatient services at medical office facility and enhancing inpatient specialization at the larger acute care hospital. Healthcare Realty has seen greater demand for on-campus medical office space by health systems pursuing proven post-reformed strategy creating clinically integrated networks that allow them to participate in coordinated care models as well as increase their physician referral base. Moody’s and Standard & Poor's recently revised their prior negative outlook for not-for-profit health system to stable on higher operating margins last year. The increase came as outpatient volume rose more than 2% in 2014 while inpatient volume declined 1% and revenue from outpatient care surpassed revenue from inpatient services. We have seen some closures of smaller rural inpatient hospitals this year not outside the normal range for yearly hospital closures. In 2013, the 25 hospitals that closed averaged only 64 beds at 34% occupancy. We expect such closures will continue its quality care and tighter reimbursement, drive more patients to outpatient setting. Healthcare Realty strategy to invest on the campuses of large investment grade health systems with strong market share in growing cities should continue to preclude the company from the effects of hospital closures in smaller communities. Approximately 80% of the company’s outpatient facilities are located on hospital campuses and more than 88% are affiliated with credit rated health systems resulting in high demand for space and tenant retention and the ability to grow rental income steadily. In addition, the company’s portfolio comprises a diverse base of physician tenants across more than 30 specialties with relatively lower concentration of Medicare and Medicaid patients and high rent coverage. Even as the Healthcare industry evolves, it is the underlying value of need driven real estate, on investment grade hospital campuses that remains the driving force for incremental demand of medical office space. David.

[David Emery:]

Thank you Bethany. Now on to Mr. Whitman to give an update on balance sheet metrics and capital market activity, Doug.

[Doug Whitman:]

For much of the third quarter macro concerns about the interest rates generated increased volatility in the capital markets, despite this unpredictability Healthcare Realty continued to execute its strategy with a strong balance sheet and limited near-term capital needs enabling the company’s consistent pursuit of lower risk growth and the on-campus medical office sector. Low cap rates have been coaxing [ph] more medical office owners to sell their assets while also providing us with a cost effective means to fund the company’s external growth. Last quarter we increased our 2015 guidance on dispositions to $125 million to $150 million and expect to be at the top end of the range by year end with the blended cap rate in the mid-5s. Historically, our primary focus has been selling older, smaller, off-campus assets that were included in larger portfolios. As part of our balanced approach not only will we continue with some level of this activity but we are also identifying assets that in our estimation have reached their growth potential, harvesting the value from these otherwise solid assets and redeploying that value into properties with even higher growth potential. We recognized that the capital markets may remain choppy for the foreseeable future but fortunately we have the ability to wait for windows when the debt and equity markets make sense. Should we need to access such a window in the debt market, our recent ratings upgrades from Moody’s and Fitch should enhance our pricing and execution. We remain confident with our strategy of strong internal growth, paired with moderate levels of acquisition and development, funded judiciously with a combination of equity, debt and dispositions will increase value over the next several quarters.

[David Emery:]

Thank you Doug. Now, on to Mr. Holmes, to give us an overview of the operating results and other financial matters, so Scott?

[Scott Holmes:]

The company reported third quarter normalized FFO per diluted share and NAREIT defined FFO per diluted share of $0.41. The normalizing item for the third quarter is an add-back for acquisition costs of just a $121,000. Normalized FFO for the third quarter grew 4.1 million or 11% year-over-year to 40.7 million, over the same time period normalized FFO per share increased 7.9%. For the third quarter the Board of Directors declared a dividend of $0.30 per share and the dividend payout percentage based on both NAREIT defined and normalized FFO is 73.2%. In the same store pool for the third quarter, the trailing 12 month NOI growth rate over the same period a year ago was 6.5% for the multi-tenant properties and 4.3% for the single tenant net-leased properties for abandoned [ph] NOI growth rate of 5.9%. The more predictive same store metrics for the third quarter were contractual rent increases of 2.9%. Cash leasing spreads on 369,000 square feet averaged 2.1% with 70% of the square feet renewed at a spread of 3% or above. Tenant retention of 82.4% and the average yield on renewal leases for the quarter increased 40 basis points. These metrics are partially reflected in the average rental rate for occupied square foot in the same store pool which increased by 2% year-over-year in the multi-tenant portfolio and 2.5% in the single tenant net lease properties. Compared to the second quarter and a year ago, occupancy increased or held steady throughout our portfolio. The company's strong tenant retention reflects the low fungible nature of the assets enabling us to maintain positive cash leasing spreads, improved releasing yields and consistent annual rent bucks. These positive indicators reflect strong momentum for the key drivers to the company's future revenue growth and we continue to be pleased with the direction of our leasing initiatives and our operational expense management.

[David Emery:]

Thank you Scott. Now on to Todd to give us review of investment activity and other matters, Todd.

[Todd Meredith:]

The company made steady progress on investment activity during the quarter. Acquiring two properties for 34.5 million, selling four properties for 40.7 million and funding 7.2 million and four development and redevelopment projects underway. In September, the company purchased a 53,000 square foot MOB for 28 million in downtown Seattle. The facilities are 100% leased by a leading orthopedic group and is fully integrated with an orthopedic surgical hospital located on the Swedish hospital campus which is part of AA minus rated Providence Health and Services, the six largest health system in the US. This MOB is also located adjacent to 82,000 square foot property, the company acquired in October of 2013. The company purchased a second property of 48,000 square foot MOB in Denver for 6.5 million in September. The property is located near the campus of CHI, St. Anthony Hospital where the company has developed two MOBs, is now developing a third. The property was 73% leased upon acquisition and is a good example of a low risk value add play that capitalizes on our local market knowledge gained from developing and leasing properties in the same affinity. Subsequent to quarter end, the company acquired two additional properties totaling a 145,000 square feet for $55.8 million. One property is a 100% leased and located adjacent to AA minus rated MultiCares Tacoma General Hospital. The second property is 97% leased and located on the campus of AA minus rated Alta Bate Summit Medical Center campus in Oakland. These two properties bring year-to-date acquisitions to seven properties for $143.6 million at a blended cap rate of 5.9%. Collectively these property strengthen our affiliations with top 50 health systems increase our proportion of on-campus locations and expand our presence in several top 25 MSAs we already know well. With a couple more acquisitions likely in the fourth quarter we're increasing the upper end of our 2015 acquisition guidance range to $175 million and maintaining our cap rate guidance of 5 and 3 quarters to six and a quarter percent. Healthcare Realty continues to take advantage of favorable market conditions to dispose of certain assets recycling proceeds and asset with higher growth potential. In the third quarter the company sold four properties for $40.7 million at a blended cap rate of 5.8%. These properties were collectively 73% occupied and were now in line with health systems or market the company is targeting. Year-to-date, Healthcare Realty sold 7 properties for $138.7 million and with two more properties under contract and expected to sale on the fourth quarter total dispositions for 2015 should be at the top end of our guidance range of a $125 million to $150 million at a blended cap rate of around 5.5%. Turning to our development and redevelopment efforts, we currently have commitments underway totaling $99.3 million including $67 million of redevelopment and $32 million of ground-ups development. These properties are collectively 78% leased scheduled to be completed over the next 18 months and on pace to generate stabilized yields of 8%. Over the next few years, the company's current development and redevelopment pipeline has potential to produce starts of around $100 million per year. HR currently controlled land representing over $250 million of development and redevelopment potential. In downtown Seattle for example, we have a site where we can develop up to 125,000 square feet on land that came with MOB acquired in 2013 and also happens to be adjacent to one of the buildings we just acquired. We have strong interest for multiple large clinical users and with a vacancy rates of less than 1% in this submarket, we're pushing to start construction as soon as possible likely toward the end of 2016. At stabilized yield targets that are 100 to 175 basis points north of current acquisition yields, development such as these will generate net asset value and earnings momentum in the coming years. Fresh on many investors' mind, the specter of overbuilding wins again for certain markets and sectors including senior housing. Difference in past cycle, the effect of oversupply could be compounded for certain REITs with direct occupancy exposure to senior housing through deal [ph] structures. All of our supply has never been a factor in the MOB business, enthusiasm has been rising for off-campus hospital anchored outpatient facilities. Although this trend makes clinical sense for health systems today as they look to expand their lower cost to outpatient networks we've remained cautious to having seen similar enthusiasm in the 1990s. Over the years we've seen many instances of anchored hospital tenants vacating off-campus facilities after a lease cycle or two for any number of reasons. Once the anchored tenant leaves, you have the equivalent of a vacant suburban office building with specialized tenant improvements destroying any original DCF or IRR expectations. We see on-campus MOBs is different from most sectors. Distinctly different than senior housing driven off-campus MOBs for various entry or much lower exact locations are less critical and more easily replaced and reimbursement risk is higher. On hospital campuses land is scarce and carefully controlled by health systems to preserve optionality for future primarily inpatient capacity, in most markets on most hospital campuses, outpatient capacity is chronically under supply. Moreover, reimbursement is proven relatively stable for on-campus outpatient services. In contrast, section 6, three of the federal budget act passed earlier this week reduced reimbursement for any of the hospital outpatient departments not located on a hospital campus which will likely dampen hospital demand for off-campus outpatient facilities. As we look ahead our ability to invest accretively in the growing outpatient sector remains robust. Driven by a balanced investment strategy and a disciplined focus on low fungibility on-campus properties with intrinsic pricing power. By integrating our disciplines of acquisition development, redevelopment and asset recycling and combining it with our leasing and operational expertise Healthcare Realty is well-positioned to create value well beyond spread investing with an operating model that can not only exists but thrive in a uncertain market cycles. David?

[David Emery:]

Thank you Todd. Operator we are now ready to begin the question-and-answer period. Thank you.

[Operator:]

Thank you Mr. Every. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Jordan Sadler of KeyBanc Capital. Please go ahead.

[Jordan Sadler:]

Thank you. Good morning.

[David Emery:]

Good morning.

[Jordan Sadler:]

So first I just like to take a look at the cash leasing spreads, any incremental color you can offer on sort of the activity during the quarter if there was anything that drove the spreads down sequentially.

[Todd Meredith:]

Hey Jordan, this is Todd. I would say that we expect it normally to move around a little quarter-to-quarter. Certainly we had a good quarter at 5% last quarter little softer this quarter. I think most importantly as just kind of looking at what's transpired over the last five quarter since we really started our revision of our leasing incentive program. What we've really seen is some improvement and the average is certainly up if you look at the last five quarters over the average for the prior 10 quarters we're up over 100 basis points on average. But more importantly and this is why we had some distribution of these cash leasing spreads. We are seeing a lot of improvement at the tails of the distribution. So we are seeing a lot fewer what you call negative cash leasing spreads below zero, a lot fewer that's been cut by literally 75% over those periods and then on the other side of cash leasing spreads that the other tail of 4% or more we've seen it double. So it's really and that's why we provided some color and I think as you look forward to future quarters we certainly expect to be up from this quarter. But not necessarily five, but in that range.

[David Emery:]

Jordan also, this is David. I think and you might be aware of this, on a weekly basis we did get a snapshot of all the new leases and renewals that have been done. I recall this past Friday I think last week in one week we did over 80,000 square feet of renewals and new leases and that was basically eight new leases and I think 18, I think it was of renewals. The new leases owns the renewal rates are over 10 from standpoint, the annual bumps was averaged 3.1% and the renewals were 3.5%. So you can see just on a kind of a weekly basis that we keep up with it that it does move around when you add it all up quarter-to-quarter but as Todd says, I think it's the smooth aspect and we tend to see the tails improving in both positive ways.

[Jordan Sadler:]

Okay. But if I were to look at let's say next year's role. If I were to assume something in the range of 3% to 4% in terms of the mark-to-market that's probably in the range.

[David Emery:]

I think that's fair to say. Obviously any quarter can be round a little bit. But I think that's a reasonable range to think about.

[Todd Meredith:]

The variability is just part of it. The quarter-to-quarter is not indicative.

[Jordan Sadler:]

Right, of course. Helpful color. The other question just really comes back to some of your commentary on the recent budget legislation and just sort of coupled with your disposition activity, you've had pretty good success on the sell side and push that guidance up last quarter obviously now you're moving toward high end and the cap rates you're achieving on dispositions are quite good quite low. Any thought to or about accelerating the disposition activity given sort of the appetite here and maybe given some of the shift in around and that maybe caused by some of the new legislation.

[David Emery:]

I think you've seen us already accelerate that just from our past history of being more in the $50 million plus or minus range. So as you said we're the top end of the current guidance range we're nearly tripled that, so we're already in our view accelerating that. To your point do we continue to - do we think we'll continue to add or increase it. I think it's just, it's got to vary depending on what we're buying and what other opportunities are to invest. So certainly we're seeing a healthy amount coming to market in terms of availability of assets and dispositions provide an attractive way to rotate into this higher quality asset. So I think you'll see us continue to keep it up at this higher level whether it gets greater than that or not probably just going to depend on what we see on the other opportunity side.

[Doug Whitman:]

And Jordan this is Doug. I think you've seen us kind of mention still asset tend to have lower growth potential overtime, and not always but sometimes those are off-campus assets and yes I think with this recent legislation change I think again that reinforces the notion that you want to be honor as close to campus as possible.

[David Emery:]

250 yards.

[Jordan Sadler:]

Last one for me, it's just on the Denver acquisition, can you maybe talk about sort of the value add opportunity there like a going in versus a stabilized cap rate and maybe how the opportunity sort of was created?

[David Emery:]

Well, it was an asset that just through our knowledge of brokers we were on the lift to look at it little smaller than what we typically go for but it happens to be right near these three development two that we've already build and one we’re starting now. So it just made a lot of sense to take the expertise we have right there on the ground and expand that to include that asset because we get folks who come over looking at the hospital campus and it doesn’t make sense for them to be on campus and those rates are clearly higher with the newer building so this gives us another price point and kind of allow us to catch more folks come into that area which is a growing area. So, it basically is something that we can go in and buy something in the 7% to 8% range and maybe go even higher as we optimize the occupancy on that. So, really a nice way to create some more return than pretty low risk away.

[Doug Whitman:]

And Jordan, this is Doug again. As you know we’ve started the third building, are going to ready to start that third building on that campus we certainly have strong demand from physician groups to be on campus, the two existing on-campus buildings are full, we can’t really accommodate them so this also provides us an opportunity with the vacancy in this acquisition to sort of warehouse those tenants temporarily in this acquisition and ultimately some of them may move to the new development.

[Jordan Sadler:]

Okay. Thank you.

[Operator:]

Thank you. Our next question is from Kevin Tyler of Green Street Advisors. Please go ahead.

[Kevin Tyler:]

Yeah. Good morning guys.

[David Emery:]

Good morning.

[Kevin Tyler:]

Thanks for taking the question. You talked quite a bit about the development picking up and we’ve seen it in a few markets and in Seattle obviously you called out today. But you’ve given a favorable commentary generally around future opportunity in that space. Can you try and quantify a bit maybe what that pipeline looks like in next year, can it double, can it triple from where we’re at today?

[David Emery:]

Well, I think certainly as I mentioned we have land that we control or we think there is value of about 250 million in terms of budget in cost to build. We also have properties and opportunities beyond that, that are not necessary in our control but we’re close to so, that probably doubles that obviously we don’t have full control on those situations. I think the important thing here is being measured about the pace of that and making sure that we have a clear picture of the demand and the leasing that we’ll see with that. Very much focused on hospital driven opportunities being on campus, being adjacent to campus or 250 aren't from campus so that we have all the available opportunity of tenants including hospital outpatient departments and so forth. So, I think, I mentioned the $100 a year, I think we right now have something in the neighborhood of 80 million to 150 million that we’re starting on right now that could kind of be in the next 12 to 18 months so I think it suggest that 100 million a year for now. I think we’ll be careful about ramping it up too much beyond that just making sure we balance it with the lease profile and it looks like the things we’re working on right now have leasing, initial leasing commitments that would be in that 70% range on average so very strong initial leasing.

[David Emery:]

A lot of these development opportunities I just reference - reverse inquiries from the hospital saying hey, we have an outpatient service department that needs space, can you provide that for us?

[Kevin Tyler:]

Okay. Thanks. That’s helpful commentary. And then we talked a little bit about the hospital operators in some of the recent troubles at the community levels and that’s when you mentioned that. But I guess at what point or what does it take for your strategy to ship from this 250 yard mentality to focus again on the physician groups that might not be affiliated with the hospital systems if we continue to see some struggles on the hospital front?

[Doug Whitman:]

Well I think as long as you concentrate on the top 100 there is no struggles.

[David Emery:]

Yeah. I think we’re being very careful for obvious reason geographically or location relative to the campus being very careful stay close to those health systems and on campus and this legislation just points further to the value of that on campus location. I think physicians alone what independent physicians want to go out and do something out campus, we’re probably not going to do that, there may be select cases where it make sense. But generally we’re going to always tie to a health system and we’re going to try to tie to hospital campus location.

[Doug Whitman:]

And again David the top 100 hospitals, these are the hospitals that have the market share, the depth, the access to resources the capitals continue to grow to invest in those new services that will attract those physicians, those are the people that you want to be partnering with.

[Kevin Tyler:]

Got it. That makes sense. The last one I had just we saw a recent transactions with Blackstone kind of validating their appetite for non-traditional or non-core real estate sectors just the breadth of what they might want to own and in the lab space. I guess I was curious how you think about a player like that as a potential partner and then the follow-on would be has anything changed in terms of succession planning David over the next just kind of few years?

[Doug Whitman:]

Right one of the first front Todd, as far as JVs and otherwise.

[Todd Meredith:]

Yeah I think maybe you’re talking about more of Blackstone taking over the entire REIT. I think obviously we’re public company and if somebody expresses that interest we have to pay attention but I think NAV discounts and that were more prevalent a month ago or so and obviously the stock moves around, everybody’s does, I think that window has closed a little bit on valuation but it doesn’t mean that there is not more opportunity for somebody like Blackstone. I think it probably becomes a little less compelling unless there's that deeper discount or that there is something particularly, particular opportunity that's not being valued in a particular company so it remains to be seen, we’ve always heard that talk about MOBs and private investors coming into that sector but we haven’t seen it in that way yet. David maybe on that the second part?

[David Emery:]

Kevin on the second part we really from the succession standpoint that’s still pretty much in the direction that we’ve indicated over this last year that you may have noted this week we also added a new board member and I think in the coming months here particularly in the first part of the year most of that will probably clarify as to what’s going to occur in the next 12 months.

[Kevin Tyler:]

Okay, thanks for the time guys.

[David Emery:]

Sure.

[Operator:]

Our next question is from Michael Carroll of RBC Capital Markets. Please go ahead.

[Michael Carroll:]

Yeah, thanks. Maybe off a little bit of a Kevin’s question would you consider doing a joint venture with a large pension fund to kind of go out there be a little bit more aggressive acquiring assets maybe be a little bit more willing to acquire the off-campus are you just kind of still focused on the on-campus stuff?

[David Emery:]

Mike, our preference has always been to really keep our story fairly simple including our balance sheet and I think also the size of our deals, we typically buying one or two buildings at a time, hasn’t really warranted that but that said, with the kind of gap out that you’re seeing, the difference in private market cap rates versus public market valuation that certainly has some logic and make some sense. I think for us if we see enough properties that meet our criteria which is kind of what you're getting at I think we would stick to primarily to our focus of on-campus high quality properties. If we see some volume of that and we think it’s worth going after this property that fit well under our portfolio and our plan then we got to look at all of our cost of capital and if it doesn’t make a lot of sense on our balance sheet alone we would look at that so I think it just kind of remains to be seen how much picks up in terms of volume and sort of where those cap rates are versus public implied cap rates if you will. So certainly an option but we’re keeping an eye on that relative to cost of capital.

[Michael Carroll:]

Okay. Then how many on-campus I guess opportunities are you currently tracking I mean do you think that the acquisition levels in 2015 can be similar to what you’ve been able to complete this year last year?

[David Emery:]

Certainly the opportunities that appears to be strong we’re seeing a lot that fits our criteria the top 100 health systems as we've said here good MSAs and on-campus and obviously other attributes that we look for so we're certainly, we like to buy things obviously that are in markets we already operate in and lease in so we’re seeing some of that so generally speaking I think we think of paid similar to this year as possible next year obviously pricing has gotten fairly rich so we have to just keep an eye on that relative to our cost of capital.

[Unidentified Company Participant:]

I think also just a temporal view, I think the cap rates have kind of gotten at the point of where it’s pushed through kind of the normal what I would call market churn and there seems to be appearing what I would refer to more as fortress assets on unbelievable hospital campuses that sometimes have been owned by individuals or groups for decades. And I think the cap rates getting to where they are, we’re beginning to see emerge really some very attractive opportunities and so I don’t know if how those trade or how that plays out but we just kind of noticed that in the last 4-3 months so to speak that some people have really fortress assets for years and years and years are now thinking about is it time for transaction for exit.

[David Emery:]

In that to add that I would say it's more on the private owner developer side. But some a little bit more than uptick in the health systems as well.

[Unidentified Company Participant:]

Yeah.

[Michael Carroll:]

Okay. And my last question is kind of relate to the SIP portfolio. Can you kind of update us with the occupancy level on those assets are right now how much NOI have they generated in, can you strip that out from the same store growth that you reported in the sub?

[David Emery:]

Sure. Overall if you look at our annual report of same-store it was 5.9, it's 2.5 without development properties. So certainly contributing nicely there and in terms of the properties themselves they cash NOI with 5.1 million in the quarter. On a run rate basis so if you have all the leasing that's in place - all the occupancy in place there for the full quarter, run rate is about 5.5 million. Occupancy is 82% currently, leasing is at 86%, that leasing will take occupancy over the next few quarters or two or three quarters I should say which will get run rate NOI up closer to 6 million and so you really just sort of have the last leg from 86 to about 94% to 95% that gets you to that 27-28 million of annual NOI.

[Michael Carroll:]

Thank you.

[Operator:]

Thank you. Next question is from Rich Anderson of Mizuho Securities. Please go ahead.

[Richard Anderson:]

Thanks. So you guys are talking about 250 yards that's actually not a random number, that's actually the law that is in section 603, is that correct?

[Unidentified Company Participant:]

Yes, it existed for some time. It's just gotten highlighted this past week and so there are some definitions to this 250 yards from where. I think the designation is kind of like front door. I think it's kind of the - what the designation is.

[Unidentified Company Participant:]

It's a little unclear right now. So I think everybody we are talking to is trying to scramble a little figure out what it means. But it is in a new definition.

[Richard Anderson:]

So should we look at every asset that you own that's 251 yards away as a potential sale?

[Unidentified Company Participant:]

Well, to some degree there is good side to the 250 and the ones that are outside the 250 are grandfathered so they're probably going up in value.

[Richard Anderson:]

Yeah, fair enough. And so speaking about kind of the broader context of external activity you're selling more, you're buying more, you're developing more again, you started that engine. What would you say is driving that beside it's just the pricing, do you have some concern as it relates to interest rate, is that a motivating factor as well and I'm just curious what's behind all that besides just the fact that you are getting good pricing, is there a sense of urgency to do it now?

[David Emery:]

No, I think some of the sellers I mean sometime it's just - it can be everything from a state planning to position getting at. I mean the motivation for selling estimate maybe interest rate driven, but I think a lot of it is, some of the sellers are just looking at different rationale, I mean everything except from a state planning developers are getting out positions, in a group maybe there are some generational change within the physician group and it's time to cash out. So as Todd referenced in the hospital as well. So they tend to be less than into the market timing, but you are seeing some of that as well.

[Todd Meredith:]

Some of the private sellers certainly price matters in its reaching of level where they it's more attracted to them. But I don't think that's the only thing I think a lot of - some of the ones we are seeing they are not necessarily medical office players, they just happen to have these fortress assets and make sense for them. But we are very sensitive to that in a way this is a richer pricing environment. So we want to be very careful about approaching this and making sure that it make sense and we have a cost of capital that matches and is appropriate.

[David Emery:]

And it's a long term growth opportunities there can help you to grow out of that initial cap rate.

[Todd Meredith:]

I think there is a little two sides of it Rich and that the more fortress assets does not attract since the lowest cap rate when you get into delve into it have the highest pricing power. So basically it's kind of a DCF kind of view. So, yes these are more expensive fortress assets but they don't have contract 2% bumps for 10 years.

[Richard Anderson:]

Okay, fair enough. So now on the 2.9% bumps that you mentioned in the release that's for the entire portfolio as you see today the multi-tenant portfolio, right?

[David Emery:]

No, that's contractual bumps not the cash leasing spreads. Its two different things.

[Richard Anderson:]

No, I know that. But you are talking about the entire portfolio has got contractual bumps of 2.9% right now on average.

[David Emery:]

No, actually what that is the contractual bonds that occurred in the quarter. So it's not but this is the case but if you had all of your leases. It would be just as in the quarter so let's just say evenly distributed it would be about quarter of your of all your leases that are in place. Obviously it can vary from a quarter. But now that's why you have to look at the history that we show and it's been between 29 and 31 for the volumes we tracked in and published.

[Richard Anderson:]

Okay so it was 29 in terms of leasing activity this quarter, but what is the entire what's number on average for the entirety of the portfolio 3?

[David Emery:]

Okay and at portfolio.

[Richard Anderson:]

And what is it 4 single.

[David Emery:]

It's probably around 2 in a quarter.

[Richard Anderson:]

Okay, good.

[David Emery:]

Well I just kind to say it's moved around a little bit in recent quarters. We had one particular single tenant deal that was in every three year that does a catch up at about 2.5 after 3 year compounded approach. So it kind - it will skew any particular period but on average you have about two in a quarter.

[Richard Anderson:]

Okay. And just - can you explain to me this leasing commission amortization. I guess and I never seen that term before or maybe I just got my head in the sand, but I mean what is that and that you're adding back to get FFO now.

[David Emery:]

It's actually I think just a conformance with NAREIT definition and making it more comparable to what you're seeing from other REITs. So it's really nothing new, it's new to us. But not new in terms of comparability’s of other REITs. And so we've just broken out and shown that's people know that it was a change from prior and we've reflected that in all prior quarters. And I think the other thing you'll see is we've now added cash or sorry leasing commissions paid. So the full amount paid each quarter to our disclosure as well. And that's in our supplemental.

[Richard Anderson:]

And so you add back those leasing commission that you paid in the past is that what that is?

[David Emery:]

It's just the amortization that is in the operating expense line of our income statement.

[Unidentified Company Participant:]

Just the GAAP amortization.

[Unidentified Company Participant:]

Yeah the GAAP amortization. So it conforms with I think what you're see and everybody do and so it makes it more comfortable.

[Unidentified Company Participant:]

I think a little bit of that rich in the past because there was not a lot of tenant ramp in the medical office space. It was a kind a de minimus for us in year's past. But since that has kind a ramped up over the last two or three years is kind a gotten to the point where we're also and we kind realize as well conventionally everybody else is doing this we need to do it too. So that's all it is.

[Richard Anderson:]

Okay. And then last question is kind a broad comment about just volatility in the medical office space you alluded to this to some degree in this call. But I'm just curious what you think about what really happens in the confines of a day-to-day in medical office. I mean your direct pure HTA has hit the markets 3% same store NOI growth for a while now. And we've debated that on that side. But I'm just curious what you think is that type of consistency what you can also expect to see over the long-term and even in the short term.

[Unidentified Company Participant:]

I think all you have to do Rich is look at our history last year or two three years what everyone want to look at. And we don't have that consistency and we don't think it sort of works in the business model that we're in which is heavily multi-tenant building. We have 15% to 20% of our leases expiring in that multi-tenant portfolio every year. And just by the nature of that it makes the revenue model very difficult to have these to have that consistent. Plus when you compounded with some expense movement here in the area and this year is pretty flat last year expenses were up 2.7. So a little bit an occupancy change because the long way and changing that consistency. So for us we do have a higher portion of multi-tenant and a lot of folks like HTA so maybe we get a little more volatility as a result. But unless you have all that leases for us there is going to be the volatility of the nature.

[Richard Anderson:]

Okay, fair enough. Thanks.

[Operator:]

Thank you. [Operator Instructions]. Our next question is from Daniel Bernstein of Stifel. Please go ahead.

[Daniel Bernstein:]

Good morning.

[Unidentified Company Participant:]

Good morning.

[Daniel Bernstein:]

Most of the good questions have been asked, I just - keep the call short. I do want to ask so in terms of the buyers for medical office, it seems like there is maybe some more sellers. What are you seeing in terms of the interest from other buyers? In my sense from talking to people is they're shifting little bit of their allocations away from seniors where there is supply to medical office. Is that something that you think you're incrementally seeing and how do you think cap rates are going to react to that if that's the case.

[Unidentified Company Participant:]

I think we certainly see the usual players, the REITs, some private funds obviously some of the names that you hear up there. So they're always there and I don't think that's changing, you're right I think it's probably anything bringing some more allocations and maybe even some more players into it which tends to keep the pricing, the cap rates low and I think that's probably going to unless there is a major, major shift in cost of capital for everybody involved which they're obviously has been some for REITs this year. You're going to see continued low cap rates for a while on the private market certainly creating more pressure on that as you know, so it's hard to say at this point, we haven't seen a tremendous change in the roster and from what we here but certainly continued interest and heightened interest by all the parties.

[Daniel Bernstein:]

Okay.

[Doug Whitman:]

And Dan this is Doug. I think where we've seen more compression on cap rates, I think it's going some of them maybe the more off-campus side, I think that have come down more towards where we have seen cap rates on the on-campus side but yes there has been some compression maybe on the on-campus but not as much, I just think it's because there is more off-campus opportunity is available and folks are looking to get some scale in the space. They're bidding those prices up, cap rates and the off-campus are coming down and approaching more into the level on-campus, asset that we traditionally investing.

[David Emery:]

And I think this new budget that just got pass with this 603 section, I think it just highlights that the risk profile and those two things are not the same, so as Doug said, the cap rates have compressed off-campus but it defies sort of the risk reward relationship that I think we see and we think should adjust.

[Daniel Bernstein:]

Okay. And in terms of we've seen some more joint ventures with the REITs with pension funds and private equity, I just want to, are you approaching or do you think others are approaching pension funds and private equity or is it the other way around, I would think at least on the private equity side they might have a strong enough cost that maybe they don't need to partner up with the REIT. So just trying to understand how that relationship works and do you have any interest in joint ventures.

[David Emery:]

Well I think I have mentioned earlier about our thought on is that certainly it's a viable alternative cost of capital. Our preference historically is not to have to go there. But it certainly something as we find our self in this situation now we're using dispositions and other as an alternative source it's certainly a viable alternative given that the outlook is strong and we see a fair bit of attractive properties out there. It's certainly on the table. In terms of how folks are doing it, I guess we don't have our experience and we haven't gone into that so we don't have great insight into how other REITs, is it going in, who is calling who on that.

[Daniel Bernstein:]

Okay.

[David Emery:]

Certainly. There is folks out there, the chatter is out there when you talk to folks whether it's investors or bankers whoever there is a lot of chatter about it so I think it becomes a self-perpetuating cycle, some ways.

[Daniel Bernstein:]

Okay. And then in terms of overall portfolio strategy, everybody focus [indiscernible] but you have some option there as well. And as you look at some of the operators they're struggling with hospital volumes and mix as well as we're probably going to get pretty big upheaval next couple of years from bundle payments, neutral payments, are you inclined to maybe dispose or shift the portfolio a little bit more towards pure medical office, just trying to get your thoughts on the inpatient rehab business a little bit.

[David Emery:]

Really, it's been a nice business for us and certainly it's been through tough times in the past and we've seen good outcomes. I think for us, it's certainly on the range of possibilities that we could do that not something eminent. But at the same time we don't necessarily think we need to be in a hurry to do that kind of thing and coverage on those is really strong and we've gone through some renewals and discussions off late that we feel like are very strong outcomes. So it's always possible and I think as we talk about earlier if we see enough opportunity on the acquisition side as we dig into more disposition activity. Those could certainly be in the discussion but nothing eminent in that way.

[Daniel Bernstein:]

Okay. That's all from me. Thanks a lot.

[David Emery:]

Thanks Dan.

[Operator:]

Our next question is from Todd Stander [ph] of Wells Fargo. Please go ahead.

[Unidentified Analyst:]

Hi. Thanks guys. Just a couple quick ones. Todd, I think you gave a blended cap rate of 5.9 was that on the new acquisitions, I didn't know if that included the Q4 activity so far?

[Todd Meredith:]

I think I was just referring to year to date or maybe in the quarter but it all happens to be pretty close together around six, so I'm just a little, you take a subset maybe just below 6 but for the year we're looking around that 6% level which is as you would expect right in the middle of the guidance range we've given.

[Unidentified Analyst:]

Okay. That's helpful. And then the Seattle asset I think in the quarter was 100% leased, does that a single tenant net leased asset. It is and what is the cap rate difference if that were to be a multi-tenant building in that same location -

[David Emery:]

In that same location, we could say maybe we would have even put more value on something like that but this is on-campus integrated with the existing on-campus facilities, in fact it fits on top of orthopedic surgical hospital that's a part of this Swedish campus. So I don't think whether it was multi or single, we have a huge difference and how we look at the value. It is downtown Seattle, very dense, great health system, great location, lot of barriers to entry so certainly commands a cap rate and it would be one that certainly follows well below the average but blends together with everything to kind of get it that 6% level.

[Unidentified Analyst:]

Got it. Thanks. And I know you spoke about the Denver MOB, you acquired, are you going to put more money into that building, how much value add do you think is going to come of that.

[David Emery:]

Not a tremendous amount cap necessarily, the price was 6.5 million but I would say most of it will be in tenant improvement allowances as we lease up the building but certainly we'll put in some dollars to improve the aesthetics and functionality of the building.

[Todd Meredith:]

Cut it, it make some new bushes upfront.

[Unidentified Analyst:]

That 6 million by itself.

[David Emery:]

That's right, really nice bushes, but not a huge dollar amount but we'll certainly do some of that the leasing justify that.

[Unidentified Analyst:]

Sure. And then just to kind of get a difference in yields if you were to build right now what are you underwriting versus to buy, obviously cap rates continue to compress, but maybe that differential between, the difference between building and buying right now is that wider than you've seen, is that going to compel you potentially to start building more.

[Todd Meredith:]

I would say and you can get it from our guidance ranges on acquisition versus development but we're in the neighborhood of 100 to 175 basis points would be a general range of - could even be more 200 basis points and it really comes down to what extreme do you take on the acquisition and how attractive that is, is that 5.5 cap rate versus something that's risky on the development side that's 7.5, 8 obviously it could get even a bigger spread but I think on the whole it's a 100 to 175 basis points and I think for us developments that have 50% or more initial leasing, they're going to be in that low 7, high 6 range compared to something that might be in the 5.5, 6 range so just kind of how we think about it obviously we look at not only that but then sort of the growth potential as Doug alluded to we see lot of good growth potential in developments usually in your great market, dense markets, great health systems, so we value that as well. So I don't know that it's changed tremendously that spread but I think it's been fairly consistent, we still see as very attractive.

[Unidentified Analyst:]

That's helpful. Thanks Todd. And just to kind of finish up anything you can glean from the buyer profile out there that folks that are buying your MOBs anything new that you could pass along to us?

[Todd Meredith:]

You mean people we are selling to.

[Unidentified Analyst:]

Yes.

[David Emery:]

It's all over the map. I think most of the time, the disposition particularly in some of the smaller properties that we've done it, teared [ph] us to be local and regional, people who have redevelopment ideas that are kind of charter schools and I mean all kind of different things but that usually is a function. I think on the market for those dispositions are local and regional but you compare that with the sale of ortho facility. I think we had 85 CAs in that from all over the place.

[Todd Meredith:]

And that sold to a large REIT as you know. So, it just varied by most of our assets that we’re selling tend to be the smaller local regional players that and again I mentioned assets we sold in the quarter around average 73% occupied so that has a little more the value add opportunity for a local buyer or a regional buyer.

[Unidentified Analyst:]

That’s helpful. Thanks guys.

[David Emery:]

Thank you.

[Operator:]

Mr. Emery there are no further questions at this time. Would you like to make some closing comments?

[David Emery:]

No that’s it. We appreciate everyone dialing in today and I guess we will see many of you at NAREIT here in the couple of weeks. So with that, we bid you good day and talk to you later. Thank you.

[Operator:]

Thank you very much. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.