Healthcare Trust of America, Inc.
Q3 2018 Earnings Call Transcript

Published: 26 Oct 2018

[Operator:]

Good day, and welcome to the Healthcare Trust of America Third Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Caroline Chiodo. Please go ahead.

[Caroline Chiodo:]

Thank you, and welcome to the Healthcare Trust of America's third quarter 2018 earnings call. We filed our earnings release and our financial supplement yesterday after the close. These documents can be found on the Investor Relations section of our website or with the SEC. Please note that this call is being webcast, and will be available for replay for the next 90 days. We will be happy to take your questions at the conclusion of our prepared remarks. During the course of the call, we will make forward-looking statements. These forward-looking statements are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although, we believe that our assumptions are reasonable, they are not guarantees of future performance. Therefore, our actual and future results could materially differ from our current expectations. For a detailed description of our potential risks, please refer to our SEC filings, which can be found on the Investor Relations section of our Web site. I will now turn the call over to Scott Peters, Chairman and CEO of Healthcare Trust of America. Scott?

[Scott Peters:]

Thank you. Good morning and thank you for joining us today for Healthcare Trust of America's third quarter earnings conference call. Joining me on the call today are Robert Milligan, our Chief Financial Officer; and Amanda Houghton, our Executive Vice President of Asset Management. As we report on the third quarter results, the fundamentals of the medical office sector remains solid in the long-term future for MOB outpatient demand looks strong. The overall tailwinds influencing the MOB sector continues. The demand for healthcare services continue to increase as the '18 population turns 65 at a projected rate of 10,000 individuals per day for the next 15 to 20 years. To focus on quality of life and life longevity has never been greater. Healthcare systems, physician groups and the medical academic universities continue to move to lower costs and more convenient outpatient locations, primarily well located medical office buildings. Development remains in check with limited speculative developments. We're seeing and being involved in specific opportunities to address specific needs with several of our healthcare system relationships. This fundamental performance can be seen in our third quarter results, same-store growth was 2.5%, driven by strong 2.7% rental revenue growth, our highest level of revenue growth in over eight quarters. Leasing metrics are solid. Total new leasing totaled over 200,000 square feet with cash releasing spreads accelerating to 3.7%. Tenant retention was healthy at 82%, and TI leasing concession costs are in line with past quarters. Forest Park Dallas is leasing up. We entered into 41,000 square feet of new leases at the campus at rates favorable to our budget. This brings our lease rate to 84% for this campus, and we expect continued leasing in the fourth quarter. The yield on our 2017 investments of $2.8 billion improved to over 5.3% on track to achieve 5.5% on lease up of artillery development. From an investment and acquisition perspective, the volume of transactions is lower than last year. However, the strong fundamentals we have talked about continued to attract private capital into the sector, keeping cap rates pretty much the same as they happen over the last 12 to 18 month, especially on high quality assets. Our investment strategy is to be patient, disciplined and focused in this environment. We recognized that the ability to acquire quality assets on an accretive basis has become challenging. However, we continue to pursue assets in our key Gateway markets that leverage our operating platform and take advantage of our recently recycling metrics. Greenville is a great example. As we look ahead to the remainder of 2018 and into 2019, it is important to review the strategic steps we have taken over the past 12 months that have positioned HTA for both internal growth and future long-term growth. We created the best-in-class medical office portfolio with the acquisition of Duke Assets last year, and are now the largest owner of on-campus assets within the public REITs. We significantly increased our presence in our key markets, which deepened and strengthened our relationships and created significant operating efficiencies. This has been positively -- this has positively impacted our operating results, and can be clearly seen in the performance of our 2017 investments, where our yield on the Duke acquisition increased from 4.75% to 5.2% over the last 12 months. We layered on development capabilities to our operating platform to drive future growth, which is gaining traction with three active developments underway. And we reduced leverage and have positioned the balance sheet to be in a position of strength and flexibility given today's market. All of these steps put HTA in a solid financial position and should enable us to outperform in future quarters. Current market conditions have enabled us to focus on our strategy of selling out of non-core assets, where we have maximized value or do not have long-term strategic future. During the quarter, we did this by disposing of over $300 million of properties in non-core markets. This includes our complete exit from the Greenville, South Carolina market at a low five cap rate as well as sales of MOB in rural secondary markets. We will continue to take advantage of strong demand for this sector and recycle out of non-core markets. We use immediate proceeds to repay about $140 million in mortgage debt, including $73 million in the third quarter and $67 million on October 1, when a prepayment window opened. This lowered our leverage to 5.3x net-debt-to-EBITDA, while maintaining over $200 million of cash. The remainder of proceeds, we will utilize to continue to pay down debt, acquire assets in key markets in a disciplined manner, invest in development in our markets or utilize our share repurchase program when appropriate. We will be patient in our execution knowing that liquidity has a significant value as markets are adjusting in a raising rates environment. This maybe diluted in the near term. However, over the course of real estate cycle, this strategy has significantly outperformed and lead to value creation. I will now turn the call over to Amanda.

[Amanda Houghton:]

Thanks, Scott. Our teams on the ground and our portfolio continued to perform well in the third quarter. We remain focused on providing best-in-class service and value for our health care tenants resulting in occupancy, rate growth and expense efficiencies. Starting with leasing. We had a very strong quarter with over 200, 000 square feet of new leases assigned, bringing our same store lease percent up 30 basis points over last year to 93.2%. This leasing activity was a result of strong relationships and demand within our portfolio. We renewed over 300,000 square feet resulting in tenant retention of 82%. Our re-leasing spreads for renewals leases for the quarter were up 3.7%. We continue to believe re-leasing spreads will remain into the 2% to 3% range for the remainder of 2018 and into 2019. Our annual escalators on new and renewals averaged 2.6%, while our leasing costs remain low with TI averaging $1.53 per year term on renewals and just over $2 per year term on new leases. Importantly, we have made great progress at Forest Park Dallas campus. During the quarter, we signed an additional 41,000 square feet, primarily with the hospital. This brings our lease rate on the campus to 84%, and we expect to get over 90% leased in the next three to six months. Importantly, these leases are being signed at rate 30% above our portfolio average and will help us drive revenue growth as the leases move to occupancy and takes full rent over the coming quarters. On the expense front, we continue to show the benefit of our economy to scale and ability to perform services using our internal engineering platform, despite overall higher tempters in utilities, in which our cooling degree days were up over 11% this quarter, we were able to lower our total same-store operating expenses versus the prior year by 1.6%. These savings are primarily driven by the increased use of our internal engineering platform, now fully integrated with our 2017 acquisitions, and the benefit of several property tax refunds and appeals in our Denver and Huston markets. It's worth noting that over the last five years or 19 reporting quarters, we have generated average quarterly same-store operating expense savings of nearly 1.4%, while our peer groups have generated an average operating expense increase of 1.3%. Our ability to operate efficiently without sacrificing service or quality is what we believe sets us apart in our market, as we perform for our tenant and ultimately drive dollars to the bottom line for investors. I will now turn the call over to Robert to discuss the financials.

[Robert Milligan:]

Thanks, Amanda. From our financial position, we’re ending the third quarter with the best balance sheet positioning we have had since we started our strategic process with low leverage and cash on the balance sheet. Over the last year, we have lowered our leverage by over one full turn of debt-to-EBITDA, and over half returns since we announced our 2017 acquisition. This positions us with significant flexibility to deploy capital strategically in this volatile market. However, will be patient, recognizing the deals today, maybe better and more accretive in the future. We will do this despite any potential near-terms earning dilution as this is the right thing to do for the long-term performance of the company. Turning to specific financial results. Third quarter normalized FFO per diluted share was $0.41, flat on a sequential basis from the second quarter and down from the prior year. Holding leverage constant, we would have been flat to up on a year-over-year basis. Funds from distribution decreased to $69 million. Same-store cash NOI was 2.5% compared to the third quarter of 2017. This is the first quarter we include the majority of our 2017 investments in the same-store reporting. And our performance was relatively consistent between the new and older portfolios. This growth was driven by rental revenue growth of 2.7% year-over-year. Our expenses were also down on a year-over-year basis, demonstrating the capabilities of our operating platform and our economies of scale. However, our total margin was down slightly in the period, primarily related to some initial accounting throughout related to our 2017 investments in the year ago period. This impact was limited to our 2017 baseline and has had minimal impact on our 2018 metrics. Our 2017 acquisitions ended the period yielding over 5.3% on pace to reach the mid 5% range once the final development in Philadelphia reaches 90% occupancy. G&A for the quarter was $8.7 million, which was approximately 5% of revenue. We expect G&A to be close to $9 million in the fourth quarter. As we look at 2019, we will be impacted by the accounting rule change ASC 842 related to the expensing and capitalization of internal leasing costs. We currently do the majority of our leasing in-house and capitalize most of these costs. Year-to-date in 2018, we are capitalized approximately $4 million or between $1 million to $2 million per quarter. This compares to more than $9 million we would've paid in third party commissions on leases completed by our team at a conservative 3% rate on the gross lease value. Nonetheless, these expenses will hit our income statement in 2019 and will impact our earnings by approximately one penny per share, per quarter, and bringing the total quarterly SG&A to $10 million to $10.5 million per quarter. Our capital expenditures increased during the period with an uptick in our first generation tenant improvement expenditures. This is primarily related to the lease up of our former Forest Park space, which has remained in shell condition. Our recurring capital expenditures typically increased in the third quarter and ran around 15% of our cash NOI. For the year though, we continue to remain at 12%. We ended the quarter with leverage of 5.3x net-debt-to-EBITDA, and less than 30% net-debt-to market capitalization. We also had over $200 million of cash. To further optimize our balance sheet, in the quarter we closed on an amendment to our $200 million term-loan due 2023. This reduced the pricing by 65 basis points and extended the maturity into 2024. We have the capacity and ability to use these proceeds in an accretive manner as the markets continue to adjust. We had used our funds to deliver and can lower even further. We also use funds to invest in our key markets through acquisitions where we can generate incremental 25 to 35 basis points from our property management platform and drive greater growth, and also through development that yield 75 to 150 basis points above current acquisition pricing. We have also started to repurchase shares albeit in a measured manner, repurchasing $16 million in total, including $7 million after quarter end. It will increase or purchase, should the pricing become even more attractive and new opportunities present itself. As always, it is important to note that will be patient and measured in our deployment of this capital. Given the significant move in rates, we believe that the flexibility and liquidity of cash that allow for significant accretion over the medium to longer terms. However, it may be dilutive for short period of time included in the fourth quarter. I will now turn it back over to Scott.

[Scott Peters:]

Thank you, Robert. And we will now open it up for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Chad Vanacore with Stifel. Please go ahead.

[Chad Vanacore:]

So given the view that you've outlined an acquisition disposition environment, should we expect to see HTA sells more assets during this year or early in 2019, and then retire more debt along the way into that market terms? Any update would be helpful.

[Scott Peters:]

I think that, right now, the environment, certainly, as we talked about and indicated in our call, its challenging to find what I considered to be quality -- high-quality assets in the markets that our long-term growth on an accretive basis. And on the other hand, I think, there are opportunities for us to sell some of the non-core assets that we have also some assets that we may feel had maximized value. We've been doing this now for 10 years. And so, most companies always take a take the opportunity to move through certain assets that reach their value or have not materialized what they think they thought they would. And I think this is a good time for us. So I do think you'll see us sell some more assets or certainly be opportunistic over the next six months.

[Chad Vanacore:]

All right, Scott. And any target markets with dispositions that we should think about?

[Scott Peters:]

We've talked in the past that there are certain markets that we don't think that there is the type of growth that we think there are in other markets. Typically we moved out of Milwaukee. We sold some stuff there. And we have a little bit left and something came along that allowed us to move out of that we would. There are some secondary markets in the Midwest that came along with acquisitions that we get before we were public, larger portfolios that had one or two of assets. We have some assets in Dayton that now have gotten to be about 86% to 90% occupied. And it would be a good time to take advantage, perhaps a local buyer. So you'll see us continue to what I would say in our overall strategic goal as a company from an investment strategy, is over the next 3 to 5 years to be invested 90% into our key 20 markets. We’re focused on one thing, and I think, it's the number one thing that the management team and our Board of Directors have focused. The company on is to get to the platform, our asset management platform, a million square feet in the markets that we think are going to grow for the next 5, 10, 15 years, and really take advantage of what we have from a relevance and from a ability to continue to produce what we think is solid same store growth. So that's really our strategy going forward.

[Chad Vanacore:]

And then, is it fair to think of the usage of cash, first, for debt repayment, and next, for share repurchase, anything else in there that I missed?

[Scott Peters:]

Well, we have development. I think the one thing that we’ve talked about in the prior couple of quarters is that the Duke acquisition or all our acquisitions last year, that was a year for us to really take what I thought was the opportunistic time to grow HTA to the largest MLB owner, and largest company from an MLB perspective. And I think that was a big step for us. And the second step for us that they were in our markets; 90% of the assets were in our markets. So we weren’t moving into markets that we had to begin with and started over from. So the development has been a very big surprise for us. I think that there are tremendous opportunities for us to align ourselves with the relationships we have in our markets and continue to generate that 50 to 150 basis points that Robert talked about in his prior remarks. For us, that’d be a couple hundred million dollars a year.

[Chad Vanacore:]

One last one. It looks like CapEx and TIs are elevated related to, probably the Forest Park leasing. Do those return back to normal in 4Q? Or is this a better run rate to think about?

[Scott Peters:]

No. We certainly expect the capital expenditures in the fourth quarter to kind of go back to the prior run rate that we saw earlier this year. Certainly as, there’ll be a couple of spaces within the Forest Park assets that as we lease up, you’ll see from shelve space expenditures. But you should see us at a lower run rate fourth quarter, first quarter next year.

[Operator:]

The next question comes from Karin Ford with MUFG Securities. Please go ahead.

[Karin Ford:]

Sticking on that theme, when does rents start commencing on your new leases at Forest Park? And can you talk about -- I read that there was a new MOB under construction by HTA going into that facility. Can you just talk about that?

[Amanda Houghton:]

So we expect the rents to commence in the first and second quarters of next year. So that’s when you’ll start to see some of the revenues pickup from the leasing. And regarding the new construction, we generally wait till HTA announces that, but they’re continuing to invest in the hospital and plan to add beds and specific to the specialty that they'll also be announcing, probably in the first quarter of next year.

[Karin Ford:]

And my second question is just on the stock buybacks. So you obviously have a great warchest of dry capital here, a lot of cash on the balance sheet. You bought back 15 million recently. But why not do more? What’s driving your decision on your volume of share repurchases?

[Scott Peters:]

So I think, we’ve always said we want to be opportunistic. We want to be although we believe to be accretive. We want to also be very pragmatic about it. And so, your original question is that, I do think we’re up from a balance sheet perspective. We couldn’t -- I don’t think be better positioned. We move out of 2017 with the largest best quality MOB assets, I think, from many MOB owners. Second, we have a platform that’s performing as we indicated when we acquired Duke. I think that was one of the big questions that came about was, can they take this 4.75 and move it up to 5.2, and then can they continue to move the overall acquisitions up. And we’re seeing that and we’re continuing to do that, so the platform's working. So what will we do? We will take the three steps that I think any logical person would at this time is we'll repay debt where it's appropriate. We will use it for development. We will find. I think, we will be, we will do acquisitions. We won’t be completely silent because there are opportunities in these selected markets that we found, and can continue to be accretive prospectively with the asset management side of the equation to it. And then we will utilize our balance sheet to buyback stocks where we think it's appropriate and with the appropriate size.

[Operator:]

Our next question comes from Tayo Okusanya with Jefferies. Please go ahead.

[Tayo Okusanya:]

Two questions from me. First of all, the same-store number, again, the decline on a quarter-over-quarter basis, again, I just want to confirm that is all being driven by the same store pool changing. And I wanted to know specifically what kind of what unique, what the assets that were added this quarter that contributed this decline?

[Scott Peters:]

Well, I think, as we talked about for this year, we expect our same-store growth to be in the 2% to 3% range. I think your -- you continue to see us really get the midpoint of that range. I think what we've been encouraged about this quarter. We continue to see is good leasing traction and positive revenue growth kind of going throughout the entire portfolio. So we are putting our 2.5% same-store growth and you’re seeing revenue growth of 2.7%. I think we see that as a positive trend for us. Specifically, as we look at some of the comparison period, this is where we added the majority of our 2017 investments into the same-store pool, not that we owned for four or five quarters. And anytime you bring a new asset, especially acquisitions of size, there's a little bit of accounting troops that take place in the first two quarters of the acquisitions. So there is a little bit of noise related to that. But overall, we see a strong trend of 2% to 3% same-store growth really continuing.

[Tayo Okusanya:]

Yes, but -- again, I appreciate those comments. But I think, again, with so much sensitivity around your same-store NOI growth, in particular, most of that maybe some of your peers. I think, it's just kind of really helpful to kind of fully understand that decline. I’m not fully, so I understand what the differences between the assets you brought in, which probably were at lower same-store NOI versus your old pool?

[Scott Peters:]

I think both of the pools, as we saw the growth in compared, certainly with the -- what our 2017 investments did compared what the legacy portfolio did. They were actually pretty consistent from a growth perspective. I think they were both actually right around the 2.5% growth trajectory there. So they were pretty consistent between both the legacy portfolio and the acquisitions that we brought on from an overall basis.

[Tayo Okusanya:]

But you still saw a 30 bps drop.

[Robert Milligan:]

So I think, yes, I think, Tayo, you’re going to see ebbs and flows. I mean, we’ve said that there is 2% to 3%. I think it's consistent. We now have 23 million square feet wherein million square feet in 10 markets, 500,000 square feet in another five. I think, with the MOB sector, and we've talked about this continually. I remember talking about it five years ago when the average growth was about 1%. I think the portfolio of this size, of this quality, is going to product 2% to 3%. It's been ebb and flow quarter-by-quarter. But what you've seen us do is focus, I think, on rent spreads. We’ve continued to move those up revenue growth, as Robert has talked about. And then, you just move through the portfolio on a quarter-to-quarter basis. So I think you’re going to see us in the 2% to 3% range. And that's where we anticipate the portfolio performance.

[Tayo Okusanya:]

The second question I have, again, Scott, that I think, again, I appreciate all your commentary around this idea of delever the balance sheet kind of REIT to kind of see what happens next with the cycle. And then the appropriate capital allocation decision when it creates some near-term earnings dilution. And I think I'll get that. But typically, in my mind, anytime I kind of see management teams take a pause that way it seems -- it feels to me like they're seeing something or there’s some uncertainty about what the future may hold. And in general, I think, people kind of look at MOB space as a fairly stable space. So I am just kind of curious why the pause or the uncertainty when I think the general viewpoint of the industry? Is that -- it's fairly stable that in fact actually have some positive tailwinds that just kind of given the demographic -- the agent demographic basis, that’s everyone seems to talk about?

[Scott Peters:]

Well, I completely agree with you. I think the MOB sector -- and MOBs are still at the forefront of the tailwinds. So I think the tailwinds are going to continue for five or 10 years. I think this election is going to come up, and November is going to even change the dynamics of healthcare systems and hospital and MOBs even further, in our favor. But I think that, when we look at the size of where we are, we bought $2.8 billion last year. We'd averaged about $300 million for the seven or eight years before that. So we made a huge step. We bought the highest quality portfolio at the time. We performed on that acquisition from a platform perspective. I think that by pausing, if you say pausing for three or six months, that's not a pause when you look at a 10-year cycle. It's not really a pause when you look at the next 10 years. We've had a tremendous move in interest rates in the environment. We've seen private equity. And I guess, I would say that your comment about, is there something unseen in the MOB space, private equity is seeing the value of the MOB space. We haven't seen the quality of product this year, frankly. There are some products out there, right now, that people are chasing that compared to the Duke portfolio of products we see quality. They're note in our markets. They’re not assets that we think are going to generate 2.5% to 3% same-store growth on a continued basis. So we will continue to be what we have been which are very dedicated, articulate, focused owners of MOBs in markets that we think that are going to grow for the next five or 10 years. And if putting a balance sheet in a position that allows you tremendous opportunity moving forward is a setback or a pause, then I would say over my last 30 years, I think, that's a pretty good place to be because I remember 2007 and 2008, when we had a lot of money on our balance sheet, more than anyone else, and we had some tremendous opportunities that presented itself. So I think we’ll continue to be patient, disciplined and prudent as it relates to shareholder value.

[Operator:]

The next question will be from Todd Stender of Wells Fargo. Please go ahead.

[Todd Stender:]

Amanda, if I heard you right, you highlighted a 2% to 3% re-leasing spread expectation. But obviously did better than that in Q3. Can you talk about the success in Q3? I did see that the expiring rents were the lower base rent than in Q1 and Q2. So I just wonder if they were just literally brought up to market or maybe there is some further color that you can share? Thanks.

[Amanda Houghton:]

So we did have over 300,000 square feet of renewal leasing, and generally maintained a 3% renewal re-leasing spread. There were several leases, 500,000 square feet in Austin, and 800,000 square feet in Florida, several in California, where we were converting more of a office or administrative use, to medical or higher executing in medical. And that's what you will see reflected in the higher rates generally.

[Todd Stender:]

Okay. And how about, any color you can provide on Q4? Any visibility on what the rents look like in Q4 and Q1?

[Amanda Houghton:]

Yes. We continue to see 2% to 3%, just as a standard. And knowing our portfolio, that's generally the range that will be, and unless you have some of those situations that we have this quarter, where you've got a change in use.

[Scott Peters:]

Todd, one of the interesting things that we are seeing from a fourth quarter and first quarter prospective is that, I think, this is the most activity we've seen from the tenant side of the business, while reaching out to us to look at either renewals or extensions on their existing leases. And you know we've had several healthcare systems reach out. And the other interesting thing is that the -- they used to be when they reached out they were looking for blend and extent, the favorite term of gee-whiz, let's try to get something more favorable by doing it. We’re seeing some increased pricing power in critical locations, in some of these key markets. And so I think we will continue to see some favorable leasing spreads.

[Todd Stender:]

And increasing the term at the same point? Any …

[Scott Peters:]

Sure. And they are putting dollars into the space. I mean, we've all seen where we’ve heard about the inflation that's coming through the economy. Certainly, we've seen it from a perspective of construction time is a little longer; permitting time in major cities is taking little longer. But the other thing that you're seeing is that the expectation or the results from the tenants are a recognition that there is a -- the escalators are three, the renewals are rolling up from where they stopped, and they are looking for a little longer term. What we're trying to do is make sure that we are positioning the assets appropriately for the next three, five, seven years.

[Operator:]

Next question comes from Vikram Malhotra with Morgan Stanley.

[Vikram Malhotra:]

Scott, just on all the comments around being patient and capital allocation, would it be safe to say you are not interested in any of the large whether it's a landmark or CNL or any of the other portfolios of there. And could you just maybe give us a bit more color how you categorized those different portfolios in terms of quality?

[Scott Peters:]

Well, Vikram, I guess, I would say that we are not in the process of -- we've looked at those portfolios. I think we're very well aware of the quality of those portfolios. I think the biggest differentiation for us, and I’m not going to get into necessary view because I think someone whoever requires it will think that they are great assets, we’re going to repaying an appropriate price. But if you look at the landmark assets, they’re not in our markets. They’re larger assets in secondary markets and the folks there, and we know them pretty well, have done a great job of build-to-suites for healthcare systems in specific locations. But again not fitting into our asset management platform and in particularly not fitting into what we think is the long-term value of key markets. CNL portfolio, we know those folks too, because, as you know, we were not traded REIT. And I think, that portfolio is also somewhat fragmented. It has some quality assets in it. But as a whole, it is also has, I believe, some non-MOB assets in it that make up that group. And I don’t think they come anywhere close to the quality from a whole of what we acquired last year. I think the pricing would be very interesting. I think that one, sometimes steps back and says, alright, how the other folks view this pricing in today's marketplace, and what is private equity if that ends up chasing here or another public entity ends up chasing it. I mean, how do they see that quality? I think that will only reflect very well on what we did last year. But we’re not chasing those two larger portfolios.

[Vikram Malhotra:]

And then just in terms of your expirations and you mentioned renewal spreads are likely to be in that 2% to 3% range. One big expiration appears to be, probably in St. Joseph, I believe, it’s next year. Any early indication of kind of what that renewal might look like? Are there any expansions or changes in that lease?

[Scott Peters:]

I’m going to let Robert talk in a moment. But I just want to talk a little bit about when you say leases and renewals and extensions, I think, I read something you came out with regarding the credit risk of some of the tenants and some of the healthcare systems. And we’ve had a -- we’ve been very fortunate, and you always knock on wood. But we had something down clearly that our healthcare system has gone through a transition. And now it's gone through that transition. And our MOB on campus there is actually going to be a positive participant in that transaction because we’re going to move some rents up. We had the same occurrence -- we have a group of assets in North Cyprus that went through a recent change, HTA bought the healthcare system. And again, that’s a higher quality. In both these two cases, it's going to be higher-quality credit force. And of course, we had Forest Park that went through a change. And that’s moved up to HTA. And, yes, that took a little longer than we had hoped because we are closed to down and HTA taking us time to that high quality credit. So I think as we've looked through our portfolio and when we try to do that, because I think that’s the biggest question mark for investors is first, what’s the quality of the portfolio, what’s the growth of the same-store pool that you’re looking at, but then what’s the credit quality, and what’s the risk associated with that. And we've come through, and I think again, it's really location of the assets that plays such a big part in the ability for to survive. I’ll let Robert talk about your specific question.

[Robert Milligan:]

Yes, I think, you mentioned St. Joseph providence, moving their assets Mission Viejo, California that we largely bought several years ago, one of the best markets in the country, certainly very tight real estate market. I think as we look at our opportunity there, we always weigh the ability to lease space today with the ability to potentially redevelop some of the campuses. So as we look at kind of renewals -- renewal ability, we don't feel simple interest right next to a great hospital system, one of the tightest markets in the U.S. So we feel very good about the options we have.

[Vikram Malhotra:]

Okay. And then, Scott, you touched upon the Webster asset that was going to be one of my questions, maybe just a bigger broader question on the strong credit and the portfolio. So looking at your supplement where you provide all the health system relationships dealer, HTA, et cetera, can you give us a sense of like what percent of the leases actually have or sort of guaranteed at corporate level have that actual credit rating? Or are these usually for a special purpose entity at a local level? And how does that play -- how does that fit into your core community side of the business? The reason I asked that is because I've heard hospitals are increasingly taking space at these off-campus locations, so the credit of those assets are likely improving.

[Scott Peters:]

I’m going to work with your last question first and let Robert or Amanda talk about the first one. But I do think that it's interesting because, I think five years ago when MOB cap rates or quality assets were seven, I talked about, I thought they were going to move down into the fives, and they were going to become varied. The quality of those would be replicated with what traditional office was. And I think we’re seeing that. I think we've seen it, I think we’re seeing it, I think we’re going to continue to see it. I think the other event that we've talked about for three or four years is that the off-campus, and again it's the off-campus, it's not a one-off building located in just arbitrarily at a corner that gathers a couple of physician groups and then they calls it a medical office building, that's not what we’re talking about. But the off-campus MOB that is a central location or a high demographic carrier that’s been looked and attached by two hospital systems or one hospital system with a large physician group. I do think that those cap rates are coming down because the credit quality and the ability to move rents and the stability of the patient mix is there. It's all the same qualities that you look at for a high use building. And again, I read something that you wrote and I agree. I think cap rates are coming down. I don't think they're coming down in secondary markets, but I do think they're coming down in the valuation, in the recognition of the value of those assets on campuses are becoming, I think apparent to investors. Robert is going to about that.

[Robert Milligan:]

Yes, I think, in the health system relationships that we've listed out, I think, as you look across the space, it's important to note that these are leases really directly with these parent tenants as well as their direct subsidiaries that they have ownership stakes in. When we typically see the leases on the health system basis, a lot of times the leases with the specific hospital campus or the physician group in the area, and you see that affectively roll up from there.

[Vikram Malhotra:]

But just to clarify the leases like with HCA, are they -- is there a corporate guarantee by HCA, or that HCA, whatever local entity your MOB is located in?

[Amanda Houghton:]

So typically with our health system leases you will have the hospital entity as a tenant and often times that the parent system as a guarantor. Now as of leases role, we have seen the health system entity we looking to be released from the guarantee, and that’s where we evaluate on a case-by-case basis depending on the health of the actual hospital that we’re working with.

[Operator:]

The next question is from Eric Fleming of SunTrust.

[Eric Fleming:]

The question is with the announcement I saw earlier of Ascension and Adventist JV getting together the headline reads about of, hey, they're going to close 50% of their outpatient facilities, but reading treatments there. That sound like it’d be actually a benefit for people like you where you got the larger MOBs? Is that as more and more health systems look to get together whether JV or not, would it be you guys benefiting with your larger buildings as they close down kind of the one and two dark facilities and merge them into the bigger facilities?

[Scott Peters:]

Yes, Eric, I think, you hit the nail in the head. When we talk, especially outpatient core community location, we really are looking for the campuses that are very well located on major roads and with a lot of folks driving by there every day in really high quality communities. So we should be the beneficiary of those. When we look at the assets, especially off-campus, we’re looking for the ones where the health systems are competing to take space, not just spacing or underwriting on who the parent tenant is there. So as you see a lot of these joint ventures take place or you see new health systems come in the market, we think our assets are pretty well positioned.

[Operator:]

The next question is from Lukas Hartwich with Green Street Advisors.

[Lukas Hartwich:]

As you evaluate dispositions, how do your hospital and senior housing assets factor into that?

[Scott Peters:]

I think we’ve gone through a process over the last couple of years. When you look at our portfolio, we’re probably the most focused MOB owner, still with 95%, 96% of our assets in medical office buildings. As we've gone through transition over the last couple of years selling assets, we certainly sold out of the majority of our senior living type assets. And I think, you’ll see us continuing to move through that process.

[Lukas Hartwich:]

Great. And then just a quick clarification question. Forest Park, that's in same-store right?

[Scott Peters:]

That’s correct. Yes, we haven’t moved just for any reason. It continues to remain in the same-store pool.

[Operator:]

The next question is from John Kim with BMO Capital. Please go ahead.

[John Kim:]

Looking at your expiration schedule on Page 18, your 2019 expirations implies a $26 base rent per square foot. And this year you find rents at $23. I am wondering if those numbers are apples to apples, and still feel comfortable at 2% to 3% renewal rent growth?

[Amanda Houghton:]

Yes, we do still feel comfortable with 2% to 3% rental escalator. The base rent is really a factor of the market, and not necessarily how strong the lease rate is. So just depending on where we’re renewing deals and what that market rate is, that will dictate the average rate that we’re renewing, but ultimately, we expect it to be 2% to 3% above what it's expiring at.

[John Kim:]

And are there any difference between either the renewal rates or the leasing spreads you’re getting between on-campus and your off-campus line?

[Scott Peters:]

We’ve over the last two years, and I would exclude the last three months, because I do think that we’ve seen some distinctive changes in leasing behavior in the last 3 to 6 months. But prior to that, we saw far more a greater ability to move rents with rent spreads our campuses that were not necessarily on-campus. I know that there is a philosophy that says that because I'm on-campus, and I'm there that I can pressure the hospital or healthcare system into a unusually high rent spread. But on the other hand, there is a relationship that is integrates both the tenant and the landlord. And if you're on healthcare systems campus, and there's a ground lease, they do have certain abilities to influence how that process works now. Now, recently, as we mentioned here, I mentioned earlier, there have been some of the healthcare systems, some of our tenants on some of the larger leases, recapture us about both extending the lease, getting additional TI's for some improvements that they want as part of that extension. And we're seeing the ability to move those rents, probably consistent with our off-campus, which is why you're seeing us now produce one the best number, I think, we produced in eight quarters here, recently, but also looking forward to the next two or three quarters where we were able to do something.

[Amanda Houghton:]

And just to add to that comment, I will say that some of the hospital transitions that Scott had mentioned before, North Cyprus in Houston, Forest Park in Dallas, Clear Lake also in Houston. As some of these hospital transitions happened, and the larger hospital leases are kind of go away, and we leased directly with smaller position groups, that’s really where we start to see more pressure, and a greater ability to get positive leasing spreads. It's when you have the larger leases that you could have that downward pressure on the re-leasing spreads because the tenant has that leverage.

[John Kim:]

I may have missed this. What’s the cap rate differential you’re seeing right now between on-campus and off-campus?

[Scott Peters:]

Well, we haven't been active in the last six months. So I can’t tell you specifically what that would be. But I still think that there is a 50, 75 basis point difference between whether you’re on-campus or off-campus. Now, I would also say that it depends on the market. If you talk about Boston -- Boston is different than I think then some other markets in the country. Tampa, very strong market. But so I think, it's 50 to 75 basis points. But again it's got be a off-campus location that is a critical component of that demographic need, and is generating high demand, high patient mix for the physician groups or the healthcare system or the healthcare systems, because, that's what we're seeing a big change in the future of healthcare. I think one of the biggest changes we will in the next 10 years is the movement from on-campus to off-campus. I think that the access to healthcare is going to increase, but the desire for the access to be efficient. And so that efficiency to be utilized by different visits, one visit for four physicians is much better than four visits to four different physicians. So I do think that our country is going to see a continued move to off-campus campuses where healthcare systems are able to deliver healthcare more efficiently and more cost-effective in downtown major cities. So I think that that cap rate probably will continue to compress in certain areas.

[Operator:]

Our next question will be from Mike Mueller with J.P. Morgan. Please go ahead.

[Mike Mueller:]

Robert, it seems like you’re trying to get people focused on dilution and the 2019 estimates that are out there. Can you talk a little bit about how much of your comments are coming from the angle, look we sold a lot, and it's going to have implications on '19, or is it a little bit more? We've sold a lot, that's going to impact '19, but we could still ultimately sell little bit more in an elevated clip going forward?

[Robert Milligan:]

I think as we look at where we’re positioned from a balance sheet perspective, and certainly, from a capital allocation perspective. With what we’ve done and taken a very measured distinct pace of reinvestment, you’ll see some dilution in the fourth quarter certainly. And as we look at 2019, most of our rate estimates can be around how do we redeploy the capital and really what’s the right time to do that. I think our view is, as Scott mentioned is, it’s a good time to have liquidity and low leverage because as the markets move, it presents some very good opportunities that are better for shareholders in the long run. So I think when we look at the dilution certainly in fourth quarter, I think as we look at the opportunities that present themselves into 2019, we could see some opportunities or we can continue to remain patient and we will have a better view of that as we get into our fourth quarter earnings call.

[Scott Peters:]

Yes. And I think that’s one of the things that we’ll do. I think that we will give some guidance and thought to where we’d be in 2019 for investors as we move through this fourth quarter. I look at the 10-year today, I don’t know 3.06, it was 3.21 two weeks ago. If you look at -- just I still think there’s an unknown in the economy. I think there’s a somewhat unknown in the real estate side of the equation because theoretically cap rates as we’ve talked about haven’t moved and you would have expected them to move or at least thought that they may have moved and maybe they’re not and maybe the 10-year is going to stay where it is but I will have some clarity as we move through November and the election will be a very big -- have a very big impact on where things move in 2019.

[Mike Mueller:]

I mean where you sit today does your -- is your gut instinct that you’d ultimately sell less do you think than you’re selling in 2018?

[Scott Peters:]

I think that -- my thought is that we’ve sold what we wanted to do in 2018. Now Greenville was a great opportunity for us and I don’t see us getting another $285 million one sale opportunity that we would take advantage of in a market like that. So I think what you’ve seen from us this year, we would not out do that probably next year.

[Operator:]

The next question will be from Daniel Bernstein with Capital One.

[Daniel Bernstein:]

Hi. I might have missed it earlier in the call. But can you just talk a little bit about the redevelopment opportunities in your portfolio in light of the low cap rates that are out there and where your cost of capital is? And I know you’re doing some development but I want to talk about what the -- what opportunities are to increase the performance of your existing portfolio with some redev?

[Scott Peters:]

Well, we’ve got settled two or three locations. Robert mentioned some of them, had a question earlier about our Mission Viejo campus, and that's an opportunity where a great real estate, fee-simple, older assets, recently new development around that that really has moved rates, great opportunity for us to have a -- to redevelop something into what will be state-of-the-art real estate but also will be receptive and proactive on where healthcare is going in the next 10 years. So the time and space that physicians and healthcare systems need over the next 15 years, I think we’re getting to that stage. I think the stage right now is how do healthcare systems, how do physician groups get better efficiencies, better economies of scale, how do you provide cost-effectiveness to those tenants. So I think we’re growing and we are being very introspective here from a management perspective when we look at these assets, can we redevelop them and if we do redevelop them, there is a demand to do that making sure that, one, we get value for it because you just don’t want to put dollars and have them wasted. But if you put dollars into something, are you going to get the reciprocal better rates, better growth, better control on expenses. And so I think you'll see us talk about two or three or four of these opportunities as we get to the fourth quarter and first quarter of next year.

[Daniel Bernstein:]

Okay. And I think the other question I had, we actually heard from a few brokers that maybe cap rates have -- they’re coming back up a little bit and by a little bit I mean less than 25 basis point. I don't know if you’ve seen any of that or is it you think maybe if that is out there it’s may be more of a quality issue that you alluded to earlier in the call?

[Scott Peters:]

Well, we’ve looked at specific assets in certain markets. But I would say that those markets are markets that we have, as we said, 15 markets and we’ve been actively looking for acquisition opportunities. Having said that, I would say that the one-off assets that we’ve seen that we’ve looked at, the expectation from the seller has not seem to have changed and that was a little bit struggling. In fact, Robert and I went on, I don’t know a trip, I’d call it a trip, but went to three or four locations and met directly with the owners of the assets that are looking to sell and half of them had unrealistic expectations of what they own. Now the other couple of two or three, we’re certainly engaged in conversation with them, and we actually hope that that would be something to add to our portfolio. So I haven't seen that. But I do think it will be interesting to see what the two larger portfolios get from a cap rate perspective. And then if anyone else happens on these calls here coming up to talk about one-off acquisitions; I haven’t heard any of the other folks talk about what they’ve acquired in the MOB side. I know that somebody reported this morning and said they’ve bought some MOB assets, but I did not hear what the cap rates for those assets were. Secondary markets, I think they may have moved a little bit. I would think that they would have moved a little bit.

[Daniel Bernstein:]

Okay. The one from this morning is a mid-5, but those were contractual already. So …

[Scott Peters:]

Alright.

[Daniel Bernstein:]

So this -- I don’t think those are markets. One last quick question if you don't mind. Nobody -- talked on this before and heard them talk about on priorities calls before about joint ventures with private equity and private buyers. Anything changes, anything new that we could expect on that front from you or is that just not seeming to materialize at this point?

[Scott Peters:]

Well, prior to the last six, nine months, even with the Duke transaction, we did not look for any other JV, equity or we did not look for a partner for that transaction. We were so convinced that we knew the asset. They were in our markets. They were in our platform that we could generate that that growth from an earnings perspective over year, get moving into the second year, I think will lead into -- we will continue to grow that yield on that portfolio. Recently, however, it has -- I think this gets back a far earlier question about the MOB space, we have been approached by certain folks to utilize our platform, and in a JV type of arrangement. The problem we had with a couple of times that we’ve entertained that now or certainly had a discussion about it is, one, the quality of the assets weren’t something that we felt that we wanted to necessarily spend attention on nor frankly use equity to invest in, even though it would've been -- and Robert would tell me, it would be somewhat accretive and it would help us in the short-term. We didn’t feel that the longer-term use of our platform or the fact that they weren't necessarily assets that we would turn around and buy three, five, seven years from now, was attractive. So we didn't do something. We kind of said no we’re flattered but not interested. So we have been approached. And I think that's an indication of our platform and we had internal discussions and Board meetings about maximizing our efficiencies, dedicating our employees to maximize shareholder value. But as the right transaction came along, or if it was beneficial for investors and it was a long-term viability for us to get high quality assets at good pricing and so forth and so forth, we’re always going to entertain something that generates shareholder value. We’ve just not seen that opportunity come through yet.

[Operator:]

The next question is a follow-up question from Tayo Okusanya with Jefferies.

[Tayo Okusanya:]

Hi. So just a quick one following up on some of Vikram’s line of questioning about the lease maturities. Anything new on the community front?

[Robert Milligan:]

Yes. From the Community Health System, I think as we continue to look at our exposure to them, we continue to see the hospital campuses perform or actually go through a transition. We did sell one of the MOBs on Community Health campus within the quarter, down in Spartanburg. We did exit that. We didn’t see that as a long-term growth campus. However, we've also just gone through a transition. We own two assets on in a former community campus in Oklahoma City. That hospital just got sold to the larger not-for-profit that’s dominant in the area. As Amanda and the team went out and talked to them, we’re excited about the transition prospects and how they’re going to continue to frankly invest more in the campus. So I think as we see a lot of these hospital transitions take place, almost in all of our experiences they’ve been positive, whether it's community selling to a not-for-profit that’s dominant or HCA buying certain other hospital campuses. We’ve just seen the positive trend as the new owner is excited by the campus they’re putting capital within to invest in it, and they’re looking to grow.

[Scott Peters:]

I would just add, again I think you’ve put something out a while ago about closing hospitals. But there was something else, closing hospitals and I think the key is location. It really comes back to MOB asset now is a major investment class and not all hospitals are created equal and the synergies associated with the hospital on a local basis determines I think the ability or the prospect of how that continues. We have something up in the Indiana that we have -- they’re expanding. And they show that they want to continue to put dollars into the MOB with the lease expiring next year and that was -- that’s interesting because that was sort of like well, gee whiz, that's not necessarily the answer that you would’ve gotten if you would have just stepped back and said “Well, this is a location in Indiana that you happen to have a MOB on.” But it’s a very, very busy hospital, a very busy MOB. And so that particular location is great. But -- so I think that we’re getting more and more into when it’s credit, when it’s tenants, when it's hospitals, when it’s closings, it really depends on location.

[Tayo Okusanya:]

And when are most of these tenant leases expiring -- community leases expiring?

[Robert Milligan:]

I think across the board, I don’t think we have any major significant role. I think it's relatively level-loaded on the community front.

[Amanda Houghton:]

Yes. We've got eight years weighted average remaining.

[Operator:]

Next question is a follow-up from Vikram Malhotra with Morgan Stanley.

[Vikram Malhotra:]

Thanks for taking the quick follow-ups. Just Robert want to clarify the FAD payout. Do you say you expect CapEx to kind of normalize and you would expect FAD to trend down towards that high 80 level?

[Robert Milligan:]

Yes, I think we typically see a seasonality for capital expenditures in the third quarter, just one more month allows for more capital projects to be completed. I think if you combine that with some of the larger leases that were frankly signed at the end of last year, we’re now completing the construction, and as Amanda mentioned, convergence to some higher acuity facilities. We definitely see that trending lower in fourth quarter and first quarter back to kind of the run rate that we saw in the first two quarters of the year.

[Vikram Malhotra:]

Okay. And then just to clarify the Webster asset, the hospital there did close and you had an MOB next to it. You’re saying that there was no impact, the MOB was fine, and instead they were -- you converted the leases to -- with physician groups or was there no change -- were they never leased to the hospital at all?

[Amanda Houghton:]

The lease continues to be an operating lease and it’s occupied by the physician group of the hospital. So despite the hospital closing, the physician group continued to operate the patients. So we’re going through the process now and as the hospital that’s coming in is evaluating and bringing those physician groups on, the tenant on our lease may ultimately change but we don’t expect to see much of an impact to our building.

[Vikram Malhotra:]

So there has been no impact to occupancy there?

[Scott Peters:]

We actually expect a positive impact. We think that -- for example an indication where they may not agree with us but we think the rents are couple of dollars under where they should be. So Amanda has got her work cut out for her, but I think we will get -- if that lease does go through a transition that will be something that we will work on to get better value out, not less.

[Vikram Malhotra:]

Got it. And then just to clarify that hospital closed in the first or second quarter of this year right?

[Amanda Houghton:]

In the first quarter.

[Scott Peters:]

And I think you saw the announcement on the new hospital coming in, announced this morning, with UTMB announcing that they're taking over the operations of the facility. So it's certainly an improvement from the one-off hospital operator that saw this as a dynamic location where they wanted to be and it’s going to be upgrade for credit and overall volumes.

[Robert Milligan:]

And the big -- again, I can’t over emphasize that. Recently fee-simple is not been given the credit it deserves compared to ground lease. If we had a ground lease at that particular MOB, the outcome of what Amanda has been talking about would not be as positive as it is now. We have fee-simple, there is competing hospitals looking to be in our MOB that want to compete with the hospital that’s taking it over. So that sort of the pressure that they have to keep their use solely in our MOB. So fee-simple at Forest Park was imperative, fee-simple at Cypress, North Cyprus was imperative, and fee-simple in Clear Lake was imperative. So we like fee-simple type assets. Now again when you develop on campus, you don't necessarily get that because the healthcare systems are becoming more and more aware of the leverage advantage between fee-simple and non. We like the fact that we predominantly early in our acquisition process bought a lot of fee-simple assets.

[Operator:]

The next question will be from Doug Christopher with DA Davidson.

[Doug Christopher:]

I did have a follow-up on the FAD, the funds available for distribution. Is this a level -- this kind of $69 million area for funds available, is that kind of a new level for you? The reason I ask is I look at its relationship to cash rents, cash NOI and historically it’d been well above kind of the 60% area on NOI and above the 40% of the cash NOI -- sorry the cash rent, sorry. And I am just wondering, is this kind of a new level, do you see that trending back up over $70 million again or how should we think about that?

[Robert Milligan:]

I think Doug -- thanks for your question. I as we look at our FAD for the period, certainly we have some elevated capital expenditures relative to how we’ve run certainly over the first two periods here. I think the second thing that you’re seeing is the fact that we have disposed of some assets and really used that to pay-off debt and lower our leverage. I mean, we're sitting right now with lowest leverage that we’ve had certainly over the last two years with $200 million of cash that hasn’t been deployed into earnings assets. So I think you’ll see our run rate certainly remain around this level until we redeploy the significant liquidity that we have. But overall our capital expenditure should also normalize and go back down in the fourth and first quarter.

[Doug Christopher:]

Yes, so that makes sense. And just on the CapEx side, you mentioned coming back down, are you -- when you bought some of the buildings, newer buildings, expected to have kind of lower CapEx versus others. Then does that CapEx -- does that remain kind of lower than average or lower than it had been as a percentage of your assets?

[Robert Milligan:]

Yes. We absolutely see that being the case. I think there’s a couple of things that we had that are required more capital as we’ve converted some space and certainly built out some shelve space. But from an overall perspective, our assets continue to require less capital. I think we’re more disciplined in how we utilize our capital both on the overall building capital that we have as well as our tenant improvement dollars where we’re getting the value that we’re putting into it. So we certainly do expect it to be a longer term in that 10% to 12% of NOI run rate.

[Operator:]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Peters for any closing remarks.

[Scott Peters:]

Well. Thank you everybody for listening and thanks very much for the questions. I think they were very insightful and we look forward to seeing certainly the analysts and investors at NAREIT coming up in San Francisco. Thank you.

[Operator:]

The conference is not concluded. Thank you for attending today's presentation. You may now disconnect.