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Edited Transcript of DOC earnings conference call or presentation 27-Feb-19 3:00pm GMT

Q4 2018 Physicians Realty Trust Earnings Call

Milwaukee Mar 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Physicians Realty Trust earnings conference call or presentation Wednesday, February 27, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bradley D. Page

Physicians Realty Trust - Senior VP & General Counsel

* Jeffrey Nelson Theiler

Physicians Realty Trust - Executive VP & CFO

* John T. Thomas

Physicians Realty Trust - President, CEO & Trustee

* Mark D. Theine

Physicians Realty Trust - EVP of Asset & Investment Management

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Conference Call Participants

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* Andrew T. Babin

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Chad Christopher Vanacore

Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst

* Daniel Marc Bernstein

Capital One Securities, Inc., Research Division - Research Analyst

* Jonathan Hughes

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Jordan Sadler

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Michael Albert Carroll

RBC Capital Markets, LLC, Research Division - Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Vikram Malhotra

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Greetings, and welcome to Physicians Realty Trust Fourth Quarter and Year-end 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Bradley Page, Senior Vice President, General Counsel. Thank you. You may begin.

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Bradley D. Page, Physicians Realty Trust - Senior VP & General Counsel [2]

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Thank you, Rav. Good morning, and welcome to the Physicians Realty Trust fourth quarter and full year 2018 earnings conference call and webcast. With me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; John Lucey, Chief Accounting and Administrative Officer; Mark Theine, Executive Vice President of Assets, Investment Management; and Laurie Becker, Senior Vice President, Controller.

During this call, John Thomas will provide a summary of the company's activities and performance for the fourth quarter of 2018 and the year ended 2018, as well as our strategic focus for 2019. Jeff Theiler will review our financial results for the fourth quarter of 2018 and year ended 2018 and will provide our thoughts for 2019. Mark Theine will provide a summary of our operations for the fourth quarter of 2018. Following that, we will open the call for questions.

Today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. They 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 our assumptions are reasonable, our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations, and those anticipated or implied in such forward-looking statements. For a more detailed description of potential risks, please refer to our filings with the Securities and Exchange Commission.

With that, I would now like to turn the call over to the company's CEO, John Thomas.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [3]

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Thank you, Brad. Good morning, and thank you for joining us today. This time last year, we told you we expect that 2018 would be a year to recycle capital, to place an extraordinary focus on operations and to position Physicians Realty Trust for 2019 and beyond. We executed on that plan through the work of our talented teams as we focused on investing it better. Our goals were largely accomplished through the selling of $220 million of older, less strategically valuable properties throughout the year. Those proceeds were reinvested in 4 of the highest quality properties in the country, occupied by high-quality health system clients and existing relationships. No property better represents this focus on quality than the North Side Medical Midtown medical office building located in the Midtown neighborhood of Atlanta. This 169,000 square-foot facility is fully leased to and occupied by North Side Physicians Outpatient Services and affiliated medical professionals. This property was nationally recognized by Healthcare Real Estate Insights, our industry's leading trade publication, with the 2018 HREI's Insights award for the best new medical office building of the year. This achievement marks the 4th such HREI award winner in our portfolio and we are proud Northside Hospital selected DOC to own that building.

In 2018, we evaluated every facet of our organization with the goal to increase revenue and decrease expenses, and we accomplished our specific financial goals by 150%. Away from the income statement, our team worked together to define the DOC difference through our mission, vision and value statements.

These efforts illustrate who we are, how we deliver results to our people, our shareholders, our providers and our clients. DOC is on a mission to help medical providers, developers and shareholders realize better healthcare, better communities and better returns. We are dedicated to making a difference in the lives of our team members, investors, healthcare partners and those who visit our property.

We do this by offering broader and deeper healthcare expertise than any other REIT, attracting solutions that benefit all parties and by leveraging our long-standing industry connections to source and sustain the highest quality facilities and tenants in the industry.

We articulate on our core values through the acronym "CARE". We Collaborate and Communicate with internal and external stakeholders. We Act with integrity. We Respect the client relationship and we Execute consistently.

I drive our organization to make decisions and manage our investments with care, we will fulfill our mission and achieve our vision. We'd also like to share more about Physicians Realty Trust's commitment to sustainability and the ESG. We have developed a G2 sustainability philosophy, a practical approach in which being green through our capital initiatives equates to a green cash result with cost savings over time. This outlook ensures the integrity, the economic viability, operational efficiency, natural resource conservation and social responsibility within our network's nationwide portfolio.

In 2018, DOC spent approximately $2.8 million on sustainability-driven capital expenditure projects within the portfolio. These efforts include LED retrofits, building automation system upgrades, and facade replacements, resulting in both immediate and long-term energy savings. The company also consolidated telecommunication bills which reduced costs and created cash management efficiency.

In 2018, Physicians Realty Trust was certified by the independent analyst as great places to work. We also earned a spot on the Milwaukee Journal Sentinels 2018 list of Wisconsin's top workplaces.

Diversity of our employee base remains a top priority for our company. I'm proud to share that women and minorities comprise 23% of our leadership team and 57% of our larger team.

On our Board of Trustees, 29% of the independent trustees are a women and a minority. Also our commitment to our CARE core values, the company provided over $180,000 in philanthropic support to charitable causes nationwide, while participating in meaningful voluntary opportunities with our team.

We are proud of our ESG progress in 2018, but understand that we can always do more. We will continue to invest in initiatives to improve our overall sustainability performance and support our long-term goals.

With this attention to detail and invest in better mentalities, we ended the year with a high quality portfolio of medical office facilities. As of December 31, 2018, approximately 96% of our 13.6 million square feet is leased with 90% of our space on campus or affiliated with a healthcare system, and an average lease term of 7.9 years.

This focus on quality extends to our tenants with 57% of our leases being signed by investment-grade quality entities or their affiliates, a metric that leads the medical office space.

It's these tenant relationships that are the catalysts for Physicians Realty Trust growth. Our working with the best health systems in the best markets, our opportunity for organic growth is second to none. In the past we have funded new development conservatively. Moving forward, we believe we can generate higher returns by increasing capital allocations to new development.

This strategy includes backing the best healthcare developers who have projects pre-leased at high rates to high-quality health systems. Projects like Northside Medical Midtown in Atlanta is a prime example of this hospital-driven self-development model. We support these efforts as well.

Today, we mentioned the closure of the El Paso surgical Hospital. In December we learned that the operator of the hospital announced they were closing at the end of the year. The hospital was very successful for many years. While the facility had challenges in 2018, the ownership, including physicians, invested millions of dollars to recruit and employ new positions in the market, open new services and upgrade the facility over the last 2 years. The facility never missed a rent payment but surprisingly closed with 3 weeks’ notice and has not yet paid its December rent. Most of the key physicians were both owners of the tenant and employees. Fortunately, the physician tenants were quickly reemployed by a wholly owned subsidiary of Sierra Providence, Tenet Healthcare's wholly-owned subsidiary in El Paso. And we executed a new 10-year lease on the facility at terms better than the existing lease. We have a number of national healthcare systems actively evaluating and interested in either leasing or purchasing the now vacant hospital. We have received and are evaluating offers to purchase and/or lease the facility and are confident we will have a new tenant in this facility in the near term.

While a disappointing surprise, the strength of this location, the market and the healthcare market and the physicians historically aligned with this facility, we believe, will allow us to quickly address the situation.

Also as noted in our press release this morning, we are proud to announce 3 promotions. Our Board of Trustees has promoted Mark Theine to Executive Vice President of asset management, recognizing his strong leadership and growth as a leader of the company. Mark's career began when he was hired by our Founder, John Sweet, to help build and run the private company that is the predecessor company of DOC and became an original officer of DOC as a Senior Vice President upon completion of our IPO. Mark is responsible for managing the daily operations of our portfolio, which has grown from 19 buildings and 500,000 square feet at the time of the IPO, to over 250 buildings and almost 14 million square feet today.

In the beginning, he managed a handful of internal employees and third party property managers, and today if you look at -- due to our growth, directly or indirectly manages over 100 people. In addition, the board promoted and expanded the responsibilities of John Lucey, recognizing his contributions as our Chief Accounting and Administrative Officer. John joined organization immediately following our IPO as our Principal Accounting Officer, and his leadership and ability to scale our team as we have experienced significant growth, has been critical to our success. John leads our Accounting, SEC and public company reporting, Human Resources, information technology professionals and oversees other administrative responsibilities as well. Among many of John's accomplishments was his decision to hire, mentor and develop Laurie P. Becker, who rose quickly through the organization. We are pleased to announce Laurie has been promoted to Senior Vice President and Controller.

Laurie will continue to report to John Lucey across his many responsibilities, with a direct focus on accounting and SEC reporting.

With that, I'll turn it over to Jeff.

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [4]

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Thanks, John. In the fourth quarter of 2018, the company generated funds from operations of $49.9 million or $0.27 per share. Our normalized funds from operations were also $49.9 million and $0.27 per share. Our normalized funds available for distribution were $44.7 million or $0.24 per share, representing an increase of $1.2 million after adjusting for last quarter's onetime benefit from the lease termination fee. For the full year 2018, the company generated funds from operations of $1.08 per share, an increase of $0.04 over 2017, and funds available for distribution of $0.94 per share, an increase of $0.01 over 2017. This represents the fifth consecutive year of per share FAD growth and a 38% increase overall from 2014's $0.68 per share return.

Our fourth quarter investments were limited to $9.8 million of funded mezzanine loans, which will generate a weighted average yield of 8.3%. The company's full year acquisitions were largely funded by the disposition of 34 noncore assets, with the $220 million of proceeds used to acquire $252 million of Class A real estate, highlighted by the $82 million Northside Medical Midtown MOB. It's common knowledge that 2018 was a very difficult year for external growth for medical office building REITs. Our cost of capital was constrained by our share price, which was much lower than warranted for the entire year. In addition, we faced very aggressive bidders for medical office buildings in the private market, both from private equity buyers who have recognized medical office as a core asset class, and therefore, have lowered their required returns for owning it, and by the large diversified public healthcare REITs, who are rapidly diversifying away from the ever worsening senior housing industry. Against this backdrop, DOC focused on making significant operational improvements in asset management by directly hiring property managers in Ohio and Kentucky and positioning itself with premier health systems and development groups to partner on their most important facilities going forward.

It was because of this work in 2018 that we can now predict $200 million to $400 million of off-market transactions at cap rates between 5.5% and 6.25%, assuming our cost of capital remains favorable. Importantly, the pricing on these transactions does not reflect lower asset quality, but rather a recommitment to the off-market and partner-driven growth strategy that has cemented DOC as the MOB owner of choice during the past 5 years. This proven strategy will enable DOC to build concentration with key health systems and widen our existing lead in investment-grade tenancy while we reward our shareholders with the earnings accretion.

We still maintain 6 assets in our slated-for-disposition bucket with a net book value of $98 million. These assets are 78% leased and are performing well, but we have determined that they no longer fit our core strategy. So we will dispose of them, if and when, we can get to the right price. Two of these assets were classified as held-for-sale last quarter because of a signed purchase contract but the buyer was unable to secure the necessary financing so they have been removed from that category this quarter.

We had very little capital markets activity in the fourth quarter with just a small amount, $2.4 million, issued on the ATM. Our balance sheet remains strong with less than $77 million of debt maturing over the next 4 years, all of which are existing mortgages, with a weighted average interest rate of 4.1%. Our net debt to adjusted EBITDAre is 5.6x, and our debt-to-total capitalization is less than 34%, providing lots of flexibility.

Our portfolio remains highly leased at 96% of total DOA, and 53% of this space is leased to investment-grade rated health systems or their subsidiaries. Each of these metrics leads the MOB REIT universe. Northside Hospital, our third largest tenant at 3.4% of portfolio DOA, does not currently issue public debt but would most certainly be investment-grade rated if they did. Our 96% leased same-store portfolio generated cash NOI growth of 1.3%, excluding the 6 properties slated for disposition.

If we included these properties, the NOI growth would be 1.9%.

G&A expense was $6.7 million for the quarter, bringing our total 2018 G&A to $28.8 million, within the expected range announced at the end of last year.

Connected in our earnings release and John's address in his prepared remarks, the tenant transition that we are working through at our El Paso Specialty Hospital in MOB. We have already released the MOB at comparable lease rates and have been working with many interested parties for the hospital asset. But until we are able to finalize a new lease, we will experience a drag on FFO and FAD of approximately $800,000 per quarter.

In terms of 2019 projections, we've already mentioned the $200 million to $400 million of off-market investments at cap rates of 5.5% to 6.25%, although the timing of those investments is uncertain. We also anticipate G&A expense of $31 million to $33 million which, like 2018, will be temporarily elevated in Q1 due to expensing of stock bonuses and then settle back now.

We anticipate CapEx will be less than 10% of NOI again as we seek to maximize the amount of rent that flows through to the bottom line for our shareholders. We don't utilize a repositioning bucket for underperforming assets, so it is difficult to predict our overall same-store NOI growth for 2019, as that number will be influenced by the speed at which we finalize our tenant replacement in El Paso. But we continue to expect 2% to 3% of cash NOI growth on a long-term basis.

I will now turn the call over to Mark to walk through some of our operating statistics in more detail. Mark?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset & Investment Management [5]

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Thanks, Jeff. We started 2018 with key objectives for the operations team, including driving organic growth through proactive asset management, improving the quality of our portfolio and expanding our property management platform. As we look back at last year, we have achieved these key goals.

In 2018, same-store NOI growth for the full year was 3.1% or 1.9% if the onetime termination fee at the Fox Valley MOB is excluded. As Jeff mentioned, fourth quarter same-store NOI growth was 1.3%, driven by a 1.8% increase in rental revenues, 20% increase in operating expense recoveries and offset by an 18% increase in operating expenses. This larger than usual year-over-year increase in operating expenses is attributable to the rise in real estate taxes at the Baylor Cancer Center as well as MOBs in Austin and Houston.

The increase in operating expense recoveries to offset this rise in taxes, demonstrates the insulated nature of our cash flow from triple net leases.

In 2018, we significantly improved the long-term quality of our portfolio by selling 34 older and smaller assets. These properties averaged 31,000 square feet each, were 82% leased, 25 years old and only had 27% investment-grade rated tenants. We recycled the capital from the sale of these assets into 4 new properties totaling 620,000 square feet. These new acquisitions averaged 155,000 square feet each, were 96% leased and only 5 years old, with limited CapEx needed in the future. Three of the four, 2018 acquisitions were with existing tenants in the portfolio, demonstrating DOC's position as their preferred real estate owner.

Stepping back and reviewing our progress over the last few years, we have improved the quality of our portfolio substantially through both acquisitions and dispositions, including the disposition of nearly half of the legacy IPO portfolio. Simply stated, DOC's portfolio transformation is real. Three years ago, 26% of our tenants were investment grade rated compared with 53% today and 84% of our top 10 tenancies is investment grade rated. We believe these new investments will provide outstanding returns for years to come and reflect a standard of exceptional quality for our acquisitions in the future. Speaking of our top 10 tenants, we would like to congratulate Catholic Health Initiatives and Dignity Health on completing their merger and rebranding under the new name, CommonSpirit Health, effective February 1.

Turning to our portfolio. In 2018, we completed over 1 million square feet of leasing activity. In the fourth quarter, specifically, we completed 270,000 square feet of leasing activity with positive leasing spreads of 3.9%. In total, we completed 146,000 square feet of lease renewals with an average lease term of 8.8 years, resulting in a tenant retention rate of 53%. The retention rate, however, was 77% in Q4, if you exclude the El Paso Specialty Hospital that John previously mentioned.

We also completed almost 125,000 square feet of new leases, with an average lease term of 11.8 years. We continue to see strong leasing momentum from our hospital partners for new space and the ability to push rent in annual rent escalators in lease renewals. In fact, 90% of our leasing activity in 2018 contains an average rent escalator of 2.5% or greater. We are proud to report that fourth quarter rate concessions were low with no free rent and very little TI required to renew in our existing healthcare provider partners. Approximately 60% of the leases renewed in the quarter did not require any TI. And the remaining 40% averaged $1.57 per square foot per year. Tenant improvements for new leases were approximately $2.29 per square foot per year during the quarter.

In 2018, we invested a total of $19.8 million in tenant improvements, recurring CapEx and leasing commissions or just 7% of the portfolio's cash NOI. The low capital investment capital expenditures relative to our peers is driven primarily by the physical quality of our buildings we have bought, attention to deferred maintenance and our low lease expirations scheduled during the year. In 2019, we expect capital investment to continue to trend on course at approximately $4 million to $5 million per quarter. As we begin 2019, we have built a high-quality portfolio operated by exceptional asset management and leasing teams that continue to deliver bottom line results. We successfully expanded these teams recently by replacing great third party property managers and directly hiring managers to the DOC team in Kentucky and Ohio, markets representing approximately 1.1 million square feet or 15% of our multitenant portfolio.

As always, our commitment to relationships and service excellence for our health care partners nationwide is the trademark of the DOC difference, ultimately driving tenant retention, cost efficiencies and profitable consistent growth for our shareholders.

With that, I'll turn the call back to John.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [6]

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Thank you, Mark. We'll now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question commerce from Michael Carroll with RBC Capital Markets.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [2]

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First I want to talk a little bit about the El Paso move out and why did the system decide to shut down its operations? And is that normal versus trying to sell the practice? I'm assuming that they just were not very profitable in 2018.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [3]

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Michael, it's hard to explain. It was a surprise to us, as we said in my comments. We had about 3 weeks’ notice. And as I said, they never missed a rent payment and the hospital has been very successful for a very long time. The physicians that were employed there and were also part owners were as surprised as we were. Again, can't explain the decision but it was made and we, like I said, we -- working with the physicians quickly moved both their employment and the lease to the medical office facility that they occupied to Tenet Healthcare and have a lot of interest in the facility. So not a great situation but we think it's short-term.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [4]

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It's encouraging that you got the MOB released so quickly. I guess, can you talk a little bit about the interest in the property? I know you mentioned you may sell or release it? Why do you think you can do it so quickly? And do you think you'll be able to get this done at similar value and/or rate as the prior lease?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [5]

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Yes, we do believe that. And 3 national healthcare operators are actively touring it, evaluating it, looking at data, due diligence from us and building a business pro forma around it. El Paso is a -- it's still a growing community. It's fairly tightly bedded on any kind of bed-to-population standard. And, more importantly, this facility has 10 ORs. It was primarily a surgical hospital and the orthopedic surgeons who were part owners and employees who are still there in the community, want to come back and start practicing in it again. So it's a very desirable location and place, and particularly for physicians and efficiency both, for inpatient and outpatient surgery.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [6]

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Is the hospital physically open right now? And if it's not open, is that an issue in terms of trying to sell it or release it?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [7]

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No, it's secured and locked up, but we're taking care of it, obviously. Whoever decides -- if one of the other hospitals in the community open it, they can open it under their license and do it pretty quickly. If somebody wanted to come in on a de novo basis, it would take a little more time. But it still wouldn't take too much time. So the hospital could be up and operating within days, depending upon which tenant -- which hospital operator decides to lease it from us.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [8]

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And finally, I guess, John, can you provide some comments on the new reimbursement change that was enacted on January 1st related to the Section 603 assets? I know that DOC has been pretty optimistic on those properties over the past few years. Does that new payment schedule alter your view on those properties?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [9]

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No. We still are attracted to off-campus outpatient care facilities, particularly if they're leased to a credit quality health system which is what 603 is all about. The AHA and a number of hospitals are suing CMS over the payment cut because it's directly contrary to the language -- plain language of Section 603. There's a bipartisan letter that came out of the Senate with I think 70 or 80 signatures so I don't think we'll have any problem addressing the situation if they have to do it legislatively. Bottom line is, we underwrite every facility based on what its current revenue and what its current reimbursement rates look like. We're not dependent upon just the statute and the regulatory protection as the basis for our decision. It's really about what are the services there? How much revenue are they generating? As I said, physicians in non-hospitals can be successful in locations like that. So it's a nice addition with the grandfathered status and we think it is particularly valuable for the long-term renewal rates of the hospitals in all locations to protect their grandfathered status. So bottom line is we still underwrite every facility and monitor every facility on our current basis based upon what CMS is paying them.

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Operator [10]

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Our next question comes from Jonathan Hughes with Raymond James.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [11]

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So it sounds like El Paso tenant clearly wasn't on the watchlist and that was unexpected. Are there any other tenants on the watchlist that lease large spaces with expirations over the next few years?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [12]

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Jonathan, I think our watchlist and, kind of, issues that we've had to deal with in the past is healthier than ever. It's stronger than ever. We certainly evaluate -- when we brought in our and created the credit watch group and underwriting team that reports to Jeff, one of the things that they went back and did is they went through all our leases and started tracking down financials and monitoring that to have visibility on the vast majority of all of our tenants, particularly all of our large tenants of any size. So that's been a very helpful team to build and they're doing a great job. So again still working through the sale foundation of the hospital in El Paso, and probably a change of ownership in San Antonio, which will be an enhancement overall, but those issues have been largely taken care of themselves.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [13]

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Okay. And then on the G&A guidance, maybe a question for Jeff. I think that includes some vesting of maybe restricted shares in the first quarter, that goes back down through the rest of the year. I think we saw the same thing last year. Is this going to be a recurring item that we should be modeling kind of in 2020 and beyond?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [14]

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Jonathan, yes. That's a great question, and you should be modeling that each year. I think you'll see a very similar pattern.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [15]

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Okay. All right. And then on the acquisition guidance, expected pricing there is in the high 5%, 6% cap rate range, a little higher from yields in this past year and you mentioned that's a reflection of your relationship network, but maybe on the marketed deals that I assume you still evaluate, have you seen any change in seller pricing there on the MOBs over the past 6 to 9 months as interest rates have stabilized higher?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [16]

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I'd say, we haven't seen a meaningful change, Jonathan. I think the 4 that have traded haven't been as -- haven't measured up on a quality basis to, say, the Duke portfolio. And there's some high quality portfolios sliding -- floating around right now. We'll see what those print at. But for the most part, I think Jeff is dead on. We're seeing lots of great opportunities with our relationships at the cap rates that you suggested.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [17]

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Okay. Any interest in large portfolios out there?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [18]

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Jonathan, we look at everything and evaluate everything that's on the market, but we tend to stay off market. That's where we find the best value and have the best opportunities with our relationships.

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Jonathan Hughes, Raymond James & Associates, Inc., Research Division - Senior Research Associate [19]

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Okay. Fair enough. And then just one more, I saw you used the ATM, during the fourth quarter. So you plan to utilize that in addition to capital recycling from the slated-for-disposition bucket to fund external growth guidance.

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [20]

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Jonathan, it's Jeff. Yes, certainly we're going to look at both of those sources as we look to fund the pipeline. We're probably pretty near target leverage right now. So it's going to depend a little bit on how fast we can generate these acquisitions and the interest that we can get in selling our properties slated for disposition. As we talked about, these are good properties, and so we are looking for good pricing on them. So that's going to factor into what source of the capital we're able to tap.

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Operator [21]

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Our next question comes from Drew Babin with Robert W. Baird.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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Quick follow-up on the G&A front for Jeff. I know that the changes in lease accounting, you're expensing more kind of property management type costs that you might have capitalized last year. I guess, can you quantify that impact to G&A? And kind of confirm that, that's sort of an AFFO-neutral change?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [23]

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Yes, Drew. That is an AFFO-neutral change. As a practical matter, we didn't have a ton of G&A that we are capitalizing in that manner. We started to try to work towards this guidance implementation earlier. So most of the G&A that you see is an increase in cost of running the company, increase in salaries and benefits for kind of the best-in-class staff that we have. So there is some benefit from capitalization, but it's not a lot.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24]

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Okay. And I guess, a related question as well. On the CapEx front, I think you mentioned in the prepared remarks, that it would remain I think less than 10% of NOI. Looking at your 2018 results, it looked like it was maybe like 7%, so I guess, throwing the 10% out there, is that just sort of a general range? I mean do you expect kind of the per square foot cost to rise significantly in '19 or should they stay relatively consistent?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset & Investment Management [25]

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Drew, this is Mark Theine. Jeff threw out the 10% number but we are really working to manage our CapEx efficiently and be in the $4 million to $5 million per quarter in 2019.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26]

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Okay. That's helpful. And just one more for me. On the $200 million to $400 million of investment guidance, does that include any mezzanine or development type fixed income investments? Or is that just pure property acquisitions?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [27]

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Yes, so that's going to be -- I guess that would be inclusive of acquisitions, some take out type deals and limited development. The mezzanine -- if we do mezzanine loans, you're going to see interest rates that are well above that range. Typically, our mezzanine rates of return are kind of in the 8% to 9% range.

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Operator [28]

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Our next question comes from Jordan Sadler with KeyBanc Capital Markets.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [29]

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The first question regarding the acquisition guidance here, just drilling down. Is there a line of sight to the $200 million to $400 million that you've offered up a specific range?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [30]

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Yes, Jordan, we've got a pretty good pipeline we're working on, so line of sight to the midpoint of that number and expect the rest of that to appear pretty quickly.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [31]

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So for modeling purposes, midyear timing kind of works?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [32]

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Yes, I think that's right, Jordan.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [33]

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And Jeff, while I have you, the funding you touched on in here, but what's embedded in the guidance in terms of funding and leverage for 2019?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [34]

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Yes, so embedded in the kind of leverage, I guess, as I mentioned we're at or near our target leverage, right. So you consider that to be 65% equity, 35% debt or so. So for your modeling purposes, that might be an easy way to do it, 65% equity. The wildcard is whether or not we are able to reach agreement on some of these assets slated for disposition. That will obviously affect the amount of equity issued.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [35]

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The dispos, are they solely related to the 6 assets in that bucket? And does that bucket include El Paso?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [36]

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So the assets slated for disposition include the foundation El Paso asset, not the El Paso Specialty Hospital. That's not in there right now. We don't think it will be. So those are assets that -- they've been in there for a few quarters now. I think we just determined they're non-core and looking to sell them. But again, as you heard in our kind of same-store remarks, they're performing well, so there's not a huge -- we're not willing to take any price, we're willing to sell them at the right price.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [37]

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Okay. They've been hanging out here for a while, so I'm just curious is there an expectation that this is a 2019 event? Or it's just we'll see what happens?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [38]

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We thought we had -- we were close to selling 2 of them. We think we'll be close to selling the 2 of them again, probably sooner rather than later. But, again, we're evaluating all prices that come in.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [39]

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Just to clarify on the El Paso Specialty Hospital. Did you -- I thought you mentioned in the prepared remarks that you may sell the asset. Is that right? Or did I mishear that?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [40]

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At least 3 of the suitors, if you will, who are interested in the facility have inquired about a purchase or a lease. So we're evaluating those options. We've received written offers that we're evaluating. Our primary desire is to lease the facility again. The operators that are evaluating and interested it are high-quality tenants that we would like to have a relationship with.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [41]

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And how should we think about the timing of the releasing and the 2 different pieces?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [42]

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We think it's quick but it's hard to predict. We think it's quick.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [43]

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First half or second?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [44]

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I think we'll have it resolved first half. It's just a matter of how quickly we can get them back in there and get it open and operating. Which can be quick, just depending on which one of the operators we end up working a deal out with.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [45]

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Lastly, on this term loan in Columbus that you've done in the first quarter, $15 million, can you shed a little bit of light on that? One of your other investments here you provided more color on this development loan. I'm just curious about the one that's in Columbus. It seems a little bit less detailed in the release.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [46]

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Yes, it's one of our large developer, healthcare developer client relationships who's took down some land and is in the process of finalizing the plan, has a lease with an investment-grade tenant. At this point, you can view it as a short-term, as kind of bridge to the bigger development project. But we're evaluating whether or not we'll participate or work out a deal with them on the second project, but near-term, it's a good investment. And well secured.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [47]

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Is it an MOB?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [48]

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A large healthcare tenant.

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Operator [49]

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Our next question comes from Vikram Malhotra with Morgan Stanley.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [50]

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Just in your prepared remarks, you referenced taking some of the management internal to the DOC team. Just wondering, some of your peers have focused or emphasized the internal management, they outlined some savings and margin growth opportunities. I'm just wondering, sort of, does this signal or is this something you're going to be looking to expand in terms of doing more internal management?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [51]

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Vikram, this is JT. We're going to continue to -- in markets where it makes sense, and where we have scale we can gain those efficiencies. And there are some other markets where we're planning to head in that direction in the near term. I don't think we'll ever find it -- in some markets, it's better to work with our third party partners like we already do. They're the ones with the existing health system relationships and they've brought us into those relationships with them. And they're great partners. They do a great job. But in markets where we have scale and otherwise, it's our relationships that we are primarily working through. We're going to continue to in-house where we can.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [52]

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Okay. Just both the merger, the CHI-Dignity merger, can you maybe update us and provide any thoughts on, is there potential rationalization post-merger, are there just candidates for disposition as you've now monitored the portfolio for a while. Something, I guess, you may have thought about post the acquisition of the CHI portfolio?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [53]

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Yes, a great question. The short answer is no. They don't overlap in any markets today, and we've had lots of dialogue with them throughout their process of merging. And getting kind of their thoughts on which markets are going to support them the best and where there might be some markets that they want to exit. As of today, we don't have any knowledge of any particular market that they plan to exit, and we've had pretty detailed conversations with them about this. As you know, CHI started the process of selling Kentucky One before they completed the merger with Dignity. So they are continuing to process that sale. It is kind of unrelated to the Dignity merger. We've got great relationships with Dignity and the combined C suite there has got a heavy component of the Dignity Health team. But a lot of our CHI leadership that we work directly with are continuing on in critical roles in the organization. So we're really excited about it. We think it's going to strengthen their balance sheet, strengthen their operations and strengthen the overall coverage of our facilities across the country.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [54]

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Okay. And then just on the development side, given the capabilities, some of your peers, maybe the more diversified ones, have outlined pipelines and partnerships with various systems, some of them stretching a couple of years. I'm just sort of wondering, can you lay out your opportunities over the next call it 2 years, and what we think of in terms of development contribution?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [55]

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I won't put dollar volume on it, but with the clients that we have where we have done this consistently over the last couple of years. And now that we're funding some development projects more directly with developers, we think the pipeline is pretty significant. We announced the one project today, that's with an existing developer relationship and existing national credit rated tenant and we think there's a pipeline with that development company and that particular tenant. But there's also others from Phoenix to Texas and other markets where we're actively working with the health systems. And we'll continue to invest in Georgia where we have fantastic relationships and see more economic growth and opportunity there.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [56]

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Okay. And then just last one, just to get a sense of the closure that you announced and then you backflow pretty quickly. But just given the surprise in terms of you mentioned they were paying rent, never missed a payment and suddenly decided to close. What does this mean for both underwriting, but more importantly, just monitoring. You have a new team, a credit team in place. And just sort of like what sort of information do you get? Describe some of the interactions you have with the tenants just to sort of have some sort of heads up, hey, it's not just going to shut down one fine day.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [57]

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It's a great question, Vikram. We always evaluate that kind of situation and we've only had a small handful over the 5-year life of the company. But in all candor, we've been working with that tenant, evaluating them, monitoring them and had been given every assurance that they were kind of continuing on and committed to the facility and the market. And then they did a 180 within weeks and closed. It's hard to explain how to change that result in that particular situation. But like I said, the upside opportunity with the other operators that are interested in that facility are better.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [58]

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This was in December, I believe, correct?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [59]

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Yes.

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Operator [60]

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The next question comes from John Kim with BMO Capital Markets.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [61]

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I'm just going to follow up on the El Paso discussion. I know you said you were surprised when they decided to close, but now that you've had some time to examine it, what do you think happened? I know they had recent new ownership of the hospital, but I'm wondering if there was also new competition in the area or there were reimbursement challenges or maybe something else?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [62]

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John, I would -- if I had a rational explanation for their decision, I would share it with you. I think the best way to summarize it is it's a national operator who had one facility in the market and decided to exit the market, and do it on a moment's notice. We really -- had 3 weeks of notice before they closed the doors. It was no expectation. All the physicians who were employed there and who were part owners of the hospital had no notice either. Like I said, it was a quick turnaround. There is -- that is a very strong health care market and there are 2 large national operators that are there and they are very strong. Tough competition for anybody. It may have been that they didn't think they could compete with them but they had for a long time and had been very successful for a long time. So we really can't explain the situation, but like I say, we've got 4 good operators that we think will step in there.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [63]

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And on the $800,000 per quarter impact, a, should we not assume there's a termination fee that you could collect? And then b, is it realistic that this would translate into an annualized impact because even if you do lease it, it may take some time for the new hospital to come in and take physical occupancy?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [64]

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Yes, I think the -- no, we wouldn't anticipate a termination fee. We are pursuing in their liquidation process, claims, but they're liquidating. So we will have to see how that plays out. The reason we did quantify it by quarter, in particular, is we think it could be a quick turnaround resolution, but it depends upon which operator we end up working an arrangement out with. It could be temporary, it could bleed into the year, depending upon the ability to get the facility re-licensed or brought under one of the existing licenses in town. And we think that's a strong likelihood.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [65]

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Okay. And then, Jeff, on your prepared remarks, you mentioned on the dispositions, they no longer fit your strategy. I was wondering if you could provide some color on what those characteristics are.

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP & CFO [66]

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Yes. So the disposition bucket includes 1 small building in Florida, that is just kind of away from the rest of our operations and it is a little bit isolated. So that's the reason that one's in there. The other ones are the foundation assets. Certainly, we've -- they're sort of the first assets that we bought in the history of the company and we've been diversifying away from these surgical hospitals. And then there's an associated MOB with each surgical hospital. So it kind of makes sense to sell those as a group. So those are the reasons that they don't meet our strategy anymore.

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Operator [67]

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Our next question comes from Chad Vanacore with Stifel.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [68]

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One quick clarification on the re-tenanting of the El Paso asset, so it looks like Tenet Healthcare, but they're only renting about 1/3 of the space. So what was the makeup of the former tenant? And why are we leasing only 1/3 of the space. Or is there more to come?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [69]

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Yes, Chad, so it's 2 buildings. One is a surgical hospital, and one is a medical office building. And to be clear, the medical office building is not on the campus, it's an off-campus building that the primarily the orthopedic surgeons who are employed by that hospital and were part owners of that hospital, occupied at the time this occurred. So we just turned around, they stayed right where they were and changed their employment to Tenet. And then Tenet signed a new lease on that building. So it's kind of the impact of this decision, about 1/3 of it was the MOB and that's what's been released. So now we're working through with hospital operators who are interested in leasing and/or buying the hospital facility. It's a surgical hospital so it's not a huge building.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [70]

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Just needed that clarification. And then just one other question for me. Sequential occupancy dropped in the fourth quarter a little bit. Were there any other vacancies that came up in 4Q that haven't been retenanted?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset & Investment Management [71]

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Chad, this is Mark. We -- actually had a positive net absorption for the fourth quarter, a small number if you exclude that El Paso hospital but the drop in the occupancy that you're referencing is a direct correlation to the El Paso facility.

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Operator [72]

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Our next question comes from Daniel Bernstein with Capital One.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [73]

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Not to ask another question on El Paso, but I feel like I have to. You said you weren't going to pursue a lease termination fee. I just wanted to understand, did you not have something in there that was contractual? Typically in your leases, what's the typical length that somebody has to go ahead and give you notification?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [74]

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Yes. So to be clear, they didn't honor the lease in their terms or the financial terms once they decided to close. So we will pursue claims, Dan. I said, I wouldn't expect a lease termination fee. This has been a long-term facility that had been well operated. This operator bought the operator who is running it -- who built it and ran it for a very long time with the physicians there. Before -- and we owned it before they were involved. So the relationship with that operator, we didn't have anything -- extraordinary credit enhancements or guarantees from that operator standing behind that lease that they purchased from another party. Typically we get -- particularly when we're making a new investment with a new operator we would get those kind of credit enhancements. It's a case-by-case basis, you don't have it with every facility.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [75]

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You didn't have any escrows or money that you could tap towards that lease termination fee then?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [76]

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The tenant is liquidating. As they collect receivables, we're making claims against those receivables like their other creditors.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [77]

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Okay. And then you made a comment earlier about escalators of 2.5% or greater. I just want to see if you can remind us how much of that is CPI versus fixed rate?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [78]

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A very small percentage is CPI. We've been working those into some leases in this environment, but the vast majority are fixed. And even if there is a CPI, there would be a floor and probably a ceiling banding around that CPI adjustment.

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Operator [79]

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Ladies and gentlemen, we've reached the end of the question-and-answer session. At this time, I'd like to turn the call back to John Thomas for closing comments.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [80]

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Thank you very much for joining us today. I know there are a number of investor conferences over the next few weeks. We look forward to seeing you at those meetings. Thank you for your time.

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Operator [81]

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This concludes today's teleconference. You may disconnect your lines at this time. And we thank you for your participation.