U.S. Markets closed

Edited Transcript of DOC earnings conference call or presentation 7-Aug-19 2:00pm GMT

Q2 2019 Physicians Realty Trust Earnings Call

Milwaukee Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Physicians Realty Trust earnings conference call or presentation Wednesday, August 7, 2019 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Jeffrey Nelson Theiler

Physicians Realty Trust - Executive VP, CFO & Head of IR

* Jennifer A.D. Manna

Physicians Realty Trust - VP & Associate General Counsel

* John T. Thomas

Physicians Realty Trust - President, CEO & Trustee

* Mark D. Theine

Physicians Realty Trust - EVP of Asset Management

================================================================================

Conference Call Participants

================================================================================

* Alexander J. Kubicek

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

* Chad Christopher Vanacore

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

* Daniel Marc Bernstein

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

* Jordan Sadler

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

* Michael Albert Carroll

RBC Capital Markets, LLC, Research Division - Analyst

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - Director & Senior Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Greetings, and welcome to the Physicians Realty Trust Second Quarter 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Manna, Vice President, Associate General Counsel. Please go ahead.

--------------------------------------------------------------------------------

Jennifer A.D. Manna, Physicians Realty Trust - VP & Associate General Counsel [2]

--------------------------------------------------------------------------------

Thank you. Good morning, and welcome to the Physicians Realty Trust Second quarter 2019 Earnings Conference Call and Webcast. With me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; Mark Theine, Executive Vice President of Asset Management; John Lucey, Chief Accounting and

Administrative Officer; Laurie Becker, Senior Vice President, Controller; and Dan Klein, Deputy Chief Investment Officer.

During this call, John Thomas will provide a summary of the company's activities and performance for the second quarter of 2019 and year-to-date as well as our strategic focus for the remainder of 2019. Jeff Theiler will review our financial results for the second quarter of 2019, and our thoughts for the remainder of 2019. Mark Theine will provide a summary of our operations for the second quarter of 2019. 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 and other important factors that could cause actual results to differ from those contained in any forward-looking statements, 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. John?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Jennifer. Good morning. Thank you for joining us today. We at Physicians Realty Trust celebrated the sixth anniversary of our initial public offering on July 19. We appreciate all of you who've been with us from the beginning, and those who joined our mission along the way. We invest in (inaudible). This past quarter's results from operations reflects our original commitment to you, our stakeholders, clients and team and the results we can achieve when we follow that simple philosophy. We started this company with a focus on the future of health care and the evidence is clear and compelling. More and more of the health care dollar in the U.S. is being spent on care in the outpatient medical office setting every day. By investing in medical office buildings, particularly those affiliated with market-leading health systems and providers, by providing high levels of customer service and attention to detail and by providing a caring approach to everything we do, we delivered 3.5% same-store NOI growth this past quarter across all of our medical office facilities.

We've just completed our annual customer satisfaction survey, and our results across the board are outstanding. Mark Theine and his team are delivering every day, working hard to exceed our clients' expectations. When health systems have the choice to choose their landlord, time and time again, Physicians Realty Trust rises to the top of the choices. We will continue our relentless effort on growing our already best-in-class medical office portfolio, anchored by health care systems and providers that are focused on the future, not the past, of health care delivery. The future is in the outpatient setting conveniently located for providers, patients, their loved ones, and the services and the technology they need to be healthy.

Our strategic mission has been to utilize our long-term relationships with industry-leading health systems to grow and manage what we sincerely and objectively believe is the best portfolio of medical office properties in the United States. We continue to see medical office as the most resilient class of real estate in the market. And our portfolio of MOBs, representing 95% of all of our real estate assets, delivered outstanding results during the quarter.

Since our last report, we've also made strategic investments to continue our return to growth of high-quality accretive assets. Consistent with our strategy, we are excited about the expansion of our existing relationships with Ascension, Community Health Network in Indianapolis, Texas Health Resources and U.S. Oncology through our recent investments. We anticipate more opportunities with each of these leading health care organizations. But we understand that we have to earn that business every day. That is the DOC way.

Our pipeline is also strong and expansive. We are under contract or close to finalizing contracts of more than $75 million of new investments and look forward to sharing more about these facilities and the associated health systems upon completion of these acquisitions. All the acquisitions are contingent upon typical closing conditions. But if closed, we will be adding new investment-grade health systems, another state to our map and new opportunities for repeat business with health care providers you know -- you will know and appreciate having in our portfolio.

We're also under a Letter of Intent or in active discussion with a number of other owners and health systems for both monetization and development opportunities, and we are humbled by our existing health system relationships with physicians who serve as references for us with these opportunities.

Business, like life, has challenges. And one of our influential and successful thought leaders, successful by every possible measure, challenges us not to be defined by our challenges, but to own our challenges, address them, but more importantly, be defined by our success. Our successes far outweigh our challenges, and the ratio is not even close. We own our challenges and no one, we believe, is better than solving them than we are. Our relationships, knowledge of health care and engagement with providers, we believe, gives us every opportunity to own and address challenges in our portfolio better than anyone. No one has more sense of urgency than we do, and when, albeit rarely, a health care provider has an issue with their business.

In this context, we are committed to transparency and integrity. Despite encouraging events with respect to each of LifeCare and Foundation El Paso, we determined it was appropriate to elect a conservative application of the recently adopted accounting standard, ASC 842, to reduce cash and noncash straight-line revenues for the quarter as a result of the Chapter 11 reorganization filing by LifeCare and 2019 challenges at the Foundation El Paso Hospital.

The LifeCare reorganization process is coming to conclusion with a new owner for our tenant, which has agreed to assume our master lease as is, and we are negotiating the terms of a sale of Foundation El Paso Hospital as well but we're not quite at the goal line there, but we do have other options if necessary. All 4 facilities remain open and serving their communities. And to that note, our hearts and prayers are with the people of El Paso.

Looking forward, we continue to believe we will have a very good opportunity to invest $200 million to $400 million of new investment in 2019, with a portion of these investments being new development starts that will have rent commencing in 2020. The DOC story has consistent growth in better and better providers and their affiliated medical office locations. Our assets are 96% occupied. Our stability in our MOB and our opportunity for relationship-driven growth, we believe, is second to none. We own our challenges, but more importantly, we do celebrate our success. Quarter 2, 2019, was very successful, and our future is bright.

Jeff will now share our 2 -- quarter 2 2019 financial highlights, and we look forward to your questions. Jeff?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, John. In the second quarter of 2019, the company generated funds from operations of $40.0 million or $0.21 per share. Our normalized funds from operations were also $40.0 million or $0.21 per share. Our normalized funds available for distribution was $42.1 million or $0.22 per share, in line with the previous quarter.

I'll spend a little more time than usual discussing these earnings because of the impact of the relatively new accounting guidance contained in ASC 842, which we adopted at the beginning of the year. Under these guidelines, straight-line rent receivables must be written off in their entirety unless the lessor has a high degree of confidence that they will collect substantially all of the rents over the remaining term of the lease.

With our LifeCare tenant in a bankruptcy process, which by definition, introduces some degree of uncertainty, we couldn't be confident that we would collect substantially all future rent despite the fact that the cash flow generated by our facilities make them highly profitable under the current lease structure. Therefore, we wrote off $3.5 million of straight-line rent receivables, reducing FFO by $0.018 per share.

Most recent update on the LifeCare bankruptcy process is that yesterday, the stalking-horse bidder won the auctions and intends to honor our leases without modification. However, until the sale process actually closes, which is projected to be near the end of the year, we will only recognize the cash rent that we have been collecting steadily since June 1. After the closing, we will likely re-recognize the straight-line rent receivable as revenue.

Similarly, we have been negotiating a sales agreement with the physician group that has been delinquent on their rent at the El Paso Hospital previously run by Foundation Healthcare. This agreement would require as a condition of the sale that the tenant repay the 6 months past-due rent before we close. However, because of the length of the delinquency in rental payments, under the new guidance, we decided we couldn't be certain that the deal would close and that we would collect substantially all of the rent. So we elected to write it off. Should the deal close as planned, we would then recapture the 6 months of rental revenue, and the straight-line rents receivable would be netted out as a gain on sales.

We are in agreement with our auditors on the above treatments, and we believe we are in compliance with ASC 842. However, as seen in this quarter, the new standard can greatly increase the volatility of earnings results on a temporary basis. This is all a brave new world of accounting so I'm happy to answer any additional questions on this after the prepared remarks.

Moving along to investments, we completed $57 million of acquisitions and new development commitments in the quarter and closed on another $47 million of investments subsequent to quarter end. This brings our year-to-date investment activity to $139 million. Looking at the acquisition pipeline, which was weighted towards the back half of the year, we feel comfortable that we can meet the guidance we laid out of $200 million to $400 million of investments, assuming favorable capital market conditions.

On the disposition side, we sold 2 smaller non-core assets for a total disposition price of $12.5 million, which was a 6.4% cap rate. These assets generated a gain on sale of $3 million and an unlevered IRR of 12%. We've made some adjustments to our same-store disclosure to segregate out the entirety of our LTACH and Hospital assets in order to focus on MOBs, which account for 97% of the NOI this quarter. This also serves to separate out the volatility associated with the accounting adjustments previously mentioned that will occur -- that will occur over the next several quarters.

The MOB same-store pool grew cash NOI at 3.5% year-over-year. Notably, this is inclusive of every single MOB asset we have owned during the time frame as we have no assets in our repositioning bucket. We've also removed the slate of our disposition categorization. We still intend to sell those assets, as demonstrated by the El Paso purchase and sale agreement we are negotiating, but because of the uncertainty over how quickly we can find the best value for these assets, we will now reserve that categorization solely for assets that can be designated as held for sale from an accounting standpoint. Our overall portfolio continues to perform well. It was 96% leased at the end of the quarter with 53% of that space tenanted by investment-grade health systems and their subsidiaries.

We utilized the ATM in the first 2 weeks of April to provide capital for our acquisitions, raising $17.9 million of net proceeds at an average price of $18.66. Our net debt to adjusted EBITDA for the quarter is 6.5x, but normalized to the accounting write-offs would be 5.7x. Net debt to gross assets was 33%.

Finally, as predicted on the last earnings call, our G&A has moved down from the seasonal peak in the first quarter and is consistent with our guidance for the year of $31 million to $33 million.

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

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Jeff. The first half of 2019, has been active and productive in managing our portfolio. Our team remains dedicated to superior customer service, the retention and recruitment of high-quality professionals and operating efficiencies to benefit both our health care partners and our shareholders.

Beyond the 3.5% MOB portfolio same-store NOI growth that John and Jeff mentioned, 3 key highlights in the second quarter include improved portfolio occupancy to 96% from 95.4% as a result of 75,000 square feet of net absorption, driven by the commencement of the lease of the El Paso Specialty Hospital. Two, continued expansion and profitability of our best-in-class property management platform, where we now manage directly 56% of our medical office buildings, representing 55% of our NOI. And three, well-managed CapEx investments totaling a mere 6.4% of cash NOI, delivering enhanced cash flow to FAD.

As we enter the second half of 2019, DOC's portfolio is an industry-leading 96% occupied, including 53% leased directly to investment-grade tenants, which we believe is more than any other publicly traded portfolio in health care real estate. High portfolio occupancy not only provides our shareholders with reliable cash flow and strong earnings growth potential, but also benefits the health care systems and provider clients who trust us with their facilities. Even further, DOC's extensive health care relationships cement our ability to attract and lease space to complementary physicians, helping our partners achieve their clinical and business goals, all while increasing access to quality care for everyone.

In Q2 2019, our leasing teams completed 242,000 square feet of leasing activity, including 127,000 square feet of lease renewals. Total retention was 76%, while our leasing spreads were a positive 1.8%. Approximately 93% of our lease renewals this quarter contained an average annual rent escalator of 2.5% or greater as we continue to build our internal organic growth strategy. During the remainder of 2019, just 1.5% of DOC's portfolio is scheduled to renew, with an average rental rate of $23.94 per square foot. And our team has strong leasing momentum in Atlanta, Houston and Phoenix to fill current vacancies.

Consistent with our plans announced earlier this year, we continue to expand our in-house property management platform. Over the past 12 months, we have transitioned property management services at 31 facilities, totaling nearly 2 million square feet in Kentucky, Ohio and, most recently, Nebraska, Washington State and the Dallas, Texas, market. During Q3, 2019, we anticipate completing the in-house management transition of the Houston, Texas, market, which includes 4 facilities totaling nearly 293,000 square feet.

As a result of this growth, we are proud to welcome to the DOC family, Jessie Ramsey, Lesley Taylor, [Scott Hendrick], Terry Smith, and [Jenny Dominic]. All are impressive individuals tasked with delivering the DOC difference every day, which is the outstanding customer service and diligent care health care providers expect from DOC. In the 6 years since our IPO, which again we celebrated on July 19, we've not only built one of the best health care real estate portfolios in the country, but we've also assembled the best health care real estate team. Going forward, we expect continued success from our asset and property management platform, resulting in enhanced local market knowledge, repeat investment opportunities with existing partners, profitable operating efficiencies and continued tenant retention.

During the second quarter, our construction and project management team also generated outstanding shareholder value by prioritizing capital in second-generation tenant improvements and facility upgrades, totaling $4.3 million or just 6.4% of the portfolio's NOI. This conservative approach to CapEx investment compares favorably to our peers and is driven by our well-diversified lease expiration schedule, tenant relationships and the desirability of our medical office portfolio. Rent concessions in the second quarter remained low, with TI allowances and leasing concessions of approximately $1.72 per square foot per year for lease renewals and $3.09 per square foot per year for new leases.

Lastly, as announced in July, we would like to congratulate Mark Dukes, DOC's VP of Asset Management, on his election as Vice Chair of the Building Owners and Managers Association, also known as BOMA International. Mark will serve as an officer for 4 years, ultimately becoming the organization's Chairman in 2021. BOMA is a recognized leader in educating and informing commercial real estate owners, managers and advocates at the federal and local levels. We are proud of Mark's achievements as a real estate professional and excited for the exposure that this position will generate for Physicians Realty Trust and the medical office sector in general. Together, with all of the DOC members of the team, we have created an incredible culture of excellence, an outstanding portfolio and a successful strategy to maximize long-term per share cash flow returns to our shareholders.

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

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thank you, Mark. Pleased to take your questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Jordan Sadler with KeyBanc Capital Markets.

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [2]

--------------------------------------------------------------------------------

Wanted to touch base on the pipeline. So I think you're running a little bit behind pace maybe relative to sort of the midpoint of guidance. Not much, but kind of curious how you think things will shape up in the back half of this year relative to what you're seeing? And maybe you could sort of provide some color around what the activity in the marketplace looks like?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. Jordan, this is John. The market, there's a lot of -- there's been several portfolios floating around the market. There's been a pretty steady supply of on-market opportunities. We really focus primarily on our off-market and relationship opportunities, and hopefully, directly -- working directly with health care providers. So the -- I mentioned in my comments, we've got some exciting assets under contract. As I said, we're going to add a new state and a new health system that's investment grade, and we're very excited about that we think we'll have some repeat business opportunities with and feel very confident about at least the midpoint of that guidance, if not more. We're also finalists in a couple of development RFPs working with some best-in-class developers with those health systems. We feel very good about it.

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [4]

--------------------------------------------------------------------------------

Can you elaborate a little bit on the stuff that's under contract in terms of maybe sizing, cap rate, quality of the system?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

System is superior. The assets and the sizing, I think, is around the $75 million number that I mentioned and fully leased. Cap rates, around 6%.

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [6]

--------------------------------------------------------------------------------

Okay. And then could you maybe speak to the Ascension development -- or the Sacred Heart Development, rather, that is taking place in Pensacola. The interest rate upfront looks a little bit on the lower side relative to what we'd expect for sort of a development loan. Could you maybe just speak to the mechanics and sort of -- is that a 4.75% funding for the entire facility? Or how does this work?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. It's pretty simple, Jordan. It's a 100% pre-leased building with Ascension -- or Sacred Heart, which is part of the Ascension Health System. So brand new building. The local developer group was pretty close or near ready to start construction. Deeni has spent some time with them and really just kind of replaced the capital structure that they were looking at. And I guess, perhaps there, the construction cycle is a little low, but the back-end yield -- it is a project that will realize early in 2020 or mid-2020 so we're going to get a very attractive yield on that investment getting into mid-2020. The option to acquire is really the structure but it's our intention to complete the funding, the construction loan, and then complete the acquisition on the back end of the -- just one way to mitigate the risk, which we think is minimal on construction.

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [8]

--------------------------------------------------------------------------------

Okay. But you have a fixed price purchase option at this point?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

That's right.

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [10]

--------------------------------------------------------------------------------

Okay. And then I guess, just quickly on LifeCare and Foundational El Paso, can you maybe speak to the prospects on those sales? I think you're looking to potentially get rid of LifeCare assets once that's all settled. I'm just curious, if you've sort of taken those to market? Or if you've gotten any feel yet? And then same thing on Foundation?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [11]

--------------------------------------------------------------------------------

Yes. So LifeCare is, again, the bankruptcy process is coming to a conclusion. The stalking-horse -- 2 different stalking-horse bidders were identified during the process, which has moved pretty quickly. The bankruptcy filing was after our last earnings call, and it looks like it evolved pretty quickly after this one. The stalking-horse bids were finalized yesterday and the winning bidder for our 3 assets are -- that we've been in discussions with understand their operating plan, our assets, particularly our Plano facility is still generating very high cash flow. And the bidders, by all accounts, are pretty excited to have the opportunity to buy them and assume our master lease as is. Again, the contingency is, it's still finalizing the bankruptcy court process and then moving towards closing. So the buyer has done all their due diligence. They will close very quickly. To be conservative, we're assuming the end of the year, but hopefully, it's sooner than that. A little bit outside our control, but we think it will be a positive result, assuming the bankruptcy court process concludes, which it should, and then the buyer performs on the contract that's in place. On Foundation -- and yes, Jordan...

--------------------------------------------------------------------------------

Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [12]

--------------------------------------------------------------------------------

And then you'd look to sell those assets?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [13]

--------------------------------------------------------------------------------

Yes. We do intend to sell those. The stalking-horse buyer for our -- sort of for the opcos in our locations is also interested in real estate, and we wanted to get the bankruptcy court in its closing -- their closing behind us and then we could move forward with those. And we'll market them as well. Secondly, is the -- on Foundation, we're very close to a contract with the physician group that's there. It is kind of long overdue, in all candor, but we really do feel we're at the goal line in that discussion and moving forward to complete that sale pretty quickly. We do have some others in the background that we will pivot to if necessary, but we feel pretty confident we'll get that sale completed. But until it's closed, it's not closed.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

Our next question comes from Alex Kubicek with Robert W. Baird.

--------------------------------------------------------------------------------

Alexander J. Kubicek, Robert W. Baird & Co. Incorporated, Research Division - Research Analyst [15]

--------------------------------------------------------------------------------

This is Alex on for Drew. First, looking at the construction loans, should we assume the Sacred Heart loan is backed by Ascension's credit directly? Or is it more a stand-alone credit with the Sacred Health group itself?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. Alex, I mean, the lease is in place. So indirectly, the credit's there, the loan is guaranteed by the development group, the development team that's the development company, which has got a number of high net worth individuals that are -- that own them.

--------------------------------------------------------------------------------

Alexander J. Kubicek, Robert W. Baird & Co. Incorporated, Research Division - Research Analyst [17]

--------------------------------------------------------------------------------

Got it. And kind of pivoting there, can you speak to the strategic purpose of that Atlanta medical condo deal. Are you guys happy owning some residential real estate? Or is there a long-term plan here? Kind of what does it look like?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. Sorry, for the confusion there. It's not residential real estate. It's the -- it's a medical office building that was divided up into a condominium structure when it was built a number of years ago. So it's an incredibly strategic location, kind of irreplaceable location and we're just in discussions with all the condo owners. We've just completed this first stage of the acquisition. At this point, the units we bought are replaced with full leases so it's a step by step structure. We can't -- we don't know when we'll complete the acquisition of all, or if we will, but that's our expectation and intentions.

--------------------------------------------------------------------------------

Alexander J. Kubicek, Robert W. Baird & Co. Incorporated, Research Division - Research Analyst [19]

--------------------------------------------------------------------------------

Understood. That's really helpful. And then kind of lastly, has there been any notable success on the appeals front just looking at taxes and -- because, look, I mean, do you guys really expect the tax growth to be a headwind kind of looking into the near and medium term? Just kind of looking for what your guys' feel is of the temperature in that realm?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [20]

--------------------------------------------------------------------------------

Yes. We work with a firm and have from the beginning that -- both in the underwriting and the acquisitions, but also post on the tax appeals, really, every asset gets scrubbed every year, and we've had a lot of great successes. In all candor, with the rising values of medical office buildings, the local tax assessors are running hard and trying to increase assessment. Some of the -- some acquisitions post some of these portfolio deals have had significant increases in property tax rates and that's something we focus on hard every day and our tenants, it all passes through on our triple-net leases, but that's still the cost of occupancy to our tenants and we work hard to mitigate that.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

Next question comes from Michael Carroll with RBC Capital Markets.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [22]

--------------------------------------------------------------------------------

I was hoping you'd provide some more information on the Foundation's El Paso Hospital. It looks like they did not pay their June rent. Did you say if they paid their July and August rental payments?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [23]

--------------------------------------------------------------------------------

Yes. They've -- Mike, this is JT, again. They didn't pay April and May. They've been paying rent since June 1.

--------------------------------------------------------------------------------

Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [24]

--------------------------------------------------------------------------------

No. He's talking about...

--------------------------------------------------------------------------------

Jennifer A.D. Manna, Physicians Realty Trust - VP & Associate General Counsel [25]

--------------------------------------------------------------------------------

(inaudible) Foundation.

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [26]

--------------------------------------------------------------------------------

Oh, I'm sorry. Yes, Foundation is behind on rent. So...

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [27]

--------------------------------------------------------------------------------

Okay. And then is -- I guess, did you say El Paso is paying their rents currently and the plan would be for them to pay the entire back-rent once or if that sale completes?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [28]

--------------------------------------------------------------------------------

They've made partial payment for August, but that's part of the finalization of that contract is to get rent started paying -- get them to pay rent while they go and complete the due diligent process and closing the sale, at which point, they'll pay all the 2019 rent.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [29]

--------------------------------------------------------------------------------

Okay. And then can you give us an update on the San Antonio facilities? Because I know that they were a little bit behind their rent, too. It seems like they're in a little bit of a better position, and you didn't do the write-off for them. So what's the thought process around San Antonio?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [30]

--------------------------------------------------------------------------------

Yes. They've -- San Antonio has a buyer for -- that's currently -- or is currently being managed by a third-party and there's a buyer anticipating closing, and we believe that will occur next week on 50% ownership of that facility with the doctors that are there. As part of that, we negotiated a new lease with them. A new 10-year lease for both the hospital and the MOB, and we expect that to -- that buyer is a well-capitalized, well-known operator. So we think everything is stable there. And they got slightly behind during the course of 2019 with rent but have been steadily catching up pretty close. Yes. Less than 2 months, in fact.

--------------------------------------------------------------------------------

Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [31]

--------------------------------------------------------------------------------

Okay. And then can you talk a little bit about the other assets that are slated for disposition? I know that you, I guess, removed that category in your supplement this time around. I guess, how big is that portfolio again? And is that going likely occur over the next 12 months or so?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [32]

--------------------------------------------------------------------------------

Other than the hospitals we've talked about selling, Foundation El Paso and the LifeCare Hospitals, we're talking about a plus or minus $100 million of other assets. And frankly, we have -- they're good assets, we have a buyer that's coming through the process of evaluating those, really just trying to match fund and with the use of proceeds. So we'd expect some closings this -- still this year.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

Our next question comes from Nick Joseph with Citigroup.

--------------------------------------------------------------------------------

Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [34]

--------------------------------------------------------------------------------

Just on same-store revenues. It was up 3.8% in the quarter, but same-store occupancy was actually down 40 bps. So I'm wondering what's the contractual rent increase for the MOB portfolio overall? And then were there any other revenue or anything else that made the same-store revenue growth at 3.8% in the quarter?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [35]

--------------------------------------------------------------------------------

Yes. Nick, this is Mark. So we're really proud of our same-store results for the quarter. Again, this is -- 2 more things to keep in mind, as Jeff mentioned in his prepared remarks, this is our core MOB portfolio, and it does include the entire portfolio. So there's no held for sale bucket or repositioning bucket. As you know, our average annual rent bumps is about 2.3%. And during the quarter, we celebrated the anniversary of the CHI portfolio, so we had about 20% of our portfolio bumped with those leases. And in our same-store portfolio, a 1% increase represents about $600,000. So it's really not a huge dollar amount, but it makes a big difference in percentage. And so what's really driving the improvements in our same-store this quarter are 2 leases which had free rent last year and they're now paying full rent this year. So again, really proud of our same-store core portfolio. Overall, the whole doing really well. We look forward to continuing that next quarter.

--------------------------------------------------------------------------------

Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [36]

--------------------------------------------------------------------------------

When do the free rent comps burn off to where it will be more in line with the contractual rent increases?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [37]

--------------------------------------------------------------------------------

They already have burned off.

--------------------------------------------------------------------------------

Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [38]

--------------------------------------------------------------------------------

Okay. So the third quarter same-store numbers should be more in line with the occupancy plus the contractual rent increase change?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [39]

--------------------------------------------------------------------------------

That should be right.

--------------------------------------------------------------------------------

Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [40]

--------------------------------------------------------------------------------

And then just in terms of the watch list you guys put out in early June, I guess, with the 4 tenants. And I know we've discussed most of them on the call, but are there any other changes to the watch list, either additions or anything coming off now?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [41]

--------------------------------------------------------------------------------

After we complete the sales we talked about, I think we'll eliminate every one of the issues on that watch list this quarter or this year, based on the timing of the LifeCare situation. But each of those have been addressed pretty thoroughly this quarter.

--------------------------------------------------------------------------------

Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [42]

--------------------------------------------------------------------------------

Sure. And any new additions to the watch list?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [43]

--------------------------------------------------------------------------------

I knew that was going to be the next question. None that meet that definition.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [45]

--------------------------------------------------------------------------------

So your net debt-to-EBITDA at 6.5x is kind of above where you held it historically. Given the current dynamics in the market where your cost of debt is going lower, arguably probably at all-time lows, cost of equity is, I guess, a little volatile right now. How do you think about operating at a higher leverage level at least in near term?

--------------------------------------------------------------------------------

Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [46]

--------------------------------------------------------------------------------

John, it's Jeff. So you're right. When you look at the headline debt-to-EBITDA, it's much higher than we typically operate. But keep in mind that, that's really impacted by a lot of these accounting adjustments, which we won't have next quarter and actually some of them will end up reversing over the next few quarters. So if you normalize that out, you're kind of more at the 5.7x, which is about in line with the leverage that we've had the last few quarters. So we're probably right near our target leverage. I think we dropped a little bit, but probably not too much more from here. So whenever we look at these acquisitions and new investments, we look at it using an appropriate mix of debt and equity and make sure it pencils out under those parameters. And so we'll continue to do that. And then we'll, in terms of funding these, we'll -- when you say the cost of debt is coming down, so that's getting more attractive. And then we'll obviously look at our equity price and make determinations about whether to use equity capital as well.

--------------------------------------------------------------------------------

Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [47]

--------------------------------------------------------------------------------

But has that -- have your views changed at all? I mean, the net debt to EBITDA, obviously, does not take into account cost of debt. So are there other metrics that you look to? Or have you -- are you more open to increasing leverage levels?

--------------------------------------------------------------------------------

Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [48]

--------------------------------------------------------------------------------

Oh, I see, I see your question. Because of the lower cost of debt, would we run a higher debt to EBITDA? I mean, it depends. I mean, the cost of debt is moving pretty rapidly around here as the 10-year drops by $0.20 or so -- 20 bps of yield over the last, it seems like a couple of weeks. So I think right now, we'll kind of stick with our target of 5x to 7x. It looks like it's a sustained move down in cost of debt, maybe that comes up a little bit. But right now, I think it's too early to make a determination because it's so volatile.

--------------------------------------------------------------------------------

Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [49]

--------------------------------------------------------------------------------

Okay. And then can we get an update on CommonSpirit. I guess, during the quarter, they've got the credit ratings confirmed at BBB+, Baa1. Does that change your views as to more investments with the partner? Or do you want to eventually reduce concentration risk?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [50]

--------------------------------------------------------------------------------

This is JT. The CommonSpirit is -- they have continued that integration of those 2 large health systems. I think it's starting to move pretty rapidly. Now it's just the people, the teams and the others. We think they're a great client, a great tenant across the board. We really look at it market by market, just whether we'd be comfortable with expanding that. In some of their markets, I do expect we would expand, and we'll have the opportunity to do that because of our relationships there. In other markets, it's probably TBD. And then from time to time, we sell 1 or more of those assets or would sell some of those assets, again, market by market, depending on the situation. We're still waiting on the Louisville market to have some clarity on what's going to happen with the hospitals that they have there. We fully expect our MOBs will be fine, but we may have a new client relationship there to work with. So great organization. We think they'll -- the combined organization, the plan they have going forward -- will just -- will make them better and all of our assets better at the same time, but it is truly market-by-market for us.

--------------------------------------------------------------------------------

Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [51]

--------------------------------------------------------------------------------

If I could just ask one more, a follow-up on the condo unit acquisition. I guess this is not an ideal ownership structure. So are you basically comfortable that there's a high likelihood that you're going to be acquiring the entire building from the other owners?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [52]

--------------------------------------------------------------------------------

Yes, that's our plan. So it's -- it's like one brick at a time. It's a condominium structure so it's one unit at a time. But we're in discussions with substantially everybody, though. Great location, it's worth the effort, worth the time.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

Next question comes from Chad Vanacore with Stifel.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [54]

--------------------------------------------------------------------------------

So just 1 quick question going back to same-store NOI at 3.5%. That's pretty well above the 2.5%, 3% target range, especially given escalators around 2.5% the rest of the year. Where is that delta? Is that a matter of change in same-store pool? Or could you really have 100 basis points reduction in expenses?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [55]

--------------------------------------------------------------------------------

Chad, this is Mark. So the primary driver of that, as I've said before, is 2 leases that had free rent last year that are now paying full rent and operating expenses. So 1% movement in our same store is about $600,000 there.

--------------------------------------------------------------------------------

Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [56]

--------------------------------------------------------------------------------

All right. And then is it possible to talk about the bidder for the LTACH at this point?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Yes. I think, I mean, a little bit. It's a public process, Chad, so there's a ton of information in the bankruptcy court filing. If you want to go look, click it through it. But it's one of the original founders of LifeCare has reorganized a company and has capital and is coming back to buy a handful of the assets. A handful...

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

Our next question comes from Daniel Bernstein with Capital One.

--------------------------------------------------------------------------------

Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [59]

--------------------------------------------------------------------------------

I wanted to ask, are there going to be any incremental cost near-term for internalizing some of your management in Houston and other metro areas?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [60]

--------------------------------------------------------------------------------

Dan, it's Mark. So internal cost, not really, not many. So we are able to pass through many of the property administration and salaries in our leases that are triple net. And then areas where we're not able to pass through salaries, there's quite a bit of opportunity and margin in the fees that we charge relative to the cost of providing those services. So net-net, a profitable opportunity for us to bring in-house property management, but also just as important and maybe more importantly is the relationship that we're focused on with our hospital system partners. So getting a step closer to them and gaining that local market knowledge is really important to us.

--------------------------------------------------------------------------------

Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [61]

--------------------------------------------------------------------------------

Okay. What percentage of the portfolio is internally managed at this point?

--------------------------------------------------------------------------------

Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [62]

--------------------------------------------------------------------------------

About 55%.

--------------------------------------------------------------------------------

Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [63]

--------------------------------------------------------------------------------

Okay. So there's plenty of runway to bring things in-house and improve operating efficiencies, is the way to think about it?

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

That's right, Dan. But don't forget, about 1/3 of the portfolio is single-tenant, no management, so the 55% is -- there's still some market opportunities, but not a lot. So if we're on that, we have to go find it.

--------------------------------------------------------------------------------

Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [65]

--------------------------------------------------------------------------------

And you can stop me, if I'm wrong. Do you guys still own KentuckyOne assets? I saw in the headlines there were some issues there with the Jewish -- sale of the Jewish Hospital perhaps could close? And I know if it's still in your portfolio, a very small portion of your portfolio, but I don't know if you could add some commentary on what is happening with those assets in the Louisville area?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [66]

--------------------------------------------------------------------------------

Yes. So again those processes -- those headlines can go around for 2 years, and we continue to be in close dialogue with KentuckyOne or CommonSpirit, in particular. The -- we feel very good about the new buyer for those hospitals and/or the other hospitals in town have a strong interest in our medical office buildings there. So we don't expect any issues with our facilities. The buildings that are closest to Jewish Medical Center itself that we have are next to the 2 other leading hospitals in the community as well as the University of Louisville Medical Center. So there's a lot of demand, a lot of use for those facilities. And I'd say that's worst-case scenario and don't expect any occupancy issues.

--------------------------------------------------------------------------------

Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [67]

--------------------------------------------------------------------------------

Okay. One more quick question. I just wanted to go back over the $200 million to $400 million investment pipeline. If you can go back over again, what is kind of the mix of development versus acquisition? And are you seeing some more leanings towards construction, loan-to-own versus acquisition at this point given the cost of capital?

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [68]

--------------------------------------------------------------------------------

Yes. So again, we're -- about $44 million of that, what we've done to date this year is used for construction commitments. So I guess, maybe that's 1/3 of the total. I think that number, if the percentage will creep up, towards back end, we're, as I said, in kind of in final position with a couple of different health systems on the new development opportunities that we would participate, finding those. So those can be bigger. By the end of the year, if we don't partner with those, then the development number won't be quite as big. On the acquisition front, as I said, we've got about $75 million under contract in a couple of different locations. That's prediction I can make right now, is 2/3 will be acquisitions, things that close this year, and 1/3 will be development starts that we have either under construction or that we win by the end of the year.

--------------------------------------------------------------------------------

Operator [69]

--------------------------------------------------------------------------------

There are no further questions at this time. I would like to turn the floor over to John Thomas for closing comments.

--------------------------------------------------------------------------------

John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [70]

--------------------------------------------------------------------------------

Again, thank you for joining us this morning. As noted, we're very excited about the success of the second quarter and look forward to a bright future. Thank you.

--------------------------------------------------------------------------------

Operator [71]

--------------------------------------------------------------------------------

This concludes today's conference. Thank you for your participation.