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Edited Transcript of DOC earnings conference call or presentation 6-Nov-19 4:00pm GMT

Q3 2019 Physicians Realty Trust Earnings Call

Milwaukee Jan 15, 2020 (Thomson StreetEvents) -- Edited Transcript of Physicians Realty Trust earnings conference call or presentation Wednesday, November 6, 2019 at 4:00:00pm 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

* Del Mar Deeni Taylor

Physicians Realty Trust - Executive VP & CIO

* Jeffrey Nelson Theiler

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

* John T. Thomas

Physicians Realty Trust - President, CEO & Trustee

* Mark D. Theine

Physicians Realty Trust - EVP of Asset 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

* 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, Research Division - Analyst

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - Director & Senior Analyst

* Omotayo Tejamude Okusanya

Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Tao Qiu

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Vikram Malhotra

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Greetings. Welcome to Physicians Realty Trust Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this conference is being recorded. I will now turn the conference over to your host, Bradley Page, Senior Vice President, General Counsel. Mr. Page, you may begin.

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

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Thank you, Oliver. Good morning and welcome to the Physicians Realty Trust Third 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, 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 third quarter of 2019 and year-to-date as well as our strategic focus for the remainder of 2019. Following John, Deeni Taylor will provide our thoughts about the market, our pipeline and investment in growth opportunities for 2020. Jeff Theiler will review our financial results for the third quarter of 2019 and our thoughts for the remainder of the year. Mark Theine will conclude with a summary of our operations for the third 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?

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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. Along with Brad Page, I'm here with Jeff Theiler, our Chief Financial Officer; Deeni Taylor, our Chief Investment Officer; and Mark Theine, our Executive Vice President for Asset Management.

We lost a true icon in our business recently. David Emery was a good friend, actually a landlord in my prior life and in many ways a mentor. I will miss him, and we just want our friends in Nashville and his family to know we are thinking of them.

We would like to begin this discussion by telling you how much we appreciate our clients, our team and our investors. This quarter proved once again the superior nature of medical office facilities, and DOC is positioned better than ever to source opportunities for investment through our vast network of clients and relationships, and we are ready to grow and grow smartly. Our clients include the largest health care organizations in the United States and many of the leading physicians and physician organizations in their specialty.

Our team includes the many professionals that recently voted Physicians Realty Trust The Best Place to Work in Milwaukee for the fourth year in a row. Our team also includes many professionals dedicated to our mission and values, along with our facility management partners and developers as well as bankers, capital markets professionals, real estate brokers, and yes, even lawyers who help us serve our clients every day to provide high-quality care and access to care in outpatient health care facilities, many of which are recognized as the newest and best facilities of their kind in the United States. We are only 6 years old, but on 4 facilities, they were awarded the National Development of the Year for the year they were built. Our team also includes those who went before us who helped build our company from scratch, especially our founder, John Sweet.

Our investors include many of the largest asset managers in the world as well as dedicated REIT investors and more and more generalists. Our investors include many of you who represent and advise our primary investors. We appreciate your participation in this call today to commit the time and effort to evaluate our performance, our financial reporting, our veracity and transparency on behalf of investors who have entrusted us with billions of dollars. We wouldn't be here without you. We wouldn't be successful for our investors without you. Thank you.

The third quarter of 2019 went as expected. Some might suggest we exceeded expectations, but not mine. We have high expectations of ourselves and we work hard every day for our clients, our team and our investors. We believe that hard work and the care we show to our clients is one of the primary reasons why when providers have a choice, they choose DOC to own, manage and grow their outpatient care medical office facilities. Our best in class operating platform performed remarkably well this quarter. Our best in class business development team delivered creative, accretive and long-term investments for us with existing and new investment grade providers who deliver high-quality care in their communities every day. Finally, our leadership enhanced and strengthened our already strong balance sheet. We are better positioned for growth today than ever before and we have every opportunity to accelerate our growth going forward.

We began this quarter, this past quarter with 1 operator reorganizing, 1 operator transitioning to a new operating platform, 1 operator partnering with a superior operator platform and 1 health system selling its assets to a university health system. All these efforts have been completed and DOC helped facilitate all of them in a proactive and active way to help make the providers better and better positioned to care for their patients, all while protecting and benefiting our investors.

Jeff will talk about the financial impact of these transitions in a few minutes, but the bottom line is our LifeCare LTACH facilities have a new operator who valued our facilities and our leases so much as we do, and assumed our leases as-is. United Surgical Partners, the owner of more than 300 surgery centers and surgical hospitals in the United States, with our assistance and encouragement, became majority owner of the Foundation San Antonio Surgical Hospital along with outstanding physicians in that community, and that tenant signed a new 10-year lease with DOC. We have sold the Foundation El Paso Surgical Hospital.

Lastly, at the request of CommonSpirit, our largest national client and the largest health system in the United States, we helped them facilitate the sale of their Louisville hospitals to the University of Louisville Health, preserving and enhancing those incredibly important providers in that community who are actively engaged in the medical education of our future providers as well as research and high-quality medical care. We welcome the University of Louisville Health who has assumed all of our Louisville KentuckyOne leases, and we look forward to growing our relationship with its outstanding university system and community.

As I've mentioned, we are well poised for growth. I've asked Deeni to provide an update on our pipeline and opportunity for growth. We continue to see and execute on high-quality off-market transactions. During this past quarter, Deeni and Josh Richmond completed one of the most complex transitions we've made -- transactions we've made, adding John Muir Health System in Walnut Creek, California to the DOC family. Deeni will share more about that transaction as well as our development and acquisition pipelines. Jeff Theiler will share our financial results and an update on our very strong balance sheet. And Mark Theine will then share our third quarter operating performance, including the results of our client satisfaction surveys.

The DOC team continues to outperform in customer service, leasing and capital maintenance of our facilities with a growing focus on sustainability and the environment. This quarter, we experienced an earthquake, floods, hurricanes and our facilities and response teams all performed well with minimal interruption to service. Deeni?

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Del Mar Deeni Taylor, Physicians Realty Trust - Executive VP & CIO [4]

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Thanks, John. As you noted, we've been working on a unique acquisition, and during third quarter, we completed the transaction, which represents our continued ability to develop positive hospital relationships and source off-market opportunities. Approximately a year ago, we began working with a seller of 5 medical office buildings totaling 93,000 square feet that are 100% leased. These MOBs are across the street from John Muir Hospital in Walnut Creek, California, part of the East Bay area of San Francisco. Most of the tenants are independent physician practices in these buildings. For this transaction, the seller wanted to partially receive DOC OP units along with cash at closing. We were able to purchase the MOBs for $34.6 million with about 50% funded with our OP units.

The first year unlevered yield on this good investment is 6.1%. Also due to the strategic location of these buildings across the street from the hospital, the hospital wanted to work with DOC on the future tenancy of the medical space. At closing, John Muir Hospital, which is a Moody's A1 credit health facility, executed a 10-year absolute net master lease for all 93,000 square feet with 2.5% annual increases. Ultimately, we were able to acquire 5 medical office buildings off market at a very attractive price and develop a long-term new relationship with a hospital in California, which adds another state to DOC's map.

For the remainder of 2019 and into 2020, our pipeline for acquisitions and new developments is strong. We are close to finalizing contracts for more than $50 million in new acquisitions in 2019, and are excited about the new relationships these transactions will have with investment grade health systems. All of these acquisitions are contingent upon typical closing conditions. As we look back on transactions we have closed in 2019 and those we are finalizing, the vast majority are off market. We believe the pipeline for 2020 will continue to be strong as DOC excels in our relationships with physicians, health systems and sellers of medical office assets.

I'll turn it now to Jeff.

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [5]

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Thank you, Deeni. In the third quarter of 2019, the company generated funds from operations of $51.2 million or $0.27 per share. Our normalized funds from operations were also $51.2 million and $0.27 per share. Our normalized funds available for distribution were $47.7 million or $0.25 per share.

DOC showed strong earnings growth this quarter and resolved the situations that were distracting from the strong performance of our core MOB business starting with the LifeCare bankruptcy resolution. Our conviction that the strong cash flows from our 3 LTACHs, which were generating around 3x EBITDAre in coverage, would insulate us from the negative impacts if the LifeCare corporate bankruptcy was proven correct. Our new operator assumed control of the assets on September 30 under the same lease we had in place with absolutely no modifications.

In addition, the operator is paying us all economic damages incurred during the bankruptcy process, including legal and late fees in monthly installments over the next year. We booked that $1.1 million of back rent and fees this quarter, which reverses out all previous charges taken. Our new tenant has an excellent long-term track record in this industry and clean balance sheet, so we expect strong performance going forward. Once there's some operating history, we will begin to report EBITDAre and coverages again in the supplement.

For our El Paso Surgical Hospital previously affiliated with Foundation Healthcare, we have closed on a sales agreement with the doctors in the facility for $32 million. As a requirement for this sale, we collected $2 million of back rent, which will be booked as revenue in the fourth quarter. The $32 million sale price consists of $4.4 million of cash from the buyer with DOC providing seller financing for the remainder under a loan not to exceed 24 months, yielding about 12% per year with fees and interest. This loan is secured by the property and guarantees from the operating entity.

Finally, the other material item on the credit watchlist was the San Antonio Surgical Hospital that was also previously run by Foundation. This outfit is now leased to a newly formed JV, comprised of the existing doctors and USPI at rental rates that are nearly identical to the old lease. The team put in a lot of work to get successful resolutions on these minor issues, and we are excited to focus again on the strong prospects that we see for the company going forward. Along those lines, based on successful resolutions of the Foundation of LifeCare assets, we no longer see any material dispositions happening in the near term nor do we have any material redevelopment plans for any assets going forward. Our expectation is therefore a return to growth, and we have seen the pipeline swell as Deeni just discussed. So the opportunity in front of us looks promising.

Year-to-date, we have completed $257 million of investments and development commitments. We remain on track to meet our guidance of $200 million to $400 million in 2019 and look to exceed that in 2020, assuming similar capital market conditions to the ones we are in today. Overall cap rates on these acquisitions will likely range from the mid-5% range to the low 6% range. We will continue to target relationship deals and the specialized off-campus medical office buildings that we think are fairly priced and most likely to retain value. We are not including any large portfolios in this forecasting estimate as those tend to attract bidders that will pay prices we think are unlikely to generate adequate returns for our shareholders. Should this competitive dynamic change, our acquisition numbers could be higher.

Our balance sheet remains in great shape as we are currently levered at 5.6x debt-to-EBITDA. We issued $52.1 million on the ATM in the last quarter at an average price of $17.41, deploying those proceeds into investments that are immediately accretive to our shareholders, while improving the overall quality of the portfolio. We are right in the middle of our target leverage range at this point and see a good opportunity to grow the portfolio with a nice balance of debt and equity.

Finally, a quick mention about G&A. We're a little higher this quarter at $8.1 million because of a slight increase in our bonus accrual, but we expect to stay in the target range of $31 million to $33 million for the year as predicated at the beginning -- at the outset of this year. We remain focused on keeping our management costs low. Last year, our G&A growth was abnormally elevated, and while we aren't ready to provide specific 2020 guidance, investors should be expecting a minimal increase at most for G&A next year as we focus on levering our cash flow to the benefit of our shareholders.

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 Management [6]

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Thanks, Jeff. The third quarter was one of the best operating quarters in the history of the company as demonstrated by a robust MOB same-store NOI growth, excellent leasing progress, improved tenant credit at several facilities and record-breaking tenant satisfaction survey results. Our better than expected third quarter results represent a further continuation of our focused execution of our relationship-based approach to real estate.

The MOB same-store growth momentum we established in the first half of the year continued into the third quarter with cash NOI growing 3.3% excluding termination fees, bringing our year-to-date MOB same-store NOI growth to 3.3% as well. This strong organic NOI growth was driven by a 2.7% increase in base rental revenue from contractual annual rent escalations and improved same-store occupancy to 95.6% from 95.3%. Operating expenses for the same-store portfolio increased 6.4% in the quarter primarily due to real estate taxes and were offset by a 9% increase in operating expense recoveries, demonstrating the insulated nature of our long-term triple net leases, which generate strong, predictable returns.

A major factor in our ability to drive revenue growth over time is our leasing team's acute focus on tenant retention, in-place contractual rent increases and cash releasing spreads. Currently, the weighted average annual increase for our portfolio is 2.3%, but so far this year, 86% of all lease renewals have contained an average rent increase of 2.5% or greater. For leases commencing this quarter, the average weighted annual increase was 2.7% and our cash releasing spreads were 1.2%. These positive drivers, along with strong tenant retention of 82% and positive 1,200 square feet of net absorption, signal sustainable growth in the years ahead.

During the remainder of 2019, just 1% of DOC's portfolio is scheduled to renew with an average rental rate of $23.46 per square foot. And our team has strong leasing momentum in Atlanta, Houston and Phoenix to fill current vacancies. We are also excited to welcome the University of Louisville to DOC's portfolio as our third largest tenant and look forward to the opportunity to grow with them in our Louisville medical office buildings where we have 35,000 square feet of space available for lease.

Although our portfolio is an industry-leading 96% leased, we see areas of opportunity for our exceptional asset management team and leasing teams to collaborate on tenant retention and new leasing to deliver bottom line results. Our asset management team's keen focus on operational excellence and outstanding customer service can also be seen this quarter in the results of our 2019 Kingsley Associates tenant satisfaction survey. This year, we surveyed nearly 450 tenants representing 3.5 million square feet. Physicians Realty Trust received an industry-leading 78% response rate. Typical response rates for these surveys are between 45% and 55%, so 78% demonstrate the exceptional relationship between our asset management team and our health care partners. We also earned a company record score in overall management satisfaction of 4.5 out of a possible 5.0 and 92% of tenant surveys gave positive indicators as to their future lease renewal intentions.

Thanks to a team effort focused on long-term value creation and growth, we had another solid quarter that validates the quality of our portfolio and our earnings. Looking ahead in 2020, we will continue to grow our integrated management and leasing platform and are well positioned to drive operational excellence, consistent same-store growth in our MOB portfolio and support near-term growth through new acquisitions. Our management structure is scalable and will continue to benefit from concentration as we invest in top quality properties and portfolios in the future.

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

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

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Thank you, Mark. We now look forward to your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Jordan Sadler, KeyBanc Capital Markets.

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

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I wanted to dig in on Shell Ridge, the cap rate, Deeni. You offered up the 6.1%. To what extent was that facilitated by the new lease with the health system there? Was there a meaningful uptick in rent versus in place on that renewal?

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Del Mar Deeni Taylor, Physicians Realty Trust - Executive VP & CIO [3]

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No. It's a reflection of what we paid for the assets directly.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [4]

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Jordan, that...

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [5]

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It seems like above market.

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

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No. It was -- the lease itself with the hospital was set at local market rates. But the...

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [7]

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No, the cap rate. The cap rates, John.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [8]

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No, I got it. It's a fantastic -- it's very accretive.

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Del Mar Deeni Taylor, Physicians Realty Trust - Executive VP & CIO [9]

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Right.

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

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And it's just a function of the relationship and structure ultimately you would point to as sort of the driver of that cap rate?

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

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Exactly.

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Del Mar Deeni Taylor, Physicians Realty Trust - Executive VP & CIO [12]

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Yes.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [13]

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Okay. And the escalators I think you said were 2?

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Del Mar Deeni Taylor, Physicians Realty Trust - Executive VP & CIO [14]

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No, they are 2.5.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [15]

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2.5. Okay. I got that wrong. All right. Great. The -- I had a question regarding the disposition outlook. I think, Jeff, you mentioned that you currently no longer expect to have much in terms of additional disposals. Did I get that right?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [16]

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Yes, that's right, Jordan. We're really pleased with the resolutions that we've had on many of the assets that we were expecting to sell. So as we sit here, we feel comfortable with the tenants and the credits. We don't think there's a near-term need to sell these assets.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [17]

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Okay. So that basically takes the LTACHs off the table in terms of being for sale, Foundation San Antonio off the table and the noncore MOBs that previously you sort of had teed up?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [18]

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Yes, that's right, Jordan. And we'd sell them at the right price to the right buyer, but they're -- we're not actively looking to sell them at this point. And again, we've got a very small percentage of our medical office buildings that kind of were not long-term keepers. So again, in time -- over time we might sell those. But right now, we're not actively looking to do so.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [19]

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Okay. And last one just on the sequential change in NOI looking into 4Q. Jeff, I heard the $1.1 million that was booked in 3Q I think, and then I heard the $2 million related to El Paso I think.

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

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Yes, that's exactly right, Jordan. Those are -- we'll get the $2 million next quarter and obviously we won't get the $1.1 million LTACH payment again in the fourth quarter. So…

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [21]

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And those are both GAAP numbers that were booked in the top line?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [22]

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Yes. It was booked and will be booked, right.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [23]

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Okay. And was there anything else related to LifeCare like in terms of a true-up or a reversal related to straight-line or anything like that? Or is everything else sort of recurring?

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

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Yes. So the only other thing that was different between 3Q and 2Q was we got $800,000 of rent, which represented 2 months of payments, but that will be flat going into the fourth quarter. So there's no other kind of onetime changes going into the fourth quarter.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [25]

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But that $800,000 was 2Q's rent that was a catch-up?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [26]

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Yes, exactly. Right.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [27]

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So you have to back that out? Is that what you're saying? Or either run rate is fine?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [28]

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The run rate is fine as long as you just back out the $1 million payment that we got as catch-up rent. Yes.

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Operator [29]

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Our next question is from John Kim, BMO Capital Markets.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [30]

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You did a fair amount of investment activity via loan structure. Can you comment on how big you want this to be as part of your acquisitions going forward?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [31]

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John, that's a great question. We view loans primarily as a strategic option in our toolbox that just matches with the situation. So kind of think about those like we do development, which is $100 million to $200 million a year of new opportunities, but we're not actively looking for loans as loans. We're looking for medical office facilities to invest in long term. So just a little uptick this quarter because of a unique situation that presented itself and ultimately hope to turn that into ownership. So…

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [32]

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Okay. Jeff mentioned in your prepared remarks no redevelopment plan, and I know that's not a huge part of your business. But is that because you're really focused on growing near-term FFO or do you not see a lot of redevelopment opportunities in your portfolio?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [33]

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No. I mean it's the latter. Remember, the portfolio is relatively new still, right? I mean we've acquired a lot of this over the last -- well, I guess all of it over the last 6 years or so. So we don't see any buildings that need material rehab or redevelopment. So I just mentioned that because some others do.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [34]

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So John, we're 96% leased, so to redevelop something we've got to move people out of a building and so that's really not in our DNA. But at the same time, we have good strategically located real estate that over time and eventually present redevelopment or enhancement opportunities, and we would expect to do that over time. But it's -- again, at 96% leased, we've got to find places to move people to redevelop them.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [35]

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Okay. And then my final question is on your lease expirations next year. It's a modest amount and the expiring base rate is about 5% below the rest of your portfolio. Can you give an estimate as to what the mark-to-market will be next year on re-leasing of those assets?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [36]

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Yes. Sure, John. This is Mark Theine. So as you mentioned, next year we've got 3.1% of the portfolio rolling, so very low turnover in our portfolio. It's about $21.44 per square foot, so as you mentioned, 5% below kind of this year. It certainly will be market dependent, but our leasing team has done a great job pushing rents where we can on our leasing spreads and getting higher contractual escalators. So far this year, as I mentioned, 86% of our leases have 2.5% escalators or more. So hopefully we can continue to push rents and we'll work hard to do that in 2020.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [37]

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Is 5% a good estimate for the mark-to-market?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [38]

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It's certainly market dependent, but rents will continue to kind of grow up 2% to 3% and in markets where we can, we'll try and push that more.

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Operator [39]

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Our next question is from Tayo Okusanya, Mizuho.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [40]

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I just wanted to follow up on Jordan's question again, the 4 kind of major pieces of transitions that were happening with LifeCare, the 2 Foundation leases, other 2 Foundation hospitals and also University of Louisville Health. Again trying to understand a little bit better what's in 3Q numbers and what's the potential pickup or fall off in 4Q associated with these transitions.

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [41]

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Okay. So I'll just kind of walk-through. In terms of cash on LifeCare, you had about a $2 million reversal, which represented getting an extra 2 months of rent payment plus the $1 million of back rent payment that we got.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [42]

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And that was all 3Q?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [43]

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What's that?

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [44]

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That was all 3Q, right? That was all in 3Q numbers?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [45]

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Yes, yes. Yes, sorry. That's all in 3Q. Exactly. And then for the Foundation El Paso assets, remember back in 2Q we took a $1 million -- we took a $2 million charge, but $1 million of that was related to Q1. So you get an extra pickup there. And then they also made a $500,000 rent payment in the quarter. So that was the difference between 3Q and 2Q. And then also remember there's a lot of El Paso assets, but the El Paso Specialty Hospital the tenant had, they started paying rent in 3Q too. So that was just under an extra $1 million there. So those are the adjustments from 3Q to 2Q, and then as you go into 4Q, I talked about it with Jordan, but you're going to get that extra $2 million of payment from the Foundation El Paso sale. And that will be recognized as rental revenue because it's a repayment of back rent.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [46]

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Yes. Okay. So that shows up in the 4Q numbers. Okay. The LifeCare -- although you're booking the $1.1 million of back rent as revenue in 3Q, since you're getting this back kind of as a monthly payment over the next 12 months, how do we kind of think about the 10% interest on that kind of receivable? Is that additional interest income to you guys for the next year as well?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [47]

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It is, but it's not a huge...

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [48]

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It's not a material number?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [49]

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Yes, yes.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [50]

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Okay. Got you. Okay, that's helpful from that perspective. Then the cash same-store NOI of 3.3%, again, that's excellent, brilliant number. When we start thinking about 2020 and the sustainability of that number, even if it's not -- even if 3.3% is kind of unusually high, I think again, how do we kind of think about a world where you're kind of putting up numbers on a sustainable basis similar to your peers of 2.5% to 3%?

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Mark D. Theine, Physicians Realty Trust - EVP of Asset Management [51]

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Tayo, it's Mark. Next year in 2020, we continue to anticipate the same kind of same-store NOI growth in that 2% to 3% there. Portfolio is doing really well, fully occupied. Most of our same stores is going to be driven by contractual rental increases. As I mentioned, those are 2.3% in the portfolio today. So where we can execute on some new leasing, hopefully we can bump that up a little bit, but we continue to see it to be pretty stable.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [52]

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Got you. Okay, that's helpful. Then last one if you would indulge me. Again, the loan investments, again, it's just interesting to me that again with the loan investments you're kind of getting kind of 6% type of rates on that. And then when you take a fee simple position it's cap rates of 6.1%. So again with the loans you're kind of high up in the capital stack, but you're kind of getting a similar type of return or yield. Does that kind of influence you thinking about doing more loans versus trying to own things outright in a fee simple structure or not really?

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

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Tayo, it's JT. Like I said before the loans -- it's a great question because we -- actually we get better yield than 6% on most of our loans. And it's always a strategic tool for us and just matching up to the situation and creativity. So the uptick this quarter was a unique situation where we have the opportunity to provide a loan to purchase of a building that had some lease-up opportunity. And then again, hopefully we don't have any rider option, but we expect once that building is completely leased to hopefully have the opportunity to convert that loan into a long-term ownership position. So again we do it in kind of the same bucket as we do development. So $100 million to $200 million of loans that are higher up in the capital stack, higher yielding and certainly have the opportunity to do more if the right situations present themselves, but it's not something we actively go looking for.

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Operator [54]

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Our next question is from Vikram Malhotra, Morgan Stanley.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [55]

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So just maybe bigger picture, you talked about no more need for disposition. So arguably you're now back in kind of a net acquisition net growth mode. So I'm just looking for some guideposts and a sense of kind of the strategy going forward. Last 3 years, you consciously made an effort to kind of move up the quality spectrum. So looking for sort of types of assets, markets maybe give the range of cap rates that you're focused on. And do you still intend -- is the goal to continue to improve or are you sort of happy with the portfolio here?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [56]

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Vikram, thanks for the question. I think the smart growth going forward is continuing focus on high-quality health system-anchored facilities. We've always liked off-campus and we continue to see those as probably the better value options while getting the same kind of credit quality and new construction for the long term that we're looking for. But again, whatever our relationships present themselves, whether they're on-campus or off-campus, but I think we're not going to -- we're going to continue the growth of the quality scale, but also just pure growth with the health system relationships. Now substantially all of our investments this year in our near-term pipeline are relationship off-market opportunities, so that usually presents a better cap rate and a better yield. And then those off-campus opportunities continue to bring better yields than on-campus. So that will be our focus going forward. On the dispositions, it will be more kind of strategic and again, from time to time, nothing is needed, but just as we have the opportunity to prove the portfolio and prune, we'll prune, but no real plans to do so.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [57]

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Okay. And is mid-5% to 6% sort of a good place -- a good number in terms of what cap rates you would be targeting in these leases?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [58]

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Yes, in this market (inaudible).

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Vikram Malhotra, Morgan Stanley, Research Division - VP [59]

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Okay, that's helpful. And then just second, some of your peers have partnerships with some of the health systems from a development perspective, some have been sort of focused on larger portfolios. So there are 2 questions. One, if you can talk about how you're thinking about partnerships with health systems that over time may lead to a more sort of steady external growth. And then second, if you can just give us a sense of any big portfolios out there in the market.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [60]

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Yes, so we view all of our health system clients as -- in relationships as partners. We have repeat business with virtually all of our top 20 tenant relationships. I think we're in 12 different markets with CommonSpirit, the largest health system in the country and continue to have opportunities for new development and acquisitions with them from time to time. So I think all of our health systems like to do repeat business with us. As Mark commented on our customer service satisfaction surveys, the return rate in and of itself is a reflection of Mark's team and how much attention to detail, how much attention we pay to those relationships and taking care of them. So those are retained and those partnerships come in all kinds of forms, so. The -- I'm sorry.

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Unidentified Company Representative, [61]

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Portfolio. Big portfolio.

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

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Oh, the -- oh, the big portfolios, exactly. So there's been several portfolios out there trading. It seems to me -- it seems or appears, at least best we can tell this, and there's one buyer in particular that's buying the portfolios and outbidding everybody for those portfolios, which is fine. We continue to have smart growth, one building at a time.

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Operator [63]

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Our next question is from Drew Babin, Robert W. Baird & Company.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [64]

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Question on the term loan investment at the Fort Worth MOB building. Can you talk at all about kind of anchor tenant expectations with that building, at least generally kind of how confident you are that that space will be at least substantially full relatively soon? And to the extent those tenants are rated, actually that'll be helpful as well. Hoping you can give a little color on that.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [65]

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Yes. Great question, Drew. It is substantially leased to 2 investment grade tenants today within 250 yards of a major health system that's an existing tenant relationship. So it's an outstanding building. Like I said, the unique set of circumstances where we provided a loan to the owner of that building and in the long term -- we have no rights to it, but in the long term we hope to have an ownership position in the building.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [66]

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Okay. Appreciate that color there. And just one more for me on the Foundation El Paso property sale. Obviously, that was pretty more financing the buyer is getting from you. And I guess what confidence do you have -- I mean obviously you have confidence, but is there anything you can talk -- speak to in terms of their ability to make you whole on that payment with interest over time? Can you comment on kind of their resources to do that and how comfortable you are there?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [67]

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Yes, it's a great question. Obviously, we'd like to have them find third-party financing, but they're part of the ownership of the -- in the majority ownership of both the opco and the propco. It's a private equity-backed new organization with a couple of other facilities I think in Texas exclusively, but looking to grow. So we have every expectation of them paying. We certainly have incentives aligned and incentivize them to find third-party financing sooner than later. So we have every expectation of that. In the meantime, we get a very large payment upfront plus the back rent. So we think the future is bright there. The physicians that we have a relationship with there are very excited about this new partner that they brought in and managed and the management is all going well.

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Operator [68]

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Our next question is from Chad Vanacore, Stifel.

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Tao Qiu, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [69]

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This is Tao Qiu up for Chad. So my first question is a follow-up on the El Paso sale. So you provided seller financing on the transaction. Is it your expectation that the buyer will pay off the loan in the next year or so?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [70]

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Yes, I would guess -- this is Jeff, sorry. Because of the interest rates and fees associated with it, we're certainly trying to incentivize the buyer to pay up the loan earlier rather than later. Generally, it's going to take about a year of history to get seller financing -- to get additional financing to pay off the seller financing. So sometime between 1 and 2 years is when we would expect that loan to be paid up.

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Tao Qiu, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [71]

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Got it. My second question is on the same-store pool. Is LifeCare El Paso in there this quarter? If so what is the impact?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [72]

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Yes, so the same-store number is our MOB portfolio, which is in that portfolio is about 91% of our square feet, 86% of our NOI. What we break out separately is the hospital in LTACHs. If we included those as the full portfolio, our same-store would have been 4.9% for the quarter. So outstanding results year-over-year there.

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Tao Qiu, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [73]

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Okay. Because you did 1.6% in the first quarter, 3.5% in the second quarter, 3.3% in the third quarter. So obviously you're trending towards the high end of the 2% to 3% range. Where do you think you end up for the full year? And I think I heard you mention that you maintained a 2% to 3% range for next year. And given the strong like contractual rent increase you just mentioned, do you kind of expect a flat to slightly improving occupancy for next year?

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

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I think the results have been higher for the year. The 3.3% is a direct result of the great team, our leasing team has done to fill some of the vacancies and they've got improved occupancy in the same-store portfolio, and then again, continue to push annual rent escalators. So full year year-to-date we're at 3.3%. Hopefully, we're going to be at the top end of that 3% for the full year. And next year, we'll continue to see stable growth in the 2% to 3% range.

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Operator [75]

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Our next question is from Nick Joseph, Citi.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [76]

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How large was the buyer pool for the Foundation El Paso asset? And did you have bids that didn't require seller financing?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [77]

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I'm sorry, you said how large was the buyer pool? Is that what you asked?

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [78]

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Yes, how many bids did you get on the Foundation El Paso asset? I'm wondering if any or how many of those bids did not require seller financing.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [79]

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Yes, so it was not actively marketed in a process. The physicians, until they brought in this new management company, a new equity into the partnership, the physicians owned 80%-plus of the facility and so we've been working with the physicians both to identify and frankly recruit in and bring in additional capital, but more importantly, management into the opco. We're working with them at the same time to facilitate a real estate transaction again to get all the incentives aligned economically between the opco and the propco and then ultimately for us to move it out.

So we're talking about the buyer pool. The buyer pool was the physicians in helping them identify a capital partner. Again, both to better operate, manage and grow the opco of the provider, but at the same time the opportunity to align incentives and buy the propco. So again if they -- if it wasn't the same buyer coming into both the opco and the propco bank financing probably have been easier to finance and identify on the sale to us, but at the same time the facilities stabilized and operating better than ever. We had other buyers for -- potential buyers to come in and buy both the opco and propco, but again, the physicians that were there have then worked hard to pay rent and were on and still are on financial guarantees to us, so we're just going to work through that situation. We think it's a great result, and like you said, as Jeff mentioned, they have every incentive to get bank financing as soon as they can. In the meantime, we got a very large cash payment upfront to kind of secure our position.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [80]

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That's helpful. And then you talked about the competitive acquisition environment. How different is the level of competition on the loans?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [81]

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Again, that -- it is a great question on the loans. But for us it's not something we're out there actively shopping for. It's just a matter of kind of off-market relationship nature of our business and strategy. From time to time, we come across opportunities where for various circumstances just a pure fee ownership or acquisition then match up the particular situation and we get creative and do a loan. So I can't answer the question about what the market size and breadth and opportunity is, which again, it's just one of those capital tools in our toolbox to make good creative investments. Again, ultimately our goal is to own the buildings we have loans on other than Foundation El Paso which was a sale. But those are -- if we can get a better return on an asset that we traded a low 5% cap rate and we can get a 6% or better return in a secure position, that's not a bad option.

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Operator [82]

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Our next question is from Michael Carroll, RBC Capital Markets.

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Michael Albert Carroll, RBC Capital Markets, Research Division - Analyst [83]

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And I jumped on late, so sorry if someone already asked this, but have you guys talked about the credit behind the loan on the El Paso sale? I mean do you have any credit enhancements like personal guarantees or anything like that?

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Jeffrey Nelson Theiler, Physicians Realty Trust - Executive VP, CFO & Head of IR [84]

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Yes, I mean Mike, the primary were secured by the property of course, right, which is the biggest security. Also guarantees of the operating entity. But really we're getting $7 million in back-date rent and equity upfront. We still have a lien on the property. So we feel pretty good about the security of that loan.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [85]

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Yes, and the physicians have guarantees behind the opco lease, again, which the new propco owner benefits from. But ultimately we have clarity through to that. And they've invested new capital into the opcos. It's a much -- a very stabilized situation. Again, we've got a lot of security (inaudible).

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Michael Albert Carroll, RBC Capital Markets, Research Division - Analyst [86]

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Okay. And then can you update us on what is the actual disposition plan going forward? And I know a few quarters ago, you were talking about how you wanted to have an ongoing capital recycling initiative kind of solving the bottom part of your portfolio year-to-year. I mean do you still plan on pursuing that?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [87]

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Great question, Mike. So given the near term, we don't have any need to sell anything. We always actively evaluate opportunities for pruning the portfolio. We just don't need to. So as we currently sit here, we don't have any plans to sell anything. Again, the all tax and kind of the lower 2%, 1% of the portfolio again, in time we will sell, but no near-term current plans to resell, but we still actively manage and prune the portfolio as opportunities present themselves.

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Michael Albert Carroll, RBC Capital Markets, Research Division - Analyst [88]

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Okay. And then just last for me, and can you talk a little bit about the new health system that's coming into the San Antonio asset? I guess who is the health system? And I guess did they -- I'm assuming that they -- you got a new lease with them, I think you kind of highlighted earlier, and the type of credit behind that lease now.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [89]

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Yes, it's United Surgical Partners, which is a wholly-owned subsidiary of Tenet Health care, which has other hospitals in that market. So great management, great capital base. They own 300-plus facilities around the United States through great management. They've been in there working with the physicians for over a year and helping to improve just the management operations of that, then ultimately had the opportunity to invest and own a majority interest in that facility. So we expect nothing but great things from them. So we signed a new 10-year lease with [Identity] with the United Surgical Partners as a majority owner, so we are very good.

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Operator [90]

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(Operator Instructions) Our next question is from Daniel Bernstein, Capital One.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [91]

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Most everything has been answered. I do have a question on KentuckyOne. I guess is there any CapEx needs in those assets that you might be able to fund?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [92]

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Yes, Dan, great question. So we -- when we bought the portfolio -- original portfolio from CHI, we spent or we kind of budgeted about $35 million -- $32 million in CapEx for all across the market. About a year later they decided they were kind of actively look for a new owner for the KentuckyOne assets in Louisville. So while we have maintained them, we haven't made major investments in there till we knew who the new owner was and then -- and stabilization. So we're very excited about the University of Louisville Health taking over and assuming 100% of those leases. And now we can actively manage the bank with a lease pipeline that has been sitting there just with physicians wanting to move in those buildings, but just waiting to see who the new operator is. And I think both they and the community and we are excited to have the University of Louisville Health in there. So as new opportunities present themselves, we'll invest CapEx in those buildings to maintain them, ultimately to potentially redevelop, but right now we have 93% occupancy and looking to lease up the last 7%.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [93]

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Okay. And I don't know if you discussed it earlier or not, but are there any redevelopment opportunities within the portfolio you're looking at?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [94]

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Yes. No. Yes, that question was asked. It's okay. The short answer is yes. The long answer is we're 96% occupied, so to redevelop any of our buildings we have to move people out of the building and so that's -- we have to do some -- do that strategically, and -- but more importantly, we would do that in a like relationship way with the health systems to improve buildings to meet their strategic needs. So the short answer is we really don't have any redevelopment opportunities or needs, but at the same time we'll actively manage those buildings with the health systems to kind of meet their outpatient and off-campus needs from time to time.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [95]

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I'll ask you a different way, are you seeing any more requests or discussion about that? In other words, nothing imminent, but maybe you're seeing a pickup in the discussion from hospital systems wanting to redevelop obsolete assets or reposition obsolete assets for more outpatient or something like that?

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [96]

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Yes, that's a great question. So I would say we haven't bought any obsolete assets, but at the same time, some of the older buildings are like these health systems. I would say we're bringing them as many ideas as they're coming to us with request, probably more. We have some specific situations. We have a couple of hospitals that are in opportunity zones, and so we've had opportunity zone investors talking to us about working together to try to redevelop or take advantage of vacant land near hospitals for various development opportunities. So it's a very active discussion. Great question. We just don't have any near-term specific building identified to redevelop.

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Operator [97]

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This concludes the question-answer session and I will now turn the floor back over to John Thomas for closing remarks.

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John T. Thomas, Physicians Realty Trust - President, CEO & Trustee [98]

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Yes, thank you again for joining us today. As I hope you can tell, we're excited about the quarter and the future, and great opportunities for growth going forward. We just look forward to seeing all of you at (inaudible) week and thanks for joining us today.

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Operator [99]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.