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Edited Transcript of HR earnings conference call or presentation 5-Nov-19 3:00pm GMT

Q3 2019 Healthcare Realty Trust Inc Earnings Call

NASHVILLE Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Healthcare Realty Trust Inc earnings conference call or presentation Tuesday, November 5, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bethany A. Mancini

Healthcare Realty Trust Incorporated - Corporate Communications

* Carla Baca

Healthcare Realty Trust Incorporated - Associate VP of IR

* James Christopher Douglas

Healthcare Realty Trust Incorporated - Executive VP & CFO

* Robert E. Hull

Healthcare Realty Trust Incorporated - EVP of Investments

* Todd J. Meredith

Healthcare Realty Trust Incorporated - President, CEO & Director

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Conference Call Participants

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* 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

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - Director & Senior Analyst

* Omotayo Tejamude Okusanya

Jefferies LLC, Research Division - Former MD and Senior Equity Research Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Richard Charles Anderson

SMBC Nikko Securities Inc., Research Division - Research Analyst

* Todd Jakobsen Stender

Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, this is the conference operator. Please continue to hold. The conference will begin shortly. Good day and welcome to the Healthcare Realty Trust Third Quarter Financial Results Conference Call and Webcast. (Operator Instructions) Note that this call is being recorded.

I would now like to turn the conference over to Mr. Todd Meredith, CEO. Please go ahead.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [2]

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Thank you, Lexi. Joining me on the call today are Carla Baca, Bethany Mancini, Rob Hull and Kris Douglas. First I'd like to make a few comments about David Emery, our Founder, who passed away on September 30. Just last week, my colleagues and I enjoyed a wonderful celebration of David's life with his family and friends. David was truly a visionary, a force of nature, he inspired everyone around him, with his intellectual curiosity, his intuition and his infectious charm and perpetual optimism. David had a remarkable degree of confidence in his abilities, yet he was acutely wary of hubris. He was a wise mentor, always leading by example. David was a renaissance man pursuing many interests, personal and professional, with great success and style. And he shared his achievements generously with family, friends and colleagues. We will miss him dearly, above all, for his genuine and loyal friendship. David was a wonderful human being who loved helping others succeed.

When it comes to the Healthcare REIT sector, David, was a true pioneer. He had the vision to start the first MOB focused REIT in the early '90s. Today we have a great company built on a strong foundation thanks to David's vision and leadership. The Board appropriately bestowed upon David the title of Chairman Emeritus. His contribution to the sector and to healthcare realty will not be forgotten. Over the past few years, David did a masterful job transitioning leadership of healthcare realty and he was especially pleased with where the company is headed today.

Now for the quarterly results. Carla, if you go ahead with the disclaimer, please.

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Carla Baca, Healthcare Realty Trust Incorporated - Associate VP of IR [3]

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Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in our Form 10-K filed with the SEC for the year ended December 31, 2018, and in subsequently filed Form 10-Q. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material.

The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operation FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA and adjusted EBITDA. Reconciliation of these measures to the most comparable of GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30, 2019. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [4]

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Thank you, Carla. I'll begin by touching on 3 key topics for the quarter. First, the strength of Healthcare Realty's operations. Second, our increasing acquisition volume and our ability to source new investments. Third and most importantly, how we see organic and external growth translating to FFO on a per-share basis.

In the third quarter, Healthcare Realty generated steady performance on strong operating results across the portfolio. Our largest driver in place contractual rent increases edged higher. This was boosted by renewals in the quarter, which had bumps above 3%. Our ability to generate healthy cash leasing spreads continues to correlate with high tenant retention. A testament to the demand for our prime locations, where price is not the primary determinant of value. Expense growth is also well contained. Expanding margins and translating to same-store NOI growth above 3%. We see stability in the portfolio's internal growth in the years ahead. Given the fundamental strength of our property locations, their alignment with leading health systems and their critical role in current health care delivery trends.

We're also bolstering the strength of our internal growth profile with selective acquisitions. Year-to-date, we've acquired 14 MOBs for more than $300 million, elevating our 2019 acquisition volume well above our historical pace. What differentiates us, is the way we pursue investments. We'd like to avoid bidding wars and paying premiums for widely marketed offerings. So far this year, we've directly sourced 2/3 of our acquisitions through relationships with owners and brokers. And what is really impressive, we've seen this exceed 75%, where we've gained scale in key markets over time, such as Seattle.

Our knowledge of targeted markets and deep network of relationships, allows us to buy more of what we want, rather than bidding on what is for sale. With the success of our sourcing efforts, we expect to sustain a healthy pace of acquisitions going forward. We increased our acquisition guidance the second time for 2019 and we see a strong pipeline looking ahead to next year. We also improved our growth profile by selectively disposing of properties, while dispositions can be counterproductive initially, a disciplined amount of pruning is necessary to maintain a high-performance portfolio over the long run.

Fortunately, looking into 2020, the costly rotation of non-MOBs in smaller markets will be largely behind us. We have moderated our disposition guidance for 2019 and looking ahead, we expect a slower pace of dispositions at better cap rates. Much like acquisitions, our pace of development is also building momentum. This quarter, we began a redevelopment in Memphis, which includes the acquisition and redevelopment of an existing MOB. Baptist Memorial, a market-leading health system with whom we've enjoyed a long-standing working relationship, called us when they needed a reliable partner to develop a strategic outpost for surgery and outpatient services.

We expect a couple of developments and redevelopments to emerge from our embedded pipeline in the coming quarters. The company's accelerated investment pace, fewer dispositions and steady organic performance is generating FFO growth per share in the second half of 2019. We expect more improvement in FFO per share in 2020 and matched with disciplined capital spending, we see incremental progress on dividend coverage as well. Relative to other property types in the healthcare sector, outpatient real estate continues to offer a compelling combination of steady returns and low risk.

We remain steadfast in our commitment to owning and operating quality medical office buildings and using our experience and refined strategy to deliver steady growth in FFO per share and create long-term value for shareholders.

Now, I'll turn it over to Ms. Mancini for a closer look at healthcare trends. Bethany?

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Bethany A. Mancini, Healthcare Realty Trust Incorporated - Corporate Communications [5]

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Thank you. The 2020 presidential election and the race for the Democratic nomination continue to dominate headlines and once again have brought health insurance policy to the forefront of politics. The array of Democratic candidates covers a wide range of platform calling for various forms of increased government funding of health insurance, whether through current policies under the ACA, a public option buy-in or Medicare for all. While polling suggests voters are attracted to such ideas, support of Medicare for all dropped significantly when faced with the high costs and the need for greater taxation and elimination of private plans to find single payer public health insurance.

Political rhetoric of the day, however, does not signal a change in the direction of rising health care demand, clinical delivery trends or relatively stable reimbursement rate. In addition, the overall course of health policy legislation in Congress is not expected to change in the near term with a divided House and Senate. Current legislative efforts are centered on lowering the cost to consumers of pharmaceutical and surprise out-of-network billing. Along with finding hospital payments for uninsured patients. Even with some bipartisanship on these issues, strong lobbying by drug companies and hospitals and ongoing political debate will likely keep any new health policy at bay, until after the Presidential Election and a new Congress convenes in 2021.

We do expect a decision in the court soon, on the outcome of the Texas (inaudible) case and the standing of the lower-court ruling last December, which declared the ACA unconstitutional. It is likely the Fifth Circuit judges will issue a stay in the case, keeping the law in place until an eventual Supreme Court hearing, possibly not until 2020 or beyond. Several states are working on their own legislation to provide health subsidies and public insurance options, but are contending with the high cost of such plans. These efforts span multiple layers and branches of government and are evidence of the politically sensitive nature of healthcare. And the value the nation places on supporting access to quality medical care. The population is aging and demand for healthcare services continues to expand. Thus the difficulty in curbing the growth of healthcare spending is acute and the need for lower cost of care essential.

Our patient services are becoming increasingly critical to meeting the nation's demand for quality healthcare, at a lower cost. And the push towards delivering our patient care in its most efficient setting is being accelerated on multiple fronts, most recently by commercial insurers, as well as providers. As of November 1, United Healthcare is shifting more of its medical spending to outpatient facilities and will no longer cover certain planned outpatient surgeries delivered in hospitals unless pre-determined to be medically necessary in most bay. Instead, the insurer will require outpatient surgery to be done in medical office and ambulatory facility.

And health system, to increase leverage with insurers and capture market share, we'll continue to align with physician groups to offer services across the continuum of care, in the most efficient and profitable setting. We expect Healthcare Realty's medical office facilities and tenants and our relationships with health system, we'll continue to benefit from these primary drivers and deeply embedded macro trends that will ensure the growth in outpatient facilities for years to come.

Now I will turn it over to Rob Hull. Rob?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [6]

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Thank you, Bethany. Now I'm going to give you an update on investment activity and our outlook for the balance of the year. Acquisition volumes so far this year of $316 million is at the high-end of health care realty's historical levels. We have experienced notable success and our ability to source higher volume to one and 2 building transactions. We have been expanding and developing our investment team and related processes to execute on this growing number of opportunities. Combined with a competitive cost of capital, these efforts have secured 14 properties, through 12 separate transactions this year. During the third quarter, we acquired 4 buildings totaling 175,000 square feet for $79 million.

In Los Angeles, we purchased 2 MOBs for $61 million. The buildings are located next to Huntington Hospital, a 625 bed facility in Pasadena. These properties are well positioned for strong NOI growth. What really sets these buildings apart is a diverse roster of specialists, such as cardiology and women's health. We value the proximity to the hospital in this densely populated area. In Houston, we acquired an on-campus MOB located in the fast growing Sugar Land submarket for $14 million. This acquisition expands our portfolio in the fifth largest market in the country to over 620,000 square feet. It also adds a third, high-quality relationship in the market with Houston Methodists.

In Oklahoma City, we purchased an MOB adjacent to a leading health system campus and immediately next to a building we purchased last year, where we recently increased occupancy to nearly 100%. The new building is currently 76% occupied and produces a 6.3% cap rate. We expect the yield to increase in the high 6s by boosting occupancy to around 90%. Already in the fourth quarter, we are off to a strong acquisition pace. We bought 2 additional properties in October. In Raleigh, we made our first investment in the market, a 57,000 square foot MOB for $22 million. The building is in a rapidly growing area and is adjacent to market-leading WakeMed North Hospital.

Also in the fourth quarter, we purchased a property in Dallas adjacent to Baylor Scott & White's Plano hospital for $20 million. This building is anchored by a Baylor USPI surgery center. Leveraging our relationship with the hospital, we also executed a lease with the Baylor outpatient rehab joint venture. This lease was signed and we expect the build-out of the suite to begin soon. The property expands our presence on the campus, where we already own and 174,000 square foot MOB we developed in 2004. With year-to-date acquisitions totaling $316 million and a robust pipeline, we are moving up acquisition guidance for the year to $350 million to $400 million.

Moving to development. We placed one project in the pre-construction in this quarter and have 1 or 2 starts expected in the coming quarters. In Memphis, we commenced pre-construction activity for the redevelopment of a 111,000 square foot MOB. Baptist Memorial, looking to secure a leading orthopedic practice, as a joint venture partner and a surgery center, needed a developer that can move quickly. What is important here is that the hospital reached out to us, given our longstanding relationship and development experience. The redevelopment has a total budget of $28 million with an expected stabilized yield of 7.6%, including the $9 million acquisition of the existing MOB from the health system. We will have lease commitments representing 81% of the building, including the surgery center, orthopedic room and several hospital practices. Occupancy is now 37%, the balance of the remaining leases are expected to take possession early in the first quarter of 2021.

We also continue to make steady progress on additional future development projects in Washington, Colorado, Texas, and Tennessee, sourced from our embedded pipeline and existing health system relationships. Each development we are pursuing is expected to yield 6% to 7.5% at stabilization, representing significant FFO contribution and value creation.

Looking at dispositions, we have closed on $29 million in sales so far this year. We are reducing disposition guidance to $50 million to $75 million at cap rates from 6.5% to 8%. The reduction is due to a few MOB dispositions originally targeted for sale in 2019, shifting into our plans for next year. Going forward, we expect disposition volume will remain at this lower range, consisting primarily of MOBs, which will produce more favorable sales cap rates. Most recently, we sold 3 buildings for a total of $16 million, including an inpatient rehab facility for $14 million. I'm pleased with the pickup in net investment volume for the year and the bright outlook for 2020.

Now, I will turn it over to Kris to discuss financial and operational performance for the quarter.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [7]

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Thanks, Rob. The third quarter showcased the same positive themes as the first half of the year, including a healthy acquisition pace and sustained internal growth. This translated year-over-year to a 3.2% increase in FFO per share to $0.40. Sequentially, FFO increased $500,000 over the second quarter. This was primarily as a result of a $1 million increase in NOI from net investment activity.

The higher NOI was partially offset by $500,000 increase in costs, mainly related to interest expense. As is typical in the third quarter, seasonal utilities were up $1.4 million sequentially over the second quarter. However, this expense increase was completely offset by rental rate escalations and operating expense reimbursements. In the fourth quarter, we typically experienced a $600,000 to $800,000 increase, and sequential NOI due primarily to the reversal of the third quarter seasonal utilities. For the trailing 12 months, same-store NOI increased 3.3%, driven by 3.6% increase in NOI from the multi-tenant properties and a 1.8% increase from single-tenant.

The performance of our multi-tenant properties continues to be reliably strong. Revenue per average occupied square foot increased 3%, while expenses were up just 1.8%, largely due to a 3% decrease in utilities. This reduction came from a combination of the mild winter we discussed earlier this year, as well as energy management investments. Our ongoing ability to drive multi-tenant revenue growth is due in no small part to our persistent efforts to maximize in-placed contractual increases and cash leasing spreads.

In the third quarter, future contractual increases for the leases executed in the quarter were once again strong at 3.06%, while cash leasing spreads averaged 3.3% highlighting our pricing power, especially with the outsized volume of renewals and 90% tenant retention this quarter. Not to be overlooked, average in-place contractual rent increases have improved 13 basis points over the last 8 quarters, up to 2.93%. Achieving this in just 2 years is noteworthy and has compounding power when applied over our 12 million square foot same-store portfolio. It represents not only the value of our leasing teams concerted efforts, but also the benefits of owning quality, high demand properties.

Turning to the single-tenant portion of our same-store portfolio. The 1.8% growth in NOI was as expected, with nearly 30% of our rent escalators being non-annual, quarterly NOI growth will fluctuate around the in-placed average of 2.12%, depending on the timing of the non-annual increases. The next non-annual increase, which happens to be the largest at over 20% of single-tenant base rent, is scheduled to occur in October 2020. Until that time, single-tenant NOI growth will run below the in-placed average.

At the single-tenant property level, we sold an inpatient rehab facility in Erie, Pennsylvania, as Rob mentioned. This leaves us with one remaining [ERV] on a 400-bed tenant hospital campus in Los Angeles, where we also own 5 medical office buildings. We just completed a 5-year renewal for this inpatient rehab facility at a 7.6% cash rent increase with no TI. The FAD payout ratio was 91% for the third quarter and year-to-date, as capital expenditures and second generation TI have been running at the low-end of expectations. We expect maintenance CapEx will be higher in the fourth quarter and the full-year 2019 FAD payout ratio to be at or below 95%. This is a reduction of approximately 5 percentage points of our full year 2018 and we expect additional improvement in 2020.

Our balance sheet is healthy with debt-to-EBITDA of 5.2 times at quarter end. We raised $72 million of equity during the quarter through the ATM, which was used to fund the $79 million of acquisitions in the quarter. Since the end of the quarter, we've issued an additional $78 million of equity to fund a growing pipeline of accretive investments, including 2 properties acquired in late October for $42 million.

As we approach the end of the year, performance and momentum across the portfolio are strong, driven by internal growth, a solid balance sheet and a rich pipeline of pre-funded investments. We expect the FFO per share growth, we saw in the third quarter, to continue in the fourth quarter and 2020.

Operator, we're now ready to open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Chad Vanacore with Stifel.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [2]

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All right. So, you've stepped up acquisition guidance, then reduced dispositions. Has anything changed in the competitive landscape for acquisitions that you see either asking prices or competition from alternative buyers?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [3]

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No. Chad, I think what you're seeing from our team is, and it goes back to sourcing process that we discussed on the last call and of course today, you're seeing the benefits of us going into a market and identifying properties that we want to own. Then, our team forming relationships with those building owners, brokers and other groups in that marketplace, that are giving us the opportunity to buy these buildings that are not necessarily being marketed. And in many cases, you're not competing with a broad group of folks. And, it's allowing us to bring some nice assets into the portfolio.

I think in terms of pricing, we're continuing to see stable pricing and I think there have been some deals out there that have dipped below 5 here recently. I think those were deals that were more marketed deals. And I think, we're looking at is still in that range of around 5.5, so we expect to see that continue.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [4]

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All right. And then just on the flip side, your dispositions it will get pushed off into 2020. Is there anything going on there that is delaying your sale of those properties, or do you just feel more comfortable keeping them a little bit longer?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [5]

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No, it's really just timing-specific to those sales. I mean, there's nothing in particular that's causing us to hang on to them longer, but it is just taking longer to close the transaction. We do expect those to be part of our disposition plan for next year, $50 million to 75 million, and those are largely MOBs that are in that lower cap rate range of 5.5 to 6.5.

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Chad Christopher Vanacore, Stifel, Nicolaus & Company, Incorporated, Research Division - Senior Analyst [6]

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All right. And then just to bring this full circle. Can you describe any of the key differences between what you're buying today and what you're selling?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [7]

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I think that what we're buying today is in good growing markets, aligned with leading health systems in those markets, multi-tenanted on-campus billings or adjacent to campuses. In contrast to what we're selling, typically those are in smaller markets, perhaps the markets that aren't growing and we don't see the growth potential in those markets that we do in some of these other markets. So, it's largely really assets that don't fit the strategic long-term plan of the organization, versus those assets we're buying or have a higher propensity for growth and really fit our long-term goals.

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Operator [8]

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Your next question comes from Nick Joseph with Citi.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [9]

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I'm wondering if you can walk through the sales process for the assets sold in the third quarter. Obviously, the cap rate was probably a little higher than expected, is there any color there?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [10]

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Yes. That process was a purchase option, fair market value purchase option that was driven by an appraisal process and it was different than what you typically see when you have appraisal processes in those types of agreements. This one took the average of 3 appraisals one submitted by the buyer, one submitted by the seller and then a third averaging. Oftentimes you'll see the appraisal that's furthest away from the other 2 be thrown out and the other 2 be averaged. In this case, all 3 were averaged, that was the way it was written into the agreement. That incented the buyer to submitting a low valuation, in this case, evaluation of zero, which was on the verge of absurd. And there were also some utilities that serve the building, that were provided by a third-party that detracted from the value in the appraisal process as well.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [11]

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Thanks. How many other assets at similar fair market purchase options in the portfolio?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [12]

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We don't have any that are similar to that process.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [13]

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That was just a one-off?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [14]

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Yes.

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Operator [15]

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

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [16]

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First, I just wanted to offer sincere condolences on the passing of David to the team. And then, in terms of my question, what's causing the continued increase in the activity and the acquisition activity year-to-date to third consecutive bump up? I've noticed a little bit of a mix in the shift away from on-campus, I don't know from overly reading into the 100 basis points uptick in the asset ownership mix here year-to-date. Any insights should be appreciated.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [17]

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Jordan, thanks first for your comments and thanks for your nice comments in your note as well. We saw that, I appreciate it. I would say, for us it really goes to the volume question, it goes to the sourcing process and that's a multi-year effort as Rob said, we've been expanding our investment team with some young professionals, they've been getting their legs under them helping out our senior folks really attack these markets in a proactive way as Rob described. So I think, we're just seeing the fruits of that, number one. But to your question about distance from campus, I think there, you have a little bit of a unique situation where earlier, I guess last quarter, we bought a couple of properties that were just beyond our own definition of adjacent to campus. I think they were 0.27 and 0.3 miles from campus. So when you get into Seattle or a dense market like that, sometimes there are certainly some attractive properties that may be just outside that definition. So pretty subtle difference there, no big change in strategy. We certainly are open to assets that are away from campus, more materially away, but as you know, we have a history of being careful around that. So it's not that we won't invest occasionally in some off-campus assets that really align with health systems and we think are really have strong real estate characteristics, we just want to tilt towards campus on or adjacent. So no material change, but certainly a willingness to look at assets that make sense even if they're a little outside the range.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [18]

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So fair to sort of characterize it as a little bit of a greater opening in terms of catching a little bit of a wider net to certain properties or is that overstating it even?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [19]

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It's probably overstating a little. I will say in a market like Seattle, where we have such a strong presence and we know that market really well, we have a lot of folks locally on the ground, operating there, including one of our leaders of our leasing team, about half the country that she leads and has been with us for 20 years. And so we just have a lot of resources there that know that market well. It's clearly a dense market, so you might see it in situations like that. Los Angeles might be another market, where we've had scale and we see something like that, but it's probably not too much to read into that.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [20]

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Okay. And then on the same-store NOI trajectory, I know you guys look at it on a trailing 12, it's sort of a better indicator, but I'm trying to look at this quarter to see if there is anything to perceive in terms of what's going to happen going forward. I noticed sort of the year-over-year decel in multi-tenant, but also as you called out the single-tenant side, as we look forward, will this sort of lowered rate be more of a steady state or should it bumped back up and what would be the drivers?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [21]

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Yes, good question. Kind of 2 pieces to that. I'll break it into the single-tenant and the multi-tenant. On the single-tenant, as I mentioned in my prepared remarks, we have seen the timing of our non-annual escalators is running through. And so we have over 25%, almost 30% of our properties that not had an increase in the last 24 months. And so that is not because they don't have them. It's just because of the timing of them and so you -- we did see the lower growth as a result of that this quarter and that will continue until the next non-annual escalator occurs in October of 2020. So you should expect to see that in the single-tenant.

On the multi-tenant, as you mentioned, we do believe that trailing 12 months is a better signal as to the performance of the business and that was 3.3% this quarter. Quarterly results can have a lot of noise due to fluctuations in individual line items, which is actually what did occur this quarter. We had an unfavorable comparison to third quarter 2018 due to $600,000 of expense reimbursement true-ups in that period. So excluding that $600,000 revenue per average occupied square foot as well as total revenue would have been greater than 3%, which is more in line with our expectations. So moving forward on a trailing 12-month basis, we still expect in multi-tenant NOI growth to be in that plus or minus 3%. But as pointed out, there will be fluctuations quarter-to-quarter all the time.

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Jordan Sadler, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [22]

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Okay. And then I guess within that same sort of framework, just expenses -- anything you're seeing on the expense front as you look forward, Kris, that sort of would knock you off sort of this low 1.8% trajectory you've seen over the last 12 months.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [23]

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Yes, we have been benefiting from the expenses, as we've talked about this year that are running below our historical average, we say long term we expect it to be more in that 2%, 2.5% range. Right now, we're running about 108 and a lot of that has to do with utilities that are running negative 3%, which is great when you can get it. Part of that was due to the milder winter that we had in the first quarter, which really resulted on a quarter-over-quarter basis, basically flat overall expense growth.

So we're not going to kind of predict and project what the weather is going to be for the next year, but we are certainly benefiting from that. We are continuing to see pressure on property taxes. But I would say that that's -- there's nothing different there from what we see historically, especially as you're buying additional assets, you're developing assets that a lot of times there will be a catch-up in the assessed value. So, property taxes run well above the average, 4 plus percent, but with some cost controls and other places, we do feel like long term we can continue to control expenses more in that 2% to 2.5% range.

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Operator [24]

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

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [25]

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On the acquisitions that you acquired during the quarter, which were, I think primarily, it's adjacent. Can you comment on the pricing differential you're seeing right now between adjacent and on-campus acquisitions? And is it fair to assume that on these acquisitions, you acquired the fee simple interest with no purchase option?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [26]

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Yes, John. I think when it comes to your question about on versus adjacent, really not seeing much difference in pricing there, if any. I mean, that's our definition of adjacent is within a quarter model and so that's in most cases across the street from the hospital. So just not seeing a lot of price difference there. And then in terms of fee simple versus ground lease, I think it's in the mix --

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [27]

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I think, everyone in this quarter.

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [28]

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Everyone this quarter was fee, sorry. Everyone this quarter was fee. So we didn't have any that we bought on ground leases.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [29]

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Yes, the one that was in October in Dallas. That is a ground lease, but it was -- it's not with the hospital, it's just -- it's a dense area and the developer who put it together ended up ground leasing the land from someone who has owned it for some time.

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [30]

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It's just economic and there is no purchase options.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [31]

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Got it, okay. And then, Todd, you mentioned a strong pipeline of acquisitions for next year. Any way you can quantify that at all on how that related to the $350 million to $400 million that you plan for this year?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [32]

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Sure. It's clearly early to really call out what the range would be for 2020. But as Rob suggested and I did as well, we certainly see a strong momentum building going into 2020. And we'll clearly have more color on that as we get to the next quarterly report. But all that to say, we certainly see an ability to continue at this level that you're seeing now. It's subject to a number of things, as you can imagine. One of the things we just talked about was the sourcing efforts and that is clearly different than just bidding on what's for sale. We like that, it does give us a little more predictability. But it's also a lot more lead time and work to generate that pipeline. So because of the back work we've done on that, again, some of these deals we bought this past quarter and even into the fourth quarter, the result of years of digging in a market with a broker with building owners. So it takes a while, but we're encouraged by what we see and we think this level, whether it's that exact level of this year, but something on this order of magnitude is certainly something we see being able to move towards in 2020.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [33]

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And then I had a couple of questions on your Memphis redevelopments. It looks like the asset will be 37% occupied during the redevelopment phase. Can you provide some color on what work is being done on this project? And also --

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [34]

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Yes, so that -- sorry go ahead.

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

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I was going to say the 7.6% stabilized yield, what occupancy does that assume?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [36]

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Yes, so just I'll answer both of those questions. First on the 7.6%, that is a stabilized occupancy in the low '90s -- in the low 90% range. As far as what's being done, the building is currently -- it currently exists today. There is a surgery center inside of the building. We are redeveloping the building in the sense that most of the areas inside of the building will be touched, some existing tenants will be moving around, the surgery center will be expanded, there will be some additional parking added to it. The hospital has some existing uses there now, but they will be bringing some additional uses. So, it's really a comprehensive redevelopment of the asset even though the asset is in place today. The 37% occupancy represents tenants that are there today and will remain in place until such time as we're to move them inside of the building or the new lease takes effect after the redevelopment of the property.

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

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How big do you think the -- your redevelopment program can be? It seems like there's a lot of on-campus older vintage MOBs out there.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [38]

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Sure. I mean there's certainly opportunity out there, we're finding. I think that working with these health systems. We've done a number of redevelopments over the past 2 years. I think if you go to our embedded pipeline, we do think that there's some opportunity there and you expect to see one or 2 of those every year that we're working on. Those come from having relationships with the hospital, they oftentimes get into a situation when they need some money to move quickly, they've worked with you before, they know you that you can produce and oftentimes you're at the call like we did here. So, I think there's some good opportunity there.

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Operator [39]

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Your next question comes from Rich Anderson with SMBC.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [40]

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And I'd like to also second to the condolences to David. He made me a better analyst, better person. Very genuine approach to people, whoever he interfaced within. The height of his role as CEO, he always showed me respect, whether there was agreement or disagreement or maybe is blowing smoke up, but at least I felt that way. And I did got a chance to email and before he passed, I'm going to assume that he did read it. And my condolences to everybody on the call. One good thing is my vocabulary is improved, so I'll never say the word, just say regardless, orientated, and I'll have conversations, but I will not conversate. All right, so now rigidly move on to the business, we're talking about medical office, which kind of feels wrong, but got to do it, got to move on. So, are you seeing more in the way of PE investing in your space, capital flowing, your lot of the elephant hunting is now gone as everyone suggesting? Are there different types of capital flowing into the space that you see?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [41]

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It's not palpable in terms of the short-term. I do think, if you look back over a multi-year period, certainly that's true. And you're seeing more private equity developed funds, whether it's private, non-traded REITs under a new model. But, you've seen a number of very credible, large private equity groups develop an MOB program, they might partner with different smaller operators, developers, investors and you've been seeing that for a while. It's really not new, but you're right, I think the pace of that is very high. And some of them are doing quite a nice job of really tackling the one and 2 building approach. So, it's not without competition and certainly I would say, as we described our sourcing process, we're not trying to suggest there is no competition. There is always competition, even when you're talking with an owner about doing a deal outside of a market process. They're aware and they're savvy and they often will have, either they or brokers that can do market checks. So, there's plenty of that, but I think it's again, just developing deeper relationships and getting access to the deals that we see in the markets we want to be in. Really, I don't see the level of competition any more heightened than it's been in a long time. It's just different players and the public markets will tend to move around a bit more and have different cost of capital in shorter time periods, but we've seen continued rising pressure with private equity over some time. I wouldn't say it has risen in the last year or so, any more than what we've seen in the last 3 or 4 years.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [42]

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Okay. The underlying business, as described on this call, the medical office generally is good. I mean, it's getting and perhaps getting better. I don't know that there is much in the way of criticism of what you are doing, stock market increasingly fickle in its approach to any company is important to you as well though, in terms of capital raising. Do you have underperformed this year? Not a bad year in absolute terms, but still underperformed, as investors are kind of seeking alphas elsewhere perhaps. Do you feel some sort of need to change your stripes a little bit? And are you doing that? I guess on this call with the sort of lower dispositions, higher acquisitions, more development, redevelopment and so on. I'm wondering if the perception of the stock market is an important partner for you to finance your business, is influencing how you go about the world of medical office and if you were a private company, would you be going about things differently?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [43]

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Well, there's no doubt. The cost of capital is important and for us, that's the public equity markets, the bond market. Obviously, we have other sources too, bank debt, there's always joint venture capital and so forth and we've looked at all of those and we consider all those. I think for us, clearly if you were private, you would have a different set of circumstances, and you may or may not, depending on who your backers would be, have a little different objective, but I think for us, where we're at today, Rich, is really accumulation of all of the work we've been doing to really clean up the portfolio over the last several years, really try to focus on MOB. We have seen a lot of inpatient rehab sales over the last few years and really trying to streamline and get focused on the best MOB. So, not only the non-MOBs, but some of the weaker markets, weaker health systems, and trying to refine the portfolio.

So for us, the acceleration, I would call it now in the business model and the ability to not have as many dispositions and have a higher degree of acquisitions, I think really just accumulative effect and absolutely it's an important ingredient to have a great cost of capital. And if we don't have that, it obviously can impact the pace of our external growth, but we know underneath all of that the best thing we can do is have a really strong portfolio that generates those consistent results around that 3% level, that Kris walked through. So that's our main focus and then how do we add to that. And we try to take advantage of that at times where all the stars aligned and we can put capital to work very accretively. I think it's more just a cumulative effect, rather than a change in stripes.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [44]

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Okay. And then perhaps the market is taking note of your single-tenant growth that came in on the lower end of things for the reasons you described. Is there a view that portfolio as a percentage of the total should be meaningfully lower than it is? And if so, could it ever be a zero number?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [45]

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It's a 10% today of NOI plus on square feet. But it's about 10% of NOI. So, our view is that reached a natural level that makes sense. Could it be a little less than 10%, sure. Could it be a little more, that's fine too. I think we like where it is, plus or minus. And it really is a practical thing that if you look at the actual assets and our single-tenant portfolio, it's a really a strong single-tenant portfolio, a good bit of it being on campus as well and with really strong health system. So, we think it's a good balance and frankly the relationships we have with health systems can often lead to a situation like that, where we might invest in an on-campus single-tenant facility, maybe even off-campus single tenant, but I think 10% is probably about right, and not some objective of ours to get to zero.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [46]

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Okay, that's all I got. And, as I said to David in that email, it will always be the (inaudible) board. So, carry on.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [47]

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That's right. Well, thank you for your comments on that. And I can assure you his family was receiving a lot of emails and reading his emails to him in those final dates. So, I'm sure he saw it and appreciated that. Thanks, Rich.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [48]

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Great. Yes, thanks.

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Operator [49]

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Your next question comes from Daniel Bernstein with Capital One.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [50]

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I offer my condolences as well and just say that Rich missed [fungibility] as a word there.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [51]

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Dan, last week, we had a nice celebration here at the office as well, for colleagues and past alumni of Healthcare Realty and we put on one of our whiteboards all these various quotes that you have brought up and many more. So, we had a lot of fun with it and he was very memorable in that way, appreciate that.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [52]

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And we will miss him greatly. I wanted to ask you, when we toured your facilities about a month ago, we talked some about the pricing power that you're now seeing, your MOB's, the releasing spreads have been very strong. Long-term, we had some concerns for the MOB industry about potentially increasing pricing from or push back from hospital systems, as they merge, as they get larger. If you could talk a little bit more on the call about the pricing power you are seeing, about the experiences you're having with the hospital systems right now. And just sustainability of those cash releasing spreads that we're seeing in your portfolio.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [53]

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Dan, it's Kris. I'll start on that. We feel very positive about how we've been performing and outlook moving forward. One of the things that we do each quarter is break down the distribution of our cash leasing spreads. And you're just trying to think of the right analogy, maybe it's basketball, you're not going to hit a 100% of your free throws, but having 10 or plus percent that you end up with negatives. I think that's still pretty strong, so you're going to experience that in any particular period. But, the majority of what is occurring each quarter is still on that 3% to 4% and that's what we've been putting up for several years and what we continue to look at. And we think that that's reasonable and sustainable based off of our history, but then also if you look at it from the pricing power, really goes to what your replacement cost is. And in a lot of these locations, as we toured in DC, there's just not a lot of available land and so your competition would be somebody putting up some new construction. And then, new construction costs and especially with land costs and some of these dense areas, our experience is those are growing at call it 5% plus. So, we think that there is good sustainability to continue to be able to increase rents in that 3% to 4% range.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [54]

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That's really helpful. The other question involves occupancy, it has been pretty stable in the [Upper and East], particularly in the multi-tenant. You've given the comments earlier in the call about insurance carrier starting to require more outpatient use versus in hospital. What's the right stabilized occupancy for a multi-tenant portfolio? Can we see that rise over the next 3, 5, 10 years from upper '80s in the low '90s, or is there some other structural impediment there? Maybe you want to keep some vacancy opened for existing tenants to expand? Just trying to understand, if there is some upside in your occupancy, as well as the rates, maybe over a longer period of time?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [55]

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Sure, Dan. I would say, we have been in sort of the high '80s, if you will, especially on the multi-tenant MOB portfolio. And we would say, 90% is certainly achievable over time, but what we've seen over a long period of history is annual absorption being more in the 25, 30, 35 basis point range. And so, for us on a practical level, we don't expect that to suddenly happen one year. It's not as though the spaces in a block, in a convenient block somewhere where we can lease it all to one or 2 hospitals, even by market and just solve that, it's obviously a complex challenge to try to move these tenants around, if that's the case and consolidate some space.

So, that's an effort we're always going through and trying to accommodate folks, but it's an ongoing effort. I think the other side of that is, even just aside from the leasing side, it's just portfolio management and always, as I mentioned, being proactive about selling assets that might be chronically living at 60%, 70% occupancy. And we just don't see any near-term upside in occupancy or growing the rates. So, for us, it's a combination of those things, but achieving around 90% is probably the practical level on the multi-tenant side. And then, your mix with single-tenant is what creates the blend. I think when you really pulled back a lot of other people's data, they don't often provide the detail, but if you back into it, a lot of the multi-tenant MOB portfolios do live around that high '80s, 90% level. So, it seems to be a fairly industry-wide phenomenon and part of it also is short-term leases and some constant expansion, contraction, and moving around does lead to a natural level. It's a smaller average tenant size. So, there's just more of that frictional vacancy, if you will.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [56]

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Okay. And then one last question on the redevelopments. Is there any significant disruption that we should we expecting and are you going to leave those assets in the same-store portfolio, or pull them out? Just want to understand how coming quarters as you ramp that up. How we should think about that?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [57]

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I would say it's a case-by-case. The one that we talked about here in Memphis this quarter clearly is a new asset to us, we are under contract, haven't actually purchased it. So, that clearly is not going to be in same store for a while. But an asset that is already in same store, more often than not it will stay in there, but it just depends on the scope and magnitude of it, if occupancy is going to fall to below 50% or 60%, that may be a candidate for saying we're going to call that a redevelopment. The scope of the dollars would matter as well. So, it's a case-by-case. We've done it, where we've kept it in same store, if we think that makes sense. And we've also selectively taken it out and we'll be very clear about where that lives and describe that when and if we do that. But I don't think in the end, one or 2 as Rob mentioned, the year would have a material impact. We'll just be careful to describe that clearly to investors and analysts.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [58]

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Okay, sounds good and look forward to catching up with you guys in next week at REIT World.

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Operator [59]

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Your next question comes from Todd Stender with Wells Fargo.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [60]

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Yes, I just wanted to second and third everyone's comments regarding David. He was really a scholar, obviously and a gentlemen and will be missed. To David's family and you, all our best.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [61]

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Thank you, Todd.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [62]

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All right. Just shifting to the redevelopment, you highlighted the Memphis property for redevelopment. And I saw that in your supplemental. It looks to be a new acquisition, but I didn't see it on your new deal list. I just wanted to hear a little more detail on that one.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [63]

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Yes, that's correct. It's not on our new acquisition list yet and we really thought about that and said, well, we don't want to necessarily double-count those dollars. We haven't closed on the acquisition yet, we're under contract. And you'll see that obviously in the fourth quarter. So, we don't expect necessarily that that's part of the acquisition guidance. It's obviously not a huge purchase at $9 million. So again, that would be case-by-case, that one has more material dollars that we'll spend after the fact. So, we felt like that made more sense to be put into the redevelopment side rather than the acquisition side.

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [64]

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And the purchase price of $9 million is in the $28 million budget, so it's accounted for in that budget that we're showing.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [65]

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Got it, okay. And just with the equity activity lately tapping the ATM. It's been a good low cost for you. But in the broader theme of maybe raising the dividend or getting to that point. I know, Kris you kind of highlighted that the payout ratio is declining, but how are you thinking about that? Your balance sheet is in good shape, probably teeing up the opportunity maybe for debt going into next year. So, I know it's kind of a few inputs there, but I guess broadly speaking, how are you thinking about the dividend?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [66]

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Sure. As Kris described it, we obviously we're closer to a 100% in 2018. And it looks like we'll be at 95% or better as Kris described for this year. And we would certainly like to see that same level of progress more or less in going into 2020. I think for us the key is, it makes sense to be well into the '80s before we would really move the dividend. But the nice thing is, we're moving that direction and we can start having those conversations. I think it's a bit early to put a bright line on it. But we're moving in the right direction, whether that takes 2020 or into 2021, where we have a direct site on that. We are moving in the right direction. And it will just be a function obviously of how everything plays out for us, the volume of acquisitions, the internal growth, all those things. But, with a pretty strong outlook on those, I think we expect strong progress, as both Kris and I mentioned in 2020, and we'll certainly have more news to report on how we see that when we get to the end of 2020 and whether it makes sense for into the '80s and can begin to point that direction.

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [67]

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The only thing I'll add on the debt is we're certainly always looking at all of our options in terms of raising capital debt being one of those. We want to make sure we're maintaining a conservative balance sheet to be able to take advantage of opportunities right now, we're in the lower end of our debt to EBITDA range at 5.2, and we feel comfortable there. We would like to stay in that range, we do have the 7-year term loan that we completed earlier this year that has delayed-draw embedded in that, that we've been taking advantage of. So, we expect to draw down on that commitment in the first quarter, which will relieve the line of credit. We feel very good about our debt position at this point.

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Todd Jakobsen Stender, Wells Fargo Securities, LLC, Research Division - Director & Senior Analyst [68]

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How much more to draw on that, Kris?

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [69]

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There's $150 million.

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Operator [70]

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Your next question comes from Tayo Okusanya with Mizuho.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - Former MD and Senior Equity Research Analyst [71]

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I just wanted to add my own thoughts and condolences about David. When I was a young pup in this industry 15 years ago, he was just really good to me in regards to getting full understanding of the MOB space and I'm sure he will be missed and condolences to you, as well as to his family.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [72]

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Thank you, Tayo. We appreciate it.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - Former MD and Senior Equity Research Analyst [73]

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In regards to my questions, most of them have been asked, but I just had a quick one about the acquisition pursuit costs this quarter. Again, just curious, this was a little bit elevated with a lot of that, just again the same mode. Looking at a high volume of deals or was there actually like a big portfolio-type transaction you have been looking at, that didn't come your way, so to speak?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [74]

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No, I'd say, it's up a little bit from second quarter, but it's just the overall accumulation of all the transactions, as Rob mentioned. We've done 12 separate transactions this year. So, it's just a accumulation across of that, nothing out of ordinary to talk about.

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Operator [75]

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Thank you, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Meredith for any closing remarks.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [76]

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Thank you, everybody, for joining us on the call this morning and we appreciate everybody's kind remarks about David. He will be greatly missed. And we look forward to seeing everybody next week out in California at REIT World and we'll be around today, if anybody has any follow-up with us, with additional questions. Have a great day.

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Operator [77]

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