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Edited Transcript of HR earnings conference call or presentation 2-May-19 2:00pm GMT

Q1 2019 Healthcare Realty Trust Inc Earnings Call

NASHVILLE May 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Healthcare Realty Trust Inc earnings conference call or presentation Thursday, May 2, 2019 at 2:00:00pm 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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* Daniel Marc Bernstein

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

* Jordan Sadler

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

* Omotayo Tejamude Okusanya

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

* Richard Charles Anderson

SMBC Nikko Securities Inc., Research Division - Research Analyst

* Vikram Malhotra

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Good day, and welcome to the Healthcare Realty Trust First Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded.

I would like to turn the conference call over to Mr. Todd Meredith, CEO. Mr. Meredith, the floor is yours, sir.

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

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Thank you, Mike. Joining on the call today are Kris Douglas, Rob Hull, Carla Baca and Bethany Mancini. After Ms. Baca reads the disclaimer, I'll provide a few opening remarks. Then Ms. Mancini will cover healthcare trends, Mr. Hall will discuss investment activity, and Mr. Douglas will finish with a review of operational and financial results, before we move to Q&A.

Carla?

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

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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 a Form 10-K filed with the SEC for the year ended December 31, 2018, and in subsequently filed Form 10-Qs. 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 operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBIDTA, and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the first quarter ended March 31, 2019. The company's earning 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. Healthcare Realty's medical office portfolio continues to perform well, highlighted by the company's solid fundamentals and operational proficiency. Same-store NOI growth in the first quarter exceeded 4% and stands out relative to most peers whose MOBs average closer to 2%, some even lower. Healthcare Realty's leading performance has been consistent, not transitory.

Our same-store growth of 3% to 4% is derived from stable in-place rent bumps, high tenant retention, steady cash leasing spreads, and solid cost containment efforts. The reliability of these metrics reveals the underlying strength of our properties. With 25 years of experience, continuously improving our medical office portfolio, we've gained confidence in our ability to generate above-average growth throughout market cycles by remaining focused and disciplined around proven characteristics that correlate with steady growth and low risk. Properties that are located primarily on-hospital campuses align with market-leading health systems and concentrated in larger fast-growing markets.

We continue to be pleased that investors recognize the superior attributes of our MOBs relative to our healthcare peers and most REITs. Valuation levels, most notably, forward FFO multiples have long reflected these differences in performance and safety, and our spread has widened in recent years. Including a broad cross section of 130 REITs, our multiple has advanced towards the 80th percentile in the last 3 to 4 years compared to the mid-60th percentile in the prior 4 to 5 years. While popularity may drive others' valuation higher from time to time, it can be cyclical and short-lived. In contrast, our well-differentiated portfolio has yielded steady improvements in our relative valuation over many years. Looking ahead, our objective is to continue articulating the value of our approach to MOBs and demonstrating the exceptional characteristics that deliver reliable growth and safety that investors have come to know and expect from the medical office sector.

In addition to embedded internal growth, we continue to pursue investments that deliver strong results in the near term and across cycles, creating lasting value. While we remain disciplined, we will move decisively to expand our portfolio for the right properties. In March and April, we acquired several high-quality MOBs for $121 million and swiftly match-funded these properties with a 100% equity capital. And with low leverage, notably below most peers, we are well positioned to pursue additional investments. We are encouraged by our acquisition pipeline as well as increasing activity around development and redevelopment. We increased our acquisition guidance this quarter to reflect our positive outlook for the balance of the year.

Favorable demographic trends and accelerating demand for outpatient services should bolster our operational performance and investment prospects in the coming quarters and years. Around densely populated health centers, where we like to invest, medical office supply is inherently constrained and providers are chronically in need of more outpatient space. Technology, consumer preferences, and reimbursement trends continue to push more healthcare services into the lower-cost outpatient setting, both on and off-campus, especially with the leading edge of the baby boomers approaching their mid-70s, when healthcare utilization and acuity notably increase.

Healthcare Realty's best days are in front of us. Driven first and foremost by superior internal growth and complemented by an expanding set of opportunities to invest accretively in the highest quality medical office properties. Bethany?

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

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Positive earnings for hospital companies in the first quarter are confirming an improved outlook for the sector. In contrast, market sentiment among healthcare investors has been impacted by political rhetoric in Congress and the typical headlines leading up to an election. Democrats have renewed inertia for Senator Bernie Sanders' Medicare-for-all proposal. Under such a sweeping plan, Medicare would replace commercial insurance that currently covers more than 150 million Americans as well as a third of seniors on Medicare Advantage plans.

While investors are contemplating the threat of lower government pricing levels for health insurance and the impact on the healthcare sector. There is very low probability of passing wholesale Medicare expansion. Independent analyses have put the price tag of a single Medicare payer system at roughly $32 trillion over a decade. The government-funded program currently pays hospitals only 87% of their average cost, while commercial insurers pay 145%. Medicare would need to increase payment rates by at least 20% to keep hospitals in business and willing to provide care.

The formidable hospital lobby, representing the largest labor force and most congressional districts, has already formed a coalition to oppose such proposal. On the other side, Sanders' supporters in Congress are unlikely to unify in large numbers, given the significant increase Medicare-for-all would require in consumers taxes, the loss of jobs, and the staggering overall cost. The effects would be untenable, politically and economically. More incremental approaches to expanding government-funded health insurance may have a better chance of building support, including Medicare buy-in at age 55 or allowing a public insurance option on the ACA exchanges.

While we expect the debate to continue, market sentiments should get a dose of reality, as these proposals go beyond attractive sounding ideals and are vetted for their actual economic feasibility. Democratic primary candidates will also need to go on record for their support, which will severe many. In our view, the need-based demand for healthcare services will continue to help support reimbursement stability for hospitals and physicians, and the 18% of our nation's GDP that healthcare represents. For the year 2019, public health policy will likely center on more bipartisan issues that can garner the support of hospitals as well as a divided Congress.

Regarding the ACA, legal matters remain ongoing, appeal arguments for Texas versus Azar will be heard later this summer, with odds in favor of overturning the ruling that declared it unconstitutional last December. This would remove some overhang of uncertainty in the market for hospitals stocks, although hospitals' financial exposure is minimal, with less than 2% of the population currently enrolled in the 2019 ACA exchange.

Looking ahead, hospitals and physicians' pricing for their services will continue to rise and the percentage of healthcare costs reimbursed by the government will expand, as more baby boomers enter retirement age and Medicare roles grow. Over the next 5 years, Medicare payments are expected to increase 7% annually, up from 3% for the previous 5 years. Even though, the high costs of a single payer healthcare system make it an improbability, the issue of rising prices and costs from insurers and hospitals are taking center stage in the national debate. Providers and payers will continue to turn to outpatient delivery in lower cost settings, both on and off-campus, because it represents one of the most effective, proven, and politically feasible means in today's environment to lower spending growth and improve providers' profit margins. In future political environment, perhaps with more chance of expanding Medicare beyond the 65-plus population, outpatient settings will only become more critical to hospitals, as efficiency is increasingly paramount with low margin government funding.

Often a key benchmark of economic strength, job hiring in the healthcare sector outperformed in March and reinforced positive annual trends for hospitals and outpatient care. Ambulatory care settings including physician offices took its usual position as the top hirer, adding 253,000 jobs over the past 12 months. Strength in hospital hiring as well indicate service expansion on hospital campuses and the need for additional physician office space.

HR's conversations with health system partners regarding real estate investments and medical office development continue to be centered on their service expansion and market relevance, having little to do directly with reimbursement policy. Consolidation and market share remain the primary drivers to health system's pricing strength and revenue growth. Outpatient services play an increasingly vital role for health systems as they comprise almost half of hospitals' revenues, and offer a more efficient means of care for lower acuity services. Attractive to providers, payers, and patients alike, outpatient trends will continue to offer sustainable growth and lasting benefit for Healthcare Realty's medical office portfolio.

Rob?

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

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Investment activity this year has been robust with early sizable acquisition volume relative to prior years and solid progress on current and prospective developments. Our focus remains on properties with exceptional, long-term growth potential, aligned with leading health systems and markets where we already have a presence. Preferably, we invest in one and 2 buildings at a time, avoiding outsized portfolio premiums, and more effectively controlling for quality.

Our proven approach to investing affords us the ability to bring together buildings that produce superior performance compared to the average MOB. So far this year, we have purchased 4 MOBs for $121 million at a blended cap rate of 5.3%. Combined, the buildings totaled 350,000 square feet and are 89% leased.

In Washington DC, we purchased 2 multi-tenant MOBs totaling 158,000 square feet that are 75% leased. The buildings are located on AA+ rated Inova Health's Fair Oaks Hospital campus and offer direct connectivity to the hospital. At a $46 million purchase price, the investment will generate a 5.2% cap rate. Driving this acquisition was the opportunity to increase the performance and value of the buildings by applying our leasing and management expertise. During underwriting, our team developed a marketing plan to increase occupancy to over 90% within the next 24 months and achieve a projected stabilized yield of over 6%. Since closing on the properties, we've received interest from several prospective tenants as well as existing tenants who would like to expand their current space.

In Indianapolis, we acquired a 100% leased 143,000 square foot multi-tenant MOB. The purchase price was $47 million at a 5.1% cap rate. The property is on-campus and integrated with AA rated IU Health's market leading 589 Methodist Hospital. IU Health has announced a comprehensive $1 billion renovation and expansion plan to transition clinical services to this campus from its nearby medical school and research facility.

In early April, we purchased a 48,000 square foot multi-tenant MOB in Atlanta for $28 million at a cap rate of 5.7%. The property is 100% leased and located adjacent to AA minus rated Piedmont Healthcare's 508-bed Atlanta hospital in the thriving Buckhead submarket. This hospital is currently undergoing a $600 million expansion project that will add new inpatient beds to accommodate its growing cardiovascular service line.

Each of these properties is in a market where we already have a presence and on a campus undergoing or planning for a significant expansion, including the addition of inpatient beds. Our acquisition pipeline remains solid, consisting primarily of stabilized properties with a few having development and redevelopment potential. We are expanding the upper end of our acquisition guidance range to $250 million, with cap rates remaining on average 5.1% to 5.8%. With 4 MOBs under contract or letter of intent totaling $74 million and negotiations underway for a few additional MOBs, the outlook for making accretive investments in the coming quarters is bright.

Year-to-date, disposition activity included the sale of 4 properties in Tucson, Arizona, totaling 67,000 square feet for $13 million at a blended cap rate of 6.2%. 3 of the 4 buildings were off-campus, with the fourth on Tenet Health St. Mary's Hospital. For the year, we are maintaining our disposition guidance of $75 million to $125 million at a blended cap rate of 6% to 7.5%.

Moving to development, activity has accelerated around several projects associated with some of our longstanding hospital relationships: in Tennessee, a 100,000 square foot redevelopment that will house a market-leading orthopedic group and hospital affiliated ASC; in Washington State, a 20,000 square foot expansion of one of our properties; in Texas, a 100,000 square foot MOB on a campus where we own 2 other buildings; and in Colorado, a 60,000 square foot on-campus MOB adjacent to one of our existing properties. Each of these developments is being driven by expanding outpatient services centered on specialties such as orthopedics, oncology, and cardiology. Exact development start dates can be unpredictable, but with recent positive discussions, we are optimistic, one or more of these could start in the second half of this year.

With the properties we have already acquired, plus those under contract, or LOI, and an active acquisition and development pipeline, I am pleased with the progress we have made toward our 2019 investment objectives.

Kris?

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

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The first quarter was a positive start to the year, fueled by reliable same-store performance, disciplined expense management, and new investments poised to enhance future growth. Normalized FFO for the first quarter was $48.6 million or $0.39 per share. As expected, same-store performance was solid with same-store NOI increasing 4.1% over the first quarter of 2018. Trailing 12-month growth was 3.5%, driven by a 3.4% increase in same-store NOI for the single-tenant properties and 3.5% at the multi-tenant properties.

Contributing to the healthy increase in same-store multi-tenant NOI was the operating leverage generated by modest 1.6% increase in operating expenses, partially due to a mild winter and strong revenue growth of 2.7%. On a per-occupied square foot basis, revenue increased 2.9%, bolstered by our portfolio of sought-after medical office space, with a leasing strategy informed by years of experience. Evidence of first quarter success on this front includes, tenant retention of 86%, in-place contractual increases of 2.91%, and average cash leasing spreads of 3.3% for the 541,000 square feet of renewals. Notably, 91% of renewed leases had a spread of 3% or greater, a product of tenant demand that springs from the inherent quality of our portfolio and signals the viability of ongoing internal growth.

Looking forward, we continue to make progress on retenanting the Baylor Fitness Center in Dallas that I spoke about last quarter. Baylor would like to retain wellness services on the campus and recommended a third-party operator interested in the facility. As part of ongoing discussions, Baylor extended the lease 90 days through September 30 to avoid a gap in services before the new tenant would take over. The additional time will allow the new operator to revise its programing and space plans, which have expanded from approximately 50,000 square feet when we began talking to now just over 80,000.

Turning to single-tenant, I had mentioned in recent quarters, the trailing 12-month NOI growth continues to track higher than normal, due to the benefit of 2 leases with non-annual escalators that increased over 5% in late 2017. The benefit from these non-annual escalations will dissipate over the next 9 months. The outcome of the 2 2019 single-tenant net lease expirations are progressing consistent with the expectations we communicated in February.

For the inpatient rehab facility in Erie, Pennsylvania, UPMC exercised its purchase option. The price will be determined by fair market value appraisals from 3 independent appraisers who are in the process of being appointed. The outcome of the appraisal process will be known late this summer. For the inpatient rehab facility in Los Angeles, tenant exercised a 5-year renewal option. The renewal rent will be at the prevailing market rental rate which we are currently evaluating, but will in no event be less than the current rent. Tenant has also requested a proposal for a longer-term renewal.

The FAD payout ratio for the quarter improved to 87%, primarily due to lower maintenance capital expenditures, which totaled $9.3 million in the first quarter compared to $15.4 million last quarter. The lower spending was the result of continued discipline on capital project priorities as well as normal quarter-to-quarter fluctuations in expenditures. For full year 2019, we expect the FAD payout ratio to be above the 87% for the quarter, but below our 2018 ratio.

To fund the $121 million of year-to-date acquisitions that Rob described, we issued 3.7 million shares of common stock in March for net proceeds of $115.8 million and raised $4.3 million through the ATM. We were able to deploy all the proceeds from the March equity issuance into accretive acquisitions within 2 weeks, so there was minimal timing dilution. In addition, fully funding the acquisitions with equity, brought our debt-to-EBITDA down to the low end of our guidance range of 5.0x, providing flexibility in how we fund acquisitions through the balance of the year.

The first quarter was a productive start to 2019. As the year unfolds, we look forward to harnessing this momentum in capitalizing on our sturdy balance sheet, low leverage, and ample liquidity to continue investing in properties that meet our criteria and augment the strong internal growth that defines our portfolio.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [8]

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Thank you, Kris. That concludes our prepared remarks. We are now ready to begin the question-and-answer period.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question we have will come from Jordan Sadler of KeyBanc.

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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 start off on the development side. It sounds like you've got quite a bit brewing, I know you offer up some development funding guidance for the year, but I was kind of curious, just to get the full scope or the picture, what is the potential development start volume for 2019?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [3]

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Jordan, I'd say that the developments that I described, targeting the second half of this year to start those. I described before, if you look at our typical guidance on starts, we're targeting that $50 million to $100 million a year. I think, if we started couple of those projects that I described, that will get you into that range. So looking at the back half of this year to start those, you are looking $50 million to $60 million.

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

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And then, did you say what the returns would look like?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [5]

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I didn't, but I think our -- what we state in the supplemental will give some guidance around that. These developments will generally be in that 6% to 7.5% stabilized yield, so consistent with what we've...

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

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Okay. And then I know -- while I have you, Rob, what -- the underwriting there, I know it's a 5.2% cap, I think first year NOI as well. Is that based on 75% occupancy or is that on getting somewhere closer to the 90%?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [7]

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That's based on 75% occupancy.

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

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So it's got an -- it's an in-place 5.2% essentially?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [9]

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Yes.

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

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Okay. And any catalysts you can sort of point to as they're driving the new proposals that you're seeing from some of the existing and their other tenants?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [11]

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I think, if you look at that campus, there were some product that came on a few years ago, and it's our thought that the previous investor didn't pursue tenants with as aggressively maybe they could have. There were some additional products that came on that needed to be absorbed and most of that product has been absorbed, and we think that with some good leasing activity and good leasing momentum, we can go out and attract new tenants with some additional capital and also accommodate tenants who want to expand in the building. We've had some recent discussions with a few tenants about expansion possibilities. We've also had some dialog with some new prospects.

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

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Okay. My last one would just be on the property operating agreements that expired in the quarter, the last one, what was the change, Kris, from 4Q to 1Q that happened as a result of the expiration in February?

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [13]

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4Q to 1Q, you can see that in the supplemental in terms of the reconciliation. I'm turning to it now. I can't remember the exact number off the top of my head. So it was 187,000 in the fourth quarter and 128,000 and in the first quarter of '19.

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

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And we had 2 months of it in the first quarter, so it makes sense.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [15]

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We had 2 months in the first quarter that will go away beginning in the second quarter.

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Operator [16]

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And next, we have Vikram Malhotra of Morgan Stanley.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [17]

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So just wanted to ask one on the recent acquisition and the one that's 100% leased. I think it was a sort of a 5.1% cap. Can you sort of talk about any prospects in terms of any role, maybe what the rent bumps were and just sort of where you see sort of that on a longer-term basis, sort of that cap rate shaking out?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [18]

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Yes, I think the weighted average lease term in that building is I believe around 5 years. So we see some good role here in the next few years. That escalators in that building on average are in the 2.5% range, maybe slightly higher. We see an opportunity to increase those as the leases come up for renewal over the next few years.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [19]

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And what would sort of mark to market be on those renewals?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [20]

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I would say that in terms of increase in the rents, I mean, we're typically looking at the properties that we're acquiring, cash leasing spreads in that 3% to 4% range and I think this property will be able to produce those types of increases.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [21]

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There is a portion of the building that may have some additional upside from there. The prior owner had done some improvements in the rents that were a little lower historically, but we see there's that room for that 3% to 5% and maybe even for a small portion of the building a little more, but I think over time, it's 3% to 5%. 3% to 4%, 3% to 5%.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [22]

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Okay, makes sense. And then just on expirations, you have a decent chunk over, call it, the next 2 or 3 years. One of your peers sort of mentioned tenants approaching them and doing sort of early renewals and being able to get better spreads and rent bumps. I know you've had this program or over time, you've been trying to get better bumps on new leases. So can you talk about any big chunks in the expirations over the next sort of 2 years and any sort of forward leasing that you're probably -- you may be engaging in?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [23]

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I would say, for us, it's been pretty consistent over the last several years, so we're not seeing a big change. We're always having discussions with tenants before their leases are coming up, some early before the expiration. So we're not seeing a big change. Also in terms of the overall amount of expirations, it's pretty consistent with what we historically have. We say that we expect 15% to 20% of our leases to roll every year, which is what we have seen and what we expect over the next several years as well.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [24]

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I think, Vikram, too, you also see that -- more of that trend more when you have larger tenants or more single-tenant. And I think we would say that's probably where we would see that over time, rather than in the normal course multi-tenant portfolio where the average tenant is smaller. I think, one I can think of on one of our peers was a pretty sizable deal, sizable building, maybe not single tenant, but large tenant size and I would say that's been our pattern in history as well.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [25]

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And just to clarify, any of the top tenants are up for renewal over the near term?

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [26]

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It's consistent throughout our portfolio. As Todd talked about our multi-tenant average lease size, it's about 4,100 square feet and that's equally spread out across all of our hospital relationships or associated hospitals. So we're not seeing anything in the next several years that's outside the norm.

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [27]

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The only one that we've been talking about for a while, as you know, and Kris talked about it, was this fitness center with Baylor in Dallas. So that -- again, that's again a very sizable lease and those are the ones that probably fit into the category you're looking at, rather than the normal course as Kris described.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [28]

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Okay, great. And then just last one, maybe more on cap rates. They've also been -- there have been several portfolio deals. So I'm just curious to sort of get your comments on where -- portfolios versus individual assets with similar quality, but also your reference to more systems looking at more outpatient. So just sort of what you're seeing between off and on-campus?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [29]

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Yes, I mean, I think in terms of the cap rates, we are continuing to pursue the one and 2 building opportunities of the highest and we see cap rates remaining fairly steady in the low to mid-5% for those assets. I think where you might have seen some slight uptick in cap rates has been for the lower quality assets, maybe there's been a bit of an increase in the spread between the on and the off-campus product. That spread is probably in that 50 basis point range, 50 basis points to 75 basis points depending on where you are and what markets you're in. In terms of portfolios, we haven't seen a lot of new portfolios out there. I think, consistent with what you saw last year the spreads between individual assets and portfolios remains pretty constant.

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Operator [30]

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And next we have Rich Anderson, SMBC Nikko.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [31]

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So just another question on cap rates and I'm -- recognize I've been sort of spouting a little bit about this lately, but I think it was -- was that Rob that mentioned, the spread between high and low being around 50 basis points. Perhaps a year ago that spread was negligible. Would you agree with that? And would you say that the market is now differentiating more? Is that the message you're sending with that comment?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [32]

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Yes, I think that's correct, Rich. I mean, you've seen over the past year, year and a half, you've seen a slight increase in the spread between the higher quality properties and lower quality properties.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [33]

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Rich, I would say that the data shows that. You look at Revista, other sources, you will see that our view of course is that we think it should be much wider. So we like the trend of where that's going. We think it's becoming more appropriately priced. But in our view, as we've articulated for a long time, we think the simple difference without getting into more complicated math, is just you have growth rates that tend to be 3% plus even in the on-campus setting, given the nature of that strong demand that you have there versus off-campus where you have more long-term tenants, larger tenants, more single-tenant. They have more options. In our view, that's closer to 2. And just that fact alone suggests you ought to be looking at 75 basis point to 125 basis point difference on cap rate and that's without getting into discussions about the risk at the end of the lease and renewal retention rates, renewal rates, so forth. So our view is, we're headed in the right direction on that in terms of trend, but -- and I think, too, you have to be careful about treating everything too homogeneously. That's a broad statement and obviously, as you know, we all have to dig in and then figure out each asset, whether it's priced appropriately to reflect all those items.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [34]

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Yes. So that was kind of my next question. When you think about larger portfolios, and there is the grey area of within that large portfolio, there are high and low-quality assets. And so would you say that if this 50 basis point, 75 basis point spread sort of thesis is appropriate for single assets? Is it some number lower than that when you look at the portfolio transaction, because there is a mix between high and low quality or does the portfolio premium wipe out any kind of spread that you might see between high and low from making any sense at all?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [35]

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Well, there's a lot of inference you have to get to, to -- I see where you're going, but it's obviously difficult to unpack without looking at a specific situation. I think you're generally right, it probably gets murky and muddy a little when you compare that, and we really have an apples-to-apples situation if ever for somebody else's transaction. Based on our experience, we try to keep our pricing on a relative scale appropriate within a portfolio when we're looking at portfolios. And then, I think on top of that, you then have to add the portfolio premium hopefully if you've done your underwriting writing or pricing, you can apply that premium if you're having to pay one, which again it may be warranted to pay some level of premium for a large group of assets, which are difficult to come by. But I have a feeling that it often gets lost in the flurry of a deal and that's the concern we always have with the large portfolios that you end up mispricing the real risks that are out there, especially when you hit the lower quality and off-campus.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [36]

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Yes. And I guess the point is like some REITs are saying, cap rates are going up, some are saying,,, they are stable like you guys and some are sort of avoiding the question, I guess. But just I guess we'll figure it out as we go. The other question I have is, is there an optimal exposure to single-tenant, triple net for you guys, single-tenant, I should say, assets that you would like -- want to hold on long-term? You talk a lot about multi-tenant when you discuss your portfolio. Does it make sense to ever be like almost 100% multi-tenant?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [37]

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I don't think it's practical to get to 100%. I think the progress you've seen us make over the years clearly comes from our view that we see better outcomes long term, more safety, even better growth with the multi-tenant side. Obviously, it's a different animal in terms of the way the business runs and there's obviously more CapEx associated with it, but as we've articulated with a lot of people, we still think the relative return including that CapEx is well worthwhile compared to the alternative in the single-tenant side, but as a practical matter, our customer base, our health systems, the physicians, often organize in ways that dictate those needs and demand single-tenant or off-campus assets and we're okay with that. Our big issue with all that is to make sure we price risk accordingly and sometimes the market and other provider -- or other competitors of ours will price it differently. And that's just our view and I think that's where our discipline comes in and we say, we're willing to pass on something if we don't think it's priced appropriately.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [38]

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The only thing I would add to that is that our mix I would say is being driven more by the value we see on the on-campus versus the off-campus and it's oversimplification, but we typically see more single-tenant when you -- in larger tenants when you go off-campus. And so that's been probably what you are seeing driving our shift. We do have some on-campus single-tenant that we really like the quality of the location, the quality of the tenancy there. So we do not have a goal or desire to get to 100% multi-tenant versus single-tenant.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [39]

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Okay, fair enough.

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [40]

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We're about 90% now, Rich, and I would say, in a bandwidth of 15% or less single-tenant, it's very comfortable for us.

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Operator [41]

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Next we have Tayo Okusanya of Jefferies.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [42]

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Most of my questions have been answered. But I just wanted a clarification on the same-store OpEx growth this quarter. You said it was particularly favorable simply because of weather and does that mean we should expect it to kind of bounce back up the rest of the year?

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [43]

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Yes, we had a lot of help from a milder winter, but I would also say that there's some -- lot of work that's gone into that as well on the utility side in terms of managing our cost and usage. So hopefully we'll get some continued benefit there. I had mentioned last quarter that property taxes have been going up across the board, across the country. So we're obviously fighting that as well. We typically say kind of that 2% to 2.5% range is where we expect operating expenses. So it's great to be able to be at the low end of that and a little bit below it for this quarter. But somewhere in that 2% range is something that we think is certainly achievable moving forward.

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Operator [44]

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The next question we have will come from Daniel Bernstein of Capital One.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [45]

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I noticed that your weighted average lease term on renewals and new leases was down this quarter versus 1Q last year and actually almost all of last year. How much that was a factor in the lower CapEx in this quarter versus previous quarter, especially as a percent of NOI and maybe what trends are you seeing in the WALT?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [46]

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Yes, I would say, I wouldn't read too much into that. As we've talked about before, the actual spend as you think about maintenance CapEx in the second-generation TI will spread across multiple quarters. It can -- the spin can actually be 2 or 3 quarters before lease commences to 3 or 4 quarters beyond when someone has moved in. So I wouldn't put too much stock in trying to correlate those 2 items. We have seen our overall weighted average lease term has been -- it's down compared to 7, 8 years ago as we've kind of shifted more towards multi-tenant versus single-tenant, but over the last 3 to 4 years, say, it's generally been consistent. The other thing I would point out is, you also have to look, when you're looking at the total kind of the mix of your renewals and new leases, we do typically expect our renewals to have a shorter term than the new. And in the mix, this quarter was substantially higher on renewals versus new. So a lot of different things moving around, a lot of data points to look at there, but we're not seeing any material shift that is changing our expectations moving forward.

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Daniel Marc Bernstein, Capital One Securities, Inc., Research Division - Research Analyst [47]

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Okay. I only ask that because, again, one of your peers kind of signaled that maybe weighted average lease terms are moving out. But maybe that has to do with the size of the tenant as well. So the other question I had, has there been any change in terms of you think the buyers and sellers on the MOB side, you're starting to see a little bit of differentiation between -- the A assets and the B assets are on and off? And has the mix of the sellers or buyers changed? And has that influenced kind of the differentiation now between the A and the B assets?

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Robert E. Hull, Healthcare Realty Trust Incorporated - EVP of Investments [48]

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No, I think you've -- I mean, I think the buyer pool remains pretty consistent. I mean, I think, you've got quite a bit of private capital out there still chasing MOB assets, given the attractiveness of the sector and then the public groups have come back in as we all know and have been active over the past few quarters. So I think it's a consistent base and we think we'll see that throughout the rest of the year.

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [49]

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And I wouldn't say that we've seen a distinct change or noticeable change on the seller composition either. Just very similar to...

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Operator [50]

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(Operator Instructions) Next, we have (inaudible) of JPMorgan.

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Unidentified Analyst, [51]

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Just on for Michael Mueller today. Just a quick question on the trailing 12 month same-store guidance for the multi-tenant. I saw it went up a little bit. Could you talk about what drove that, just on the strong first quarter results and any visibility into the coming quarters?

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James Christopher Douglas, Healthcare Realty Trust Incorporated - Executive VP & CFO [52]

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Actually, we didn't change anything in terms of our guidance. It really had to do with formatting in terms of the page and the supplemental. Last quarter, those items were taken out to 2 decimal points, in this quarter, they are down to 1 decimal point. So no change there. Obviously, we did -- we're at the upper end and even a couple of places over the upper end for this quarter, which obviously is a positive and it's a great thing to achieve. But no signal in terms of what we think for the rest of the year.

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Operator [53]

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At this time, we're showing no further questions. I'll go ahead and conclude the question-and-answer session. I'd now like to turn the conference call back over to the management team for any closing remarks. Ladies and gentlemen?

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Todd J. Meredith, Healthcare Realty Trust Incorporated - President, CEO & Director [54]

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Thank you for everybody joining on the call this morning and we will be available for any follow-up if anybody has any questions and we'll see a lot of you at NAREIT in a little over a month. Everybody have a great day. Thank you.

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Operator [55]

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We thank you sir and to the rest of the team for your time also today. Again, the conference call has now concluded. At this time, you may disconnect your lines. Everyone, thank you again. Take care and have a great day.