Q1 2023 Physicians Realty Trust Earnings Call
Participants
Bradley D. Page; Senior VP & General Counsel; Physicians Realty Trust
Jeffrey Nelson Theiler; Executive VP, CFO & Head of IR; Physicians Realty Trust
John T. Thomas; President, CEO & Trustee; Physicians Realty Trust
Mark Theine
Austin Todd Wurschmidt; VP; KeyBanc Capital Markets Inc., Research Division
Derek Mettler
John Pawlowski
Joshua Dennerlein; VP; BofA Securities, Research Division
Juan Carlos Sanabria; MD & Senior U.S. Real Estate Analyst; BMO Capital Markets Equity Research
Michael Albert Carroll; Analyst; RBC Capital Markets, Research Division
Michael Anderson Griffin; Senior Associate; Citigroup Inc., Research Division
Michael William Mueller; Senior Analyst; JPMorgan Chase & Co, Research Division
Omotayo Tejamude Okusanya; Analyst; Crédit Suisse AG, Research Division
Steven James Valiquette; Research Analyst; Barclays Bank PLC, Research Division
Presentation
Operator
Greetings, and welcome to the Physicians Realty Trust Earnings Call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Page, SVP, General Counsel. Please go ahead.
Bradley D. Page
Thank you. Good morning, and welcome to the Physicians Realty Trust First Quarter 2023 Earnings Conference Call and Webcast. Joining me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Del Taylor, Chief Investment Officer; Mark Theine, Executive Vice President, Asset Management; John Lucey, Chief Accounting and Administrative Officer; and Laurie Becker, Senior Vice President, Controller.
During this call, John Thomas will provide a summary of the company's activities and performance for the first quarter of 2023 and our year-to-date performance as well as our strategic focus for the remainder of the year. Jeff Theiler will provide our financial results for the first quarter of 2023, and Mark Theine will provide a summary of our operations for the first quarter.
Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect the views of management regarding current expectations and projections about future events and are based on information currently available to us. Our forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties. You should not rely on them as predictions of future events.
Forward-looking statements depend on assumptions, data and methods that may be incorrect or imprecise. Therefore, we do not guarantee that the transactions and events described will happen as described or that they will happen at all. For a more detailed description of risks and other important factors that could cause actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission.
With that, I would now like to turn the call over to the company's President and CEO, John Thomas. John?
John T. Thomas
Thank you, Brad. Physicians Realty Trust provides real estate capital to health care providers that specialize in outpatient medical services. We provide this capital in a number of ways. We acquire outpatient medical real estate designed to facilitate surgery, oncology and other specialty services required by patients in high demand and the physician patient encounters ancillary to these medical services.
We financed the development of these types of buildings. And we financed the transformation of buildings that may have become out of date as is, but provide a low-cost option for transforming to host these medical services and meet the demands of our drilling and aging U.S. population. Our facilities and providers we partner with around the country provide access to care for the entire population in the markets where we are located, not just the finite a small percentage of seniors that can pay for and want senior housing.
For years, the fundamental case for owning outpatient medical facilities has been strong, but is now stronger than ever. First, health care providers benefit from undeniable demographic tailwinds currently and that will dramatically increase demand for services in both the near and long term. Second, due to Medicare's progressive payment system and Part C modernization, providers are incentivized to provide care at the lowest possible cost, consistent with the clinical science available at the time to treat the patients safely and effectively.
Third, current expense pressures are temporary and correctable. These pressures are caused by the unique combination of real-time inflation and backward-looking payer revenue rates that are set based on past costs rather than current or future expected costs. Each of these factors incentivizes health systems to move patients out of the inpatient hospital setting and into newer, lower-cost outpatient sites of care as a means of improving their margin on services provided.
These trends have been known and visible for years and have only accelerated in the post-COVID world. Time and time again, billings hosting outpatient medical services have proven to be resilient and an essential class of real estate. When one of our clients choose to reduce their space at the end of their lease is not due to -- it is not due to a desire to work from home, the result of slowing demand or a consequence of a rapid rise in interest rates. Rather, our nonrenewals are driven by unique and specific situations like physician retirements or a change in practice ownership. These are not structural trends or challenges. Our real estate is necessary for physicians and health systems to deliver their mission to meet ever-increasing demand.
Unlike other real estate asset classes, faced with declining demand for space, revenue from outpatient medical services grew 8% in 2022. In comparison, inpatient revenues experienced no growth. High construction cost and eliminate supply growth have allowed us to meaningfully increase rental rates in most markets, and we expect to see that trend continue. The opportunity for new acquisition investments remains low for now as private investors make short-term wagers on medical office cap rates returning to 2020 levels, even at the cost of negative leverage.
We believe that patience is a virtue and we will benefit from outsized growth and acquisition opportunities with our dry powder when market cap rates and the long-term cost of capital retake equilibrium. We do see a growing number of opportunities to finance new outpatient medical investments, and our active pipeline in discussions now exceeds $300 million. We're proud of the 2 projects we started this past quarter, including our first on-balance sheet development and expect to start several new projects later this year.
We're excited to share that we've executed contractual commitments related to a $40 million medical office development located in the high-growth at Atlanta suburb or Buford, Georgia. The 97,000 square foot outpatient medical facility, which includes an ambulatory surgery center is 100% pre-leased on 10-year triple-net lease terms with 91% leased directly to Northside Hospital and investment-grade quality health system. The site also allows for an additional 100,000 square foot medical facility in the future, where we will have the development rights to build.
Northland Hospital and affiliated physicians have executed leases based on a 6.2% yield on cost to deliver the project with 3% escalators on all lease agreements. Physicians that will lease space and provide services in the building have contributed 44% of the capital to develop this building. This investment increases our long-standing partnership with Northside Hospital and is a direct reflection of DOC's strong relationships with health systems who want to work with a long-term partner who knows health care first.
Before our next earnings call, we will celebrate the 10th anniversary of our initial public offering. We appreciate your support, the support of all the families that work for and with DOC and the investment-grade credit and high-quality providers that partner with us to meet the health care needs in the communities we serve. We look forward to the next 10 years and beyond.
We believe we have the highest occupancy, the best balance sheet and the best strategy for outsized growth well into the next 10 years and beyond. Quarter 1 was uneventful until we lost George Chapman, who passed away unexpectedly and well before his time. George made health care RIETs the powerhouse that it is today. I can't count the number of senior executives and professionals at public and private REITs and otherwise that owe their careers to Georgia's inspiration and mentorship. I can name at least 3 public REIT CEOs who are stewards and direct beneficiaries of Georgia's leadership.
But more important than all the financial and business success, George was motivated most by his love for family, Toledo, the Arts, Cornell and the University of Toledo and taking care of seniors and advancing access to health care services for all, regardless of their ability to pay. I believe George is looking down on all of us as to see how we are going to work to expand access to care to all expanding senior housing to more and providing professional opportunities to the use of Toledo and everywhere to meet these objectives.
George we miss you. We at Doc are committed to your passion and mission. Jeff will now share our comments on our financial results of Q1 2023, and Mark will discuss our operating results. Jeff?
Jeffrey Nelson Theiler
Thank you, John. In the first quarter of 2023, the company generated normalized funds from operations of $60.3 million or $0.24 per share. Our normalized funds available for distribution were $59.7 million, an increase of 3% over the comparable quarter of last year, and our FAD per share was $0.24.
The portfolio showed consistent operations with same-store NOI across our entire MOB portfolio increasing at 1.0%. This is below our long-term expectations for the portfolio. As we've discussed over the past 2 quarters, we anticipate this metric returning to our long-term expectations in the back half of the year as our repositioning properties start to roll back online.
Our renewal spreads for the full MOB portfolio were negative 0.7% as one renewal had an outsized effect on an otherwise strong period of leasing. Despite this, we still anticipate averaging positive mid-single-digit leasing spreads over the entire year, in line with our previous guidance.
Across the portfolio, we continue to see evidence that our existing rents are under the current market rates, which allows for additional pricing power on new and renewal leases. Additionally, the historic rise in construction costs and uncertainty in asset pricing have been significant hurdles for new medical office development, which we believe will enhance our ability to retain tenants.
On the acquisitions front, we are starting to deploy capital but in a careful manner. Our new investments have been concentrated on development projects with health care partners that have been in planning for multiple years. Encouragingly, the acquisition pipeline that we are actively negotiating has picked up significantly since the beginning of the year. We believe this will enable us to generate accretive external growth in the second half of the year.
In order to reduce debt -- existing debt and allow ourselves to be prepared for these future opportunities, we strengthened the balance sheet with $66 million of equity issued on the ATM in the beginning of the first quarter. We had previously disclosed this activity on our last earnings call. We feel that we are in an excellent position from a capital perspective at 5.3x consolidated debt to EBITDA.
Finally, we remain on track for our overall G&A guidance. A quick reminder to our analysts and investors that our G&A is always seasonally higher in the first quarter, and we expect it to moderate going forward. With that, I'll turn it over to Mark to walk through some additional operational details. Mark?
Mark Theine
Thanks, Jeff. To best capitalize on the opportunity we have within our portfolio, we are occasionally better served by transitioning space from one physician organization to another. These decisions are made to improve the overall financial health and value of our buildings over the long term, but generally have a short-term impact on our net operating income.
Among other benefits, these strategic efforts have served to dramatically improve the credit profile of our portfolio. This is especially relevant in today's environment where higher operating expenses are offsetting revenue gains for health systems. Docs portfolio remains well insulated from these pressures by the underlying credit quality of our tenants, 67% of which are investment-grade quality. Better yet, 90% of our investment-grade tenants have a credit rating of A minus or higher. This means that these tenants would need to be downgraded several times before they can potentially lose their investment-grade status.
Our commitment to credit quality remains unmatched by our peers, and we believe this strategy will pay dividends for our shareholders in any economic environment. MOB same-store NOI growth was 1.0% during the quarter, our 20th consecutive quarter of positive same-store growth. Headline performance during the period was adversely affected by a unique situation at a single location in our portfolio.
Specifically, our asset management team was faced with a physician group tenant that had a reduced need for real estate and an in-place plan to consolidate locations. We made the decision to move aggressively to retain at least part of their space in our building as a means of preserving the health care ecosystem of the asset, and we are already in discussions with several potential providers to lease space not renewed by this tenant. Overall, this asset represents less than 1% of the same-store pool.
Conversely, the 14 building Landmark portfolio joined the same-store pool this quarter. As expected from such a high-quality portfolio, occupancy is up 50 basis points since our acquisition and the portfolio grew cash NOI by 4.1% year-over-year. In total, the portfolio is exceeding our underwriting expectations and is representative of the quality facilities and tenants at the center of DOC's investment criteria.
First quarter renewal spreads were impacted by the same scenario I just discussed during our same-store commentary with headline spreads totaling negative 0.7%. Excluding this one asset, renewal spreads for the quarter were positive 10.1%. In total, our leasing team completed 367,000 square feet of leasing activity this quarter, including 289,000 square feet of lease renewals and a 72% retention rate.
The great work this quarter by our leasing team to reprice lease renewals at today's fair market value with a 10.1% leasing spread should not be overlooked by one lease. Additionally, this leasing activity offers strong compounding growth for the future as approximately 60% of our leases signed this quarter contain annual rent escalations of 3% or more.
Looking back to the 2018 to 2021 time period, only 25% of our leasing activity on average contained annual rent escalations of 3% or more. Despite the short-term impact of a few vacancies in the portfolio, we believe the long-term value opportunity for our portfolio is fully intact as outpatient services drive retention and market pressures continue to increase triple net rental rates. Our team is focused on unlocking the full value of our portfolio through aggressive leasing initiatives, exceptional property management and smart capital improvement investments.
Before turning the call back to JT and opening for questions, I'd like to quickly say congratulations to John Sweet, the founder of Doc for earning the 2022 Lifetime Achievement Award from Healthcare Real Estate Insights. The award was presented in January at the Revista Medical Real Estate Investment Forum. John has always been owned by hospital executives, brokers, developers and investors for his wittysense of humor, unwavering integrity and creativity and structuring investment transactions.
As we celebrate the company's 10th anniversary this July, we could not be happier to honor John for his career and contributions to the medical office industry, and we recognize as mentorship and friendship to all of us at Doc. Congratulations, John. With that, I'll turn the call back over to J.T.
John T. Thomas
Thank you, Mark. Thank you, Jeff. We'll now take questions.
Question and Answer Session
Operator
(Operator Instructions). And our first question comes from Austin Wurschmidt with KeyBanc Capital Markets Inc.
Austin Todd Wurschmidt
You guys have spoken about sort of stable occupancy previously in the first half and headwinds abating in the back half of the year. But clearly, there was an impact for this -- from this one tenant you highlighted in your prepared remarks. I'm just curious how that changes the cadence for occupancy comps in the first half and even back half of the year relative to those prior expectations?
Mark Theine
So as I mentioned in the prepared remarks, our leasing statistics were outsized by this one tenant. But our portfolio, we're really starting from a position of strength with industry-leading 95% occupancy. Over the history of our company, we've always been in that 95% occupancy range. So we are experiencing a couple of one one or 2 kind of move-outs and normal churn of the portfolio. But long term, our occupancy has always been around 95%. We've been well served by our triple net leases, high occupancy, especially in this inflationary environment.
Austin Todd Wurschmidt
So within the same-store pool, when do you think full occupancy, you've said is 95%, 96%. When do you think the same-store pool gets back to within that range?
Mark Theine
Yes. So again, we feel very confident in our comments about the improvements in the back half of the year. Really pointing to that, we do have 58,000 square feet of leases signed that are under construction, and we expect rent commencement in the back half of the year. So as those leases start to come on, we'll recognize them in our occupancy and obviously, our rent growth. So that will get us more in line with our expectations of the 2% to 3% same-store growth in the back half of the year.
Austin Todd Wurschmidt
And then just last one for me on the investment pipeline. You highlighted that acquisitions have picked up since earlier this year. I'm just curious if you could put a finer point on sort of the size of that pipeline, where bids spreads are today, whether they've narrowed to a level that you think makes sense for you to transact?
John T. Thomas
Yes. Austin, thanks. This is JT. It's still modest on the acquisition front. I mean we do have some growing pipeline. There's some activity out in the market. There's still private buyers, in particular, in the low 60s range. We'd like to be higher in the 60s and up into the 7 cap rate. But without jeopardizing quality or the credit quality or the quality of the facilities.
So we'll see some activity pick up, and we kind of expect more to come to market, working with some health systems looking at some potential monetizations there. So we're excited about that. The real pipeline is on the development front and just working through kind of final documentation and pricing of those transactions.
Operator
Our next question comes from Juan Sanabria, BMO Capital Markets.
Juan Carlos Sanabria
Just hoping to expand on that last piece about the development funding. It seems like the deals you've done recently are in the low 6s. Is that a good bogey for development capital, given your comments about where traditional acquisitions are, how should we think about that development capital, you mentioned $300 million opportunity set going forward?
John T. Thomas
Yes, Juan, we does get priced well in advance of actual construction starts. And the Buford project has -- with the 3% bumps, the quality of the location, our IRR on that facility is much closer to the 8.5% to 9%. So we'd like it to be higher when we start on that particular project, but it's still a fantastic project. The second project is not priced, and we would price it at a different rate today in the current market.
At the time we were negotiating through that, MOB purchase acquisition rates were in the low 5s. So it's just -- it's always a timing thing with that. And we're looking at different ways to to think about that and the long-term commitments we make there. So development starts to things we're negotiating now in the high 6s, low 7s from a current yield because most projects we do are on a kind of loan down or more of a construction loan project, and those are in the high 6s to low 7s if we were pricing them today.
Juan Carlos Sanabria
Great. And then just curious on any dispositions you guys have targeted. You had kind of a small one done in the first quarter. Any other opportunities? And if you can give us any color on the cap rate on that small piece that was sold off in the first quarter.
John T. Thomas
Yes. I'll speak about dispositions and ask Mark to give you more specific details. We don't have a meaningful disposition strategy for this year. Opportunistically, we may sell a building here or there. We have -- we own 300 -- almost 300 buildings. So there's always a handful in the portfolio that are older, smaller and different markets where we're not strategically growing. So from time to time, we may strategically dispose of something, but nothing specific, no material plans. Mark, do you want to talk about this.
Mark Theine
Yes. Juan, more specifics on just the one small asset we sold in the quarter was -- that building was originally acquired in the early life of Doc as part of a 5 building portfolio. This is the one building that was not as strategic and the existing tenant in the building asked if they could purchase the building from us. The cap rate on that was actually just below 4%. But again, very small building and was more representative of our disposition strategies what we completed last year with great Falls. We had an amazing exit with a great partner there in Great Falls and redeployed that capital accretively.
Operator
Our next question comes from Ronald Kamdem with Morgan Stanley.
Derek Mettler
This is Derek Mettler on for Ron. Thanks for the question. So curious about the one asset that dragged down same-store NOI. Could you provide any more color on the impact that it had given your confidence that it was a relatively small asset?
Mark Theine
Yes. This is Mark. I'll take that one again. So I'll start with the fact, again, this is our 20th consecutive quarter of same -- positive same star NOI growth. And we currently -- we don't have a redevelopment or repositioning bucket. We report on all of our properties.
So as we mentioned last quarter, we were expecting same-store to have a little bit of a slower start, but picking up in the back half of the year. And this one building in particular, was a 110,000 square foot cancer center that we acquired in 2014 at a 7 cap. And for 9 years, they paid their rent on time every month. And we -- through our relationship with them, became aware of their plans to consolidate their office space and really reduce their square footage by about 50%, some of which was admin space some of which was clinical space, but the direct impact from this one tenant on same-store this quarter is 73 basis points of same store. So our one would have been 1.73% excluding this building, and it had a 30 basis point impact on our occupancy year-over-year.
So just to help kind of contextualize this a little bit more $200,000 in our same-store pool out of $82 million of cash NOI moved same-store 25 basis points. So it doesn't take a lot of cash flow to really move same-store percentage quarter-over-quarter. So again, what I said before, what gives us confidence in the back half of the year is the lease assigned that are under construction and will commence in the back half of the year.
Our target for increasing our occupancy there is really our investment-grade hospital systems that are existing in the buildings, and we're working closely with them to continue to expand.
Derek Mettler
Understood. I appreciate that. I guess the follow-up is, have you identified any more tenants that are potentially at risk for reducing their space similarly?
Mark Theine
No, nothing to this size.
Operator
Our next question comes from Michael Michael Carroll with RBC Capital Markets.
Michael Albert Carroll
JT, I wanted to touch on the private investment market. I know last quarter, you highlighted that cap rates were in the mid-6s trending upwards towards 7. But today, you highlighted that the private market bid is aggressive and maybe those cap rates are in the low 6 today. Are you surprised by the strong private bid and how it has not changed as quickly as you would have expected?
John T. Thomas
Yes. It's really trying to understand how that is -- how they're making the math work on those projects and talking to some of those private buyers. They have some all equity with low return expectations. There's not a lot of bank financing. I wouldn't say there's a high volume of those transactions, but there are people out in the market kind of high 5s, low 6s. So I don't think that's reflective of what the current value is. It's more a reflection of people with buckets of capital they're willing to take a bet that interest rates decline next year and cap rates go back to the 5%. It's -- I think that's kind of the simple math they're doing.
We -- our acquisition pipeline it's in the high 6s, low 7s. We don't have a lot of volume at those numbers, but we do have good discussions in place.
Michael Albert Carroll
Okay. So your active pipeline right now, you do have sellers that are contemplating on selling at those high fixed levels.
John T. Thomas
Yes.
Michael Albert Carroll
Okay. And then on the North side development, when was that agreement reached? I guess I was surprised that at that cap rate was fairly low. I mean even at that cap rate, is it accretive to you? Or are you guys -- is that deal kind of expecting that you need interest rates to drop for that to kind of drive some accretion?
John T. Thomas
No, it's got 3% bumps. Again, about half of the equity is coming from the physicians that are leasing the building, they've already written those checks. So we've got this advanced funded from last year. It was really early of last year, mid-spring kind of discussion around the pricing at the time 6s was much higher than acquisition cap rates in time. So we -- again, the development is not a spot financing production. So it's -- we were pricing it today, it would be higher.
Our long-term IRR on that project, Mike, is still in the mid-8 to 9 and that's without executing another transaction changing cap rates or interest rates in the future. So we feel good about it. We'd price it higher today if we could, but we're still going to make money on the project.
Michael Albert Carroll
Okay. And then why did you elect to do that project on an on-balance sheet development? I know historically, you've been more doing these construction loans. So I guess, why is that project different?
John T. Thomas
There's some unique circumstances with Northside in this location. They own the land. So it's on our ground lease. The second building is already designed, and we think there's leasing demand to move forward with that project in the next year, and that one will move price again based upon kind of current pricing at the time, but -- and it would be priced differently if we were starting it today.
But it's Northside has to build it on balance sheet, again, for some unique circumstances. The tenant base is partly their employees, partly affiliated physicians that aren't employed by them. It's a combination of health care compliance and Norside their own balance sheet management. So we're excited to do it. We're working with RTG as the developer on that project, who we partnered with before. They do a great job and have done a great job getting the building to 100% pre-leasing before we started funding it.
Michael Albert Carroll
Okay. So then this is more of a unique situation, we shouldn't expect future ground-up developments on balance sheet?
John T. Thomas
I think you'll see some, but our preference is the loan down where we're getting a current construction loan yield and have more optionality on the back end to -- on the potential of an acquisition. But you may see it from time to time, but we're excited to do it and expand our relationships. It's a great market. Atlanta is still very high.
Operator
Our next question comes from Michael Griffin with Citi.
Michael Anderson Griffin
Maybe to start off with the capital allocation kind of strategy, high level picking backing off the previous Mike's question. I think you've talked about in the past about your solid balance sheet, a strategy for outsized growth. I mean I'm curious maybe if you can elaborate, JT on where this growth is coming from and probably the capital question for Jeff, why put capital out today? Will joint ventures make sense? You talked about the development funding just a minute ago. So any commentary on that would be helpful.
John T. Thomas
Yes. Beginning in the fourth quarter of last year as interest rates were rising dramatically and fast and cap rates on acquisitions was not keeping up with it and still hasn't really reached equilibrium. We've been very modest on acquisitions, knock a lot of (inaudible) trying to continue discussions. We've walked away from opportunities that were very attractive 18 months ago that aren't attractive -- aren't as attractive today.
Many sellers are just holding firm and hoping that interest rates decline and the cap rates improve from their perspective next year. So we don't expect a lot of acquisition opportunity this year. The development pipeline, again, those are usually 2 years of construction projects, and we can't get outsized deals there, but you do take some capital risk and you do take some modest development risk, which we don't think we're taking any there because of the -- getting to 100% pre-leasing with investment-grade quality tenants like the Northside project.
So I think those will mitigate over time. That $300 million pipeline we're talking about, much of which won't even price or get started into later in the year. So again, it's a balance and forward-looking projection as best we can about how to price those products. Jeff?
Jeffrey Nelson Theiler
Yes, a little bit on the capital side. So obviously, we reduced our leverage a little bit in the face of rising interest rates and to try to build up some capacity and dry powder to take advantage of acquisitions and development opportunities. So we issued some stock around $15 per share. So that's kind of a, call it, 6.4%, 6.5% implied cap rate. We feel confident that when we redeploy those proceeds, we'll be getting yields in excess of that. So I think we can utilize the capital that we raised accretively in the back half of the year. And again, as JT's talked about, it's a little bit market dependent on how fast we can get that out the door. But we feel like we're in a good position to do so.
Michael Anderson Griffin
I appreciate the additional disclosure on the release about the ATM issuance, I double checked with the prior quarter 1. And so it wasn't any new news. So I appreciate that. And then maybe one for Mark, just on the leasing side of things. I think the lease percentage ticked down a little bit in the quarter, but it's still pretty high at around 95%. I mean how are you kind of incorporating this into expectations around leasing, occupancy growth this year and the ultimate impact on same store?
Mark Theine
Yes, I'll definitely take that. So on leasing, as you just mentioned, I mean, again, we're starting 95% occupancy. So very full, but one thing we're doing -- actually 2 things we're doing a little differently right now. One is we're more proactively investing CapEx dollars into some of the vacancies to make sure the spaces are ready available for lease immediately that we're not caught with supply chain challenges, anything like that. So we're being very proactive with our CapEx dollars to have spaces that are show ready.
And then second, our leasing team this year has done a great job, and I mentioned this on the first -- the last earnings call that we've really increased our online marketing efforts and our broker outreach to enhance communication and really market those vacancies online and with the new virtual reality technology and online tours. So it's definitely a focus of our entire team to improve occupancy throughout the year.
Michael Anderson Griffin
And as an Atlanta native, I just wanted to say I have to check out the new properties next time I'm back back there.
Mark Theine
We'd love to take you for a tour and everybody.
Operator
Our next question comes from John Pawlowski, with Green Street.
John Pawlowski
I know you talked -- touched on the Landmark portfolio briefly in your prepared remarks. So I apologize if I missed this data point, but could you quantify what type of lift the landmark portfolio had on the same-store NOI growth in the quarter?
Mark Theine
Yes. John, this is Mark again. So first, welcome to the Doc call. Great to have you here. We appreciate the support from Green Street recently. So Landmark, it's about 1.4 million square feet out of our 15 million square foot, 15.2 million square foot same-store portfolio. So while great results there, just based upon the overall size of the same-store portfolio, it doesn't have an outsized impact on our same-store results. But those properties alone right there, 4.1% from the same store is as a result of some increased occupancy and I've done a really good job. The landmark portfolio itself is 11% of the same-store pool, though. So year-over-year, again, 4.1% growth there.
John Pawlowski
Okay. So I know with the portfolio, there's always a syncratic moving pieces. But if you exclude the one property that had a large decline in renewal spreads, it sounds like that was a 70 bps drag, but landmark was a positive. So it feels like if you exclude those 2, I think pieces, the rest of the same-store is kind of stuck in the low 1% NOI growth range. So if you look through the portfolio, is there any other concerning trends that test take a while longer to get back to that historical growth profile.
Mark Theine
Yes, John. So the one thing I would add to what you just said, you're starting to build on it correctly with the -- excluding ZenMate, but the one thing I'd add, again, is the 58,000 square feet of leases that are already signed and under construction. Once those come online on a run rate basis, they'll add to approximately $400,000 of NOI a quarter. So that will continue to help build our same store, and that's going to be another 40, 50 basis points there just from leases that are already signed.
So again, that's on a run rate basis. They'll come online throughout the back half of the year, not all at the same time, obviously, but throughout the back half of the year. And that's what gives us confidence that we'll be rebounding into our more historical into 2% to 3%.
John Pawlowski
Okay. Last one for me, just on the development appetite for development. And so I understand the lag of when deals are priced versus when you're actually committing capital. Just curious, John, why not walk away or reprice the economics of the $41 million construction start if the world changes? Just curious why you're kind of anchoring the pricing a year ago.
John T. Thomas
John, there's -- we have a core value called CARE, where we collaborate, communicate act with integrity, we respect the relationships, and we execute consistently. We've built this company for 10 years by being reliable with our health system partners. And we do reprice. We have repriced where we have the opportunity. And again, we are in the high 8s on an IRR basis on this transaction. The 6.2% is the first year yield that grows 3% a year within primarily an investment-grade health system, and we'll have the opportunity to expand this campus by another 100,000 feet in the near future.
So we don't see it as a project you walk away from. We see it as a project you work with your partner and get to the finish line where you can. Other projects, we've done exactly what you suggested. We've walked away from purchase options that, again, where we have the optionality, and that's kind of the preferential way we'd like to do the development projects. So each situation stands on its own merits and and circumstances.
Operator
Our next question comes from Mike Mueller with JPMorgan.
Michael William Mueller
Just a quick one. On the construction loan, the $35 million construction loan looks like that's tied to a project with a renovation attached to it for surgery center. And it looks like you're planning to take that out in the back half of the year. I guess what's the cost of that that you'll be acquiring? And then does that effectively just kind of come out of the loan balance? Is that the way to take of it?
John T. Thomas
No, it's a small part of the total project. The ASC, which is the first step of the redevelopment of that location with Emory is it's -- the cap rate is in the high -- it's closer to an 8, but we're committing capital to redevelop that. So the ultimate yield on that is in the 7s. And then the construction project is a separate loan and that's priced at 6.75%, 6.8% and then we have optionality whether to purchase that building on the back end, and we'll evaluate to John's point a minute ago, we evaluate the value of that purchase option at the time of execution or walk away from it or try to reprice it. So it's a small piece, the ASC piece, it's nice yielding, but a small $4 million, $5 million acquisition. And then we've committed capital to renovate and improve that building.
Operator
Our next question comes from Tayo Okusanya with Credit Suisse.
Omotayo Tejamude Okusanya
In regards to the space you guys are kind of strategically holding back for the kind of right tenant. Could you just kind of talk us through a little bit about kind of what that total square footage is, what kind of rents you're ultimately kind of expecting on that space and kind of the kind of earnings contribution once all that's kind of leased up and kind of what's the internal timing around our internal targets around some of that stuff?
John T. Thomas
One clarification. You said kind of holding out or non-renewing space to hold out for a better tenant. That's really not exactly what we do. We nonrenewed space because we have a better tenant in hand. And that's the perfect example is the 55,000 square feet of leases that are under construction. So it just takes a period of time to build out that space for the incoming tenant. And we don't count that at least occupied space until the rent commences as appropriate accounting. And that particular location are those 55,000 50 bps of same-store?Yes. Yes. So pretty meaningful contribution. It gets us back to 95% actual lease space windows commenced.
On the building that -- where we had the repositioning this quarter, we already have an active lease pipeline. Again, those discussions have been in place for a while. And Amy Hall and her team have done a great job of building a a list of tenants to backfill and lease that space at market rates. And we think that building will get back to kind of high occupancy in second half of this year, first half of next year. So it will start contributing again momentarily.
Omotayo Tejamude Okusanya
Okay. And like target economics for the -- I mean, when you kind of release the space, you -- is the goal you want 10%, 20% spreads on kind of what the old leases look like? Or just trying to get a general sense of what kind of economics you're targeting
John T. Thomas
Yes, Kyle. So I think you're making a great point here, which is that our vacancy and short-term leases really have an opportunity right now to increase cash flow as we're in an environment where rental rates are increasing quickly. In fact, just yesterday, just as an example, we were shared a leasing flyer for our brand-new development in Texas in our second largest market. It's not an investment that a development deal that we're directly involved with, but it's located right next to a large existing building we own. And the development rental rates in that leasing fire were 40% higher than the rents we have in place in our existing building that was built 5 years ago. So similar quality, even larger building, but a large delta between what current construction rental rates, asking rental rates are and where are the embedded in rental rates of our portfolio are. So there's a great opportunity. And that's where our leasing team, our asset management team is focused on is really understanding each market and bringing those current leases mark-to-market.
And as I said, absent the one lease we discussed, we had 10.1% leasing spreads this quarter, which is a phenomenal job by our entire leasing team and great retention with our asset management team.
Operator
Our next question comes from Josh Dennerlein with Bank of America.
Joshua Dennerlein
Just kind of wanted to ask about something you mentioned in the opening remarks. I think if I heard correctly, you mentioned you expect the transaction activity to pick up in the second half of this year. What's driving that you expect -- that expected to pick up?
John T. Thomas
I think the -- just knowing what's in our pipeline and discussions. Again, when we don't do much at all, any new acquisition is a pickup, right? So -- but we do have some active discussions, but it's not the kind of volumes we've done historically because we're really pushing long-term cost of capital trying to match up with market first year yield. So -- but I do think the market generally, there's a lot of loans, IO loans that were issued in 2019, 2020 that we're attached to buildings that were purchased at 4.5% to 5% yields and those loans are now costing 7%, 7.5%. So it's -- there's a mismatch there, negative leverage on acquisitions to cash flow.
The LTVs are not -- don't support the size of those loans. So we're starting to see -- it's small right now, but I think that activity will pick up where we see not distressed buildings but owners who don't want to come out of pocket to support that kind of cash flow. So we think there's a pretty large volume of that kind of opportunity out there. We'll see if it materializes or not. If interest rates fall, maybe people kind of ride it through to to the future. But right now, we're starting to see some evidence of those kind of -- that kind of combination coming to fruition.
Joshua Dennerlein
Interesting. Are those mostly like one-off assets? Or are they more like portfolios of size?
John T. Thomas
Yes, I'd say a combination. But one-off assets is primarily what we look at. It's rare that we do -- we've done 2 very large portfolios, but we've really built the company in one building at a time.
Operator
Our next question comes from Steven Valiquette with Barclays.
Steven James Valiquette
Great. You touched on this a little bit, but I guess I was kind of curious to just on the -- for the same-store NOI numbers. I think this is like maybe the fifth quarter in a row where the expense growth was faster than the revenue growth. And I was wondering if there's just a line of sight to when that might reverse when the same-store revs would maybe ideally be growing faster than the expense line. You talked about part of the remedy on that, but I'm curious if there's any -- if it's continued just upon that, additional leasing you talked about or just other factors as well, maybe controlling expenses there. Just more color on that would be helpful.
John T. Thomas
Yes, Steve. So operating expenses in the same-store pool were up 6.9% year-over-year, sort of in line with some recent inflation fries. We're coming off of a period last year where this comparable operating expenses were really flat in the comparable period, but prior year ago. And if you look a little deeper into that, what we're seeing on operating expense growth is #1 utilities is not necessarily consumption because we made some very intelligent and large capital investments in the building. But in the rate of utilities, we're seeing a pretty large increase.
And then we're also seeing some increases in labor expense related to janitorial engineering, things like that. So year-over-year, that's where the operating expense growth is. But again, one of the benefits of our highly occupied triple net lease portfolios that those operating expenses are nearly offset in our recoveries, which are baked into that rental revenue line item there as well. So our asset management team, property management team are always focused on keeping total occupancy costs low, managing operating expenses well and leveraging economies of scale. But we'll continue to try and focus on keeping those operating expenses below the inflation line.
Operator
We are closing our question-and-answer session. Now I would like to turn the floor back over to John Thomas for closing comments.
John T. Thomas
Thanks again, everybody, for joining us today. We look forward to be seeing you at NAREIT in the future investment conferences and speaking to you again in August. Thanks.
Operator
This concludes today's conference call. You may now disconnect your lines. Thank you for your participation, and have a great day.
