Q3 2021 Physicians Realty Trust Earnings Call
<unk> long term accretive returns, resulting from our relationship focused strategy rather than just meeting a calendar.
We appreciate your confidence through the first half of the year, while we completed our negotiations with landmark and were patient with our great partner in Scottsdale Honor health, while they completed the construction of two of the most recent additions to the Doc portfolio.
On October one we announced our agreement to purchase the 15 building landmark health care facility portfolio four $764 million.
<unk> portfolio includes one 4 million square feet with an average building size of 97000 feet.
Each asset is affiliated with a premier health system, including 10, new system relationships to dock.
Those include the investment grade rated University of Florida, Health, Beaumont Health and Mclaren Health care.
Two combined for 40% of the portfolio tenancy.
In total 74% of the landmark portfolio is leased to an investment grade health system.
And the portfolio carries over seven years of average remaining lease term.
Each providing great stability for years to come.
Additionally, the transaction includes a purchase option on another 46000 foot on campus mob that landmark has developed <unk>.
Currently with Doc mezzanine capital and their own equity and construction financing that.
<unk> will be completed in 2022.
Upon completion of this acquisition our share of leases to investment grade health systems as a percentage of our gross leasable space, while increased from 64% today to 65% on a pro forma basis.
We are excited to add these relationships and assets to our portfolio and are well into the final due diligence and closing process, including the transition of property management responsibilities where applicable.
Well one of our health systems could exercise their rights to match, our purchase price or other conditions could prevent us from closing we do not anticipate any material reduction in this investment opportunity and expect to close a landmark acquisitions by the end of the year.
The two new honor health medical facilities, we acquired were self developed by honor health.
The other health neuroscience facility located on their flagship Osborn campus.
It was 109000 rentable square feet and is 100% leased with a weighted average remaining lease term of seven seven years.
<unk> Medical office facility of 60000 square feet on the campus and attached to honor Health <unk> Hospital and serves that high growth sub market northwest of feedings.
These investments expand our total investments anchored Bonder hill to eight facilities totaling approximately 459000 square feet.
We expect to continue to grow with this outstanding investment grade health system, and the physicians aligned with them in the future.
With these announced investments we now exceed $1 billion of new investments closed or under contract during 2021.
<unk> growth has been fueled by our relationship with healthcare systems and physician groups and the developers working directly with those providers.
Those developers include Cambridge, Healthcare Davis Group landmark Meridian catalysts and others.
Theres nothing wrong with private ownership of medical office facilities as a unique advantage public companies like Doc have with long term ownership of medical office facilities in line with best in class Health care providers.
Most of our largest clients our faith based or community nonprofit tax exempt organizations, who are focused on access to healthcare for the next 50 years not the interest rate in the next five years.
Our stability and long term approach to capital and ownership and laser focused best in industry customer service and property management.
<unk> is a measurable advantage to sourcing and completing our investments growth strategy and goals.
We believe investors want access to a publicly traded best in class pure play Medical office REIT and we humbly believe all the data identifies physicians Realty Trust.
Our board and our management is the best option for that investment.
Before I turn the call over to Jeff to review our financials. We're also excited and humbled to announce the doctor's among modern healthcare's 2021 best places to work.
Our ranking of 26 and the supplier category represents our debut periods, earning this distinction while serving as the highest rated health care real estate provider among the honorees.
Dr. Couldnt be voted a best place to work without our exceptional team and today I want to recognize our very own Mark Dukes VP of asset management.
Just began his one year term as chairman of BOMA International.
His leadership and attention to dock will not waver this recognition and leadership to the commercial real estate industry is a tribute to his professional and personal excellence and we are blessed to have him on our leadership team.
We'd also like to recognize Mark time, our EVP of asset management and one of <unk> founders.
Who was recently named by Globe Street to the 50 under 40 list for people to know in the U S commercial real estate industry.
Congratulations Mark and Mark and keep up the outstanding leadership to Doc and the providers and the communities we serve Jeff.
Thank you John in the third quarter of 2021, the company generated normalized funds from operations of $58 million or <unk> 26 per share our normalized funds available for distribution were $55 million, an increase of five 3% over the comparable quarter of last year and our fad per share was 24.
<unk>.
In the third quarter. The company delivered consistent performance with same store NOI growth of two 5% and same store occupancy down 50 basis points year over year as strong lease spreads have offset a handful of deliberate non renewals.
The portfolio saw no material impact at all from the Delta variant and we continue to collect over 99% of all contractual rents and accounts and accounts receivable balances remained at the lowest levels in the history of the company.
Looking back over the past two years, although we were optimistic that the portfolio would weather the pandemic better than most real estate asset classes has performed so well it has even surprised us as we continue to invest in building the best tenant base in the industry refine our credit monitoring process and dispose of our limited noncore assets.
We did with our recently announced <unk> sale, we see no reason why we won't continue to perform even better over the long term.
The company closed $109 million of investments this quarter at an average first year unlevered yield of five 4% highlighted by the off market acquisition of a newly constructed on campus mob with honor health.
In October the company closed another $100 million of deals and announced the $764 million landmark transaction to.
<unk> 15 building portfolio was 74% leased to investment grade tenants and not only provides an exceptionally high quality portfolio today, but also opens the door to 10, new health system relationships for future growth.
Since many of our acquisitions are repeat deals often directly with health systems. We would expect this latest transaction to provide future benefits as well.
We continue to see enhanced demand for medical office properties as private market participants aggressively pursue the product. However, the difficulty of prime these assets away from health system owners is significant which enhances the value of our existing portfolio as well as our platform.
We had a busy quarter on the financing side of the business, we amended and extended our revolving credit facility pushing the term out until 2025 and reducing our current costs by five basis points.
We also took advantage of our upgraded rating profile for Moody's and S&P to issue $500 million in 10 year bonds with a 262, 5% coupon.
We used a portion of the proceeds to repay our $250 million term loan and expect to continue to build out our long term debt curve over time as we grow the company.
As of now we have only $84 million of debt coming due through 2025, providing exceptional financial stability for our investors.
We issued $53 million on the ATM in October at an average price of $18 61.
As we see the pipeline continue to build for next year.
Additionally, we recently signed a contract to sell our three long term acute care assets for $62 million finally, eliminating some noncore assets that we bought in the early years of the company.
These were assets that went through the bankruptcy process in 2019 and generated some temporary negative sentiment, while we achieved a 9% unlevered IRR on our <unk> investment we prefer the risk adjusted returns of medical office buildings over the long term and capitalize on the opportunity to sharpen our pure play mob focus.
Following this transaction medical office buildings will now provide 96% of our overall NOI and increase of 2% from last quarter.
Turning to other relevant portfolio metrics, our third quarter G&A came in at $9 $5 million and recurring capital expenditures were $6 7 million for the quarter. So both are trending towards our full year guidance of $36 million to $38 million for G&A and 25% to $27 million for Capex I will now turn the call over.
To Mark to walk through some of our portfolio statistics in more detail Mark.
Thanks, Jeff.
<unk> continues to benefit from our growing operating platform and strong relationships with health care partners.
Before highlighting our Q3 performance I'd like to start by recognizing two outstanding recent achievements by the team.
Physicians Realty Trust was selected by the Institute of Real estate management as the 2021 accredited management organization of the year.
The Amo accreditation was established 75 years ago to advanced best practices and real estate management at the company level.
With 560 worldwide firms holding this prestigious accreditation.
Today, we are exceptionally proud to be at the very top of that list is the 2021 accredited management organization of the year.
Second we recently announced our inaugural <unk> score of 75 in their 2021 real estate assessment.
Performing the international score of 73 out of 100.
In addition.
We received a green star designation, recognizing the teams work implementing and measuring sustainability policies.
As these achievements indicate Dr remains committed to acting as an ESG leader as we accelerate our external growth momentum.
We continue to expand our in house property management and leasing platforms. During the third quarter laying the groundwork for additional cost efficiencies to deliver long term enterprise value for our shareholders.
As an example, our recent off market acquisition of two newly constructed facilities occupied by honor health, our 14th and 15th real estate investments in the Phoenix, Arizona MSA.
Through our in House management teams, we are excited to expand this trusted partnership with honor health. While also realizing the benefit of our management infrastructure through additional property management fees.
Looking forward our management structure is scalable and will continue to benefit from concentration as we invest in top quality properties and portfolios like the landmark portfolio that are scheduled to close in Q4.
In the third quarter, we saw the power of our platform and portfolio generate both internal and external growth opportunities.
Led by same store growth of two 5% leasing spreads of positive four 4%.
And in in house leasing team that saved over $4 million year to date and commissions that would have otherwise been paid to outside leasing brokers, assuming a conservative 3% fee.
Our same store MLB portfolio, which again does not exclude repositioning assets generated cash NOI growth of two 5% for Q3 2021.
NOI growth was driven primarily by a year over year to 5% increase in base rental revenue.
Operating expenses were up seven 3% and offset by an eight 4% increase in operating expense recovery revenue once again, demonstrating the insulated nature of our triple net leases.
Year over year operating expenses were up $2 2 million overall, primarily due to a <unk> 8 million increase in property insurance costs, and a zero point $7 million increase in real estate taxes.
Same store occupancy year over year was down approximately 50 basis points as we intentionally vacated several suites this quarter to make room for anchor tenants with stronger credit to expand at better rates and lease terms.
Year to date, our leasing team has completed nearly 800000 square feet of leasing activity with an 80% retention rate and positive two 7% leasing spreads.
In Q3, specifically tenant retention was 72% across 179000 square feet of lease renewals with cash renewal leasing spreads of positive four 4%.
To further drive future internal growth, 80% of the leases executed this quarter contained an annual rent escalation of at least two 5%.
Notably these results were also achieved with limited leasing costs.
Italy, $1 47 per square foot per year across the full volume of consolidated leasing activity.
Figure thats much more efficient than industry averages.
Our successful net effective rent outcomes are driven by the quality of our assets and backed by the market pressures driving increases in rental rates in construction pricing.
As we look at our portfolio moving forward docks investments are diversified geographically with no one states accounting for more than 15% of Rins and no single tenant accounting for more than five 7%. Additionally.
Additionally, our investment grade quality tenants improved to 64, 4% in the third quarter from 62, 5% in the second quarter as a result of the Lifecare portfolio disposition and honor health investment.
These metrics and all of our portfolio quality metrics will further improve with the acquisition of the class a landmark portfolio that is 74% leased to investment grade tenants and includes 10 New hospital relationships.
The team is focused on the due diligence and integration of this portfolio by the end of the year and overall very excited about growing the Doc portfolio from $5 billion in real estate investments at the beginning of 2021 to nearly $6 billion in real estate investments by year end with that I'll now turn the call back.
Over to John.
Thank you Mark and I will take your questions.
Thank you, ladies and gentlemen, if you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is another question in queue.
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Participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys, one moment. Please on the call for questions.
Our first question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thanks, Good morning, I'm here with Juan Sanabria.
There's a lot going on in medical office today, including HCA announcing its strategic review. This morning I was wondering if you can comment on your interest level in participating in a potential sale process.
Versus other opportunities that youre seeing in the market.
John.
We're focused on in our core business.
Acquiring new investments in investment grade quality medical office buildings and financing developments of those facilities. So again, we see every opportunity.
Publicly available and evaluate those but we don't comment on them.
So thanks for the question.
Okay.
Last quarter, you mentioned John.
Cap rates for high quality portfolios going in the low fives.
And I'm wondering if you can update us on.
This quarter on what Youre seeing for those assets.
Yes, I think we've seen.
We think the landmark portfolio is humbly is the highest quality portfolio we've seen.
And execute on that in an off market basis, we are seeing portfolios trade frankly, well below in the mid fours now today, so again high quality assets and kind of sizable portfolios, but we think the landmark.
Portfolio, we acquired at an attractive price and frankly better than and openly marketed process.
I was going to ask about that so the 49 was negotiated a while ago that trade.
Today, if it were to be sold and can you also comment on the brokers you mentioned you weren't that concerned about it but how many assets or what percentage of the portfolio will have that option.
Yes. So these were all built purpose developed for those health systems. I think one was acquired by landmark in the process of their relationship with that health system.
But all of them have a ROFO, where they're on the ground leases with when you are landmark are both have visited with all of the health systems and.
Starting to received waivers back verbally.
<unk> and writing so they still have some time left.
In their review process, but we expect substantially all of them if not all of them too to waive those brokers and complete the acquisition.
And your other question again.
Being prints.
<unk>.
Assets sold in the open market portfolio sold in the open market in the mid fours. So again, we think the landmark portfolio with <unk>.
Specifically with the quality of the billing at the age of the buildings that Walter the buildings the health system credits involved seven.
74% of these buildings are leased to investment grade.
<unk> had some credit so we think it would trade in the <unk>.
Mid force did not locally.
Got it.
That's very helpful. Thank you.
Yes. Thank you.
Thank you. Our next question comes from the line of Jordan Saddler with Keybanc capital markets. Please proceed with your question.
Great.
I think the previous guidance was for $400 million to $600 million. So.
I guess that's.
Hey, guys are blowing through that any any.
Sort of Goalposts, you would offer up.
<unk>.
So that's sort of remainder of the year or just on a look forward basis John or.
Just kind of trying to frame up what the investment opportunity it looks like it really seem to hit after the third quarter.
Yes.
Depending on how you count Theres a lot out there available in the market and we're still evaluating some opportunities for the year end and I don't think were prepared to kind of.
<unk> guidance, if you will as we did blow through the four to 600.
Included in that is.
We've got we did announce and over 1 billion of investments, which biggest chunk. This landmark of course, we.
We do have three projects still under construction one of those will break ground.
The first week of December its a 100% leased beautiful facility.
I think it will be an award winner next year and in the Minneapolis market got one in the New York MSA under construction with landmark and we now have an option to acquire that building when it's completed next year.
Then we have a project with an investment grade tenant in the Dallas Fort worth market. So.
I think we will see a little bit.
More completed this year and then first quarter pipeline is really building up nicely.
Okay and then.
Can you speak to sort of the financing of all this maybe.
Jeff you can kind of.
Trademark where you are on leverage right now on a pro forma basis for all this activity and sort of where you expect to be.
Sure.
Expect to get back to sort of the target range.
Sure. Thanks, Jordan. So if you look at our third quarter on an enterprise debt to EBITDA, we are about five times.
Pro forma for all this activity assuming landmark closes completely in the fourth quarter.
That would bring us to about six times debt to EBITDA.
So that's certainly at the higher end of where we've operated historically.
However, if you look at our portfolio, we're 65% investment grade tenancy.
Collected 99% of all our rents during kind of.
A terrible pandemic.
We're effectively 98% triple net leased so there is no more.
Operating margin risk in there.
We only have 4% to 6% of our leases expiring each year over the next three years.
And we've prepaid pretty much all of our debt. So we only have $84 million of debt to refinance through 2025.
We think we're in an incredibly stable financial position. So we will leverage trend down from six times pro forma yes, it probably will.
Are we nervous about carrying six times debt to EBITDA for some period of time no absolutely not.
So we'll be opportunistic.
As we look at funding will depend a lot on the upcoming pipeline and we will just kind of continue to evaluate it.
Okay.
That's helpful and then maybe Jason just coming back to.
Landmark, but also the honor health transactions, including.
One of the more recent ones.
Construction asset.
Well, let's take a four five cap can you maybe speak to the merit of investing and MOBA is sub five at sub five cap rates and maybe it would help thanks.
Planing and a difference in the growth profile of <unk>.
The.
Maybe the animal health assets versus the operator's portfolio for example, where youre getting.
<unk>.
Thank you, yes, I think yes.
Understood Jordan the Phoenix market is really as hard as it can be pardon the pun with Phoenix.
We think the rents in that.
New buildings are below market at this point.
Certainly in the current market, we have some shorter term leases and those going to be a a nice long Walt overall in them and both of those buildings, but we have some shorter term leases, where we can move some things around and take advantage of some of those kind of mark to market in that building. So we think the.
The kind of opportunity set there in particular is much stronger than that that stated first year cap rate. So.
And we have opportunities for <unk>.
More development and more acquisitions with without our help itself directly and so these were off market transactions they were under construction.
Went into a pre sale arrangement with them mid year.
Took them until now the uncompleted.
And rent commencing so.
Kind of the rationale for that I think I think Jeff can walk through the math.
And kind of with the with the rent bumps and again, our expectation of moving some rents up more aggressively and parts of those buildings.
There'll be accretive in 2022.
Okay.
Okay.
Thanks for that.
Okay.
Thank you. Our next question comes from the line of Jason.
Italy with RBC. Please proceed with your question.
Hey, good morning, guys. It sounds like you have an opportunity to potentially drive rent growth higher.
<unk> been holding back some space. So I was wondering if you could quantify that opportunity.
Yeah sure Jason This is mark so as you mentioned.
We said in our prepared remarks, we deliberately did not renew a few leases this quarter to make room for our anchor tenants in many cases investment grade rated hospital systems to expand and <unk> and.
And take over the full building that's a specific example in Louisville that we have just.
<unk>.
And then.
Year over year some of the other spots, where we're really we're really picking our spots and.
Focused on markets like Phoenix, Orlando, Dallas, where market rental rates are increasing more than the averages. So.
For us.
Our portfolio is 96% leased but theres opportunities.
Maybe 1%, 2% of the portfolio here to really pick our spots and try and drive.
Rental increases in market rents higher than normal.
Okay.
As we look into the acquisition pipeline I guess looking ahead to 2022, obviously 2021, its very backend weighted should we expect anything similar in 2022, given you're still going to be digesting the landmark deal or will it be more evenly spread out throughout the year.
Yes, it's good question as I've said in my introductory remarks, you'd like to good ratably during the year.
And I think back to one of the other questions.
We'll issue guidance for next year.
With our next earnings call.
But we've been deploying 502 billion almost every year and again most years, it's more ratable throughout the year. This one we just had the opportunity to capture a very large transaction in and also to two development projects that just took longer to complete than we expected. So.
Again, I think hopefully we'll see some more ratable first quarters is building up.
Nice right now and we're in negotiations with a couple more development projects, which have not commenced.
Commenced yet probably commence first quarter and we'll be able to include that in our numbers for next year.
Okay. Thanks.
Okay.
Thank you. Our next question comes from the line of Richard Hill with Morgan Stanley. Please proceed with your question.
Hey, good morning, guys one of the things that we've noticed and certainly in our.
And our channel checks as there's a lot more interest from from private equity and medical office and I'm wondering as you think about that how do you. How do you think about those competitive pressures how do you dry how do you drive accrete.
Accretive growth.
Would you consider levering up here a little bit given your balance sheet, just sort of thinking about a pretty pretty strong background backdrop for medical office and how your how your capital allocations that drive can drive through that.
Yes, if you look at if you look at institutional real estate investors, whether there'll be public or private.
When you look across all commercial real estate asset classes.
Think theres another one maybe but cell towers that collected virtually all their ramps in 2020.
And many are still suffering through significant declines in occupancy and high wage labor cost.
Which don't affect us so.
Allocating capital in an institutional investor.
It's no surprise that some of the worlds biggest private equity firms in.
Non traded Reits are going to be very attracted to the medical office space and on desk driving.
Appreciation of those assets again.
Five private data.
F&B of best in class assets generally a four five cap rate going in but we look at our investments and our long term IRR basis, and so again.
Those investors that have a three to five year horizon, whether it'd be private equity or other private capital. We think we compete very well against that we think the health systems are looking for long term owners with the.
The transparency about public company and kind of the business model of a public company.
Wants to be.
Create situations relationships that are win win and Thats, we think thats, how come we keep getting repeat business with the likes of honor health.
And others.
<unk> had a great long term relation with landmark and they finally decided just to.
So with all of their assets. So we think thats the.
Kind of the opportunity.
Farmers are welcome to the party, we have great relationships with most of them in.
Look from time to time with potential joint venture opportunities, but.
For the most part.
Adding assets to our balance sheet is.
As our primary focus Jeff.
Yes, that's helpful guys.
If I may.
I appreciate the color on the Unlevered yields for landmark, but any any thoughts or anything you might be willing to share on accretion in 'twenty. Two 'twenty three recognize its early recognize you haven't guided so if the answer is no I completely get it but I figured I'd ask.
Yes, the answer is generally no, but the landmark portfolio does have some.
More vacancy across the portfolio than our core portfolio and we're already working on and evaluating lease up opportunities for that space I mean, you're talking about two or 300 basis points, but.
And there are some shorter Walton and some of those buildings and as we've talked about before and market rents are moving more aggressively up in those markets and so again.
We expect to take full advantage of those those opportunities with those health systems, and and source new developments with those health systems.
Got it thank you guys.
Thank you ladies and gentlemen at this time there are no further questions I would like to turn the floor back to management for closing comments.
We appreciate everybody joining us. This morning, we look forward to follow up calls and NAREIT. Unfortunately zooms next week, but we look forward to seeing you one way or the other I'm, saying thanks for participating.
Thank you ladies and gentlemen. This concludes today's teleconference. Thank you for your participation you may disconnect your lines at this time.