Q3 2022 Physicians Realty Trust Earnings Call
Greetings and welcome to physicians Realty Trust's third quarter 2022 earnings conference call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded it is now my pleasure to introduce your host Brad Page Senior Vice President General Counsel. Thank you you may begin.
Thank you Doug good afternoon, and welcome to the Physicians Realty Trust third quarter 2022 earnings Conference call and webcast. Joining me today are John Thomas Chief Executive Officer, Jeff Theiler, Chief Financial Officer.
Taylor Chief Investment Officer, Mark <unk> Executive Vice President.
Management.
John Lucey, Chief accounting and administrative officer, Laurie Becker Senior Vice President Controller, and Amy Hall, Senior Vice President leasing and physician strategy.
During this call John Thomas will provide a summary of the company's activities and performance for the third quarter of 2022 and year to date as well as our strategic focus for the remainder of 2022.
Jeff Theiler will review our financial results for the third quarter and Mark will provide a summary of our operations for the third quarter.
Today's call will contain forward looking statements made pursuant to the provisions of the private Securities Litigation Reform Act of $19 95.
It reflects the views of management regarding current expectations and projections about future events and are based on information currently available to US. These 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 maybe incorrect or imprecise and therefore, we may not be able to realize that.
We do not guarantee the transactions that are best described will happen as described right 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'd now like to turn the call over to the company's CEO John Thomas John .
Thank you Brad and good afternoon. Thank you for joining us.
The third quarter of 2022 is a quiet and steady as you go quarter for Doc further demonstrating the stability of medical office as an essential real estate class.
This year has been challenging for health systems, and physicians alike as medical cost structures had been impacted by double digit inflation in both staffing cost and supply as it had been further complicated by lagging government and commercial reimbursement.
Despite these headwinds the United States demand for health care services is at an all time high in the past as the population ages and patients receive procedures that were deferred during the pandemic.
Providers have continued the long term shift of care to the outpatient setting where advances in clinical science now allow for many higher margin services like orthopedic surgery to be performed in a lower cost environment.
CMS has again expanded list of procedures that can be performed in ASC is going into 2023.
This trend is predictable and rational outpatient care sites benefited from a more stable staffing model increased operating efficiency and improved patient convenience, all while freeing up hospital capacity for higher acuity needs.
Our portfolio was built with this dynamic in mind, while capital market volatility continues to produce a mismatch between buyers and sellers and the pricing of new investments. Our entire team is focused on portfolio optimization and working with our health system partners to address their real estate needs for the years ahead.
This partnership focus continues to enhance our development pipeline and we continue to see the potential for a higher volume of development financing opportunities in 2023.
Within the existing portfolio, we continue to benefit from the increased market rental rates, driven primarily by general inflation and rising construction cost.
Renewal spread has exceeded our expectations at six 2% for the third quarter, bringing our year to date spreads to five 7% across 670000 square feet of activity within our consolidated portfolio.
Importantly, these high spreads have not come at the expense of retention, which remains near 80%.
We remain excited about the performance of our portfolio, despite a challenging macroeconomic environment.
Mark will share more details in a few minutes.
September Hurricane E N called wide scale destruction in the West coast of Florida, and our prayers and best wishes go out to the families directly affected by the storm, our Florida base team's quick response helped to mitigate the storm's impact on our health care partner providers their patients and our real estate assets.
Fortunately, we experienced only minor wind damage to a couple of our smaller facilities and the properties will be back in operation quickly, we had no material financial impact from the storm and we will.
Paul that our team members and their families affected by the storm our site.
We've all seen the difficult expense environment health care organizations are experiencing driven by extraordinarily tight labor markets and medical supply cost as well as noncash mark to market losses and their investment balances.
We've devoted significant resources are docked to building a professional credit team, who assist us in underwriting our investments, but also of periodically reviewing the financial results of our tenants.
We have visibility through lease reporting requirements into 94% of our tenants by ABR with the average size of the tenants without this requirement totaling less than 5000 square feet.
We also utilized utilized independent claims data to monitor procedure volumes across our portfolio.
Our largest tenant concentration as with common spirit across 12 markets common spirit to S&P investment grade AA minus credit rating was reaffirmed in September with a stable outlook.
Moody's and Fitch also reaffirmed their respective I G rating for common spirit as well.
According to S&P common spirit strong credit rating reflects common spirit is exceptionally broad geographic reach supporting a financially diversified health system across 21 states with a large $34 billion revenue base.
Common spirit has $15 billion of unrestricted reserves and 175 days cash on hand.
While commentary 2022 operating margins were strained at negative four 5% S&P you believes common spirits labor initiatives and market strategies and performance initiatives should help the system achieved their targeted 5% to 6% EBITDA target by June of 2023.
With 66% of our space leased a similarly strong investment grade health systems, we see similar is the resiliency across our tenant base despite broader market challenges.
Across the health care delivery industry volumes and opportunity for revenue growth is there and CMS Medicare and commercial insurers are increasing reimbursement rates for 2023, reflecting higher inflation and labor cost.
Yeah.
That continues to make progress in our sustainability efforts, creating value for our health care provider partners shareholders and communities through short and long range business human capital and operations planning.
As a benchmark for all of our efforts stock earned a score of 75 out of 100 and the recently released 2020 to grasp the real estate assessment output.
Outperforming the international average of 74.
We also earned a green star designation awarded to submit or is achieving scores at 50, plus on groceries implementation and measurement at the management and policy sections.
In addition, the company earned an a rating and a score of 98 out of 100 on the 2020 to grasp the public disclosure level ranking first in its health care comparison group.
As we looked at 2023 it is difficult to project the external growth until capital calls become more predictable and we can match our cost of capital to market opportunities acquisitions or development financing.
That said the market appears to recognize an asset valuations will need to adjust to complete transactions and construction supply chain seem to be improving in our favor.
Our balance sheet is in great shape, and our debt metrics are well managed with no near term maturities. So that when the current market conditions settle down we are well positioned to grow and grow at higher levels. We.
We expect to continue to capture higher leasing spreads and those increases in contractual revenue along with our 2020 acquisitions in our 2021 development financing will increase our 2023 NOI, including same store NOI.
We will complete our 10th anniversary in July 23, and a very positive way.
We believe medical office as an asset class has proven time and time again to be the safest and most defensive and most predictable real estate for investment and operational success.
Now ask Jeff to present, our Q3 financial performance and then Mark will address the performance of our high performing award winning asset and property management team Jeff.
Thank you John in the third quarter of 2022, the company generated normalized funds from operations of $61 $4 million or 26 cents per share our normalized funds available for distribution were $61 $8 million, an increase of 13% over the comparable quarter of last year and our fad per share was <unk>.
96 cents.
The company's operating.
<unk> operations were stable this quarter with same store NOI growth of one 1%. This came in below our expected range due to 40 basis points of occupancy loss, which mark will discuss in a moment.
We continue to believe that our rents are below market current market levels evidenced by the six 2% re leasing spreads achieved in the third quarter.
Are largely investment grade tenant base continues to perform as expected with no material increase in defaults for rental relief request. Despite the inflationary pressures that J P discussed in his remarks.
Finally in terms of our own margins, we remained shielded by our triple net leased triple net lease structure with 84% of all operating expenses reimbursed to us by tenants in the third quarter.
Our acquisition volumes increase in the third quarter, primarily due to the purchase of the Calgary Medical Center in Brooklyn, New York.
Our expectation is that acquisition volumes will be lower in the fourth quarter as we wait for sellers to adjust their pricing expectations to better align with the current capital market environment in.
In the meantime, we will be lining up potential opportunities. So that we can take full advantage of accretive deals at the right price.
Along those lines, we continue to maintain a strong balance sheet that provides plenty of flexibility to be patient during this time.
Our consolidated net debt to EBITDA was five six times at the end of the third quarter and we have no material debt refinancings until 2025.
We raised $8 million on the ATM in the third quarter at $18 15 per share and have $300 million remaining in the current ATM program.
Finally, a few updates to our 2022 guidance, we expect G&A to come in near the lower end of the $40 million to $42 million range that we set out at the beginning of the year.
We are also reducing our guidance for recurring capital expenditures to 25% to $27 million for the year down by $4 million at the midpoint.
This reduction is due to the better than expected condition of the $750 million landmark portfolio as well as impacts from tenants exercising automatic renewal options, which pushed more of the capex responsibility to the tenant.
With that I'll turn it to mark to walk through some additional operational details mark.
Thanks, Jeff.
Physicians Realty Trust completed a productive third quarter with our portfolio of outpatient medical facilities demonstrated stability growth amid amid the current economic environment.
We are especially proud to share this quarter that our leasing team achieved above average leasing spreads of six 2% in Q3 on the heels of an impressive 8% leasing spread last quarter in Q2.
The consecutive quarters of strong re leasing spreads above the historical 2% to 3% is a direct result of the mission critical nature of our assets and the enhanced value.
Of our portfolio during a rapidly rising replacement costs.
Importantly, we've achieved these results without sacrificing retention without excessive concessions and not discounting annual rent escalators.
In total tenant improvement and incentive packages totaled 61 cents per square foot per year on renewals, while we achieved an 81% retention rate and a three 1% average annual rent escalator across our 251000 square feet of leasing activity and the consolidated portfolio during the quarter.
Leasing costs were particularly low this quarter as 25% of our renewal volume was completed via automatic lease renewal language in the lease or buy tenant options to extend the term with no landlord contributions for tenant improvements or conditions.
Given the current cost to build and finance a new development, we anticipate healthcare providers will continue to utilize existing medical office inventory ultimately driving up total occupancy cost and quality facilities with well capitalized real estate partners.
In terms of new leasing activity. Dr. Currently has 85000 square feet of executed leases in construction, but not yet paying rent we anticipate approximately 20000 square feet of these leases will commence in Q4 with the remainder commencing rent payments in the first half 2023.
And it will be same store NOI grew one 1% during the third quarter with result, lagging due to a 40 basis point decline in same store occupancy.
Over half of this decline resulted from an opportunity to increase occupancy long term in a building with an investment grade ASC tenants.
While we're not satisfied with the 1.1% result, it is important to view the occupancy in the context of the broader and it'll be landscape.
Our 94, 7% same store leased rate is meaningfully higher than industry averages.
Tenant demand for medical office facilities has never been stronger and we remain focused on unlocking the value of our portfolio for the long term.
When necessary. This includes the selective vacating or suites that have higher potential with a different tenant.
Even if growth is impacted on a short term basis.
Looking ahead, we expect same store occupancy the bottom in fourth quarter before returning to prior ranges as suites currently under construction to come on line.
Same store operating expenses were up just two 1% year over year. Despite the high single digit inflation experienced throughout the economy.
This performance is a credit to our asset and property management teams working diligently on behalf of our health care provider partners to minimize total occupancy costs spin.
Specifically this quarter's result was driven by the successful challenging of several real estate tax assessments, resulting in a year over year property tax decline of nearly $1 million that served to offset increases in non controllable utility expenses.
These property tax outcomes are just one example, among many of the ways that our team worked diligently to execute consistently on behalf of our shareholders and hospital system partners to deliver value. During this period of economic uncertainty.
I'll turn the call back over to John .
Thank you Jeff Thank you Mark.
Doug will now be ready for questions.
Thank you ladies and gentlemen at this time, we will be conducting a question and answer session.
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Our first question comes from the line of Tayo Okusanya with Credit Suisse. Please proceed with your question.
Hi, yes, good a good afternoon everyone.
So the first one for me just you know general hospital backdrop seems challenging and getting all the public hospital names you know seemed to have been a rough couple of quarters.
Curious as you interact with you know with your hospital tenant base, what there you know.
What they're seeing what they're hearing and if you know demand for MLB space is you know it seems like it you know whether there any kind of changes to demand trends just kind of given the top the tough operating backdrop for hospitals.
Yeah, Great Great question Tayo.
We prefer and we've always focused on really nonprofit hospitals primarily is.
As the <unk>.
Strength in the market share of those facilities typically have in the long term commitments at those facilities, but the markets. As you know <unk> came out of the Ascension system for 25 years, I would say immersive and dialer for 10 years.
The providers and the organizations that we partner with and the vast majority of our investment grade tenant base.
Which is 66% of the whole portfolio or.
Our nonprofit health systems with long term commitments to those communities and so what we're seeing is a lot of.
Again, like I said portfolio optimization, where you know they want at least the right space at the right price.
For both of us at market rents, which are increasing.
And then the stronger systems again that we work with are looking at new growth opportunities and that's where the development financing opportunities are coming so it's a tough market revenue and volumes are high the.
The challenge many hospitals are having with the volumes.
And the revenue opportunities as they don't have the staff to actually provide the service.
Our health systems are fighting through those issues and again have again high utilization.
But the expense structures wage cost supply cost.
Our exceeding reimbursement rates, which there's always a time lag.
And the government in particular as you know it can be a year or two years behind.
Kind of current inflation call. So CMS did better this year, they're not doing enough for physicians and we expect that they will address that during the lame duck session.
The commercial insurers are stepping up as well too to increase reimbursement to appropriate inflationary levels. So.
We're seeing a lot of positive momentum everybody is tightening their belt the best they can.
But most of the systems, we're working with in the bigger markets. The stronger markets are really looking at expansion opportunities not retrenching.
Gotcha. Okay. Then the next one for me just same store NOI growth again, we've all been trained to kind of expect steady 82% to 3% you've kind of even below that range for the past two quarters at least.
Everything seems to be growing right in terms of you know the mark to markets, you're getting 6%. The fact much more focused on operating expenses. So just kind of curious like when do you expect a lot of these kind of initiatives to ultimately kind of reis.
Same store NOI growth to that kind of 2% to go even better relative to your peers.
Yeah, our expectation is we'll be back to a normal pace in 2023 as I mentioned a minute ago, we're really focused on portfolio optimization right. Now we've had two or three locations, where we just didnt renew the lease on purpose.
So that we can provide expansion opportunity for frankly stronger tenants in those buildings. So you know same store can be such a short term number who are really focused on the long term performance of the portfolio.
And with that we've had a couple of quarters in a row with dynamics like that did better.
Short term negative impact on same store, but have a long term benefit to the organization Mark you want to expand on that yeah.
That's perfectly set and I think it's also important to keep in context that our same store occupancy is at 94, 7%. So it's a very full portfolio.
And the 40 basis point.
Decrease in same store occupancy represents about 53000 square feet in total.
The.
The example that we were referencing with the ASC.
Is a building in Minnesota, where we deliberately did not renew a couple leases to make room for a large full floor tenant.
With an investment grade rated system so.
That's an example, where we're going to take a little bit of Oh hurt on the same store growth in the near term while that space was under construction, but ultimately will add great long term value and take a building that was 90% occupied 100% occupied for the years to come.
Thank you very much.
Thanks, Tom.
Our next question comes from the line of Juan Sanabria with BMO capital markets. Please proceed with your question.
Hello.
Hoping to spend a little bit more time on the leasing side you have had great success on renewals for the last couple of quarters, but just curious on the new lease side.
What those spreads look like and how much capital is being spent on that side I think he gave it to her.
Annual numbers on both on the on the she is in the prepared remarks, but just hoping a little bit more on the new side.
Yeah, absolutely. So our leasing team has been doing a great job on both renewals and out there focusing on leasing the vacant space that we have.
As I mentioned, we've 85000 square feet of new leases that are signed and under construction.
When those are completed and generating revenue.
At about a 100 basis points to our same store.
To recruit new tenants. It is tough right now given the construction climate out there.
And on a per square foot basis per year. This last quarter. I think we were close to six $6, which is a per square foot per year meaningfully higher than our renewals where were experiencing quite a bit of a tenant's.
Tenants exercising options to renew or we have auto lease renewal language and a lot of our leases keeping our capex low on renewals.
Yes.
And then just.
On the tenant credit side, which Tayo just hit on.
Is there anybody on the watch list I mean, the tone sounds definitely a little bit more cautious which I get.
Or has the rent coverage numbers at those moved materially too and if you could provide any sense of a range of Weirdoes carpet you start just to get a sense of question, where we are today, even with the turbulence going on in the market.
Yeah.
Yeah, Hey, Ron This is Jeff no I mean, we haven't seen anything material.
In terms of.
Any relief requests or anything like that coverages remain about the same I mean, there are probably a little bit down, but not nothing that would concern us at this point I think J T. His remarks were just addressing the overall industry and you know what the health systems are going through right now but.
But we're not concerned.
About our own our own portfolio at this point.
That's it for me thank you.
Hi, Glenn.
Our next question comes from the line of Boston, where Schmidt with Keybanc. Please proceed with your question.
Yeah, Hi, good afternoon, everybody I'm, just curious on the 25% automatic renewals that you referenced how how our leasing spreads negotiated for those types of deals given you're spending less on Ti dollars and are you able to change for the escalator dynamics within those types of leases.
Yeah, that's certainly varies lease by lease, but a lot of leases do have fair market value language included in them. So that is a conversation that we certainly have with the health care partners in some cases brokers in the market to help us determine the fair market value.
Clearly in many markets, that's increasing as a result of the construction costs and.
And the inflation that we're experiencing in this environment.
There are a few examples where the lease has just continued to escalate to the previously negotiated annual rent escalator, which may be two or 3% I think that really makes our leasing spreads that much more impressive when you factor in some of those options to renew that are renewing at 2% to 3%.
That's helpful and I know next year's explorations not really a huge number overall, but you did highlight this quarter is coming in above your expectation I suspect those might've been negotiated during a different economic backdrop. So what does it give you guys. The confidence you can continue to achieve.
You know re leasing spreads above historical levels, given sort of this tenants are catching up the reimbursement environment is catching up and it's just a little bit tough.
Tougher overall for a given some of the expense pressures et.
Et cetera.
Yes.
J P often the.
So the confidence level comes from again real time market discussions as you mentioned most of the leasing is an 18 months conversation before.
<unk> concludes and we still have high construction cost. It's it is the growth in that construction cost is moderating it's coming down with certain types of materials. Some labor, but we still have a high inflation rate, that's going to drive better leasing spreads for the foreseeable future. So.
We'll have more kind of foreshadowing in our next call at the beginning of the year, but for now we see continued positive trend.
And higher than usual rates.
Thanks for the time.
Yep.
Our next question comes from the line of Michael Griffin with Citi. Please proceed with your question.
Great. Thanks, maybe starting on the transaction market. It looks like things have obviously slowed I'd be curious to get additional thoughts on if you're sick of private market appetite for for Mlps out there and maybe a sense of where cap rates are if they've traded have sort of gone in and have you noticed a change in the spread between on versus off campus cap rates.
<unk>.
Yeah, they're just the market.
The most part just shut down right now.
Interest rates declined dramatically since since our most recent investment in the second quarter or the beginning of the third quarter.
Banks have shut down lending to the private market.
Well you can find a loan from small regional banks youre not going to get large capacity for port volumes are there.
Expensive assets so asset.
Looking at cap rates.
I think now the brokers learn that it's you know it's going to.
Best case scenario to six and if you look at the cost of debt. If you can even get it.
And the equity prices of MOV buyers in the public market Youre in the sixes and sevens before it becomes accretive.
And you match up capital market cost with the most.
I'm a seller expectations. They just haven't caught up there yet so.
We've just paused, we're continuing with our development financing.
We're at about 200 million of total investments for the year, we're still working through some of our development pipeline.
Assuming we can get.
Kind of can match up our yield expectations and needs compared to our capital costs.
And we expect next year to be pretty robust buyers' market. If you will so market just does not.
<unk> discovery continues its getting closer, but we're not there yet.
Capture that's that's helpful and maybe just staying on the recent transaction activity I'd be curious to get a little more color on the Calico acquisition you know maybe why it made sense. You know also the JV partner and it could there be a potential for future opportunities with this partner going down the road and maybe an additional color there would be helpful.
Yes, let me address the JV partner first it's one of our long standing partners.
As I mentioned earlier, we're in our 10th anniversary year.
As a public company are they beginning in year. One we did we started doing some <unk>.
<unk> hundred one.
<unk> opportunities with them.
Great sophisticated.
Private company in Dallas that we've known for a long time and they found opportunities for us to go invest and we sold them asset we bought assets from them et cetera. So a great partner they brought us into this opportunity. So if you recall, we had just completed the sale of great falls in Montana that $4 seven cap rate.
This is an asset that wasn't the.
Taco asset in Brooklyn was not on the market.
When our JV partner started talking to them earlier this year expectations.
And fair expectations were in the low four cap rate range.
By the time, we were invited to join those discussions.
We had just completed the great falls transaction.
We needed to substantially better price in the low fours, we were able to convince the seller to accept our first year five five cap rate this is little bit of leasing opportunity there.
Not much but long term rate investment grade tenant base a lot of physicians affiliated with that health system in the building new asset.
Relatively new building less than nine years old and the Brooklyn market and the opportunity for cap rate compression once cap rates start going back in that direction.
<unk> outstanding so the Irr's look fantastic and again, we just had that that recent sell just perfect perfect opportunity to recycle.
That cash those proceeds.
Into our high yielding long term asset.
Alright, that's it for me thanks for the time.
Thanks.
Our next question comes from the line of Joshua would better align with Bank of America. Please proceed with your question.
Yeah. Thanks, guys, maybe just a follow up on the Calico acquisition I'm, just curious how you're how you're thinking about your weighted average cost of capital.
So that five five.
What's it for.
Yes, Josh just mentioned that that was really an opportunity to roll four seven cap rate proceeds from.
Asset that we generate a very large.
Net gain from the withheld for nine years said Opportunistically.
Rolling that cash into that investment if we were pricing it today and we haven't sold and sold assets to recycle that in an accretive way like that.
We would think about the pricing differently interest rates have gone up 150 basis points since we completed that transaction.
A different world.
You know two months three months later, but at the time it was a perfect opportunity to roll roll that cash into an accretive acquisition and as I mentioned, we think about these investments on a 10 year plus IRR basis.
If you think about the long term opportunity for compression in that market of a new asset.
We think its outstanding long term IRR.
Okay.
How are you thinking about your WAC These days, where where does it stand.
But on a long term basis.
Hey, just so you know when we look at our our weighted average cost of capital and use that to evaluate potential acquisitions. We're obviously looking at cost of equity cost of debt because of that.
You know the debt markets are not super functional right now, but I think we could probably do long term 10 year debt.
The six and a half to seven range.
Depending on what day. It is a 10 year stumping all around these days.
Cost of equity is obviously going to be higher than that.
Kind of look at a bad yield plus an expected growth rate. So you know we're looking at IRR that are between eight and nine is it like a target range.
Levered basis.
And so I think that matches up pretty well with what Jay was talking about when he was saying that cap rates need to be in the six isn't possibly sevens in order to be accretive.
Okay. That's helpful.
Our next.
Question comes from the line of Randall Camden with Morgan Stanley . Please proceed with your question.
Great just a couple quick ones are just starting on the debt side.
Just looking at the stack here I see the $2 $62 million on the revolver.
That's floating I see the one O five that's floating is wow.
Yeah, you guys are sort of thinking about next year, yeah. It sounds like every 1% move in rates on the floor is there's sort of $3 6 million of headwinds how're.
How are you guys thinking about for the headwinds from that potentially next year are you thinking about hedging.
I'm just curious thanks.
Yeah, It's a good question.
We've got about 18% variable rate debt, which you know, we're certainly cognizant of that especially as rates seem like they're going to continue to increase.
We do like having some cushion to variable rate debt, that's easy to pay down if.
If we have loan paybacks from our mezzanine program and that kind of thing. It's a good short term use of proceeds that there's kind of anti dilutive when you get paid back.
But certainly that's something that we continue to evaluate on a quarter to quarter basis.
Hedging strategies et cetera.
Yeah.
Great and then just continuing to put together you know some of the bread crumbs on the same store NOI fraud.
You know I think sort of the previous question I think you've talked about.
Some of the you know some of the repositioning and stuff that that's that's being a drag a little bit from the historical 2%, maybe a little bit lower this quarter, but even if you get back to that at two per sat isn't there a scenario that that basically a F. L. O F. I was actually flattish next year or.
Just I'm just trying to think about the interest cost headwind versus the same store NOI growth am I thinking about that correctly or how do you guys think about it.
Yeah, I mean, you know like like everyone.
Fight interest rate headwinds as they continue to go up.
You know I think the same store NOI, particularly if you add in some additional leasing opportunities that we think we might be able to get we do believe we'd be able to overcome that kind of headwind if you will.
But certainly.
It's kind of a tight environment right now.
Ideally, we get some accretive acquisition opportunities as well, which could further enhance our F. A D and <unk> per share growth.
Makes sense and my last one is just going back to the transaction markets.
You know you did some some equity at sort of 18.
She now the stocks are a little bit lower with the soft and the market is it fair to say that you know other than maybe sort of recycling.
Assets, where you know you're selling to buy into it. It's it's sort of it might be tricky to do anything else.
Going forward or is that like is there any sort of other source of capital JV capital that you guys are thinking about or is sort of recycling kind of be the main.
The main driver from here.
You know I think it depends it's Jeff again, it depends on you know kind of where we can find pricing in the market I mean theres certainly.
Potential.
Acquisition pricing that would work even at our cost of equity right now.
Like we haven't seen it yet because the market has kind of shut down but should the pricing go to there I think.
Using equity would be a viable way to do that certainly we look at capital recycling as well and we've been in contact with potential JV partners for.
Years.
And if we had an opportunity that we could avail ourselves of that source of capital. We would also consider that as well.
Great. Thanks, so much.
Okay.
Our next question comes from the line of Michael Carroll with RBC Capital markets. Please proceed with your question.
Yeah. Thanks, So I wanted to touch back on overall market rent I mean for Mlps I mean, how broad base is rent growth I mean is it really regional I mean are you seeing it I guess the difference between on campus off campus I mean, how much has it been up really in 2022 and have you seen it accelerated through the end of this year.
Hey, Mike, It's J D I'll, let mark comment as well, it's mark it's market to market.
It's kind of where you're starting from that's why.
It's not like rent growth slowed down because this quarter was 6% last quarter was 8%.
It's the leases coming due and what they are where they are in their current market compared to the existing market nationwide construction cost or high those markets that are the strongest Atlanta Minneapolis, you know some of the some of the Smiley face markets Phoenix.
We're growing at faster rates than than others, but we're seeing opportunities really across the board. So we do expect that to continue.
And again.
It's going to be quarter by quarter, but also market by market and where the opportunities are as you know most of our acquisitions come with new 10 year leases. So we only have so much roll each year.
To be able to capture this rent growth.
Attunity.
And then those tenants as we mentioned where they have options to renew at either fixed rates or current plus 2% kind of roll or some kind of market rent.
Arbitration process.
That changes that dynamic again, just based upon the leases in place. So it's truly across the board the opportunity across the country, though is to roll rents up.
In most markets, assuming where we were at market rates common spirit as an example, we disrupt those 10 year leases in 2016 those were all struck based upon the market rates in place in those individual markets at that time, So again all of those should be.
At faster rates today.
Yeah, I think it also varies a little bit by specialty.
And into as well, where there's higher acuity specialty and more custom build out those are very sticky spaces, and therefore have a little bit.
More opportunity to influence the rental rate upon renewal.
Just the alternative and the construction cost to relocate those are very difficult, especially and expensive in todays market. So when you have a little bit more of an opportunity to increase based on specialty yeah and Mike. The other thing I mentioned is.
The difference between on and off campus I would tell you most of our development financing is off campus as health systems are trying to penetrate new markets and capture market share.
As they came out of the pandemic with balanced balance sheet strength.
So I'd say, there's probably more opportunity in the off campus.
New growth locations.
While there is still strength in the <unk>.
Billings as well. So you know we're about 50 50, so we have kind of both sides of that.
No that's helpful and I know, it's probably difficult to kind of answered this down just because the market is still uncertain.
Due to current market rents today can you support a new development project or a break ground on new development project, given where things are right now or just rents need to go up a certain percentage should really kind of make some of that underwriting workout.
You hit the nail on the head.
Sweet demands are.
Highly pre leased 90% plus most of them run in the 100% at 100% with health system anchor tenants.
And they are approaching that we're approaching that on a yield on cost basis, and then comparing that to the actual construction cost.
Comparing that to market rents, which are by definition today are going to be higher than kind of an existing building, but as I mentioned these are health systems trying to capture new market share.
Expanding locations geographies, where they don't exist today so.
It's a balancing act. So we were only going to fund those where we're comfortable that that spread to an existing building.
You know can be achieved in the services that the health system is going to put in those buildings.
I think all of the things we're looking at right now they have bandwidth more surgery centers, and then partnered with physicians partner of orthopedic surgeons.
High margin services moving into those locations. So it's a balance it's something that we have to be careful about in our underwriting and we're confident that we are.
Okay, and then just how difficult it is to probably source new acquisitions. I mean are you seeing other opportunities on the debt side I mean could we expect you to be a little bit more active.
Making debt investments over the next few quarters or do you really need to see where interest rates kind of really hammer out before you are willing to do either that type of stuff.
I think that's a great question, Mike I think.
Yeah.
Historically made dead investments either as part of development.
Sort of a recap of the seller, who is not ready to sell but as Wellington ready to partner with us in some kind of economic basis.
Most of the private activity because you know we've been competing more with private buyers in the last three to five years and we have a public buyers.
Most of that activity and high cap rates was done with.
Low cost debt that was three to five year debt. So just do the math, we're looking at 2023 2024.
An opportunity to step in in a very beneficial way for.
For high debt or high yield higher yielding debt or acquisition opportunities.
They are preferable cap rate. So that's why we're excited about next year.
The following year both of them.
Operations, but also the opportunity to deploy capital again, assuming.
The capital markets to open up for us to match fund that.
Great. Thanks, I appreciate it.
Yep.
Our next question comes from the line of Steven Valiquette with Barclays. Please proceed with your question.
Great. Thanks, good afternoon, everybody so.
This was touched on a little bit, but just back on the question on the components of the same store cash NOI growth.
Because last quarter, you had same store revs.
At 4% operating expenses up 8% to get to the 1.9.
This quarter, it's revs up one point for operating expenses, you know much more in line and only up to to get to that 1.1.
Talk about the reasons why that is where it is for the quarter Thats all kind of understood. I guess the question is if you had a crystal ball this for next year.
The round numbers I mean, what are the components just on the revenue growth and expense growth to get to where you think and I would say.
Same store NOI, what kind of shake out for next year once the dust settles on the re tenant paying and everything else.
Yes, I'll take that.
Next year, we do think that theres going to be a nice rebound in our same store.
Our operating expenses this quarter were particularly low because of some of the real estate tax challenges.
That we were successful in contesting on behalf of our health care partners without those real estate tax.
Benefits, we would've been closer to 7% increase in our operating expenses and you know it is an inflationary environment up there. We will continue to work on behalf of our health care partners to keep those operating expenses as low as we can but the nice thing about our portfolio, it's very well insulated due to our high occupancy and triple net lease structure. So we think that those off.
Operating expense increases next year will be offset.
And therefore, we're really going to benefit from the leasing work we've done both in terms of the new leases coming online the 85000 square feet I mentioned.
These leasing spreads and so I think in 'twenty three we will start to see the benefit of that and get back to our normal levels or even just a bit above our normal levels in the back half of next year.
Okay I got it okay. That's it for me thanks.
Thank you.
Our next question comes from the line of Mike Mueller with Jpmorgan. Please proceed with your question.
Yeah, Hi, I have two quick leasing related questions first mark on your comment about same store occupancy bottoming in the fourth quarter.
What's the rough magnitude of the decline relative to <unk> 94, 7% and the second question is just on the rent escalators, you've baked into your 2022 leasing how do they compare to prior years escalators.
Yeah, so on the first part.
Q4 occupancy, we do know of our.
Our retention rate is historically, 80%. So we know that there's going to be some some move outs, but we're going to offset that with some new leases as well. We've got 20000 square feet of leases signed that will come online in Q4, but we do think same store will bottom.
Occupancy will bottom next quarter, and then rebound in 2023.
In terms of our annual Escalations.
Our leasing team did an outstanding job this quarter, averaging three 1%.
Much better than our historical.
Averages in the 2% to 3%, we're really pushing three and even four sometimes when we can get it on our annual escalators to build in that long term growth over a.
Five to 10 year lease.
Got it okay. Thank you.
Our next question comes from the line of Dave Rodgers with Robert W. Baird. Please proceed with your question.
Yeah. Good afternoon, Mark I wanted to go back to the the sweet turnover that you talked about in the re tenant them that'll drive some of the results in 2023, which was there something that drove this year to be a higher amount of turnover within the portfolio I would think that would be kind of a recurring natural thing for you guys. So I'm curious about how you view that in the next year or two versus.
Maybe what made this year, a bigger year of that turnover.
Yeah, I don't know that this is necessarily that much bigger of a leasing volume or our turnover.
Next year, we've got about four 6% of our leases up for renewal, it's kind of been our average and our lease exploration schedule has been 3% to 4% a year.
And until we get to 2026 and those common spirit leases so.
Yeah right now, there's just been construction timing of.
New leases.
Completing those and starting rent payments.
Yes, I think the this is J T. I think I think part of the dynamic is so like the ASC option here.
They were probably looking at building their own building or.
Kind of going into a new development at higher rents as we talked about the development financing, we're doing with health systems that are capable of absorbing those higher rents, but doing much larger buildings and footprint. So high construction costs makes moving into an existing building a better option or repurposing.
Existing building, a better option than a brand new development projects. So I think that's probably driving some of the some of these changes and to do that if you need 20000 square feet. We don't have 20000 square feet available in the building.
We're gonna have to eliminate non renewing some leases to make that happen.
Alright, that's fair enough and then J D. Maybe just for you with regard to you talked about kind of fully leased acquisitions, you've got you know fully stabilized developments that you're financing.
Do you see an opportunity between that to do more maybe on the value add side with the leasing team you have and the people that are in the organization to maybe add incremental value, particularly coming out of the backside of the dislocation in pricing.
Yes, no I think we were exploring all those opportunities again right now, but kind of just investment pipeline is still there it's just quiet and.
Sellers, if they are not forced to sell right now we're trying to kind of ride it out as well.
But I think we will see more buying opportunities next year, but no. We've always look for opportunities where they might be 80% leased but we have a tenant in hand, we have so much repeat business and so much.
Aggregate the business with hospitals, all over the country with physicians groups in multiple locations. So.
We're kind of always looking for an opportunity to buy 80% occupied building and backfill it with a with a lease in hand with an existing client. So that is a great great comment great suggestion and something we explore.
I appreciate it thank you.
Yes.
There are no further questions in queue I'd like to hand, the call back to management for closing remarks.
Doug I appreciate it. Thanks, Thank you everyone for joining us.
I'd like to welcome to the Doc family Q and.
His wife had a young baby Girl last night, we're just excited for him to use leads our credit efforts and he will be back doing credit analysis Tomorrow I'm sure.
Now he will take appropriate amount of time and get to notice new daughter.
We just appreciate everybody joining us today.
Okay.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.