Q4 2022 Physicians Realty Trust Earnings Call
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Earnings Conference call.
At this time all participants are in Arlington.
Hey, Matt.
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And no one should require operator assistance during the conference ladies crash.
On your telephone keypad.
Sure.
This conference is.
It is now my pleasure to introduce your host Brett. Thank.
Thank you.
Yeah.
Thank you Maria good morning, and welcome to the Physicians Realty Trust fourth quarter 2022 earnings conference call and webcast joining.
Joining me today are John Thomas Chief Executive Officer.
Jeff Theiler Chief Financial Officer.
Our Chief investment Officer, Mark Klein Executive Vice President of asset management.
John Lucey, Chief accounting and administrative officer, Laurie Becker, Senior Vice President Controller, and Dan Klein Deputy Chief Investment Officer.
During this call John Thomas will provide a summary of the company's activities and performance for the fourth quarter of 2022, and our year to date performance in 2023 as well as our strategic focus for the remainder of 2023, Jeff Theiler will review our financial results for the fourth quarter of 2022, and Mark will provide a summary of our operations for the fourth.
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Today's call will contain forward looking statements made pursuant to the provisions of the private Securities Litigation Reform Act of 1995.
Collect 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.
We're looking statements depend on assumptions data methods that may be incorrect or imprecise and we may not be able to realize them.
We do not guarantee that the transactions that are best described will happen as describe whether they will happen at all for a more detailed description of risks and other important factors that could cause our 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 .
Brad.
This drill two trusts demonstrated resilience throughout 2022.
And then there is 2023 from a position of strength our assets are performing well demand for our space remains strong and our balance sheet is well positioned for outsized external growth.
We're proud of our achievements during the year, including attainment of the highest annual fad.
Funds available for distribution per share and the history of the company.
Cash.
Growth is supported by record leasing performance for the year, we executed leases totaling more than 1 million rentable square feet, including over 800000 feet renewals at an average spread of 6% retention remained strong at 77% and more than 60% of our executed leases had an average annual escalator of 3%.
Our greater.
We remain focused on creating long term value on behalf of our shareholders. This can occasionally require the selective non renewal of leases. When we believe that the space can be re let to stronger health system tests well. This has the effect of hurting total occupancy and same store NOI growth in the short term what do you believe that these decision.
And result in a stronger portfolio that deliver superior cash flow growth in the future.
During 2022, we increased the amount of space leased to investment grade quality tenants from 65% to almost 67% and we believe that we continue to have the highest portfolio leased rate of any public.
Medical office building Investor.
Rapidly changing interest rate environment required us to be disciplined when evaluating external growth opportunities. During 2022, still we were able to add to shareholders.
Value to shareholders through the transactions, we did choose to pursue and July we opportunistically sold disposed of are three great falls, Montana medical facilities at a four 7% cap rate generating a $54 million game and an outstanding 16% Unlevered IRR.
We match this transaction with a 160 million of new investments in 2022 highlighted by our $82 million acquisition of the Castle Medical Center in Brooklyn, New York, and a five 5% stabilized cash yield.
We also continue to work with several health systems to move development and redevelopment projects Board that we expect to proceed in 2023 and generate rent in 2024.
Our financial achievements were matched by our accomplishments that it as they relate to corporate responsibility in 2022.
We made measurable progress toward our goal of being a sustainable sort.
Staying ability leader across all real estate industry sectors for the year, we invested in 31 projects totaling.
$5 $6 million that will directly reduce the energy footprint of our facilities. While also enhancing the desirability of these assets to tenants.
Thoughtful investments like these are a critical part of our long term sustainability objectives, including our goal announced in 2021 to reduce our portfolio's greenhouse gas emissions by 40% by.
About 2030 over our 2018 baseline.
Social accomplishments in 2022 include 900 in two hours of volunteer work.
Individually and Corporately to the communities, we serve which exceeded our 600 hour goal by over 50%.
Doc also provided more than $408000 to philanthropic fund raising and in kind donations to community and health care provider organizations.
Sending their research admission initiatives in it.
Additionally in 2022, we earned recognition for modern health care is one of the best places to work in health care for the second year in a row and top workplaces honors from the Milwaukee Journal Sentinel and our headquarters for the fifth year in a row.
Our ESG efforts continue to receive recognition at asset and corporate levels there.
During 2020, 'twenty 210 dock assets were certified by item under the certified sustainable property program, bringing our aggregate count to 38 properties with this designation.
Separately, we earned 16, new energy Star property certifications under their recently relaunched it medical office building program.
Bringing our certification count to 26.
Qualifying dock is a premier member of the certification nascent efforts.
We're also proud to share that we were named to Bloomberg's gender equity index. In January of 2023 is the first time submitter distinguishing our work and gender equity in enhanced public discovered disclosure.
We're thankful to have been recognized in each of these.
<unk> and remain committed to maintaining our status as a leader within the health care REIT sector on matters of ESG.
In a few minutes, Jeff will discuss the strength of our balance sheet and Mark Don will provide more details on our operating results before that I'd like to take a moment to speak.
Toward our expectations for the year.
Go ahead.
In 2023, we have set ambitious goals to increase our occupancy at market rates and continue seeking medical office acquisitions and development opportunities.
Our development financing pipeline is more extensive than ever with more than 200 million at cost of opportunities under evaluation in exclusive negotiations.
We expect to proceed with many of these opportunities and are targeting stabilized project yields in the 7% to 8% range.
The acquisition market that has not yet stabilized with current capital market conditions on market transactions are working around the high six cap rate still with low volumes and a limited financing market. We do not believe the market has reached equilibrium with our weighted average cost of capital or the market's got to cap.
Generally.
In conclusion physician truly trusts enters 2023 with a strong stable and proven portfolio. Our balance sheet is strong and we remain disciplined in capital deployment patiently waiting for acquisition and development opportunities that will be accretive to our long term financial goals.
We celebrate our 10th anniversary this summer and we are proud that we have built this company to last for decades to come.
I will now turn the discussion over to Jeff Jeff.
Thank you John in the fourth quarter of 2022, the company generated normalized funds from operations of $61 $5 million or 26 cents per share our normalized funds available for distribution were $57 $9 million, an increase of five 4% over the comparable quarter of last year and our fad per share it.
Was 24 cents for.
2022, our normalized Fad was $242 million, an increase of 10, 6% over 2021 and our full year Fad per share was a dollar one.
Re leasing spreads remained strong this quarter at 7%.
And we expect the broader economic environment to support our efforts to roll the portfolio's rent up overtime.
On the expense side, we're protected from stubbornly high inflation by our standard Triple net lease structure in which we recover 84% of all operating expenses, which is about 20 percentage points higher than our peer group.
Well year over year same store NOI growth was below expectations at one 5% due to the movement due to the move outs discussed earlier in the year, we see positive results on a sequential basis with quarter over quarter same store NOI growing by one 3%.
On the acquisitions front, we had projected minimal acquisition activity in the fourth quarter and saw that play out with just a handful of strategic transactions, taking place along with some funding on existing loans patients continues to be the theme here.
While cap rates have drifted significantly higher we are not yet seeing a high volume of deals that meet our quality thresholds at pricing that makes sense in this capital environment.
Our cost of capital is extremely competitive right now so it isn't that we're competing against cheaper capital instead, we see this as the usual delay that happens when sellers have to adjust the pricing that is less advantageous than they could have received several months ago.
Therefore, we are reluctant to put out acquisition guidance at this time we.
We believe that either cap rates will adjust to historical norms based on current debt costs or we will see improvements in our cost of capital that will create opportunities in the current market environment.
We are in constant dialogue with potential sellers and health system partners and believe we will be in an excellent position to grow the company's earnings substantially when this bid ask spread closes.
We took steps to bolster our balance sheet further by issuing $74 million of equity in the fourth quarter on the ATM along with another $66 million on the ATM in January .
This places our balance sheet on a debt to EBITDA run rate of five two times on a consolidated basis and provides plenty of dry powder for us to utilize at the right time.
Finally, a few updates to our 2023 guidance, we expect G&A to increase by about four 5% at the midpoint to a range of $41 million to $43 million.
Recurring capital expenditures are expected to increase modestly by about 5% at the midpoint to a range of $24 million to $26 million as we.
To see tenants trade Ti dollars for lower renewal spreads.
As mentioned earlier acquisition guidance will be withheld until we have more visibility on how cap rates and capital costs evolved in 2023.
With that I'll turn it over to Mark to walk through some additional operational details mark.
Thanks, Jeff.
Our tenured asset management leasing and capital project teams are United in our focus to serve our health care partners, while growing cash flow for our stakeholders.
We contributed to these goals in 2022 by delivering record renewal spreads maintaining retention and efficiently prioritizing capital project investments in this inflationary environment.
These successes are the direct results of our commitment to outstanding customer service and in line with our care core values.
Despite the difficult macro environment, we delivered record full year renewal spreads of 6%, while maintaining retention of 77%.
Importantly, these results were achieved without offering excessive incentives with full year renewal Ti is totaling just 80 cents per square foot per year.
This efficiency was matched by our capital projects team, who deployed $23 $9 million of recurring Capex in 2022, representing $1 48 per square foot.
During the fourth quarter, we continued our positive momentum by achieving renewal spreads of 7% on 141000 square feet of volume with leasing cost totaling <unk> 45 per square foot per year.
In addition, new leases totaling 42000 square feet commenced during the quarter at an average rate of $18 64.
Tenant improvement costs on new leases totaling $3 89 per square foot per year remained well within industry averages demonstrating our commitment to bottom line effective rent rather than headline rate.
The weighted average annual rent escalator on this quarter's 182000 square feet of leasing totaled two 9% a significant increase against the portfolio average of two 4%.
And mob same store NOI growth was one 5% in the fourth quarter below our historical 2% to 3% growth rate due to the 30 basis.
Basis point decline in occupancy from the vacancies, we discussed last quarter.
In total this 51000 square feet of lost occupancy across $13 5 million square foot same store portfolio is largely explained by activity at two specific buildings.
Same store occupancy continues to be impacted by the strategic non renewal of suites and MLB in Minnesota.
Allow for the construction of a brand new ASC that is currently under construction at least to the dominant investment grade health system in the market.
The new 21000 square foot surgery center is expected to be completed and paying rent during the third quarter of 2023.
Second 22000 square feet of vacancy is attributable to an MLP in Pennsylvania, where our historical physician tenants were employed by a hospital and relocated to the hospital owned medical office facility at the end of the lease term.
We are making several investments to improve this space and we have partnered with a local brokerage team with strong health care relationships.
Overall, we do not view the small amount of negative net absorption to be indicative of market conditions or our potential for internal growth, but rather one off events that will have a short term impact on the portfolio.
Excluding these two assets MLB same store NOI growth would have been 2%.
Well, we don't typically highlight our sequential same store results. The one 3% growth in NOI stable occupancy and 0.5% reduction in operating expenses show positive progress and the impact of our teams' efforts. This.
This is our 19th consecutive quarter of positive same store NOI cash growth.
Again, we enter 2023 with strong leasing momentum.
The macro leasing environment continues to offer an advantage to existing medical office inventory with quality space in move in condition due to the cost and time required for new construction, especially in markets like Phoenix, Nashville, Atlanta, and Dallas, where Doc has a strong presence.
At the beginning of the year, our leasing and marketing teams launched a comprehensive campaign to increase online exposure of our properties target key brokers and market influencers and leverage the relationships and knowledge of our in house property management team.
Just two months into the year, our efforts are already yielding results as tours of vacant space are up nearly 30% year over year and we're trading proposals on over 162000 square feet of vacant space in the portfolio.
Our leasing and property management teams have a busy calendar of broker open houses to showcase our portfolio and demonstrate new virtual reality technology, which allows prospective tenants to visualize a customized suite and finishes before commencing expensive construction.
We have dedicated approximately 60% of our 2023 recurring capital budget of $24 million to $26 million to leasing initiatives that include renovating vacant suites.
Tenant improvement allowances to retain and attract health care providers and general building renovations, where there's a strong leasing activity due to the supply and demand of physicians in the market.
Through these collective efforts, we believe there is opportunity for an increase in total portfolio occupancy in the back half of the year.
Following a typical three to six months it takes to design construct and commenced the new lease.
We expect this positive momentum to also appear in lease renewals.
While 2023 scheduled exploration volume remained small at four 5% of the consolidated portfolio.
The market conditions that helped contribute to our success in 2020 to remain intact.
For the full year, we expect renewal spreads to be in the mid single digits compared to the long term and maybe industry expectations of 2% to 3% and we anticipate retention to be in line with our historical average of 75%.
To conclude.
We anticipate that our operational initiatives will lead to improved same store NOI growth beginning in the third quarter of 2023.
While below target same store performance is frustrating in the short term, we believe that long term value is maximized through thoughtful portfolio management intelligent capital investments and aggressive leasing initiatives.
The thesis for medical office is as strong as ever and we're excited to execute on behalf of our stakeholders in 2023 with that I'll turn the call back over to John .
Thank you Mark Maria we're now ready for questions.
Yeah.
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Your question please.
I was wondering I'm, sorry, spreadsheet comes from Shannon and Brent with BMO capital markets. Please go ahead.
Hi, good morning, and thanks for the time.
Just hoping to talk a little bit more about the leasing efforts in the occupancy upside.
Can you kind of quantify how much occupancy upside you expect I think you said it in the back half of the year and would that really be driven by filling.
Current vacancy or is it more incremental new leasing of space.
Sitting vacant.
Ben.
And given me you kind of give the piece parts of releasing spreads and occupancy a bit what is your expectations for same store NOI for for 'twenty three.
Hey, Juan Thanks, a lot this is J T.
You know I think.
Our ambitious goals this year are around both vacancy and.
Really kind of non renewing.
Lower quality credit tenants with higher quality health system tenants, who need the kind of need to expand in this space and they are building so.
You know, 95% to 96% is somewhere in that number is full occupancy and so you know our ambitious goals or just kind of it's kind of hit those numbers and so positive accretion for the year and our compensation goals are tied to that as well so.
We think that's very achievable.
Somewhere in that range and.
You know same store.
A number that is impacted by.
A small percentage very small percentage of.
Move out some of which we caused on our own.
In sequential quarters, and it takes a couple of more quarters to backfill that space with both <unk>.
Lease is signed but also more importantly, kind of completing the ti and the commencement of those leases so back half of the year, we have high expectations for good solid kind of return to our same store growth.
Or is that a historical.
First half of the year, we're kind of burdened by the kind of decisions. We made we think the right decisions in the third and fourth quarter of 2022.
Okay, and then I was just hoping for some color on the transactions market and kind of where you see that the bid ask spreads in terms of cap rates of where dollars are still holding on or what you think is realistic.
Your capital costs are generally higher capital across across the market.
Yes, great Great question.
We're seeing a significant movement in cap rates that are just not many transactions occurring sellers are just holding on.
<unk> that we've returned to the.
Glory days of 2020 and in 2019 from a cap.
Great perspective, but.
Transactions are occurring in the mid sixes.
We think and we think we have a great cost of capital in the current environment, but that cost of capital still.
Specs needs.
So kind of high sixes to mid sevens kind of cap rates, depending upon the annual increases in the rents and things like that.
To to execute so we think there's a good opportunity in the back half of the year, assuming that are kind of the market reaches equilibrium in that range, but in the current environment. We're just not seeing many trades that are right quality right credit.
Alright location.
That we want to buy.
Kind of in the mid sixes. So we want to get we want to see that those cap rates move up.
Thanks.
Jeff said, we've got a balance sheet loaded two to.
To execute once we reach equilibrium is my word.
And cap rates with market cost of cap.
Thanks, Sean.
Next one.
Our next question comes from Josh <unk>. Please.
Bank of America. Please go ahead.
Yeah, Hey, guys I just wanted to follow up on some of your opening remarks on the lease escalators. Thank you said you are.
For leases signed in <unk>, you're guiding to 9%.
Up from two points, where the in place portfolio I guess, how are the current conversations going for leases renewing in 2023 are you able to push a little bit more.
Aggressively.
On the go forward leases.
Hey, Josh Great question.
That's one of them that's one of the things that just kind of understated in our comments.
Oh.
Sir you May proceed.
Maria can Nate can you hear us.
Yeah, Hey, Josh can you hear us okay.
Hi, Yeah went out basically right when you started talking I'm sorry.
The best comments I've ever made on an earnings call.
Yeah, that's what I figured.
All the good feedback exactly exactly suite the stock would have gone up 20%.
Now just getting a job what I was saying was.
I think 60% or more of our leases in the fourth quarter, we renewed with an average annual increase was over 3% or 3% or more.
And you know.
The compounding effect of that is probably the best thing we can do in our leases and just moving our kind of average annual escalator up from two 4% I think we're up to two 5% now we continue to move that up so those conversations continue to be strong and we continue to have a kind of some negotiating.
Power and the average annual increase was to move those up beyond historical averages and our leasing team led by Amy Hall and her team are doing a great job.
Kind of a focus on not only the renewal rate, which again for last year was 6% or more.
But also that average annual increase or so.
We tried to get CPI them, we cannot try to get floors in.
In that CPI increaser, but you know just moving that number up has a long term compounding effect, we don't sign one night leases or two or 30 day leases or even one year leases, we signed five years or more.
Increase leases and extensions on existing leases and that average increases are really important part of our strategy to grow NOI over the time.
Okay I appreciate that color and then you move on.
Hey make sure your question for me.
Any kind of changes you're seeing with health systems in the current environment kind of coming out of Covid I know they had some labor pressures.
Some challenges on that front like anything they are looking to do differently that might help your business or are hurting a little bit.
To get a sense of the landscape.
Yes, since 1982, there's been a push by Medicare and payers to move more care out of the hospital into outpatient settings, I think health system realized during COVID-19, they don't have enough outpatient space.
Available for the kind of demand in their markets and so what we're seeing differently from health systems that it is a more intensive strategy to open new outpatient locations in strong demographic locations and that's what's leading to a lot of development opportunities for us.
All health systems investment grade and otherwise had challenges in 2022 with inflation and labor.
Shortages and stress of labor and things like that we're starting to see that stabilize.
The revenue side or the reimbursement side of healthcare.
There's always a lagging indicator not lagging indicator lagging impact on there.
P&L statements and so expenses are real time revenue.
Reimbursement rates take time to catch up with the.
Inflationary pressures.
And so we're starting to see starting to see stability there, but at the same time.
Reimbursement increases kind of catch up with inflation so.
Lots of lots of ways to go but.
U S health care economy. This year is going to be three five trillion dollars. So there's lots of lots of money in the system lots of intensive.
Efforts to move more care to the outpatient setting which is more profitable and at the same time some stability in the labor market.
Appreciate that thank you.
Thank you.
Sure.
Great.
Jim.
Question. Please.
Please go ahead.
Hi, Yes, good morning, everyone.
Question on internal growth.
Everything that's happening on the topline is pretty impressive even with some of the deliberate occupancy drag.
But with Opex I think you gave the same store opex growth was nine 8%.
Can you just talk a little bit about.
What's the kind of mitigate.
Some of the Opex increases.
Going forward and specifically is part of that just because of again.
Triple net leases, but not everything is possible at this point, Jeff I believe you mentioned that the Ada.
4% reimbursement rate could you just talk a little bit about how.
Estimate in some of the Opex growth get mitigated going forward for better same store NOI growth performance.
Yes. Thank you Tayo I might ask mark to respond to that yeah, I think more entitled.
So.
As you pointed out our operating expenses in the fourth quarter were up nine 8%, it's definitely higher than historical norms, but.
One thing kind of below the surface, that's really pushing it up this quarter is.
Some one time insurance costs, our insurance in the quarter was up $1 $2 million over over the prior year.
And again those were some one time costs in the quarter.
But one of the things we really appreciate about our portfolio.
As Jeff alluded to is that we're 95% occupied and highly triple net leased so our operating expense recoveries were actually up 10, 3% offset that increase.
What our asset management team is really focused on is controllable expenses and you know where we've got the ability to impact <unk>.
Long term the operating expenses of the portfolio and if you look specifically a controllable operating expenses in the quarter those were up about 555%.
So that's.
Pretty good run rate and great work by our asset management team in this inflationary environment to really focus on those controllable expenses.
Which exclude insurance and taxes.
That's helpful.
And then the continued investment in real estate technology, you guys, but like half a million into that again this year. This.
This quarter could you just talk a little bit about again the ultimate.
Return on investment that you were looking for how this is going to help you die.
Operating expenses.
Can you just kind of looked at more investments on the technology side.
What exactly do you kind of expect to get out of that.
Hey, Tayo this is Jeff.
Good question. So you know look we think we will get a good return out of that investment.
On a monetary basis, but really the investment is also designed to help us stay in front of the latest technology latest real estate technology and to your point I mean help us manage our operating expenses going forward. So we think it is going to be a good return on the investment side, but it also.
Gives us front row access to all these new companies that are coming out with innovative real estate solutions and really helps us be at the forefront of having the best possible.
Management of our properties and keep our operating expenses low for our tenants and which of course helps the company itself.
Are you partnering with any of those companies at this point I mean any kind of result.
Tom I think it's.
As J J D. I think I think part of the opportunity.
And this prop tech investment we made is to work with other reach to kind of.
Identify and <unk>.
Benefit from kind of the best.
<unk> out there so I don't think our shareholders are looking for us to.
To our own platform I think that the benefit is we're investing alongside other Reits and other.
Institutional real estate owners to kind of develop tools that we will benefit from and at the same time have a great IRR or return on investment from those that direct investments. So we haven't seen anything directly but we get to explore these tools, which is part of the opportunity.
That are underdevelopment are that are kind of leading edge technology. So we'll see some long term benefits eventually.
Great and then one more for me if you can indulge me just from a capital allocation question. So some of the recent equity issuance.
Again, what again are going to be the use of.
Of the funds must be just kind of given the issuance of that your current kind of implied cap rate.
And lastly, how do we think about the dividend outlook going forward given like the 96% payout.
Payout ratio.
Yeah, Jeff.
Hey, Tayo, so yes, we did some.
Equity issuance on the ATM, we're trading at an implied cap rate in the mid 6% range. That's.
That's consistent with where we've seen class a medical office buildings being marketed we haven't seen many transactions closing still.
And cap rates have really only been moving in one direction, which is up so we thought it was prudent to strengthen our balance sheet at these levels, which we think is going to give us a great opportunity when when the market stabilizes at what we think the right numbers are too to really be an active investor in to really.
Generate strong earnings accretion, which is.
Certainly a departure from the previous times when cap rates were so low it's hard to generate earnings accretion, we think we're going to be able to get.
Best in class class a mlps.
At really good pricing so we feel good about the strengthening of the balance sheet.
Obviously in the meantime, it also pays down our variable rate debt, which as you know.
Also seems to be only moving in one direction, which is which is higher with the fed's increases.
No.
It's a smart capital allocation decision.
Great. Thank you.
Thanks Tayo.
Our next question comes from Michael <unk>.
Please please go ahead.
Great. Thanks, maybe to follow up on <unk> last question there related to the equity issuance I mean, you've talked about being disciplined in 2022 patients continues to be a theme you mentioned a competitive cost of capital.
Why the equity issuance now I guess, just given the sense that it's at a.
Pretty notable discount to consensus NAV is that you seem like you're fine for them from a balance sheet perspective. It seems like the capital markets are going to be pretty muted for the near term.
Why did it make sense now and why not maybe put it off for them you know until capital markets activity improves.
Yeah, Hey.
Hey, Mike.
I'll take that yeah look I think we're running at the low end of our leverage range right, which we've put our leverage range out at five five to six.
Certainly one could argue that the capital markets have been very choppy over the last few months I mean, certainly we've had a good month in the capital markets. Overall are good year to date I should say.
But that's not guaranteed by any stretch.
So really the idea is it's it's kind of.
It's not a discount to where we're trading on an implied cap rate versus where we'd be buying assets today, if they were closing.
So I think it makes sense to have that optionality to kind of build that dry powder now such that if the capital markets freeze up for some reason, we're still going to be in a position to grow and grow when others can't.
Right. So it seems that in your view its relative unemployed cap rate basis, maybe investors should be thinking about it on that basis relative to your premium or discount to Nab am I reading that correctly.
I think that I mean, they go they go hand in hand, right, but yes, I think that's how we're thinking about our implied cap rate versus where assets are trading in the or are being marketed right now I should say, okay cool.
And then maybe one for Mark I know you talked about you're selective non renewal of certain leases you mentioned, the mlps in Minnesota and Pennsylvania as examples.
Get the long term strategic rationale behind this but I just wanted to know.
Clarify or is there any potential for additional strategic nonrenewals that could impact occupancy in 2023 and any additional color on that would be helpful.
Yes sure.
So again, we strategically.
Did not renewed two leases do in Minnesota to bring in an investment grade tenants. So that's been a great great long term value for the company for the portfolio for shareholders and we're going to continue to look at opportunities always to replace existing tenants with investment grade quality, great long term tenants. So it does create a near term drag on our same.
Of our results, which is frustrating, but it provides the right long term value.
And we will always look for those opportunities in 2023 and years after that so.
But the good news is our leasing team has done a fantastic job this year already.
Commencing conversations on 162000 square feet of new leases on vacant space now not all of that will get done but those are good conversations to start the year and we feel good about filling vacant spaces throughout 2023.
And really growing our net absorption.
Alright, that's it for me thanks for the time.
Appreciate it.
Our next question comes from.
Kim.
Please Morgan Stanley . Please go ahead.
Hey, just two quick ones stay on the balance sheet. So the if I look at the $66 million plus or minus equity issuance post Q, just trying to get a sense of what that was put towards and sort of a related question to that as well.
If I annualize your interest cost for Q I got to sort of an $80 million number is that sort of the right ballpark or you know, it's a decade paydown.
Hopefully that makes sense.
It does Jeff so we put that towards paying down the revolving line of credit so.
You know obviously were.
We expect eventually to redeploy.
Those proceeds into acquisitions, but in the meantime, we pay down the line of credit with it. So it will bring the interest expense down with it.
Got it.
And then just on the acquisition I know you guys are not providing guidance.
Given sort of what you've talked about.
Can you talk a little bit more about just what the competition is like Wow why cap rates, staying so tight who's sort of stepping up and and still buying here and why haven't we seen sort of more widening.
Yes, J T. I think I think it's just a sellers holding out and hoping.
So eventually hope can flex with the rising interest rates on.
Short term loans that were used to acquire forecast five cap assets in the 2017 to 2020 range.
But I think I think until we see kind of more distress on the ownership side of the capital side.
Medical office buildings.
I don't see a lot of trades occurring so it's moving in the right direction. It just takes time for the market to kind of rationalize between cost of capital and it's been a 20 year Bull run and in medical office, and the 10 year Treasury and kind of other things. So it's.
It just takes time for the.
When interest rates rise 400, 500 basis points like they have in the last six to nine months.
It just takes time for them to kind of the market.
To reconcile itself. So it will get there and we expect to we expect a pretty good backup backup.
Half of the year, but.
The market has got to get there.
Got it that's it for me thanks, so much.
Yes. Thanks.
Your next question comes from Michael Carroll with RBC. Please go ahead.
Yes, Thanks, J T. Just staying on the MLB private market valuations I think you highlighted that assets were being marketed in the mid 6% cap rate range right. Now is that a fair valuation or do you think it needs to go higher from that mid six type cap rate.
Yes, Mike Great question.
That's when their market in that rate almost by definition that means that the price should be better from a ship.
Should move up from that range and so.
Frankly, the fact that assets are even marketed above six is a dramatic change from where they were market is six months ago and they you know they still need to move a little higher so.
We're waiting patiently, we're not we're not out of the market as far as.
Exploring opportunities but.
When we when we make an offer on a class a asset that we're really excited about it's going to be higher than mid.
Mid sixes.
So we're thinking more of like a high six army Dod talking about 7% type range or I guess mid six is obviously a pretty wide range.
And higher than that.
Yes generally.
IRR investors so.
It depends on the annual increaser, where they are in market rents and things like that so it's a combination of factors, but from a cap rate perspective just.
Just the market generally as you know.
Were seeing trades very few but we are seeing trades in the mid sixes on assets that you know.
If they were trading at let's just call. It seven we would be pretty excited about it moving in the right direction. So just few and far between but we.
The market is moving in the right direction as a buyer.
Long term investment.
Okay, and what's the appropriate IRR target I mean trying to translate those from a cap rate to an IRR I mean are we talking about eight plus percent IRR.
Yeah, I think that's a fair way to think about it.
Okay, and then are these high quality MLB, so like off campus affiliated with a major health system is that what we're generally talking about here.
Yes.
We're very transparent that's all we buy and so that's what we're talking about so you can get lower quality.
You can get lower quality.
Hi, Ray do you can you can do other asset classes at a higher rate, but right now for class a assets and that's and I think in part that's where we see development kind of leading kind of leading the way for the next several years as health systems really are looking for new.
Strategic locations and we're working with several right now on kind of helping them develop those locations.
And a more attractive yield in the current cost of capital environment.
Okay.
And then I know earlier in your prepared remarks and through some of these questions you talked about selectively not renewing some tenants. If you think that there is a better tenant that could take that space. I mean are we talking about some of the things that you already did or are there additional leases that you plan on doing this within 2023.
That's a great question. So it was about.
We have 16 million square feet, and we're talking about 40000 square feet, where we did that last year and we're already back filling that space. It just takes time for the new leases to commence post ti.
There'll be a little bit of that in the first quarter of this year, but it's.
When the tenants when the tenant has too much space I mean, that's almost worst than having the tenant.
Kind of renew a lease and occupy space that we think there is a better market rates for out there for.
To compete for that space. So we have a little bit of that in the first quarter of this year, but.
It's not a it's not a lot across 16 million square feet.
Short term.
Negative long term is very beneficial to them.
To the company.
Okay, great. Thank you.
Okay.
Our next question comes from Dave Rodgers. Please go ahead.
Go ahead.
Yes. Good morning, just a couple of follow ups on investments I think the first would be around the development funding pipeline $200 million that you talked about I think this was a similar number to where you started last year, maybe give us a sense of kind of how it kind of wound up in 2022 versus that expectation I think it's probably lower but just give us your own assessment of that and then I guess what gives you call.
And that number for this year in that market, maybe part of that the second would be maybe a follow up to Mike's question, just a minute ago in terms of the investment activity that you expect to accelerate in the second half is that because you're seeing more rfps on the market more packages coming out is it more hope or you're actually seeing good.
The amount of activity that would lead you to be able to close activity or close acquisitions in the second half of the year.
Those are all great questions Hope's not a strategy.
We don't depend upon rfps to find assets or work with health systems.
Those tend to be those tend to be auction type processes, where theres always some low.
Low bidder that.
You don't want to compete with.
Not that we couldn't and so I think the 200 million as active discussions with health systems.
Last year, when both supply chain and inflation was going up you couldnt get a construction.
Our contractor.
To give you a quote on a car and a contract to build a building that was good for more than a day.
Historically, you get a get a bid in 90 days later 108 days later it was still a good number so last year a lot of the projects that we're working on are still there.
The confidence in that $200 million number.
As some of those projects that are carrying over and we're just you know we the health system the physicians.
We're waiting on some stability stabilization in the construction and also the timeline with supply chain and other things that are kind of beyond everybody's control and so.
Numbers are coming in today, we're proceeding with some projects that we thought we would would it begun construction in the fourth quarter, but you know the tenant.
The capital Us.
Contractors.
I'll have more stability today than we had three months ago, and frankly, that's going to create much more long term value for us by that short delay in those on those projects. So we will be breaking ground in the next 30 days on projects that we've been working on for a couple of years. So we feel really confident in that number going forward and we see a lot of more opportune.
<unk> in that space.
Alright, great. Thank you.
Your next question comes from Steven Valiquette with Barclays. Please go ahead.
Great. Thanks, good morning, everybody.
So I guess not to get too granular on the same store opex that was up nine 8% in the fourth quarter, but.
The kind of flipped the narrative around here a little bit.
With the one time insurance cost that you mentioned you absorbed in the fourth quarter that makes the favorable.
0.5% sequential decline in Opex, you know kind of actually a little more impressive so I guess with the assumption that the insurance costs were probably up sequentially.
In <unk> versus <unk>, just remind us which cost category has actually improved the most sequentially.
And then also were there any seasonal factors worth mentioning one way or the other that may impact that favorable sequential comparison on the opex. Thanks.
Yes, Stephen this is mark thanks for pointing that out shipments.
I mentioned it earlier, but we've done a great job sequentially, keeping our operating expenses actually declined a little bit.
Contributing to that sequential change utilities.
<unk> was a large contributor kind of quarter over quarter.
And actually a decrease in holding that.
Relatively flat and stable general maintenance category there year over year are those were those two categories were up.
About 700000, and 600000, but quarter over quarter, we did a great job with our asset management team to keep those flat.
And I think we're also seeing the results of some of our ESG efforts in the utility expense from led upgrades things like that where we've made wise capital investments and we're starting to see that reduction in the operating expenses.
From some of those projects that we completed this year.
Okay.
Yeah, and you mentioned that you don't normally do those sequential comparisons, but again with just I guess the reason why you don't do that is there just some seasonality factors that just <unk> that have sometimes just curious I know needs through your reminders on any seasonal factors out sequential comparisons either <unk> or just any other times throughout the year as far as any obvious wanted to stick out here.
Obviously wanted to be snow removal in markets with North Dakota was hit pretty hard with our snow removal costs in the fourth quarter, but.
Really.
We don't have a lot of seasonality in our operating expenses outside those obvious ones and.
And again are highly occupied triple net lease portfolio help insulate the overall NOI.
Same store numbers, there, but clearly we watch that carefully for our for our health care tenants and partners because it's the overall occupancy cost of matters, when we talk to them about lease renewals.
Got it okay alright. Thanks.
Okay.
The next question comes from Mike Mueller with Jpmorgan. Please go ahead.
Yes, hi.
Two questions first one on the $200 million of development funding that's under discussion I guess.
If all that comes to fruition how much capital do you think could go out the door in 2023 and generate a return on it. That's the first question second one is what's the return profile on piecing. These smaller condos together like in Atlanta versus a typical building acquisition that you would make.
I can't help but laugh at the second question, it's a great question actually.
The long term return profile, there is much better than <unk>.
Anything else, we do it just its just taking time, it's a very strategic location.
For some reason 20 years ago, 25 years ago physicians and hospitals thought condo projects for them the right way to build buildings and invest in buildings and in this particular case, a condo was built.
Incredibly strategic location across the street from the <unk>.
<unk> health systems and so.
We're really excited about the long term it may be and maybe the best kind of IRR cash yield will ever get from individual investments. It just takes time to accumulate the condos overtime. So.
Great question, we know that we know it looks odd but at the same time.
Back in we're going to have fantastic returns from those investments.
On the on the development.
That's a good question. It takes 18 months to build these buildings so the ones under construction or about to begin construction.
You know those.
It just it just plays out over time or will that 18 month construction cycle, so of that $200 million.
You know.
For your model average it out over 18 months, but it's something like that so it's and frankly, that's that's the projects. We know we will properly financed this year.
Contractually commit to financing this year.
We're working on others. So I think there's I think the opportunities for kind of outsized investment on the development side.
Got it okay. Thank you.
Okay.
There are no further questions at this time I would like to turn the floor back over to John Thomas for closing comments. Please go ahead.
Yes, Maria Thank you and thanks, everyone for joining us on the call. Today, we are really excited about 2023, it's a it's a different market and at a different time, but.
We think.
A 20 year Bull run in seller's market has turned into outsized opportunity for Doc.
Physicians Realty Trust this year and.
We look forward to seeing some of the investor conferences coming up soon thank you.
Yeah.
Okay.
The conference you may disconnect your lines at this time and thank you for your participation and have a great day.
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