Q2 2023 Physicians Realty Trust Earnings Call
Good morning, and welcome to the Physicians Realty Trust second quarter 2023 earnings call.
Participants will be in listen only mode should you need assistance. Please signal conference specialist by pressing the star key followed by zero.
After today's presentation there'll be an opportunity to ask questions to ask a question you May Press Star then one on you touched on phone to withdraw from the question queue. Please press Star then two.
Please note. This event is being recorded I would now like to turn the conference over to Bradley Page Senior Vice President General Counsel. Please go ahead.
Thank you Jason Good morning, and welcome to the Physicians Realty Trust second quarter 2023 earnings Conference call and webcast. Joining me today are John Thomas Chief Executive Officer, Jeff Theiler, Chief Financial Officer, <unk>, Taylor Chief Investment Officer.
Mark <unk> Executive Vice President asset management, John Lucey, Chief accounting and administrative officer, Laurie Becker Senior Vice President controller.
During this call John Thomas will provide a summary of the company's activities and performance for the second quarter of 2023, and our year to date performance as well as the strategic focus of our strategic focus for the remainder of 2023, Jeff Theiler will review our financial results for the second quarter of 2023.
<unk> spine will provide a summary of our operations for the second quarter.
Today's call will contain forward looking statements made pursuant to the provisions of the private Securities Litigation Reform Act of 1995 that reflect the views of management regarding current expectations and projections about future events and are based on information currently available to us.
Forward looking statements involve numerous risks and uncertainties depend on assumptions data and methods that may be incorrect or imprecise you should not rely on our forward looking statements as predictions of future events and we do not guarantee that the transactions or events described will happen as described or that they will happen at all.
For a more detailed description of other 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 would like to now turn the call over to the company's CEO John Thomas John . Thank you brand on July 19th we celebrated docs 10th anniversary as a public company from our earliest days as the custodians of a modest portfolio of 19 buildings. The Doc team has remained committed to a disciplined strategy of thoughtful growth and.
Prudent balance sheet management, the steadfast approach combined with our unmatched partnerships with health systems and physicians across the country has propelled our portfolio of nearly 300 of owned assets totaling over 16 million rentable square feet.
While we are proud to reflect on our achievements. So far we are excited to embrace the opportunities available for docs next decade, the demands in the U S health care delivery system will continue to grow in tandem with the aging of America and providers need to expand their outpatient presence to effectively care for their patients physicians Realty Trust remains ready to partner with our.
To address these changes.
Well positioned dance and own the purpose built outpatient facilities that will replace expensive and aged inpatient space.
The opportunity to deliver accretive growth through acquisitions has been limited for much of the past two years due to rapidly rising interest rates and the expected uncertainty as to where investment yield should settle.
We've chosen to remain patient during this time prudently waiting for market pricing to meet our cost of capital.
That doesn't mean, we've been stagnant our team has worked diligently to remain connected with our health system partners. While also thoughtfully evaluating where the puck is moving for outpatient real estate.
We're pleased to share that our patience is beginning to be rewarded during the quarter. We completed a modest number of acquisitions highlighted by the purchase of the cardiovascular associates building in Birmingham, Alabama and a.
First year yield of 7%. This 73000 square foot building was designed and built in response to market innovations that now allow many cardiology services and procedures to be performed in an outpatient facility.
This is a natural clinically evolution with Medicare and commercial payers, each recognizing the higher quality and lower cost of providing cardiology services in an outpatient location. We expect this to be a growth strategy for US is the first of many similar cardiology focused outpatient facilities, we will purchase develop in finance in the future.
In addition to the acquisition of stable properties, who we will continue to invest meaningful capital in the development of outpatient medical facilities. This capital will be provided in various forums, including loan down debt facilities and mezzanine financing arrangements on heavily pre leased projects.
Many of these projects will eventually come on balance sheet through contractual take out commitments. Our pipeline includes $68 million in contractual commitments to projects under construction and the potential for 500 million of further investments and projects in the planning stage.
Projects within our development pipeline are diverse in nature, reflecting the robust opportunity available for outpatient medical investors.
For projects in our active pipeline on the Redevelopments of existing buildings. One is the conversion of a vacant big box retail anchor and three represent the conversion of suburban General office buildings in each case. These projects will soon be helping leading health care providers deliver care in their communities.
We expect that our stabilized yields on these opportunities will exceed the interest rates received during each respective construction period with first year rent returns that we project to exceed 7% once stabilized.
In any case these financing opportunities will have higher long term IRR then we can achieve in the current acquisition market.
We've not finalized these capital commitments and some or all of them may not come to fruition. Yeah. We are confident that our opportunity for attractive development financings will continue to grow.
Within the existing portfolio docs leasing team continues to do an outstanding job of maximizing the performance of our portfolio. We have ambitious goals to achieve positive net absorption. This year, while also capturing the exceptional renewal spreads and increasing escalators that we've delivered in recent quarters that.
That momentum has continued this quarter with leasing spreads totaling seven 8%.
Over time, the cheap the achievement of leasing results in excess of historical levels, and maintaining or improving total occupancy should lead to sustainable and elevated in or you know why growth overtime that is sustainably higher than what we what the outpatient medical space has provided in the past.
We projected this past quarter is the trough for same store growth as we sign and command smoked both new and renewal leases in the future.
Jeff will now share comments on our financial results second quarter, 2023, and Mark will discuss our operating results Jeff.
Thank you John in the second quarter of 2023, the company generated normalized funds from operations of $61.2 million or 25 per share our normalized funds available for distribution were $60 $2 million or <unk> 24 per share we paid our second quarter dividend of <unk> 23 per share on July 18th.
Thank you I appreciate the color and then just shifting gears to leasing if I can in the prepared remarks I believe you said the leasing spreads were seven eight for the quarter. What's your expectation for the average spreads just as we think about the second half and into 2020 for exploration.
I find quite a fair an internal cap or any kind of any kind of internal risk mitigation that you put on just could not have too much exposure there.
You know kind of changes deal by deal and then the and the location and the quality of the provider et cetera, but.
I think we're doing a good job getting getting better returns out of our development financings and then mitigating that both the interest rate time risk and the development risk.
Thank you very much.
The next question comes from Michael <unk> from Green Street. Please go ahead.
Thanks.
So one on pricing power for me just curious if youre seeing any bifurcation between the companies on campus and off campus portfolios in terms of re leasing spreads.
Yeah. This is Marc I'll take that we really are not.
Isn't that much difference between on campus or off campus.
Yeah, I think even going back to Covid one of the things. We saw was that there wasn't enough a surgery center space off campus and we saw a lot of.
Our services moving to the off campus setting, but really what's driving our leasing spreads is the use of the comparable construction cost and relocating costs and just with today's higher interest rates and the higher construction cost. It just much more expensive to move and you know were able to negotiate higher spreads and still.
The less expensive than the cost to relocate so again seven 8% leasing spreads. This quarter is a trend that we think we can continue in the back half of the year as a as we work with tenants to renew space at a very high level.
Great. Thanks, and then maybe one more.
So despite some pretty high construction costs, we are still seeing some elevated MLB construction activity are there any pockets of your portfolio, where you are becoming increasingly worried about new supply.
Yeah, I don't think so.
Most of the development is purpose built for a health system or physician group looking for newer better space in a better demographic location. So.
Phoenix is hot but it's hard.
And literally and physically.
But the population is growing dramatically. So it's a it's kind of matching up with the population needs that are there and we don't we don't see any.
Heavy construction and heavy locations, where theres not a population driver Atlanta is the same way as we have Buford project.
<unk> already discussed.
It's a good question something we monitor in our underwriting, but we're not seeing that any of the any of our markets.
Great. Thank you.
Okay.
The next question comes from Michael Carroll from RBC Capital markets. Please go ahead.
Yeah. Thanks, maybe this is a question for Jeff I know after the term loan your cash balance increased pretty significantly I mean, what's the near term plans for that cash balances that earmarked for for new investments or is there some debt pay downs that you want to utilize that cash for it too.
Yeah. Thanks, Mike No you know the nice thing about our balance sheet is that we really don't have any more significant debt pay down. So we've really earmarked that cash for new acquisitions and like I said, it's <unk>.
Turning a kind of a nice yield and a short term highly liquid money market accounts. So.
Certainly feel good about the ability to deploy that hopefully sooner rather than later, but in the meantime, it's not too much of a drag.
Okay, and then what's the the preference for investment activity over the next six to 12 months I know that you highlighted acquisitions developments mezz debt I mean, where are the bigger opportunities right now.
The bigger opportunities are development by that I mean, it's just there's but there's.
A long pipeline of acquisition opportunities.
I wouldn't say in the market, but that were financed three and four and five years ago with 3% that are those loans are maturing now at 7%.
We've only got a couple of opportunities, where we're working with our current owner and you know either refinancing or acquiring a facility like that but when we think there's a good pipeline of those opportunities that will come and mature eventually.
So our preferences acquisitions always will be at least for now and that you know if we can find it at the right price and right quality the right credit, but we're seeing more opportunities in the development.
Okay, and the cap rates that I had been hearing I guess, where mlps are trading at or at least higher quality ounces and obese is like in the low to mid six range.
J T, you're highlighting and just completed some deals with the seven and I guess, what's different about the type of deals that you're looking at or are these just more off market relationship type deals that are getting you up into that 7% range.
Yeah, it's more off market relationship deals in it.
And it's also I think just the reality of some.
Some owners are using all equity and you know kind of willing to accept negative leverage in anticipation of lower interest rates.
And compressing cap rates, when we're not prepared to make.
That gamble, we don't think that's for us the appropriate way to invest.
Okay, and you would agree that the higher quality deals are trading in the low to mid sixes I guess generally right now in the MLP space.
I would say there are some in that in that range again.
We are.
Focused on our cost kaplan into higher quality off market transactions.
Okay, great. Thank you.
Thanks, Mike.
Yeah.
The next question comes from Steven Valiquette from Barclays. Please go ahead.
Hey, Thanks, good morning, guys.
I'm juggling a couple a few earnings calls you're simultaneously, but obviously the AR with the same store cash NOI growth slowing down a little bit.
I'm, just curious get a little more color around what's happening there and if you look at it sequentially everything it looks like there's really no change at all but really its just its one of the year over year. There was just some deceleration in that same store pool. Some of the garage versus what you had sequentially year over year growth last quarter, but just oh sure. There were still kind of that unique single location situation, that's still hitting the <unk>.
But just curious to get more color around all that.
Yeah, I'll have mark give you a little more color, but it's you know we really do think we've got a trial there and again, there's still a kind of quarter over quarter with an intentional non renewal last year and then.
Non renewal, but a tenant where they cut some space back at the beginning of the year, which have had a kind of quarter over quarter.
You know continued impacts, but we do think this corners that draw them.
Kind of what leases, both commencing and being executed in the near term and net absorption. We're heading the right direction Mark you want to add anything yeah. So it's even so sure I had them all here.
First of all again, our leasing team did a great job growing cash leasing spreads of seven 8%. So from a renewal perspective, we're growing our cash flow there.
Our same store performance was really as a result of a change in occupancy as I mentioned in our prepared remarks to 94, 4% from 95%. So still a very highly occupied portfolio, that's performing well, but to give a little more context to that 60 basis point decline and as you mentioned some unique kind of one off things happening there.
That decline is about 90000 square feet nearly half of which is that cancer center that we talked about last quarter and during this quarter, we actually executed 5600 square foot lease in that facility and have had good tours and momentum to fill up that facility and then as J P mentioned, one of the things that's going to offset that cancer Center facility.
<unk> is the Minnesota surgery centers that we've talked about in the past that was a 22000 square foot surgery center that really for the last year has been in negotiation and under construction and it'll start commencing rent payments here in the third quarter of 2023, so zooming back out to the to the high level here.
We have a leasing environment the macro environment, that's working in our favor as I mentioned, our leasing leads are up our tours are up but more importantly, our proposals on vacant space are up so.
Bottom line is our cash NOI is growing.
Just not growing at our historical pace, but as J P said, we think this is the trough and we will be moving in the right direction in the back half of the year here.
Okay got it that's helpful. Thanks.
The next question comes from Ronald Camden from Morgan Stanley . Please go ahead.
Hey, just a couple quick ones from me, so going back to sort of the capital allocation.
So one on the acquisition front, obviously, not seeing enough deals and leaning more toward some of these development any way to sort of quantify what that run rate could be sort of on a long term basis. Like is there 100 million 200 million of opportunities as you're building out. These relationships just how can we get some more sort of hard numbers around that.
Yeah.
Yeah, so for the development pipeline.
Think.
A good run rate for us is going to be.
Again these products are still an informative data. So we're you know we want to be careful not to get too ahead of ourselves, but certainly $100 million to $200 million as the pipeline I think is achievable in a reasonable period of time.
You know at some point, maybe we'd start limiting the size of that pipeline based on the overall size of the company, but I think we've got a pretty good runway to get there.
So that's just kind of a short term plan, yeah, and I think part of that is like right. Now we have more opportunities in that and I think the ideas will get kind of a continuous cycle of those facilities coming online starting commencing in as new buildings are coming online and stabilized paying rent.
We will start new constructions as well. So just you know again, we're really working to build up that kind of.
Continuous cycle, there and see good opportunity to do that.
Great and then just my last one and then maybe you touched on this earlier, but just on the MLB same store cash NOI maybe.
Maybe can you remind us what are some of the sort of the one time me.
You know things are impacting sort of that 80 basis points year over year number and what.
You know when does that sort of clear up so you can get back to sort of the 2% to 3% range hopefully that makes sense I think mark Yeah, I think mark just to address that but what you can and just to repeat is really kind of three events are two intention on one where attendant cut back some space and we're already in the process of back filling that space with a lot of tours and then they partially.
At least some of that space already so second half of the year, we'll start seeing the benefits of those but the non renewed leases something we did intentionally.
One of those that surgery center that.
It's now come online has been accredited and are starting to treat patients and paying rent in this quarter. So we'll start seeing the benefits of all that it's really two or three events out of 300 buildings.
Got it alright, thanks, so much super helpful.
Yep.
The next question comes from Alex Fagan from Baird.
Go ahead.
Hi, Thank you for taking my question. The first one is kind of quick how much rent is expected to commence in the second half of this year.
Yeah. This is Marc so in total we have about 34000 square feet of leases that are executed under construction and will commence in the back half of the year, that's what's executed.
So if you took an average of a $20 in a triple net rent in $10 of operating expenses, that's close to $1 million, but you know it'll be staggered throughout the back half of the year, but a decent run rate, what's actually executed and then of course as I said, we're we've got a very active pipeline of leasing activity.
Beyond that that it'll take a little time to work through that as we negotiate the construct and commence rent that that's castle that it'll start in the back half of or near the end of 2023 and into 2024.
Got it thanks.
You mentioned with the new embedded escalators been able to achieve.
On average, 3% and even some 4% can you remind me what the weighted average escalators embedded in the entire portfolio is.
Yes.
Historically about two 5%, but every one of these new leases.
In the last few quarters has been higher than that so it's.
Just take time to grow the average, but we're heading in the right direction. So if we can maintain these type of renewal spreads in some of the new market for leasing accelerators, we think.
We're headed to headed toward up 3% world, but its going to take several years to get there.
And hopefully more.
Okay got it thank you guys.
The next question comes from Connor Seversky from Wells Fargo. Please go ahead.
Hey, good morning, guys, Hey, Suzanne for Conor today, Thanks for taking the question.
In terms of competition for assets do you guys still see a lot of activity from foreign capital or have those entities move to the sidelines and potentially offering more opportunities for physicians group.
Hum you know I'd say it slowed down, but we do still see foreign capital in the market both directly and indirectly through other.
Private equity type shops or directly from foreign pension funds, where we are in a JV with foreign capital and I think they continue to like the space.
As well along with the with remedy and Kayne Anderson.
So I'd say, we've seen a slowdown in transaction activity is in trade some gap in cap rates kind of rationalized, but.
But we do we do have slack in our Buford project with physician co investors in that project with us to the tune of about $11 million.
Straight equity into that deal. So we still see a lot of interest in physicians wanting to co invest or.
Our our remain part owners in investments we make.
Yeah.
Great and can you offer any color as to how much the portfolio is utilized by admin or non medical function like the revenue cycle. For example, do you get that leases up.
Go ahead.
Go ahead go to ask questions.
Yeah, It's gonna say do you get the sense that these sizes could decrease as leases rollover in the company utilizes those hybrid structures.
Yeah. So we do have a very small percentage of space that is.
It would be kind of a general administrative space.
Two of our redevelopment projects are we're in deep discussions with clinical providers to Theres still leased Theres still you know frankly lease for many years in their existing form, but we're in discussions with clinical provider to convert those buildings to clinical space.
And frankly, I'm really excited about those opportunities and then.
When projects in our pipeline would be an acquisition of a suburban office building and again to convert it to medical use as well. So we see a lot of great opportunity, there and our own space and our own buildings, we have a small percentage.
Well leased all in all being paid but at the same time.
We like others would like to see that convert to clinical office space overtime.
Yeah.
Great. Thanks, guys.
Yes.
The next question comes from Michael Gorman from B T. I G. Please go ahead.