Healthpeak Properties, Inc. (DOC) Q4 2014 Earnings Report, Transcript and Summary

Greeting, and welcome to the Physicians Realty Trust's fourth quarter and yearend 2014 earnings conference call. [Operator Instructions] I would now like to turn the conference over to our host, Mr. Jeff Theiler, Chief Financial Officer, for Physicians Realty Trust. Thank you. You may begin.

Thank you. Good morning and welcome to the Physicians Realty Trust's fourth quarter 2014 conference call and audio webcast. With me today are John Thomas, Chief Executive Officer; and John Lucey, Principle Accounting and Reporting Officer. During this call, John Thomas will provide a company update and overview of recent transactions and our strategic focus. Then I will review the financial results for the fourth quarter and our thoughts for 2015. Following that, we will open the call for questions. I'd like to remind you that today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 that can be identified by words such as believes, expects, anticipates, plans, projects, seeks and similar expressions and involve numerous risks and uncertainties. The company's actual results could differ materially from those anticipated or implied in such forward-looking statements as a result of certain factors as set forth in the company's filings with the Securities and Exchange Commission. With that, I would now like to turn the call over to the company's CEO, John Thomas. John?

Good morning. Physicians Realty Trust established a foundation for success in healthcare real estate in 2014, and we capped it off with another strong fourth quarter of investments and growth in our cash flow. During the fourth quarter we completed $104.8 million of investments, highlighted by a number of investments with Pinnacle Health in Pennsylvania, the Carle Clinic Foundation in Illinois and a hospital MOB monetization with Columbus Regional Health in Columbus, Georgia. 2014, we completed $565 million worth of investments with leading healthcare providers in the communities they serve, bringing our total real estate assets to $819 million, as of December 31, 2014. We have since closed on another $172 million of investments in very high-quality medical office facilities as of February 27, 2015, and now own just over $990 million of medical real estate. With over a $100 million of additional asset under a binding purchase agreement, we expect to exceed more than $1.1 billion in gross real estate investments in the very near future. I would also like to highlight the growth in our portfolio-wide occupancy rate, which increased to 94.6% by December 31, 2014, both with the acquisition of high-quality well occupied facilities, but also through the active internalization of property management and leasing, led by Mark Theine, our Senior Vice President of Asset Management. With the recent 2015 investments, we now have more than 3.5 million square feet of medical office and outpatient care facilities, and are approaching a critical mass for cost-effective property and asset management. This has enabled us to strengthen our normalized funds from operations as well as pay a fourth quarter dividend to our shareholders of $0.2250 per share paid on February 6, 2015. As we move into '15, we are excited about the opportunities we see in front of us. We have a strong balance sheet with significant capital available in light of our $400 million unsecured line of credit, and a very successful equity offering in January, which raised almost $300 million in net proceeds. This will provide us with the firepower we need to capitalize on our growing pipeline and high-quality assets. With our substantial growth, we have been prudent stewards of our resources, but have made investments in people, people we view as DOC eligible, to support our accounting and property management underwriting and investment teams. We are pleased that Brad Page has joined us recently as Senior Vice President and General Counsel. Brad and his legal assistant, [ph] Jill Marinello have been so critical to the success of DOC from the beginning, and we are honored that they have moved in-house, which will not only save us cost, but make us even more efficient and effective in identifying, underwriting, closing and managing our medical facilities in our organization overall. John Sweet, our Founder, Executive Vice President and Chief Investment Officer, has recently agreed to extend his employment through the end of 2016, and we will be working to identify his successor later this year. We are so grateful to John and his tremendous success in sourcing and closing so many fantastic new physician relationship investments in 2014 and already in this year. I want to be as clear as possible about our current status and the direction and future of this company. We just completed our annual three-day strategic planning discussion with our Board, led by DOC's Chairman of Board, Governor Tommy Thompson. Physicians Realty Trust trustees reaffirmed our long-term strategic plan to build a visionary organization to stand the test of time. We have a unique culture and talents, as we know healthcare and focus on the real estate needs of high-quality physicians and providers, if they serve their patients. We believe investments consistent with that core ideology will allow us to make attractive returns on invested capital, relative to our cost of capital, and thus delivering outstanding total shareholder returns. While we've had tremendous success in 2014, we believe we can do better, and we'll focus on getting better with everything we do, finding more and higher quality healthcare facilities, more physician and provider relationships, who meet our investment criteria and be excellent stewards of our shareholders' and stakeholders' capital. We didn't achieve everything we wanted in 2014, but we continue to have a disciplined focus on three fundamentally important strategic philosophies. One, the dividend should be covered by AFFO, that is real investments in our target asset classes. And it is very important to keep that policy in mind, as we evaluate short and long-term investment opportunities as well as balance sheet management. We're getting closer, and as you can see, to achieving this goal, but we're not there yet, but we will be soon. Number two, we are healthcare people, and as such, we continue to differentiate ourselves, especially in our ability to evaluate, select and then work with our clients and partners, and those that are expected to pay us rent, to help them be more successful and thus provide greater value to our shareholders. And number three, we should be mindful of our founding investors and our current shareholders and the opportunity to attract future long-term investors, as we build and grow this visionary company. As a REIT, we are mindful of the short and long-term tools to fuel and grow this organization, and we will select the tools available, mindful of our core ideology and strategic philosophy. While the timing is not certain, now that we are about to surpass the $1 billion mark in real estate assets and market capitalization, we expect to pursue an investment-grade rating in 2015, and if successful, begin the transformation to a long-term capital structure. We also believe for now that the focus on medical office and outpatient facilities is the most appropriate healthcare real estate asset class to achieve our plan and short and long-term goals. But as always, we will evaluate opportunities when appropriate for other potential healthcare real estate, but we don't expect that to occur in the foreseeable future. Thank you for taking the time to listen and speak with us today. I will now ask Jeff Theiler to review our financial results. Thank you.

Thank you, John. We had an extremely successful fourth quarter of 2014, which capped off a very exciting year. Our funds from operations or FFO for the fourth quarter of 2014 were $9.7 million or $0.19 per diluted share. Our normalized FFO, which added back $1.6 million of acquisition expenses and some other small normalizing adjustments were $11.3 million or $0.22 per diluted share, an increase of 29% from the third quarter of 2014. Normalized funds available for distribution or FAD, which consist of normalized FFO, adjusted for various non-cash items and recurring capital expenditures, including tenant improvements and leasing commissions, were approximately $10.5 million or $0.20 per diluted share. We closed on approximately $105 million of real estate investments in the fourth quarter of 2014, at an average first year cash yield of 7.6%. These assets generated about $800,000 of cash net operating income in the fourth quarter. And if we had owned these assets for the entire quarter, they would have generated an additional $1.2 million. We were able to find over $550 million of attractive investment opportunities in 2014, more than tripling our asset base, also at an average first year unlevered cash yield of 7.6%. Following-up on that strong momentum, we have announced another $172 million of investment so far in 2015, highlighted by the $116 million Minnesota portfolio, one of our most exciting and certainly the largest acquisition in our company's history. The first year cash yield on acquisitions completed so far in 2015 is 6.8%, which is lower than our usual yield, but reflective of the very high-quality of assets we acquired, particularly the Minnesota portfolio, which we acquired for 6.4% unlevered cash yield. As usual, we have been very conservative with our balance sheet in the fourth quarter of last year and through the first part of 2015. We utilized our at-the-market or ATM facility for the first time in the fourth quarter, raising roughly $55 million. The majority of these proceeds were raised in conjunction with our inclusion into the Morgan Stanley RIET Index, which provided several days of very strong investor demand that we matched with issuance from our ATM. We ended the year with $78 million of secured debt and $138 million drawn on the revolver, for a debt to enterprise value of 19% and net debt to adjusted EBITDA ratio of 3.6x. In January of 2015, we raised an additional $4.2 million on the ATM, but more notably completed our fourth follow-on equity offering, raising $311 million in gross proceeds. This offering funded our new acquisitions and enabled us to pay down the existing the revolving credit facility. All of our acquisition and funding decisions are made with the intention of creating a company that is positioned for long-term success. One of the key pillars of that success is having a strong balance sheet, and we will continue to keep that focus in 2015. General and administrative cost for the quarter were $2.6 million overall and $2.0 million on a cash basis. We had seasonally low professional fees this quarter and expect these to tick up slightly going into 2015. We also recorded an impairment of $1.5 million in the fourth quarter, which was a reduction in the book value of our vacant property in Lansing, Michigan. This property was part of the original Ziegler portfolio, and was also vacant during the formation transactions associated with our IPO. Finally, to touch on our expectations for 2015, our FFO and FFO per share are dependent on investment volume, investment timing and assumptions for raising capital. Those factors are highly variable, making it extremely difficult to provide meaningful guidance. However, based on the composition of our current investment pipeline, we are comfortable providing guidance of $500 million to $700 million of total investments for 2015. This guidance includes acquisitions already announced this year and at the midpoint, represents a modest increase over the investment volume we achieved last year. With that, I'll turn it back over to John.

Thank you. Melissa, we're now ready for questions.

[Operator Instructions] Our first question comes from the line of Craig Kucera with Wunderlich Securities.

Looking at your pipeline, I just wanted to get some clarity. Did you say you had another $100 million under contract currently, or did I give that incorrectly?

Yes, we've got another $100 million under contract. We have announced I think all of that. The biggest part of that is the Kennewick, Washington medical office building that's under construction. We expect that to close this summer, but we've got more than $25 million of other assets under contract.

Appreciate the color on the G&A. You mentioned some cost savings by bringing things inside. What's the current expectation this year for G&A? Is it still sort of, I believe, at last it was maybe in the $14 million plus or is that still on track?

I think that's pretty consistent with what we are thinking this year. I'd say, on a cash basis, we are probably going to run around $2.5 million a quarter, maybe a touch higher, so on a cash basis maybe $10 million to $11 million for 2015, and then probably another roughly $1 million a quarter for stock-based comps, so overall, $14 million to $15 million.

And then finally, and I'll jump back in the queue. In the past you guys have looked also at some of the specialty hospitals. I think the cap rates on those has sort of been arched down to where MOB is. Is that still the situation today? And is that why you sort of are saying you're continuing to go the path of going more for MOBs and outpatient facilities?

It's generally the case, but we do have a couple of, I'd say, exciting opportunities early of that evaluation, but we're seeing a couple of specialty hospitals at appropriate pricing, we may or may not pursue, but you'll see us pick one of those off here and there. But the very focus is on the outpatient care and medical ops going.

Our next question comes from the line of Jordan Sadler with KeyBanc Capital Markets.

Quick question on the acquisition guidance. Expectations on pricing, should it be more consistent with the transactions completed year-to-date. I'd imagine obviously that would be skewing it or should we expect the balance to sort of move back up toward the levels we saw last year? Just what are we seeing?

I think, if we found quality, we've paid up for quality. And then Minnesota is a very high-quality portfolio, and we felt both is necessary, but valuable to make that investment in the 6.4% cap rate range, but we see most of our pipelines between 6.5% and 7.5%, so 7% is a good blended number, but we've got plenty of opportunities above 7% and where we can find quality, it seems to be necessary to pay somewhere in the high-6s.

In terms of financing the activity, obviously, you've got quite a bit of powder for now, but I guess, given sort of the anticipation of trying to move toward the investment grade rating this year, what are we thinking in terms of the financing strategy for the year?

When we raised our offering in January, we did that with the intention of not having to go back to the market, in advance of going for investment grade rating. And that's assuming our acquisitions as we see them today. So if we get a great opportunity obviously, that thinking could change. But as we look at it based on the pipeline that we see today, we think that we've got plenty of dry powder for that and can achieve all those acquisitions and still maintain a sensible leverage.

So you didn't think you'd have to go back to the market for the bulk of the year, to get through this acquisition guidance, you thought the January deal would hold you over through?

I think it's fair to say that we don't think we would go back to the market for the bulk of the year, that's fair.

So was the ATM kind of turned off post that deal as well or -- I know there was a small amount of issuance, I think, just prior?

Yes, exactly. So there was a little bit of issuance prior to that deal, and since that deal has been turned off.

Lastly, just on the dividend. I know that first philosophy, sort of the opportunity to be covering the dividend with AFFO. What's the time frame looking like based on sort of what's under contract going forward? Is this yearend opportunity?

I think by the end of the year, we should be in good shape with that. Obviously, we had the big equity raise in January, which pushed us out a little bit more than it look last year, but certainly by yearend we think we'll be in good shape with our dividend coverage.

Our next question comes from the line of Paul Morgan with MLV & Co.

Just talking about acquisitions more broadly, when you were formed in a lot of your kind of strategic outline, you gave yourself the flexibility to pursue deals outside kind of the narrow core sub-sectors that you've actually focused on. As you look into '15 and over the next several quarters at least, do you see yourself still sticking to essentially the portfolio as it is now, or do you ever take a look at healthcare real estate outside those areas? And is that a longer term thing, or are you happy with where you're looking at right now?

I was trying to articulate that at the end of my comments. Generally, we spend a lot of time at this Board meeting and strategic planning discussion with exactly that question. And I think long-term, we will broaden and diversify, but right now I mean outpatient care medical office is really our core. And we see tremendous opportunities to continue to grow in that space and thinks that where our focus should remain. But we see what most people see on the other asset classes as well. We'll keep our eye on it, and be opportunistic. But I wouldn't expect to see anything in the foreseeable future, but long-term broadly.

So you don't really spend much time looking at deals outside of that area right now at least?

No, just because we have more than we can process in that office space, but all joking aside, I mean that's where our core focus is and we're going to stay focused on that.

And then you had some OP units in Indiana deal this quarter. I mean, how is the conversation with sellers going in terms of using their units as currency? Should we expect to see more of that in terms of what your near-term pipeline is over the course of the year?

I think it will just continue probably at the same pace. We estimate tremendous tool for us. So many of the sellers we're talking to are physicians that have self developed their own facilities and enter into sale-leasebacks with us, and so they like the attractiveness of that tax deferral and they like the investment in DOC. So a lot of our early transactions were OPU transactions and those physicians have held on to their OPUs and the value that they've written and have been great referrals of other opportunities for us. So you continue to see that, but just it's really on the case-by-case basis. We're probably getting a little more selective about where we offer it, but the Minnesota transaction had a component with the OPUs. It was a brand new building. So it was important part of there negotiation and convincing the seller there to go ahead and make the trade now.

Then just lastly, what about development? I mean, are there opportunities you're exploring with your existing tenants or with new projects? Is this something that we should look for this year?

So it's kind of all of the above. So I want to be very clear about that. We have several tenants who are in need to expand their existing facilities and we are very engaged with them about doing that. So you'll see that kind of development, which is six to nine month kind of funding. They'll typically fund the construction, and then will refund that and amend the lease when they're completed, is the typical way we approach that. In the future, you may see us again partnering with a developer and looking to fund completely pre-leased or highly pre-leased outpatient care facilities. But that's not a core part of our near-term strategy. The Kennewick, Washington investment that's under contract is a development take out, where we didn't put any capital into that. We're not at any development risk. The developer there has got to complete the construction, and the lease it's a 100% leased and the leases got to commence before we're obligated to close or would close. So we'll see some of that as well, but kind of 10% of our target investments are focused on those kind of opportunities, but we're not going to take development risk. We're not going to take speculative development at all.

Our next question comes from the line of Juan Sanabria with Bank of America.

I was hoping you could speak to the pipeline of opportunities on the acquisitions in? And what you're seeing in terms of small deals versus more medium or large size portfolio opportunities? And kind of where your focus is and where you want to butter your bread on the deal front and this spread on the cap rates between those two opportunity sets.

I think the Minnesota investment, which we'll probably talk about for years to come through, we're so excited about it. That was a rare portfolio of that quality and essentially brand new real estate. The average age of those eight buildings is less than three years old, and one of them just went into service. So those types of portfolios, if you will, are kind of few and far between, but we continue to move up the minimum kind of dollar amount of our transaction. I mean this is a $20 million to $25 million space. We've got plenty of $10 million investments, so we're evaluating several in the $25 million to $40 million. So that's the sweet spot for this space, but anything that gets larger, we'll look at. And hopefully, like Minnesota be somewhat off market and have the opportunity to earn the opportunity.

So the focus remains from small portfolios and single asset transactions?

Yes, I mean, I guess in contrast to M&A or anything like that. I mean, we'll evaluate all of the opportunities that are presented to us or that we find, but you'll just continue to see us execute our core plan.

And then, I guess just a question for Jeff. So what would be the plan or what's your current thinking when you eventually do get the investment grade about what you'd like to do to the balance sheet?

As we think about building a long-term company and having a stabilized balance sheet, in my mind that's terming out long-term fixed rate debt, so call it 10-year debt, and running leverage at probably the lower investment grade levels. So we want to continue to be very conservative. But for us it's been a little bit unsatisfactory, because we've had a revolver and you have this growing the revolver and then paying it off and it's a little bit of the yo-yo leverage plan. So I think it will be a much better outcome to have long-term debt out there, so you can have a little bit more stabilized capital structure and be able to plan your earnings, et cetera a little bit better.

And then I wanted to follow up on the ATM. So is the plan not to have to tap the ATM for the balance of the year to sort of match fund acquisitions as you complete them over the course of the year or just --

I think we'll be flexible with that. And I think it's going to depend on the acquisition volume, when it comes. It's easier to predict the total for the entire year, but it's very difficult to predict when those opportunities are going to present themselves, in which quarter. So I think we'll be flexible with the ATM. It's certainly not our plan to just have it running all year, but we'll certainly look at that, if match funding, certain types of acquisitions makes sense, then we might do that.

Our next question comes from the line of Jonathan Hughes with Raymond James.

I was wondering, if you could comment on rent spread growth and the types of tenants you saw leasing space during the quarter? And then if you could talk about how you're thinking about rent spreads on the 2015 expirations, and granted you only have 3% and 4% of rents expiring this year and next, but any color there would be helpful.

Yes, I'm going to have Mark Theine to answer that question. I will say, while he is getting to the phone, last year's renewals averaged 2% or better and we continue to see the opportunity to move around. So we don't have much 2015 expirations, but Mark has been engaged in that. Mark, have you got any comment?

Yes, absolutely. In 2015, we have just 3% of the portfolio we're doing. So it's a very small size of the portfolio, 31 leases in total. And as John just said, for 2014, we had about 2% spread on lease renewal. And during the year, we had 82% retention rate. And again, a very small percentage of the portfolio we're renewing, so we are seeing leases rolling up.

Yes, I think that what we didn't retained was practices that expanded and needed more space than we had available in the building. So we're really excited about the work Mark's doing in keeping tenants happy, but are able to move around at appropriate levels.

And then are you seeing any current tenants like in the multi-tenant MOBs looking to proactively the new leases or expand space, given the performance within the sector?

Absolutely, yes, we've had quite a few tenants that we're looking proactively to expand their lease now at this time.

And then, I guess, just one last one. I know we've already talked a lot about acquisitions. But the $500 million to $700 million execution guidance, is that a net of any dispositions? Do you anticipate recycling maybe some legacy properties in the new investments?

Yes, we've announced the contract to sell one of the small facilities in Columbus, Ohio from the legacy portfolio. We don't have any active disposition plans, but it would not be a material amount of cash for that. So that's really a gross and net number, if you will.

Our next question comes from the line of Wilkes Graham with Compass Point.

John, just one question. As you continue to increase the acquisition guidance, you guys obviously have done a great job with the portfolio thus far. Can you just give us some color on maybe how many deals you end up turning down and maybe what the mix of those assets that you pass on between price and credit?

We don't keep a formal tally of that, Wilkes, but I would tell you that most of the things we pass on are the widely-marketed auctions. I think every day there is a new medical office building or hospital that pops up on the internet for sale and we rarely evaluate those. And that's probably 80% or 70% of what we see. So the remaining 20% to 30%, I think it turns into the quality of the physician or provider of the quality of the markets that they're in, the quality of the real estate they're in that narrows the focus. Kind of assets in existing markets where we're at or expansion opportunities with existing clients usually jumps to the top of our priority chain, and usually most successful, kind of repeat business or direct referrals from existing. So I'd say its 10% to 20% of everything we see. We pursue and we close on 75% of that, if it meets underwriting.

I think this was asked before, but are portfolios anymore widely available than they were six months ago in terms of the products you see out there at returns you like?

Yes, it's about the same, and I think the key question is if the returns you like. There are some lower quality portfolios flooding around, which we don't even sign the NDA and get the -- we know enough about the market, so we don't spend time on those. The Davis portfolio Minneapolis was a very exciting find and surprised, frankly. I would say it's one of the best portfolios I've been involved in the last five years and pretty proud of what we were able to accomplish in the past, but those are few and far between. But one thing about the Davis portfolio is Mark Davis, the developer of those, is taking the proceeds from the transaction and reloading with a number of projects he is already working on and starting to lease up for development later this year. We are going to have the opportunity in 2016 probably in order to continue to grow that relationship in that market, so long-winded answer to your question. But those are few and far between, but if they're out there, we see them. Some of the portfolios have traded in the last six months, just traded at prices that didn't make sense to us.

Thank you. Ladies and gentlemen, we've come to the end of our allowed time for questions. I'd like to turn the floor back over to Mr. Thomas for any closing remark. End of Q&A

Again, thanks everybody. Thanks for taking the time to join the call this morning. As you can probably tell from our voice, we are very excited about what we accomplished in 2014. We are very focused on building a great visionary company here and continuing that growth in 2015. We just look forward to seeing you soon and talking with you in May. Thank you.