Healthpeak Properties, Inc. (DOC) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to the Physicians Realty Trust Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Jennifer Manna, Vice President Associate General Counsel. Please go ahead.

Thank you. Good morning and welcome to the Physicians Realty Trust second quarter 2019 earnings conference call and webcast. With me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; Mark Theine, 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 second quarter of 2019 and year-to-date as well as our strategic focus for the remainder of 2019. Jeff Theiler will review our financial results for the second quarter of 2019 and our thoughts for the remainder of 2019. Mark Theine will provide a summary of our operations for the second quarter of 2019. Following that we will open the call for questions. Today's call will contain forward-looking statements as defined by the Private securities Litigation Reform Act of 1995. They are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks trends uncertainties and factors that are beyond our control or ability to predict. Although we believe our assumptions are reasonable our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations and those anticipated or implied in such forward-looking statements. For more detailed description of potential risks and other important factors that could cause actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission. With that, I would now like to turn the call over to the company's CEO, John Thomas. John?

Thank you, Jennifer. Good morning. Thank you for joining us today. We at Physicians Royalty Trust celebrated the sixth anniversary of our initial public offering on July 19th. We appreciate all of you have been with us from the beginning and those who joined our mission along the way. We invest in -- this past quarter's results from operations reflects our original commitment to you our stakeholders, clients, and team and the results we can achieve when we follow that simple philosophy. We started this company with a focus on the future of healthcare and the evidence is clear and compelling. More and more of the healthcare dollar in the U.S. is being spent on carrying outpatient medical office setting every day. By investing in medical office buildings, particularly those affiliated with market-leading health systems and providers by providing high levels of customer service and attention to detail and by providing a caring approach to everything we do, we delivered 3.5% same-store NOI growth this past quarter across all of our medical office facilities. We just completed our annual customer satisfaction survey and our results across the board are outstanding. Mark Theine and his team are delivering every day working hard to exceed our client expectations. Health systems has the choice to choose their landlord time and time again, Physicians Realty Trust rises us to the top of thire choice. We will continue our relentless effort on growing our already best-in-class medical office portfolio anchored by healthcare systems and providers that are focused on the future not the path of healthcare delivery. The features in the outpatient setting conveniently located for providers, patients, their loved ones, and the services and the technology they need to be helpful. Our strategic mission has been to utilize our long-term relationships with industry-leading health systems to grow and manage what we sincerely and objectively believe is the best portfolio of medical office properties in the United States. We continue to be medical offices, the most resilient class of real estate in the market. In our portfolio of MOBs representing 95% of all of our real estate assets, delivered outstanding results during the quarter. Since our last report, we've also made strategic investments to continue our return to growth in high-quality accretive assets. Consistent with our strategy, we are excited about the expansion of our existing relationships with Ascension, Community Health Network in Indianapolis, Texas Health Resources and U.S. Oncology through our recent investments. We anticipate more opportunities with each of these leading healthcare organizations. But we understand that we have to earn that business every day. That is the DOC Way. Our pipeline is also strong in expenses. We are under contract or close to finalizing contracts of more than $75 million of new investments and look forward to sharing more about these facilities in the associated health systems upon completion of these acquisitions. All the acquisitions are continued upon typical closing conditions. But if closed we will be adding new investment-grade health systems, another state to our map, and new opportunities for repeat business with health care providers you will know and appreciate heading in our portfolio. We're also under our letter of intent or active discussion with a number of other owners and health systems for both monetization and development opportunities and we are humbled by our existing health system relationships that Physicians serve as references for us with these opportunities. Business like life has challenges and one of our influence successful thought leaders successful by every possible measure counsel you not to be defined by our challenges, but to own our challenges, address them, but more importantly, be defined by our success. Our successes far outweigh our challenges and the ratio is not even close. We own our challenges and no one we believe is better than solving them then we are. Our relationships and knowledge of healthcare and engagement with providers, we believe gives us every opportunity to own and address challenges in our portfolio better than anyone. No one has more sense of urgency than we do, and when I'll be really a healthcare provider has an issue with their business. In this context, we are committed to transparency and integrity. Despite encouraging events with respect to each of LifeCare and Foundation El Paso, we determined it was appropriate to elect a conservative application of the recently adopted accounting standard ASC 842 to reduce cash and non-cash straight-line revenues for the quarter as a result of the Chapter 11 reorganization filing by LifeCare and 2019 challenges at the Foundation El Paso Hospital. LifeCare reorganization process is coming to conclusion with a new owner for our tenant which has agreed to assume our master lease as is, and we are negotiating the terms of the sale of the Foundation El Paso Hospital as well. We're not quite to the Goldline there. But we do have other options, if necessary. All four facilities remain open and serving their communities and they know our hearts and prayers are with the people of El Paso. Looking forward, we continue to believe, we will have a very good opportunity to invest $200 million to $400 million of new investments in 2019. For the portion of these investments being new development starts that will have rent commencing in 2020. The DOC story is consistent growth and better and better providers and their affiliated medical office locations. Our assets are 96% occupied. Our stability in our MOB is in our opportunity for relationship driven growth, we believe is second to none. We own our challenges, but more importantly, we do celebrate our success. Quarter two 2019 was very successful and our future is bright. Jeff will now share our quarter two 2019 financial highlights. And we look forward to your questions. Jeff?

Thank you, John. In the second quarter of 2019, the company generated funds from operations of $40.0 million, or $0.21 per share. Our normalized funds from operations were also $40.0 million, or $0.21 per share. Our normalized funds available for distribution for $42.1 million, or $0.22 per share in line with the previous quarter. I'll spend a little more time than usual discussing these earnings because of the impact of the relatively new accounting guidance contained in ASC 842, which we adopted at the beginning of the year. Under these guidelines straight-line rent receivables must be written off in their entirety unless the lessor has a high degree of confidence that they will collect substantially all of the rent over the remaining term of the lease. With our LifeCare tenant in a bankruptcy process which by definition introduces some degree of uncertainty. We couldn't be confident that we will collect substantially all future rent. Despite the fact of the cash flow generated by our facilities make them highly profitable under the current lease structure. Therefore, we wrote off $3.5 million of straight-line rent receivables reducing FFO by $1.08 per share. Most recent update on the LifeCare bankruptcy process is that yesterday the stalking-horse bidder won the auctions and in terms to honor our leases without modification. However, consolidated sale process actually closes, which is projected to be near the end of the year. We will only recognize the cash rent that we have been collecting steadily since June 1. After the closing, we will likely re-recognize the straight-line rent receivable as revenue. Similarly, we have been negotiating a sales agreement with the Physician Group that has been delinquent on their rent at the El Paso Hospital, previously run by Foundation Healthcare. This agreement would require as a condition of the sale of the tenant repay the six-month past due rent before we close. However, because of the length of the delinquency in rental payments under the new guidance, we decided we couldn't be certain that the deal would close and that we would collect substantially all of the rent so we elected to write it off. Should the deal closes as planned we would then recapture the six months of rental revenue and the straight-line rents receivable would be netted out as a gain on sale. We are in agreement with our auditors on the above treatments, and we believe we are in compliance with ASC 842. However, as seen in this quarter, the new standard can greatly increase the volatility of earnings results on a temporary basis. This is all a brave new world of accounting. So I'm happy to answer any additional questions on this after the prepared remarks. Moving along to investments, we completed $57 million of acquisitions and new development commitments in the quarter and closed on another $47 million of investments subsequent to quarter end. This brings our year-to-date investment activity to $139 million. Looking at the acquisition pipeline, which is weighted toward the back half of the year, we feel comfortable that we can meet the guidance we laid out of $200 million to $400 million of investments assuming favorable capital market conditions. On the disposition side, we sold two smaller non-core assets for a total disposition price of $12.5 million, which was a 6.4% cap rate. These assets generated a gain on sale of $3 million, and an unlevered IRR of 12%. We've made some adjustments to our same-store disclosure to segregate out the entirety of our LTACH Hospital assets in order to focus on MOBs which account for 97% of the NOI this quarter. This also service separate out the volatility associated with the accounting adjustments previously mentioned that will occur over the next several quarters. The MOB same-store pool through cash NOI at 3.5% year-over-year, notably this is inclusive of every single MOB asset we have own during the time frame as we have no assets in our repositioning bucket. We've also removed the slated for disposition categorization. We still intend to sell those assets as demonstrated by the El Paso purchasing sale agreement we are negotiating, but because of the uncertainty over how quickly we can find the best value for these assets, we will now reserve that categorization solely for asset that can be designated as held for sale from an accounting standpoint. Our overall portfolio continues to perform well. It was 96% leased at the end of the quarter with 53% of that space tenanted by investment grade health systems and their subsidiaries. We utilize the ATM in the first two weeks of April to provide capital for our acquisitions raising $17.9 million of net proceeds at an average price of $18.66. Our net debt to adjusted EBITDA for the quarter is 6.5 times. But normalized for the accounting write-offs would be 5.7 times. Net debt to gross assets was 33%. Finally, as predicted on the last earnings call, our G&A's move down from the seasonal peak in the first quarter and is consistent with our guidance for the year of $31 million to $33 million. I will now turn the call over to Mark to walk through some of our operating statistics in more detail. Mark?

Thanks, Jeff. The first half of 2019 has been active and productive in managing our portfolio. Our team remains dedicated to superior customer service, the retention and recruitment of high-quality professionals and operating efficiencies to benefit both our healthcare partners and our shareholders. Beyond the 3.5% MOB portfolio of same-store NOI growth that John and Jeff mentioned, three key highlights in the second quarter include improved portfolio occupancy to 96% from 95.4% as a result of 75,000 square feet of net absorption driven by the commencement of the lease of the El Paso Specialty Hospital. Two, continued expansion and profitability of our best-in-class property management platform, where we now manage directly 56% of our medical office buildings, representing 55% of our NOI. And three, well managed CapEx investments totaling a mirror 6.4% of cash NOI delivering enhanced cash flow to FAD. As we enter the second half of 2019, DOC's portfolio is an industry-leading 96% occupied including 53% leased directly to investment grade tenants, which we believe is more than any other publicly traded portfolio in healthcare real estate. High portfolio occupancy not only provides our shareholders with reliable cash flow and strong earnings growth potential, but also benefits the healthcare system and provide our clients who trust us with their facilities. Even further, DOC's extensive healthcare relationships cement our ability to attract and lease space to complementary physicians helping our partners to achieve their clinical and business goals all while increasing access to quality care for everyone. In Q2, 2019, our leasing team completed 242,000 square feet of leasing activity including 127,000 square feet of lease renewals. Total retention was 76%, while our leasing spreads were positive 1.8%. Approximately 93% of our lease renewals this quarter contained in average annual rent escalator of 2.5% or greater as we continue to build our internal organic growth strategy. During the remainder of 2019, just 1.5% of DOC's portfolio is scheduled to renew with an average rental rate of $23.94 per square foot and our team has strong leasing momentum in Atlanta, Houston and Phoenix to fill current vacancies. Consistent with our plans announced earlier this year, we continue to expand our in-house property management platform. Over the past 12 months, we have transitioned property management services at 31 facilities totaling nearly two million square feet in Kentucky, Ohio and most recently Nebraska, Washington State and the Dallas Texas market. During Q3, 2019, we anticipate completing the in-house management transition of the Houston Texas market, which includes four facilities totaling nearly 293,000 square feet. As a result of this growth, we are proud to welcome to the DOC family, Jessie Ramsey, Lesley Taylor, Scott Hedrick, Teri Smith and Jennie Dominic [ph]. All are impressive individuals tasked with delivering the DOC difference every day, which is the outstanding customer service and diligent care healthcare providers expect from DOC. In the six years, since our IPO, which again we celebrated on July 19th, we've not only built one of the best healthcare real estate portfolios in the country. But we've also assembled the best healthcare real estate team. Going forward, we expect continued success from our asset and property management platform resulting in enhanced local market knowledge, repeat investment opportunities with existing partners, profitable operating efficiencies and continued tenant retention. During the second quarter, our construction and project management team also generated outstanding shareholder value by prioritizing capital in second generations and an improvements and facility upgrades totaling $4.3 million or just 6.4% of the portfolio's NOI. This conservative approach to CapEx investment compares favorably to our peers and is driven by our well diversified lease expiration schedule, tenant relationships and the desirability of our medical office portfolio. Rent concessions in the second quarter remained low with TI allowances and leasing concessions of approximately $1.72 per square foot per year for lease renewals and $3.09 per square foot per year for new leases. Lastly as announced in July, we would like to congratulate Mark Dukes, DOC's VP of Asset Management on his election as Vice-Chair of the Building Owners and Managers Association, also known as BOMA International. Mark will serve as an officer for four years, ultimately becoming the organization's, Chairman in 2021. BOMA is a recognized leader in educating and an informing commercial real estate owners, managers and advocates at the federal and local levels. We are proud of Mark's achievements as a real estate professional and excited for the exposure that this position will generate for Physicians Realty Trust and the Medical Office sector in general. Together with all of the DOC members of the team, we have created an incredible culture of excellence and outstanding portfolio and a successful strategies to maximize long-term per share cash flow returns to our shareholders. With that I'll turn the call back to John.

Thank you, Mark. I'm pleased to take your questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Good morning. Wanted to touch base on the pipeline, so I think you're running a little bit behind pace may be relative to sort of the midpoint of guidance not much, but kind of curious, how you think things will shape up in the back half of this year relative to what you're seeing? And maybe you could sort of provide some color around what the activity in the marketplace looks like?

Yes, Jordan, thanks a lot. This is John. The market -- there's a lot of -- there's been several portfolios floating around the market. There has been pretty steady supply of on market opportunities. We really focused primarily on our off market in relationship opportunities and hopefully directly -- working directly with healthcare providers. So the -- as I mentioned in my comments, we've got some exciting assets under contract. As I said we're going to add a new state and a new health system that investment grade and we're very excited about that. We think we'll have some repeat business opportunities with and feel very confident about at least the midpoint of the guidance if not more. We're also finalist in a couple of development RFPs working with some best-in-class developers with those health systems. We feel very good about it.

Can you elaborate a little bit on the stuff that's under contract in terms of maybe sizing cap rate quality of the system?

Our system is superior. The assets and the sizing I think is around the $75 million number that I've -- that I mentioned and fully leased. Cap rates are around 6%.

Okay. And then, could you maybe speak to the Ascension development or the Sacred Heart development rather that is taking place in Pensacola. The interest rate upfront looks a little bit on the lower side, relative to what we'd expect for sort of a development loan. Could you maybe just speak to the mechanics and sort of -- is that a 4.75% funding for the entire facility or how does this work?

Yeah, it's pretty simple Jordan. It's a 100% pre-leased building with Ascension or Sacred Heart which is part of the Ascension Health System. So Randy building the local developer group, it was pretty close near ready to start construction. Deeni has spent some time with them and really just kind of replace the capital structure that they were looking at. And the I guess perhaps during the construction cycle, it's a little low. But the back-end yield there's a pricing we'll realize early 2020 or midpoint of 2020. So we're going to get very attractive yield on that investment beginning of 2020. The option to acquire is really the structure, but it's our intention to complete the funding of construction loan and then complete the acquisition on the back-end and see just one way to mitigate the risk which we think is no longer on construction.

Okay. But you have a fixed price purchase option at this point?

That's right.

Okay. And then I guess just quickly on LifeCare and Foundation El Paso. Can you maybe speak to the prospects on those sales? I think you're looking to potentially get rid of LifeCare assets once that's all settled. I just curious, if you sort of taken those to market or if you've gotten any feel yet and then same thing on Foundation?

Yeah. So LifeCare is again the bankruptcy process is coming to conclusion. The stalking horse two different stalking horse bidders were identified during the process which is moved pretty quickly. The bankruptcy filing with after our last earnings call and looks like it evolved pretty quickly after this one. The stalking horse bids were finalized yesterday and the winning bidder for our three assets are we've been in discussions with. I understand their operating plan, our assets, particularly our Plano facility is still generating very high cash flow and then the bidders by all accounts pretty excited to have the opportunity to buy them and assume our master lease as is. Again to continue to see is it's still finalizing the bankruptcy court process and then moving toward closing. So, buyers done all their due diligence, they would close very quickly to be conservative, we're assuming the end of the year, but hopefully, it's sooner than that. So, a little bit outside our control but we think it will be a positive result assuming the bankruptcy court process concludes which should. And then the buyer performs on the contract that's in place. On the Foundation, and yes, Jordan….

And then you'd look to sell those assets?

Yeah. We do intend to sell those the stalking horse buyer for -- sort for the OpCo's in our locations is also interested in the real estate and we want to get the bankruptcy court in his closing their closing behind us and then we look forward to this.

Okay.

And we will market them as well. Secondly, is the -- on Foundation, and we're very close to a contract with the physician group is there. This kind of long overdue in all candor, but we really do feel we're at the go line in that discussion and moving forward to complete that sale pretty quickly. We do have some others in the background that we'll pivot to if necessary, but we feel pretty confident we'll get that sale completed. But until it's close, it's not closed.

Okay. Thanks guys.

Yes.

Our next question comes from Alex Kubicek with Robert W. Baird. Please go ahead.

Good morning. This is Alex on for Drew. First looking at the construction loans, should we assume the Sacred Heart loan is backed by extensions credit directly or is it more a standalone credit with the Sacred Health Group itself?

Yes. I mean, the leases in place so indirectly the credits there. The loan is guaranteed by the development group, the developing team, its the development company, which is Just a number of high net worth individuals that out there.

Okay. Got it. Thanks for the color. And kind of pivoting there, can you speak to the strategic purpose of that Atlanta and medical condo deal. Are you guys happy owning some residential real estate, or is there a long-term plan here kind of what does it look like?

Yeah. Sorry for the confusion there, it's not residential real estate. It's the medical office building that was divided us into condominium structure when it was built a number of years ago. So it's an incredibly strategic location kind of irreplaceable location and we're in discussions with all the condo owners. We just completed this first stage of the acquisition. At this point, the units we bought are replaced with all leases. So it's a step-by-step structure. We can't -- we don't know when we'll complete the acquisition of all or we will, but that's our expectation.

Understood. That's really helpful. And then kind of lastly, has there been any notable success on the appeals front just looking at Texas and because of, I mean, do you guys really expect tax growth to be a headwind kind of looking into the near and medium-term just kind of looking for what you guys feel as of the temperature in that realm?

Yeah. We work with the firm and have from the beginning that both in the underwriting and the acquisitions, but also post on that tax appeals really every asset gets scrubbed every year and we've had a lot of great successes. Now condo with the rising values in medical office buildings, local tax assessors are running hard and trying to increase assessments. Some acquisitions post some of these portfolio deals, a significant increases in property tax rates. And so it's something we focus on hard everyday and our tenants, it all passes through on our triple net leases, but still the cost of occupancy to our tenants we work hard to mitigate that.

Got it. Thanks for the color. Thanks for taking my question guys.

Sure. Thanks, Alex.

Next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.

Yeah. Thanks. I was hoping you could provide some more information on the Foundation El Paso Hospital. Looks like they did not pay their June rent, did you say if they paid their July and August rental payments?

Yeah. Thanks Mike. This is Jeff again. They didn't pay April and May. They have been paying rent since June 1.

No. He is talking about…

Foundation.

Foundation. Oh, I’m sorry, Foundation.

Yeah Foundation is behind on rents, so.

Okay. And then is I guess did you say El Paso is paying their rents currently and the plan would be for them to pay the entire back rent once or if that sale completes?

They've made partial payment for August, but that's part of the finalization of the contract is to just to get rent started paying -- give them to pay rent, while they go complete the due diligence process and closing the sale at which point they'll pay all of 2019 rent.

Okay. And then can you give us an update on the San Antonio facilities because I know that they were a little bit behind their rent too. It seems like they're in a little bit of a better position and you didn't do the write-offs for them. So what's the thought process around San Antonio?

Yeah, San Antonio has a buyer for it's currently -- it currently being managed by third-party. There’s a buyer anticipating closing. And we believe that will occur next week on 50% ownership of that facility with the doctors there. As part of that we negotiated a new lease with them, a new 10-year lease for both the hospital and MOB and we expect that to -- that buyers are well-capitalized, well known operator. So we think everything is stable there. And they got slightly behind in the course of 2019 with rent, but have been steadily catching up pretty close. Yeah. Less than two months.

Okay. And then can you talk a little bit about the other assets that are slated for disposition. I know that you I guess removed that category in your supplement this time around. I guess, how big is that portfolio again. And is that going to likely occur over the next 12 months or so?

Other than half of -- we talked about selling Foundation El Paso and the life care hospitals, we're talking about plus or minus $100 million of other assets and frankly we have if they're good assets we have a buyer that's can massively by waiting those, really just trying to match fund and with the use of proceeds. So we expect some closings this -- still this year.

Okay, great. Thank you.

Yes.

Our next question comes from Nick Joseph with Citigroup. Please go ahead.

Thanks. Just on same-store revenue, it was up 3.8% in the quarter but same-store occupancy was actually down 40 bps. So I'm wondering what's the contractual rent increase for the MOB portfolio overall. And then were there any other revenue or anything else that made the same-store revenue growth that 3.8% in the quarter?

Good morning, Nick this is Mark. So we're really proud of our same-store results for the quarter. Again this is -- two more things to keep in mind as Jeff mentioned in his prepared remarks. This is our core MOB portfolio and it does include the entire portfolio. So there is no held-for-sale bucket or repositioning bucket. As you know our average annual rent bumps is about 2.3% and during the quarter we celebrated the anniversary of the CHI portfolio. So we had about 20% of our portfolio from those leases and in our same-store portfolio, a 1% increase represents about $600,000. So it's really not a huge dollar amount but it makes a big difference in percentage. And so it's really driving the improvements in our same-store this quarter. Our two leases, which had three rent last year and are now paying full rent this year, but, again, really proud of our same-store core portfolio overall as a whole doing really well. We look forward to continuing that next quarter.

Thanks. When do the free rent comps burn off to where it will be more in line with the contractual rent increases?

They already have burned off.

Okay. So the third quarter same-store number should be more in line with the occupancy plus the contractual rent increase change?

That should be right.

Thanks. And then just in terms of the watch list you guys put out in early June, I guess with the four tenants and I know we've discussed most of them on the call but are there any unfair changes to the watch list either additions or anything coming off now?

As we complete the sales we've talked about, I think will eliminate every one of the issues on that watch list this quarter or this year based on the timing of the LifeCare situation but each of those have been -- and addressed pretty thoroughly this quarter.

Sure. And any new additions to the watch list?

I knew that was going be the next question. Not to repeat that definition.

Thanks.

Thanks Nick.

Our next question comes from John Kim with BMO Capital Markets. Please go ahead.

Thank you. So your net debt to EBITDA at 6.5 is kind of above where you held at historically. Given the current dynamics in the market where your cost of debt is going lower arguably, probably at all time lows. Cost of equity is, I guess a little volatile right now. How do you think about operating at a higher leverage level at least in near-term?

Hey John, it's Jeff. So you're right. When you look at the headline net debt to EBITDA, it's much higher than we typically operate. But keep in mind that that's really impacted by a lot of these accounting adjustments, which we won't have next quarter and actually some of them will end up reversing over the next few quarters. So if you normalize that out you're kind of more at the 5.7, which is about in line with the leverage that we've had the last few quarters. So we're probably right near our target leverage. I think we got a little bit, but probably not too much more from here. So whenever we look at these acquisitions and new investments, we look at it using an appropriate mix of debt and equity and make sure it pencils out under those parameters and so we'll continue to do that. And then we'll -- in terms of funding needs we'll -- but you said the cost debt is coming down, so that's getting more attractive. And then we'll obviously look at our equity price and make determinations about whether to use equity capital as well.

But have your views changed at all. I mean the net debt-EBITDA obviously does not take into account cost of debt. So, are there other metrics that you look to or have you -- are you more open to increasing leverage level?

I see. I see, your question, because of the lower cost of debt, we run a higher debt to EBITDA. I mean, it depends. I mean the cost of debt is moving pretty rapidly around here as the 10-year drops by $0.20 or 20 bps of yield over the last, it seems like couple of weeks. So I think right now we'll kind of stick with our target of 5% and if it looks like, it’s a sustained move down in cost to debt, maybe that comes up a little bit. But right now I think it's too early to make a determination, because it's so volatile.

Okay. And then, can we get an update on Common Spirit. I guess, during the quarter that got the credit ratings confirmed at BBB+ Baa1. Does that change your views as to more investments with the partner, or do you want to eventually reduce concentration risk?

Yes. This is JT. Common Spirit is -- they continue that integration of those two large health systems, I think, is starting to move pretty rapidly, now just the people and teams and the other integrations. We think they're great client, a great tenant across the board. We really look at market-by-market, as whether we'd be comfortable with expanding that, in some of their market that you expect we would expand and we'll have the opportunity to do that, because of our relationships there. In other markets, it's probably TBD. And then from time to time we sell one or more of those assets or would sell some of those assets, again, market-by-market depending on the situation. We're still waiting on the local market to have some clarity on what's going to happen with the hospitals that they have there. We fully expect our MOBs would be fine, but we may have a new client relationship there to work with. So great organization, we think they'll -- the combined organization, the plan they have going forward, it will just -- will make them better and all of our assets better at the same time, but it is truly market-by-market for us.

If I could just ask one more, a follow-up on the condo unit acquisition. I guess this is not an ideal ownership structure. So are you basically comfortable that there's a high likelihood that you're going to be acquiring the entire building from the other owners?

Yeah. That's our plan. So it just takes one -- like, brick at a time to condominium structure. So it's one unit at a time but we're in discussions with substantially everybody involved.

Yes. Thank you.

Great place and it's worth the effort, worth the time.

Thanks.

Next question comes from Chad Vanacore with Stifel. Please go ahead. Chad your line is now open.

Hello. Thank you. So just one quick question going back to same-store NOI, 3.5%, that's pretty well above the 2.5%, 3% target range, especially given that loiters around 2.5% the rest of the year. Where is that delta? Is that a matter of change in same-store pool or could you really have a 100 basis points reduction in expenses?

Yes, Chad. This is Mark. So the primary driver of that, as I was saying before is, two leases that had free rent last year that are now paying full rent and operating expenses, so 1% movement in our same stores about $600,000 there.

All right. And then, is it possible to talk about the bidder for the LTACH at this point?

Yeah, I think, I mean, a little bit. It's a public process Chad. So there's a ton of information in the bankruptcy court filings, if you want to go look, click through it. But it's a one of the original founders of LifeCare has reorganized the company and as capital and is coming back to buy a handful of the assets.

All right. That's it from me.

Our next question comes from Daniel Bernstein with Capital One. Please go ahead.

Hi. Good morning. I wanted to ask, are there going to be any incremental cost near-term for internalizing some of your management and you still in other metro areas?

Good morning, Dan. I'm Mark. So internal cost, not really, not many. So we are able to pass through many of the property administration and salaries in our leases that are triple-net. And then, areas where we're not able to pass through salaries, there's quite a bit of opportunity of margin in the fees that we charge relative to the cost of providing those services. So net-net, profitable opportunity for us to bring in-house property management, but also just as important and maybe more importantly is the relationship that we're focused on with our hospital system partners. So getting a step closer to them and gaining that local market knowledge is really important to us.

Okay. What percentage of the portfolios internally managed at this point?

About 55%.

55%. Okay. So there's plenty of runway to bring things in-house and improve operating efficiencies, is the way to think about it?

That's right, Dan. But don't forget about a-third of the portfolio is single-tenant management fall. So the 55% is -- there's still some market opportunities, but not a lot of the growth that we're providing.

Okay. And you can stop me, if I'm wrong you guys still own KentuckyOne assets, I saw the headlines there were some issues there with you Jewish Hospital perhaps could close and I know if it's still in your portfolio a very small portion of your portfolio but I know if you could add some commentary on what is happening with those assets in the Louisville area?

Yeah. Again, that processes the headline similar ramp for two years and we continue to be in close dialog with KentuckyOne or Common Spirit in particular. We feel very good about a new buyer for those hospitals and/or the other hospitals in town have strong interest in our medical office buildings there. So we don't expect any issues with our facilities.

Okay.

The buildings that are closest to the buildings that are closest to the Jewish Medical Center itself that we are or next to the two other leading hospitals in the community as well as University of Louisville Medical Center. There's a lot of demand lot of use for those facilities. And I'd say that's worst case scenario and don't expect any occupancy issues.

Okay. One more quick question, I just wanted to go back over the $200 million to $400 million investment pipeline, if you go back over again what is kind of the mix of development versus acquisition and are you seeing some more winnings toward construction loan to own versus acquisition at this point given the cost of capital?

Yeah, so again we're about $44 million of that what we've done to date this year is construction commitments, so I guess maybe that's a third of the total. I think that number as a percentage will creep up back – toward the back end where as I said in kind of in final position with a couple of different health systems on new development opportunities that we would participate finding those. So those could be bigger. By the end of the year if we don't – we don't -- aren't aware of those in development number will be quite as big. On the acquisition front as I said, we've got about $75 million under contract in a couple of different location – the best prediction I can make right now is two-third of the acquisitions I think we close this year and third will be development starts that we either under construction or that we win by the end of the year.

That's all helpful. Thank you very much. I'll hop off.

Yeah.

There are no further questions. At this time, I would like to turn the floor over to John Thomas for closing comments.

Again, thank you for joining us this morning. As noted, we're very excited about the success of the second quarter, and look forward to a bright future. Thank you.

This concludes today's conference. Thank you for your participation.