Healthcare Realty Trust Incorporated (HR) Q4 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the Healthcare Realty Trust's Fourth Quarter 2014 Analyst Conference Call. All participants will be in listen only mode. [Operator Instructions]. After today’s presentation there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Emery, Chairman and Chief Executive Officer. Please go ahead.

Joining us on the call today is Scott Holmes, Doug Whitman, Todd Meredith, Carla Baca and Bethany Mancini. Ms. Baca will now read the disclaimer. Carla?

Thank you. Except for historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the Form 10-K filed with the SEC for the year-ended December 31, 2014. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operations, FFO or FFO per share. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the fourth quarter ended December 31, 2014. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.

Okay. Thank you. We're again pleased with the company’s progress in 2014. Positive operating metrics and active leasing produced stable cash flows and consistent revenue growth. The company's tenant retention, cash re-leasing spreads and annual rental bumps again reflected healthy momentum in the portfolio. The progression of the company’s operating metrics over the past year validates our strategic discipline to increase lease rates and manage operating expenses. Modified leasing incentives are also starting to show results, changing focus to realize greater benefit from the value that is inherent in the company’s properties. Being aligned with well-established health systems and having superior rent coverages and low fungibility we foresee meaningful and sustainable internal growth enabling the company to be selective in prospective acquisitions and reducing risk and enhancing returns. Healthcare Realty’s acquisition for 2014 reflected our pursuit of value creation not mere top line growth, in the midst of a hot market where quality differentiation is also lacking. We continue to see opportunities for investments in ‘15 in properties that meet our criteria for location, fungibility and internal growth. Health systems are resurfacing from the implementation of the Affordable Care Act as they look to strategically realign their assets and position themselves for the future of outcome-based lower cost care. With reimbursement policies now propelling outpatient expansion, combined with increasing capital demands discussion with health systems for new outpatient facilities are more active than we’ve seen in sometime. The size and growth of the outpatient property market gives us the ability to be selective with our development projects and proceed at a measured pace, for us mostly on-campus facilities with significant leasing from hospital-driven services. Development remains a key component of the company’s investment strategy, targeting assets with characteristics that ensure lasting growth. We avoid offerings of aggregated disparate properties. The local knowledge perspective we have from our people on the ground at the property level gives us an advantage for selective investments and better returns and less risk overtime. There’s no better investment than one on a campus where we already have facilities, or in the market we already know. We expect that 2015 will be another positive year for the company with good incremental growth prospects and operating metrics and especially cash flows. With that we’ll move on to Ms. Mancini to gives us the summary of the current events and trends related to Healthcare industry. Bethany?

Thank you. Health insurance performed [ph] in the ramification of the Affordable Care Act or ACA continue to unfold, elevating the insured population and intensifying pressure on healthcare providers to lower cost and improve quality of care. Health systems are facing critical cost reduction demands due to tighter reimbursement rates like in-patient admissions for more price sensitive consumers and new payment models based on shared risk and reward. Several of the nation’s largest health systems recently announced the joint task force with the goal of shifting 75% of their business by the year 2020 to contract with incentives for quality and lower cost healthcare. The announcement came just shortly after the Department of Health and Human Services released its own version of a similar plan for Medicare fee-for-service-spending. The level of cost savings these models will generate through accountable care organizations and other forms of bundled payments remains to be seen. However, health systems are already expanding their outpatient services as a definitive coordinated means to lower their cost of care and are actively acquiring physician practices to create clinically integrated networks that allow them to participate in risk-based payment model as well as increase their referral base. The American Hospital Association released its latest industry statistics revealing a 2% decline in hospital in-patient admission but a 1.2% increase in outpatient visits to more than 787 million visits in 2013. Healthcare employment reflect these trends as well. Job growth in healthcare services picked up pace towards the end of 2014 with the largest gains in outpatient setting. For the year that ended in January the ambulatory care workforce grew by approximately 242,000 jobs or 3.7% versus hospital employment growth of only 1.2%, a closely watched indicator of anticipated healthcare spend. It is in the context of this changing healthcare environment that we believe Healthcare Realty is distinctly positioned to accelerate the internal growth of its core portfolio and pursue opportunities for hospital-directed outpatient facility development. Healthcare providers are facing headwinds however from ongoing political and legal battles over the ACA, including the King v Burwell case that will be heard by the Supreme Court in March with a decision possibly in June on the legality of federal subsidies to enroll in states that participate in the federal exchange. In the event that the Supreme Court decides to clean it states are expected to work around the issue by establishing state based exchanges that could possibly be outsourced to healthcare.gov. Other items on the forefront of the Congressional agenda Republicans will look to repeal unpopular measures of the ACA such as the individual mandate, although the threat of a Presidential Veto will be limiting. Also the legislation or Doc 6 that provided stable physician Medicare payments over the past year will expire at the end of March, when Congress is expected to offset a 21% cut with another one year patch unless funding can be found for a longer term solution. There is widespread support in Congress to a follow-up [ph] Physician Medicare payments, since they are critical to driving new reform based initiatives and providing care to the rising insured population. Healthcare Realty remains committed to its low business risk strategy investing in outpatient facilities which have proven a profitable defensive sector throughout the past 20 plus years. Approximately 82% of the company’s outpatient facilities are located on hospital campuses and 62% are affiliated with investment grade rated health systems. Such health systems will be the ones that best provide evolving healthcare environment and continued political vagary of health policy, as they attract greater in-patient volume, expand market reach through partnering and specialization and adopt payment models that target ACA incentives. These systems will increasingly become centers of excellence with the strategy for healthcare delivery that is patient-centric and physician-led. David?

Thank you, Bethany. Now to Mr. Meredith to give us more specific information regarding recent investments and development activities. Todd?

The company acquired two MOBs for $40.1 million in the fourth quarter. The first, a 69,000 square foot, 97% leased MOB in Oklahoma City, is located on the campus of investment grade rated Norman Regional Health System and the second a 60,000 square foot, 98% leased MOB in Seattle located on the campus of a hospital affiliated with A-rated Catholic Health Initiatives. In early January 2015, the company purchased for $39.3 million, a 111,000 square foot, 97% leased MOB in Freemont, California located adjacent to two hospital campuses; one affiliated with Kaiser Permanente and another with Washington Hospital Healthcare System, that together lease 59% of the building. This property was expected to close in December, but was delayed until 2015 for the seller’s tax purposes. Combining this property with the six MOBs required in calendar 2014 for $83.1 million the company’s recent acquisitions totaled $122.3 million at cap rates ranging from the low to upper 6% level. Each of these properties is located on or adjacent to a leading investment grade rated hospital in a growing market and with clinical tenancy directly linked to the joining hospital; attributes that assure consistent demand and limit new supply, yielding pricing power and the propensity to increase rents as leases roll. Healthcare Realty purposely avoids off-campus properties with little to no pricing power, especially smaller properties that purport to be affiliated with a hospital such as urgent care clinics and small free standing EDs. While convenient for patients these specialized facility should be concerning to landlords. Too often these one facilitated smaller properties become challenged at lease expiration. With extended vacancy rent roll down and outsized capital improvements. In recent months we’ve seen many investors chasing top line asset growth, mostly aggregators clamoring to amass properties and often over paying for substandard portfolios with a disproportionate share of these off-campus loosely affiliated properties. Healthcare Realty meanwhile remains focused on quality individual properties. Our best investment prospects with the highest returns and lowest risks or guided by our lease-by-lease focus on internal growth, including selective on campus acquisitions with sustainable rent growth. Low risks developments on campuses where we have already done business and redevelopments of existing properties at attractive returns on incremental capital. The development conversion properties made study progress throughout 2014 reaching occupancy of 80% by year-end and generating $4.2 million in NOI in the fourth quarter for a sequential improvement of nearly $1 million. NOI would have been 5.1 million had all, current tenants occupied their space and paid rent for the entire quarter. In place NOI is now on pace to exceed $20 million in 2015 compared to $13 million for 2014 and well along the way to annual NOI of $25 million to $30 million. 10 of the 12 properties are now 91% leased with the other two approaching 60% and strong momentum ahead. Given their progress all 12 properties will be included in the same-store portfolio beginning in the first quarter of 2015. We expect in the near-term to break ground at an on-campus MOB in Denver where the company developed and owns two 1,000 square foot MOBs. This third 80,000 square foot MOB was recently approved by the health system and we are finalizing agreements before proceeding. The hospital will lease more than one-third of the MOB for outpatient surgery and outpatient surgery center and multiple specialty clinic. We are in the early stages of developments in locations where we already own and operate properties including Austin, Memphis and Des Moines. We anticipate a couple of starts in 2015 with completions in mid to late 2016. The company also recently committed to move forward with redevelopments in two locations. In Nashville we have spent $4 million of a $9 million phase I plan to upgrade common areas and a parking garage at a 245,000 square foot building on the campus of Saint Thomas in Midtown. In 2015 and 2016 we will proceed with Phase II, investing in additional $31 million in more common area upgrades, tenant improvements, another parking garage and a 65,000 square foot expansion to house a surgery center and a leading orthopedic group. New executed leases and LOIs will take the current occupancy from 67% to well over 90%, including the expansion. In Birmingham we are in the process of executing an 11-year 130,000 square foot lease renewal and expansion with LabCorp, where we will invest $15.4 million in building upgrades, tenant improvements and a new parking garage. Both of these redevelopments are expected to generate stabilized returns in excess of 8% on incremental capital. The Birmingham property will be completed late in 2015 and the Nashville properties are scheduled to complete in phases through late 2016 and early 2017. The company sold nine properties in 2014 for $34.9 million at an average cap rate below our implied cap rate. The majority of these properties were picked up in portfolio transactions, eight being off-campus and they were collectively 50% occupied. While the company has long maintained a disposition program to rotate in to safer higher growth properties it recognizes the current favorable environment for harvesting incremental gains where appropriate. We expect $50 million to $100 million of dispositions in 2015, slightly higher than our typical range and largely a function of market conditions. Our investment outlook for 2015 remains bright for acquisitions, developments and redevelopments with an eye towards bolstering the company’s internal growth profile. David?

Okay, thank you and on to Mr. Whitman to his update, balance sheet, capital market activities et cetera.

Thank you, David. Despite the abundance of capital available throughout 2014 Healthcare Realty remained disciplined in its investments and capital markets activity. During the fourth quarter the company raised $23.9 million of equity through its aftermarket program to fund two on-campus acquisitions. For the year the company raised $75.7 million of equity through its ATM program, which accretively funded the $83.1 million of acquisitions made during the year. The company expects that it will be similarly efficient in its equity issuance in 2015 raising capital as needed for upcoming acquisitions. We continue to see improvement in several of our key debt metrics with overall leverage remaining steady at $42.4%, fixed charge coverage up to 2.8 times and debt-to-EBITDA down to 6.4 times. With the internal growth from our existing portfolio, including the development from virgin assets we expect these debt metrics to continue to improve throughout 2015. As capital cost declined throughout 2014 cap rates moved lower in tandem. Despite this compression capital costs remain attractive relative to investment opportunities and we have remained methodical in pursuing better quality assets, particular those with strong long-term growth prospects. We expect that we can fund our anticipated amounts of internal capital needs, acquisitions, development starts and redevelopment of existing properties with free cash flow from our portfolio, the judicious sale of equity and recycling the proceeds from dispositions. Given the current level of asset pricing for healthcare properties we see the opportunity for targeted dispositions that would increase our disposal volume above our historical norm. While these selective assets sales could provide with a moderate amount of funding the primary motivation is simply to reallocate capital. Looking ahead to 2015 we continue to be cautious in raising addition debt and equity, being careful to balance the need to fund new investments with low cost capital while maintaining a healthy and flexible balance sheet, allowing our shareholders to benefit from the solid FFO growth expected in 2015. David?

Thank you, Doug. Now on to Scott to give us an overview of operating results and other financial measures. So Scott?

The company reported fourth quarter normalized FFO per diluted share of $0.38. NAREIT defined FFO per share was also $0.38. The company's normalizing items, which offset each other this quarter include an add-back for acquisition costs of $0.5 million, a reduction for the modification to restricted stock award of a Director on resignation of $0.1 million and a reduction of $0.4 million -- a reversal of an out-of-period income item. For the fourth quarter, the Board declared a dividend of $0.30 per share and the dividend payout percentage on normalized FFO is 78.9%. For the full year 2014 total revenue was $370.9 million, an increase of $40 million or 12.1% over 2013. Similarly for the full year 2014 normalized FFO increased by $19.6 million or 16.1%. For the fourth quarter normalized FFO dollars year-over-year grew $3 million or 8.8% to $37.6 million. Over the same time period normalized FFO per share increased 5.6%. Sequentially normalized FFO dollars increased by $1.7 million or 4.7% attributable primarily to acquisitions in the third quarter and fourth quarter, which contributed $0.6 million and a decrease in portfolio utility expenses of $1.4 million. The company again produced solid leasing results in the same-store multi-tenant portfolio. The fourth quarter cash re-leasing spread was 4% compared to 1.4% in the previous quarter. Annual rent bumps were steady at 2.9%; tenant retention was up to 88.6% this quarter, the yield on leases renewed during the quarter again increased and the average rental rates for occupied in the multi-tenant portfolio and 3.1% in the single-tenant net leased properties. During the quarter leases totaling 342,000 square feet commenced or renewed at the company’s multi-tenant properties including 271,000 square feet in the same-store portfolio. For the full year leases totaling 1.9 million square feet commenced or renewed at company's multi-tenant properties including 1.4 million square feet in the same-store portfolio. Compared to year-end 2013 occupancy increased or held steady across the board throughout our portfolio. Same-store occupancy was flat at 90.5%. Occupancy in the development conversion properties increased from 63% to 80% which resulted in total occupancy increasing from 85.1% to 86.4% inclusive of recent acquisitions with occupancy of 93.1%. As I have emphasized before some quarterly metrics fluctuate a great deal, creating near-term noise and should not necessarily be taken as indicative of long-term performance trend. We continue to be pleased with the direction of our leasing initiatives, combined with operational expense management. The company’s strong tenant retention reflects the low fungible nature of the assets enabling us to maintain positive cash re-leasing spreads, improved re-leasing yields and consistent annual rent bumps. These positive indicators reflect strong momentum for the key drivers to the company’s future revenue growth. David?

Thanks Scott. Operator we are ready for the question-answer period.

We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Karin Ford with KeyBanc Capital Markets. Please go ahead.

Hi, good morning.

Good morning.

My first question is on the 4% rent spread growth that you got this quarter, with a nice pick up. Can you just talk about what type of tenants you saw in the pool this quarter and how the leasing initiative, the leasing incentive initiative impacted the improvement there. And can you talk about how you are thinking about rent spreads on the 2015 expiration?

Karin, this is Todd. I would say that the composition of the tenants is really no different. We have a pretty consistent mix, from quarter-to-quarter. I will say last quarter was probably less representative in that mix. We had one larger tenant that was a -- this is Bailer [ph] there was a fitness center that’s over 100,000 feet downtown on the campus and that rent spread was actually lower than the average and dragged down the result last quarter. So I would say the last two quarters certainly have been strong. I would say that we are not suggesting it’s going to be four every quarter next year. I think we still feel comfortable in that two to four range on those kind of numbers and it can vary from quarter to quarter. But I would say anywhere from what you have seen this year to little higher is probably the right range. And yeah, we have seen some initial good indications based on our leasing program as Scott mentioned. And we are pleased with that and certainly like what we saw the last two quarters.

Thanks for the color. And you also talked about in the components of expected 2015 FFO your assumption there for same store multi-tenant NOI growth of two to five. Can you just talk about how you expect to achieve that relative to what you did in 2014?

Sure, the two to five really is kind of two pieces. You got 2 to 4 which is our normal range that we talk about for the same store portfolio. Again we didn’t quite hit that in ’14 and we will talk about that as well. But I think more importantly we expect that going forward in the two to four range and then when you layer in the twelve development properties that certainly is additive and so we kind of look at that as being sort of three to five putting things in a three to five range. So we’ll obviously update that and share those results as we go through ’15.

And what are you guys trying to do differently in 2015 versus 2014 that you think will get you into that two to four range?

Sure, I think you have to break it down into sort of the components and you look at the rate per foot, you look at the occupancy and then expenses. And so if you look at the rate the real important trends that drive 2% to 4 % that we talked about, it’s really three things and Scott mentioned these in his last remarks. It is the contractual bonds that are in place. That’s a large percentage of our revenue base. Those have been running around 3% for quite some time and we don’t expect that to change. Our tenant retention is the next piece, that’s been running 75 to 85, in fact it was on the high end of that range in ’14. We expect that to continue in that range in ’15. And then cash releasing spreads that we just talked about we see those trending as stronger and stronger. So you put those together they really comprise about 98% of the base revenue for the company. So we see that as a strong trend. The other piece is occupancy and turnover. Obviously that can vary from quarter-to-quarter. We did have some of that effect on us in 2014 and we can give you more color on that. But I think if you look at that, that’s what give us that confidence that ’15 is two to four. The expense side is the other piece and obviously if we can be at the 2% level, if you do that math it puts the same store NOI in that 2 to 4 range and really right on the 3% level.

Thanks for the color. And then just last question, are there any opportunities to prepay any of your senior notes this year at all?

This is Doug, Karin. We certainly have the opportunity to do so. The senior notes have make-whole provisions in them. As you know we have been sort of looking at the debt markets and interest rates for quite some time now with an eye towards 2017 and the drop in interest rates over the past year has made the potential refinancing more attractive. But by the same token interest rates are forecast to remain relatively low for the foreseeable future. So we can afford to be patient. We hear the demand for re-debt is strong among fixed income investors and so I think should we opt to pursue a refinancing the market would be definitely wide open for us.

Okay, thank you.

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

Thanks, can you give us some color on the development discussions? I know in your remarks you mentioned that you’re going to or you expect to break ground on the project in Denver. You closed on any other projects?

We’re certainly working on a couple of others, as I mentioned Mike. The one in Denver certainly you know about. That one we’re looking to proceed here, if not in the first quarter certainly under construction soon thereafter. So we’re looking at several others. I would say any other starts would be a little later in the year. But again I think you could have a couple of starts that would complete in ’16. And we put in our guidance range, I think of $10 million to $20 million of spend on development for ’15 which obviously would be the partial completion of those.

Okay and Todd can you give us an update on the acquisition pipeline. What are you seeing in the market and it looks like you reduced your cap rate expectations again this quarter, as that pricing just continued to get a little bit more expensive?

That’s right. I think we’ve been -- obviously everybody has been watching the same thing as interest rates and other factors and just appetite for the assets has increased, cap rates have come down. I think everybody knows that for the highest quality assets you’re starting to see trades below six here and there, certainly on bigger portfolios. So that’s just reflecting that trend as I mentioned in my comments. Our acquisitions in ’14 range from the low to upper 6% range but we probably would be safer to assume that 6, 6.5 level for the ’15 level of acquisitions.

Okay and then lastly can you give us some color on your occupancy trend, in the line of the guidance that says the same-store multi-tenant occupancy is going to be between 87% to 89%, does that include the stabilized and processed portfolio too?

It does. Those certainly are at 80%. So they certainly will have some effect on that, and the ability to see the overall number move up. But we do generally think it will be flat to up as a trend line in 2015.

Great, thanks.

The next question comes from Kevin Tyler with Green Street Advisors. Please go ahead.

Thanks, good morning guys.

Good morning.

Your single tenant portfolio is about 8% of your total investment balance. And I see it is about 17% of total square feet. You show that the assets are currently a 100% occupied in the same-store pool but I noticed you’ve got two leases rolling in ’16 and then five in ’17. Can you talk a little bit about the breakout between percent of roll or roll as a percent of revenue that’s coming from single tenant versus multi-tenant. You lumped it all together I was just curious if you could parse it out?

Yes, we can give you the specific numbers offline. I don’t have them at our finger tips right here. Obviously in ’15 we don’t have any rolling, ’16 like you said a couple and a few more after that. We can give you some exact figures offline if you call us after the call.

Okay great. I’ll follow up with you, thanks. And then I noticed you added some additional disclosure on the purchase options, I appreciate that, in the 10-K. It seems like of the $160 million or so that are at fair value that are exercisable now or become exercisable in ’15 I was just curious if you can give any color on where those properties might be located, are they in any particular market and then maybe walk us through the mechanics of the appraisal process?

Yes, I mean there’s obviously a lot of different nuances in those. We tried to give a fairly simplified explanation in there and give a little more color. We really don’t have a lot of concern with those that have fair market value mechanisms. We can walk you through maybe offline some of the details but geographically I think there’s not one tenant concentration or geographic concentration. Yes, so I mean on the fair market value we really look at those as market driven and so there’s not necessarily some below market opportunity for somebody to get at those assets. And even in those that do have some different mechanisms than fair market value there’s only really one investment about $14 million, we’ve talked about this before that we think could be considered in the money and we’ve had discussions with the health system and they are not inclined to do anything about it. We talked about a solution and right now they are fine just leaving as it is.

Okay, thanks I’ll follow up with you on those as well, and the last one from me David we were glad to see you move towards the staggered board. I was just curious if you have any more color on what led you to the decision and maybe why make the move now?

Well I don’t think there’s anything particularly other than just convention, that’s basically the trend and it’s just -- it was no particular reason that trips some kind of wire that we should do something or whatever. It’s just kind of staying with the convention of what is the normal practice among peers and others.

Okay, that’s helpful. Thank you, guys.

Thank you.

The next question comes from Rich Anderson with Mizuho Securities. Please go ahead.

Hey, thanks. Along that last question, why not then opt out of [indiscernible].

Well, I don’t know. We didn’t have much discussion about the Maryland law related to that. But I can probably have some discussion with you about it when I get up to speed as to why we particularly didn’t follow in on that.

Okay. Just wasn’t part of my question I figured to ask. So can you help and maybe I’m just not getting this yet, but can you help me connect the dots, you get it 4% rent, cash rent spreads, you get it the annual three percentage rent bump, tenant retention is great and yes 0.4% same-store NOI growth. What was it that caused that to fluctuate so downward like that and maybe you said it, I apologize, but I don’t have it yet?

I don’t think we got specifically into that. I think it’s a good question. Obviously, if you look at last quarter, we had a 3.6 and then the quarters before that were sort of in between the 0.4 and 3.6. So I think the key there is to see the variability when you look at quarterly results. And it something we’ve seen for some time, quarterly results or just often false positives and false negatives in terms of indicators. Obviously their hindsight and I think what you’re talking about is how do I look forward based on this. And I think the more important thing, and we think actually annual results are better. That’s why we didn’t change our disclosure to reflect that, you have the 1.6 for ’14 versus ’13. So I think the important part is to say, what is going to change that or drive that going forward. And it’s really again those three revenue drivers which are the contractual bumps that you mentioned, the tenant retention , the cash, the re-leasing spreads which are positive. The things that happen obviously that can change that, the variances can be in expense line or could be occupancy. So if you look year-over-year probably the biggest impact you get two things. You had one which was in the first quarter we had some accepted snow costs and utilities related to remember this is first quarter of ’14 and that was about $800,000. And then the other side with occupancy, we had about 35,000 square feet of reduction in occupancy and average occupancy comparing the two years and that was about a million dollar impact of the revenue per occupied spread level we’re at. If you combined those two things it really would go from 1.6 to 2.7, so if you kind of break it down that way. So I think the question becomes occupancy and as we said before we’re confident about where those vacancies are. One of them is here Rich in Nashville, other building that you’ve seen on one of the campus here. We put them on the top of our score sheet for fungibility scores. We’re not concern about backfilling, even if it takes a little time. So it’s really, I think importantly where you have occupancy issues, it’s important to ask the question of what’s your confidence level about backfilling at better rates and based on these indicators we’re very confident about that.

Right, but is there a specific, the snow issue was a one first quarter event. Right, so like what…

That was a [ph] fourth quarter

That kind of jumped out this quarter?

Right. So fourth quarter was a couple of things. You had about a $900,000 difference that was comprised of three things. The first and the largest is really an operating expense reconciliation comparison, fourth quarter of ’14 to ’13. That had a net effect of about 500,000. And so just to explain that the true-up in the fourth quarter of ’13 was favorable that we had throughout the operating expense reconciliation and we had increase of $310,000 in the fourth quarter of ’13. And then it went the other way and was a negative for us in the fourth quarter of ’14 by about $180,000. So combined about a $500,000 unfavorable comparison. So that’s a big part of it. We also had a lease termination fee of $100,000 in the third quarter of ’14, which was unfavorable comparison. And then the last piece was really just a timing issue with occupancy and a couple of lease expirations that had about $250,000 impact. So you put all that together instead of 0.4 you’d be at about 2.4 recognizing some of that’s occupancy and we have to backfill that.

Okay. Fair enough, thank you. The two of the 12 assets that are kind a still troubled in that what you used to call SAP portfolio, have you thought [ph] maybe selling this.

Rich, the word’s not troubled.

Excuse me.

I told you there is no chain link [ph] expenses around those builds.

I mean mothers love all their children.

I know, I know but troubled is not the right word, but go ahead.

I won’t use troubled, I apologize for use of words. But I mean the 12 -- of the two that haven't yet -- haven't caught up with the rest in terms of occupancy, is there any thought about selling them at some point or is it you're going to stick with them at this point.

No, they're good properties. All these have their particular stories. As we get told you the one that is in Elgin [ph] is across the street from brand new, I guess $400 million $500 million hospital that has gone through from a local not for profit to being affiliated with Advocacy and once that -- all that whole process just froze all the physicians and other tenants in that area during that time, and that was also exacerbated by the healthcare reforms. So that property I think in recent times and we've even had one of the competitors of the hospitals takes space in the building. So that is not a -- that's not a troubled property. There would be no reason we would sell it because it's well positioned and has a good future to it. The other one at Overlake in Seattle is -- I consider to be one of the best buildings we have in the whole portfolio. And so they are -- that’s just the matter of absorption overtime, but it again kind of because of the timing and otherwise suffered through the period of know exactly who the tenants were going to be because everybody is kind of waiting on the healthcare reform.

Great. Thanks for that explanation. And maybe just a quick question how do you calculate cap rates, Todd you mentioned low to high-6% range, what -- is there a CapEx factor in that analysis?

There is in ours and I think you're onto something interesting although it's not huge difference. I think when a broker or somebody generically talks about a cap rate they'll just talk about first year NOI over the price. We tend to probably penalize it a little bit by putting in costs related to closing transaction cost and also our estimated capital in TI and so forth in the first year. So that's not fully loaded for all CapEx that we think needs to be spent overtime, but it does -- that’s loaded in there. So you might see a 10, 20, 30 basis point difference on occasion, but we tend to track that and we tend to focus on our approach. Obviously because it's for our own benefit to look at it more realistically.

Okay, and then the last big picture question, some rumblings of in long-term rates starting to head back up, we'll see if that really is going to happen. But is there any change in the thought pattern related to M&A in the MOB space in your mind David as it relates to just interest rate environment. And the defensive nature of MOBs and how they fit well in this type of environment.

Well I think the attributes of the various portfolios, HR particularly others they are components of the larger REIT portfolios. You do have the aggregation going on at various portfolios at some of those. So I think the nature of the properties that’s intrinsic what the type property is will make them always attractive. I think from the standpoint of that's the individual property level cap rate value and so forth. From a corporate level standpoint, there is a little bit of the difference in the light of the fact of our equity multiple compared to others and so on and so forth. So it's kind of the dilutee [ph] from the get go even before you start premium discussions. So I think the mechanics while the portfolios are very attractive I would say that would probably they would be more attractive to like sovereign credit kind of acquisitions and those kind of things. I don't think the mechanics are much there for peer-to-peer type thing.

Okay, wonderful, thanks.

Your next question comes from Michael Mueller with JPMorgan. Please go ahead.

Yes hi. Going back to the same-store NOI growth and specifically with the other revenue growth, if the base case is 3% revenue growth, you've had almost flat occupancy. I mean there’s about 10, 20 basis point erosion year-over-year so not much and then you had positive lease spreads. Even if you’re looking on a full year basis where the revenue growth was 1.9 what snuff that out, why wouldn’t it be 3 plus?

Well I don’t think the base line is -- I guess you’re saying contractual bonds at 3.

Yes.

You really have to layer that in which is the biggest piece and then you have to use also the piece -- there are leases that don’t have bumps every year. It’s a small percentage and we break this out in our supplemental. So you kind of do all that math and you get to a more 2.5 level is probably more the all-in revenue number. If you look at our disclosure and our newer disclosure on the annual same-store we actually provide our revenue per average occupied foot comparison and it’s actually up 2.1% rather than 1.9%. So that tries to at least eliminate that occupancy noise you mentioned. And I will say small changes in occupancy as you know have a pretty significant impact on our comparison. It’s almost a one-for-one in terms of basis points. So if you had a 20 basis points reduction in occupancy you can almost get a 20% basis points reduction in your growth rate in revenue. And then almost double that in NOI. So it shows - it’s pretty sensitive to occupancy and I think again it’s back to confidence levels in trend lines on filling space which -- that’s back to the three things, which is the cash re-leasing spreads, the tenant retention those are both strong and I think continue to be strong as we look into ’15 so those are the key indicators to watch on occupancy, and driving that revenue growth.

Okay and then you’re going to put the development properties in the same-store pool. Do you plan on still providing some updates in terms of the NOI progression like you have in the past or are you going to not give that anymore?

Well I think you may see it like in the NAV schedule which is basically where it is now. Certainly we’ll answer any questions about it. We’re not going to provide a same-store with and without other than just verbally we’ll certainly talk about it. We’re not going to continue to provide some breakout of that. But certainly we have no problem answering that question and giving some updates on the progress.

Okay, that was it, thank you.

Thank you.

Your next question comes from Daniel Bernstein with Stifel. Please go ahead.

Hi good morning guys.

Good morning.

I guess I have a question on your gross leases versus triple net, how do you see the benefit of one versus another and you see your trends towards hospitals or physicians one versus -- I'm thinking about like the expense variability you’ve had that may have impacted your NOI growth in 2014. Do you want to move more towards triple net leases or you’re happy doing some kind of gross or modified gross?

I mean part of it is defined by markets. Some markets are more net oriented some are more gross or mix gross. So you’ve kind of got that and I would say we’re not necessarily inclined to move toward the net environment but if you do that you’ll eliminate the opportunity for operating leverage which is I think Todd touched on earlier. If you can get the top line growth at 2.5%, 2.75%, 2.83% and keep operating expenses below that to a quarter then you create that ponds of operating leverage to get the overall NOI closer to the three range, if all leases are simply net you eliminate that opportunity for growth. So yes it’s going to lead to more variability quarter to quarter but we believe long-term that we can achieve that operating leverage and maintain it and improve ourselves that way.

Okay and in that note are you doing anything further to control expenses especially consumed on the utility side, are you renovating facilities at all to make them more efficient? And the facilities that you are looking to get rid of this year are those maybe facilities that are older less efficient, just trying to think again about how are you going to control those expenses going forward?

I think Dan, this is David I think in generally on a broad perspective we always have our eyes on like you said the older buildings with older systems and some those kind of things. But Julie Wilson and her folks, the efforts that they put in on expenses and the staff that we have that follows that maybe some time when you are by our office we can show you, they basically -- a lot of the control of utilities is one of the biggest items and we’ve basically gotten down to doing that in real-time. We don’t look at last month’s utility bills. They are basically daily now and that has to do with degree days. And so there are programs and things that we have now that basically alert us to any anomalies, , between degree days and actual consumption and some of those kind of things. So it's quite interesting to take a look at. I don't think you can look at on the iPhone yet but I think we're headed in that direction. So I think you have to break it down and taxes are always a big part. We have a lot of people with big sticks around the country trying to continually beat back the tax increases and those kind of things. The rest of it is just normal prudence on spending. So I personally, based on what her efforts and her staff efforts are we are on that big time.

Okay, yes I wasn’t trying to be critical, I was just trying to understand.

Yes and I understand well, but it's a lot of the utility thing. That and so we've ploughed most of our efforts into that and a lot of that just have is with people turning things on and off too early or too late or some things like that, but there is real-time analysis. I think overtime we will really see the benefit.

And I think too Dan to add to that where we do see the most variability is in the utilities and the taxes as David mentioned. And so from a lease structure standpoint while a lot of it is market-driven, we do go through a great effort to where we can get some mitigation of exposure to those particular items. So if you look at -- we actually have in our disclosure our supplemental we break down the lease types. And we're worried about 80% that have some formal of expense reimbursement and in most cases that's going to at a minimum address overages and taxes and insurance and utilities. So those are kind of the things we do on a lease structure where we can to sort of go away from just the market convention.

Okay, now that is great color. And then in terms of the development, you have it developed in a while and given the implementation of the ACA, are you seeing any design changes for the development that you're looking to do. Are people looking for more nurse practitioner stations or something different than what you built in back all four or five of those six is there anything different on the design side.

Only difference I think is within maybe the suite of a build -- the tenant itself, building envelope itself isn't fundamentally changing much. Those things are pretty long-term in nature and stand the test of time. I think it's -- you're seeing more open clinic models. So you might use -- have a full floor where you come off the floor and you've got a common waiting for several lanes of pods and so forth with different specialties, that might be a part of a big multi-specialty group. You're seeing more of that because there is a tighter integration between health systems in hospitals and the physician group. So you're seeing that at the margin a little more, but I'd say 90% of the step out there is still in your standard suite format. And that's easy to change as that model shifts a little bit.

Okay but basically the stuff that you have in the portfolio and now you're not seeing is obsolete or something like.

No.

Okay that's good for me. Thanks a lot.

Thanks.

[Operator Instructions]. The next question comes from Todd Stender with Wells Fargo. Please go ahead.

Hi good morning guys.

Good morning Todd.

Did you disclose the cap rates on the two MOBs you acquired in the quarter?

We don't usually give exact cap rates. Again I would say the cap rates for everything that we've brought in '14 as well as the one in January of this year were in that low to upper 6% range sort of the mid-sixes on average.

Okay that's helpful and that you're entering it -- they're highly occupied, if they're 97% 98% occupied. How do you guys drive value if you're buying in low-sixes is it really making it up in the lease maturity schedule, hopefully getting some…

Yes I think the time we do the analysis Todd you've hit it exactly. It's not the NOI today it's basically how does it work out overtime. So usually on those we abstract all the leases that’s how it get modeled up. There is a lot of discussion about what is the potential turn, what percentage you have in every year, how much can you expect, are the expenses good or down, all those kind of things and so that really have more to do with our decision to invest in the property more than the incremental accretion that might occur in year one.

The other thing I would add to that Todd is that -- that's within the buildings themselves. The other piece is I would say over the last two years there have been have been at least four assets where we are looking at buying those assets, not just for the building itself but for what it might come with, which we think is a redevelopment opportunity or you know expansion opportunity for that asset. In couple of assets we have bought in tight areas where there is very limited supply and you have gotten enough land there to add another building that might be as big as the one we bought. It is literally in the parking you have to build parking deck and so forth but that’s kind of what we look to see beyond just the value of assets itself is what else can we do that. And then the optimal scenario obviously is when we can buy in an place where we already own something. So we have that on the ground intelligence that David talked about earlier and then we can really drive with good knowledge that lease turnover opportunity that David talked about.

That was my next question, Todd what came along with the Seattle asset for example, that is pretty tight market anything else any options that came along with that?

Yes, I would say it kind of fits a little bit of what I just talked about.

Great. And are there any assumed debt any other value that can be created with a lower cost of capital that you guys out?

Assumed debt generally it is you would like to think it would come favorable but it usually ends up not being any better on average then the debt that we already have access to. So we tend to retire it when it comes due and just roll it into our current structure.

Okay, thanks. And just moving to sources of capital sounds like your disposition proceeds will be your primarily funding sources here. Does that suggest you won’t be tapping the ATM as much even though share price remains really above the range of what you have been issuing at?

Again I think if conditions are favorable in terms of market and share price, if the demand is there. I mean you are right, it is bouncing act, we sort of look at dispositions and expected proceeds from that and balancing that with how much ATM activity we may or may not need. We noted before dispositions, the sales, the timing of those can sometimes -- because there are generally one-off transactions can be a little bit lumpy. So the timing of those and the proceeds may not always kind of line up and so just kind of keep in mind. You need some ATM activity in the background to fund upcoming acquisitions but also keeping in mind what dispositions may or may not be coming down that pipe. We try to kind of be judicious about them.

Okay, thanks and just finally for the development conversion projects, what is the timing for when you can expect to get full NOI contribution, just to get to that $5.1 million figure?

The 5.1 is based on the current occupancy. So you know that really is something I would say is about a two quarter delay so you ought to see that by roughly the second quarter of ‘15.

Great, thank you.

Sure.

Thank you, sir.

This concludes our question-and-answer session. I would like to turn the conference back to David Emery for any closing remarks.

Okay. Thank you, everyone, for being on the call. And as Todd indicated we will be around if anybody would like to draw down or having any color on some of the discussion. With that we appreciate everyone today and we will talk with you next quarter. Good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.