Healthcare Realty Trust Incorporated (HR) Q2 2015 Earnings Report, Transcript and Summary

Greetings. And thank you for joining today’s 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 call over to Ms. Jessica Thorsheim, Director of Investor Relations. Ms. Thorsheim, the floor is yours, ma’am.

Thank you, and welcome to Healthcare Trust of America’s second quarter earnings call. Today, we filed our second quarter earnings release, and our financial supplement. These documents can be found on the Investor Relations section of our website or with the SEC. This call is being webcast and will be available for replay for the following year. We will be happy to take your questions at the conclusion of our prepared remarks. During the course of this call, we will make forward-looking statements. These forward-looking statements 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 that our assumptions are reasonable, they are not guarantees of future performance. Therefore, our actual future results could materially differ from our current expectations. For a more detailed description on some potential risks, please refer to our SEC filings, which can be found on the Investor Relations section of our website. I will now turn the call over to Scott Peters, Chairman and CEO of Healthcare Trust of America. Scott?

Thank you, Jessica, and good afternoon everyone. Welcome to Healthcare Trust of America’s second quarter 2015 earnings conference call. We appreciate you joining us today as we discuss our second quarter results, our progress in 2015 and our views on the medical office building space. Joining me on the call today are Robert Milligan, our Chief Financial Officer; and Mark Engstrom, our Executive Vice President of Acquisitions. At Healthcare Trust of America, we are dedicated to owning, operating and leasing the highest quality portfolio of medical office buildings in the U.S. We believe that MOB is located on healthcare system campuses in community core locations and on or around academic medical university campuses, will be core critical real-estate for decades to come. Our investments, acquisition decisions and underlying market criteria and rifle-shot approach underline our business strategy to focus on accumulating critical mass in key markets. This allows our in-house asset management leasing platform to drive earnings growth, maximize expense efficiencies and generate long-term enterprise value for our shareholders. Our view at the MOB sector is in very early stages of consolidation, from both an ownership key market perspective and from an operational and key relationship standpoint. The ACA and the healthcare market, is and will continue to transition. The Affordable Care Act is taking hold, providing insurance to millions of additional Americans. The population continues to age and healthcare delivery is being pushed to more cost efficient and integrated outpatient settings. Hospitals are transitioning their business models to capture gains and efficiency and physician groups are consolidating into larger practices to lower their overhead and invest in new technology. As a result, the demand for core critical MOBs and outpatient space will continue to increase. HTA’s performance for the second quarter of 2015 represented another quarter of solid consistent and disciplined performance. We continue to deliver sector-leading portfolio same-store growth with an MOB dedicated portfolio that exhibits relatively lower operating risk as compared to the overall healthcare sector. We are growing occupancy in our overall portfolio and our acquisitions are disciplined, accretive and increasing scale in key markets. We have also maintained our conservative balance sheet with debt to enterprise value of 35%. Turning to specific results in the quarter. We continue to produce consistent results. A 6% increase in FFO per share to $0.38, 3% same-store NOI growth, the 11th consecutive quarter of growth at 3% or higher. Accretive acquisitions about $190 million bring the full year total to $226 million, we’re 7% overall portfolio growth and expanding upon our current relationships in our key markets, Boston, Charleston, Indianapolis and Raleigh. And finally, continued focus on disciplined capital deployment, with leverage under 35%. Subsequent to the quarter end, we continued our capital recycling program with a disposition of five medical office buildings for approximately $35 million. These assets were non-core and generally located in secondary markets. We also utilized our ATM program raising $45 million in equity, furthering our philosophy of a conservative utilization of equity and debt as we continue to grow. As of today, 91% of HTA’s assets are invested in top 75 MSAs. Our investment criteria for key markets focus on macroeconomic trends with key indicators such as growth and population over time period, a relatively high educated workforce, a robust and growing healthcare system infrastructure and HTA’s ability to selectively acquire critical mass in the market or submarket. For us, establishing scale in these markets and deploying our institutional asset management leasing platform will help generate long-term consistent earnings growth, cost savings and efficiencies and long-term tenant retention. We currently have over 120 regional property managers, engineers and leasing professionals who are dedicated to our key markets within our regions. Turning now to the portfolio performance and operations. Our property management and leasing platform continues to drive sector-leading internal growth. At the end of the second quarter, over 14.5 million square feet or 94% of our total GLA was managed by our teams. The portfolio ended the quarter at 91.7% leased, up 20 basis points from the second quarter of 2014. And we expect to grow overall occupancy in 2015 by an additional 50 basis points to 100 basis points. Much of this growth is focused on larger spaces leased by physician groups or healthcare systems that are consolidating. Total leasing activities for the quarter was 291,000 square feet or 1.9% of total GLA and same property tenant retention was 85%. Consistent with this activity, over 83% of our total new leasing activity in the quarter was also with existing tenants, primary groups that are expanding and consolidating space. Cash lease spreads were up for the year and our tenant TI and pre-rent for new space continues its downward trend. Annual escalators in our leases signed this quarter was 2.7% on average and our lease roll-over may implemented averaging just over 9% per year over the next five years. On the investment front, we acquired six medical office buildings or 457,000 square feet for $190 million. The majority of the acquisitions here to date were acquired directly from developers or healthcare systems. Average occupancy for our second quarter acquisitions is 99%. In Boston, we increased our scale and presence to almost 850,000 square feet with a purchase of the 670 Albany building. The property is a 161,000 square-foot state-of-the-art biomedical research facility located on the joint campus of Boston Medical Center and Boston University Medical Center, one of the leading academic medical centers in the Northeast. The medical center is currently investing over $270 million into its campus and it’s also home to a recently developed $200 million National Institute of Health Laboratory. 670 Albany is 100% leased to both BU and BMC and our tenants are consistent with those found in our traditional MOBs. 670 Albany is located in Bio-Square just 1-mile from HTA’s recent acquisitions last year of the Tuffs Medical office buildings in Downtown Boston. The remaining second quarter acquisitions were purchased in existing markets of Charleston, Indianapolis and Raleigh. Each acquisition was sourced directly from the original developers. In fact, the first acquisition we made in Raleigh, where the developer was followed by subsequent opportunity to acquire a second MOB in Raleigh this quarter. Each acquisition also extended relationships with current tenants in the markets including MUSC in Charleston, Community Health in Indianapolis and Rex Hospital in Raleigh. As we’ve discussed, we are continuing our capital recycling program for our non-core properties, subsequent to quarter we closed on the sale of five MOBs for $35 million bringing total disposition activity over the last nine months to $118 million. As we move into the second half of the year, we continue to be committed to our business strategy of expanding our portfolio in key markets and using our institutional asset management and leasing platform to continue to driver earnings growth, generate synergies, maximize expense efficiencies and build lasting tenant relationships. With that, I will turn the call over to Robert Milligan, our Chief Financial Officer.

Thanks Scott. I will now walk through our second quarter earnings results, our balance sheet and capital funding plans for the remainder of 2015. For the second quarter, normalized FFO per diluted share was $0.38, an increase of $0.02 or 6% compared to the second quarter of 2014. Overall, normalized FFO increased to 11.5% to $48.5 million as compared to the prior year. The increase in year-over-year normalized FFO was primarily due to our same property cash NOI growth of 3% and the accretive NOI generated from over $450 million in acquisitions completed over the last four quarters. Our same property cash NOI growth was primarily driven by our contractual base rent which accounted for 80% or 2.4% of our growth. The remaining 20% of our NOI growth was driven by operating efficiencies that we continue to achieve through our asset management platform. G&A was $6.2 million for the second quarter, slightly below our expectation of $26 million for the full year. Interest expense for the quarter excluding the change in fair market value of derivatives was approximately $15 million. During the quarter, we did recognize a $1.7 million impairment charge. This was related to a smaller asset that we purchased early in our lifecycle as part of a portfolio. We sold the property in July for total proceeds of $1 million. Normalized FAD per diluted share ended the quarter at $0.35, an increase of $0.02 or 6% compared to the second quarter of 2014. Over dividend payout ratio for the quarter was a comfortable 83% within our 80% to 90% range that we target over the long term. We remain committed to a strong and conservative balance sheet, and ended the quarter with leverage at 35% debt to total capitalization and 6.1 times debt to EBITDA. Following the end of the quarter, we raised $80 million of capital to reduce our short-term borrowings. This included the sale of $35 million of non-core MOBs and $45 million in equity raised through our ATM at a price of $25 a share. Going forward, we continue to view capital recycling as a primary option for funding our normal run-rate acquisitions but are always evaluating the capital markets to find opportunities to efficiently raise long-term capital at attractive pricing. At the end of the period, we had total liquidity of $631 million including $16.6 million in cash. Our average interest rate on the portfolio was 3.25% down over 60 basis points from the comparative period last year. The primary reason for our reduction in average rates was due to pay-down of secured debt in the second quarter. Including hedges, we remain approximately 75% fixed rate at the end of the period. And weighted average remaining term of our debt is 5.2 years roughly equal to our outstanding leases, a very balanced position. I will now turn it back to Scott.

Thank you, Robert. And this concludes our formal remarks for today’s call. Operator, we can now open up the call to questions.

[Operator Instructions]. And the first question we have comes from Jonathan Hughes of Raymond James. Please go ahead.

Hi guys, good quarter. I just wanted to ask, how do you plan specifically to achieve some expense savings over the next several years? And what savings can you squeeze out of your key MSAs by achieving your targeted 750,000 and 1 million square feet of GLA in those markets?

Well, thanks for joining the call, good question. What we’re looking at is, and if you look at some of the materials we put out recently, we’re really trying to focus what we think is a first-off, a very acute fragmented marketplace from an MOB perspective. The ownership in MOBs is fragmented. And if we can concentrate in those 15 to 25 key markets, if we can bring our asset management platform, get critical mass, accumulate those efficiencies that come from that sort of consolidation, I think we’re just beginning. We’re now about $3.5 billion in acquisitions. And so if you continue to focus in the markets that bring efficiencies, every time we move out of a market that has a one-off asset in it, and redeploy into the market that has size and scale, we don’t necessarily bring increased amount of asset management expenses to the equation. We probably have this, an engineer that is able to handle that building, we have property managers we have leasing expertise. So we’re pretty excited about the opportunity to continue to do that over the next two or three years.

And I would just add to that Jonathan, I think what we’re really looking to get is consistently 20, 30, 40 basis points of NOI growth from these expense savings. Specifically, really the expense is across the board as you do get the scale, it’s looking at maintenance, bringing some of the maintenance in-house, leveraging the contracts there. It’s janitorial, its administrative costs, its utilities, there is, a lot of advantages that you get by generating the scale. And again, the magnitude of what we’re looking to drive is 20, 30, 40 basis points of NOI growth from that on an annual basis.

Okay, that’s very helpful. Thank you for that. And then turning to acquisitions, are you seeing more opportunities to acquire Life Sciences assets with kind of a research skew similar to the Boston property you recently acquired?

Well, I think that the opportunity to get invested, first-off, additionally invested in Boston, now that Boston is our top-top market, to add-on to the opportunity that we bought last year with Tuffs. If you go to the campus, tremendous campus that Boston Medical Center has down there, great asset. Those are the opportunities that I think are going to come from the transition that we’re seeing through the Affordable Care Act, where the future of medicine, the future of healthcare, it’s integrated, it’s integrated between the universities, that’s integrated between the medical centers, we see it here in Phoenix, we see it in other locations. And that’s very, very good real-estate for us to own. Mark will talk a little bit about some of the characteristics we see.

I think it’s interesting that this property is very much like other properties that we buy, it’s an on-campus property with Boston Medical Center and Boston University, they’re the tenants in the building which is very typical for our portfolio overall. So, underwriting it from that perspective is really no different than any other. Then the next thing we look at is what are they doing in the building, and is it core services that support the mission of, in this case Boston Medical Center or BU. And clearly what they’re doing in the building is core to research, education and clinical care. So, from that perspective, we feel very comfortable making the investment. Again, it’s on an academic medical center campus, so I wouldn’t characterize it as Life Sciences per say, but they’re certainly doing lab research and education in the building.

Okay, all right. Thanks for that. And then, lastly, I apologize if I missed it, but what were the leasing spreads on the new renewals during the quarter, I know it was 291,000 square feet, but I was just curious if you could give spread there on those leases?

The leasing spreads for the quarter overall we’re up about 20 to 50 basis points for the quarter. So we continue to see things in the zero to 50 basis points. I think what’s interesting too, on top of just the leasing spreads we continue to see a downward trend in the TIs that were given out, the TI dollars on renewals continue to be under $1 per square-foot per year of term loan continues to be under $4 per square-foot per year of term loan on new leasing. The number of free months we have to give away as well, which often times masks what this true underlying economics. We’re under a month of free rent on all the renewals that we did. So, I think overall, we do very much focus on kind of the overall economic picture of that. We’re continuing to see positive momentum.

Okay. Thanks. That’s it from me guys. I’ll jump off.

Next we have Michael Gorman with Cowen Group.

Thanks, good morning guys. If I could just go back to the NOI the expense savings for a second, do you have this, sort of a target NOI margin in mind for the in-house managed properties? And I know you talked about kind of the annual expense savings for those, but I was wondering if there was an NOI margin target there too as well?

Well, as we continue to get size and depth, we continue to transition our self-management and we’ve been at this now for about 4 years. I think we have shown a sector-leading same-store growth, I think from a company perspective, if you look at the growth on an NOI basis we’ve been extremely consistent. We’re getting better at our asset management, we’re getting better at our leasing property management, we now have engineers that are getting certified for certain things that in the past we would use for third parties. So, while I don’t have a specific number that I can tell you that we’re going to target. I can say with pretty good confidence that we are at the, we’re not even in the middle of what I consider to be the opportunity for us as a company. If we are successful and if we execute, if we execute in markets that we like, if we build that 1 million to 1.5 million square feet, if we continue to find property managers that do a tremendous job of managing their properties. I think we have opportunity to take this for quite some time. From an acquisition perspective, I think we’re different in this space. We don’t chase development. So, our acquisition philosophy isn’t based upon having to find an asset development with a healthcare system, it’s more focused on, what do we - do we like the markets, can we grow in the markets it’s an opportunity for us to get that scale. From a targeted acquisition perspective, we target individual assets. A lot of times, we get the question as, are you going to buy large portfolios. Well, my view is that a large portfolio that is fragmented and is predominantly outside what we like is our key market, would actually be - who wouldn’t be accretive to us from an asset management perspective because we wouldn’t get the synergies that come from building that critical mass in the key markets that we were investing in. So, I do think our investment philosophy is unique, it’s continued. I think it’s become more disciplined. And the asset management side of the equation is frankly the huge beneficiary of this process.

Okay, great thanks. And then, just looking at the 94% of the total portfolio that’s in-house managed now. What does that number look like for the same-store portfolio?

Mike, I think it’s going to be pretty consistent with that, clearly as we’re continuing to buy assets. If you look at where we’ve acquired assets really over the last three years and they’ve all been in key markets where do we have an asset management platform on-board. So, I’d say going forward I mean, you can certainly expect that most of the acquisitions are going to be managed by our asset management platform outside of other opportunities that come up with developers or other situations. But by and large it’s going to be in our key markets.

Okay, great. And then just last question from me, the information on the lease spreads was very helpful. Do you have the average escalators on the new leases that you signed in the quarter, do you have that available?

No, we do continue to see that move up. Average escalators in the quarter were 2.8. So, we continue to see that move up from an overall portfolio perspective.

So that’s 2.8 for the total portfolio or for the new leases that were signed?

For the new leases, sorry, for the new leases that we signed in the quarter.

Perfect. That’s all from me. Thanks.

Next we have Todd Stender with Wells Fargo.

Hi, thanks. Just to lead with that last question. It was 2.8% on the new leases. What’s the range of expectations, what’s probably a low-end for a lease bump and probably what’s the high-end can you expect over the near term?

Todd, this is Scott. I think that the range right now in the market we find ourselves in. And again I think their all markets are not the same. And I think that all assets are not the same. But with our portfolio of what we’ve got, I think it’s 2.5 to 3. There are a few markets that it’s harder to get to 2.5 but we push it in and we kind of say this is where we think our assets need to be because of location, synergy and so forth. But I would say 80% of the markets we’re in right now, three is very acceptable. And it’s something that isn’t getting a lot of push back, push back where the negotiation really comes more in the TI amount, the amount of free rent. And then the lease spreads from a renewal perspective. But 2.5 to 3 very comfortable, I think that has changed over the last 24 months.

Okay, that’s helpful. And can you, just to stay with you Scott, if you can speak to the size of the medical office buildings that you just acquired kind of like what you’re looking at for the next couple of quarters, how that relates to just three years ago? My point is that really the size requirements of your current tenants and your perspective tenants are changing, they’re getting larger. So can you just kind of speak to that dynamic of what you’re seeking and what that competitive landscape looks like now that you’re looking at larger assets?

I do think that the size that you’re traditional physician group is taking has expanded. Now it’s 7,500 to 10,000 square feet. In the past your make-up may have been 3,500 to 2,500 square feet. So I think when you’re looking at assets to buy, you’re looking at location of course because that’s where it starts. But then you’re looking at, who are the key tenants and how will that process move forward over the next three, five, seven years because you want tenants that are going to stay long-term. I don’t think these tenants are going to end up moving. I think this transition in healthcare, there is two transitions going on, one: being fragmented is getting consolidated, two: relationships that are very new, I mean, I would say being in this marketplace to last eight years. There has been tremendous change in those decision makers over the last three or four years. If you look at [indiscernible] you see that people change. So they’re building relationships with people that they feel comfortable with just like the asset we bought in Boston, we were up talking to the folks before we even bought it because we wanted to make sure that the relationship was going to be consistent. And that in fact, what were they looking for from the landlord. So, I think the building size is important, I don’t want 150 tenants in one building, I think a building with 50 different tenants in 50,000 square feet is 10 times harder to manage than an asset that - that same asset with three or four tenants or five tenants where you know where the synergies are, you know where their benefits are and they’re long-term. So, the part of the criteria that Mark goes through is in fact looking very, very seriously at the composition of the size of the asset and the tenant mix of the asset.

Is that changing pricing at all, are you planning more per square foot on a cap rate basis for those types of assets?

I think it is, I think that there is better credit with larger physician groups, certainly better credit with healthcare systems, certainly better credit when you look at what we bought in Boston with a combination of the two groups on our leases. But quality, I think investors want location, they want in that credit from a tenant, they want good assets because those are the assets that are going to really perform well over the next 10 to 15 years. The marginal assets, the secondary markets, the one-off assets out in the community, I think they struggle. I don’t think they have the same synergies or the same desired occupancy. So, I do think that that as a process is going on and you’ll expect to see us as I think our acquisitions over the last three years, we want assets that are very high-quality assets with high-quality tenants and with consistency of revenue stream.

That’s helpful Scott. And then, Robert, if you could just speak to the funding sources, you’ve already tapped the ATM in July. How are you looking at the cost of your equity right now and how are you budgeting potentially for maybe some debt for the second half of the year?

Yes, well, I think that’s a good question. It’s one that’s obviously very top-call and that we pay a lot of attention to. When we’re certainly making our acquisitions, we’re always looking to have that accretive spread to day one. And so, from a funding perspective, when we look at our cost of equity right now, it’s very consistent with where we were in the call it, third and fourth quarter of last year. And so, from an acquisition perspective, we’re right there as well. So we continue to see a pretty attractive opportunity to buy and fund long-term at a very accretive basis. But certainly as on the debt side as the tenure has moved up, you have seen the cost of debt go up. So, we’re looking, we’ve seen an increase in that cost as well. So the good news is that we do still think we’ve got a very kind of accretive basis from which to go on.

Great. Thank you.

Next we have Mike Mueller of JPMorgan.

Hi, most things have been asked already. But just one quick clarification, did you mention anything either on the acquisition or disposition side that you expected to close either in the third or fourth quarter?

Well, from an acquisition perspective, we continue to be selective and look for opportunities to adapt. I think we’ve been consistently on that side of the equation that we like to grow our portfolio 10%. I think we’re still there. We always want to be disciplined, we want to go back to make sure that we’re accretive from an acquisition perspective. And from a disposition perspective, we will continue to find opportunities if it’s non-core, if there is an opportunity to reallocate, recycle those same funds to key markets, it’s a win-win because what we’re seeing is that we’re getting relatively strong cap-rates for what we would consider to be a market that we don’t want to expand into. And then turn it around and expanding into a marketplace and have synergies and get those additional asset management benefits that we talked about earlier. So, I think you’ll see from us just the same consistency that you’ve seen from us now for three years.

Okay. But nothing definitive that’s going to, that’s planned on hitting in the next month or quarter or something like that it sounds like?

Nothing that we’ve talked about now.

Got it, okay. Thank you.

[Operator Instructions]. Next we have Dan Bernstein with Stifel. Please go ahead.

Good afternoon, this is Elizabeth Moran calling for Dan. I actually, I think all of my specific questions have been answered. But just going back to a very high-level view, we’ve heard over the last few months actually since interest rate has started to rise and stay somewhat elevated. The cap rates have largely halted to move downward but not backed up at all. Is that consistent with what you’re seeing as well?

Well, I don’t think that they have backed up. I think cap rates have stayed pretty much where they are. But I do think that there is still a, in fact as rates have moved up a little bit, I think that there is even a stronger sense of quality that is being looked at. I think it’s an acquirer of assets. You want the highest quality assets you can find for the best value that’s accretive for your shareholders. There is, a lot of assets out there right now, there are C Assets that are trying to be sold for B. And I think those are the ones that might not have the performance or not frankly be worth the value that’s being asked. I don’t think those cap rates are backed up either. So it’s still pretty competitive and I think it will stay pretty competitive.

Okay. Well that is all from me. Thank you.

Thank you.

At this time, we’re showing no further questions. We’ll go ahead and conclude our question-and-answer session. I would now like to turn the conference call back over to Mr. Scott Peters, Chairman, CEO and President for any closing remarks. Sir?

I thank everybody for joining us on the second quarter. I look forward to seeing you over the next several months when we’re out on the road. In the course, any questions or follow-ups, please don’t hesitate to call anyone. So, thank you very much.

And we thank you sir, to the rest of the management team for your time also. The conference call is now concluded. At this time you may disconnect your lines. Thank you and have a great day everyone.