Healthcare Realty Trust Incorporated (HR) Q2 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Healthcare Realty Trust Second Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Todd Meredith, CEO. Please go ahead.

Thank you. Joining me on the call today are Rob Hull, Chris Douglas, Bethany Mancini, and Carla Baca. After Ms. Baca reads the disclaimer, I'll provide some initial comments, followed by Ms. Mancini with an update on healthcare policy and trends, then Mr. Hull will discuss investment activity, and Chris Douglas will cover financial and operating results before we move to Q&A. Carla?

Thank you. Except for the 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, 2017, and in subsequently filed Form 10-Q. 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, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the second quarter ended June 30, 2018. The company's earnings press release, supplemental information, Forms 10-Q and 10-K, are available on the company's Web site.

Thank you, Carla. We are pleased to report another quarter of solid performance. Same-store NOI grew at a notable pace, above 3% annually, generated by healthy contractual rent bumps, cash leasing spreads over 6%, tenant retention well over 80%, and positive sequential absorption. Overall, a strong quarter for the company's core fundamental operations and long-term sustainable growth. Healthcare Realty's competitive advantage is derived from its hands-on leasing and management expertise, and well-honed investment criteria, sharpened by more than two decades of experience, resulting in a highly regarded MOB portfolio with robust performance and intrinsic value. The quality of cash flows derived from MOBs stands out relative to many other healthcare property types, namely, senior housing and skilled nursing, where wage pressures, competitive supply, and reimbursement challenges have led to thin rent coverage, forcing a number of REITs and their financially-restrained operators to reduce and restructure rents. There is a start contrast in risk between these healthcare property types, a difference we see as miss-priced in today's market. Investing in MOBs is an immensely safer business model aligning with A and AA rated health systems in high growth densely populated markets, housing, the expanding need for outpatient services, and generating rents from tenants to average 4,000 square feet and cover their rents eight to ten times. The diversity and steadiness of cash flows from Healthcare Realty's MOBs is central to our ability to proactively manage the portfolio and afford the necessary cost of redeploying disposition proceeds into more attractive properties. Having stable internal growth also allows us to be patient during periods of divergence between public and private valuations, and remain well-prepared to invest its public capital cost and property level valuations realigned. While public MOB revaluations have partially recovered, they remain undervalued relative to the robust private bid for MOBs. This is particularly true for Healthcare Realty, where we have demonstrated the ability to select the right combination of properties and apply our expertise to generate superior internal growth and steady cash flows. In the transaction market, MOBs remain well-valued across the board, with buyers affirming cap rates a plus or minus 5% with clear premiums for size and quality. With deep market support from private institutional capital, we expect no change in cap rates in the near-term. In contrast, public MOB REITs have been much more volatile and are currently valued more than 50 basis points above recent transaction level. Accordingly, Healthcare Realty has issued no equity in 2018 and used very little incremental debt; thanks to the conservative balance sheet and relatively modest capital needs. Even so we have been actively investing in recent months, recycling proceeds from asset sales into more sustainable cash flows with yields at or above our implied cap rates. As we continue to monitor transaction flow for quality investments, we have yet to pass on anything solely due to price. However, we are seeing a steady rise in the availability of attractive investments, both acquisitions and developments. As outpatient healthcare delivery remains a top priority for health systems. Our means to expand their market presence while also shifting gear to a lowest cost setting, consistent things in our conversations with health systems. Demand for outpatient properties has been growing for over 25 years and we will continue the tangible solution in the quest occur rising healthcare costs and improve outcomes. And the need for outpatient capacity is expected to accelerate over the coming years as the front-end of the baby-boomers reach their mid-70s. Looking ahead, we will continue to allocate capital judiciously, investing at accretive yields relative to our implied cap rates. With a solid balance sheet, ample liquidity and multiple capital options, we are well-positioned to create value through selective investments. In addition to traditional sources of debt, equity, and dispositions, we continue to carefully evaluate asset level joint ventures of viable alternatives if the public private valuation gap persists. Most importantly, we will continue to apply our operational know-how to bolster performance, the competitive advantage in today's pricing environment, and we will selectively invest with discipline, safely and profitably for the long-term. Bethany?

The tone in Washington has been largely optimistic for healthcare providers so far this year, with a quite legislative front and balanced regulatory proposal. The center or Medicare and Medicaid services announced its 2019 physician fee schedule proposal, generally positive on the whole with measures to lessen the regulatory and reporting burden for physician. The proposal includes an exemption from value-based reimbursement policy known as MACRA for practices with relatively low Medicare patient populations allowing physician some flexibility in adopting new payment methods. While continuing to meet the demands of what largely remains a volume based care system. CMS also proposed higher rates for ambulatory surgery centers in 2019. As well as for hospital based outpatient services. The latter increased mostly offset by their site-neutral payment policy. To bring payments for clinic visit in off campus location in line with lower comparable physician office rate. This represents an ongoing effort by the CMS to curve incentives for hospitals to acquire off campus, outpatient practices or add new providers and services to existing off campus location and charge higher hospital based rate. Non-campus outpatient Medicare rates remain stable, 79% of Healthcare Realty's MOBs are located within 250 yards of a hospital pointing to the on campus integration of our facilities and strong demand fundamentals. Regardless of the direction of site-neutral policies down the road, we are confident the expansion of outpatient facilities will be supported on and off campuses both from the perspective of payers as well as health system. Within the landscape of regulatory changes, government reimbursement, insurance challenges and the like hospitals and physicians remain focused on increasing market share and financial alignment and positive demographic market. According to a recent survey by the 2018 advisory board of health system CEOs, the top strategic concern among healthcare executive were pursuing sustainable cost controls and increasing revenue growth, both being achieved through the enhancement of outpatient care delivery. These strategies are out linked to health system to other or publicized initiatives including population health management, accountable care organizations MACRA IT and other health reform related efforts. Hospitals are shifting more low acuity care to outpatient lower cost setting and at the same time more specialty procedures are now being able to be performed on an outpatient basis. While this trend has pressured inpatient hospital volume, health systems are centralizing higher acuity patient at acute care hospitals, thereby increasing revenues for inpatient admission. Combined with growth and outpatient revenues health systems with dominant market presence are seeing higher profit margin. We do help system and physician interdependent as strong than ever. The importance of physician specifically to the direction of patients, promotion of outpatient service growth and revenue generated for hospitals empathizes the critical nature of a strong physician presence on hospital campuses. Additionally, the potential for fewer Stark Law regulation, currently under consideration in Congress, could also lead to stronger position, hospital financial ties and their connection to the hospital campus. These meaningful trends should benefit the Healthcare Realty's portfolio of medical office building and it's development of new facility affiliated with top credit rated health system in top MSAs. Having a broad base of physician tenants across more than 30 specialties, relatively lower concentration of Medicare and Medicaid patients and high rent coverage, Healthcare Realty will continue to capitalize on the inherent growth and stability of its property in the years to come. Rob?

Healthcare Realty had a productive investment quarter, purchasing five buildings for $70.4 million at a blended first-year yield of 5.9% and primarily funding them with $55.7 million of disposition proceeds in the quarter. The properties acquired totaling 370,000 square feet are in Seattle, Denver and Oklahoma City. All five are located on or adjacent to hospital campuses associated with leading health systems with four of the five on campuses where we already own buildings and two providing future redevelopment opportunities for the company. The market for medical office buildings remains active with pricing essentially unchanged from last year, we are seeing cap rates for individual MOBs and smaller portfolios in the mid 5% range and pricing for larger portfolios at about 5% with the couple of sizable transactions in the mid-4s including and well publicized asset that recently traded in Houston. Consistent pricing in the private market over the past year stands in short contrast to the volatility in public market valuations giving rise to valuation gap. As a result, the company's acquisition guidance for the year remains $75 million to $125 million in-line with our disposition guidance. When the relationship between our implied cap rates and asset pricing improves, we will revisit acquisition guidance. Disposition activity included the sale of seven properties in Roanoke, Virginia as a result of the fixed price purchase option for $46.2 million and five skilled nursing facilities in Michigan for $9.5 million bringing total sales for the year to $55.7 million. For the remainder of the year, we expect additional dispositions of around $50 million at a blended cap rate of 5.5% to 7%. Turning to development, we continue to see steady leasing demand at our two projects in Seattle and Charlotte scheduled for completion in the first half of 2019, we are also making steady progress on a couple of projects that should start within the next several quarters as we work with hospitals on their outpatient programming in the since. Our investment approach, including acquisitions is done with an eye towards incremental development and redevelopment. Investments with expansion potential give us more control over timing and the ability to capture future demand and will generate better yields compared to widely marketed developments. We have identified over 1.5 million square feet representing three quarters of a $1 billion of development and redevelopment potential embedded in the portfolio, half of this potential involves the replacement or expansion of existing properties. With the other half being ground up development on excess land associated with MOBs we've acquired. While it will take many years to harvest this potential, we are in continuous discussions with multiple hospitals on a handful of projects, totaling around 200,000 square feet that could translate into one or two incremental development starts in the next 12 to 24 months. With ready sources of capital including dispositions and then ample pipeline of investment prospects we are well positioned to invest creatively relative to our implied cap rate in the second half of 2018 and into 2019. Chris?

Normalized FFO for the second quarter was $49 million flat over the first quarter. With no shares issued, normalized FFO per share remain unchanged at $0.40. Our strong internal growth in operational efficiencies helped to keep sequential quarterly FFO stay even as we continued our initiative rotating out of off campus slower growth properties and into on campus multi tenant MOBs with greater long-term value. A $600,000 increase in NOI net of straight line rent and a $700,000 reduction in G&A expenses offset a $400,000 increase in interest expense and $800,000 of net dilution from the partial period impact of dispositions and acquisitions in the second quarter. Looking ahead to the third quarter we expect an additional $500,000 of net dilution from the second quarter dispositions. And while we expect continued revenue growth from contractual escalators, typical third quarter seasonal utilities which can increase expenses as much as $1.5 million over the second quarter, will likely result in no increase in sequential same-store NOI. This typically reverses in the fourth quarter to more normal levels of $700 to $900 and sequential NOI growth. Shifting to portfolio NOI for the quarter, total trailing 12-month same-store NOI increased 3.2% with single tenant net leased assets growing 3% and same-store multi-tenant properties growing 3.3%. As expected, single tenant NOI growth continue to improve in the quarter increasing 5.8% every second quarter of 2017. The improvement was primarily driven by two large leases with non-annual escalators greater than 5% that occurred in late 2017 as well as a lease that commenced in March of last year that had a couple months of rent concessions resulting in a partial period of rent in second quarter 2017 versus a full-quarter of rent in 2018. Within our multi-tenant same-store portfolio, revenue grew 2.9% driven by 2.6% increase in revenue per average occupied square foot and a 20 basis point increase in average occupancy to 88.4%. This revenue growth combined with a modest 2.2% increase in operating expenses creates operating leverage that generated multi-tenant same-store NOI growth of 3.3%. Our leasing and management team continued to execute well using key drivers of internal revenue growth specifically in-place contractual increases and cash leasing spreads. In the quarter, average in-place contractual increases continued to make steady marginal improvement at 2.84% compared to 2.81% in the first quarter and 2.68% eight quarters ago. Future contractual increases for leases executed in the quarter were 3.2%, which is above the average in-place contractual increases pointing to accelerated growth in future periods. Cash leasing spreads were 6.4% with over 92% of the renewed leases having cash leasing spreads of 3% or greater. Now, a few comments on our maintenance CapEx which totaled 428.7 million year-to-date; we had three items worth noting in the quarter. First, we had $900,000 of second gen TI that was over and above allowances and that the tenants will reimburse us in the coming quarters for the average. These reimbursements were not netted in the TI spend disclosure. Second, we spent $2.1 million move-in ready suites. Year-to-date, we have built out or underway with 40,000 square feet move-in ready suites and have leased or have under LOI half of the space so far. Although we don't breakout renew enhancing capital, these dollar should boost absorption in future revenue. Lastly, we funded $1.4 million of capital expenditure associated with projects underwritten as part of acquisitions. However, the spending fell into maintenance CapEx because it took longer than our timeframe for inclusion in our planned acquisition capital. Including these three items, our FAD payout ratio through the first two quarters of 2018 was 98%. Without them, our FAD payout ratio would have approximately 94%. While the stock price has risen 13% over the last couple of months, improved our implied capitalization rate to approximately 5.6%, we do not currently have plans to issue equity to fund investments. With $465 million available in the line of credit, debt to EBITDA of 5.1 times, interest from private capital to form JVs and healthy pipeline of dispositions for the remainder of 2018 were well poised to make investments that will generate operating leverage continue to drive robust internal growth. Todd?

Thank you, Chris. Operator, that concludes our prepared remarks. We are ready to begin the question-and-answer period.

[Operator Instructions] The first question comes from Vikram Malhotra of Morgan Stanley. Please go ahead.

Thanks for taking the question. Maybe just first question you alluded to kind of the CapEx being elevated for certain items and ex-FAD, the FAD payout being 94. Can you just maybe walk us through your thought process over the next solid six to 12 months? Where would you like to get that payout ratio and what parameters -- what are you watching to see or monitoring such that you could start maybe raising the dividend?

Thanks, Vikram. As Chris walked through obviously 98 is the FAD payout ratio year-to-date and then with some of these adjustments to that 94 level. And I think if you look at 2017 we are right in the middle of that, little over 96%. So, I think as you said say before this year probably looks a lot like last year on average. And I think the second-half of the year should fall sort of in that range as well. So I think really it's talking about '19 and where we see that going. And I think certainly as internal operations continue to perform well, we see that improving incrementally each quarter and each year especially going into '19. I think our view is we clearly want that to continue to go down over time. But with internal growth being the driver of that it's going to be stairsteps that will be incremental progress. So I think as we go through '19, we expect to see that come down a bit, longer term where we would like certainly it to go with the below 90% certainly. And I think that's certainly what it takes before we talk about getting to incremental dividend increases. So I think our view is we will continue to address that in the coming quarters to give some insight as we get closer to '19 and continue to monitor that and give some thoughts as to how we look at that in terms of coverage and dividend increase.

One thing I would add to that, Vikram, is as Todd mentioned we expected 2018 to be pretty similar to 2017. And as we talked with many of you about a lot of that has to do with the fact that selling single tenant net lease buildings and buying multi-tenant buildings, the all $55 million dispositions that we have done so far this year were single tenant net lease which don't have much, if any, capital especially on a run-rate basis. So, as you go through that transition, we knew that that was going to kind of put a pause on us driving down the payout ratio. But we still think that it's the right decision will help drive long-term value and growth as we are able to get better internal growth out of our multi-tenant properties than we see out of this single tenant net.

Okay. And then just one more, you talked a little bit about the redevelopment and development potential over the next few years, can you help us -- give us more context, give us some more numbers around it? What sort of opportunities are these and just maybe overall where are you -- what level are you comfortable at in terms of taking the development pipeline especially development opportunities?

Sure. Yes, thanks Vikram. I think if you look at the pipeline that I described, we really view those as long-term opportunities. As we said, some of those are potential developments on excess land acquisitions that we required. Some of them are potential redevelopments of existing buildings. And so, we view that as a long-term development potential. I think if you look at the rate that we projected in terms of what we like to do in development, it's still in that $50 million to $100 million range. That range is generally made up of some redevelopment opportunities as you have seen with our Charlotte redevelopment. But it also includes outside development opportunities. And so, we look at this longer-term pipeline as really additive to that or helps us get to that higher end of that $100 million range. So, we still think that $50 million to $100 million a year is the right range for us. Depending on leasing of those developments and where they are, we could get to the top end of that range, but I think really long term that development -- that pipeline that I described is more additive to our existing efforts. And really the key there is in all of those situations we control the opportunity either through simple land that we own or a long-term ground lease that we have. So those are well-located on or adjacent to campuses and it kind of keep us out of the reliance on marketed opportunities.

And then what users are you targeting on those opportunities -- those redevelopment opportunities?

Generally, the yields that we are looking at we said before that those are typically 100 to 200 basis points above where we are seeing similar stabilized asset yield. So, our guidance on the acquisitions right now 5.25 to 6. So we would look at 6.25 up to 7.5 on those opportunities.

Okay, got it. Thank you.

The next question is from Jordan Sadler. Please go ahead.

Thank you. Good morning. Can you give us a little bit of insight into what potential Joint Venture might look like for you guys, would it be stabilized asset Joint Venture that you would see with assets and look to grow with essentially a cheaper cost of capital or would it be the pursuit of new assets altogether?

Sure Jordan, I would say both is the answer. I think we will look at both of those. We are certainly having discussions around that, we've for sometime more than probably a couple of years talking to different private capital sources but that as you've seen out in the market that has certainly ramped up more or so lately and I think we would certainly look at those. You've seen some of the transactions just recently yesterday, an announcement on a sale of properties but then turned around investing some more properties. So I think both of those would things on the table and I think as you know, that's to be very disciplined and selective. We are being thoughtful about that process not only what the structure looks like but who we are partnering with and how that fits into the bigger picture. So we continue to evaluate that and really more importantly I think just being prepared for that depending on sort of where is the market dynamics play out in terms of the public versus private valuation levels.

Okay. And then, just another question, you guys talked about where you are seeing CapEx, obviously the private market that continues to be pretty aggressive, you guys are trading a 5, 6 cap and we've seen select assets that we described trade, pretty aggressively in the mid to low 4s I think. Any thoughts on how else sort of narrow the gap vis-à-vis your portfolio valuation and quality versus payment market?

Sure, I mean certainly the prior question gets to that point with the JV structure looking at different sources of capital other than equity and traditional debt sources. So that certainly is one. I think certainly patients are important here. I mean, obviously last quarter about a quarter ago, we are all looking at this and we were probably at an implied cap rate of closer to 6%, so not saying that waiting is a strategy necessarily. But I do think patients is a virtue and I think one other things that we certainly saw a quarter ago is that we didn't all have great information on the transaction market and the question was out there, would the private market continue to support a strong bid for MOBs or at least as strong as everybody have seen last year and I think a quarter later everybody can confidently say that is certainly the case, that's a private investor's institutional capital have created a strong level of support at the same levels as last year. So I think a lot of that is education and understanding for all of us that participate in this market and I think that will continue to help close that gap. But obviously as you said, we are looking at proactive things we can do. Clearly, our internal growth model drives us towards that, I think further appreciation of that is good. We are continuing to be thoughtful about dispositions and redeploying that capital and just being mindful and not getting too eager to invest before, it makes sense profitability.

Just sort of one last follow-up on that point, if you were to sort of give us some guideline on the scope of the portfolio that has a growth portfolio that's low what you've been targeting and then how big is that portfolio today really sort of sub 3% escalator or more of the flatter type revenue growth profile?

It's pretty small these days, if you look at some of our disclosure around our average contractual increases. I think over 90% of our leases, this is multi-tenant specifically have contractual escalators that average just under 3%. So it's gotten pretty small and certainly that reflects all the work over the years that we've been doing to try to get to your point which is trying to call the portfolio and find these things that aren't growing as well as, as we'd like and I think single tenant as Chris described earlier, it's certainly an area where we've been working on that overtime and on top of that non-MOB type properties. So you've seen a lot of that from us, we just find that generally single tenant in this largely indicate off-campus as well, tends to grow closer 2%. Our average single tenant escalator is 2.13%, so clearly it's our contrast with something closer to three. So I think you will see at the margin that continues for us, we are okay with some single tenant, there is certainly some good investments out there. They are off-campus or single tenant, but we will always sort of be biased towards that multi-tenant for the reasons of growth. So I would say less than 5% to answer your specific question.

Okay, lastly any color you can provide around the Michigan portfolio sale, in terms of that cap rate?

Yes, that was cap rate. I think it was little -- I think, it was low level 25%, it was five buildings that we sold that were in small markets in Michigan, properties were about 45 years old and we sold that to an operator in Michigan who is a second largest operator in Michigan and we feel like they could pay the most for it. So I feel like it was a good transaction. The operations in those buildings had dropped off from, I can see there from the low 90s down to the low 70s the cash flow was deteriorating.

And the previous operator was exiting to market.

Yes, that's right.

Okay, were they covering?

No they were not covering.

- it's probably below one.

Yes, it is below one.

Yes, it is certainly below one and have been droppings and we can just tell the operator in terms of their focus of leaving the market. Then it's all the fair amount of other properties and exit that they were not the people that we are going to be able to turnaround. So the question was do you go through and try to re-cut a lease with a new tenant who is going to need to put capital and take some time to turn the operations around or is it just better to sell a new one. So we decided giving our focus that it was better just to sell a new one at that point.

Okay. Thanks guys.

Thanks Jordan.

The next question is from Chad Vanacore of Stifel. Please go ahead.

Thanks. My call has been in and out. But I will apologize, it's already been answered. But cash releasing spreads were elevated at 6.4%. And then, it's been pretty well elevated than last couple of quarters, what leases are driving that and why?

I would say generally, it's pretty you know, deep and wide as I mentioned you had 93% of our leases that were 3% or greater. I will point out, it was one lease, this quarter that skated a bit higher, it's for off-campus building where the hospital wanted to expand as doing some reprogramming. So we did agree to provide them some additional capital associated with that. So our TI per square foot for lease here was higher than average and it's around $3.81 for that deal. We had a 17% cash leasing spread. But if you excluded that one deal, the cash leasing spreads were still 5% and our TI per square foot for lease here would have been a $1.78, which is right in line with what our average was for 2017. So there was one like I said, just get a bit higher but still even excluding that one, still very strong, like we always say long-term, we think that the right level is 3% to 4%. But when you do have opportunities where you have something that can be a bit outsized and keep those negatives as minimal as possible and that certainly helps your average.

And Chad that deal, that particular deal that Chris mentioned was I think 47,000 feet. So pretty large in our typical leases being 4,000, 5,000 feet that was a large one. So it did have that effect as Chris described.

Okay. And then, Todd, your commentary basically around the market and the difference in pricing through public and private fee, how do you think that affects your acquisition based on four if you are in -- really cut that down a bit. And what would you have to see change for you, open it up bit more?

Yes, I think the good news is as Rob went through, we certainly found a nice group of acquisitions that were yielded above our average implied cap rate, so I think we're confident comfortable that we can produce as we said up to $125 million this year of acquisitions that can still be in that 5.5 to 6 range, so they're accretive, I think to your question if we were going to turn that up, clearly we would need to see a continuation of sort of the improvement in stock price and implied cap rate for us to really see that turn up. So I mentioned about a 50 basis point or more gap between where we are at 5, 6, mid-five level and sort of the broader market for some larger transactions being closer to five, kind of plus or minus five but you could certainly argue either side of that, so could even be more than 50 basis points. I think as we see that, as we see our implied cap rate move to the low-five's, it certainly opens it up for us and allows us to kind of expand our view of what we can do whether we can do that this year obviously remains to be seen obviously we'll re-evaluate that as we go into 2019 but certainly seems like we're headed in a better direction a quarter later.

All right, thanks a lot.

Thank you.

The next question is from John Kim of BMO Capital Markets. Please go ahead.

Thank you. The occupancy in your multi-tenant portfolios remains very steady at 88% but still seems little low just given the demand for outpatient care in the strong economy but it's just basically the price of doing business on campus multi-tenants or is there anything that you could do to drive this figure above 90%?

Sure, I think long-term John, we will continue to drive it towards that 90% level, I do think you're right that if you're able to parse out other folks' portfolios that were true multi-tenant mostly on-campus, you would find a very similar number, I think if you look at some folks out there whether it's HCP or Ventas who may have more of that maybe than our direct peers, you'll find that but even as it we've said this before, if you look at HTA and you kind of parse out their multi-tenant versus single tenant from their disclosure, you'll find it's not too dissimilar, it's that same 88, 89 level. So long-term though certainly we look to see getting absorption and some of that is lease-up, but some of it is continuing to manage the portfolio and calling those properties that may be just lagging and stuck and not able to generate as much absorption. So I think 90 is certainly a goal in our mind over time, it's not going to happen overnight but as we've said 20, 30 basis points a year of absorption is a realistic pace.

But even in that scenario 90% is as good as it gets could ever get up to 95 plus?

It's going to be very dependent upon the composition of the portfolio, I think if you're just saying hey what is an on-campus multi-tenant MOB typically run, you're going to in a broader portfolio of 150, 200 properties you're going to get closer to that 90, not say you can't have a building that's 100% or 95%, it's just when you look across a broader universe, I think you're going to be closer to that 90. It's lot of it's just functional turn that you have as we describe there's a lot more activity when you have a multi-tenant building of coming, going. So you get the sort of more frictional vacancy and then over time as the building has been around a while, you can be left with some smaller spots that are more challenging to lease and you're sort of waiting for a tenant who is adjacent to that space to expand and take it and with all of that across 200 buildings, you tend to be close to that 90% level.

Okay. And then on your general acquisitions this quarter, can you discuss the cap rate differential between the office and MOB assets that seem like they're almost identical assets; I realized occupancy part of that but still it's a pretty wide gap between those two cap rates?

Yes, there was two buildings there adjacent to the St. Anthony's Hospital there where we have other investments, one of the buildings we classified is office, it's got General Office tenancy in it and so we there was a difference in the value that we assigned to each of the buildings and so that's primarily the difference between the two, the vacancy obviously and the one in the medical office building we see is having potential lease-up, when that gets into, there's currently some leasing activity that's out there right now, we think of bringing into mid-80s on an occupancy level and ultimately when stabilize, it'll stabilize in that mid to high 6% level. So there's some room to close that gap between the two but there is a difference in the two buildings.

Same location, same tenants, same size?

Yes, same location I mean we look at, these are two buildings we think that there's probably some long-term redevelopment opportunity here as well. These two buildings sit on the same parcel of land 13 acres of land at the front door to the hospital, so we think there's some long-term value there for redevelopment which is really the attractive thing about these buildings.

And John, I think the other piece of that is the office building with the higher cap rate, we have a large user in there that's actually looking to expand and take the balance of the space and we think they're committing longer term, so we think it will remain office frankly until as Rob said, down the road it becomes a potential redevelopment play. So we kind of looked at that very differently in that's going to remain office for some time whereas the other building can continue to improve as Rob said financially as a leasing to medical tenants, so we just put different valuations internally on that.

Okay. And then a couple of questions for Chris on the CapEx, I think you mentioned that there will be a TI reimbursement in the future period, how will that be recorded?

The cash will come in and then we will just recognize the income, we'll get all the cash upfront and then we'll recognize that income on a straight line basis over the associated lease.

And then you also mentioned that there was higher maintenance CapEx fix of some acquisition costs for deferred acquisition CapEx deferred, Can you just remind us how you define CapEx on acquisitions versus what you have new CapEx?

Yes, so what we do is when we are buying a property a lot of times, we will have acquisition capital either TI or maintenance CapEx that we will underwrite into the project and it will be reflected in the cap rate that will show for the investment in our investment activity in the supplemental. And so that capital we look at is acquisition capital as opposed to maintenance CapEx because we've already kind of taking into account in terms of that that cap rate. And what we do is that any of that capital that is spent in the first year or two goes into that acquisition capital and in the instances this quarter just for various timing on some of the projects it took longer than that you're to get completed. And as a result based off of kind of the internal guidelines we've set up it fell into maintenance CapEx as opposed to the acquisition capital but if it would've been a quarter maybe two quarters previous it would have been an acquisition capital, so that was the reason for point that out.

And maybe, John, also on that it's partly related to our same store principle of bringing assets into the same store pool after eight quarters for a year-over-year comparison and so we basically that cut off in that being at the two year period, so once again same store it's we say it's clearly maintenance CapEx and that's kind of what happened this quarter.

Okay, thanks for the clarity.

The next question is from Rich Anderson of Mizuho Securities. Please go ahead.

Thanks. Good morning everybody.

Good morning.

So let's say the acquisition environment continues along these lines and perhaps you're and you still are quite ready to raise conventional equity and given like the miss that the match between dispositions and acquisitions using that kind of math would you be more inclined to be a buyer of sort of the value add type of product. And sort of juice returns over the course of the coming year or so, or are you more inclined to be taking more the safer route and sort of fully occupied assets.

I think you've seen as over time to a little both, I think value add in medicals pretty safe that in terms of value add it's not higher risk like you might traditionally think but to your point some of that is what Rob was just describing with the two properties in Denver, the occupancy clearly and being in the 80% it's certainly kind of value add if you will in the medical office play and as Rob said long-term, we see redevelopment opportunity there or just with 13 acres of land maybe we can add building in parking garage there as well. So I say it's both clearly our primary focus historically and going forward is buying quality stabilized assets but we also have done a lot of work in the last couple years as Rob said with an eye towards building that development a redevelopment potential which is a bit of a value-add play maybe a little twist on value-add where again if you can buy them individually as we've done this year and we did some of last year outside of the Atlanta deal buying things. Little one in two at a time were cap rates might be 5.5 to 6 rather than five for a bigger portfolio.

Okay, and then with your guidance your acquisition guidance of about $100 million Same for dispositions but then you talked the possibility of joint venture creations whether it's internal with your assets or buying external from you at this point. I'm curious what would it take for there to what kind of size would it require for you to go the JV routes and see it at the present time, you're assuming sort of dispositions fund's acquisitions?

Well, I think just simple math would say to your point, if we're selling $100 million plus or minus at the top end and buying that if we saw something that became a little more sizable than that whether it was just one assets that kind of pushed us well over that limit or it was a portfolio we liked that said hey this is $100 million on top of what we can normally do maybe we need to look at that. I think also you have to consider if you're JV being with somebody and starting a relationship in that manner, you probably are going to do it on one small asset, so it might be something that is $100 million or greater I think to answer your question.

Okay, that's the magic number of $100 million perhaps to hold you to that?

Sure.

Okay, that's all I got. Thanks.

Sure, thanks, Rich.

The next question is from Omotayo Okusany of Jefferies. Please go ahead.

Hi, good morning. Most of my questions have been answered but I just want to focus a little bit on the CMS proposals put out last week I know you make them initial commentary around it during the call but just curious specifically if that changes your perception or if you think any of those rules would change investor perception about cap rate differentials between off campus and on campus whether this should start to expand out again or whether you just kind of think it's more par for the course it's not really investors are not going to look at any of this news as being serial in anyway?

Yes, I think Omotayo, it's interesting always to watch some of those incremental changes that they make and I think certainly some of the tweaks they made continue to really emphasize the site neutral. Initiative that they have and really it's something that they were trying to do back in 15 when they passed this the whole 603 piece and I think what you're seeing now with these proposals and then the actual rules is just continuing to enforce that and try to curb anybody who's trying to sort of take advantage of that because they were really serious about saying hey, when a hospital department goes off campus. There's really no logic to charging higher rates, so I think it's just continuing to implement that, so it's not surprising I don't think it's a huge shift. I think for us it's simply points us back to the campus and where we know it's very safe and critical for those services and whether they go to site neutral everywhere on campus or not, we think broadly speaking outpatient is a huge part of the solution to driving lower health care costs, improving outcome. And so that's going to help you know obviously on campus where we think it's safer and it's even going to help off campus as well but on the margin we like the on campus safety and I think your question about cap rates. I don't know if it's a big enough incremental change this time to suddenly suggest a big shift in cap rates. I think we have a biased view based on our long experience that it should be a significant difference, whether everybody else reads that I think it has to play out a little bit more of the time.

Got it. Do you think you could ever get to a world where everything is just site mutual?

Sure, I think CMS has a mindset of looking at that over time whether they go to that on the campus at hard to now but it's certainly a broader initiative and certainly helps at the margin bringing down the cost of care, so it could happen but we think, the reasons to be on campus have a lot more to do than just those arbitrage of reimbursement levels and there's clearly compelling reasons for surgeons all kinds of specialists that truly need to be near their ORs, their patient beds all the different services they provide that are hospital-based. So there's just, there's only more pressure growing on these physicians to be more productive, waste less time, so getting into car and going off-campus for those folks just isn't really in the picture.

Got it, all right, that's helpful. Thank you.

Thanks.

The next question is from Daniel Bernstein of Capital One. Please go ahead.

Hi, good morning.

Good morning.

I just wanted to ask, you put in this wall weighted average lease term, I just want to make sure is that just for the quarterly renewals and new leases or was that for the total portfolio, it seems like it stretched out a little bit and so it's fine to understand if we're seeing few changes in how tenants are looking in terms of lease term and if that's impacting the TI CapEx as well?

Yes, we actually show in two different places, Dan. So I just want to be right clear, on Page 10 of the supplemental, when we talk about our leasing commitments in the wall there, that is related to the renewals that are in place for the quarter.

Okay.

Yes and as I mentioned inside of those renewals, we had a 47,000 square foot deal that we gave a little bit more TI, it also had a longer term 10 to 12 years can't exactly which one and then we also had two single tenant net leases in there which are longer-term and they were, those were 10 year deals. So when you exclude those three and get back to your kind of standard multi-tenant which is what you're comparing across those other five periods on that page, the term I think was 41, 42 months, so pretty much in line with what we've seen historically.

Okay, so no change in trend there. And the other question I had is just one follow-up on kind of like Richard question on value-add versus A assets, have you seen any changes in pricing or the spread between say value add B assets, A assets that would make you weak one where the other is this were this competition spreads kind of limiting the ability to find value of or B assets, maybe you don't want those either in some ways but it the spread between A and B. assets kind of really thin at this point or is it winding out trying to think about direction.

I would say it's gotten tighter, certainly in the last 12, 24 months and that certainly reflects a lot of the capital that come into the space, I think the public have public reach through generally toward certainly the quality higher quality side of that certainly in the last two years, so I think the privates have certainly come in and struggled with the fact that to get a little better return due they need to go up the route out on the quality scale. And I think they've seen, they've been taking some of the things that I would say are kind of B, A versus B and so B is probably compress a little to the A and so then I think there's sort of A and B as you describe which may be from five to six and then there's everything else that probably there's a kind of a more of a traditional gap for some of things that we certainly wouldn't be looking at or chasing and privates are still playing at it but probably not as aggressively and they're not in scale, so there's probably still some gapping out where you can get things that are six all the way up to eight if you're willing to go out the risk out on the risk curve. I guess going forward I could see it basically staying pretty compressed where it is just given all the private capital.

And same would go maybe for primary versus secondary markets as well there's really been the GAAP is come in a lot?

Yes, I mean I think that's right. I think there's the same sort of logic applies primary markets versus the secondary markets I mean you just there's Todd said there is a lot of capital out there, chase these deals and those guys that we're looking at maybe find something six cap, 6.5 cap having to, having to drop down a little bit and get a little more aggressive on what they would normally be buying but paying little more forward.

Sounds good. Thank you for taking my questions.

Sure, thanks Dan. Welcome back by the way.

Thank you.

[Operator Instructions] The next question is from Eric Fleming of SunTrust. Please go ahead.

Good morning. So just wondering if the market stays compressed on the cap rate side through the end of '18, I know you guys have talked about around the edges, yield dispositions, but if we keep these aggressive cap rates, would you guys be willing to dig a lot deeper around your portfolio and sell some stuff that might not be non-core, but it's kind of capped out in terms of where it -- the opportunity for you guys?

I think we would see that as the normal course for us. I think somebody else asked what do you have that's not growing at three, so that's one way to look at it, but there is also just saying, okay, now that our average is around three, what are the things -- you know, the question is what's below three, what is it that maybe isn't growing or said to grow well above three for sometime, and so we will look at that. I don't think we are looking to ramp that up in a huge way. I don't think there is a huge need to demonstrate some kind of pricing or mark; there is a lot of that out there. So I don't know that that's the benefit. I think more for us it's about looking at the trajectory of each of these assets and kind of where they're headed and just managing that just continually trying to improve that and the stability of that and the steadiness of it. So I don't think it's a huge acceleration, but obviously if we saw some things that made sense that we could put in a JV or just sell it out right, and it was time for us to rotate out of those assets and buy something else, certainly we will look at it. I don't foresee us doing that in a massive way relative to the portfolio.

Okay, thanks.

Sure.

This concludes our question-and-answer session. I would like to turn the conference back over to Todd Meredith for closing remarks.

Okay, thank you. We appreciate everybody joining us this morning, and we will be around here if anybody has any follow-up. Thank you. And everybody have a guidance day. Thanks.

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