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Physicians Realty Trust
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Greetings, and welcome to the Physicians Realty Trust Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Bradley Page, Senior Vice President, General Counsel for Physicians Realty Trust. Thank you, Mr. Page, you may begin.
Thank you. Good afternoon and welcome to the Physicians Realty Trust third quarter 2018 earnings conference call. With me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; John Lucey, Chief Accounting and Administrative Officer; Mark Theine, Senior Vice President, Asset and Investment Management; and Daniel Klein, Deputy Chief Investment Officer.
During this call, John Thomas will provide a summary of the company's activity during the third quarter of 2018 and year-to-date, as well as our strategic focus. Jeff Theiler will review the financial results for the third quarter of 2018 and our thoughts for the remainder of the year. Mark Theine will provide a summary of our operations for the third quarter of 2018. Following that, we will open the call for questions.
Today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. They are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe our assumptions are reasonable, our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations, and those anticipated or implied in such forward-looking statements. For more detailed description of potential risks, please refer to our filings with the Securities and Exchange Commission.
With that, I would now like to turn the call over to the company's CEO, John Thomas.
Thank you, Brad, and good afternoon, and thank you for joining us for the Physicians Realty Trust third quarter 2018 earnings call. We are happy to report a steady as she goes quarter.
Medical office buildings continue to be the strongest performing class of real estate in all economic conditions. Private and foreign capital continues to pour into our space in spite of rising interest rates, keeping asset prices very high, a good and bad phenomenon that inhibits external growth, while also growing our underlying net asset value.
In anticipation of this continued inflow of capital, we entered 2018 expecting a year of low external growth, and chose to take advantage of a favorable market by pruning our portfolio at attractive prices while deploying our modest acquisition capital with existing partners. We are well positioned for this period of discipline, with the highest medical office occupancy among all public REITs, at 96%, growing cash flows, and favorable capital allocations. We don't have to grow or take short or long-term risk in different or riskier asset classes to cover our dividend, and we continue to grow our FAD.
As we entered 2018, we expected to be selective with new investments and to fund those investments from the sale of older, smaller, less long-term strategically important assets to our long-term plan. The third quarter reflected those plans. During this quarter, we sold $127 million worth of medical office facilities, and deployed that capital directly with Northside Hospital, in Atlanta, Georgia, in their brand new medical Midtown MOB, a 169,000 rentable square foot medical office facility. 82% is leased directly to Northside Hospital, and the building is 98% leased overall without patient services, including urgent care, specialty physician services, radiation oncology, and outpatient surgery.
We have a letter of intent signed with a tenant to occupy the last 2% of the space. This real estate is core to Northside's mission and core real estate in Atlanta's dense Midtown, located near Georgia Tech University, the Varsity, and some of Atlanta's most popular businesses and urban residential neighborhoods. We look forward to organizing an Atlanta property tour to share this and some of our other newest and best MOBs with you in the near future. Our first-year yield in this facility is 5%. While expensive, we are pleased that Northside came to us directly with the opportunity to expand our relationship with them.
They selected us for this sale leaseback and agreed to a price we believe is very attractive compared to the yield and IRR of other Class A medical office facilities that have traded this year, and over the last two years. In addition, this investment is yet another in our collaborative partnership with Northside that delivers other mutually valuable benefits. We believe this asset will yield strong and reliable growing cash flow for a very long time. Including our relationship with Northside Hospital, we now have more than 56% of our gross leasable space leased directly to an investment-grade credit-worthy tenant or their affiliates. And to our knowledge, this is the highest such percentage in actual gross space so leased in our industry.
Fortunately, because of the continued transformation of our portfolio toward the best healthcare credits, we continue to enjoy the benefits of a very healthy portfolio. Healthcare is local, and as we have always believed, the health of our investments is not directly tied to the credit quality of the corporate parent, but the health of the hospital, physicians, and economy where our investments are located, which has been a critical part of our underwriting. We're also very focused on the scope of services in our facilities. Approximately 20% of our buildings are anchored by outpatient surgery, and another 20% are anchored by oncology services.
These anchored tenants not only attract synergistic, ancillary, and complimentary services, but are also unique and sticky anchors. Many of these anchors also benefit by grandfathered hospital outpatient department reimbursement status, we call 603. As our growth and strong relationship with Northside demonstrates, we execute our vision on behalf our investors and stakeholders every day with care. We live this out every day as we collaborate and communicate, act with integrity, respect the relationship, and execute efficiently and with a win-win approach to our business. This makes us different and better.
In a few moments Mark Theine will share more details about our portfolio's operating results. Mark's leadership running our best-in-class operating platform delivered strong operating results, and we are on track to have our best year ever from operations. Mark and his team have had an eventful quarter tracking multiple hurricanes, and preparing for any recovery that would've been necessary. Fortunately our facilities have weathered those storms well with minimal downtime. Unfortunately, the storm has had a major impact on the regions affected and others lost lives, property, and access to healthcare and other services. Our hearts and prayers go out to all of their clients, patients, and their families as we do our part to aid in the recovery.
For the balance of the year, we do not anticipate a significant amount of investment activity as we continue to look for high-quality assets at a price that is accretive to our cost of capital. We remain on the hunt for investment-grade quality tenants and their assets, and welcome opportunities with existing and desirable high-quality health systems who reach out to us to partner with them on the purchase or monetization of their outpatient care facilities. Under the right circumstances we may partner with private capital to make these investments in an effort to meet out clients' needs but at the same time preserve our access to these long-term investments without burning our balance sheet or FAD.
A few updates. The Vatican has approved the pending merger of CHI and Dignity Health. Each system continues to work through the details to complete their merger and become the largest health system in the United States, perhaps as soon as the end of the year. Trios and Foundation legacy providers are all paying rent as scheduled, and we continue to expect to sell the Foundation assets.
Jeff, will now review our financial results, and then Mark will share more about our operations, and then we'll be happy to take your questions. Jeff?
Thank you, John. In the third quarter of 2018, the company generated funds from operations of $51.7 million or $0.28 per share. Our normalized funds from operations were also $51.7 million and $0.28 per share. These statistics include the net positive $1.8 million impact of a lease termination at an asset we own in Appleton, Wisconsin. Our normalized funds available for distribution were $45.7 million, or $0.24 per share, which included the $2.2 million cash impact of the same termination. The lease termination fee occurred when our tenant, Fox Valley Hematology and Oncology, was purchased by ThedaCare, an A1 rated health system and leader in that marketplace.
We entered into a new lease with ThedaCare, effective October 19th, and added two years to the backend of that lease. So the lease term is now 15 years with an A1 credit rated health system tenant, all in all a good outcome for us. We continue to see strong pricing of the medical office buildings in the third quarter, and we previously announced, took advantage of this pricing to sell a $127 million portfolio to a private equity sponsor. This portfolio consisted of solid assets which we consider to be noncore because they were generally smaller in size, not leased to investment-grade rated healthcare systems, and in secondary markets.
On the acquisition side, we completed a transaction that had been negotiated at the end of 2017 for the brand new Northside Medical Midtown MOB, in Atlanta. The longer lead time works for us in this regard as we believe the asset would trade at a better cap rate today than our price of 5.0 stabilized yield. If the acquisitions and dispositions that took place in the third quarter had both occurred at the beginning of the quarter, the net impact to cash NOI would have been an additional $225,000. On the capital market side of the business, we were able to take advantage of the favorable bank market environment to amend and extend our credit facility. We reduced the cost of our revolving line of credit by 10 basis points to LIBOR plus 110.
We also reduced the cost of our $250 million term loan, expiring in 2023, by 55 basis points to LIBOR plus 125. Considering the effect of our in-place hedges, this term loan now bears interest at the fixed rate of 2.3%. Our balance sheet remains in great shape this quarter, with less than $100 million of debt maturing over the next three years, all of which are existing mortgages with an average interest rate of 4.5%. Our net debt to adjusted EBITDAre [ph] is 5.4 times, and our debt to total capitalization is less than 33%, giving us plenty of financial flexibility to adjust to different market environments.
At the end of the quarter, our portfolio is 96.0% leased, with 52% of that space leased to investment-grade rated health systems or their subsidiaries. Our same-store portfolio occupancy decreased by 90 basis points, and generated same-store cash NOI growth of 5.6%, including the lease termination fee on the Fox Valley asset previously mentioned. If we exclude that asset, our same-store cash NOI growth was 1.8%. G&A expense was $6.6 million, as expected this quarter, and we continue to expect to finish the year within our guidance.
Finally, a note about FASB Topic 842, we have historically classified the indirect cost of leasing impacted by this guidance in our G&A already, so we would expect no material changes to our income statements as a result of the documents rule in 2019.
I will now turn the call over to Mark to walk through some of our operating statistics in more detail. Mark?
Thanks, Jeff. Solid revenue and FAD growth continue to highlight the company's positive operating metrics. As John mentioned, our asset management platform is delivering steady internal growth, primarily generated from in-place annual lease escalators of 2.3% across the portfolio, and an industry leading 96% leased. Our leasing and CapEx teams helped drive top and bottom line improvements in the quarter as well, including limited CapEx investment that totals just 6.9% of our cash NOI. Our operations team, known for its close hospital relationship, also continued to execute on its plan to expand in-house property management and leasing, laying the groundwork for additional institutional cost efficiencies and generating long-term enterprise value for our shareholders.
In Q3, leasing activity totaled 325,000 square feet, including 283,000 square feet of lease renewals, and 42,000 square feet of new leasing. Tenant retention, excluding the Fox Valley facility and the favorable outcome, as Jeff mentioned, is 93%. Rent concessions including TI and leasing commissions in the quarter for lease renewals totaled approximately $2 per square foot per year, and $2.50 per square per year for new leases. The positive cash re-leasing spreads for the quarter were 1.7%, and included average annual escalators of 2.51%. Our in-house leasing team continues to do an exceptional job renewing our existing healthcare partners at market rental rates, and recruiting the right mix of physicians critical to creating the dynamic healthcare ecosystem, and ultimately generating strong returns from predictable long-term triple net leases.
Year-to-date, in 2018, this team has saved our investors approximately $3 million in leasing commissions compared to what we would have paid to third-party brokerage companies assuming a 3% commission rate. Looking ahead, we expect this savings to continue to grow as we are proud to welcome two new leasing team members to the DOC team. Audra Cunningham, based in Atlanta, Georgia, will focus on the southeastern portion of the country, brining over 20 years of leasing experience to DOC. Elson Dimaro [ph] based in Denver, Colorado, will focus on the western part of the country, adding her excellent healthcare and REIT experience.
Similarly, we added to our property management team this quarter by transitioning facilities in our third largest market, Louisville, Kentucky, and our eighth largest market, Columbus, Ohio to our in-house platform. We are very proud to welcome Barb Bennett, Sidney Turtle, Amy Washburn to the DOC family. All are impressive individuals tasked with delivering outstanding customer service and the diligent care that our team has become known for, also known as the DOC difference. We believe that tenant retention starts with property management the day the lease is signed, and we are committed to showing our hospital and physician partners, through our actions, that we care about enhancing the patient and physician experience.
From an overall operations perspective, DOC has never been in a better position to service our healthcare partners, invest in our relationships, and efficiently manage our facilities to drive FAD to the bottom line by keeping occupancy high and our capital expenditures low. Finally, we'd like to take a moment to thank our operation team members and our partners for the tremendous preparation and communication during the recent hurricanes, Florence and Michael. While DOC ultimately had just 8,400 directly in the path of Hurricane Michael, the entire southeastern region prepared well for high winds and severe rain. Fortunately our facilities fared well with very minimal downtime.
And we have already offered assistance to some less fortunate healthcare providers who lost their facilities to use the limited amount of space we have available in those markets. Again, we sincerely thank our southeast team for their preparedness, communication, and care.
With that, I'll now turn the call back over to John.
Thank you, Mark. We'll now take questions, please.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Juan Sanabria with Bank of America Merrill Lynch. Please proceed with your question.
Hi, good afternoon guys. Just hoping to start on the acquisition side, there's a couple larger portfolios out there. Just trying to get a sense of where you think pricing is for high-quality portfolios and your appetite to either do it on balance sheet and/or via joint ventures. You kind of threw that out there in your prepared remarks, John.
Yes, Juan, thanks for the question. We look at everything. As we noted, we focus primarily on the higher grade health systems and especially where we have existing relationships. I think the two portfolios that you're speaking of -- or I assume you're speaking of are large enough that they'll probably attract some portfolio premium, but also a lot of interest from private capital. So we would anticipate the cap rates to be in the fives with various levels of quality in each portfolio. So the sizing of that and where our stock price is and cost of capital, if we pursued those it'd probably be with a private capital partner in some level of mix, so.
Great, thank you. And then one for Jeff, on the balance sheet, I think you've got about $430 million on a credit facility. Any plans to trim that out or balance sheet initiatives that we should be thinking about thinking about '19 earnings?
Yes, so that's going to include the $250 million term loan which we have fixed with hedges. So you're really kind of closer to $200 million -- a little bit under $200 million on the line. So, we always think about terming out our debt. We're always in conversations with banks and private capital sources to see where that pricing is. But where we sit today, I don't think it's urgent but it's something that we always look at.
Great. And just one quick word for me, the term fee, so it sounds like you had a replacement tenant, is there any impact on a go-forward basis ex that one-time income on the rent that you're getting from the new tenant versus the old?
Yes, it's really a good situation. The hospital bought the group that was occupying that space, it's an oncology group, and we worked at the hospital to kind of alter the least going forward. We extended it, and the group paid us a termination fee at the same time as we entered into a new lease with the hospital so there's a momentary lapse in occupancy which hits our statistic negatively, but it was a literally a 24-hour impact on the statistics. So we took the fee in hand and had this new 15-year lease with an investment grade tenant. So it's was really a win-win situation for everybody involved.
But the rents are the same?
No, the rents are lower, and that's the balance of the -- kind of economic impact from the old lease to the new lease was essentially made up by determination fee.
Got you. Great, you.
Our next question comes from the line of Jonathan Hughes with Raymond James. Please proceed with your question.
Hey, good afternoon. Thanks for the time and the prepared remarks earlier. So, for the most part, the entire portfolio was bought in the past five years. So my question is when you underwrote those properties how did you look at the required CapEx spend at the time of acquisition, and then how did you look at any future lease expirations that may come with some needed second-gen TI spend that could impact your FAD. I know most of your tenants are on longer-term leases so those expirations may be years away, but I'd just like to get a better understanding of expected TI spend in the future.
So, Jon, and this is Mark. So when we're underwriting our acquisitions we, of course, assume a renewal probability and TI associated with renewing those tenants. And we look very closely what the rental rates are and how we can renew those at least in place, if not continue to escalate them and assume a TI along with those renewals. We also have property condition reports done during our due diligence, and we identify immediate repairs needed as well as strategic capital that we can make enhancements in those buildings. So we layer all that into our underwriting and creating our capital expense budgets. As I mentioned, we're at about 7% of cash NOI this quarter, and that's where we try to budget, is in the high single digits for our CapEx spends.
And Jonathan, just to add, so much of our business is direct relationship negotiated transaction. So our CHI investments, which were approximately $900 million, if you'll recall, we closed a fairly large adjustment to the purchase price to address deferred maintenance, the hospitals had kind of left it in place and have spent that -- most of all that has been deployed now back into the buildings per agreement with the hospital, the seller. So we certainly take all that into account and increases in property taxes as well, which is a very important, critical part of underwriting in these high-price markets, so.
Yes, okay. And so Mark, is the mid -- this high single-digit as percentage of NOI for CapEx spend next year that's a fair estimate in run rate to go by?
Yes.
Okay. And then an extension of that, maybe one for you or John, but are physicians groups and healthcare systems, are they demanding more customized buildouts or configurations than, say, five or 10 years ago. Meaning has the cost of acquisition of a new lease inflated more than construction cost inflation, just curious to hear your thoughts there.
I don't think so. I mean, on a gross dollar basis our buildings, I noted, have a large percentage of outpatient surgery and in oncology facilities which those spaces in and of themselves are more expensive and require more TI. But typically this kind of the TI contribution from us is pretty much the same across the board. And then we work with the tenant to either finance that excess TI dollar or they'll provide it themselves. We just renewed a lease with a large group in one of our buildings, and we put in a million dollars of new TI and they put in a couple of million dollars of TI to convert the space. So it all gets blended in. You got to stay within market rents as you're providing that TI and that's what we do as we change those leases or change the space for them.
Okay, and then just one more. On the lease expirations for next year, granted it's pretty minimal at only 3% of AVR, but where are those rents relative to the market, I think I saw they were a little bit above the portfolio average? I get that it's market specific but just any color there.
Yes, Jon, and Mark again. You're exactly right, it's market specific. But if you look at it across the whole portfolio in the next 12 months upcoming, our average rate is $22.08, so we're in line with where we think rental rates are for those markets, and we'll work hard to continue to renew those at favorable terms.
Yes, and those are in place, so right now it's an inflationary market, should not catch up to those if they are at the higher end, but also be able to push those rents more than we have historically been able to in the past.
Okay, that's it from me. Thanks.
Thanks, Jon.
Our next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please proceed with your question.
Thank you. Good afternoon. First, wanted to just ask you a question about the capital markets, it's -- I wouldn't say you're trading at a big discount NAV per say, but your cost to capital is not what it was, and obviously it's tough to compete versus all the capital that you talked about that's out there. What are you doing or what are you planning to do to sort of capitalize on the differential or the opportunity there in terms of the assets you own and the valuation of them versus all the capital that's out there?
Yes, Jordan, it's JT. I think as we've demonstrated all year, we've really funded acquisitions -- we've been very selective with what acquisitions we've been doing, and in limited amount. And we funded those by selling kind of some of our older and less strategic assets at pretty favorable pricing that we anticipated would've been available when we bought those assets. So I think for the foreseeable future that will be the primary funding source. So I noted, to do much more volume, if you look to a larger volume or three or four billings in a portfolio, that we would explore private capital partnering, and 50-50, 70-30, kind of whatever blended math it worked from a capitalization standpoint.
So, to be able to grab hold of those assets with our clients for the long-term, but do it in a way that doesn't impact the balance sheet. So I don't think you'll see anything different for the foreseeable future. Stock has been acting better, but certainly not today. And I think this market has got a downdraft, hopefully we'll get back to going in the right direction here soon with all the healthcare REIT stocks and equities.
Can you maybe speak to the acquisition in the quarter of Northside, first I'd be curious what the GAAP cap rate looked if -- what the escalators are there? And separately, the extent that you, going forward, if the stock remains down here would you be a buyer at a similar price level going forward?
Yes, I think it's -- again, I think the asset is well worth the price, as noted. Northside self-developed that building and entered into a pre-sale agreement, if you will, with us last year. So main respects -- we look to funding that from kind of our capitalization from last year and then the sale of assets this year. So the fantastic asset, and as said, I think it's reflects off market pricing as expensive as it is. And then, from an IRR perspective, the nice kind of traditional bombs in the lease that get us kind of the high single-digits and the GAAP cap rates are in kind of the high-five range. Jordan?
Okay. And then, the same-store occupancy, the decline year-over-year the 90 basis points, was that a function of the move out in the quarter?
The dollar was.
Lease termination fee.
Dollar was.
Okay.
And it's the same impact, same the renewal or lack of renewal was just replacing tenant with one tenant, ability of the tenant also.
So, and can you just break out the rent that was included in the quarter from that tenant who moved out as opposed to the lease term fee?
Yes. So there is something incremental above the 1.8.
Yes. Now so the rents, it actually works out about the same and because the tenant moved out before the end of the quarter, so it's -- as JT mentioned earlier, it's a slightly reduced rent, but there's going to be no net impact between this quarter in the fourth quarter because of the time that the assets sat vacant or not vacant but sat without lease.
Okay. Thank you.
Our next question comes from the line of Chad Vanacore with Stifel. Please proceed with your question.
Hey, good afternoon. This is Seth Canetto on for Chad. Not to be a dead horse, but I did have a question about the MOB, you guys acquired in Atlanta anchored by Northside. I know you said you extended at least by two years, but was there any change to the rent escalators going forward or any other incremental details you can provide?
Two different situations, so the Northside buildings got long-term leases in it, there's no change there. We just -- we bought those with it -- with those new leases in place.
The Fox Valley situation, we kind of changed the lease from a physician group that the hospital bought to the hospital itself and then adjusted the rent with a -- in addition to the termination fee and extended the lease term so it's two different situations.
All right, great. Thanks for clarifying that. And maybe the --
I'm sorry with the -- and with the same box in that lease.
Okay, great. Thanks. And then, looking at the press release, you guys had mentioned the expected yield on that acquisition as 5% upon stabilization that building is 90% lease. So does that assume that the yield is lower than that right now or can you just send me a little bit?
You've got -- we have 1% -- we have 2% of the building. This is not currently leased, we have a letter of intent for that lease, so it's that 2% rule of the Delta, it's minor.
Okay. And then, can you guys provide same-store NOI, excluding a lease termination fees but inclusive of the six assets related for distribution?
We don't have that Seth. Those are assets, two of those are now held for sale. So these are assets that were selling in the near-term, so we don't include those in our same-store NOI.
All right. Thanks a lot.
Our next question comes from the line of Drew Babin with Robert W. Baird and Company. Please proceed with your question.
Hey, good afternoon.
Hi, Drew.
Quick question on the assets sold during the quarter and we talked about the IRR economics of Northside kind of building up to a high single-digit return, can you talk about the unlevered IRR realized on the assets that were sold during the quarter, and then, sort of how you think about and maybe the IRR. You know from this point forward, if you were to continue down those assets and sort of how it compares to the acquisition?
Yes, it's good question Drew. So the IRR and those assets that we sold is also kind of a high single-digit IRR. We felt that the pricing was particularly good right now in the market. So clearly, we felt that by selling it now IRR is going to be a little bit better than if we held it for the longer term and put in the necessary capital and everything to release it, so the return on the assets was pretty much what we had underwritten when we bought them. And we felt like it was a good time to proving the portfolio a little bit, sell assets that what we thought was a pretty good IRR. And then, redeploy those assets into these higher quality investment grade rated anchored systems that we've been looking at. It was noted. I mean, those were older buildings, we're going to require more CapEx over time; this is a brand-new building and again, self-develop on Northside. So no different maintenance, no expectation of capital needed for a very long time.
Great, that's helpful. And just one quick follow-up here, you talked before about potentially selling the LTACH, and I guess have there been bidders out there, what's pricing look like? And should we expect that the LTACH portfolio is kind of sold, maybe rapidly over the next year or so?
And I think that'd be our expectation there. I mean, frankly aren't a lot of buyers for the LTACHs, but they've been performing, reasonably well. I mean, we never had a rent as your payment issue there. We've got 14.8 years left on those leases and lots of credit enhancement from the parent. So, again, we'd like to sell them but we don't feel compelled to do that do at better low prices.
Great. That's all for me. Thank you.
Thanks Drew.
Our next question comes from line of Michael Carroll with RBC Capital Markets. Please proceed with your question.
Yes, thanks. Just on the LTACH portfolio, it looks like coverage bounced pretty well this past quarter, do we expect that to be a trend? Or do you think it's going to be stabilizing around that 17 level?
I think it hit the floor and going back to the -- in the right direction. So I think it'll continue to creep, but it's not going to be huge, but it's coming from kind of the expansion of services in those buildings primarily they've been buying that the owner has been buying a lot of home health and generating a lot of revenue from their home health acquisitions. Again, which are complimentary services to the LTACH business, so I think it'll continue to improve and hopefully to talk about in the last question increase the Optum [ph] and to sell those with a good price.
Okay, great. And then, related to our foundations. I know that's the plan to still sell those assets; they're not included in the one-slated for sale? And if not, do you have a timing, or is that just something that you have targeted to do sometime in the future?
Yes, we've got -- two are in the help for sale and we've been in negotiations and trying to finalize the process to sell those to the physicians that are currently providing services there, so hopefully that's a near-term event and 2018 event but, we can't know for sure, but we expected the -- certainly within the year but hopefully within this current calendar year.
Okay, great. Thanks.
Yes.
Our next question comes from the line of Vikram Malhotra with Morgan Stanley. Please proceed with your question.
Thanks for taking the question. Just wanted to first get your thoughts on the Fox Valley asset, I don't know would there be a difference in cap rate just given the credit enhancement, if you had sold that building free kind of this -- the 10 move out versus now where you have this hospital, is there a different if you suspect in the cap rate, if you were to sell it today versus…
Yes, no question at all. I mean, we got an investment grade long-term lease and they're now it was a great group that we, if was the physicians themselves we bought it from in a sale leaseback. And then, they later sold themselves to the hospital, so yes, I wouldn't say a substantial fleet different cap rate, but it would be an improved cap rate.
Okay. And then, with Northside, you've now done a couple of buildings with them. I'm just wondering from here on, what sort of opportunities exist with Northside on, off campus maybe, is this sort of a tenant where you look to expand with?
Yes, we certainly look to expand with them. We have a great partnership relationship that's primarily different from Deeni's, a prior life to where he developed a couple of buildings with Northside which we now own. And then, I think we have five total buildings that are substantially -- are anchored by or substantially or 100% occupied by Northside services. So we have some development rights to land next to the Center Point building that -- again, it's a building that have Northside purchase and redevelop several years ago. They're in the process of trying to acquire the Gwinnett Health System, which has been approved by the State Attorney General, and they're just working through that FTC and other regulatory approvals for that. So that will be a three building to add to that portfolio if that merger is completed, otherwise Gwinnett stands on its own fine. So North Midtown building we just bought is really their first kind of move to downtown and headed toward the Southern part of the city and counties in the South of Atlanta and we would expect to grow with them.
Got it. And then just last one maybe for Jeff, just from a fad perspective, where should we expect that to trend over 2019, I know there's obviously the cash impact from the termination, but can you give us a sense of where just a range where it could trend into 2019 then just sort of your longer term target call it two to three years out?
Yes, Vikram, I mean I think if you back out the lease terminations fee and you do the adjustments that we talked about with the acquisitions, dispositions for the quarter just to get the timing, you'll see that we're kind of covering the dividend, we're just paying out just under 100%, I think what you'll see is assuming no other acquisitions which I'm not saying that's what we're going to do but you should see our in-place rent escalators continue to grow at 2.5%, so you can put a leverage on that and you'd see just kind of generally fad should be growing at 3% to 4% or so just on a standalone basis and then anything that we do on the acquisition side would be complementary to that. So it's kind of hard to put a target on it because we're not exactly sure what the capital markets are going to give us next year. So we're just trying to take it as it comes.
Okay. Great, thank you.
Our next question comes from the line of Tayo Okusanya from Jefferies. Please proceed with your question.
Hi, yes, good afternoon. I just wanted to go back to Fox Valley for a second, just from a modeling perspective to make sure what's capturing this out right, could you tell us what the GAAP rent is for the new leases, kind of make sense remodeling going forward, we have the right number in there versus that?
Yes. So I can tell you for a go-forward basis, the cash rent for Fox Valley is going to be just around $100,000 a quarter, little bit over $100,000 a quarter and that's 15 year lease, the escalators on that are 2.5%. So you do sort of understand right now.
Thank you.
Our next question comes from the line of Daniel Bernstein with Capital One.
I will come back to you probably. Go ahead, Dan.
All right. Actually most of my questions have been answered, only one I had really at this point was on Northside, not so much about any of the particulars of the lease but the fact that hospital is selling the asset, maybe how that came about, did they recently developed and want to keep it on balance sheet and decide that they want to go ahead and monetize, given where cap rates are, what other deals they have and maybe is there anything, I should or other should read into that in terms of monetizations in the space?
No, they just like the idea of self-developing it, monetizing it, they've worked with several developers over the years and none of which are available now other than Deeni with us. So they self-developed it, had their partner RTG work with them to do that and then agreed early on in that process and I think was their intention to monetize that at the end and reached out to us to do that. So I said great relationship, they've got a great balance sheet, they have virtually no debt, they don't have a credit rating because they don't issue taxes and bonds and they have very strong balance sheet which they share their financials with us obviously as part of our underwriting but they're not really publicly available.
Maybe they will buy another hospital you can grow with them now? It's trend of the day, right. The only other question I have was on the 2.5% escalators you just mentioned, are those mainly fixed or CPI what's the mixture?
Those are fixed.
Okay.
You mean across the whole portfolio, Dan? Sorry.
Yes, yes, yes.
Yes, I mean those are actually almost all fixed in my remark. That's correct, yes.
Okay. And that's right across the whole portfolio to that 2.5%?
Yes, I mean it's a little bit under across the whole portfolio, I think it's just 2.3 but…
2.3% okay, all right. That's all I had. Thanks guys.
Thanks.
Our next question is coming from Tayo Okusanya. Please proceed with your question.
Hi.
Sorry, sorry…
Okay, so the new lease is 105 a month in cash and 126 a month in GAAP.
That's the new. Okay so that's on a going forward basis?
And that's a similar number versus the pro-rata amount you had in your 3Q numbers.
Exactly. That's exactly right.
So that's number one. And then number two, could you -- I mean thank you for the information about the divinity deal now finally happening I think again we've kind of since another hospital merger get announced very recently as well. I mean when you got kind of feel this consolidation going on in the hospital space, what do you kind of think about that trend in general? And then two, what do you think it kind of means for MOBs and MOB valuation if anything at all?
Yes, so again from our perspective the mergers that we've seen or associated with. We do it very positively; they're not in overlapping markets. There's no rationalization of closing one hospital to benefit another in those particular mergers that we see dignity and CHF particular. And we see combined better balance sheet if you read the credit agency reports on that merger in particular. They know that positive impact to CHIs credit rating from as a result of that merger.
So we view that very positively and don't see a negative impact, specifically on any marketer or MOB as a result of the merger. Similarly, like Baylor Scott and White and Herman Memorial in Texas, we have assets with both hospital systems there again they're complementary markets. They don't compete with each other head-to-head. We've got great relationships with those. We think that as positive positively said, from our perspective it's the ones we're involved in. We see as a win, a net win for us and others where, how hospitals in a market that are merging or become closer together like in Chicago.
You certainly would see a rationalization that certain sites and locations that would be preferable to other sites and locations and that would have a negative impact on the owners of those sites that aren't selected. So it's case-by-case, I think that you know the driving point is are they in competing or are they in a competing market today or is it complementary. The Northside/Gwinnett merger is complementary as well. It's just adding another region and location where Northside is not currently in and adding a great health system to their existing geographic location.
Got it. That's helpful. And just one more quick one if you can indulge me, can you just the breadth on the new trios lease as well?
Yes, at least was the new lease cut the rents in half of the first year as part of kind of the turnaround plans that coming out of bankruptcy with the new owner? But then those grow better than average increases over the eight years and get us back to market fairly quickly and then have kind of market resets at the end of each lease which we again would you be going up not down with those market resets, so…
What happened?
Yes, so this year is exactly. So this year it's about half of what we were -- otherwise expected, so that's not good of course, but we do get substantial increases over the next -- every year over the next eight years, and should they get long-term investments…
Okay. On the straight-line basis, it's kind of half of what it used to be at least on a near term basis?
That's cash. I mean on a straight-line basis, it's about 60% of what it used to be.
Okay.
So that's the cap and that's the GAAP.
Okay, perfect. Thank you very much.
Thank you. We look forward -- thanks for joining us today, we look forward to seeing you at NAREIT, and we would like to welcome Baby Bowden, Benjamin Becker to the world. Thank you very much.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.