Physicians Realty Trust

NYSE:DOC

Earnings Call Transcript 2022-Q3

[Operator]

Greetings and welcome to the Physicians Realty Trust Third Quarter 2022 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, Brad Page, Senior Vice President, General Counsel. Thank you. You may begin.

[Bradley Page, Senior Vice President, General Counsel]

Thank you, Doug. Good morning and welcome to the Physicians Realty Trust third quarter 2022 earnings conference call and webcast. Joining me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; Mark Theine, Executive Vice President, Asset Management; John Lucey, Chief Accounting and Administrative Officer; Lori Becker, Senior Vice President and Controller; and Amy Hall, Senior Vice President Leasing and Position Strategy.

During this call, John Thomas will provide a summary of the Company's activities and performance for the third quarter of 2022 and year-to-date, as well as our strategic focus for the remainder of 2022. Jeff Theiler will review our financial results for the third quarter of 2022 and Mark Theine will conclude with a summary of our operations for the third quarter of 2022.

Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect view of management regarding current expectations and projections about future events and are based on information currently available to us. These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties. You should not rely on them as predictions of future events.

Our forward-looking statements depend on assumptions, data and methods that may be incorrect or imprecise, and therefore, we may not be able to realize that. We do not guarantee the transactions and events described will happen as described or that they will happen at all. For more detailed description of risks and other important factors that could cause actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission.

With that, I'd now like to turn the call over to the Company's CEO, John Thomas. John?

[John Thomas, Chief Executive Officer]

Thank you, Brad, and good afternoon. Thank you for joining us. The third quarter of 2022 is a quiet and steady as you go quarter for DOC further demonstrating the stability of medical office as an essential real estate class. This year has been challenging for health systems and physicians alike, as medical cost structures have been impacted by double-digit inflation in both staffing costs and supplies that have been further complicated by lagging government and commercial reimbursements.

Despite these headwinds, the United States demand for healthcare services is at an all-time high in the past as the population ages and patients receive procedures that were deferred during the pandemic. Providers have continued a long-term shift of care to the outpatient setting where advances in clinical science now allow for many higher margin services like orthopedic surgery to be performed in a lower cost environment.

CMS has again expanded the list of procedures that can be performed in ASCs going into 2023. This trend is predictable and rational. Our patient care sites benefit from a more stable staffing model, increased operating efficiency and improved patient convenience, all while freeing up hospital capacity for higher acuity needs. Our portfolio is built with this dynamic in mind. While capital market volatility continues to produce a mismatch between buyers and sellers in the pricing of new investments, our entire team is focused on portfolio optimization and working with our health system partners to address their real estate needs for the years ahead.

This partnership focus continues to enhance our development pipeline, and we continue to see the potential for a higher volume of development financing opportunities in 2023. Within the existing portfolio, we continue to benefit from the increased market rental rates, driven primarily by general inflation and rising construction cost. Renewal spreads exceeded our expectations at 6.2% for the third quarter, bringing our year-to-date spreads to 5.7% across 670,000 square feet of activity within our consolidated portfolio. Importantly, these high spreads have not come at the expense of retention, which remains near 80%. We remain excited about the performance of our portfolio despite a challenging macroeconomic environment. Mark will share more details in a few minutes.

In September, Hurricane Ian calls wide-scale destruction on the west coast of Florida, and our prayers and best wishes go out to the families directly affected by the storm. Our Florida based team's quick response help to mitigate the storms impact on our healthcare partner providers, their patients and our real estate assets. Fortunately, we experienced only minor wind damage to a couple of our smaller facilities and the property will be back in operation quickly. We had no material financial impacts in the storm, and we will thankful that our team members and their families affected by the storm our site.

We've all seen the difficult expense environment healthcare organizations are experiencing driven by extraordinarily tight labor markets and medical supply cost as well as non-cash mark-to-market losses in their investment balances. We've devoted significant resources at DOC to building a professional credit team who assist us in underwriting our investments but also periodically reviewing the financial results of our tenants. We have visibility through lease reporting requirements into 94% of our tenants by AVR with the average size of the tenants without this requirement totaling less than 5,000 square feet.

We also utilize independent claims data to monitor procedure volumes across our portfolio. Our largest tenant concentration is with CommonSpirit across 12 markets. CommonSpirit's S&P investment grade A minus credit rating was reaffirmed in September with a stable outlook. Moody's and Fitch also reaffirmed their respective IG rating for CommonSpirit as well. According to S&P, CommonSpirit's strong credit rating reflects CommonSpirit's exceptionally broad geographic reach, supporting a financially diversified health system across 21 states with a large $34 billion revenue base. CommonSpirit has $15 billion of unrestricted reserves and 175 days cash on hand.

While CommonSpirit's 2022 operating margins were strained at negative 4.5%, S&P believes CommonSpiritt's labor initiatives and market strategies and performance initiatives should help the system achieve their targeted 5% to 6% EBITDA targets by June of 2023. With 66% percent of our space leased to similarly strong investment grade health systems, we see similar resiliency across our tenant base despite broader market challenges. Across the healthcare delivery industry, volumes and opportunities for revenue growth is there, and CMS, Medicare and commercial insurers are increasing reimbursement rates for 2023, reflecting higher inflation and labor costs.

Doc continues to make progress in our sustainability efforts, creating value for our healthcare provider partners, shareholders and communities through short and long range business human capital and operations planning. As a benchmark of our efforts, Doc currently scored 75 out of 100 in the recently released 2022 GRESB Real Estate Assessment. Outperforming the international average is 74. We also earned a Green Star Designation award to submitters achieving scores of 50-plus on GRESB's implementation and measurement of the management and policy sections. In addition, the Company earned an A rating and a score of 98 out of 100 on the 2022 GRESB Public Disclosure Level, ranking first in its healthcare comparison group.

As we look to 2023, it is difficult to project external growth until capital costs become more predictable, and we can match our cost of capital to market opportunities, acquisitions or development financing. That said the market appears to recognize that asset valuations will need to adjust to complete transactions and construction supply chains seem to be improving in our favor. Our balance sheet is in great shape and our debt metrics are well managed, with no near-term maturities so that when the current market conditions settle down, we are well-positioned to grow and grow at higher levels.

We expect to continue to capture higher leasing spreads and those increases in contractual revenue along with our 2020 acquisitions and our 2021 development financing will increase our 2023 NOI including same-store NOI. We will complete our 10th anniversary in July '23 in a very positive way. We believe medical office has as asset class has proven time and time again to be the safest and most offensive and most predictable real estate for investment and operational success.

I will now ask Jeff to present our Q3 financial performance and then Mark will address the performance of our high-performing award winning asset and property management team. Jeff?

[Jeff Theiler, Chief Financial Officer]

Thank you, John. In the third quarter of 2022, the Company generated normalized funds from operations of $61.4 million or $0.26 per share. Our normalized funds available for distribution were $61.8 million, an increase of 13% over the comparable quarter of last year, and our FAD per share was $0.26.

The Company's operations were stable this quarter with same store NOI growth of 1.1%. This came in below our expected range due to 40 basis points of occupancy loss, which Mark will discuss in a moment. We continue to believe that our rents are below current market levels, evidenced by the 6.2% releasing spreads achieved during the third quarter. Our largely investment grade tenant base continue to perform as expected, with no material increase in defaults or rental relief requests, despite the inflationary pressures that JT discussed in his remarks.

Finally, in terms of our own margins, we remain shielded by our triple net lease structure, with 84% of all operating expenses reimbursed to us by tenants in the third quarter. Our acquisition volumes increase in the third quarter primarily due to the purchase of the Calko Medical Center in Brooklyn, New York. Our expectation is that acquisition volumes will be lower in the fourth quarter, as we wait for sellers to adjust their pricing expectations to better align with the current capital market environment.

In the meantime, we will be lining up potential opportunities so that we can take full advantage of the creative deals at the right price. Along those lines, we continue to maintain a strong balance sheet that provides plenty of flexibility to be patient during this time. Our consolidated net debt to EBITDA was 5.6 times at the end of the third quarter, and we have no material debt refinancings until 2025. We raised 8 million on the ATM in the third quarter at $18.15 per share, and have 300 million remaining in the current ATM program.

Finally, a few updates to our 2022 guidance. We expect G&A to come in near the lower end of the $40 million to $42 million range that we set out at the beginning of the year. We are also reducing our guidance for recurring capital expenditures to 25 million to 27 million for the year, down by 4 million at the midpoint. This reduction is due to the better than expected condition of a $750 million landmark portfolio, as well as impacts from tenants exercising automatic renewal options, which push more of a CapEx responsibility to the tenant.

With that, I'll turn to Mark to walk through some additional operational details. Mark?

[Mark Theine, Executive Vice President, Asset Management]

Thanks, Jeff. Physicians Realty Trust completed a productive third quarter with our portfolio of outpatient medical facilities demonstrated stability growth amid the current economic environment. We are especially proud to share this quarter that our leasing team achieved above average leasing spreads of 6.2% in Q3 on the heels of an impressive 8% leasing spreads last quarter in Q2.

The consecutive quarters of strong releasing spreads above the historical 2% to 3% is a direct result of the mission critical nature of our assets and the enhanced value of our portfolio during a rapidly rising replacement costs. Importantly, we've achieved these results without sacrificing retention, without excessive concessions, and not discounting annual rent escalators. In total, tenant improvement and incentive packages totaled to $0.61 per square foot per year on renewals, while we achieved an 81% retention rate and a 3.1% average annual rent escalator across our 251,000 square feet of leasing activity in the consolidated portfolio during the quarter.

Leasing costs were particularly low this quarter as 25% of our renewal volume was completed via automatic lease renewal language in the lease or by tenant options to extend the term with no landlord contributions for tenant improvements or commissions. Given the current cost to build and finance a new development, we anticipate healthcare providers will continue to utilize existing medical office inventory, ultimately driving up total occupancy costs in quality facilities with well capitalized real estate partners.

In terms of new leasing activity, Doc currently has 85,000 square feet of executed leases in construction, but not yet paying rent. We anticipate approximately 20,000 square feet of these leases will commence in Q4, with the remainder commencing rent payments in the first half of 2023.

MOB same-store NOI grew 1.1% during the third quarter, with results legging due to a 40 basis point decline in same-store occupancy. Over half of this decline resulted from an opportunity to increase occupancy long-term in a building with an investment grade ASE tenants. While we're not satisfied with the 1.1% result, it's important to view the occupancy in the context of the broader MOB landscape. Our 94.7% same-store lease rate is meaningfully higher than industry averages.

Tenant demand for medical office facilities has never been stronger and we remain focused on unlocking the value of our portfolio for the long-term. When necessary, this includes the selective vacating of suites that have higher potential with a different tenant, even if growth is impacted on a short-term basis.

Looking ahead, we expect same-store occupancy the bottom in fourth quarter before returning to prior ranges as suites currently under construction become online. Same-store operating expenses were up just 2.1% year-over-year, despite the high single digit inflation experienced throughout the economy. This performance is a credit to our asset and property management teams working diligently on behalf of our healthcare provider partners to minimize total occupancy costs.

Specifically, this quarter's results was driven by the successful challenging of several real estate tax assessments, resulting in a year-over-year property tax decline of nearly $1 million that served to offset increases in non-controllable utility expenses. These property tax outcomes are just one example among many of the ways that our team works diligently to execute consistently on behalf of our shareholders and hospital system partners to deliver value during this period of economic uncertainty.

I'll turn the call back over to John.

[John Thomas, Chief Executive Officer]

Thank you, Jeff. Thank you, Mark. Doug, we'll now be ready for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Omotayo Okusanya with Credit Suisse. Please proceed with your question.

[Omotayo Okusanya, Credit Suisse]

So the first one for me just. Just general hospital backdrop seems challenging you know the public hospital names seem to have been having a rough couple of quarters. Curious as you interact with your hospital tenant base, what they're seeing what they're hearing? And if demand for MOB space is, seems like it's, whether there any kind of changes to demand trends, just kind of given the top operating backdrop for hospitals?

[John Thomas, Chief Executive Officer]

Yes, great, great question Omotayo. That's one of the reasons we've preferred and we've always focused on really non-profit hospitals primarily is the market strength and the market share. Those facilities typically have and the long-term commitments of those facilities have to their markets. As you know, DE came out of the accession system to 25 years. Obviously, the systems and merchants have been mailer for 10 years. It's the providers and the organizations that we partner with and vast majority of our investment grade tenant base, which is 66% of the whole portfolio, our non-profit health systems with long-term commitments to those communities.

And so what we are seeing is a lot of, again, like I said, portfolio optimization where they want to lease the right space at the right price for both of us at market rents, which are increasing. And then the stronger systems, again that we work with are looking at new growth opportunities and that's where the development financing opportunities are coming. So, it's a tough market. Revenue and volumes are high. The challenge many hospitals are having with the volumes and the revenue opportunities is they don't have the staff to actually provide the service. Our health systems are fighting through those issues and again have high utilization. But the expense structure, wage cost, supply costs are exceeding reimbursement rates, which there is always a time lag.

And government in particular can be a year to two years behind kind of current inflation costs. So, CMS did better this year. They are not doing enough for physicians, and we expect that they will address that during the line of accession. The commercial insurers are stepping up as well to increase reimbursement to appropriate inflationary levels. So, we are seeing a lot of positive momentum. Everybody is tightening their belt as best they can. But most of the systems we are working with, in the bigger markets stronger markets, are really looking at expansion opportunities not retrenching.

[Omotayo Okusanya, Credit Suisse]

Got you. Okay. Then the next one for me. Just same-store NOI growth again. We've all been trained to kind of expect steady 82% to 83%. You are kind of in below that range for the past two quarters at least. Everything seems to be going right. In terms of the mark-to-market you are getting 6% to 8%, much more focused on operating expenses. So just kind of curious like, when do you expect a lot of these kind of initiatives to ultimately kind of raise the same-store NOI growth to that kind of [indiscernible] way win better relative to your peers?

[John Thomas, Chief Executive Officer]

Yes, our expectation is we will be back to a normal pace in 2023. So, as I mentioned a minute ago, really focused on portfolio optimization right now, we have had two or three locations, where we just didn't renew it at least on purpose, so that we provide an expansion opportunity for, frankly stronger tenants in those buildings. So, same-store can be such a short-term number, really focused on the long-term performance of the portfolio. And with that, we have had a couple of quarters in a row with dynamics like that short-term negative impact on same store, but hit a long-term benefit to the organization. Mark, do you want to expand on that?

[Mark Theine, Executive Vice President, Asset Management]

Yes. No, that's perfectly said. And I think it's also important to keep in context that, our same store occupancy is at 94.7%. So it's a functionally very full portfolio and the 40 basis point decrease in same-store occupancy represents about 53,000 square feet in total. The specific example that we were referencing with the ASC is a building in Minnesota, where we deliberately did not renewed a couple leases to make room for a large full floor ASC tenant, with an investment grade rated system. So that's an example where we are going to take a little bit of -- on the same store growth in the near-term while that space is under construction. But ultimately we will have great long term value and take a building that was 90% occupied to 100% occupied for the years to come.

[Operator]

Our next question comes from the line of Juan Sanabria with BMO Capital Markets. Please proceed with your question.

[Juan Sanabria, BMO Capital Markets]

Just hoping to spend a little bit more time on the leasing side. You have had great success on renewables for the last couple of quarters. But just curious on the new lease side, what those spreads look like and how much capital is being spent on that side? I think he gave us to renewal numbers on both on the on the TIs in the prepared remarks. So just talking a little bit more on the new side.

[Jeff Theiler, Chief Financial Officer]

Absolutely. So our leasing team has been doing a great job on both renewals and out there focusing on leasing the vacant spaces that we have. As I mentioned, we have 85,000 square feet of new leases that are signed in under construction, when those are completed and generating revenue bill at about 100 basis points same-store. To recruit new tenants and it is tough right now given the construction climate out there. And on a per square foot basis per year, this last quarter, I think we were close to $6, which is per square foot per year, meaningfully higher than our renewals where we're experiencing quite a bit of tenants exercising options to renew or we have auto lease renewal language and a lot of our leases, keeping our CapEx low on renewals.

[Juan Sanabria, BMO Capital Markets]

And then just on the tenant credit side, which Theiler just hit on. I mean, is there anybody on the watch list, I mean that the tone sounds definitely a little bit more cautious which I get or have the rent coverage numbers. And those moved materially to, if you could provide a sense of a range of where those coverages are just to get a sense of crashing, where we are today, even with the turbulence going on in the market?

[Jeff Theiler, Chief Financial Officer]

Juan, this is Jeff. No, I mean, we haven't seen anything material in terms of any relief request or anything like that. Coverages remain about the same. I mean, they're probably a little bit down, but nothing that would concern us at this point. I think JT's remarks were just addressing the overall industry. And what the health systems are going through right now. But we're not concerned about our own portfolio at this point.

[Operator]

Our next question comes from the line of Austin Wurschmidt with KeyBank. Please proceed with your question.

[Austin Wurschmidt, KeyBank]

I'm just curious on the 25% automatic renewals that you referenced. How are leasing spreads negotiated for those types of deals given you're spending less on TI dollars? And are you able to change for the escalator dynamics within those types of leases?

[Jeff Theiler, Chief Financial Officer]

That's certainly varies least by lease, but a lot of leases do have fair market value language included in them. So that is a conversation that we certainly have with the healthcare partners and in some cases brokers in the market to help us determine the fair market value. Clearly, in many markets that's increasing as a result of the construction costs and the inflation that we're experiencing in this environment.

There are a few examples where the lease has just continued to escalate at the previously negotiated annual rent escalator which maybe 2% or 3%. I think that it really makes our leasing spreads that much more impressive when you factor in some of those options renew that are renewing a 2% to 3%.

[Austin Wurschmidt, KeyBank]

And I know next year's expirations, not really a huge number overall, but you did highlight this quarter is coming in above your expectation. I suspect those might have been negotiated during a different economic backdrop. So, what does give you guys the confidence you can continue to achieve releasing spreads above historical levels, given sort of this tenants are catching up the reimbursement environments catching up, and it's just a little bit tougher overall for given some of the expense pressures, etc?

[John Thomas, Chief Executive Officer]

Yes, this is JT. The confidence level comes from, again, real time kind of market discussions, as you mentioned, most of leasing kind of has that is an 18-month conversation, before concludes, and we still have high construction costs. It is -- the growth in that construction cost is moderating. It's coming down to certain types of materials, some labor, but we still have a high inflation rate that's going to drive better lease experience for the foreseeable future. So well, that more kind of foreshadowing in our next call at the beginning of the year. But for now, we see continued positive trend at higher than usual rates.

[Operator]

Our next question comes from the line of Michael Griffin with Citi. Please proceed with your question.

[Michael Griffin, Citi]

Maybe starting on the transaction market, it looks like things have obviously slowed. I'd be curious to get additional thoughts on, if you're seeing a private market appetite for MOBs out there. And maybe a sense of where cap rates if traded have sort of gone? And have you noticed the change in the spread between on versus off campus cap rates?

[Jeff Theiler, Chief Financial Officer]

Yes, the markets the most part is shut down. Right now, I mean, the interest rates have climbed dramatically since our most recent investments in the second quarter or the beginning of the third quarter. Banks have shut down lending to the private market. So, while you can find a loan from small regional banks, you're not going to get large capacity for portfolios are their expensive assets. So assets, looking at cap rates.

I think now the brokers have learned that it's going to best case scenario to six and if you look at the cost of debt, if you can even get it and the equity prices of the MOB buyers in the public market, you're in the 60s and 70s before it becomes accretive. And you match up capital market cost with going with seller expectations. They just haven't caught up there yet. So we've just paused. We're continuing with our development financing.

We're about 200 million of total investments for the year. We're still working through some of our development pipeline. Again, assuming we can get kind of can match up our yield expectations and needs compared to our capital cost. And we expect next year to be pretty robust buyers market, if you will. So, market just as not pricing discovery continues. It's getting closer, but we're not there yet.

[Michael Griffin, Citi]

And maybe just staying on the recent transaction activity. I'd be curious to get a little more color on the Calko acquisition, maybe why it made sense? Also the JV partner and it could there be a potential for future opportunities with this partner going down the road and maybe an additional caller? They would be helpful.

[Jeff Theiler, Chief Financial Officer]

Yes, let me address the JV partner first. It's one of our long standing partners. As I mentioned earlier, we're in our 10th anniversary year as a public company. Are they beginning in year one we did, we started doing some one-on-one JV opportunities with them. That's a great sophisticated private company in Dallas that we've known for a long time and they found opportunities for us to co-invest and we sold them assets, we bought assets from them, etc. So a great partner they brought us into this opportunity.

So if you recall, we had just completed the sale of Great Falls in Montana at 4.7% cap rate. This is an asset that wasn't Calko asset and Brooklyn was not on the market, when our JV partner started talking to them earlier this year. Expectations and fair expectations are in the low four cap rate range. By the time we were invited to join those discussions, we had just completed the Great Falls transaction. We needed a substantially better price than the low fours. We were able to commence seller to accept a first year 5.5% cap rate.

There is a little bit of leasing opportunity there, not much, but long-term great investment grade tenant base, lot of physicians affiliated with that health system in the building, new asset, relatively new building less than nine years old in the Brooklyn market. And the opportunity for cap rate compression, once cap rates start going back in that direction, we thought are outstanding. So the IRRs look fantastic. And again, we just had that recent sale just perfect opportunity to recycle that cash, those proceeds, into a high yielding long-term asset.

[Operator]

Our next question comes from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.

[Joshua Dennerlein, Bank of America]

Yes, thanks guys. Maybe just a follow-up on the Calko acquisition. Just curious how you're thinking about your weighted average cost of capital and how that compares to that 5.5 about for asset?

[John Thomas, Chief Executive Officer]

Yes, Josh. As I just mentioned, there was really an opportunity to roll 4.7% cap rate proceeds from an asset that would generate a very large net gain from that we have held for nine years to opportunistically rolling that cash into that investment. If we were pricing it today and we hadn't sold assets to recycle it in an accretive way like that, we would think about the pricing differently. If the trade has gone up 150 basis points since completed that transaction, so it's a different world, two months, three months later. But at the time, it was a perfect opportunity to roll that cash into an accretive acquisition. As I mentioned, we think about these investments on a 10 year plus IRR basis. And if you think about the long-term opportunity for compression in that market of a new asset, we think, it's outstanding long-term IRRs.

[Joshua Dennerlein, Bank of America]

Okay. But how are you thinking about your WAC these days? Where does it stand? How do you think about on a long-term basis?

[Jeff Theiler, Chief Financial Officer]

Hey, Josh. So when we look at our weighted average cost of capital and use that to evaluate potential acquisitions, we are obviously looking at cost of equity, cost of debt. The cost of debt, debt markets are not super functional right now, but I think we could probably do long-term 10 year debt in the 6.5% to 7% range depending on what day it is. 10 years shopping all around these days. Cost of equity is obviously going to be higher than that, kind of look at a FAD yield plus expected growth rate. So we are looking at IRRs that are between 8% and 9% like a target range on a levered basis. And so I think that matches up pretty well with what JT was talking about when he was saying that cap rates need to be in the 6s and possibly 7s in order to be accretive.

[Operator]

Our next question comes from the line of [Rondel Camden] with Morgan Stanley. Please proceed with your question.

[Unidentified Analyst]

Great. Just a couple of quick ones. Just starting on the debt side. Just looking at the stack here, I see the 262 million on the revolver. That's floating. I see the 105, that's floating as well. You guys are sort of thinking about next year. It sounds like every 1% moving rates on the floor is this is sort of 3.6 million of headwinds. How are you guys thinking about for the headwinds from that potentially next year? Are you thinking about hedging just curious?

[Jeff Theiler, Chief Financial Officer]

Yes, that's a good question. We've got about 18% variable rate debt which we're certainly cognizant of that especially as rates seem like they're going to continue to increase. We do like having some cushion a variable rate debt that's easy to pay down, if we have loan paybacks from our mezzanine program and that kind of thing. It's a good short-term use of proceeds that is kind of anti-dilutive when you get paid back. But certainly, that's something that we continue to evaluate on a quarter-to-quarter basis, hedging strategies, et cetera.

[Unidentified Analyst]

And then just continue to put together you know, some of the breadcrumbs on the same-store NOI front. I think sort of the previous question. I think you talked about some of the repositioning and stuff that that's being a drag a little bit from the historical 2%, maybe a little bit lower this quarter. But even if you get back to that 2% isn't there a scenario that basically AFFO or FFO is actually flattish next year or just. I'm just trying to think about the interest costs headwind versus the same store NOI growth. Am I thinking about that correctly? Or how do you guys think about it?

[Jeff Theiler, Chief Financial Officer]

I mean, like everyone, the freight interest rate headwinds as they continue to go up. I think the same store NOI, particularly if you add in some additional leasing opportunities that we think we might be able to get. We do believe we'd be able to overcome that kind of headwind, if you will. But certainly it's kind of a tight environment right now. Ideally, we get some creative acquisition opportunities as well, which could further enhance our FAD and FFO per share growth.

[Unidentified Analyst]

My last one is just go back to the transaction markets. You did some equity, it's sort of 18. Obviously, now, the stocks a little bit lower with the soft in the market. The fair to say that other than maybe sort of recycling assets, where you're selling to buy into it's sort of going to be tricky to do anything else going forward? Or is that like -- is there any sort of other sorts of capital JV capital that you guys are thinking about or a sort of recycling going to be the main driver from here?

[Jeff Theiler, Chief Financial Officer]

I think it depends, Jeff again. So, it depends on, kind of where we can find pricing in the market. I mean, there's certainly potential acquisition pricing that would work even at our cost of equity right now. We haven't seen it yet because the markets kind of shut down. But should the pricing go to there, I think using equity would be a viable way to do that. Certainly, we look at capital recycling as well. And we've been in contact with potential JV partners for years. And if we had an opportunity that we could avail ourselves of that source of capital, we would also consider that as well.

[Operator]

Our next question comes from the line of Michael Carroll with RBC Capital Markets. Please proceed with your question.

[Michael Carroll, RBC Capital Markets]

I'm going to touch back on an overall market rent. I mean, for MLPs I mean, how broad base is rank growth? I mean, is it really regional, I mean, are you seeing it like there's a difference between on campus off campus? I mean, how much has it been on up really in 2022? And have you seen it accelerated through the end of this year?

[John Thomas, Chief Executive Officer]

Mike, it's JT. I'll let Mark comment as well. It's market to market. And it's kind of where you're starting from, that's why, it's not like rent growth slowed down, because this quarter was 6%, last quarter was 8%. It's the least is coming due and where they are in their current market compared to the existing market. Nationwide, construction costs are high, those markets that are the strongest Atlanta, Minneapolis, some of the smiley face markets, Phoenix, are growing at faster rates than others, but they never seeing opportunities really across the board. So, it's -- we do expect that to continue.

And, again, it's going to be quarter by quarter, but also market by market and where the optics are, as you know, most of our acquisitions come with new 10 year leases, so we only have so much rolled each year, to be able to capture this rent growth opportunities. And then those tenants, as we mentioned, where they have, options to renew that either fixed rates or a current plus 2% kind of role or some kind of market rent kind of arbitration process that changes that dynamic, again, just based upon the leases in place. So it really across the board, the opportunity across the country, though, is to roll rents up in most markets, assuming where we were at market rates.

CommonSpirit is an example. We did struck those 10 year leases in 2016. Those were all struck based upon the market rates in place in those individual markets at that time. So, again, all of those should be growing at faster rates today.

[Mark Theine, Executive Vice President, Asset Management]

Yes, I think it also varies a little bit by specialty of the tenant as well, where there's higher acuity specialty and more custom build out. Those are very sticky spaces, and therefore have a little bit more opportunity to influence the rental rate upon renewal. Just the alternative and the construction cost to relocate, those are very difficult and especially and expensive in today's market. So you have a little bit more of an opportunity to increase based on specialty.

[John Thomas, Chief Executive Officer]

Yes, and Mike, the other thing I mentioned is, the difference went on and off campus, I will tell you, most of our development, financing is off campus sale systems are trying to penetrate new markets and capture market share is they came out of the pandemic with balance sheet strength. And so, I'd say there's probably more opportunity off campus, new groves locations, while there's still strength in the on campus buildings as well. We're about 50/50s, we have, kind of see, both sides of that.

[Michael Carroll, RBC Capital Markets]

Yes, that's all fine. Now, it's probably difficult to kind of answer this now just because the market is so uncertain. But to current market rents today, can you support a new development project or break ground a new development project given where things are right now? Or does rent need to go up a certain percentage to really kind of make some of that underwriting workout?

[John Thomas, Chief Executive Officer]

You hit the nail on the head. The projects we finance are highly preleased, 90% plus, most of them are at 100% with system anchor tenant, and they're approaching that or we're approaching that on the yield on cost basis, and then comparing that to the actual construction costs. And comparing that to market rents, which are, by definition today are going to be higher than kind of an existing building.

But as I mentioned, these are health systems trying to capture new market share and expand in locations geographies where they don't exist today. So, it's a balancing act. So, we're only going to fund those where we're comfortable that that spread to an existing building can be achieved in the services that the health system is going to put in those buildings.

And I think all of the things we are looking at right now have ambulatory surgery centers in them, and partnered with physicians partnered with orthopedic surgeons. So, there are high margin services moving into those locations. So it's a balance of something that we have to be careful about in our underwriting and we are confident that we are.

[Michael Carroll, RBC Capital Markets]

Okay. And then just how difficult it is to probably source new acquisitions? I mean, are you seeing other opportunities on the debt side? I mean, could we expect you to be a little bit more active making debt investments over the next few quarters? Or do you really need to see where interest rates kind of really hammer out before you are willing to do even that type of stuff?

[John Thomas, Chief Executive Officer]

I think that's a great question, Mike. And I think we have historically made that investments either as part of development or part of a recap of the seller who's not ready to sell, but is willing to raise your partner with us in some kind of economic basis. Most of the private activity -- because we have been competing more with private buyers in the last three to five years than we have with public buyers, most of that activity at high cap rates was done with low cost debt that was three to five year debt. So just do the math. We are looking at 2023, 2024 probably an opportunity to step in very beneficial way for high debt or higher yielding debt or acquisition opportunities at profitable cap rates. So that's what we are excited about next year and the following year both in operations, but also the opportunity to deploy capital, again assuming the capital markets that open up for us to match to fund that.

[Operator]

Next question comes from the line of Steven Valiquette with Barclays. Please proceed with your question.

[Steven Valiquette, Barclays]

Great. Thanks. Good afternoon everybody. So this was touched on a little bit, but just back on the question on the components of the same-store cash NOI growth. Because last quarter you had same store revs up, call it, 4% operating expenses up 8% to get to the 1.9. This quarter revs up 1.4%, operating expenses much more in line and only up 2% to get to that 1.1%. You talked about the reasons why that's where it is for the quarter. That's all kind of understood. I guess the question is, if you had to crystal ball this for next year just the round numbers. I mean, what are the components just on the revenue growth and expense growth to get really kind of same-store NOI will kind of shake out for next year, once the dust settles on the re-tenanting and everything else?

[Jeff Theiler, Chief Financial Officer]

Yes, I'll take that. So I think next year we do think that there is going to be a nice rebound in our same-store. Our operating expenses this quarter were particularly low because of some of the real estate tax challenges that we were successful in contesting on behalf of our healthcare partners. Without those real estate tax benefits, we would have been closer to 7% increase in our operating expenses and it is an inflationary environment out there, we will continue to work on behalf of our healthcare partners to keep those operating expenses as low as we can.

But the nice thing about our portfolio is that it's very well insulated due to our high occupancy and triple net lease structure. So we think that those operating expense increases next year will be offset. And therefore really going to benefit from the leasing work we have done both in terms of the new leases coming online, the 85,000 square feet I mentioned and these leasing spreads. And so, I think in 2023, we will start to see the benefit of that and get back to our normal levels or even just a bit above our normal levels in the back half of next year.

[Operator]

Our next question comes from the line of Mike Mueller with JPMorgan. Please proceed with your question.

[Mike Mueller, JPMorgan]

I have two quick leasing related questions. First, Mark, on your comment about same-store occupancy bottoming in the fourth quarter, what's the rough magnitude of the decline relative to 3Q 94.7%? And the second question is, just on the rent escalators, you've baked into your 2022 leasing. How do they compare to prior years escalators?

[Mark Theine, Executive Vice President, Asset Management]

Yes. So on the first part, in the Q4 occupancy, we do know of our retention rate is historically 80%. So, we know that there's going to be some move out, but we're going to offset that with some new leases as well. We've got 20,000 square feet of leases signed, that'll come online in Q4. But we do think same-store will bottom, occupancy will bottom next quarter and then rebound in 2023. In terms of our annual escalations, our leasing team did an outstanding job this quarter averaging 3.1% and much better than our historical averages in the 2% to 3%. We're really pushing three and even four sometimes, and we can get it on our annual escalators to build in that long-term growth over a 5- to 10-year lease.

[Operator]

Our next question comes from the line of Dave Rodgers with Robert W. Baird. Please proceed with your question.

[Dave Rodgers, Robert W. Baird]

Mark, I wanted to go back to the suite turnover that you talked about and the retaining that will drive some of the results in 2023. Was there something that drove this year to be a higher amount of turnover within the portfolio? I would think that would be kind of a recurring natural thing for you guys. So curious about, how you view that in the next year or two versus maybe what made this year a bigger year of that turnover?

[Mark Theine, Executive Vice President, Asset Management]

Yes, I don't know that this was necessarily that much bigger of leasing volume or turnover. And next year, we've got about 4.6% of our lease is up for renewal, that's kind of been our average, and our lease expiration schedules been 3% to 4% a year, until we get to 2026 in those CommonSpirit leases. So right now, there's just been construction timing of the new leases completing those and starting rent payments.

[John Thomas, Chief Executive Officer]

Yes, this is JT. I think, part of the dynamic is. So like the ASC option here, they were probably looking at building their own building or kind of going into a new development at higher rents, as we talked about development financing we're doing with health systems that are capable of absorbing those higher rents, but doing much larger buildings and footprint. So, high construction costs makes moving into an existing building, a better option or repurposing an existing building a better option than a brand new development project. So, I think that's probably driving some of these changes. And to do that, if you need 20,000 square feet, we don't have 20,000 square feet available in the building. And we are going to have to eliminate or non-renew some leases to make that happen.

[Dave Rodgers, Robert W. Baird]

And then JT, maybe just for you, with regard to you talked about kind of fully leased acquisitions, you've got fully stabilized developments that you're financing. Do you see an opportunity between that to do more maybe on the value add side with the leasing team you have and the people that are in the organization to maybe add incremental value particularly coming out of the backside of the dislocation and pricing?

[John Thomas, Chief Executive Officer]

No, I think we're exploring all those opportunities. Again, right now that kind of investment pipeline is still there. It's just quiet -- and sellers, if they're not forced to sell right now we're trying to ride it out as well. Again, but I think we'll see more buying opportunities next year. But now we've always looked for opportunities where building might be 80% leased, but we have a tenant in hand. We have so much repeat business and so much, aggregation of business with hospitals all over the country and with physicians groups in multiple locations. So I'm kind of always looking for an opportunity to buy an 80% occupied building and backfill with a lease in hand with an existing client. So that is a great comment, great suggestion and something we explore often.

[Operator]

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

[John Thomas, Chief Executive Officer]

Doug, I appreciate it. Thank you everyone for joining us. We'd like to welcome to the Doc family [Kew] and his wife had a young baby girl last night. We're just excited for him. [Kew] leads our credit efforts and he will be back doing credit analysis tomorrow, I'm sure.

Now, [Kew] will take appropriate amount of time and get to know this new daughter and we just appreciate everybody joining us today.

[Operator]

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.