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Physicians Realty Trust
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Greetings, and welcome to the Physicians Realty Trust, Fourth Quarter 2017 and Year End Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Bradley Page, Senior Vice President and General Counsel. Thank you, Mr. Page, you may begin.
Thank you. Good afternoon and welcome to the Physicians Realty Trust, fourth quarter full year 2017 earnings conference call and webcast. 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 of Asset and Investment Management; and Daniel Klein, Deputy Chief Investment Officer.
During this call John Thomas will provide a company update, an overview of recent transactions and our strategic focus for 2018. Jeff Theiler will review the financial results for the fourth quarter and full year 2017 and our thoughts for 2018. Mark Theine will provide a summary of our operations for the fourth quarter of 2017. 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 a more detailed description of some 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. John.
Thank you, Brad. Thank you everyone for joining us this morning. In 2017 Physicians Realty Trust delivered another record year of value creating growth, while demonstrating the strength of our hospital relationships through the acquisition of some of the finest quality – highest quality medical office facilities in the world.
We invested nearly $1.4 billion in 2017 at an average first year yield of 5.6%. During the fourth quarter Mark Theine and his outstanding asset and property management team delivered 3% same store NOI growth driven by occupancy gains, outstand lease renewals and absorption, as well as attention to operating expenses.
We now have more than 14 million square feet of high quality medical office space with approximately 50% of all of that space leased to investment grade health systems and their affiliates. We believe that more space leads to an actual investment grade healthy system than any other medical office REIT or investor.
85% of our growth space is on campus and we are affiliated with a healthcare system. We believe 2017 with six of our top ten tenants being owned by invested grade credit quality providers. We began 2018 with nine out of the top 11 being investment grade quality. Our success is the result of outstanding relationships with the finest healthcare providers in the United States, our execution, disciplined strategy, experienced team and superior insight into the future of healthcare delivery in the United States. We welcome you to visit our assets and speak to our hospital clients.
Our commitment to operational excellence and asset management has also furthered our repetition as the preferred owner and manager of medical office facilities in the public REIT market and otherwise.
In a moment Jeff will discuss our financial results and Mark will provide more color on our portfolio management and results, but I’d like to share with you our 2017 success story, an update on our opportunities for improvement and our commitments to patients in the long term in this capital market.
2017 was a year for high quality. As of December 31, 2017 we now own more than $4 billion of medical real-estate assets with none more impressive than that 458,000 square foot Baylor Charles A. Sammons Cancer Center in Dallas Texas. This mission critical facility is arguably the best medical office building in the United States if not the world.
Our acquisition of this property was the direct result of our relationship centric approach to investing as we were chosen by Baylor Scott & White to step into their rights to purchase that building. In addition to Baylor, we were in fact invited by a number of hospital tenants to acquire properties through these types of rights during 2017. Such acquisitions include state of the art facilities leased to affiliates of Ascencion Health in Austin Texas and Indianapolis, Indiana, as well as North South Hospital in Atlanta. We are also invited by CHI to expand our relation with them and we did so very successful. CHI has been and continues to be a fantastic partner.
During the fourth quarter all of our investments were relationship driven and off market, expanding seven different existing relationships. These include Ascencion Health, facilities in Tennessee and Indianapolis, USPI and Tennessee in Arizona, North South Hospital and their newest affiliate Gwinnett Health in Atlanta.
We also acquired a brand new on campus medical office facility from Dignity Health in Phoenix, in a strategic and creative structure that enhanced our relationship with IMS, our existing large multi-specialty physician group partially owned by Dignity Health. This acquisition helped further Dignity’s goals of getting the aligned IMS physicians on to their new hospital campus, as well as strategically positioning IMS in the market.
CHI and Dignity Health have announced their intentions to merge and we are excited to explore future opportunities with the new combined health system once completed. We understand they are working towards closing that merger later in 2018.
Following our investments in 2017, Physicians Realty Trust now owns 14 million square feet that is 96.6% leased, again with over 50% of that space leased directly to investment grade rated healthcare systems and their subsidiaries. During 2017 the weighted average age of our building improved from 20 years to 18 years and the average size of our facilities increased from 44,000 feet to 50,000 feet.
Our occupancy leads the public medical REIT industry and our average lease term is 8.3 years. Our portfolio is extensive, stable and resilient; a combination which we believe will produce reliable dividends for years to come.
2017 was an eventful year in medical office real-estate, with industry data indicating that more than $13 billion of facilities were purchased, highlighted by three major portfolios that traded at set-back cap rates.
We have grown rapidly since our humble beginnings transforming Physicians Realty Trust to make small scale investor in medical office buildings to their premier partner of the largest and most extensive healthcare systems in the U.S. Through our buildings we help healthcare systems service their physicians, providers and most importantly patients as they visit our facilities for their outpatient healthcare services.
Our operating platform led by Mark Theine improved our operating metrics across the board that focus on people, process and performance. Last year we seamlessly absorbed over 3.3 million square feet in medical office space from new acquisitions. In 2017 our leasing team also created significant shareholder value. Mark will provide more details in just a minute.
Our commitment to service excellence drives retention at reasonable rental rate growth and just as importantly as we saw and realized in 2017, when healthcare systems had the choice of who owns their medical office building facilities on their campus or mission critical off-campus locations, they choose Physicians Realty Trust.
I’d like to update you on Foundation and Trios. As you know, each had challenges last year. We are very pleased to report that Foundation facilities in San Antonio paid all of their rental obligations in 2017 and have made additional rent payments to catch up on their 2016 back rent days. They are substantially in compliance with their lease obligations and we continue to process with them the opportunity to sell those facilities back to the physicians.
El Paso has paid their hospital rent consistently since April 1, 2017 and we continue to work with them to catch up on their prior rent obligations, which have been previously shared with you. The Oklahoma building is stable and we continue to seek to rent the space vacated by Foundation Healthcare, but all of the non-Foundation related tenants in that building have performed further lease obligations.
Trios continues to filter through the bankruptcy reorganization process and Regional Care, a well capitalized hospital operator backed by Apollo Capital, continues to work toward an acquisition of the hospital. We have a tentative agreement with Regional Care to lease 100% of our medical office building, if they are successful in acquiring the Trios Hospital Operations and we understand they are making slow but steady progress in negotiating agreements with all the material parties necessary to acquire that operation, including the Attorney General of the State of Washington.
It’s important to remember that our medical office facility leased to Trios is 100% occupied and never went dark. In fact physicians in the hospital are there today treating patients and serving that community. The same is true with the Foundation Facilities in San Antonio and El Paso.
We added dedicated credit risk expertise to our underwriting asset management team and just as importantly focused our business development and investments more in Investment Grade Health Systems to enhance the overall stability of our portfolio as reflected in the improvements in the credit quality of our cost impacts. These are great improvements for the further, but the positive developments in San Antonio, El Paso and Trios are a tribute to our team’s healthcare expertise and ability to manage challenges.
Congressed passed and the President signed Sleeping Tax Legislation in 2017. These new laws dramatically changed our corporations and pass through entities like real estate investors and their owners are taxed. We are excited that individual shareholders will now have a lower effective tax rate on their REIT dividends, enhancing your after tax returns from owning shares of Physicians Realty Trust. This rate is now an effective tax rate of 29.6%.
Also new limits on the ability to deduct the interest expense without similar limitations on rent expense, potentially enhance the benefit of renting versus owning medical office space for our physicians and taxable providers. These and other changes in the tax laws are a net benefit to the Physicians Realty Trust.
In contrast, the financial markets renewed expectations of economic growth, driven in part by the tax law changes as well the Federal Reserve’s decisions to increase interest rates, as call to investors rotate their investments from REIT equity to more economically cyclical securities. While growth and employment are great for our core business, as our providers gain better and more secure reimbursement, the short term impact of the lower stock price in REITs and as a result of Physicians Realty Trust and all of our REIT peers began 2018 year-to-date with lower stock prices.
History shows us that REITs can deliver attractive total shareholder returns and periods of rising interest rates as real estate can increase in value as a hedge against inflation. REITs with strong balance sheets and low ratios of debt, especially variable debt in relation to their total capitalization tend to fare better.
Physicians Realty is well positioned as we enter 2018 with very little short term debt. We termed that our share term debt with the 10 year publically traded bonds in December 2017 and we have substantial liquidity available to us.
We’ve used this capital selectively, as we continue to evolve and improve the overall quality of our medical office facilities and investments, knowing where and when we can deploy capital accretively and for the long term benefit of our shareholders. Our board and team are committed to patience in this capital market, maximizing the performance of our industry leading occupancy and quality, while also pruning assets that no longer fit our long term plans.
This year we also welcomed and would like to introduce Pam Kessler as our newest Board Member. Ms. Kessler brings 11 years of experience as a Senior Executive of LTC, a REIT focused on the long term care industry and she adds a depth and an excellent council to our broad and her experience and leadership in previous capital market cycles like we are experiencing now is invaluable.
Jeff and Mark will now update you on our financial and operating results. Then we’ll be happy to answer your questions. Jeff.
Thank you, John. I’d like to start with a few general comments before discussing our quarterly results. Our company along with the rest of REIT sector has been underperforming over the past couple of months, primarily due to macro economic factors. That’s said, we remain highly confident in our business plan and asset class over the long term.
Well it’s true that MOBs has been the best performing healthcare asset class over the past two years. We feel strongly that this outperformance will only continue to grow over time. Therefore we remain optimistic on our core business of owning and operating outpatient medical office buildings leased to premium healthcare systems. After all, our ability to source these opportunities and effectively manage our portfolio has delivered extraordinary returns to our shareholders.
Since our IPO in 2013 we have generated a 69% total return versus a negative total return for the overall healthcare REIT sector. Importantly, our total return during this time period has also doubled that of the overall REIT index and more than doubled that of the composite of our closest MOB peers.
While we have experienced rapid growth in our portfolio over this time, we also truly understand cost of capital. That is why we evaluate every acquisition by our current ability to fund it using a conservative mix of equity and debt. This philosophy makes certain activities like development difficult for us, as we are hesitant to commit to long periods of capital spending when it’s impossible to know the overall cost to our shareholders.
The events over the past couple of months have certainly reinforced that macro factors can quickly and dramatically impact a REITs cost of capital, which can make seemly good developments turn into value destroyers for years to come.
For 2018 our focus will be on squeezing the best performance we can out of our portfolio, while keeping our occupancy high and our capital expenditures low, so that we can distribute that money to our shareholders instead. We will also be flexible in our growth strategy and be conscious of market conditions on our acquisition plans. We do believe however that our relationships in the healthcare industry give us a better chance than any other MOB company, to find the occasional deep value opportunities that meets our cost of capital.
Turning to our quarterly results, in the fourth quarter of 2017 the company generated funds from operations of $46.2 million or $0.25 per share. Our normalized funds from operation were $49.6 million. Normalized funds from operations per share were $0.27 and our normalized funds available for distribution were $44.2 million or $0.24 per share. For the full year of 2017 our normalized FFO per share of $1.04 represents a 6% increase over the comparable period last year.
In the fourth quarter of this year our management teams unparalleled relationships in the healthcare industry yielded $387 million of additional investments. These included some of our previously announced [inaudible] generated deals, where leading health systems like North South and Gwinnett exercise their right to choose DOC as a landlord, as they felt we were the partner that best understood the healthcare industry and their business.
Our acquisitions were fairly well distributed throughout the quarter. Had they all occurred at the beginning of the quarter, we would expect them to generate an additional $2.6 million of cash NOI.
In this first quarter of this year we have closed on two additional investments for $100.7 million. We also have three additional acquisitions opportunities that we have been negotiating over the past few months.
We are working towards respective purchase and sales agreement for each of these acquisitions which will total roughly $180 million. We believe that we can fund these deals with recycled capital from future dispositions and our line of credit.
Turning to operations, our same store portfolio which represents 66% of our total portfolio generated year-over-year cash NOI growth of 3%, mostly driven by contractual rent growth and partially offset by increased operating expenses.
Our portfolio remains highly utilized with 96.6% of our space currently leased and our recurring capital expenditures were well contained at only 6% of cash NOI. This all translates into the generation of more cash flow that we are able to return to our investors.
We issued our second public bond in the fourth quarter fixing $350 million of debt at a rate of 3.95%. We issued some opportunistic equity in the fourth quarter on the ATM amounting to $40 million, which was used to partially fund our acquisitions leaving us with only $80 million remaining on the line of credit at the end of the year.
Our debt to total capitalization in the fourth quarter was 31% and our net debt to adjusted EBITDA was 5.7 times. We feel comfortable with our current leverage and debt profile, with only 16% of our debt maturing over the next five years.
We came in at almost exactly the mid-point of our $22 million to $24 million G&A guidance for the year, incurring a total of $22.96 million of G&A in 2017. Looking forward, G&A for 2018 should be between $27 million to $29 million.
Finally in terms of the acquisition guidance, we expect a volatile capital environment in 2018 and will adapt to our changing capital costs as necessarily. We are therefore not providing explicit acquisition guidance for the year.
We are confident however that we will continue to have a distant advantage on off market acquisition opportunities through our established relationships with leading healthcare systems, which may lead to some investment opportunity. But as we view the market today its unlikely to reach the volume we have come to expect over the past several years.
With that, I’ll turn it over to Mark who will walk you through some of our operational statistics in more detail.
Thanks Jeff. In 2017 was the landmark year for DOC with $1.4 billion in total investments, demonstrating the power of our hospital relationships though the acquisition of some of the highest quality medical office facilities in the country. During the year we seamlessly integrated over 3.3 million square feet and 260 new tenants to our ownership.
In total, we acquired 40 facilities this year which were 98% leased with an average lease term remaining of 9.8 years upon closing. Approximately 70% of these acquisitions are multi tenant facilities, now under DOC management, including several of the largest and most complex facilities that we’ve acquired to-date. These properties require the skillful coordination, constant communication and diligent care that our team has become known for, also known as the DOC difference.
In fact the average size facility acquired this year was nearly 55% larger than those acquired in 2016, averaging nearly 83,000 square feet. Similarly, the average age of the acquisitions improved in 2017 by nearly half. From 20 years in 2016 to 11 years in 2017.
Lastly and perhaps most importantly, the credit strength of our tenant base also improved with the 2017 acquisitions, as 49% of our occupancy is from investment grade quality tenants compared with 44% a year ago. Altogether we believe that our 2017 investments will provide outstanding returns for years to come and demonstrates the standard of exceptional quality to expect from acquisitions in the future.
Total same store NOI for the trailing 12 months ending December 31, 2017 increased by 3%, led by 3.7% growth from multi tenant facilities and 2.2% for single tenant facilities. The same store increase was driven by a 3.3% increase in rental revenue attributable to the increase in same store occupancy to 95.6% from 95.3% in the comparable periods. Same store revenue was also fueled by contractual annual rent escalators that average 2.3% across the portfolio, which is predictable, stable and not influenced by operating results or flu seasons. Looking ahead we expect that our same store cash NOI growth will be between 2.5% and 3% over the next 12 months, unadjusted for any perspective distributions.
Turning to leasing activity, our leasing team has created significant shareholder value by completing over 1 million square feet of leasing activity in 2017. We continued to see strong leasing momentum and our team has produced outstanding results through our responsiveness and streamlined approval process.
Overall in 2017 we completed 840,000 square feet of lease renewals with an average lease term of nine years and a 78% retention rate. Additionally, we completed 224,000 square feet of new leases with an average lease term of 9.2 years. For the fourth quarter specifically we completed 464,000 square feet of lease renewals with an 89% retention rate. Our leasing expense for the quarter were a negative 2.2% as a result of an early blend and extended master lease, but its excluded the leasing spreads for the quarter were a strong 6.15%.
We are proud to report that rent concessions in the quarter are among the lowest in the industry with no free rent and very little TI required to renew our existing healthcare provider partners. In the fourth quarter TI for lease renewals was $0.54 per square foot per year on a weighted average basis. In fact, approximately 75% of the lease renewals completed in the quarter did not require any TI to renew the lease and the remaining 25% averaged $2.10 per square foot per year.
Tenant improvements for the new leases were approximately $4.75 per square foot per year during the quarter. In total we invested $15.3 million in tenant improvement and leasing commissions in 2017, or just 6.2% to the portfolios NIO. The low investment in capital expenditures relative to our peers is driven primary by our low lease expiration schedule.
Our portfolio known for its high occupancy and low turnover will continue to deliver significant cash flow directly to FAD as it requires little tenant improvement and leasing commissions due to our staggered lease exploration schedule. In 2018 we have just 2.9% of the portfolio scheduled to renew and have no more than 8% of the portfolio schedule to renew in any one year through 2025. Our lease exploration schedule is deliberately laddered to staying at lease exploration dates, ultimately driving a predictable, growing cash flow for our investors for years to come.
As we begin 2018, we have built a high quality portfolio that is operating well. With an exceptional asset management and leasing team that has and will continue to deliver bottom line results. Our commitment to relationships and service excellence for our healthcare partners is the trademark of the DOC difference and what we believe ultimately drives tenant retention, cost efficiencies and a profitable consistent growth for our shareholders.
With that, I’ll now turn the call back to John.
Thank you, Mark. I’d now be happy to take questions.
Thank you. [Operator Instructions]. Our first question comes from the line of Jonathan Hughes with Raymond James. Please proceed with our question.
Hey, good morning; thanks for the time. Jeff, you talked about acquisitions and I think I heard $180 million are under contracts, but are not giving formal guidance beyond that. But it sounds like it’s fair to assume some details will happen. So how do plan to fund those details given the leverage you know will be kind of near the high end of your previously stated target range and its share still traded at double digit discount to NAV.
Yeah, it’s a great question Jonathan. So if you look at what we completed in the first quarter plus what we announced as future additional acquisitions that are under some form of LOI at this point, that would bring us right up to kind of close to 40%, which is probably near the top of our target leverage range.
We are planning on – we have assets later for disposition and some other assets that we are thinking about disposing, which I think could fund the majority of those acquisitions in a leverage neutral manner and then as far as future acquisitions over that, you know I think we tried to be clear in the prepared remarks that we are really going to evaluate that, such that it only makes sense at our current cost of equity capital. So we think it will be fewer overall acquisitions or lower overall volume, but to the extent that we do additional acquisitions, they will be value enhancing at our current cost of equity and debt.
Okay, that’s fair and then you know I know you sourced a lot of deals through the relationship network, generally get better pricing because of that. But have you seen any change in cap rates for marketed deals given the rise in rates over the past several months?
I mean all the recent parameters have been in line with last year. Still a lot of capital flowing into this space primarily by private investors. There is a deal in the market now we’re not anticipating into the year, but at the same mid to low five cap rate is the discussion.
Is that a portfolio of just a large single asset?
Portfolio.
And then just one more, and then I’ll jump off. So with lower external growth prospects focus well kind of shipped internally for growth, and Mark you touched on this earlier, but could you just talk about expectations for specific same store growth opportunities and how that should trend throughout the year within that kind 2.5% to 3% range.
Yes, sure Jonathan, good morning. As I mentioned in the prepared remarks, we expect that our same store looking forward will be in the 2.5% to 3% range. One of the benefits that we are starting to see as a five year old company is the same store portfolio is increasing in size. 66% of our portfolio is currently in the same store and then have some imbedded growth rate in the contractual rent increase of 2.3%. The same store portfolio is very well leased at 95% or 96%. So we see maybe just a little bit of upside in that, but the majority of same store going forward will be based upon the contractual rent bumps built into the leases.
Are there any expense savings opportunities in there with the larger company gaining scale on certain markets, you know you can leverage contracts across that portfolio.
Absolutely! As we gain concentration in certain markets, we’ll continue to benefit from some economies of scale. Our portfolio is 91% triple net lease or absolute triple net lease. So a lot of that savings will go back to tenants, but we will certainly experience some of that ourselves as well.
Okay, that’s helpful. I’ll jump off, thanks for talking my questions.
Thanks Jonathan.
Our next question comes from the line of Jordan Sadler with KeyBanc Capital Markets. Please proceed with your questions.
Thank you, good morning. So I want to just come back to the acquisition market a little bit. It sounds like you know there is still – it’s still pretty headed in terms of pricing. What would we expect or should we expect for the $180 million or any other opportunities, given where your stock price is today cap rate wise.
Yes, hey Jordan. So for the $180 million, it’s hard to exactly because we are still finalizing the negotiations, but at the point we’d expect the high five cap rate on those acquisitions. And then as we look forward its – I mean look, we are just going to really be patient and see where we are in a cost of capital standpoint, see where the market is shaping out and that’s really going to dictate the volume for the rest of the year.
Okay, and that’s to be funded predominately from dispositions it sounds like. So are the dispositions…
Yeah.
Is that right?
Yes, that’s right.
And so that’s – the assets slated for sale will be in a range of 150 to 200? Is that a fair assumption or is that…
Yeah, I think that’s fair.
Any additional assets in there? Okay.
Yeah, that’s fair. I mean there’s other assets. You know the VL Tax for example that we could put in there which we are not really exclusively modeling, but that general range in correct. And the MOVs, I mean you didn’t ask the question, but you probably will. They’ll probably sell in the range of the mid six cap rates.
In mid six’s, okay perfect! Thanks for jumping ahead of me on that one. It saved me a question. And then the last question I have for you is on Trios. You’ve got – it sounds like something tied up potentially if the bankruptcy goes through with RCCH. What would the rate be or what would the haircut be relative to the previous in place rent?
Yeah, we can’t share that just yet, but you can expect it will be a cut near term with the opportunity to make that up over the long term under renewed lease.
Okay. Any anticipation or expectations on timing? It seems like your getting some pretty good progress.
Yeah, we hope it’s alive first. We’ve done what we can control and you we’re just bogged the processes and it’s just clogging through the bankruptcy process and in the State Attorney General’s Office; that’s our expectation, our hope.
Okay, I’m going to hop out of the queue. Thank you.
Thanks Jordan.
Our next question comes from the line of Daniel Bernstein with Capital One. Please proceed with your question.
Hi, good morning.
Good morning.
I just wanted to – I may not have head it, but is the 3% same store NOI growth that you posted this year, that excludes Kennewick. What would be the same store growth if you included Kennewick.
Yes sir, that same store number does exclude Kennewick. If Kennewick was included, it would have been about a positive 63 basis points.
And then the 2018 guidance, is that including anything from getting that back from the Trios Kennewick property?
No.
Okay. Do you expect – is the expectation that you’ll have some additional rent in 2018 from Trios or is that just too early?
Yeah, I mean that’s our expectation, that’s what we are just talking about Dan. We hope that we – begins again in July, around July 1. It could be sooner, but could be later but that’s our...
Okay, so there is a little bit of upside in the same store.
That’s right.
If you get through March, okay. And then one other question, in terms of the quality of assets that you are seeing out there and cap rates. You know cap rates obviously as you just said are staying very low and there are lots of private equities. Is there any moment in the A assets versus B assets or on-campus versus off-campus. That might give you a little bit of wiggle room to maybe make some more acquisitions this year? Not that you would dip down in quality, but are you seeing any better pricing and maybe some of those off campus assets at this point?
Yeah, I think even on the portfolios we saw three large portfolios, all trades up five and that did reflect the quality of those assets. One portfolio traded in the mid-sixes, which for a lack of better word, there were some A's and B’s in that portfolio, so it was not as – it was more mixed. So there is some differentiation in the market, but you know cap rates are just compressed across the spectrum, you know for all the levels of medical office. We haven’t seen any movement there.
Alright, and one more quick one if I can and I’m sure somebody is going to ask it and has that on their list, but given the discount to NAV, what kind of – what’s your thought process on buybacks?
I think our broad will consider picking it all out, options with proceeds from dispositions, but right now it’s not an expectation.
Okay, that’s good. Thanks very much for the color guys.
Yes, thanks.
Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.
Thank you. So your multi tenant MOB is now consist of 59% of your portfolio and that’s up from 54% last quarter. Do you have a goal of where you want this to go to?
You know John, that’s a great question. We’ve had a lot of discussion about kind of the science of the asset mix between single and multi tenant. We are benefiting and Mark’s team is squeezing a lot more return out of the multi tenant buildings right now, but they are highly leased. So, I don’t think we have a specific target on multi tenant versus single tenant.
We do have specific goals to continue to move up the healthcare system on campus or affiliated to 90% or more, we are 85% today. So we have some room and opportunity there and as we see acquisitions throughout the year, whether they be single tenant or multi tenant, you can expect them to be highly leased and occupied by credit grade to help the system.
You know I was going to ask about that. Because the single tenant you have higher occupancy mostly likely lower CapEx, which you highlighted in your prepared remarks and so I was just wondering how you balance the benefits versus the potential higher growth in the multi tenant assets.
Yeah, I mean it certainly goes into the underwriting and the pricing of the assets.
Okay, and then I think John you mention the willingness to expand your relationship with Catholic Health. You know currently they are 19% of your revenue. I’m just wondering, are you limited by the credit rating agencies to have any tenant more than 20% of your sequential portfolio?
I wouldn’t say specifically limited, but it is something that we manage to and are very cognizant about. As you know CHI is really 12 different tenants, 12 different credits. We think about it that way, but we also think about the aggregate as well. So today being – and being with the health which they are merging with is the higher credit rating for CHI. So it’s going to be an enhancement of the total balance sheet once those two come together. So, once they do complete their merger, we’ll think about those as one aggregated tenant and show that, but at the same time each market stands on its own from a credit perspective.
Do the rating agencies look at it as one entirety or multiple entities?
No multiple.
Okay and in this quarter you had an impairment of $965 million. Was that related to Kennewick or assets held for sale or maybe something else?
To be clear John, not to correct you, its $965,000, and yeah, it was tied to one small asset that we sold, but we just sold it out at a loss.
Got it, okay. Thank you.
Our next question comes from the line of Vikram Malhotra with Morgan Stanley. Please proceed with you questions.
Thanks for talking the question. Maybe just stepping back, you know a couple of years ago you sort of embarked on this transportation if I may say that, but it was trying to take the company to a level where – or the portfolio to ‘higher quality or lower cap rate or different markets.’
I think you also sort of over the last few months said that you’d start disposing some lower quality assets that would maybe just get the portfolio up. Given sort of where we are with the market in general, obviously lot of it is not in your control. Can you maybe just talk us through over the next, assuming we stay in a very bumpy environment, sort of where are we in this process today and what can you do over the next 12 months to maybe keep that direction.
Yeah, so I think as we shared Vikram and good morning, the – we have $180 million or so kind of under contract as well, the deals that evolved out of the fall and as we sit here today we fully expect to fund most if not all of it through dispositions. So there will be a slight dilution. We just shared that those dispositions would probably be in the mid-sixes range, most likely in the acquisition or in the high fives just under six.
So slight dilution in cash, but a substantial improvement in quality and again towards the evolution of where we want to go and continue to go. But we have a very strong stable portfolio and as Mark pointed out, it’s going to – we expect that to grow 2.5% to 3% this year on cash flow. We are in a fantastic position being in this cycle and we’ll be patient for the long term.
Vikram, just to add on. I mean the bad thing about MOB pricing being so high right now is it’s hard to buy things, but the good thing is that its earlier to dispose of assets. So we are really trying to take advantage of the market where we can.
Yeah, that makes sense. And then just on the – just going back sort of Trios, you sort of highlighted maybe mid-year is when you start getting income back. Just maybe update us on the broader portfolio, anything else that stands out, that’s been on the watched list, anything you are monitoring?
No, I mean brining in the credit analysis mid-year last and kind of improved process internally. We significantly improved overall AR in our process and kind of understanding of what’s going with our tenants and with [inaudible] of asset management and financial review. So we are really excited about the stability of the tenant base overall.
Okay, great. Thanks.
Our next question comes from the line of Chad Vanacore with Stifel. Please proceed with your question.
Thanks and good morning.
Hi Chad.
So I was just thinking about your cash punching experience in the quarter compared to contractual rents. Were there any other slow payers out there other than Trios and then you mentioned Trios, it’s 100% occupied, but I don’t think you recognize any rents for them in the quarter. So what is the back rent currently owned?
Back rent on Trios, when we stopped incurring it and wrote off a straight line two quarters ago, we can get you that number.
But we don’t anticipate collecting that back rent Chad.
Okay, but Jeff on any other slow payers out there that maybe put your cash collections at lower than your contractual rents?
Not material.
Nothing material, no.
Alright. Just one more from me, on dividend payout expectations, it looks like you are running in mid to 80% of FFO. I mean should we expect you to continue around that level for the foreseeable future?
Yeah, I mean Chad look, it’s always something that we are evaluating every quarter. You know certainly if you have really accretive acquisitions, you are able to raise that dividend faster. So it’s hard to say through the balance of the year how fast we can grow. Our AFFO, a lot of is just depending on external growth. So you know we’ll evaluate it and we think we are at a pretty good level at this point. So we’ll continue to evaluative it through the rest of the year.
Alright, I’m going to sneak one more in here which is on cap rates. So you said that, you did in the quarter – at lease during the first quarter some acquisitions in the mid to low 5% range. You seem to have LOIs, you can call it mid to high 5% range. Previously you expected I think 5.5% to 6% cap rates going forward. Are we still in that range or is that range maybe widened out a little bit?
I would say we are still in that range, the mid 5.5% to 6%.
Alright, that’s it from me thanks.
But obviously you know where we see opportunities, but again we are going to be patient with seeing that thing.
Got it.
Our next question comes from the line of Michael Carroll with RBC Capital Markets. Please proceed with your question.
Yeah thanks, just a few quick ones on Trios. I think there are still a lot of questions on them. But I know Regional Care has been working on acquiring Trios for several quarters now. Is there anything specific heading up that deal or is just a slow bankruptcy process?
It’s a slow bankruptcy process. They kind of have three major creditors if you will. Goldman Sachs owns the hospital real estate and we own the medical off building leased to the hospital, and then you have equipment vendors and then you have other creditors, unsecure creditors out there and then you have I think most of the staff in the hospital, the nurses and others are unionized, we got to work though that and ultimately you got the attorney general of the State of Washington to sign off on it. So painfully slow and you know we are being patient because we executed our deals and are moving forward very quickly and this is just the process of a government entity bankruptcy.
Okay, and then if the doctors are still residing in the – and operating within the MOB right now, correct me if my wrong, you are not collecting any rent from them. I guess why is that if they are still making money doing their practices. Are you able to collect rent on that?
No, I mean the bankruptcy process stays off cash flows and mange through bankruptcy. So, at some point the bankruptcy court and we’ve asked – you know we’ve made motions to compel this. You know a lot will require the creditor and the debtor, excuse me, to confirm the lease and start paying rent or reject the lease and move out. That’s not their intentions. The bankruptcy court is again really focused on this sale process and really just kind of stayed all cash flow.
So they do pay their operating expenses so there is now negative drag on ROI. They pay their – its expensive paying taxes or otherwise they are paying that, but the benefits of the bankruptcy process for them is the situating we are in. So we are certainly filing motions in trying to force the process and force the hand. But the best conclusion we see at this point is Regional Care, finalizing the deal, getting approval and signing a new lease with us.
Okay great, and then just last question, can you talk a little bit about the L Tax? Have you seen improvement there? I know that the coverage ratios has just kind of held steady at that one-four type level. What’s the outlook for those assets?
Yeah, we are seeing improvement there and I’d say that the conversion to critical or to clinical criteria, I think it kind of bottomed down from a reimbursement perspective and made operational improvements otherwise and pursued new lines of business.
So like there is a very strong management team and operation and – we have the full credit of the entire organization, not just our three assets and of our three assets one is – probably one of the two or three best performing L Tax in the country and stilling on a very valuable piece of land in Plano, Texas, you know North Dallas. So it’s kind of a mixed bag, but we don’t have any credit concern issues there, but on the other hand we would sell them if we got the opportunity to.
Okay, great. Thanks.
Our next question comes from the line of Drew Babin with Robert W. Baird. Please proceed with your question.
Hey, good morning. A quick question on the amount of rent recouped from the foundation during the quarter. Could you tell us what that amount is and how much is left in terms of what’s owned beyond the current rent they are paying?
Yeah, so San Antonia for the most part is kind of fully caught up. They will be this quarter. I mean they are kind of at the end of their payment plan to make up that rent number. The Foundation, El Paso had about a little over $2 million in back rent that they – while they have made improvements in changing management, they haven’t made enough improvements to start making catch-up payments, but we are working with them on several different ideas to get that down. So very focused on it, but a little over $2 million is kind of the lot number, maybe $2.5 million in total.
Okay, and a quick question on the rating.
They have been cash-only throughout ‘17 and as I said, El Paso in particular has been very consistent with the rent since April and San Antonia never missed a rent payment and made extra rent payments.
Great, that’s helpful. A quick question on new MOB lease underwriting. Has anything changed from the beginning of ’17 until now in terms of kind of call the occupancy cost to the tenant in the way leases were underwritten. Are we getting to point where the rent is paid to the MOB landlord or are getting to be a more relevant part of the expense structure of tenants or was it still pretty low when the grants came in? Thanks.
Yeah, I think it’s a percentage of kind of their operating expenses and still – they are still pretty low and you know it depends on what’s in the space, cancer center space, it’s going to be much higher. It’s just clinical, orthopedic clinical space is going to be much lower. But as a percentage of their revenue lines it’s still 5% to 10% generally had moved.
Okay, and one last one just on investments. I looks like to me it’s a very small, looks like a mez investment during the fourth quarter. Could this be the start of something larger where we might see more aggressive investments in the mez space rather than acquisitions this year or will it just kind of be a steady drip going forward?
Yeah, I think they are probably – you might see more throughout the year. We are seeing a lot of health system led development plans coming together. So Mark Davis and Jim Bremner and Cornerstone is kind of the three developers we worked most closely with and we will have the opportunity to put the mez capital out funding, helping them to fund those healthy system anchored development opportunities that again ideally will be completed in 2019 and we’ll have the opportunity to purchase those, get a capital market support there, and so we’ll probably see a little uptick there, but it’ll still be a very small percentage of our asset base.
Great, that’s all from me. Thank you.
Our next question comes from the line of Eric Fleming with SunTrust Robinson Humphrey. Please proceed with your question. .
Good morning. The question I had is with the cap rates that you are talking about and low outlook on the investments. Any opportunity to get more aggressive on dispositions rather than just the 10 you got outlined. Could you go deeper?
Yeah, we can go deeper. I mean I think we think about 5% to 7% of our portfolios is something that we have filtered through and identified as potential disposition. So again, depending upon the marketing and pricing, some of those are strategic dispositions and some are people approach us opportunistically and that’s how some of the dispositions we have in process came about.
Okay, thanks.
Our next question is a follow up question from the line of Jordan Sadler from KeyBanc Capital Markets. Please proceed with your questions.
Sorry, as a follow-up to that last question which is, so would you consider carving out or is there an opportunity to carve out a larger size $300 million to $500 million type size portfolio from the legacy DOC portfolio to sort of continue this march to improving quality and then maybe seeding some of the demand out there for these types of assets?
I wouldn’t expect it to be that large. I mean we certainly could, I mean we take advantage of pricing, but really 5% to 7% is really kind of the top end of what we see is, it would be strategically well positioning in the portfolio. We are not suggesting only 85% of our portfolio is high quality. We think it’s much higher than that.
No, I’m sure it’s very, very high.
That just seems large. Again, I think we’ll keep our options opened. But we certainly would have the opportunity to do that Jordan, but I wouldn’t expect to see it get that big.
Okay, and then on this – you made a comment in your prepared remarks regarding renting versus owning benefits and I’m just curious its probably early in the game here, but are you anticipating significant portfolios coming to market for sale and is there anything that sort of early talks. I know some of the hospitals for example have high leverage and as a result of this tax change your only obviously able to deduce a certain amount of interest expense of which some of these hospitals would probably be hurt relative to their effective statutory tax rate. So is there an opportunity that you are seeing specifically or is it just kind of make sense to you?
I think it’s more in the make sense category right, but I think more and more operators are getting a better understanding of that and two years from now in that interest limitation is substantially, just substantially higher. The limitation is much stronger in a couple of years when it goes from EBITDA to EBIT and so you know I think people are planning out the future, it will certainly come into their process.
Okay and then lastly and I’ll hop off , as it relates to Trios, RCCH announced their public-private partnership with UW Medicine which RCCH is still operating the hospitals, but it is supposedly in Washington and Alaska and then in Idaho. Would you expect Kennewick to be one of the candidates for this partnership?
We think that’s critical to their plans for that hospital and certainly part of our influence in our decision to work with Regional Care and are excited about it.
Okay, thanks guys.
Our next question is a follow-up question from the line of Jonathan Hughes with Raymond James. Please proceed with our question.
Hey, thanks for the follow-up. Just one but on G&A, I think I heard that was expected to be $27 million to $29 million this year; that’s up about 15% from the 4Q run rate. Just what’s driving that increase? Sorry if I missed that in the prepared remarks.
No, that’s alright Jonathan, this is Jeff. You know we are implementing that ASU 2017-01 which is a different way of accounting for business combination. So some the expense that we previously had under acquisition expense gets shifted over to G&A and that’s about $4 million. So that really accounts for the vast majority of that increase. And so importantly it’s not a change in any expenses, it’s just the shifting from acquisition expense into G&A.
Okay, that makes sense. Take care. Thanks, I appreciate it.
There are no further questions in the queue. I would like to hand the call back to management for closing comments.
Yeah, thank you again for joining us. As we said, we are very excited about the results for 2017 and look forward to kind of steady as she goes in 2018. Got a great portfolio, great balance sheet and great team and we are all optimistic about the future, but at these times we will be patient and put in what we can and deploy capital where we can do it accretively, but look forward to speaking with you soon.
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.