Healthcare Realty Trust Inc

NYSE:HR

Earnings Call Transcript 2021-Q1

[Operator]

Good day, and welcome to the Healthcare Realty Trust First Quarter Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Carla Baca, Associate Vice President Investor Relations and Corporate Responsibility. Please go ahead.

[Carla Baca, executive]

Thank you for joining us today for Healthcare Realty's First Quarter 2021 Earnings Conference Call. Joining me on the call today are Todd Meredith, Bethany Mancini, Rob Hull, and Kris Douglas. A reminder that except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in a Form 10-K filed with the SEC for the year ended December 31, 2020. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material.

The matters discussed in this call may also contain certain non-GAAP financial measures such as funds from operations, FFO; normalized FFO; FFO per share; normalized FFO per share; funds available for distribution, FAD; net operating income, NOI; EBITDA; and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the quarter ended March 31, 2021. The company's earnings press release, supplemental information and Forms 10-Q and 10-K are available on the company's website.

I'll now turn the call over to our Chief Executive Officer Todd Meredith. Todd?

[Todd Meredith, executive]

Thank you, Carla. And thank you everyone for joining us today. We are very encouraged to see outpatient volumes getting back to pre-pandemic levels. This will drive our internal growth toward our long-term growth profile. When we add our accelerated pace of external growth, we are building positive momentum in FFO and FAD per share. Foot traffic and patient flow in Healthcare Realty's facilities is fast approaching normal patterns. Now at about 95% of pre-pandemic levels. Some disparity still exists between markets. For example, the Bay Area is several months behind Nashville, where providers have been back to normal for a while. We've seen a noticeable uptick in traffic in just the last 2 months, which is correlating with vaccination levels.

The most vulnerable group, the 65-plus cohort, is well vaccinated and consumes the most health care per capita. 83% of these folks have received at least one dose and will be fully vaccinated in a matter of weeks. These folks are increasingly comfortable going to the doctor's office. As vaccination levels steadily rise and patient volumes normalize, optimistic providers are reengaging in plans for growth. We expect this to translate to more leasing momentum in the coming quarters. We see several positive indicators that will improve same store NOI from 2% today toward our long-term growth rate of 3%. We are raising rents steadily and retaining our tenants at very high levels. And we are seeing strong underlying demand for space at our properties. All MOBs are poised to do well in the short term as patient volumes returned to normal. Longer term, the common denominator for success is aging demographics.

Three keys to our ability to outperform are choosing the best markets, leveraging our local relationships and aligning with the best providers. Our core business is on and around hospital campuses where performance is consistently strong. What's new is that we're also finding some attractive off-campus opportunities. Typically, these buildings are in close proximity to our hospital clusters. Our teams are plugged in to local relationships that help us identify the off-campus buildings in high demand from providers. The MOB sector is highly competitive with plenty of capital chasing limited supply. Highly desirable properties around hospital campuses are difficult to source, especially at scale, and thus have a long history of steady, rich pricing. For these properties, we have an edge over the competition due to our long-standing credibility and networks of relationships. This helps us invest in more than our share of hospital-centric properties.

Looking ahead, we see the bulk of our investment allocations going to these properties around the hospital campus. We will also invest selectively in higher yielding off-campus properties with a higher allocation going to our joint venture in order to balance our risk and return on capital. Healthcare Realty is off to a robust acquisition pace in 2021, and with providers actively reengaged in growth plans, we expect to initiate multiple development starts this year. This strong external growth together with accelerating internal performance is translating to attractive FFO and FAD per share momentum.

Now I'll turn it over to Bethany.

[Bethany Mancini, executive]

Thanks, Todd. I'd like to provide an overview of the current state of health care and government health policy. We've been encouraged by recent for-profit hospital company financial results. Volume is down, but heading in the right direction. And EBITDA margins are up based on solid revenue growth. COVID cases are decreasing as a percentage of inpatient volume and growth in outpatient surgeries is positive. Hospitals continue to be impacted by fewer low acuity ER visits. Still, year-over-year, same store revenue has remained strong, on average, up 10% from higher acuity services and insured patient mix. These results have been similar for not-for-profit hospitals, which make up the majority of our health system relationships. Health systems continue to focus on strategies to lower costs, preserve and even expand inpatient capacity and increase services in outpatient settings.

On the physician office side, other than a select few markets slower to reopen, our tenants are seeing positive patient flow and strong demand for services. With an increasing number of vaccinations, particularly among those 65 or older, most physician practices are looking past COVID recovery toward growth. On average, the 65-plus population visits a physician office 2.5 times more each year than those under 45 years old. As a percentage of the total population, this cohort is expected to increase from nearly 16% today to over 19% by 2028. Underlying demographic growth is clearly in place to support the long-term value of MOBs.

The regulatory and legislative landscape remains relatively benign for health care providers. The Biden administration's agenda is focused on expanding health insurance coverage through adjustments to the ACA while also supporting health care providers through ongoing COVID relief. The most recent $1.9 trillion COVID relief bill increased ACA subsidies and lowered premiums for at least the next 2 years. Incentives to close the low income insurance coverage gap are expected to increase the number of people eligible under the ACA by 3.6 million and signal a positive direction for providers' compensated care. There is strong political support to make these benefits permanent and to offset health care funding that expires down the road. Conventional wisdom still holds that it is very difficult to take away a benefit once provided. Truer now, as congress continues to shore up health care providers in the wake of COVID-19.

Other items potentially on the legislative agenda, two of President Biden's campaign hallmarks were a public insurance option that would allow people to buy into Medicare and a reduction in the age of Medicare eligibility to age 60. The political balance in congress will keep large-scale policy proposals more limited in scope for passable legislation in the near term. Expansion of government-funded health insurance should be measured in incremental, a positive for health care providers. As hospitals and physicians look to move beyond COVID, they will benefit from steady commercial payer mix, a rise in the total insured population, and support for positive Medicare rate increases in 2022.

Insurance payers, both private and public, continue to promote health care delivery in outpatient settings. We view any legislative or regulatory effort to lower health care costs as an advantage to outpatient care and the development of more outpatient facilities. The value of physician offices and hospitals has been underscored in the last 12 months. With aging demographics, their services will be more critical as they meet rising demand in the years ahead. Healthcare Realty's long-standing relationships with many of the nation's leading providers will bolster opportunities for growth. Now I will turn the call over to Rob.

[Robert Hull, executive]

Thank you, Bethany, and good morning everyone. I will summarize Healthcare Realty's first quarter investment activity and our outlook for the remainder of the year. We are off to a solid start investing this year. Our relationships with health systems, property owners, and brokers often give us access to deals before they become widely marketed. And as we deliberately build scale and target markets, we are often viewed as the preferred buyer for buildings. These advantages have enabled us to maintain a robust acquisition pace and attractive cap rate levels. This is especially noteworthy as more buyers have moved back into the market and pricing remains competitive.

So far this year, we have purchased 10 buildings for $129 million, including 4 purchase through our joint venture with teachers for $67 million. All 10 buildings are located in our core markets, including San Diego, Dallas, Atlanta, DC, and Denver. And what I really like is that the majority of these add to our existing clusters. As an example, in Orange County we acquired our fourth property around the campus of Saddleback Hospital, which is part of Memorial Care. We now have a sizeable portfolio around this hospital of on, adjacent, and off-campus properties, which places us at the center of deal flow. Recently, a practice from another submarket had a need to expand into this area. We were able to show them a range of locations, price points, and interior finish levels. Having multiple product types was instrumental in keeping them exclusively engaged with us throughout their decision making process.

Another example was in Atlanta. We acquired 2 properties around WellStar's hospital in Douglasville, where we already own 2 buildings. Our expanding relationship with the hospital gives us insight into its future plans and potential demand for these 4 buildings. Cap rates for these 10 acquisitions average 5.5% with a low of 4.5% and a high just over 7%. The low is a value-add opportunity within an existing cluster and the highs in off-campus property. Both of these buildings were purchased through our joint venture with teachers.

For some additional color around cap rates, we included a page in our investor presentation that lays out cap rate ranges by region for the $1 billion of acquisitions we've completed over the last couple of years. What you will see is that we have been able to expand our footprint beyond the campus and generate incrementally higher returns. Our off-campus acquisitions have been at spreads of 40 and 90 basis points above on-campus properties, depending on geographic location.

Our acquisition pace shows no sign of slowing as we continue to grow our pipeline. Currently, we have properties under contract, or LOI, totaling over $150 million that we expect to close near the end of the second quarter. With the strength of our year-to-date acquisitions, we are raising our guidance range by 50 million at the midpoint with an upper end of 550 million. We also took advantage of a strong pricing environment to sell 3 properties for $34 million at a combined cap rate of 4.8%. These buildings were not in line with our strategy to build out clusters of properties around leading hospitals. We reinvested the proceeds accretively into MOBs with superior long-term growth prospects.

Looking at redevelopment, in March, our first new tenant took occupancy at our project in Memphis. This 29,000-square-foot orthopedic group will drive volume to the surgery center in the building. The surgery center is currently being renovated and expanded to accommodate more volume. This property is well on its way to stabilization early next year at a projected yield over 7.5%. In April, we started a redevelopment in Seattle that includes expanding one of our existing buildings by 23,000 square feet. This 100% lease project has a budget of $12 million and an estimated stabilized yield of 6%. We expect tenants to move in and start paying rent by the middle of next year.

Looking ahead, we have a couple of more developments expected to start this year. Our developments create financial value with targeted yields 100 to 200 basis points above comparable stabilized assets. Additionally, they foster deeper relationships with hospitals and providers as we work closely with them to plan for their outpatient growth.

In summary, our acquisition and development strategies are paying off. I look forward to carrying this momentum into the quarters ahead. Now we'll turn it over to Kris.

[J. Douglas, executive]

Thank you, Rob. The positive momentum we saw late last year continued into '21. First quarter year-over-year FFO per share grew 2.6%. What's noteworthy is that in each of the pandemic-impacted quarters of the last year, we had positive FFO per share growth. This was possible due to the underlying revenue growth drivers of our portfolio as well as accelerating external investments. In the first quarter, sequential FFO increased $1.7 million. This was driven by a $3.1 million increase from the full quarter contribution of the $337 million of fourth quarter acquisitions. This contribution was offset by a $1.3 million increase in G&A, $900,000 of which is related to first quarter only items. We see current same store NOI of 2% turning back to, or even above, our long-term average of approximately 3% as the impact from the pandemic dissipates.

Where we really saw COVID effects in the last year was the loss of parking income and occupancy during the second and third quarters. This was partially offset by lower operating expenses. The timing of the rebound to pre-pandemic levels for these items will fluctuate and vary by market. However, with vaccinations becoming more widespread and the number of leasing tours increasing, we see a path to accelerated growth in the quarters ahead.

The growth potential embedded in our existing leases remained solid. The average in place contractual increase for our portfolio is 2.86%. For leases renewed in the first quarter, the average cash leasing spread was 4.4% and the average future contractual increase will be 2.98%. Our ability to achieve this level of performance is tied to targeting markets where population growth runs well above national averages and drives our expectation for future internal growth. Solid operating fundamentals and a strong pipeline of accretive investments will ensure the ongoing strength of our FAD payout ratio, which was 88.7% over the last 12 months. It is worth noting FFO per share grew 8% over the prior 12 months. This drove the improvement in our payout ratio even as we increased the dividend in March. In the first quarter, maintenance CapEx decreased to $8.4 million, down from a seasonal high of $21.1 million in the fourth quarter of 2020. Maintenance CapEx spending will fluctuate quarter-to-quarter, however, we expect to maintain a trailing 12-month FAD payout ratio below 90%. Net debt to EBITDA was 5.3x at the end of the first quarter. This is right in the middle of our target range of 5 to 5.5x. Net acquisitions of $69 million in the first quarter were primarily funded through $63 million of net proceeds from the settlement of forward equity.

Looking ahead, we have multiple sources of capital to fund over $150 million in our near-term acquisition pipeline. Our funding options include up to $127 million of proceeds from yet to be settled forward equity, more planned dispositions and joint venture capital, along with nearly full capacity under our revolver.

As we reflect on the pandemic hurdles of the last year, we're pleased with the stable performance of our portfolio and encouraged for the future. We see the most significant impacts of COVID-19 on our portfolio fading with widespread vaccinations and foot traffic at our properties increasing. Underlying solid growth of our revenue drivers, including healthy escalators and cash lease and spreads are poised to drive same store growth to 3% or more. Improving internal growth and a robust pipeline of a accretive investments will accelerate per share earnings growth in the quarters ahead. Sarah, we are now ready to open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from one Juan Sanabria with BMO Capital Markets.

[Juan Sanabria, analyst]

I was just hoping you could give a little bit more context with regards to the benefit from parking to same store. Is there a way to quantify kind of how much you're generating today versus what the normalized pre-COVID levels were?

[J. Douglas, executive]

Yes. Right now, we are running about 80% of what first quarter of 2020 parking income was. So we do see that as a benefit to us in the coming periods, as we start to see that rebound back to more normal levels. And that ended up being that was impacted same store results by, call it, about 50, 60 basis points.

[Juan Sanabria, analyst]

Great. And then I was just hoping, maybe more of a conceptual question, but the local cluster you guys have been able to generate. What impact does that have to margins as you benefit from local know-how and maybe having lower personnel by asset, or is that not really a driver to margins and it's more of just local know-how. Just curious on what you're seeing and what that means for margins and same-store NOI growth?

[J. Douglas, executive]

Yes. I would agree with where you were headed there, which is that we really see it as more of a revenue driver benefit, a leasing benefit, and a momentum benefit rather than just an expense savings benefit. Clearly, there can be some of that expense savings as you scale up, but what we also find, if you look at probably our premier example, and we show this in our investor presentation in Seattle, we're very spread out there across a lot of different clusters, across a pretty big region in the Puget Sound. And so you don't just centralize with one office and send everybody out. It's a high level of service, a lot of folks in the buildings that we own. So we don't want to cut customer service due to the high traffic in our buildings and so forth. So really to us is a benefit of being in the flow of the leasing discussions that are going on, whether it's with brokers or directly with hospitals or physician tenants. So it's much more of a revenue piece and driver and accelerating revenue and occupancy than expense savings.

[Juan Sanabria, analyst]

And maybe just one last quick one, what do you expect the development deliveries to kind of averages as that ramps up going forward?

[Robert Hull, executive]

When you say development delivery...

[J. Douglas, executive]

Just the volume.

[Robert Hull, executive]

Oh, the volume? Yes, I think as we move forward, we're looking at starting anywhere from 2 to 3 projects a year, and it's generally on the volume side, that's generally going to be in that $50 million to $100 million a year in starts that we're targeting.

[J. Douglas, executive]

And right now we're at $60 million, we could probably easily push towards the upper end that would be underway by the end of the year, if not exceeded, but on average, I think, Rob's right over time. 2 or 3 projects that are active or getting started each year.

[Operator]

Our next question comes from Nick Joseph with Citi.

[Nicholas Joseph, analyst]

You talked about the geographic differences that you're seeing, but I'm wondering if you're seeing any differences across different specialties or practices of volumes returning or patient flows?

[Todd Meredith, executive]

Not tremendous. Certainly you see the specialists clearly are getting very much back to normal. I think it is much more geographic than it is necessarily by specialty. There are some extreme examples as you might point out, or we might point out that some of the cognitive counseling, psychology, psychiatry, some of those things, certainly behavioral health, there are some things that can lend themselves much more to not getting back to normal and can be somewhat handled in a more virtual telehealth manner. But most of what is in our buildings, we're seeing back to normal, most of those specialists. Certainly even the ones that we saw impacted pretty significantly like dentists and dermatologists, all that's very much back to normal.

[Nicholas Joseph, analyst]

That's helpful. And then, what do you think about, I guess, leasing on a geographic basis? Are you seeing differences there just given what's happening kind of from a volume perspective? Is that leaking through in the leasing market at all?

[Todd Meredith, executive]

I'd say a little bit, certainly the emerging signs of more growth, as all of us touched on, would be much more concentrated in some of your places that are little more -- have been back to normal longer, whether that's here in Nashville or in Texas over North Carolina, in different places like that, where Rob's team is very active, I would say that does correlate somewhat with markets that have been much more open sooner. And so a place like the Bay Area is definitely going to look a little sleepier on that front. Southern California is a very different story though. I'd say as Rob gave an example, that was in Orange County and we've seen tremendous engagement there and momentum. So it is very specific to particular markets.

[Operator]

My next question comes from Nick Yulico with Scotiabank.

[Joshua Burr, analyst]

This is Joshua Burr with Nick. So maybe could you guys just talk about what you're seeing in terms of leasing activity? Leasing bonds were pretty strong this quarter, re-leasing spreads and retention rates are both at the high end of guidance. So any color that you could provide on lease expectations for the rest of the year would be helpful.

[Todd Meredith, executive]

Yes, you're right. First quarter was strong in terms of our leasing metrics, specifically to our cash leasing spreads. They were a little bit above what our guidance range of 3 to 4 for the year, but really that has to do with just where the ultimate mix comes out. We ended up with, I think, it was about 3% of the leases that had negative spreads. So having a very small number in that bucket certainly lets your higher-end renewals play through to the average. But if you look at it still, the vast majority of the renewals were in the 3% to 4% range and that's still what we expect for the year. Overall, in terms of absorption, we did have positive portfolio absorption, we're pretty flat on a same store basis. That can fluctuate from quarter-to-quarter. But as we've been talking about, there's some positive signs of things improving across the country that we think can help drive absorption as we look to the back half of the year and into in next year. And then just overall, you also heard us talk about the backdrop behind the whole sector with the aging demographics and the need for additional space we think is going to be a benefit to leasing, not just in the year ahead, but in the years ahead.

[Joshua Burr, analyst]

Got it. That's helpful. And then could you just give an update on the current acquisition pipeline in terms of activity and pricing? Maybe you could just talk about what drove the increase in acquisition, disposition guidance, and then the better pricing on dispositions?

[J. Douglas, executive]

Yes. I'd say on the pipeline, we certainly started off the year strong investment activity, 10 buildings, $129 million at a blended cap rate of 5.5%. We do have a -- continually to building our pipeline. And I think it really stems from our process of how we're building that pipeline. We're very much going into our targeted markets. We have around 30 markets that we are intently focused on. We see an opportunity to grow in, our team is there building these relationships, getting to know building owners. And so that creates some visibility for us in terms of what we see out in the future. And so given the strength of that pipeline and the -- I mentioned $150 million that we have under contract for LOI that we think is going to close around into this next quarter, that volume and that activity level are giving us confidence that we're going to get to the upper end of that new range that we've given the investors.

On the disposition side, yeah, I mean, I think this quarter you saw us sell a few properties at low cap rates. But the cap rate there was 4.8%, selling into the strength of the pricing market. Those were properties that didn't fit in with our cluster strategy, our long-term cluster strategy. And so we took the opportunity to recycle those assets and those dollars and put them into accretive MOB transactions. And you'll see us continue to do that this year. We've got some opportunities to realize some nice value from some of our properties and we'll rotate that into accretive MOB transactions.

[Operator]

Our next question comes from Jordan Sadler with KeyBanc Capital Markets.

[Jordan Sadler, analyst]

Rob, I'd like to follow up on the dispos. Maybe you can just walk us through the rationale on the two that closed this quarter and I know you got a couple more teed up I saw on the queue, a couple of bigger ones in Virginia, et cetera. But Valley Presbyterian in L.A., or Piedmont in Atlanta, what was sort of the rationale around these couple sales?

[Robert Hull, executive]

Yes, I'd say the Valley sales, that was a campus that we had 2 properties there. When we look at that hospital, we didn't see a lot of additional opportunity to build out properties in and around that campus. And the buyer of that property, a tenant was an owner in the building or part of the ownership group. And they made an offer at a very aggressive cap rate. And so we wanted to take advantage of that and sell to that group and rotate that into an area and some assets where we saw potential for growth and to build out clusters down the road. The other asset was an off-campus asset in a similar theme. We didn't see an opportunity to build out in that immediate area, a cluster of properties over the long term. So we took the opportunity to sell on the strength of this pricing market and deploy those dollars elsewhere.

[Jordan Sadler, analyst]

Okay. And in terms of the stuff that's teed up, I did see one larger asset that seems like it's held for sale? [ 52 million ]?

[J. Douglas, executive]

Yes, the one in Virginia you're talking about, that one is an on-campus building, but it's interesting that it has some capacity to actually convert a portion of that building to inpatient. And so the hospital had approached us of their interest in buying that asset to help them with some expansion opportunities they're looking at on the inpatient side. And so we were able to agree on a price at a favorable cap rate, I think it's a sub 4 cap rate on that one. So a good opportunity to accretively dispose and reinvest that capital.

[Jordan Sadler, analyst]

Okay, that makes sense. And then Kris, I was just curious on the FFO side, sequentially, you commented on a full quarter's contribution from all the acquisitions that closed in the quarter, but I was kind of -- the headwinds -- one of the headwinds you pointed out was $900,000 of G&A that is not going to continue. Was there anything else that was a headwind in the quarter aside from sort of the elevated G&A? Because I would've thought FFO would have been sort of pressured a little bit higher based on sort of the underwriting and some of the metrics you guys had provided...

[J. Douglas, executive]

No, I mean, that really is a main item with the G&A. We've talked about that each year, we kind of have that in the first quarter, that's seasonal only. So if you would have had that, that would have started pushing on a rounded basis that your FFO growth back up, call it another penny or so. So that is certainly the main item. Obviously, we've talked about that our same store is growing a little slower than frankly what it has been historically because of the COVID issues that we experienced last year. So as we see that rebounding, that will provide some additional lift for us on overall growth. But as we look at it, I think things are lining up very well especially as we look towards the back half of the year and moving into next year of a very strong per share growth on FFO and FAD.

[Jordan Sadler, analyst]

Out of curiosity, less important, but just for sake of the metric, and you pointed to it, the GAAP same store NOI growth year over year?

[J. Douglas, executive]

I don't know the exact number off the top of my head, but you can see inside of our supplemental, we do lay out the straight-line rent. So the math wouldn't be that difficult to calculate.

[Jordan Sadler, analyst]

Yes. I'll follow up with you. It's hard to actually get there because you guys provide -- you don't provide the line items for revenue and expense for the acquisitions, redevelopment, disposition line items. So it's a little bit -- but I'll follow up with you on that one. On the shares settled in the quarter, in terms of the equity, can you give us timing on that? Was that late in the quarter or early?

[J. Douglas, executive]

It would have been...

[Jordan Sadler, analyst]

[indiscernible]...

[J. Douglas, executive]

Yes, it was... Trying to remember the exact timing, but I think it was late February or early March.

[Operator]

Our next question comes from Vikram Malhotra with Morgan Stanley.

[Vikram Malhotra, analyst]

Just wanted to maybe get some of your latest thoughts on how big the opportunity set is for -- leaving aside the pure or on campus for a Healthcare Realty just the off-campus adjacent, other nomenclature, is how big the opportunity set for you is? And maybe over time, where you think that goes in terms of a percent of the portfolio, I asked this given, obviously, the broader talk about hospitals incrementally looking to take pieces of their business -- of their operations and move it more into the community to off-campus settings, more procedures being reimbursed for that. So just wanted to get your how much of this is you're building toward a slightly different not completely, but somewhat different health care delivery model versus this is an opportunity set that you find sort of accretive, and maybe it's a bit of both. But any of updated thoughts would be helpful.

[Todd Meredith, executive]

Sure, Vikram. I think it is a bit of both, we probably have a slightly different view than maybe sort of this prevailing binary view that, you know, there's a fixed bucket of services on a campus, and it's anything that can't be in the bucket smaller on campus. We don't really subscribe to that. We think that bucket is always growing. The acuity levels are growing, the volumes are growing. I mean the amount of inpatient expansion we see that sort of counters the narrative that hospitals are somehow shrinking, we just don't see it. And so we're seeing and we're seeing more demand and more on-campus MOBs being built. And a lot of what Rob's working on his stuff, right around the hospital campuses. So we think it's all a growing sector. So we'll continue to invest in both aggressively but there's no doubt. And we've always said, it's a very real trend that things have been moving also off campus as well. And over time, acuity in the off-campus setting can improve, too, and it is, and as you just pointed out, there's going to be more and more that can be done in those off-campus settings. So we like the odds of all of it. We think what's really important, though, is learning how do you navigate that and balance the risk and the return that I think that's what you've heard us express today that, that we're finding our own way to get better returns with a strat and have more risk and less variability by looking at things that have a strategic alignment with our clusters. Also, it's an extension of relationships that we have, being in denser, larger markets, all those things that help mitigate sort of the risk of just small, rural, off-campus buildings that can go dark on you. So it's -- there is no hard and fast number. I think Rob maybe mentioned that we've got in our JV, we're doing more off-campus there. I think the JV to date is roughly 40% off campus. So that's a very different picture than the balance sheet, which is, high 80s on campus and around the campus. So our view is there's not a hard and fast number. We still, as I mentioned, are allocating the bulk of things to the campus model. But we're we are opening up and I think it does increase the addressable market for us, which is very encouraging.

[Vikram Malhotra, analyst]

That makes sense, and then given this sort of can you talk about just competition from maybe away from your traditional peers that has a playing field changed in any way over the last 3, 6 months as the recovery is picked up? Have you seen new players come in and maybe just give us the latest thoughts on what pricing is?

[Robert Hull, executive]

Yes, Vikram. I would say that's right. I mean we have seen really buyers that maybe were sitting on the sidelines last year, they've, they've moved back into the mode of competing for product, certainly on the marketed deal side. Oftentimes, we say it's a lot of the same names, but we really think about it from the standpoint of the capital that's behind the same names, in many cases. And so we are seeing quite a bit of capital move into the space. And they're chasing, chasing opportunities, just like we are. And so you're saying a little cap rate compression, mostly on the portfolio side where these guys are trying to get in and make a big, big move on the what we're calling the ultra-core side, you're seeing a little bit of it as well. So cap rates, certainly moving a bit, but we've been able to -- through our process, we've been able to find the right deals for us and a accretive cap rate levels. And make sense of them. And a lot of those are being borne out by relationships that we've established previously. Repeat sellers, repeat -- folks that we're doing repeat business with, they know that we can, we can, we'll close on the transaction, they know that we'll underwrite it properly, and they're getting a fair price. And so we're really finding that that's paying off as we're, we're out there in this competitive environment.

[Vikram Malhotra, analyst]

Got it. That makes sense. And then just one last one on, you referenced obviously, the developments over time and you're increasing the pipeline. Given sort of all the cost pressures, across you know, various materials, I'm just wondering, as you think about underwriting here, are there certain areas you're focused on, or markets you're focused on, where you may feel you have a little bit more pricing power from an underwriting standpoint, just trying to figure out the underwriting in light of where costs of constructions going?

[Todd Meredith, executive]

Yes, I mean, I think that that's certainly an observation. And it's the right observation. I mean you're seeing some escalation in construction prices from various things, everything from materials and labor, in some cases. And really, as we look at development, we've always said we're focused on this embedded pipeline that we have internally we shared that with you over the years. And that's where we see our, our pipeline, the kind of built and feeding our development efforts. And so they are -- yes, you're right, we're focused in markets where we feel like rent growth has been strong, rent levels are strong, where they've been able to keep up with some of the escalating construction prices, hospital systems are growing aggressively. And so they have a need for additional space. And they've built in the price escalations in the cost to construct into their business plans. Places like Seattle where we just started this redevelopment here in Nashville, we're working on a development opportunity that we have to kick off this year and rents here have been very strong. And so that's what we're spending our time. It's really driven by our hospital relationships and a need. And in focusing on that targeted yield, 100 to 200 basis points above, where we're seeing stabilized assets.

[Operator]

Our next question comes from Connor Siversky with Berenberg.

[Connor Siversky, analyst]

Just a follow up on the development pipeline, you mentioned multiple starts. So I'm wondering if these are all built-to-suit projects? And then can you provide any color as to what the facilities plan specializations are, whether it's dermatology, oncology, something like that?

[Todd Meredith, executive]

Yes. I mean, I think, certainly, the -- our developments are being driven by but growth initiatives of the hospital. And so just for example, we're working on a development here in Nashville with the health system, and it's going to be on the campus, that hospital is growing, they are enhancing their women's services on the campus, and that's going to be a big part of this building. They are also growing their cardiology service lines, and so the other buildings in and around the campus are tall and they need to grow and they need to grow that service line. So there's dialogue with them about putting more cardiac services into the building. So it's mostly specialty physicians, service lines that are certainly growing higher acuity service lines that need to be in on campus or around campus, and that's what we're seeing and that's really what's driving the bulk of our development efforts.

[Connor Siversky, analyst]

Okay. And then just a bit more on some of these cost pressures that Vikram had mentioned. So have any decisions or has anything been signed related to the leases in these development projects? Or would those rates be reflective of the end project cost?

[Todd Meredith, executive]

No. I mean the development we just started. We have a signed lease for 100% of the building and the rate is set. And that's where when we go into these projects, that is what we're doing before we commit to put the shovel in the ground.

It may not go 100%. But whatever that hospital-driven service line or multiple service lines, usually you're working out, you're working hand-in-hand with your contractor. You're not just saying let's get a lease, and then we'll go figure out what it costs. It's a parallel process that you're constantly working at the same time. So you're keeping your construction costs estimates live with your contractor working towards a contract, just like you're doing with your lease -- for your leases?

[Connor Siversky, analyst]

Okay. That's helpful color. And then just one last piece of this. Do you foresee? Or is there any expectation maybe for delays in starts or ongoing project schedules?

[Todd Meredith, executive]

I mean you're certainly planning the development. It certainly has its ebbs and flows. I mean as we're pacing right now, we're on target to start as we've laid out and complete as we've laid out in our schedules. Certainly, permitting and getting a building permit in this day and age, it certainly can be more challenging. But we feel like if you hire the right contractors and you have the right team in place, you're going to get those pushed through and you're going to get started.

[Operator]

Our next question comes from Tayo Okusanya with Mizuho.

[Omotayo Okusanya, analyst]

Question. So I'm sure you guys have seen the recent Revista report out there that's just kind of talking about off-campus versus on-campus, and they're actually putting real data behind this and kind of join the conclusion that off-campus affiliated assets have actually tracked well, if not better than on-campus assets, but you trade at wider cap rates. First of all, I'm curious what you think about this data kind of given the historical argument that on-campus should do better than off campus? And second of all, does it influence you in regards to having more off-campus assets on balance sheet?

[J. Douglas, executive]

Yes. It's interesting. We've certainly seen that report. We've read it. I think it's a good effort for them to try to cover that type of information. I think it's a little early for them to come out with a thesis that says, we put a stamp on it, off-campus is just as good. One thing you'll notice that's not in that data is NOI growth. You'll notice also they only looked at 3 years. And I think that's the benefit we have in some of our peers. You heard, I believe Healthpeak yesterday got into this a little bit, that they're doing a deeper dive over a longer time frame. We've been doing that for a long time. We're doing the same thing. And I think when you look over time and you have -- you go through cycles, you factor in the fact that buildings can go dark. If they're off-campus, sometimes even if they're anchored, one lease cycles are passed. The lease expirations occur. So there's some real challenges to trying to do that on a third-party basis. There's also a lot of data integrity issues that they're mashing up lease rates of all different varieties and types that don't really fully tell the picture. Again, I think I'd applaud them for trying, and I think there's something to glean from it. But our experience is a little different. We think there is a difference between on-and-off performance. Another key difference that we saw in that report is they throw all the adjacent properties into the off category. Well, adjacent behaves a lot more like on. And so you're lifting your off performance by bearing the adjacent in there. That's another issue. So there's a lot more nuance to it than that report suggests. I think that's our job is to figure that out and learn from what we have experienced over the years, what we see changing and put that to work to generate better performance. And I think the key thing that we would say is on these ultra-core properties that are on-campus or right around the campus, they tend to perform better, higher growth, and they tend to do it with less variability. When you get off, you just start opening up the performance issues and variability, and so you have more risk. And so that's why we put together some of our on versus off cap rates in our investor presentation. And you'll see, as Rob said, we've been getting 40 to 90 basis points of spread on versus off, and we think there's some rationale for it. And so we're very careful in how we look at that risk. And we'll certainly bring more as well, like Healthpeak mentioned to NAREIT to talk about as well on that topic.

[Operator]

Next question comes from Rich Anderson with SMBC.

[Richard Anderson, analyst]

So on the off-market commentaries you made about the relationships and whatnot. Is that a price situation where you get a better cap rate exclusively? Or is there some sort of -- it's just easier, you can almost customize things a little bit, and you can have a little bit more flexibility on how to approach things? And is that like the trade-off and maybe you don't get a special bargain, but you get more flexibility out of that. Is that a fair way to think about off market?

[Todd Meredith, executive]

Yes, Rich, I mean, I certainly think that's it. I mean I don't think we're sitting here saying that we're getting discounts on acquisitions because we're buying them off market. To me, it's more about building that relationship with that seller. We've had a number of deals that we've done recently that are -- that is repeat business. Isn't the same building owner told us something they had in a different area. And they came straight to us. And I think that is right, you've built a relationship with them. They know you can close. They know your reputation. They know you know how to underwrite the property appropriately so that they feel like they're getting a fair value, and it becomes an easy process. And so that's where the real value comes in for us in doing off-market is that we know we can kind of look and build that pipeline and see what it looks like further out rather than just waiting for marketed properties to hit the market and then reacting to those.

[Richard Anderson, analyst]

And maybe the savings comes from it doesn't -- it's not as hard to process and you save money by chasing around maybe -- just sort of speculating...

[Todd Meredith, executive]

But I think the other thing, and Rob mentioned earlier, if you allow these properties to get pushed into a big portfolio, that's where you avoid the premium as well. So by getting to these early and through these relationships, it just saves them a lot of headache, the seller. But they, again, they want a fair price. It's -- my joke is always when you go knock on that house that you really -- you and your family have liked and always wanted to buy and you go knock on their door, chances are they're not going to sell it to you for a steal. But the idea here, we see is that there is premium in portfolio size, and so you avoid that by building it the way we've been doing.

[Richard Anderson, analyst]

Well, with me, they wouldn't even open the front door, but that's another issue. When you talk about getting -- able to push rents and you're not seeing too much pushback, do you have a comfort level about retention going down? Do you have something in mind like, okay, let it trickle down a couple of percent? Or if you see any indication of retention being impacted by pushing rents that you'll take your foot off the gas?

[J. Douglas, executive]

Yes. For us, Rich, we say that our expectation on retention is kind of 75 to 90. We've frankly been running more in that kind of plus or minus 85 for some time. And that's going to ebb and flow by quarter. And as we look at it, we say we're looking to grow 3% to 4%, but we have some markets that we're doing better than that. Then you have some markets that, yes, you have to recognize what's going on in the market and the competition, and you have some roll down. This year -- this quarter, it was pretty minimal, that I think, 3%. And so you're just trying to build a portfolio that gives you the opportunity that you can hopefully, over time, grow that at a more consistent rate and a stronger rate. And as we look -- we've had some people who have asked us 3% to 4% are reasonable compared to inflation. So well we really look at things from a construction cost replacement value, which has been growing north of that 3% to 4% for some time. And frankly, right now, with some of the questions we've had on this call, there's some concern of could that speed up moving forward? And so we think that there's still plenty of room, and we think that we're still showing value to our tenants in terms of making sure that we have properties that have the space they need that are maintained, we certainly make sure that we are investing the capital and TIs as well as building CapEx to be able to maintain this level of growth that we think is sustainable long term.

[Operator]

Our next question comes from Todd Stender with Wells Fargo.

[Todd Stender, analyst]

And thanks for sticking around. Rob, for you, you highlighted the off-campus property you acquired, I think here in Q2, I don't know if it was the Colorado Springs one at a 7% plus cap rate. If that's a redevelopment candidate, what kind of cap rate do you think that will look like on a stabilized basis? Just narrowing down the value creation opportunity there.

[Robert Hull, executive]

Yes, Todd, I think I heard you say, I'm having a little bit of a hard time hearing you, but I think I heard you say a property that we said was 7% cap rate.

[Todd Stender, analyst]

Yes...

[Robert Hull, executive]

That was actually a deal in San Antonio. And that was an interesting situation where our kind of our direct sourcing process really paid off for us. There, the seller of that property was wanting a quick process and then a surety of close, they wanted to move really fast. And the broker that was working that deal knew we were familiar with that market, knew we could achieve that, and came to us. And they weren't as interested in maximizing value as they were just getting out of the property real quickly. So we just got through telling Rich that we weren't getting discounts, but probably on that one, we might have gotten a discount.

[Todd Stender, analyst]

So what is the cap rate compression expectation there? If you're buying it a 7, is that market something in the 5s? Is that ambitious?

[Todd Meredith, executive]

Yes. I mean I'd say in high 5s is probably low 6s, high 5s.

[J. Douglas, executive]

Yes. I think, Todd, if you were to take that out into a portfolio, not that we're going to do this, but package it with some other nice properties in a portfolio. Yes. You would see compression well into probably the high fives. And so, yes, there's a lot of value creation that can be had there.

[Operator]

Our next question comes from Mike Mueller with JPMorgan.

[Michael Mueller, analyst]

Just in terms of getting back up to the 3% same store NOI CAGR, what are the P&L headwinds that you're facing today to get there? Because your in-place bumps are almost at 3, rent spreads are fine. Is it the parking or bad debts elevated in any way? I mean what's the drag today in the P&L?

[J. Douglas, executive]

Yes, the main things that we've talked about, it was really the parking, then operating expenses, and then occupancy changes. So bad debt is back to minimal, if any. We've collected basically all of our deferred rent, so that's not an issue. But the parking, like I said, is probably impacting on the revenue side 50, 60 basis points on an NOI. It's frankly even a little bit more than that. On a revenue per average occupied, we are trending below our average because of lower operating expenses. Right now, we had negative operating expenses this last quarter, which is great, but that's unusual. But the operating expense pass through on the other side reduces that revenue growth. Now to the NOI bottom line, that's still a positive for us.

But then we did experience the loss in occupancy in the second and third quarters of last year, which is rolling through, I call it 50, 60 basis points. And so we always say that you're going to end up, that's going to have a one-to-one impact on the revenue growth. So that could bring down your close to 3% revenue growth down into the mid-2s. And then as you take that to the NOI with our margin, it's really a 2 to 1. So you can have almost 100 basis point impact as it relates to the occupancy. So as we see the parking coming back, as we see that the operating expenses kind of more normalizing, and we think that the occupancy is hopefully at least bottoming out, although it could move around each quarter and over the long term we think can grow. When you build all of that back together, you get to see that revenue model and that NOI model that gets back to those long-term averages of 3%, or frankly even more if we're able to see some absorption.

[Michael Mueller, analyst]

Got it. And then I know you said the parking was off. I think it was off 20% year over year, but just thinking bigger picture, if you have $100 of revenues, how many -- what portion of that comes from parking? Just to put parking into perspective versus everything else on the revenue side?

[Todd Meredith, executive]

Yeah, it's very low. I'll get the exact number out for you...

[Robert Hull, executive]

So less than 2%?

[Todd Meredith, executive]

Yes. I was going to say about 2%.

[J. Douglas, executive]

It's a runway of 2 million a quarter on 120 million of revenue a year ago. So it's less than 2.

[Operator]

[Operator Instructions] Our next question comes from Daniel Bernstein with Capital One.

[Daniel Bernstein, analyst]

Just one quick question. It seems like both you and your peers' retention rates have really gone up in the first quarter. I didn't know if that was just kind of like a one-off thing or if you're seeing an actual trend due to maybe changes in tenant movement or a desire to stay in the buildings and expand into buildings. I'm just trying to understand if there's a trend there and how that might -- how you think about that and how it might impact your occupancy and TIs going forward.

[J. Douglas, executive]

Dan, I wouldn't read too much into 1 quarter. It does move around like we described. We're comfortable 75 to 90, it has been running a little higher. I don't think it's unusual given the pandemic that people are getting themselves back on their feet, running at full capacity, they've been focused on safety protocols and just running things back to normal. So that may explain some of it, but also we're seeing a lot of interest in expansion and so forth. So again, that may help, too. And I think as some people have asked, maybe some perception that rents are rising elsewhere, construction costs are rising, that helps a little bit at the edge, too. But we're not suggesting next quarter is going to be the same or better. I think we're still comfortable in our range and it will move around a little bit. So I wouldn't read too much into it. I think it's probably just in a range that we've been in 80 to 85 plus.

[Daniel Bernstein, analyst]

Would that be the same answer for the length of term? That bounces around a lot too, but that again, any change from tenants in terms of what they've been asking for in terms of length of term, especially with inflation going up?

[J. Douglas, executive]

I would say on a long-term to long-term basis, I don't think we've seen a big difference. I will say that last year, while we were in the midst of the pandemic, it trended down. There were people that just weren't in a position to make a long-term commitment, and we were comfortable with that. And we signed a little bit, probably a higher percentage of short-term deals. And so as a result, you may have seen our averages trend down a little bit. But now that we're getting back to kind of a more normal environment, I don't think that our expectations are much different than they were over a year ago.

[Operator]

Our next question is a follow-up from Jordan Sadler with KeyBanc Capital Markets.

[Jordan Sadler, analyst]

Thanks. I was just parsing through the supplement a little bit. On Page 25 on your same store reconciliations, there's something called rent concessions. Can you just remind me what that is exactly? I saw that it spiked up, but I wasn't sure if that related to the increased leasing or if that was more like a deferral or abatement, what is that?

[J. Douglas, executive]

Yes, it will be tied to multiple things, but typically it's going to be some type of free rent that is going to be related to mostly new tenants. We don't really have any on renewals. I think that the -- I have to dig into the specifics, but we did have a couple of tenants inside our redevelopments that started. And so those typically end up with a little bit of free rent at the front end. So that would be my guess specifically why it is a little bit higher, although I'd still say it's still not that meaningful to the overall revenue. But that's the reason that you're seeing a little bit higher this quarter than previous.

[Jordan Sadler, analyst]

There's no abatement in there or anything like that?

[J. Douglas, executive]

No, no. Nothing like that. This is really about some free rent for a tenant, specifically a new tenant, especially on redevelopment where they may be still having to build out some space or moving from one building to the next and you're kind of helping them out as they're moving across buildings, but no, it's not rent abatement's.

[Jordan Sadler, analyst]

Okay. That's helpful. And then as it relates to your lease structure, I think the preponderance of your leases are fixed, but I know there's also a CPI portion as well. So I was just curious, on the upside, we don't talk about this that often, but I know this theme has sort of popped up here a little bit, but is there a cap on CPI on the CPI escalator?

[J. Douglas, executive]

Generally, no. There are all kinds of leases out there and there are some that will have maybe a 4 or 2, a cap of 5. But I would say generally they're more just tied to whatever CPI is. Overall, CPI is not a large percentage of our structure. It's under 5% of our leases have a CPI-based escalator. We are typically more fixed as you pointed out. And historically, we frankly have done better with our fixed, running it closer to 3 than where CPI has been. And people have questioned like, well, if CPI starts ticking up, is that a risk? And so, well, we also have generally a pretty regular turn in our leases, with about 20% that are up for renewal each year. So if we do start to see pressure on costs across the board in construction costs and janitorial costs or elsewhere, we think we have a very reasonable amount of our leases that we can start to look to try to recapture that, if that does start to occur.

[Jordan Sadler, analyst]

Okay. And then lastly, I think on the joint venture deals, I know a handful of these happened this quarter and you've got some more teed up for next quarter. And I'm just curious what sort of, and since you have some examples here of deals that you've closed, what's the sort of thinking of JV versus on balance sheet transactions? Like what are you showing them versus what are you not showing them? And some of these deals look like straight up the middle, HR deals. And I'm just trying to figure out how we're supposed to tell what the difference is?

[J. Douglas, executive]

Yes. I mean I think if you look at what we did this quarter and really look like what we did in the fourth quarter as well in the JV, you had an opportunity that really looked some more of a value-add opportunity where it was a building that we purchased that had some upside in terms of occupancy. And so opportunities like that, where we think there might be some near-term drag because of the lower occupancy, but we see a nice upside, those are opportunities where we're going to entertain those in the JV. And we did. One of the buildings that we bought this past quarter was really our fourth building around a campus in Orange County. And we have been placing buildings into the JV around that campus.

And we see some real upside, we seem to real absorption in the other buildings. And so that's where you'll see us participate and share those to the JV. The other side is really on the off-campus side. Three buildings that we put in there this quarter, were off-campus properties, where we think that there is some additional risk. And so we're putting out half the capital, but getting that higher incremental return. And so those are opportunities that we're sharing in -- with the JV. The stuff that's down the fairway, you said, where we already have nice relationships on or adjacent. We're generally keeping those on our balance sheet. And we intend to. As we said before, we're not obligated to show them a certain number of deals or certain types of deals.

It's really at our discretion. And so you'll see us continue to do that. And I think that Todd pointed out that in our supplemental, I think it's Page 19, where we're showing the breakdown of the JV, I think 40% of the properties that are in there are now off-campus as opposed to our on balance sheet portfolio that's staying down around that 12% range. So I think that's really the way to think about it is, when you get into those situations where the cap rate's a little richer, and we can make better sense of it, or maybe there's some upside that may have some near term drag, and then the off-campus buildings.

[Operator]

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

[Todd Meredith, executive]

Thank you, Sarah. And thank you everybody for tuning in today. We'll be available for follow up if you have any questions, and we look forward to connecting with most of you at NAREIT soon. Have a great day.

[Operator]

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