Healthcare Realty Trust Inc

NYSE:HR

Earnings Call Transcript 2019-Q2

[Operator]

Good day, and welcome to the Healthcare Realty Trust Second Quarter Financial Results Conference Call. [Operator Instructions]. Please note, this event is being recorded. At this time, I would like to turn the conference over to Todd Meredith, CEO. Please go ahead.

[Todd Meredith, President, CEO & Director]

Thank you. Joining me on the call today are Bethany Mancini, Rob Hull, and Chris Douglas. After the disclaimer, I'll provide a few opening remarks. Ms. Mancini will cover Healthcare trends, Mr. Hull will discuss recent investment activity, and Mr. Douglas will review operational and financial results, before we move to Q&A. Bethany?

[Bethany Mancini, Corporate Communications]

Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in a Form 10-K filed with the SEC for the year ended December 31, 2018, and in subsequently filed Form 10-Q.

These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures such as funds from operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the second quarter ended June 30, 2019. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.

[Todd Meredith, President, CEO & Director]

Thank you, Bethany. We are pleased to report another quarter of steady results and increasing momentum on multiple fronts. Specifically, I'll focus on three key topics: first, the strength of our acquisition activity year to date; second, how we are proactively sourcing attractive investments; and third, how we see organic and external growth translating to FFO on a per-share basis.

Starting with external growth, our acquisition pace is up notably, and we are pleased to report nearly $200 million of completed acquisitions at midyear. We see continued momentum, and we've increased our guidance for the year. We've been pleased to see a consistent flow of attractive properties. Sellers and brokers have gained confidence, aided by fewer portfolios of scale consuming everyone's attention, plenty of public and private buyers, low interest rates, and stable cap rates.

At the same time, Healthcare Realty's cost of capital has strengthened and afforded us the ability to invest more accretively. We are capitalizing on attractive market conditions to unearth more investments using our proactive sourcing process. This involves the practice of deeply embedding ourselves in targeted, high-growth markets. Using a team-based approach, we gather local intelligence, systematically collect and analyze market data, and identify desirable properties and potential developments that are not available to the broader market. This quarter, three of the properties we acquired were in the Seattle area, and a result of using our market expertise and three years of patiently working our local connections.

We are also seeing increasing benefits from the company's solid reputation in the MOB space. Healthcare Realty is known for completing transactions smoothly, following through reliably, and taking great care of our properties and tenants. Over time, our reputation has spread among an expanding network of brokers, sellers, physicians, and health systems, and it leads to repeat business. This credibility has been years in the making and is yielding a marked difference in our ability to source more quality, accretive investments. As an example, two of our longtime health system partners recently reached out regarding potential development projects. With positive traction on these and other developments in our embedded pipeline, we expect a couple of starts in the second half of '19.

The combination of our reputation, our proactive sourcing process, and favorable market conditions is yielding a higher pace of investments. While we certainly evaluate marketed deals, we're not simply waiting around for offering memorandums and RFPs. We are using our deep market knowledge, our local connections, and shoe leather to insert internally-source and directly negotiate many investments.

Shifting to organic growth, our strong second quarter results reflect the benefits of steadily refining our portfolio toward more on-campus, multi-tenant medical office buildings in better markets with top health systems. Discipline around these characteristics has led to superior contractual rate increases, cash leasing spreads, and tenant retention, and has enabled us to generate same-store NOI growth of 3% or higher, at the top end of expectations for the sector.

While we will always refine the portfolio to improve internal growth and reduce risk, going forward, we see less impact on our bottom-line growth, little need to reduce leverage, less rotation out of lower-quality and non-MOB properties, fewer leases with unfavorable purchase options, and minimal need to reduce our exposure to off-campus or single-tenant properties. With these structural changes largely behind us, we see a clearer path for organic and external growth to flow straight through to FFO per share, giving us a bright outlook for 2020 and the years ahead. Bethany?

[Bethany Mancini, Corporate Communications]

The political environment has certainly brought some theater to the healthcare sector since the beginning of the year, although actual health policy is expected to remain stable for the next 18 months, leading up to the next election. Many anticipate a moderate Democratic presidential candidate will rise from the pack, following months of heated rhetoric and sharp debate, but time will tell. Health insurance companies and hospital industry groups favor a bipartisan, more centrist-leaning approach away from the total government takeover of health insurance, and more toward incremental expansion of coverage. With Congress expected to remain divided, a tempered approach remains the most likely course.

Turning to the status of current healthcare legislation, the Affordable Care Act remains under scrutiny in the Fifth Circuit Court of Appeals. Many expect the law will remain in place, whether in whole or in part. Republicans cannot afford to face an election having overturned health coverage expansion with no replacement to cover those previously insured by the ACA, and without hope of passing major legislation in such a partisan Congress. It is not surprising that legal experts on both sides of the aisle agree the ACA should stand, at least for now.

Political debate will continue to intensify throughout the election season, but market sentiment should increasingly reflect reality, as candidates' proposals are vetted for their economic and political feasibility. Healthcare stocks have been recovering from their mid-April lows, and investor focus is returning to earnings and fundamentals. In recent quarters, hospital companies have reported renewed admissions growth, a positive signal for the direction of the sector.

In general, the reimbursement and pricing environment for healthcare providers has been fairly stable this year. As disruptive as the ACA was at the time, the healthcare sector has adapted well and is moving forward. Government-funded health insurance has remained relatively level, representing 41% of total healthcare spending today, compared to 39% in 2010, even before the implementation of the ACA. Given the stability in reimbursement mix and accelerating demographic need for healthcare, demand for real estate is now more promising than ever.

Health systems continue to pursue strategies for enhancing market share, focused on expanding their revenue base. Both inpatient and outpatient services are being targeted for consolidation, expansion, new construction, and employment growth. Health systems are looking to gain the correct balance of efficiency and acuity, cost savings and revenue growth. High-acuity inpatient services are being centralized at market hubs and centers of excellence, while at the margin, health systems are moving less intensive services toward lower-cost outpatient settings, both on and off campus, with care being organized along a continuum of acuity that generally increases with proximity to the hospital campus. In our view, on-campus locations of outpatient facilities remain the most integrated and low-risk investments, strategic to the mission of the health system.

Longer-term, outpatient delivery represents one of the most effective, proven, and politically feasible means to lower spending growth and improve providers' profit margins. Regardless of political outcome, outpatient settings will only become more critical to hospitals, as caring for the aging population efficiently becomes increasingly paramount. Rob?

[Robert Hull, EVP, Investments]

Investment activity this year continues to outpace our expectations coming into 2019. Year-to-date, have closed $195 million in acquisitions, with an average cap rate of 5.5%. Cap rates have remained consistent in the low- to mid-5s for higher quality, on-campus MOBs. With investor interest in medical office remaining high and a stable interest rate environment, we don't foresee a large move in either direction for cap rates.

This quarter, we acquired five properties for $102 million, which includes the $28 million Atlanta purchase in April that we discussed on our last call. These acquisitions are especially attractive because they increase our local market share and complement our existing footprint by building on our leasing team's extensive knowledge and leveraging our property management resources.

In Seattle, we purchased two properties for $50 million. They are around the corner from two fully occupied buildings we own on U.W. Medicine's Northwest Hospital campus in Seattle's growing Northgate submarket. These investments highlight the experience and teamwork found across our company. Our leasing team wanted more product in Northgate, and our acquisitions group, drawing from internal market data and our ongoing contacts with local property owners, delivered with these two buildings. The buildings are ideally located with direct access to Interstate 5 and near a new light rail stop in a massive Simon Properties redevelopment. They sit between the Northwest Hospital campus and its large, comprehensive outpatient center, which are less than a mile apart. We now own four properties totaling over 250,000 square feet around this growing hospital, and one of the properties could accommodate an in-fill development of up to 100,000 square feet, with a structured parking garage.

Our other two acquisitions during the quarter, in Tacoma and Ft. Worth, total 119,000 square feet, for a combined investment of $25 million. Both buildings are adjacent to hospital campuses where we have acquired or developed properties, giving us additional scale. And each hospital has recently undergone an expansion, or is planning to expand in the near future, pointing to increasing demand for medical space around each campus.

With nearly $200 million in acquisitions closed year-to-date, and another $75 million in advanced discussions, we are increasing our acquisition guidance. Our new range is $225 million to $325 million. We are optimistic about our ability to achieve the upper end of this higher range, given our strong start to the year and robust pipeline.

Now, moving to development, we completed the $12 million redevelopment of our MOB on Atrium Health's University Campus in Charlotte, adding 40,000 square feet to the building. Most importantly, the first two tenants, totaling 32,000 square feet, took occupancy in early June. And in Seattle, a 151,000 square foot MOB on UW Medicine's Valley Medical Center campus is nearing completion. A lease with a 30,000 square foot surgery center is expected to commence in the fourth quarter. As current leases in both developments take occupancy over the next 4 quarters, we expect NOI from these properties to ramp to $782,000 per quarter.

Among prospective developments, we are making progress on a few projects sourced from our embedded pipeline. In Colorado, we recently conducted a design and programming meeting with the hospital for the development of a 60,000 square foot, on-campus MOB, with a budget of $19 million. The MOB will be home to the hospital's newly established, comprehensive cancer center. In Texas, we signed our second letter of intent for space in a to-be-developed, 120,000 square foot on-campus MOB, having a budget of $36 million. And in Tennessee, we are in advanced discussions with the hospital to purchase and redevelop a 110,000 square foot building, currently owned by the hospital. As part of the $26 million redevelopment, the hospital and related providers will execute leases for approximately 80% of the building.

Each of these developments is expected to yield 100 to 200 basis points above where these similar buildings would trade today as a stabilized acquisition. And as the properties come online and lease up, they represent significant FFO contribution and value creation. We expect a couple of these to start this year.

I am pleased with our accretive acquisitions so far this year, adding properties with a high propensity for sustainable long-term growth. Our team is continually building a solid pipeline of investment prospects, both development and acquisitions, that position us well for the second half of the year. Chris?

[James Douglas, EVP & CFO]

This quarter's robust internal growth was complemented by the heightened pace of year-to-date acquisition activity. These positive trends are evident in our second quarter same-store and overall financial results. Specifically, normalized FFO of $51.2 million, or $0.40 per share, increased $2.5 million over the first quarter. This increase was primarily the result of a $1.9 million sequential increase in NOI for year-to-date acquisitions. We expect these recent acquisitions to generate the same 3% plus NOI growth as our same-store assets, a level that continues to differentiate our portfolio.

The trailing 12-month same-store NOI increased 3.6% this quarter, with a 3.8% increase in the multi-tenant assets, a testament to our deliberate focus on owning high-growth properties. In our experience, investments generating the best performance are multi-tenant MOBs affiliated with top health systems in growing submarkets, and this knowledge has shaped the composition of our portfolio.

Our 3.8% multi-tenant increase was driven by 3.1% growth in revenue per occupied square foot versus 1.7% growth in operating expenses. The lower-than-historical expense growth was principally the result of a 1.5% decrease in utility expenses due to milder weather. It is worth noting that we typically experience a seasonal uptick in third quarter utility expenses by as much as $1.5 million over the second quarter. Longer term, we expect the operating expenses to increase in the 2% to 2.5% range, still providing positive operating leverage.

A major factor in our ability to optimize our portfolio and drive revenue growth over time is our emphasis on in-place contractual increases and cash leasing spreads. Currently, the weighted average annual increase for all multi-tenant same-store leases is 2.91%, which is well above what we see for most other MOB portfolios. For leases commencing in the quarter, the weighted average future annual increase is 3.2%. And notably, the weighted average cash leasing spread was 5%, which benefitted from 90% of the leases having a spread of 3% or greater. These positive drivers, along with tenant retention of 87%, signal sustainable growth in the years ahead.

Achieving these levels of internal performance is not an accident. It is the outcome of decades of experience managing, leasing, and investing in medical office buildings. As 2019 progresses, we look forward to making additional investments that complement the quality and growth potential of our existing portfolio. And with solid FAD coverage, comfortable leverage, and a wide variety of available capital options, including expected dispositions, we're well positioned to fund the growing acquisition and development pipelines Rob discussed. We see our strong internal performance, combined with the increasing acquisitions and flexible balance sheet, leading to improving FFO per share growth through the remainder of 2019 and into 2020.

[Todd Meredith, President, CEO & Director]

Thank you, Chris. Operator, we are now ready to move to the question-and-answer period.

[Operator]

[Operator Instructions]. The first question comes from Nick Joseph with Citi.

[Michael Griffin, Citi]

This is Michael Griffin on for Nick. Rob, you mentioned the strong transaction market that you've been seeing recently on the acquisition side with the cap rate. How does this change your disposition strategy going forward, selling into that strength?

[Robert Hull, EVP, Investments]

You know, I think our disposition strategy this year has been that we've got a-guidance-giving guidance of [indiscernible] $75 million to $125 million at an average cap rate between 6% and 7.25%, or 7.5%. I think over the past few years, you've seen us sell around $100 million to $125 million in assets, which has really been the refinement of the portfolio that Todd mentioned. I think that going forward, we're largely finished with that refinement, and you'll see us do more maintenance selling going forward, so that pipeline or that-those levels will probably come down to $50 million to $75 million per year.

[Michael Griffin, Citi]

Got you. And then, one thing on markets. You mentioned a number of acquisitions in the Seattle area this quarter. Are there any markets in particular that might appeal, as compared to others that you're looking at?

[Robert Hull, EVP, Investments]

You know, I think we continue to look in markets where we already have a presence. As Todd mentioned, our sort of internal sourcing process continues to benefit us in areas like Denver and Seattle, Dallas-we made an acquisition this quarter where we already have a presence. We think that those are right markets for us going forward, and we'll continue to look in those areas.

[Operator]

The next question comes from Vikram Malhotra with Morgan Stanley.

[Vikram Malhotra, Morgan Stanley]

You referenced, I guess on the margin, you're starting to see more services, some types of services being pushed to non-hospital locations, whether that's on the campus or off the campus. Just curious, sort of this trend, even though it's slowed, does this trend change your appetite for off-campus acquisitions as you look forward?

[Unidentified Company Representative]

Vikram, thanks for the question. No, I would say for us, you'll still see us probably allocating certainly more and consistently to on or adjacent to campus. But, to your point, we certainly think the off-campus locations are valid. I think for us, it's more of a deeper understanding of what is in that building, how committed is the health system to it, and then really, most importantly, how strong is that real estate that is off campus. Is it just a suburban office building with some medical tenants in it that could be difficult to re-lease someday, or is it something that really stands out on its own and we see the ability to generate strong rent spreads, contractual bumps that are more in line with our portfolio? So it's, I think just by nature of our criteria, you're going to see less off-campus; however, we're open to it. And I think, obviously, the key is paying the right price for that, and for us, that's been a little tight. That spread's been a little tight, and we'd love to see it-you know, opportunities, if we see them where it's a better spread, we will look at those. And frankly, the portfolio we have of off-campus properties is a very, very nice portfolio with a very strong, in-place growth rate and ability to push rents. So we're certainly open to it, but we still lean towards the on-campus, the safety and growth of that.

[Vikram Malhotra, Morgan Stanley]

Okay, and [indiscernible] impairment charge of real estate this quarter, can you provide a little bit more color on what that was?

[Unidentified Company Representative]

Yes, Vikram, that's a building that we've had and held for sale for a couple of years now. It was previously an LPAC that was operated by LifeCare. We are now under contract with a new buyer who's going to buy and redevelop the property as a drug and alcohol rehab facility, so we expect that to close later here in the third quarter.

[Unidentified Company Representative]

And it's been-Vikram, it's been vacant for a while, so the actual outcome of that is a positive because we've had some caring costs to it, so selling that is clearly accretive for us.

[Vikram Malhotra, Morgan Stanley]

And just curious, so it's under contract. Can you give us some sort of range on pricing or some sort of metric per foot? I know it's empty, but just to get a sense of, given the [indiscernible] that often. Just curious on pricing. Is there any color you can give?

[Unidentified Company Representative]

Yes, the price on that is a little over $3 million, $3.5 million; I can't remember the exact price. But it does reflect the significant capital that the new operator is going to invest in the building. And we considered, you know, does it make sense for us to invest that capital ourselves and re-lease the facility to them? But, given the fact that that's not where our focus is, we decided it was best to go ahead and take those proceeds and let them invest that additional capital into the facility to redevelop it.

[Vikram Malhotra, Morgan Stanley]

Okay, that makes sense. And then, just last bigger-picture question, I think yesterday or the day before, the CMS came out and sort of encouraged more hospital price transparency, and this has been in the news for a couple of months now. Just curious if you have any thoughts on what they does longer term to hospitals.

[Unidentified Company Representative]

Sure. You know, I think it's obviously early. We've all just been watching those headlines and some of the administration's comments and moves on that. I think you saw a little bit of that play out on the pharmaceutical side, where it was pushed into the advertising side, and that's already been pulled back by the courts. So I think that's a signal that this has probably got a long way to go through the legislative, and even the court system. So long term, certainly I think maybe there's a good outcome that can be beneficial broadly to helping at least provide some clarity on what we're all purchasing in the healthcare system.

I think the real difficulty is, a lot of us-most people-have some form of insurance, and they're not necessarily directly exposed to the full cost, so they don't even know what to expect when you're shopping, especially for the bigger ticket items. I mean, it's one thing for the small items. So I think there's a lot of risk for unintended consequences and a lot of confusion and a long road through the courts. So, you know, to your point, it's a big-picture question, it's long term. I think you're going to see hospitals and providers push back pretty hard here to help get more clarity around how it actually is implemented.

[Operator]

The next question comes from Chad Vanacore with Stifel.

[Chad Vanacore, Stifel, Nicolaus & Company]

You've done about $13 million in dispositions versus the $75 million to $120 million that's targeted. How should we think about the timing of those dispositions?

[Unidentified Company Representative]

Yes, I mean, I think we've-looking at the pipeline, those are obviously going to be back-ended this year. I think we started out the year saying that, that they would be-dispositions would be largely back-ended. We've got a handful of those that should close here late third quarter, early fourth, with a few more, about half of it probably closing towards the latter part of the year. So, you know, working with different sellers and timing on these dispositions can sometimes fluctuate, but right now, that's the time frame that we're looking at.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right, then thinking about the flip side of that, which would be acquisitions. In your guidance range, that would imply acquisitions and dispositions about even out, but you seem to be a little more positive on the higher end of acquisitions, so how should we think about that?

[Unidentified Company Representative]

Yes, I think just looking through the end of the year, I mean, I think those acquisitions will be spread throughout the end of the third and into the fourth quarter. So, you know, those are $75 million that I mentioned, you know, those have cap rates in the mid-5% range, so I think just timing-wise, they'll be spread through the remainder of the year pretty evenly.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right, and just thinking about financing on that side, how do we think about target leverage at end of the year and any additional equity issuance in the works, just given that the-you've upped your acquisition guidance?

[Unidentified Company Representative]

Chad, as you pointed out, and at the midpoint, we are pretty evenly distributed between acquisitions and dispositions through the remainder of the year, so not a ton of additional capital that is needed. If we are able to view a little bit to the upside on acquisitions, we do have plenty of options to be able to raise additional capital. You know, we did renew and expand our credit facility with a new seven year term loan this last quarter, so we have availability there. The ATM is obviously always an option as well, if we are seeing more volume. And then, you know, other sources of capital are always on the table as well.

[Chad Vanacore, Stifel, Nicolaus & Company]

All right, and just one more from me. Looking at first half TIs and CapEx running below the midpoint of your outlook. Should we be thinking about, you know, a $1 million to $2 million sequential pickup, or maybe something less for the full year?

[James Douglas, EVP & CFO]

You're right that, so far for the year, we are running kind of below the midpoint on our maintenance CapEx items. We do anticipate that for the full year, we still feel good about our guidance ranges and expect those to come in, depending on the category, somewhere in the middle of the ranges that we've laid out, which would indicate a little bit of a pickup here in the third and the fourth quarter. But overall, with the ranges we've outlined, it still points to solid FAD coverage in the mid-90s, which is a nice pickup compared to what we saw in 2018, when we were running closer to 100%.

[Chad Vanacore, Stifel, Nicolaus & Company]

Chris, where would most of that spend be going to?

[James Douglas, EVP & CFO]

I mean we lay it out kind of between the three different categories, and we give specific guidance on each of those in terms of the leasing commissions, as well as the second-gen TI and the building CapEx. Off of memory, I think on the low end of anything right now, it's more on the second-gen TI, but on all of these maintenance CapEx items, we say it really fluctuates quarter to quarter, just with when the actual money is spent when the bills arrive. But nothing in particular out of the ordinary on any of the three categories.

[Chad Vanacore, Stifel, Nicolaus & Company]

Okay, I was thinking more or less across the portfolio or any specific properties taking excess CapEx.

[James Douglas, EVP & CFO]

No, you know, it's pretty even with where our leasing is going on, which is pretty spread out across the portfolio. We had, I think it was 18 different markets in the second quarter that we had renewals on. I think year-to-date, we're in 24 different markets, so it's pretty spread out across the country.

[Operator]

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

[Jordan Sadler, KeyBanc Capital Markets]

I wanted to just sort of back it up a little bit, a little bit more macro. We've talked about this before, and I know you guys presented on Page 16 of your deck in terms of the overall tenant diversity. And I'm just curious, you know, to touch on this topic again of how you guys are positioning your portfolio vis-Ã -vis sort of the growth in telehealth, urgent care physicians and the like, and just the general decline in the population, maybe say millennials, who have a primary care physician these days. So you guys are I think 16% square footage overall, total, would be primary care. Can you just remind us how you're thinking about it?

[Unidentified Company Representative]

Yes, I mean, obviously, the utilization of healthcare is heavily skewed to age and increasing with age, so it wouldn't be surprising, obviously, to see that the younger aged category, or cohort, wouldn't be using as much. And then, as you point out, things change, and technology changes. As much as all these technology inventions and ideas and applications are very interesting and helpful, I think, really, it's important to remember you're not necessarily solving everything through those. They're ways to enhance the experience, the follow-up, the maintenance of things. And so, it usually still involves-again, you know, younger folks may go to the doctor one time a year, if that, especially in that cohort you're talking about, and some --

[Jordan Sadler, KeyBanc Capital Markets]

Well, I'm not really focused on sort of age and acuity of health. I'm focused on you and I have primary care physicians because that's how we were raised. I'm talking about the guys who are in our offices who are 10 years younger than us don't have primary care physicians. And I'm more thinking about how are you thinking about that as you're underwriting new deals and you're looking at your existing portfolio. I mean, I obviously get that there is an acuity of health that comes with age. I appreciate that.

[Unidentified Company Representative]

But also, remember, the setting and the episode of using urgent care relates to people who have very few incidences or emergent type issues. When you start having more regular things, you go see subspecialists. They're not sitting at the urgent care's office. If you've got an allergy issue, an ENT issue, a cardiology issue, if you have cancer, those aren't solved in the urgent care setting. Not to say that things don't evolve, but you have a coordinator of care, and that's an important part of the process is having a coordinator of care that then arranges your care with these subspecialists.

So, frankly, that's again why we look more on-campus than off. When you get off campus, you do have a little more vulnerability to that, because simply, urgent cares with new changes like you're talking about in behaviors and practices can challenge that. But when you are dealing with these more complex issues, whether it's age-related or you have it congenitally, you know, from a young age, you have a much more complicated situation that has nothing to do with urgent care.

So, I do think it matters in terms of the setting and the age or the acuity of things. And I know everybody wants to fast-forward into disruptiveness, but everybody has a tight grip on that because it's interesting to talk about. But the reality is, people are not suddenly getting less sick and less acute issues. We're actually seeing more of that, and then the aging on top of that is more, and it's a whole ecosystem. And I think for us, it's a much, much safer investment on the whole to link yourselves to those high-acuity settings. Most of our new developments that we're talking about, most of our acquisitions have complicated cancer services, they have linear accelerators, surgery centers, I would say orthopedic-more joints being done in these surgery centers that are on and off campus. Those are the kind of things we're seeing drive our usage.

And we think for the next 10, 15, 20 years, with all the aging demographics pushing that, it's not going to be as much about the millennial piece. And then, by that time, that group is changing, having children, having doctors, primary care doctors, and falling into those patterns. Yes, it may change a little, but we don't thing that is what's driving utilization.

[Operator]

Pardon me, Mr. Sadler, are you there?

[Jordan Sadler, KeyBanc Capital Markets]

Sorry about that. Yes, I was muted. So you think there's a lot of noise about sort of telehealth--

[Unidentified Company Representative]

No, no, no, I don't want to be-we're not dismissive of it. We really are not. I mean, it's a very important piece of it, and we have several board members who we talk with regularly who are health system executives, CEOs, and dealing with that. It's very real, and it's an important piece of it, but it's not a substitution, necessarily. It's a complement to what's going on. And then, obviously-I mean, one of the key things about telemedicine is, if you have these high-end specialists, there's fewer of them. It's hard to pull them to smaller communities or outlying communities, so you create that hub in your hospitals, and then they can serve a broader population set that are not in these urban settings, maybe near the academic medical center or the large community hospitals. So it's important, I think it's just we tend to be so much closer to the hub, rather than taking the risk out there that would be jeopardized by that change.

[Jordan Sadler, KeyBanc Capital Markets]

I guess, putting it in dollars and cents, do you see, or would you change your return expectations, or have different return expectations going in, i.e., pay a higher price for a higher-acuity, you know, tenancy or a specialist tenancy, versus something that had a higher mix of internal medicine or family practices?

[Unidentified Company Representative]

I think it already is embedded in the market. I think that's absolutely how the market's working. So when we're buying some properties that are in the low- to mid-5s, as Rob described the market, that generally is the case, or the developments we're pursuing, that generally is the case. And if you go to something that's much more, as you said, primary care based, out in the market, not near a hub or a dense area around a hospital, then you see a difference in cap rates. The exact spread is debatable, depending on the content within the tenancy, as well as the real estate market dynamics. But that is definitely an embedded principle, I think, in the market-for everyone, not just us.

[Jordan Sadler, KeyBanc Capital Markets]

Okay, And then just lastly, for Rob, because this is the second quarter in a row he's been able to raise guidance on the acquisitions, and now it seems like you're optimistic around the high end of the range, even, which is good. Do you see the potential to be having a similar conversation 90 days from now, Rob? I mean, is the pipeline-I heard robust. Is it that good?

[Robert Hull, EVP, Investments]

Yes, I think-yes, I mean, I think our pipeline is robust, as I described, and I think we're in a favorable cost-of-capital environment right now that is affording us the ability to make those acquisitions at an accretive level. So I think as that continues, I think that we have the opportunity to target the high end of that range.

[Unidentified Company Representative]

I think that's the caution for us, is just that obviously, a year ago we had a very different capital market environment. So there's certain things we can control and certain things we cannot, but I think what we're trying to certainly relay is that, right now, with the cost of capital where it is, the strength in that, but combined with our sourcing efforts, plus what's coming to market, we really like the pace of what we're seeing. But we do have to be careful, obviously, because things can change fairly quickly.

[Jordan Sadler, KeyBanc Capital Markets]

And just lastly, you guys, you provide the cash yields. How would I-you've done 5.5% cash yields on the 185 acquired to date. How would I think about that from a GAAP perspective?

[James Douglas, EVP & CFO]

I wouldn't have that number at my fingertips.

[Jordan Sadler, KeyBanc Capital Markets]

Do you have average escalators, maybe?

[James Douglas, EVP & CFO]

Yes, I was going to say, you can look at the average escalators of 2.91%, and I think we ended up-I can get you the exact weighted average lease term, and so you can do the math and calculate it. Our renewals were 53 months, so you can use the escalator and that WALT [ph], as well as the cash leasing spread, to come up with the GAAP yield.

[Unidentified Company Representative]

Yes, for the acquisitions, I would say we-this is a generalization, but 25 basis points is probably realistic, given what Chris just described. So we tend to obviously focus on the cash yields, but we certainly at least are aware of what the GAAP yield might be.

[Operator]

The next question comes from Rich Anderson of SMBC.

[Richard Anderson, SMBC]

So I think it was Chris that said the acquisitions are producing similar same-store NOI growth to the rest of the portfolio. Did I hear that correctly?

[James Douglas, EVP & CFO]

Yes, and the bumps are a little bit below what we have on average right now --

[Chris Douglas]

2.8 versus [indiscernible], but we think that long term, those should be able to generate the same level of growth.

[Richard Anderson, SMBC]

That's not the question. I just want to make sure I heard that right. The question is, if you're buying at a healthy pace now, what's benefitting the portfolio, except for the fact that you're getting larger? I would think that, when you acquire, you would want to be additive not only to the size of the company, but to the growth profile of the company. How would you respond to that question?

[Todd Meredith, President, CEO & Director]

Well, to Chris's point, the average escalators on the acquisitions are just barely different than the in-place. So when you look at that relative to expense controls, we think we can get very similar growth at NOI level, just starting out. Obviously, there's accretion and spread from actually buying the assets, but not just to get larger.

What we're looking for, to your point, is how to accrete to that same-store growth profile, so putting that together, our acquisitions, with the existing assets we have, we think we can combine that and accelerate. And as Rob went through, I think pretty much one-by-one on the acquisitions, each of these buildings that we're looking at are increasing our scale, leveraging our resources, leasing and management in that same market. And so, basically, you're able to then capture some incremental growth, as you are describing, that's beneficial beyond just saying, hey, we're bigger.

[Richard Anderson, SMBC]

Okay. Have you given any additional new thought to providing bottom-line FFO guidance? I know you give all these components and stuff, but you just sort of take us right to the, you know, one-inch yard line or whatever. You know, you're doing all this work, and yet it kind of exists in a little bit of an information vacuum, because you don't really see it in how it impacts your bottom-line number. It's not a hard business to estimate going forward, given its kind of consistency. I'm just curious, I know you've been asked this question probably a thousand times, but maybe the thousand-and-one time, you'll say, yes, we're going to continue to-we're going to start to do guidance. What are your thoughts on that as of today?

[Todd Meredith, President, CEO & Director]

We're not there. We understand the point. I think what was important, when we started many years ago providing all the details was that we did have some pretty wide interpretations, if you will, of our remarks and so forth, and we didn't have all those details in the guidance that we now have. And so, you've seen everybody I think become much more in line with what our own expectations are, and we've tried to communicate that and help folks walk through the business.

But I think the important thing is, by providing all those pieces, we're getting people focused, like yourself and investors, on the actual business, rather than talking about the odds of the game in the press conference. We'd rather talk about the actual plays and players on the field. And it, again, I know most people, you know, have a different view of that. But our view is we're not uncomfortable with where all the estimates are, and if we see a material issue there, I think it would raise that question further, but we're okay with what we see there.

[Richard Anderson, SMBC]

Okay, and then last question, I think Bethany went through the political environment and the ACA and all that. I know you're ramping up acquisitions, but you're doing it in front of a presidential election. I'm wondering if there's sort of an implied risk in the timing of all this, because you know, if Trump gets reelected, perhaps that's bad at the margin for the business of hospitals and healthcare and whatnot. So I'm just curious if you can comment on that and how that's working into your mindset.

[Todd Meredith, President, CEO & Director]

Well, all this, as Bethany said, is a lot of campaign theater right now. And not to belittle it, I think we have a long way to go to figure out which direction it will go and whether, as you said, one victor versus the other will drive it strongly in one direction or the other. I think as Bethany tried to suggest, usually the more moderate, incremental approach wins the day, and we think that's really more likely either direction. Especially with a divided Congress, I think it always ends up being more incremental than we all see in the headlines or the debates, and so we really expect it to be much more reasonable.

And, as Bethany said, the ACA was pretty disruptive. In hindsight, it didn't have a huge impact, necessarily, because what it really is about is health insurance and how you pay for it. It doesn't change actual need for care, especially those critical services, those acute services, which we're focused on. It obviously presents some interesting things, and we have to navigate that. But I think in general, the trends are strong, and it will be okay either way.

[Operator]

The next question comes from Michael Mueller of JPMorgan.

[Michael Mueller, JPMorgan Chase & Co.]

On the three upcoming potential developments you mentioned, I think you said the Tennessee one was going to have-it was going to be partially leased by the system. Were the Colorado and Texas developments, were they going to be fully leased?

[Todd Meredith, President, CEO & Director]

They will-at the outset, they will not be fully leased. There will certainly be a large hospital component to it. They will be well leased, probably in that 50% to 60% range, out of the cage.

[Michael Mueller, JPMorgan Chase & Co.]

Okay, and then is that similar for the Tennessee redevelopment?

[Todd Meredith, President, CEO & Director]

Yes, the Tennessee redevelopment will actually be probably up in the 80% leased range.

[Unidentified Company Representative]

But it's also a hospital and then a joint venture with a physician group that comprise much of that 80%.

[Michael Mueller, JPMorgan Chase & Co.]

Got it. And if we're thinking about development, say development starts over the next 3 to 5 years, I mean, does it seem like this is a pretty good template to think of, where you have-it's not 100% build to suit, not pure spec, but you know, something with a heavy pre-leasing component?

[Unidentified Company Representative]

Yes, I think if you-I mean, I think if you look at our-the four that I laid out, they're primarily coming from our embedded pipeline, so locations where we have control of the site, where we are in good dialogue with the hospital, aware of what's going on the campus and what their evolving needs are. So, yes, I think going forward over the next 3 to 5 years, you can see this type of development being more what we do.

[Operator]

The next question comes from Todd Stender with Wells Fargo.

[Todd Stender, Wells Fargo Securities]

Just looking kind of at the front page of your press release, when you're looking at the average cash leasing spreads of 5%, you've got a breakdown of the percentages of where those were. To get to 5%, does that suggest that that 4%-plus were on larger renewals? How did you get to the 5%?

[Todd Meredith, President, CEO & Director]

No, it's pretty spread across all the leases, and so that's really on the percentage of square feet. So we had 37% of our square feet, and it was not a big concentration in any one particular lease or even any one particular market. We had, I think it was 16 of our 18 markets this quarter had cash leasing spreads of 3% or greater, so it was pretty wide and deep. The largest market that we had renewals this year was in D.C., which I think made up a little over 25% of the renewals for the quarter. It averaged about 6.5%, but it was not the highest market in terms of cash leasing spread. So, as I mentioned, pretty wide and deep, and that's been consistent with what we've seen for the year and even looking back into 2018.

But long term, we still look at the majority of the leases are coming in in that 3% to 4% range like it did this quarter, with 53% of them in that range, and so that's where we think the long-term expectation for cash leasing spread should be.

[Todd Stender, Wells Fargo Securities]

Would you characterize these leases to be, or have-they were, I guess, below market, or really, you have some pretty good pricing power here. How do you characterize I guess maybe what happened in the quarter and what you're expecting for the rest of '19?

[Todd Meredith, President, CEO & Director]

I would definitely say it's more the latter, the pricing power. Because our average lease term, and you see it on our leasing commitments each quarter, they run, as Chris said I think this quarter 53 months, so call it 4.5, 5 years. We're not getting materially out of line with market, necessarily. There are those opportunities here and there, and we've benefitted sometimes from that, but I would say generally speaking, it's an ability to just continue the momentum that you have because of the pricing power, or the competitive alternatives, they aren't as plentiful, and so you just have that ability to push. And, clearly, what we're always looking at is, what is the potential competition? What's replacement cost? How are we, relative to that? And we see plenty of room there across many of the markets, as Chris described.

[Todd Stender, Wells Fargo Securities]

That's helpful; thanks, Todd. And then, when you're looking at-I guess one of the acquisitions in the quarter, the Seattle one, the cap rate was pretty high on the 30,000 square foot property. It's 100% leased. Is the lease coming due soon? I mean, it's still triple-or, actually, double-A rated. What contributed to that pretty high yield?

[Todd Meredith, President, CEO & Director]

Yes, that was a property that was internally sourced and directly negotiated with the seller by our guys here, a good opportunity for us. It was a little unique. The primary lease in the building with MultiCare, the hospital system, which was largely-the largest tenant in the building, had a termination option in it that was a few years out. And we, with our relationship with MultiCare, we were able to go to them and eliminate that termination option, and they actually extended the terms. So we created some value there--

[Unidentified Company Representative]

Ten years, so that extended it.

[Todd Meredith, President, CEO & Director]

Yes, they extended the term for 10 years, and so we created some value there. You know, I think that was a benefit of us having two buildings on the adjacent campus. You know, we've been on that campus for over 10 years. Both of the buildings are well leased. We've worked with them, you know, well during that timeframe, so I think that really benefitted us there.

[Operator]

The next question comes from Daniel Bernstein from Capital One.

[Daniel Bernstein, Capital One Securities]

So I've noticed your retention rate, and I know it jumps around. It can jump around a lot quarter to quarter, even year to year. But you go back two years ago, it was in the low 80s, sometimes in the 70s, and the last two quarters it's in the mid-upper 80s. Are you doing something different to retain tenants? Are the hospitals, the tenants, thinking differently about moving to other locations? Just trying to understand the trends there, and do you see that kind of high retention rate continuing? You know, it has relevance to the TI and CapEx, so just trying to get your thoughts there.

[Unidentified Company Representative]

Yes, good question, and we're not seeing a material change in terms of discussions with the hospitals. I think you may see a little bit of the improvement go to the mix in terms of our assets. Back to the point that Todd made of some of the refinement that we've been making over the years in terms of the mix of our assets, that the markets, as well as the location on and off campus, may be benefitting us some. You know, we still give guidance of 75% to 90%, but as you point out, we've been running more at the mid to the upper end of that. We don't see that changing, but obviously, in any particular quarter, it can fluctuate within that range.

But it certainly does help, as you pointed out, on the capital side, because if you're able to retain tenants, the capital or the TI associated with that is substantially-it could be half of what-

[Unidentified Company Representative]

Easily half of what you experience, looking to have to backfill that space.

[Daniel Bernstein, Capital One Securities]

All right, and [indiscernible] quarter saying CapEx is going to be better than you forecast. But if retention rates continue to stay high, then that would be a possibility, right?

[Unidentified Company Representative]

Yes it certainly does help. As I pointed out earlier, we still feel comfortable with the ranges that we've given on all of our CapEx, including the second-gen TI, which takes into account the broader range on retention.

[Daniel Bernstein, Capital One Securities]

Okay. And then kind of also another kind of broad-company question. You seem to be sourcing a good number of transactions, both on the acquisition side and the investment side. Is there something you've changed in the last couple of years, or even more recently, in terms of trying to build relationships with the hospital systems, something strategically that you're doing different in terms of your sourcing? Just trying to understand the long-term sustainability of maybe getting a higher acquisition or investment level than what you had in the last several years.

[Unidentified Company Representative]

Sure, as I think Rod touched on and I did as well, Dan, I think it's come together in terms of that internal sourcing process that we've been working on for years. It's not new. I think we're just seeing the dividends pay off in terms of ability to source those. But, obviously, it helps to have a more constructive capital markets environment and a very effective cost of capital. So it definitely takes, you know, things we can control, but also some things we can't, but we have to be positioned to take advantage of. So that's, really, I think the confluence that has helped us. We obviously want to take advantage of that while we can.

And, it's interesting; we've looked back, to your point about new versus-new trends, I would say we've actually probably been a little bit careful about talking about our ability to do this sourcing too much, because you just don't have full control of the markets in terms of what comes to market, the cost of capital. But looking back even 10 years, we've been pretty consistently able to source acquisitions that are not just being marketed heavily, whether that's very little marketing to a few, handful of buyers and we're in that small circle, or it's truly things as Rob described this one in Tacoma, where we have our connections and worked with some sellers locally. So we're seeing a consistent ability to add that value on top of just what's in the market, and we're encouraged by what we're seeing in the landscape with sellers, the capital market environment, the interest rate environment. So it's, to us, it feels fairly sustainable, but we always have to match fund and carefully watch the capital markets.

[Daniel Bernstein, Capital One Securities]

Okay. I think what I was trying to get to was, is there something that you've done differently the last couple of years, 3, 5 years, than you did the 5 years prior, that may be-in the right market environment, something strategically that you've done different?

[Unidentified Company Representative]

I would say we certainly put-we've seen the success of it from years prior, and we've been just adding resources towards that effort. So, as Rob described Seattle, we're getting more and more out of that effort in Seattle, or a Denver, or a Dallas, and some other markets that we're looking at, and even some new markets. I think it's just steadily improving that process, refining it, getting more people embedded; coordination, as Rob described, between our leasing, property management, as well as our investments team. And it's just, frankly, gelling better, and I think we're applying more to it, and the markets are more conducive to that, so it's certainly helping pick up the pace, and we're encouraged by the accretion that can come from that, and then also the acceleration of internal growth that can come out of that as well.

[Operator]

[Operator Instructions]. This concludes our question-and-answer session. I would now like to turn the call back to Todd Meredith for any closing remarks.

[Todd Meredith, President, CEO & Director]

Thank you, everybody, for listening this morning, and we will be around for follow-up if anybody has additional questions. We hope everybody has a great day. Thank you.

[Operator]

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