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Healthcare Realty Trust Inc
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Good day, and welcome to the Healthcare Realty Trust Third Quarter Financial Results Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this call is being recorded,
I would now like to turn the conference over to Mr. Todd Meredith, CEO. Please go ahead.
Thank you, Lexi. Joining me on the call today are Carla Baca, Bethany Mancini, Rob Hull and Kris Douglas.
First, I'd like to make a few comments about David Emery, our Founder who passed away on September 30th. This last week my colleagues and I enjoyed a wonderful celebration of David's life with his family and friends. David was truly a visionary a force of nature inspired everyone around him with this intellectual curiosity, his intuition, and his infectious charm and perpetual optimism. David had a remarkable degree of confidence and his abilities yet he was acutely wary of hubris. He was a wise men to work always leading by example. David was a renaissance man pursuing many interests, personal and professional with great success and style. And he shared his achievements generously with family, friends and colleagues. We will miss him dearly above all for his genuine and loyal friendship. David was a wonderful human being who loved helping others succeed.
When it comes to the Healthcare REIT sector David was a true pioneer. He had the vision to start the first MOB focus REIT in the early 1990s. Today, we have a great company built on a strong foundation. Thanks to David's vision and leadership. The Board appropriately bestowed upon David the title of Chairman Emeritus. His contribution to the sector and to Healthcare Realty will not be forgotten. Over the past few years, David did a masterful job transitioning leadership of Healthcare Realty and he was especially pleased with where the company is headed today.
Now for the quarterly results, Carla if you go ahead with the disclaimer please?
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 our Form 10-K filed with the SEC for the year ended December 31st 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. Reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30th 2019. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.
Thank you, Carla. I'll begin by touching on three key topics for the quarter, first the strength of Healthcare Realty's operations; second, our increasing acquisition volume in our ability to source new investments; third, and most importantly, how we see organic and external growth translating to FFO on a per share basis.
In the third quarter, Healthcare Realty generated steady performance on strong operating results across the portfolio. Our largest driver in place contractual rent increases edged higher. This was boosted by renewals in the quarter, which had bumps above 3%. Our ability to generate healthy cash leasing spreads continues to correlate with high tenant retention, a testament to the demand for our prime locations where price is not the primary determinant of value.
Expense growth is also well contained. Expanding margins and translating to same-store NOI growth above 3%. We see stability in the portfolios internal growth in the years ahead, given the fundamental strength of our property locations, their alignment with leading health systems, and their critical role in current healthcare delivery trends. We're also bolstering the strength of our internal growth profile with selective acquisitions.
Year-to-date, we've acquired 14 MOBs for more than $300 million elevating our 2019 acquisition volume well above our historical pace. What differentiates us is the way we pursue investments. We like to avoid bidding wars and paying premiums for widely marketed offerings. So far this year, we've directly sourced two-thirds of our acquisitions through relationships with owners and brokers. And what is really impressive, we've seen this exceed 75% where we've gained scale in key markets over time such as Seattle.
Our knowledge of targeted markets and deep network of relationships allows us to buy more of what we want rather than bidding on what is for sales. With the success of our sourcing efforts we expect to sustain a healthy pace of acquisitions going forward. We increased our acquisition guidance the second time for 2019 and we see a strong pipeline looking ahead to next year. We also improved our growth profile by selectively disposing of properties while dispositions can be counterproductive initially, a disciplined amount of pruning is necessary to maintain a high performance portfolio over the long run.
Fortunately, looking into 2020, the costly rotation out of non-MOBs in smaller markets will be largely behind us. We have moderated our disposition guidance for 2019 and looking ahead, we expect a slower pace of dispositions at better cap rates. Much like acquisitions, our pace of development is also building momentum. This quarter, we began a redevelopment in Memphis, which includes the acquisition and redevelopment of an existing MOB.
Baptist Memorial, a market-leading health system with whom we've enjoyed a long-standing working relationship called us when they needed a reliable partner to develop a strategic outpost for surgery and outpatient services. We expect a couple of developments and redevelopments to emerge from our embedded pipeline in the coming quarters.
The company has accelerated investment pace fewer dispositions and steady organic performance is generating FFO growth per share in the second half of 2019. We expect more improvement in FFO per share in 2020 and matched with disciplined capital spending, we see incremental progress on dividend coverage as well.
Relative to other property types in the healthcare sector, outpatient real estate continues to offer a compelling combination of steady returns and low risk. We remain steadfast in our commitment to owning and operating quality medical office buildings and using our experience in refined strategy to deliver steady growth in FFO per share and create long-term value for shareholders.
Now, I'll turn it over to Ms. Mancini for a closer look at Healthcare trends. Bethany?
Thank you. The 2020 Presidential election and the race for the Democratic nomination continue to dominate the headlines. And once again have brought health insurance policy to the forefront of politics. The array of Democratic candidates covers a wide range of platform calling for various forms of increased government funding of health insurance whether to current policies under the ACA, a public option volume or Medicare for all.
While polling suggests voters are attracted to such ideas, support of Medicare for all dropped significantly when faced with the high cost and the need for greater taxation and elimination of private plans to fund single-payer public health insurance. Political rhetoric of the day however does not signal a change in the direction of rising healthcare demand, clinical delivery trends or relatively stable reimbursement rate. In addition, the overall course of health policy legislation in Congress is not expected to change in the near-term with a divided House and Senate.
Current legislative efforts are centered on lowering the cost to consumers of pharmaceuticals and surprised out of network billings along with funding hospital payments for uninsured patients. Even with some bipartisanship on these issues strong lobbying by drug companies and hospitals and ongoing political debate will likely keep any new health policy at bay until after the Presidential election and a new Congress convenes in 2021.
We do expect a decision in the court soon on the outcome of the Texas Vs our case. And the standing of the lower-court ruling last December, which declared the ACA unconstitutional. It is likely the Fifth Circuit Judges will issue a stay in the case keeping the law in place until an eventual Supreme Court hearing possibly not until 2020 or beyond.
Several states are working on their own legislation to provide health subsidies and public insurance options, but are contending with the high cost of such plan. These efforts span multiple layers and branches of government and are evidence of the politically sensitive nature of Healthcare and the value the nation places on supporting access to quality medical care. The population is aging and demand for healthcare services continues to expand thus the difficulty in curbing the growth of healthcare spending is acute and the need for lower cost of care essential.
Outpatient services are becoming increasingly critical to meeting the nation's demand for quality healthcare at a lower cost. And the push toward delivering outpatient care and its most efficient setting is being accelerated on multiple fronts most recently by commercial insurers as well as providers.
As of November 1, United Healthcare is shifting more of its medical spending to outpatient facilities and will no longer cover certain planned outpatient surgeries delivered in hospitals unless predetermined to be medically necessary in most dates. Instead, the insurer will require outpatient surgery to be done in medical office and ambulatory facility.
In Health Systems, to increase leverage with insurers and capture market share, we'll continue to align with physician groups to offer services across the continuum of care in the most efficient and profitable setting. We expect Healthcare Realty's medical office facilities and tenants and our relationships with Health Systems will continue to benefit from these primary drivers and deeply embedded macro trends that will ensure the growth in outpatient facilities for years to come.
Now I will turn it over to Rob Hull. Rob?
Thank you Bethany. Now I'm going to give you an update on investment activity and our outlook for the balance of the year. Acquisition volumes so far this year of $316 million is at the high-end of Healthcare Realty's historical levels. We have experienced notable success in our ability to source higher volume to one and two building transactions. We have been expanding and developing our investments team and related processes to execute on this growing number of opportunities. Combined with a competitive cost of capital these efforts have secured 14 properties through 12 separate transactions this year.
During the third quarter, we acquired four buildings totaling 175,000 square feet for $79 million. In Los Angeles, we purchased two MOBs for $61 million. The buildings are located next to Huntington Hospital, a 625 bed facility in Pasadena. These properties are well-positioned for strong NOI growth.
What really sets these buildings apart is a diverse roster of specialists such as cardiology and women's health who value the proximity to the hospital in this densely populated area.
In Houston, we acquired an on-campus MOB located in the fast growing Sugarland submarket for $14 million. This acquisition expands our portfolio in the fifth largest market in the country to over 620,000 square feet. It also adds a third high-quality relationship in the market with Houston Methodist's.
In Oklahoma City, we purchased an MOB adjacent to a leading health system campus and immediately next to a building we purchased last year where we recently increased our occupancy to nearly 100%. The new building is currently 76% occupied and produces a 6.3% cap rate. We expect the yield to increase in the high sixes by boosting the occupancy to around 90%.
Already in the fourth quarter, we are off to a strong acquisition pace. We bought two additional properties in October. In Raleigh, we made our first investment in the market, a 57,000 square foot MOB for $22 million. The building is in a rapidly growing area and is adjacent to market leading WakeMed's, North Hospital.
Also in the fourth quarter, we purchased a property in Dallas adjacent to Baylor Scott & White's Plano Hospital for $20 million. This building is anchored by a Baylor USPI surgery center.
Leveraging our relationship with the hospital, we also executed a lease with the Baylor outpatient rehab joint venture. This lease was signed at closing and we expect to build-out the suite to begin soon.
The property expands our presence on the campus where we already own a 174,000 square foot MOB we developed in 2004. With year-to-date acquisitions totaling $316 million and a robust pipeline, we are moving up acquisition guidance for the year to $350 million to $400 million.
Moving to development. We placed one project in the pre-construction this quarter and have one or two starts expected in the coming quarters. In Memphis, we commenced pre-construction activity for the redevelopment of 111,000 square foot MOB. Baptist Memorial looking to secure a leading orthopedic practice as a joint venture partner and a surgery center needed a developer that can move quickly.
What is important here is that the hospital reached out to us given our long-standing relationship and development experience. The redevelopment has a total budget of $28 million with an expected stabilized yield of 7.6% including the $9 million acquisition with the existing MOB from the health system.
We will have lease commitments, representing 81% of the building including the surgery center, orthopedic group and several hospital practices. Occupancy is now 37%. The balance of the remaining leases are expected to take possession early in the first quarter 2021.
We also continue to make steady progress on additional future development projects in Washington, Colorado, Texas and Tennessee sourced from our embedded pipeline and existing health system relationships. Each development we are pursuing is expected to yield 6% to 7.5% at stabilization, representing significant FFO contribution and value creation.
Looking at dispositions. We have closed on $29 million in sales so far this year. We are reducing disposition guidance to $50 million to $75 million at cap rates from 6.5% to 8%. The reduction is due to a few MOB dispositions originally targeted for sale in 2019 shifting into our plans for next year.
Going forward, we expect disposition volume will remain at this lower range, consisting primarily of MOBs, which will produce more favorable sales cap rates. Most recently, we sold three buildings for a total of $16 million, including an inpatient rehab facility for $14 million. I am pleased with the pickup in net investment volume for the year and the bright outlook for 2020.
Now, I will turn it over to Kris to discuss financial and operational performance for the quarter.
Thanks, Rob. The third quarter showcases the same positive themes as the first half of the year, including a healthy acquisition pace and sustained internal growth. This translated year-over-year to a 3.2% increase and FFO per share to $0.40. Sequentially, FFO increased $500,000 over the second quarter. This was primarily as a result of a $1 million increase in NOI from net investment activity.
The higher NOI was partially offset by $500,000 increase in costs, mainly related to interest expense. As is typical in the third quarter seasonal utilities were up $1.4 million sequentially over the second quarter. However this expense increase was completely offset by rental rate escalations and operating expense reimbursements.
In the fourth quarter, we typically experience a $600,000 to $800,000 increase in sequential NOI due primarily to the reversal of the third quarter seasonal utilities. For the trailing 12 months same-store NOI increased 3.3%, driven by 3.6% increase in NOI from the multi-tenant properties and a 1.8% increase from single-tenant. The performance of our multi-tenant properties continues to be reliably strong.
Revenue per average occupied square foot increased 3%, while expenses were up just 1.8%, largely due to a 3% decrease in utilities. This reduction came from a combination of the mild winter we discussed earlier this year as well as energy management investments.
Our ongoing ability to drive multi-tenant revenue growth is due in no small part to our persistent efforts to maximize in-place contractual increases and cash leasing spreads. In the third quarter, future contractual increases for the leases executed in the quarter were once again strong at 3.06%, while cash leasing spreads average 3.3% highlighting our pricing power, especially with the out-sized volume of renewals and 90% tenant retention this quarter. Not to be overlooked, average in-place contractual rent increases have improved 13 basis points over the last eight quarters, up to 2.93%.
Achieving this in just two years is noteworthy and has compounding power when applied over our 12 million square foot same-store portfolio. It represents not only the value of our leasing team's concerted efforts but also the benefits of owning quality high demand properties.
Turning to the single-tenant portion of our same-store portfolio the 1.8% growth in NOI was as expected with nearly 30% of our rent escalators being non-annual, quarterly NOI growth will fluctuate around the in-place average of 2.12% depending on the timing of the non-annual increases. The next non-annual increase which happens to be the largest at over 20% of single-tenant base rent is scheduled to occur in October 2020. Until that time, single-tenant NOI growth will run below the in-place average.
At the single-tenant property level we sold an inpatient rehab facility in Erie Pennsylvania as Rob mentioned. This leaves us with one remaining earth on a 400-bed Tenet Hospital campus in Los Angeles, where we also own five medical office buildings. We just completed a five-year renewal for this inpatient rehab facility at a 7.6% cash rent increase with no TI. The FAB payout ratio was 91% for the third quarter and year-to-date, as capital expenditures and second generation TI have been running at the low end of expectations.
We expect maintenance CapEx will be higher in the fourth quarter and the full-year 2019 FAB payout ratio to be at or below 95%. This is a reduction of approximately five percentage points of our full year 2018 and we expect additional improvement in 2020. Our balance sheet is healthy with debt-to-EBITDA of 5.2 times at quarter-end. We raised $72 million of equity during the quarter through the ATM, which was used to fund the $79 million of acquisitions in the quarter.
Since the end of the quarter, we've issued an additional $78 million of equity to fund a growing pipeline of accretive investments, including two properties acquired in late October for $42 million. As we approach the end of the year performance and momentum across the portfolio are strong, driven by internal growth, a solid balance sheet and a rich pipeline of pre-funded investments. We expect FFO per share growth we saw in the third quarter to continue in the fourth quarter and 2020.
Operator, we're now ready to open the line for questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Chad Vanacore with Stifel. Please go ahead.
Hey, good morning all.
Good morning.
All right. So you've stepped up acquisition guidance then reduce dispositions. Has there anything change in the competitive landscape for acquisitions that you see either asking prices or competition from alternative buyers?
No. Chad, I mean I think what you're seeing from our team is -- and it goes back to sourcing process that we've discussed on the last call and discuss today. I mean, you're seeing the benefits of those going into a market and identifying properties that we want to own. And then our team forming relationships with those building owners, brokers and other groups in that marketplace that are giving us the opportunity to buy these buildings that are not necessarily being market. And so in many cases, you're not competing with a broad group of folks. And so it's allowing us to bring some nice assets into the portfolio.
I think in terms of pricing I think pricing -- we're continuing to see stable pricing. I think there has been some deals out there that have dipped below 5% here recently and I think those were deals that were more marketed deals. And so I think we're looking at is still in that range of around 5.5%. So we expect that to see that continue.
All right. And then just on the flip side, your dispositions you will get pushed off into 2020. Is there anything going on there that is delaying your sale of those properties or do you just feel more comfortable keeping them a little bit longer?
No, it's really just timing -- sort of specific to those sales. I mean there's nothing in particular that's causing us to hang on to them longer, but just take a little longer to close the transaction. We do expect those to be part of our disposition plan for next year $50 million to $75 million. And those are largely MOBs that are in that lower cap rate range of 5.5% to 6.5%.
All right. And then just to bring this full circle. Can you describe any of the key differences between what you're buying today and then what you're selling?
I think that what we're buying today is in good growing markets aligned with leading Health Systems in those markets multi-tenanted on-campus billings or adjacent to campuses. In contrast to what we're selling, typically those are in smaller markets, perhaps their markets are not growing and we don't see the growth potential in those markets that we do in some of these other markets. So it's largely really assets that don't fit the strategic long-term plan of the organization versus those assets we're buying or have a higher propensity for growth and really fit our long-term goals.
All right. I'll leave it there. Thanks.
Thank you. Your next question comes from Nick Joseph with Citi. Please go ahead.
Thanks. So I wonder, if you can walk through the sales process for the -- sold in the third quarter, obviously the cap rate was probably a little higher than expected. So any color there?
Yeah that process was a purchase option fair market value purchase option that was driven by an appraisal process. And it was -- so it was different than what you typically see when you have appraisal processes in those types of agreements. This one took the average three appraisals one submitted by the buyer, one submitted by the seller and then a third averaging. Oftentimes, you'll see the appraisal that's furnaced away from the other two be thrown out and the other two be average. In this case, all three were averaged that was the way it was written into the agreement. And that incentive the buyer to submit a low valuation in this case valuation zero which was on the verge of absurd. And there was also -- there is some utilities that serve the building that were provided by third-party that detracted from the value in the appraisal process as well.
Thanks. How many other assets have similar fair market purchase options in the portfolio?
We don't have any that are similar to that process.
So that is just a one-off?
Yes.
Thank you.
Thanks, Nick.
Thank you. Your next question comes from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.
Thank you. Good morning. First, I just wanted to offer sincerest condolences on the passing of David to the team. And then in terms of my question, what's causing sort of the continued increase in the activity -- in the acquisition activity year-to-date to sort of third consecutive bump up? I've noticed a little bit of a mix in the shift away from on-campus.
I don't know from overly reading into the 100 basis points uptick in the asset ownership mix here, year-to-date, any insight would be appreciated?
Well, Jordan thanks first for your comments. And thanks for your nice comments and your note as well. We saw that, appreciate it. I would say for us it really goes to the volume question, it goes to the sourcing process. And that's a multi-year effort.
As Rob said, we've been expanding our investment team with some young professionals. They've been getting their legs under them helping out our senior folks really attack these markets in a proactive way, as Rob described. So I think, we're just seeing the fruits of that, number one.
But to your question about, distance from campus. I think, there you have a little bit of a unique situation where, earlier I guess last quarter, we bought a couple of properties that were just beyond our own definition of adjacent to campus.
I think, they were 0.27 …
0.27 and 0.3 maybe…
… 0.3 miles from campus. So when you get into Seattle or dense market like that sometimes there are certainly some attractive properties that may be just outside that definition, so pretty subtle difference there, no big change in strategy.
We certainly are open to assets that are away from campus more materially away. But as you know we have a history of being careful around that. So, it's not that we won't invest occasionally in some off-campus assets that that really aligned with Health Systems. And we think are really have strong real estate characteristics.
We just want to tilt toward campus on/or adjacent. So, no material change but certainly a willingness to look at assets that make sense even if they're a little outside the range.
So, fair to sort of characterize it is a little bit of a greater opening in terms of, getting a little bit of a wider net to certain properties? Or is that, overstating it even?
It's probably overstating a little. I will say in a market like Seattle, where we have such a strong presence. And we know that market really well. We have a lot of folks locally on the ground operating there, including one of our leaders, of our leasing team about half the country that, she leads and has been with us for 20 years.
And so we just have a lot of resources there that know that market well. It's clearly a dense market. So, you might see it in situations like that. Los Angeles might be another market where we've had scale and would see something like that. But it's probably not too much to read into that.
Okay. And then, on the same-store NOI trajectory. I know you guys look at it on trailing 12, it's sort of a better indicator. But I'm trying to look at this quarter to see, if there is anything to perceive in terms of what's going to happen going forward.
I noticed, sort of the, year-over-year de-sale -- in multi-tenant. But also as you called out the single-tenant side, as we look forward, will this sort of lowered rate be more of a steady state or should it bump back up? And what would be the drivers?
Yeah. Good question. Kind of two pieces to that, I'll break it into the single-tenant and the multi-tenant. On the single-tenant, as I mentioned in my prepared remarks, we have seen the timing of our non-annual escalators is running through. And so we have over 25% almost 30% of our properties.
They've not had an increase in the last 24 months. And so that's -- it's not because they don't have them it's just because of the timing of them. And so we did see the lower growth as a result of that this quarter. And that will continue until the next non-annual escalator occurs in October of 2020. So you should expect to see that in the single-tenant.
On the multi-tenant, as you mentioned, we do believe the trailing 12-month it's a better signal, as that the performance of the business. And that was 3.3% this quarter. Quarterly results can have a lot of noise due to fluctuations and individual line items which are actually what did occur this quarter.
We had an unfavorable comparison to third quarter 2018 due to $600,000 of expense reimbursement true-ups in that period. So excluding that $600,000 revenue per average occupied square foot as well as total revenue, would have been greater than 3%, which is more in line with our expectations.
So moving forward on a trailing 12-month basis, we still expect multi-tenant NOI growth to be that, plus or minus 3%. But as pointed out, there will be fluctuations quarter-to-quarter all the time.
Okay. And then, I guess within that same sort of framework just expenses, anything you're seeing on the expense front as you look forward. Kris, that's sort of, would knock you off sort of this low 1.8% trajectory you've seen, over the last 12 months?
Yeah. We have been benefiting from the expenses as we've talked about this year that, are running below our historical average. We say, long-term we expect it to be more in that 2% to 2.5% range. Right now, we're running about 1.8% and a lot of that has to do with utilities that are running negative 3%, which is great. When you can get it part of that was due to the milder winter that we had in the first quarter, which really resulted in on a quarter-over-quarter basis, basically flat, overall expense growth.
So we're not going to predict and project what the weather is going to be for the next year but we are certainly benefiting from that. We are continuing to see pressure on property taxes but I would say that's -- there's nothing different there from what we see historically, especially as you're buying additional assets, you're developing assets that a lot of times there will be a catch-up in the assessed value.
So property taxes run well above the average four plus percent but with some cost controls and other places we do feel like long-term we can continue to control expenses in that 2% to 2.5% range.
Great. Thank you.
Thank you. Your next question comes from John Kim with BMO Capital Markets. Please go ahead.
Thank you. Good morning. On the acquisitions that you acquired during the quarter which were -- I think primarily adjacent. Can you comment on the pricing differential you're seeing right now between adjacent and on-campus acquisition. And is it fair to assume that on these acquisitions you acquired to feasible interest with no purchase option?
Yeah. John, I think when it comes to your question about on versus adjacent really not seeing much difference in pricing there if any. I mean, you know, that's our definition of adjacent is -- within a quarter-mile. And so that's -- in most cases across the street from the hospital. So just not seeing a lot of price difference there.
And then in terms of fee simple versus ground lease I think it's a mix -- everyone this quarter was fee – sorry, everyone this quarter was fee. So we didn't have any that we bought on ground leases.
Yeah the one that was in October in Dallas that is a ground lease but it was -- it's not with the hospital, it's a dense area and the developer who put it together ended up ground leasing the land from someone who is owned it for some time.
It's just economic and there is no purchase options.
Got it. Okay. And then Todd you mentioned a strong pipeline of acquisitions for next year. Anyway you can quantify that at all on how that relates to the $350 million to $400 million that you plan for this year?
Sure. It's clearly early to really call out what the range would be for 2020 but as Rob suggested and I did as well, we certainly see a strong momentum building going into 2020 and will clearly have more color on that as we get to the next quarterly report.
But all that to say, we certainly see an ability to continue at this level that you're seeing now. It's subject to a number of things as you can imagine. I mean, one of the things we just talked about was the sourcing efforts and that is clearly different than just bidding on what's for sale. We like that. It does give us a little more predictability. But it's also a lot more lead-time and work to generate that pipeline.
So because of the back work we've done on that again, some of these deals we bought this this past quarter and even into the fourth quarter are the result of years of digging, digging in a market with a broker with building owners. So it takes a while but we're encouraged by what we see and we think this level whether it's that exact level of this year but something on this order of magnitude is certainly something we see being able to move toward in 2020.
Okay. And then I had a couple of questions on your Memphis redevelopments. It looks like the asset will be 37% occupied during the redevelopment phase. Can you provide some color on what work is being done on this project? And also...
Yeah. So that -- sorry go ahead.
I can say the 7.6% stabilized yield what occupancy does that assume?
Yeah. So just I'll answer both of those questions. First on the 7.6% that is a stabilized occupancy in the low '90s not in the low 90% range. As far as what's being done, the building is currently -- it currently exists today. There is a surgery center inside of the building.
We are redeveloping the building in the sense that most of the areas inside of the building will be touched. Tenants -- some existing tenants will be moving around. The surgery center will be expanded. There will be some additional parking added to it. The hospital has some existing uses there now but they will be bringing some additional users. So it's really a comprehensive redevelopment of the asset even though the asset is in place today.
The 37% occupancy represents tenants that are there today and will remain in place until such time as we to move them inside of the building or the new lease takes effect have to the redevelopment of the property.
How big do you think that your redevelopment program can be? It seems like there's a lot of on-campus older vintage MOBs out there?
Sure. I mean there's certainly opportunity out there. We're finding I think that working with these Health Systems and we've done a number of redevelopments over the past few years. I think if you go into our embedded pipeline, we do think that there is some opportunity there. And expect to see one or two of those every year that we're working on. Those come from having relationships with the hospital. They often times get into a situation where they need to manage move quickly. They worked with you before. They know that you can produce. And often times you have to call like we did here. So, I think there's some good opportunity there.
Great, thank you.
Thank you. Your next question comes from Rich Anderson with SMBC. Please go ahead.
Thanks. Good morning. And I'd like to also say condolences to David. He made me a better Analyst, better person, very genuine approach to people whoever you interfaced with. And the height of his role as Chief Executive Officer, he was always want to show me respect whether there was agreement or disagreement or maybe he's blowing smoke up, but at least I felt that right. And I do get a chance to email him before he passed. I'm going to assume that he did read it and my condolences to everybody on the call.
Thank you, Rich.
Now -- and one good thing is my vocabulary has improved, so I'll never say that we're just be regardless orientated, and I'll have conversations, but I will not conversate.
Very good.
All right. So now, rigidly move on to the business I talking about medical office, which is kind of feels wrong, but you got to do it, and got to move on. So, are you seeing more in the way of PE investing in your space? Do you -- capital flowing, a lot of the elephant hunting is now gone as everyone suggesting. Is there different types of capital flowing into the space that you see?
There is not -- I mean it's not palpable in terms of the short-term. I do think if you look back over a multi-year period, certainly that's true. And you're seeing more private equity develop funds, whether it's private non-traded REITs under a new model. But you've seen a number of very credible large private equity groups develop an MOB program. They might partner with different smaller operators, developers, investors, and you've been seeing that for a while.
So it's really not new, but you're right I think the pace of that is very high. And some of them are doing quite a nice job of really tackling the one and two building approach. So, it's not without competition. And certainly, I would say, as we described our sourcing process, we're not trying to suggest there is no competition.
There is always competition even when you're talking with an owner about doing a deal outside of a market process. They're aware and they're savvy and they often will have -- you did themselves are brokers that can do market checks. So, there's plenty of that, but I think it's again just developing deeper relationships and getting access to the deals that we see in the markets we want to be in.
Really, I don't see the level of competition any more heightened than it's been in a long time, it's just different players. And the public markets will tend to move a bit more -- move around a bit more and have different cost of capital in shorter time periods, but we've seen continued rising pressure with private equity over some time, and I wouldn't say it has risen in the last year, so anymore than what we've seen in the last three years or four years.
Okay. The underlying business as described on this call and medical office generally is good. I mean it's getting and perhaps getting better. And so, I don't know that there is much in the way of kind of criticism of what you guys are doing. Stock market increasingly fickle, and it's approach to any company, it is important to you as well though in terms of capital raising?
Do you -- you guys have underperformed this year, not a bad year in absolute terms, but still underperformed as investors are kind of Seeking Alpha's elsewhere perhaps. Do you feel some sort of need to change our stripes a little bit? And are you doing that I guess on this call with the sort of lower dispositions higher acquisition is more development, redevelopment, so on.
I'm wondering if the perception of the stock market is an important partner for you to finance your business is influencing how you go about the world of medical office. And if you were a private company, would you be going about things differently?
Well, there's no doubt. The cost of capital is important, and for us that's the public equity markets, the bond market. Obviously, we have other sources to bank debt. There is always joint venture capital and so forth. And we've looked at all of those and we consider all those. I think for us, if we were – clearly, if you were private, you would have a different set of circumstances and you may or may not depending on who your backers would be have a little different objective.
But I think for us, where we're at today, Rich is really accumulation of all of the work we've been doing to really clean up the portfolio over the last several years really try to focus on MOB, you've seen a lot of inpatient rehab sales over the last few years and really trying to streamline and get focused on the best MOB. So, not only the non-MOBs, but some of the weaker markets, weaker health systems and trying to refine the portfolio.
So for us, the acceleration, I would call it now, in the business model and the ability to not have as many dispositions and have a higher degree of acquisitions. I think really just a cumulative effect. And absolutely, it's an important ingredient to have a great cost of capital. And if we don't have that it obviously can impact the pace of our external growth. But we know kind of underneath all that, the best thing we can do is have a really strong portfolio that generates those consistent results around that 3% level that Kris walk through.
So, that's our main focus. And then how do we add to that. And we try to take advantage of that at times where all the stars aligned and we can put capital to work very accretively. So, it's -- I think it's more just a cumulative effect rather than a change in stripes.
Okay. And then perhaps the market is taking note of your single-tenant growth that came in on the lower end of things for the reasons you described. Is there a view that portfolio as a percentage of the total should be meaningfully lower than it is. And if so, could it ever be a zero number?
No, it's 10% today with NOI less on square feet, but it's about 10% of NOI. So, our view is that sort of reached a natural level that makes sense. Could it be a little less than 10%? Sure. Could it be a little more? That's fine too.
I think we like where it is plus or minus. And it really is a practical thing that if you look at the actual assets in our single-tenant portfolio there. Actually it's a really a strong, strong single-tenant portfolio. A good bit of it being on campus as well and with really strong health system.
So, we think it's a good balance and frankly the relationships we have with health systems can often lead to a situation like that where we might invest in an on-campus single-tenant facility maybe even off-campus single-tenant. But I think 10% is probably about right and not some objective of ours to get to zero.
Okay, that's all I got. And as I've been closing as I said David in that email, it will always be Emery Board. So, carry on.
That's right. Well, thank you for your comments on that. And I can assure you his family was receiving a lot of emails and reading his emails to him in those final days. So, I'm sure he saw and appreciated that. Thanks Rich.
Great. Yeah thanks.
Thank you. Your next question comes from Daniel Bernstein with Capital One. Please go ahead.
Hi good morning. I offer my condolences as well and just say that Rich missed little fungibility as it were though.
Dan last week had a nice celebration here at the office as well for colleagues in past alumni of Healthcare Realty. And we put on one of our whiteboards all these various quotes that you guys have brought up in many more. So, we had a lot of fun with it and he was very memorable in that way. I appreciate that.
Yeah. And we'll miss him greatly. So, I want to ask you when we toured your facilities about a month ago, we talk some about the pricing power that you're now seeing your MOBs the releasing spreads have been very strong. Long-term we had some concerns for the MOB industry about potentially increasing pricing power from or push back from hospital systems as they emerge as they get larger.
And I know if you could talk a little bit more on the call about that the pricing power you are seeing about the experiences you're having with the hospital systems right now and just sustainability of the cash releasing spreads that we're seeing in your portfolio?
Dan it's Kris, I'll start on that. I'd say we feel very positive about how we've been performing and the outlook moving forward. One of the things that we do each quarter is breakdown the distribution of our cash leasing spreads. And you're just trying to think the right analogy, maybe it's basketball you're not going to hit a 100% of your free throws. But having 10 or plus percent that you end up with negatives I think that's still pretty strong.
So, you're going to experience that in any particular period. But the majority of what is occurring each quarter is still on that 3% to 4% and that's what we've been putting up for several years and what we continue to look at.
And we think that that's reasonable and sustainable based on our history, but then also if you look at it from the pricing power really goes to what your replacement cost is. And in a lot of these locations as we toured in D.C. there's just not a lot of available land. And so your competition would be somebody putting up some new construction. And new construction costs especially with land costs and some of these dense areas. Our experience is those are growing that -- call it 5% plus. So, we think that there is good sustainability to continue to be able to increase rents in that 3% to 4% range.
That's really helpful. The other question involves occupancy has been pretty stable on the operating, particularly in the multi-tenant. Given the comments earlier in the call about insurance carrier starting to require more outpatient use versus in hospital. What's the right stabilized occupancy for a multi-tenant portfolio?
Can we see that rise over the next three years five years 10 years from upper 1980s in the low 1990s or is there some other kind of structural impediment there maybe you want to keep some vacancy opened for existing tenants to expand?
Just trying to understand if there is some upside in your occupancy as well as the rates maybe over a longer period of time?
Sure. Dan, I would say we have been in sort of the high 1980s if you will especially on the multi-tenant MOB portfolio. And we would say that 90% is certainly achievable over time but what we've seen over a long period of history is annual absorption being more in the 25 basis point 30 basis point 35 basis point range and so for us on a practical level, we don't expect that to suddenly happen one-year. It's not as though the spaces in a block and a convenient block somewhere where we can lease it all to one or two hospitals even by market and just solve that, it's obviously a complex challenge to try to move these tenants around if that's the case and consolidate some space.
So that's an effort we're always going through and trying to accommodate folks but it's an ongoing effort. I think the other side of that is even just aside from the leasing side is just portfolio management. And always as I mentioned being proactive about selling assets that might be chronically living at 60%, 70% occupancy and we just don't see any near-term upside in occupancy or growing the rates.
So for us it's a combination of those things, but achieving around 90% is probably the practical level on the multi-tenant side. And then your mix with single-tenant is what creates the blend. And I think when you really pulled back a lot of other people's data they don't often provide the detail but if you back into it a lot of the multi-tenant MOB portfolios do live around that high 80%s 90% level. So it seems to be a fairly industry-wide phenomenon and part of it also is short-term leases and some constant expansion contraction and moving around does lead to a natural level. It's a smaller average tenant size. So there's just more of that frictional vacancy, if you will.
Okay. Okay. And then one last question, on the redevelopments is there any significant disruption that we should we expecting and are you going to leave those assets in the same-store portfolio or pull them out. I just want to understand how – in upcoming quarters if you – as you ramp that up how we should think about that?
I would say it's case-by-case the one that we're talking that we've talked about here in Memphis this quarter, clearly the new asset to us. We were under contract have and actually purchased it. So that clearly is not going to be in same-store for a while. But an asset that is already in same-store more often than not it will stay in there, but it just depends on the scope and magnitude of it if occupancy is going to fall to below 50% or 60% that may be a candidate for saying we're going to call that a redevelopment the scope of the dollars would matter as well. So its case-by-case we've done it where we've kept it in same-store if we think that makes sense. And we've also selectively taken it out and will be very clear about where that lives and describe that when and if we do that. But I don't think in the end one or two as Rob mentioned the year would have a material impact we'll just be careful to describe that clearly to investors and analysts.
Okay. Sounds good and look forward to catching up with you guys next weekend.
Thanks, Dan.
Thank you. Your next question comes from Todd Stender with Wells Fargo. Please go ahead.
Hi, thanks. Yeah. I just wanted a second and third everyone's comments regarding David he was really a scholar obviously gentlemen and will be missed. So David's family and you guys all our best.
Thank you, Todd.
All right. Just shifting to I guess the redevelopment you guys highlighted the Memphis property for redevelopment. And I saw it in your supplemental. It looks to be a new acquisition, but I didn't see it on your new deal list. I just wanted to hear a little more detail on that one?
Yeah. That's correct. It's not on our new acquisition list yet and we really thought about that and said well we don't want to necessarily double-count those dollars. We haven't closed on the acquisition yet we're under contract and you'll see that obviously in the fourth quarter. So we don't expect necessarily that that's part of the acquisition guidance. It's obviously not a huge purchase at $9 million. So again, that would be case-by-case. That one has more material dollars that will spend after the fact. So we felt like that made more sense to be put into the redevelopment side rather than the acquisition side.
And the purchase price $9 million is in the budget $28 million budget. So it's accounted for in that budget to pursuing.
Got it. Okay. And just with the equity activity lately tapping the ATM, it's been a good low cost for you guys. But on the broader theme of maybe raising the dividend or getting to that point I know Kris you kind of highlighted that the payout ratio is declining, but how are you guys thinking about that? Your balance sheet is in good shape. Probably teeing up the opportunity maybe for debt going into next year, so I know it's kind of a few inputs there, but I guess broadly speaking how are you guys thinking about the dividend?
Sure. As Kris described it, we obviously were closer to 100% in 2018 and it looks like will be at 95% or better as Kris described for this year. And we would certainly like to see that same level of progress more or less going into 2020. I think for us the key is it makes sense to be well into the 1980s before we would really move the dividend, but the nice thing is we're moving that direction and we can start having those conversations. I think it's a bit early to put a bright line on it, but we're moving in the right direction whether that takes 2020 or into 2021 where we have a direct site on that, we are moving in the right direction.
And it will just be a function obviously of how everything plays out for us, the volume of acquisitions, the internal growth all those things. But with a pretty strong outlook on those, I think we expect strong progress as both Kris and I mentioned in 2020, and we'll certainly have more news to report on how we see that when we get to the end of 2020 and whether it makes sense for into the '80s and can begin to point that direction.
One thing I'll add on the debt is, we're certainly always looking at all of our options in terms of raising capital debt being one of those. We want to make sure we're maintaining a conservative balance sheet to be able to take advantage of opportunities right now. We're in the lower end of our debt to EBITDA range at 5.2%. We feel comfortable there. We would like to stay in that range.
We do have the seven-year term loan that we completed earlier this year that has a delayed draw embedded in that that we've been taking advantage of. So, we expect to drill down on that commitment in the first quarter which will relieve the line of credit. So we feel very good about our debt position at this point.
How much more to draw on that Kris?
It's $150 million.
Okay. Great. Thank you.
Thank you. Your next question comes from Tayo Okusanya with Mizuho. Please go ahead.
Hi. Yes good morning. I just wanted to add my own thoughts to and condolences about David. When I was a young pup in this industry 15 years ago, he was just really good to me, in regards to getting full understanding of the MOB space. And I'm sure he will be missed and condolences to you guys and as well as to his family.
Thank you, Tayo. We appreciate it.
In regards to my questions most of them have been asked, but I just had a quick one about the acquisition pursuit costs this quarter. Again just kind of curious was a lot -- looks a little bit elevated with a lot of that just again the same mode looking at a high volume of deals or was there actually like a big portfolio type transaction you may be have been looking at that didn't come your way so to speak?
No, I'd say it's up a little bit from second quarter, but it's just the overall accumulation of all the transactions as Rob mentioned. We've done 12 separate transactions this year. So it's just the accumulation across so that nothing out of ordinary to talk about.
Okay. Great. I appreciate that. Thank you.
Thanks, Tayo.
Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Meredith for any closing remarks.
Thank you everybody for joining us on the call this morning and we appreciate everybody's kind remarks about David. He will be greatly missed. And we look forward to seeing everybody next week out in California at REIT World and we'll be around today if anybody has any follow-up with us with additional questions. Have a great day.
Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.