Healthcare Realty Trust Inc

NYSE:HR

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, and welcome to the Healthcare Realty Trust third quarter financial results conference call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Todd Meredith, CEO. Please go ahead.

[Todd Meredith, executive]

Thank you, Debbie. Joining me on the call today are Carla Baca, Bethany Mancini, Kris Douglas and Rob Hull. Carla, if you could first read the disclaimer.

[Carla Baca, executive]

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, 2019, 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 third quarter ended September 30, 2020. The company's earnings press release, supplemental information, forms 10-Q and 10-K are available on the company's website. Todd?

[Todd Meredith, executive]

Thank you, Carla. We are pleased to report positive results for the third quarter. My opening comments this morning will focus on 3 themes: first, that business for our tenants has rebounded quickly; second, our properties are performing well; and finally, how we are accelerating the pace of acquisitions. We are encouraged to see health systems, frontline health care professionals and patients adapting to the demands of COVID while addressing much needed routine care and surgical cases. This is evident in the activity levels at our buildings, including foot traffic, patient visits and parking, which have all rebounded to 90% or better and are steadily improving. The country is seeing a rise in COVID cases in certain markets, but we expect our facilities to remain open and elective procedures to continue. Public health officials and providers are better equipped and have more experience managing inpatient capacity than back in the spring. They have gained valuable understanding of effective therapies, and availability of vaccines is on the horizon. Our tenants are now operating at productive and sustainable levels. We credit their resilience to the critical need for specialty outpatient services. Requests for rent deferrals tapered off months ago, and rent collections have returned to normal. We have seen property tours pick up notably, which bodes well for absorption in future periods. While there may be bumps along the way, we expect our portfolio to perform well and steadily improve in the quarters ahead. These positive trends have encouraged us to shift to offense. We are capitalizing on a sizable and growing pipeline, and we have increased acquisition guidance substantially for a second time this year. Ramping up our investment pace has come about organically. Our experienced team has worked proactively in our target markets to source more properties. We are extending our reach deeper in these markets, amassing MOBs in tight clusters. Concentrated scale can help spread costs, but the primary benefit is leveraging our local market intelligence to capture more leasing volume on better terms. We continue to have a strong preference for on-campus multi-tenant MOBs, but we also see the ability to create value by investing in more adjacent and off-campus properties that complement our hospital-centric portfolio. These strategies are enabling us to elevate our acquisition pace on a consistent basis yet maintain discipline and quality. The common link is our relentless focus on dense, high-growth markets and aligning with the strongest providers. We could not have possibly anticipated COVID-19, but many of our target markets, such as Nashville, Raleigh, Denver or Atlanta, are benefiting from the trend of migration from some of the largest cities. Through the course of the pandemic, the medical office business has proven essential. Looking ahead, our portfolio is optimized to produce above-average internal growth while exhibiting the hallmark low-risk attributes of the MOB sector. And our efforts to sustain a higher level of complementary acquisitions are translating to more FFO per share and better dividend coverage. Over the long term, a steady rise in demand for outpatient services will ensure our ability to generate attractive growth and solid risk-adjusted returns for shareholders. Now I'll turn it over to Bethany for additional information on health care policy and recent trends. Bethany?

[Bethany Mancini, executive]

With an uncertain backdrop of macroeconomic and political factors, health care providers have proven quite resilient in 2020. Providers are focused on meeting strong demand for health services and much-needed delayed care. Higher acuity inpatient volume and surgeries have ramped up quickly for hospitals, while their lower acuity service lines are expected to normalize in the months to come. If COVID continues to spike, we expect providers to be able to treat patients without shutting down other scheduled care. Hospitals now have adequate staffing, PPE and better coordination of inpatient bed capacity as well as more use of outpatient facilities. Health care providers could also potentially benefit from additional federal assistance, whether through a fifth economic stimulus bill or with the remaining funds previously allotted to them under the CARES Act. For physician offices, HR's tenants have returned to 90% or more of normal volume on average. They have seen a heavy shift back to in-person care, even as higher Medicare reimbursement remains in place for telemedicine visit. Physician office hiring in September outpaced every other health care subsector, adding 18,200 jobs. This is more than 3x the average monthly hiring for physician offices pre-COVID. After several months of steady hiring, physician offices are now at 97% of pre-COVID staffing levels, a sign of strong patient demand, physician revenue growth and a positive outlook for the coming months. Tuesday's election, once decided, will have implications for the direction of health policy over the next 4 years. Several swing states remain under contention, but Republicans are likely to hold the majority in the Senate. If former Vice President Biden prevails in the Presidency with a split Congress, we expect status quo for health care at least until the next midterm election. A more progressive agenda on health policy, such as a public insurance option, would likely be difficult to pass, which should keep legislation incremental in scope. If President Trump ultimately wins the election, his administration will continue to implement executive orders to increase market competition and consumer choice in health care and deemphasize ACA insurance marketplaces. We generally expect stable Medicaid enrollment and support for Medicare payment rates for providers. In either presidential scenario, a political balance in Congress and the need for bipartisanship present less risk of change for health care providers and should result in stable reimbursement levels. On November 10, the Supreme Court is expected to hear oral arguments in the California v. Texas case to determine if the ACA can remain intact without the individual mandate penalty. We expect the court to consider the loss favorable from the mandate and keeping with the original intent of Congress for expanded insurance coverage. With any political agenda, the nation's spending on health care services will continue to rise. And with the aging of our population, the ability to deliver more specialty outpatient care will become increasingly critical. Healthcare Realty's medical office facilities are strategically positioned in growing markets to enable providers to expand their services and meet greater patient demand. Now I will turn it over to Kris Douglas for an overview of operational and financial results. Kris?

[J. Douglas, executive]

Thank you, Bethany. Performance in the third quarter was strong, rebounding well from the COVID impacts we saw in the second quarter. Healthy rent collections and internal growth, combined with accretive acquisitions, contributed to normalized FFO per share of $0.41. It is noteworthy that this is $0.01 above a year ago, even with almost $0.02 of dilution from the $244 million disposition of the Mercy assets in July. And looking forward, we are on pace to more than redeploy these proceeds by year-end, which positions us well to sustain meaningful FFO per share growth in 2021. Our ability to grow FFO amidst pandemic-related challenges is a testament to our portfolio's strength. As expected, we experienced sequential quarterly impacts from the typical third quarter seasonal utility expenses as well as the Mercy dispositions. These were partially offset by a nearly 50% increase in parking income over second quarter. In addition, we benefited from a $1 million sequential swing in COVID rent deferral reserves, including a $300,000 release from the reserve in the third quarter. The deferral reserve was reduced given that we collected over 96% of scheduled deferred rent payments and there were no material new deferrals granted. Further, and most importantly, third quarter rent collections were 99% back to pre-pandemic levels. Remaining deferrals are scheduled to be repaid by year-end. Turning to operating performance. Same-store NOI was driven by a 2.4% growth over the third quarter of 2019 for the multi-tenant properties. Same-store multi-tenant NOI growth was enhanced by operating leverage created from quarterly year-over-year revenue growth of 1.6% and operating expense growth of just 0.5%. Building utilization has rebounded from second quarter lows but is still running below pre-pandemic levels. This contributed to the expense growth below our long-term average of 2% to 2.5%. We expect to see a gradual return to typical expense levels moving forward. Our key revenue drivers bolstered multi-tenant performance. In-place contractual escalators of 2.9% and cash leasing spreads of 4.5% drove revenue per occupied square foot to 2.6%. Overall revenue growth was impacted by a few COVID-related items. First, year-over-year parking income was down $189,000. However, sequentially, parking income bounced back by nearly $400,000 from the same-store portfolio in the third quarter. This is reflective of patient traffic continuing to improve. Secondly, we saw a 60 basis point decrease in occupancy in the last 2 quarters, mainly due to a slowdown in property tours in second quarter. Tours have rebounded meaningfully in the third quarter, indicating considerable pent-up demand. We are optimistic about absorption moving into 2021. It is worth noting that an unintended welcome benefit of the slower leasing activity was less second-generation TI spend. This is reflected in lower TI guidance for the year. The lower spend benefits the FAD dividend payout ratio, which we expect to be at or below 90% for full year 2020. Shifting to the balance sheet. Net debt-to-EBITDA was 4.8x at the end of the third quarter, below our target range of 5 to 5.5x, mainly due to the $183 million of cash on hand at September 30. After we fully reinvest this cash in the fourth quarter, debt-to-EBITDA will be in the low 5s. We took a number of steps to maintain our conservative and flexible balance sheet. In October, we entered into forward equity contracts under our ATM, bringing total available capital from foreign equity to over $112 million. Also, we issued $300 million of senior notes due 2031 with a coupon of 2.05% and called our 3.75% senior notes due 2023. This refinancing extended our average debt maturity to almost 7 years and lowered the blended interest rate by over 30 basis points. We now have no material debt maturities until 2024 and no senior notes expiring until 2025. As we look back on the first 3 quarters of 2020, we are pleased with the resiliency of our tenants and portfolio. Our market selection and asset quality have generated steady internal growth through challenging times. Strong internal revenue drivers indicate this organic growth will continue. In addition, we are well positioned to fund our growing acquisition pipeline with numerous capital sources available. In summary, strong internal growth, accretive acquisitions and low leverage positions us well for accelerating FFO per share growth. Now I'll turn it over to Rob for an overview of investment activity. Rob?

[Robert Hull, executive]

Thanks, Kris. Healthcare Realty is confidently moving forward with additional investments. This confidence is supported by the resilient cash flows and strong rent collections from quality medical office buildings. As the pandemic unfolded, a number of marketed deals were pulled, and many investors hit the pause button. In contrast, we remained active assembling a robust pipeline, sourcing 1 or 2 buildings at a time. Over 3/4 of our pipeline this year has been directly sourced from building owners and relationships we've cultivated over many years. Our focus has been primarily centered on creating concentrations of buildings around leading hospitals, serving dense growing populations. Over 95% of our purchases in the last 3 years have been in markets where we were already invested, with the balance located in a couple of target markets where we see a clear path to invest in more buildings. Since July, Healthcare Realty has acquired 7 MOBs for $117 million. These properties illustrate our focus on forming property clusters around leading hospitals. These clusters position us well to leverage local leasing knowledge and provide a diverse mix of options to tenants with varying space needs. Local expertise also helps us identify and underwrite additional investments in the market. A recent example is a multi-tenant MOB purchased in Los Angeles. The building is 100% leased and located adjacent to Huntington Hospital. This growing, 503-bed hospital signed a definitive agreement to affiliate with Cedars-Sinai. This is our third acquisition in the last year around this campus, and we have gained line of sight on additional prospects adjacent to the hospital. Another in Colorado Springs is an off-campus MOB next to a building we acquired in March of this year. The investment gives us control of a 2-property complex that provides a convenient destination for medical services along a growing commercial and residential corridor. These properties serve as an attractive alternative for tenants that don't require an on-campus presence. And they are located a short distance from 3 other buildings we own on 2 leading hospital campuses. And in Houston, we purchased an MOB adjacent to Memorial Hermann's 397-bed Hospital in the Woodlands. The building is located around the corner from our 4 other MOBs adjacent to this hospital and is also near a competing hospital where we own 2 on-campus properties. This acquisition expands our portfolio to 7 on and adjacent buildings in the immediate area that total 440,000 square feet. The average cap rate for our recent acquisitions is 5.8%, and we expect to end the year at around 5.5%. This aligns with broader market -- with the broader market where pricing for core and core plus MOBs has remained steady in the 5% to 6% range supported by a diverse group of well-capitalized buyers. We have recently seen an uptick in marketed deals as sellers return after taking a wait-and-see approach during the early period of the pandemic. A couple of larger portfolios are on the market that don't measure up for us. These particular portfolios do not align well enough with our preferences: a greater on-campus mix, robust rent growth potential and overlap with our target markets. Looking ahead, we have prospective acquisitions totaling $276 million under contract and another $105 million under letter of intent. While some of these may close in early 2021, we fully expect to have the mercy proceeds and more invested by year-end. We are raising guidance well above our top end from last quarter. 2020 guidance is now $400 million to $475 million. As we approach the end of a solid year of investing, we remain confident that our team can continue building a robust pipeline that will deliver a strong start to 2021 and contribute to meaningful growth in FFO per share. Operator, we are now ready to open the call for questions.

[Operator]

[Operator Instructions] The first question comes from John Sanabria with BMO.

[Juan Sanabria, analyst]

It's Juan here. Just on the investment pipeline. I just wanted to get a clarification of how the prospects that you're looking for are maybe different mix between on- and off-campus versus your current portfolio. Maybe it sounded like you're a little bit more after or wanting to take on more off or adjacent assets. And if so, if you could comment on the relative pricing differential from a cap rate perspective on versus off?

[Robert Hull, executive]

Yes. I think if you look at our acquisitions that we've made this year, there have been more adjacent properties, most of them have been adjacent. There have been a few off-campus properties in there. I think when it comes to the -- and I think if you look at the pipeline for the remainder of the year, it'd be a similar mix of on and adjacent, largely on and adjacent, and a few off-campus sprinkled in there. I think when you look at the pricing difference, there's typically seeing -- depending on the market, you can see anywhere from a 50 to 75 basis point pricing difference between those. In some cases, it could be slightly higher than that. But generally, it's in that 50 to 75 basis point range.

[Todd Meredith, executive]

And that's really -- Juan, I guess I would say that's sort of the on versus off, and then adjacent is going to skew closer to the on cap rates. So not as much of a difference there the closer you are to the hospital. I mean it's almost kind of a linear line of distance to hospital, but it can vary by market, as Rob said.

[Juan Sanabria, analyst]

Great. And then you kind of alluded to it in -- for '21 in your acquisitions, you said you had a multitude of kind of capital sources. So how should we think about how you feel about your cost of capital relative to cap rates today and your willingness to either equity fund? Or would you be more likely to fund via capital recycling as you move forward in '21, assuming a status quo in your cost of capital today?

[J. Douglas, executive]

Yes. First, right now, we do have the cash proceeds to redeploy. So we will start there. I guess blended, we're working to keep our leverage in the low 5s, where we are or where we will be once we redeploy this cash. And so we are looking at it from kind of that blended WACC basis. And right now, that is certainly accretive for us based off of where we're able to purchase assets in the market in that kind of mid-5s range. And so we will continue to fund with a mix of debt and equity. We are well positioned on the equity front with the forward ATM proceeds that we have lined up so far this year. We have $112 million available through that forward equity right now. So that will be used once we go through our cash that we have on the balance sheet to fund the current pipeline. So well positioned, but we also certainly have access to other forms of capital outside of that as well.

[Operator]

The next question comes from Jordan Sadler with KeyBanc.

[Jordan Sadler, analyst]

Just a follow-up on sort of the last question regarding the pipeline of potential acquisitions, the under contract and the under LOI. Is the mix there heavily skewed as well toward off-campus?

[Robert Hull, executive]

No. I think the mix is heavily skewed in the under contract and mix is skewed towards on and adjacent, not much off.

[Jordan Sadler, analyst]

On and adjacent, okay.

[Robert Hull, executive]

Yes. If you think about the definition of our adjacent, it's within a quarter mile.

[Jordan Sadler, analyst]

No, I follow that. I'm just -- I mean it looks like a lot of it -- I mean a lot of what you guys have done. I caught a nuance, I think, in your prepared remarks, Bob, where you said you have a strong preference for on-campus, multi-tenant MOBs. I just -- I noticed that's kind of that piece of the mix is kind of going down. I'm just kind of curious, are you still able to source those on-campus transactions specifically? Or is it really more of this adjacent?

[Robert Hull, executive]

Yes. I think, yes, we are still able to source on-campus. I think what you've seen, we've -- over the past 3 years, we've -- acquisitions have been -- 95% of our acquisitions have been in target markets where we already have a presence. If you look even closer, about 70% of those have been around campuses where either on or adjacent to campuses where we already have a presence. So I think what you're seeing is us having success in building out these clusters or tight clusters around campuses where we want to build out a presence. And so where you've seen a number of acquisitions that we've made here recently as adjacent, those are part of our strategy of building out smaller portfolios around campuses where we want to be. So I think it's -- we can still get at the on-campus properties. It's just our work and the way we source properties through these direct relationships and local knowledge, where we're going out and buying 1 and 2 at a time. Oftentimes, it comes with buying one property to enter that submarket and then building upon that. And so that's really where the strength of our portfolio pipeline building comes in, and we're constantly buying properties around campuses where we want to be, and we've identified an opportunity to build out significant square footage.

[Jordan Sadler, analyst]

Okay. That's helpful. I know there's quite a bit of a narrative, obviously, surrounding sort of work from home for traditional -- more traditional locations or traditional office space and office users, obviously, versus your primary tenancy. Has this kind of -- how do you think about this in underwriting, Rob, when you're looking at even adjacent stuff around these hospitals and these infill locations? Do you think there'll be potentially more product available for sale as a result of this because, obviously, some of these other landlords are hurting?

[Robert Hull, executive]

Yes. I think that when you look at our underwriting and when we're underwriting the adjacent buildings as well as the on, I mean there's still a significant demand for tenants to be located on or around the campus. We've seen -- our statistics show that even during the pandemic where we had this falloff in foot traffic and some of the on-campus traffic that was really caused by these restrictions around elective surgeries and inpatient services, that's largely rebounded. And I think that shows up in our statistics. And so we think that there's going to be continued demand for tenants and space around not only on but adjacent to the campus as they serve these higher acuity services that still need to be located in and around the hospital.

[J. Douglas, executive]

And I might add -- go ahead, Todd.

[Todd Meredith, executive]

Go ahead, Kris -- well, probably the same comment. I think you're on to something in one -- on one hand that you're right, if somebody has a local investor or a regional has a portfolio and they're struggling in retail or they're struggling in some other sector for the reasons you cited, economic generally or even the work-from-home trend, I think you're right. They're looking at some liquidity from an area like MOB, where the value has been preserved and doing well. But on the other hand, there's going to be probably a similar amount of people that are saying, I want to hang on to that if I can because it's doing really well. And then there's a lot of other demand from institutional capital to move into MOB. So it's a balance, but I do think you're right, it probably lends itself to a little more availability at the margin. And I think you've seen us certainly benefit from that. And I think it will continue to be the case for a while.

[J. Douglas, executive]

Jordan, this is Kris. I'll add one thing, actually, back to your previous question about the on versus adjacent. As we look at that, as Rob mentioned, our definition is it's pretty tight at a 1/4 mile. And if you look at a lot of campuses, frankly, walking across the campus could be more than 1/4 of a mile. And so we look at those pretty close to interchangeably. And if we look at our performance across our on properties versus our adjacent properties, they're very, very similar. So I wouldn't read too much into a slight shift in one quarter or even one year of adjacency versus on. They're very, very similar.

[Jordan Sadler, analyst]

That's helpful. And then just, Kris, while I have you, a clarification. Just I looked at the same-store portfolio page that you guys provided, it's helpful. Can you just shed a little bit of light on the 3 assets that were moving out from reposition, the 443,000 square feet?

[J. Douglas, executive]

Yes. We had a couple of assets, things that are moving around. We had some that were sold. We have a couple that got moved into reposition. One of those is one that we have talked about before, that is the fitness center down in Dallas that we are in the process of reconfiguring that fitness center. It was over 100,000 square feet. Currently, we are -- the new fitness center is going to be about half that, and we're going to be spending dollars to upgrade the building and convert the remainder of that space into clinical space. Another one, we had a general office building in Dallas as well that we had a tenant that had moved out, multi-floor tenant that we are backfilling with multi-tenant floors. We actually already had a new 10,000 square foot tenant that is taking some space in there. So we're already in that process. But there's just going to be some transition that goes on as we are repositioning those assets. So that's kind of the main culprits in terms of the shift in the overall square footage. But that one building in -- where the fitness center is, it's over 200,000 square feet. And so it makes up the predominance of the change in the square footage that you noted.

[Operator]

The next question comes from Vikram Malhotra with Morgan Stanley.

[Vikram Malhotra, analyst]

I know you mentioned we shouldn't read too much into kind of the on versus adjacent. But I guess it's also one of the few or maybe one of the first times you've actually outlined kind of growing the pie, so to say, by looking at adjacent and more so off, like you mentioned. So I'm just -- maybe just higher level, if you can give us a sense of what's the impetus for this change even if it's slightly on the margin. And then related to that, how is your underwriting maybe different for when you look at off-campus versus what you've traditionally looked at in terms of tenants or bumps or any other metric you may be looking at?

[Todd Meredith, executive]

Yes. Vikram, I think -- it's a good question. And I think certainly, we would agree, it's obvious we are doing a little more adjacent. And it's really not so much new. We've actually been doing it for a while. I think what you're seeing is our ability to accelerate that trend. And it's really stacking up nicely this year, and we're continuing to add those on-campus buildings. But what you're seeing a lot of this year is our ability, as Rob described, over 70% of these assets are where we're developing that cluster. Again, that tight ring, 1/4 mile around the campus, and either adding to the cluster of adjacency or -- our ideal scenario is we have adjacent, we have on. And then as we build sort of what I would call the network effect among the tenants and the leasing and the knowledge that we have from being in that flow, all of a sudden, we have a sense of, well, what are the right competitive buildings where we see ourselves competing the most, whether that's on, adjacent or off. And so what we often -- we get in the flow of that information, whether it's through brokers or directly ourselves and the dialogue with the hospital and the providers, and suddenly you realize that one building down the street a mile, which is off-campus by our definition, is really a strong building and competing well. We like that. Let's go look at that. Let's go see if we can get ahold of that building. And so you develop that knowledge the longer you're in a market and the more critical mass you build. And then obviously, the flip side of that is you get some more benefit just from a cost standpoint. But our view is really it's a revenue-enhancing play rather than just a cost because there's a limit to the cost benefits. So our view is just building out sort of that cluster strategy and the network effect, and it's anchoring it always with some line of sight down the road of getting on-campus and really tethering yourself to the strength of that local submarket, that cluster effect.

[Vikram Malhotra, analyst]

Yes, that's actually where I was going with -- you mentioned cluster, so I was trying to get a sense of what you hope to kind of enhance in terms of bumps or your rent spreads or then even, from a cost perspective, maybe the overall margin in that specific market. So I'm wondering if you have any anecdotes or experiences to share where you do have clusters, kind of how some of those metrics may have started to pan out or what the goals are if you don't.

[Todd Meredith, executive]

Yes. I think it's early to give you this concrete example of it does X or Y exactly. But what we are really seeing, I mean, several places from -- just all over the place, Memphis, Nashville, Denver, all these different places where we own these on and adjacent or we see -- if we don't own those, in some cases, where these tenants might be going and where that demand builds, and so it gives us that insight. But I think the core of it is what you said. It's getting to stronger absorption trends. That's a way we see to building that absorption, that positive absorption and then translating that to sustaining sort of the 3% to 4% cash leasing spreads. Potentially more than that in any given period but, over the long run, we think that is a very compelling way to generate those spreads. And again, it's not a new concept, we've been doing it for a while, and now we're trying to really aggressively move more in that direction. And so you're seeing it help us sort of accelerate and elevate the pace of our acquisitions. And frankly, we think it's very sustainable. I mean, we have a strong pipeline going into next year. Rob mentioned the group of properties under LOI and even some of the ones under contract that may not close, they'll close in the first quarter. So we'd be off to a great start next year to kind of keep up a pace, at least as strong as this year.

[Robert Hull, executive]

One thing I might add to that, Vikram, what I might add to that is, over the last 5-plus years, you have seen us selling some off-campus buildings. I would say those are ones that, though, didn't fit with this kind of cluster idea. But at the same time, we always said we weren't going to 100% on or adjacent. We said there's some good properties that we owned and kind of fit this characteristic that Todd's talking about. So right now, we're, call it, 10%, 15% that is off-campus. And so if you see us buying somewhere in that range, it will probably stay in a similar range to what we currently have in terms of the overall mix. So I would say it's all marginal. And it's not a -- it's not an overall major shift in terms of what you've seen out of our portfolio. But we do think it can certainly be additive for us.

[Vikram Malhotra, analyst]

Okay. Fair enough. And then just one last one. You've done a great job sort of in getting the payout now, as you mentioned, hoping to be 90% or lower. I'm just wondering kind of if you have updated thoughts that you can share when investors might think about or see a dividend increase.

[Todd Meredith, executive]

Sure. So clearly, as you pointed out, we've made some progress. And I think, as Kris outlined, we should be 90% or better for the calendar year of 2020. Some of that is clearly attributable to a little bit of the leasing slowdown we saw off the back of tours slowing down in the second quarter. So that's helped us a little this year. So we don't want to get too ahead of ourselves on that. But even if we spend a little more next year to make up for that, it's obviously for the right reasons. It's getting occupancy and absorption. So -- but we still are optimistic about next year. And our goal is really to drive comfortably into the 80s and really see line -- direct line of sight and ability to drive into the mid-80s. But I think the good news is, it's not if, it's when. And I think as we put together our assessment of '21, our forecast internally, we will be very focused on that. So it's -- I wouldn't suggest it's imminent, but it is certainly in our planning thoughts, and we hope to be there sooner rather than later, but I think we've got to take a hard look at how the leasing and the payout looks for '21.

[Operator]

The next question comes from Nick Joseph with Citi.

[Nicholas Joseph, analyst]

You gave some details around tour activity. So I'm just curious how you think about that as a leading indicator for ultimately leasing and kind of what the typical relationship is between that activity and ultimately sign it.

[J. Douglas, executive]

Yes. This is Kris. I'll take that. We certainly track our leasing and then kind of conversion ratios. And we did see a drop off, as we had talked about, in the second quarter. Rebounded very nicely in the third quarter, when you average those 2 together, it's pretty similar to what we saw over the first quarter. That's what's kind of giving us some of this optimism as well as what we are hearing just on the ground from our leasing people of discussions with providers as well as with hospital systems that are looking to move forward with various clinical plans. So we'll continue to track that tour activity as we move into fourth quarter. There is a bit of a lag there in terms of tour -- initial tour converting into occupancy. But we're pleased with how well it has rebounded in the third quarter, and that's providing a lot of the optimism that you're hearing for us going into next year.

[Nicholas Joseph, analyst]

And then just from your tenants, do you have a sense of how much pent-up demand is still kind of unsatisfied from previous lockdowns? Or are we back to generally normal course of business at most of these positions?

[Todd Meredith, executive]

I would say it's not quite back to normal. I think they're still working through it. I mean we -- you probably experienced it in your own lives if you're trying to get a doctor's appointment, it's still usually a pretty good delay right now. So I think there's still pent-up demand. I don't think it's terribly high such that it's going to take forever to work through it. But I do think you still are seeing some of that. And there -- I think the biggest bottleneck is just kind of being very safe in everybody's practices and making sure you don't crowd waiting rooms and kind of overwhelm the system. So I think everybody is doing their best to sort of keep it safe and do the appropriate volume right now. So I think it will continue to benefit. It will be a grind here. As we said, we're about 90% plus, varies from 80% to 100% across the market. So I would see that as just grinding higher until we really see -- I think we're all sort of looking for some of the trends to improve probably into the spring. And obviously, the vaccines will be, I think, the real moment when I think you'll have worked through most of that and get back to sort of a run rate that's 100% or better of where we were pre-COVID.

[Operator]

The next question comes from Rick Anderson with SMBC.

[Richard Anderson, analyst]

So just quickly, on the mercy disposition, was that cap rate kind of in the realm of normal, like 5.5%? And just curious if you're making any money on that deployment trade or if that's more about a longer-term kind of growth thesis redeploying those proceeds.

[J. Douglas, executive]

Yes. No, that was a higher cap rate. It was 7.5% cap rate. It was really about the higher rates that we had there in some smaller markets and the single-tenant risk. So we did have some dilution that was associated with that. But we think from a long-term value, it's still a good trade for us.

[Richard Anderson, analyst]

Yes. I'm sorry. I remember that now. I apologize. On the adjacent sort of theme that we're talking about here, is anything about that -- I understand the clusters, and you can own -- move away from the center of a hub, of a circle, you naturally would go off-campus. But is there anything also about that, that is a sign of the times, people maybe don't want to be so close or even connected to a hospital because of the environment? Or is that not playing a role at all in sort of how the market -- and you're behaving in the marketplace from an acquisition standpoint?

[Todd Meredith, executive]

No, not at all. I mean, we absolutely want to do the on-campus . I think what you've seen from us is that we kind of strategically pick which markets, number one, that we want to go into, as Rob said, over 95% of those have been the ones we're already in. And then we go down and drill down and say, well, what hospitals do we want to be around? We've done that well. And then now what we're doing is -- as you heard, as we've said and you mentioned, we're building that out by the adjacency. And again, that's a very tight circle.

So it's -- there's no change that we want to be on-campus. We absolutely do. And frankly, our portfolio, which is heavily on-campus, as you know, we have not seen any concerns there. It's not like we're seeing different foot traffic levels and activity levels. I certainly didn't see it play out in the deferral situation in the second quarter. Differently on versus adjacent versus off. So it's very much a concerted effort to sort of develop these clusters. And Rob talked about 70% of what we're doing is in the same cluster. Well, then the 30% that's not in the same clusters that's us trying to find the next cluster. Maybe we get a single on-campus building somewhere in a new submarket or maybe we get an adjacent one. And then immediately, what our team is doing is saying, who are we -- talk with our leasing people. Who are we competing with? And therefore, what buildings would we want to own in that submarket. So it's just -- frankly, it's more likely you're going to get to the adjacent first because the hospitals often own the on campus, if they're not already owned by some other institutional buyer like us. And so you can get a foothold, oftentimes adjacent initially, and then you can usually build on that more. But getting that on-campus is sort of priming yourself to get in position to be the best buyer of the on-campus, if you don't already own it.

[Richard Anderson, analyst]

Okay. And then let me think about this a little bit differently then. If perhaps there's a bit more attention being drawn by medical office in this environment for all the reasons you'd probably be able to list pretty quickly. And that includes distance off-campus where people -- maybe there's some consistency to the idea of being close to a home, people might feel safer and whatnot and all that, I don't know how long that will last. But is this an environment where you can actually sell more of what you do own off-campus? Is the environment's more sort of accommodating of that? Or is there really no movement there either to speak of?

[Todd Meredith, executive]

Well, I would say, as Kris pointed out earlier, we have probably historically sold a fair bit of our off-campus, and it was really going through and identifying which ones we wanted to own long term versus not. And so we've kind of whittled it down to a lot of the off-campus we have, which is, again, a fairly small percentage. Those are the places where we want to continue to invest and develop clusters in those markets. So I would say we're not looking at taking advantage of that trade. Now on the margin, may we do that here or there? Sure. But I would say generally, we're very comfortable with the off that we have. And I would say, you will see that off-campus for us tick up a little because, as Kris said, I mean we're almost 90-10 on an adjacent versus off. And so I could see that drifting to 85%, 80% on an adjacent. But we're comfortable there. As long as it fits strategically, it's the right demographics, it kind of plays into our clusters. So we're very comfortable with that mix.

[Robert Hull, executive]

Yes. And Todd, I would just add to that. This is Rob. I would just add to that point about clusters. If you are investing in us, you're generally going to see is we already have a significant on or adjacent presence. So it's really complementary to that clustering effect. It's not going to be where we're going in and starting a cluster with an -- truly off-campus building.

[Richard Anderson, analyst]

Yes. Got you. Last one, perhaps for Kris. If you're 4.8x debt-to-EBITDA lower than your target and you go into 2021, and you said, I think, 5.5-ish type of range. How much does that feed growth? In other words, by levering up a little bit in 2021 assuming low interest rates and all the rest, you got a lot of accretion from the next incremental acquisition if it's funded entirely with debt. So I'm curious, how much does that move the needle when you're talking about material FFO growth next year?

[J. Douglas, executive]

Yes, Rich, I think the way to think about that is you kind of really have to pro forma it for the cash that you have on the balance sheet. So that was kind of what I was trying to highlight in my prepared remarks. So yes, we are a 4.8 today. But if you take our $183 million of cash and redeploy that in the mid-5s, that debt-to-EBITDA ends up going back into the low 5s, low 5x on a debt-to-EBITDA basis. And so we're really already in our target range of 5 to 5.5. And so I wouldn't anticipate a meaningful shift and leverage moving forward. I will point out that we did see some benefit to earnings from the refinancing that we did back in October with the new bond issuance. A new 10 plus year -- 2.5-year bond issuance at just over 2%, which brought down our blended interest rate by 30 basis points. So we are seeing some benefit on that. But I would say we're not looking to try to accelerate earnings moving forward by levering up. We plan to keep that leverage there in the low 5s, which is frankly, kind of where it is today once that cash is redeployed.

[Operator]

The next question comes from Lukas Hartwich with Green Street Advisors.

[Unknown Analyst]

It's [ John ] here on for Lukas. Congrats on the quarter. Just, I guess, a 2-parter from me. I just wanted to get a better understanding of the supply outlook, particularly around your cluster markets and where you see kind of the lack of supply, coming on. What's your desire there to have step in on the development side to fulfill that need?

[Robert Hull, executive]

Yes. I think on the supply side, I think when we evaluate markets, certainly starting with our target markets and then, as Todd said, going in and identifying a campus that we want to locate around, certainly, supply becomes a driving factor. And really, with the way that we source buildings, we're going out and identifying the buildings that we want to own. And figuring out who owns those buildings and then engaging in a dialogue with either building owners or local brokers there that can help us begin to form those relationships. And so that certainly drives our -- some of the identification of these clustered markets. And if we don't feel like there's a substantial enough opportunity to get enough buildings, then we'll certainly move on to the next -- the market -- next market that we've identified. And certainly, as it relates to development, sure, if there's -- if it's a tight market, oftentimes, when we're in the clusters, we have -- we've formed a nice relationship with the hospital. And that's really what's been driving our development efforts of late. We certainly want to develop properties inside of those clusters when we see the opportunity, but those are going to be largely driven by the hospital there and their needs and their growth. And so we have certain situations where we've done that. Our current building that we have under development that we finished this year, Valley. That was a situation where we were already on-campus and had an opportunity to develop an additional building there through our relationship with the hospital. So certainly something that we will continue to evaluate while we're building out these clusters and have -- actually have a couple of opportunities that we've been working on that fit that criteria. So the next couple of months we'll probably begin -- be coming out with a couple of new developments.

[Operator]

The next question comes from Jon Petersen with Jefferies.

[Jonathan Petersen, analyst]

A few kind of COVID-related questions sort of. On TIs, they were a little bit lower this quarter, but I was actually just wondering whether you can talk about renewals or new leases with some of your tenants, if there's -- if they have reconfiguration needs, social distancing or telehealth or anything like that, that would necessitate TIs to go higher going forward?

[Todd Meredith, executive]

Yes. On TIs, we kind of look at it based off of spend as well as commitments. And our spend is down, but that, frankly, is because the volume is down a little bit, as we talked about, because of the slowdown in tours that we saw earlier this year. If you look at our commitments, they're frankly kind of right in the range of what we historically expect. We say renewal is kind of $1.50 to $2, more in that $4 to $5 for new leases. So we're pretty close to that right now, so we're not seeing a meaningful shift. We're monitoring what may occur with any changes for COVID in terms of space needs. We're not seeing people as of yet, making a material shift in the way they're using that space. I think there's a lot of discussion around that and are there things that could be done and probably also depends on the specific of the location. People are getting much better of using online, check-in, so you don't have to have as many people in a waiting room and being able to turn exam rooms and cleaning and such. And so we'll be on the lookout for that, but we have not seen anything as of yet that would make us change -- our typical expectations of what our leasing TI commitments would be.

[Jonathan Petersen, analyst]

Okay. All right. That's helpful. And then yesterday, we hit the unfortunate milestone of 100,000 new cases. I'm just curious if you're having discussions with your neighboring health systems on creating additional capacity for them or if there's kind of been plans in place or whatnot for another spike in overcapacity at your neighboring hospitals.

[Todd Meredith, executive]

It really has not returned to anything like what we saw in the spring, which is good news. The bad news is there are specific places we know that are spiking. It doesn't seem as though it's currently happening in our markets to a material degree. So it really hasn't led to sort of that return to discussion about more addressing these issues in some more dramatic fashion or just a helpful way. We haven't even had a lot of that. So I would say right now, we're not seeing it. The good news is we all went through this in the spring and even sort of a second surge in July in a couple of markets. So I think everybody feels a little better, is breathing a little easier about our ability to sort of react and handle that well. And I say our ability, it means really the hospitals and us lending a hand with whatever we can do. So we feel good about it. We were even having a discussion with a couple of our Board members who lead health systems in different markets. And they feel way better than they did back in the spring about inability to handle these spikes. So very encouraging what we're hearing. Obviously, it's hard to know going into the winter, but so far, so good.

[Jonathan Petersen, analyst]

If I could, just one more kind of COVID-related question. If we get a vaccine, I would assume there's going to be a very high-volume of people that are going to be seeking, I guess, to get the vaccine and for it to be administered. Does that create any opportunities or anything for you guys? Any short term, I guess, demand for administering the vaccine?

[Todd Meredith, executive]

I think it certainly will lend itself to more demand for these fairly low acuity visits to people going to get the vaccines. If they're kids, it's a pediatrician's office or more likely internal medicine, family practice type offices. We'll see. I mean, obviously, none of us has great insight into exactly how this is all going to work. But I think it will be good, and it will hopefully lead to people being more confident to kind of return to normal activity. So it clearly will be a benefit, but nothing specific at this point.

[Operator]

The next question is from Daniel Bernstein with Capital One.

[Daniel Bernstein, analyst]

I think you kind of answered this in the last set of questions. But have you seen any difference in, I guess, the demand for the size of of your tenants? I mean are your tenants looking for any additional space or expansions? I mean you had a lot of confidence in your ability to increase occupancy over the next 12 months just from leads, but I'm wondering if tenants are actually asking for more space as well.

[Todd Meredith, executive]

I would say, generally, yes. I mean we are definitely seeing a fair amount of expansion talk. It's proportionate. I think it's similar to the positive signs for more new leasing and absorption. So we definitely see that. I wouldn't say it's a 10x type of consideration. But we are very encouraged by that. And one place that we've seen a lot of that going on is this redevelopment in Memphis. It has really just kind of grown through expansion. And a big driver of that, one part, it's hospital building out their outpatient practices there but also a orthopedic and surgery center that is really ramping up. So very encouraging signs, I would say, on some of that higher acuity demand. And we think that will translate to some more expansions but in proportion, just generally more demand.

[Daniel Bernstein, analyst]

Okay. Not -- I guess it's like not related to COVID. You're not looking for more space because they need...

[Todd Meredith, executive]

Right, it's more just -- it's just volume. Yes, it's not -- back to Kris' comment...

[Daniel Bernstein, analyst]

Volume of health care needed, okay.

[Todd Meredith, executive]

Yes, volume of health care, not just saying we need bigger waiting rooms or anything like that.

[Daniel Bernstein, analyst]

Right. Right. And then just -- I don't know if you could talk about a little bit through the sellers -- not by name but by characteristic, the sellers of the assets that you're looking to buy from. I mean are -- is it hospitals monetizing assets? Or is it just private landlords? I guess trying to just get a flavor for whether we might see some more hospital monetizations here, whether people are reallocating capital somehow. Or again, is this just private sellers looking to capitalize on the cap rates that are out there and reallocate someplace else within their portfolios?

[J. Douglas, executive]

Yes. I mean, I think that's right. I think it's primarily private building owners that are looking to sell. We've talked over the years about hospital monetizations and kind of waited for the wave to come, but we're just not seeing that. We had the Mercy assets that we sold, the hospital that purchased those last quarter. I think there's been another instance that I saw recently where a hospital purchased some buildings. So I don't view them as a large source of product now or in the near term.

[Daniel Bernstein, analyst]

Okay. And just going back to the on versus adjacent question, do you see any discernible difference in occupancy or rate growth between an on-campus and an adjacent property? I'm just trying to understand that if you -- I know it might be an incremental shift, but if you shift it all to adjacent, do the fundamentals of your rate increases change at all?

[Todd Meredith, executive]

No. I would say, I think Kris alluded to this, we really see a very common pattern between on and adjacent. Yes, there are some differences. One thing we tend to see on-campus, and this is a good thing, but oftentimes you have a strong anchor occupancy, not one lease but a lot of leases with a hospital. And they oftentimes have a right to take or meet terms of third-party leases as those come up, whether it's a new lease or a renewal. And so a lot of times, these hospitals will backfill or just take space as it becomes available. And that's great for us, but at the same time, you're losing a provider, a third-party provider that wants to be around that campus. And so that's a benefit we see with adjacent is that you get that synergy of, hey, we can own the building across the street. And if we have multiple buildings, we can capture that tenant as they look to continue to be around that campus. So that's certainly a benefit we see. And so we kind of see again, just slightly different behaviors but very similar operating trends in occupancy, retention, leasing spreads, all those metrics look very similar.

[Daniel Bernstein, analyst]

And these are feasible, right? There's no ground lease or anything?

[Todd Meredith, executive]

Yes. Almost always, you would see that be feasible.

[Operator]

The next question comes from Omotayo Okusanya with Mizuho.

[Omotayo Okusanya, analyst]

Congrats on the solid quarter. It looks like your kind of '21 and near-term outlook is pretty solid as it pertains to external growth, internal growth as well and, of course, potential dividend growth. So the question I have for the team is at this point, what kind of still keeps you worried or up at night, just kind of given there's a lot of positive indicators at this point for your earnings outlook?

[Todd Meredith, executive]

Sure. One thing that, I think, Bethany touched on. Some of these things we -- none of us can control, right, but it's these external factors. And some of that is just the capital markets. But that's -- that seems to be settling down positive right now. And I think, clearly, the political environment. And it's not that there were particularly bad outcomes on the horizon in any of these outcomes, it was just that uncertainty, lack of visibility. Those were some of the things that I think have been hanging on the capital markets, but also hanging over the health care world as well. And I think now that we have this sort of insight that it's probably going to be a mixed outcome, I think as Bethany articulated, it looks like it should be a much more tame, less volatile environment for at least 2 years, if not longer. So I think there's a pretty nice sigh of relief on everybody's part that maybe we'll see a little less change here and people can continue to get on with focusing on their business and growing and, frankly, recovering from COVID. I think COVID still presents some uncertainty, but I think everybody feels more confident today than we did several months ago. And I think all those things combined give us that confidence on top of really just organically what we're doing, as you said, the portfolio plus a really great amount of traction on building the pipeline for acquisitions and seeing that ability to keep it up. So we are very optimistic about '21.

[Omotayo Okusanya, analyst]

Okay. That's helpful. And then just if you could indulge me, if we go down the ACA rabbit hole for a little bit, and let's kind of assume [ it ends up as stewards, kind of says it's unconstitutional ], the whole thing kind of gets scrapped, how do you guys think about what the potential impact could be to hospitals and hospital systems, which again are your major client base?

[Todd Meredith, executive]

Sure. I think, obviously, you know this and suggested it. It is a rabbit hole. It's speculation. As Bethany kind of described in her remarks, we really do feel very confident that it will be determined as severable, there's just a lot of precedent on that. Obviously, we could be wrong. You never know where it could go. Maybe back to the benefit of the split outcome between the administration and Congress and Senate and the House. I think hopefully, what that leads to is a more productive environment that says we have to get some things done. That may show up in the form of a stimulus bill. It could show up in the form of something that would sort of step in if that were to happen, if the ACA were struck down. I think you would see a quick effort from the administration, if it's Biden, obviously, from the House, but even the Senate to say, we've got to do something to cover these lives and shore that up. So I just think that it's so unlikely that it's probably not worth a whole lot of time on it, but I don't even think that's a draconian outcome.

[Operator]

The final questioner is Sarah Tan with JPMorgan.

[Mei Wen Tan, analyst]

Just one question on my end. I noticed that your proportion of renewal leases was a negative leasing rate increase this quarter. Should we be reading into that?

[Todd Meredith, executive]

Yes. It's -- I would say it's really a tail -- it's a story of the tails this quarter. So we did have a bit more that were on the negative, but we also had a bit more that were on the positive. And so they kind of balanced each other out and back to the performance that you've seen from us. On the left tail, they're on the negative, we did have one property that had an unusual renewal -- some unusual renewal option language that was a bit more favorable for the tenant, which drove the higher proportion of that negative spread. Excluding that one property, you would have had 10% of the spreads, would have been negative, which is pretty consistent with our historical range and what we have described as a reasonable long-term expectation on that end. But as I mentioned, the good news is that we also had 31% that were greater than 4 this quarter. So they did a bit cancel each other out. So I would say an anomaly and not something that we would expect long term and still very pleased with the overall performance.

[Operator]

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

[Todd Meredith, executive]

Thank you, Debbie. We appreciate everybody tuning in this morning and showing your interest and your questions. And we will be available today for follow-up or any time, and we look forward to virtually meeting a lot of you at NAREIT. Everybody, have a great day. Take care.

[Operator]

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