Healthcare Realty Trust Inc

NYSE:HR

Earnings Call Transcript 2021-Q3

[Operator]

Good afternoon, 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 Kara Smith, Investor Relations. Please go ahead.

[Kara Smith, executive]

Thank you for joining us today for Healthcare Realty's third quarter 2021 earnings conference call. Joining me on the call today are Todd Meredith, Bethany Mancini, Rob Hull and Kris Douglas.

A reminder that except for the historical information contained within the matters discussed on this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in a Form 10-K filed with the SEC for the year ended December 31, 2020. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material.

The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30, 2021. The company's earnings press release, supplemental information, and Form 10-Q and 10-K are available on the company's website.

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

[Todd Meredith, executive]

Thank you, Kara. Good morning, everyone, and thank you for joining us for our third quarter earnings call. Yesterday, we reported quarterly FFO per share growth of 6.4%. This growth was largely driven by over $800 million of acquisitions over the past 12 months. Just as important, we're seeing operational improvements across the portfolio. Healthcare providers in our buildings are incredibly busy as outpatient utilization normalizes. So, not surprisingly, our leasing activity is up too and momentum is building.

In the near term, like everyone, we're working through supply chain issues. As build out time frames for new tenants stabilize and these tenants take occupancy, we expect our same-store NOI growth to return to our historical 3% range. The MOB sector's proven resiliency is attracting more capital. Like many real estate asset classes, MOB valuations are trending higher. Cap rates into the 4s are now common for large portfolios and certain individual assets with bond like characteristics. In contrast, so far this year, we've acquired 26 high-quality, mostly multi-tenant properties for $481 million at a 5.3% cap rate. We've been able to acquire these properties asset-by-asset at meaningfully higher initial returns through our direct sourcing model.

Beyond initial pricing, our targeted acquisition approach and operational platform delivers superior same-store growth over time. We're buying these properties in clusters within our existing markets where population growth is meaningfully above the norm. These are dense supply constrained markets, places like Los Angeles, Dallas, Denver and San Diego. We continue to acquire stabilized properties that are on and adjacent to campus. As we build scale within a sub-market, our local knowledge and relationships lead to more investments and allow us to safely expand our strike set. This extends our range to include ultra core on-campus, value-add and nearby off-campus properties. And we use our cluster strategy and our JV partnership to balance risk and return across these settings.

Years of diligent refinement and execution allowed us to build the highest quality growth-oriented MOB portfolio. Combined with our proven operating platform, this creates an attractive long-term return profile. And looking to the future, we're keeping our foot on the gas pedal. After achieving record acquisition volumes in 2019 and 2020, we're on pace to exceed these levels in '21. We've increased our guidance again due to the strength of our pipeline and see the ability to sustain annual investment volumes of more than 10% of enterprise value in the years ahead. With an aging population, driving continued growth in healthcare utilization, our strategy and ability to execute is poised to deliver strong FFO growth, like we're doing this year, consistently and on a long-term basis. The compounding effect of this level of growth and safety over many quarters and years is very compelling.

Before I turn the call over, I want to mention, we recently published our third annual Corporate Responsibility Report, which is available on our website. We're proud of the numerous ESG goals and milestones we've achieved, including our GRESB participation. I want to thank Carla Baca and our sustainability committee for leading these important initiatives, and we look forward to making further strides in the years ahead.

I'll now turn the call over to Bethany for an update on healthcare trends.

[Bethany Mancini, executive]

Thanks, Todd. The healthcare sector continues to ramp up operations, positive momentum across the board, both inpatient and outpatient, signals a move towards growth. Delayed routine care and treatment for chronic conditions are adding to high demand, undeterred by the delta surge in the third quarter. Hospitals are seeing wage pressures, but cost controls are proving effective, reimbursement has been positive and patient volumes are strong.

Physician offices are also performing on track with consistent growth in outpatient visits and surgery. Outpatient trends remain a bright spot in the sector. Physician office employment was steady in September, even amid economic uncertainty and higher demand for labor. Physician groups are looking to expand their presence and service lines both within their markets and regionally. Their strength should continue to support Healthcare Realty's internal growth and demand for MOB space. Overall, healthcare providers continue to prove their resiliency.

Government reimbursement has been a boost to margins since 2020. Temporary increases in Medicare rates due to COVID relief will sunset at the end of 2021, with strong performance this year even amid declining pandemic volumes the need for marginal federal relief is reduced. Congress had signaled support for healthcare providers and continued to look for ways to extend higher ACA subsidies and Medicaid coverage. More certainty in health insurance coverage for the future is a positive sign for patient demand and providers plans for growth. If we have learned anything over the past 2 years, it is the necessity of our nation's healthcare system. We are pleased with the strength of HR's hospital partners and physician tenants and the steady performance of our MOB.

Now, I will turn the call over to Rob for an update on our investment activity. Rob?

[Robert Hull, executive]

Thanks, Bethany. Acquisition momentum continues to build. Year-to-date, we have invested $481 million across 26 and 21 separate transactions, all within our existing markets. For the year, we have moved our guidance up to $700 million at the high-end. We are curating a high-quality MOB portfolio, not simply chasing volume for the sake of volume. This starts with our data-driven market research, vast network of industry relationships and deep local market knowledge. For us recognizing quality begins by identifying fast growing markets where we can build scale alongside leading healthcare providers. We determine the buildings we want to own whether for sale or not and leverage our relationships to gain access and ultimately acquire these properties.

Beyond acquisition volume, owning multiple buildings and clusters provides opportunities over time to enhance operational and leasing performance. To highlight the advantages of our process, it is worth contrasting our $481 million of activity with the widely marketed portfolios. So, far this year, we have evaluated 10 widely marketed -- market MOB portfolios above $100 million, representing over $3 billion of real estate. Our acquisitions have superior demographics when compared to these portfolios.

There are 3 data points. First, population growth around our acquisitions averaged 5.4%. This is nearly double that of the marketed portfolios and the national average. Second, our population density of 841,000 was 50% greater than the marketed deals. And third, our median household income of $94,000 is 40% higher than both these portfolios and the national average. In addition to superior demographics, our real estate fundamentals are better. 78% of our acquisitions were on or adjacent to campus versus 35% for these marketed deals. It's also worth noting that 100% of our acquisitions were in our existing markets, not only are weighing great markets that we know well, but we are also directly partnered with leading health systems.

In short, with the blended cap rate approximately 30 basis points higher than the average for these portfolios, we are buying better real estate at better valuations. In the third quarter, we acquired 10 properties for a total of $165 million. 2 of these properties were in Raleigh, part of the fast-growing tech-driven research triangle, a market we entered just 18 months ago. And 6 buildings were in Colorado, a market we've been investing in since 2008. We now own 28 buildings, totaling over 1.8 million square feet in this state, mostly concentrated in Denver and Colorado Springs.

Looking ahead, we will finish the year with a strong fourth quarter. We have over $250 million under contract for LOI, all in our existing markets at an average cap rate in the low-5s. Driven by the strength of the market, dispositions remain an accretive source of capital to fund acquisitions. Year-to-date, we have completed $128 million in sales at an average cap rate of 4.1%. We expect to sell a few more buildings this year in markets where we don't see a path to add significant square footage and drive long-term growth. We are increasing the upper end of our disposition guidance to $200 million.

Development activity remains on track and focused around our target markets. We have $100 million of development currently underway in Nashville, Seattle and Dallas. Our projects are primarily sourced from our embedded pipeline of over $1 billion. We are having meaningful discussions with several existing health system partners in Georgia, North Carolina and Texas, a strong sign that providers continue to look ahead and plan for growth. As we look to 2022, our investment pipeline is as large as it's ever been. It is constantly being replenished through sourcing efforts in our target markets. We have grown our team and refined our process to sustain higher levels of activity. Our ability to consistently execute has set us apart and we are better positioned than ever before for accelerated accretive external growth.

Now, I'll turn it over to Kris for a review of our financial results.

[J. Douglas, executive]

Thanks, Rob. Strong third quarter results demonstrate how our steady operating performance and healthy acquisition volume contribute to meaningful FFO per share growth. Year-to-date, FFO per share is up 3.5%, and for the quarter, it was up 6.4%. While many have experienced extreme earnings volatility over the last couple of years, we have reported reliably positive quarterly FFO per share growth, exactly what our quality MOB platform is built to deliver.

Our same-store NOI growth has been between 2% and 3% throughout the challenges of the last 18 months. Currently, our same-store NOI is running at approximately 2%. This even includes the impact of a 50 basis point decline in average occupancy. This drop was due to a pause in tenant activity in the summer of 2020 and ongoing delays in build out time lines. We saw the build out time lines and occupancy stabilized sequentially. The stabilizing occupancy will allow our same-store NOI to trend back towards our in-place contractual escalators of 2.9% over the next several quarters.

What is really encouraging is that our leasing team is reporting strong interest for new and existing tenants for more space. Our ability to drive consistent internal performance is supported by our embedded portfolio growth drivers. This quarter, cash leasing spreads were 3%. Our in-place contractual escalators were 2.91%, and for leases commencing in the quarter, our bumps were also 3%. The these built-in increases compound annually and fuel our earnings growth engine. This quarter we added new disclosure to help better communicate the escalators across our portfolio. We are now breaking out the in-place rent increases for acquisitions. Typically, acquisitions have lower escalators than our portfolio average. What is important is that this provides a very attractive opportunity to improve the growth profile of these assets. As leases roll, we expect to improve these escalators. Our success in doing so provides meaningful incremental value over and above day 1 cap rate accretion.

Regarding our balance sheet and liquidity, we continue to benefit from access to multiple sources of capital to accretively fund our external growth. We have $116 million of forward equity contracts to be settled over the next 12 months. And with low leverage, our debt ratings were recently affirmed by Fitch and S&P. Beyond the public markets, we have a unique source of long-term capital through our joint venture with Teachers. Over the last 12 months, we invested almost $250 million with this partnership and there is significant capacity for more. With respect to our dividend coverage, our FAD payout ratio was 87% year-to-date and 90.8% on a trailing 12-month basis. Maintenance CapEx is typically seasonally higher in the fourth quarter. But even so we are on track to end the year with a FAD payout ratio below 90%.

As we look ahead to next year, we are encouraged by strong demand for outpatient care across our markets and a robust investment pipeline. This will drive improving internal growth and accelerating acquisition volume with the margin of safety unique to medical office. A flexible balance sheet and multiple sources of capital position us well to translate those into continued attractive FFO per share growth.

Operator, we're now ready to open the line for questions.

[Operator]

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

[Juan Sanabria, analyst]

Just curious on your comments about cap rates moving lower you kind of into the 4s. So, are the deals that you've been signing recently indicative of kind of oil pricing that has tightened since or is -- or the cap rates are quoting somehow being benefiting from your strategy of being -- building local presences and the kind of the operating platform, just trying to get a sense of the disconnect, or is it purely that the one-off deals are not as sought after and there's not as much competition, and that's where you can find that kind of value add opportunity?

[Todd Meredith, executive]

Juan, certainly more the latter of what you just said. I think clearly we've been pointing out for some time that there is -- there has been a while -- for a while substantial portfolio premiums being paid. It's just the sort of the sought after nature of getting scale in MOB, a lot of private capital, a lot of folks chasing it. So when those portfolios come of scale, you see a lot of fever around that. And so cap rates come down. We're also seeing, as I mentioned in my prepared remarks, in some certain individual assets where you see these bonds like characteristics, super long lease term, our view is it doesn't fit our portfolio as well. It may complement a cluster. Occasionally, we may look at those. But generally speaking, those are slower growth vehicles. And maybe as Kris just described, not places where we can enhance the growth profile of those assets. So our view is our platform and our approach going asset-by-asset in our markets does give us an advantage of not paying those extra premiums. And I think as Rob pointed out, the deals under contract or LOI are at very similar cap rates to what you've seen us do year-to-date. So I think those are very current fresh cap rates.

[Juan Sanabria, analyst]

And then just curious on your comments about delays in, I guess, sitting out the space. So, when do you think we'll start to see occupancy tick back up and the confidence that the issues with regards to labor availability won't get worse before they get better?

[Todd Meredith, executive]

Yes, you're right. We have seen some extended time lines in our build outs. We talked about that a little bit last quarter. And it's extended from pre-pandemic levels by, call it, about 30%. The positive was that this quarter kind of stabilized. So, we weren't seeing those time lines extend. So, even with just the stabilization that will help us in terms of occupancy to be able to stabilize and hopefully start to rebound over the next several quarters into next year. And then if they can start to -- if the build out time lines can start to shorten, then that just helps in terms of being able to speed up the positive absorption. One of the things that we've looked at, I think, is interesting is our amount of lease but unoccupied space has also expanded in concert with what's been happening with the longer build outs.

And so it's also about 30% longer than or larger than what we were seeing before the before the last 18 months. And so if you look back and said that if our leased but unoccupied space was the same as it was in first quarter of '20, occupancy this quarter would have been 40 basis points higher just because of that difference in that lease but unoccupied space, which would have a meaningful difference in occupancy as well is our same-store NOI growth. But all that's say, stabilization is good, and we think that will allow us going next year to start to see that same-store NOI trend back up in line with our contractual escalators in the high 2s, approaching 3. And then if we can see any benefits that will just speed that up and also provide some incremental additional growth.

[Operator]

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

[Jordan Sadler, analyst]

I just wanted to clarify that last point on sort of the lease but not occupied and maybe compressing or watching that trend normalize. What's sort of the time frame for that 40 basis points, if you will, to come online?

[Todd Meredith, executive]

I guess, the way I'm looking at it right now, Jordan, is just the fact that it's stabilizing, and it's not growing. So, it's kind of staying in that 30% higher than what we saw before. That in and of itself provides a benefit because you're not losing ground, so you're not losing occupancy. So that in and of itself will provide some uplift to be able to see that over the next several quarters the NOI rebound closure to our escalators. If -- and we're -- at this point we're not going to pick a date and tell you when we expect those build out time lines to rebound to normal. But when that does happen, that just will be incremental improvement over and above the benefit we're already seeing from just the stabilization.

[Jordan Sadler, analyst]

And just specifically, how would you characterize what's driving that -- those delays? Is it -- you don't have material -- because I think you mentioned supply chain and I was taking back a little bit because I wasn't looking or thinking would be supply chain issues, rearing the head necessarily within the medical office space in particular. And then I'm just kind of curious to hear some of the detail around what may be causing these issues.

[J. Douglas, executive]

It's a combination of things. A portion of it is permitting. So, it's getting longer to get through the permitting depending on the local municipality, especially in high growth markets, like a Dallas or a Nashville, Denver, those types of areas. So, that's one issue. And as it relates to the supply chain, it really has to do with the build out of the space and the materials. And frankly, it's not consistent across the board on every project of what you see. In some areas, we're seeing paint could be more difficult to source HVAC equipment. Frankly, it kind of differs depending on the project.

We are doing things of what we can to try to offset some of those delays, trying to buy some -- if we know we have a kind of consistent back to the paint that I was mentioning, if we know that we have a consistent color scheme that we use when we find supplies of that going ahead and make sure we have that on hand, I think everybody is adjusting to the time lines and trying to get better about ordering things ahead of time so that it doesn't create a backlog and waiting on supplies to arrive. But I think everybody is just trying to figure out how to work through it. But it's really the combination of the material supply chain as well as the permitting.

[Todd Meredith, executive]

And Jordan, I wouldn't call this out as something unique to medical office. I think these are the same things you're hearing across real estate, across individual issues. If you order a refrigerator right now for your house, it's going to take a lot longer. It's the same issues, it's materials all the way from electronics down to paint, as Kris said.

[Jordan Sadler, analyst]

And I wasn't continuing, it was just MOBs. I just -- I wasn't expecting to hear it within MOB that just -- that wasn't something I was thinking of the bus risk factor per se, okay. No, that's helpful color. And maybe, Todd, about have you. So, you guys spent a ton of time over the last several years, refining the portfolio really aggressively, asset managing the portfolio and working to maximize the portfolio's growth and growth potential, especially as it related to escalators, but also refining the quality of the asset base. Can you maybe offer some insight around the current strategy in terms of the external growth piece of it? And how the addition of these assets is accretive to the company's overall growth?

[Todd Meredith, executive]

I think it's certainly, you're right, it goes back to sort of refining the portfolio over the years, really focusing in on the markets we want to be in, looking for those quality assets, places where we can build scale and have great relationships, as Rob said, alongside these health care providers. So, we've done that for a long time. And I think our view now is we're getting a lot of traction from our reputation and our expertise in the space and all of the relationships that we have where we're finding more and more opportunities to expand that. And so Seattle is the perfect example. We have a page in our investor presentation where we talk about the benefits of scale in Seattle. And it's certainly on the expense side, but I'd say it's even more powerful on the leasing side. And you've heard several of us talk about how we can not only have day 1 accretion, to your point, but then also go in and create value through our platform, meaning we have the leasing expertise locally to continue to push and enhance those escalators, as Kris said, on the acquisitions we make. So, if we buy assets and they're at 2% escalators or 2.5%, we can work through the lease role as that occurs over several years after we buy it and move that up towards the average we have in place, that's 2.91%. So, there's clear accretion benefits beyond the initial acquisition from that. And then clearly, beyond that, you also build relationships with healthcare providers.

And so when we go off-campus, we're usually looking at providers, whether it's hospital or doctor groups that are identifying locations they want to expand their business away from campus. So, we can follow those quality providers. And in many cases, it helps us also find some acquisitions that may have higher -- a little higher return, a little higher risk reward profile. As you know, we put a lot of that in the JV and kind of balance that risk. So, we view that as building out the whole strategy and enhancing growth, and we see external growth always have, but now more so than ever in a very focused way, see external growth adding to the power of that internal growth that we've been building up.

[Operator]

Our next question comes from Nick Joseph with Citi.

[Nicholas Joseph, analyst]

Maybe following up on the disposition. So you mentioned a handful maybe for the remainder of this year. What's beyond those asset sales in terms of assets that don't fit within the current strategy and portfolio?

[Robert Hull, executive]

I think that if you look at what we're selling -- planned to sell for the remainder of this year, it's sort of fine tuning, continuing to fine tune the portfolio. We have a handful of assets out there that are what we deem to be orphan assets. So, this certainly candidates places where we don't think we can continue to build scale and drive growth as Todd just described. So, I think as we move into next year and look at opportunities for dispositions, it would be similar to that, things that we just don't see a good opportunity to grow and build out the clusters and benefit from the enhanced scale within a market.

[Nicholas Joseph, analyst]

But that could be a source of capital for next year's external growth as well, additional dispositions that don't fit?

[Robert Hull, executive]

Yes. Certainly, we'd view it that way. I think if you look at where we're -- the cap rates where we're selling today, certainly taking advantage of the strength of the pricing in the market and taking those dollars and rotating in the assets where we can grow meaningful clusters and drive long-term growth. So that's our -- that will continue to be our strategy with dispositions going forward.

[Nicholas Joseph, analyst]

And then maybe just following up on the same-store growth. Appreciate the commentary on kind of getting back to that long-term run rate and the additional disclosure. But you maintained 2021 same-store cash NOI guidance. Is there anything in the fourth quarter that could get you up to that midpoint or are things trending towards the low-end at least for 2021?

[J. Douglas, executive]

For full year, we'll probably be below that midpoint. There are, as we talked about last quarter, there's a lot of comparability issues quarter-to-quarter that are going on given the unusual circumstances that occurred over the last 18 months related to parking and rent deferrals and some of those things. For this quarter, the rebound in parking and the reversal of some of our rent deferral reserves pretty much offset each other. They provided a bit of a lift last quarter. And so you have those things that are bouncing around. But the main piece that is driving right now that lower same-store NOI is the occupancy that we talked about. And so our hope and expectation is that stabilizing will start to rebound, but that will take several quarters to build back up to those more in line with the contractual escalators. But still within the 2% to 3% range, but as you pointed out, probably below the midpoint.

[Operator]

Our next question comes from Rich Anderson with SMBC.

[Richard Anderson, analyst]

So, Kris, I think you said tenant delays, getting back to the same-store conversation, tenant delays started in the summer of 2020. Did you -- did I hear you correctly?

[J. Douglas, executive]

Yes, you had a couple of things. Then you just had such a pause in terms of leasing activity during the summer of 2020. And so that did play through a bit of the leasing momentum that was going on at that point. Once things did late last year start to kind of get back to normal in terms of tours and leasing velocity that was then compounded by the delays in being able to convert those from leased into occupancy because of the supply chain. So as you look at it on a kind of trailing 12-month basis, you've got the combination of both of those items.

[Richard Anderson, analyst]

So, then why were you able to produce in line, if not better, same-store growth in the first and second quarter of this year? Why didn't it play into those numbers?

[J. Douglas, executive]

And that was, as we talked about, specifically last quarter, it has a lot to do with those comparability issues. It's the rebounding of the parking. It's the offset from quarter-to-quarter and year-over-year as you look the deferrals, the repayment of the deferrals, the reversal of some of the reserves that we took going on. So that's, as we've talked about earlier in the year, that creates some noise from a comparability issue. We still had some of that going on this quarter as well, but they -- but frankly they just kind of offset each other. And so it's -- those items and the impact of them in any one particular quarter is going to be what is creating some of the variability that you're seeing.

[Richard Anderson, analyst]

So, if I'm hearing you right, then, if I take out the variability from parking and rent deferral noise that this occupancy issue would have been kind of present in the first and second quarter as well in terms of this bottom line same-store growth that you see.

[J. Douglas, executive]

Yes, certainly. And I look at it, it just goes back to the kind of the algorithm and the math. If you go -- our growth from our contractual escalators is 2.9% or cash leasing spreads or 3%, 3-plus. The underlying growth that you're seeing should be kind of plus or minus 3%, all else equal. And then occupancy for us, given our margin, has about a 2% to 1% impact to your NOI. So, if you're running -- if the expectation is you should be running kind of high 2s and then whatever your change in your overall occupancy that is going to have a 2% to 1% impact to your NOI. So for this quarter, a 50 basis point drop in occupancy kind of moves you from the 3s down to the 2s. So that's what you should expect, and that's what I would expect to see from other portfolios. Now, like I said, those comparabilities issues that would make you see results that might differ from that algorithm and what you would expect.

[Richard Anderson, analyst]

Second question for whomever. So I'm trying to triangulate -- you get -- let's just say you recover this 50 basis points of occupancy over the coming year and that, obviously, is the factor in the same-store calculation. How much of the cost to create that occupancy gain are capitalized, and hence, not included in the same-store calculation? I'm just trying to -- I know that's how the business works, but I'm just curious what's hiding behind the scenes a little bit in terms of the expense side of the same-store calculation?

[J. Douglas, executive]

On the expense inside of your same-store NOI, you're really not going to have much of an impact. Where you're going to see it is related to your maintenance CapEx and the TI build that you're going to have there.

[Richard Anderson, analyst]

So it's all capitalized. That's all this is capitalized.

[J. Douglas, executive]

Yes, exactly. The TI is going to be capitalized associated with that. And that's one of the reasons you have seen with those longer time lines and build-out we haven't spent the money as fast this year and so it's one of the reasons that we're trending on the low end, especially on our TI spend compared to what we expected at the beginning of the year.

[Richard Anderson, analyst]

And again, I know this is how it works, but you kind of get the benefit of the revenue, but you don't in the same-store calculate. I mean, it all comes down to the bottom line earnings. So I'm not troubled by it, but the optics are what they are. Last question...

[Todd Meredith, executive]

Rich, one thing I would point out there. It's almost the opposite is that to the AFFO is that you end up spending all of that capital upfront, and it goes through your maintenance CapEx, where the revenue you're going to get over the life of that lease. And so as you start to think about the impact to AFFO in terms of positive absorption, there is a little bit of a headwind there. But over the long-term that positive earnings growth is more than worth it.

[Richard Anderson, analyst]

I 100% agree. And I always say people should be focusing on earnings and not in same-store for perhaps that very reason among others, but yes, I get that completely. Last question, and maybe for Rob or whoever, acquisitions, 5% plus type cap rates, dispositions close to 4%. Are they being calculated the same way apples-to-apples because that spread seems pretty wide, assuming you're selling harrier stuff and buying better stuff, of course?

[Robert Hull, executive]

I mean, I think in terms of the cap rates, it's certainly figured on a trailing NOI number. And I would also say that many of those properties or some of those properties that we've sold, they are low occupancy properties. They're not growing. We don't see a lot of opportunity for growth in the marketplace. And so there is some impact from selling those in low occupancy.

[Richard Anderson, analyst]

So, dispositions on trailing 12 acquisitions on forward 12?

[Robert Hull, executive]

Generally speaking, that's right, because it's the dispositions are what you're taking out of your model, for example, and then obviously, going forward, what you project with those acquisitions. So that's about the only difference it's price and NOI otherwise.

[Operator]

Our next question comes from Connor Siversky with Berenberg.

[Connor Siversky, analyst]

Just wanted to zero in on second-gen TI. So, with the reiterated guidance range, I think it was $28 million to $34 million. I'm just wondering if you could comment on how this is trending into Q4. And I'm wondering because just to get to that midpoint requires a pretty hefty spend for the fourth quarter even relative to what we would typically assume in seasonality.

[J. Douglas, executive]

Yes. I think you're right. And it goes back to what we were just talking about with Rich in terms of the second-gen TI, in particular, with the longer time lines there that spend is coming in on the low-end of the guidance range on the leasing commissions and the CapEx, they're going to be probably closer to the midpoint. But yes I think you're -- I think that is reasonable and appropriate to assume that it will be at or below the midpoint. But I would point out and you are right that there is typically a seasonally higher spend in the fourth quarter, and we expect that to occur this year as well. But even with that our expectation is for -- to be able to generate a dividend FAD payout ratio that's below 90%, which is how we're trending so far on year-to-date.

[Connor Siversky, analyst]

And then are you seeing any kind of trends in terms of TI? I mean, are tenants looking for anything new within these improvements relative to what you've seen in your FDA?

[J. Douglas, executive]

Not materially different, not at all. I mean, certainly, we see like everyone in real estate cost increases, but not from a design standpoint. It would materially change that, just the typical pressures of construction costs, but nothing that would materially change that cost level or the design. I mean, it's -- we've been on the lookout for that ever since the pandemic started and haven't really seen a material shift.

[Connor Siversky, analyst]

And then a bit of a higher level question. Just considering your operators segments, are you seeing or hearing any commentary that would suggest increased demand for assets that can facilitate certain specializations, whether that's oncology or cardio, for example, compared to perhaps something in a lower acuity setting?

[Todd Meredith, executive]

Different demand based on specialty. I mean, I would say, that concept has been in the market for a long time. And clearly, as we focus more heavily on and around campus, we tend to see a lot of that on the specialty side. And if you look at our list and our presentation of our top specialties, the ones you just cited are very high because we're near campus. So you'll see cardiology and oncology be very strong in our on campus and you can kind of see that we break it down on versus off. But I wouldn't say we're seeing a dramatic shift here at this point. I mean, we continue to see a lot of that congregating around campus.

I think more broadly speaking, you see groups have gotten larger over time and they tend to have more and more locations, and they want to be in really all the locations that can be to cover the market and attract patients and expand. Bethany talked about that a little bit in her remarks. So, usually, a group today, wherever you might be, they may be on-campus and on multiple campuses around a market, and then they have a whole lot of off-campus sprinkled around as well. So, it's really kind of everywhere, not just one versus the other.

[Operator]

Our next question comes from John Pawlowski with Green Street Advisors.

[John Pawlowski, analyst]

Maybe just one follow-up question on that topic of kind of structural changes in tenant preferences. Do you guys expect over the coming years any shift in average lease term in your negotiations?

[Todd Meredith, executive]

Not materially. No, we certainly keep an eye on that, keep an ear on that with our leasing team and all the feedback that they get. We're usually not pushing hard in one direction or the other. We're comfortable with what we generally see out there, which is typically either side of 5 years. A lot of times the -- a new tenant comes in wants a longer lease, because they may be spending some dollars and want to spread it out. That is certainly true in the development area as well. But I would say, generally speaking, we're not seeing a dramatic change in lease terms for any of those reasons.

[John Pawlowski, analyst]

Second question, on your -- are you guys cash leasing spread distribution where you break out less than 0% spread all the way up to greater than 4% spread. Could you just help me understand the type of markets and the type of product type within the markets that fall within those go posts? So what type of properties you're seeing cash leasing spreads decline and which ones are the outsized growth areas?

[Todd Meredith, executive]

We look at that every quarter. We track that by market. And I will tell you, you look for patterns and you usually find it as soon as you think you're onto something that something happened in Memphis versus Nashville, it reverses. So, I would say we haven't seen a very discerning trend that suggests, oh, we're just having the lower spreads here versus there. I would say maybe at the extremes, we've certainly seen some geographic concentrations of maybe at the high end. We saw a fair bit in the D.C. corridor that area in our portfolio for quite a long time. In Hawaii, we saw some really strong as well.

But I wouldn't say that there's a very clear pattern that, oh, it's really consistently poor here. And if we do pick up on that, it kind of feeds what Rob talked about, which is, hey, that's a little bit how we think about dispositions. If we start picking up on that, we might -- it might inform how we think about our ability to grow and expand performance and the portfolio in a particular market.

[J. Douglas, executive]

One thing I would add to that is it's not big extremes of the plus 4% versus the negatives, but just incrementally, we do see slightly higher average escalators and cash leasing spreads for the smaller leases and which makes sense. You end up with a small tenant close to campus if not as may not have as much pricing power as well. It's maybe a smaller percentage of their overall cost structure on the lease. So, we do see some incremental better spreads in those locations. And that's one of the reasons that we like the multi-tenant MOBs because you start getting up to your larger single tenant, and it just frankly changes some of the dynamics in the lease negotiation.

[Operator]

Our next question comes from Mike Mueller with JPMorgan.

[Michael Mueller, analyst]

Just wondering given the number of development inquiries you've been seeing, when would you expect the annual spend on the development front to start to ramp up?

[Robert Hull, executive]

I think that this year, we're -- we got about $100 million that we're working on. And we -- most of that has come from our embedded pipeline. We've talked about that before, where we control those opportunities, have great relationships with the health systems where we're developing and have the opportunity to develop. And I think that's where you'll continue to see us live on the development side. We've kind of looked at that portfolio and think that over the next 8 to 10 years, we can produce around that $100 million, $125 million of starts every year in terms of new developments. We've got a number of conversations going on right now with systems in North Carolina, Texas and Colorado in terms of new developments. And we think it's going to kind of continue to be at that level in the $100 million range year in and year out.

And so quite frankly that's the level that we're comfortable with. We think that developing to the spreads where we think we can develop 100 to 200 basis points above where cap rates are today for stabilized assets. We think that provides the meaningful value and also provides a service to our health system partners where we can grow with them. So, we like where we stand on the development side. Certainly, we have the opportunity to move that up slightly, we might. But the great thing is that but by developing out of our embedded pipeline, we feel like the sort of the traditional development risk is mitigated by -- we know the markets, we know the health system, we know the demands in terms of space demands that are needed and so we think it mitigates a lot of the traditional development risk.

[Operator]

Ladies and gentlemen, this will conclude 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, everybody, for joining us today, and we appreciate your time and interest in Healthcare Realty, and we look forward to speaking with many of you next week at Nareit. Have a great day.

[Operator]

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