Healthpeak Properties Inc (DOC) 2022 Q3 法說會逐字稿

Greetings, and welcome to Physicians Realty Trust Third Quarter 2022 Earnings Conference Call. (Operator Instructions) as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Page, Senior Vice President, General Counsel.

Thank you. You may begin. Thank you, Doug. Good afternoon, and welcome to the Physicians Realty Trust Third Quarter 2022 Earnings Conference Call and Webcast. Joining me today are John Thomas, Chief Executive Officer; Jeff Tyler, our Chief Financial Officer; Del Mar Taylor, Chief Investment Officer; Mark Theine, Executive Vice President Asset Management; John Lucey, Chief Accounting and Administrative Officer; Laurie Becker, Senior Vice President Controller; and Amy Hall, Senior Vice President, Leasing and Physician Strategy. During this call, John Thomas will provide a summary of the company's activities and performance for the third quarter of 2022 and year-to-date as well as our strategic focus for the remainder of 2022. Jeff Theiler will review our financial results for the third quarter, and Mark Theine will provide a summary of our operations for the third quarter. Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect the views of management regarding current expectations and projections about future events and are based on information currently available to us. These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties. You should not rely on them as predictions of future events. Our forward-looking statements depend on assumptions, data and methods that may be incorrect or imprecise, and therefore, we may not be able to realize them. We do not guarantee the transactions and events described will happen as described or that they will happen at all. For a more detailed description of risks and other important factors that could cause actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission. With that, I'd now like to turn the call over to the company's CEO, John Thomas. John?

Thank you, Brad, and good afternoon. Thank you for joining us. The third quarter of 2022 is a quiet and steady-as-you-go quarter for Doc, further demonstrating the stability of medical office as an essential real estate class. This year has been challenging for health systems and physicians alike as medical cost structures have been impacted by double-digit inflation in both staffing costs and supplies that have been further complicated by lagging government and commercial reimbursement. Despite these headwinds, the United States demand for health care services is at an all-time high as the population ages and patients receive procedures that were deferred during the pandemic. Providers have continued the long-term shift of care to the outpatient setting, where advances in clinical science now allow for many higher-margin services like orthopedic surgery to be performed in a lower-cost environment. CMS has again expanded the list of procedures that can be performed in ASCs going into 2023. This trend is predictable and rush.

Outpatient care sites benefit from a more stable staffing model, increased operating efficiency and improved patient convenience. -- all while freeing up hospital capacity for higher acuity needs. Our portfolio is built with this dynamic in mind. While capital market volatility continues to produce a mismatch between buyers and sellers and the pricing of new investments, our entire team is focused on portfolio optimization and working with our health system partners to address their real estate needs for the years ahead. This partnership focus continues to enhance our development pipeline, and we continue to see the potential for a higher volume of development financing opportunities in 2023.

Within the existing portfolio, we continue to benefit from the increased market rental rates driven primarily by general inflation and rising construction costs. Renewal spreads exceeded our expectations at 6.2% for the third quarter, bringing our year-to-date spreads to 5.7% across 670,000 square feet of activity within our consolidated portfolio. Importantly, these high spreads have not come at the expense of retention, which remains near 80%. We remain excited about the performance of our portfolio despite a challenging macroeconomic environment. Mark will share more details in a few minutes. In September, Hurricane -- in caused wide-scale destruction in the West Coast of Florida, and our prayers and best wishes go out to the families directly affected by the storm. Our Florida-based team's quick response helped to mitigate the storm's impact on our health care partner providers, their patients and our real estate assets.

Fortunately, we experienced only minor wind damage to a couple of our smaller facilities, and the properties will be back in operation quickly. We had no material financial impact in the storm, and we're thankful that our team members and their families affected by the storm are safe. We've all seen the difficult expense environment health care organizations are experiencing driven by extraordinarily tight labor markets and medical supply costs as well as noncash mark-to-market losses in their investment balances. We've devoted significant resources at Dock to building a professional credit team who assist us in underwriting our investments, but also periodically reviewing the financial results of our tenants. We have visibility through lease reporting requirements into 94% of our tenants by ABR, with the average size of the tenants without this requirement totaling less than 5,000 square feet. We also utilize independent claims data to monitor procedure volumes across our portfolio.

Our largest tenant concentration is with Common Spirit across 12 markets. Common Spirits S&P investment-grade A- credit rating was reaffirmed in September with a stable outlook. Moody's and Fitch also reaffirmed their respective IG rating for Common Spirit as well. According to S&P, Common Spirit's strong credit rating reflects Common Spirit's exceptionally broad geographic reach, supporting a financially diversified health system across 21 states with a large $34 billion revenue base. Common Spirit has $15 billion of unrestricted reserves and 175 days cash on hand. While Common Spirit's 2022 operating margins were strained at negative 4.5%, S&P believes Common Spirit's labor initiatives and market strategies and performance initiatives should help the system achieve their targeted 5% to 6% EBITDA targets by June of 2023. With 66% of our space leased to similarly strong investment-grade health systems, we see similar resiliency across our tenant base despite broader market challenges.

Across the health care delivery industry, volumes and opportunity for revenue growth is there, and CMS, Medicare and commercial insurers are increasing reimbursement rates for 2023, reflecting higher inflation and labor cost. Dockan continues to make progress in our sustainability efforts, creating value for our health care provider partners, shareholders and communities through short- and long-range business, human capital and operations planning. As a benchmark for of our efforts, Dockan’s score of 75 out of 100 in the recently released 2022 GRESB real estate assessment, outperforming the international average of 74. We also earned a Green Star designation award to submitters achieving scores of 50-plus on GRESB's implementation and measurement of the management and policy sections. In addition, the company earned an A rating and a score of 98 out of 100 on the 2022 GRESB public disclosure level, ranking first in its health care comparison group.

As we look to 2023, it is difficult to project external growth until capital costs become more predictable and we can match our cost of capital to market opportunities, acquisitions or development financing. That said, the market appears to recognize that asset valuations will need to adjust to complete transactions and construction supply chains seem to be improving in our favor. Our balance sheet is in great shape, and our debt metrics are well managed with no near-term maturities so that when the current market conditions settle down, we are well positioned to grow and grow at higher levels. We expect to continue to capture higher leasing spreads and those increases in contractual revenue, along with our 2020 acquisitions and our 2021 development financing will increase our 2023 NOI, including same-store tea.

We will complete our 10th anniversary in July 23 in a very positive way. We believe medical office as an asset class has proven time and time again to be the safest and most defensive and most predictable real estate for investment and operational success. I will now ask Jeff to present our Q3 financial performance, and then Mark will address the performance of our high-performing award-winning asset and property management take. Jeff?

Thank you, John. In the third quarter of 2022, the company generated normalized funds from operations of $61.4 million or $0.26 per share. Our normalized funds available for distribution were $61.8 million, an increase of 13% over the comparable quarter of last year, and our FAD per share was $0.26. The company's operations were stable this quarter with same-store NOI growth of 1.1%. This came in below our expected range due to 40 basis points of occupancy loss, which Mark will discuss in a moment. We continue to believe that our rents are below current market levels, evidenced by the 6.2% re-leasing spreads achieved in the third quarter. Our largely investment-grade tenant base continues to perform as expected with no material increase in defaults or rental relief requests despite the inflationary pressures that JT discussed in his remarks.

Finally, in terms of our own margins, we remain shielded by our triple net lease structure with 84% of all operating expenses reimbursed to us by tenants in the third quarter. Our acquisition volumes increased in the third quarter, primarily due to the purchase of the Calculo Medical Center in Brooklyn, New York. Our expectation is that acquisition volumes will be lower in the fourth quarter as we wait for sellers to adjust their pricing expectations to better align with the current capital market environment. In the meantime, we will be lining up potential opportunities so that we can take full advantage of accretive deals at the right price. Along those lines, we continue to maintain a strong balance sheet that provides plenty of flexibility to be patient during this time.

Our consolidated net debt to EBITDA was 5.6x at the end of the third quarter, and we have no material debt refinancings until 2025. We raised $8 million on the ATM in the third quarter at $18.15 per share and have $300 million remaining in the current ATM program. Finally, a few updates to our 2022 guidance. We expect G&A to come in near the lower end of the $40 million to $42 million range that we set out at the beginning of the year. We are also reducing our guidance for recurring capital expenditures to $25 million to $27 million for the year, down by $4 million at the midpoint. This reduction is due to the better-than-expected condition of the $750 million landmark portfolio as well as impacts from tenants exercising automatic renewal options, which pushed more of the CapEx responsibility to the tenant. With that, I'll turn it to Mark to walk through some additional operational details. Mark?

Thanks, Jeff. Physicians Realty Trust completed a productive third quarter with our portfolio of outpatient medical facilities demonstrated stability growth amid the current economic environment. We are especially proud to share this quarter that our leasing team achieved above-average leasing spreads of 6.2% in Q3 on the heels of an impressive 8% leasing spread last quarter in Q2. The consecutive quarters of strong re-leasing spreads above the historical 2% to 3% is a direct result of the mission-critical nature of our assets and the enhanced value of our portfolio during a rapidly rising replacement costs.

Importantly, we've achieved these results without sacrificing retention without excessive concessions and not discounting annual rent escalators. In total, tenant improvement and incentive packages totaled just $0.61 per square foot per year on renewals, while we achieved an 81% retention rate and a 3.1% average annual rent escalator across our 251,000 square feet of leasing activity in the consolidated portfolio during the quarter. Leasing costs were particularly low this quarter as 25% of our renewal volume was completed via automatic lease renewal language in the lease or by tenant options to extend the term with no landlord contributions for tenant improvements or commissions. Given the current cost to build and finance a new development, we anticipate health care providers will continue to utilize existing medical office inventory, ultimately driving up total occupancy costs in quality facilities with well-capitalized real estate partners.

In terms of new leasing activity, Dockan currently has 85,000 square feet of executed leases in construction, but not yet paying rent. We anticipate approximately 20,000 square feet of these leases will commence in Q4 with the remainder commencing rent payments in the first half of 2023. MOB same-store NOI grew 1.1% during the third quarter, with results lagging due to a 40 basis point decline in same-store occupancy. Over half of this decline resulted from an opportunity to increase occupancy long term in a building with an investment-grade ASC tenant. While we're not satisfied with the 1.1% result, it's important to view the occupancy in the context of the broader MOB landscape. Our 94.7% same-store lease rate is meaningfully higher than industry averages. Tenant demand for medical office facilities has never been stronger, and we remain focused on unlocking the value of our portfolio for the long term. When necessary, this includes the selective vacating of suites that have higher potential with a different tenant even if growth is impacted on a short-term basis.

Looking ahead, we expect same-store occupancy to bottom in fourth quarter before returning to prior ranges as suites currently under construction become online. Same-store operating expenses were up just 2.1% year-over-year despite the high single-digit inflation experienced throughout the economy. This performance is a credit to our asset and property management teams working diligently on behalf of our health care provider partners to minimize total occupancy costs. Specifically, this quarter's results was driven by the successful challenging of several real estate tax assessments resulting in a year-over-year property tax decline of nearly $1 million that served to offset increases in noncontrollable utility expenses. These property tax outcomes are just one example among many of the ways that our team works diligently to execute consistently on behalf of our shareholders and hospital system partners to deliver value during this period of economic uncertainty. I'll now turn the call back over to John. Thank you, Jeff.

Thank you, Mark. Doug will now be ready for questions. Thank you.

Ladies and gentlemen, at this time, we will be conducting a question-and-answer session.(Operator Instructions) .Our first question comes from the line of Tayo Okusanya with Credit Suisse.

Yes. So the first one for me, just general hospital backdrop seems challenging. Again, all the public hospital names seem to have been having a rough couple of quarters. Curious as you interact with your hospital tenant base, what they're seeing, what they're hearing and if demand for MOB space is -- it seems like it's -- whether there are any kind of changes to demand trends, just kind of given the top operating backdrop for hospitals.

Yes. Great question, Tayo. One of the is we prefer and we've always focused on really non-profit hospitals primarily as the market strength and the market share those facilities typically have and the long-term commitments that those facilities have to the markets. As you know, Deanie came out of the Ascension system for 25 years. I violate sits immersing in Baylor for 10 years. It's the providers and the organizations that we partner with and the vast majority of our investment-grade tenant base, which is 66% of the whole portfolio, our non-profit health systems with long-term competitors to those communities. And so what we're seeing is a lot of -- again, like I said, portfolio optimization where they want at least the right space at the right price for both of us have market rents, which are increasing. And then the stronger systems, again, that we work with are looking at new growth opportunities, and that's where the development financing opportunities are coming. So it's a tough market revenue and volumes are high.

The challenge many hospitals are having with the volumes and the revenue opportunities is they don't have the staff to actually provide the service. Our health systems are fighting through those issues and again, have again, high utilization. But the expense structure, wage costs, supply costs or exceeding reimbursement rates, which there's always a time lag. And the government, in particular, can be a year to 2 years behind kind of current inflation costs. So CMS did better this year. They're not doing enough for physicians, and we expect that they will address that during the lame-duck session. The commercial insurers are stepping up as well to increase reimbursement to appropriate inflationary levels. So we're seeing a lot of positive momentum. Everybody is tightening their belt best they can. But most of the systems we're working with in the bigger markets, the stronger markets are really looking at expansion opportunities not retrenching.

Got you. Okay. Then the next one for me, just same-store NOI growth, again, we've all been trying to kind of expect steady 82% to 3%. You're kind of in below that range for the past 2 quarters at least. Everything seems to be going right in terms of the mark-to-market you're getting 6%, much more focused on operating expenses. So just kind of curious like when do you expect a lot of these kind of initiatives to ultimately kind of raise the same-store NOI growth to that kind of 2 to 3 even better relative to your peers.

Yes. Our expectations is we'll be back to a normal pace in 2023. As I mentioned a minute ago, we're really focused on portfolio optimization right now. We've had 2 or 3 locations where we just didn't renew a lease on purpose so that we could provide an expansion opportunity for, frankly, stronger tenants in those buildings. So same-store can be such a short-term number. We're really focused on the long-term performance of the portfolio. And with that, we've had a couple of quarters in a row with dynamics like that, that have had a short-term negative impact on same-store, but have a long-term benefit to the organization. Mark, do you want to expand on that?

Yes. That's perfectly said. And I think it's also important to keep in context that our same-store occupancy is at 94.7%. So it's a functionally very full portfolio. and the 40 basis point decrease in same-store occupancy represents about 53,000 square feet in total. The specific example that we were referencing with the ASC is a building in Minnesota, where we deliberately did not renew a couple of leases to make room for a large full floor ASC tenant with an investment-grade rated system. So that's an example where we're going to take a little bit of hurt on the same-store growth in the near term while that space is under construction, but ultimately will add great long-term value and take a building that was 90% occupied to 100% occupied for the years to come.

Our next question comes from the line of Juan Sanabria with BMO Capital Markets.

Just hoping to spend a little bit more time on the leasing side. You had great success on renewals for the last couple of quarters. But just curious on the new lease side, what those spreads look like and how much capital is being spent on that side? I think you gave us the renewal numbers both on the TIs in the prepared remarks, but just hoping a little bit more on the new side.

Yes, absolutely. So our leasing team has been doing a great job on both renewals and out there focusing on leasing the vacant spaces that we have -- as I mentioned, we have 85,000 square feet of new leases that are signed and under construction. When those are completed and generating revenue, they'll add about 100 basis points to our same store. To recruit new tenants, it is tough right now given the construction climate out there. And on a per square foot basis per year, this last quarter, I think we were close to $6, which is per square foot per year, meaningfully higher than our renewals, where we're experiencing quite a bit of tenants exercising options to renew or we have auto lease renewal language in a lot of our leases, keeping our CapEx low on renewals.

And then just on the tenant credit side, which Tayo just hit on, I mean, is there anybody on the watch list? I mean the tone sounds definitely a little bit more cautious, which I get. Or has the rent coverage numbers -- have those moved materially to -- and if you could provide any sense of a range of where those coverages are just to get a sense of cushion where we are today, even with the turbulence going on in the market.

Yes. No, I mean we haven't seen anything material in terms of any relief request or anything like that. coverages remain about the same. I mean, they're probably a little bit down, but not -- nothing that would concern us at this point. I think JT's remarks were just addressing the overall industry and what the health systems are going through right now. But we're not concerned about our own portfolio at this point.

Our next question comes from the line of Austin Wurschmidt with KeyBanc.

I was curious on the 25% automatic renewals that you referenced. How are leasing spreads negotiated for those types of deals given you're spending less on TI dollars? And are you able to change for the escalator dynamics within those types of leases?

Yes, that certainly varies lease by lease, but a lot of leases do have fair market value language included in them. So that is a conversation that we certainly have with the health care partners and in some cases, brokers in the market to help us determine the fair market value. Clearly, in many markets, that's increasing as a result of the construction costs and the inflation that we're experiencing in this environment. There are a few examples where the leases just continue to escalate at the previously negotiated annual rent escalator, which may be 2% or 3%. I think that really makes our leasing spreads that much more impressive when we need factor and some of those options renew that are renewing at 2% to 3%.

That's helpful. And I know next year's expiration is not really a huge number overall, but you did highlight this quarter is coming in above your expectation. I suspect those might have been negotiated during a different economic backdrop. So what does give you guys the confidence you can continue to achieve re-leasing spreads above historical levels given sort of this tenants are catching up, the reimbursement environment is catching up and it's just a little bit tougher overall for -- given some of the expense pressures, et cetera?

Yes. This is JT. The confidence level comes from, again, real-time kind of market discussions. As you mentioned, most of the leasing kind of has is an 18-month conversation before it concludes. And we still have high construction costs as it is -- the growth in that construction cost is moderating. It's coming down with certain types of materials, some labor, but we still have a high inflation rate that's going to drive better leasing spreads for the foreseeable future. So we'll have more kind of foreshadowing in our next call at the beginning of the year. But for now, we see continued positive trend at higher than usual rates.

Our next question comes from the line of Michael Griffin with Citi.

Great. Maybe starting on the transaction market. It looks like things have obviously slowed. I'd be curious to get additional thoughts on if you're seeing a private market appetite for MOBs out there and maybe a sense of where cap rates if they've traded, have sort of gone? And have you noticed a change in the spread between on versus off-campus cap rates?

Yes. They're just -- the market is, for the most part, just shut down right now. I mean interest rates have climbed dramatically since our most recent investment in the second quarter or the beginning of the third quarter, banks have shut down lending to the private market. So while you can find a loan from small regional banks, you're not going to get large capacity for portfolios or other expensive assets. So assets looking at cap rates, I think now the brokers have learned that it's going to -- at best case scenario a 6. And if you look at the cost of debt, if you can even get it and the equity prices of the MOB buyers in the public market, you're in the 6s and 7s before it becomes accretive, and you match up capital market costs with when we sell our expectations, they just haven't caught up there yet. So we've just paused. We're continuing with our development financing. We're at about $200 million of total investments for the year. We're still working through some of our development pipeline. Again, assuming we can get -- kind of can match up our yield expectations and needs compared to our capital cost. And we expect next year to be pretty robust fires market, if you will. So market just is not -- pricing discovery continues, it's getting closer, but we're not there yet.

Got you. That's helpful. And maybe just staying on the recent transaction activity. I'd be curious to get a little more color on the Calco acquisition. Maybe why it made sense. Also the JV partner, and it could there be a potential for future opportunities of this partner going down the road? And maybe additional color there would be helpful.

Yes. Let me address the JV partner first. It's one of our long-standing partners. We've -- as I mentioned earlier, we're in our 10th any-- we're in our tenth year as a public company. I think beginning in year 1, we did -- we started doing some one-on-one JV opportunities with them. That's a great sophisticated private company in Dalas that we've known for a long time, and they've found opportunities for us to go invest in. We sold them assets. We bought assets from them, et cetera. So a great partner, they brought us into this opportunity. So if you recall, we had just completed the sale of -- great Falls in Montana, that 4.7% cap rate. This is an asset that wasn't -- the calco asset in Brooklyn was not on the market when our JV partners started talking to them earlier this year, expectations and fair expectations were in the low 4% cap rate range. By the time we were invited to join those discussions, we have just completed the -- great Falls transaction. We needed a substantially better price than the low 4s.

We were able to convince the seller to accept a first year 5.5% cap rate. There's a little bit of leasing opportunity there, not much, but long-term great investment-grade tenant base, a lot of physicians affiliated with that health system in the building, new asset, relatively your building less than 9 years old in the Brooklyn market. And the opportunity for cap rate compression once cap rates start going back in that direction, we thought are outstanding. So the IRRs look fantastic. And again, we just had that recent sell just perfect opportunity to recycle that cash, those proceeds into a high-yielding long-term asset.

Our next question comes from the line of Joshua Dennerlein with Bank of America.

Maybe just a follow-up on the Calco acquisition. Just curious how you're thinking about your weighted average cost of capital and how that compares to that $5.5 million about the Calco asset for?

Yes, Josh, I just mentioned that was really an opportunity to roll 47 cap rate proceeds from an asset that generated a very large net gain from -- that we held for 9 years, said opportunistically rolling that cash into that investment. If we were pricing it today and we hadn't sold assets to recycle in an accretive way like that, we would think about the pricing differently. Incentives have gone up 150 basis points since we've completed that transaction. So it's a different world. 2 months, 3 months later. But at the time, it was a perfect opportunity to roll that cash into an accretive acquisition. And as I mentioned, we think about these investments on a 10-year plus IRR basis. And if you think about the long-term opportunity for compression in that market of a new asset, we think it's outstanding long-term IRRs.

Okay. But how are you thinking about your WACC these days? Where does it stand? Or how do you think about on a long-term basis?

Josh. So when we look at our weighted average cost of capital and use that to evaluate potential acquisitions. We're obviously looking at cost of equity, cost of debt. The cost of debt, that markets are not super functional right now, but I think we could probably do long-term 10-year debt in the 6.5% to 7% range depending on what day it is with 10 years jumping all around these days. Cost of equity is obviously going to be higher than that, kind of look at a FAD yield plus than expected growth rate. So we're looking at IRRs that are between 8% and 9% is like a target range on a unlevered basis. And so I think that matches up pretty well with what JT was talking about when he was saying that cap rates need to be in the 6s and possibly 7s in order to be accretive.

Our next question comes from the line of Ronald kamdem Camden with Morgan Stanley.

Great. Just a couple of quick ones. Just starting on the debt side. Just looking at the SAC here, I see the $262 million on the revolver, that's floating. I see the 105, that's floating as well. As you guys are sort of thinking about next year, it sounds like every 1% move in rates on the forward as sort of $3.6 million of headwinds. How are you guys thinking about sort of the headwinds from that potentially next year? Are you thinking about hedging? Just curious

Yes, it's a good question. We've got about 18% variable rate debt, which we're certainly cognizant of that, especially as rates seem like they're going to continue to increase. We do like having some cushion of variable rate debt that's easy to pay down. If we have loan paybacks from our mezzanine program and that kind of thing, it's a good short-term use of proceeds that is kind of hand-idilutive when you get paid back. But certainly, that's something that we continue to evaluate on a quarter-to-quarter basis, hedging strategies, et cetera.

Great. And then just continuing to put together some of the bread crumbs on the same-store NOI front, I think sort of the previous question, I think you talked about some of the repositioning and stuff that's being a drag a little bit from the historical 2%, maybe a little bit lower this quarter. But even if you get back to that 2%, isn't there a scenario that basically AFFO or FFO is actually flattish next year? Or just -- I'm just trying to think about the interest cost headwind versus the same-store NOI growth. Am I thinking about that correctly? Or how do you guys think about it?

Yes. I mean like everyone, we fight interest rate headwinds as they continue to go up. I think the same-store NOI, particularly if you add in some additional leasing opportunities that we think we might be able to get, we do believe we'll be able to overcome that kind of headwind, if you will. But certainly, it's kind of a tight environment right now. Ideally, we get some accretive acquisition opportunities as well, which could further enhance our FAD and FFO per care growth.

Makes sense. My last one is just going back to the transaction markets. You did some equity at sort of '18. Obviously, now the stock is a little bit lower with the soft of the market. Is it fair to say that other than maybe sort of recycling assets where you're selling to buy into, it's sort of going to be tricky to do anything else going forward? Or is that -- like is there any sort of other source of capital, JV capital that you guys are thinking about? Or is sort of recycling going to be the main driver from here?

I think it depends -- it's Jeff again. So it depends on kind of where we can find pricing in the market. I mean there's certainly potential acquisition pricing that would work even at our cost of equity right now. Like we haven't seen it yet because the market is kind of shut down. But should the pricing go to there, I think using equity would be a viable way to do that. Certainly, we look at capital recycling as well, and we've been in contact with potential JV partners for years. And if we had an opportunity that we could avail ourselves with that source of capital, we would also consider that as well.

Our next question comes from the line of Michael Carroll with RBC Capital Markets.

I wanted to touch back on overall market rent. I mean for MLPs, I mean, how broad based is rent growth? I mean, is it really regional? I mean are you seeing it, I guess, the difference between on-campus off campus? I mean how much has it been up really in 2022? And have you seen it accelerated through the end of this year?

Mike, it's JT. I'll let Mark comment as well. It's market to market, and it's kind of where you're starting from. That's why it's not like rent growth slowed down because this quarter was 6%. Last quarter, it was 8%. It's the leases coming due and what the -- where they are in their current market compared to the existing market. Nationwide construction costs are high. Those markets that are the strongest Atlanta, Minneapolis, some of the smiley face Marcus Phoenix are growing at faster rates than others, but we're seeing the opportunities really across the board. So it's -- we do expect that to continue.

And again, it's going to be quarter-by-quarter, but also market by market and where the opportunities are. As you know, most of our acquisitions come with new 10-year leases. So we only have so much roll each year to be able to capture this rent-growth opportunities. And then those tenants, as we mentioned, where they have options to renew at either fixed rates or current plus 2% kind of roll or some kind of market rent kind of arbitration process. That changes that dynamic, again, just based upon the leases in place. So it's really across the board, the opportunity across the country, though, is to roll rents up in most markets, assuming we were at market rates. Common Spirit as an example. When we did struck those 10-year leases in 2016. Those were all struck based upon the market rates in place in those individual markets at that time. So again, all of those should be growing at faster rates today.

Yes. I think it also varies a little bit by specialty of the tenant as well, where there's higher acuity specialty and more custom build out. Those are very sticky spaces and therefore, have a little bit more opportunity to influence the rental rate upon renewal. Just the alternative and the construction cost to relocate those are very difficult and especially and expensive in today's market. So we have a little bit more of an opportunity to increase based on specialty.

Yes. And Mike, the other thing I mentioned is the difference between on and off campus. I will tell you most of our development financing is off-campus as health systems are trying to penetrate new markets and capture market share. as they came out of the pandemic with balance sheet strength. And so I'd say there's probably more opportunity in the off-campus new growth locations, while there's still strength in the on-campus buildings as well. We're about 50-50. So we have kind of see both sides of that.

That's helpful. I know it's probably difficult to kind of answer this now just because the market is so uncertain. But do current market rents today, can you support a new development project or a break around a new development project, given where things are right now? Or does rents need to go up a certain percentage you really kind of make some of that underwriting work out?

You hit the nail on the head. The projects we finance are highly pre-leased, 90% plus. Most of them... 100%... At 100% with health system anchor tenants. And they're approaching that -- we're approaching that on a yield on cost basis and then comparing that to sort of the actual construction costs and comparing that to market rents, which are by definition today are going to be higher than kind of an existing building. But as I mentioned, these are health systems trying to capture new market share and expand in locations, geographies where they don't exist today. So it's a balancing act. So we're only going to fund those. We're comfortable that, that spread to an existing building can be achieved in the services that the health system is going to put in those buildings. And I think all of the things we're looking at right now have ambulatory surgery centers in them, partnered with physicians, partner with orthopedic surgeons. So they're high-margin services moving into those locations. So it's a balance is something that we have to be careful about in our underwriting, and we're confident that we are.

Okay. And then just how difficult it is to probably source new acquisitions? I mean, are you seeing other opportunities on the debt side? I mean, could we expect you to be a little bit more active on making debt investments over the next few quarters? Or do you really need to see where interest rates kind of really hammer out before you're willing to do and that type of stuff?

I think that's a great question, Mike. I think we've historically made debt investments, either as part of development or as part of a recap of the seller who's not ready to sell, but is willing to partner with us in some kind of economic basis. Most of the private activity because we've been competing more with private buyers in the last 3 to 5 years than we have with public buyers. Most of that activity at ICAP rates was done with low-cost debt that was 3- to 5-year debt. So just do the math, if we're looking at 2023, 2024, probably an opportunity to step in, in a very beneficial way for high debt or higher-yielding debt or acquisition opportunities. at preferable cap rates. So that's why we're excited about next year and the following year both in operations, but also the opportunity to deploy capital, again, assuming the capital markets to open up for us to match fund that.

Next question comes from the line of Steven Valiquette with Barclays.

Great. So this was touched on a little bit, but just back on the question on the components of the same-store cash NOI growth because last quarter, you had same-store revs up, call it, 4%, operating expenses up 8% to get to 1.9%. This quarter, it's revs up 1.4% operating expenses, much more in line and only up to get to that $1.1 billion -- you talked about the reasons why that is where it is for the quarter. That's all kind of understood. I guess the question is, if you had a crystal ball this for next year, just the round numbers, I mean what are the components just on the revenue growth and expense growth to get to same-store NOI will kind of shake out for next year once the dust settles and the retenanting and everything else.

Yes, I'll take that. So next year, we do think that there's going to be a nice rebound in our same-store. Our operating expenses this quarter were particularly low because of some of the real estate tax challenges that we were successful in contesting on behalf of our health care partners. Without those real estate tax benefits, we would have been closer to 7% increase in our operating expenses, and it is an inflationary environment out there. We will continue to work on behalf of our health care partners to keep those operating expenses as low as we can. But the nice thing about our portfolio is that it's very well insulated due to our high occupancy and triple net lease structure. So we think that those operating expense increases next year will be offset. And therefore, we're really going to benefit from the leasing work we've done, both in terms of the new leases coming online, the 85,000 square feet I mentioned and these leasing spreads. And so I think in 2023, we'll start to see the benefit of that and get back to our normal levels or even just a bit above our normal levels in the back half of next year.

Our next question comes from the line of Mike Mueller with JPMorgan.

I have 2 quick leasing related questions. First, Mark, on your comment about same-store occupancy bottoming in the fourth quarter, what's the rough magnitude of the decline relative to 3Q, 94.7%? And the second question is just on the rent escalators you baked into your 2022 leasing, how do they compare to prior year's escalators?

Yes. So on the first part, in the Q4 occupancy, we do know of our retention rate is historically 80%. So we know that there's going to be some move outs, but we're going to offset that with some new leases as well. We've got 20,000 square feet of leases signed that will come online in Q4. But we do think same-store will bottom occupancy will bottom next quarter and then a rebound in 2023. In terms of our annual escalations, our leasing team did an outstanding job this quarter, averaging 3.1%, and that's much better than our historical averages in the 2% to 3%. We're really pushing 3 and even 4 sometimes, and we can get it on our annual escalators to build in that long-term growth over a 5- to 10-year lease.

Our next question comes from the line of Dave Rodgers with Robert W. Baird.

Mark, I wanted to go back to the suite turnover that you talked about and the re-tenanting that will drive some of the results in 2023. Was there something that drove this year to be a higher amount of turnover within the portfolio? I would think that would be kind of a recurring natural thing for you guys. So I'm curious about how you view that in the next year or 2 versus maybe what made this year a bigger year of that turnover.

Yes, I don't know that this is necessarily that much bigger of leasing volume or turnover. And next year, we've got about 4.6% of our leases up for renewal. That's kind of been our average and our lease expiration schedule -- it's been 3% to 4% a year. And until we get to 2026 in those common spirit leases. So right now, there's just been construction and timing of the new leases, completing those and starting rent payments.

Yes, I think the -- this is JT. I think part of the dynamic is to like the ASC option here, they were probably looking at building their own building or kind of going into a new development at higher rents as we talked about the development financing we're doing with health systems that are capable of absorbing those higher rents, but doing much larger buildings and footprint. So high construction cost makes moving into an existing building, a better option or repurposing an existing building, a better option than a brand-new development projects. So I think that's probably driving some of these changes. And to do that, if you need 20,000 square feet, we don't have 20,000 square feet available in building. And we're going to have to eliminate our nonreducing leases to make that happen.

All right. Yes, that's fair enough. And then JT, maybe just for you with regard to -- you talked about kind of fully leased acquisitions. You've got fully stabilized developments that you're financing. Do you see an opportunity between that to do more maybe on the value-add side with the leasing team you have and the people that are in the organization to maybe add incremental value, particularly coming out of the backside of the dislocation in pricing.

Yes. No, I think we're exploring all those opportunities. Again, right now, the kind of just investment pipeline is still there. It's just quiet and sellers, if they're not forced to sell right now or kind of ride it out as well. But again, but I think we'll see more buying opportunities next year. But we've always looked for opportunities where billing might be 80% leased, but we have a tenant in hand. We have so much repeat business and so much aggregation of business with hospitals all over the country and with physician groups in multiple locations. So we're kind of always looking for an opportunity to buy an 80% occupied building and backfill it with a lease in hand with an existing client. So that is a great, great comment, great suggestion and something we explore often. There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Thank you, everyone, for joining us. And we just appreciate everybody joining us today.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.