Healthcare Realty Trust Inc (HR) 2013 Q2 法說會逐字稿

Good day, and welcome to the Healthcare Trust of America second quarter 2013 earnings conference call. All participants will be in a listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Robert Milligan, Senior Vice President of Corporate Finance. Please go ahead.

Thank you, and welcome to Healthcare Trust of America's second quarter earning call. Joining me on the call today are Scott Peters, our President and Chief Executive Officer, and Kellie Pruitt, our Chief Financial Officer. We'll be happy to take your questions at the conclusion of our prepared remarks. Last night, we filed our second quarter's earnings release for 2013. This document can be found on the Investor Relations Section of our website or with the SEC. This call is being webcast live from our website, and will be available for replay for the next 90 days.

During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the current beliefs of Management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance. Therefore, our actual future results can be expected to materially differ from our expectations. For a more detailed description on some potential risks, please refer to our SEC filings, which can be a be found in the Investor Relations Section of our website. I will now turn the call over to Scott Peters, President and CEO of Healthcare Trust of America. Scott?

Thank you, Robert, and good morning, everyone. We appreciate you joining our call today as we discuss HTA's second-quarter performance. At Healthcare Trust of America, as you are aware, we are focused on the medical office building sector, acquiring a leading portfolio through a very disciplined process, principally one asset at a time, with a focus on growth, stability, management expertise, and creating long-term shareholder value. In addition, our organization is dedicated 100% to the medical office sector, and we do not spend time on development or the other healthcare asset types. Our Company is approximately $3.5 billion in size with 12.9 million square feet in 27 states. That makes us one of the largest owners of MOB's in the country. However, our size still affords us the ability to demonstrate meaningful acquisition growth to our rifle-shot approach of acquiring targeted assets.

Over the last three years, we have created what we believe is a unique, regionally based Asset Management and leasing platform that optimizes the occupancy, efficiencies and relationships that are critical in achieving lasting same-store growth. As a management team, we believe we have a Company that is well-positioned to grow and succeed as the economy recovers and the healthcare landscape evolves under the rollout of the Affordable Care Act. For the second quarter, we reported our third consecutive quarter of same-store growth exceeding 3%. This reflects the performance of our entire portfolio. We believe this performance reflects our dedicated focus on the medical office sector, the quality of the assets we have assembled, the benefits from our regional in-house Asset Management and leasing platform, and the beginning of several macroeconomic trends, including the Affordable Care Act and the resulting impacts on healthcare providers and healthcare systems. We were fortunate to have completed our first full year as a publicly-traded company in June, a significant milestone for our Company.

We continue to focus our attention on the strength of our investment-grade balance sheet, the performance of our assets, the quality and accretive fundamentals of our acquisitions, and the focus of creating long-term value for our shareholders. We continue to believe that this is a great time to be invested in the medical office building sector, with several key trends that will benefit sector growth over the next five years. One, the demographic trends, mainly the aging of the US population. Two, the implementation of the Affordable Care Act and the increasing demand for healthcare services, especially those provided in outpatient settings such as our MOB's. Three, the continued employment growth in the healthcare sector. Healthcare is in the fastest-growing sector in the US job market today, expected to outpace the overall employment trends by a significant amount over the next 10 years. And four, medical office is becoming a core critical Real Estate for healthcare providers. Assets located on adjacent to healthcare system campuses are the beneficiary of the significant infrastructure investments made by these healthcare systems.

Within this quarter, there were two external events that impacted the medical office sector. The first, the Affordable Care Act, continues to be implemented, with certain provisions moving forward on time. As with any major change, there have also been some delays that have pushed back certain provisions of the law. These delays are not a surprise, and are consistent with our expectations. They also provide additional time for hospitals and physicians to position their business plans to meet the changing landscape. This is beneficial, for healthcare systems always move slowly. More importantly, the parts of the law that should have the greatest impact on increasing the number of insured, the insurance exchanges and the incentives for healthcare providers to deliver the most cost-effective care, are scheduled to roll out on time starting in 2014. Still, we do not expect to see a significant impact on patient demand from the Affordable Care Act until 2015. This positions MOB's for long-term rent growth.

The other major items impacting both the medical office sector and the Real Estate markets was the movement in interest rates. Interest rate -- increasing rates have certainly impacted the broader markets and requires our management team to continually evaluate our business plan. Our business plan continues to be focused on being prudent, patient and disciplined in our management decisions. From a Company perspective, we raised capital in the first half of the year, ending the quarter with approximately $120 million of cash. This capital was raised at what we felt was attractive pricing. Equity raised at $11.53 per share. We also completed our $300 million initial public bond deal, which was priced at 3.7%. We have continually discussed our commitment to maintaining HTA with low leverage and matching our acquisitions with long-term capital. This philosophy keeps us very disciplined in our underwriting and will allow us to execute in any cycle.

Now turning to our second quarter, I'm happy to report another strong quarter of growth, performance and discipline. For the quarter ended June 30, we reported same-store growth of 3.4%, our third consecutive quarter with same-store performance over 3%. This growth was driven by new leasing activity, annual rent escalators, the continued progress of our internal Asset Management platform expansion, and our focus on operating expenses. On our last earnings call, we discussed the increasing consolidation of physicians by either healthcare systems or larger physician groups. We indicated that the level of activity for these groups, representing 5,000, 10,000, 15,000 square feet spaces, was increasing. In the second quarter, we started closing these leases, part of the larger trend that has being spurred on by the Affordable Care Act.

For the second quarter, we closed approximately 240,000 square feet of new and renewal leasing. Approximately half of these leases were with new tenants. 11 of these leases were for tenant spaces over 5,000 square feet in size. Our tenant retention continued to be excellent at 85%. In addition, re-leasing spreads were positive and we continue to push to reduce leasing concessions. As a result of this activity, our lease occupancy increased 40 basis points to 91.3%, our highest rate in over three years. We continue to expect further occupancy increases over the coming quarters.

We ended second quarter with a portfolio totaling 12.9 million square feet in 27 states. 97% of our portfolio is on-campus or aligned with leading healthcare systems. 72% of that is directly on-campus. The portfolio is 91.3% occupied, with 58% of our annual base rent coming directly from credit-rated tenants, 42% from investment-grade tenants. As of the end of June, we are continuing our implementation of our internal Asset Management platform across our portfolio. We currently manage over 90% of our portfolio in-house. These services include property management, engineering, construction services, billing, accounting and leasing. We believe this direct interaction with our tenants has helped us realize strong portfolio growth and should position us well in the future as the leasing dynamics in our markets continue to change. It will also enable us to continue to improve to operating efficiencies at our properties. Although we do not receive all the direct benefits from these savings, these savings are good for our tenants, lead to strong retention, and improve the long-term value of our assets.

Based on our good relationship with the Steward Health Care System, we were able to modify our lease structure, which enabled us to take over much of the day-to-day operations of these buildings. We were also able to convert 5 of the 13 assets into multi-tenanted buildings, with direct interaction with the local physician practices, and improve the basic economic terms of these transactions. This allowed us to expand our presence and market opportunities in the Boston market. Most of our markets have seen an uptick in leasing activity. However, one market that continues to lag is our properties in the Phoenix suburb of Sun City and Surprise. This area has undergone significant changes economically, as it is a Senior-based community and the Affordable Care Act has not yet kicked in. However, the demographic trend in the area remain attractive for healthcare, and we acquired the assets at a good time in 2009. With the combination of the Affordable Care Act, economic recovery, and some repositioning of the assets, we believe this campus can see good growth over the next several years.

In June, we celebrated the first anniversary of our listing on the New York Stock Exchange. This was a significant event, as we have spent the last year introducing HTA to public investors, a process that continues every day. We appreciate the time that folks are spending getting to know our story, with many of you visiting our properties and meeting our management team. The close of our first year also marked the unlocking of our third tranche of shares. As many of you know, when we listed on the New York Stock Exchange, we split our shares into four separate tranches and entered into a phased-in liquidity process. This has been a disciplined approach that has enabled us to introduce our Company to the markets and to demonstrate our financial performance over the last four quarters.

With the third tranche unlocked, we now have almost $2 billion of free-floating shares. This significant amount of liquidity has been recognized by the markets, with HTA being added to various indexes over the last six months. Including the Russell 1000, various Wilshire indexes, and the RMZ, which will re-balance in August to include our June tranche. The fourth and final unlock is currently scheduled to take place in December 6 of 2013.

On the acquisition front, we continue to believe that our rifle-shot approach to acquiring targeted assets enables us to improve our portfolio with each individual acquisition. With our size, it also enables us to demonstrate meaningful growth while acquiring assets within our targeted range of $25 million to $75 million per asset. It also allows us to remain extremely disciplined in our underwriting. Turning down larger portfolios that are comprised of certain assets do not have the growth market rental rates, long-term critical location, or pricing that we believe are required for long-term success.

We do not have a development platform, which enables us to be an acquirer of choice for the local and regional developers that have local relationships and knowledge to win many of the new developments with the healthcare systems that come to market, something that has been proven with our acquisitions over the last several years. In the first two quarters of the year, HTA invested over $94 million to acquire three high-quality MOB's that were on-campus or adjacent to major healthcare centers. In the first quarter, we acquired two MOB's for $88 million that were located in College Station, Texas and in Dallas, Texas. This quarter, we acquired a $6 million MOB in Atlanta. This Atlanta acquisition also included the right of first offer on two additional developments that the seller has in the Atlanta market. These first half assets were acquired for cap rates between 7% and 7.25%, and were acquired directly from local or regional developers who we have known for some time.

Since the end of the second quarter, we have closed on two additional acquisitions totaling $57 million. These MOB's were acquired as an average cap rate between 7.25% and 7.5% and feature average in place rent escalators of 3% or greater. Both were acquired from original developers, both of whom we have previously done business with. On July 12, we acquired 115,000 square foot multi-tenant medical office complex located in the Pittsburgh suburb of Monroeville, Pennsylvania. The Monroeville asset is 98% occupied and is located adjacent to the new UPMC East Hospital. UPMC serves as a major tenant in this multi-tenanted asset. We acquired this property for a little over $15 million. Pittsburgh is currently our second-largest market, with over 1.1 million square feet after this transaction. It has also been one of our best performing markets, with limited vacancy and increasing market rents. This acquisition allows us to expand our Pittsburgh portfolio, increasing the efficiencies of our existing property management team while gaining a new high-quality relationship with UPMC. On top of that, we believe that the existing in-place rents are below market, and will enable us to roll them higher as leases expire in the next few years and as UPMC continues to expand and take additional rollover space.

Early this week, we closed on an acquisition of the Lincoln Medical Center, a 115,000 square foot MOB located in Parker, Colorado, an affluent suburb of Denver, for $42 million. This building is in the middle of a healthcare complex and is strategically located between two dominant healthcare systems, less than a mile away. This property was acquired directly from a local developer. This is the second transaction we have completed with this local developer over the last four years and allows us to expand our Denver presence to more than 260,000 square feet. Based on our balance sheet execution, we funded these recent acquisitions with capital raised in the first two quarters. As we mentioned, we ended the second quarter with $120 million cash, a $650 million unused credit facility, and leverage of 30%. We feel this provides us with the opportunity to prudently and selectively take advantage of future acquisitions that specifically meet our criteria and gives us strong opportunities for growth as a Company moving forward. We are pleased with the results of this quarter and look forward to the rest of 2013. Now for a more in-depth look at our financial and operating results of the quarter, I will turn the call over to Kellie.

Thank you, Scott. Let me start with our second-quarter results. Normalized FFO for the quarter was $0.16 per diluted share, flat to our year-ago period. Our 3.4% same-store portfolio growth and acquisition activity were offset by one, the slightly higher interest expense pursuant to our $300 million,10-year bond issuance at 3.7%, which was partially used to repay short-term debt. And two, higher shares outstanding and cash on our balance sheet. This liquidity provides us with the ability to continue to grow in a disciplined and accretive manner. Normalized FAD was $0.14 per share in the quarter, an increase of almost 8% compared to the year-ago period, and our payout ratio was around 100%. Our same-store cash NOI growth was 3.4% for the quarter. This was driven primarily by annual contractual rent bumps and savings generated from our internal property management platform, and to a lesser extent, operating expense savings.

Same-store occupancy increased slightly. However, the impact it's had on NOI in the quarter was insignificant, given the free rent and lead time associated with lease space converting into physical occupancy. We had approximately 1.9% of our portfolio with expiring leases in the second quarter. In total, we completed almost 240,000 square feet of new or renewal leases executed in the quarter. Tenant retention was a solid 85%. For the rest of the year, we have only 3% of our total GLA coming up for renewal, with just under 6% rolling in 2014. Leasing progress for these tenant spaces is well underway. We continue to focus on maintaining a balance between occupancy, rate and concessions. For the first half of the year, renewal rental rates were slightly positive and averaged 4.7 years of term. TI's were around $0.75 per year of term. New leases averaged 6.3 years of term, with TI's coming in at $1.60 per year of term. Excluding one large new tenant lease, TI's for new leases were closer to $4 per year of term.

From an accounting perspective, this was a very clean quarter, with expenses associated with our listing going away. Our G&A expense was $6.2 million for the second quarter, down slightly from the first quarter. This is up from the year-ago period, primarily related to the rollout of our internal property management platform over the past year. Looking towards the rest of the year, we now expect to have a total G&A run rate of $24 million to $25 million for the year, a slight increase from our previous estimate, resulting from an acceleration of the rollout of our internal property management platform. Our performance has demonstrated that our platform is effective, and with the infrastructure we have in place, we are well-positioned to expand our platform and our markets over the next three or four years without adding significant costs. It is important to note that our year-ago period also included $1.7 million in non-traded REIT expenses, primarily related to our investor relations program. Including these expenses, we actually decreased our public company overhead by $0.5 million or almost 6%.

Given the current volatility in the debt and equity markets, we believe it is prudent to manage our capital in a manner that preserves our ability to pursue attractive opportunities as they arise. With that in mind, we conserved our liquidity in second quarter. As Scott mentioned earlier, we ended the quarter with $120 million of cash and a $650 million undrawn credit facility, 30% leverage, and debt-to-EBITDA of 5.1 times. We think these are extremely strong fundamentals as an investment-grade company. In regards to interest rates, we have limited debt maturities through 2016, with $6.4 million of debt due in 2014 at an average rate of 5.8%, and $72.6 million of debt coming due in 2015 at an average rate of 5.4%. Our average effective term on our debt of $1.1 billion is approximately 5.6 years.

In addition, we are also evaluating opportunities to recycle non-core assets. We currently have classified one property in California as being held for sale. We would anticipate that total proceeds from recycling assets could be between $50 million and $100 million over the next 12 months. We think this is a prudent -- in an effort to improve our portfolio, and we allocate capital to key MOB assets. Last night, we announced our third-quarter dividend, which represents an annualized rate of $0.575 per share. In summary, we have been public for a year and we have unlocked three-quarters of our shares. We have a fortress balance sheet, and our operating performance has been solid and consistent, giving us the ability to continue to buy great assets.

Finally, I would like to thank all of you who voted in our annual shareholder elections. We value a high standard of corporate governance, and we will continue to focus on creating value for shareholders. I will now turn it back to Scott.

Thank you, Kellie. This concludes our prepared remarks. I will now open it up for questions.

(Operator Instructions)

Todd Stender, Wells Fargo.

Starting with the same-store growth in the portfolio, the NOI grew at a pretty good rate of 3.4%. But looks like more of the drop in operating expenses helped that number versus the top line, which looks like flat year-over-year growth. Can you provide more color on the top line, maybe separate what the growth rate is on the true base rent component? And stripping out the tenant reimbursement?

We sure can. And I would like to say, Todd, thanks for the question, and also thanks for pointing it out in something that I saw this morning that you put out. And I think what we'd like to do, based on some things that we have seen, is a little bit misunderstood. And we would like to take a moment to go through how we view the same-store growth and how it affects our top line revenue number.

First of all, I think we had a very good quarter at 3.4% same-store growth, and I say that not just because of the number of 3.4% or the fact that we've now done that for a while over 3%, but because we're delivering that growth on both the leasing and an operational front. And I think that's very important. From a financial perspective, the MOB space is different than the triple net lease space found in the other healthcare REIT's. We operate our buildings, and that is core to what we felt was very important when we put in an Asset Management, leasing, property management platform. And we started that two and a half years ago.

But as operators of our buildings, we have common area maintenance expenses. And these expenses are largely passed on to our tenants, and we'll talk a little more about that in a moment. And Kellie will go through and break out some of the numbers for you so that you get a feeling for what in that 3.4% and how that is generated. But 75% to 80% of our total revenue number is made up of our base rent. And that's obviously the critical core strong rent that we focus on from a perspective of leasing. That was up over 2% this -- year-over-year, and we think that's the very significant number. And that's a number that the operating platform that we'll talk about really helps to reinforce.

But the 2% year-over-year, that's primarily the annual rent escalators that we have that are in our portfolio. Up until the last 12 months or so, we were seeing 1% to 2% growth in annual rent escalators. And as we've talked about, certainly over the last 12 months and more focused on the last six months, we're now seeing 2.5% to 3% rent escalators in all of our leases that are rolling over. That's very good.

Second, you heard me just comment on the fact that our recent acquisitions are focused on annual rent escalations at 3% or more. So that's going to get us growth, and I think that the rent component that we see is also going to allow us to push same-store growth.

But we also think that the important part of the leasing is the fact that we do save expenses, because the majority of these expenses that we save that are in the revenue line and in our expense line are the expenses that are passed through to the tenants. And if we save the tenants money, they recognize that. It really is a component of showing me as CEO that our platform is working. The last thing you want to do is you want to have a building that is passing on increasing rent expenses to tenants. That's not very competitive. You, in fact, want to be able to demonstrate that you're saving them monies, that you are -- that their CAM year-over-year is going down. And we do save a small portion of that, but that allows -- to what I see is the strong retention that we're getting in our platform.

So I think it's very important for us to continue to focus on expense savings, even though we don't see the majority of those savings. And in fact, if we do a good job, it comes out of our revenue number that is just a gross number that you look at. As I've mentioned, 20%, 25% of the top line is expense reimbursements. Those are offset of property level expenses. And that's just -- again, that's good operational on our part, and I think we need to continue to focus on that. Bottom line, I think if you can save expenses, pass those expenses savings on to tenants, it puts you in a tremendous position to retain tenants. It allows you to compare your assets against the assets that are down the road.

And how we're doing that, frankly, I think, is the fact that we do the leasing, we do the property management, we have the engineers, we have the, what we call the folks who are overseeing, the directors of operations who are overseeing the expenses. Because as you know, in today's world, tenants are very concerned about the total rent that they pay, both base rent and those common area maintenance expenses that are passed through. So let me have Kellie give you some of the specific numbers from this quarter to give you a feel for how that 3.4% was made up.

Sure. As Scott said, 80% of the total revenue is made up of our base rent, and that's up about $1 million this quarter, or 2%. That's good. That's the quality revenue that you're looking for. We think this will continue to improve. As Scott mentioned, we're seeing rent bumps move up to 3% in our leases, and everything we're buying right now has 3% bumps.

The other 20% or 25% is our expense reimbursements, or the CAM's. For the quarter, we had $800,000 in savings for expenses. So the reimbursements related to that were down by $600,000. So we net $200,000 of that as, again, we pass along about 75% or 80% of that. The majority of the expense savings were related to utilities, resulting from our energy management, property taxes as a result of successful appeals, and then more efficient building maintenance. And then overall savings from our national contracts.

As we continue to efficiently manage these costs, and save costs for our tenants, again, as Scott said, that will -- we will retain our tenant. Tenants are concerned about expenses. This is how we bring value to our tenants. Ultimately, we'll be able to push rents, retain our tenants, and gain occupancy, and better than the building across the street. So the remaining $500,000 is the true management fee savings that we have from bringing the property management in-house. So those are the components that make up the 3.4%. I hope that provides a little more clarity for you.

It sure does. Thank you for the thorough explanation. I really appreciate that. POM lease turn -- rollover, your tenant retention remains really high. Can you provide the change in rents on renewals you're seeing? And as we look at the remainder of this year, about 3% of the leases expire, not quite 6% next year, can you give your thoughts and what you're seeing upon rents on renewals?

Yes. I'll start by saying we've seen larger tenants, and I think that's great to see the fact that six months ago, we saw these larger physician practices and are renting larger spaces, and that is continuing. We're seeing, right now, and we expect to continue to see, 1% to 2% lease spreads on a positive side. We combine that with the fact that we are cutting back on TI dollars. We are cutting back on free rent. We're trying to do what I think the MOB space should do. If you're core-critical, you're located in a great location, you have good, strong tenants, you have energy in your building, you're passing on savings to folks. You should be at a premium, and you should market your building like that.

And we're excited about the fact that, while we now have 90%, or approximately, in-house, we're still moving through this process. We still expect to see savings that can be passed onto tenants. We still expect to see savings that we can gain from gross rent leases that are out there that we do have. So, we like what we see right now going forward for the rest of 2013, and we actually also think that 2014 will be -- will continue on the positive side.

Okay. And my final question, for Kellie, you raised $20 million in equity through your ATM. You acquired the property in the quarter for $5 million. Just trying to reconcile where the capital had been deployed, and has it been fully deployed yet?

It has not. As you see, we had $120 million of cash on our balance sheet at the end of the quarter, and we've acquired $57 million in acquisitions after the quarter thus far. So, we still have a little bit of cash on our balance sheet.

And Todd, I would say about acquisitions, we looked at the second quarter as, frankly, being a quarter where pricing was getting extremely expensive. There was portfolios out there that the best asset was getting the price and the worst asset was tagging along. And so we frankly backed up a little bit.

We were able to -- I don't want to -- modifying some of the pricing that we closed on here after the second quarter, after things moved through its 100 basis points or 75 basis points move on the 10-year treasury. We also see very good opportunity from an acquisition standpoint. We're very comfortable with where we think we will be at the end of the year compared to last year. But we are even more comfortable with the fact that we can continue to get that 50 to 75 to 100 basis point spread for what the equity that we are applying to those acquisitions and the opportunities that we're getting. So, we feel very good about both being able to accretively put that capital out and more importantly, with assets that can show growth, 3%, 4% growth as we move forward into 2014, 2015.

Okay.

Jeff Theiler, Green Street.

I'm sorry to go back to the same property NOI, because I know you covered it at length. I was just trying to understand a couple things. First off, in terms of the top line growth, is the right way to think about it, you add back the $600,000 of CAM reimbursements to the revenue so you come up with a 1.2% top line growth -- or 1.3%, I guess?

I'm going to have Robert Milligan take that question.

Yes, Jeff, that's a good question. From a total revenue perspective, I think you're right. You would take that $600,000 CAM reimbursement and add it to the revenue growth that we saw there. The one thing that we -- I want to point out, though. We're really focused on the 80% of revenue that's the true base rent that's not related to the tenant reimbursements. Obviously, we have the 20%, 25% of revenue, which is the tenant reimbursement, was actually going negative this quarter. So, not only is that not helping us grow revenue, which we don't want it to be, it's pulling down the average. So, when we look at that true base rent that's 75% to 80% of the revenue, that was actually up a little over 2%, about 2.1% year-over-year.

Okay. And then, can you help me understand, in your same property performance table, the three months ended June 30, 2012. Those numbers don't add up. And I'm trying to understand -- maybe it has to do with that footnote. But can you help me out -- is it an administration payment of certain obligations or something?

Give us a moment here.

Sure.

Jeff, let us circle back up with you on that.

Okay, yes. It just looks like the NOI, according to that, would be $47.03 million. I don't know. Just trying to understand that. Okay. I guess I'll follow-up with you off-line.

Daniel Bernstein, Stifel.

In terms of the pipeline, have you seen a difference in the types of buyers that are out there since interest rates have gone up? And maybe you could talk a little bit about the -- where you think maybe cap rates are going for medical office over the next 6 to 12 months?

I do think that there has been, or there should be some reflection of the movement in the 10-year treasury. I think that there is some folks that got themselves wed to some things that they ended up closing. Which they might, in hindsight, have said, gee whiz, it might have been better if it was 50 basis points that were different than what it was when we were 60 days,120 days or 150 days ago.

I think core, good-quality MOB's on campus across the street, with a relationship that leads to more than one thing, was a component of it that says that we care about who owns and operates this facility. And this gets back to our same-store growth. It gets back to the expense savings that we were able to pass on to both our physicians and our healthcare tenants. We passed on approximately $400,000 to IU last year in Indianapolis that they didn't have to pay from the year before. And it was directly related to us being the managers and bringing it in-house.

I think those components are going to continue to give us, as we've always said, even when things were getting very heated over the last nine months or a year, gives us an advantage. And we're continuing to look for that ability to not go after widely-marketed transactions, not buy portfolios that have three good and three bad, but go after opportunities that are -- add to our geographic locations. Add to the fact that we've had a relationship with the group, or someone knows that the person that we've dealt with, and just to operate on a very pragmatic basis. And that will get us what we think is going to be the greatest long-term value for investors who want to be in the MOB space with a company that is dedicated to that. So, I do think that you have to recognize that, and I think we're in a very good position to be able to do that.

Okay. And are you expecting cap rates to back up at all here, given the interest rates, and again, maybe cap rates hit bottom in second quarter? Is that how you're thinking about the pricing environment?

I certainly think that when it was a yield-driven environment and a financial engineering model that people were buying off of, that that has changed. I think we, as buyers of single MOBs, $25 million to $75 million, we should take advantage of that as that flows through, and we will. And so I think, again, performance is going to begin to play a bigger part of what I hope investors look at when assets are bought and results are issued.

Okay. And a few of your peers talked about some sellers now coming out with better assets at better pricing. Not just MOB's but other asset classes. But have you seen any of that in terms of some folks who may have been holding out for that -- for the best price now starting to bring MOBs out to the market at better quality and better pricing? Have you actually seen that, and do think your pipeline's going to expand? Have you seen that to the point that you think your pipelines going to expand over the next 6 or 12 months?

I think that there is a reaction -- I think there will be sellers. I think you have to find the sellers who have -- are rational, because I still think it hasn't gone through the total system yet. There are still buyers that just want to buy, and for -- because they are -- have an urgent need to grow. But we have seen more assets over the last 90 days come to market. We've seen more opportunities. And we continue to put the same specific underwriting and relationship-focused efforts on the transaction. And as I mentioned, we were able to work with the sellers on both the assets that we acquired here in the third quarter. And we actually had -- you saw our move of 25 basis points, thereabouts, in -- from first quarter to third quarter.

Okay. And not to beat a dead horse here, but going back to the NOI growth. If I'm going forward now, and I'm thinking about how, when I look at your next couple supplemental -- quarter supplementals. Am I going to see a similar pattern where the revenue, because of the decrease in CAM, is flattish looking, while your expenses continue to be year-over-year fairly down? But net net around a 3% NOI growth? Is that how I should be thinking about what I -- what to expect when I look at the next couple quarters of NOI growth?

I'll let Robert answer that.

Dan, I think certainly, we're going to continue to focus on generating increased operational savings for the buildings. So I think that's going to be a component that you see over the next couple quarters. However, I think what you saw also in this quarter was, we started to see a bit of leasing momentum. From the first quarter, we were able to increase total portfolio occupancy of about 40 basis points. So I think you'll start to see a bit of a revenue increase on top of that, as well. But clearly, as we continue to focus on improving the operations of our buildings, that's always going to be a component, probably over the next four, six, eight quarters.

Okay.

And I would just like to finish with this NOI and the operational savings. That's the genesis of being a good owner of an asset. The value to the tenant is the quality of the building, the way the building's operated, and what value can I as a landlord bring to that tenant? So we're focused on this.

I think there's been a little bit of a misunderstanding on everybody just looking at gross revenues, but the worst thing that we could be doing is saying, let's have our expenses up 10%, our revenues go up 10%, our expenses go up 10%. And gee whiz, we're raising the top line revenue number. We want to bring value, and we want to bring it to the tenants, we want to have a unique value-added platform that generates the 2% to 3% same-store annual rent increases on a quarterly basis.

And then we want to continue to be able to add to that from an operational savings perspective by saving tenants rent, saving healthcare systems dollars. Taking more of their properties into our management to tie the relationship that we have, like we did in Boston, like we're talking to a couple other systems with. You're just going to use third-party property management. You can't do that. Because they're not focused on it.

Are you -- so that -- you are looking at that as a competitive advantage for you. It's not in response to what other MOB managers, operators are doing?

Yes. I'll go out on -- I've said this before. If you own assets, you should manage them, operate them to the -- and be the number one at it. And when you can do that, then you can go against some third-party asset manager or property manager and find a tenant and say, this is what we're going to do. Be in our building. And I don't know any other way to operate Real Estate.

Okay. Appreciate the color, and I'll hop off.

Collin Mings, Raymond James.

Congratulations on the solid quarter, guys. Couple of questions. First, Scott, I know we've talked in the past about your intent to dispose of some non-core assets. I think during the prepared remarks, Kellie mentioned $50 million to $100 million of asset sales, potentially, over the next 12 months? Can you put a little bit more color around what you're looking to sell and the broad opportunity to refine your portfolio?

There's two types. There's just the non-core, which is in the other asset classes that -- healthcare classes that we have. We certainly will look to move one or two of those. I think it's very opportune time to do that. There's some folks that, again, need some growth, and it will be a good transaction for us. Second, there are also some non-core MOBs, which I think, while occupied, good fundamentals, bought well, are not core-critical to us because they're not in a close geographic location to the Asset Management program that we're putting in place.

So, I think there will be a blend of those, and I think it's anywhere from $50 million to $150 million -- $50 million to $100 million. And I think that's good for us, because it again improves our portfolio. If folks look at what we have bought over the last 18 months or over the last 12 months, and folks have gone and visited it. And we're extremely proud of the fact that we're improving our portfolio and improving the same-store growth that we're getting from escalators in the rents with quality tenant. So we're excited.

Okay. And then you guys have obviously talked a lot on the call already, in both in prepared remarks and Q&A about the benefit of having a lot of the property management in-house. But given where you stand right now, roughly 90% of your square footage, what's the upside, really, over the next 12, 18 months for that number? I know that there's, obviously, some benefits of what's transitioned recently that's going to flow through. But can you talk about the opportunity to drive that number higher?

I think we would like to say, we accelerated the pace. And we did not anticipate to be this far along a year ago or six months ago, when we were talking to folks. We accelerated because we saw the benefits. And we've seen the benefits, and we've talked about some of those benefits. There is no better thing to say, gee whiz, in Indianapolis, we're struggling a little bit two years ago, but here's how we can get better and deliver value to our tenants.

It's showing. It's showing by the results and it's showing by the leasing that we're seeing. We're starting that in Atlanta. You do that, and then you move up to Boston, where we've now brought that portfolio in-house with the Steward Health Care System. That leads us to go to a couple other healthcare systems and sit down and say, we can help you with that.

We're -- I think that -- are we 60%, 70% through this process? Perhaps. But I think when we talk internally, when we go out and visit our regional offices, when we visit the buildings, there is still a lot of savings that we can continue to drive over, certainly, the next six quarters. And then I would hope to think that we can continue to drive that, because the healthcare systems are going to come to the conclusion that they've come to now, which they don't want to own the buildings. The next things they don't want to do is manage the buildings.

They want institutionalized management to come to those buildings. And institutionalized management is not third parties. I ran Grubb & Ellis. I know how that works. It's not the same as having your own people, your own relationships, and a direct conversation with people who are concerned about how their assets are running, what type of expenses are being passed through, and can I share those things? So, I think this is a -- not a one quarter benefit. And I'm looking for a benefit over, frankly, the next 6 to 12 quarters. And will be very disappointed if we can't, every quarter, talk about what efficiencies we're bringing to assets, to this portfolio, from an Asset Management platform.

Okay. Then really just one last one. At a high level, and you touched on this a little bit in the prepared remarks, Scott. But what's the latest feedback you're getting from tenants as it relates to some of the issues with the Affordable Care Act? And recognizing that it's still, obviously, going to be a tremendous long-term positive for you guys, can you maybe talk about how you refined your strategy over the last 6 or 12 months?

Certainly, we have focused on the location of the asset. I think we have -- I talked to many folks and said I was convinced that we liked MOBs, but I am even more convinced I like them on-campus or adjacent to the campus. I think we focused on the fact that the healthcare system has to be aggressive looking for the market share, either acquiring doctors or looking to track doctors in locations that will service their hospitals, that give them privileges at the particular hospital.

So from that perspective, we've gotten very particular about the type of asset that we're looking for and the type of tenant mix that were looking for. We think that you've got to bring value to the tenant. And that was the biggest thing we saw a couple years ago. When we were -- two, three years ago, when we were looking at Asset Management. It was, gee whiz, when you pass on a CAM charge to a tenant, year-over-year, it goes up 10% or 20%. Or give them an expense to pay that you can't explain or that was miscommunicated, you get unhappy tenants.

And that was really the driving force for us as an organization to say, how do we make ourselves unique? Or how do we set a distinction within our markets? We've got, I think, great people. I think the results are showing it. We're a new company. Everybody's pretty much been hired since 2009. I've been here since, of course, starting in 2006. But we've got people who like doing what they do. They -- attracting new tenants, servicing these tenants, so it's a mutual thing. It's no good to buy an asset and have the operating metrics deteriorate, or not be able to track tenants, or not be able to get a premium rent compared to the competition next door.

Okay. Thank you for the color and good luck in the back half of the year.

(Operator Instructions)

Dave Rodgers, Baird.

Scott, on the leasing front, just a question for you. Are you losing more deals, do think now, because a new supply is out there? So two angles to the question. One, are you wanting a bigger share of the deals or not? And two, how much new supply out there of newly-built MOBs is impacting your ability to lease more effectively or get the growth that you think you should be getting?

We haven't seen a lot of development. I look around at our peers and I don't see them doing a lot of development. We do see some folks now getting -- some local folks that are getting an opportunity to do something, but they're looking for takeout capital. And frankly, they're looking for non-competition in that space going forward. So that's good. We've actually been out on the road the last couple, two and a half weeks, and met with folks, and it's been good interaction. I would say they have some optimism. And two years ago, there was no optimism. So that's -- we don't see the competition.

And second, if you buy buildings that are on-campus or adjacent, most of the time, you don't have a lot of space to expand in the second, in regards to, let's put another building up right next door. We are winning the deals, from a leasing perspective, that we want to win.

We went from, three years ago saying, okay, let's get occupancy, let's keep rents stable, let's make sure that we're competitive, to last year saying, okay, let's be particular, let's actually look -- be very specific. We've got -- our leasing folks now talk very knowledgeable about the competitive landscape within the region. Here in Phoenix, we can talk about the marketplace. We took that in-house at the beginning of the year.

So we're blending and trying to balance occupancy, rent growth, stability, as we talked about. Making sure that some of the tenants have dollars into the space. That's a new thing that we're starting to see now. Is that actually the tenants are coming to some conclusion, the larger physician groups that say, okay, I understand what the standard TI is, but the location, our long-term business plan now, we were going to put some of our own dollars into this. You didn't see that necessarily three, four years ago.

So we're -- I think our results are showing it. I think that leasing is looking better than it did a year ago. And so we're comfortable with where we are.

And lastly, you historically had three markets that were on your list of weaker markets or weaker assets. I think you narrowed that down to just Phoenix this time around, but one of the ones that have been on there, I think, was Atlanta. Was there anything specific in that market, or with the particular asset, that changed the market dynamic there for MOB?

It's interesting. Phoenix, from a healthcare system perspective, is probably behind the transition from the Affordable Care Act. Atlanta now has had some mergers. They've -- we've seen some expansion from the existing healthcare systems, as they've taken more space. That's, frankly, the first thing that we've really started seeing in that market in the last six months. And we've won some deals there. We didn't give it away. We've never given away space just to have it occupied.

So Atlanta has -- we've seen some positive impacts, and I think that's -- again, we brought the leasing in-house, we have a new regional asset manager there. We're focused. Indianapolis has continued strong. East Coast has been strong. The Pittsburgh market, the Albany market in New York, we're like 98% occupied. We're moving rents. Texas is strong. We've had leases there.

So what do I -- I do spend a whole bunch of time, and we do as an organization, just making sure that we're doing the same things here in Phoenix that we've done in other markets, because Phoenix will come along. I think that -- I just saw something today or yesterday that said that it's in the top five of recent job growth or something. And so as the job growth comes along, and the construction comes along, you're going to see the healthcare systems move down the path of having to adapt to the Affordable Care Act.

All right. Thanks for the color.

There appears to be no further questions at this time, so I'd like to turn the conference back over to Management for any closing remarks.

All right. Thank you, everybody, for joining us today. And as I said, we're very pleased to have now been a public company for a year. We're looking forward for the next year, and we thank everybody for listening and, of course, their support. And if there's any questions, please don't hesitate to call us. Thank you.

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