Healthcare Realty Trust Inc (HR) 2014 Q3 法說會逐字稿

Good afternoon and welcome to the Healthcare Trust of America third-quarter 2014 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Alisa Connolly, Director of Asset Management. Please go ahead.

Thank you, and welcome to Healthcare Trust of America's third-quarter earnings call. Yesterday we filed our third quarter earnings release, our financial supplement, and our fourth quarter dividend announcement. These documents can be found on the Investor Relations section of our website or with the SEC. This call is being webcast and will be available for replay for the next 90 days. We will be happy to take your questions at the conclusion of our prepared remarks.

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 could materially differ from our current expectations. For a more detailed description on some potential risks, please refer to our SEC filings which can be found in the Investor Relations section of our website.

I will now turn the call over to Scott Peters, Chairman and CEO of Healthcare Trust of America. Scott?

Thank you. Good morning everyone.

Welcome to Healthcare Trust of America's third-quarter 2014 earnings conference call. We appreciate you joining us on the call this morning as we discuss our third quarter results. Joining me on the call today are Robert Milligan, our Chief Financial Officer; Amanda Houghton, our Executive Vice President of Asset Management; and Mark Engstrom, our Executive Vice President of Acquisitions. Last night we reported our third quarter earnings results, which were highlighted by record normalized FFO of $0.19 per share. This represents a 19% increase from a year ago and continues to demonstrate the growth, discipline and focus of our Management team and the strength of our MOB platform.

Our operating results for the third quarter were highlighted by 3.1% same-store cash NOI growth. This marks the eighth consecutive quarter of 3% growth or above. Over 500,000 square feet of leasing activity, the total portfolio occupancy increasing to 91.8%. We invested $106 million in high-quality medical office buildings in core markets utilizing our disciplined rifle-shot and focused approach, initiated our capital recycling program, in which we entered into contracts to sell certain non-core MOBs for approximately $83 million, resulting in gains of approximately $28 million. This includes $42 million of assets which closed in the third quarter. And finally, we continue to focus and stay disciplined on maintaining one of the strongest balance sheets in the healthcare sector, with a solid investment grade rating, low leverage of 35% debt to market cap, and with no development, construction risk, or JV exposure.

Our results for the quarter and year-to-date continue to reinforce the strong macroeconomic trends existing in the healthcare sector. The Affordable Care Act is now starting to demonstrate tangible results, with healthcare systems and physician practice volumes and profitability continuing to improve. Healthcare employment growth continues to grow to meet the Affordable Care Act long-term demand, and our credit tenant mix and metrics continue to improve as physician practices grow in size and scope.

From an investment perspective, we continue to see high levels of interest in the medical office sector as institutional investors take note of these favorable macroeconomic trends. We also note the significant appetite for large, aggregated portfolio transactions in the healthcare sector and that the cap rate environment continues to move lower. Investment criteria is extremely important in today's acquisition marketplace.

Fortunately, as dedicated MOB owner and operator, our disciplined investment approach remains consistent, and is focused on investments in existing core markets, expanding our local relationships, and focused on typically multi-tenanted assets, with strong long-term fundamentals, which are acquired on an accretive basis. We are purchasers of key critical real estate, not just buyers on financial spreads, and believe that at this time in the real estate cycle, that this is imperative for long-term performance, value and annual cash flow growth.

Within the quarter, we were able to close on $106 million in investments, including $64 million for a five-MOB destination healthcare campus in the affluent market of White Plains, New York, one that is located next-door to the new $120 million Sloan Kettering Cancer Center, $25 million MOB in Charleston, South Carolina for a newly developed affiliated medical office building well located at the entrance to the Mount Pleasant market, and a $17 million acquisition for an on-campus MOB in Tampa, Florida.

For the year, we have now closed on growth investments of approximately $318 million, with average cap rate in the range of 6.25% to 6.75%. All of the acquisitions have been on campus or affiliated with leading health systems, and are located and what we believe are key geographic locations. In total, we expect to expand our portfolio by a net 8% to 12% in 2014, consistent with our growth over the last several years.

In the third quarter we initiated our capital recycling program, something we have discussed on recent calls. As such, we are actively and selectively taking advantage of market conditions and expect to continue to recycle additional assets in 2015. During the third quarter, we sold $42 million in non-core MOBs at prices in the low [$6 millions] and resulted in a gain of $12 million. These MOBs were located in Lima, Ohio and Baltimore, Maryland, and were not in core markets going forward. Since the quarter ended we also had closed on additional $41 million disposition for three single-tenant MOBs in Sun City at a low [6%] cap rate.

We expect this transaction to realize approximately a $16 million gain, and certainly believe that these two transactions are an indication of the investment value that has been created for HTA shareholders from our acquisition program over the last eight years. Just as important, our 2014 investments in disposition activity continues to improve the overall quality of our portfolio and the ability to drive long-term cash flow growth.

Turning to our asset management leasing platform, as of the end of the third quarter, our medical office portfolio consisted of almost 14.6 million square feet located in 27 states, with over 90% in-housed. The quality of our portfolio and operating platform continues to be demonstrated with our same-store cash NOI growing at least 3% for the eighth consecutive quarter. The leasing environment in medical office has actually picked up over the last three to six months. We've seen the impact in our portfolio this quarter, where we leased over 0.5 million square feet, and our total portfolio occupancy has increased to the highest reported level in our Company history at 91.8% and retention has remained strong at 85%.

In addition, we continue to focus on improving the overall economic terms of our leases with a focus on annual escalators, concessions and rate. For the year, our new leases have average over 2.7% in annual escalators, an increase from our approximate 2% average escalators in our existing portfolio. Concessions have decreased with average TI per year of term decreasing to $2.93 for the new leases, and $1.35 on renewal leases. Free rent remains low at less than one month per year of term on new leases and less than one-half a month on renewals. Our re-leasing spreads remain slightly positive for the year, excluding the large renewals in our Sun City portfolio that we discussed last quarter.

Our property management teams remain focused on growing tenant relationships and improving the operating efficiencies for the 13 million square feet we actively manage. During the third quarter, we opened in staffed our Florida office located in Miami. This office will oversee the recent acquisitions over the last six to nine months, and begin to manage the leasing in these markets.

Finally, for the first three quarters of 2014, HTA has invested $318 million in core critical assets, achieved the third consecutive quarter of 3% or greater cash NOI growth, execute on a $300 million seven-year bond issuance, received a credit rating investment upgrade from rating agencies, increased our portfolio occupancy year-over-year to 91.8%, raised our dividend for the first time, and have now completed recycling of $82 million in dispositions. Management continues to execute our business plan by utilizing our operating platform, target investment strategy, strong balance sheet and mid-cap size to grow shareholder value over the long-term.

I will now turn it over to Robert to discuss the financial performance and some specifics from our third quarter.

Thanks, Scott. Let me walk through our third quarter earnings, balance sheet, and capital plans going forward.

For the third quarter, normalized FFO per diluted share was $0.19, an increase of $0.03 or almost 19% compared to the third quarter of 2013. Overall normalized FFO increased 20% to $45.5 million compared to the prior year. The increase in year-over-year normalized FFO was primarily due to our same-property cash [NOI] growth of 3.1%, and additional NOI generated from the more than $400 million in net acquisitions we have completed over the last 12 months. Our same-store NOI growth was largely the result of strong top-line growth resulting from annual rent bumps, higher average occupancy, and a slight reduction in free rent in the quarter. Given our size and focus, the majority of our NOI growth falls straight to the bottom line.

Our G&A expense was $5.9 million for the quarter, down from the $6 million we had in the third quarter of 2013. For the year, our G&A is now at $18.1 million, near the lower end of the $24 million to $25 million run rate we laid out at the beginning of the year. Our asset-management infrastructure is largely built out in our existing markets, allowing us to expand without adding significant overhead. At the end of the period our average interest rate on our debt portfolio was 3.74%, down 40 basis points from the 4.2% in place at the end of the third quarter 2013. This reflects our credit rating improvement, which lowered the rates on the credit facilities and term loans, and recent bond issuance which was partially used to repay a higher coupon mortgage debt.

We continue to focus on our capital expenditures, including leasing concessions. Over the last two quarters we have signed over 1 million square feet of leases, including several large, longer-term leases. Although our concessions per year of term have been trending down, those longer leases have caused our absolute leasing capital to increase this quarter above our normal run rate. As a result, normalized FAD increased 7% to $0.15 per diluted share. Our payout ratio was in the low 90%s.

As a Company, we remain dedicated to a strong, conservative, flexible, and liquid balance sheet, which combined with the risk characteristics and stable cash flows associated with the medical officer sector and our lack of development, give us considerable balance sheet strength. We ended the quarter with very low leverage, below 35% on a debt to market cap basis, and approximately 5.4 times on a debt to EBITDA basis. We have over $600 million of available liquidity and very limited near-term debt maturities. We came into the quarter with a significant amount of cash, following our $300 million seven-year bond issuance which we priced in June at 3 3/8%.

We used approximately $56 million of this to repay existing mortgages with average interest rates of 6.1%. The total prepayment penalties were approximately $5 million, allowing us to generate significant ongoing interest savings and lock in today's low rates. Within the quarter, we invested approximately $106 million in new acquisitions, all of which closed in the back half of the quarter. We acquired these at average cap rates in the 6 1/4% to 6 3/4% range. We funded these primarily with existing cash and asset sales, which closed in the mid to low 6% cap range. This recycling process was accretive to our acquisitions, allowing us to improve our portfolio and grow earnings at the same time.

This also demonstrated the strong performance of our earlier investments, with the announced dispositions generated unlevered returns averaging 11% per annum. For the rest of the year, our balance sheet strength provides us with the flexibility to be very opportunistic as it relates for capital funding, using the appropriate blend of debt, equity, and dispositions, depending on market conditions and relative cost of capital. I'll now turn it back to Scott.

Thank you, Robert. I think the third quarter continues to demonstrate Management's capacity to continue to perform in the public marketplace. We continue to see strong growth in the medical office building space and think that the macroeconomic trends that we see, that we have seen, and we think are going to see, take place over the next 6 to 12 to 18 months. It's just going to continue to enhance shareholder value.

With that, that concludes our prepared remarks and we will now open it up to questions.

(Operator Instructions)

Michael Knott, Green Street Advisors.

I think you'd said on the last call that you thought occupancy of 92% by year-end was achievable. Just wanted to check in on that and then clarify if that was overall or same-store?

We do think 92% is achievable, as we mentioned on the call. We continue to see good activity and it would be, overall, from a 92% perspective.

Okay, thanks. Just curious -- given the fact that you are seeing better activity and the fact that you do have low lease expirations, why didn't we see even maybe a little bit more improvement in the percent leased rate during the quarter?

I'll let Amanda address that.

As you know, Michael, during the quarter we did see a 40 basis point year-over-year increase in total occupancy from 91.4% to 91.8%. From a same-store standpoint we did remain stable at that 91.4%. And it was up 10 basis points over Q2, which we think was good improvement.

I think when we are looking at our portfolio, depending on the particular rollover in any quarter, we may have lease percentages in any particular quarter that are lumpy. We are now looking at Q4 with less than 1% of our GLA rolling, 2015 with less than 6% of our GLA rolling. We feel very good about at our ability to continue to increase our same-store portfolio occupancy over time.

Okay and then last one for me and I will hop back in the queue. I think you guys had mentioned on the last call, so that I think you said 94% to 95% you thought was achievable. I think you'd said in 30 months.

I guess at that time that would have been year-end 2016, I guess. Just curious if you guys still feel good about that, as well.

Well, I think we do. What we continue to buy is great property that is located in what we think are opportunities that will continue to get leasing if rollover renewals, expansions -- one of the things that Amanda touched on is that 60% of the new leasing that we did this last quarter, was expansion space. So, one of the things that we're working through, and it might give you some insight into your earlier question, is we are being very cognizant as a company -- our leasing folks in each of our regions, as we go through our budgeting for 2015, our preferred tenant is expansion.

We think -- if we can work with that tenant, if we are in their plans, they have plans to expand, then they are our priority. So as we move through this process over the next 24 months, I think you'll continue to see our vacant space continue to lease. But it may not lease at a particular rate that could be leased if it was to an independent third party.

It might be that we say we want to wait and allow that expansion for that core critical tenant in a building that they feel is extremely important for them long-term. So, we like the metrics from a leasing perspective and I think that we are doing the right thing, which is we are getting tenants, we're increasing occupancy, but the tenants are long-term tenants and they're tenants that are expanding if someone does not renew or if there's space that becomes available.

Okay. Thanks.

Dave Rodgers, Robert W. Baird.

This is Matt here with Dave. In the quarter you initiated a strategic disposition strategy selling $42 million a quarter.

Number one, and we expect that this platform will provide the needed capital to maintain leverage instead of the ATM issuances for your external growth opportunities? Number two, can you maybe talk about the appetite for MOB assets and the pricing that you are seeing versus the beginning of the year?

Sure, well, first question is that we are always going to keep our balance sheet and our balance for investments and what we consider to be conservative, which we've done, now, over the last 2 1/2 years. So you won't see a change in our balance sheet and we'll continue to recycle the dispositions with opportunities for acquisitions and, hopefully, we'll continue to grow our portfolio that 8% to 12% on an annual basis.

We don't think that what we've seen in the marketplace has generally impacted us significantly. We are not buyers of large portfolios. We're not competing with the nontraded REITs who are more in the diversified space. We're buyers of MOBs in the $25 million, $50 million. We've done almost -- 50% to 60% of our acquisitions have been with folks that we've done an acquisition before. We've been at this now for eight years, so we've got great relationships. Mark Engstrom has been instrumental in developing these contacts and so we think that's a great prospect for us as we move forward.

From a pricing perspective, I reinforce what I've said before. We think this is a great space and the good news is that other people think that it's a great space. Bad news is that -- and I don't know that it's bad news, but cap rates continue to be competitive. We like that. I think that shows that the economics of occupancy of growth, recession proof was always the thing for healthcare but I think MOBs, we're actually seeing same-store growth now.

2 1/2 years ago when we came public, folks said well, it's a 1% growth sector and it's pretty boring. We always said it's 2.5% to 3.5% and we are now eight quarters into that 3% or better same-store growth. We see some of our peers now getting that 3%, 3.5% growth. So this is a great sector. I think it's going to continue to be a good sector and I think that as you see the economy improve, we might be actually able to get a little better growth than 2.5% to 3%, traditional. So we like where we're at and we're looking forward to 2015.

Thanks, Scott. That's very helpful.

And then maybe for Robert, in the quarter there was a sizable unrealized gain in your derivative financial instruments with rates moving down substantially in the current quarter. Can you provide any color on what you might expect for 4Q if rates were to stay where they are today?

Yes. We discussed this with you guys before. And most of this is related to the movement of the hedges that we have on the term loans.

So we've taken this position that we've hedged most of our [footing] on debt. It just hasn't been qualified for hedge accounting at the time. As the rates move around, certainly that's where you see the movement in that, really, the non-cash changes of fair market value of derivatives.

I think how you are reading that is correct, as rates -- as rates go down, the value of the hedged portfolio has an inverse relationship to that. So, I think you are reading through that correctly.

Thanks, guys. Appreciate it.

Todd Stender, Wells Fargo.

I may have missed this, Robert. Did you tap the ATM in the quarter? I didn't know if you have mentioned that.

No, we did not. Year to date, we've only issued about $18 million of equity through the ATM. Mostly the other funding that we've done, to fund the acquisitions, has really either been through the bond issuance that we did in June, or through the disposition program that we've started to undertake there.

And just along the theme of sourcing capital, are the gains you've realized on these dispositions lately a surprise? Were they original -- were they originally in your budget at the beginning of the year? And maybe that's contributed to, maybe, not tapping the ATM lately?

Todd, this is Scott. Was it a surprise? No, I think that we feel that -- and we've talked about this fact, and I've made a big deal about it the last -- certainly, a couple years ago, that our opportunity to buy a couple billion dollars of acquisitions during 2008 and 2009 and 2010 was a tremendous advantage for us as a company and certainly for investors.

I think this is the first time that we, in a recycling program, have taken what we think are non-core assets in markets that we don't see our long-term future in, or as an example, the assets in Sun City that are triple net leased assets that we restructured the leases, as you remember last quarter, which we had discussion on. It just shows that, I think, that we bought good assets, that those assets -- while they may not be core to us and our criteria, as we see moving forward, they are very valuable in the marketplace today and they are important to someone else's portfolio. So, I don't think it's a surprise, I'm frankly very appreciative of the fact that we were able to do this and I think that it reflects, overall, what I think is inherent from bottom to top in our portfolio.

That's helpful, Scott. Thanks. And just along that theme, can you talk about the balancing act of selling assets right now?

You are losing that rent and you're also, at the same time, trying to lower the dividend payout. So ultimately, maybe give a bigger dividend raise than you did this year, next year. Can you just talk about how you balanced those two items?

Yes. We have, for example, this quarter -- currently -- we feel very confident that we'll get that net $300 million, $250 million to $350 million of acquisitions. I think that we are timing our dispositions with acquisitions that we find. We've always said that we want to be a net-net acquirer of 8% to 10% growth in our portfolio, given the fact that everything else is consistent with our cost of capital and our debt. I think that's very doable.

We've been very fortunate that we've been able to do this timing. And I think that's one of the things that is incumbent upon management, is to try to do this so that it makes the best benefit for shareholders and doesn't impact anything significantly as it relates to losing something and not having it replaced.

Thanks, and just switching gears, your operating expense savings have really helped drive 3%-plus same-store NOI growth. How much visibility do you have into that savings to keep that trend going? And do you attribute a lot of that towards moving the portfolio towards the in-house property management?

Good question. We get that question a lot. I'm going to turn that over to Amanda Houghton here to give you some of her views on where we see our operating platform and our asset management platform, certainly, over the next 24 to 36 months.

Hi Todd, thanks for the question. I'd say to start, our asset management platform, we are very much a person to person business. I think being able to hand-select a team of individuals that are interacting with our tenants and communicating a consistent message with an institutional quality platform is key for us and what we are trying to accomplish.

I think that our platform itself has very much impacted our ability to do several things very well. The efficiencies is one of those things, continued expense savings. We have been able to, not only save in the third-party management fees which we were otherwise paying, but also through utilizing our in-house team bundling contracts, establishing national contracts, we're able to use our size and generate scale, and we do expect to continue to get savings as we continue to acquire new buildings, move them onto our in-house platform, and we'll continue to see that 20 to 25, upwards of 30 basis points of our same-store growth attributed to that expense savings and increased efficiencies from our platform.

Thanks; Amanda. Just to expand on that, just finally, of the seven properties you guys acquired in the quarter, are they under third-party management contracts? And if they are, when could they be transitioned to internal?

They are in a process of being transitioned now. All of this -- the stuff in New York will come under our Northeast operations. Stuff in Florida will be operated through our Florida stuff and we already operate our Charleston properties, and I think one of the things that -- to reinforce your question, because I think it's a great question and we get that question a lot about the platform.

Our view is that the MOB market is hugely fragmented. Developers have different focuses when they put buildings into play, which is focused on occupancy, not necessarily rate, not necessarily cost savings. They don't have access to the national contracts, or the efficiencies that come from running a national and regional program.

I think it's a huge opportunity for Healthcare Trust of America, as we continue to grow size, continue to get better at our program. We've just started the last 2 1/2 years, really, of being a manager of our assets. And the efficiencies that will come, is I think, will look a lot like the efficiencies that have been in other sectors in the REIT world, where as you pay attention to get your folks in place, put programs in place, almost as simple as the fact that we have engineers now, and our engineers are part of each of our assets.

And not only do they look and take care of the assets, but they also -- Amanda makes sure that our directors of operations talk to them about how -- the expenses of each of the buildings. This isn't done traditionally if it's a one-off property or owned by a small group.

So I'm excited about our asset management program, I know Amanda is, I know the folks that help us here are. And we look forward to continuing those savings and getting better at what we do.

Great. Thank you.

Collin Mings, Raymond James.

In the prepared remarks you guys discussed a little bit about the leasing spreads remaining positive for the year ex the Sun City portfolio. Can you maybe talk a little bit more about the pricing power you see out there?

And then do think it's reasonable -- I know you guys the last couple quarters have talked a lot about the contractual rent escalators you guys have been getting on some of the renewals. Is it possible that you could even see that now maybe move north of 3% over the next six or nine months? Just, again, maybe a little more color about the pricing power and those escalators you're getting?

Sure, I'll start and then I will let Amanda add anything if she wants. I think the escalators -- and I will work backwards -- I think our escalators now are pretty inherent in our portfolio at 3%. A year ago when we looked at the leases that came through and we look at each of the leases, some of our leasing folks would struggle in some cases to get the tenant either in a renewal or in a new lease, to that 3% level.

This year, certainly the last six months, if we've seen 100 leases, 96 of them or 90% of them have been very consistent at 3%. I think that all revolves around one thing, the location of the asset and the synergy that's being generated by the physician group or by the healthcare system for the desire for that location. You aren't seeing that, we aren't seeing that, necessarily, in off-campus buildings.

When we look for acquisitions, Mark Engstrom looks specifically and says okay, where are the existing leases? What have the tenants been accustomed to? And how are they responding to our what do they see from an energy perspective within that building?

Part of the Affordable Care Act, what we are seeing, is large physician groups. Larger physician groups want lots of patients. That means that they need to be key located next to the hospital, across the street, or they're specialists and that specialist has that need to be in that location.

Off-campus, I think it's still something that is more of a struggle. That's why about a year and a half, two years ago, we said we like multitenanted buildings, we like them on campus, across the street, and we see that more and more of our tenants are becoming the specialists or the larger physician groups. So, Amanda, anything want to give on the pricing?

I would echo what Scott said on the escalators. I think our ability to get year-to-date, we've averaged 2.7% annual escalators on the lease deals we've done. I think that's very much reflective of our market and the core critical nature of our buildings to the health system.

We have started to see certain of our markets, parts of Florida, Raleigh, parts of Texas, some markets in our Northeast, when leases are rolling, they are rolling up and not just $0.50 up, they are rolling $1 up. And those are those markets that we kind of earmark for -- okay -- if 3% isn't keeping up with the market, maybe we do have the opportunity there to push that escalator up over 3%. So, we are constantly monitoring and measuring.

And ultimately, we want to reflect the market. Any of our leases should reflect the market. We don't want to have a big roll down when leases roll off and we don't want a big roll up, that means that we've messed an opportunity to gain along the way. So we're trying to reflect the markets as we go, and that's why we're so focused on investing in the right markets and the right buildings with the right health systems.

And I would just add one thing, Collin, to a question asked earlier about our occupancy. One of the things that Amanda has commented recently, and I think it's so important and I thought it was very, very enlightening at one of our discussions, was that our space is very valuable. There was a time period five years ago, four years ago, where you were in a position of looking for occupancy, looking for tenants.

I think we, as a general rule now at HTA think our space is valuable. We want 3% escalators. We want to have market rents, we don't want to have huge roll downs. And therefore, we want expansion with existing tenants. And therefore, the leasing is thoughtful. It's not just, let's lease it up and get it occupied and maybe miss an advantage or not take advantage of what shareholders would want us to do from a long-term perspective.

So I think we're being very diligent. At least, we think we're trying to be very diligent as we discuss with our leasing people in each of our regions the leases that they are contemplating doing as we go through the year.

Okay, great, that was useful color. And maybe I missed this, but can you talk a little bit more, Scott, just as it relates to the acquisitions that you closed during the quarter, as far as how they were sourced? Again, obviously a couple questions already as far as the cap rate compression you guys have seen over the last year.

But kind of tying back, maybe, to the deals you did most recently, how that ties back to your acquisition strategy. And is the cap rate compression that you are seeing having you to change either your underwriting requirements or your acquisition strategy at all in the margin?

Well, we're seeing more liquidity in the space. There's more transactions going on. That's one of the results of lower cap rates.

We're seeing, as we mentioned, private folks that are looking for acquisitions, looking for yield, looking for longer-term leases. I think that for us, we continue to look for relationships with the seller. We continue to look for acquisitions that add to our core markets.

We are what I would consider -- and we've said this -- we look for the rightful shot, each asset we visit before we offer, so we know what we are getting, we know what we are negotiating. We're not the portfolio buyer, we are not the large buyer of an aggregated group of assets, and we're very focused on our criteria. Because I think again, in this market where we are at right now, and I think cap rates for MOBs continue to stay in this range and I think they may even get -- they may go lower. Because I think it's a great space. I think it's fragmented, as we mentioned. There's not a real focus on asset management in the past because it has been hugely fragmented.

So we just continue to work what we've done over the last, certainly, five years and we see our opportunities. Now we have lost some, or have just backed out of some, that have been extremely low, low fives, where the buyer may be a private buyer looking for a triple net long-term lease. They just want yield. Fortunately, we are not a buyer of that type of asset right now. We are a buyer of the assets that are multitenanted, that offer our asset management the advantage of being able to operate it.

Okay. Maybe just specifically as it relates to deals in the quarter. Scott, you'd characterize those as really relationship based?

They have been. It's a small marketplace. So, almost, I could stretch that definition pretty far, but I won't, it's a little more specific.

We try to have -- I would say 90% of all the deals we do, either both Mark Engstrom and myself know the people, have met with the folks that are selling, have been around that asset for a while. We don't get something in, we don't put a bid into it and then it happens to have a transaction. So, this is an enjoyable -- it's an enjoyable experience to be able to buy assets that way, and that's how we've done it and that's how we continue to do it.

Okay, and then just one last quick one on the planned asset sales. It sounds like what you have in the short term is going to be some more MOBs. As far as exiting some of the non-MOB assets, do you see that being a 2014 event? Or you think some of those properties might carry into 2015 as you think about exiting those? And maybe any sort of color around what type of pricing you might expect on the non-MOB assets might be helpful, as well.

I think the answer to your question is that we will continue to look into 2015 to maximize any sales of what we call the non-MOB stuff. There will probably be a mix moving into 2015. Our view is that we'll try to get as low a cap rate or as high a value as we possibly can and turn around and invest that into assets that replace both the yield, but also allow us the long-term accumulation of a very high grade portfolio.

Okay. Thanks, Scott.

Richard Anderson, Mizuho Securities.

So just to make sure I understand the escalators, was it 2.7% or 3% for the quarter? I heard both numbers.

For the quarter it was 2.7%.

You were just rounding up, Scott?

Well, what we do is we try to get 3% for the majority of the leases. There are certainly some in certain locations, as Amanda pointed to, that we get 2.5%. Or in some cases, there is reasons that you don't get the 3%, but 2.7% as an average for all the leases in the third quarter.

Okay. Robert mentioned asset management infrastructure is built out. So minimal cost to expand the internalization. Does that mean that you can get significantly higher than 91% internally managed in leasing? Or, what you think the ceiling is there?

Well, we've always -- I've always said that I thought 90% was probably something that was very consistent for us. It will ebb and flow. Mark's relationships with some of the developers, some of the acquisitions that we do, they want to manage it for a little while.

In fact, in the right situations, it's very beneficial for us to work with them to do that. So I think 90% is probably a decent number and you might see us ebb and flow as we go through each quarter.

Okay.

And Rich, just to comment on that -- and I think as I was referencing -- as we grow in certain markets, our portfolio is getting larger. I think the infrastructure that's required, say, in a market like Atlanta, if we were to grow in a market like that, we wouldn't need significantly more infrastructure even a portfolio for there, so the 90% is probably overall where it ends up. But it does allow us to expand in markets without adding a lot of overhead there.

Got you. On the acquisitions, you mentioned that everything was either on campus or affiliated. What percent was on campus and what percent was affiliated?

About what we would consider about 75% was on campus and we would consider the Charleston asset to be affiliated. The Charleston asset, if you've been to Charleston, it's at the bottom of the bridge that connects Mount Pleasant to Charleston. I happened to live in Charleston for almost eight years, so I know that area pretty well. And it's in between two hospitals and it's got about 60 physicians in the building and it was actually a -- excuse me? With Roper St. Francis, and it actually was bought from the physicians.

And it's something that, that's a prime example of a relationship that Mark Engstrom worked on for a good six to nine months and we were very -- I think, very fortunate because it was not only buying an asset, but they were very, very concerned about who was going to manage the asset and own the asset. And that was a great acquisition for us.

Okay and would you say that 75%/25% is kind of a reasonable breakout for the full year stuff, as well?

Rich, it would be. I would like to say that in paper, I'd like to be 80%/20%. But in reality, it's probably going to be -- certain quarters it will be 70%/30%, other quarters it will be 90%/10%. I think we had a couple quarters ago where it was 100% on campus, but there are some very good opportunities that we see.

For example, like the Charleston asset, even though it wasn't on campus, it just was such a strong asset, in fact, that there was an asset bought in the marketplace almost 100 basis points lower than ours, just about the same time. It was an asset you wouldn't pass up. And the relationships that come from an acquisition like that are critical. So I think 75%/25% is probably where we will settle out over time.

Okay, and then on cap rates, I guess you get the 6.5% average in the midpoint for your acquisitions. Sounds like you are doing dispositions, at least for medical office, closer to 6%. So you're actually getting a better return -- a better number from your disposition than you are from acquisitions. That's interesting, but, I guess will say that's driven by your relationships.

But I guess my question, to be clear, is are they being calculated the same way? Or is one backward-looking cap rate, one forward-looking cap rate?

Well they're being calculated the same way, which is good. Because you want to make sure that it's consistent. I think that in this particular case, let's look at what we talked about.

We sold three triple net long-term leases, actually two of the properties didn't have long-term triple net, but they were full buildings so they had a full user to them. Very attractive to the potential buyer or the buyer that transacted that. No real management included in that. Good location out here in Sun City.

For us, we had renegotiated the leases. We put in some escalators that were better than before. But we weren't getting any -- what we thought would be long-term advantage from our asset-management program. So that was a great opportunity for us to actually turn something and get a better value than what we replaced it with.

The portfolio in Lima, we bought that, again, almost five years ago. It's on campus. The acquirer, I think, will do a very good job with that. But for us, there was no more to be able to be bought in Lima, Ohio. It had come with a bigger portfolio.

So that, for us, made it a smart decision, I think, for us to say, let's relocate back to markets that we actually are going to grow in, we can have an asset-management presence in, we can get leasing in-house. So those were strategic and I think that they were good examples of good for them -- the buyer -- and very good for us, as the former owner.

Okay but is that the right spread to be thinking about? 50 basis points to the positive?

I would say it's probably flat going all over. These first two were -- they were good transactions. I wouldn't want to mislead you and say that they're going to be 50 or 75 basis points, because I think that if we're selling some stuff that, again, not in core markets that we like, not necessarily accumulated or aggregated in huge portfolios.

Okay, and then I'm looking at a few numbers on the model, here. Last quarter and this quarter you have an enormous add-back for expensed acquisition costs. $4.9 million in the second quarter off of $200 million of acquisitions and $2.8 million this quarter on $100 million.

I'm just curious how you are calculating that. Looking back at other REITs it's just way, way higher than it is for other REITs. Can you just kind of explain the math there?

Everything that's gone into the acquisition costs, there, generally relates to either legal fees or transaction fees that get baked into there. You know, on some of the bigger transactions that we've had there was an advisory fee, for instance, and a piece of it, rather small. But for the most part, it's either -- it's all either the legal fees, the transaction costs in there.

And we'll look at your comment about it being bigger than other REITs.

Other REITs, I'd say, maybe 1% of acquisition cost, something in that range. Yours is more like 2.5 or 3%. So for those (multiple speakers).

-- and we'll get back to you. But I don't think I would say, looking at our acquisition program, looking at it historically, looking how we actually do it, that it can be anything other than pretty much normal, because we don't have anything un-normal in it.

Okay, last question is, when you guys get your incentive comp packages, how are they -- do you have any kind of acquisition volume element to it? Or is it purely, kind of, growth, NOI growth, or relative growth versus your peers? How are those incentive compensation packages mathematically done?

Well, without getting into specific details, which I think you can get into if you look at our recent proxy, but none of it is specifically broken down into -- Mark Engstrom does not get compensated if he does X amount of acquisitions or not. It's more peer focused, it's NOI focused. It's same-store growth. Do we achieve what our targeted is from budget? I mean it's the three or four or five metrics that would be traditional from an overall Company perspective.

Okay, I appreciate the dispositions this quarter. And I've always bugged you about this issue, anyway. So I actually wasn't going to ask the question, but then I figured what the heck, I'm going to ask you. So appreciate it, Scott. Thank you.

Daniel Bernstein, Stifel.

I just want to follow up on the leasing, in terms of lease terms that you are seeing. Are you seeing -- are the length of your leases increasing, and how is that affecting your TI? Are the tenants who are coming into longer-term leases expecting more CapEx? Or is the TI just a function of the longer lease that you are having?

Three questions, there, I think. So I will answer it then and Amanda can add anything. But what we're seeing is five-, seven-year leases. We particularly aren't seeing shorter leases as perhaps we were, because our tenant mix is changing.

We've talked about the fact that the sector has changed. Last year, first quarter this year, we had quite a few single practitioners move out of our buildings and not take the additional space. We've seen physicians join with physician groups that may or may not be in our building or in our building. So, that mix has changed. So, the term has therefore changed.

Single practitioners to one two practices like short leases because the security of what they were doing was not as certain. Larger physician groups, especially in buildings that they see are going to be critical to their five-, ten-year plans, want longer leases, five, seven years. We don't like longer than five or seven years, frankly, because we like the ability to think that our locations are going to generate greater value over time, coming off of what we think is a trough on a rent basis.

So that's kind of where we see the five- to seven-year, and then the TIs, we're actually seeing physician groups put more money into their practices because it's a bigger space. Amanda, any other thoughts?

Yes, just from a dollar per square foot per year of term, which is how we look at it when we look at leases, that as a metric is trending downwards. As Scott mentioned we are doing longer-term leases overall and on average. But that dollar per square foot per year is going down and that's what we like to see on the tenant improvement side.

On the leasing commission side, again, as we continue to do more and more leasing in-house, that continues to go down. Year-to-date, I think we are close to (technical difficulties) million now in leasing commission savings that we otherwise would have paid third party. So, that trend will continue as we do more and more in-house. And as tenants do get more comfortable with us as the landlord representing party and they don't bring, necessarily, their tenant representing party to the table when we go to do a negotiation.

Is there difference in lease bumps between a longer-term lease and a shorter-term lease? In other words, you want to get these 3% lease bumps but if you are doing a seven-year lease, maybe they are higher or lower than that 3%? I'm just trying to understand the difference (multiple speakers).

I don't think there's a difference. I'd like to tell you that there's a difference. I think the difference is that when we have a five- or seven-year lease, we are far more adamant about the 3% or 2.5%.

We would not be very receptive from a management perspective if someone said here's a seven-year lease and a 2% escalator. I can tell you that probably doesn't get to me because Amanda probably pushes it back and says that's not going to work for us. A shorter-term lease, if we try to get a little more rent, we try to give far less concessions and we would push for that 2.5%, 3% bump.

Okay, and then in terms of your dispositions, MOBs, it seems like, to me, that you got rid of -- I guess maybe it's not single tenant, but a very highly occupied triple net lease property. Do have a lot more of that in the portfolio that you are reviewing to go ahead and sell? Or, going forward, are we going to see mainly sales of the seniors housing and the hospital assets?

We don't have what we -- we have, I would say, a couple, two or three additional assets in that single tenant triple net lease category that we would categorize as either not in a location that we want to grow in or not necessarily something that we want to hold on long-term. We have properties, for example -- if you look at Greenville, if you look at the Tufts we just bought, you look at some stuff we own in Aurora, you look at -- we have some really good relationships with stuff we have with Highmark in Pittsburgh.

We are not sellers of that. That's core, critical real estate that is just going to continue to get better. Most of those, if not all of those leases, are at least 2.5% escalators. So of the stuff we did with Steward, for example, we are owners long-term. So that was more of a selected opportunity, as I mentioned. They were three in Sun City and each one of them had a distinctive reason, for us, that we said this is better to go ahead and dispose of today and recycle into some multitenanted assets and do that.

So I think that the answer to you is that we'll see us sell some of the other stuff and then you'll see, again, if it's not a core market or if it's not something that we see future concentration in, that might be something that we would dispose of. We've always said there's $200 million to $300 million of assets in a $3.5 billion portfolio that one would probably say if I had to buy them individually, would I buy them again? And we are going through that process.

Okay. Thanks a lot. I will hop off.

Michael Knott, Green Street Advisors.

I think you may have touched on this earlier. But I just wanted to ask it, maybe, a different way on the dispositions. Where you guys show your portfolio composition, will be off campus allocation go to zero once you're done with this disposition program from 4%, now?

No, I think that's -- it's like I mentioned before, the Charleston asset, that's off campus. It's at the bridge of the bridge between Mount Pleasant and Charleston. It's got 45 physicians and total practice is about 80. It's with Ropers, great asset. It's an outpost, it's in between two of the major healthcare systems. It helps our other two assets we own there.

That's a great acquisition. We would buy that every day. But, fundamentally, I would like to say that if a year or two years from now, you said let's go visit every one of your properties, Scott, I would like to say that well, 75 of them you are going to get to see across the street or on campus from the hospital and then there would be 25% of them, probably, that have that type of story to them when they are off campus.

Got it, okay, and then from a capital allocation standpoint, some of your comments earlier about the 10% annual portfolio growth, it sounded almost like you think about it like a -- that it's programmatic or sort of already dialed in. But, it's my strong sense that you think about capital allocation as being dependent on cost of capital signals at any point in the future. And so just wanted to give you a chance to clarify that, if I maybe misheard you or --

Well, thank you, and I think I will clarify that. It's always -- like rule number one is cost of capital, is it accretive? Are investors looking for you to continue to buy the assets and are they representing that that is in fact something you are doing well?

So when I say we'll do that 8% to 10% a year, it's based upon, that's number two or three. Number one is, are we doing a good job? Are we getting the positive signal from investors who own our stock or who are interested in it? And if we are, then we will continue to execute. If we're not, then we will back off and we will wait until something else comes to our attention.

Okay. Thanks.

Douglas Christopher of Crowell, Weedon.

I have two areas of questions. The first is on the general and administrative dynamics. You've been in the $6 million per quarter area for some time.

And really, since June 2013, grown your assets over 20% since that time your [gross] investments made some changes to the portfolio. Just wondering, I know you mentioned that there's -- you are getting some leverage from the internalization, but how much -- how long can it stay in that $24 million to $26 million area? How much bigger can you get?

Well, thank you for the question and thanks for joining us. I think that when we went public, folks, I have a long memory, but they said oh, my goodness, $25 million, $26 million in G&A, I can't believe that. What we had said then was that we're building a platform, not only at $3 billion, but a platform that goes a couple of billion dollars higher.

So, we are in that $24 million to $26 million range. And right now, if we are at $3.5 billion invested, we certainly can get to $5 billion. Because what we're doing is we're moving out of markets that we're not concentrated in. We're moving into markets where we get some concentration and we have staffed ourselves so that we are able to take that additional depth into our platform, and it's going to be there for the benefit of our investors who have joined us, because we are not going to need to add significant amounts or even what I consider to be material amounts of G&A in order to expand our platform.

Okay, thank you for that. Second is going back to one of the comments in the presentation discussing the expansion, your preferred area of investment are the existing tenants that are expanding. Is there a way that you can see how much current potential there is for expansion within your existing portfolio? In other words, that segment of tenants that wants to expand versus external growth or some acquisition?

Well, we're going through our budgeting process right now. And I can tell you that Amanda, Alisa, who introduced our call, their focus right now is, in fact, individually talking to our leasing folks and analyzing each of the assets where we see vacancy. And one of the benefits of having your leasing people and having your property management and so forth and so forth is that you have interaction with these tenants. And I think that's just extremely important in today's environment with the change in the healthcare sector, with the change of healthcare systems and physicians and larger tenants.

I've been very surprised. If we had this conversation 18 months ago, I would not have said to you that I would've expected the amount of expansion space to be taken by existing physicians that we had at that time or healthcare systems. I would have said I would have hoped that the healthcare Affordable Care Act was going to move that direction, but we've actually seen numbers now, and track numbers that show that it's going to continue.

So, I wouldn't expect it not to continue. I think that it will continue and I think our priority, of course, has to be from a management perspective, to know who is in our buildings and what their expectations are for the next 18 months.

And just a follow-up, does that mean, too, that those expanding physicians' practices would be -- or expanding tenant practices would have a more favorable cap rate versus traditional investing?

I think that someone who's expanding is not ignorant of the marketplace. So, when they say I'll expand, I think it does save us. It saves us -- normally, we don't have a broker involved. They actually call us and say I want an extra 1000 square feet. Where is somebody rolling over, not renewing? Can we move somebody? Can you relocate them?

That's a more efficient transaction than a third-party broker transaction where you go through the process. It's quicker. It takes less time to get executed. So, I think there are substantial, both tangible and intangible savings from that.

We've said two things consistently. Number one, we like our own leasing people, because they know the tenants and we cooperate fully with third-party brokers who represent tenants, but on our part we don't need someone representing us. We know our buildings. And number two, if we can get the expansion from existing tenants and keep the renewal at 85% or 90%, then the portfolio is going to continue to benefit and it's going to continue to generate NOI growth.

Thank you very much.

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

I want to thank everybody for joining us. A great group of questions from folks and we look forward to seeing anyone next week at NAREIT, and please reach out to Robert if you want any additional information or if we can schedule something to get together. Thank you.

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