Healthcare Realty Trust Inc (HR) 2018 Q3 法說會逐字稿

Good day, and welcome to the Healthcare Trust of America Third Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Caroline Chiodo. Please go ahead.

Thank you, and welcome to the Healthcare Trust of America's Third Quarter 2018 Earnings Call.

We filed our earnings release and our financial supplement yesterday after the close. These documents can be found on the Investor Relations section of our website or with the SEC. Please note that 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 the call, we will make forward-looking statements. These forward-looking statements are based on 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 the current expectations. For a detailed description of our 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, and thank you for joining us today for Healthcare Trust of America's Third Quarter Earnings Conference Call. Joining me on the call today are Robert Milligan, our Chief Financial Officer; and Amanda Houghton, our Executive Vice President of Asset Management.

As we report on the third quarter results, the fundamentals of the medical office sector remain solid, and the long-term future for MOB outpatient demand looks strong. The overall tailwinds influencing the MOB sector continues. The demand for health care services continue to increase, as the aging population turns 65 at a projected rate of 10,000 individuals per day for the next 15 to 20 years. The focus on quality of life and life longevity has never been greater.

Health care systems, physician groups and the medical academic universities continue to move to lower-cost and more convenient outpatient locations, primarily well-located medical office buildings. Development remains in check with limited speculative developments. We are seeing and being involved in specific opportunities that address specific needs with several of our health care system relationships.

This fundamental performance can be seen in our third quarter results. Same-store growth was 2.5%, driven by strong 2.7% rental revenue growth, our highest level of revenue growth in over 8 quarters.

The leasing metrics are solid. Total new leasing totaled over 200,000 square feet, with cash re-leasing spreads accelerating to 3.7%. Tenant retention was healthy at 82%, and TI leasing concession costs are in line with past quarters.

Forest Park Dallas is leasing up. We entered into 41,000 square feet of new leases at the Campus at rates favorable to our budget. This brings our lease rate to 84% for this Campus, and we expect continued leasing in the fourth quarter.

The yield on our 2017 investments of $2.8 billion improved to over 5.3%, on track to achieve 5.5% upon lease-up of our Philly development.

From an investment and acquisition perspective, the volume of the transactions is lower than last year. However, the strong fundamentals we have talked about continue to track private capital into the sector, keeping cap rates pretty much the same as they have been over the last 12 to 18 months, especially on high-quality assets.

Our investment strategy is to be patient, disciplined and focused in this environment. We recognize that the ability to acquire quality assets on an accretive basis has become challenging. However, we continue to pursue assets in our key gateway markets that leverage our operating platform and take advantage of our recent recycling efforts. Greenville is a great example.

As we look ahead to the remainder of 2018 and into 2019, it is important to review the strategic steps we have taken over the past 12 months that has positioned HTA for both internal growth and future long-term growth. We created the best-in-class medical office portfolio with the acquisition of Duke Assets last year and are now the largest owner of on-campus assets within the public REITs. We significantly increased our presence in our key markets, which deepened and strengthened our relationships and created significant operating efficiencies.

This has been positively -- this has positively impacted our operating results and can be clearly seen in the performance of our 2017 investments, where our yield on the Duke acquisition increased from 4.75% to 5.2% over the last 12 months. We layered on development capability to our operating platform to drive future growth, which is gaining traction with 3 active developments underway. And we reduced leverage and have positioned the balance sheet to be in a position of strength and flexibility given today's market. All of these steps has put HTA in a solid financial position and should enable us to outperform in future quarters.

Current market conditions have enabled us to focus on a strategy of selling out of noncore assets, where we have maximized value or do not have long-term strategic future. During the quarter, we did this by disposing of over $300 million of properties in noncore markets. This includes our complete exit from the Greenville, South Carolina market at a low 5 cap rate as well as sales of MOBs in rural secondary markets. We will continue to take advantage of strong demand for the sector and recycle out of noncore markets.

We used immediate proceeds to repay about $140 million of mortgage debt, including $73 million in the third quarter and $67 million on October 1 when a prepayment window opened. This lowered our leverage to 5.3x net debt-to-EBITDA while maintaining over $200 million of cash.

The remainder of proceeds, we will utilize to either continue to pay down debt, acquire assets in key markets in a disciplined manner, invest in development in our markets or utilize our share repurchase program when appropriate. We will be patient in our execution, knowing that liquidity has a significant value as markets are adjusting in a rising rate environment. This may be dilutive in the near term. However, over the course of real estate cycles, this strategy has significantly outperformed and led to value creation.

I will now turn the call over to Amanda.

Thanks, Scott. Our teams on the ground and our portfolio continued to perform well in the third quarter. We remained focused on providing best-in-class service and value for our health care tenants, resulting in occupancy, rate growth and expense efficiencies.

Starting with leasing. We had a very strong quarter with over 200,000 square feet of new leases signed, bringing our same-store lease percent up 30 basis points over last year to 92.2%. This leasing activity was the result of strong relationships and demand within our portfolio. We renewed over 300,000 square feet, resulting in tenant retention of 82%. Our re-leasing spreads for renewal leases for the quarter were up 3.7%. We continue to believe re-leasing spreads will remain in the 2% to 3% range for the remainder of 2018 and into 2019.

Our annual escalators on new and renewals averaged 2.6% while our leasing costs remain low, with TI averaging $1.53 per year of term on renewal and just over $2 per year of term on new leases.

Importantly, we have made great progress at Forest Park Dallas Campus. During the quarter, we signed an additional 41,000 square feet, primarily with the hospital. This brings our leased rate on the Campus to 84%, and we expect to get over 90% leased in the next 3 to 6 months. Importantly, these leases are being signed at rates 30% above our portfolio average and will help us drive revenue growth as the leases move to occupancy and pay full rent over the coming quarters.

On the expense front, we continue to show the benefit of our economies of scale and ability to perform services using our internal engineering platform. Despite overall higher temperatures in utilities, in which our cooling degree days were up over 11% this quarter, we were able to lower our total same-store operating expenses versus the prior year by 1.6%. These savings are primarily driven by the increased use of our internal engineering platform, now fully integrated with our 2017 acquisitions, and the benefit of several property tax refunds and appeals in our Denver and Houston markets.

It's worth noting that over the last 5 years or 19 reporting quarters, we have generated average quarterly same-store operating expense savings of nearly 1.4%, while our peer group has generated an average operating expense increase of 1.3%. Our ability to operate efficiently without sacrificing service or quality is what we believe sets us apart in our markets as we perform for our tenants and ultimately, drive dollars to the bottom line for our investors.

I'll now turn the call over to Robert to discuss the financials.

Thanks, Amanda. From a financial position, we are ending the third quarter with the best balance sheet positioning we have had since we've started our strategic process, with low leverage and cash on the balance sheet. Over the last year, we have lowered our leverage by over 1 full turn of debt-to-EBITDA and over 0.5 turn since we announced our 2017 acquisitions.

This positions us with significant flexibility to deploy capital strategically in this volatile market. However, we will be patient, recognizing that deals today may be better and more accretive in the future. We will do this despite any potential near-term earnings dilution, as this is the right thing to do for the long-term performance of the company.

Turning to the specific financial results. Third quarter normalized FFO per diluted share was $0.41, flat on a sequential basis from the second quarter and down from the prior year. Holding leverage constant, we would have been flat to up on a year-over-year basis. Funds for distribution decreased to $69 million.

Same-store cash NOI was 2.5% compared to the third quarter of 2017. This is the first quarter we included the majority of our 2017 investments in the same-store reporting, and our performance was relatively consistent between the new and older portfolios. This growth was driven by rental revenue growth of 2.7% year-over-year.

Our expenses were also down on a year-over-year basis, demonstrating the capabilities of our operating platform and our economies of scale. However, our total margin was down slightly in the period, primarily related to some initial accounting true-ups related to our 2017 investments in the year-ago period. This impact was limited to our 2017 baseline and has had minimal impact on our 2018 metrics.

Our 2017 acquisitions ended the period yielding over 5.3%, on pace to reach the mid-5% range once the final development in Philadelphia reaches 90% occupancy.

G&A for the quarter was $8.7 million, which is approximately 5% of revenue. We expect G&A to be close to $9 million in the fourth quarter.

As we look at 2019, we will be impacted by the accounting rule change, ASC 842, related to the expensing and capitalization of internal leasing costs. We currently do the majority of our leasing in-house and capitalize most of these costs. Year-to-date, in 2018, we have capitalized approximately $4 million or between $1 million to $2 million per quarter. This compares to more than $9 million we would have paid in third-party commissions on leases completed by our team at a conservative 3% rate on the gross lease value. Nonetheless, these expenses will hit our income statement in 2019 and will impact our earnings by approximately $0.01 per share per quarter and bring in the total quarterly SG&A to $10 million to $10.5 million per quarter.

Our capital expenditures increased during the period with an uptick in our first-generation tenant improvement expenditures. This is primarily related to the lease-up of our former Forest Park space, which has remained in shell condition. Our recurring capital expenditures typically increase in the third quarter and ran around 15% of our cash NOI. For the year though, we continue to remain at 12%.

We ended the quarter with leverage of 5.3x net debt-to-EBITDA and less than 30% net debt-to-market capitalization. We also had over $200 million of cash.

To further optimize our balance sheet, in the quarter, we closed on an amendment toward $200 million term loan due 2023. This reduced the pricing by 65 basis points and extended the maturity into 2024.

We have the capacity and ability to use these proceeds in an accretive manner as the markets continue to adjust. We have used our funds to delever and can lower it even further. We also use funds to invest in our key markets through acquisitions, where we can generate incremental 25 to 35 basis points from our property management platform and drive greater growth and also through development that yield 75 to 150 basis points above current acquisition pricing.

We have also started to repurchase shares, albeit in a measured manner, repurchasing 16 million in total, including 7 million after quarter-end. And we'll increase our purchase should the pricing become even more attractive and the opportunities present itself.

As always, it is important to note that we'll be patient and measured in our deployment of this capital. Given the significant move in rates, we believe that the flexibility and liquidity of cash that allow for significant accretion over the medium to longer terms. However, it may be dilutive for a short period of time, including in the fourth quarter.

I will now turn it back over to Scott.

Thank you, Robert, and we will now open it up for questions.

(Operator Instructions) The first question comes from Chad Vanacore with Stifel.

So given the view that you've outlined on the acquisition and disposition environment, should we expect to see HTA sell some more assets either during this year or early in 2019 and then retire more debt along the way until that market turns? Any update would be helpful.

I think that right now, the environment, certainly, as we've talked about and indicated in our call, it's challenging to find what I consider to be quality, high-quality assets in markets that are long-term growth on an accretive basis. And on the other hand, I think there are opportunities to -- for us to sell some of the noncore assets that we have, also some assets that we may feel have maximized in value. We've been doing this now for 10 years. And so most companies always take a -- take the opportunity to move through certain assets that have reached their value or have not materialized to what they think they thought they would. And I think this is a good time for us. So I do think you'll see us sell some more assets. We'll certainly be opportunistic over the next 6 months.

All right. Scott, any target markets with dispositions that we should think about?

We've talked in the past that there are certain markets that we don't think that there is the type of growth that we think there are in other markets. Typically, when we moved out of Milwaukee, we've sold some stuff there, and we have a little bit left. And if something came along that allowed us to move out of that, we would. There are some secondary markets in the Midwest that came along with acquisitions that we did before we were public, larger portfolios that had 1 or 2 off assets. We have some assets in Dayton that now have gotten to be about 86%, 90% occupied. And it would be a good time to take advantage of perhaps a local buyer. So you'll see us continue to -- what I would say in our overall strategic goal as a company from an investment strategy is over the next 3 to 5 years to be invested 90% into our key 20 markets. We're focused on one thing. I think it's the #1 thing that the management team and our board of directors have focused the company on is to get the platform, our asset management platform, 1 million square feet in the markets that we think are going to grow for the next 5, 10, 15 years and really take advantage of what we have from a relevance and from an ability to continue to produce what we think is solid same-store growth. So that's really our strategy going forward.

All right. And then is it fair to think of the use of the cash, first, for debt repayment, next, for share repurchases? Anything else in there that I missed?

Well, we have development. I think the one thing that we've talked about in the prior couple of quarters is that the Duke acquisition or our acquisitions last year, that was a year for us to really take what I thought was the opportunistic time to grow HTA to the largest MOB owner, the largest company from an MOB perspective, and I think that was a big step for us. And then the second step for us is that they were in our markets. 90% of the assets were in our markets, so we weren't moving into markets that we had to begin with and start over from. So the development has been a very big surprise for us. I think that there are tremendous opportunities for us to align ourselves with the relationships we have in our markets and continue to generate that 50 to 150 basis points that Robert talked about in his prior remarks for us, and that will be a couple of $100 million a year.

All right. And one last one. It looked like CapEx and TIs are elevated related to probably the Forest Park leasing. Do those return back to normal in 4Q? Or is this a better run rate to think about?

No. We certainly expect the capital expenditures in the fourth quarter to kind of go back to the prior run rate that we saw earlier this year. Certainly, as -- there'll be a couple of spaces within the Forest Park assets that as we lease-up, you'll see some shelf space expenditures. But you should see us at a lower run rate in fourth quarter, first quarter next year.

The next question comes from Karin Ford with MUFG Securities.

Great. Sticking on that theme, when does rent start commencing on your new leases at Forest Park? And can you talk about -- I read that there was a new MOB under construction by HCA going into that facility. Can you just talk about that?

So we expect the rent to commence in the first and second quarter of next year. So that's when you'll start to see some of the revenues pick up from the leasing. And regarding the new construction, we generally wait until HCA announces that, but they are continuing to invest in the hospital and plan to add beds and use of -- specific to the specialty that they'll also be announcing probably in the first quarter of next year.

Okay. Then my second question is just on the stock buyback. So you obviously have a great warchest of dry capital here, a lot of cash on the balance sheet. You bought back 15 million recently, but why not do more? What's driving your decision on your volume of share repurchases?

I think we've always said we want to be opportunistic. We want to be -- although we believe to be accretive, we want to take it also -- be very pragmatic about it. And so your original question is that I do think we are up from a balance sheet perspective. We couldn't, I don't think, be better positioned. We moved out of 2017 with the largest, best-quality MOB assets, I think, from any MOB owner. Second, we have a platform that's performing, as we indicated, when we acquired Duke. I think that was one of the big questions that came about, was can they take this 4.75% and move it up to 5.2%, and then can they continue to move the overall acquisitions up? And we're seeing that, and we're continuing to do that. So the platform is working. So what will we do? We'll take the 3 steps that I think any logical person would at this time is we'll repay debt where it's appropriate. We will use it for development. We will find, I think -- we will be -- we will do acquisitions. We won't be completely silent because there are opportunities in these selected markets that we've found that can continue to be accretive prospectively with the asset-management side of the equation to it. And then we'll utilize our balance sheet to buy back stock where we think it's appropriate and with the appropriate size.

Our next question comes from Tayo Okusanya with Jefferies.

Two questions from me. First of all, the things to our number again, the decline on a quarter-over-quarter basis. Again, I just wanted to confirm that is all being driven by the same-store pool changing. And I wanted to know specifically kind of what's unique with the assets that were added this quarter that contributed to the decline.

Well, I think as we've talked about for this year, we expect our same-store growth to be in the 2% to 3% range. I think you'll continue to see us really hit the midpoint of that range. I think what we've been encouraged about this quarter, I think we continue to see is good leasing traction and positive revenue growth kind of going throughout the entire portfolio. So we were putting up 2.5% same-store growth, and you're seeing revenue growth at 2.7%. I think we see that as a positive trend for us. Specifically, as we look at some of the comparison period, this is where we added the majority of our 2017 investments into the same-store pool that we've owned them for a full 5 quarters. And anytime you bring in new assets, especially an acquisition of this size, there's a little bit of accounting true-ups that take place in the first 2 quarters of the acquisition. So there's a little bit of noise related to that. But overall, we see the -- a strong trend of 2% to 3% same-store growth really continuing.

Yes. But I -- and again, I appreciate those comments, but I think again with so much sensitivity around U.S. same-store NOI growth, in particular, more so than maybe some of your peers, I think it'll just kind of be a little bit helpful to kind of fully understand that 30 bps decline. I'm not fully sure I understand what the difference is between the asset you brought in, which probably were lower same-store NOI, versus your old pool.

I think both of the pools, as we saw the growth and compared certainly with what our 2017 investments did and compared to what the legacy portfolio did, they were actually pretty consistent from a growth perspective. I think they were both actually right around the 2.5% growth trajectory there. So they were pretty consistent between both the legacy portfolio and the acquisitions that we brought on from an overall basis.

But you still saw a 30 bps drop though? I haven't seen that before.

I think, Tayo, you're going to see ebbs and flows. I mean, we've said that it's 2% to 3%. I think it's consistent. We now have 23 million square feet. We're in 1 million square feet in 10 markets, 500,000 square feet in another 5. I think that the MOB sector -- and we've talked about this continually. I remember talking about it 5 years ago when the average growth was about 1%. I think the portfolio of this size, of this quality is going to produce 2% to 3%. It's going to ebb and flow quarter-by-quarter. But what you've seen us do is focus, I think, on rent spreads. We've continued to move those up. Revenue growth, as Robert has talked about. And then you just move through the portfolio on a quarter-to-quarter basis. So I think you're going to see us in the 2% to 3% range, and that's where we anticipate the portfolio to perform.

Okay. All right. The second question I had, again, Scott, I think -- again, I appreciate all your commentary around this idea of delever the balance sheet to kind of see what happens next with the cycle and the appropriate capital allocation decision even if it creates some near-term earnings dilution, and I think I get that. But typically, in my mind, anytime I kind of see management teams take a pause that way, it seems -- it feels to me like they are seeing something or there's some uncertainty about what the future may hold. And in general, I think people kind of look at the MOB space as a fairly stable space. So I'm just kind of curious why the pause or the uncertainty when I think the general viewpoint of the industry is that it's fairly stable and in fact, actually has some positive tailwinds that -- just kind of given the demographic, the aging demographic basis that everyone seems to talk about.

Well, I completely agree with you. I think the MOB sector and MOBs are -- it's still at the forefront of the tailwinds. I think the tailwinds are going to continue for 5 or 10 years. I think this election that's going to come up in November is going to even change the dynamics of health care systems in the hospitals and MOBs even further in our favor. But I think that when we look at the size of where we are, we bought $2.8 billion last year. We'd averaged about $300 million for the 7 or 8 years before that. So we made a huge step. We bought the highest-quality portfolio at the time. We performed on that acquisition from a platform perspective. I think that by pausing -- if you say pausing for 3 or 6 months, that's not a pause when you look at a 10-year cycle. It's not really a pause when you look at the next 10 years. We've had a tremendous move in interest rates in the environment. We've seen private equity. And I guess I would say that your comment about is there something unseen in the MOB space, private equity is seeing the value of the MOB space. We haven't seen the quality of products this year, frankly. There are some products out there right now that people are chasing that, compared to the Duke portfolio, are probably C quality. They're not in our markets. They're not assets that we think are going to generate 2.5% to 3% same-store growth on a continued basis. So we'll continue to be what we have been, which are very dedicated, articulate, focused owners of MOBs in markets that we think that are going to grow for the next 5 or 10 years. And if putting a balance sheet in a position that allows you tremendous opportunity moving forward is a setback or a pause, then I would say over my last 30 years, I think that's a pretty good place to be because I remember 2007 and 2008, when we had a lot of money on our balance sheet more than anyone else, and we had some tremendous opportunities that presented itself. So I think we'll continue to be patient, disciplined and prudent as it relates to shareholder value.

The next question will be from Todd Stender of Wells Fargo.

Amanda, if I heard you right, you highlighted a 2% to 3% re-leasing spread expectation but obviously, did better than that in Q3. Can you talk about the success in Q3? I did see that the expiring rents were at a lower base rent than in Q1 and Q2. So I just wonder if they were just literally brought up to market or maybe there are some further color around you could share.

Sure. So we did have over 300,000 square feet of renewal leasing and generally maintained a 3% renewal re-leasing spread. There were several leases, 5,000 square feet in Austin, 8,000 square feet in Florida, several in California, where we were converting more of an office or administrative use to medical or a higher acuity in medical. And that's what you'll see reflected in that -- in the higher rates generally.

Okay. And how about any color you can provide on Q4? Any visibility on what the rents look like, Q4 and Q1?

Yes. We continue to see 2% to 3%, just as a standard. And knowing our portfolio, that's generally the range that, that will be unless you have some of those situations that we had this quarter, where you've got a change in use.

Todd, one of the interesting things that we are seeing from a fourth quarter and first quarter perspective is that I think this is the most activity we've seen from the tenant side of the business reaching out to us to look at either renewals or extensions on their existing leases. And we've had several health care systems reach out. And the other interesting thing is that the -- it used to be when they reached out, they were looking for blend and extend, the favorite term of, oh, gee-whiz, let's try to get something more favorable by doing it. We're seeing some increased pricing power in critical locations in some of these key markets. And so I think we'll continue to see some favorable leasing spreads.

And increasing their term at the same point? Any...

They are. And they're putting dollars into the space. I mean, I -- we've all seen or we've heard about the inflation that's coming through the economy. Certainly, we've seen it from a perspective of construction time is a little longer. Permitting time in major cities is taking a little longer. But the other thing that you're seeing is that the expectation or the result from the tenants are a recognition that there is a -- the escalators are 3, the renewals are rolling up from where they stopped and they are looking for a little longer-term. And what we're trying to do is make sure that we are positioning the assets appropriately for the next 3, 5, 7 years.

The next question comes from Vikram Malhotra with Morgan Stanley.

Scott, so just on all the comments around being patient in capital allocation. Would it be safe to say you are not interested in any of the large -- whether it's landmark or CNL or any of the other portfolios out there? And could you just maybe give us a bit more color how you categorize those different portfolios in terms of quality?

Well, Vikram, I guess I would say that we are not in the process of -- we've looked at those portfolios. I think we are very well aware of the quality of those portfolios. I think the biggest differentiation for us, and I'm not going to get into necessarily our view because I think someone whomever requires it will think that they're great assets and they're going to be paying an appropriate price. But if you look at the landmark assets, they're not in our markets. They are larger assets in secondary markets. And the folks there, and we know them pretty well, have done a great job of build-to-suits for health care systems in specific locations. But again, not fitting into our asset management platform and particularly not fitting into what we think is the long-term value of our key markets. The CNL portfolio, we know those folks, too, because, as you know, we were an untraded REIT. And I think that portfolio is also somewhat fragmented. It has some quality assets in it. But as a whole, it also has, I believe, some non-MOB assets in it that make up that group. And I don't think they come anywhere close to the quality from a whole of what we acquired last year. I think the pricing will be very interesting. And I think that one sometimes steps back and says, "All right. How do other folks view this pricing in today's marketplace? And what is private equity if that ends up chasing it or another public entity ends up chasing it? I mean, how do they see that quality?" And I think that will only reflect very well on what we did last year, but we're not chasing those 2 larger portfolios.

Okay. And then just in terms of your expirations, and you mentioned renewal spreads are likely to be in that 2% to 3% range. One big expiration appears to be probably on St. Joseph, I believe it's next year. Any early indication of kind of what that renewal might look like? Are there any expansions or any changes in that lease?

Well, I'm going to let Robert talk in a moment, but I just want to talk a little bit about, when we say leases and renewals and extensions, I think I read something you came out with regarding the credit risk of some of the tenants in some of the health care systems. We've had a -- we've been very fortunate, and you always knock on wood, but we had something down in Clear Lake that our health care system that's gone through a transition. And now it's gone through that transition and our MOB on-campus there is actually going to be a positive participant in that transaction because we're going to move some rents up. We had the same occurrence. We have a group of assets at North Cyprus that went through a recent change, HCA bought the health care system. And again, that's a higher quality. In both these 2 cases, it's going to be higher-quality credit for us. And of course, we had Forest Park that went through a change, and that's moved up to HCA. And yes, that took a little longer than we had hoped because we had closed it down, and HCA had taken it's time to -- that's higher-quality credit. So I think as we've looked through our portfolio -- and we try to do that because I think that's the biggest question mark for investors is, first, what's the quality of the portfolio, what's the growth of the same-store pool that you're looking at but then what's the credit quality and what's the risk associated with that. And we've come through, and I think, again, it's really location of the assets that plays such a big part in the ability for it to survive. I'll let Robert talk about your specific question.

Yes. I think you've mentioned St. Joseph Providence. These are assets in Mission Viejo, California that we largely bought several years ago. One of the best markets in the country, certainly very tight real estate market. I think as we look at our opportunity there, we always weigh the ability to lease space today with the ability to potentially redevelop some of the campuses. So as we look at kind of renewals -- renewal ability and fee-simple interest right next to a great hospital system and one of the tightest markets in the U.S., so we feel very good about the options we have.

Okay. And then yes, you -- Scott, you did touch upon the Webster asset. That was going to be one of my questions. Maybe just a bigger, broader question then, just around credit and the portfolio. So looking at your supplement where you provide all the health system relationships, Baylor, et cetera -- HCA, et cetera. Can you give us a sense of like what percent of the levers actually have -- are sort of guaranteed at a corporate level have that actual credit rating? Or are these usually for special purpose entity at a local level? And how does that play -- how does that fit into your -- the core community side of the business? And the reason I ask that is because I have heard hospitals are increasingly taking space at these off-campus locations so the credit of those assets are likely improving.

Well, I'm going to work with your last question first and then let Robert or Amanda talk about the first one. But I do think that it's interesting because I think 5 years ago, when MOB cap rates for quality assets were 7, I talked about I thought they were going to move down into the 5s, and they were going to become very -- the quality of those would be replicated with what traditional office was, and I think we're seeing that. I think we've seen it, I think we're seeing it, I think we're going to continue to see it. I think the other key event that we've talked about for 3 or 4 years is that the off-campus -- and again, it's the off-campus. It's not a one-off building located in just arbitrarily at a corner that gathers a couple of physician groups and then calls it a medical office building. That's not what we're talking about. But the off-campus MOB that is a central location for a high-demographic area that's being looked at and attached by 2 hospital systems or 1 hospital system with a large physician group. I do think that those cap rates are coming down because the credit quality and the ability to move rents and stability of the patient mix is there. It's all the same qualities that you look at for a high-use building. And again, I read something that you wrote, and I agree. I think rate -- cap rates are coming down. I don't think they're coming down on secondary markets. But I do think they're coming down in the valuation, in the recognition of the value of those assets on campuses are becoming, I think, apparent to investors. Robert, you want to talk about that?

Yes. I think in the health system relationships that we lease out, I think as we look across the space, it's important to note that these are leases really directly with these parent tenants as well as their direct subsidiaries that they have ownership stakes in. And when we typically see the leases on the health system basis, a lot of times, the leases with the specific hospital campus or the physician group in the area. And you see that effectively roll up from there.

But just to clarify, the levers like with HCA, are they -- is there a corporate guarantee by HCA or that's HCA local -- whatever local entity your MOB is located in?

Yes. So typically, with our health system leases, you'll have the hospital entity as a tenant and oftentimes, the parent system as the guarantor. Now as our leases roll, we have seen the health system entity be looking to be released from the guarantee. And that's what we evaluate on a case-by-case basis depending on the health of the actual customer that we're working with.

The next question is from Eric Fleming of SunTrust.

Yes. The question is with the announcement I saw earlier of Ascension and Adventist JV getting together, and the headline reads that of, hey they're going to close 50% of their outpatient facilities. But we're reading deeper than that. It sounds like it would be actually a benefit for people like you, where you've got the larger MOBs. Is that -- as more and more health systems look to get together whether JV-ing or not, would it be you guys benefiting with your larger buildings as they close down kind of the 1 and 2 DOC facilities and merge them into bigger asset facilities?

Yes. Eric, I think you hit the nail on the head. When we talk, especially outpatient core community locations, we really are looking for the campuses that are very well-located on major roads and with a lot of folks driving by there every day and really high-quality communities. So we should be the beneficiary of those. When we look at the assets, especially off-campus, we're looking for the ones where the health systems are competing to take space, not just basing our underwriting on who the parent tenant is there. So as you see, a lot of these joint ventures take place where you see new health systems come in the market. We think our assets are pretty well positioned.

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

As you evaluate dispositions, how do your hospital and senior housing assets factor into that?

I think we've gone through a process over the last couple of years. When you look at our portfolio, we're probably the most focused MOB owner still with 95%, 96% of our assets in medical office buildings. As we've gone through a transition over the last couple of years selling assets, we've certainly sold out of the majority of our senior living-type assets. And I think you'll see us continue to move through that process.

Great. And then just a quick clarification question. Forest Park, that's in same-store, right?

That's correct. Yes, we haven't removed it for any reason. It continues to remain in the same-store pool.

The next question is from John Kim with BMO Capital.

Looking at your expiration schedule on Page 18, your 2019 expiration implies a $26 base rent per square foot. And this year, you signed rents at $23. I'm wondering if those numbers are apples-to-apples and if you still feel comfortable with that 2% to 3% renewal rate growth.

Yes. We do still feel comfortable with 2% to 3% rental escalator. But the base rent is really a factor of the market, not necessarily how strong the lease rate is. So just depending on where we're renewing deals and what that market rate is, that'll dictate the average rate that we're renewing. But ultimately, we expect it to be 2% to 3% above what it's expiring at.

And are there any differences between either the renewal rates or the leasing spreads you're getting between on-campus and your off-campus alliance?

We have, over the last 2 years -- and I would exclude the last 3 months because I do think that we have seen some distinctive changes in leasing behavior in the last 3 to 6 months. But prior to that, we saw far more -- a greater ability to move rents with rent spreads on our campuses that were not necessarily on-campus. I know that there is a philosophy that says that because I'm on-campus and I'm there that I can pressure the hospital or health care system into an unusually high rent spread. But on the other hand, there's a relationship that is integral to both the tenant and the landlord. And if you're on a health care systems' campus and there's a ground lease, they do have certain abilities to influence how that process works. Now recently, we -- as we've mentioned here or I mentioned earlier, there has been some of the health care systems, some of our tenants on some of the larger leases reach out to us about both extending the lease, getting additional TIs for some improvements that they want as part of that extension, and we're seeing the ability to move those rents probably consistent with our off-campus, which is why you're seeing us now produce one of the best number I think we produced in 8 quarters here recently but also looking forward to the next 2 to 3 quarters where we're able to do something.

And just to add to that comment. I will say that some of the hospital transitions that Scott had mentioned before, North Cyprus in Houston, Forest Park in Dallas, Clear Lake also in Houston, as some of these hospitals' transition happen and the larger hospital leases kind of go away and we lease directly with smaller physician groups, that's really where we start to see more pressure and a greater ability to get positive leasing spreads. It's when you have the larger leases that you could have that downward pressure on the re-leasing spreads because the tenant has that leverage.

I may have missed this, but what's the cap rate differential you're seeing right now between on-campus and off?

Well, we haven't been active in the last 6 months, so I can't tell you specifically what that would be. But I still think that there's a 50, 75 basis point difference between whether you're on-campus or off-campus. Now I would also say that it depends on the market. If you talk about Boston, Boston's different than, I think, than some other markets in the country. Tampa, very strong market. But -- so I think it's 50 to 75 basis points. But again, it's got to be an off-campus location that is a critical component of that demographic need and is generating high-demand, high-patient mix for the physician groups or the health care system or the health care systems because that's what we're seeing a big change in the future of health care. I think one of the biggest changes we'll see in the next 10 years is the movement from on-campus to off-campus. I think that the access to health care is going to increase, but the desire for the access to be efficient and for that efficiency to be utilized by different visits, 1 visit for 4 physicians is much better than 4 visits to 4 different physicians. So I do think that our country is going to see a continued move to off-campus campuses where health care systems are able to deliver health care more efficiently and more cost effective than downtown major cities. So I think that, that cap rate probably will continue to compress in certain areas.

Our next question will be from Michael Mueller with JPMorgan.

Robert, it seems like you're trying to get people focused on dilution and the 2019 estimates that are out there. Can you talk a little bit about how much of your comments are coming from the angle, "Look, we've sold a lot, and it's going to have implications on '19" or is it a little bit more "We've sold a lot. That's going to impact '19, but we could still ultimately sell a little bit more at an elevated clip going forward?"

I think as we look at where we're positioned from a balance sheet perspective and certainly from a capital allocation perspective, with what we've done in taking a very measured, distinct pace of reinvestment, you will see some dilution in the fourth quarter certainly. And as we look at 2019, most of our earning estimates are going to be around how we redeploy the capital and really what's the right time to do that. I think our view, as Scott mentioned, is it's a good time to have liquidity and low leverage because as the markets move, there could present some very good opportunities that are better for shareholders in the long run. So I think while we look at the dilution, certainly in fourth quarter, I think as we look at the opportunities that present themselves into 2019, we could see some opportunities or we can continue to remain patient. And we'll have a better view of that as we get into our fourth quarter earnings call.

And I think that's one of the things that we will do. I think that -- we will give some guidance, some thought to where we'll be in 2019 for investors as we move through this fourth quarter. I look at the 10-year today, it's around 3.06%. It was 3.21% not 2 weeks ago. You look at -- I still think there's an unknown in the economy. I think there's a somewhat unknown in the real estate side of the equation because theoretically, cap rates, as we've talked about, haven't moved. And you would have expected them to move or at least thought that they may have moved and maybe they're not and maybe the 10-year's going to stay where it is. But I think we'll have some clarity as we move through November. I think the election will be a very big -- have a very big impact on where things move in 2019.

And where you sit today, does your gut -- is your gut instinct that you'd ultimately sell less do you think than you're selling in 2018?

I think that -- it -- my thought is that we have sold what we wanted to do in 2018. Greenville was a great opportunity for us, and I don't see us getting another $285 million one-sale opportunity that we would take advantage of in a market like that. So I think that what you've seen from us this year, we would not outdo that probably next year.

The next question will be from Daniel Bernstein with Capital One.

I might have missed it earlier in the call, but can you just talk a little bit about the redevelopment opportunities in your portfolio in light of the low cap rates that are out there and where your cost of capital is? And I know you're doing some development and overdevelopment, but I wanted to talk about what the -- what opportunities are to increase the performance of your existing portfolio with some redev.

Well, we've got sold 2 or 3 locations. Robert mentioned something. We had a question earlier about our Mission Viejo campus, and that's an opportunity where a great real estate fee-simple older assets, recently new development around that, that really has moved rates. Great opportunity for us to have a -- to redevelop something into what will be state-of-the-art, so to speak, but also will be receptive and proactive on where health care is going in the next 10 years, the types of space that physicians and health care systems need over the next 15 years. I think we're getting to that stage. I think the stage right now is how do health care systems, how do physician groups get better efficiencies, better economies of scale? How do you provide cost-effectiveness to those tenants? So I think we are going in and we're being very introspective here of -- from a management perspective of when we look at these assets, can we redevelop them? And if we do redevelop them and if there's a demand to do that, making sure that, one, we get the value for it because you just don't want to put dollars and have them wasted. But if you put dollars into something, are you going to get the reciprocal better rates, better growth, better control on expenses? And so I think you'll see us talk about 2 or 3 or 4 of these opportunities as we get to the fourth quarter and first quarter of next year.

Okay. And I think the other question I had, we actually heard from a few brokers that maybe cap rates have been coming back up a little bit. And by a little bit, I mean maybe less than 25 basis points. I don't know if you've seen any of that. Or is it -- do you think maybe if that is out there, it's maybe more of a quality issue that you've alluded to earlier in the call?

Well, I -- we have looked at specific assets in certain markets. And I would say that those markets are markets that we have, as we've said, the 15 markets. And we've been actively looking for acquisition opportunities. Having said that, I would say that the one-off assets that we've seen, that we have looked at, the expectation from the seller has not seemed to have changed. And that was a little bit startling. In fact, Robert and I went on a -- I don't know a trip, I'd call it a trip, but we went to 3 or 4 locations and met directly with the owners of the assets that were looking to sell. And half of them had unrealistic expectations of what they own. Now the other couple, 2 or 3, we're certainly engaging conversation with them, and we actually hope that, that would be something to add to our portfolio. So I haven't seen that, but I do think it will be interesting to see what the 2 larger portfolios get from a cap rate perspective. And then if anyone else happens on these calls here coming up to talk about one-off acquisitions, I haven't heard any of the other folks talk about what they've acquired in the MOB side. I know that one -- somebody reported this morning and said they had bought some MOB assets, but I did not hear what the cap rate for those assets were. On secondary markets, I think they may have moved a little bit. I would think that they would have moved a little bit.

Okay. Now the one from this morning was a mid-5, but those were contractual already. So I don't think those are markets. One last quick question, if you don't mind. Nobody -- we've talked about this one before and we've talked about in prior earnings calls before about joint ventures with private equity and private buyers. And anything changing, anything new that we could expect on that front from you? Or is that just not seeming to materialize at this point?

Well, prior to the last 6, 9 months, even with the Duke transaction, we did not look for any other JV equity or we did not look for a partner for that transaction. We were so convinced that we knew the asset, they were in our markets, they were in our platform that we could generate that growth from an earnings perspective over -- in over a year. Keep moving into the second year, I think we'll even do -- we'll continue to grow that yield on that portfolio. Recently, however, it has -- and I think this gets back to a far-earlier question about the MOB space, we have been approached by certain folks to utilize our platform in a JV-type of arrangement. The problem we had with the couple of times that we've entertained that now or certainly had a discussion about it is, one, the quality of the assets weren't something that we felt that we wanted to necessarily spend attention on nor, frankly, use equity to invest in, even though it would have been, as Robert would tell me, it would be somewhat accretive and it would help us in the short-term, we didn't feel that the longer-term use of our platform or the fact that they weren't necessarily assets that we would turn around and buy 3, 5, 7 years from now was attractive. So we didn't do something. We kind of said no, we're flattered but not interested. So we have been approached, and I think that's an indication of our platform. And we've had internal discussions at board meetings about maximizing our efficiency, dedicating our employees to maximize shareholder value. But if the right transaction came along or if it was beneficial for investors and it was a long-term viability for us to get high-quality assets at good pricing and so forth and so forth, we're always going to entertain something that generates shareholder value. We have just not seen that opportunity come through yet.

The next question is a follow-up question from Tayo Okusanya with Jefferies.

Yes. Just a quick one, following up on some of Vikram's line of questioning about lease maturity. Anything new on the community front?

Yes. From the Community Health system, I think as we continue to look at our exposure to them, we continue to be -- to see the hospital campuses perform or actually go through a transition. We did sell one of the MOBs on a Community Health campus within the quarter down in Spartanburg. We did exit that. We didn't see that as a long-term growth campus. However, we've also just gone through a transition. We own 2 assets on a former community campus in Oklahoma City. That hospital just got sold to the larger not-for-profit that's dominant in the area. As Amanda and the team went out and talked to them, we're excited about the transition prospects and how they're going to continue to, frankly, invest more in the campus. So I think as we see a lot of these hospital transitions take place, almost in all of our experiences, they've been positive, whether it's community selling to a not-for-profit that's dominant or HCA buying certain other hospital campuses, we've just seen a positive trend as the new owner is excited to buy the campus, they're putting capital in to invest in it and they're looking to grow.

I would just add, again, I think you put something out a while ago about closing hospitals. But there was something else about closing hospitals. And I think the key is location. It really comes back to MOB asset now is a major investment class, and not all hospitals are created equal. And the synergies associated with the hospital on a local basis determines, I think, the ability or the prospect of how that continues. We have something up in Indiana that we have, and they're expanding. And they've showed that they want to continue to put dollars into the MOB with the lease expiring next year. And that was -- that's interesting because that was sort of like, well, gee whiz, that's not necessarily the answer that you would've gotten if you would have just stepped back and said, well, this is the location in Indiana that you happen to have an MOB on. But it's a very, very busy hospital, a very busy MOB. And so that particular location is great. So I think that we're getting more and more into when it's credit, when it's tenants, when it's hospitals, when it's closings, it really depends on location.

And when are most of the tenant leases expiring -- community leases expiring?

In Oklahoma?

I think across the board, I don't think we have any major significant roll. I think it's relatively level-loaded on the community front.

Yes. We've got 8 years weighted average remaining.

The next question is a follow-up from Vikram Malhotra with Morgan Stanley.

Just, Robert, I wanted to clarify the FAD payout. Do you say you expect CapEx to kind of normalize? And you'd expect FAD to trend down towards that high 80 level?

Yes. I think we typically see a seasonality for capital expenditures in the third quarter, just warmer months allows for more capital projects to be completed. I think if you combine that with some of the larger leases that were, frankly, signed at the end of last year, where we're now completing the construction and as Amanda mentioned, conversion to some higher-acuity facilities. But we definitely see that trending lower in the fourth quarter and first quarter, back to kind of the run rate that we saw in the first 2 quarters of the year.

Okay. And then just to clarify, the Webster asset, the hospital there did close, and you had an MOB next to it. You're saying that there was no impact, MOB was fine. And instead, they were -- you converted the leases to -- with physician groups? Or were there no change -- or were they never leased to the hospital at all?

Yes. So the lease continues to be operating, an operating lease that is occupied by the physician group of the hospital. So despite the hospital's closing, the physician group continued to operate and see patients. But we're going through the process now. As the hospital that's coming in is evaluating and bringing those physician groups on, the tenant on our lease may ultimately change, but we don't expect to see much of an impact to our building.

So there has been no impact to occupancy there?

No. We actually expect a positive impact. We think that -- for example, this is an indication where they may not agree with us but we think that we're actually a couple of dollars under where they should be. So Amanda has got her work cut out for her, but I think we'll get -- if that lease does go through a transition, that will be something that we will work on to get better value out of, not less.

Got it. And then just to clarify, that hospital closed in the first or second quarter of this year, right?

I think it was the first quarter.

And I think you saw the announcement on the new hospital coming in, announced this morning, with UTMB announcing that they're taking over the operations of that facility. So it's -- and it's certainly an improvement from the one-off hospital operator that saw this as a dynamic location where they wanted to be, and it's going to be an upgraded credit and overall volumes.

The big -- again, I can't overemphasize that recently, fee-simple has not been given the credit that it deserves compared to ground lease. If we had a ground lease at that particular MOB, the outcome of what Amanda has been talking about would not be as positive as it is now. We have fee-simple. There is competing hospitals looking to be in our MOB that want to compete with the hospital that's taking it over. So that's sort of the pressure that they have to keep their use solely in our MOB. So fee-simple at Forest Park was imperative, fee-simple at Cypress, North Cyprus was imperative and fee-simple in Clear Lake was imperative. So we like fee-simple-type assets. Now again, when you develop on-campus, you don't necessarily get that because the health care systems are becoming more and more aware of the leverage advantage between fee-simple and non. We like the fact that we, predominantly early in our acquisition process, bought a lot of fee-simple assets.

The next question will be from Doug Christopher with D.A. Davidson.

I did have a follow-up on the FAD, the funds available for distribution. Is this a level -- this kind of $69 million area for funds available, is that kind of a new level for you? The reason I ask is I look at its relationship to cash rents, cash NOI, and historically, it had been well above kind of the 60% area on NOI and above the kind of the cash NOI -- the cash rent, sorry. And I'm just wondering, is this kind of a new level? Do you see that trending back up over $70 million again? Or how should we think about that?

Well, I think -- Doug, thanks for your question. I think as we look at our FAD for the period, certainly, we had some elevated capital expenditures relative to how we've run over, certainly over the first 2 periods here. I think the second thing that you're seeing is the fact that we have disposed of some assets and really used that to pay off debt and lower our leverage. I mean, we're sitting right now with the lowest leverage that we've had certainly over the last 2 years with $200 million of cash that hasn't been deployed into earning assets. So I think you'll see our run rate certainly remain around this level until we've redeployed the significant liquidity that we have. But overall, our capital expenditure should also normalize and go back down to the fourth and first quarter.

Yes, that makes sense. And just on the CapEx side, you mentioned it coming back down. When you bought some of the buildings, newer buildings, expected to have kind of lower CapEx versus others? Then does that CapEx, does that remain kind of lower than average or lower than it had been as a percentage of your assets?

Yes. We absolutely see that being the case. I think there's a couple of things that we've had that have required more capital as we've converted some space and certainly built out some shelf space. But from an overall perspective, our assets continue to require less capital. I think we're more disciplined in how we utilize our capital, both on the overall building capital that we have as well as our tenant improvement dollars, where we're getting the value that we're putting into it. So we certainly do expect it to be at longer term in that 10% to 12% of NOI run rate.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Peters for any closing remarks.

Well, thank you, everybody, for listening. And thank you very much for the questions. I think they were very insightful. And we look forward to seeing certainly the analysts and investors at NAREIT coming up in San Francisco. Thank you.

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