Healthpeak Properties, Inc. Q2 FY2022 Earnings Call

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

Thank you, Brad. Physicians Realty Trust continues to deliver stable and reliable cash flow growth during the second quarter, driven by exceptional leasing spreads of 8% on 256,000 square feet of renewals and our asset management team's thoughtful management of operational expenses. These results will be impressive in any period, but are especially remarkable in an economic climate made challenging by double-digit inflation and rapidly rising interest rates. Doc was built with times like these in mind, where we have a foundation of strength with almost 300 facilities in 36 states, 95% leased and no meaningful debt maturities before our revolving line of credit matures in 2025. Our balance sheet couldn’t be stronger, supplemented by the recent Great Falls Disposition. In addition, we remain protected from inflation operating expense growth, given our portfolio is 95% leased with only 2% exposed to full-service gross leases impacted by inflation. We don’t believe that any other healthcare real estate portfolio, public or private, can come close to providing investors with that level of cash flow stability. In past periods of volatility, if they have provided any lesson to real estate investors, it is that there is almost always a timing disconnect between the changes in investors' cost of capital and potential sellers' expectations on valuation. This scenario is precisely what we’ve seen in the first half of 2022, and while Doc has chosen to remain disciplined in our deployment of capital toward new investments, this discipline does not mean we have been passive as volatility can also create opportunities. A great example of this strategy is our just-announced disposition of a surgical hospital and two adjacent medical office buildings in Great Falls, Montana. Mark will share more details in a moment. We are beginning to see evidence that rational investors like Doc are shifting the transaction market to a more balanced bid versus ask. We've made progress in advancing our pipeline accordingly and remain focused on the development of highly pre-leased outpatient care facilities anchored by our existing investment-grade health system partners. Our pipeline for development financing currently includes over $100 million in potential commitments. Finalized construction of these projects will begin in 2023, and we have more opportunities in discussion. Our acquisition pipeline for stabilized assets remains muted while price discovery in this environment continues. Still, we remain confident in our full-year investment guidance, including development commitments and acquisitions of at least $250 million, with the potential for more. Despite the challenges of the current economic climate, we continue to execute consistently on our overall ESG strategy with the recent publication of our third annual ESG report and recognize the critical need to invest in healthy, physical and social spaces for our communities. Within our ESG report, we have substantially enhanced our disclosures by aligning with the global reporting initiative while expanding our reporting within the frameworks of the sustainability accounting standards board and task force on climate-related financial disclosures. We adopted a climate mitigation plan recognized by the science-based targets initiative in line with a well-below two-degree Celsius strategy. This increased transparency provides a better understanding of our impacts on the environment and society and the direct economic benefits to our tenants. We have taken bold steps to build upon our DE&I efforts to shape an open and diverse internal culture while setting aggressive multi-year goals to chart our progress. While we're proud to celebrate our milestones, we recognize that our progress is simply a step forward for Doc as we continue to invest in better in our communities and families. We remain firm in our conviction that outpatient care medical office facilities lead to investment-grade tenants, offering the best risk-adjusted returns in real estate. We seek to improve the quality of our portfolio with each investment decision we make. We will continue to focus on creating long-term value for our shareholders while ultimately getting the portfolio to a 100% concentration in outpatient care facilities over time. Before opening the call to Q&A, Jeff Theiler will share our financial results and Mark Theine will provide more detail on our exceptional operating performance. Jeff?

Thank you, John. In the second quarter of 2022, the company generated normalized funds from operations of $63.7 million or $0.27 per share. Our normalized funds available for distribution were $61 million, an increase of 11% over the comparable quarter of last year, and our FAD per share was $0.26. In the broader economy, we now have two consecutive quarters of negative GDP growth and whether this will technically be defined later on as a recession is unclear. It is clear, however, that we are in highly uncertain times. The economic experts are debating whether we have bigger inflation problems or recession problems and while we hope for a soft landing like everyone else, we have positioned our portfolio to perform well in any scenario. With the sale of the Great Falls hospital, we have improved the percentage of our rent from investment-grade quality entities to 66%. This is far better than any other healthcare REIT and will provide exceptional stability to our rental income. Alongside safety, we also see green shoots of growth in an industry typically defined by more modest rent increases. The 8% leasing spreads in the current role should lead to increasing internal growth in the quarters to come and alongside this enhanced rent growth, we are well shielded from inflationary increases in operating expenses based on our lease structure and high occupancy. 98% of our leases are protected from expense pressures through their triple net structure and our expense loss to vacancy is only 5%. Our overall capital structure is designed to be conservative while providing the flexibility needed to grow our company when the time is right. We have eliminated virtually all refinancing risks over the next three years and currently maintain a consolidated debt-to-EBITDA ratio of 5.65 times, which will be reinforced with the $116 million of cash proceeds from the Great Falls sale. We also raised $18 million on the ATM this quarter at an average price of $18.61 to help fund our acquisition pipeline. With that, I'll turn it over to Mark to walk through the details of the Great Falls sale and other operations. Mark?

All right. Thanks, Jeff. We're proud to announce another very successful quarter of growth, driven by our long-term strategy of partnering directly with high-quality health systems and physician groups to meet their real estate needs. At the heart of this strategy is an acute focus on improving the overall quality of our real estate portfolio, operating results, and relationships. We successfully made progress on all three of these initiatives this quarter as demonstrated by one; the profitable sale of the Great Falls clinic facilities, two; achievement of record releasing spreads, and three; excellent Kingsley Tenant satisfaction survey results. Starting with the Great Falls disposition; since our first investment in 2013, we have watched the Great Falls clinic grow as an essential provider of care to the people of Great Falls, the State of Montana, and even patients from Canada. Over time, we ultimately acquired three facilities on this campus for a blended 7.9% cap rate, consisting of an inpatient surgical hospital, an ambulatory surgery center, and a medical office building. The facilities were 100% occupied and leased to the Great Falls clinic, now a wholly-owned subsidiary of Surgery Partners. In 2019, Doc began discussions with the Great Falls clinic leadership team about a potential expansion to the hospital and surgery center facilities. Under the leadership of Dave Domres, our VP of Construction and Project Management, Doc assisted in the design, coordination, and financing arrangements of these expansions in exchange for new long-term leases covering the entire campus. These lease extensions executed in September and October of 2021 increased the overall annual rental revenue, increased the existing annual rent escalator by 50 basis points, and extended the term to 20 years at each facility. Through the value created with these new leases, Doc ultimately was able to opportunistically sell the existing facilities and future development expansion last month for approximately $116.3 million in net proceeds representing a gain on sale of $53.9 million, a 4.7% disposition cap rate, and a 16% unlevered IRR. As Jeff mentioned, the proceeds from this sale provide capital to recycle into accretive future acquisitions. It also improves the quality of our portfolio and the security of our cash flows by increasing our investment-grade tenancy to 66%. The life cycle of this investment is an outstanding example of the value created by the Doc team through its active asset management and trusted healthcare relationships. Our leasing team also continues to leverage trusted healthcare relationships and market knowledge to unlock the value of the Doc portfolio through strong tenant retention and lease renewal spreads. During the second quarter, our leasing team completed 256,000 square feet of lease renewals on the consolidated portfolio at an aggregate releasing spread of 8.0%, the highest quarterly mark in the company's history. Importantly, we achieved these results without sacrificing retention or leasing costs. In total, tenant improvements and incentive packages totaled just $2.19 per square foot per year on renewals, well below industry averages, as we continue to focus on net effective rent as the most important measure of total leasing performance while tenant retention of 76% is in line with long-term medical office averages. Given the strong demand for outpatient real estate, both on and off campus, we remain committed to unlocking the full value of our real estate through leasing. When appropriate, this strategy includes the selective vacating of suites that have higher rental potential with different tenants, even if that impacts same-store metrics on a short-term basis. Looking forward to the second half of 2022, we expect lease renewal spreads to continue to be between 5% and 7% as the cost of new construction continues to outpace the benefit of renewing leases in place. Simply stated, we believe this is the strongest leasing market in the company's history, and we are optimistic about our pricing power in the years ahead. At the portfolio level, MOB same-store NOI growth was 1.9% in the second quarter. The NOI was driven primarily by a year-over-year 2.1% increase in base rental revenue. Operating expenses were up 8.0%, slightly below the 9.1% year-over-year CPI change as of June 30. As expected, increased operating expenses were largely offset by an 8.7% increase in expense recovery revenue due to the high occupancy and triple net structure of our portfolio. In the nine years since our IPO, we have not only built one of the highest quality healthcare real estate portfolios in the industry, but we have also assembled an award-winning healthcare real estate team. Our efforts directly translate into care for tenants, evident in our 2022 Kingsley Associates tenant satisfaction survey results. This year, we surveyed nearly 320 tenants representing approximately 5.5 million square feet. Physicians Realty Trust received an impressive 74% response rate compared to the industry average of approximately 55% this year. In addition, we beat the Kingsley index in every property management category, including overall management satisfaction with a score of 4.48 out of 5.0. While we sincerely appreciate the positive feedback from our healthcare partners, the surveys that we actually value the most offer opportunities for improvements and where we can invest better in order to earn our tenants' trust and secure their renewal before the lease expiration. At Doc, we believe that great customer service does not happen by accident. It happens by design, and it all starts with the great team dedicated to our mission to help medical providers, developers, and shareholders realize better healthcare, better communities, and better returns. With that, I'll turn the call back to John.

Thank you, Mark. Michelle. We're now ready for Q&A.

Thank you. We'll now be conducting a question-and-answer session. Our first question comes from Juan Sanabria with BMO Capital Markets. Please proceed with your question.

Hi, good morning. Just hoping to start on the releasing spreads, obviously a great number. Just curious on as part of those negotiations, what kind of annual rent increases you're getting and is there any shift away from a fixed towards a more of a floating structure, maybe with a cap collar? So just curious on a little bit more fuller details on those lease negotiations.

Sure. Good morning, Juan. This is Mark. So yeah, we're really proud of our leasing team's efforts this quarter and seeing really strong leasing momentum to achieve those 8% releasing spreads. In addition to focus on the initial rate when the renewal kicks off, we're also focused on the annual escalators you mentioned. In fact, two-thirds of our lease escalators this quarter had a rent bump of 3% or higher. So we're excited about the compounding cash flow from those embedded annual escalators going forward. And we do try and put a lot of CPI adjustments into our new lease renewals that comes with sometimes the floor and the ceiling. And in the negotiations now I'd say, since the CPI number has been even higher than anticipated, we're getting requests for more fixed escalators, and those we're now pushing back in the 4% range on leases going forward.

How quickly do you think you can achieve a 3% or higher escalator? Should we consider your average lease term and the 5% rolling increases and think that those will be above 3%, similar to what you mentioned at the end of the quarter?

It's JT, and we're seeing incremental growth across the portfolio. Walt has always been a positive aspect until the past couple of years. We're experiencing a 2% increase this year and a projected 3% next year, but it is gradually improving. Previously, about 10% of the portfolio was aligned with CPI increases, a strategy we adopted four years ago as we started to focus on new generation and renewal leasing. It will take some time, but I believe the larger increases could happen sooner than we anticipated.

Regarding the investments pipeline and dispositions, we are still adhering to our guidance, and it appears there will be a greater commitment to development. Currently, I would like to clarify if the dollar amount you previously had in mind refers to the committed funds we should be considering for allocation, or if it reflects actual expenditures on which you expect to earn returns this year.

It includes the future development commitments and really always has. We maybe have not made that as clear as we should, but we think we'll clear $250 million of development commitments and/or acquisitions this year, probably 50-50 weighted, maybe a little bit more toward the development commitments. Most of those dollars, the development dollars will be spent in 2023 and those will start generating returns in 2024.

Thank you. Our next question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets. Please proceed with your question.

Hi, good morning, everybody. Just curious how the disposition in Montana came about, how long that deal was in the works, and then maybe if you could just speak to like the depth of the buyer pool?

Yeah. We've been really proud of that facility. Mark kind of walked through the history of it. It was one of our first investments in the surgical hospital out there and then there's a separate MOB with an ambulatory surgical center in it, all on the same campus and then a fairly large medical office building. We've been working with the physicians who were co-owners out there again for eight years. So we really hadn't had a plan to sell it. It was a very high-yielding asset, but we'd been approached by a number of potential buyers and then just started exploring some price discovery with them, and frankly, those exceeded our expectations. So it wasn't a planned disposition, but really an opportunity. So I need to pull really deep. I think we kind of once we started getting some offers that were attractive, we kind of took it to a broader market. So there's still a broad pool out there, and again, we're excited, the new owners are people we trust to take care of those physicians and that's important to us.

That's helpful. And then, so with sort of this sale, I guess, and the majority, or sorry, half of the capital needs on the $250 million being spent next year, does this Montana sale kind of meet the capital needs now for the year? Or are there other deals you're contemplating given the strong pricing you achieved here on this transaction?

Hey, Austin, I'll take that. This is Jeff. Look, we're always looking at opportunistic dispositions. The Great Falls sale takes us down in terms of leverage about a quarter turn. So that puts us in a really good position to fund our acquisition pipeline through the remainder of the year, but that said, we have been getting inbounds on various assets, and so we always look at opportunistically selling something to help fund our pipeline.

Got it. And then just one clarification. I couldn't make out what the development financing pipeline is today. Could you share that figure again?

It's currently over $100 million, and we are engaged in negotiations for additional opportunities. We initially thought we might reach $100 million to $150 million in commitments this year. Most of this funding will be utilized next year, and I believe we are on track to achieve that.

Thank you. Our next question comes from the line of Connor Siversky with Berenberg. Please proceed with your question.

Morning out there. Thanks for having me on the call. Just to clarify, the $65.8 million you have in real estate held for sale on the balance sheet for Q2 that did not include the payment assets, correct?

Oh, no, it did. It did include those assets. Where a subsequent event, the sale does.

They went under contract and then didn't close, went under a contract in the second quarter, didn't close till a subsequent event. So we had to put it in held for sale at that point.

Okay. Okay. And then, on the broad subject of cap rate expansion, I'm just wondering on a market-by-market basis, if you're seeing any more upward pressure, in any market in particular versus others.

Yeah. There are hot markets like the Texas market continues to be high, Florida continues to be high, and Atlanta continues to be strong. But you really across the board, and we’re seeing more and more assets that were for sale that went kind of off market, i.e. under LOI or kind of contemplated transactions and then have seen some of those assets come back to market at potentially better cap rates for the buyer. So I think we're still in that price discovery phase, but there's still a strong bid out there for medical office buildings.

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

Yeah. Something to drill down into the development interest that you're tracking in the marketplace. Is it more difficult for Doc to find those types of investments just given the higher construction costs that make it harder to pencil out those deals or are most of those deals more strategic in the actual cost for the health system or the developer is not as important as you would typically think?

Yeah, Mike, obviously cost is important to everybody, but these are all related to health system expansion, strategic expansions. I think they're all but one are 100% pre-leased by the health system and the other one is heavily preleased to a health system, with a clear track on where the physicians will come from to fill that space. Construction costs are high. These are all yield on cost transactions. That's why I'm a little hesitant to say exactly what the commitments are, because some in the end may determine they're too expensive based on kind of current market rents. But these are all heavily preleased strategic developments with high revenue outpatient surgical services that the hospitals want to pursue. So kind of a balanced approach. We're not out there to inspect development. We're not out there, and our funding comes with signed leases and with this signed GMP contract where we know exactly what the cost is going to be.

Has your yields, the yields that you demand for those, initial funding and takeout acquisitions opportunity have, have those changed given what happened with interest rates.

Yeah. Those are trying to move up.

Okay. And then, you talked about this in your prepared remarks. I'm not sure if I missed this part, I know you said that the market is still in a price discovery mode right now. How long do you think it's going to take for you or the market to better understand where cap rates are? I'm not sure. Did you indicate of how much you think cap rates have increased so far or where you expect them to kind of settle out at?

I think we're beginning to notice assets that underwrite well and are appealing, moving to levels above five, with mid-fives to high-fives becoming more common. However, these values don't always reflect the quality and credit we aim for. While we still receive numerous inquiries for assets in the low fours, I don't believe anyone is actually paying those rates right now.

Thank you. Our next question comes from the line of Michael Griffin with Citi. Please proceed with your question.

Hey, thanks for checking the question. Just going back to the 250,000 of renewals, can you talk about maybe what drove that? Was there any specific tenant types? Were they looking for expansions staying in their existing space? Any additional color on that would be great.

Sure. Our renewals covering 256,000 square feet reflect a retention rate of 77%. We anticipate that tenants prefer to remain in their current units, particularly as construction costs are rising, making relocations more expensive. There are also supply chain challenges that complicate the timing of relocations. This combination is allowing us to improve our leasing spreads while maintaining high retention rates. Our customer service and property management teams are doing an excellent job of keeping these tenants satisfied and encouraging long-term renewals in their spaces.

Great. That's helpful. And then on the real estate technology fund investment mentioned in the release, can you maybe expand on that a little bit what that is, maybe a continuing focus on investment in technology in your business? Some additional color there would be great.

Yeah. Michael, this is Jeff. So it was a relatively small investment in a real estate technology fund that's run by Fifth Wall. It actually has a lot of other REITs and real estate companies as LPs. And while we think the investment itself will perform well, the primary reason for the investment is to just get an early look at the real estate technologies that are out there. So you get enhanced access and early access to these types of technologies and ultimately what we'd like to do is just enhance the efficiency of our operations and our portfolio. So we think it's a win-win from both access to these technologies as well as a good return.

Thank you. Our next question comes from the line of Steven Valiquette with Barclays. Please proceed with your question.

Thanks. Good morning, everybody. So I guess with your bullish comments that we're in one of the strongest leasing environments in the history of the company and that releasing spread is trending quite favorably, just hoping you can maybe give some more color on just the context of that in the fact that the operating expenses in the same-store data we're up 8% year-over-year. So I guess with the better leasing environment is also higher cost. I guess the question is, at the end of the day, if same-store cash NOI growth is kind of hanging around that 2% to 3% range with the better leasing environment, could that accelerate or do higher expenses kind of offset that, and you kind of maintain that same sort of cash NOI growth up in the next couple of years. Just want to get more thoughts around that. Thanks.

Yeah, Steve, it's a great question. So as Mark alluded to, high construction costs and higher opportunities for other space at much higher rates allows us to push kind of retention rates at a higher cost. At the end of the day, there's a total to your point the total cost of occupancy that the tenant bears, the hospital system, investment-grade tenants like we like to least to can bear. So that's why service to those tenants and managing operating cost and expenses the best we can really matters, really paying attention to the energy cost of the building, the utility cost generally. So, the more we can do to help hold those costs down, the more we can kind of push on the rent side as well in a balanced way. So, 8% is an outstanding number. I think it's a little unique to some of the particular buildings and leases that were impacted by that 8%, but we are seeing 5% and 6% for the next couple of quarters. So it'll be a balance over time, but for the foreseeable future, we see the real opportunity to do that while at the same time, impressing our tenants with management of the operating expenses to hold those down the best we can.

Okay. Got it. Okay. All right. That's it for me. Thanks.

Thank you. Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.

Hey guys. Good morning, and thanks for taking the question. I guess kind of a little bit similar to the prior question, but just kind of looking at this quarter same-store NOI number, I think a little bit below kind of what we were expecting and I think others as well. And I think maybe below kind of the historical trends that you guys have kind of performed at as well, wondering if there's anything in that number that maybe brought it a little bit lower and then kind of just thinking broader, higher level, right? It's really positive leasing momentum you guys are doing. When do we kind of start to see that, I guess in kind of the same-store NOI quarterly figures?

Adam is Mark, I'll take that. That's a great question. Our same-store number that's quarter 1.9 is slightly below our historical average in our rent bump around 2.4%, and, as we were mentioning about the leasing results we're really excited about the leasing momentum that we have because what's pulling our same-store down this quarter is a slight dip in our occupancy of that same-store portfolio. So looking forward at the leasing momentum, we've had, we actually have a 100,000 square feet of leases that are executed, but not yet commenced. They're under construction and so we're excited that those leases will be coming on later this year in early part of 2023 and, just looking if you had performed all those 100,000 square feet as paying rent today our same-store would have been about 2.8% this quarter. So there's a nice pipeline coming of leases that are under construction. And as you know, these leasing results lag just a little bit until the cash flow starts. Yeah to be clear under construction is the TI build-outs. So…

That's really helpful guys. And I think that's really helpful to be able to kind of quantify the 2.8 number. Are you able to kind of give a obviously not exact number, maybe more of a range of kind of the cash NOI that this development would yield bridging to that 2.8% from the 1.9%?

Yeah. So the new developments technically our yield on cost of 6% plus, I'm not sure that's the question you are asking, but that's in the new developments, those numbers tend to be more than 6% and much higher than kind of current acquisition cap rates.

Okay. Got it. That's helpful. And then just maybe switching gears a little bit and just the final one here just the opportunities in the loan book, maybe comparing that, today versus call it three, six, twelve months ago, and how things may have changed.

The loan book has some unusual characteristics compared to a year ago, primarily because we had $50 million allocated for the landmark mezzanine loans, which was an initial step towards acquiring that portfolio. We are identifying several opportunities now, particularly in mezzanine financing, which offers higher yields as part of the capital structure for those projects. Additionally, some of our development projects are funded directly from our own resources, allowing us to allocate more capital. Although we are seeing an increase in loan opportunities, last year's figures were exceptionally high due to the landmark loans, which are no longer part of our portfolio following the acquisition.

Really helpful guys. Thanks again for the time. Chat soon.

Thank you. Our next question comes from the line of Dave Rodgers with Baird. Please proceed with your question.

Yeah. Good morning. Wanted to follow up on the leasing spreads. JT, you made a comment just a couple minutes ago regarding next couple of quarters, had some good visibility, but there were some unique things about the assets that drove the bigger increases. So I guess the first question is, do you not really see that continuing into next year? Is that just kind of cautiousness? And then maybe Mark, this would be a better question for you on the rent spreads that you've achieved in the escalator increases. Is there anything unique between on-campus or off-campus or single-tenant or multi-tenant that's driving those numbers higher in the second half of this year?

Yes, as I mentioned earlier, we are currently seeing a number of opportunities in the range of 4% to 6% for roll-ups. The availability of these opportunities depends on the specific markets and the rate at which we can increase those rates. I'll let Mark answer the second part of the question. Yeah. So looking forward for our leasing spreads in the back of the year, you think we'll be looking at, 5% to 7% releasing spreads on target, which is, as I mentioned in the prepared remarks. In terms of what we're seeing single-tenants, multitenant or single tenants typically have very long leases, we don't have too many single-tenant renewals right now. So primarily, our leasing activity is in the multi-tenant buildings and not seeing too much difference in the on-campus versus off-campus. Again, we're really paying attention to what the overall market rate is for the particular location of that asset.

Thank you. Our next question comes from the line of Tayo Okusanya with Credit Suisse. Please proceed with your question.

Hi. Yes. Good morning, everyone. So first of all, just on acquisitions, your target for the year versus where you are right now, you seem to be running a little bit behind if you would, let me use those words. I'm just kind of curious, is it the whole kind of price discovery scenario right now that's making you maybe not be as aggressive, but maybe you expect to have better acquisition volumes in the back half of '22.

I can't say a better time. There are many opportunities, but sellers' expectations are outdated by about a year. However, we are getting closer to finding a price that works for both us and the sellers. You can expect to see more acquisitions in the second half of the year.

Okay. That's helpful. And then just curious, in markets where you tend to overlap, HTA and HR, but just kind of post-merger, what are you hearing from hospital systems in those markets? So what are you seeing in regards to how the merged MTD may be competing differently and again, how are you guys kind of responding to that? If anything is changing at all?

Well, a lot of our development opportunities are coming from health systems who are looking for kind of expansion and strategic relocation of some of their practices. We're seeing some other opportunities in some markets that are more acquisition in nature and backfilling buildings that are less than occupied by those health systems where they would be interested in occupying them more. If we were the owner. We'll see some opportunities.

So you actually think that that's going to create more opportunities for you because physician practices and hospital systems are looking for alternatives to that?

Yeah. I don't know if they're looking for alternatives to others. I just think we're working closely with several health systems on opportunities just like that. So either new development on and off campus or occupying more space in existing buildings that they are in today, but will move more space into it, but you own the buildings in the future.

Okay. And the last one for me, just can any updates from a regulatory perspective, anything changing from a Medicare reimbursement or commercial insurance or reimbursement perspective that potentially could impact physicians and hospital systems that maybe we should be aware of?

We are not directly affected by inpatient rates, but they do influence the financial performance of health systems, where we lease 66% of our space, primarily outpatient. Recently, CMS adjusted their proposals for next year, providing a 4.3% increase, although this is likely insufficient to address existing inflation and particularly nurses' salaries. However, it is an improvement compared to last year. According to the health systems that have shared their negotiation data with us, commercial insurance rates are increasing at a rate of 5% to 6% or more, depending on the market. We are still awaiting CMS's proposal on physician reimbursement, which is currently lower than expected, but they typically start low and adjust upwards by the final rule, so we anticipate improvement that reflects inflation. For outpatient surgery, they are considering a 3% increase, and we expect them to advocate for more. Commercial insurance rates for outpatient surgery center operators should exceed a 3% growth given the space we lease.

Okay. That's helpful. Thank you.

Thank you. Our next question comes from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.

Yeah. Hey everyone. Thanks for the question. Just kind of curious how you're thinking about debt needs over the next 18 months and what kind of rates you could potentially achieve?

Hey Josh, this is Jeff. The positive aspect of our lease maturity schedule is that we don’t have any refinancing on the horizon for the next three years. We are currently satisfied with our position, so we don’t see a necessity to extend that debt. It’s challenging to pinpoint what long-term rates will be, especially regarding our 10-year rates, due to the low market activity. There’s not much clarity right now, but we estimate it could be around 5%, give or take. As I mentioned, we don’t think we’ll need to act on it, but that's our outlook on current rates.

I've noticed some other REITs in like the net lease space kind of like term loans. Like, would you do like 10-year or worse like a term loan, if you needed to term out the line kind of look attracted?

Yeah. If we decided that we wanted to term out the line, we'd probably look, term loans, a better execution right now than 10-year debt. I thought you were just asking about 10-year costs.

Yeah. Sorry. I was probably too specific just to get a sense of where the cost of capital is across all the companies. So appreciate that. Thanks guys.

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the call back over to Mr. Thomas for any closing remarks.

Thank you, Michelle. Thanks for everybody for joining us today. We're excited about the prospects of the third quarter and look forward to seeing you at the investor conferences and on the next earning call. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.