Healthpeak Properties, Inc. Q1 FY2023 Earnings Call

Greetings and welcome to the Physicians Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Page, SVP, General Counsel. Please go ahead.

Thank you. Good morning and welcome to the Physicians Realty Trust's first quarter 2023 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, Controller. During this call, John Thomas will provide a summary of the company's activities and performance for the first quarter of 2023 and our year-to-date performance as well as our strategic focus for the remainder of the year. Jeff Theiler will review our financial results for the first quarter of 2023, and Mark Theine will provide a summary of our operations for the first quarter. Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect the 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 our 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 would now like to turn the call over to the company's CEO, John Thomas. John?

Thank you, Brad. Physicians Realty Trust provides real estate capital to healthcare providers focusing on outpatient medical services. We offer this capital through various means, including acquiring outpatient medical real estate intended for surgery, oncology, and other specialty services in high demand, as well as financing the development and transformation of older buildings into facilities that can host these essential medical services, addressing the needs of our aging US population. Our facilities and the providers we collaborate with ensure accessible care for all demographics in our service areas, beyond just the limited percentage of seniors seeking housing. The case for owning outpatient medical facilities has always been strong and is even more robust now due to several factors. Firstly, healthcare providers are benefiting from significant demographic trends that will increase demand for services both in the near and long term. Secondly, Medicare's Progressive Payment System and Part C modernization encourage providers to deliver care at lower costs while ensuring patient safety and effectiveness. Thirdly, the current pressures on expenses are seen as temporary and can be addressed. These pressures stem from inflation and outdated payer revenue rates based on past costs instead of reflecting current or projected costs. These conditions push healthcare systems to shift patient care from hospitals to more cost-effective outpatient settings to enhance their service margins. These trends have been evident for years, and they have been accelerated by the post-COVID landscape. Facilities focused on outpatient medical services have consistently shown resilience and represent a vital segment of real estate. When a client decides to downsize at the end of their lease, it typically results from specific circumstances such as physician retirements or changes in practice ownership, rather than broader challenges like declining demand or rising interest rates. Our real estate remains critical for enabling physicians and health systems to fulfill their missions in meeting the increasing demand for care. Revenue from outpatient medical services rose by 8% in 2022, while inpatient revenues stagnated. High construction costs and limited supply growth have enabled us to significantly raise rental rates in most areas, a trend we expect to continue. Currently, opportunities for new acquisitions are limited as private investors speculate on medical office cap rates returning to pre-2020 levels, despite the risk of negative leverage. We believe in exercising patience, and we anticipate gaining considerable growth and acquisition opportunities once market cap rates and long-term capital costs stabilize. We are seeing a growing number of opportunities to finance new outpatient medical investments, with discussions exceeding $300 million in our active pipeline. We are proud of the two projects we initiated this past quarter, including our first on-balance sheet development, and we plan to commence several new projects later this year. We have entered into contracts for a $40 million medical office development in a rapidly growing area of Atlanta, specifically Beaufort, Georgia. This 97,000 square foot outpatient facility, including an ambulatory surgery center, is fully pre-leased on 10-year triple net lease terms, with 91% of the space leased to Northside Hospital, a high-quality health system. The site has potential for an additional 100,000-square-foot medical facility in the future, for which we hold development rights. Northside Hospital and its affiliated physicians have agreed to leases based on a 6.2% yield on cost for the project, with 3% escalators in all agreements. The physicians leasing space within this building have also invested capital towards its development, reinforcing our longstanding partnership with Northside Hospital and reflecting our strong connections with healthcare systems. We seek collaborations with partners who prioritize healthcare above all. Ahead of our upcoming earnings call, we will mark the 10th anniversary of our initial public offering. We thank you for your support, along with the support of all the families involved with DOC, and the high-quality partners that join us in addressing healthcare needs within our communities. We anticipate the next decade and beyond with confidence, supported by our high occupancy rates and solid financial strategy for growth. The first quarter was relatively quiet until we lost George Chapman, who passed away unexpectedly. George was instrumental in making Healthcare REIT what it is today, and many professionals across the industry owe their careers to his inspiration and guidance. Several public REIT CEOs are direct beneficiaries of his leadership. More importantly, George's legacy is rooted in his profound love for his family, his community, the arts, Cornell, the University of Toledo, and his commitment to enhancing access to healthcare for all, regardless of financial ability. I believe George would want us to focus on expanding access to care, increasing senior housing options, and creating opportunities for the younger generations in Toledo and beyond. George, you are missed. We at DOC are devoted to upholding your passion and mission. Jeff will now provide insights into our financial results for Q1 2023, followed by Mark, who will discuss our operational achievements. Jeff?

Thank you, John. In the first quarter of 2023, the company generated normalized funds from operations of $60.3 million or $0.24 per share. Our normalized funds available for distribution were $59.7 million, an increase of 3% over the comparable quarter of last year and our FAD per share was $0.24. The portfolio showed consistent operations with same-store NOI across our entire MOB portfolio increasing by 1.0%. This is below our long-term expectations for the portfolio. As we've discussed over the past two quarters, we anticipate this metric returning to our long-term expectations in the back half of the year as our repositioning properties start to roll back online. Our renewal spreads for the full MOB portfolio were negative 0.7% as one renewal had an outsized effect on an otherwise strong period of lease. Despite this, we still anticipate averaging positive mid-single-digit leasing spreads over the entire year, in line with our previous guidance. Across the portfolio, we continue to see evidence that our existing rents are under the current market rates, which allows for additional pricing power on new and renewal leases. Additionally, the historic rise in construction costs and uncertainty in asset pricing have been significant hurdles for new medical office development which we believe will enhance our ability to retain tenants. On the acquisitions front, we are starting to deploy capital, but in a careful manner. Our new investments have been concentrated on development projects with healthcare partners that have been in planning for multiple years. Encouragingly, the acquisition pipeline that we are actively negotiating has picked up significantly since the beginning of the year. We believe this will enable us to generate accretive external growth in the second half of the year. In order to reduce debt and allow ourselves to be prepared for these future opportunities, we strengthened the balance sheet with $66 million of equity issued on the ATM in the beginning of the first quarter. We had previously disclosed this activity on our last earnings call. We feel that we are in an excellent position from a capital perspective at 5.3 times consolidated debt to EBITDA. Finally, we remain on track for our overall G&A guidance. A quick reminder to our analysts and investors that our G&A is always seasonally higher in the first quarter, and we expect it to moderate going forward. With that, I'll turn it over to Mark to walk through some additional operational details. Mark?

Thanks, Jeff. To best capitalize on the opportunity we have within our portfolio, we are occasionally better served by transitioning space from one physician organization to another. These decisions are made to improve the overall financial health and value of our buildings over the long term, but generally have a short-term impact on our net operating income. Among other benefits, these strategic efforts have served to dramatically improve the credit profile of our portfolio. This is especially relevant in today's environment where higher operating expenses are offsetting revenue gains for health systems. DOC's portfolio remains well-insulated from these pressures by the underlying credit quality of our tenants, 67% of which are investment-grade quality. Better yet, 90% of our investment-grade tenants have a credit rating of A minus or higher. This means that these tenants would need to be downgraded several times before they could potentially lose their investment-grade status. Our commitment to credit quality remains unmatched by our peers and we believe this strategy will pay dividends for our shareholders in any economic environment. MOB same-store NOI growth was 1% during the quarter, our 20th consecutive quarter of positive same-store growth. Headline performance in the period was adversely affected by a unique situation at a single location in our portfolio. Specifically, our asset management team was faced with a physician group tenant that had a reduced need for real estate and an in-place plan to consolidate locations. We made the decision to move aggressively to retain at least part of their space in our building as a means of preserving the healthcare ecosystem of the asset, and we are already in discussions with several potential providers to lease space not renewed by this tenant. Overall, this asset represents less than 1% of the same-store pool. Conversely, the 14-building landmark portfolio joined the same-store pool this quarter. As expected from such a high-quality portfolio, occupancy is up 50 basis points since our acquisition and the portfolio grew cash NOI by 4.1% year-over-year. In total, the portfolio is exceeding our underwriting expectations and is representative of the quality facilities and tenant at the center of DOC's investment criteria. First quarter renewal spreads were impacted by the same scenario I just discussed during our same-store commentary with headline spreads totaling negative 0.7%. Excluding this one asset, renewal spreads for the quarter were positive 10.1%. In total, our leasing team completed 367,000 square feet of leasing activity this quarter, including 289,000 square feet of lease renewals and a 72% retention rate. The great work this quarter by our leasing team to reprice lease renewals at today's fair market value with a 10.1% leasing spread should not be overlooked because of one lease. Additionally, this leasing activity offers strong compounding growth for the future as approximately 60% of lease assignments this quarter contain annual rent escalations of 3% or more. Looking back to the 2018 to 2021 timeframe, only 25% of our leasing activity on average contained annual rent escalations of 3% or more. Despite the short-term impact of a few vacancies in the portfolio, we believe the long-term value opportunity for our portfolio is fully intact as outpatient services drive retention and market pressures continue to increase triple net rental rates. Our team is focused on unlocking the full value of our portfolio through aggressive leasing initiatives, exceptional property management, and smart capital improvement investments. Before turning the call back to JT and opening for questions, I'd like to quickly say congratulations to John Sweet, the Founder of DOC, for earning the 2022 Lifetime Award from Healthcare Real Estate Insights. The award was presented in January at the Revista Medical Real Estate Investment Forum. John has always been known by hospital executives, brokers, developers, and investors for his witty sense of humor, unwavering integrity, and creativity in structuring investment transactions. As we celebrate the company's 10th anniversary this July, we cannot be happier to honor John for his career and contributions to the medical office industry, and we recognize his mentorship and friendship to all of us at DOC. Congratulations, John. With that, I'll turn the call back over to JT.

Thank you, Mark. Thank you, Jeff. We'll now take questions.

Thank you. We will now be conducting a question-and-answer session. And our first question comes from Austin Wurschmidt with KeyBanc Capital Markets Inc.

Hey, good morning, everybody. Guys, you've spoken about stable occupancy previously in the first half and headwinds abating in the back half of the year. But clearly there was an impact from this one tenant you highlighted in your prepared remarks. I'm just curious how that changes the cadence for occupancy comps in the first half and even back half of the year relative to those prior expectations?

Hey, good morning Austin. It's Mark Theine. So, as I mentioned in the prepared remarks, our leasing statistics were outsized by this one tenant, but our portfolio is really starting from a position of strength with industry-leading 95% occupancy. Over the history of our company, we've always been in that 95% occupancy range. So, we are experiencing a couple of one or two kind of move-outs and normal churn in the portfolio. But long-term, our occupancy has always been around 95%. We've been well served by our triple net leases, and high occupancy, especially in this inflationary environment.

So, within the same-store pool, when do you think full occupancy you've said is 95%, 96%. When do you think the same-store pool gets back to within that range?

Yes. So, again, we feel very confident in our comments about the improvements in the back half of the year. Really pointing to that, we do have 58,000 square feet of leases signed that are under construction and we expect rent commencement in the back half of the year. So, as those leases start to come on, we'll recognize them in our occupancy and obviously, our rent growth. So, that'll get us more in line with our expectations of the 2% to 3% same-store growth in the back half of the year.

Thanks for that. And then just last one for me on the investment pipeline, you highlighted that acquisitions have picked up since earlier this year. I'm just curious if you could put a finer point on sort of the size of that pipeline, where bid-ask spreads are today, and whether they've narrowed to a level that you think makes sense for you to transact?

Yes. Awesome. Thanks, it's JT. It's still modest on the acquisition front. We do have some growing pipeline. There's some activity out in the market. There's still private buyers in particular in the low sixes range. We'd like to be higher in the sixes and up into the seven cap rate, but without jeopardizing quality or the credit quality or the quality of the facility. So, we'll see some activity pick up and we can expect more to come to market. Working with some health systems, looking at some potential monetizations there, so we're excited about that. The real pipeline is on the development front, and just working through kind of final documentation and pricing of those transactions.

Hi. Just hoping to expound on that last piece about the development funding. It seems like the deals you've done recently are in the low sixes. Is that a good benchmark for development capital, giving your comments about where traditional acquisitions are? How should we think about that development capital mentioned $300 million opportunities going forward?

Yes, Juan, we tend to price those well in advance of construction starts. The Beaufort project, with the 3% increases and its prime location, has an internal rate of return much closer to 8.5% to 9%. We would prefer it to be higher when we begin that project, but it's still an excellent opportunity. The second project isn't priced yet, and we would evaluate it at a different rate today given the current market conditions. During negotiations, we were looking at purchase acquisition rates in the low 5%. It’s a matter of timing, and we are exploring different strategies regarding the long-term commitments involved. Currently, the development starts we are negotiating are yielding in the high sixes to low sevens, as most of our projects are structured as construction loans, which would align with those rates if priced today.

Great. And then just curious on any dispositions you guys have targeted. You had a kind of a small one done in the first quarter? Any other opportunities? And if you can give us any color on the cap rate on that small piece that was sold off in the first quarter?

Yes, I'll speak about dispositions and ask Mark to give you some more specific details. We don't have a meaningful disposition strategy for this year. Opportunistically, we may sell a building here or there. We own almost 300 buildings. So, there's always a handful in the portfolio that are older, smaller, in different markets where we're not strategically growing. So, from time to time, we may strategically dispose of something, but nothing specific. No material plans. Mark, do you want to talk about this?

Yes. Juan, on the more specifics on just the one small asset we sold in the quarter, that building was originally acquired in the early life at DOC as part of a five-building portfolio. This is the one building that was not as strategic in the existing tenant in the building as if they could purchase the building from us. The cap rate on that was actually just below 4%. But again, very small building and what's more representative of our disposition strategy is what we completed last year with Great Falls. We had an amazing exit with a great partner there in Great Falls and redeployed that capital accretively.

Hi, this is Derrick Metzler on for Ron. Thanks for the question. So, curious about the one asset that dragged down same-store NOI. Could you provide any more color on the impact that it had given your comment that it was a relatively small asset?

Yes. This is Mark. I'll take that one again. So, start with the fact, again, this is our 20th consecutive quarter of same-positive same-store NOI growth. And we currently we don't have a redevelopment or repositioning bucket; we report on all of our properties. So, as I mentioned last quarter, you know, we were expecting same-store to have a little bit slower start, but picking up in the back half of the year. This one building in particular was a 110,000 square foot cancer center. We acquired in 2014 at a 7 cap and for nine years, they paid their rent on time every month. Through our relationship with them, we became aware of their plans to consolidate their office space and really reduce their square footage by about 50%. Some of which was admin space, some of which is clinical space. But the direct impact from this one tenant on same-store this quarter is 73 basis points same-store. So, our one would have been 1.73 excluding this building, and it had a 30 basis point impact on our occupancy year-over-year. So, just to help kind of contextualize this a little bit more, $200,000 in our same-store pool out of $82 million of cash NOI moves same-store 25 basis points. So, it doesn't take a lot of cash flow to really move same-store percentage quarter-over-quarter. So, again, what I said before, what gives us confidence in the back half of the year is the lease signed that are under construction and will commence in the back half of the year. Our target for increasing our occupancy there is really our investment-grade hospital systems that are existing in the buildings, and we're working closer with them to continue to expand.

Understood. I appreciate that. I guess the follow-up is have you identified any more tenants that are potentially at risk of reducing their space similarly?

No. Nothing, nothing to this size.

Yes. Thanks. JT, I wanted to touch on the private investment market. I know last quarter you highlighted that cap rates were in the mid-sixes trending upwards towards 7. But today, you highlighted that the private market bid is aggressive and maybe those cap rates are in the low six today. Are you surprised by the strong private bid and how it has not changed as quickly as you would have expected?

Yes. It's important to understand how the math is working on those projects and engage with some of the private buyers. They are using all equity with low return expectations, and there isn't much bank financing available. While the volume of those transactions isn't high, there are participants in the market achieving returns in the high fives to low sixes. However, I don't believe this reflects the current value; rather, it indicates that there are investors with significant capital willing to bet on a decline in interest rates next year, which would bring cap rates down to the 5s. That's the reasoning they are using. Our acquisition pipeline is active, sitting in the high 6s to low 7s. Although we don't have a large volume in these figures, we are engaged in productive discussions.

Okay. So, it's your active pipeline right now. You do have sellers that are contemplating on selling at those high 6 levels?

Yes. No. It has 3% increases. About half of the equity is coming from the physicians who are leasing the building, and they have already made those payments. We received advanced funding from last year, stemming from discussions early last year around pricing, when 6.2% was significantly above acquisition cap rates at that time. The development is not a one-time financing project. If we were to price it today, it would be higher. Our long-term internal rate of return on that project is still between 8% and 9%, even without executing another transaction or changing cap rates or interest rates in the future. We feel confident about it. We would set the price higher today if we could, but we are still expecting to profit from the project.

Okay. And then why did you like to do that project on an on-balance sheet development? I know historically you've been more doing these construction loans. So, I guess why is that project different?

There are some unique circumstances with Northside and its location. They own the land. So it's on our ground lease. They have the second building's already designed and we think there's leasing demand to move forward with that project in the next year and that one will price again based upon kind of current pricing at the time. But it would be priced differently if we were starting it today. But it's worth that ask for us to build it on balance sheet again for some unique circumstances. The tenant base is partly their employees, partly affiliated positions that aren't employed by them. A combination of, health care compliance and Northside their own balance sheet management. So we're excited to do it. We're working with RTG as the developer on that project, who we partnered with before. They do a great job and have done a great job getting the billing to 100% pre-leasing before we started funding it.

Okay. So then this is more of a unique situation. We shouldn't expect future ground-up development fund balance sheet?

I think you'll see some activity, but we prefer the loan down where we can obtain current construction loan yields and have more flexibility on the back end regarding potential acquisitions. You may notice this occasionally, but we are excited to pursue it and enhance our relationship. The market is strong, and Atlanta remains very vibrant.

Great. Thanks. Maybe to start off with the capital allocation kind of strategy high level, piggybacking off the previous Mike's question. I think you've talked about in the past about, you know, solid balance sheet, a strategy for outsized growth. I mean, I'm curious maybe if you can elaborate JT on where this growth is coming from, and probably the capital question for Jeff, why put capital out today? Would joint ventures make sense? You talked about the development funding a minute ago. So any commentary on that would be helpful?

Yes. You know, beginning in the fourth quarter of last year, as interest rates were rising dramatically and fast and cap rates on acquisitions were not keeping up with that and still haven't really reached equilibrium. We've been very modest on acquisitions. Not even a lot of builders trying to continue discussions we've walked away from opportunities where they were very attractive 18 months ago that aren't attractive or aren't as attractive today. Many sellers are just holding firm and hoping that interest rates decline and the cap rates improve from their perspectives next year. So we don't expect a lot of acquisition opportunity this year. The development pipeline, again, those are usually two years of construction projects and we can get outsized deals there. But you do take some capital risk and you do take some modest development risk, which we don't think we're taking any there because of the getting to 100 percent pre-leasing with investment grade quality tenants like the Northside project. So, I think those are mitigated over time that $300 million pipeline we're talking about, much of which won't even price or get started into a later in the year. So, again, it's a balance and forward-looking projection if best we can about how to, how to price those projects. Jeff?

Yes. Regarding capital, we've worked to reduce our leverage amidst rising interest rates to enhance our capacity for acquisitions and development opportunities. We issued some stock at around $15 per share, which reflects an implied cap rate of approximately 6.4% to 6.5%. We believe that when we reinvest those proceeds, we will achieve yields above that rate. I think we can effectively use the capital we've raised in a beneficial way in the latter half of the year. As JT mentioned, our timing will depend on market conditions, but we feel well-positioned to proceed.

Yes, we're starting with 95% occupancy, which is a strong position. We are taking a proactive approach by investing capital into vacant spaces to ensure they're ready for leasing right away, avoiding supply chain issues. Our leasing team has significantly enhanced our online marketing and broker outreach, which has improved our communication and marketing of available spaces. Additionally, we are using new virtual reality technology and online tours as part of our strategy. Overall, our team's focus is on improving occupancy throughout the year.

Hey. Good morning. Thanks for the time. I know you talked touched on the landmark portfolio briefly in your prepared remarks. So I apologize I missed this data point, but could you quantify what type of lift the Landmark portfolio had on the same-store NOI growth in the quarter?

Hey John, this is Mark again. First, welcome to the DOC call. It’s great to have you here, and we appreciate the support from Green Street. The Landmark portfolio consists of about 1.4 million square feet out of our total 15 million square foot, 50.2 million square foot same-store portfolio. While we saw excellent results there, given the overall size of the same-store portfolio, it doesn’t significantly impact our same-store results. However, those properties contributed 4.1% to the same-store growth due to increased occupancy, and we’ve done a really good job there. The Landmark portfolio makes up 11% of the same-store pool, resulting in 4.1% year-over-year growth.

Okay. So I know, a portfolio, there's always it is, so graphic moving pieces. But instead they exclude the one property that had a large decline and renewal spreads, it sounds like that was a 70 bps drag, but landmark was a positive. So it feels like if you exclude those two pieces, the rest of the same store is kind of stuck in the low 1% analog NOI growth range. So if you looked through the portfolio. Is there any other concerning trends that are best to take a while longer to get back to that historical growth profile?

Yes, John. I would like to add to what you just mentioned about excluding the one centerpiece. Specifically, there are 58,000 square feet of leases that are already signed and under construction. Once these leases are operational, they are expected to contribute approximately $400,000 of net operating income per quarter. This will help enhance our same-store performance and could add another 40 to 50 basis points from the already signed leases. This increase will occur throughout the latter half of the year, albeit not all at once. This gives us confidence that we will be returning to our historical growth range of 2% to 3%.

Okay. Last one for me, just on the development, I understand the lag at when deals are priced versus when you're actually committing capital. Just curious, John, why not walk away or re-price the economics of the $41 million construction start if the world changes. Just curious why you're kind of anchoring the pricing a year ago?

Yes. John, we have a core value called CARE, where we collaborate, communicate, act with integrity. We respect the relationships and we execute consistently. We've built this company for 10 years by being reliable with our health partners, and we do re-price. We have re-priced where we have the opportunity. Again, we are in the I8 on an IRR basis on this transaction, 6.2 is the first year yield that grows 3% a year within, primarily an investment-grade health system, and we'll have the opportunity to expand this campus by another 100,000 feet in the near future. So, we don't see it as a project you walk away from. We see it as a project you work with your partner and get to the finish line where you can. Other projects we've done exactly what you suggested. We've walked away from purchase options that again where we have the optionality and that's kind of the preferential way we like to do the development projects. So each situation stands on its own merits and circumstances.

Yes. Hi. Just a quick one. On the construction loan, the $35 million construction loan, looks like that's tied to a project with a renovation attached to it for surgery center, and it looks like you're planning to take that out in the back half of the year. What's the cost of that that you'll be acquiring, and then does that effectively just kind of come out of the loan balance? Is that the way to think of it?

No, it's a small part of the total project. The ASC, which is the first step of the redevelopment of that location with Emery, it's cap rates in the high. It's been closer to an eight, but we're committing capital to redevelop that. So, ultimate yield on that's in the sevens. And then the construction project is a separate loan, and then it's priced at 6.75% 6.8%. And then we have optionality whether to purchase that building on the back end and we'll evaluate to John's point a minute ago, evaluate the value of that purchase option at the time of execution or walk away from it or try to reprice it. So it's a small piece, the ASC piece. It's nice yielding with a small $4 million or $5 million acquisition, and then we've committed capital to renovate and improve that building.

Hi. Yes. Good morning, everyone. In regards to the space, you guys are kind of strategically holding back for the kind of 'right tenant'. Could you just kind of talk us through a little bit about kind of what that total square footage is? What kind of rents you're ultimately kind of expecting on that space? And kind of earnings contribution once all that kind of leased up and kind of what's the internal timing around or internal targets around some of that stuff?

Hey, Tayo. One clarification, you said, you know, kind of holding out or non-renewal space to hold out for a better tenant. That's really not exactly what we do. In non-renewal space because we have a better tenant in hand. And that's the perfect example is the 55,000 square feet of leases that are under construction. So it just takes a period of time to build out that space for the incoming tenant. And we don't count that as least occupied space until the rent commences, as appropriate accounting. And that particular location or those 55,000 feet. Is 50 bps of same-store? Yes. Yes. Yes. So, pretty meaningful contribution. And it gets us back to 95% actual lease space when those commence. On the building that where we had to repositioning this quarter. We already have an active lease pipeline. Again, those discussions have been in place for a while. Amy Hall and her team have done a great job of building a list of tenants to backfill and lease that space at market rates. And we think that building get back to kind of high occupancy in the second half of this year or first half of next year. So it'll start contributing again momentarily.

Okay. When you plan to release the space, are you aiming for 10% to 20% spreads compared to what the old leases looked like? I'm just trying to get a general sense of the economic targets you have in mind.

Yes, Tayo. So I think you're making a great point here, which is that our vacancy and short-term leases really have an opportunity right now to increase cash flow as we're in an environment where rental rates are increasing quickly. In fact, just yesterday, just as an example, we were shared a leasing flyer for our brand new development in Texas and our second largest market. It's not an investment that development deal that we're directly involved with, but it's located right next to a large existing building we own. And the development rental rates and in that leasing flyer were 40% higher than the rents we have in place in our existing building that was built five years ago. So similar, you know, quality, even larger building a large delta between what current construction rental rates asking rental rates are and where are they embedded in rental rates of our portfolio are. So there's a great opportunity. And that's where our leasing team, our asset management team is focused on, is really understanding each market and bringing those current leases mark to market. As I said, absent the one lease we discussed. We had 10.1% leasing spreads this quarter, which is a phenomenal job by our entire leasing team and great potential with our asset management team.

Yes, thank you for the opportunity to speak. I wanted to follow up on a point you made in your opening remarks. If I heard you correctly, you mentioned that you anticipate an increase in transaction activity in the second half of this year. What factors are contributing to this expected increase?

Yes. I believe that given our pipeline and ongoing discussions, any new acquisition is essentially a gain for us, even though we haven't been very active. We do have some discussions taking place, but the volume isn't what we've historically experienced since we're focused on long-term cost of capital and aligning with current market yields. Generally, there are many interest-only loans issued in 2019 and 2020 linked to properties that were bought at yields of 4.5% to 5%. These loans are now costing 7% to 7.5%, creating a mismatch with negative leverage affecting cash flow, and the loan-to-value ratios don't support the loan amounts. We're beginning to notice some activity, though it's limited at the moment. I think we'll see more of this as property owners may hesitate to invest out of pocket to improve cash flow, which signals a significant potential for these types of opportunities. We'll see if this unfolds, especially if interest rates decrease, as some may choose to wait it out. Currently, however, we are observing signs of this situation developing.

Great. Thanks. Good morning. You touched on this a little bit, but I guess I was kind of curious too just on the for the same-store NOI numbers. I think this is like the maybe the fifth quarter in a row where the expense growth was faster than the revenue growth. And I was wondering if there's just a line of sight to when that might reverse when the same-store revenues would maybe ideally be growing faster than the expense line. You talked about the part of the remedy on that, but I'm curious if there's any other one. If it's contingent just upon that additional leasing you talked about or just other factors as well maybe controlling expenses there. Just more color on that would be helpful. Thanks.

Yes, Steve. So operating expenses in the same-store pool were up 6.9% year-over-year sort of in line with some recent inflation for this. We're coming off of a period last year where these comparable operating expenses were really flat in the comparable period one year ago. If you look a little deeper into that, what we're seeing on operating expense growth is number one, utilities, not necessarily consumption, because we made some very intelligent and wise capital investments in the building. But in the rate of utilities, we're seeing a pretty large increase. And then we're also seeing some increases in labor related to janitorial engineering, things like that. So year-over-year, that's where the operating expense growth is. But again, one of the benefits of our highly occupied triple net lease portfolio is that those operating expenses are nearly offset in our recoveries which are baked into that rental revenue line item there as well. So our asset management team and property management team are always focused on keeping total occupancy costs low, managing operating expenses as well, and leveraging economies of scale. But we'll continue to try and focus on keeping those operating expenses below the inflation line. Thanks again everybody for joining us today. We look forward to seeing you at NAREIT and future investment conferences, and speaking to you again in August. Thanks.

This concludes today's conference call. You may now disconnect your lines. Thank you for your participation, and have a great day.