Healthpeak Properties, Inc. Q2 FY2023 Earnings Call

Good morning and welcome to the Physicians Realty Trust's Second Quarter 2023 Earnings Call. All participants will be in listen-only mode. After today's presentation, there'll be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Bradley Page, Senior Vice President, General Counsel, please go ahead.

Thank you, Jason. Good morning and welcome to the Physicians Realty Trust second 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 second quarter of 2023 and our year-to-date performance, as well as our strategic focus for the remainder of 2023. Jeff Theiler will review our financial results for the second quarter of 2023 and Mark Theine will provide a summary of our operations for the second 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 views of management regarding current expectations and projections about future events and are based on information currently available to us. Our forward-looking statements involve numerous risks and uncertainties and depend on assumptions, data, and methods that may be incorrect or imprecise. You should not rely on our forward-looking statements as predictions of future events. And we do not guarantee that the transactions or events described will happen as described or that they will happen at all. For a more detailed description of other risks and 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. On July 19, we celebrated DOC's 10th anniversary as a public company. From our earliest days as the custodians of a modest portfolio of 19 buildings, the DOC team has remained committed to a disciplined strategy of thoughtful growth and prudent balance sheet management. This steadfast approach, combined with our unmatched partnerships with health systems and physicians across the country, has propelled our portfolio to nearly 300 owned assets totaling over 16 million rentable square feet. While we are proud to reflect on our achievements so far, we are excited to embrace the opportunities available for DOC's next decade. The demand for the U.S. healthcare delivery system will continue to grow in tandem with the aging of America, and providers need to expand their outpatient presence to effectively care for their patients. Physicians Realty Trust remains ready to partner with our clients to address these changes. We are well positioned to finance and own the purpose-built outpatient facilities that will replace expensive and aged inpatient space. The opportunity to deliver accretive growth for acquisitions has been limited for much of the past two years due to rapidly rising interest rates and the expected uncertainty as to where investment yields should settle. We've chosen to remain patient during this time, prudently waiting for market pricing to meet our cost of capital. That doesn't mean we've been stagnant. Our team has worked diligently to remain connected with our health system partners while also thoughtfully evaluating where the puck is moving for outpatient real estate. We're pleased to share that our patience is beginning to be rewarded. During the quarter, we completed a modest number of acquisitions, highlighted by the purchase of the Cardiovascular Associates building in Birmingham, Alabama, with a first-year yield of 7%. This 73,000 square foot building was designed and built in response to market innovations that now allow many cardiology services and procedures to be performed in an outpatient facility. This is a natural clinical evolution with Medicare and commercial payers each recognizing the higher quality and lower cost of providing cardiology services in an outpatient location. We expect this to be a growth strategy for us as the first of many similar cardiology-focused outpatient facilities that we will purchase and develop financing in the future. In addition to the acquisition of stable properties, we will continue to invest meaningful capital in the development of outpatient medical facilities. This capital will be provided in varying forms including loan-down debt facilities and mezzanine financing arrangements on heavily preleased projects. Many of these projects will eventually come on balance sheet through contractual take-out commitments. Our pipeline includes $68 million in contractual commitments to projects under construction and the potential for $500 million of further investments in projects in the planning stage. Projects within our development pipeline are diverse in nature, reflecting the robust opportunity available for outpatient medical investors. Four projects in our active pipeline are redevelopments of existing buildings, one is the conversion of a vacant big-box retail anchor, and three represent the conversion of suburban general office buildings. In each case, these projects will soon be helping leading healthcare providers deliver care in their communities. We expect that our stabilized yields on these opportunities will exceed the interest rates received during each respective construction period, with first-year rent returns that we project to exceed 7% once stabilized. In any case, these financing opportunities will have higher long-term IRRs than we can achieve in the current acquisition market. We have not finalized these capital commitments, and some or all may not come to fruition, yet we are confident that our opportunity for attractive development financings will continue to grow. Within the existing portfolio, DOC's leasing team continues to do an outstanding job of maximizing the performance of our portfolio. We have ambitious goals to achieve positive net absorption this year while also capturing the exceptional renewal spreads and increasing escalators that we've delivered in recent quarters. That momentum has continued this quarter with leasing spreads totaling 7.8%. Over time, the achievement of leasing results and excessive historical levels, along with maintaining or improving total occupancy, should lead to sustainable NOI growth that is sustainably higher than what the outpatient medical space has provided in the past. We project this past quarter as the trough for same-store growth as we sign and commence most both new and renewal leases in the future. Jeff will now share comments on our financial results for the second quarter of 2023, and Mark will discuss our operating results. Jeff?

Thank you, John. In the second quarter of 2023, the company generated normalized funds from operations of $61.2 million or $0.25 per share. Our normalized funds available for distribution were $60.2 million or $0.24 per share. We paid our second-quarter dividend of $0.23 per share on July 18, which represented a bad debt ratio of 95%. We started the quarter with a strong balance sheet; however, with the prospect of the Federal Reserve keeping rates higher for longer, we decided to take advantage of the inverted yield curve to source additional capital and pay down expensive short-term debt. We closed on a five-year $400 million term loan in May and concurrently entered into a five-year swap agreement, which fixed our interest expense at 4.69% for the duration of the debt. As everyone knows, 2023 has been a very challenging year to raise capital. However, the deep banking relationships that we've built over the past 10 years enabled us to successfully execute this deal. Even in that difficult backdrop, we are grateful for these partnerships. We used a portion of the proceeds of the term loan to repay our entire revolving line of credit and placed the remaining proceeds in liquid funds that are currently earning just over 5%. We therefore maintain a positive spread on these funds while our investments team actively works with health systems across the country to generate attractive acquisition opportunities. Following that transaction, we start the third quarter in an enviable capital position. Our consolidated net debt to EBITDA ratio is 5.3 times. Furthermore, the successful execution of the term loan enabled us to reduce our variable rate debt percentage from 13.4% at the beginning of the quarter to 4.8%. While the current mood of the market seems to indicate that inflation is coming under control, we are prepared for either scenario with debt maturities that are well staggered and pushed out. Of our $2 billion of consolidated debt, only about $85 million or 4% matures before 2026. We're free to execute our business plan without any limitations on the capital side. As previously noted, our $1 billion revolving line of credit is completely undrawn, and when combined with the cash on the balance sheet, provides us with $1.25 billion of near-term liquidity. Current commitments still to be drawn on our developments and outstanding loans are modest at roughly $68 million. This leaves us with dry powder for new acquisitions of roughly $300 million. We've been measured in our acquisition activity so far this year, but we're starting to see more and more attractive opportunities. So while we still aren't providing definitive acquisition guidance, we can say that we expect the acquisitions to increase steadily through the remainder of the year. We will seek to deploy capital to traditional acquisitions, new development projects, and our mezzanine lending platform. Turning to just a few other items, we're working hard to mitigate the impacts of inflation on our corporate expenses. We remain on track for the G&A guidance of $41 million to $43 million. Our construction team is also managing to the guidance of $24 million to $26 million for recurring capital projects, and we don't expect any surprises there. With that, I'll turn it over to Mark, to walk through the details of the second-quarter portfolio operations.

Thanks, Jeff. Outpatient medical same-store NOI growth totaled 0.8% for the quarter. This deviation from our long-term trend of 2% to 3% is the result of a decline in same-store portfolio occupancy to 94.4%. While incremental vacancy creates near-term headwinds, we believe that the current economic environment provides us with the opportunity to create long-term value through aggressive leasing initiatives. We appreciate that value creation requires patience, but our conviction in the unique pricing power offered by our high-quality portfolio and best-in-class management platform couldn't be greater. This confidence is substantiated by full portfolio renewal spreads that have outpaced our closest peers since the beginning of 2022. That momentum continued this quarter, where we achieved renewal spreads of 7.8% across 244,000 square feet of leasing activity. Importantly, tenant retention remains high at 78%. We successfully increased contractual escalations on lease renewals by 40 basis points relative to expiring levels. These exceptional renewal results were achieved with modest leasing costs of $1.19 per square foot per year. As seen elsewhere in the broader real estate sector, health system tenants are currently engaging in a flight to quality. Rising construction expenses and stubbornly high-interest rates have increased the cost of building new, benefiting existing owners of quality real estate. Our leasing team is focused on capitalizing on the opportunity to boost occupancy and remains engaged in a comprehensive campaign to increase the visibility of our space. This includes improved online marketing, leveraging technology to demonstrate the capabilities of our space, and targeting key brokers to drive foot traffic. We're seeing these efforts gain traction. For the quarter, we realized positive absorption of 4,100 square feet and average annual escalations of 3% on new leasing activity. Our pipeline of new leasing activity continues to accelerate, with active proposals extended on over 120,000 square feet of vacant space. We are encouraged by these early indicators for future net absorption, and we'd like to express our gratitude to all of our nationwide leasing partners. We sincerely value the relationships with this accomplished team of healthcare leasing professionals and look forward to seeing many of them at our annual DOC Management Summit in Milwaukee this September. Beyond these excellent leasing efforts, we are focused on the efficient management of operating expenses across the portfolio. The $1.7 million annual increase in same-store expenses was primarily attributable to increases in janitorial maintenance, payroll, and security costs. However, most of these increases were experienced early last year amid a higher inflation environment. Sequentially, operating expenses are down by $0.2 million or negative 0.4%. Inflationary pressure on operating expenses appears to be easing, which we believe will allow our leasing discussions to focus on growth in base rent and ultimately fuel future NOI growth. We're accomplishing these financial goals while also remaining focused on developing our strong relationships with industry-leading health systems and physician practice tenants. After all, it is these relationships that have contributed toward our success in building the portfolio since our IPO in 2013. Ten years later, the continued strength of these relationships is evident in our 2023 Kingsley Associates Tenant Satisfaction Survey results. This year, we surveyed over 450 tenants representing approximately 4.9 million square feet. Physicians Realty Trust received an impressive 73% response rate compared to the industry average of 58% this year. In addition, we beat the Kingsley Index in every major property management category, including overall management satisfaction with a score of 4.53 out of 5. While we sincerely appreciate the positive feedback from our healthcare partners, the surveys we value the most are those that offer opportunities for improvement and where we can invest better in order to earn that tenant's trust and lease renewal before the lease expiration. This year, fewer than 2% of the 458 survey tenants affirmatively indicated that they are unlikely to renew their lease when it expires. Based on this feedback from our healthcare provider partners, Physicians Realty Trust is well positioned to capitalize on the continued demand for outpatient space while driving long-term value for our shareholders. With that, I'll turn the call back to JT.

Thank you, Jeff. Thank you, Mark. Jason, we'll now take questions.

Thank you. We will now begin the question-and-answer session. Our first question comes from Juan Sanabria from BMO. Please go ahead.

Hi, good morning. This is Regan Sweeney on with Juan. I just want to open up a broad question on investments and cap rates. Can you discuss the acquisition market? What is the current bid-ask spread and is pricing adjusting to the higher interest rates? And where you're looking for cap rates to ultimately adjust to?

Yeah, good question. There's not a lot of trades happening. What we're seeing is, you know, things in the mid-6s to low-7, you know, for our underwriting and the criteria and the quality that we want to acquire. We're looking at high-6s and low-7s as being kind of matching cost of capital, but at the same time, not going up the risk spectrum to achieve those yields. So, again, not a lot of trades happening. There's still some trades happening in the mid-6s. We're really excited about CDA, which we were able to work with our partners to achieve a 7% first-year yield on that acquisition, a smaller transaction was 8%. And then we had another one at 7%. So those are the target ranges we're looking for with our cost of capital without jeopardizing the quality and credit or the buildings themselves.

Thank you. Appreciate the color. And then just shifting gears to leasing if I can. In the prepared remarks, I believe you said the leasing spreads were 7.8% for the quarter. What's the expectation for the average spreads? Just as we think about the second half and into 2024 expirations?

Yeah, this was Mark, I'll take that one. So at least, the team's been doing a great job both focusing on retention and leasing spreads. We've consistently been in that mid-single digit and we had a very strong quarter of 7.8% leasing spread this quarter. Going forward in the back half of the year, we expect that trend to continue in the mid to high single-digit leasing spreads, and we're not only focused just on that spread but also increasing the annual escalator over the life of the term of the lease. And we've been very successful in getting three and occasionally even 4% rent bumps built into the lease going forward.

Thank you, I appreciate it.

The next question comes from Nick Joseph from Citi. Please go ahead.

Thanks. Maybe just following up on the acquisitions, how are you thinking about your current weighted average cost of capital, maybe both from the equity and where you can issue debt today? And then, when you think about that, relative to the cap rates you just quoted, what makes it attractive to do deals today versus continuing to be more patient?

Yeah, thanks, Nick. And I'll ask Jeff to respond.

Hi, Nick. And so yeah, when you look at our current cost of capital, a shorter hand way to look at it is just kind of implied cap rate cost of long-term debt, which gets you to kind of like a mid-6%, depending on what the day is mid to high-6. So that's why when we look at these deals, we're really trying to push a 7% cap rate. But importantly, we're also trying to improve the quality of the portfolio when we buy these assets. So we're really looking for kind of high credit assets, long-term leases, with great partners that we think we'll be able to maintain that building for a very long period of time. So that's kind of the short answer. The long answer is we do a 10-year IRR model and really are a little bit more scientific about it. But gets you to about the simplest.

Yeah, no, that's very helpful. Thank you. And then just in terms of providing capital for developments. How's the competition changed there? You've seen a pullback on banks, I would think you would be from construction lending. So does that actually open up even more of an opportunity than you'd seen previously?

Yeah, if you go back to the last quarter, I said we had $300 million in the pipeline. We currently have over $500 million in discussions. And it really bodes well for the opportunity to grow the kind of loan dome structure with health systems who are building these for outpatient medical services, moving care out of the inpatient facility into better locations that are demographic. So we continue to see significant opportunities in that space.

Thanks. And as that pipeline grows, and sort of internal cap or any kind of any kind of internal risk mitigation that you put on just to not have too much exposure there.

Yeah, and one thing we've gotten more sophisticated with just internally and also in our negotiations is more kind of real-time variability on both the construction period interest rates that we're charging plus what the ultimate yield will be on the back end of the once the project has stabilized and commences. So that kind of changes deal by deal. And then the location and the quality of the provider, et cetera. But I think we're doing a good job getting better returns out of our development financiings and then mitigating both the interest rate time risk and the development risk.

Thank you very much.

The next question comes from Michael Stroyeck from Green Street. Please go ahead.

Thanks. So one on pricing power for me. Just curious if you're seeing any bifurcation between the companies on-campus and off-campus portfolios in terms of releasing spreads?

Yeah, this is Mark, I'll take that. We're really not seeing that much difference between on-campus or off-campus. I think even going back to COVID, one of the things we saw was that there wasn't enough surgery center space off-campus, and we saw a lot of services moving to the off-campus setting. But really, what's driving our leasing spreads is the use of the comparable construction costs and relocating costs. And just with today's higher interest rates, and those higher construction costs, it's just much more expensive to move. And we are able to negotiate higher spreads and still be less expensive than the cost to relocate. So again, 7.8% leasing spread this quarter is a trend that we think we can continue in the back half of the year as we work with tenants to renew space at a very high level.

Great, thanks. And then maybe one more. So despite some pretty high construction costs, we are still seeing some elevated AOB construction activity. Are there any pockets of your portfolio where you are becoming increasingly worried about new supply?

I don't think so. Most of the development is specifically designed for health systems or physician groups looking for new, better spaces in more favorable demographic areas. Phoenix is experiencing significant growth in population, which aligns with the demand for such spaces. We haven't identified any heavily constructed areas that lack a population driving demand. Atlanta is similar based on our projections. It's a valid concern that we keep an eye on in our assessments, but we're not witnessing this trend in any of our markets.

The next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.

Yep. Thanks. Maybe this is a question for Jeff. I know after the term loan, your cash balance increased pretty significantly. What's the near-term plan for that cash balance? Is that earmarked for new investments or are there some debt pay downs that you want to utilize cash for?

Yeah, thanks, Mike. The nice thing about our balance sheet is that we really don't have any more significant debt pay down. So we've really earmarked that cash for new acquisitions. And like I said, it's earning a kind of a nice yield in the short term, highly liquid money market account. So certainly feel good about the ability to deploy that, hopefully sooner rather than later. But in the meantime, it's not too much of a drag.

Okay, and then what's the preference for investment activity over the next six to 12 months? I know that you highlighted acquisitions, developments, mezzanine debt. I mean, where are the bigger opportunities right now?

The bigger opportunities are in development. However, there is a substantial pipeline of acquisition possibilities. These were financed several years ago at low interest rates, and those loans are now maturing at higher rates. We have only a few cases where we are collaborating with current owners to either refinance or acquire such facilities. Nonetheless, we believe that many more opportunities will arise as these loans mature. Acquisitions will always be our preference for now, provided we can find the right price, quality, and credit. Nevertheless, we are observing an increase in opportunities within development.

Okay. And the cap rates that I've been hearing, I guess we're MOBs are trading at or at least higher quality. And MOBs is like in the low to mid-6 range. And I know JT, you're highlighting and just completed some deals at the seven. I guess what's different about the type of deals that you're looking at? Are these just more off-market relationship type deals that are getting you up into that 7% range?

Yeah, it's more off-market relationship deals. And it's also I think, just the reality of some, some owners are using all equity and kind of willing to accept negative leverage in anticipation of lower interest rates and compressing cap rates. We're not prepared to make that gamble. We don't think that's the appropriate way to invest.

Okay, and you would agree that the higher quality deals are trading in the low to mid-6s, I guess generally right now in the MOB space.

I would say there are some in that range. Again, we are focused on our cost of capital and the higher quality off-market transactions.

Okay, great. Thank you.

Thanks, Mike.

Next question comes from Steven Valiquette from Barclays. Please go ahead.

Hey, thanks. Good morning, guys. Generally, a couple of earnings calls here simultaneously, but obviously, with the same-store cash NOI growth slowing down a little bit. Just curious to get a little more color around what's happening there. And if you look at it sequentially, everything looks like there's really no change at all. But really, it's just more of the year-over-year there was just some deceleration in that same-store pool. What do you have sequentially, year-over-year growth last quarter, but just not sure there was still kind of that unique single location situation that's still hitting the results, but just curious to get more color around all that. Thanks.

Yeah. Hi. I'll have our give you a little more color, but we really do think we've hit a trough there. And again, it's still kind of quarter-over-quarter with an intentional non-renewal last year and then a non-renewal but tuck-in where they cut some space back at the beginning of the year, which had a quarter-over-quarter continued impact, but we do think this quarter is a trough. With leases, both commencing and being executed in the near term and net absorption, we're headed in the right direction. Mark do you want to add anything?

Yeah. So, Steven, so sure, I have a lot here. First of all, again, our leasing team did a great job growing cash leasing spreads and 7.8%. So from a renewal perspective, we're growing our cash flow there. Our same-store performance was really the result of a change in occupancy, as I mentioned in our prepared remarks, to 94.4% from 95%. So still a very highly occupied portfolio that is performing well. But to give a little more context to that 60 basis point decline and as you mentioned, some unique kind of one-off things happen in there. That decline is about 90,000 square feet, nearly half of which is that cancer center that we talked about last quarter. During this quarter, we actually executed a 5,600 square foot lease in that facility and have had good tours and momentum to fill up that facility. As JT mentioned, one of the things that's going to offset that cancer center facility is the Minnesota Surgery Center that we talked about in the past. That was a 22,000 square foot surgery center that really for the last year has been in negotiation and under construction. It will start commencing rent payments here in the third quarter of 2023. So just zooming back out to the high level here, we have a leasing environment, the macro environment that's working in our favor. As I mentioned, our leasing leads are up. Our tours are up, but more importantly, our proposals on vacant space are up. So bottom line is the cash NOI is growing. It's just not growing at our historical pace. But as JT said, we think this is the trough and we'll be moving in the right direction in the back half of the year here.

Okay, got it. That's helpful. Thanks.

The next question comes from Ronald Camden from Morgan Stanley. Please go ahead.

Hey, just a couple quick ones for me. So going back to sort of the capital allocation, so one on the acquisition front, obviously, not seeing enough deals and leaning more towards some of these developments. Any way to sort of quantify what that run rate could be sort of on a long-term basis? Like, is there $100 million-$200 million of opportunities as you're building out these relationships? Just how can we get some more sort of hard numbers around that?

For our development pipeline, I believe a reasonable target is $100 million to $200 million in projects. These initiatives are still in the early stages, so we need to proceed cautiously. At some point, we might consider capping the pipeline size based on the overall company size, but we have a solid opportunity to reach that target in the near term. That's basically our short-term strategy.

Yeah. I think part of that is like, right now we have more opportunities in there. I think that is, we'll get kind of a continuous cycle of those facilities coming online, starting to commence, and as new buildings are coming online and stabilized paying rent, we'll start new constructions as well. So, again, we're really working to build up that kind of continuous cycle there. It's a good opportunity to do that.

I have one last question. Could you remind us of the one-time factors affecting the same-store cash NOI that has contributed to the 80 basis points decrease year-over-year? Additionally, when do you expect those issues to resolve so you can return to the 2% to 3% growth range? Thank you.

Yeah, I think Mark just addressed that. But again, just to repeat, it's really kind of three events, two intentional and one were intended to cut back some space. And we're already in the process of backfilling that space with a lot of tours. And they partially lease some of that space already. So second half of the year, we'll start seeing the benefits of those. But the non-renewed leases that we did intentionally, one of those that surgery center that is now come online, is accredited, and is starting to treat patients and paying rent in this quarter. So we'll start seeing the benefits of all that. It's really two or three events out of 300 buildings.

Got it. All right, thanks so much. Super helpful.

Yep.

The next question comes from Alex Fagwin from Baird. Please go ahead.

Hi, thank you for taking my question. The first one is kind of quick, how much rent is expected to commence in the second half of this year?

This is Mark. So in total, we have about 34,000 square feet of leases that are executed under construction and will commence in the back half of the year that was executed. So if you took an average of $20, and a triple net rent and $10 of operating expenses, that's close to a million dollars. But it'll be staggered throughout the back half of the year, but a decent run rate, what's actually executed. And then of course, as I said, we've got a very active pipeline of leasing activity beyond that that will take a little time to work through that as we negotiate the construction-commenced rent that that's cash flow that will start in the back half of 2023 and into 2024.

Got it. Thanks. You mentioned with the new embedded escalators being able to achieve on average 3% and even some 4% can you remind me what the weighted average escalators embedded in the entire portfolio is?

Yeah, it's historically about 2.5%. But every one of these new leases being in the last few quarters has been higher than that. So it's going to just take time to grow the average, but you're heading in the right direction. So if we can maintain these types of renewals spreads and kind of the new market for leasing accelerators, we think we're headed toward a 3% world, but it's going to take several years to get there. And hopefully more.

Okay, got it. Thank you, guys.

The next question comes from Connor Siversky from Wells Fargo. Please go ahead.

Good morning, everyone. I’m stepping in for Connor today. Thank you for taking my question. Regarding asset competition, do you still see significant activity from foreign capital, or have those investors taken a step back, potentially creating more opportunities for physician groups?

I would suggest that while there has been a slowdown, we still observe foreign capital in the market, both directly and through other private equity firms or foreign pension funds. We are in a joint venture with this foreign capital, and they also seem to favor this area, along with Remedy and Cain Anderson. Transaction activity has slowed down, with some cap rates normalizing, but we continue to have significant interest in our Beauford project, with Physicians co-investing about $11 million in equity. There remains a strong desire from Physicians to co-invest or stay involved as part owners in our investments.

Great. And can you offer any color as to how much the portfolio is utilized by admin or mathematical functions, like the revenue cycle for example? Do you get those leases? Go ahead.

We have a very small percentage of space that could be considered general administrative space. For two of our redevelopment projects, we are actively engaging with clinical providers regarding their leases, which have several years remaining. We are discussing converting those buildings into clinical space, and we are quite enthusiastic about these opportunities. Additionally, one of the projects in our pipeline involves acquiring a suburban office building to also convert it to medical use. We see a lot of potential in our own buildings. While we have a small percentage that is well-leased and generating income, we would like to see that space transition to clinical office space over time.

Great. Thanks, guys.

The next question comes from Michael Gorman from BTIG. Please go ahead.

Yeah, thanks. Good morning, JT, maybe kind of continuing off of what you just mentioned there, how do we contextualize the opportunity set that you have with some of these redevelopments? And I understand it's purpose-built versus the risk of kind of new supply? And I know, we talked about that earlier, but just maybe less disciplined operators than yourselves just taking suburban office portfolios or vacant big boxes and trying to just slap an MOB label on them and jump into the marketplace? What's the potential risk there?

Yeah, I don't. I mean, I don't think there's a lot of spec development in medical. We just haven't seen that since the crash in 2008-2009. In all the redevelopments that whole pipeline we're talking about, we have a provider in hand or a healthcare credit in hand working with us to do that conversion to clinical space. So it's, I don't see. I mean, it's well publicized how many malls are in distress. We've seen that recently in various reports as well, how many general office buildings are 20% occupied, even if leased. But the development and redevelopment projects we're looking at which are pretty sizable have a provider and/or a healthcare credit. We're working hand in hand to sign with the providers to insert those buildings. And we wouldn't be contractually committed until we had those leases and that credit enhances.

Great, that's helpful. And then you started out the comments, obviously highlighting 10 years as a public company, which is great. And then it was just reminded me that one of the things that you focused on when you first came out was exploiting kind of a risk-return gap in the MOB marketplace that you saw. I'm curious. I know, there's not a lot of transaction volume. But as we've seen the capital markets and the transaction markets get more stressed, are you seeing any kind of risk-reward gaps that would be more interesting to you, whether it's a particular physician group type or whether it's a particular geography that as the markets get better, they're likely to generate more deal volume for you?

Yeah, I think I alluded to this before. I mean, there's a lot of what I would call distressed capital, ownership, but not distressed buildings. And that's what we're really trying to preserve dry powder at the right price, to capitalize on and to grow substantially again. Hopefully, some more of that materializes in the second half of the year. We do think 2024 is still going to be a robust year for those kinds of opportunities. We're starting to see those, I'd say anecdotally, in the context of one building or two buildings at a time, we're not seeing huge numbers of those kinds of discussions going on. But the list is out there. It's pretty obvious where those kinds of buildings, those kinds of interest rate structures or loan structures that were in place that are maturing into a very new environment. Jeff's done a great job with our balance sheet to remove that type of risk for us and position us well to step in and be the owner and/or mezzanine lender of choice to help refinance those buildings or acquire those buildings.

Got it. So it's more on the ownership side than on the actual building side where you see that differentiation?

I believe it's a combination of both. We are not value-add buyers. The redevelopments I mentioned involve either empty buildings or leased buildings that we plan to convert with a provider and a lease in place for clinical use. We are looking for high-quality buildings and high-quality tenants that have a broken capital structure. Also, I want to remind you that we sold the hospital loan, which was our first acquisition with IPO proceeds, about three years ago. At that time, we completed a full 10-year cycle and achieved over 10% internal rate of return, which worked out well for us.

I remember it well. Absolutely.

So thanks for being with us, and look, we'll go to the next caller.

The next question comes from Mike Miller from JPMorgan. Please go ahead.

Yeah. Hi, just a quick one here. For the CVA acquisition, just curious why your partner wanted to have a 1% stake in the JV.

The existing owner appreciated the returns from the buildings, which were developed in collaboration with the physician group. They are a fantastic partner, and we are exploring additional opportunities together. It was more than just an accommodation; he and his group were genuinely interested in maintaining that partnership. We are already making progress, and he is focused on helping us lease the remaining 10% of that space. Additionally, we have a solid leasing pipeline in place. It's a straightforward relationship.

Okay, that was it. Thank you.

The next question comes from Austin Wurschmidt from Keybanc Capital Markets. Please go ahead.

Great. Thanks, and good morning. Just curious on the incremental developments you added to the backlog? Are you seeing any increase on yields for those deals? Or is 7% to 8% still the right range?

I think we're seeing an increase. The 7% to 8% is with the first-year kind of stabilized yield, about 7% is kind of what we're seeing in the current market. There is some competition in the general market for some of these developments. But at the same time, these are 100% pre-leased buildings, trying to mitigate risk and at the same time getting long term leases with good escalators. So we're pushing to kind of risk-adjusted returns 7% to 8%, where we see the market. At some point, you get to a point where the rent is too high for the provider to make it for it to make sense for us.

Got it. That's helpful. And then Mark, I believe you said 34,000 square feet of executed leases commencing in the back half of the year. I think that figure previously was in the 58,000 square feet. So just wanted to clarify, is it safe to assume that the delta there is just what commenced in the second quarter?

Yeah, that's exactly right. That's primarily that surgery center in Minnesota. So yeah, that's exactly right.

Got it. Understood. And then as the tenants take occupancy in the back half and we continue to see positive net absorption how do we think about the expense benefit and sort of that operating leverage moving forward?

Yeah, that's a great point. It's not just the base rent, that we'll pick up when we improve our occupancy from those leases. But it's also the drag on operating expenses from the CAM reimbursement. CAM and buildings is averaging $12 to $13. So it's the pickup of both the base rent and the CAM, which will improve our margins as occupancy improves as well.

That's helpful. Thanks for the time.

Thank you.

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

Thank you, Jason. We appreciate everybody's interest today and the questions. We'll look forward to follow-up discussions. Please call us if you have any questions. Thank you.

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