Earnings Call Transcript - DOC Q4 2022

Operator, Operator

Greetings and welcome to the Physicians Realty Trust Fourth Quarter 2022 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. Thank you, Mr. Page. You may begin.

Brad Page, Host

Thank you, Maria. Good morning and welcome to the Physicians Realty Trust fourth 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 fourth quarter of 2022 and year-to-date performance in 2023, as well as our strategic focus for the remainder of 2023. Jeff Theiler will review our financial results for the fourth quarter of 2022, and Mark Theine will provide a summary of our operations for the fourth 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'd now like to turn the call over to the company's CEO, John Thomas, John?

John Thomas, CEO

Thank you, Brad. Physicians Realty Trust demonstrated resilience throughout 2022 and enters 2023 from a position of strength. Our assets are performing well, demand for our space remains strong, and our balance sheet is well-positioned for outsized external growth. We're proud of our achievements during the year, including the attainment of the highest annual funds available for distribution per share in the history of the company. The cash growth is supported by record leasing performance. For the year, we executed leases totaling more than one million rentable square feet including over 800,000 feet of renewals and an average spread of 6%. Retention remained strong at 77%, and more than 60% of our executed leases had an average annual escalator at 3% or greater. We remain focused on creating long-term value on behalf of our shareholders. This can occasionally require the selective non-renewal of leases when we believe that the space can be re-let to stronger health system tenants. While this has the effect of hurting total occupancy and same-store NOI growth in the short term, we believe that these decisions result in a stronger portfolio that delivers superior cash flow growth in the future. During 2022, we increased the amount of space leased to investment grade quality tenants from 65% to almost 67%. And we believe that we continue to have the highest portfolio leased rate of any public medical office building investor. The rapidly changing interest rate environment required us to be disciplined when evaluating external growth opportunities during 2022. Still, we were able to add value to shareholders through the transactions we chose to pursue. In July, we opportunistically sold our three Great Falls, Montana medical facilities at a 4.7% cap rate, generating a $54 million gain and an outstanding 16% unlevered IRR. We matched this transaction with $160 million of new investments in 2022 highlighted by our $82 million acquisition of the Calco Medical Center in Brooklyn, New York, at a 5.5% stabilized cash yield. We also continued to work with several health systems to move development and redevelopment projects forward that we expect to proceed in 2023 and generate rent in 2024. Our financial achievements were matched by our accomplishments as they relate to corporate responsibility in 2022. We made measurable progress toward our goal of being a sustainability leader across all real estate industry sectors. For the year, we invested in 31 projects totaling $5.6 million that will directly reduce the energy footprint of our facilities while also enhancing the desirability of these assets to tenants. Thoughtful investments like these are a critical part of our long-term sustainability objectives, including our goal announced in 2021 to reduce our portfolio's greenhouse gas emissions by 40% by 2030, over our 2018 baseline. Social accomplishments in 2022 include 902 hours of volunteer work, individually and corporately, to the communities we serve, which exceeded our 600-hour goal by over 50%. We also provided more than $408,000 to philanthropic fundraising and in-kind donations to community and healthcare provider organizations, benefiting their research and mission initiatives. In addition, in 2022, we earned recognition from Modern Healthcare as One of the Best Places to Work in Healthcare for the second year in a row, and Top Workplaces Honors from the Milwaukee Journal Sentinel at our headquarters for the fifth year in a row. Our ESG efforts continue to receive recognition at the asset and corporate levels. During 2022, our assets were certified by IREM under their Certified Sustainable Property program, bringing our aggregate count to 38 properties with this designation. Separately, we earned 16 new ENERGY STAR property certifications under their recently relaunched medical office building program, bringing our certification count to 26 and qualifying Doc as a premier member of the Certification Nation's efforts. We're also proud to share that we were named to Bloomberg's Gender Equity Index in January of 2023 as a first-time submitter, distinguishing our work in gender equity and enhanced public disclosure. We're thankful to have been recognized in each of these ways and remain committed to maintaining our status as a leader within the healthcare REIT sector on matters of ESG. In a few minutes, Jeff will discuss the strength of our balance sheet, and Mark Theine will provide more details on our operating results. Before that, I'd like to take a moment to speak toward our expectations for the year ahead. In 2023, we have set ambitious goals to increase our occupancy at market rate and continue seeking medical office acquisitions and development opportunities. Our development financing pipeline is more extensive than ever, with more than $200 million at cost of opportunities under evaluation and exclusive negotiation. We expect to proceed with many of these opportunities and are targeting stabilized project yields in the 7% to 8% range. The acquisition market has not yet stabilized with current and capital market conditions. Market transactions are occurring around the high six cap rate. Still, with low volumes and a limited financing market. We do not believe the market has reached equilibrium, with our weighted average cost of capital or the market's cost of capital growth generally. In conclusion, Physicians Realty Trust enters 2023 with a strong, stable and proven portfolio. Our balance sheet is strong, and we remain disciplined in capital deployment, patiently waiting for acquisition and development opportunities that will be accretive to our long-term financial goals. We celebrate our 10th anniversary this summer, and we are proud that we have built this company to last for decades to come. I will now turn the discussion over to Jeff.

Jeff Theiler, CFO

Thank you, John. In the fourth quarter of 2022, the company generated normalized funds from operations of $61.5 million or $0.26 per share. Our normalized funds available for distribution were $57.9 million, an increase of 5.4% over the comparable quarter of last year, and our FAD per share was $0.24. For 2022, our normalized FAD was $242 million, an increase of 10.6% over 2021, and our full-year FAD per share was $1.10. Releasing spreads remain strong this quarter at 7%, and we expect the broader economic environment to support our efforts to roll the portfolio's rent up over time. On the expense side, we're protected from stubbornly high inflation by our standard triple net lease structure, in which we recover 84% of all operating expenses, which is about 20 percentage points higher than our peer group. While year-over-year same-store NOI growth was below expectations at 1.5% due to the move-outs discussed earlier in the year, we see positive results on a sequential basis with quarter-over-quarter same-store NOI growing by 1.3%. On the acquisitions front, we had projected minimal acquisition activity in the fourth quarter and saw that play out with just a handful of strategic transactions taking place, along with some funding on existing loans; patience continues to be the theme here. While cap rates have drifted significantly higher, we are not yet seeing a high volume of deals that meet our quality thresholds at pricing that makes sense in this capital environment. Our cost of capital is extremely competitive right now. So it isn't that we are competing against cheaper capital. Instead, we see this as the usual delay that happens when sellers have to adjust to pricing that is less advantageous than they could have received several months ago. Therefore, we are reluctant to put out acquisition guidance at this time. We believe that either cap rates will adjust to historical norms based on current debt costs or we will see improvements in our cost of capital that will create opportunities in the current market environment. We are in constant dialogue with potential sellers and health system partners and believe we will be in an excellent position to grow the company's earnings substantially when this bid-ask spread closes. We took steps to bolster our balance sheet further by issuing $74 million of equity in the fourth quarter on the ATM, along with another $66 million on the ATM in January. This places our balance sheet on a debt to EBITDA run rate of 5.2 times on a consolidated basis and provides plenty of dry powder for us to utilize at the right time. Finally, a few updates to our 2023 guidance. We expect G&A to increase by about 4.5% at the midpoint to a range of $41 million to $43 million. Current capital expenditures are expected to increase modestly by about 5% at the midpoint to a range of $24 million to $26 million. As we continue to see tenants trade TI dollars for lower renewal spreads. As mentioned earlier, acquisition guidance will be withheld until we have more visibility on how cap rates and capital costs evolve in 2023. With that, I'll turn it over to Mark to walk through some additional operational details.

Mark Theine, Executive Vice President, Asset Management

Thanks, Jeff. Our tenured asset management, leasing and capital projects teams are united in our focus to serve our healthcare partners while growing cash flow for our stakeholders. We contributed to these goals in 2022 by delivering record renewal spreads, maintaining retention, and efficiently prioritizing capital project investments in this inflationary environment. These successes are the direct results of our commitments to outstanding customer service and in line with our core values. Despite the difficult macro environment, we delivered record full-year renewal spreads of 6% while maintaining retention of 77%. Importantly, these results were achieved without offering excessive incentives, with full-year renewal TI's totaling just $0.80 per square foot per year. This efficiency was matched by our capital projects team, who deployed $23.9 million of recurring CapEx in 2022, representing $1.48 per square foot. During the fourth quarter, we continued our positive momentum by achieving renewal spreads of 7% on 141,000 square feet of volume, with leasing costs totaling $0.45 per square foot per year. In addition, new leases totaling 42,000 square feet commenced during the quarter at an average rate of $18.64. Tenant improvement costs on new leases totaling $3.89 per square foot per year remain well within industry averages, demonstrating our commitment to bottom line effective rent rather than headline rate. The weighted average annual rent escalator on this quarters' 182,000 square feet of leasing totaled 2.9%, a significant increase against the portfolio average of 2.4%. MOB same-store NOI growth was 1.5% in the fourth quarter, below our historical 2% to 3% growth rate due to a 30 basis point decline in occupancy from the vacancies we discussed last quarter. In total, this 51,000 square feet of lost occupancy across our 13.5 million square foot same-store portfolio is largely explained by activity at two specific buildings. First, same-store occupancy continues to be impacted by the strategic non-renewal of suites in an MOB in Minnesota to allow for the construction of a brand new ASC that is currently under construction and leased to the dominant investment-grade health system in the market. The new 21,000 square foot surgery center is expected to be completed and paying rent during the third quarter of 2023. Second, 22,000 square feet of vacancy is attributable to an MOB in Pennsylvania, where our historical physician tenants were employed by a hospital and relocated to the hospital's owned medical office facility at the end of the lease term. We are making several investments to improve this space and we have partnered with the local brokerage team with strong healthcare relationships. Overall, we do not view the small amount of negative net absorption to be indicative of market conditions or our potential for internal growth, but rather as one-off events that will have a short-term impact on the portfolio. Excluding these two assets, MOB same-store NOI growth would have been 2%. While we don't typically highlight our sequential same-store results, the 1.3% growth in NOI, stable occupancy and a 0.5% reduction in operating expenses show positive progress in the impact of our team's efforts. This is our 19th consecutive quarter of positive same-store NOI cash growth. Again, we enter 2023 with strong leasing momentum. The macro leasing environment continues to offer an advantage to existing medical office inventory, with quality space in move-in condition due to the cost and time required for new construction, especially in markets like Phoenix, Nashville, Atlanta and Dallas where we have a strong presence. At the beginning of the year, our leasing and marketing teams launched a comprehensive campaign to increase online exposure of our properties, target key brokers and market influencers, and leverage the relationships and knowledge of our in-house property management team. Just two months into the year, our efforts are yielding results, as tours of vacant space are up nearly 30% year-over-year, and we are trading proposals on over 162,000 square feet of vacant space in the portfolio. Our leasing and property management teams have a busy calendar of broker open houses to showcase our portfolio and demonstrate new virtual reality technology, which allows prospective tenants to visualize a customized suite and finishes before commencing expensive construction. We have dedicated approximately 60% of our 2023 recurring capital budget of $24 million to $26 million to leasing initiatives that include renovating vacant suites, tenant improvement allowances to retain and attract healthcare providers and general building renovations where there's strong leasing activity due to the supply and demand of physicians in the market. Through these collective efforts, we believe that there is an opportunity for an increase in total portfolio occupancy in the back half of the year. Following a typical three to six months, it takes to design, construct and commence a new lease. We expect this positive momentum to also appear in lease renewals, while 2023 scheduled expiration volume remains small at 4.5% of the consolidated portfolio. The market conditions that helped contribute to our success in 2022 remain intact. For the full year, we expect renewal spreads to be in the mid-single digits compared to the long-term MOB industry expectations of 2% to 3%. And we anticipate retention to be in line with our historical average of 75%. To conclude, we anticipate that our operational initiatives will lead to improved same-store NOI growth beginning in the third quarter of 2023. While below target same-store performance is frustrating in the short term, we believe that long-term value is maximized through thoughtful portfolio management, intelligent capital investments and aggressive leasing initiatives. The thesis for medical office is as strong as ever, and we're excited to execute on behalf of our stakeholders in 2023. With that, I'll turn the call back over to John.

John Thomas, CEO

Thank you, Mark. Maria, we're now ready for questions.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Juan Sanabria with BMO Capital Markets. Please go ahead.

Juan Sanabria, Analyst

Hi. Good morning, and thank you for your time. I would like to discuss the leasing efforts and the potential for increased occupancy. Can you provide an estimate of the occupancy improvement you anticipate? You mentioned this would occur in the latter half of the year; will it primarily result from filling existing vacancies, or will it involve additional leasing of spaces that have been unoccupied for some time? Additionally, could you share details about re-lease spreads and occupancy expectations? What are your projections for same-store NOI for 2023?

Jeff Theiler, CFO

Hey, Juan, thanks a lot. This is JT. I think our ambitious goals this year around both vacancy and really non-renewing lower quality credit tenants with higher quality health system tenants who need to expand into space in their buildings. So it's 95%-96% somewhere in that number is full occupancy, and so our ambitious goal is just to hit those numbers, and so positive accretion for the year, and our compensation goals are tied to that as well. So we're, you know, we think that's very achievable, somewhere in that range, and same-store is a number that is impacted by a small percentage, a very small percentage of move outs, some of which we caused on our own in sequential quarters and it takes a couple of more quarters to backfill that space with both leases signed, but also more importantly, completing the TI and the commencement of those leases. So, back half of the year, we have expectations for good, solid return to our same-store growth numbers that are historical. The first half of the year, we're burdened by the decisions we made, we think the right decisions in the third and fourth quarter of 2022.

Juan Sanabria, Analyst

Okay. And then I was just hoping for some color on the transactions market and where you see that the bid-ask spreads, maybe in terms of cap rates of where sellers are still holding on what you think is realistic, given your capital costs are generally higher capital across the market.

John Thomas, CEO

Yeah. Great question. And we're seeing a significant movement in cap rates; they're just not many transactions occurring. Sellers are just holding on, hopeful that we return to the glory days of 2020 and 2019 from a cap rate perspective. But transactions are occurring in the mid-sixes. We think we have a great cost of capital in the current environment, but that cost of capital still needs high sixes to mid-sevens cap rates, depending upon the annual increase reserves in the rents and things like that to execute. So, we think there's a good opportunity in the back half of the year assuming that market reaches equilibrium in that range. But in the current environment, we're just not seeing many trades that fit the right quality, right credit, and right location that we want to buy in the mid-sixes. So we want to see those cap rates move up. And, like Jeff said, we've got a balance sheet loaded to execute once we reach that equilibrium. It's my word in cap rates with market cost of capital.

Juan Sanabria, Analyst

Thanks, John.

John Thomas, CEO

Next one.

Operator, Operator

Your next question comes from Joshua Dennerlein with Bank of America. Please go ahead.

Joshua Dennerlein, Analyst

Yes, I wanted to follow up on your comments regarding the lease escalators. You mentioned that in the fourth quarter, you signed a lease with an increase of 2.9%, up from 2.4% in the existing portfolio. How are the current discussions going for leases that are set to renew in 2023? Are you finding that you can negotiate more aggressively on future leases?

John Thomas, CEO

Hey, Josh, great question. That's one of the things that just kind of understated in our comments. I believe more than 60% of our leases in the fourth quarter, we renewed with an average annual increase of over 3%. The compounding effect of that is probably the best thing we can do in our leases. We continue to move our average annual escalator up from 2.4%. I think we're up to 2.5% now, and we continue to move that up. So those conversations continue to be strong. And we continue to have some negotiating power in the average annual increase sort of to move those up beyond historical averages. Our leasing team is doing a great job focusing on not only the renewal rate, which again, last year was 6% or more, but also that average annual increase. So, we try to get CPI, we try to get floors in that CPI increaser, but just moving that number up has a long-term compounding effect.

Joshua Dennerlein, Analyst

Okay. Appreciate that color. And then, maybe one big picture question for me. Any kind of changes you're seeing with health systems in the current environment coming out of COVID? I know they did have labor pressures. Just some challenges on that front. Like, anything they're looking to do differently that might help your business or hurt it a little bit? Just trying to get a sense of the landscape.

John Thomas, CEO

Yes. Since 1982, there's been a push by Medicare and payers to move more care out of the hospital into outpatient settings. I think health systems realized during COVID, they don't have enough outpatient space available for the kind of demand in their markets. What we're seeing differently from health systems is a more intensive strategy to open new outpatient locations in strong demand locations, and that's what's leading to a lot of development opportunities for us. All health systems, investment grade and otherwise had challenges in 2022 with inflation, labor shortages and labor stress. We're starting to see that stabilize. The revenue side or the reimbursement side of healthcare is always a lagging indicator, not a lagging indicator, lagging impact on their P&L statements. Expenses, a real-time revenue, take reimbursement rates, take time to catch up with inflationary pressures. We are still seeing great opportunities to grow as the US healthcare economy this year is going to be $3.5 trillion.

Joshua Dennerlein, Analyst

Appreciate that. Thank you.

John Thomas, CEO

Thank you.

Operator, Operator

Your next question comes from Tayo Okusanya with Credit Suisse. Please go ahead.

Tayo Okusanya, Analyst

Yeah, good morning, everyone. Question on internal growth. I think everything that's happening on the top line is pretty impressive, even with some of the deliberate occupancy drag. But with OpEx, I think you're getting the same store OpEx growth was 9.8%. Could you just talk a little bit about efforts to kind of mitigate some of the OpEx increases going forward, and specifically is part of that just because of again, your triple net leases, but not everything is passed through at this point? Jeff, I believe you mentioned, you had like an 84% reimbursement rate. Could you just talk a little bit about again how ultimately some of the OpEx growth gets mitigated going forward for better same store NOI growth performance?

Jeff Theiler, CFO

Yeah, thank you, Tayo. I’m going to ask Mark to respond to that.

Mark Theine, Executive Vice President, Asset Management

Yeah, good morning, Tayo. So you point out our operating expenses in the fourth quarter were up 9.8%. It's definitely higher than historical norms. One thing kind of below the surface that's really pushing it up this quarter is some one-time insurance costs; insurance in the quarter was up $1.2 million over the prior year. Again, those are some one-time costs in the quarter. But one of the things we really appreciate about our portfolio is just, as alluded to, we're 95% occupied and highly triple net lease. So, our operating expense recoveries were actually up 10.3% to offset that increase. Our asset management team is really focused on controllable expenses, where we've got the ability to impact the long term operating expenses of the portfolio. For controllable operating expenses in the quarter, those are up about 5%, 5.5%. So, that's a pretty good run rate and great work by our asset management team in this inflationary environment to really focus on those controllable expenses, which exclude insurance and taxes.

Tayo Okusanya, Analyst

That’s helpful. And the continued investments in real estate technology again, I think you guys put like $0.5 million into that again this year, this quarter. Could you just talk a little bit about again your ultimate return on investment that you're looking for? How this is going to help you guys in lowering operating expenses, just again, as you just kind of look at more investments on the technology side. What exactly you kind of expect to get out of that?

Jeff Theiler, CFO

Hey, Tayo. This is Jeff. Good question. We think we'll get a good return out of that investment just on a monetary basis. But really, the investment is also designed to help us stay in front of the latest technology, the latest real estate technology. To your point, I mean, help us manage our operating expenses going forward. We think it is going to be a good return on the investment side, but it also gives us front-row access to all these new companies that are coming out with innovative real estate solutions, which really helps us be at the forefront of having the best possible management of our properties and keep our operating expenses low for our tenants, which, of course, helps the company itself.

Tayo Okusanya, Analyst

Are you partnering with any of those companies at this point and seeing any kind of result?

Jeff Theiler, CFO

You know, Tayo, I think it's JT– I think part of the opportunity in this PropTech investment we made is to work with other REITs to kind of identify and benefit from some of the best IT minds out there. I don't think our shareholders are looking for us to create our own IT platform. I think the benefit is we're investing alongside other REITs and other institutional real estate owners to kind of develop IT tools that we will benefit from and at the same time, have a great IRR or return on investment from that direct investment. So, we haven't seen anything directly, but we get to explore these tools, which is part of the opportunity that are under development or leading-edge technology. So, we'll see some long-term benefits eventually.

Tayo Okusanya, Analyst

Right. And then one more for me if you can indulge me, just some capital allocation question. So some of the recent equity issuances again, what again are going to be the use of the funds, especially this kind of given the issuance of at your current kind of implied cap rate? And lastly, how do we think about the dividend outlook going forward, given like the 96% EFFO payout ratio?

John Thomas, CEO

Yes, Jeff?

Jeff Theiler, CFO

I’d be happy. Hey, Tayo, so – yes, we did some equity issuance on the ATM; we're trading at an implied cap rate in the mid 6% range. That's consistent with where we've seen Class A medical office buildings being marketed. We haven't seen many transactions closing still. Cap rates have really only been moving in one direction, which is up. So we thought it was prudent to strengthen our balance sheet at these levels, which we think is going give us a great opportunity when the market stabilizes at what we think the right numbers are to really be an active investor and generate strong earnings accretion, which is certainly a departure from the previous times when cap rates were so low; it's hard to generate earnings accretion. We think we're going to be able to get best-in-class, Class A MOBs at really good pricing. So, we feel good about the strengthening of the balance sheet. Obviously, in the meantime, it also pays down our variable-rate debt, which seems to also be only moving in one direction, which is higher with the Feds increases. We think it's a smart capital allocation decision.

Tayo Okusanya, Analyst

Great. Thank you.

John Thomas, CEO

Thanks Tayo.

Jeff Theiler, CFO

Thanks Tayo.

Operator, Operator

Our next question comes from Michael Griffin with Citi. Please go ahead.

Michael Griffin, Analyst

Great. Thanks. Maybe to follow-up on Tayo's last question there related to the equity issuance. I mean you talked about being disciplined in 2022; patience continues to be a theme. You mentioned a competitive cost of capital. You why the equity issuance now, I guess, just given the sense that it's at a pretty notable discount to what consensus NAV is that, you seem like you're fine from a balance sheet perspective. It seems like the capital markets are going to be pretty muted for the near term. Why did it make sense now and why not maybe put it off until capital markets activity improves?

Jeff Theiler, CFO

Yes, I think we're currently at the lower end of our leverage range, which is set between 5.5% and 6%. The capital markets have indeed been quite unstable over the past few months. While we've experienced a good month and year-to-date performance in the capital markets, there's no certainty moving forward. The concept here is that it's not advantageous to base our purchasing decisions solely on where we're trading in relation to an implied cap rate compared to current asset acquisition prices. Having the ability to maintain liquidity now is crucial so that if capital markets were to face a downturn, we would still be positioned to grow while others might struggle.

Michael Griffin, Analyst

Right, so it seems that in your view, it's relative on an implied cap rate basis, maybe investors should be thinking about it on that basis relative to premium or discount to NAV, am I reading that correctly?

Jeff Theiler, CFO

Yes, I believe they go hand-in-hand. That's how we're considering it – our implied cap rate in relation to the current marketing of assets.

Michael Griffin, Analyst

I have a question for Mark. You mentioned the selective non-renewal of certain leases, specifically the MOBs in Minnesota and Pennsylvania. I understand the long-term strategic reasons for this decision, but I would like to know if there is a possibility of additional strategic non-renewals that could affect occupancy in 2023. Any further details on this would be appreciated.

Mark Theine, Executive Vice President, Asset Management

Yes, certainly. So, again, we strategically did not renew two leases to bring in an investment-grade tenant. So, that's going to create great long-term value for the company, for the portfolio, for shareholders. We'll continue to look for opportunities to replace existing tenants with investment-grade quality, great long-term tenants. It does create a near-term drag on our same-store results, which is frustrating, but it provides the right long-term value and we will always look for those opportunities in 2023 and years after that. The good news is our leasing team has done a fantastic job this year of already commencing conversations on 162,000 square feet of new leases and taking space. Now, not all that will get done, but those are good conversations to start the year. We feel good about filling vacant spaces throughout 2023 and growing our net absorption.

Michael Griffin, Analyst

All right, that's it for me. Thanks for the time.

Mark Theine, Executive Vice President, Asset Management

Appreciate it.

Operator, Operator

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

Ronald Camden, Analyst

I have two quick questions about the balance sheet. First, regarding the equity issuance of approximately $66 million after the quarter, could you clarify what that funding was allocated for? Additionally, if I annualize your interest costs for the quarter, I arrive at around $80 million. Is that figure in the right range, or has some debt been paid down? I hope that makes sense.

Jeff Theiler, CFO

It does. Hey, Ron, it's Jeff. So yeah, we put that towards paying down the revolving line of credit. So, obviously, we expect eventually to redeploy those proceeds into acquisitions, but in the meantime, we pay down the line of credit with it. So, it'll bring the interest expense down a bit.

Ronald Camden, Analyst

Got it. Regarding the acquisition, I understand you aren't providing guidance based on what you've discussed. Could you elaborate on the competitive landscape, why cap rates are so tight, who is still active in purchasing, and why we haven't seen more widening? Thanks.

John Thomas, CEO

Yeah, it's JT. I think it's just sellers holding out and hoping. Essentially, hope conflicts with rising interest rates on short-term loans that were used to acquire for four cap, five cap assets in 2017 to 2020 range. Until we see kind of more distress on the ownership side of the capital side of medical office buildings, we won't see a lot of trades occurring. So it's moving in the right direction. It just takes time for the market to reconcile cost of capital, it's been a 20-year bull run in medical office and the 10-year treasury, and kind of other things. It just takes time for the market to reconcile itself. So, it’ll get there, and we expect a pretty good back half of the year. But the market is going to get there.

Ronald Camden, Analyst

Got it. That's it for me. Thanks so much.

John Thomas, CEO

Yeah. Thanks.

Operator, Operator

Next question comes from Michael Carroll with RBC. Please go ahead.

Michael Carroll, Analyst

Yeah. Thanks. JT, just staying on the MOB private market valuations, I think you highlighted that assets were being marketed in the mid-6% cap rate right now. Is that a fair valuation or do you think it needs to go higher from that mid-6% type cap rate?

John Thomas, CEO

Yeah, Mike, great question. When assets are marketed at that rate, it implies that the price shouldn't increase from that range. The fact that assets are even being marketed above six represents a significant change compared to six months ago, and they still need to rise a bit higher. We're patiently waiting and are still exploring opportunities in the market. When we make an offer on a Class A asset that we are very enthusiastic about, it will be at a rate higher than mid-6%.

Michael Carroll, Analyst

So we're thinking more of like a high 6%, are we talking about 7% type range, or I guess, like mid-6%, obviously, pretty wide range? I mean, are we talking higher than that?

John Thomas, CEO

Generally. And we're IRR investors. It depends on the annual increases, where they are market rents and things like that. It's a combination of factors, but from a cap rate perspective, we are seeing trades; very few. We are seeing trades in the mid-6s on assets that, if they were trading, let's just call it seven, we would be pretty excited about it moving in the right direction. So it's just few and far between, but we think the market is moving in the right direction, as a buyer and a long-term investor.

Michael Carroll, Analyst

Okay. And what's the appropriate IRR target? I mean, trying to translate this from a cap rate to an IRR. I mean, are we talking about 8% plus IRR?

Jeff Theiler, CFO

Yes, I think that's a fair way to think about.

Michael Carroll, Analyst

Okay. And then are these high quality MOBs, so off-campus affiliated with a major health system? Is that what we're generally talking about here?

John Thomas, CEO

Yes. We're very transparent. That's all we buy. That's what we're talking about. You can get lower quality at a higher rate. You can do other asset classes at a higher rate. Right now for Class A assets, I think in part that's where we see development leading the way for the next several years as health systems are looking for new strategic locations. We're working with several right now on helping them develop those locations and getting attractive yields in the current cost capital environment.

Michael Carroll, Analyst

Okay. And then I know earlier in your prepared remarks and through some of these questions, you talked about selectively not renewing some tenants if you think that there's a better tenant that could take that space. Are we talking about some of the things that you already did, or are there additional leases that you plan on doing this with in 2023?

John Thomas, CEO

That's a great question. We have 16 million square feet, and last year we dealt with 40,000 square feet, and we are already working to fill that space again. It just takes time for new leases to start after the tenant improvements. There will be a little of that in the first quarter of this year, but when a tenant has too much space, it can be more problematic than renewing a lease with a tenant that could potentially pay better market rates for that space. So, we have a bit of that in the first quarter, but it’s a small amount compared to our total of 60 million square feet. In the short term, it’s a negative; in the long term, it’s very beneficial to the company.

Michael Carroll, Analyst

Okay. Great. Thank you.

Operator, Operator

Our next question comes from Dave Rodgers with Baird. Please go ahead.

Dave Rodgers, Analyst

Oh, yes, good morning. Just a couple of follow-ups on investments. I think the first would be around the development funding pipeline $200 million that you talked about. I think this was a similar number to where you started last year. Maybe give us a sense of how it kind of wound up in 2022 versus that expectation; I think was probably lower, just to give us your own assessment of that. And then I guess what gives you confidence in that number for this year and debt markets maybe part of that? The second would be maybe a follow-up to Mike's question just a minute ago. In terms of the investment activity that you expect to accelerate in the second half, is that because you're seeing more RFPs on the market, more packages coming out? Is it more hope? Or are you actually seeing a good amount of activity that would lead you to be able to close activity or close acquisitions in the second half of the year?

John Thomas, CEO

Dave, those are all great questions. Hope is not a strategy, and we do not depend upon RFPs to find assets or work with health systems. Those tend to be auction-type processes where there's always some low bidder that you don't want to compete with, not that we couldn't. I think the $200 million is active discussions with health systems. Last year when both supply chain and inflation were going up, you couldn't get a contractor to give you a quote on a contract to build a building that was good for more than a day. Historically, you got a bid and 90 days later or 180 days later, it was still a good number. So last year, a lot of the projects we're working on are still there and that's the confidence in that $200 million number. Some of those projects are carrying over, and we're working with health systems that are waiting on some stabilization. So, we'll be breaking ground in the next 30 days on projects that we've been working on for a couple of years.

Dave Rodgers, Analyst

All right, great. Thank you.

Operator, Operator

Your next question comes from Steven Valiquette with Barclays. Please go ahead.

Steven Valiquette, Analyst

Great. Thanks. Good morning, everybody. So, I guess not to get too granular on the same-store OpEx that was up 9.8% in the fourth quarter, but I guess to flip the narrative around here a little bit with the one-time insurance costs that you mentioned you absorbed in the fourth quarter that makes the favorable 0.5% sequential decline in OpEx a little more impressive. So I guess with the assumption that the insurance costs were probably up sequentially in 4Q versus 3Q, just remind us which cost categories actually improved the most sequentially? And then also, were there any seasonal factors worth mentioning one way or the other that may impact that favorable sequential comparison on the OpEx?

Mark Theine, Executive Vice President, Asset Management

Yeah, Steven. This is Mark. Thanks for pointing that out. I've done a great job sequentially keeping our operating expenses actually declined a little bit. Contributing to that sequential change, utilities was a large contributor quarter-over-quarter and actually a decrease in holding that relatively flat and same with the general maintenance category there; year-over-year those were up about $700,000 and $600,000. But quarter-over-quarter, we did a great job with our asset management team to keep those flat. I think we're also seeing the results of some of our ESG efforts in the utility expense from LED upgrades, things like that, where we've made wise capital investments, and we're starting to see that reduction in the operating expenses from some of those projects that we completed this year.

Steven Valiquette, Analyst

Okay. And you mentioned that you don't normally do those sequential comparisons, but again, I guess the reason why you don't do that as they're just some seasonality factors that just muck that out sometimes. Just curious any reminders on any seasonal factors on sequential comparisons either 4Q to 1Q or just any other times throughout the year as far as any obvious ones that stick out?

Mark Theine, Executive Vice President, Asset Management

Yeah, the obvious ones would be snow removal. Markets like North Dakota were hit pretty hard with our snow removal costs in the fourth quarter, but really don't have a lot of seasonality in our operating expenses outside those obvious ones. Our highly occupied triple net lease portfolio helps insulate the overall NOI same-store numbers there. But, clearly, we watch that carefully for our healthcare tenants and partners because it's the overall occupancy cost that matters when we talk to them about lease renewals.

Steven Valiquette, Analyst

Got it. Okay. All right. Thanks.

Operator, Operator

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

Mike Miller, Analyst

Yes. Hi. So, for two questions. The first one, on the $200 million of development funding that's under discussion, I guess if all that comes to fruition, how much capital do you think could go out the door in 2023 and generate a return on it? That's the first question. Second one is what's the return profile on piecing these smaller condos together, like in Atlanta, versus a typical building acquisition that you would make?

John Thomas, CEO

I appreciate the second question because it's an excellent one. The long-term return potential from this investment significantly surpasses most of our other projects. It does require time to develop. This site is in a highly strategic location, and around two to three decades ago, the trend among physicians and hospitals was to invest in condo developments. The strategic advantage of this particular site is that it is positioned directly across from three health systems. We're genuinely optimistic about the long-term prospects, potentially yielding the best internal rate of return and cash yield from our individual investments. However, acquiring these condos will take time. Regarding the development aspect, it typically takes about 18 months to complete construction. For those projects currently underway or about to start, we will see results unfold over this 18-month period. Out of the $200 million, if we spread that across 18 months, this amounts to the projects we are likely to finance or have contractual commitments for this year. We are also exploring additional opportunities. I believe there are significant investment possibilities on the development front.

Mike Miller, Analyst

Got it. Okay. Thank you.

Operator, Operator

There are no further questions at this time. I would like to turn the floor back over to John Thomas for closing comments. Please go ahead.

John Thomas, CEO

Yes, Maria. Thank you. And thanks, everyone for joining us on the call today. We're really excited about 2023. It's a different market and at a different time. We think a 20-year bull run and seller's market has turned into outsized opportunities for DOC, Physicians Realty Trust this year, and we look forward to seeing you at some of the investor conferences coming up soon. Thank you.

Operator, Operator

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