Earnings Call Transcript - DOC Q1 2024

Operator, Operator

Thank you for joining us. My name is Eric, and I will be your conference operator today. I would like to welcome everyone to the Healthpeak Properties First Quarter 2024 Financial Results Conference Call and Webcast. I will now turn the call over to Andrew Johns, Senior Vice President of Investor Relations. Please proceed.

Andrew Johns, SVP, Investor Relations

Welcome to Healthpeak's First Quarter 2024 Financial Results Conference Call. Today's conference call contains certain forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our expectations. A discussion of risks and risk factors is included in our press release and detailed in our filings with the SEC. We do not undertake a duty to update any forward-looking statements. Certain non-GAAP financial measures will be discussed on this call. In an exhibit to the 8-K we furnished to the SEC yesterday, we have reconciled our non-GAAP financial measures to most directly comparable GAAP measures in accordance with Reg G requirements. The exhibit is also available on our website at healthpeak.com. I'll now turn the call over to our President and Chief Executive Officer, Scott Brinker.

Scott Brinker, President & CEO

Okay. Thanks, Andrew. Good morning, and welcome to Healthpeak's first quarter earnings call. Joining me today for prepared remarks is Pete Scott, our CFO; and the senior team is available for Q&A. We are extremely pleased with our first quarter results, and our momentum is positive on every key metric. We increased our 2024 earnings guidance by $0.02 at the midpoint, driven by same-store results, outperformance on merger synergies, and accretive stock buybacks. The merger has proven to be a meaningful positive catalyst for the company, and the integration is exceeding our expectations. Many public company mergers are done through auctions, which delays the ability to integrate the two companies. Our transaction is completely different. Neither company would have proceeded with the merger without high confidence in our ability to put the teams and platforms together in a way that one plus one could equal three. That meant having extensive conversations on people, processes, systems, and capabilities before we agreed to proceed. Our integration planning was underway before we even announced the transaction. In the six months since that announcement, our combined team has done an exceptional job integrating every aspect of our business. The continuity and buy-in from JT and the senior team who joined Healthpeak has been critical to the integration, including key health system relationships. Property management internalization has been a huge success to date and is a good example of the merger augmenting our platform. Strategically, it was important to me that our own employees are interacting with our tenants every day. And financially, we're now capturing additional profit that flows through property-level NOI. To date, we've internalized ten markets, covering seventeen million square feet. We chose to accelerate the rollout given our success to date, and we expect to internalize an additional four million square feet by year-end. Significant upside remains to be captured. We're evaluating ten-plus million square feet for internalization in 2025 and '26, which in aggregate would allow us to internalize more than 70% of our total footprint. The positive feedback from the property managers on the ground and our tenants further validates the strategic decision to internalize. Let me take a minute on the value proposition in our stock today, which we think is compelling. The baseline is a strong balance sheet with a high-quality portfolio with 3% to 5% same-store growth and a mid-6% dividend yield with a conservative payout ratio. Beyond that baseline, we've identified $80 million of NOI upside potential, none of which is included in our 2024 guidance from additional merger synergies and leasing up our active life science redevelopment pipeline. We also see 30% upside by recapturing our discount to consensus NAV, which we expect to do through consistent earnings growth and smart capital allocation. Industry headlines notwithstanding, over the past two years, we grew AFFO per share by 13%, and we expect to continue growing earnings moving forward. Moving to our Outpatient business. The fundamentals have never been stronger. Patient volumes are increasing, absorption is accelerating, and new development remains low. That's driving strong re-leasing spreads, retention, and NOI growth. In addition, progressive health systems have a strategic focus to grow their outpatient revenue. It's less expensive for payers, more convenient for consumers, and more profitable for the providers. We have the premier platform and relationships to capture this outpatient growth, whether on-campus or off-campus at locations that are necessary to capture demand. We expect new supply to remain low given the cost of construction. Today, our triple-net equivalent rents are in the low twenties while most new developments are $35 to $40 per foot. Turning to our Life Science business. IPO and venture capital funding have improved recently, which is driving demand for space. Our leasing pipeline today is up 80% from last quarter. We're increasingly optimistic that pipeline will generate lease executions for the balance of 2024 and into 2025. Roughly 70% of our pipeline is with existing tenants, many of which are deals that don't come to the broader market, again providing us a big advantage versus the new entrants who can't tap into an existing portfolio of recurring tenants. We're also seeing a massive reduction in new construction starts that should extend for multiple years, creating a far more favorable leasing environment for landlords. Let me close with capital allocation. The strategic merger with Physicians Realty closed on March 1 and is accretive to our earnings, balance sheet, and platform. Year-to-date, we sold $363 million of fully stabilized assets at a 5.8% cap rate, plus $69 million of loan repayments. The most recent sale was an R&D flex office portfolio in Poway, east of San Diego that we sold to an affiliate of the tenant in an all-cash deal for $180 million, which was a 6% cap rate. We have additional asset sales in various stages of negotiation and execution, but given the environment, we'll provide details if and when they close. We took advantage of the disconnect in our stock price and repurchased $100 million of stock at an average price just above $17 per share, which represents an implied cap rate of 8%. The year-to-date asset sales are more than 200 basis points inside that level, delivering immediate value to shareholders. Our remaining authorization today is roughly $350 million, and we'll continue to pursue buybacks as priority number one on capital allocation, obviously, depending on our stock price and the arbitrage opportunity from asset sales. Priority number two for capital is new outpatient medical development with key health system partners, provided their strong pre-leasing and a positive spread to our asset sales. This capital recycling would be accretive to asset quality and stabilized earnings. We do have an attractive pipeline of such projects today in the $200-plus million range. Priority number three is distressed opportunities in life science, which we are starting to see, especially development projects lacking capital and/or leasing traction. These would be purely opportunistic and could be done on the balance sheet or via joint ventures. Most of the distress won't be interesting to us, as we'll focus on our own core submarkets where we can use our scale and relationships to drive outperformance. I'll turn it to Pete for financial results and guidance.

Peter Scott, CFO

Thanks, Scott. 2024 is off to a great start. For the first quarter, we reported FFO as adjusted of $0.45 per share, AFFO of $0.41 per share, and total portfolio same-store growth of 4.5%. Let me briefly touch on segment performance. Starting with outpatient medical, we reported same-store growth of 2.6%, driven by a positive 3.4% rent mark-to-market and an 84% retention rate. Our strong leasing activity continues. During the quarter, we signed nearly 1.5 million square feet of leases, and we have a backlog of 2.5 million square feet in active discussion, including 700,000 square feet under LOI. Importantly, we expect outpatient medical same-store growth to increase as the year progresses due to accelerating internalization and an increase in occupancy from continued leasing. Turning to Lab. We reported same-store growth of 2.7%, driven by 3% plus contractual rent escalators and a 2.6% positive rent mark-to-market, partially offset by an anticipated tickdown in occupancy. During the quarter, we signed approximately 150,000 square feet of leases, and we have a robust leasing pipeline of nearly 2 million square feet. We have 455,000 square feet under LOI, positioning the second quarter to be one of our best lab leasing quarters in recent years. In addition, we also expect lab same-store growth to accelerate for the balance of the year as free rent from some large lease commencements burns off. Finishing with CCRCs, we reported same-store growth of positive 27%, driven by increased occupancy and rate growth. Occupancy in our CCRC portfolio ended the quarter at 85.2%, and we expect continued positive performance. Shifting to the balance sheet. We had a very active quarter. We successfully completed the assumption of $1.9 billion of debt with a weighted average interest rate of 4%. We closed on our newly originated 5-year $750 million term loan, which we swapped to a fixed rate of 4.5% prior to the recent spike in interest rates. And as Scott mentioned, we opportunistically repurchased $100 million of stock. Subsequent to quarter end, we fully repaid our commercial paper with proceeds from the Poway sale. Pro forma this transaction, our net debt to EBITDA is 5.2x. We have $3.1 billion of liquidity, no floating rate debt, and an AFFO payout ratio of approximately 75% and nearly $350 million of authorization left on our stock buyback program. Finishing now with guidance. We are increasing our FFO as adjusted guidance range by $0.02 and tightening the range to $1.76 to $1.80. We are increasing our AFFO guidance range by $0.02 and tightening the range to $1.53 to $1.57. Our increase in earnings guidance is driven by three items: First, we increased same-store guidance by 25 basis points to 2.5% to 4%. Second, merger synergies continue to exceed expectations and are now forecast to be $45 million in 2024. Third, we have bought back $100 million worth of stock at an FFO yield in excess of 10%. One last note before Q&A, we published a revamped supplemental alongside our earnings release. You may have noticed that we streamlined the document and modified it to more closely align with how we view the business. We also added an NAV input page to assist with modeling, which we felt was important for our stakeholders. With that, operator, let's open the line for Q&A.

Operator, Operator

Your first question comes from the line of Josh Dennerlein with Bank of America.

Joshua Dennerlein, Analyst

I wanted to follow up on your comment that the second quarter should be one of the best for lab leasing. My first question on that is how are rents trending on what you're signing compared to a few quarters ago? Also, what can you tell me about tenant improvements and concessions?

Peter Scott, CFO

Yes, Josh, I can start with that. I think rent and TIs, as we look across our portfolio, it's been pretty steady for the last six months or so. As we look at market rents today, it's probably in that 5% to 10% premium when you compare it to our in-place rents across the portfolio, which is around $60 per square foot. On new lease deals, tenants are certainly seeking more turnkey space, which has increased the overall TI packages. But as I said, that's been much more steady the last six months or so. And I think from a lease term perspective, on renewal deals, we're probably seeing more 3- to 5-year terms. On new leasing deals, we're seeing more 7 to 10 years there. And then obviously, the last piece I'll just say fundamentally is lease deals just take a little bit longer, especially as you price out the TI packages. So if a lease deal took 2 to 3 months to get done a couple of years ago, it's probably closer to 6 months today, but we're certainly highly motivated to get our lab leasing pipeline, which has increased a lot over the last year or so, converted from a pipeline into a lease transaction.

Scott Brinker, President & CEO

Yes, Josh, I'd just add, our leasing costs have been really pretty modest. If you just look in the supplemental for renewal leases, our TI and LC has been 5% or less of the rental rate, and even for new leases, it's in the 10% range. I mean, it's really pretty modest and very low free rent as well. So I think we held in exceptionally well, just given the quality of the portfolio and the submarkets and the relationships.

Joshua Dennerlein, Analyst

I appreciate that color. And Scott, one follow-up for you. You mentioned you expect about 70% of the MOBs will eventually be internalized. How do you think about that 30% that you won't be able to internalize? Is that stuff you would eventually want to sell or maybe add scale in the market to get to a point where internalization makes sense?

Scott Brinker, President & CEO

Yes. I wouldn't say it's assets we want to sell. It's more markets where we don't have significant scale. And then there are some markets where we have a big health system relationship where they prefer to use their own in-house property management firm, and Atlanta is a good example of that, that we still had market. The fact that health system wants to use their own people, we can live with that.

Operator, Operator

Your next question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets.

Austin Wurschmidt, Analyst

Can you guys provide a breakdown of what's driving the increase to same-store cash NOI growth by segment?

Scott Brinker, President & CEO

We didn't provide a breakdown, but I can tell you that all three segments are trending at or above the midpoint of the initial guidance. So we've got good traction across the board. Obviously, this particular quarter, CCRC was above. I expect that growth rate to normalize for the balance of the year. And then in lab and outpatient medical, I think all three quarters from here should be above what we reported in Q1, but there's volatility quarter-to-quarter.

Austin Wurschmidt, Analyst

Yes. I mean, I guess, just specific to the cash same-store NOI lab guidance, I think it was 1.5% to 3%. Pete, you referenced there's acceleration through the balance of the year as rent burns off, I think, related to the RevMed and Voyager deals you've highlighted. So I guess, can you give us a sense of what the magnitude of upside is there? And then also just maybe what the risks are that's holding you back from going ahead and raising that at this point in the year?

Peter Scott, CFO

Yes. Well, I would say that the 25 basis point raise that we did this quarter on the aggregate same-store guidance certainly reflects the improved performance in lab. On the lab side, in particular, we've been pretty consistent in saying this, that at the beginning of the year, we will have a little bit of bad debt cushion incorporated into the guide that we put out. And as we look at where we are today and look at all the capital raising that's gotten done, we feel like we probably had too much of a cushion at the beginning of the year. So we've released a little bit of that. And then we are getting internalization benefit as well. So we're probably trending towards the higher end of that initial 1.5% to 3% guidance number. The biggest headwind, and this is something that we've talked about, is just the fact that we did have an occupancy decline as we look towards full year 2023 compared to where we expect that to be in full year 2024. We do think we'll see an occupancy increase as the year progresses in our operating portfolio, but we're comparing that to the full year number last year.

Austin Wurschmidt, Analyst

Okay. Got it. That's helpful. And then I'm just curious, certainly, some of the VC funding and capital raising, you highlighted, have been positive, presumably for some of the leasing discussions in the pipeline. I'm just wondering if there's been any change in those discussions or the pace with which things are moving forward on the leasing front and lab just given some of the added economic uncertainty and volatility we've seen in the capital markets. And then just maybe even as you think forward from here, I know it's been sort of the last 30 days or so, but any impact you see that having on sort of the future pipeline and decision-making.

Peter Scott, CFO

I mean if you look, Austin, the capital raising has been at least year-to-date in '24 relative to year-to-date 2023, I mean, it's been up across every single category, especially on follow-on equity offerings as well as private placements that we fit into that bucket well. Certainly, there could be some risk going forward with interest rates going up. I think it's a little less rate-sensitive in the lab side of it and maybe cap rates in the world of real estate, and those private placements and follow-ons do take some time to come together. They're still happening. If you look across the last 30 days, the data will show you that even with the increase in rates, you're seeing capital flowing into biotech, the XBI is still holding up pretty well. Last night, there were some pretty good tech earnings as well despite the interest rate environment, so we still remain optimistic that, that capital raising environment has a pretty decent runway in front of it.

Operator, Operator

Next question comes from the line of Juan Sanabria with BMO Capital Markets.

Juan Sanabria, Analyst

Just hoping you could talk a little bit more about the disposition pipeline, how much is potentially for sale and what you could expect to transact on and how those proceeds would be split between debt reductions to be staying leverage neutral versus buybacks from here.

Scott Brinker, President & CEO

Yes, Juan, it's Scott here. We've done $350 million plus of pure asset sales year-to-date. The pipeline is at least that large, but it's a volatile environment as Austin just pointed out. So when we have clarity on transactions, we'll announce the details at that time, but it's certainly a big pipeline, more focused on outpatient medical, whereas the sales to date have been more life science or this R&D portfolio that we had in Poway. So yes, it's an active pipeline in terms of how the proceeds would be used. In large part, it depends on the environment in the stock price, in particular. That's been the highest and best use of capital in recent months just given where the stock was trading. If that continues to be the case, then that would be priority number one. If interest rates stay high or move higher, obviously, we could always delever even beyond staying leverage-neutral, which is just we for sure will do that. We won't lever up the balance sheet to buy back stock. So those are kind of priority numbers one and one A.

Juan Sanabria, Analyst

And just as a quick follow-up on that question. You previously talked about $500 million to $1 billion of potential dispose. Is that still kind of a big placeholder in people's minds just to think about that going forward for the balance of the year?

Scott Brinker, President & CEO

It's probably the right range. Yes.

Juan Sanabria, Analyst

And then just curious as a second question, just on AI, lots of discussions, not just in real estate on what the transition is going to mean for everybody. But just curious, when we think about the physical infrastructure plant in lab, what the incremental use of power may mean for CapEx or just the buildings being able to handle it? Just curious on your early thoughts as this kind of progresses and evolves.

Scott Bohn, Additional Speaker

Juan, it's Scott Bohn. With AI, we might observe some automation labs, but the majority of those facilities will still include chemistry and biology in your typical lab designs. Therefore, we aren't experiencing any significant changes in the construction for our tenants who are more focused on AI. Our buildings are equipped with extensive power, infrastructure, and capabilities to meet those requirements.

Operator, Operator

Next question comes from the line of Rich Anderson with Wedbush.

Richard Anderson, Analyst

So nice beat on the synergies, typical, I guess, most REITs that's the low-hanging fruit of the story. But going forward is perhaps a little bit more difficult, which is the life science leasing that you've been talking about. I think $60 million of upside. Can you take a shot about what the timing of that is? It's not all next year. Could it be as far out into 2027? Or how long of a tail to the life science leasing do you think is possible here going forward?

Peter Scott, CFO

Yes. Rich, well, as you mentioned on the synergies, I'll just start there, we do feel quite good about the trajectory that we're on, $45 million that we've been able to articulate we think we can hit this year. And we feel very confident in our ability to hit the $60 million run rate as we head into the next year. Obviously, the trickier part that you mentioned is on the leasing pipeline and especially those 3 marquee campuses. What I can say is that within our pipeline, we are having discussions on all of those campuses. I'd say some of those discussions are much further along than others. Realistically, if we signed a lease today or in the second quarter, it really wouldn't commence given some of the work we have to do until the earliest the beginning of 2025. So what I would say probably is it's high level, it's probably a 1- to 2-year period where we phase in and get to the full run rate there on the NOI. And it's probably the best guidance I can give you as we sign leases, and we're pretty good at disclosing those. We can try and get a little bit more specific on that number, but it's probably a bit in '25, a bit more in '26 and hitting that full run rate number probably towards the end of 2026.

Scott Brinker, President & CEO

Rich, one of the things, I wouldn't characterize the synergies as low-hanging fruit. Most mergers actually don't achieve their projections. We've got a team of 300-plus people here that have been working on the clock to achieve those synergies. So hats off to them for making it happen. It was anything but low hanging fruit.

Richard Anderson, Analyst

I don't mean to trivialize it. Let's call it, middle-hanging fruit, right? So second question might be a tough one to answer, but I'm going to ask it anyway. When you think about the entirety of the transaction, including everything, including whatever the transaction fees were, if that's 3% of $5 billion, that's $150 million. When do you think the merger, the combination is truly kind of breakeven for the company when you take everything into consideration?

Scott Brinker, President & CEO

Yes, if you're talking about the payback period, it's less than three years when you compare the synergies to the initial costs. However, company valuation focuses on future cash flows rather than just one year. We are very confident in achieving those synergies, and they will be permanent. The present value of those future cash flows significantly exceeds the initial transaction costs, making this a value-creating transaction. Most importantly, for our Board and the Physicians Realty Board, we have established the best platform in the sector, which brings lasting intangible benefits. It's challenging to quantify that, but it's an asset we now possess.

Operator, Operator

Your next question comes from the line of Michael Griffin with Citi.

Michael Griffin, Analyst

I was wondering if you could give some more color on the Poway disposition. You mentioned it's a mix of industrial lab and office space. Is the cap rate indicative of where lab might be trading today? Or were there some specificities given the asset mix that might warrant a higher cap rate?

Scott Brinker, President & CEO

Yes, it wasn't really a life science property in any event. It's kind of a mix of uses, R&D, there's some manufacturing, some office, kind of an industrial footprint and build-out. In parts of it, it certainly wasn't traditional life science nor was it in the traditional life science market, so I wouldn't view that as a read-through. I think it was a great price. That's why we sold it. So we were happy to recycle those proceeds into the balance of our portfolio. But yes, I don't think that's indicative of life science cap rates.

Michael Griffin, Analyst

And Brinker, where would you say kind of Class A lab space is trading these days on a cap rate basis?

Scott Brinker, President & CEO

It's difficult to determine cap rates in the life science sector due to the disparity between market rents and current in-place rents. For instance, in San Diego's Torrey Pines area a couple of months ago, rents were nearly aligned with the market, which made the cap rate a more accurate reflection of valuation. In that instance, the cap rate was in the low 5s, reflecting a prime submarket, a new building, and a creditworthy tenant. Therefore, if you're categorizing properties, this one would definitely qualify as an A+ example. I would consider this the lower end of the spectrum for life science properties.

Michael Griffin, Analyst

Got you. That's helpful. And then maybe could you add some commentary around supply, particularly in South San Fran, where I think we've seen kind of elevated relative to the other core markets. And how might your competitive set compare to market supply overall?

Peter Scott, CFO

Yes. Maybe I'll just touch on supply for a second, Griff, because it is a good question, and I'm going to repeat a statement that we've been saying for a while and others have been saying as well, but not all new supply is built equally. And we do fully expect the incumbent landlords, which there's not a lot of that out there in the core submarkets to outperform. As we think just big picture, there are a lot of new entrants into the space over the last couple of years, not surprising because it was such an incredible moneymaking subsector in real estate for such a long period of time. But I think a lot of these new entrants, and I think a lot of the very poorly capitalized landlords that we see now, they just fail to underwrite this incumbent risk, and we think a lot of them will struggle. But as we look at each one of our core submarkets, when you look at the headline number that gets quoted by brokers, when we parse through the data, and we have included this in our investor presentation, the competitive supply going back to the fact that I said not all supply is created equal. What we view as competitive, and I think we're probably still conservative in what we include in that bucket as well, it's a very manageable number.

Operator, Operator

The next question comes from the line of Michael Carroll with RBC Capital Markets.

Michael Carroll, Analyst

I wanted to touch on the life science LOIs that you kind of highlighted in the press release. I mean how many of those are true expansionary spaces that could be earmarked to push up overall occupancy levels within the space?

Peter Scott, CFO

Yes. Well, maybe I'll just talk quickly about the overall leasing pipeline, Mike. I think that may be an easier way to answer your question, but our lab leasing pipeline today sits at around 2 million square feet, and all of those LOIs are included within that pipeline. Obviously, we have a pretty high degree of confidence those LOIs are going to turn into leases. But as we look at some of the parsing of that 2 million square feet, I'd say about 70% of that is with existing tenants within the portfolio. And then taking it even a step further, I'd say that probably 50% new lease deals, about 1 million square feet, would be new lease deals within the portfolio. And then the rest would be renewals. So a nice 50-50 split. And if you think about the amount of vacancy that we have within the portfolio across the marquee project, whether it be Vantage or Gateway as well as portside in South San Francisco, 1 million square feet within our pipeline of new lease deals actually matches up quite well with what we have as vacancy for new lease deals.

Michael Carroll, Analyst

And I guess related to that pipeline, how many tenants need to raise funds to kind of takedown that space? Or will any of those tenants decide to delay making decisions just given the increased volatility that we see in the capital markets over the past handful of weeks?

Peter Scott, CFO

Yes. I'd say very few need to raise capital, if any. We wouldn't be having active discussions. In fact, you don't really have a lot of active discussions for deals that are contingent upon capital raising; those discussions tend to happen, at least today, after the capital has been raised. So I'd say that there's really no risk to that within the pipeline.

Michael Carroll, Analyst

Will those tenants postpone their decision-making? Do you think they might wait longer considering the recent changes in the capital markets and the geopolitical situation?

Peter Scott, CFO

No. Because, as I said, I think all those tenants have effectively raised capital if they needed to raise capital. Not all of them need to raise capital. There's some mid-cap and large-cap names in there as well. So I think the answer to that is no, they're not delaying decisions. It does take a little bit longer to get lease deals done today though, specifically as you price out the various TI packages and build-outs.

Michael Carroll, Analyst

Okay. And then just one more question for me. I know there have been issues over the past year where companies wanted to downsize, but their Boards have rejected those moves. Do you know if the Boards have approved the leasing that is currently in the pipeline? And do you think they might end up vetoing some of those transactions or at least delaying them?

Scott Brinker, President & CEO

I mean the pipeline is 30-plus tenants, so we'll refrain from going down the list, but the quality of the discussions today is much higher than it has been in the last two years. So we can't give you certainty on any of the stuff. And certainly, the geopolitical environment doesn't help at the margin, but I don't think it's a driving factor. The bottom line is the pipeline is massively bigger than it ever has been in the last two years, continues to grow, and the quality of the conversations is higher.

Operator, Operator

Next question comes from the line of Wes Golladay with Baird.

Wesley Golladay, Analyst

Just want to follow up on the new lease conversation. Looking at the 1 million square feet, are you seeing any change in demand for first-generation space, any submarket standing out and any kind of categories picking up activity?

Peter Scott, CFO

Yes. I mean I think the part of that I'd like to focus on is the submarkets. We never really exited or I should say we’ve carried outside of the core submarkets that we wanted to focus on. So in San Diego, it's Torrey Pines and Sorrento Mesa. In Boston, it's the Lexington 128 market in West Cambridge and it's really South San Francisco. And what we're actually seeing is a gravitation towards tenants wanting to be in those core submarkets. And I think some of those other submarkets that were not fully proven, irrespective of development done in those, they're going to take a lot longer to lease up if they ever do lease up.

Wesley Golladay, Analyst

Okay. And then when you look at potential distressed opportunities, do you think you'll get any distressed pricing for those? Or is there still a lot of capital allocation in those great submarkets? And how would you look to potentially get involved? Would it be a JV, mezz-lending? Can you elaborate on that?

Scott Brinker, President & CEO

It could be any of the above. It would be very opportunistic, but it would have to be in core submarkets. We really bring something unique to the table, which is our existing footprint, tenant relationships, broker relationships, et cetera. So we'll be very focused on particular submarkets, but we could be more open-minded on deal structure, but it would have to be opportunistic-type pricing.

Operator, Operator

Next question comes from the line of Jim Kammert with Evercore.

James Kammert, Analyst

Just building a little further, if possible, on the lab leasing demand, it sounds like your pipeline is larger, these tenants have funding. Is that translating into any ability for landlords like yourself to kind of hold the economics in terms of TI packages and whatnot? Because if I recall, that was kind of being pushed more and more towards landlords in terms of $150, maybe to $250 and plus. Any comments there? And if you are still being required to pay those, are you able to get an economic return on that and effectively bake it into the rent?

Scott Brinker, President & CEO

Yes. Our re-leasing spread in the first quarter was around 3%. It could vary quarter to quarter. But as we look at our current pipeline, the renewal spreads will be above that level in the aggregate, some higher, some lower, but on average, certainly above the 3% across the portfolio. We still feel like it's in the 5% to 10% range. And at least in recent quarters, the leasing and TI that we're putting into the buildings to drive those rents is very modest, around 5% of rent on renewal leasing and around 10% on new leasing. So those are pretty modest leasing costs across commercial real estate.

James Kammert, Analyst

Right. I'm sorry, I wasn't clear, but I meant like on asset brand new space, weren't landlords being required to put in $250 type of allowance and stuff to make the deal happen? Or am I mistaken?

Scott Brinker, President & CEO

Yes. So for new development, that's true. I was speaking more to renewal and re-leasing spreads. But for new development, certainly, there's an expectation of turnkey or closer to it, which we've been talking about for the last year or so that we're actually having more success in the current environment on our second-generation space. It's turnkey in nature, but at a much more modest investment, but lower rent, lower OpEx, and no TI from the tenants. So that's certainly a big part of our leasing pipeline. But we are getting some interest in our development projects as well.

Operator, Operator

Your next question comes from the line of Mike Mueller with JPMorgan.

Michael Mueller, Analyst

Just curious, how do you see tenant retention shaping up for the balance of the year? And where do you think the 96% operating portfolio occupancy could end the year?

Peter Scott, CFO

Yes. Mike, it's Pete. Tenant retention, the headline number was a little bit lower, assuming you're talking just about labs, just because we actually had a subtenant that went direct, and we don't include that in the retention statistics. It was NGM that went direct on one of the Amgen buildings, and they have been a subtenant in that building for years. But the way we report it, we don't include that as the tenant was retained within the building. We report that as a new lease. Therefore, if you did include it as tenant retention, you'd be right around 60%. And I would say that that's probably a pretty good number; lab is always going to be a little bit below what we achieve in outpatient medical, which I think this quarter we put a number out there, we were 84%, which was pretty darn high. So I think the tenant retention number is a little bit misleading and you got to dig into it. And then occupancy...

Scott Brinker, President & CEO

Yes. And then on occupancy, on the 96%, our view is that, that should pick up a little bit. In fact, I know there was a sequential decline from the fourth quarter to the first quarter. That was actually a proactive termination we did at the towers building in South San Francisco, and we've actually already re-leased that space, it just hasn't commenced yet, so we don't include that in the occupancy number until the lease commences. So just if you factor that in alone, we'd expect the occupancy to tick up a little bit as the year progresses.

Operator, Operator

Your next question comes from the line of Michael Stroyeck with Green Street.

Michael Stroyeck, Analyst

Could you just provide some color on the outpatient medical sequential occupancy decline during the quarter and just whether that largely came from legacy DOC or legacy peak portfolios?

Thomas Klaritch, Additional Speaker

Yes. Typically, there is a decline from Q4 to Q1 because many doctors take a break over the holiday season, and once things calm down after the start of the new year, they begin to schedule again. This is quite common. I wouldn’t attribute this to legacy peak or legacy dock.

Michael Stroyeck, Analyst

Got it. So I guess nothing really stands out in terms of like tenant credit, asset quality or anything else, just normal seasonality?

Thomas Klaritch, Additional Speaker

Just normal rhythm during the year.

Michael Stroyeck, Analyst

Got it. Okay. And then maybe following up on the Poway disposition discussion, can you just help us understand how much of your portfolio is similar to these assets in terms of it not necessarily being traditional life science properties?

Scott Brinker, President & CEO

That was really it. I mean we have like the land bank and conversions in West Cambridge, where we'll eventually tear buildings down and build by science. But in terms of the stabilized assets, that's it.

Operator, Operator

Next question comes from the line of Vikram Malhotra with Mizuho.

Vikram Malhotra, Analyst

You've discussed the life sciences leasing pipeline extensively, but could you provide an update or some insights on the watch list? Given the amount raised in capital, I expect it to be lower, but could you share any figures or details on what's included in the guidance for the watch list?

Peter Scott, CFO

Yes. Vik, it's Pete here. I think you've done a very nice job actually in your research talking about this. And what's happening is actually following suit with what's staying. The strong capital raising is certainly causing us to have a much lower tenant monitoring list. No, our monitoring list would be a tenant that's got less than 12 months of cash runway. And if you just want to put percentages on that, I'd say that list today is 50% of the size of what it was a year ago, continues to trend in the right direction. So it's down considerably. And the other thing I would just mention, we said this before, even in the best of lab markets, you're always going to have a couple of tenants. We've got 200 tenants. You're always going to have a couple of tenants that you're paying close attention to because it really comes down to the science and the success of the science and not necessarily always about the capital markets and ability to raise capital.

Vikram Malhotra, Analyst

Okay. That's helpful. Just a moment, I'm curious about the programmatic deal you had with HCA regarding MOBs, which has been quite successful. With the combined company and the physicians, is there a chance of a similar deal with another system? Or is it that, given the current capital environment, even hospital systems are holding off on development?

John Thomas, Additional Speaker

Vikram, it's JT. We have many long-standing relationships throughout our portfolio. We maintain a consistent pipeline with several health systems across different states. All of these are highly pre-leased outpatient services that offer better margins and are needed to expand into new markets for improving access to care. This approach is quite systematic and requires the right price and market conditions for us to move forward, but we experience a steady stream of off-market relationship business.

Vikram Malhotra, Analyst

And then just one more, if I may. Just a clarification. I think on the medical office rent spreads, there was a 500,000-plus-square-foot deal that I think you noted was not in there or it would impact rents later on. Can you just elaborate upon that? Like when will that hit the rent spread metrics? And what was that?

Thomas Klaritch, Additional Speaker

Yes, that lease was a master lease with a system in Houston, covering three campuses. I want to highlight that we managed the lease internally, which saved us around $3.5 million in lease commissions. Additionally, there was no tenant improvement contribution, and we reduced our capital liability for 10 years. Overall, it was a favorable deal. Two campuses experienced an increase, while one saw a decrease, which will affect the mark-to-market in July of 2025, with an estimated decline of 6% to 8%. However, this deal is beneficial because we have no capital obligations for 10 years on 600,000 square feet.

Operator, Operator

The next question comes from the line of Tayo Okusanya with Deutsche Bank.

Omotayo Okusanya, Analyst

Congratulations on a strong quarter and a positive outlook. I'd like some clarification on the MOBs and the synergies. When you proceed with the next round of internalization, are the targeted internalizations expected to result in additional synergies beyond the $45 million already identified? Is there a possibility of adding another $20 million to that figure? Additionally, can you discuss the revenue synergies and how they relate to the $20 million additional revenue target you've mentioned?

Thomas Klaritch, Additional Speaker

Yes, Tayo, it's additional, and it's actual net cash revenue that we receive. We are ahead of schedule in internalizing markets across our portfolio, and more will follow. We have planned to internalize most of the markets where we have scale and it makes sense over the next couple of years. This results in continuous net cash to the bottom line year after year.

Peter Scott, CFO

Yes. And then on revenue synergies, we've been pretty clear that, that $60 million run rate does not include revenue synergies, so that could be some upside, whether that's through better lease execution, better retention, better lease rates, so on and so forth, that would be upside. I think it's a little challenging to articulate to go through what we think that is, but we certainly think that there are revenue synergies out there for us to get.

Operator, Operator

I will now turn the call back over to Scott Brinker for closing remarks. Please go ahead.

Scott Brinker, President & CEO

Yes. Thanks for joining us, everyone. Good momentum here. Happy to talk about it today and look forward to seeing you in the coming weeks and months. Take care.

Operator, Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.