Healthcare Realty Trust Inc Q1 FY2020 Earnings Call

Good morning. Welcome to Healthcare Realty Trust's first quarter financial results. Please note, this event is being recorded. I would now like to turn the conference over to Todd Meredith. Please go ahead.

Thank you, Kate. Joining me on the call this morning are Carla Baca, Bethany Mancini, Rob Hull, and Chris Douglas. Ms. Baca, if you would read the disclaimer.

Except for the historical information contained within, the matters discussed on this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in a Form 10-K filed with the SEC for the year ended December 31, 2019, and in subsequently filed Form 10-Q. These forward-looking statements represent the Company's judgment as of the date of this call. The Company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures such as funds from operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FAD, net operating income, NOI, EBITDA, and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the Company's earnings press release for the first quarter ended March 31, 2020. The Company's earnings press release, supplemental information, forms 10-Q and 10-K are available on the Company's website. Todd?

Thank you, Carla. Before jumping into business, we would first like to acknowledge those who face difficult times due to COVID-19 or may have lost someone to the disease. We offer our sincere gratitude to first responders and healthcare providers. I know many of you on the call this morning are in hotspots such as New York City, and we hope that you and your families are safe and doing well. On a brighter note, we're encouraged by what we've seen recently. Governors and mayors are prioritizing elective medical procedures in Phase 1 of the reopening plans. Timing will vary, but elective procedures are already restarting in most markets. At Healthcare Realty, 88% of our properties are located on or adjacent to campus. During COVID-19, we've been working even more closely with our hospital partners to ensure protocols and facilities are safe for providers and patients. For example, we've helped hospitals create screening areas on-campus, so building visitors can be screened for symptoms. We also have 15 COVID-19 testing sites at our properties. Here in Nashville, we're working with hospital administrators to transform our parking lot into a drive-through site for patients to be tested before their scheduled procedures. It's worth noting that 100% of our properties have remained open throughout this crisis. Nine out of ten of our tenants have continued to provide patients with essential care in their offices despite significant declines in patient volume. Many tenants who closed temporarily have reopened or will in the coming weeks. About half of our space is leased to smaller independent physician practices, the lifeblood of our hospital partners. We took an early position to help these practices understand the availability of financial assistance programs, from federal grants and loans to our own rent deferral program. We are reviewing and granting deferrals one month at a time, knowing that circumstances are changing rapidly. April rent collection was successful with 89% collected, and we've been able to help over 400 smaller tenants with some form of deferral. So far, May collections look to be a bit stronger than April, although it's still too early to know the final outcome. We are confident our deferral program will help our smaller independent practices pull through this pandemic, recover more quickly, and be stronger in the long run. Many of these tenants are already ramping up routine care and procedures and plan to pay back deferred rent in the second half of the year as they address pent-up demand. Given the average physician generates $2.4 million in annual hospital revenue, this will greatly benefit our hospital partners who make up the other half of our space. These are mostly large, investment-grade health systems with deep financial footing and community ties. New leasing was inevitably slower in April with prospect tours at half of our normal pace. We have been pleased to see tours begin to pick up in the last two weeks. We expect tenant retention to remain high, potentially higher than usual, as providers focus on rebuilding their patient volume. During this time of uncertainty and even as the recovery begins, we're not asking tenants to make long-term leasing decisions. The intrinsic value of our real estate gives us confidence with short-term renewals. We are encouraged by the increased use and reimbursement of telemedicine during this pandemic, allowing providers to stay connected with their patients. Going forward, we expect providers to incorporate telemedicine into their daily routines in their medical office space. Select providers can boost productivity and revenue by handling a higher portion of their low-acuity care through telemedicine and increasing their capacity for in-office higher acuity care. That equates to more revenue per square foot of office space. Looking ahead, outpatient facilities will become increasingly critical as patients and providers seek to shift more care to the safest and lowest-cost setting. Even during the pandemic, many of our health system partners have continued to plan for outpatient expansion. Healthcare Realty is well positioned to take advantage of rising demand for outpatient facilities with a strong pipeline of acquisitions and developments. We look forward to sharing progress on this front and the resiliency and strength of our healthcare tenants as the recovery unfolds in the quarters ahead. In closing, we're deeply grateful for the doctors, nurses, hospitals, and patients we serve every day in our facilities. Our property management team and, in particular, our 90 maintenance engineers have been a daily presence, keeping our properties open, clean, and running smoothly throughout this pandemic. Now I'll turn it over to Ms. Mancini for some additional information on our COVID response and healthcare trends. Bethany?

Thank you. Healthcare Realty's long-standing health system relationships have proven invaluable during the COVID-19 pandemic. We have been able to support both hospital and physician tenants. From mid-March to April, our tenants were compelled to limit elective cases and office visits to allow for inpatient bed and ICU capacity. By mid-April, our property managers reported a trough in building foot traffic and maintenance orders, ranging from third to half of normal activity levels. Signs of improvement, though, over the past few weeks. Nearly 90% of our tenants remained open across primary and specialty care with their staff in place and have continued to meet the essential needs of their patients. Where possible, providers have transitioned lower acuity clinical needs to telehealth and are maintaining communication with patients as they ramp up elective care and office visits. Throughout COVID-19, HHS has issued regulatory updates in an effort to provide sweeping flexibility and support to the U.S. healthcare system. They have lifted constraints and eased federal rules on a variety of Medicare policies affecting providers. HHS has offered assurance that any healthcare provider will be considered eligible for federal relief who has cared for COVID patients or limited services for COVID capacity, making virtually every provider eligible for assistance. Our tenants began receiving federal relief funds under the CARES Act as early as April 10. The CARES Act provides grants, loans, and higher Medicare rates to healthcare providers. In total, HHS has $175 billion in healthcare stimulus funding. The first $50 billion, slated for general hospital and physician relief, is estimated to equate to one to two months of lost cash flow from the impact of COVID-19 on the average provider. Another $50 billion will be distributed for COVID-specific relief to hotspots, rural areas, and uninsured care. The remaining $75 billion has yet to be allocated. HHS has distributed more than $100 billion in Medicare loans under the expanded Accelerated and Advance Payment Program. Analysts have estimated this equates to an additional two to three months of lost cash flow to be repaid by year-end at zero interest. Many of our non-hospital tenants, primarily small independent physician practices, have also qualified for PPP forgivable SBA loans, equivalent to generally two months of payroll, rent, and utilities. Hospitals critically depend on these physicians to generate revenue even more during this recovery phase. Our health system partners are actively engaged with our medical office tenants to ramp up elective outpatient care as quickly and safely as possible. Elective procedures were closed an average of 34 days in HR's top markets and began reopening by the end of April. Different from discretionary services, elective care is essential, just planned in advance. Over time, elective care becomes more urgent the longer the wait. Our tenants are preparing for an increased caseload from delayed elective care, and our property management teams are working with them to plan for potentially longer workday hours and safety precautions for their most vulnerable patients. The ability to recapture pent-up demand should bolster HR's tenants. In contrast to many non-healthcare businesses that may operate at limited capacity for a prolonged time, HR's tenants comprise a greater proportion of essential and critical services, which are accelerating their return to more typical operations. Higher acuity outpatient services also require more in-office care. We do not anticipate telemedicine will displace elective or in-office visits and outpatient procedures. Telemedicine has advanced quickly over the past two months and proven it can play an increasingly profitable role for physicians in allowing more efficient, time-saving strategies to manage lower acuity services. Providers now have the ability to schedule reimbursable telemed visits for follow-up to operative care, routine checks, prescription refills, and delivering test results. Previously, these were often unreimbursed patient phone calls. We anticipate that the cost savings and better revenue generated for lower acuity care will serve an additive role within the physician's office as providers meet greater healthcare demand from an aging population. Healthcare Realty is committed now more than ever to owning outpatient facilities that are integrated with the clinical missions of strong health systems, and we are honored to play a role in our communities as we work together to safely reopen needed healthcare services. Now I'll turn it over to Rob for a review of our investment activity. Rob?

Thank you, Bethany. Healthcare Realty's investment activity in the first quarter was strong. Although the transaction market has slowed as it digests COVID-19's impact, our team continues to cultivate a robust pipeline, positioning us for a return to investing as market conditions improve. In the first quarter, we purchased seven buildings for $102 million at a blended cap rate of 5.8%. The properties are located in Los Angeles, Atlanta, Raleigh, Colorado Springs, and Denver. What I really like is that they are associated with leading health systems in dense, attractive growth markets where we have been successfully investing for years. All of these properties were sourced and closed prior to the pandemic. More recently, a number of heavily brokered deals have been delayed indefinitely or pulled from the market. In contrast, we source most of our acquisitions through our internal process, which has created advantages for us as we navigate COVID-19. We are in direct contact with many sellers in our pipeline, which facilitates our ability to extend inspection periods and transaction timelines. This gives us the opportunity to monitor the operational and financial performance of the tenants over multiple rent cycles before proceeding. We've revised our acquisition guidance for the year to reflect not only the delay in timing but also the potential of our pipeline when market conditions improve. At our two development projects underway, we have remained largely on schedule even as hospital leadership has shifted its focus to the coronavirus during recent months. In Memphis, the redevelopment of a 111,000-square-foot medical office building is moving forward. Leasing continues to climb. In April, Baptist Memorial Hospital signed lease amendments for additional space in the building that increased it to 90%. Further commitments recently made by several other existing tenants should move leasing to over 95%. In Seattle, we completed our development of UW Medicine's Valley Medical Center campus. More importantly, on February 1, a lease for a 30,000-square-foot surgery center commenced. On May 1, the hospital's 61,000-square-foot cancer center began paying rent. The hospital continues to evaluate its need for more space, and leasing discussions with a third-party women's group and a behavioral health provider are active. Several of our prospective developments remain active such as Nashville, Charlotte, and Memphis. These projects, sourced from our embedded pipeline, are supported by expansion plans at hospitals that are part of strong health systems. Recent discussions with our health system partners indicate that each opportunity remains integral to their growth plans. Once we are on the other side of the pandemic, we believe these developments will move forward. I am pleased with our team's ability to maintain and expand the quality investment pipeline despite disruptions in the market. Our direct sourcing channels, along with our long-standing hospital relationships, have positioned us well to benefit from what we see as another push in demand for outpatient services. Now I will turn it over to Chris to discuss financial and operational performance for the quarter.

Thanks, Rob. First quarter results were positive, highlighted by strong FFO growth and improved liquidity. After briefly commenting on quarterly results, I will focus on COVID-19's impact on our portfolio and our subsequent response. Normalized FFO in the first quarter was $54.5 million, up 12% over the first quarter of 2019. FFO per share in the quarter was $0.41, increasing 4.4% over the first quarter of last year. Trailing 12-month NOI was consistent with expectations at 2.6% for multi-tenant and 2.4% for total same store. Multi-tenant results were curbed slightly by higher-than-average expense growth. This was partially driven by the difficult comparison to first quarter 2019 when operating expense growth was less than 1%. In addition, the first quarter was impacted by $600,000 of expense true-ups primarily related to property taxes. Much of the expense true-ups were recouped in operating expense reimbursements, evidenced by the 3.5% growth in revenue per occupied square foot in the first quarter. We expect operating expenses in the second quarter to be more in line with our historical norms of 2% to 2.5%. Trailing 12-month multi-tenant revenue increased 2.6% or 2.8% per square foot, offsetting the above-average expense growth. Solid leasing activity included tenant retention of 84% and average cash leasing spreads of 4.4%. During the quarter, we took several steps to extend our debt maturity schedule and increase liquidity. On March 4th, we issued $300 million of unsecured bonds at a 2.4% coupon. We also extended the delay draw at the end of May for our $150 million 2026 term loan. As a result, at March 31, we had $738 million of liquidity with less than $50 million of debt maturities through 2022. Shifting to COVID-specific issues. The response was swift and significant from Washington with numerous programs to support the healthcare system. At the same time, we proactively worked with our tenants to ensure they would weather the impact of shelter-in-place orders and be in a position to thrive as restrictions lift. In March, we rolled out materials to educate our tenants on various COVID-19 financial resources. In particular, we highlighted the Payroll Protection Program, given that we have over 2000 small independent physician practice tenants. The PPP loans through the SBA include forgiveness of funds used for payroll as well as rent and utility expenses. In addition, we created a rent deferral and repayment application reviewed on a case-by-case basis with focus primarily on these small independent physician practices. We processed over 500 deferral requests for April and provided deferral agreements to over 400 tenants, representing 7% of total rent. Individual deferrals range from 50% to 100% of the tenant's April rent with repayment in monthly installments in the second half of the year. The average deferral tenant size was 3400 square feet compared to the 4400 square feet average for our portfolio, highlighting how most requests came from smaller independent groups. It is still early, but May deferral requests are running in line with what we saw for April at this point in the cycle. A critical number I know everyone is focused on is April rent collections of 89%. This is better than what we projected in our April 6 business update. The 89%, combined with the 7% of deferral agreements, accounts for 96% of April rent. The remaining 4% in April accounts receivable. For context, our historical current period accounts receivable has averaged 4% to 9%, which is typically collected within the following 30 to 60 days. This strong collectibility is evidenced by our bad debt expense, which averaged less than $100,000 annually over the last two years. We analyzed our deferral requests to determine if there were any consistent themes. We saw that deferrals were highly correlated to non-hospital tenancy as well as specialties with more elective procedures such as dentistry and plastic surgery. After controlling for these two factors, we did not see meaningful correlation between on versus off-campus buildings or geography. I point you to Pages 5 and 6 of our COVID-19 update for more detail on this analysis. Our portfolio, composed of a diversified mix of tenants associated primarily with the country's highest credit-rated not-for-profit health systems, is especially poised to perform well. The work we have done over the past 10 to 15 years to enhance the quality of our portfolio, combined with our ample liquidity, positions us well to overcome the challenges facing the broader economy and deliver safe and attractive risk-adjusted returns to our investors. Todd?

Thank you, Kris. Before we go to questions, I'll just mention to everyone that we're practicing social distancing here, and we'll do our best to not interrupt each other. Operator, with that, we're prepared to begin the question-and-answer period.

We will now begin the question-and-answer session. Our first question is from Jordan Sadler from KeyBanc Capital.

Kris, specifically in your prepared remarks, you touched on May rent. I think you said deferral requests were running in line. I wanted to just clarify and ask if collections are also running in line with April.

Yes. Actually, collections are running slightly above what we saw in April. So we're doing a little bit better than we saw last month on collections. And then on deferrals, as you mentioned, it's pretty close to what we were seeing in April. It's still early in the cycle, but encouraging signs, nonetheless.

I suspect that may be a function of some of the openings that are referenced in your slides. Can you speak to, maybe, Todd, what you're sort of seeing in early days in terms of utilization, especially in the places that have been open already a week or two and how those facilities have come back online?

Sure. Jordan, you're right. A lot of places, especially the elective procedures, are beginning to ramp up. So we've been really dialoguing with all of our property management folks across the country and monitoring that weekly to sort of see what anecdotally or what they're observing in the buildings. Also, we look at maintenance orders, so the number of maintenance orders relative to historical volumes is a pretty strong correlation. We saw probably in mid-April volume on average, and this is just on average, but it sort of corresponds with the maintenance orders, probably 60% to 70% reduction in activity in the buildings across the board. We began to see that lift almost two weeks ago now. So we've definitely seen that uptick where you're starting to cross 50% in many cases, even more than that in some others. Anecdotally, certainly, even locally, I know we, one of our directors of real estate was talking with some providers in the building, and they were excited that they were back to five days a week in their work schedule. So definitely seeing a lot of that. As I mentioned, we're working with some hospitals to figure out the logistics of how we're going to not only screen folks but move to the next recovery phase, which is how do we help them screen for procedures? And how do we, as the buildings get more full, create the proper protocol, social distancing cues, and safety measures? So all of that is beginning to feel very real, and we're seeing it, as I said, in the maintenance orders. They're definitely back up for sure.

And I'll just add to that, Todd, that, and just to clarify on utilization, all of our buildings were open. And nine out of ten of our tenants remained seeing patients inside of their suites, did not even temporarily shut their doors. But obviously, it reduced volumes. And so that was driving those work orders. We're starting to see those volumes ramp back up, but all of our buildings did remain open, and a super majority of our tenants continued to use their space, but obviously just at a lower rate.

Just to come back to one of the comments there on screening at your facilities. Is it your perception that each of your facilities are screening for COVID patients prior to letting folks into either doctor suites or offices?

We're not necessarily taking a one-size-fits-all approach to it. So I can't say it's 100%. It's really being driven largely by that heavy coordination with hospitals, but also just the tenants in the building. A lot of tenants are proactively looking to do that. Whether it's coordinated, whether it's sort of a central screening for every visitor in the building or it's specific to a suite, we're allowing that to work case by case. So it's definitely, we're not trying to be healthcare providers. We are trying to be facilitators of what our tenants want to do. It's largely driven by the hospitals that are key tenants in our buildings. Also, we work with the hospitals there.

And Jordan, I would add to that it really, when you use the word screening, there's a continuum there as well. All of our buildings have signage up that if you have symptoms, fever, etc., you were to contact your healthcare provider before entering the building. Some of the buildings, we're also then going through screening to look for and ask about any symptoms you may have. It continues all the way on to actual testing. So you may have testing that is going on in the building or potentially out in the parking lot before someone would be entering the building for a procedure. Typically, that testing is going to be done a day or two ahead, depending on how rapidly they can get those tests back. We are certainly putting in place protocols to limit exposure, but the extent of screening to testing kind of goes across a continuum.

Our next question is from Nick Joseph from Citi.

How long do you expect it to take to work through the pent-up demand for these nonessential medical procedures to get back to more of a normal monthly run rate?

Obviously, Nick, it is a little challenging to know that. But I think as everybody would like to do, we make our best educated guesses at that. Based on the feedback we get from a lot of conversations, we do get a lot of feedback through the deferral program. We're asking a lot of questions in those applications as well as just the conversations we're having with our local staff. Our view is generally that May is clearly going to be a month of transition. That's really ramping up but probably not all the way back in a lot of cases. I think it's going to take through June easily to really get back to somewhat more normal levels. Hopefully, we'll roll into the beginning of the third quarter in July looking a lot more like normal. Obviously, that remains to be seen. Looking at the feedback, it looks like there will be a lot of pent-up demand being addressed in the second half of the year. Obviously, it will vary a bit by location, specialty, and how different providers choose to ramp up and so forth. So it's encouraging right now that it looks like it could be largely in the second half, but it's a month-by-month evaluation.

Thank you.

Our next question is from John Kim from BMO Capital. Go ahead.

Good morning. Todd, in your prepared remarks, you mentioned the increased use of telehealth as one of the near-term impacts of COVID-19. I was wondering if there were any other ramifications that you foresee, whether it’s increased demand, for instance, for off-campus medical office buildings as some patients have become more reluctant to go to hospitals?

We certainly don't expect that. I think as you would imagine, the nature of our on-campus medical office buildings tends to skew towards higher acuity specialists, which is less optional. While we think of elective as being optional, it's really not. When it comes to serious issues like cancer or cardiology, people ultimately trust their physician. They may be hesitant, but if their physician advises it's safe, they will come in. Regarding deferrals and telemedicine, we have not seen a distinction between the physician aspect of that on- or off-campus. Unfortunately, this pandemic has been indiscriminate, impacting everyone.

Okay. And on the increased use of short-term renewals that you're anticipating or offering, can you provide some color on what the economics of those look like? Are these more month-to-month or one year out and flat rents to what they were paying before as far as any free rent period offered?

Yes. On the renewals, as Todd mentioned in the prepared remarks, we're not asking people to make long-term decisions while they're trying to handle short-term uncertainty. We are comfortable with doing six-month or maybe even a year renewal, allowing people to see the rebound and get comfortable making longer-term commitments. Our expectation is probably more in that zero to three percent range for cash leasing spreads, not looking to do a significant mark-to-market at that point. We’ll take the current situation or the current growth that's embedded in the lease and return to the longer-term discussion. One of the advantages is that we don’t anticipate needing to spend any capital associated with those short-term renewals.

Do you think this will have a near-term positive impact on same-store growth or more of a neutral impact?

No. On same-store in our guidance, we assume that it would be down slightly, primarily due to expectations for new leasing. There can be a lag of about six months between when tours commence and when someone actually starts leasing. As a result of that, we’re looking at occupancy that is flat to maybe slightly down. This could mean a bit of slowdown on same-store growth. However, we are still looking at a little over two percent growth, still solid growth overall.

Our next question is from Rich Anderson from SMBC.

So Kris, to you, the 4% in AR that you went through, would that be correctly described as an abatement or forgiveness that you offered? Or are people that simply didn't communicate an interest in a deferral plan and you haven't been able to track down? I'm just curious if you can give the cadence of that 4% of the April.

Yes. Rich, it's not abatement. It's more of just pieces that have been uncollected as of yet. Each month, you'll have a piece of that for various reasons. Many times, these short pay balances relate to operating expense billings, after-hour billings, etc. A large portion of this is a balance that's outstanding. As those are cleared up over the next 30 to 60 days, they get paid. That's been our historical experience over the years. We're reaching out to all of our tenants to understand whether we need to have a discussion regarding a deferral. Nothing at this point seems out of the ordinary.

Okay. So when it was 9%?

I would have to check back, but our average usually ends up being about 5%.

Okay. I didn't know if there was any relevance to that number. Okay. When you're kind of going through this and thinking about next quarter, I wonder how much of an effort will be put into really determining whether a bad debt reserve is needed, whether or not you'll have to move to cash basis versus GAAP. Are all these moving parts left to work through? Or do you not think that much accounting change will be necessary?

Yes. We're still working through determining exactly how we'll handle that. Obviously, we will take collectibility into account as it relates to bad debt. The FASB has provided some relief in lease accounting in terms of how to account for these deferrals. We are analyzing both methods, determining which is best for us. Ultimately, we expect that these deferral amounts will be repaid by year-end, so regardless of which method you use, the results should be similar.

Okay. Bethany went through some interesting information about different stimulus programs and how that equates to months of business activity or rent. I'm curious if you have a sense of how much smaller physician practices, which make up half of your business, have received and what that equates to in terms of months? Have you done that math?

We certainly have, Rich. Most providers received money from the Medicare allocations. One to two months of cash flow seems to be fitting for our physician tenants. The PPP would apply to many of our physician tenants as well. There’s a significant amount of relief provided, but things will still be tight for many of the physician practices. Our deferrals will help that as well, but overall, one to two months has been helpful.

Okay. Last one for me to Rob. It was mentioned about pent-up demand for elective surgeries and how you're monitoring that as it relates to external growth and getting in front of it to possibly do deals pre that activity, leading to arbitrage. Is it too soon to know if you could get a decent deal at a higher cap rate than normal?

I think it's too soon to know whether there's going to be a real impact on pricing. We’re getting longer inspection periods and closing timelines, monitoring the health of tenants over multiple rent cycles. We'll determine at that point whether an adjustment in price is needed as we gather more clarity with patients and income.

Thanks, Rich. I would just add to Rob's comments that some opportunities also come from things you don't want to be involved with. Generally, we're not seeing reasons for cap rates to change dramatically unless there’s a distressed situation. There could be some private capital wishing to move in right now, so we’re having conversations, but we don't see a big move up at this point. There's a lot of forces suggesting stability in cap rates unless circumstances change dramatically.

Our next question is from Daniel Bernstein from Capital One.

I really just have one question, and that's regarding the design of the facilities. Do you see any, and maybe this is early, but any potential design changes or trends emerging post-COVID? Anything near-term that might require CapEx in your facilities?

Dan, I think it is too early. People will be thinking through that in terms of tenants planning new space. We are not seeing a significant change other than temporary measures for testing. We’ve contemplated a shift within the suites to provide telemedicine capabilities. Private offices may return slightly, but everything remains to be seen. Overall, we have not identified any significant impact at this point.

No delays in the current development pipeline, thinking about those design trends, something for future developments that you haven't started?

Correct. It hasn't shown up yet.

Okay. And then in terms of strategy, do you see a shift towards off-campus assets or non-affiliated assets? Are you going to maintain your current strategy of more on-campus, affiliated properties?

I don't think we need to shift. As Chris described, we did see better outcomes on-campus, but it is not solely because they are on-campus. We have a higher mix of hospital tenancy, and there’s safety in these larger, financially backed entities. We do not see a significant change in our strategy; we are still interested in off-campus but selective about it.

Our next question is from Connor Siversky from Berenberg.

I appreciate the color you provided in the business update presentation. A quick one on lease expirations. You seem to have taken out a sizable chunk of 2020 maturities in Q1. How are those conversations progressing for the remainder? Any color on potential renewal spreads through the end of the year?

Yes. We made good progress in Q1 across our expirations. We expect to maintain strong tenant retention. We updated guidance on our components of expected FFO. Cash leasing spreads may come down. We may be doing more short-term renewals rather than three- to five-year agreements, typically. Our expectation is more in the zero to three percent range for cash leasing spreads, depending on the duration.

I noted that same-store property expenses increased significantly in Q1. Was this due to any measures related specifically to COVID, or is there something else driving that increase?

Nothing related to COVID had a significant impact on revenue or expenses in Q1. The higher expense growth is primarily due to difficult comps compared to Q1 2019 and about $600,000 in expense true-ups related to property taxes. Going forward, expenses should align more closely with our historical norms.

Our next question is from Lukas Hartwich from Green Street Advisors. Go ahead.

Thanks. The occupancy on the LA acquisition seems a little low. Is there any leasing upside there?

Yes, there is some leasing opportunity there, and we are actively discussing with potential tenants. We think there's a bit of upside there.

Is that factored into the cap rate, the 5.3% cap rate? Or would that be incremental?

That would be incremental, over and above the 5.3%.

Okay. And then I know it's hard to know what happened to asset values because it's still early. If you all were underwriting acquisitions today, how would you adjust your return expectations given the current environment?

Our sense is that we’re not seeing any change in cap rates. On the underwriting side, we’re seeking longer inspection periods and closing timelines, allowing us to monitor tenant health over multiple rent cycles. We'll decide if we need to adjust the price based on that monitoring.

And I would add that quite a lot of private capital built up before this pandemic wanted to move into the medical office buildings sector, creating competition. We are looking for clarity in the pricing, but we believe that cap rates are largely stable unless there's a significant distress, which should be careful about.

Our next question is from Tayo Okusanya from Mizuho. Go ahead.

Good afternoon. Also let me add my thanks for all the disclosure and information. As we start to think three to six months out, could you talk about how you think about hospital profitability, given the high unemployment rates? What implications could that have for demand for medical office buildings or even for the ability to pay rent?

Certainly, our history does not suggest, and even the month of April does not imply, major issues with hospital collections due to financial crises. While there may be more uninsured patients due to unemployment, we don't expect this to be a problem for rent collections. Hospitals may undergo some margin pressure due to increased uninsured patients, but we seek assurance in outpatient care. That’s becoming a bright spot as health systems remain engaged in expansion plans.

Got you. So just at this point, when you think about your business, what are you most worried about? Is it the second wave of the pandemic? I'm curious what your primary concerns are.

Certainly, that's a big unknown we're all facing. It looks favorable right now, but there's a good chance we may need to revisit steps if cases surge. Healthcare is fundamental; it's need-driven, and our providers are under pressure, but we have faith that concerns regarding guidelines will aid us in maintaining service levels even during possible surges.

Got you. Lastly, regarding the dividend policy going forward, how should we think about that, especially with a decent amount of rent deferrals?

We don't see anything at this point that would cause us to rethink our dividend policy. While growth is likely not something we will pursue right now, we believe our cash flow and coverage will be solid, and our dividend remains secure.

And our last question is from Mike Mueller from JP Morgan.

I didn't realize I was in the queue again. So I don't have a question.

This concludes our question-and-answer session. I would now like to turn the conference back over to Todd Meredith for closing remarks.

Thank you, Kate, and thank you, everybody, for listening this morning. We hope everybody stays safe and hopefully can start to do a few more normal things very carefully and social distancing and so forth. We thank everybody for joining us today, and we will be around if you have any additional questions. Have a great day. Thank you.

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