Healthcare Realty Trust Inc Q2 FY2020 Earnings Call

Good day, and welcome to the Healthcare Realty Trust Second Quarter Financial Results Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Todd Meredith. Please go ahead, sir.

Thank you, Chuck. Joining me on the call this morning are Carla Baca, Bethany Mancini, Rob Hull and Kris Douglas. Ms. Baca, if you could now read the disclaimer.

Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the 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 second quarter ended June 30, 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. First, I’d like to offer our best wishes to everyone as we approach five months since the start of the pandemic. We are encouraged by the positive signs of recovery in the healthcare space and grateful for those who’ve worked tirelessly throughout this pandemic, including our tenants and partners. They have demonstrated extraordinary resilience, well beyond what we anticipated. We expect we will continue to contend with COVID-19 as it ebbs and flows. What’s encouraging is the progress of better treatments and promising vaccine developments. Moderna, Pfizer, AstraZeneca and many others are reporting positive results from fast-track clinical trials. Many expect a successful vaccine in 2020 with widespread availability next year. Public health officials are also taking a much more targeted approach to addressing hot spots, which is allowing healthcare services to remain open. Across the country, we are seeing physicians ramp up their volumes quickly, now approaching pre-COVID levels. They are experiencing heightened demand for delayed care. Providers are balancing the delivery of much-needed care with safety precautions, and they have gained valuable experience in treating their COVID patients. As a result, we are not seeing the use of lengthy or widespread bans on elective procedures. Several publicly traded national healthcare companies, including HCA, Surgery Partners and Tenet, have recently reported steady improvements in volumes throughout May, June and July. Likewise, we have seen tenant utilization in our buildings rebound to nearly 90% of pre-COVID levels. It does vary geographically somewhat from a low of 75% in Washington, D.C. to 100% here in Nashville. Tenant work order requests are now running at pre-COVID levels. And leasing momentum has also rebounded. Tours with prospective tenants, which dipped below 50% of typical volumes in April, are now running well above average. Rent collection stands at 97% for the second quarter as well as July. New deferral requests have fallen to nearly zero in the last 30 days. Over half of deferrals granted during the second quarter were repaid early, which is very encouraging. Forgivable PPP loans kicked in as designed for payroll, rent and utilities. The healthcare sector received more than 12% of all PPP loans, with the biggest recipients being physician offices at more than $8.4 billion. HR’s operating results for the second quarter were steady despite the impact of COVID. Strong cash leasing spreads, high tenant retention and stable contractual rent bumps were positive signs of the resiliency of our tenants and the stability of our portfolio. With tours being well off pace in April and May, occupancy could be marginally softer in the second half of the year. However, with a sharp recovery in June and July, we expect occupancy to strengthen going into 2021. As a result, same-store NOI growth will likely be closer to 2% in 2020 and bounce back toward 3% next year. External growth is still on pace for a solid 2020. The pipeline is strong even after we took extra time to underwrite the financial health of tenants. We’ve increased the top end of our acquisition guidance to be in line with our volume last year and well ahead of our historical average. We have plenty of funding capacity from the Mercy dispositions, cash on hand, forward equity and full availability on our line of credit. We are poised to take advantage of a sizable and growing pipeline. The pandemic has underscored the critical nature of healthcare services even in uncertain times. It has shown that hospitals are the hub of essential care, including high-acuity outpatient services, which drive the stability of our cash flows. Despite the pandemic, we still expect to produce positive FFO per share growth in 2020. Rising secular demand, a strong balance sheet and a robust pipeline position us well to grow safely in the years ahead. Now I’ll turn it over to Ms. Mancini for some additional commentary on healthcare trends. Bethany?

Thank you. The healthcare sector continues to prove its resilience and significance to the U.S. population and economy. After five months of experience with COVID-19, hospitals and physicians are now better equipped with protocols in place and adequate PPE to serve COVID patients. At the same time, providers are managing higher demand from the delay of scheduled care. Second quarter employment growth numbers are showing COVID’s unprecedented impact on jobs in April and May, with promising signs of recovery in the healthcare sector from late May into June and continued positive momentum heading into the third quarter. Notably, the pace of recovery in the ambulatory sector, including physician offices, has doubled that of the broader economy. Healthcare providers are meeting pent-up demand for elective care and the resurgence of strong utilization trends, returning to more normalized levels quickly. HR’s tenants on average are operating near full capacity, and they are better prepared to provide ongoing outpatient care, even in the event of a local surge. Telemedicine served a critical role in April and May for many providers. The easing of its restrictions and higher reimbursement helped sustain patient care and physician practice revenues during the height of the pandemic and the shutdown of non-emergent care. Since then, physician offices in most of our markets have returned to seeing a majority of patients in person. The administration issued an Executive Order earlier this week to review and continue Medicare’s coverage of telehealth services. After which, CMS proposed to permanently allow Medicare providers to use telehealth for evaluation and management services, along with visits for some mental health-related care. Depending on reimbursement and technology and security requirements, we foresee telemedicine allowing our tenants to improve their efficiency in providing lower acuity services. It could spur greater access of rural communities to urban care centers and support providers in general as they meet rising demand for high-acuity care from an aging population. CMS remains active on the regulatory front in pursuing several Medicare cost-saving initiatives. These include hospital pricing transparency, site-neutral payments for off-campus hospital-based outpatient care and the addition of newly covered services in outpatient settings. These initiatives incentivize care in lower-cost settings typically in medical office buildings and ambulatory surgery centers. As we approach the Presidential election, we can expect heated public debate over another round of federal stimulus and COVID-19 relief for healthcare providers. We believe the sector is positioned well, even absent additional legislation, to continue to meet the demands of responding to COVID and deliver the underlying growth in healthcare services our population will need in the quarters to come. The results of the election for both the Presidency and Congress could impact the nation’s mix of health insurance coverage and expansion of Medicare and Medicaid. Regardless of election results, we expect the shift of healthcare delivery will continue toward lower-cost outpatient settings. Now I will turn it over to Rob Hull for an overview of investment activity. Rob?

Thank you, Bethany. Healthcare Realty’s investment activity during the quarter can be characterized as two distinct periods: defense at the outset; and back to offense by the end of the quarter. We started on defense by shoring up liquidity with an agreement to sell two single-tenant net lease properties to St. Louis-based Mercy for $244 million or $633 per square foot. What’s also important is that this transaction represents a meaningful shift out of slower-growing properties, in smaller markets and into attractive growing MSAs with significant opportunities for future investment. Additionally, we took a deeper dive in due diligence for acquisitions rather than terminating contracts and risk losing solid deals because of COVID-19. For example, we doubled the length of inspection periods to monitor the health and stability of these properties. We also conducted extensive tenant interviews over multiple billing cycles. And we analyzed rent collection and deferral requests at buildings under contract, compared it to our own portfolio, and it stacked up really well. These critical steps allowed us to shift to offense as we approach the third quarter. In July, we closed on four MOBs for $83 million. One property marks our first acquisition in the San Diego market, a market where we have identified substantial opportunity for future investment. Another in Los Angeles will benefit from the hospital’s recent affiliation with AA-minus-rated Cedars-Sinai Health System, which will provide an infusion of capital to increase hospital services in this dense market. The last two, located in Atlanta and Seattle, represent additional investment in attractive growth markets on campuses where we own multiple properties. All through the quarter, our team continued to use their deep industry relationships to source deals and build a pipeline even as the volume of marketed transactions declined. We now have ten buildings under six separate contracts or letters of intent for an additional $163 million. These targeted acquisitions are located in six markets where we already have investments. We expect to close these deals by year-end. Along with properties closed in July, we’ll fully reinvest the $244 million of Mercy proceeds. Our renewed confidence to proceed with closings and a growing pipeline are driving the increase in our acquisition guidance, up to $300 million to $375 million for the year. We expect our average cap rate to remain between 5% and 5.8%. The outlook for acquisitions remains positive as healthcare providers continued to experience meaningful improvement in patient visits and procedures. MOB rent rolls are holding up, allowing sellers to return to the market. Although a few buyers are temporarily on the sidelines, cap rates are steady as investor demand is wide and deep with stable cash flows from MOBs. While several sizable portfolios are available, we haven’t found them compelling enough to deviate from our targeted process of investing in one or two buildings at a time. On the development front, we are making steady progress on the $30 million redevelopment project in Memphis. During the course of the pandemic, several tenants expanded their space requirements including the surgery center and a large orthopedic tenant. As a result, the lease percentage has moved up to 94%. During the first quarter of 2021, we expect exterior improvements to be completed and the building’s anchor tenant to take occupancy. The remainder of the suites will take occupancy throughout the second and third quarters of 2021. The pandemic has delayed some development discussions, but hospitals are not abandoning long-term expansion plans. For example, in July, a leading health system in Tacoma announced a $300 million investment in a new bed tower. Next week, here in Nashville, Saint Thomas will break ground on its $300 million expansion. We are planning redevelopments at both of these campuses, and we expect to start these projects soon. I am pleased with our team’s ability to build a solid investment pipeline during these times. Their hard work will lead to the timely reinvestment of proceeds generated from recent sales and positions us well for accretive growth in 2021. Now I will turn it over to Kris to discuss financial and operational performance for the quarter.

Thanks, Rob. Second quarter performance was strong as COVID-related revenue impacts were offset by operating expense controls and G&A reductions. Normalized FFO per share of $0.42 was an increase of 5% over the same period a year ago. Before diving into the specific operating metrics for the quarter, I will touch on rent collection and deferrals. We saw significant sequential improvements in May, June, and July. This was the result of a swift rebound in patient volumes following the end of government-mandated shutdowns early in the quarter. We collected over 99% of second quarter rent, including 2% of deferrals. These deferrals are to be paid back in the second half of the year. For July, deferrals were less than $100,000 of our over $40 million in monthly rent. In addition, over half of deferrals granted in the second quarter were repaid early, signaling how our tenants are getting back to business. Scheduled rent deferral payments for July are tracking well at 88%. While this is promising, it is early in the process, so we took a $730,000 bad debt reserve, representing 25% of outstanding deferrals at quarter end. We will continue to monitor and analyze collections through the balance of the year and adjust reserves accordingly. Now shifting to operating performance. Trailing 12-month same-store NOI grew 1.9%, which was impacted by lockdowns in the quarter in three main ways. First, there was an $800,000 sequential reduction in transient parking income. Parking volumes returned to approximately 80% of pre-pandemic levels by the end of June. Second, $673,000 of the total rent deferral reserve was in the same-store portfolio. Third and most notable was a benefit of $1 million from a reduction in net operating expenses due to lower building traffic in the quarter. The primary reductions were in maintenance and utilities, which each declined over $0.5 million compared to the previous year. As utilization in foot traffic has rebounded in June and July, we expect operating expenses to return to normal third quarter levels, including typical seasonal utilities. But for these three impacts, trailing 12-month same-store growth would have been approximately 20 basis points higher. NOI growth in future periods should be reliably strong, given the multi-tenant leasing metrics this quarter, including retention of 84.6%, average in-place contractual increases of 2.89% and cash leasing spreads of 4.5%. In the quarter, we had 179,000 square feet of new leases take occupancy, led by gains at several reposition and development properties. This level of new leasing exceeded our historical average of approximately 100,000 square feet per quarter. Looking forward, given a slowdown in leasing tours early in the second quarter due to local restrictions, we could see leasing drop below our historical average in the second half of the year. Our same-store guidance reflects the potential for this impact. Moving into 2021, we expect leasing to increase as tours have already rebounded to pre-COVID-19 levels and demand for outpatient space continues to strengthen. Now shifting to liquidity and leverage. Our FAD dividend payout ratio was 84% for the quarter and 93% for the trailing 12 months. We expect full year 2020 to be in the low 90s and net debt-to-EBITDA improve to 5.1x, including the issuance of $33 million of equity through the ATM. In addition, we entered into forward equity contracts for an additional $74 million. These proceeds can be drawn at our election over the next 12 months. We don’t expect to draw any of the forward equity proceeds until 2021, given the substantial liquidity available to fund our growing investment pipeline. Our liquidity includes $44 million of cash at quarter end and $244 million from the Mercy dispositions, which closed last week. Our investment in the Mercy properties resulted in an unlevered IRR of 11.5%, while the reinvestment in multi-tenant MOBs in major MSAs will improve the diversification and growth profile of our portfolio. For example, contractual escalators for the Mercy assets have been running 1.7%, which is more than 100 basis points below our existing portfolio and our acquisition pipeline. The cap rate rotation upon reinvestment will result in a little more than $0.03 of annual dilution. The timing of the reinvestment through the third and fourth quarters will bring forward all of the $0.03-plus into 2020. However, even with this dilution and the COVID-19 impacts discussed earlier, we anticipate positive FFO per share growth in 2020, and we are positioned well for continued FFO per share growth in 2021 and beyond. Todd?

Thank you, Kris. Operator, Chuck, we will be ready to open it up to the question-and-answer period.

And our first question will come from Nick Joseph with Citi. Please go ahead.

Thank you. Appreciate the color on the acquisition pipeline. What’s the typical hit rate on assets that are in negotiation?

Yes. I think if you look at the pipeline, $163 million that we’re looking at right now, they’re within our range that we’ve given, the 5% to 5.8%, probably down in the low to mid-5s is where, on average, those are going to be. Are you, Nick, just...

Yes. I guess I’m more curious on the – yes, the $120 million in negotiation, I mean, would you expect to close on 100% of those? Or what’s typically the fallout for that bucket of potential acquisitions?

Yes. I mean I think if you think about the $120 million, we’ve said that there are some in there that we think might close by the end of the year and then moving into early next. And I would say the cap rates in those buildings are in a similar range to what we have under contracted pipeline. Certainly, it’s early, and we’re in discussions with those sellers. There are some that sometimes may fall out or take longer to close on, but we have a good line of sight on those and are optimistic about the opportunities there.

I would add to that. Maybe, Nick, it’s a little hard to obviously give you a 1 percentage probability, but it’s a range. But I think it’s not 50-50, if that helps you. It’s probably not 100%, as Rob just said, but maybe it’s 70%, 80% at least. The nice thing is, I mean, those are ones that are pretty far along in discussions. There’s clearly a lot of other things not in that number that are a little further out there, maybe not as highly probable. So I think it’s – that number is a strong number, just in general, if you think about productivity going into 2021.

Thanks. That’s helpful. And then you mentioned the portfolios on the market today. What would make you more interested? Is it pricing, is it something specific about the mix of assets within those that would get you more interested in executing on those?

Yes. I’d say that rather than pricing, just the markets and the systems that they’re associated with. The strength of those markets, the opportunities for growth is really a key piece that we look at. And I would also say that the on-adjacent makeup versus the off makeup, typically, what you see is there’s a number of properties – a few properties in there that you really like, but then there’s other properties in there that you really don’t like. And I think that’s where these portfolios that are out there kind of fall into now.

And Nick, I think as we’ve looked at portfolios over the years, we also recognize you can’t always find the perfect portfolio by definition. It really comes down to, is there a high enough proportion of what Rob described as attractive assets that would be worth taking on a few of those things that we don’t like as much? And so we’ve always struggled with that. We obviously think our portfolio reflects a lot of the quality metrics we’re looking for, and we want to improve the average. But if 70%, 80% of the assets really fit, then I think it makes some sense. The medicine-only transaction and the Atlanta transaction three years ago is a great example of that. We certainly looked at the Duke transaction hard and competed for that. I’d throw that in there. But some others like CNL and others, we couldn’t get there.

Thank you.

Our next question will come from Sarah Tan with JPMorgan. Please go ahead.

I’m on for Michael Mueller. Good morning. Just have one question. Could you talk about the acquisition landscape and what cap rates are looking like?

I’m sorry. I didn’t hear the end of your question. Can you repeat that?

I’m sorry. I just wanted to ask, could you discuss the acquisition landscape and what cap rates look like?

Sure. I would say that pricing for acquisitions has remained steady. The cash flows in MOBs have held up remarkably well during this period, and I think that’s a testament to the security and reliability of the asset class. And so you’re seeing, again, continued demand for the product. There have been a few buyers that are temporarily on the sidelines, but we see plenty of capital continuing to participate in the space. And because of that, we just haven’t seen any meaningful movement in cap rates.

The other thing, Rob, I might add to that would be you’ve even seen, really since COVID, a couple of transactions by Welltower that are very supportive of that, that you’ve seen cap rates sort of right in the mid-5s for those portfolios. I think that sort of underscores that 5.5% range for typical MOBs, portfolios is very consistent over the last really couple of years. Occasionally, you see deviations from that more when you get down to specific assets that may drive it towards 5% or less or the other way for lower-quality assets.

Thank you.

Our next question will come from Vikram Malhotra with Morgan Stanley.

Thanks for taking the question. Just first one, you had a nice improvement on the FAD payout, and you highlighted where you think this could kind of end up towards year-end. I’m just wondering how sustainable that level is. Is there any CapEx kind of bump we should expect next year? Or do you think this level is sort of sustainable going forward?

Vikram, obviously, you – Kris, I’ll touch on it, maybe you jump in. But remember, we’re all social distancing. So we aren’t as easily able to – not talk over each other, which I apologize, Kris. But I would say on the dividend, you’re exactly right, Vikram. Kris mentioned low 90s for this year. Certainly, we’re trying to steadily improve that. So we do hope to maintain that level, if not improve it, each year. But as Kris also talked about, we’ve got a lot of leasing strengthening as we go into the later part of this year and into next year. We do expect that what probably benefited us, frankly, in the second quarter and maybe even in the third would be a little less spending on TI because of the slowdown in leasing. We see that probably picking right back up later in the year and into next year. It’s a little early to tell exactly where we’ll be for 2021, but we like the direction generally where we’re headed. We’ll certainly have a better sense of that as we start putting our plans together for 2021 later this year.

Okay. Great. And then just – sorry, go ahead.

I think Todd is right. The only thing I would add to that is just the idea that where we are in terms of our capital other than TI, I don’t see any major shifts there. If we don’t see the continued improvement that we have been seeing in the last several years, it will be tied to that – be tied to absorption, new leasing, which is great for long term in terms of earnings and such but could slow the momentum temporarily in terms of continued driving that payout ratio lower. But long term, we’re certainly moving in the right direction.

Okay. Great. And then just on the – a little bit more color on the pipeline. I know in the past, you’ve alluded to potentially looking a bit more at off-campus. I’m just wondering through COVID, are there – how has that thought process changed? Maybe give us a sense of the pipeline mix between on and off? Also just through COVID, are there any other markets you’re thinking about in terms of new investments or development?

Rob, do you want to touch on maybe the current pipeline and what that might look like, on versus off? And then I can add to it.

Yes. I think that when you look at the current pipeline, the majority of it is on adjacent, but there are a few assets in there that kind of fall into the on-campus category by our definition. Those are kind of similar to what you’ve heard us say in the past, Vikram, about strong markets that are markets where we already have investment. If we are going to go off-campus, that’s where you think we will do that kind of investing, markets that we know and familiar with and investing in off-campus assets that are part of the provider network and lend itself to that relationship.

I would add, Rob, that in terms of just thinking differently post-COVID or now we’re still in COVID, as we look ahead, I don’t see that we would make a tremendous change in the markets that we’re going after. The ones we’ve been working on, building our presence in, still look very attractive to us even with what’s going on now. Obviously, like everyone, we’re going to be watching all the trends. We’re not heavily exposed to certain markets in the Northeast, New York, Boston. Great cities, obviously, but there are some bigger challenges that may come over time with office demand and so forth. Less about healthcare there, but I would say we really like some of the tech job concentration that we see in a lot of the markets we’ve been focused on. Two of the markets that we’ve added, you kind of asked that question about adding markets, we just added San Diego, as Rob pointed out, in the last year. We’ve been adding a bit in Raleigh – the Raleigh-Durham area, which we like as well. Nearly 90% of what we’ve been doing – 80%, 90% of the activity in the last few years has been very focused on our top 15 markets. So it’s a lot of activity in the same markets we’ve been building scale in. Occasionally, reaching out, like I mentioned, in San Diego, Raleigh, some others like that. There’s probably, Rob, four or five other markets we would certainly look at and see some depth in. But we’re definitely leaning towards the markets we’re currently invested in.

Okay. Thank you.

Thank you, Vikram.

Our next question will come from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Thank you. First, I just want to follow up on the pipeline. I’m not sure if I’m overly reading into your commentary, but it sounded like you mentioned a large and growing pipeline. Is there potentially more behind this? Or are there a handful of larger deals that you’re looking at? Because I’m noticing you’ve taken the leverage on a pro forma basis quite low, and I know it’s a challenging environment. So it does make sense. But I’m guessing pro forma leverage with the forward equity and sale of Mercy is probably closer to 4x, correct me if I’m wrong. So kind of curious what you’re teed up for.

Yes. I would say on the pipeline, Jordan, our team is always building and adding to our pipeline. I mean we take the approach of – I think if you look at what we’ve closed on this year, about 80% of that is what we would consider off or lightly marketed deals. So our team is out there constantly developing those relationships. We’ve identified buildings that we want to own. We have dialogue with the sellers or brokers in those markets that we trust and are constantly trying to get those sellers to the table. We think that behind what we’ve laid out here, certainly, there’s more opportunity that we’re working on. I think that’s where we see the growth in the pipeline coming and setting us up well for 2021. So I think that’s why we have the confidence that we do because we see the dialogue that our team is having with these sellers that are sort of behind what we’ve laid out here.

And Jordan, I would add to that. I do think – I think maybe what’s in your question too, is sort of are we preparing for something bigger? I think it’s more about – I mean, in some ways, yes, but it’s not a complete change of stripes for us. I think it’s very much sticking to what Rob just described, really going after and targeting what we want rather than waiting on the marketed deals. That said, of course, we look at the marketed deals. If they measure up, we certainly go after them. It’s not – we certainly are encouraged that we would like to go after some deals if we can, in this situation where we seem to be able to, as you said, have the capital and the resources. But again, we’re going to probably stick to, as you would know us to do, stick to the quality side of things. We’re encouraged by the productivity and the effectiveness that Rob described of sustaining a higher level of acquisition. I think that’s the key, and really recognizing the importance of prudent growth through external growth, in addition to our internal growth to kind of work that algorithm of FFO growth per share.

Is the mix – and I know – I think there was – you just spoke to a question of a similar vein. But is the mix going to skew – continue to skew towards the adjacent-type assets, do you think?

I certainly think we will skew towards on adjacent versus off. But again, we’re okay with off. I think Rob touched on that. We are okay with that. I would say, today, we sit closer to almost 90% on adjacent. We have done a fair bit of adjacent, as you kind of point out. Sometimes what you find is those are the ones that you can go in and target and get – really get those assets more regularly. The on-campus, it’s tough because you’re waiting for those hospitals to let that go typically. We really like the dynamic though on adjacent. I could see the off fluctuating. I think we maybe last year hit around 25% off. So we’re okay with that. It’s still going to skew that way towards on adjacent though.

Okay. And then lastly, like maybe for Kris, on the cap rates. I’ve got the cash cap rate. I’m kind of – you mentioned the escalators on Mercy. Can you give me the GAAP cap rate on that disposition? And then I’m just curious what the escalators and GAAP cap rate look on the acquisitions as well.

Yes. On Mercy, the GAAP and cash were pretty close to the same because we were about at the midpoint of the lease turn. So they’re kind of right on top of each other. In terms of the new acquisitions that we’re looking at, the escalators, as I mentioned, are pretty similar to what our existing portfolio is, call it the 2.8 to 2.9 range in terms of escalators. It varies on the impact of – to GAAP based off of the term that is inside of our acquisitions. In general, we typically say the GAAP adds about 25 to 50 basis points to the cap rate on a GAAP basis in our acquisitions.

Okay. Thanks for clarifying.

Our next question will come from Lukas Hartwich with Green Street Advisors. Please go ahead.

All right. Thanks everyone for your time this morning. This is John on for Lukas. Just a quick one for me. Looking at the improvement in your expectations for the cash re-leasing spreads on the multi-tenant side. What’s behind that optimism? The year-to-date trends are pretty favorable. Just wondering if there’s actually some opportunity for some upside there as well.

Yes. If you really look at the change in our guidance on the cash leasing spreads, we did change it this quarter compared to last, but that really was just kind of bringing it back more in line with what we had seen pre-COVID. Last quarter, we were taking – we didn’t want to be overly aggressive, not having a lot of leasing data in the midst of what was going on. We had taken down our expectations. But as we worked through leases during the quarter and continued our discussions, things have really shown great resilience. Our expectations is that our cash leasing spreads will be able to kind of maintain what we had been seeing previously, which long-term, we say we expect 3% to 4%. So we’re – so far, we’re seeing that those types of metrics are holding up well.

And our next question will come from Rich Anderson with SMBC. Please go ahead.

Thanks, everybody. Good morning. One thing we are not talking about is the risk going forward of reinfection? Many of the states that you traffic in, we’ve seen some uptick. But no talk of sort of a reversal of elective surgery shutdowns and whatnot. Can you discuss that a little bit about how you’re seeing that play out? I mean even though the availability – or states are allowing for elective surgeries, are people really jumping in and doing it? Is there a risk that a month or so from now, we could be having another conversation about shutting it down?

Rich, it’s a very good question. I think we all sort of have that unease going into the fall, I think, collectively, that things can change. We have the flu season coming, and things get worse typically in the winter. So it’s a very good question. I do think – we don’t want to be glib about the optimism because it’s a long road here and maybe the toughest time ahead of us. The good news, I think, as I think Bethany pointed out and I pointed out and we’ve all seen, there’s just been a lot of improvement on treatments and how to deal with this. We all feared obviously in the front end that hospitals would just be totally overwhelmed. Obviously, that was tested in a couple of places including New York. The good news is we came out on the better end of what we all feared. You’re seeing it, as you said, in hot spots. It’s kind of – it’s the hot spots, it’s these fires that kind of come up and then burn out. I hope that continues to be quelled and contained. I think it’s very encouraging what we’re seeing. Even though we might experience some issues, I think we’re encouraged. The public companies that report their surgery numbers have been really incredible. I don’t think there’s a big hesitation to come back and do it. It will just be a matter of the public health officials continue to sort of treat this in a targeted way rather than a blanket way. We think that will be the case.

Okay. My second question and last question is, what is your perspective of how the hospital industry looks after this is all done? I mean would you say the hospital business, not the medical office business per se, but the hospital business is weakened by all of this in the sense that we kind of went in over hospitals to begin with? Maybe this fast-tracks some consolidation or closings that probably or maybe would have happened eventually? I’m just wondering if you think sort of picking your relationships becomes even more important in the aftermath because the hospital industry overall is probably a notch weaker because of everything that happened?

Yes. I think it’s a fair assessment and good commentary. We were having a discussion with our Board earlier this week about that with several health system leaders there on our Board. I think it’s what you said. You’re going to – it’s the classic problem that these crises cause. The strong are going to get stronger, the weak are going to get weaker, and there are different dynamics to that. But in the hospital world, that’s very true. You’re seeing HCA do extremely well coming through this. I think they do a good job of figuring it out. There are a lot of not-for-profit systems that are leaders in their markets. I do think that strength and scale matters. Larger systems versus small independent systems, obviously, more urban versus suburban versus rural is going to be a huge trend. I know the trend of moving into the cities, everyone is questioning a little bit. But I still think those strong population growth centers are going to be where you’re going to see the success. You are correct that picking the right partners will matter more. Being a sharpshooter will continue to be critical for success. I think that’s something we’ve been honing ever since we found that trend to be true from the financial crisis and even before. It’s true. Hospitals probably taken – have clearly taken a hit and were helped a lot by the CARES Act and CMS in general. But I think we are encouraged that the strong ones – I mean this is a demand, need-based business. It’s very much need-based. There’s a huge need for – as I made my comments or remarks, hospitals are proving that they’re so critical, and I think the acuity level at hospitals is only going to continue to climb, and you’re going to see acuity level at outpatient climb, both on and off-campus. It’s a continuum. All those innovations will continue, and it will be a little bit more of a winner versus loser game. I think we’re pretty well positioned to follow that trend.

As related to that response – thanks, Todd, that was great. Do you think the long-awaited monetization of hospital-owned medical offices will be more of a realistic outcome of this, even for stronger hospitals that maybe you’re now taking on more market share, need more technological advances and so on? Is that something that we can finally say?

Not to get religious, but it’s like testing our faith in this theory, right? We’ve got to keep the hope alive, right? We just haven’t seen it is the real answer. It has all the makings to suggest that would be possibly true. We have a very contradicting data point here with the Mercy transaction that we just did. It’s a little bit of a specific situation where they had a propensity to want to own their assets. It’s a little different. But we’ve heard of a few other anecdotes just recently of some other hospitals doing similar things. So hospital systems think strategically very differently. They focus on providing care and all the things they need to do to expand their business and succeed. They’re not sitting around thinking about cap rates for MOBs. I think there’s going to be – there are going to be some more of those. It may be a little bit more from your stressed systems. Weeding through that, back to your earlier question, figuring out is it worth it, is it the right systems to be with, is the question for that. Thank you, Rich.

The next question will come from John Kim with BMO Capital. Please go ahead.

Thanks. Good morning. Todd, in your opening remarks, you mentioned same-store NOI trending back to 3%, which is certainly against recent trends of not only HR but other MOB leads. I’m just wondering if you could discuss your confidence levels in that statement. If that’s being driven by occupancy picking up or leasing spreads on leases that you’re negotiating now?

I think the simple answer is, and Kris always hits this, it’s that our average contractual rent bump across multi-tenant and single-tenant is 2.83%. It’s 2.89% for the multi-tenant. That’s the driver of our same-store growth. What Kris always walks through is, okay, we grew the revenue at that level. You’re right, you advance that ball a little bit with cash leasing spreads. That’s a pretty small piece of the pie each quarter or year. You do help that. A little bit of turnover as well can hurt that. The revenue model is more of a high 2s kind of number. It really becomes, what are your expenses doing? How much operating leverage do you have in your margin? That’s the algorithm we see that gets us there pretty conservatively with it – but it’s really – the big driver is our revenue model of our escalators, and we continue to feel good about that. The cash leasing spreads help at the margin. As Kris talked, we’re looking to try to drive absorption as we go into 2021. That will help too. But even without a lot of increased absorption, you can see same-store NOI growth running around 3%.

How does free rent impact this number? I imagine you’re offering more free rent or you have been more recently.

Kris, do you want to touch on that?

Yes. I mean obviously free rent will go into it if you have a larger percentage of it versus what you had before. Generally, no, we’re not adding a lot of free rent. We really don’t have much, if any, inside of our renewals. If we’re doing it at all, it typically is inside of new leasing. When you have that with the new leasing, it just kind of creates a little bit of a delay before you see the revenue impact from that absorption. But overall, no, we’ve not seen a marked expansion of free rent.

Okay. And then maybe I’ll ask Nick Joseph’s question a little bit differently. I think in G&A, you mentioned $150 million of acquisitions you had under contract, and now you’ve closed $83 million post quarter. Are you still on track to close that remaining $70 million or so? Or have any of those deals fallen apart?

Yes. We’re still on track to close those. I think we’ve got – I think I mentioned we have $163 million that’s either under contract or LOI. So we’ve actually increased that under contract amounts since the last time.

Right. And the four adjacent acquisitions, you mentioned adjacent – the A-rated health systems. Are those health systems at all tenants in the buildings you acquired?

They have – I would say that they certainly have physicians that are utilizing the hospital next door. I think there’s one where the hospital is not a tenant but all the others are tenants by the hospital.

Great. Thank you.

Thanks, everyone. This concludes our earnings call. Have a great day.