Good day and welcome to the Healthcare Realty Trust First Quarter Financial Results Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Carla Baca, Associate Vice President Investor Relations and Corporate Responsibility. Please go ahead.

Thank you for joining us today for Healthcare Realty's first quarter 2021 earnings conference call. Joining me on the call today are: Todd Meredith, Bethany Mancini, Rob Hull, and Kris Douglas. A reminder that 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, 2020. 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 fund 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 quarter ended March 31, 2021. The company's earnings press release, supplemental information, and Form 10-Q and 10-K are available on the company's website. I'll now turn the call over to our Chief Executive Officer, Todd Meredith. Todd?

Thank you, Carla. Thank you everyone for joining us today. We're very encouraged to see outpatient volumes getting back to pre-pandemic levels. This will drive our internal growth toward our long-term growth profile. When we add our accelerated pace of external growth, we're building positive momentum in FFO and FAD per share. Foot traffic and patient flow in Healthcare Realty's facilities is fast approaching normal patterns now at about 95% of pre-pandemic levels. Some disparity still exists between markets. For example, the Bay Area is several months behind Nashville, where providers have been back to normal for a while. We've seen a noticeable uptick in traffic in just the last two months, which correlates with vaccination levels. The most vulnerable group, the 65 plus cohort is well vaccinated and consumes the most healthcare per capita. Eighty-three percent of these individuals have received at least one dose and will be fully vaccinated in a matter of weeks. These individuals are increasingly comfortable going to the doctor's office. As vaccination levels steadily rise and patient volumes normalize, optimistic providers are reengaging in plans for growth. We expect this to translate to more leasing momentum in the coming quarters. We see several positive indicators that will improve same-store NOI from 2% today toward our long-term growth rate of 3%. We're raising rents steadily and retaining our tenants at very high levels, and we're seeing strong underlying demand for space at our properties. All MOB's are poised to do well in the short term as patient volumes return to normal. Longer-term, the common denominator for success is aging demographics. Three keys to our ability to outperform include choosing the best markets, leveraging our local relationships, and aligning with the best providers. Our core business is on and around hospital campuses where performance is consistently strong. What's new is that we're also finding some attractive off-campus opportunities. Typically, these buildings are in close proximity to our hospital clusters. Our teams are plugged into local relationships that help us identify the off-campus buildings in high demand from providers. The MOB sector is highly competitive, with plenty of capital chasing limited supply. Highly desirable properties around hospital campuses are difficult to source, especially at scale, and thus have a long history of steady rich pricing. For these properties, we have an edge over the competition due to our longstanding credibility and networks of relationships. This helps us invest in more than our share of hospital-centric properties. Looking ahead, we see the bulk of our investment allocations going to these properties around the hospital campus. We'll also invest selectively in higher yielding off-campus properties with a higher allocation going to our joint venture in order to balance our risk and return on capital. Healthcare Realty is off to a robust acquisition pace in 2021. And with providers actively reengaged in growth plans, we expect to initiate multiple development starts this year. This strong external growth, together with accelerating internal performance, is translating to attractive FFO and FAD per share momentum.

Thanks, Todd. I'd like to provide an overview of the current state of healthcare and government health policy. We've been encouraged by recent for-profit hospital company financial results; volume is down but heading in the right direction and EBITDA margins are up based on solid revenue growth. COVID cases are decreasing as a percentage of inpatient volume, and growth in outpatient surgeries is positive. Hospitals continue to be impacted by fewer low-acuity ER visits. Still, year-over-year, same-store revenue has remained strong, with an average of 10% from higher acuity services and insured patient mix. These results have been similar for not-for-profit hospitals, which make up the majority of our Health System relationships. Health Systems continue to focus on strategies to lower costs, preserve, and even expand inpatient capacity, and increase services in outpatient settings. On the physician office side, other than a select few markets slower to reopen, our tenants are seeing positive patient flow and strong demand for services. With an increasing number of vaccinations, particularly among those 65 or older, most physician practices are looking past COVID recovery toward growth. On average, the 65 plus population visits a physician's office two-and-a-half times more each year than those under 45 years old. As a percentage of the total population, this cohort is expected to increase from nearly 16% to over 19% by 2028. Underlying demographic growth is clearly in place to support the long-term value of MOBs. The regulatory and legislative landscape remains relatively benign for healthcare providers. The Biden administration's agenda is focused on expanding health insurance coverage through adjustments to the ACA while also supporting healthcare providers through ongoing COVID relief. The most recent $1.9 trillion COVID relief bill increased ACA subsidies and lowered premiums for at least the next two years. Incentives to close the low-income insurance coverage gap are expected to increase the number of people eligible under the ACA by 3.6 million, signaling a positive direction for providers compensated care. There is strong political support to make these benefits permanent and to offset healthcare funding that expires down the road. Conventional wisdom still holds that it is very difficult to take away a benefit once provided, especially as Congress continues to shore up healthcare providers in the wake of COVID-19. Other items potentially on the legislative agenda include President Biden's campaign hallmarks, such as a public insurance option that would allow people to buy into Medicare and the reduction in the age of Medicare eligibility to age 60. The political balance in Congress will keep large-scale policy proposals more limited in scope for possible legislation in the near term. Expansion of government-funded health insurance is likely to be measured and incremental, serving as a positive for healthcare providers, as hospitals and physicians look to move beyond COVID. They will benefit from a steady commercial payer mix, a rise in the total insured population, and support for positive Medicare rate increases in 2022. Insurance payers, both private and public, continue to promote healthcare delivery in outpatient settings. We view any legislative or regulatory efforts to lower healthcare costs as an advantage to outpatient care and the development of more outpatient facilities. The value of physician offices and hospitals has been underscored in the last 12 months. With aging demographics, their services will be more critical as they meet rising demand in the years ahead. Healthcare Realty's longstanding relationships with many of the nation's leading providers will bolster opportunities for growth. Now, I will turn the call over to Rob.

Thank you, Bethany, and good morning everyone. I'll summarize Healthcare Realty's first quarter investment activity and our outlook for the remainder of the year. We're off to a solid start investing this year. Our relationships with health systems, property owners, and brokers often give us access to deals before they become widely marketed. And as we deliberately build scale in target markets, we're often viewed as the preferred buyer for buildings. These advantages have enabled us to maintain a robust acquisition pace at attractive cap rate levels. This is especially noteworthy as more buyers have moved back into the market, and pricing remains competitive. So far this year, we have purchased 10 buildings for $129 million, including four purchased through our joint venture with Teachers for $67 million. All 10 buildings are located in our core markets, including San Diego, Dallas, Atlanta, DC, and Denver. And what I really like is that the majority of these add to our existing clusters. For example, in Orange County, we acquired our fourth property around the campus of Saddleback Hospital, which is part of Memorial Care. We now have a sizable portfolio around this hospital of on, adjacent, and off-campus properties, which places us at the center of deal flow. Recently, a practice from another submarket had a need to expand into this area. We were able to show them a range of locations, price points, and interior finish levels. Having multiple product types was instrumental in keeping them exclusively engaged with us throughout their decision-making process. Another example is in Atlanta. We acquired two properties around Wellstar Hospital in Douglasville, where we already own two buildings. Our expanding relationship with the hospital gives us insight into its future plans and potential demand for these four buildings. Cap rates for these 10 acquisitions average 5.5%, with a low of 4.5% and a high just over 7%. The low is a value-add opportunity within an existing cluster, and the high is an off-campus property. Both of these buildings were purchased through our joint venture with Teachers. For some additional color around cap rates, we included a page in our Investor Presentation that lays out cap rate ranges by region for the $1 billion of acquisitions we've completed over the last couple of years. What you will see is that we have been able to expand our footprint beyond the campus and generate incrementally higher returns. Our off-campus acquisitions have seen spreads of 40 to 90 basis points above on-campus properties, depending on geographic location. Our acquisition pace shows no sign of slowing as we continue to grow our pipeline. Currently, we have properties under contract for LOIs totaling over $150 million that we expect to close near the end of the second quarter. With the strength of our year-to-date acquisitions, we're raising our guidance range by $50 million at the midpoint, with an upper end of $550 million. We also took advantage of a strong pricing environment to sell three properties for $34 million at a combined cap rate of 4.8%. These buildings were not in line with our strategy to build out clusters of properties around leading hospitals. We reinvested the proceeds accretively into MOBs with superior long-term growth prospects. Looking at redevelopment, in March, our first new tenant took occupancy at our project in Memphis. This 29,000 square foot Orthopedic Group will drive volume to the surgery center in the building. The surgery center is currently being renovated and expanded to accommodate more volume. This property is well on its way to stabilization early next year, at a projected yield over 7.5%. In April, we started a redevelopment in Seattle that includes expanding one of our existing buildings by 23,000 square feet. This 100% leased project has a budget of $12 million and an estimated stabilized yield of 6%. We expect tenants to move in and start paying rent by the middle of next year. Looking ahead, we have a couple more developments expected to start this year. Our developments create financial value with targeted yields of 100 to 200 basis points above comparable stabilized assets. Additionally, they foster deeper relationships with hospitals and providers as we work closely with them to plan for their outpatient growth. In summary, our acquisition and development strategies are paying off. I look forward to carrying this momentum into the quarters ahead. Now, I'll turn it over to Kris.

Thank you, Rob. The positive momentum we saw late last year continued into 2021. First quarter year-over-year FFO per share grew 2.6%. What's noteworthy is that in each of the pandemic-impacted quarters of the last year, we had positive FFO per share growth. This was possible due to the underlying revenue growth drivers of our portfolio, as well as accelerating external investments. In the first quarter, sequential FFO increased by $1.7 million. This was driven by a $3.1 million increase from the full-quarter contribution of the $337 million of fourth-quarter acquisitions. This contribution was offset by a $1.3 million increase in G&A, $900,000 of which is related to first-quarter-only items. We see current same-store NOI of 2% trending back to or even above our long-term average of approximately 3% as the impact from the pandemic dissipates. Where we really saw COVID effects in the last year was the loss of parking income and occupancy during the second and third quarters. This was partially offset by lower operating expenses. The timing of the rebound to pre-pandemic levels for these items will fluctuate and vary by market. However, with vaccinations becoming more widespread, and the number of leasing tours increasing, we see a path to accelerated growth in the quarters ahead. The growth potential embedded in our existing leases remains solid. The average implied contractual increase for our portfolio is 2.86%. For leases renewed in the first quarter, the average cash leasing spread was 4.4%, and the average future contractual increase will be 2.98%. Our ability to achieve this level of performance is tied to targeting markets where population growth runs well above national averages and drives our expectation for future internal growth. Solid operating fundamentals and a strong pipeline of accretive investments will ensure the ongoing strength of our FAD payout ratio which was 88.7% over the last 12 months. It is worth noting FFO per share grew 8% over the prior 12 months. This drove the improvement in our payout ratio even as we increased the dividend in March. In the first quarter, maintenance CapEx decreased to $8.4 million, down from a seasonal high of $21.1 million in the fourth quarter of 2020. Maintenance CapEx spending will fluctuate quarter to quarter. However, we expect to maintain a trailing 12-month FAD payout ratio below 90%. Net debt-to-EBITDA was 5.3 times at the end of the first quarter. This is right in the middle of our target range of 5 to 5.5 times. Net acquisitions of $69 million in the first quarter were primarily funded through $63 million of net proceeds from the settlement forward equity. Looking ahead, we have multiple sources of capital to fund over $150 million in our near-term acquisition pipeline. Our funding options include up to $127 million of proceeds from yet to be settled forward equity, more planned dispositions, and joint venture capital, along with nearly full capacity under our revolver. As we reflect on the pandemic hurdles of the last year, we're pleased with the stable performance of our portfolio and encouraged for the future. We see the most significant impacts of COVID-19 on our portfolio fading, with widespread vaccinations and foot traffic at our properties increasing. Underlying solid growth of our revenue drivers, including healthy escalators and cash leasing spreads are poised to drive same-store growth to 3% or more. Improving internal growth and a robust pipeline of accretive investments will accelerate per share earnings growth in the quarters ahead. Sarah, we're now ready to open the line for questions.

Thank you. We'll now begin the question-and-answer session. My first question comes from Juan Sanabria with BMO Capital Markets. Please go ahead.

Good morning. I was just hoping you could give a little bit more context with regards to the benefit from parking to same-store. Is there a way to quantify how much you're generating today versus what the normalized pre-COVID levels were?

Yes, right now we are running about 80% of what first quarter 2020 parking income was. So we do see that as a benefit to us in the coming periods as we start to see that rebound back to more normal levels. And that ended up being impacted same-store results by about 50 to 60 basis points.

Great. And then I was hoping maybe more of a conceptual question. For local clusters you guys have been able to generate, what impact does that have on margins as you benefit from local knowhow and maybe having lower personnel by asset? Or is that not really a driver of margins, and it's more just local knowhow? Just curious on what you're seeing and what that means for margins in same-store NOI growth?

Yes, I would agree with where you were headed there, which is that we really see it as more of a revenue driver benefit, a leasing benefit, and a momentum benefit rather than just an expense savings benefit. Clearly, there can be some of that expense savings as you scale up. But what we also find if you look at probably our premier example, and we show this in our Investor Presentation in Seattle, we're very spread out there across a lot of different clusters across a pretty big region in the Puget Sound. And so you don't just centralize with one office and send everybody out; it's a high level of service, with a lot of folks in the buildings that we own. So we don't want to cut customer service, due to the high traffic in our buildings and so forth. So really to us, the benefit of being in the flow of the leasing discussions that are going on, whether it's with brokers or directly with hospitals or physician tenants, is much more of a revenue piece that drives and accelerates revenue and expense savings.

Thank you. And maybe just one last quick one, what do you expect the development deliveries to average as they ramp up going forward?

Yes, when you say development delivery, it's the volume. The volume, yes, I think as we move forward, we're looking at starting anywhere from two to three projects a year. And that's generally on the volume side. It's generally going to be in that $50 million to $100 million a year in storage that we're targeting. Right now we're at $60 million; we could probably easily push towards the upper end that would be underway by the end of the year, if not exceeded. But on average, I think Rob's right over time, two or three projects that are active and are getting started each year.

Our next question comes from Nick Joseph with Citi. Please go ahead.

Thanks. You talked about the geographic differences that you're seeing. But I'm wondering if you're seeing any differences across different specialties or practices of volumes returning on patient flows?

Not tremendous. Certainly, you see the specialists clearly are getting very much back to normal. I think it is much more geographic than it is necessarily by specialty. There are some extreme examples you might point out or we might point out that some of the cognitive, counseling, psychology, psychiatry, and some of those things, certainly behavioral health, there are some things that can lend themselves much more to not getting back to normal and can be somewhat handled in a more virtual telehealth manner. But most of what is in our buildings we're seeing back to normal, most of the specialists, certainly even the ones that we saw impacted pretty significantly like dentists and dermatologists, all that's very much back to normal.

That's helpful. Then what do you think about leasing on a geographic basis? Are you seeing differences there just given what's happening, kind of from a volume perspective? Is that impacting the leasing market at all?

I'd say a little bit. Certainly, the emerging signs of more growth are all of us touched on would be much more concentrated in some of your places that had been back to normal longer, whether that's here in Nashville or in Texas, over in North Carolina, and different places like that, where Rob seems very active. I would say that does correlate somewhat with markets that have been much more open sooner. And so a place like the Bay Area is definitely going to look a little sleepier on that front. Southern California is a very different story though. I'd say that's Rob gave an example that was in Orange County, and we've seen tremendous engagement there in momentum. So it is very specific to particular markets.

Our next question comes from Nick Yulico with Scotiabank. Please go ahead.

Hi there, this is Jasper on for Nick. So maybe could you guys just talk about what you're seeing in terms of leasing activity? Leasing bonds were pretty strong this quarter; releasing spreads and retention rates are both at the high end of guidance? So any color that you could provide on leasing expectations for the rest of the year would be helpful.

Yes, you're right, the first quarter was strong in terms of our leasing metrics, specifically to our cash leasing spreads. They were a little above our guidance range of 3% to 4% for the year, really that has to do with, which is where the ultimate mix comes out. We ended up with it was about 3% of the leases that had negative spreads. So having a very small number in that bucket, certainly lots higher end renewals play through to the average. But if you look at it, still the vast majority of the renewals were in the 3% to 4% range. And that's still what we expect for the year. Overall, in terms of absorption, we did have positive portfolio absorption; we're pretty flat on a same-store basis that can fluctuate from quarter to quarter. But as we've been talking about, there are some positive signs of things improving across the country that we think can help drive absorption as we look to the back half of the year and into next year. And then just overall, you also talk about just the backdrop behind the whole sector, with aging demographics and the need for additional space, we think is going to be a benefit to leasing, not just in the year ahead, but in the years ahead.

Got it. That's helpful. And then could you give an update on the current acquisition pipeline in terms of activity and pricing? Maybe you could just talk about what drove the increase in acquisition, disposition guidance, and then the better pricing on dispositions?

We started the year with strong investment activity, acquiring 10 buildings for $129 million at an average cap rate of 5.5%. We are actively expanding our pipeline, focusing on around 30 targeted markets. Through building relationships with owners, our team is gaining visibility into future opportunities. With a strong pipeline, including $150 million under contract for letters of intent expected to close by the end of the next quarter, we are confident in reaching the upper end of our new range for investors. This quarter, we sold a few properties at low cap rates of 4.8%, capitalizing on strong market pricing. These properties did not align with our strategy of clustering around leading hospitals, so we chose to recycle those assets into accretive medical office building transactions. We plan to continue this strategy and anticipate realizing substantial value from some properties to further invest in accretive transactions.

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

Thanks, Rob. I'd like to follow up on the disposals. Maybe you can kind of just walk us through the rationale to that close this quarter. I know you got a couple more teed up; I saw in the Q a couple bigger ones in Virginia, etc. But Valley Presbyterian in LA or Piedmont in Atlanta, what was sort of the rationale around these couple of sales?

Yes, I'd say with the Valley sales, that was a campus that we had two properties there. When we look at that hospital, we didn't see a lot of additional opportunity to build out properties in and around that campus. And the buyer of that property, the tenant was an owner in the building and part of the ownership group. They made an offer at a very aggressive cap rate. So we wanted to take advantage of that and sell to that group and rotate that into an area and some assets where we saw potential for growth and to build that clusters down the road. The other asset was an off-campus asset in a similar theme. We didn't see an opportunity to build out in that immediate area, a cluster of properties over the long term. So we took the opportunity to sell into the strength of this pricing market and deploy those dollars elsewhere.

Okay. And in terms of the stuff that's teed up, I did see one larger asset; it seems like you helped sell for $52 million?

Yes, the one in Virginia; you're talking about, that one is an on-campus building. But it's interesting that it has some capacity to actually convert a portion of that building to inpatient. The hospital had approached us; they were interested in buying that asset to help them with some expansion opportunities they're looking at on the inpatient side. So we were able to agree on a price at a favorable cap rate, and it's a sub-four cap rate on that one. So a good opportunity to accretively dispose and reinvest that capital.

Okay, that makes sense. Kris, I was curious about the FFO sequentially. You mentioned the full quarter's contribution from all the acquisitions that closed during the quarter, but one of the challenges you pointed out was $900,000 in G&A that won't continue. Was there anything else that impacted the quarter aside from the elevated G&A? I expected FFO to be somewhat pressured higher based on the underwriting and some of the metrics you provided.

That has really been a key aspect regarding G&A, and we've discussed this each year, particularly in the first quarter, which is typically seasonal. If that were not the case, it would have positively affected your FFO growth by approximately $0.01. This is certainly the primary factor. Additionally, our same-store growth has been somewhat slower than historical trends, largely due to the COVID challenges we faced last year. As we see a recovery, it should give us a boost in overall growth. Overall, I believe that things are aligning very well, especially as we approach the latter half of the year and into next year, with strong per share growth expected for FFO and FAD.

Do you, out of curiosity, is less important, but just for the sake of the metric, and you pointed to it, the GAAP same-store NOI growth year-over-year?

I don't know the exact number off the top of my head, but you can see inside our supplemental, we do lay out the straight line rent. So the math wouldn't be that difficult to calculate.

Yes, I'll follow up.

With my record.

I'd actually get there because you guys provide, you don't provide the line items for revenue and expenses for the acquisitions, redevelopment disposition line-items, so it's a little bit tricky, but I'll follow up with you on that one. On the shares settled in the quarter, in terms of the equity was, can you give us timing on that? Was that late in the quarter or early?

It would have been, yes it was I don’t remember the exact timing but I think it was late February, early March.

Our next question comes from Vikram Malhotra with Morgan Stanley. Please go ahead.

Good afternoon. Thanks for taking the question. Just wanted to maybe get some of your latest thoughts on how big the opportunity set is for leaving aside the pure on-campus for Healthcare Realty just the off-campus adjacent, in other nomenclature, how big the opportunity set for you is and maybe over time, where you think that goes in terms of a percent of the portfolio? I ask just given obviously the broader talk about hospitals incrementally looking to take pieces of their business of their operations and move it more into the community to off-campus settings, more procedures being reimbursed for that. So just wanted to get your thoughts on how much of this you're building towards a slightly different, not completely, but somewhat different healthcare delivery model versus this being an opportunity set that you find sort of accretive and maybe it's a bit of both, but any of these thoughts would be helpful?

Sure, Vikram. I think it is a bit of both. We probably have a slightly different view than maybe sort of this prevailing binary view that there's a fixed bucket of services on a campus, and it's anything that can't be in the bucket smaller on-campus. We don't really subscribe to that; we think that bucket is always growing, the acuity levels are growing, and the volumes are growing. I mean, the amount of inpatient expansion we see counters the narrative that hospitals are somehow shrinking; we just don't see it. We’re seeing more demand and more on-campus MOBs being built. And a lot of what Rob's working on is stuff right around the hospital campuses. So we think it's all a growing sector. We'll continue to invest in both aggressively, but there's no doubt and we've always said it's a very real trend that things have been moving also off-campus as well. And over time, acuity in the off-campus setting can improve too and is, and as you just pointed out, there's going to be more and more that can be done in those off-campus settings. So we like the odds of all of it. What's really important, though, is learning how do you navigate that and balance the risk and the return? I think that's what you've heard us express today that we're finding our own way to get better returns with that and have more risk and less variability by looking at things that have a strategic alignment with our clusters. It's also an extension of relationships that we have, being in denser, larger markets, all those things that help mitigate the risk of just small, rural, off-campus buildings that can go dark on you. So there is no hard and fast number. I think Rob maybe mentioned that we've got in our JV; we're doing more off-campus there. I think the JV to-date is roughly 40% off-campus. So that's a very different picture than the balance sheet, which is high 80s on-campus and around the campus. Our view is there's not a hard and fast number. We still, as I mentioned, are allocating the bulk of things to the campus model. But we're opening up and I think it does increase the addressable market for us, which is very encouraging.

That makes sense. Given this sort of, can you talk about just competition from maybe away from your traditional peers that has the playing field changed in any way over the last, three, six months as the recovery has picked up? Have you seen new players come in and maybe just give us the latest thoughts on what pricing is?

Yes, and Vikram I would say that’s right. I mean we have seen really buyers that maybe were sitting on the sidelines last year, they've moved back into the mode of competing for products, certainly on the marketed deal side. Oftentimes we say it's a lot of the same names, but we really think about it from the standpoint of the capital that's behind the same names, in many cases. We're seeing quite a bit of capital move into the space, and they're chasing opportunities just like we are. So you're seeing a low-end, low cap rate compression, mostly on the portfolio side where these guys are trying to get in and make a big move on what we're calling the ultra-core side. You're seeing a little bit of it as well. So cap rates, certainly moving a bit, but we've been able to, through our process, we've been able to find the right deals for us at accretive cap rate levels and make sense of them. A lot of those are being borne out by relationships that we've established previously, repeat sellers, repeat folks that we're doing repeat business with; they know that we can, we'll close on the transaction, they know that we'll underwrite it properly, and they're getting a fair price. So we're really finding that that's paying off as we're out there in this competitive environment.

Got it. That makes sense. And then just one last one on, you referenced the developments over time, and you're increasing the pipeline. Given sort of all the cost pressures across various materials, I'm just wondering, as you think about underwriting here, are there certain areas you're focused on, or markets you're focused on, where you may feel you have a little bit more pricing power from an underwriting standpoint? Just trying to figure out the underwriting in light of where the cost of construction is going.

Yes, that's certainly a valid observation. We're experiencing some increases in construction costs due to various factors, including materials and labor. As we consider our development strategy, we remain committed to our internal pipeline, which we've discussed over the years. This pipeline is essential for driving our development efforts. You are correct that we're concentrating on markets where rent growth is robust, and rent levels are strong enough to keep pace with rising construction costs. Hospital systems are expanding rapidly, creating a demand for additional space, and they've accounted for the heightened construction expenses in their business plans. For example, in Seattle, we recently began a redevelopment project, and in Nashville, we are preparing to launch a development opportunity this year, where rents have also been very strong. Our focus is on these relationships with hospitals and on targeting yields of 100 to 200 basis points above stabilized assets.

Our next question comes from Connor Siversky with Berenberg. Please go ahead.

Hey, everybody, thanks for having me. Just a follow-up on the development pipeline; you mentioned multiple starts. So I'm wondering if these are all build-to-suit projects. And then can you provide any color as to what the facilities plan specializations are, whether it's dermatology, oncology, something like that?

Yes, I mean, I think certainly our developments are being driven by growth initiatives of the hospital. Just for an example, we're working on a development here in Nashville with the health system, and it's going to be on the campus; the hospital is growing, they're enhancing their women's services on the campus, and that's going to be a big part of this building. They're also growing their cardiology service lines, and so the other buildings in and around the campus are tall, and they need to grow that service line. So it's mostly specialty physicians, service lines that are certainly growing, higher acuity service lines that need to be in on-campus, around campus, and that's what we're seeing, and that's really what's driving the bulk of our development efforts.

Okay. And then just a bit more on some of these cost pressures that Vikram had mentioned. So have any decisions or has anything been signed related to the leases in these development projects? Or would those rates be reflective of the end project costs?

No, I mean, the development we just started has a signed lease for 100% of the building, and that's where we're focusing. We ensure that we have commitments like this before we begin construction.

Okay.

Okay, percent, whatever that hospital-driven service line or multiple service lines, usually you're working out hand-in-hand with your contractor; you're not just saying, let's get a lease, and then we'll go figure out what it costs. It's a parallel process that you're constantly working at the same time. So you're keeping your construction costs, estimates live with your contractor working towards the contract, just like you're doing with your lease releases.

Okay, that's helpful color. And then just one last piece of SD, do you foresee? Or is there any expectation maybe for delays in starts or ongoing project schedules?

I mean, you're certainly planning developments at startup certainly has its ebbs and flows. As we're pacing right now, we're on target to start, as we've laid out and complete in our schedules. Certainly, permitting and getting a building permit in this day and age can be more challenging. But we feel like if you hire the right contractors, and you have the right team in place, you're going to get those push through and you're going to get started.

Our next question comes from Tayo Okusanya with Mizuho. Please go ahead.

Yes. Good afternoon, everyone. Question, so I'm sure you guys have seen the recent report out there that's just talking about off-campus versus on-campus and actually putting real data behind this. And drawing the conclusion that off-campus, if elusive assets have actually tracked well, if not better than on-campus assets, but yet trade at wider cap rate. First of all, I'm curious what you think about this data, kind of given the historical argument that on-campus should be better than off-campus? And second of all, does it influence you in regards to having more off-campus assets on balance sheet?

Yes, we have seen the report and reviewed it. It’s a commendable attempt to address that type of information. However, I believe it’s premature to assert that off-campus assets are just as good. One important aspect missing from their data is NOI growth, and they only examined a three-year period. This is where we have an advantage, as well as some of our peers, such as Healthpeak, which has been delving deeper over a longer timeframe. We’ve been conducting similar analyses for a long time. Over time, and through different cycles, it’s crucial to consider that off-campus buildings can face challenges, especially when lease expirations occur. Attempting to do this on a third-party basis comes with notable challenges, including various data integrity issues. They have combined lease rates from differing categories that don’t fully represent the reality. While I commend their efforts, our experience tells us there is a distinction in performance between on-campus and off-campus properties. Another point in their report is that they group all adjacent properties in the off category, yet adjacent properties behave more like on-campus properties, which skews their off-campus performance. There is much more complexity involved than their report implies, and it’s our responsibility to discern and apply what we have learned over time to improve performance. Importantly, ultra-core properties located on or near campus generally exhibit better performance with higher growth and less variability. In contrast, off-campus assets tend to introduce more variability and risks. This is why we have included a comparison of our on-campus and off-campus cap rates in our Investor Presentation. As Rob mentioned, we have observed a spread of 40 to 90 basis points between on and off-campus properties, which we believe is justified. We approach this risk cautiously and will continue to share insights on this topic, including at NAREIT.

Our next question comes from Rich Anderson with SMBC. Please go ahead.

Hey, good morning. So on the off-market commentary you made about the relationships and whatnot, is that a price situation where you get a better cap rate exclusively? Or is there some sort of, it's just easier? You can almost customize things a little bit, and you can have a little bit more flexibility on how to approach things? Is that like the tradeoff? And maybe you don't get a special bargain? But you get more flexibility out of that? Is that a fair way to think about off-market?

Yes, Rich. I mean, I certainly think that's it. I don't think we're sitting here saying that we're getting discounts on acquisitions because we're buying them off-market. To me, it's more about building that relationship with that seller. We've had a number of deals that we've done recently that is repeat business; this is the same building owner told us something they had in a different area. It came straight to us. And I think that is right; you've built a relationship with them. They know you can close, they know your reputation, they know you know how to underwrite the property appropriately, so that they feel like they're getting a fair value, and it becomes an easy process. And so that's where the real value comes in for us and doing off-market is that we know we can look and build that pipeline and see what it looks like further out, rather than just waiting for marketing properties to hit the market and then reacting to this.

Maybe the savings come from the process being easier, which allows you to save money by not having to chase after deals; perhaps I'm just speculating.

But I think the other thing, as Rob mentioned earlier, if you allow these properties to get pushed into a big portfolio, that's where you avoid the premium as well. By getting to these early into these relationships, it just saves them a lot of headache, the seller. But they again, they want a fair price; it's my job is always, when you go knock on that house that you really even, your family has liked and always wanted to buy and you go knock on their door, chances are they're not going to sell it to you for a steal. But the idea here is we see is that there is a premium in portfolio size, and so you avoid that by building it the way we've been doing.

Well, maybe they wouldn't even open the front door. But when you talk about getting able to push rents, and you're not seeing too much pushback, do you have a comfort level about retention going down? Do you have something in mind like, okay let it trickle down a couple percent? Or if you see any indication of retention being impacted by pushing rents that you'll take your foot off the gas?

Yes, for us, Rich, we say that our expectation of retention is 75 to 90; we've frankly been running more in that kind of plus or minus 85 for some time. And that's kind of ebb and flow by quarter, and as we look at it, we've said we're looking to grow 3% to 4%. But we have some markets that we're doing better than that, but then you have some markets that yes, you have to recognize what was going on in the market in the competition, and you have some roll down this year; this quarter was pretty minimal at 3%. So you're just trying to build a portfolio that gives you the opportunity that you can hopefully over time grow that in a more consistent rate and a stronger rate. As we look, we've had some people have asked us, like 3% to 4% are reasonable compared to the inflation. We really look at things from a construction cost replacement value, which has been growing north of that 3% to 4% for some time, and frankly right now, with some of the questions we had on this call, there's some concern of could that speed up moving forward. We think there's still plenty of room and we think that we're still showing value to our tenants in terms of making sure that we have properties that have the space; they need that are maintained. We certainly make sure that we're investing the capital and TI as well as building CapEx to be able to maintain this level of growth that we think is sustainable long-term.

Our next question comes from Todd Stender with Wells Fargo. Please go ahead.

Thanks, and thanks for sticking around. Rob, for you, you highlighted the off-campus property you acquired, I think in here in Q2. I don't know if it was the Colorado Springs One at a step-plus cap rate. If that's a redevelopment candidate, what kind of cap rate do you think that will look like on a stabilized basis? Just kind of narrowing down the value creation opportunity there?

Yes, Todd, I think I heard you say, had a little bit of hard time hearing you. But I think I heard you say a property that we said was 7% cap rate that was actually the deal in San Antonio. That was an interesting situation where kind of our direct sourcing process really, really paid off for us. That was the seller of that property was wanting a quick process, and then surety of close; they wanted the room move really fast. The broker that was working that deal knew we were familiar with that market, knew we could achieve that, and came to us. They weren't as interested in maximizing value as they were just getting out of the property real quickly. So we just got through telling, telling Rich and we weren't getting discounts that probably on that one, we might have gotten a discount.

And so what is the cap rate compression expectation there? If you're buying it as 7%, is that market something in the fives? Is that ambitious?

Yes, I mean, I'd say in high fives is probably low six and high fives.

Yes, I think Todd, you were to take that out into a portfolio, not that we're going to do this, but package it with some other nice properties in a portfolio. Yes, you would see compression well into probably the high fives. And so yes, there's a lot of value creation that can be out there.

Our next question comes from Mike Moeller, with JPMorgan. Please go ahead.

Yes, hi. Just in terms of getting back up to the 3%, same-store NOI CAGR, what is the P&L headwinds that you're facing today to get there because your in-place bumps are almost at 3%, rent spreads are fine. Is it the parking or bad debts elevated anyway? I mean, what's the drag today in the P&L?

Yes, the main things that we've talked about is really the parking, then operating expenses, and then occupancy changes. So bad debt is back to minimal with any; we collected basically all of our deferred rent. So that's not an issue. But the parking, like I said is probably impacting on the revenue side, 50, 60 basis points on an NOI is frankly, even a little bit more than that. On a revenue or revenue per average occupied, we're trending below our average because of lower operating expenses. Right now, we had negative operating expenses this last quarter, which is great, but that's unusual. But the operating expense pass-through on the other side reduces that revenue growth. Now to an NOI, to the NOI bottom line, that's still a positive for us. But then we did experience the loss in occupancy in the second and third quarters of last year, which is rolling through I'll call it 50, 60 basis points. We always say that you're going to end up, that's going to have a one to one impact on the revenue growth. So that can bring down you're close to 3%, revenue growth down to, into the mid-twos. As we see the parking coming back, as we see the operating expenses kind of more normalizing, and we think the occupancy is hopefully bottoming out although it can move around each quarter and over the long term we think can grow. When you build all of that back together, you get to see that revenue model and that NOI model to get back to those long-term averages of 3% or frankly even more, if we're able to see some absorption.

Got it. And then I know you said the parking was off, I think it was off 20% year-over-year. But just thinking bigger picture, if you have $100 of revenues? How many, what proportion of that comes from parking? Just to put parking into perspective versus everything else on the revenue side?

Yes, it is very low; I get the exact number out for you.

So less than 2%.

Yes, $2 million a quarter on $120 million of revenue a year-ago.

Thank you. Our next question comes from Daniel Bernstein with Capital One. Please go ahead.

Just one quick question; it seemed like both you and your peers' retention rates have really gone up in the first quarter. Is that I didn't know if that was just kind of like a one-off thing or if you're seeing an actual trend due to maybe changes in tenant movement or desire for tenants to stay in the buildings and expanding the buildings. Just trying to understand if there's a trend there and how that might impact your occupancy and TIs going forward?

And I wouldn't read too much into one quarter; it does move around as Rob described. We're comfortable 75 to 90, it has been running a little higher. I don't think it's unusual, given the pandemic, that people are getting themselves back on their feet, running at full capacity, they've been focused on safety protocols and just run things back to normal. That may explain some of it. But also, we're seeing a lot of interest in expansion, and so forth. So again, that may help too. I think as some people have asked, maybe some perception that rents are rising elsewhere, construction costs are rising, that helps a little bit the H2, but we're not suggesting next quarter is going to be the same or better. I think we're still comfortable in our range and we'll move around a little bit. So I wouldn't read too much into it. I think it's probably just in a range that we've been in 80 to 85 plus.

Our next question is a follow-up from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.

Thanks. I was just parsing through the supplement a little bit. On Page 25, when you're saying for reconciliations, there's something called rent concessions. Can you just remind me what that is exactly? I saw that it sort of spiked up, and I wasn't sure if that related to the increased leasing or if that was more like a deferral or abatement. What is that?

Yes, it will be tied to multiple things, but typically, it's going to be some type of free rent that is going to be related to mostly new tenants. We don't really have any on renewals. I think and I have to dig into the specifics, but we did have a couple of tenants inside our redevelopments that started. And so those typically end up with a little bit of free rent at the front end. So that would be my guess is specifically why it is a little bit higher, although I still say it's not that meaningful to the overall revenue. But that's the reason you're seeing a little bit higher this quarter than previous.

There's no abatement in there or anything like that?

No, nothing, nothing like that. This is really about some free rent maybe for a tenant is specifically a new tenant, especially on redevelopment where they may build out some space or moving from one building to the next. And you're kind of helping them out, as they're moving across buildings. But no, it's not. It's not rental payments.

Okay, it’s helpful. And then as it relates to your lease structure, I know, I think the preponderance of your leases are fixed. But I know there's also a CPI portion as well. So I was just kind of curious on the upside; we don't talk about this that often. But I know this theme has sort of popped up here a little bit. But is there a cap on CPI, on your CPI escalator?

Generally, no. There are all kinds of leases out there. Some of them will have a floor to a cap of five. But I would say generally, they're more just tied to whatever CPI is. Overall CPI is not a large percentage of our structure; it's under 5% of our leases have a CPI based escalator. We are typically more fixed, as you pointed out. Historically, we frankly have done better with our fixed running closer to three than where CPI has been. People have questions like, well, what if CPI starts taking off, is that a risk said; we also have generally a pretty regular turn in our leases with about 20% that are up for renewal each year. If we do start to see pressure on costs across the board in construction costs and janitorial costs, or elsewhere, we think we have a very reasonable amount of our leases that we can start to look to try to recapture that if that does start to occur.

Okay. And then lastly, I think on the joint venture deals, I know a handful of these happened this quarter, and you've got some more teed up for next quarter. I'm just curious, what sort of since you have some examples here of deals that you've closed, what's the sort of thinking of JV versus on balance sheet transaction like? What are you showing them versus what are you not showing them? Some of these deals look like straight-up the middle HR deals and I'm just trying to figure out how we're supposed to tell what the differences?

Yes, I think if you look at what we did this quarter and really what we did in the fourth quarter as well, in the JV you had an opportunity to really look more of a value-add opportunity where it was a building that we purchased that had some upside in terms of occupancy. So opportunities like that where we think there might be some near-term drag because of the lower occupancy, but we see a nice upside, those are opportunities where we're going to entertain those in the JV and we did. One of the buildings that we bought this past quarter was really our fourth building around a campus in Orange County. We have been placing buildings into the JV around that campus. We see some real upside; we've seen some real absorption in the other buildings. That's where you'll see us participate and share those to the JV. The other side is really on the off-campus side. Three buildings that we put in there this quarter were off-campus properties where we think that there is some additional risk. We're putting out half the capital, but getting that higher incremental return. Those are opportunities that we're sharing with the JV. The stuff that's down the fairway, you said, I mean, yes, that's where we already have nice relationships on or adjacent. We're generally keeping those on our balance sheet and we intend to. As we said before, we're not obligated to show them a certain number of deals or certain types of deals. It's really at our discretion, and so you'll see us continue to do that, and I think that Todd pointed out in our supplemental things Page 19, where we're showing the breakdown of the JV, I think 40% of the properties that are in there now off-campus, as opposed to our own balance sheet portfolio that's staying down around that 12% range. So I think that's really the way to think about it is when you get into those situations where the cap rates are a little richer, we can make better sense of it. Or maybe there's some upside; it may have some near-term drag in the off-campus buildings.

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

Thank you, Sarah. And thank you, everybody for tuning in today. We'll be available for follow-up if you have any questions and we look forward to connecting with most of you at NAREIT soon. Have a great day.

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