Healthcare Realty Trust Inc Q2 FY2022 Earnings Call

Good afternoon. Thank you for attending today's Healthcare Realty Trust Second Quarter Financial Results. My name is Francis, and I'll be your moderator today. I'd like to pass the conference over to our host, Kris Douglas, CFO.

Thank you for joining us today for Healthcare Realty's Second Quarter '22 Earnings Conference Call. Joining me on the call today are Todd Meredith and Rob Hull. 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 company's Form 10-K filed with the SEC for the year ended December 31, 2021, and Form 10-Qs filed with the SEC for the quarters ended March 31 and June 30, 2022. 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, or FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, or 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 June 30, 2022. The company's earnings press release, supplemental information, and Form 10-Q are available on the company's website. I'll now turn the call over to Todd.

Thank you, Kris, and thank you, everyone, for joining us for our second quarter 2022 earnings call. 20 days ago, we closed our transformational combination with HTA. Since we initially began pursuing HTA nearly a year ago, the market has presented a lot of challenges to navigate, rising debt costs, geopolitical turmoil and record inflation, among others. We're incredibly fortunate and proud to be where we are today. First, I'd like to express our gratitude to shareholders who voted overwhelmingly in favor of the combination. 79% of shares outstanding and 92% of those who voted. Thank you for your vote of confidence. I'd also like to thank my fellow board members and my colleagues at HR and HTA. We could not have achieved this outcome without their support and hard work. I'm particularly humbled by the commitment and perseverance of my colleagues. And we're also grateful for the counsel of our advisers and the commitment from our bank group throughout this process. Looking forward, we know we have a lot of work ahead. We're excited about the opportunity to demonstrate for investors, tenants, and our partners the strength and benefits of the new Healthcare Realty. Importantly, we never lost sight of why we're pursuing this combination. We see tremendous advantages to increase scale. The combined portfolio includes well over 700 properties and 40 million square feet. And when I look at the combination, we've nearly doubled the percentage of our portfolio in markets where we own more than 1 million square feet. This is notable in a largely fragmented MOB sector. We now have unmatched scale in 14 markets. Dallas is our top market where we now own nearly 4 million square feet. What this means is we can operate much more efficiently, strengthen our market knowledge and leverage much deeper relationships to accelerate leasing and investment momentum. Fortunately, we operate in a sector with steady historical demand even in uncertain economic times. Demand for outpatient health care in the U.S. is projected to accelerate over the next decade. A sharp rise in the aging population will drive outpatient utilization regardless of economic conditions. What's important is our portfolio is concentrated in dense, high-growth markets to capture this demand. Over 3/4 of our properties are attractive coastal and Sunbelt markets like Seattle, Dallas, Atlanta, Nashville, Raleigh, Tampa and Boston. We have clusters in the right locations, giving us great relationships with the leading health systems in each market. The combination of rising demand, growing markets and deep relationships will accelerate bottom line growth. In the coming quarters, we're focused on a few key performance indicators that will demonstrate progress and illustrate the power of our combined companies. Number one, asset sales and our joint venture program. We've made great progress and expect to complete the majority of asset sales in the next 30 days to fund the $1.1 billion special cash dividend. Number two, integration. We're hard at work combining our companies to optimize our teams and realize our targeted annual synergies. It's critically important to take care of our talented people and maintain our culture during this process. Number three, leasing momentum. In the second quarter, both HTA and HR generated robust leasing volume. Together, we have over 600,000 square feet of new leases that are now in buildout. This record leasing activity will contribute to solid occupancy and NOI improvement. We see momentum building moving into 2023. And number four, relationships. We expect to tap into our expanded relationships to increase our pace of investment. We have greater visibility on several development starts in the coming quarters. We're intently focused on these four priorities. Delivering these results will begin to capture the value of the combination, which is not currently reflected in our stock price. Later, Kris will touch on some key valuation markers that should help our investors realize the potential for attractive returns. When I look at the combination, we have many more properties and many more options to refine the portfolio and generate proceeds when there's a disconnect between public and private valuations. We will use excess proceeds from asset sales together with our expanded joint venture program to invest in MOBs where we can create the most value through scale, clustering, and our expanded relationships. While we're only 20 days into the new Healthcare Realty, we're off to a great start. We look forward to executing on our priorities in the coming quarters, and we intend to deliver attractive long-term shareholder value through a compelling combination of lower risk, increased liquidity, and accelerated growth. Now, I'll turn it over to Rob to provide an update on our JV and asset sales as well as our investment activity.

Thanks, Todd. Healthcare Realty has made substantial progress to fund the $1.1 billion special dividend through joint venture transactions and asset sales. Specifically, we have closed on $433 million of properties, and we are under contract on another $613 million expected to close by the end of August. Combined, these transactions are at a blended cap rate of just under 4.8%. By the end of the third quarter, we expect to complete the remaining sales that will bring the total to over $1.1 billion. The stability of MOBs is translating to more stable pricing relative to other asset types. Every sector is experiencing the headwind of rising rates, yet lenders remain active in the MOB space. The training credit environment has pushed the market into a period of price discovery with a wider bid-ask spread on certain offerings. Our asset sales are evidence that MOB pricing remains strong, especially for portfolios valued from $100 million to $200 million. In the next several quarters, we plan to sell additional properties totaling $500 million to $1 billion. These sales will further refine the portfolio and generate proceeds for accretive reinvestment. In terms of investment activity, acquisitions for the combined company this year stands at $417 million at a blended cap rate of 5.2%. Since we last reported earnings, we closed 7 additional investments for $58 million. All were in existing markets. One notable acquisition was in Raleigh, where we purchased 3 buildings for $27.5 million. Among these were 2 medical office buildings adjacent to WakeMed's Cary Hospital. Including HTA properties, the company now has substantial scale with 13 buildings totaling 478,000 square feet in this cluster and 1.1 million square feet in the growing research triangle area. Looking ahead, our team remains focused on fostering lasting relationships in markets where robust population growth is increasing demand for health care services. We will remain disciplined as we selectively pursue acquisitions in target markets that build upon our cluster strategy. For the year, we expect to invest $500 million to $750 million in the low to mid-pods, funded largely through asset recycling. Solid demand for MOB space is driving lease-up in the portfolio and across our developments. Hospital demand for MOB space remains strong. This demand is largely driven by health systems' need to recruit new physicians to support the expansion of service lines such as radiology, oncology, and women's services. Third-party demand for space also remains healthy, particularly in the areas of cardiology, dermatology, internal medicine, and ambulatory surgery centers. We are also seeing a lot of interest in moving ready suites; tenants see significant value in avoiding delays caused by supply chain and permitting issues. Strong demand for outpatient services is also leading to an increase in development activity. Our developments are largely sourced through existing relationships in target markets, giving us greater control of the process. In contrast, heavily marketed RFPs generally attract developers looking for fees rather than an appropriate spread above a stabilized acquisition. We have seen our development spreads remain steady, 100 to 200 basis points over acquisition yields. Including HTA's pipeline, we currently have $181 million of development and redevelopment projects underway, with about half of this already funded. Our pipeline continues to grow as health systems expand their market footprints. Over the next 12 to 18 months, we expect to start another $100 million to $200 million of redevelopment and development projects. These are primarily located in target markets such as Atlanta, Dallas, Houston, and Orlando, and include a couple of projects from HTA's development pipeline. Longer term, we expect the addition of HTA's portfolio to be a rich source of development opportunity as we build towards $300 million in annual starts. We remain committed to pursuing accretive investments, focusing on target markets and clusters where we can build scale. The addition of HTA's portfolio gives us a broader base from which to meet the robust demand for MOB space and grow cash flow per share. I'll now turn it over to Kris for a review of our financial results.

Thanks, Rob. Before getting into specifics on results, I would like to point out that second-quarter financials are for stand-alone HR and HTA, given the merger closed after quarter-end. This morning, we published separate financial and supplemental reports for both companies. The third quarter will be the first period with combined results. Our remarks will focus on legacy HR second quarter results while also highlighting HTA performance. HR's normalized FFO per share increased 4.7% over the second quarter, from $0.21 to $0.45. FAD per share increased 11% year-over-year, driving our FAD payout ratio down to 83% for the quarter and 86% for the trailing 12 months. HTA's normalized FFO for the second quarter was $101 million or $0.43 per share. HTA's FAD payout ratio was 92% for the quarter. Looking forward, we expect the combined company's FAD payout ratio to remain below 90%. For HTA, second quarter same-store NOI grew 1.6% year-over-year, an improvement from 0.8% in the first quarter. HR's year-over-year quarterly same-store NOI growth increased 3.3%, driven by a 3.4% increase in revenue, offset by a 3.5% increase in operating expenses. Operating expense growth decelerated from 6.6% in the first quarter due primarily to property tax refunds. Excluding property taxes, operating expenses increased 5.3% year-over-year, with the primary driver being utilities. We expect utilities to remain elevated in the third quarter with the extreme heat across the country. However, we remain insulated from the higher than historical expenses, with over 90% of the combined companies' leases having a pass-through of increased operating expenses. Year-over-year, second-quarter revenue per occupied square foot increased 2.8%, which is generally consistent with our in-place contractual escalators of 2.89%. Second quarter cash leasing spreads of 3.4% were in line with our expectations and historical range of 3% to 4%. Overall revenue growth benefited from a 50 basis point improvement in average occupancy. It is noteworthy that we had 215,000 square feet of signed leases in the same-store portfolio that are in the process of build-out. This represents 1.6% of total same-store square footage. HTA had a record number of new leases executed in the second quarter and has over 431,000 square feet of leases that are in the process of build-out. This represents 1.9% of its total same-store square footage. Given the record amount of new leases and build-out across both portfolios, nearly double historical norms, we are optimistic about meaningful absorption in the coming quarters. Converting these suites to occupancy will create significant incremental NOI and per share value. Looking further ahead, bringing HTA's current multi-tenant occupancy of 84%, in line with HR's existing multi-tenant occupancy of 88%, generates over $28 million of annual NOI. From there, bringing both portfolios' multi-tenant occupancy to 90% generates another $28 million for a total of $56 million of annual NOI. This will take multiple years but can provide significant value beyond the $33 million to $36 million of G&A synergies we expect to generate in the next 12 months. Now, shifting to the balance sheet. We finalized the recast of the combined HTA and HR bank credit facilities in the second quarter. The new combined facilities include $650 million of new term loans to repay the approximately $550 million outstanding on the existing revolvers and to fund remaining transaction costs. We currently have near full capacity under the new $1.5 billion revolver. The new $1.1 billion asset sale term loan was drawn at merger closing to fund the $4.82 per share special dividend to HTA shareholders. We expect to repay the asset sale term loan with the proceeds from the JV and asset sales that are currently in process. We provided a couple of updated valuation disclosures this quarter. First, we added at the end of the HR supplemental, a summary combined company pro forma NAV schedule. It shows our current implied cap is in the high 5s, well above the transaction pricing Rob described earlier. As we complete additional asset sales, we will look at opportunistic share repurchases if our implied cap is more attractive than acquisition and development yields. To that end, last week, the board authorized a $500 million share repurchase program. Second, we provided an updated accretion bridge for 2023 FAD on Page 20 of our investor presentation. There is significant share price upside when we applied these expected results to the historical multiples as shown on Page 21 of the investor deck. Please note this analysis focuses on FAD accretion and multiples. There will be several non-cash accounting adjustments, including the reset of straight-line rent and mark-to-market outstanding debt that will make FFO results less meaningful in the coming quarters. In July, HR and HTA declared and paid quarterly stub dividends of $0.01 and $0.09, respectively. The balance of the HR stub dividend of $0.109 was declared last week. The result is HR shareholders will receive a combined dividend of $0.31 this quarter, which is the same as the main dividend. We expect to maintain the legacy HR dividend policy and cadence moving forward. HR and HTA made great progress this quarter in closing the merger while also continuing to execute operationally. Most noteworthy was the strong leasing results across the two portfolios. And looking ahead, we are eager to continue this progress and maximize the value from our combination. Francis, we're now ready to open the line for questions.

Our first question comes from Rich Anderson with SMBC.

I wanted to start by discussing the $1.1 billion dispositions, which are obviously taking longer than expected to complete. However, you're still seeing the same pricing that you've mentioned. What do you think is causing this delay? We anticipated being finished by mid-August based on your earlier comments. Can you walk us through the timeline of this process?

I would say there hasn't been a significant delay. Based on our most recent communication, today's progress aligns with what we discussed earlier. From the initial timeline, you might have a good point, and it's clear that the markets are challenging. Rob mentioned that lenders are still active in the MOB space. However, buyers who rely on debt are having to adapt due to different debt terms than they initially anticipated. We're not worried about this situation. We're on track, with nearly half closed now and the remainder expected to close in August. Even if it's a bit slower, we feel positive about the progress.

You mentioned in your opening comments that three-fourths of your portfolio is in densely populated areas of the country. This leads me to ask about the combined company. You mentioned plans for up to $1 billion in dispositions over the next few quarters. What do you think is the optimal balance for the combined company regarding on-campus versus off-campus properties? Additionally, what do you identify as the non-core elements of your portfolio that are likely to be sold over time, perhaps not in the coming year, but over the next few years?

Sure. If you look at the combination of the two companies, we end up at about 68% on or adjacent to campus. And I think we've shared with folks that certainly, you've seen us in the past be much higher than that. Although, I think Rob has communicated a number of times that our investment pace over the last several years has been about 75%, 25%, so 75% being on or adjacent. I would say that's probably a longer-term target that we're looking at. So the asset sales that we're working on now that Rob addressed, that will pick up beyond an adjacent a little bit, maybe 1% or so. And I think over time, as we continue to sell assets, as we continue to invest in new assets, we'll drive that up into the mid-70s, plus or minus. So I think that's our long-term view. As you've heard us talk about our cluster strategy, we've gotten much more comfortable with the idea of investing again, primarily on adjacent settings, but then complementing that with off-campus that's strategic and relevant to these health systems and providers that we work with in these markets. And I think as we gain scale in these markets, filling that in between our campus-based clusters really makes a lot of sense. So that's a long-term target about 75%.

Okay. Last one for me. Now that you're a much bigger enterprise, understanding that it's a fairly fragmented market still, do you think that HR can institute real change in terms of how people view the business from the lens of the REIT? We had typical 3% type same-store NOI growth, 3% cash re-leasing spreads in that range, sometimes more, sometimes less. But when you look at some of the other sectors in the REIT space, the math is much different, right, for like industrial, where there is a price-insensitive tenant base like yours, they get much bigger cash releasing spreads, bigger same-store numbers. Is that something that you think you can achieve over the long term, institute real change in terms of the growth profile of the company? I know you've listed a lot of things in the future, but I'm thinking more about systemic change to the medical office business having more of a growth element to it in your umbrella.

Sure. I understand the question. I think fundamentally, we're not going to change medical office from a non-cyclical business to suddenly a cyclical business. I think that's the trade-off. And of course, we've been running for long in the tooth on the cyclical sectors that have really had a huge tailwind for an extended period. And I think we're seeing that slow down, whether that's apartments or industrial. It's still very attractive, but it's slowing down, and that will change in the future. That can change. I think medical office is different. It's really built to grind at these more steady rates but through economic cycles. And so I think that's the difference. So I'm not going to pretend to suggest we're going to suddenly transform this into a cyclical business that creates big peaks and valleys. I do think though we can incrementally move higher on the growth profile. I think we can sustain a 3%-plus type growth profile. And you've seen Healthcare Realty do that over the years. And I think we can apply that to this broader portfolio, use our strengths to do that. And I think that will show up in our rent bumps. It will show up in our cash leasing spreads, obviously, same-store NOI. But we're not here to tell you that suddenly we can produce high single-digit, low double-digit type growth in the business on a sustainable basis. I think that just would defy gravity. And this is about safety. MOBs are largely more about non-cyclical and safety. And that fundamentally factors aren't changing that business fundamentally hospitals aren't. So I think it's just different than something like industrial or other sectors.

Our next question comes from Michael Griffin with Citi.

I just want to go back to the accretion bridge page in the presentation. Just on the HTA FAD of $370 million for '23. If you look at the current run rate, it's implying about flat relative to last year of $325 million. So I'm just curious how you're anticipating that extra, call it, $45 million of pickup from FAD on HTA on just that stand-alone basis?

Yes, Michael, this is Kris. Yes, when you look at it, and you take kind of their stand-alone, we have assumed they're going to be able to grow in the low to mid-2s on a same-store basis. You also get the full impact of their acquisitions that they completed in '21 that needs to be added to that number that you were that you were talking about as well as a full impact of some of the developments, including some current pay construction loan type developments that will go into that as well as some incremental acquisitions that we hit assumed for this year, now we've pulled some of that back. But when you roll through all of the impacts from the growth as well as those incremental acquisitions that weren't in that '21 number. That's what gets us up to the $370 million. And I will say that we did bring down that $370 million from $390 million previously as we have cut back on the assumption of how much acquisitions we would be doing for the balance of this year moving into next year with HTA, given where the current stock price is or effectively what you see in the accretion bridge is more of an asset recycling as opposed to significantly more external growth. However, we are assuming with that asset recycling that we're able to redeploy those proceeds accretively. So really, in terms of the accretion bridge, that change in net investment activity is not having a big impact. Really, almost all, if not all, of the change from what we have presented previously can be related to a change in interest rates.

So should we then assume that, that $20 million of net investment activity decrease applies to '22 as well? Because I'm assuming that '23 number is the one detailed on the proxy of the $390 million and then for '22, that's a $354 million. So track $20 million for that, call it, 334 FAD for HTA for '22. Is that fair to assume?

That might be a bit premature because some of the acquisitions from earlier in the year will be considered. However, I would say a significant portion will be in 2023, with some impact also seen in 2022.

Cool. I appreciate the color on that. And then just maybe touching on leverage. Just curious where it sits on a pro forma basis with the disposed that have already occurred and sort of do you still anticipate hitting that 6% to 6.5% range? Or could there be anything to kind of change the mindset on that?

No, we're still optimistic about reaching that 6% to 6.5% range. We have a bit more to go on the term loan related to the asset sale, but we expect to fully repay it before the end of this quarter. So, overall, we should hit the target range we've indicated.

Our next question comes from Steven Valiquette with Barclays.

All right. Great. The one main question I have was actually just touched on a little bit, and it comes back to the projections in the proxy prospectus filed on June 10th for each stand-alone company through 2026. You just kind of talked about the '22 numbers around that. But I guess beyond that for '23 through '26 before any consideration for the planned divestitures. Are those numbers still valid to use for just projecting out long term for each stand-alone company? Or are they stale for one reason or another? Just wanted to visit that for the out years as well.

Yes. And obviously, it depends on exactly where we are of the volume of external growth. However, as I pointed out, to Michael, that's really not having a significant impact on the overall results, given the fact that we are assuming that we are in an asset recycling phase as opposed to net external growth that we're able to do that on an accretive basis by selling small portfolios like Rob talked about reinvesting in individual assets. So that really doesn't have a major impact, really what is driving the change in what we presented, and you could run that through the balance of those pro formas would be change in interest rates, which obviously have adjusted since earlier in the year when those original pro formas were put together. And that's the reason we wanted to provide this updated accretion bridge to make sure that people were picking that up. And I think a lot of people were. I think I don't think that, that's any surprise to anyone, but we just want to make sure that that was abundantly clear.

Okay. The only real quick follow-up around that is just that at the time these numbers came out back in June 10th, I mean, they were projected before that, obviously, but both set of numbers were above street consensus at the time. So I don't know if that stood out to you, maybe you just gave the answer on why you think it might have been above. But what's the catch to you on why those projections were above the street consensus at the time? And I guess, if it's not obvious, we can just talk about it more offline later, but I was just curious if you had any quick thoughts around that.

I'm happy to provide more details if you have specific questions later. During a merger, the consensus numbers can vary significantly depending on individual assumptions and perspectives on the potential growth and impact on general and administrative expenses. We've established our own assumptions, but not everyone shares the same outlook, which can lead to varied results in the consensus numbers. If you'd like to discuss this further, I would be glad to follow up with you later.

Our next question comes from John Pawlowski with Green Street.

Great. Todd, could you give us a sense from HTA senior management is leading the day-to-day integration given the other CFO left day one?

Sure. We set up integration teams some time ago, and we have personnel from HTA paired with our counterparts. Julie Wilson, our EVP of Operations, is our main contact for integration and has been working closely with Amanda Houghton. Additionally, David Gershenson, our Chief Accounting Officer, and others on his team are also instrumental in this integration. Key functions such as accounting and human resources are critical to this process. Both sides have dedicated staff focused on this effort, but it is clearly the leadership from legacy Healthcare Realty that is steering this initiative.

Okay. And then a follow-up on the transaction market regarding the asset sales, you are still achieving solid pricing. Has the pool of assets changed at all as the months go on and we experience volatility in the debt markets? Are there any other concessions outside of price that you have to make in order to close at that 4.8 unaffected pricing?

This is Rob. No, I would say no. I mean, as we indicated throughout the process, we did break the transactions up into multiple transactions, smaller bite sizes that we were comfortable with, and we were seeing a deeper market for those a deeper pool of buyers. But in terms of making concessions, I wouldn't say there are any meaningful concessions that were given in order to achieve that pricing.

Yes. One of the things we did, which we discussed in the spring, was to evaluate a larger group of assets. We didn’t just jump in without consideration; we worked through the options. We had indicated that we were looking at an amount closer to $1.6 billion to $1.7 billion. From that pool of assets, we identified what we believed we could effectively execute within our targeted timeframe. We prioritized accordingly. Ultimately, we're satisfied with the process and the results we've achieved.

Okay. But was the final pool of assets sold or about to be sold, higher quality than the initial assets you guys were underwriting?

No, I wouldn't say that.

I wouldn't say they're higher quality than what we already sold. Yes, I would say the assets that we're selling are similar to the overall mix, although a couple of preferences, as I articulated earlier, a little more off-campus, a little more single-tenant. We're selling some assets that are micro-hospitals that great markets, great health system, but an asset type that we wanted to reduce our exposure to. So there's some things in there that for us on the margin actually improved the resulting quality of the combination after the sales.

Our next question comes from Jonathan Hughes with Raymond James.

I was hoping you could stick with the JVs and dispositions that John was just asking about. I think we saw another $600 million that was mentioned in the press release from a month ago. That was liked to be marketed or in the process. Is that $600 million still expected to be marketed and attempted to be sold in the near term? Or is that going to be added to that Phase 2 of the post-merger HR and a little bit further down the road?

Yes, we're considering that as part of the merger once we finish the asset sales and joint venture transactions linked to the special dividend and its funding. Following that, we will enter the next stage of refining our focus, continuing to enhance our portfolio. This will involve identifying opportunities to exit markets where we don't foresee long-term growth, particularly through clustering and collaboration with our health system partners. We aim to divest those types of assets and properties in favor of investing in existing markets and developing clusters. Essentially, it's a strategy of refinement and rotating into beneficial transactions within the markets where we intend to grow.

And I think in terms of timing on that, I would say some of that certainly we would expect to occur in calendar '22, but some of it will obviously potentially flow over into '23. But we certainly continue to work on those assets that you're referring to. Those are discussions that are ongoing. But we're formalizing a process of selling an additional $500 million to $1 billion that Rob referenced. So I think that's kind of in that phase, and we'll see some of that progress this year as well as going into next year.

Got it. Okay. And then maybe turning to that accretion bridge in the slide deck this morning and looking at the 2023 FAD estimate for HTA, it's now $365 million versus the $390 million previously; that's down 6% versus the last estimate due to the higher rates than less acquisitions that you talked about earlier, Kris. But on the 2023 FAD estimate for HR stand-alone, that dropped almost 10% due to the same higher rates and less acquisitions. Can you just walk us through why the drop was greater for HR versus HTA when leverage is not that dissimilar? And I think the acquisition activity for this year and future years sounds like it was unchanged?

Yes. As we discussed, the primary factor for the change is interest rates. Although there was a decline in net investment activity, we also reduced the shares connected to that growth. The impact is largely tied to interest rates and the difference between the fixed and floating percentages of the two portfolios. Our capital structure typically consists of about 70% to 75% fixed, but HTA is currently almost 100% fixed. Therefore, changes in interest rates have a more significant effect on us compared to them. However, on a combined basis, we maintain a fixed percentage of 80% to 85%. We believe this is a favorable position as it provides us with substantial flexibility. We will continue to monitor our options in the bond markets and consider using swaps to extend some of our debt. This explains the differing effects of interest rates.

Okay, that accretion. And then one more for me on sticking with that accretion bridge page, the JV and asset sales there show $44 million of FAD removed on the $1.1 billion of sales. Did that imply the 4% yield? So how do we score that with the reported 4 cap rate on those transactions?

Yes. This is FAD. And so the difference there is the maintenance CapEx is associated with it.

Got it. And is that CapEx assumption still to 12.5% of NOI, I think in the last deck, that's what it was. Is that unchanged?

Yes. It's in that ballpark.

Our next question comes from Tayo Okusanya with Credit Suisse.

The first question is about the share buyback program. It seems logical considering our implied cap rate is in the mid-6s. However, I'm curious about how you are managing that alongside the increased leverage from share buybacks. What can we anticipate moving forward regarding the aggressiveness of the share buyback strategy?

We would consider using the proceeds from asset sales to evaluate whether it makes more sense to repurchase our stock for a potentially better yield and return, or to invest in development and acquisitions. Given current stock price levels, buying back shares could be an attractive option. We prefer this approach over increasing leverage. This isn’t about taking on more debt; rather, it's about finding an alternative use for the proceeds from asset sales. We're comfortable maintaining our debt to EBITDA ratio in the range of 6 to 6.5 times and do not intend to exceed that just to facilitate stock repurchases. That's the framework we are considering.

That's helpful. And then also the FAD per share growth acceleration, I think, again, the drivers of that all makes sense. But in terms of occupancy gains, I mean, especially, again, a lot of it feels like it's going to be focused on the multi-tenant HTA portfolio, where often occupancy has been stubbornly stuck for a very long time. Again, you guys have had some chance at some time now to do some due diligence. I mean what do you see there that gives you this confidence you have occupancy gain when occupant our portfolio has not grown for the longest time?

Yes. There are a few points I want to highlight, Tayo, for consideration. One aspect we've discussed differs from our leasing strategy. At Healthcare Realty, we have historically engaged with the brokerage community to enhance our reach in finding new tenants, which helps improve occupancy. We are seeing significant benefits from this approach. Having a larger presence in a market with more clusters allows us to attract attention from brokers and receive initial inquiries directly from prospective tenants. We observe considerable strength emerging from developing these critical levels of scale. With our combined portfolio at scale and a broker-focused strategy, we believe we can gain considerable advantages within the HTA portfolio. Most of this opportunity, indeed, resides in their multi-tenant portfolio, but there is also substantial potential in the legacy Healthcare Realty multi-tenant portfolio. Kris mentioned some figures indicating that we could see over $55 million in NOI growth if we can raise the overall portfolio occupancy toward that 90% level. We are optimistic, as there are considerable tailwinds at play. The industry is experiencing rising replacement costs, resulting in limited affordable supply, which we believe will benefit our buildings. Additionally, we are witnessing strong demand from providers, likely a result of pent-up needs after a couple of years focused on COVID. So, we are very positive and can see the impact in our leasing activities, as previously mentioned.

I’d like to point out that we’re already observing some positive trends in the HTA portfolio. While this isn't yet reflected in occupancy rates, their lease percentage in the same-store portfolio has increased by 70 basis points year-over-year. Additionally, there’s a significant volume of leases in both portfolios currently undergoing build-out, nearly double historical levels. Once these build-outs are completed and can be converted to occupancy, we anticipate strong potential for growth, which will positively impact occupancy, rent, NOI, and overall earnings growth. We’re not suggesting that integration will take a long time before we start to see results. In fact, you can already notice this positive setup within both their portfolio and ours, allowing us to take advantage of the expected occupancy growth.

Got you. If you could indulge me with one more question. One of your peers on their earnings call kind of really talked about a really remarkable mark-to-market of about 8%. I think you guys kind of see in the last 3.5% or 3.4%. Just using with everything you're seeing with inflation, do you expect market to market to accelerate going forward? Or how do you kind of look at that versus the need to kind of manage the client relationship?

Yes, that's a great question. We noticed that as well and certainly don't want to downplay the strong numbers that physicians have reported for this quarter regarding cash leasing spreads. In their own comments, they recognized that these results may not align with their expectations for the upcoming quarters. However, like them, we are optimistic about the tailwinds that indicate we can continue to push rates higher. With replacement costs significantly increasing and build-out expenses rising for both leasing and development activities, we have favorable conditions to push on rate. Even higher rates are more cost-effective compared to new developments. While I won’t claim this is the new norm, we've seen ourselves achieve numbers reaching similar levels in recent years. We believe that a range of 3 to 4 is very achievable, and occasionally reaching the 3 to 5 range is also possible. Overall, we maintain an optimistic outlook on this, similar to our peers.

Our next question comes from Michael Griffin with Citi.

It's Michael Bilerman here with Griff. Todd, regarding the cost of capital, it's clear that since last August, the overall cost of capital for the sector has significantly increased. However, for your company, it's risen even more since your stock has decreased relative to your peers, while their equity values have gone up. On the debt side, your spreads have widened more than those of other REITs. You've created significant value at HR over time through external investments, whether from acquisitions or development and redevelopment efforts. Following your recent transaction, it seems the market has reacted. You might feel the market is overlooking something, but your current multiple is noticeably lower than historically, as your slides indicate. You have limited free cash flow, with a dividend of $1.30 compared to $1.45 of FAD expected next year. Your leverage is at the higher end of your target range, limiting your aggressiveness without asset sales. What steps do you envision to move past this situation? What catalyst do you expect to trigger market recognition that would allow you to lower your cost of capital and pursue accretive growth?

Sure. Yes. Framework and question. I think clearly, where we are today is we've just completed the merger. And I think no surprise, that's why I articulated these 4 priorities in my remarks, clearly, we need to keep demonstrating progress and success on the asset sales in the JV. I think people want to keep seeing that progress. It's a tough market out there. We all know we're all trying to figure out where cap rates are and where they're going with driving debt costs. So I think people want to see that come through. I think we clearly need to keep showing progress on the synergies. But I think probably the key answer to your question is in the near term, it's what Kris just talked about on leasing. It's that leasing momentum and really driving operational improvement that like Kris said, we're not waiting 2 years from now to get to, we see that progress coming and we're excited about getting after that and demonstrating those results, and we think it's coming through. I think clearly, development is also a piece where we think we can create long-term value that's higher returns. But at the end of the day, you're right. We obviously need to show progress on all those things and earn back that reputation for delivering those results so that we can get back to a valuation multiple that makes sense to grow through external growth as well. It takes all those pieces, as you well know, to deliver that 5% to 7% per share growth. We know that. So we've got to get out of that. But I think for us, it's just executing and executing and showing how we can drive the operational benefit of this combination to then get back to that external side.

The question is how long it will take to achieve our goals, along with the potential capital needed and the execution of our plans. We are looking at a timeframe of almost 2.5 years where the situation can be described as a bridge since the initial value of $1.45 will settle at about $0.45 at the end. At some point, it will be essential to demonstrate a clear rationale for pursuing this merger. I understand that you conducted a stock-for-stock exchange and used asset sales to fund the dividend. While I see the advantages of this, the stock values are low, and effectively you provided a higher exchange ratio due to being the buyer. However, we need to think long term about how to transition smoothly to the other side of this merger. Will leasing operate differently now that we are a combined entity compared to how things were before? I know both companies had strong relationships, but I question whether the margin will allow for significantly more deals—will it be 20 instead of 10? Please help clarify this aspect.

Yes, I agree. As Kris mentioned, both companies are experiencing increased momentum in leasing independently. You are correct in noting that both have strong relationships and capabilities to generate leasing results, but we anticipate even more significant outcomes from our combination due to the increased market volume. This should lead to greater opportunities for expanded development and redevelopment activities, allowing us to create net new space. We see considerable potential in this area, and we believe that rent growth will be bolstered. Not only will we improve occupancy rates, but we will also better enhance rent growth through this merger. We don't see this as a long-term objective; we expect to see these changes in the near future and will keep track of both our progress and specific merger metrics. Additionally, the combination provides us with substantial opportunities related to asset sales. We can divest quality assets that may not align with our strategy at potentially favorable cap rates, allowing us to reinvest those funds into more attractive investment projects. This isn't about entirely halting investments; rather, it's a focus on making smart capital allocations.

Right. Anyway the particular portfolios together, there's more opportunities to sell down because you have greater scale, so less impact and you're being able to maintain the platform and things like that. So that definitely makes sense. One thing just on the bridge page. Does this include anything on additional asset sales and tapping into that buyback or all of that is separate. That's something that we should think about as we start to model for '23 additional is of sales and buybacks. There's nothing in here particularly for that, right?

Yes, there isn't anything regarding share buybacks. We're considering a shift in net investment activity towards more asset recycling. This means we are planning to sell certain assets and reinvest in new acquisitions. However, as Todd mentioned, our decisions will depend on when the proceeds from these sales come in and the current share price. If the share price is favorable, there could be potential benefits from the accretion we achieve. We'll need to monitor how things develop.

I guess how much accretion do you have in her from capital recycling then because you over to you in selling assets and buying assets if there's a positive spread, you could have some accretion? Or is it limited…

Yes, we do. We're running, call it, about 30 basis points or so, 30, 40 basis points of spread between our acquisition and disposition inside of here with the ability to sell, as Todd is talking about portfolios and reinvest those into individual assets. So we're not paying the same portfolio premium.

So what is that? Because I assume that part of that '22 and '23, how much accretion is based in that $1.45 from accretive capital recycling?

Yes, I would say it's more in the $0.02 to $0.03 range, which is pretty similar to what we have seen historically. Once again, it depends on how it builds over time. So I apologize for not being able to provide a direct number, but yes, it falls within that $0.02 to $0.03 range.

I was just trying to understand what's in there. So that as we go through a benchmark, we actually understand what's coming in and out. And it may be helpful to include these slides in the supplemental that way. We heard from some people that they didn't realize it was out there. So perhaps as wrap that into the press release and the supplemental in 3Q.

Our next question comes from Daniel Bernstein with Capital One.

Some of my questions were actually just answered. But I just wanted to go back to how you're thinking about the buybacks versus investments. I mean, like you said, you're in the upper implied yield, but the real IRR is probably a lot higher given the upside of HTA occupancy. So I don't know if you can just talk about maybe the thought process a little bit more of buybacks versus investments, especially at the current stock price.

Yes, Dan, you make a good point. We believe that buying back our stock is a solid investment, not only due to its appealing yield but also because there is significant potential for upside. We share that opinion. We are evaluating options after the sale of $500 million in assets, considering whether to pursue acquisitions, development projects, or simply to buy back more stock. Our approach is quite analytical. We will assess the internal rates of return from potential acquisitions and developments compared to what we can gain from repurchasing shares. At the current stock prices, we find our stock very attractive, making buybacks our clear preference at this time.

Could you provide some historical perspective on when there are wide bid-ask spreads in the MOB space? Typically, what timing can we expect for them to close? If today isn't the right time to push for external growth due to increased debt costs, when can we anticipate higher cap rates and initial yields in the MOB sector? Is this something we might see in mid-2023, for example? Is it usually a 3-month process, a 6-month process, or even longer? I understand these are unusual times, but I'm curious about your insights.

I believe it's important to address that. While I typically would have estimated a timeframe of 6 to 12 months, I’m not certain if that's still the case. Historically, we would lean toward that range. However, we've witnessed significant interest from buyers seeking quality assets and an increase in portfolio activity. As Rob mentioned, we've scaled back to a portfolio size of about $100 million to $200 million, and the demand remains strong, with more opportunities available. There's a lot of capital out there, but buyers are trying to navigate the challenges posed by increasing debt costs in the market. It's challenging to predict precisely; we're all trying to understand where debt costs are heading. It seems there may have been an overreaction, yet we anticipate a long-term upward trend. Thus, it's going to take some time. I can't say if that will be 6 months or a year, but I would argue we are already past the 6-month mark, so it likely extends beyond that. We'll have to wait and see.

Our next question comes from Jonathan Hughes with Raymond James.

On the share repurchase program, I see that operates a week ago, but was also authorized, I think, back on May 3rd. Is it only a 3-month authorization? I'm just trying to understand why the need to redo that program for May if it really is something new.

The merger was completed, and we wanted the new Healthcare Realty Board to approve that. I believe the authorization is typically for about a year.

Yes. I can't remember specific in that language, but we typically look at that every year. And Todd, you're right that we already had it. But with the new board, we needed to go ahead and get that reauthorization.

Got it. And then I noticed in the supplement, I think the components of expected FFO page was removed, but can you just confirm expectations for same-store NOI growth or unchanged or maybe even higher since the legacy HR portfolio is actually running north of 3% closer to that higher end of guidance for May?

Yes, you're correct. We took a step back because we thought that providing a standalone HR guidance wouldn't be particularly beneficial. In the upcoming quarters, we plan to offer more updates. However, our expectations regarding leasing, as well as our cash leasing spreads and bumps, have not undergone any significant changes. Overall, the contractual escalators are maintaining a range of 2.5% to 3%, which seems reasonable without any shifts in occupancy. Yet, we remain hopeful that occupancy may improve in the future, potentially increasing that figure.

Our next question comes from Mike Mueller with JPMorgan.

Kris, I guess I appreciate the comments on accounting issues. But is there any shot at providing even rough FFO guidepost for '23? I mean that is the most standard reporting metric. And when you look at estimates now, the range is high $1.60s to almost $1.90, so it's pretty wide.

Yes, that sounds reasonable. We would like to provide some additional information, even if it includes noncash accounting items. However, I currently don't have that information as we are still assessing the opening balance sheet and the valuation data. This will impact our ability to provide specifics right now, and it could lead to a wider range of potential outcomes depending on how this data turns out, rather than reflecting the core fundamentals, which will relate more to the FAD numbers we share with stakeholders. One important aspect is that we need to adjust all of our debt to fair market value, which includes over $3.1 billion of debt on the HTA balance sheet. Depending on the final rates decided in comparison to current payments, this could significantly affect our outcomes. I believe this discrepancy is a major factor, and as we gain more clarity on these numbers, we will report them. Regardless, I still believe that while these adjustments are noteworthy, they are not as critical to understanding the overall value and cash flow of the combination moving forward, which is why our focus remains on FAD growth.

No, I appreciate that, but I'd imagine the range would probably not be the $0.20-some range that it is now, at least with on Bloomberg. And again, that's the headline reported.

Yes, I understand. I believe it also varies depending on Mike and how individuals interpret this situation. There are diverse opinions on assessing synergies. Some may normalize the figures and assume the benefit is already realized, while others will factor in the potential drag. Therefore, I think there are likely differences in how people approach or define the earnings results.

Our next question comes from Daniel Bernstein with Capital One.

Some of my questions were actually just answered. But I just wanted to go back to how you're thinking about the buybacks versus investments. I mean, like you said, you're in the upper implied yield, but the real IRR is probably a lot higher given the upside of HTA occupancy. So I don't know if you can just talk about maybe the thought process a little bit more of buybacks versus investments, especially at the current stock price.

Yes, Dan, I agree with you. We believe that buying back our stock is a solid investment not only due to its attractive yield but also because there is significant upside potential. We share your perspective. We will evaluate any potential reinvestment opportunities in light of our recent decision to sell $500 million in assets. We need to consider whether to invest in acquisitions, development, a combination of both, or simply repurchase stock. This decision will be made based on a thorough analysis of the internal rates of return we might achieve from potential acquisitions and development projects compared to what we would gain from buying back our stock. At today's prices, we find the stock very appealing, making it our clear preference at this moment.

Well, thank you all for all the questions. We appreciate your time today. We look forward to seeing many of you at conferences in the fall here as we wrap up summer and look forward to catching up with each of you then. Thank you all. Have a great day.

That concludes the Healthcare Realty Trust second quarter financial results. Thank you for your participation. You may now disconnect your lines.