Hello and welcome to the Healthcare Realty Trust Third Quarter Earnings Conference Call. My name is Harry, and I'll be your operator today. I would now like to turn the call over to Ron Hubbard, Vice President of Investor Relations to begin. Please go ahead.

Thank you for joining Healthcare Realty's third quarter 2023 earnings conference call. Joining me on the call today are Todd Meredith, Kris Douglas, 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, 2022, and the Form 10-K filed with the SEC for the quarter ended September 30, 2023. 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 September 30, 2023. 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, Ron. Good morning from Nashville, and thank you everyone for joining us for our third quarter 2023 earnings call. I would also like to thank those of you who joined us a few weeks ago at our Investor Day in Raleigh. If you did not attend, I would encourage you to go to our Investor Relations section of our website and see the presentation materials and posted videos. We've included a short highlight reel as well as long-format videos with the content of the day. The focus of our Investor Day was Healthcare Realty's competitive advantages of market scale and relationships. We showcased how we're using these advantages to drive leasing and occupancy gains and we illustrated how our approach enhances long-term growth through the expansion of our market and cluster strategy. A key differentiator within our strategy is our proven leasing model. Post-merger, it took us about two quarters to fully mobilize the internal leasing team and our brokerage partners across the combined portfolio. Leasing momentum picked up quickly in the first quarter of 2023. Now in the third quarter, we've generated record new leasing volume of 447,000 square feet. This includes 269,000 square feet at the HTA multi-tenant properties where we have the most upside opportunity. Looking ahead, our current leasing momentum is setting the table for occupancy gains and NOI growth in 2024. Today, we're providing a roadmap and occupancy and NOI growth bridge that outlines our expectations for the fourth quarter and full year 2024. The bridge represents both multi-tenant properties, and the total portfolio. Our single-tenant properties are fully occupied with consistent NOI growth. I'll focus most of my comments on the multi-tenant properties, where we have upside. As a baseline, our multi-tenant occupancy is currently 85.1% and our year-over-year NOI growth is currently running at 2.3%. In the fourth quarter of 2024, we expect multi-tenant occupancy gains of 35 to 50 basis points. NOI growth is expected to improve to the mid-2% level, but not fully reflective of the occupancy gains since they will be back-ended. Looking into 2024 we split our bridge into the first and second half of the year. In the first half, we expect cumulative occupancy gains of 70 to 100 basis points of recurrent occupancy. We expect NOI growth to elevate to a range of 2.7% to 4%. In the second half, we expect cumulative occupancy gains of 150 to 200 basis points compared to the current multi-tenant occupancy of 85.1%. We expect multi-tenant NOI growth to accelerate to the 4.5% to 5.5% range in the second half. Folding in the single-tenant properties NOI growth is expected to be approximately 4% to 5% in the second half of 2024. Occupancy and NOI improvement is expected to build over the next five quarters. What we're most focused on is reaching a 4% to 5% run rate in the latter part of 2024 providing tremendous velocity going into 2025. I'm confident we have the best team in the industry to deliver this upside. We're laser-focused on leasing momentum, tenant retention, and expense controls that will drive occupancy and NOI gains in 2024. Stepping back to the broader context, we've done the hard work to merge and integrate two of the largest MOB companies. We are now the safe choice to invest in a high-quality pure-play MOB company. We have tangible operational upside in our sites bolstered by secular tailwinds. MOB fundamentals are sound. Demand is accelerating from aging demographics, the supply-demand picture for MOBs is tightening in our favor and health systems are re-engaged and expansion plans as their margins improve. Turning to third quarter results, we're pleased to have met our expectations on a number of fronts. Normalized FFO was in line with our expectations at $0.39 per share. Same-store NOI growth improved 20 basis points to 2.3% compared to the second quarter. In-place contractual rent escalators moved incrementally higher to 2.76%, and cash leasing spreads jumped to 4.8% well above our guidance range. We also sold five properties in the quarter for net proceeds of over $200 million funding our capital requirements and reducing our floating rate debt. These bright spots are counterbalanced by a couple of areas where we have plans to improve. Operating expense growth was 4.8% in the third quarter. This is down materially from the second quarter, but well above where we need to be to meet our NOI goals. We're actively working on a number of cost reduction initiatives to reduce operating expense growth to a run rate of 2.5% by the end of 2024. Another key area is tenant retention. Third quarter retention of 76% was below our long-term expectation of 80% or higher. Retention at the HTA properties has been running about 5% to 10% lower than the HR properties. Our team is actively improving customer service and tenant satisfaction to lift tenant retention into our historical range. Tenant survey scores have already improved at the HTA properties, and we expect retention to follow in 2024. After Kris and Rob, I'll circle back to provide some additional comments before we shift to Q&A. Now I'll turn it over to Kris to discuss financial results.

Thanks, Todd. We're pleased to report a steady quarter, with improvements on several key fronts. Normalized FFO per share for the third quarter was $0.39. This was consistent with the second quarter, as seasonal utilities and higher interest expense were offset by G&A savings. FFO for the fourth quarter is expected to grow modestly, generating per share results of $0.39. As a result, we expect full year FFO at the low end of our guidance range. Trailing 12-month same-store NOI increased 2.8%. Year-over-year, quarterly NOI grew 2.3%, a 30 basis point improvement over the second quarter. In particular, we incrementally improved our rent growth drivers. Annual in-place contractual increases now averaged 2.76%, up five basis points from last quarter. The improvement was driven by future contractual increases of 3% for the 1.1 million square feet of leases that commenced in the quarter. Cash leasing spreads averaged 4.8%, up significantly from 3% last quarter. Tenant retention was at the bottom end of our expected range. As a result, sequential occupancy was down modestly by 10 basis points. Looking forward, we expect move-outs to moderate which will help drive positive absorption from significant new leasing volumes. As Rob will discuss in more detail, we executed 447,000 square feet of new leases in the quarter. This drove a 30 basis point sequential improvement in the total portfolio lease percentage to 89.2%. Operating expense growth of 4.8% in the quarter was driven primarily by continued labor inflation and janitorial and personnel expenses, which were up a combined 9%. These two categories comprise 20% of our operating expenses. Excluding them, operating expenses increased 3.7% year-over-year. The higher janitorial and personnel expense was primarily driven by a goal to improve overall service at the legacy HTA properties. We will start to lap these higher comps as we move into early 2024. Together with cost reduction initiatives, we expect to bring overall operating expense growth below 3% in the back half of 2024. Net debt to adjusted EBITDA at September 30 was 6.6 times consistent with the second quarter. Net debt was $112 million lower than June 30 from $209 million of asset sales in the quarter. We have $138 million of asset sales under contract that are expected to close in the fourth quarter. In addition, we currently have $182 million of properties under LOI that are expected to close by year-end or early 2024. We expect these asset sales to fund our development commitments as well as reduce variable rate debt and overall leverage to within our target range of six to 6.5 times. We're also continuing to work on a joint venture with an SEC portfolio of existing HR assets. Given the volatility in the market, we announced at our Raleigh Investor Day that we expect the size of a JV to be at the lower end of our target range of $500 million to $1 billion. We expect to generate proceeds of $400 million to $500 million. As interest rates have moved higher over the last few months, cap rates have also increased to the upper 6% to 7% range. Of course, this does not consider the pullback in rates this week. And we'll have to see how that plays through to debt financing and cap rates moving into 2024. I'll now turn it over to Rob to delve further into recent leasing success.

Thank you, Kris. We are observing strong underlying fundamentals in the MOB sector, with the supply-demand dynamics favoring landlords. On the demand side, demographic trends are accelerating and have a long runway ahead. Additionally, healthcare providers are showing improved operational trends. A tightening supply situation is becoming apparent, as higher construction and capital costs present significant challenges for new supply, suggesting that new starts will remain low for some time. This creates a favorable environment for improving occupancy in existing MOBs. In the third quarter, our leasing team signed 142 new leases totaling 447,000 square feet, which is a record for us and represents an 86% increase over the first quarter of this year. Nearly 70% of these new leases are in our top 15 markets, which account for 60% of our total portfolio. The signed non-occupied leases across the multi-tenant portfolio currently represent 210 basis points of future occupancy, expected to begin mostly over the next three quarters, up from 140 basis points in the first quarter. At the HTA properties, these leases account for 250 basis points of future occupancy, increasing from 150 basis points in the first quarter, and we see attractive occupancy and NOI growth opportunities in our redevelopment properties, where we have 630 basis points of SNO leases. Furthermore, our prospective leasing pipeline now exceeds 1.7 million square feet, an increase from the 1.5 million I reported at our Investor Day. Almost 20% of this pipeline is in the lease-out and documentation phases, while another 30% is in the LOI and proposal phases, with the remainder actively turning. This pipeline offers us about four quarters of new leasing visibility to boost our occupancy in 2024. The bridge Todd mentioned can be found on Page 19 of our updated investor presentation. This multi-tenant occupancy and NOI bridge spans the fourth quarter of 2023 through the end of 2024. In the fourth quarter, we expect to see positive absorption that will signal the start of steady occupancy gains throughout 2024. Together, these gains are projected to increase occupancy by 150 to 200 basis points above our current level of 85.1% for multi-tenant properties. Strong new leasing activity is anticipated to replenish our snow pipeline as new leases start. In the first half of the year, we expect new lease commencements of approximately 400,000 square feet per quarter. In the second half, we expect this to rise to about 430,000 to 450,000 square feet per quarter. Move-outs, which are part of the absorption equation, are aligned with our expiration schedule. According to our bridge, we expect move-outs as a percentage of expirations to remain in the mid-to-high-20s, consistent with historical averages for both HR and HTA. We predict vacancies of around 340,000 square feet per quarter in the first half of the year, driven by a higher number of expirations during that time. In the second half, we anticipate this to drop to about 225,000 to 290,000 square feet per quarter. To reach our occupancy targets, it is crucial to prevent move-outs, just as much as it is to secure new lease commencements. I have confidence that we have the right team and processes in place to achieve our desired occupancy levels. We expect NOI growth to fall within the 4% to 5% range in the second half of 2024, setting us up for continued success in 2025.

Thanks, Rob. Now I'd like to hit a couple of key points before we move to Q&A. First, I'll comment on our dividend. Our Board of Directors is keenly focused on our upside potential and is 100% committed to maintaining our current dividend. While we expect to have an elevated payout ratio as we invest in occupancy gains, we remain extremely bullish on our ability to improve our payout ratio as we look beyond 2024. Second, we want to stress discipline around capital allocation. In this environment, we remain net sellers. We're not pursuing acquisitions, we are avoiding new development starts and we're pursuing only selective redevelopments of existing assets where it makes sense to maximize value. We will continue to meet our current development and funding obligations through non-strategic asset sales with excess proceeds earmarked for debt repayment. Once we're comfortably within our target leverage range, we will balance further debt repayment with accretive capital redeployment, including the repurchase of stock. We now have four full post-merger quarters behind us with the major merger integration work complete. We shifted to the blocking and tackling phase that allows us to deliver operational upside that's not driven by the interest rate environment. We are focused on accelerating NOI growth through occupancy gains, improved tenant retention, and operating expense control. We remain committed to achieving NOI growth in the 4% to 6% range. We expect to elevate our NOI growth run rate throughout 2024 reaching the 4% to 5% range in the second half. This gives us tremendous velocity going into 2025. With the occupancy and NOI bridge, provided today, our aim is to create a heightened sense of visibility for investors and accountability around our goals and objectives both internally and externally. We look forward to discussing this further, our bridge, and road map with many of you in the coming weeks. Thank you for listening this morning and we'll now turn it over to the operator for our Q&A portion of the call.

Thank you. Our first question today is from Michael Griffin of Citi. Michael, your line is now open. Please proceed.

Great. Thanks. This is Aubrey Paris on for Michael Griffin. Kris, I know you touched on this in your opening remarks, but can you expand on how operating costs are trending versus your expectations? And if you could just touch on the cost-saving initiatives you're undergoing that would be great. Thanks.

Yes. They are still elevated compared to where we like them long-term. We've made some improvements since the last two quarters, but still higher than we like to see. As I mentioned a lot of that has to do with inflationary items on the janitorial and personnel side. And some of that was known given the fact that we were attempting to improve some service levels. But we're going to be looking throughout the cost structure at ways that we can bring down costs. We'll also start to lap some of those comps that we had from last year as we improve the service level. So with that we do see that operating expense is trending lower as we move into next year, but likely looking more towards the back half of the year before we can get back to more historical levels below 3%.

That's helpful. Just for a quick follow-up. Just wondering what our retention rate is assumed in the occupancy and NOI bridge that you provided in the deck?

Yeah. We use move-outs as a percentage of expirations. The rate that was used in the deck was in the mid to high 20s for the different levels on a move-out percentage, yes, it’s correct.

Got it. Thanks. Very helpful. That’s all for me. Thank you.

Our next question today is from the line of Connor Siversky of Wells Fargo. Connor, your line is open. Please proceed.

Hi, there. Thanks for taking the question. Just thinking about the 2024 guide figures that you have in the presentation and in terms of leasing, how should we be looking at new leases or the spread between new leases versus natural move out such that you can hit those occupancy figures and get to that 4.5% to 5.5% range?

Yes, Connor, this is Todd. If you refer to the bridge in our investor presentation, it's clearly outlined there, and Rob covered it as well. We achieved a new leasing volume this quarter of about 450,000 square feet, which is expected to continue throughout 2024. We really expect to gain momentum in the second half of the year, moving from the high 300,000 square foot level in new leases during the fourth quarter, to crossing into the 400,000 range in the first half, and reaching the 450,000 range per quarter in the latter half of the year. This level is crucial, and during our Investor Day, we noted that the third quarter leasing volume aligns with our plans to generate new leases that will enhance occupancy. However, as Rob mentioned, the move-out figures are equally important. In the third quarter, the number of move-outs exceeded our expectations, leading to lower retention rates than we desired. Therefore, we are implementing various strategies to boost tenant retention, and we anticipate that these efforts will yield results. We have seen progress already, based on survey feedback, and expect the move-out rates to align more closely with expirations, targeting the mid to high 20% range. When we calculate that, it correlates to the occupancy gains we displayed in our bridge, which are projected at 150 to 200 basis points from our position at the end of the third quarter. I hope that helps, Connor.

I appreciate the color there. And just maybe taking a longer-term view on the business, I appreciate the comments on responsible capital allocation for the next year or so. But when you look out past 2024, what does that opportunity set look like in outpatient medical? I mean, I would assume that we're only really looking at on-campus assets, maybe a smaller slice of the broader pie, but just any indication of what that addressable market looks like would be appreciated.

Sure. We actually touched a little bit on that on the Investor Day. At least one of the buses that I was on, Ryan Crowley, who heads up acquisitions and his team have a very specific analysis of the total addressable market. And it's quite large, gives us a lot of runway. And that was certainly one of the compelling pieces to the merger is to put together the two companies and have as many clusters that are especially better hospital-centric as you mentioned, that we can go in and expand. So we're very focused on 30 to 40 markets, where we can go in and expand our clusters, it's much, much larger than our company as it exists today. So it gives us a long runway to grow. And yes, it would be hospital-centric, but certainly, we're comfortable expanding our clusters even a little further away from the hospital, but they still are in sort of that two-mile radius of a hospital and complement our existing clusters. So, we see that as a very addressable runway. We talked about during the merger. Obviously, we're not doing this now, but really being able to elevate acquisition volume to $1 billion plus. And we were frankly on that path back on interest rates were lower and pre-merger, and we see that ability and we just have a richer target total addressable market and target markets that we can do post-merger, given all the clusters and markets that we're in.

Got it. I’ll leave it there. Thank you.

Sure.

Our next question today is from the line of Rich Anderson of Wedbush. Rich, your line is open. Please proceed.

Thanks. Good morning everyone. My question is about why now. We've discussed creating more growth in medical office for a long time, and I'm interested in your thoughts on why the opportunity is coming to fruition at this moment. Is it primarily due to the Healthcare Realty event, or do you believe that the overall business will begin to grow as well, possibly at a faster rate? I would appreciate any insights you can provide on that.

Sure, Rich. It's great to hear from you. The short answer is yes to both questions. As we've discussed, there are some ongoing trends that we believe will positively impact the broader medical office sector. Our focus, particularly after the merger, is to increase occupancy at the HTA properties, which have faced challenges in recent years, including a decline in occupancy due to a lack of attention and the impact of COVID. We see a significant opportunity ahead with our leasing, property management, and asset management teams to improve those figures. To address your question about why now, we anticipated a greater increase in the third quarter than we actually achieved. Our tenant retention wasn't high enough, but we expect improvement starting next quarter. So, we are a bit disappointed with the move-outs we experienced this quarter. The leasing side is performing as expected, and we are looking at 2024 as a pivotal year, beginning next quarter. Specifically, I believe we have a solid opportunity to reach a sustained run rate of around 4% to 5%, with aspirations to exceed that in our broader target for 2025. Overall, the medical office sector seems to be gaining significant momentum.

A lot of it is occupancy gains but are you also kind of conditioning tenants for higher rent growth as well because I just wonder about the sustainability of 5% same-store NOI growth in the back on the other side of this effort through 2024, once you achieved…

Occupancy cannot continuously increase, which we acknowledge. However, we have established a target of 90% for our multi-tenant portfolio, and currently we are around 85%. Achieving this 90% will provide us with a significant opportunity for growth, generating between 100 to 200 over the next year, which could allow us to maintain high growth levels through occupancy improvements for several years. Additionally, rent growth is an important factor in this equation. Our cash leasing spreads stand at 4.8%, and other medical office building companies are also reporting strong numbers, indicating positive momentum in this area. While we will primarily concentrate on occupancy, we will actively implement a dynamic pricing model where feasible. We have been advocating for this for some time and see it as a vital component of our strategy moving forward. Ultimately, the focus over the next two to three years will be on enhancing our occupancy rates.

Okay. Last for me. Rob, you mentioned mid-20s move-out percentage as a percentage of expirations. Just definitionally so I understand does that not mean sub-80% retention?

Yes. The way we're looking at it is move out as a percentage of expirations and the historical numbers put you in that mid to high 20% levels. It is sub-80%, but I think it's the retention levels that we've been reporting they do include our holdover bucket whereas this analysis that we're running does not include that holdover bucket. So there is a difference…

So we shouldn't interpret mid or mid-20s move-outs in your bridge as tenant retention running below 80% it's apples to oranges?

That's correct. There's just a definitional difference. So the way that tenant retention is calculated does get the benefit of month-to-month or holdover as well. And so that tends to add 5-plus percent to your retention rate.

Okay. Fair enough. Thanks. Thanks, everyone.

Thanks, Rich.

Our next question today is from the line of Mike Mueller of JPMorgan. Mike, your line is open. Please go ahead.

Yes. Hi. Curious where in the portfolio are you expecting most lease-up to occur? I know it's going to be tied to HTA, but is there anything notable in terms of geographies or tenant categories where you're seeing a bit more of outsized demand?

Sure. We briefly discussed this at Investor Day, but to emphasize, we definitely observe a significant presence in our top markets, which is encouraging because those are the areas where we see the greatest potential, resources, and skilled teams ready to capitalize on that. For example, we see substantial opportunities in Houston, which we've mentioned before. Other strong markets include Denver, Nashville, and various other appealing locations. Our focus remains on the larger markets where we have scale. As you noted, the HTA portfolio shows a considerably higher potential in these larger markets. Lastly, I want to mention our redevelopment group of properties, which have occupancy rates closer to 50%. This indicates considerable upside potential. Rob mentioned the signed but not occupied properties, where there is a notable difference of 630 basis points between occupied and leasing rates. We’re observing momentum in that area, with substantial changes taking place. We are actively repositioning and reinvesting capital, as well as tenant improvements, to enhance occupancy. There’s a wealth of untapped opportunity there as well.

Got it. And then what's the current thinking on dispositions outside of the JV formation and outside of what's expected to close in Q4 and Q1? So if we're thinking beyond what's been announced so far how significant can dispositions be in 2024?

Yes. It's a balance. Kris talked about $138 million that are under contract and scheduled to close this year, and another 180 behind that that could kind of flip on either side of the fourth and first quarter. I would tend to think—and this is our view currently which we'll continue to adjust as interest rates and cap rates evolve—but I would say we are still net sellers and we will continue to lean into non-strategic asset sales. And we haven't put out guidance for 2024, but I think directionally you could expect to see us putting out something that is in the neighborhood of what we did this year, which is maybe starting at $300 million and going up as we get more visibility through the year. So, certainly continuing to push that refining the portfolio trying to—as Kris articulated at Investor Day trying to do two things. One is use that incrementally to refine the portfolio, generate proceeds, pay down debt and so forth but it also improves the quality of the portfolio. And frankly the focus of our team on where we have that upside. So we'll continue to lean into that in this environment for sure.

Got it. And just one clarification. When you're talking about a starting point potentially being a similar number to this year is that inclusive of thinking of the JV as being effectively a disposition? Or are you talking about ignoring the JV this is all separate from the JV?

Ignoring the JV. So just completely separate. I really think about it as non-strategic asset sales whereas the JV would be much more about strategic assets in a seed portfolio.

Got it. Okay. Thank you.

Thanks.

Our next question today comes from Juan Sanabria of BMO Capital Markets. Juan, please go ahead.

Great. Thank you. It's Regan Sweeney on for Juan. Most of my questions have been addressed in the prepared remarks and some of the better questions here now. Also, I appreciate the NOI bridge. I just wanted to follow up on the signed but not occupied delta multi-tenants are at 210 basis points with HTA at 250? What's the historical spread just to kind of help contextualize this opportunity here?

The historical spread for HR before the merger was typically around 100 basis points or less. Currently, the Healthcare Realty segment of the portfolio is approximately $140 million, which is above our historical norms. Additionally, on the HTA side, at 260 basis points, it is significantly higher than our historical trends. This provides some context for the situation.

Okay. Thank you. And then just on the pipeline of the 1.7 million square feet obviously up from the Investor Day, how does this compare to historical levels? And then what's your historical conversion rate on the pipeline? Thank you.

Yes. I think if you look at if you kind of look at the pipeline in total I said $1.5 million at Investor Day it's now $1.7 million. It does has been ebb and flow at those levels. It's been pretty consistent this year. It's up some from the first of the year. I would say that that's when we put our processes and our leasing team in place we saw an uptick in the pipeline there. But I would say that really looking at the current levels and looking out over the course of the next year I view it as it's about four quarters' worth of activity. So it's probably going to remain pretty consistent at those levels and is enough to continue to drive the levels of new leasing that we've seen. So, we're very comfortable and optimistic with the level of the pipeline right now. In terms of the conversion rate I think I threw out the percentages of hey, you've got about 20% of that that's currently in the lease-out and documentation phase. That equates to about a little over 300,000 square feet. I would say that that's probably a pretty continuous level of percentage of the portfolio. We do view those as highly, highly probable that they'll all of that will convert. And so we're generally looking at about 20% to 30% out of that total pipeline. So, I do think that out of the lease-out and LOI piece, we generally find that we pull some of that forward as well and get it executed in the same quarter. So, some of that will feed the continuing new leasing pipeline or new leasing activity that we've targeted that's about 400,000 to 450,000 square feet.

And we have no further questions in the queue at this time so I'd like to hand back to the management team for any closing remarks.

Thank you, Harry and thank you everybody for joining us today. I know today is a busy earnings day with other companies as well. We look forward to seeing a lot of you at NAREIT in a couple of weeks and we'll be available otherwise. Have a great day. Thanks.

This concludes today's conference call. Thank you all for joining. You may now disconnect your lines.