Healthcare Realty Trust Inc Q2 FY2025 Earnings Call

Thank you for joining us. My name is Ian, and I will be your conference operator. I want to welcome everyone to the Healthcare Realty Second Quarter 2025 Earnings Conference Call. I will now hand the call over to Ron Hubbard, Vice President of Investor Relations. Please proceed.

Thank you for joining us today for Healthcare Realty's Second Quarter 2025 Earnings Conference Call. A reminder that except for the historical information contained within, the matters discussed on this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These 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. A discussion of risks and risk factors are included in our press release and detailed in our filings with the SEC. Certain non-GAAP financial measures will be discussed on this call. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings release for the quarter ended June 30, 2025. The company's earnings press release, earnings supplemental information, and Form 10-Q are available on the company's website. Now I'd like to turn the call over to our President and CEO, Pete Scott.

Thanks, Ron. Joining me on the call today are Rob Hull, our COO; and Austen Helfrich, our CFO. Also available for the Q&A portion of the call is Ryan Crowley, our CIO. We had a very busy second quarter with excellent results and contributions across the organization. Fundamentals are quite strong in outpatient medical, and that was clear with our second quarter print. Normalized FFO was $0.41 per share, a $0.02 sequential increase. FAD was $0.33 per share, a $0.04 sequential increase. Same-store occupancy was 90%, a 40 basis point sequential increase. Same-store NOI growth was 5.1%, a 280 basis point sequential increase. And net debt to adjusted EBITDA sits at 6x. In addition, it was the second highest new leasing quarter in the last three years. Year-to-date sales increased to $211 million at a blended 6.2% cap rate. We have over $700 million of additional assets under contract or LOI. We completed a very successful renewal of our revolver. We extended the tenor of our term loans, and we raised guidance. Rob and Austen will cover these items in more detail. A special thanks to the entire Healthcare Realty team for their extraordinary efforts this quarter. Moving on to our strategic plan, which we published on our website, concurrently with our earnings release. I have now been at Healthcare Realty just over 100 days, and my time has largely been spent seeing the real estate, assessing the team, and receiving valuable feedback from our shareholders. During the quarter, the team and I toured 10 core markets encompassing approximately 50% of our overall NOI and, more importantly, about 2/3 of our overall real estate value. In addition, I spent considerable time with our teams out in the field, including leasing and operations. Each of these interactions has influenced the strategic plan, and I am confident now is the right time to disclose the vision for Healthcare Realty 2.0. Let me start with my overall assessment. The good news. We have a best-in-class outpatient medical portfolio. We have scale in the right markets, and we are aligned with the nation's leading healthcare systems. In short, we have the essential ingredients of what is needed to be a successful real estate company: great assets, desirable locations, and solid tenants. That said, we have fallen short of expectations despite our solid foundation. Healthcare Realty 1.0 was a transactions-oriented culture that relied almost exclusively on acquisitions and development to drive growth to the detriment of asset management. This strategy worked too, and for many years, the company traded at a premium valuation. Unfortunately, this business model collapsed in 2022, and swift changes are necessary to reverse course and reestablish credibility. Healthcare Realty 2.0 will be an operations-oriented culture where earnings growth is paramount, strong tenant relationships are essential, leasing decisions are made based on economic fundamentals, and capital allocation is initially prioritized towards accretive reinvestment into our existing portfolio. With that as the backdrop, let me elaborate on the five key action items of the strategic plan. First action item, improved corporate governance. As was previously disclosed, we reduced the size of our Board from 12 to 7 directors. The go-forward Board brings fresh perspective and decades of industry experience to support our value creation initiatives. Five of the seven directors have been appointed since 2024, and all directors have been appointed since 2020. In addition, five Board members have REIT CEO experience. Second action item, a significant organizational restructuring. We have implemented a new operating model that will drive meaningful cost savings and promote incremental accountability at the property level between our operations and leasing personnel. This new asset management-oriented platform will create stronger and better-aligned tenant relationships. Over the past few months, I have had the benefit of sitting down with leadership at some of our largest health system tenants to discuss expansion opportunities. These tenants include Baylor Scott & White, HCA, Ascension, CommonSpirit, and Banner Health. With our enhanced platform and renewed focus, we can and will do better. To advance our platform changes, during the second quarter, we hired Tony Acevedo and Glenn Preston to lead our asset management efforts. Tony and Glenn have extensive track records in the outpatient medical sector, with 16 years and 25 years of experience, respectively. They have been trusted partners of mine in the past, and they have hit the ground running. Another important restructuring initiative is streamlining our corporate overhead costs. We've completed a thorough review of every line item and have already achieved our initial goal of at least $10 million in run rate G&A savings. One hundred percent of this has been captured through headcount reduction, office expense savings, and of course, the previously mentioned reduction in our Board size. At year-end, Julie Wilson, EVP and Chief Administrative Officer, will be departing the organization after a 24-year career with the company. We would all like to express sincere thanks to Julie, who played a valuable role in the growth of the organization. She will be missed. Third action item, portfolio optimization to maximize NOI growth. We have completed a full bottom-up, property-by-property analysis and segmented all 650 assets into three distinct buckets: the stabilized portfolio, the lease-up portfolio, and the disposition portfolio. Each of these buckets has different characteristics. Starting with the stabilized portfolio, which is 75% of the total. Ours is hands down, the premier outpatient medical portfolio, and our well-performing stabilized assets will be the primary engine of growth for Healthcare Realty 2.0. The stabilized portfolio consists of 470 properties, encompassing over 25 million square feet. It includes trophy properties on flagship campuses, such as Ascension St. Thomas Midtown in Nashville, MultiCare Overlake Medical Center in Seattle, and Baylor Scott & White All Saints Medical Center in Fort Worth, just to name a few. Current occupancy is 95%, NOI margins are over 65%. Our average lease term is 8 years, and our average escalators are 3%. Our strategy with this portfolio is to maintain high occupancy and maximize lease economics to drive consistent NOI growth. Moving to the lease-up portfolio, which is approximately 13% of the total. These 95 assets contain over 7 million square feet of well-located, health system aligned clinical space. Performance has lagged due to years of underinvestment or deteriorated local relationships. These properties are primarily located within our priority markets, with the top three markets of Denver, Dallas, and Phoenix comprising 25% of the square footage. We have strong conviction that through targeted ROI-driven investments and engaged asset management leadership, we can harvest meaningful upside in this portfolio and generate up to $50 million of incremental NOI. Current occupancy in these properties is 70%, NOI margins are 55%, and our rents are nearly 20% below market. In a bit, I'll touch more on unlocking this potential through prudent capital allocation. Shifting to the disposition portfolio, which is approximately 12% of the total. Over the last two years, NOI growth for these assets has lagged our stabilized portfolio by 700 basis points. In addition, 80% of this portfolio is located outside of our priority markets, where demographic trends are weaker, limiting upside potential. We can capitalize on the current strength in the outpatient medical transaction market to strategically exit these assets at attractive relative valuations. Today, we have a robust and balanced disposition pipeline across a variety of asset profiles to maximize value and minimize execution risk. We expect asset sales of approximately $1 billion to close in 2025 at a blended cap rate of 7%. We extensively evaluated the real estate fundamentals of these assets and believe our time and capital are best focused on the lease-up portfolio. The end result of the portfolio optimization strategy will be significantly improved occupancy and margin, an enhanced NOI growth profile, and a sharpened geographic focus. Fourth action item, reprioritizing our capital allocation internally. Our near-term priority will be investing capital back into our lease-up portfolio. This will come through two different types of targeted investments. Number one, ready to occupy spec suites, which we refer to as RTO, and our strategic investment into select vacant suites to drive leasing. Number two, redevelopment, which are significant investments to reposition buildings and drive higher rental rates, occupancy, and cash-on-cash returns. Between RTO and redevelopment opportunities, over the next three years, we estimate approximately $300 million of capital investment at attractive returns. Additional accretive opportunities, including acquisitions and development, will come when our cost of capital allows for it or we have sufficient balance sheet capacity. As our balance sheet continues to improve, we could utilize a portion of sale proceeds to repurchase stock should the opportunity present itself. Fifth action item, an improved balance sheet. The company has been playing defense for years with extremely limited financial flexibility due to excessive leverage. With the sale of the disposition portfolio, we expect net debt-to-EBITDA to be in the mid-5x area by year-end. This lower leverage, combined with extended maturities, will allow us to gradually shift from defense to offense. Turning now to the dividend. As a final part of the strategic plan, we completed a thorough and careful evaluation of the dividend. The result of this analysis is that the Board unanimously approved a dividend reduction of 23% to $0.24 per share on a quarterly basis. While we could maintain the dividend and grow into a sustainable payout ratio over time, the key factors for rightsizing the dividend are: it alleviates pressure from $1.4 billion of low coupon bonds maturing over the next 3 years; it provides $100 million annually of capital that we need to reinvest into our portfolio to drive performance; and it positions the company to maximize our go-forward earnings potential. Let me finish with the value creation opportunity. In our strategic plan presentation, we have included a high-level framework for a potential earnings growth over a 3-year forward-looking period. There is a clear path to creating attractive FFO per share, and the analysis excludes any upside from accretive capital allocation. In addition, we currently trade at approximately 10x FFO, which is 6 turns below both our 10-year average and the 10-year average of our healthcare REIT peers. We know our evaluation is a function of many self-inflicted wounds and a loss of credibility and does not remotely reflect the significant value embedded in our irreplaceable portfolio. With the purposeful changes underway at Healthcare Realty 2.0, we see a real opportunity to improve operating performance, restore credibility, and unlock shareholder value. With the implementation of our strategic plan, we will remain the only public REIT focused exclusively on outpatient medical. We will have a positive earnings outlook. Our balance sheet will be a source of strength. We will no longer be burdened by an uncovered dividend. We can use free cash flow to invest accretively in our portfolio. Our assets will be operating at maximum NOI capacity. We will have a lean cost structure, and we will have a best-in-class team and Board. We are firmly committed to this vision and are confident it will maximize value for all stakeholders. Nevertheless, over time, if our platform continues to trade at a significant discount to our intrinsic value, then it will be our responsibility to explore all additional alternatives needed to unlock value. Let me now turn the call over to Rob.

Thanks, Pete. Demand for outpatient medical space remains strong, driven by tightening supply and the ongoing migration of services into a lower-cost outpatient setting. During the quarter, we executed nearly 1.5 million square feet of leases, including over 450,000 square feet of new leases. Our signed non-occupied pipeline, or SNO, remains solid at nearly 610,000 square feet, representing almost 170 basis points of occupancy in the coming quarters. We continue to see robust demand from our health system partners, accounting for about one third of our lease execution this quarter. A few notable transactions include a 24,000 square foot new lease in a redevelopment project on the campus of HCA's North Cypress Hospital in Houston; a 42,000 square foot renewal, also in Houston, with a premier pediatrics group associated with Texas Children's Hospital; and a 23,000 square foot new lease in Orange County, California, with UC Irvine Health. UCI recently acquired the campus hospital from Tenet Health. Looking ahead, our new lease pipeline remains solid at over 1.3 million square feet and growing. Within our pipeline, about 60% is in the letter of intent or lease documentation phase, indicating a high probability of lease execution. Shifting to operations. The second quarter marked the beginning of our transition to an operating platform with a greater focus on asset management. As Pete mentioned, we made some key hires to lead the team and have taken the initial steps to transition portfolio operations under their leadership. We expect to complete the transition to this new model by year-end. Once completed, we will continue to refine the platform over the next year by implementing new operating procedures, identifying further efficiencies, and emphasizing discipline around leasing decisions based on economic returns. Turning to our same-store portfolio. With strong new lease commencements and tenant retention of 83%, we gained 40 basis points of occupancy this quarter. Consistent with seasonal trends, we expect most of our occupancy gains to come in the second half of the year. Our outlook for 2025 remains 75 to 125 basis points of absorption by year-end. I want to congratulate our team on the leasing and absorption progress we made this quarter. With a robust leasing pipeline, strong tenant retention, and tightening supply, our portfolio is poised to see further leasing momentum and NOI growth throughout the remainder of the year and into 2026. I will now turn it over to Austen to discuss financial results.

Thanks, Rob. In my remarks this morning, I will cover our second quarter results, progress on asset sales, balance sheet improvements, and increased 2025 guidance. But before I jump in, let me say how pleased I am with our performance this quarter and our momentum heading into the back half of the year. Now let's dive into the details. Normalized FFO per share was $0.41 for the quarter, up nearly 7% year-over-year, driven by strong occupancy gains, disciplined cost management, and a decrease in share count. Quarterly FAD per share increased to $0.33, representing a 96% payout ratio, a significant improvement from the first quarter, primarily due to strong earnings growth and lower seasonal maintenance capital. Second quarter same-store cash NOI growth of 5.1% was the highest in nine years, as a 100 basis point increase in occupancy, coupled with strong expense controls, drove 50 basis points of year-over-year margin improvement. Since the start of the year, I've been transparent that we expected the first quarter to be a difficult comp and growth to meaningfully accelerate beginning in the second quarter. I will say that I'm very pleased with the level of growth in the second quarter and believe that it more accurately reflects the strong current fundamentals in our business. On disposition activity, we completed $211 million of asset sales through the end of July. Inclusive of a $38 million loan repayment, our total proceeds generated year-to-date are approximately $250 million. Consistent with our disposition strategy, the sales were largely concentrated in assets with weaker growth prospects outside of our priority markets. Importantly, we fully exited two smaller, slower growth MSAs in Indiana and Washington. With an additional $700 million under contract or LOI, we are raising our full year disposition outlook to $800 million to $1 billion as part of our strategic plan. Turning to the balance sheet. In the second quarter, we successfully completed the first phase of our derisking strategy. Today, we are pleased to announce the recast of our $1.5 billion revolver as well as the addition of extension options to all of our outstanding term loans. We extended the outside maturity of our revolver to 2030 and term loans to 2027 and 2029. With this, we have decreased the amount of debt maturing through the end of 2026 from $1.5 billion at the end of the first quarter to approximately $600 million today. This decrease in near-term maturities gives us financial flexibility and bolsters our liquidity profile. We'd like to thank our bank partners for a very successful transaction. Over the coming quarters, we will execute the next phase of our balance sheet strategy as we delever by paying off our 2027 term loans with disposition proceeds. Pro forma for our July asset sales, our net debt to EBITDA is 6x, and we expect leverage to decrease into the mid-5s to the balance of the year. Coupled with the announced dividend resizing, our liquidity and leverage profile has vastly improved from just a few quarters ago. I'm very pleased to report that we are raising our 2025 normalized FFO per share outlook by $0.01 at the midpoint to $1.57 to $1.61. Driving this change is the reduction in our G&A expectations reflecting the restructuring efforts discussed in our strategy presentation, as well as a 25 basis point increase in our same-store NOI guidance. We are proud of our second quarter financial performance and energized by our improved outlook for the year despite an almost $500 million increase to our disposition guidance. Before turning to Q&A, I'd like to highlight two items from our second quarter press release regarding reporting. First, this quarter, we began reporting leverage utilizing the carrying value of debt. This aligns with the methodology of our peer group as well as the rating agencies. Second, we adjusted our maintenance capital definition to align with peers by classifying leasing commissions based on corresponding TI classifications. Simply put, any leasing commissions associated with first-generation capital spend will now also be classified as first generation. This aligns us with industry norms, and we expect this change to reduce maintenance capital by approximately $5 million to $10 million annually. It is important to note that our FAD per share in the second quarter would have been $0.32 even without this change. Operator, we're now ready to move to the Q&A portion of the call.

Our first question comes from Nick Yulico with Scotiabank.

I would like to start by asking about the strategic plan, particularly regarding the lease-up portfolio. Could you elaborate on its composition? Is it entirely multi-tenant, or does it include any single-tenant properties? Additionally, I want to clarify the potential upside; you mentioned an upside of $20 million to $40 million in that portfolio over three years, but there's also a $50 million figure referenced elsewhere. Could you explain the difference between these two figures and provide more detail on the portfolio composition?

Nick, it's Pete here. Hope all is well, and great to hear from you. I'm glad you brought up the $20 million to $40 million versus the $50 million of upside. We see $50 million in total upside. I think realistically, it will take us some time to start to spend that capital. To get that return immediately, these redevelopment projects can take upwards of 12 to 18 months. We've obviously identified a nice group of assets that will go into redevelopment. But to get the full $50 million within the first three years, I think, would be a very aggressive assumption. So we did add some footnote disclosure that we still assume we'll get the full $50 million, but it's going to get layered in or phased in over a little bit of time. As to the lease-up portfolio, I think what gets me really excited about the opportunity to get the upside, the $50 million that we're talking about is if you simply just look at that map page and you see where these assets are located, I mentioned the top markets being Denver, you got Dallas in there as well. There's some other really good markets too, Houston, Charlotte. And the way I think about it is it's really like a value-add portfolio embedded within our primary markets, and we really like the demographic trends within those markets. So that's what gives us the confidence to be able to put out a number like that, which is a pretty big incremental amount of capital and amount of NOI. But we feel quite good about our ability to achieve that.

I wanted to clarify the capital being allocated to that portfolio. You mentioned $300 million over three years, but I wasn't certain if there was additional funding needed to reach the total upside of $50 million. Also, I understand you have funds saved from the dividend cut, but I believe there may be some capital from asset sales, aside from what you're using to pay off debt, that will be allocated to this portfolio.

We believe that $300 million is necessary to achieve the full $50 million. We don't anticipate needing additional capital to cover the remaining amount you're referring to. Our main source of funding is through the adjustment of dividends. However, the funds are interchangeable. Therefore, if we can start some of these developments or redevelopments earlier, we could use proceeds from sales for that purpose. We're positioning our balance sheet to transform it from a weakness into a strength. The source of the funds is flexible; we don’t need to wait until year three to spend that capital if opportunities arise sooner.

Our next question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets.

Just wanted to follow a little bit up on sort of the redevelopment pool and some of the rents that you've outlined and the confidence that you can kind of get from that low $20 range up to nearly $40 once you invest this capital. Just, can you talk about that versus maybe underlying market dynamics?

Yes, I can address that. We do observe some below-market rents in the areas where we plan to redevelop our properties. While I might not point to the White Plains example we've included in our presentation, it does illustrate how we can reach a solid 10% cash-on-cash yield. Rents there were in the low 20s, and with our capital investment, they've increased to around $40 a share, which is a significant rise. However, White Plains is a unique market, and we've had considerable leasing activity with White Plains Hospital. Still, this might be an extreme case of what can be achieved. The internal rates of return for that project would be significantly higher than the 10% cash-on-cash yield. With capital being invested, we see opportunities to enhance rental rates. While I can't guarantee they'll rise from $23 to $40, we do anticipate a healthy increase. Our underwriting approach will be cautious, and we do require that 10% cash-on-cash yield.

I apologize for the confusion. That was just one example. Austen, I wanted to ask about the significant increase in capitalized interest, which I assume is related to some of the redevelopment. Was there any change in the policy regarding this? You mentioned the capital needs and the decision to move these forward into redevelopment, but it doesn't seem that it was included in the projects currently under construction in the supplemental.

I want to emphasize that in the supplemental materials, we currently have nearly 2 million square feet designated for redevelopment. On the redevelopment page, we specifically outline around 650,000 square feet, but there's an additional 1.2 million square feet that is not detailed on that page, as mentioned in the footnote. We've been actively working on these redevelopment projects since the beginning of the year, with a substantial part of them starting in the second quarter. Consequently, this commencement has led to an increase in capitalized interest, which I believe you are referring to. Moving forward, as we focus on our strategic plan for redevelopment over the next three years, we will provide more detailed information on that page to give you a clearer view of our redevelopment portfolio.

So how much of that should we align with the spending, and should that increase as you progress with the redevelopment efforts?

Yes. I think from here, Austin, what I would tell you is given the increased level of spend that we will have in redevelopments and the increased projects that Pete spoke about earlier in the lease-up portfolio, I think you should assume that capitalized interest stays at around this level going forward. It will obviously move from quarter to quarter, just depending on development moving out or redevelopments moving in and out. But I think generally, around this level would be a good assumption.

Our next question comes from the line of John Pawlowski with Green Street.

Rob, I wanted to drill into the lease-up portfolio, but specifically the ready to occupy space. Can you give me some historical context of why you couldn't get this occupied, why was it under managed and what you're going to do specifically going forward to unlock that potential?

Yes. John, maybe I'll start with that. And then I want Rob to go through the RTO program, which we've had a lot of success on. I mean, I went out and saw a lot of markets this last quarter, and I intend to see a lot more going forward. I'd like to see every single asset in the portfolio. What I would say is that it was very clear as I went out into the market that certain assets had just been underinvested into for many, many years. And that would be well before the merger as well. And a lot of these assets were assets that came over as part of that merger. We own them now, so they're ours, right? But they clearly had not been invested into. And the other thing I would say that became very clear to me in certain markets is the relationship with the health system had deteriorated or declined to a level where they were not supporting our assets even if they were proximate to the hospital. And that's a problem, when you don't have your health system and your partner in that market supporting your real estate. We are fixing that. The team has been fixing that. Good work has been done, but there is more work to continue to do. And I'd say a great example of where this has turned around is in Houston with our North Cypress assets. I would say the relationship with HCA was fractured for many, many years. We are redeveloping that campus. We're actually having a lot of progress there in leasing that up. And we're getting the support of the local hospital CEO, who is actually encouraging tenants to look at our properties now, as opposed to discouraging them in the past. So those are really the main two drivers. I mean, there's more in there, John, but I just wanted to lay out what I saw when I went out into the road that became abundantly clear to me. Maybe I'll have Rob just talk about the RTO program now.

Yes, thank you, Pete. The RTO program has clearly been successful for us in the past and is doing even better now. To date, we've leased just over 100,000 square feet through this program. In the second quarter, around 16% to 17% of our new leases came from the RTO program, indicating strong success. The program allows us to meet the needs of tenants who require quick move-ins, sometimes even within the same month. Having move-in ready suites is crucial for our leasing team. Additionally, the transition from signing a lease to receiving cash rent is considerably expedited through the RTO program. Typically, we see an improvement of 6 to 10 months in this timeline. This results in significant benefits for our cash flow. In terms of returns, we are generally aiming for mid-teens IRRs with an expected hold period of about seven years for these deals, providing substantial returns and effective use of capital for the organization.

Okay. Second question is on the pool of assets you've sold or in the process of selling. I think the average 7% cap rate struck us as high given they're only 80% occupied. So maybe buyers would be underwriting a higher going-in yield. Is it mostly a function of deferred CapEx or onerous or short-term ground leases? What's pushing those cap rates on those assets higher in terms of a stabilized cap rate?

Yes, it's a variety of factors. Let me have Ryan Crowley provide some insights on that portfolio.

Yes. When you think about what we have under contract or LOI, you're looking at over 40 different assets and nearly 20 different transactions. And these assets really run the spectrum of MOB types, whether it's on-campus or off-campus, single tenant, multi-tenant, large, small ground lease terms of various term lengths. So yes, you're right. I'd say there's definitely a value-add component in there. But there's also some core assets in undesirable markets that are sprinkled in there. So when you think about what we're really doing, the overarching theme is that we're exiting markets with weak real estate fundamentals where we don't have scale and we don't see a path to scale. But by and large, the disposition portfolio is generally characterized by lower occupancy, lower margin and older vintage. And all those things play into that 7% blended cap rate you're talking about.

Our next question comes from the line of Omotayo Okusanya with Deutsche Bank.

Pete, great to see you shaking the table so soon. Question around the lease-up portfolio, the $300 million you talked about. Trying to understand the $50 million NOI opportunity there. How much of that is just pure lease-up versus how much of it again is kind of getting better pricing after you reposition these assets? And could any of the repositioning or redevelopment be disruptive to current NOI?

Yes, it's great to talk with you too. I would say that most of the $50 million comes from increasing occupancy from 70% to 90%. However, improving rental rates will also contribute. Currently, we aren't generating any income from the vacant space, and we're covering all associated expenses. The primary driver of this increase will be filling those spaces with tenants. That said, we believe there is potential to raise rates with the capital we invest. If we don't see that potential, we may consider selective renovations and focusing on vacant suites. Not all of this growth will stem from redevelopment; among the 95 assets we’re looking at, we identify about 10 that are suitable for redevelopment where we expect to achieve the necessary returns. The remainder will largely come from targeted investments in the vacant suites.

Got it. That's helpful. And then Austen, just hoping you could help us kind of reconcile guidance. Again, you have a $0.01 increase in the guidance. You are picking up from increased same-store NOI of $0.01 or $0.02, you are picking up on the G&A spend, about $0.01 or so. It sounds like you're talking about a higher capitalized interest, that's also a couple of pennies. You have an offset from increased asset sales, but it still feels like that all kind of sums up to $0.03 or $0.04, but guidance was already increased by $0.01. Just trying to understand the difference.

Yes. Thanks for the question. I think you should assume that we had good insight into the capitalized interest moves at the beginning of the year. And so what I would point you to from a guidance perspective is really the $4 million decrease in G&A, coupled with the 25 basis points increase in same-store NOI. And then obviously, we've taken disposition volume up $0.5 billion. What I would also say, Tayo, is we're halfway through the year. Ryan and his team are very hard at work at getting through the $1.2 billion of strategic dispositions as quickly as they can. We've guided $800 million to $1 billion this year. But I would say it's early in the year, and there's continued timing uncertainty around when exactly Ryan will close on dispositions in the back half of the year. So I'd say when you put all that together, we're pleased to be able to raise $0.01 given the increase in dispositions and given what Ryan and his team are working to accomplish this year.

Our next question comes from the line of Seth Bergey with Citigroup.

What gives you the confidence you can achieve the 92% to 93% occupancy given occupancy has kind of trended near the high 80% range over the past several years? Is that just a function of go-forward portfolio composition? Is it the change in the structure to better align leasing and operations? Just, if you could talk a little bit more about that.

Yes, I would like to emphasize a few points. First, the overall economic climate has improved, and if you look back over the last five years, especially the last couple, we've observed an upward trend in outpatient medical occupancy. This indicates that demand is surpassing supply, and I believe this trend will continue into the foreseeable future, presenting us with significant opportunities. Additionally, we are making substantial updates to our asset management platform, which I mentioned in my earlier comments, and we anticipate seeing positive outcomes from this initiative. We're also divesting from assets that have traditionally experienced low occupancy. As we transition from the high 80s occupancy rate to the low 90s, these asset sales will definitely contribute to that goal. Currently, our same-store occupancy stands at 90%, which I believe is the highest it has been since around 2016. It's been nearly a decade since we achieved a 90% occupancy in the same-store metrics. Clearly, changes are happening organically. Furthermore, as noted in my previous remarks, the company was not in a position to generate free cash flow for reinvesting in its assets before. The balance sheet represented a significant liability rather than a strength, but we are addressing those issues. I am now quite confident that we have the cash flow needed to reinvest in our assets and increase occupancy, something that hasn't been possible for a long time. For all these reasons, I am optimistic that we can reach the 92% to 93% occupancy range over time. It won't happen overnight, but you should see incremental improvements as we complete more asset dispositions.

And then you talked in your opening remarks about the opportunities for expansion with some of your top tenants. Can you just provide a little bit about what that looks like? Is that kind of investing in the portfolio and leasing existing space to them? Is that external acquisitions? Just kind of what does the growth opportunity look like with that?

Yes. I think first and foremost, it's having our health systems expand within our existing portfolio if there's room for that. And I think what we outlined on that slide in the strategic plan was in some cases, we can do better, right? And I think we will do better, and we've opened communication with all those health systems to improve upon that. And I feel confident that we will gain some traction within that. I don't know, Rob, if you want to add anything more on to that topic?

Yes. I believe restructuring the platform will be beneficial in this regard. Strengthening local relationships is essential. Additionally, there are significant opportunities within the redevelopment lease-up portfolio, where we have established strong relationships that we intend to build upon. We anticipate that many of these opportunities will be pursued by health systems. As I mentioned earlier, approximately one third of our leasing came from our health system partners, and I believe we can improve on that. Therefore, we will continue to focus on increasing that statistic.

Our next question comes from the line of Juan Sanabria with BMO Capital Markets.

All right. Just maybe piggybacking off of Tayo's prior question with regards to dispositions and the earnings. So how should we think about the exit run rate? Because it seems like some of the disposition dilution won't necessarily be fully factored into this year's increased FFO guidance. And as part of that, could you talk about the kind of the next leg of cost cutting and what's driving that?

Yes, let me begin by saying that we've been dedicating a significant amount of time to reviewing the platform and identifying savings. We've focused heavily on the general and administrative side and are pleased to have identified approximately $0.03 in savings to help mitigate some of the dilution as we aim to strengthen our balance sheet. While these discussions can be challenging, there is a shared understanding of our objectives among the team. We will continue to seek further savings, primarily at the property level, which will enhance our margins as we finalize dispositions and manage our stabilized and lease-up portfolio. Although the reduction in the total number of employees in the platform contributes to margin improvement, the primary factor for enhancing margins will be increasing occupancy. Our emphasis will shift to this area. We do have more cost-saving opportunities available, but the key to driving FFO growth will come from lease-up and revenue growth.

Juan, it's Austen. Maybe I'll just touch on your disposition. I think at the beginning of that, you had a question around disposition timing as well?

Yes. More just the run rate given the acquisitions are going to be back half loaded on how you'll exit the year from an FFO perspective vis-a-vis your revised guidance?

Yes, that makes sense. I would refer you to Page 28 of the strategy presentation, Juan, to provide some insight on this. Regarding the dispositions, we are looking at $1.2 billion at a 7% cap rate. You should anticipate that we are selling assets at that 7% cap rate to reduce debt at about 5%. We have provided the $0.06 of projected dilution based on the revised guidance for '25. It is reasonable to assume that most of that $0.06 will impact 2026. If we finalize additional asset sales in '26, I would expect those to occur earlier in the year. Therefore, it is a good idea to factor in the full $0.06 impact in your '26 projections.

Perfect. Could you provide a breakdown of the capital expenditure for the lease-up? Some of it seems to be for redevelopment, while some is first generation, which is currently not included. I'm interested in understanding the different categories of CapEx that will contribute to driving higher lease-up occupancy and what will and won't be included in that, if that makes sense?

Yes, I think it's a good question, Juan. If you look at redevelopment and the RTO, RTOs fall into first-gen capital. And then obviously, we break out the redevelopment separately. So I would assume that the vast majority of that $300 million will not be included in maintenance capital.

Our next question comes from the line of Michael Gorman with BTIG.

Pete, could you spend just a minute on kind of the core portfolio? You talked about a focus being maximizing lease economics. And maybe give us some context that with the new organizational structure and with kind of the refined focus, maybe what the opportunity set there is from the lease escalator perspective or the lease spread perspective to kind of drive incremental growth out of that 75% that really represents kind of the core of the HR platform?

That's an excellent question, Michael. I believe that's going to be the primary factor driving our growth and earnings expansion in the future. One encouraging observation during my recent visits to the real estate was that, while it doesn't happen in every lease, we're sometimes achieving escalators of up to 4%. In the past, escalators were typically around 2.5% and remained stagnant for extended periods. Now, we’re seeing a trend toward 3%. Currently, 3% is quite common unless a tenant has a lease extension option with a fixed escalator. In cases without that, we're securing terms of 3% or higher for every deal, and we're even discussing the possibility of pushing that further. Additionally, with our portfolio being 95% occupied, we aim to maintain high retention rates since capital expenditures and downtime significantly affect future earnings. Thus, ensuring the portfolio remains fully occupied and focusing on retention is crucial. Furthermore, when occupancy is at 95%, enhancing cash leasing spreads is also important. Overall, it’s a combination of these strategies, and I believe we're going to continue to work on increasing the escalators to achieve success.

That's helpful. And then maybe a question for Ryan. Can you just give us a sense for, as you look at the pipeline of dispositions, given the volatility we've seen year-to-date, how leverage sensitive are the buyers that are coming in and looking at these assets? Or are these more cash buyers, owner occupants? What's the composition of the buyer pool here for those dispositions?

Yes, it's a great question, Mike. And given the breadth of what we're doing, it really runs the gamut. What I would say is that today, there's more buyers and more equity looking to be deployed than there are assets available for sale. Frankly, our bid rosters, we've seen them deeper here on recent deals than we have in recent years. And we're seeing a lot of competitive bidding in the later rounds of our transaction processes, and that drives up pricing. So as we work through this large disposition portfolio, as always, it's about finding the right property for the right buyer. And the private investors, operators they've partnered in recent years with a lot of new institutional equity that's come into our space. And that equity is continuing to look to flow into the outpatient medical. Over the last several quarters, the financing market has been accretive to going-in cap rates. We've seen banks really step up. Today, they're eager to lend. We've seen compression on the spreads and we've seen good movement on the base rates. And today, if you're looking at financing a deal that you're acquiring from us, it's 5.6 to the low 6s on an all-in rate, which again is accretive to going-in cap rates. Cap rates today, we're seeing deals go off in the high 5s to the 7 range for a stabilized asset. You could see typically in that 6.5 cap rate range. But one of the more interesting observations we've had as we've been progressing through the dispositions through the year is a real increase in health system MOB acquisition activity. The proportion of deals that were going to health systems has more than doubled when you look at the transaction volume over the last two years. And what's interesting about the health systems is their decision making. It was less about price. It's more about long-term strategy and control over an asset. And frankly, that's constructive to our disposition pricing. So we're doing direct deals with health systems. We're doing marketed deals that are broker-driven. We're maximizing price and finding the right buyers. And there's no shortage of buyers out there.

Our next question comes from the line of John Kilichowski with Wells Fargo.

Great work on the strategic plan, team. My first question concerns the G&A savings. I understand that approximately $5 million has been identified. Could you help categorize that second tranche of savings, or perhaps the entire amount, into what has already been achieved and what has been identified but not yet reached? Additionally, could you provide a timeline for when you expect to achieve those savings as part of the 3-year plan?

John, it's Austen. Let me bucket this starting with the G&A savings that we have already identified and I would say, carried out the actions necessary to achieve. That is the $10 million of initial savings that we spell out in the strategy presentation. We will have achieved $5 million of that this year, and we expect to capture the remaining $5 million next year. If you then look at Page 28 of our 3-year growth plan, we are highlighting another $5 million to $10 million in additional saves beyond the $10 million of G&A that I just outlined. I think it would be safe to assume that $5 million to $10 million will be embedded more on the property operating expense side. As Pete mentioned, the majority of the increase in margin at the properties will be driven by occupancy. But with the asset management platform and new leadership, we do believe there are some opportunities to achieve some additional savings in there as well. But I would expect that to be more split over the next 3 years.

Got it. And then maybe on the same-store performance. The same-store cash NOI growth is running still well ahead of the midpoint of your new revised upward guide. I'm curious, how much of that is just you're seeing better demand for your product and better leasing up versus maybe this is also part of the culling process of those noncore assets?

That's a great question, John. To be specific, the assets sold during the quarter had a minimal impact of about 30 basis points on our same-store performance, so we maintained a 5 either way. If you examine the details, you'll find that the 100 basis points year-over-year increase in occupancy is significantly contributing to the same-store NOI growth. In the first quarter, I mentioned some tough comparisons, but as we approach the second quarter, I believe the figures will better represent my expectations for the business, given the occupancy increases we've noted year-over-year. Regarding your previous question, our same-store growth year-to-date stands at 3.9%, which is slightly above our revised guidance for the year. However, as we reach the halfway point, there's still considerable leasing to be done, so we’ll see how things unfold in the third quarter and provide an update then.

Yes. And the one thing I would add to that, John, I mean, obviously, as you look at the three-year framework that we put out in the deck, it's got 3% to 4% NOI growth embedded within it. I mean, I'm searching for the 3% to 4%. I know some of the numbers you've seen have been at 5%. If we could do better, great, but the baseline that we set out was the 3% to 4%. We're working hard to achieve that.

Okay. Very helpful. And just one last question for me. I know Pete, you've already talked a lot about this today, but regarding CapEx and the focus on the RTO plan, I'm curious about how to think about the pace of CapEx as a percentage of NOI moving forward.

Yes. Austen, do you want to take that?

Yes, I think, John, it would be a fair assumption. I answered this a little bit earlier, but just to put a fine point on it, the RTO program is really, I think, what many people call a spec suite program, which is going to fall into and does fall into our first-generation TI bucket. And then the capital for redevelopment will obviously flow through the redevelopment bucket. So I think from a maintenance capital perspective, it would be fair to look at our year-to-date experience and assume that's a reasonable starting place looking forward.

But maybe that didn't answer your question entirely. I know those are all the right facts. Your question might be how we should model the $300 million being spent. I think the RTO will probably be spent evenly over three years. For the redevelopments, the best assumption right now is that it will also likely be a steady spend. However, if we can accelerate that a bit, that would be great. We mentioned $20 million to $40 million of the $50 million in our framework, and I’d like to maximize that. Initially, we thought about spending it over three years, and if there’s an opportunity to speed it up, that would be fantastic. But for modeling purposes, I would consider that $300 million as $100 million each year for the next three years.

Our next question comes from the line of Mike Mueller with JPMorgan.

I have a couple of questions. But first, could you clarify something? Rob, when you mentioned 75 to 125 basis points of leasing absorption in '25, did that refer to overall occupancy, same-store occupancy, or multi-tenant occupancy? What was the specific metric?

Yes, that's the same-store occupancy gain guide that we gave for this year.

Okay. So that's overall. Okay. When we consider the 3-year NFFO target of 165 to 185, what are the main factors influencing the range from the top to the bottom?

Go ahead, Austen.

Yes. Good question, Mike. I think on Page 28, we try to give you some of, kind of what I'll call the goalposts here for either side. I would say I think some of the biggest things that we'll look to drive as the biggest number, if you look across this page, right, is the annual NOI growth that Pete touched on earlier for the base portfolio. So driving that compounding cash flow growth of 3% to 4% in the portfolio. The closer we can be to 4%, the bigger that delta becomes and there's obviously an enormous amount of spread there in terms of the compounding over 3 years. I think the second is how quickly can we achieve the $50 million of upside in the lease-up portfolio. From a redevelopment perspective, that can take time for that number to hit. So how much falls into that three-year period, we're going to be working as hard as we can, but that will be a little bit of a spread as well. I think from the dispose and other things we've laid out, those things kind of are what they are. And the math is what it is at this point based on the strategic plan. I would kind of point to those two topside items.

And obviously, Mike, as you know, everyone is going to model our refinancing rates in some way. And we laid out what we think the sort of bookends are with a little bit of cushion on the low end and the high end. I mean, we have zero control over that at this point in time. So obviously, that could change, and there's nothing that we can obviously do about it. I mean, obviously, we would be fans of rates declining. I think everyone in REIT land would say that'd be fantastic, but we don't have any control over that. But we did lay out what we thought were kind of the bookends today, and that could change tomorrow.

Our next question comes from the line of Omotayo Okusanya with Deutsche Bank.

I just wanted to follow up and see what your thoughts are on the Big Beautiful Bill and its possible positive or negative effects on medical office buildings.

Yes. I mean, that's a good question. I think the short answer is probably it's still a little too soon for us to know exactly what's going to happen. We actually met with one of our larger health systems earlier this year, and she conceded that they're still getting their arms around what exactly this means. So I'd say probably too soon to tell. Our initial reaction to it is like a lot of these changes, it tends to indirectly have a benefit on the outpatient model, and that's something that has not changed for a long time. And I think there are charts that show that, that's been happening for many, many years, just given the profitability inside of our buildings versus inside of the hospital. What hospitals could be most affected by this, we have talked about that as well. And I think the rural hospitals are probably the ones that will struggle the most with the Medicaid costs. We really are not impacted at all by that, just given where our assets are geographically located. So it's a good question, Tayo. We're continuing to monitor it. I mean, and outside of that, there's obviously been some CMS proposals that have been out there on site neutrality, that's come up a little bit. And again, I'll just reiterate the point I said before, which is that, to me, feels more like a real benefit to the outpatient model as doctors can choose the site where they would like that procedure to happen. They don't just have to have the default at the hospital. And again, we see that as a demand driver for our space as well. And I think a lot of our other peers have been saying the same thing as well. So it's a really good question. We're continuing to monitor it, but I don't look at it as having an impact necessarily on our business.

And there are no further questions at this time. I would like to hand the call back over to Pete Scott for some closing remarks.

Yes, perfect. Thanks very much, and look, thanks for everyone for joining the call. We put a lot out. We appreciate you digesting it all and asking some great questions on this call. We look forward to seeing all of you as we get out into the market and do a lot more IR work this quarter. So we look forward to seeing you in the upcoming months. Thanks very much.

This concludes today's conference call. You may now disconnect.