Physicians Realty Trust

Greetings, ladies and gentlemen, and welcome to Physicians Realty Trust's third quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. Should anyone require operator assistance, please press star zero on your telephone keypad. It is now my pleasure to introduce your host, Mr. Brad Page. Thank you, sir. You may begin.

Thank you. Good morning and welcome to the Physicians Realty Trust third quarter 2020 earnings conference call and webcast. Joining me today are John Thomas, Chief Executive Officer, Jeff Tyler, Chief Financial Officer, Deanie Taylor, Chief Investment Officer, Mark Fine, Executive Vice President of Asset Management, John Lucey, Chief Accounting and Administrative Officer, Lori Becker, Senior Vice President, Controller, and Dan Klein, Deputy Chief Investment Officer. During this call, John Thomas will provide a summary of the company's activities and performance for the third quarter of 2020, and year to date, as well as our thoughts for the remainder of 2020. Jeff Tyler will review our financial results for the third quarter of 2020. Then Mark Fine will provide a summary of our operations for the third quarter of 2020. Following that, we will open the call for questions. Today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. They are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although we believe our assumptions are reasonable, our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations and those anticipated or implied in such forward-looking statements. For a more detailed description of potential risks and other important factors that could cause actual results that differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission. With that, I would now like to turn the call over to the company's CEO, John Thomas. John?

Thank you, Brad. Thank you for joining us this morning. Physicians Realty Trust had another strong quarter with tenants open, operating, and providing high-quality healthcare services. Substantially, all providers that lease space from us have stabilized and are paying their contractual rent and obligations, as we have collected over 98.4% of our third quarter rent and are now near 99% for the second quarter. We continue to view medical office as the most resilient class of real estate in the market, and our portfolio of medical office buildings delivered outstanding results in this quarter. This includes the physician joint venture tenant that we mentioned last quarter. After struggling to operate and pay rent at the height of the pandemic in April and May, they are now back in their offices and have remained current on rent since September. We're pleased to share that we've agreed to a formal payment plan with this tenant for all back rent and charges due, obtaining multi-year extensions on a substantial portion of their leases in the process. Our continued emphasis on portfolio quality has distinguished us in this time of uncertainty as we believe our actual cash rent collections lead the industry. The resilience of our tenants and assets has led to more recognition. We are excited that Fitch Ratings assigned a corporate credit rating of BBB with a stable outlook to Physicians Realty Trust. In their commentary, Fitch noted that Physicians offers durable cash flows relative to the broader REIT universe, and that the coronavirus pandemic has not resulted in any meaningful erosion in Doc's credit profile. We look forward to working with Fitch and the other agencies as we continue to grow prudently, strengthening what we believe is our already best-in-class balance sheet. During the quarter, we completed the acquisition of an off-campus cancer center fully leased to Ascension St. Vincent Evansville Ministry at a 5.8% first-year yield. This asset pairs strong tenant credit with high acuity care, all while still being accretive to shareholders, perfectly representing our commitment to investment quality. We continue to be selective on new investments, building our pipeline for the year ahead with assets that meet our disciplined acquisition criteria. Our near-term pipeline includes the newly completed off-campus outpatient care facility leased to Ascension Sacred Heart Ministry, anchored by their new ASC in Pensacola, Florida. This doc-funded development is already welcoming patients, having opened ahead of schedule despite being constructed during the pandemic and enduring a direct hit from Hurricane Sally. We have an option to purchase this facility from our development partner at a first-year yield of 6.25%, which we expect to execute by the end of 2020, pending our normal closing conditions. We're starting to see more opportunities to acquire or finance medical office developments pre-leased to creditworthy tenants as a result of our longstanding health system relationships. We've recently initiated two new financings for developments to commence in 2021 and anticipate more to come. On the home front, we've been cautious with our team, with many of our colleagues living in states experiencing an increase in COVID cases. We're still working primarily from home, and as evidenced by our results, our team has answered the call and is performing very well, doing whatever it takes to manage work, family, and in many cases, virtual learning for their families. Jeff will now discuss our financial results, followed by Mark Thine with a report from operations. Jeff?

Thank you, John. In the third quarter of 2020, the company generated normalized funds from operations of $54.9 million, which was an increase of roughly 7% over the comparable quarter last year. Normalized FFO per share was 26 cents versus 27 cents in the same quarter of last year, primarily due to reduced leverage. Our normalized funds available for distribution were $51.9 million, an increase of about 9% over the comparable quarter of last year, and our fad per share was 24 cents. Our tenants continue to show impressive resiliency to the ongoing pandemic. Our cash rent collection in the third quarter was 98.4% of billed rents, consistent with past quarters. We also reached a short-term deferred rent agreement with a health system joint venture that accounted for half of the uncollected total, another 0.8% of billed rents. Of the final 0.8% of rent not collected or deferred, About two-thirds of that is currently on a cash basis. Therefore, we are not expecting to increase reserves on uncollected rent at all in the future, assuming we don't see a wholesale shift in the impact of the pandemic. We believe our insight into our tenant operations is second to none, due in large part to our dedicated credit team, which consistently monitors our tenants' financials. This insight, along with the high credit quality of our tenant base, has enabled our team to produce sector-leading rent collections. Our investment pipeline has swelled in the back half of the year with well over $100 million of investments executable in the next three to four months, assuming a stable cost of capital. In the third quarter, we completed $24.5 million of investments at an average cap rate of 5.7%. While we are poised to grow aggressively, we will continue to monitor the pandemic and economy like everyone else and adjust our strategy if necessary. Since the beginning of the year, we have raised $340 million on the ATM at an average price of $19.10. We enter the fourth quarter of the year in an excellent capital position with consolidated debt to EBITDA of 4.8 times. Additionally, as of 9-30, we had only $95 million drawn on our $850 million line of credit. While we are arguably under-levered compared to most of the healthcare REIT sector, this is not a bad capital position to be in right now, given the volatility we've seen in the equity markets. We also have no material debt coming due over the next three years and minimal CapEx obligations. We are keeping our usual levels of cash on the balance sheet based on the strong payment history of our tenants and see no need to preemptively conserve capital at this point. As John noted, we were pleased to announce that Fitch Ratings recognize our conservative capital structure and high credit tenant base with an initial rating of BBB-flat that was announced in August. This had the immediate impact of lowering our revolving debt costs by 20 basis points and our term loan costs by 25 basis points, resulting in interest expense savings of $1.2 million on an annual basis, assuming a constant revolver balance of $95 million. Our cost of capital continues to improve on a relative basis versus our peers, which will allow us to start capturing more and more of the consolidation action happening in the medical office building sector. Our same-store portfolio generated growth of 0.8%, which Mark will discuss in more detail momentarily. Our G&A was consistent sequentially at $8.3 million, as COVID impacts are still slightly reducing our overall expense load. We are currently projecting to end up the year at or slightly below the midpoint of the 2020 G&A guidance of $33.5 to $35.5 million. Finally, recurring capital expenditures for $5.3 million, which has started to trend up a bit from the beginning of the year as we go back into a more normalized CapEx schedule. I will now turn the call over to Mark to walk through our portfolio statistics. Mark?

Thanks, Jeff. Our teams on the ground in our portfolio are healthy and continue to perform well in the third quarter. We remain focused on providing best-in-class service to our healthcare partners, as they work tirelessly to offer compassionate care to COVID-19 patients, as well as care for routine patients under enhanced safety guidelines. 100% of our facilities remain open, and we have seen nearly all of our clinical lease space resume to pre-COVID office schedules and patient volumes. Tenant engagement in the buildings has also rebounded to near pre-COVID levels. Although the spread of COVID-19 continues to flare up in certain markets across the country, Our healthcare partners are much better prepared to operate in this new environment with larger inventory of PPE and enhanced social distancing and cleaning procedures. Despite the impact of COVID-19, DOCS operating results in the third quarter were steady. Strong tenant retention, renewal leasing spreads, and above average leasing activity were positive signs of the strength and resilience of our tenants and the stability of our portfolio. During the quarter, we completed a total of 335,000 square feet of leasing activity, the second highest quarterly volume in the history of the company, including nearly 225,000 square feet of early lease renewals. Tenant retention was 85%, and renewal leasing spreads were positive 2.2%. Included in these early lease renewals is the multi-specialty practice John described earlier, where we were able to successfully negotiate five-year lease extensions on 67,000 square feet in exchange for additional time to pay back four months of past due rent and late fees. These leases now extend into 2030 and were renewed early with a positive 3% leasing spread and no tenant improvement allowance or contraction in strong rental rates. In addition to the multi-specialty group, we also opportunistically executed a limited number of lease extensions providing tenants free rent in lieu of TI in exchange for long-term commitments to their suites averaging eight years and two months. While these leases total only about 86,000 square feet, it's these types of mutually beneficial transactions that create exceptional long-term shareholder value. These leases generate an excellent net effective rent above underwriting but the free rent does come with a short-term trade-off to same-store NOI growth of approximately $320,000 in Q3. As a result, our MLB same-store portfolio cash NOI growth was 0.8% due to this one-time concession, lower parking revenue from social distancing limitations within our garages, and slightly lower occupancy from one 20,000-square-foot suite that was discussed last quarter. Notably, Our operating expenses for the same store portfolio were flat during the quarter overall, but we did notice a $0.5 million drop in utility expense for the quarter, as several of our recent LED lighting and MEP upgrades provided additional efficiencies. These savings should be routine. We did have a year-over-year increase of $0.4 million in janitorial expense and maintenance payroll due to COVID-19, which we anticipate to decline over time. Turning to our CapEx investments for the quarter, we once again proactively managed our recurring CapEx investment to $5.3 million or 7% of cash NOI. Year-to-date, DOC has invested $13.2 million in recurring CapEx projects and expects to fall within the $17 to $19 million full-year CapEx guidance adjusted earlier in the year. Finally, Our asset management team's keen focus on operational excellence and outstanding customer service shined this quarter in the results of our 2020 Kingsley Associates Tenant Satisfaction Survey. This year, we surveyed nearly 500 tenants representing 4.8 million square feet. Physicians Realty Trust received a strong 69% response rate despite the ongoing COVID pandemic. Typical response rates for these surveys are between 45% and 55%. So a 69% response rate demonstrates the exceptional relationship between our asset management team and our healthcare partners. We also earned a company score in overall management satisfaction of 4.44 out of 5.0, with scores on COVID-19 communication and cleaning protocols exceeding the peer group. I'd like to end by recognizing the outstanding efforts of those on our operations team who have executed consistently during the challenges of the past several months. Thanks to a team effort focused on long-term value creation and growth, we had another solid quarter that validates both the quality of our portfolio and our earnings. With that, I'll turn the call back over to John.

Thank you, Mark and Jeff. As we look forward, it appears we may have a new administration, but perhaps a split in Congress. History suggests this will not result in any major changes in existing health care policy and payment systems, but the new administration can do many things administratively that can expand coverage under the Affordable Care Act and impact the scope of care provided in hospitals and in outpatient facilities. The APA, bipartisan legislation, and commercial insurers all agree care should be provided where clinically appropriate in the lowest cost settings. Indeed, recent CMS proposed regulations suggest eliminating the inpatient-only payment system within Medicare entirely, thus further incentivizing the transition of care to outpatient facilities like we own. We also anticipate inpatient hospitals will be encouraged to transform their facilities and services to prepare for the next pandemic, leading to more pressure on hospital capital. This pressure should cause hospitals to consider MLB monetizations and more demand for third-party capital for medical office and outpatient facilities. We are prepared to capture these opportunities. We're now happy to address your questions.

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tool will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Nick Joseph with Citigroup. Please proceed with your question.

Hey there. This is Michael Griffin on for Nick. You mentioned the Ascension acquisition earlier, and I'm just curious, are you able to give us a sense of what you think the acquisition pipeline is looking like going forward?

Yeah, Michael. Good morning. This is JT. We've got about $100 million either in PSAs or signed LOIs, and we've got a A good pipeline in addition to that, really building for 2021. So we're not really prepared to predict the size of that pipeline yet. We'll have acquisition guidance on our next call for 2021. But right now we're really excited about what we're pursuing.

Okay, thanks. And then just on the same store NOI, obviously you mentioned the impact from this quarter. Just wondering when you expect it to return to that sort of 2% to 3% historical run rates.

Hey, Warren Michael. This is Mark. So in the same story, this quarter was impacted by some of the COVID-related items that we mentioned, including parking and the one vacancy that we have in Tennessee. And we've got some good leasing activity to help that rebound here as we enter fourth quarter and for sure into 2021. Our parking revenue specifically, we're seeing rebounding off the lows in the second quarter. And the one garage that's not quite getting this all the way back is really a result of valet services that are just resuming now. So the cars and the patients are there, but there's an incremental margin on valet services that should help us rebound in our same store next quarter.

Okay. That's it for me. Thanks for the time. Thanks, Mike.

Thank you. Our next question comes from the line of Amanda Swelter with Baird. Please receive your question.

Thanks. Good morning. Can you guys talk a little bit more about the leasing dynamics during the quarter? Net absorption did fall a bit. What is your outlook for releasing that vacant space? And then have you still seen some of your existing tenants looking to expand?

Sure. Good morning, Anna. Mark again. So leasing activity was the second highest quarter we've ever had in the history of the company. A lot of that was early renewals. So as you mentioned, net absorption did fall a little bit. mentioned that same one suite that we're working on leasing up. And then we did have a second largest suite in Atlanta that we vacated because the hospital wanted to take that suite. So that's under construction, and we anticipate that being leased up quickly. I mean, overall, we're just seeing good leasing activity, especially as services are being reserved on campus and inpatient, and they're moving off campus into our outpatient buildings where we don't have any COVID patients there. So it's been good leasing activity there.

And then have you still seen your existing tenants look to expand?

Yeah, absolutely. That's consistent with what we're seeing with the results of COVID here. People looking to expand, take additional space. Of course, as you know, our portfolio is 96% leased, but we're working hard to fill up those remaining spaces.

That's helpful. And then just last question for me. Last quarter, you kind of described your balance sheet management as conservative. Any change in how you would characterize it, just given fundamentals have remained stable?

Hi, Amanda. This is Jeff. No, look, I think we're still going to be conservative on the balance sheet. Obviously, there's a lot of questions with COVID, how it's going to progress through the winter and into next year. So I think it still makes sense to be conservative at this point. We evaluate it every month, and we'll change our strategy when that's appropriate.

Thank you.

Thank you. Our next question comes from the line of Michael Lewis with Truist Securities. Please proceed with your question.

Thank you. Can you share the interest rate on the St. Louis Park MES investment in Minnesota? I don't think I saw that.

It's 8% with options related to the completion and development of that project.

Okay, got it. And then I just wanted to ask about your comfort with signing a five-year extension to a tenant who's on a deferral plan. It looks really low risk to you since they're current on September and October and there's no TI package, so not much to lose for you in the deal. But maybe tell us a little more about the situation and the risk, especially in a potential situation second wave of COVID-19, you know, why they had difficulties the first time and how you're comfortable with that?

Yeah, so, you know, it's a great result for us. It's a very large tenant that occupies a substantial part of space in five different buildings. So, you know, the biggest impact on all of our practices that had to either shut down or, you know, reduce care, reduce time of services during April and May, in particular March and April, with the lack of PPE, some personal protective equipment, masks, gowns, things like that. So that supply chain has really come back strong. There's new manufacturers that have been established and are opening up in the United States to shorten the supply chain, if you will. So we don't think that'll have an impact on, it shouldn't have an impact like it did in April, May, where the system will be able to keep providing care, particularly the off-campus locations, because that's where the non-COVID patients needed to go and wanted to go and will continue to go for their care instead of deferring that. Again, it's an outstanding result with that tenant, a large multi-specialty physician group, historically very strong. As we've talked about, they're part of a joint venture with the health system, and we anticipate that will continue to get stronger. So we don't see it as a risk of extinguishing those leases. In fact, it's a very positive result with the increasers and no TI and no lease commissions, which typically is required in any lease renewal of that size.

Okay, perfect. And then lastly from me, I guess this question is kind of a combination of questions that have already been asked. You talked about the pipeline size. You talked about your thoughts on leverage and the balance sheet. As you think about external growth opportunities, You know, what's the attractiveness there? You know, what's the attractiveness level there? You know, kind of tying it to your cost of capital versus the yields that are available in the market, the competition to buy those assets. You know, how do you kind of think about how you could drive external growth? And, you know, I think it ties in the other questions because it ties into how much leverage you're willing to take, how you use the ATM, kind of a big picture question.

Yeah. No, that's a great question. This is Jeff. So when we look at, you know, whenever we're looking at new acquisitions, we're trying to do two things. We're trying to increase the quality of the portfolio, and we're trying to drive accretive growth for the shareholders at the same time. So as we look at where our stock price has been trading, I guess, today and, you know, most of the year, really, there's a – it's definitely possible to accomplish both of those objectives together. with the pipeline that we see right now and with the pricing that we're seeing right now. So I think we're in a good spot from a cost of capital standpoint to drive external growth and complete our pipeline. You know, add to that that we're, you know, we're very conservatively levered right now. So we do have the option and the opportunity to execute on certain investments if our stock price temporarily drops because we've got a you know, stored up on the balance sheet. But, you know, even on just a go-forward basis, I think we're in a great spot to continue to grow, you know, into next year for sure.

Sounds good. Thanks a lot.

Thanks, Mike.

Thank you. Our next question comes from the line of Connor Siversky with Berenberg. Please proceed with your question.

Hi, everybody. Thanks for having me. So you had mentioned some MEP improvements that drove down utilities costs during the quarter. You know, I'm wondering if this is part of a broader project, and then if so, what kind of outlays could be associated with it, and then is there any expectation for what kind of utilities cost improvements we could see going forward?

Yeah, great question, Donald. This is Mark. So far this year, we've tackled just under a million dollars of LED lighting upgrade and MEP upgrades to just help the overall efficiency on our utility expense and also repairs expense associated with the building. Those projects are typically amortized and passed back through to the buildings, but yet the tenants are still recognizing savings by the overall drop in utility expense. So we've got more of those projects planned in 2021. And again, with our triple net lease structure, nearly all of our leases are triple net. So the expenses are passing back through to the tenants of the building. In this case, the savings are passing back through to the tenants of the buildings. But we'll try and recapture some of that on the releasing spreads as well.

Okay, and then one more kind of high-level question. I'm thinking back to the survey that you guys published. I think it was back in June. You know, and I'm just wondering in regard to, you know, outpatient versus the inpatient environment, what kind of feedback you guys have gotten on that survey, if you see those trends have continued through Q3, just any sort of commentary you could offer there.

Yeah, this is JT. You know, surveys showed what we've always anticipated, certainly didn't anticipate a pandemic further enhancing the drive for consumerism, for patients wanting to go to more convenient locations, and for physicians, you know, wanting to be in more convenient locations to their home and schools as well. So we think the evidence is very clear that, you know, people don't, if they don't have COVID or don't think they have COVID, they don't want to go anywhere near a hospital, and it realized itself or evidence in May and June when our outpatient surgical facilities away from the hospital campuses, you know, had had expanded hours to take care of all the patients that couldn't take care of in April because of the lack of masks and gowns. So that has continued. Obviously, kind of the backlog has been restored and we come back to more normal hours. But if you look at the kind of our AR balances and things like that. It's mostly the on-campus, small on-campus tenants that have been slower to kind of get back to full-time schedules. And as Mark mentioned, the parking revenue, again, the evidence is that as well. So the traffic flow there is getting back to normal, but it's still not back to where it was. Whereas in our off-campus locations, they're full and open and operating.

Okay. That's all from me. Thanks very much. Thank you.

Thank you. Our next question comes from the line of Jason Edelman with RBC Capital Markets. Please proceed with your question.

Yeah, thanks. I was wondering if you guys could touch on the pricing of the Ascension acquisition. I know that you had previously been targeting like the 7% to 8% range, and this came in below that. So just wondering what you like about that asset that allowed you to get comfortable with the pricing.

Yeah, Jason, I'm not sure that the data point on the 7% to 8%. We quoted 5.8% yield on that first-year yield on the Accenture acquisition, and 7 to 8% was kind of early in the life of the company. 7 to 8%, you may be referring to maybe a long-term IRR calculation. That 5.8% is first-year yield, not our long-term IRR. The long-term IRR would be in that 7% to 8% range or more on that asset.

Got it. Okay. And who are the sellers that are bringing product to the market today? It seems like pricing still remains pretty sticky, but are they mostly still one-off properties or are larger sellers starting to come to the market?

Yeah, most of what we're really pursuing right now are one-off, off-market opportunities, you know, one-to-twosy kind of acquisitions. So it's a combination of physicians, providers that own the buildings that are looking to monetize, We've had a couple of deals where the health systems were also involved or are also involved in the ownership of the asset. Then developers and other aggregators, if you will, are out trying to capture pricing in this market. We think the market's pretty stable. There's lots of good opportunities out there. No real large portfolios that we've seen, but again, where we do the best is in the you know, direct negotiation with providers and the development of working with those providers to acquire the assets. Both those examples we talked about today, you know, are tied to the Ascension Health System, the largest, second largest health system in the country, you know, one in Indiana and one in Pensacola. And, you know, we should continue to work with them wherever we can.

Got it. And then last one for me. What are you hearing in terms of, or from tenants in terms of the surgical pipeline and Has that been impacted at all from kind of the increase in cases, or where is that trending?

Yeah, no, I think there was a huge pipeline, or excuse me, a huge uptick, obviously, in May and June and July, so we made that for March and April. I think the case loads back to kind of normal volumes now, so like pre-COVID, you know, monthly volumes. But picking up, you know, we're not seeing people deferring care. We're not seeing communities, even with COVID spiking, you know, many locations around the country, you know, to worse levels than they were in April and May, you know, we're not seeing any impact on their outpatient care facilities, and particularly those away from the hospital campuses.

Okay, nice.

Thank you.

Thank you. Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back to management for closing comments.

Yeah, thank you all for joining us this morning. We know it's tough times, and we appreciate the audience and the questions, and we look forward to to seeing you and your clients and other investors during Navy. Thank you.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.