Physicians Realty Trust

Greetings, ladies and gentlemen, and welcome to the Physicians' Realty Trust third quarter 2021 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 during the conference, please press star zero on your telephone keypad. It is now my pleasure to introduce your host, Brad Page. Thank you. You may begin.

Thank you. Good morning and welcome to the Physicians Realty Trust third quarter 2021 earnings conference call and webcast. Joining me today are John Thomas, Chief Executive Officer, Jeff Tyler, Chief Financial Officer, Jeanne Taylor, Chief Investment Officer, Mark Thine, Executive Vice President, Asset Management, John Lucey, Chief Accounting Officer, Lori Becker, Senior Vice President and Controller, Dan Klein, Deputy Chief Investment Officer, and Amy Hall, Senior Vice President, Leasing and Physician Strategy. During this call, John Thomas will provide a summary of the company's activities and performance for the third quarter of 2021 and year to date, as well as our strategic focus for the remainder of 2021. Jeff Tyler will review our financial results for the third quarter of 2021, and Mark Thine will provide a summary of our operations for the third quarter. 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 the 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 more detailed description of potential risks and other important factors that could cause actual results to 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.

I have to admit, this may be the most anticipated earnings call I've ever had the opportunity to participate in. Physicians Realty Trust had a landmark quarter in acquisitions, operations, and balance sheet management. The momentum has continued into the fourth quarter, as subsequent to quarter end, we sold our three LTACs at a cash gain, continuing our progress to eventually become a REIT with 100% of our revenue generated by investments in outpatient medical office facilities. Despite the Delta variant COVID spikes, each of our facilities have remained open continuously since the summer of 2020, and rental income collection rates remain near 100%. In March 2021, we shared our expectations of completing 400 to 600 million in new investments during the year, including both acquisitions and development financing. It would have been easy to complete good investments pro-radiably throughout the year, but our investors are more interested in dog making great investments with better long-term accretive returns resulting from our relationship focused strategy rather than just meeting a calendar. We appreciate your confidence through the first half of the year while we completed our negotiations with Landmark and were patient with our great partner in Scottsdale, Honor Health, while they completed the construction of two of the most recent additions to the dog portfolio. On October 1st, we announced our agreement to purchase the 15-building landmark healthcare facilities portfolio for $764 million. The Class A portfolio includes 1.4 million square feet with an average building size of 97,000 feet. Each asset is affiliated with a premier health system, including 10 new system relationships to dock. Those include the investment grade-rated University of Florida Health, Beaumont Health, mclaren healthcare to combine for 40 of the portfolio's tenancy in total 74 of the landmark portfolio is leased to an investment grade health system and the portfolio carries over seven years of average remaining lease term each providing great stability for years to come additionally the transaction includes a purchase option on another 46 000 foot on-campus mob that landmark has developed currently with Doc Mezzanine Capital and their own equity in construction financing. That MLB will be completed in 2022. Upon completion of this acquisition, our share of leases to investment-grade health systems as a percentage of our gross leaseable space will increase from 64% today to 65% on a pro forma basis. We are excited to add these relationships and assets to our portfolio and are well into the final due diligence and closing process. including the transition of property management responsibilities where applicable. While Watermore Health Systems could exercise their rights to match our purchase price or other conditions could prevent us from closing, we do not anticipate a material reduction in this investment opportunity and expect to close the landmark acquisitions by the end of the year. The two new Honor Health medical facilities we acquired were self-developed by Honor Health. The Honor Health Neuroscience Facility, located on their flagship Osborne campus, has 109,000 rentable square feet and is 100% leased, with a weighted average remaining lease term of 7.7 years. The Honor Health Sonoran Medical Office Facility is 60,000 square feet on the campus and attached to Honor Health's new Sonoran Hospital and serves that high-growth sub-market northwest of Phoenix. These investments expand our total investments anchored by Honor Health to eight facilities totaling approximately 459,000 square feet. We expect to continue to grow with this outstanding investment grade health system and the physicians aligned with them in the future. With these announced investments, we now exceed $1 billion of new investments closed or under contract during 2021. Doc's growth has been fueled by our relationship with healthcare systems and physician groups and the developers working directly with those providers. Those developers include Cambridge Healthcare, the Davis Group, Landmark, Meridian, Catalyst, and others. While there's nothing wrong with private ownership of medical office facilities, there's a unique advantage public companies, like Doc, have with long-term ownership of medical office facilities aligned with best-in-class health care providers. Most of our largest clients are faith-based or community nonprofit tax-exempt organizations who are focused on access to health care for the next 50 years, not the interest rate in the next five years. Our stability and long-term approach to capital and ownership and laser-focused vesting industry customer service and property management provide us a measurable advantage to sourcing and completing our investments, growth strategy, and goals. We believe investors want access to a publicly traded, best-in-class, pure-play medical office read, and we humbly believe all the data identifies Physicians Realty Trust, our board, and our management as the best option for that investment. Before I turn the call over to Jeff to review our financials, we are also excited and humbled to announce that DOC is among Modern Healthcare's 2021 Best Places to Work. Our ranking of 26th in the supplier category represents our debut appearance, earning this distinction while serving as the highest rated healthcare real estate provider among the honorees. DOC wouldn't be voted a best place to work without our exceptional team. And today I want to recognize our very own Mark Dukes, VP of Asset Management. who just began his one-year term as chairman of BOMA International. His leadership and attention to Doc will not waver, but this recognition and leadership to the commercial real estate industry is a tribute to his professional and personal excellence, and we are blessed to have him on our leadership team. We'd also like to recognize Mark Thine, our EVP of Asset Management and one of Doc's founders, who was recently named by Globe Street to the 50 Under 40 list for people to know in the U.S. commercial real estate industry. Congratulations, Mark and Mark, and keep up the outstanding leadership to Doc and the providers and the communities we serve.

Jeff? Thank you, John. In the third quarter of 2021, the company generated normalized funds from operations of $58 million, or 26 cents per share. Our normalized funds available for distribution were $55 million, an increase of 5.3% over the comparable quarter of last year, and our fad per share was 24 cents. In the third quarter, the company delivered consistent performance with same-store NOI growth of 2.5% and same-store occupancy down 50 basis points year-over-year as strong lease spreads have offset a handful of deliberate non-renewals. The portfolio saw no material impacts at all from the Delta variant, and we continue to collect over 99% of all contractual rents, and accounts receivable balances remain at the lowest levels in the history of the company. Looking back over the past two years, although we were optimistic that the portfolio would weather the pandemic better than most real estate asset classes, it has performed so well it has even surprised us. As we continue to invest in building the best tenant base in the industry, refine our credit monitoring process, and dispose of our limited non-core assets like we did with our recently announced LTAC sale, we see no reason why we won't continue to perform even better over the long term. The company closed $109 million of investments this quarter at an average first-year unlevered yield of 5.4%, highlighted by the off-market acquisition of a newly constructed on-campus MOB with Honor Health. In October, the company closed another $100 million of deals and announced the $764 million landmark transaction. The 15-building portfolio is 74% leased to investment-grade tenants, and not only provides an exceptionally high-quality portfolio today, but also opens the door to 10 new health system relationships for future growth. Since many of our acquisitions are repeat deals, often directly with health systems, we would expect this latest transaction to provide future benefits as well. We continue to see enhanced demand for medical office properties as private market participants aggressively pursue the product. However, the difficulty of prying these assets away from health system owners is significant, which enhances the value of our existing portfolio as well as our platform. We had a busy quarter on the financing side of the business. We amended and extended our revolving credit facility, pushing the term out until 2025 and reducing our current costs by five basis points. We also took advantage of our upgraded rating profile for Moody's and S&P to issue $500 million in 10-year bonds with a 2.625% coupon. We used a portion of the proceeds to repay our $250 million term loan and expect to continue to build out our long-term debt curve over time as we grow the company. As of now, we have only $84 million of debt coming due through 2025, providing exceptional financial stability for our investors. We issued $53 million on the ATM in October at an average price of $18.61 as we see the pipeline continue to build for next year. Additionally, we recently signed a contract to sell our three long-term acute care assets for $62 million, finally eliminating some non-core assets that we bought in the early years of the company. These were assets that went through the bankruptcy process in 2019 and generated some temporary negative sentiment. While we achieved a 9% unlevered IRR on our LTAC investment, we prefer the risk-adjusted returns of medical office buildings over the long term and capitalized on the opportunity to sharpen our pure play MOB focus. Following this transaction, medical office buildings will now provide 96% of our overall NOI, an increase of 2% from last quarter. Turning to other relevant portfolio metrics, our third quarter G&A came in at $9.5 million, and recurring capital expenditures were $6.7 million for the quarter. So both are trending towards our full year guidance of 36 to 38 million for GNA and 25 to 27 million for CapEx. I will now turn the call over to Mark to walk through some of our portfolio statistics in more detail. Mark?

Thanks, Jeff. DOC continues to benefit from our growing operating platform and strong relationships with healthcare partners. Before highlighting our Q3 performance, I'd like to start by recognizing two outstanding recent achievements by the team. First, Physicians Realty Trust was selected by the Institute of Real Estate Management as the 2021 Accredited Management Organization of the Year. The AMO accreditation was established 75 years ago to advance best practices in real estate management at the company level, with 560 worldwide firms holding this prestigious accreditation. Today, we are exceptionally proud to be at the very top of that list as the 2021 Accredited Management Organization of the Year. Second, we recently announced our inaugural GRESB score of 75 in their 2021 real estate assessment, outperforming the international score of 73 out of 100. In addition, we received a Green Star designation recognizing the team's work implementing and measuring sustainability policies. As these achievements indicate, DOC remains committed to acting as an ESG leader as we accelerate our external growth momentum. We continue to expand our in-house property management and leasing platforms during the third quarter, laying the groundwork for additional cost efficiencies to deliver long-term enterprise value for our shareholders. As an example, Our recent off-market acquisition of two newly constructed facilities occupied by Honor Health are our 14th and 15th real estate investments in the Phoenix, Arizona MSA. Through our in-house management teams, we are excited to expand this trusted partnership with Honor Health while also realizing the benefit of our management infrastructure through additional property management fees. Looking forward, our management structure is scalable and will continue to benefit from concentration as we invest in top quality properties and portfolios like the landmark portfolio that is scheduled to close in Q4. In the third quarter, we saw the power of our platform and portfolio generate both internal and external growth opportunities, led by same store growth of 2.5%, leasing spreads of positive 4.4%, and an in-house leasing team that saved over $4 million year-to-date in commissions that would have otherwise been paid to outside leasing brokers, assuming a conservative 3% fee. Our same-store MOB portfolio, which again does not exclude repositioning assets, generated cash NOI growth of 2.5% for Q3 2021. The NOI growth was driven primarily by a year-over-year 2.5% increase in base rental revenue. Operating expenses were up 7.3% and offset by an 8.4% increase in operating expense recovery revenue. Once again, demonstrating the insulated nature of our triple net leases. Year over year, operating expenses were up 2.2 million overall, primarily due to a $0.8 million increase in property insurance costs and a $0.7 million increase in real estate taxes. Same store occupancy year over year was down approximately 50 basis points as we intentionally vacated several suites this quarter to make room for anchor tenants with stronger credit to expand to better rates and lease terms. Year to date, our leasing team has completed nearly 800,000 square feet of leasing activity with an 80% retention rate and positive 2.7% leasing spreads. In Q3 specifically, tenant retention was 72% across 179,000 square feet of lease renewals, with cash renewal leasing spreads of positive 4.4%. To further drive future internal growth, 80% of the leases executed this quarter contain an annual rent escalation of at least 2.5%. Notably, these results were also achieved with limited leasing costs. totaling $1.47 per square foot per year across the full volume of consolidated leasing activity, a figure that's much more efficient than industry averages. Our successful net effective rent outcomes are driven by the quality of our assets and backed by the market pressures driving increases in rental rates and construction pricing. As we look at our portfolio moving forward, DOCS investments are diversified geographically with no one state accounting for more than 15% of rent and no single tenant accounting for more than 5.7%. Additionally, our investment grade quality tenants improved to 64.4% in the third quarter from 62.5% in the second quarter as a result of the life care portfolio disposition and honor health investment. These metrics, And all of our portfolio quality metrics will further improve with the acquisition of the Class A landmark portfolio that is 74% leased to investment grade tenants and includes 10 new hospital relationships. The team is focused on the due diligence and integration of this portfolio by the end of the year. And overall, very excited about growing the DOC portfolio from $5 billion in real estate investments at the beginning of 2021 to nearly $6 billion in real estate investments by ear ends. With that, I'll now turn the call back over to John.

Thank you, Mark. Now we'll take 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 tone 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 the handset before pressing the star keys. One moment, please, when we pull for questions.

Our first question comes from the line of John Kim with BMO Capital Markets.

Please proceed with your question.

Thanks. Good morning. I'm here with Juan Sanabria. There's a lot going on in the medical office today, including HTA announcing its strategic review this morning. I was wondering if you can comment on your interest level in participating in the potential sale process versus other opportunities that you're seeing in the market.

You know, John, we're focused on in our core business and acquiring new investments and investment grade quality medical office buildings and financing developments of those facilities. So, again, we see every opportunity that's, you know, kind of publicly available and evaluate those, but we don't comment on them until we reach a conclusion. So thanks for the question.

Okay. Well, last quarter you mentioned, John, cap rates for high-quality portfolios going in the low fives. And I'm wondering if you can update us on this quarter on what you're seeing for those types of assets.

Yeah, I think we've seen we think the landmark portfolio is humbly is the highest quality portfolio we've seen and executed on that in an off market basis. We are seeing portfolios trade, frankly, well below in the mid fours now today. So, again, high quality assets and, you know, kind of sizable portfolios. But we think the landmark portfolio we acquired at an attractive price and frankly better than an openly marketed process.

I was going to ask about that. So the 409 was negotiated a while ago. Where would that trade today if it were to be sold? And can you also comment on the rovers? You mentioned you weren't that concerned about it, but how many assets or what percentage of the portfolio have that option?

Yeah, so these were all built, purpose-developed for those health systems. I think one was acquired by Landmark in the process of their relationship with that health system. But all of them have a rovers and where they're on the ground leases. We or Landmark or both have visited with all the health systems and, you know, starting to receive waivers back and, you know, verbally and in writing. So they still have some time left in their review process, but we expect substantially all of them, if not all of them, to waive those rovers and complete the acquisitions. And your other question, again, we're seeing prints, you know, of assets sold in the open market, portfolios sold in the open market in the mid fours. So, you know, again, we think the landmark portfolio with specifically with the quality of the buildings, the age of the buildings, the walls of the buildings, the health system credits involved, you know, 74% of these buildings are leased to investment grade health system credit. So we, you know, we think it would trade in the mid fours, if not low fours.

Got it. That's very helpful. Thank you. Yeah, thank you.

Thank you. Our next question comes from the line of Jordan Sadler with KeyBank Capital Markets.

Please proceed with your question.

Great. So I think the previous guidance was for 400 to 600 million. So I guess that's over with. You guys are blowing through that. Any sort of goalposts you'd offer up? for the sort of remainder of the year or just on a look forward basis, John, or, you know, just kind of trying to frame up what the investment opportunity looks like. It really seemed to eat up in the third quarter.

Yeah, well, there's, depending on how you count, there's a lot out there available, you know, in the market. And we're still evaluating some opportunities for the year end. And I don't think we're prepared to kind of update guidance, if you will, as we did blow through the four to 600. You know, included in that is, you know, we've got a, we did announce, you know, over a billion of investments, which the biggest chunk is Landmark, of course. We do have three projects still under construction. One of those will break ground the first week of December. It's 100% leased. Beautiful facility. We think it'll be an award winner next year and in the Minneapolis market. Got one in the New York MSA under construction with Landmark, and we now have an option to acquire that building when it's completed next year. And then we have a project with an investment grade tenant in the Dallas-Fort Worth market. So, you know, I think we'll see a little bit, you know, more completed this year, and then first quarter pipeline is really building up nicely.

Okay. And then... Can you speak to sort of the financing of all this? Maybe, Jeff, you can kind of frame up where you are on leverage right now on a pro forma basis for all this activity and sort of where you expect to be or how you expect to get back to sort of the target range.

Sure. Thanks, Jordan. So, If you look at our third quarter on an enterprise debt to EBITDA, we were about 5.0 times. Pro forma for all this activity, assuming landmark closes completely in the fourth quarter, that would bring us to about six times debt to EBITDA. You know, so that's certainly at the higher end of where we've operated historically. However, you know, if you look at our portfolio, we're 65% investment grade tenancy. We collected 99% of all our rents during kind of a terrible pandemic. We're effectively 98% triple net lease, so there's no operating margin risk in there. We only have 4 to 6% of our leases expiring each year over the next three years. And we've prepaid pretty much all of our debt, so we only have $84 million of debt to refinance through 2025. You know, we think we're in an incredibly stable financial position, so will leverage trend down from six times pro forma? Yeah, it probably will. Are we nervous about carrying six times debt to EBITDA for some period of time? No, absolutely not. So we'll be opportunistic as we look at funding. It will depend a lot on the upcoming pipeline, and we'll just kind of continue to evaluate it. Okay.

That's helpful. And then maybe, JT, just, you know, coming back to, you know, Landmark, but also, you know, the Honor Health transactions, including one of the more recent ones, this new construction asset closing at what looks like a four and a half cap. Can you maybe speak to the merit of investing in MOBs sub five at sub five cap rates? And maybe it would help. explaining the difference in the growth profile of, you know, maybe the honor health assets versus the Atkins portfolio, for example, where you're getting, you know, a five and a half.

Thank you. Yeah, I think, yeah, understood, Jordan. You know, the Phoenix market is really as hot as it can be. Pardon the pun with Phoenix. You know, we think the rents in those two buildings are huge. below market at this point, certainly in the current market. We have some shorter-term leases in those buildings. We have a nice long vault overall in both those buildings, but we have some shorter-term leases where we can move some things around and take advantage of some of those kind of mark-to-market in that building. So we think the kind of opportunity set there in particular is much stronger than that stated first-year cap rate. And we have opportunities for more development and more, you know, acquisitions with Honor Health itself directly. And so these were off-market transactions. They were under construction, you know, kind of went into a pre-sale arrangement with them mid-year. And it, you know, just took them until now to get them completed and CO'd and rent commencing. So kind of the rationale for that. I think Jeff can walk through the math in terms know kind of with the with the rent bumps and again our expectation of moving some rents out more aggressively and parts of those buildings um they'll be accretive you know in 2022. okay uh thanks for that thank you our next question comes from the line of jason idling with rbc please submit your question

Hey, good morning, guys. It sounds like you have an opportunity to potentially drive rent growth higher. You've been holding back some space, so I was wondering if you could quantify that opportunity.

Yeah, sure, Jason. This is Mark. So, yeah, as you mentioned, and we said in our prepared remarks, we deliberately did not renew a few leases this quarter to make room for our anchor tenants, in many cases, investment-grade rated hospital systems to expand and and take over the full building. That's a specific example in Louisville that we have just seen. And then year over year, some of the other spots where we're really picking our spots and focused on markets like Phoenix, Orlando, Dallas, where market rental rates are increasing more than the averages. So for us, Our portfolio is 96% leased, but there's opportunities for maybe 1%, 2% of the portfolio here to really pick our spots and try and drive rental increases and market rents higher than normal.

Okay. And then as we look into the acquisition pipeline, I guess looking ahead to 2022, obviously 2021 is very back-end weighted. Should we expect anything similar in 2022, given you're still going to be digesting the landmark deal, or will it be more evenly spread out throughout the year?

Yeah, it's a good question. As I've said in my introductory remarks, you know, you like to do it, you know, radically during the year. And I think back to one of the other questions, we, you know, we'll issue guidance for next year, you know, with our next earnings call. But we've been deploying 500 to a billion almost every year. And again, most years it's more ratable throughout the year. This one, we just had the opportunity to capture a very large transaction and also two development projects that just took longer to complete than we expected. So again, I think hopefully we'll see something more ratable. The first quarter is building up very nice right now. And we're in negotiations with a couple more development projects which have not commenced yet, probably commence first quarter, and we'll be able to include that in our numbers for next year.

Okay, thanks.

Thank you. Our next question comes from the line of Richard Hill with Morgan Stanley. Please proceed with your question.

Hey, good morning, guys. One of the things that we've noticed, and certainly in our channel checks, is there's a lot more interest from private equity and medical office. And I'm wondering how you think about that. How do you think about those competitive pressures? How do you drive a creative growth? Would you consider levering up here a little bit given your balance sheet? Just sort of thinking about a pretty strong backdrop for medical office and how your capital allocations drive through that.

Yeah, if you look at institutional real estate investors, whether they be public or private, you look across all commercial real estate asset classes. I mean, I don't think there's another one maybe, but cell towers that collected virtually all their rents in 2020. And many are still suffering through significant declines in occupancy and high wage labor costs, which don't affect us. And so as you're allocating capital in an institutional investor, It's no surprise that some of the world's biggest private equity firms and non-traded REITs are going to be very attracted to the medical office space and just driving appreciation of those assets. Again, 4.5 is probably the kind of FMV of best-in-class assets, generally a 4.5 cap rate going in, but we look at our investments on a long-term IRR basis, and so, again, Those investors that have a three to five-year horizon, whether it be private equity or other private capital, we think we compete very well against that. We think the health systems are looking for long-term owners with the transparency of a public company and the business model of a public company that wants to create situations, relationships that are win-win. We think that's how we keep getting repeat business with the likes of Honor Health and and others and um you know had a great long-term relationship with landmark and and they finally decided just to sell us all their assets so you know we think that's the um kind of the opportunity the firms are welcome to the to the party um we have great relationships with with most of them and uh you know look from time to time with you know potential joint venture opportunities but you know we for the most part i think adding assets to our balance sheet is um you know is our primary focus jeff

Yeah, that's helpful, guys. And if I may, I appreciate the color on the unlevered yields for landmark. But any thoughts or anything you might be willing to share on accretion in 22 or 23? Recognize it's early. Recognize you haven't guided. So if the answer is no, I completely get it. But I figured I'd ask.

Yeah, the answer is generally no. But the landmark portfolio does have some, you know, more vacancy across the portfolio than our portfolio. our portfolio, and we're already working on and evaluating lease up opportunities for that space. I mean, talking about 200 or 300 basis points. And there's some shorter waltz in some of those buildings. And as we talked about before, the market rents are moving more aggressively up in those markets. And so, again, we expect to take full advantage of those opportunities with those health systems and source new developments with those health systems.

Got it. Thank you, guys.

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.

We appreciate everybody joining us this morning. We look forward to follow-up calls and may read, unfortunately, Zooms next week, but we look forward to seeing you, you know, one way or the other. Thanks for participating.

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