Physicians Realty Trust

Good morning and welcome to the Physicians Realty Trust second quarter 2023 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Bradley Page, Senior Vice President,

general counsel please go ahead thank you jason good morning and welcome to the physicians realty trust second quarter 2023 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 asset management john lucy chief accounting and administrative officer and Lori Becker, Senior Vice President, Controller. During this call, John Thomas will provide a summary of the company's activities and performance for the second quarter of 2023, and our year-to-date performance, as well as our strategic focus for the remainder of 2023. Jeff Tyler will review our financial results for the second quarter of 2023, and Mark Vine will provide a summary of our operations for the second quarter. Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect the views of management regarding current expectations and projections about future events and are based on information currently available to us. Our forward-looking statements involve numerous risks and uncertainties. They depend on assumptions, data, and methods that may be incorrect or imprecise. You should not rely on our forward-looking statements as predictions of future events, and we do not guarantee that the transactions or events described will happen as described or that they will happen at all. For a more detailed description of other risks and other important factors that could cause our 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 like to now turn the call over to the company's CEO, John Thomas. John?

Thank you, Brad. On July 19th, we celebrated DOC's 10th anniversary as a public company. From our earliest days as the custodians of a modest portfolio of 19 buildings, the DOC team has remained committed to a disciplined strategy of thoughtful growth and prudent balance sheet management. This steadfast approach, combined with our unmatched partnerships with health systems and physicians across the country, has propelled our portfolio to nearly 300 owned assets, totaling over 16 million rentable square feet. While we are proud to reflect on our achievements so far, we are excited to embrace the opportunities available for docs next decade. The demands of the U.S. healthcare delivery system will continue to grow in tandem with the aging of America, and providers need to expand their outpatient presence to effectively care for their patients. Physicians for Realty Trust remains ready to partner with our clients to address these changes. We are well positioned to finance and own the purpose-built outpatient facilities that will replace expensive and aged inpatient space. The opportunity to deliver accretive growth through acquisitions has been limited for much of the past two years due to rapidly rising interest rates and the expected uncertainty as to where investment yields should settle. We've chosen to remain patient during this time, prudently waiting for market pricing to meet our cost of capital. That doesn't mean we've been stagnant, Our team has worked diligently to remain connected with our health system partners while also thoughtfully evaluating where the puck is moving for outpatient real estate. We're pleased to share that our patience is beginning to be rewarded. During the quarter, we completed a modest number of acquisitions highlighted by the purchase of the Cardiovascular Associates Building in Birmingham, Alabama at a first year yield of 7%. This 73,000 square foot building was designed and built in response to market innovations that now allow many cardiology services and procedures to be performed in an outpatient facility. This is a natural clinical evolution with Medicare and commercial payers each recognizing the higher quality and lower cost of providing cardiology services in an outpatient location. We expect this to be a growth strategy for us as the first of many similar cardiology-focused outpatient facilities we will purchase, develop, and finance in the future. In addition to the acquisition of stable properties, we will continue to invest meaningful capital in the development of outpatient medical facilities. This capital will be provided in varying forms, including loan to own debt facilities and mezzanine financing arrangements on heavily pre-leased projects. Many of these projects will eventually come on balance sheet through contractual takeout commitments. Our pipeline includes $68 million in contractual commitments to projects under construction and the potential for $500 million of further investments in projects in the planning stage. Projects within our development pipeline are diverse in nature, reflecting the robust opportunity available for outpatient medical investors. Four projects in our active pipeline are redevelopments of existing buildings. One is the conversion of a vacant big box retail anchor, and three represent the conversion of suburban general office buildings. In each case, these projects will soon be helping leading healthcare providers deliver care in their communities. We expect that our stabilized yields on these opportunities will exceed the interest rates received during each respective construction period with first-year rent returns that we project to exceed 7% once stabilized. In any case, these financing opportunities will have higher long-term IRRs than we can achieve in the current acquisition market. We have not finalized these capital commitments, and some may not come to fruition, yet we are confident that our opportunity for attractive development financings will continue to grow. Within the existing portfolio, DOC's leasing team continues to do an outstanding job of maximizing the performance of our portfolio. We have ambitious goals to achieve positive net absorption this year while also capturing the exceptional renewal spreads and increasing escalators that we've delivered in recent quarters. That momentum has continued this quarter with leasing spreads totaling 7.8%. Over time, the achievement of leasing results in excessive historical levels and maintaining or improving total occupancy should lead to sustainable and elevated NOI growth over time that is sustainably higher than what the outpatient medical space has provided in the past. We project that this past quarter is the trough for same-store growth as we sign and commence both new and renewal leases in the future. Jeff will now share comments on our financial results of second quarter 2023, and Mark will discuss our operating results.

Jeff.

Thank you, John. In the second quarter of 2023, The company generated normalized funds from operations of $61.2 million, or 25 cents per share. Our normalized funds available for distribution were $60.2 million, or 24 cents per share. We paid our second quarter dividend of 23 cents per share on July 18th, which represented a fad payout ratio of 95%. We started the quarter with a strong balance sheet. However, with the prospect of the Federal Reserve keeping rates higher for longer, we decided to take advantage of the inverted yield curve to source additional capital and pay down an expensive short-term debt. We closed on a five-year $400 million term loan in May and concurrently entered into a five-year swap agreement, which fixed our interest expense at 4.69% for the duration of the debt. As everyone knows, 2023 has been a very challenging year to raise capital. However, The deep banking relationships that we've built over the past 10 years enabled us to successfully execute this deal, even in that difficult backdrop, and we are grateful for these partnerships. We used a portion of the proceeds of the term loan to repay our entire revolving line of credit and place the remaining proceeds in liquid funds that are currently earning just over 5%. We therefore maintain a positive spread on these funds while our investment team actively works with health systems across the country to generate attractive acquisition opportunities. Following that transaction, we start the third quarter in an enviable capital position. Our consolidated net debt to EBITDA ratio is 5.3 times. Further, the successful execution of the term loan enabled us to reduce our variable rate debt percentage from 13.4% at the beginning of the quarter to 4.8%. While the current mood of the market seems to be that inflation is coming under control, we are prepared for either scenario with debt maturities that are well staggered and pushed out. Of our $2 billion of consolidated debt, only about 85 million, or 4%, matures before 2026. We are free to execute our business plan without any limitations on the capital side. As previously noted, our $1 billion revolving line of credit is completely undrawn, and when combined with the cash on the balance sheet, provides us with $1.25 billion of near-term liquidity. Current commitments still to be drawn on our developments and outstanding loans are modest at roughly $68 million. This leaves us with dry powder for new acquisitions of roughly $300 million. We've been measured in our acquisition activity so far this year, but we are starting to see more and more attractive opportunities. So while we still aren't providing definitive acquisition guidance, We can say that we expect acquisitions to increase steadily through the remainder of the year. We will seek to deploy capital to traditional acquisitions, new development projects, and our mezzanine lending platform. Turning to just a few other items, we are working hard to mitigate the impacts of inflation on our corporate expenses, and we remain on track for the G&A guidance of $41 to $43 million. Our construction team is also managing to the guidance of $24 to $26 million for recurring capital projects, and we don't expect any surprises there. With that, I'll turn it over to Mark to walk through the details of the second quarter portfolio operations.

Thanks, Jeff. Outpatient medical same-store NOI growths totaled 0.8% for the quarter. This deviation from our long-term trend of 2% to 3% is the result of a decline in same-store portfolio occupancy to 94.4%. While incremental vacancy creates near-term headwinds, we believe that the current economic environment provides us with the opportunity to create long-term value through aggressive leasing initiatives. We appreciate that value creation requires patience, but our conviction in the unique pricing power offered by our high-quality portfolio and best-in-class management platform couldn't be greater. This confidence is substantiated by full portfolio renewal spreads that have outpaced our closest peers since the beginning of 2022. That momentum continued this quarter, where we achieved renewal spreads of 7.8% across 244,000 square feet of leasing activity. Importantly, tenant retention remained high at 78%, and we successfully increased contractual escalations on lease renewals by 40 basis points relative to expiring levels. These exceptional renewal results were achieved with modest leasing costs of $1.19 per square foot per year. As seen elsewhere in the broader real estate sector, health system tenants are currently engaging in a flight to quality. Rising construction expenses and stubbornly high interest rates have increased the cost of building new, benefiting existing owners of quality real estate. Our leasing team is focused on capitalizing on the opportunity to boost occupancy and remains engaged in the comprehensive campaign to increase the visibility of our space. This includes improved online marketing, the leveraging of technology to demonstrate the capabilities of our space, and targeting of key brokers to drive foot traffic. We're seeing these efforts gain traction. For the quarter, we realized positive absorption of 4,100 square feet and averaged annual escalations of 3.0% on new leasing activity. Our pipeline of new leasing activity continues to accelerate with active proposals extended on over 120,000 square feet of vacant space. We are encouraged by these early indicators for future net absorption and we'd like to say thank you to all of our nationwide leasing partners. We sincerely value the relationships with this accomplished team of healthcare leasing professionals and look forward to seeing many of them at our annual Dock Management Summit in Milwaukee this September. Beyond these excellent leasing efforts, We are focused on the efficient management of operating expenses across the portfolio. The $1.7 million annual increase in same-store expenses was primarily attributable to increases in janitorial, maintenance payroll, and security costs. However, most of these increases were experienced early last year amid a higher inflation environment. Sequentially, operating expenses are down $0.2 million, or negative 0.4%. Inflationary pressure on operating expenses appears to be easing, which we believe will allow our leasing discussions to focus on growth and base rent and ultimately fuel future NOI growth. We're accomplishing these financial goals while also remaining focused on developing our strong relationships with industry leading health systems and physician practice tenants. After all, it's these relationships that have contributed towards our success in building the portfolio since our IPO in 2013. 10 years later, The continued strength of these relationships is evident in our 2023 Kingsley Associates tenant satisfaction survey results. This year we surveyed over 450 tenants representing approximately 4.9 million square feet. Physicians Realty Trust received an impressive 73% response rate compared to the industry average of 58% this year. In addition, We beat the Kingsley Index in every major property management category, including overall management satisfaction with a score of 4.53 out of 5.0. While we sincerely appreciate the positive feedback from our healthcare partners, the surveys we actually value the most are those that offer opportunities for improvement and where we can invest in better in order to earn that tenant's trust and lease renewal before the lease expiration. This year, fewer than 2% of the 458 surveyed tenants affirmatively indicated that they are unlikely to renew their lease when it expires. Based on this feedback from our healthcare provider partners, Physicians Realty Trust is well positioned to capitalize on the continued demand for outpatient space while driving long-term value for our shareholders. With that, I'll turn the call back to JT. Thank you, Jeff.

Thank you, Mark. Jason will now take questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Juan Sanabria from BMO. Please go ahead.

hi good morning this is regan sweeney on with juan i just wanted to open up a question on investments and cap rates can you discuss the acquisition market what is the current bid ask spread and then is pricing adjusting to the higher interest rates and where you're looking for cap rates to ultimately adjust to yeah uh good question you know there's not a lot of trades happening you know what what we're seeing is you know things in the mid sixes to low sevens um you know for

our underwriting and the criteria and the quality that we want to acquire. We're looking at high sixes and low sevens as being kind of matching cost of capital, but at the same time not going up the risk spectrum to achieve those yields. So again, not a lot of trades happening. There's still some trades happening in the mid-sixes. We're real excited about CBA, which we were able to Work with our partners there to achieve a 7% first year yield on that acquisition. A smaller transaction was 8%, and then we had another one at 7%. So those are the target ranges we're looking for with our cost of capital without jeopardizing the quality and credit or the buildings themselves.

Thank you. Appreciate the color. And then just shifting gears to leasing, if I can, in the prepared remarks, I believe you said the leasing spreads were 7.8 for the quarter. What's the expectation for the average spread just as we think about the second half and into 2024 expiration?

Yeah, this is Mark. I'll take that one. So our leasing team has been doing a great job both focusing on retention and leasing spreads. We've consistently been in that mid single digit and had a very strong quarter at 7.8% leasing spread this quarter. Going forward in the back half of the year, we expect that trend to continue in the mid to high single digit leasing spreads. And we're not only focused just on that spread, but also increasing the annual escalator over the life of the term of the lease. And we've been very successful in getting three and occasionally even 4% rent bumps built into the lease going forward.

Thank you. I appreciate it. The next question comes from Nick Joseph from Citi. Please go ahead.

Thanks. Maybe just following up on the acquisitions. you know, how are you thinking about your current weighted average cost of capital? You know, maybe both from the equity and where you could issue debt today. And then, you know, when you think about that relative to the cap rates you just quoted, what makes it attractive to do deals today versus continuing to be more patient?

Yeah, thanks, Nick. I'll ask Jeff to respond.

Hey, Nick. So, yeah, when you look at our current cost of capital, You know, a shorthand way to look at it is just kind of implied cap rate, cost of long-term debt, which gets you to kind of like a mid-six, you know, depending on what the day is, mid to high six. So that's why when we look at these deals, we're really trying to push a 7% cap rate. But importantly, we're also trying to improve the quality of the portfolio when we buy these assets. So we're really looking for you know, kind of high credit assets, long-term leases with great partners that we think we'll be able to, you know, maintain that building for a very long period of time. So that's kind of the short answer. The long answer is we do a, you know, 10-year IRR model and really are a little bit more scientific about it, but gets you to about the same place.

Yeah, no, that's very helpful. Thank you. And then just in terms of providing capital for developments, you know, has the competition changed Are you seeing a pullback on banks? I would think you would be from construction lending. So does that actually open up even more of an opportunity than you'd seen previously?

Yeah. If you go back to last quarter, I said we had $300 million in the pipeline. We currently have over $500 million in discussions. And it is really construction debt at the banks has dried up. If you can get it, the terms are more difficult, not only rate, but just covenants and collateral and other things. It really bodes well for the opportunity for the kind of lone-dome structure with health systems who are building these for outpatient medical services, moving care out of the inpatient facility into better locations, better demographics. So we continue to see significant opportunities in that space.

Thanks. And as that pipeline grows, is there an internal cap or any kind of internal risk mitigation that you put on just to not have too much exposure there?

Yeah, and, you know, one thing we've gotten more sophisticated with just internally and also in our negotiations is more, you know, kind of real-time variability on both the construction period interest rates that we're charging plus the, you know, what the ultimate yield will be on the back end of the, you know, once the project is stabilized and commences. So that, you know, kind of changes deal by deal in the location and the quality of the provider, et cetera. But I think we're doing a good job getting better returns out of our development financings and then mitigating that, both the interest rate, time risk, and the development risk.

Thank you very much.

The next question comes from Michael from Green Street. Please go ahead.

Thanks. So one on pricing power for me, just curious if you're seeing any bifurcation between the companies on campus and off campus portfolios in terms of releasing spreads.

Yeah, this is Mark. I'll take that. We really are not seeing that much difference between on-campus or off-campus. I think even going back to COVID, one of the things we saw was that there wasn't enough surgery center space off-campus, and we saw a lot of services moving to the off-campus setting. But really what's driving our leasing spreads is the comparable construction costs and relocating costs. And just with today's higher interest rates and those higher construction costs, it's just much more expensive to move. And we're able to negotiate higher spreads and still be less expensive than the cost to relocate. So again, 7.8% leasing spread this quarter is a trend that we think we can continue in the back half of the year as we work with tenants to renew space at a very high level.

Great, thanks. And then maybe one more. So despite some pretty high construction costs, we are still seeing some elevated MLB construction activity. Are there any pockets of your portfolio where you are becoming increasingly worried about new supply?

Yeah, I don't think so. most of the development is you know purpose-built you know for a health system or a physician group you know looking for newer you know better space in a better demographic location so um you know phoenix is hot but it's it's hot um literally and physically um you know but it's but the population is growing dramatically so it's um you know it's kind of matching up with the population needs that are there and we don't we don't see any you know heavy construction and heavy locations where there's not a population driver. Atlanta's the same way as we have the Beaufort project that we've already discussed. So it's a good question, something we monitor in our underwriting, but we're not seeing that in any of our markets. Great. Thank you.

The next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.

Yeah, thanks. Maybe this is a question for Jeff. I know after the term loan, your cash balance increased pretty significantly. I mean, what's the near-term plans for that cash balance? Is that earmarked for new investments, or is there some debt paydowns that you want to utilize that cash for too?

Yeah, thanks, Mike. No, you know, the nice thing about our balance sheet is that we really don't have any more significant debt paydowns, so we've really earmarked that cash for new acquisitions. And like I said, it's earning a kind of a nice yield in a short term, you know, highly liquid money market account. So certainly feel good about the ability to deploy that hopefully sooner rather than later. But in the meantime, it's not too much of a drag.

Okay. And then what's the preference for investment activity over the next six to 12 months? I know that you highlighted acquisitions, developments, Mesdet. I mean, where are the bigger opportunities right now?

Well, the bigger opportunities are development, Mike. But there's a long pipeline of acquisition opportunities, I wouldn't say in the market, but that were financed three and four and five years ago at 3%. Those loans are maturing now at 7%. We've only got a couple of opportunities where we're working with a current owner in either refinancing or acquiring a facility like that. But we think there's a good pipeline of those opportunities that will come and mature eventually. So our preference is acquisitions, always will be, at least for now, and that, you know, if we can find it at the right price and the right quality, the right credit, but we're seeing more opportunities in the development.

Okay. And the cap rates that I've been hearing, I guess, where MOBs are trading at or at least higher quality MOBs is like in the low to mid six range. I know JT, you're highlighting and just completed some deals at the seven. I guess what's different about the type of deals that you're looking at? Are these just more off-market relationship type deals that are getting you up into that 7% range?

Yeah, it's more off-market relationship deals. And it's also, I think, just the reality of some owners are using all equity and kind of willing to accept negative leverage in the anticipation of lower interest rates and And, you know, compressing cap rates, we're not prepared to make that gamble. We don't think that's, for us, the appropriate way to invest.

Okay. And you would agree that the higher quality deals are trading in the low to mid sixes, I guess, generally right now in the MOB space?

I would say there are some in that range. Again, we're focused on our cost of capital and the higher quality off-market transactions.

Okay, great. Thank you.

Thanks, Mike.

The next question comes from Stephen Valliquette from Barclays. Please go ahead.

Hey, thanks. Good morning, guys. I'm juggling a couple of few earnings calls here simultaneously, but obviously with the same store cash NOI growth slowing down a little bit, I'm just curious to get a little more color around what's happening there. If you look at it sequentially, everything looks like there's really no change at all, but really it's more of the year over year. There was just some deceleration in that same store pool. some of the growth versus what you had sequentially year-over-year growth last quarter. But just not sure there was still kind of that unique single location situation that's still hitting the results, but just curious to get more color around all that. Thanks.

Yeah, I'll have Mark give you a little more color, but it's, you know, we really do think we've hit a trawl there. And again, it's still a kind of quarter-over-quarter with an intentional non-renewal last year and then a non-renewal by a tenant where they cut some space back at the beginning of the year. which have had a kind of quarter over quarter, you know, continued impact. But we do think this quarter is a trial and, you know, kind of with leases both commencing and being executed in the near term and net absorption, you know, we're heading in the right direction. Mark, do you want to add anything?

Yeah, so Stephen, so sure. I'll add a little here. You know, first of all, again, our leasing team did a great job growing cash leasing spreads at 7.8%. So from a renewal perspective, we're growing our cash flow there. Our same store performance was really the result of a change in occupancy, as I mentioned in our prepared remarks, to 94.4% from 95%. So still a very highly occupied portfolio that's performing well. But to give a little more context to that 60 basis point decline, and as you mentioned, some unique kind of one-off things happening there, that declines about 90,000 square feet, nearly half of which is that cancer center that we talked about last quarter. And during this quarter, we actually executed 5,600 square foot lease in that facility and have had good tours and momentum to fill up that facility. And then as JT mentioned, one of the things that's going to offset that cancer center facility is the Minnesota Surgery Center that we've talked about in the past. That was a 22,000 square foot surgery center that really for the last year has been in negotiation and under construction, and it'll start commencing rent payments here in the third quarter of 2023. Just zooming back out to the high level here, we have a leasing environment, the macro environment that's working in our favor. As I mentioned, our leasing leads are up, our tours are up, but more importantly, our proposals on vacant space are up. So bottom line is the cash NOI is growing. It's just not growing at our historical pace, but as JT said, we think this is the trough and we'll be moving in the right direction in the back half of the year here. Okay, got it. That's helpful. Thanks.

The next question comes from Ronald Camden from Morgan Stanley. Please go ahead.

Hey, just a couple of quick ones from me. So going back to sort of the cap allocation. Um, so one on the acquisition front, obviously not, not seeing enough deals and leaning more towards some of these development, any way to sort of quantify what that run rate could be sort of on a long-term basis. Like, is there a hundred million, 200 million of opportunities as you're building out these relationships just How can we get some more sort of hard numbers around that?

Yeah, so for the development pipeline, you know, I think a good run rate for us is going to be, you know, again, these projects are still in formative stages. So, you know, we want to be careful not to get too ahead of ourselves. But certainly $100 to $200 million as a pipeline, I think, is achievable in, you know, a reasonable period of time.

uh yeah you know at some point maybe we'd start limiting the size of that pipeline based on the overall size of the company but i think we've got a pretty good runway to get there um so that's that's kind of the short-term plan yeah i think part of that is is like right now we have more opportunities than that and i think the idea is we'll get you know kind of a continuous cycle of those facilities you know coming online starting commencing and and as new buildings are coming online and stabilized paying rent you know, we'll start new constructions as well. So it's, you know, again, we're really working to build up that, you know, kind of continuous cycle there and see a good opportunity to do that.

Great. And then just my last one, and maybe you touched on this earlier, but just on the MOB-themed store cash NOI, maybe can you remind us what are some of the sort of the one-timey, you know, things that are impacting sort of that 80 basis points over year number and When does that sort of clear up so you can get back to sort of the 2% to 3% range? Hopefully that makes sense.

Yeah, I think Mark just addressed that. But again, just to repeat, it's really kind of three events, two intentional and one where a tenant cut back some space. And we're already in the process of backfilling that space with a lot of tours. And they partially leased some of that space already. So second half of the year, we'll start seeing the benefits of those. But the non-renewed leases that we did intentionally One of those is a surgery center that has now come online. It's been accredited and is starting to treat patients and paying rent in this quarter. So we'll start seeing the benefits of all that. It's really two or three events out of 300 buildings. Got it.

All right. Thanks so much. Super helpful.

Yep. The next question comes from Alex Fagwin from Baird. Please go ahead.

Hi, thank you for taking my question. The first one is kind of quick. How much rent is expected to commence in the second half of this year?

Yeah, this is Mark. So in total, we have about 34,000 square feet of leases that are executed under construction and will commence in the back half of the year. That's, you know, what's executed. You know, so if you took an average of $20 and of triple net rent and, you know, $10 of operating expenses. That's close to a million dollars. But, you know, it'll be staggered throughout the back half of the year, but a decent run rate of what's actually executed. And then, of course, as I said, we've got a very active pipeline of leasing activity beyond that. It'll take a little time to work through that as we negotiate, you know, and construct and commence rent. That's cash flow that'll start in the back half or near the end of 2023 and into 2024. Got it. Thanks.

You mentioned with the new embedded escalators being able to achieve on average 3% and even some 4%. Can you remind me what the weighted average escalators embedded in the entire portfolio is?

Yeah, it's been historically about 2.5%, but every one of these new leases is being in the last few quarters has been higher than that. So it's going to just take time to grow the average, but we're heading in the right direction. You know, if we can maintain these type of renewal spreads and, you know, kind of the new market for leasing accelerators, you know, we think, you know, we're headed toward a 3% world, but it's going to take several years to get there and hopefully more.

Okay. Got it. Thank you, guys.

The next question comes from Connor Siversky from Wells Fargo. Please go ahead.

Hey, good morning, guys. Hey, Seuss, I'm for Connor today. Thanks for taking the question. In terms of the competition for assets, do you guys still see a lot of activity from foreign capital, or have those entities moved to the sidelines and potentially offering more opportunities for a physicians group?

You know, I'd say it's slowed down, but we do still see foreign capital in the market, both directly and indirectly through other private private equity type shops or directly from foreign pension funds. We're in a JV with foreign capital, and I think they continue to like the space as well, along with Remedy and Kane Anderson. So I'd say we've seen a slowdown really in transaction activity as interest rates and cap rates kind of rationalize, but But we do have, like in our Beaufort project, we have physician co-investors in that project with us to the tune of about $11 million in straight equity into that deal. So we still see a lot of interest in physicians wanting to co-invest or remain part owners in investments we make.

Ray, and can you offer any color as to how much the portfolio is utilized by admin or non-medical functions, you know, like the revenue cycle, for example? Do you get the sense that leases... Go ahead. Oh, go ahead. Go ahead and ask the question. Oh, yeah. I was just going to say, do you get the sense that lease sizes could decrease as leases kind of roll over and the company utilizes, you know, those hybrid structures?

Yeah, so we do have a very small percentage of space that is... you know, would be kind of general administrative space. Two of our redevelopment projects are, you know, we're in deep discussions with clinical providers to, they're still leased. They're still, you know, frankly, you know, leased for many years in their existing form. But we're in discussions with clinical providers to convert those buildings to clinical space. And frankly, we're really excited about those opportunities. And then, you know, one project in our pipeline would be an acquisition of a suburban office building. And again, to convert it to medical use as well. So we see a lot of great opportunity there in our own space, in our own buildings. We have a small percentage, well-eased, all being paid. But at the same time, you know, we, like others, would like to see that convert to clinical office space over time.

Great. Thanks, guys.

The next question comes from Michael Gorman from BTIG. Please go ahead.

Yeah, thanks. Good morning. JT, maybe kind of continuing off of what you just mentioned there, how do we contextualize the opportunity set that you have with some of these redevelopments? And I understand it's purpose-built versus the risk of kind of new supply. And I know we talked about that earlier, but just maybe less disciplined operators than yourselves just taking suburban office portfolios or vacant big boxes and trying to just slap an MOB label on them and jump into the marketplace. What's the potential risk there?

Yeah, I don't think there's a lot of spec development in medical. We just haven't seen that since the crash in 2008, 2009, and all the redevelopments, that whole pipeline we're talking about. We have a provider in hand or a healthcare credit in hand working with us to do that conversion to clinical space. So it's, I don't see, I mean, It's well publicized how many malls are, you know, we saw that this week in the Wall Street Journal, as well publicized how many malls are in distress and how many, you know, general office buildings, you know, are 20% occupied, even if leased. But the development and redevelopment projects we're looking at, which are pretty sizable, you know, have a provider, you know, and or a healthcare credit where we're working hand in hand to find the providers, you know, to insert those buildings. And that's we wouldn't be contractually committed until we had that, you know, those leases and that credit in hand.

Great. That's helpful. And then you started out the comments, obviously highlighting 10 years as a public company, which is great. And it was just reminded me that one of the things that you focused on when you first came out was exploiting kind of a risk return gap in the MOB marketplace that you saw. I'm curious, I know there's not a lot of transaction volume, but as we've seen the capital markets and the transaction markets get more stressed, are you seeing any kind of

risk reward gaps that would be more interesting to you whether it's a particular physician group type or whether it's a particular geography that as the markets get better they're likely to generate more deal volume for you yeah i think i think i've alluded to this before i mean there's a there's a lot of what i would call distressed capital ownership but not distressed buildings and that's what we're really trying to preserve dry powder and at the right price um to capitalize on and to grow substantially. Again, hopefully some more of that materialized the second half of the year. We do think 2024 is still going to be a robust year for those kind of opportunities. We're starting to see those. I'd say anecdotally in the context of one building or two buildings at a time, we're not seeing huge numbers of those kind of discussions going on. The list is out there. It's pretty obvious where those kind of buildings, those kind of interest rate structures or loan structures that were in place that are maturing into a very new environment. Jeff's done a great job with our balance sheet to remove that type of risk for us and position us well to step in and be the owner and or mes lender of choice to help refinance those buildings or acquire those buildings.

Got it. So it's more on the ownership side than on the actual building side where you see that differentiation.

I think it's, yeah, I think it's both. We would, you know, we're really not value-add buyers. I mean, these redevelopments I'm talking about are, you know, empty buildings today or leased buildings today that we would be converting with a provider in hand, with a lease in hand to clinical. Yeah, but, you know, we would be looking for... high quality buildings, high quality tenants with a broken capital structure. And Mike, I have to remind you being with us from the very beginning, the hospital would let the loan that was paid off, we really sold that three years ago, I think, but that was the very first acquisition we made with our IPO proceeds. So we kind of did a full 10 year round trip with that building and got better than 10% IRR on it and worked out well for us.

I remember it well, absolutely. So thanks for being with us, and we'll go to the next question.

Thank you.

The next question comes from Mike Moeller from JP Morgan. Please go ahead.

Yeah, hi. Just a quick one here. For the CBA acquisition, just curious why your partner wanted to have a 1% stake in the JP?

Yeah, it was the existing owner. likes the returns of the buildings, developed that building with the physician group. It's a great partner we are looking at other opportunities with. And I'd say it's more than an accommodation. It was just an interest that he had and his group had an interest in maintaining that interest. And he's really the point on helping us fill up the last 10% of that space. And we have a good leasing pipeline there as well. So pretty simple just relationship.

Okay, that was it. Thank you. The next question comes from Austin Worshmith from KeyBank Capital Markets. Please go ahead.

Great, thanks, and good morning. Just curious on the incremental developments you added to the backlog. Are you seeing any increase on yields for those deals, or is 7% to 8% still the right range?

I think we're seeing an increase, but 7% to 8% is, you know, with the first year kind of stabilized yield, about 7% is kind of what we're – you know, kind of seeing in the current market. There is some competition in the general market for some of these developments, but at the same time, you know, these are 100% pre-lease buildings, kind of mitigating, you know, risk, and at the same time getting long-term leases with good escalators. So, you know, we're pushing to, you know, kind of risk-adjusted returns, 7% to 8%, you know, where we see the market. At some point, you get to a point where the rent is too high for the provider for it to make sense for us.

Got it. No, that's helpful. And then, Mark, I believe you said 34,000 square feet of executed leases commencing in the back half the year. I think that figure previously was in the 58,000 square feet. So I just wanted to clarify, is it safe to assume that the delta there is just what commenced in the second quarter?

Yeah, that's exactly right.

That's primarily that surgery center in Minnesota. So, yeah. That's exactly right. Understood. And then as those tenants take occupancy in the back half and we continue to see positive net absorption, how do we think about the expense benefit and sort of that operating leverage moving forward?

Yeah, that's a great point. It's not just the base rent that we'll pick up when we improve our occupancy from those leases, but it's also the drag on operating expenses from the CAM reimbursement. CAM at a building is averaging $12, $13. So it's the pickup of both the base rent and the CAM, which will improve our margins as occupancy improves as well.

That's helpful. Thanks for the time.

Thank you. This concludes our question and answer session. I would like to turn the conference back over to John Thomas for any closing remarks.

Thank you, Jason. We appreciate everybody's interest today and the questions. We look forward to follow-up discussions. Please call us if you have any questions. Thank you.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.