Healthcare Realty Trust Incorporated

Good afternoon. Thank you for attending today's HelpCare Realty Trust second quarter financial results. My name is Frances, and I'll be your moderator today. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. If you'd like to ask a question, please press star 1 on your telephone keypad. To pass the conference over to our host, Chris Douglas, CFO. Hello.

Thank you for joining us today for Healthcare Realty's second quarter 22 earnings conference call. Joining me on the call today are Todd Meredith and Rob Hull. A reminder that except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in the company's Form 10-K filed with the SEC for the year-ended December 31, 2021, and form 10Qs filed with the SEC for the quarters ended March 31 and June 30, 2022. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operations or FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution or FAD, net operating income, NLI, EBITDA, and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earning press release for the quarter ended June 30, 2022. The company's earnings press release, supplemental information, and Form 10-Q are available on the company's website. I'll now turn the call over to Todd. Thank you, Chris, and thank you, everyone, for joining us for our second quarter 2022 earnings call. Twenty days ago, we closed our transformational combination with HTA. Since we initially began pursuing HTA nearly a year ago, The market has presented a lot of challenges to navigate, rising debt costs, geopolitical turmoil, and record inflation, among others. We're incredibly fortunate and proud to be where we are today. First, I'd like to express our gratitude to shareholders who voted overwhelmingly in favor of the combination. 79% of shares outstanding and 92% of those who voted. Thank you for your vote of confidence. I'd also like to thank my fellow board members and my colleagues at HR and HTA. We could not have achieved this outcome without their support and hard work. I'm particularly humbled by the commitment and perseverance of my colleagues. And we're also grateful for the counsel of our advisors and the commitment from our bank group throughout this process. Looking forward, we know we have a lot of wood to chop. we're excited about the opportunity to demonstrate for investors, tenants, and our partners the strengths and benefits of the new healthcare realty. Importantly, we never lost sight of why we're pursuing this combination. We see tremendous advantages to increased scale. The combined portfolio includes well over 700 properties and 40 million square feet. And when I look at the combination, we've nearly doubled the percentage of our portfolio in markets where we own more than 1 million square feet. This is notable in a largely fragmented MOB sector. We now have unmatched scale in 14 markets. Dallas is our top market, where we now own nearly 4 million square feet. What this means is we can operate much more efficiently, strengthen our market knowledge, and leverage much deeper relationships to accelerate leasing and investment momentum. Fortunately, we operate in a sector with steady historical demand, even in uncertain economic times. Demand for outpatient healthcare in the U.S. is projected to accelerate over the next decade. A sharp rise in the aging population will drive outpatient utilization regardless of economic conditions. What's important is our portfolio is concentrated in dense, high-growth markets to capture this demand. Over three-quarters of our properties are in attractive coastal and Sunbelt markets like Seattle, Dallas, Atlanta, Nashville, Raleigh, Tampa, and Boston. We have clusters in the right locations, giving us great relationships with the leading health systems in each market. The combination of rising demand, growing markets, and deep relationships will accelerate bottom line growth. In the coming quarters, we're focused on a few key performance indicators that will demonstrate progress and illustrate the power of our combined companies. Number one, asset sales in our joint venture program. We've made great progress and expect to complete the majority of asset sales in the next 30 days to fund the $1.1 billion special cash dividend. Number two, integration. We're hard at work combining our companies to optimize our teams and realize our targeted annual synergies. It's critically important to take care of our talented people and maintain our culture during this process. Number three, leasing momentum. In the second quarter, both HTA and HR generated robust leasing volume. Together, we have over 600,000 square feet of new leases that are now in build-out. This record leasing activity will contribute to solid occupancy and NOI improvement. We see momentum building moving into 2023. And number four, relationships. We expect to tap into our expanded relationships to increase our pace of investments. we have greater visibility on several development starts in the coming quarters. We're intently focused on these four priorities. Delivering these results will begin to capture the value of the combination, which is not currently reflected in our stock price. Later, Chris will touch on some key valuation markers that should help our investors realize the potential for attractive returns. When I look at the combination, We have many more properties and many more options to refine the portfolio and generate proceeds when there's a disconnect between public and private valuations. We will use excess proceeds from asset sales together with our expanded joint venture program to invest in MOBs where we can create the most value through scale, clustering, and our expanded relationships. While we're only 20 days into the new healthcare realty, we're off to a great start. We look forward to executing on our priorities in the coming quarters, and we intend to deliver attractive long-term shareholder value through a compelling combination of lower risk, increased liquidity, and accelerated growth. Now I'll turn it over to Rob to provide an update on our JV and asset sales, as well as our investment activity. Rob? Thanks, Todd. Healthcare Realty has made substantial progress to fund the $1.1 billion special dividend through joint venture transactions and asset sales. Specifically, we have closed on 433 million of properties, and we are under contract on another 613 million expected to close by the end of August. Combine these transactions that are at a blended cap rate of just under 4.8%. By the end of the third quarter, we expect to complete the remaining sales that will bring the total to over 1.1 billion. The stability of MOBs is translating to more stable pricing relative to other asset types. Every sector is experiencing the headwind of rising rates. Yet, lenders remain active in the MOB space. The changing credit environment has pushed the market into a period of price discovery with a wider bid-ask spread on certain offerings. Our asset sales are evidence that MOB pricing remains strong, especially for portfolios valued from $100 to $200 million. In the next several quarters, we plan to sell additional properties totaling $500 million to $1 billion. These sales will further refine the portfolio and generate proceeds for accretive reinvestment. In terms of investment activity, acquisitions for the combined company this year stand at $417 million at a blended cap rate of 5.2%. Since we last reported earnings, we closed seven additional investments for $58 million. All were in existing markets. One notable acquisition was in Raleigh, where we purchased three buildings for $27.5 million. Among these were two medical office buildings adjacent to Wake Med's Carey Hospital, including HTA properties The company now has substantial scale with 13 buildings, totaling 478,000 square feet in this cluster and 1.1 million square feet in the growing research triangle area. Looking ahead, our team remains focused on fostering lasting relationships in markets where robust population growth is increasing demand for healthcare services. We will remain disciplined as we selectively pursue acquisitions in target markets that build upon our cluster strategy. For the year, we expect to invest $500 to $750 million in the low to mid fives, funded largely through asset recycling. Solid demand for MOB space is driving lease up in the portfolio and across our developments. Hospital demand for MOB space remains strong. This demand is largely driven by a health system's need to recruit new physicians to support the expansion of service lines such as radiology, oncology, and women's services. Third-party demand for space also remains healthy, particularly in the areas of cardiology, dermatology, internal medicine, and ambulatory surgery centers. We are also seeing a lot of interest in move-in-ready suites. tenants see significant value in avoiding delays caused by supply chain and permitting issues. Strong demand for outpatient services is also leading to an increase in development activity. Our developments are largely sourced through existing relationships and target markets giving us greater control of the process. In contrast, heavily marketed RFPs generally attract developers looking for fees rather than an appropriate spread above a stabilized acquisition. We have seen our development spreads remain steady, 100 to 200 basis points over acquisition yields. Including HTA's pipeline, we currently have 181 million of development and redevelopment projects underway, with about half of this already funded. Our pipeline continues to grow as health systems expand their market footprints. Over the next 12 to 18 months, we expect to start another 100 to 200 million of new redevelopment and development projects. These are primarily located in target markets such as Atlanta, Dallas, Houston, and Orlando, and include a couple of projects from HTA's development pipelines. Longer term, we expect the addition of HTA's portfolio to be a rich source of development opportunity as we build towards 300 million in annual starts. We remain committed to pursuing accretive investments focusing on target markets and clusters where we can build scale. The addition of HTA's portfolio gives us a broader base from which to meet robust demand for MOB space and grow cash flow per share. I'll now turn it over to Chris for a review of our financial results. Thanks, Rob. Before getting into specifics on results, I would like to point out that second quarter financials are for standalone HR and HTA given the merger closed after quarter end. This morning we published separate financial and supplemental reports for both companies. The third quarter will be the first period with combined results. Our remarks will focus on legacy HR second quarter results while also highlighting the HTA performance. HR's normalized FFO per share increased 4.7% over the second quarter of 21 to 45 cents. FAB per share increased 11% year-over-year, driving our FAB payout ratio down to 83% for the quarter and 86% for the trailing 12 months. HCA's normalized FFO for the second quarter was $101 million, or 43 cents per share. HCA's FAB payout ratio was 92% for the quarter, Looking forward, we expect the combined company's FAB payout ratio to remain below 90%. For HTA, second quarter same-store NOI grew 1.6% year-over-year, an improvement from 0.8% in the first quarter. HR's year-over-year quarterly same-store NOI growth increased 3.3%, driven by a 3.4% increase in revenue, offset by a 3.5% increase in operating expenses. Operating expense growth decelerated from 6.6% in the first quarter due primarily to property tax refunds. Excluding property taxes, operating expenses increased 5.3% year-over-year, with the primary driver being utilities. We expect utilities to remain elevated in the third quarter with the extreme heat across the country. However, we remain insulated from the higher than historical expenses, with over 90% of the combined company's leases having a pass-through of increased operating expenses. Year-over-year second quarter revenue per occupied square foot increased 2.8%, which is generally consistent with our in-place contractual escalators of 2.89%. Second quarter cash leasing spreads of 3.4% were in line with our expectations and historical range of 3 to 4%. Overall revenue growth benefited from a 50 basis point improvement in average occupancy. It is noteworthy that we had 215,000 square feet of signed leases in the same store portfolio that are in the process of build out. This represents 1.6% of total same store square footage. HCA had a record number of new leases executed in the second quarter and has over 431,000 square feet of leases that are in the process of build-out. This represents 1.9% of its total same-store square footage. Given the record amount of new leases in build-out across both portfolios, nearly double historical norms, we are optimistic about meaningful absorption in the coming quarters. Converting these suites to occupancy will create significant incremental NOI and per share value. Looking further ahead, bringing HTA's current multi-tenant occupancy of 84% in line with HR's existing multi-tenant occupancy of 88% generates over $28 million of annual NOI. From there, bringing both portfolios' multi-tenant occupancy to 90% generates another $28 million for a total of $56 million of annual NOI. This will take multiple years, but can provide significant value beyond the $33 to $36 million of G&A synergies we expect to generate in the next 12 months. Now, shifting to the balance sheet, we finalized the recast of the combined HTA and HR bank credit facilities in the second quarter. The new combined facilities include $650 million of new term loans to repay the approximately $550 million outstanding on the existing revolvers and to fund remaining transaction costs. We currently have near full capacity under the new $1.5 billion revolver. The new $1.1 billion asset sale term loan was drawn at merger closing to fund the $4.82 per share special dividend to HTA shareholders. We expect to repay this asset sale term loan with the proceeds from the JV and asset sales that are currently in process. We provided a couple of updated valuation disclosures this quarter. First, we added at the end of the HR supplemental a summary combined company pro forma NAV schedule. It shows our current implied cap is in the high fives, well above the transaction pricing Rob described earlier. As we complete additional asset sales, we will look at opportunistic share repurchases if our implied cap is more attractive than acquisition and development yields. To that end, last week the Board authorized a $500 million share repurchase program. Second, we provided an updated accretion bridge for 2023 FAT on page 20 of our investor presentation. There is significant share price upside when you apply these expected results to the historical multiples as shown on page 21 of the investor deck. Please note this analysis focuses on fad accretion and multiples. There will be several non-cash accounting adjustments, including reset of straight line rent and mark-to-market outstanding debt, that will make FFO results less meaningful in the coming quarters. In July, HR and HTA declared and paid quarterly stub dividends of 20.1 cents and 2.9 cents, respectively. The balance of the HR stub dividend of 10.9 cents was declared last week. The result is HR shareholders will receive a combined dividend of 31 cents this quarter, which is the same as the May dividend. We expect to maintain the legacy HR dividend policy and cadence moving forward. HR and HCA made great progress this quarter in closing the merger while also continuing to execute operationally. Most noteworthy was the strong leasing results across the two portfolios. And looking ahead, we are eager to continue this progress and maximize the value from our combinations. Frances, we're now ready to open the line for questions.

Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If you'd like to remove that question, press star followed by two. Again, to ask a question, please press star one. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. Our first question comes from Rich Anderson with SMBC. Please go ahead.