Healthcare Realty Trust Incorporated

Good morning or good afternoon, and welcome to the Healthcare Realty Trust Second Quarter Earnings Conference Call. My name is Adam, and I'll be your operator for today. If you'd like to ask a question at the Q&A portion of today's call, you may do so by pressing star followed by one on your telephone keypad. I will now hand the call over to VP of Investor Relations, Ron Hubbard, to begin. So, Ron, please go ahead when you are ready.

Thanks, Adam. Thank you for joining us today for Healthcare Realty's Second Quarter 2023 Earnings Conference Call. Joining me on the call today are Todd Meredith, Chris Douglas, and Rob Hull. A reminder that except for the historical information contained within, the matter 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, 2022. and a Form 10-K filed with the SEC for the quarter ended June 30, 2023. 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, NOI, EBITDA, and adjusted EBITDA. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the quarter ended June 30, 2023. 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, Ron. And thank you everyone for joining us this morning for our second quarter 2023 earnings call. Healthcare Realty generated steady second quarter operating results. Despite a volatile macro environment, we remain extremely bullish on our ability to capture operational upside from our portfolio. We saw record new leasing activity in the quarter. Robust tours and executed leases are early indicators of the occupancy gains and momentum we expect to see later this year and moving into 2024. We are also refining the portfolio further through asset sales and positioning healthcare realty for growth through the formation of a joint venture. On this point, I want to be clear that we are net sellers in this environment. Like many, healthcare realty's current public valuation is not conducive to accretive acquisitions. Our implied cap rate is in the high sixes, nearly 7%. This is disconnected with where we're currently seeing assets trading in the private market. Core strategic assets are trading either side of 6%, some well into the fives. We are actively selling non-core less strategic assets on average around 6.5%. Given this disconnect, we're pursuing the sale of non-strategic assets, which also improves the quality of our remaining portfolio. It's rare when proceeds from non-strategic asset sales can be recycled accretively. We are seizing this window to further refine our portfolio and concentrate on our highest growth properties. We also recently launched a process to form a strategic joint venture. Selling assets into a JV seed portfolio will generate significant proceeds while retaining ownership of strategic properties. These proceeds will more than fund healthcare realty's portion of any go-forward investments. We expect to redeploy meaningful excess proceeds from a seed portfolio into a broad range of options, including stock repurchase, debt repayment, development funding, and growth capital to drive occupancy gains. Through the JV, we can generate attractive returns on limited capital, and importantly, diversify healthcare realty's capital sources. Looking ahead, it also provides a means to invest accretively and grow with our healthcare providers who continually need real estate capital and services, regardless of capital market conditions. Forming a strategic joint venture in the current environment will position us well for what we expect to be an improving backdrop in 2024. I'll circle back after Chris and Rob to discuss our leasing momentum and growth outlook. Now I'll turn it over to Chris. Thanks, Todd. Our second quarter operating performance reflects the stability investors have come to know and appreciate from the medical outpatient business. On the macro front, interest rate increases moderated in the second quarter. Despite the moderation, we still experienced a 45 basis point increase in SOFR compared to the first quarter. This was the primary driver behind the sequential change in normalized FFO per share to $0.39. The FFO for the quarter excludes a one-time benefit of $18 million, or approximately $0.05 per share. This was related to a refund of transfer taxes paid in third quarter 22 and included in merger-related cost. Trailing 12-month same-store NOI increased 2.9%. Year-over-year quarterly NOI grew 2.1%. These both benefited from the company's share of JVs, which had NOI growth of over 6.5%. We had tremendous success this quarter, maximizing rent growth and occupancy gains to accelerate revenue growth to 3.2% for the quarter. Annual in-place contractual increases now average 2.71%, up five basis points from last quarter. The improvement was driven by future contractual increases of 3% for the million square feet of leases that commenced in the quarter. Cash leasing spreads in the quarter also averaged 3%. What is striking is that there are six markets with spreads between 5.6% and 17.8%. For example, Seattle had spreads of 8.7% on over 130,000 square feet of renewals in the last year. This shows the deep pricing power in this market where we have significant scale. Year-over-year average occupancy increased 20 basis points to 89.0% for the same store properties. Total portfolio multi-tenant occupancy is just over 85%. The largest opportunity for occupancy gains is in the legacy HTA multi-tenant portfolio. where current occupancy is over 400 basis points below its pre-COVID levels. Returning this portion of the portfolio to pre-COVID levels is more than achievable. This is seen by the fact that LegacyHR's current multi-tenant occupancy of 87.7% is 100 basis points higher than LegacyHTA's pre-COVID levels. We are already making progress with over 200 basis points of leases and build-out across these HTA properties. As Rob will discuss in more detail, we saw over 375,000 square feet of new leases executed in the quarter. This drove a 30 basis point sequential improvement in the total portfolio lease percentage. These new leases will drive future absorption as most of these suites move in through the balance of the year. Revenue growth was offset by a 5.3% increase in operating expenses. Net of recoveries, quarterly operating expenses increased 4.7% year-over-year. This is an improvement over what we saw in 2022, but still elevated compared to historical norms of less than 3%. The primary expense driver was continued labor inflation and janitorial and personal expenses, which were up approximately 10%. Looking ahead, we expect labor pressures to subside later in the year. This will allow operating expenses to trim back toward more historical levels as we move into 2024. Maintenance CapEx increased from the seasonal low in the first quarter to 15.1% of NOI in the second quarter. An increase of $8 million in tenant improvement spending is tied to the strong leasing momentum and is expected to continue through the back half of the year. This growth capital is increasing our payout ratio We're comfortable that the payout ratio will come back below 100% as strong NOI growth generated from the positive absorption and underlying portfolio cash flow is realized. Now a few comments on the updated guidance. FFO guidance for the year was adjusted to $1.57 to $1.60 per share. The revision was primarily driven by two separate but related macro factors. First, inflation is moderating, but not as quickly as our original expectations. This is driving higher labor costs and lower operating margins. In addition, interest rates this year are not declining as previously expected. Short-term interest rates in the third and fourth quarter are now projected to be higher than what we experienced in the second quarter, before declining in 2024. Additionally, we lowered straight line rent guidance, a non-cash item, to reflect year-to-date actual as well as the impact of higher expected dispositions. Our additional disposition guidance was increased to $350 to $450 million. With over $300 million of dispositions under contract or LOI, we expect to have significant excess proceeds after funding developments and other growth capital. The excess proceeds will be primarily allocated to debt repayment as well as opportunistic share repurchases. The debt repayment will further reduce our floating rate debt, which is currently 14% of total debt, down from almost 20% a year ago. With this repayment, we expect debt to be in our target range of six to six and a half times. The strength and balance sheet will position us well to capitalize on accelerating same store and FFO growth in 24, as the strong leasing activity we're seeing boost occupancy. I'll now turn it over to Rob for more color on leasing and investment activities.