Healthcare Realty Trust Incorporated

Hello and welcome to the Healthcare Realty First Quarter Earnings Conference Call. My name is Elliot and I'll be coordinating your call today. If you would like to register a question during today's event, please press star followed by one in your telephone keypad. And I'd like to hand over to Ron Hubbard. The floor is yours. Please go ahead.

Thank you for joining us today for Healthcare Realty's First Quarter 2024 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 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 into December 31, 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 March 31, 2024. The company's earnings press release, supplemental information, and Form 10-K are available on the company's website. I'll now turn the call over to Todd.

Thank you, Ron. Healthcare Realty is pleased to report strong first quarter results. FFO per share was at the top half of our expected range, as were most of our key operating metrics. Solid NOI growth was driven by robust cash leasing spreads, improved tenant retention, positive multi-tenant absorption, and tight operating expense controls. Most importantly, we're focused on two top priorities, capital allocation and operational momentum. First, our top near-term priority is accretive capital allocation. Our express goal is to accelerate FFO growth and improve dividend coverage as quickly as possible. More specifically, we intend to use proceeds from JVs and asset sales to repurchase stock on a leverage neutral basis as long as the company trades at a substantial discount to NAV. As a major first step, yesterday we announced a strategic relationship with KKR that is expected to generate proceeds of $300 million within the next 60 days. And there is more KKR capital behind this initial JVC portfolio, which I'll cover in more detail later. We also expect another $300 million of proceeds in the next 90 days from separate transactions. And in April, we repurchased $42 million of stock at very accretive levels. The average price represents an 8% implied cap rate, which compares favorably to expected JV and asset sale cap rates in the 6.5 to 6.75 range. Our second priority is operational momentum. This is primarily about increasing multi-tenant occupancy. Occupancy gains in the first quarter were on track with expectations that we communicated in our multi-tenant bridge. New leasing volumes remain elevated, and we expect absorption to gain momentum in the second quarter and into the second half of 2024. Many of you will recall we initially published our bridge two quarters ago. We expected absorption to increase by 150 to 200 basis points over five quarters through the end of 24. Two quarters in, we have generated 70 basis points of absorption, which is exactly on track with our plan. I'm particularly pleased with the diligent effort and focus of our leasing and operations teams. Our leasing team has produced new leasing volume of more than 400,000 square feet in each of the last three quarters. This quarterly pace is an important indicator of our ability to continue elevating multi-tenant occupancy. Our operations team is focused on accelerating NOI growth by quickly converting new leases to occupancy and controlling operating expenses. Total multi-tenant NOI grew 2.8% in the first quarter, well above 2023 growth of 2.3%. Looking ahead, we're on track to achieve the 4.4% to 5.5% multi-tenant NOI growth published in our bridge for the second half of 2024. Our leasing confidence is boosted by the constructive backdrop for MOB supply and demand. Aging demographics and strong patient utilization are pushing demand steadily higher. Hospitals and providers are initiating more and more outpatient expansion plans. At the same time, a sharp rise in construction and financing costs has severely limited development starts. These tailwinds translate to positive absorption and rising rental rates. Typical replacement net rents are pushing $40, setting up for multi-tenant occupancy gains and robust rate increases for average net rents at existing buildings that are in the low $20 range. Now I'll turn it over to Chris to discuss financial and operating results. Thanks, Todd. The year is off to a great start on operational and capital allocation efforts. Normalized FFO per share of 39 cents was at the upper end of our guidance range for the quarter. Debt income for the quarter was impacted by a $250 million goodwill write-off. This non-cash accounting impairment was driven by the current macroeconomic environment and does not speak to the durability or growth potential of our assets. In fact, same-store cash NLI growth accelerated in the first quarter to 3% up from 2.7% last quarter. Cash NOI margins improved 30 basis points year-over-year as a result of holding operating expense growth below our average in-place rent escalators of 2.8%. First quarter operating expenses increased 1.7%. This was a significant improvement compared to 4.1% in the fourth quarter and 4.3% for full year 23. Disciplined and proactive efforts, especially on property taxes and labor costs, helped to control operating expenses. The successful property tax appeals in the fourth quarter resulted in first quarter year-over-year property tax increases of just 1.1%. Labor costs increased 2.7% in the first quarter, compared to 10% in the fourth quarter and 9.5% for full year 23. The improvement was achieved through right-sizing of staffing, and rebidding service contracts, particularly in markets with scale. We don't expect the 1.7 percent growth in the first quarter to be our new run rate, but we are on track to beat the full year expense growth assumptions in the occupancy and NOI bridge. Revenue drivers were also strong in the first quarter. Cash leasing spreads were pushed to 3.7 percent, up from 3.3 percent last quarter. Initiatives to retain tenants were successful as tenant retention improved significantly from 78% in the fourth quarter to 85% in the first. Notably, the 85% was consistent in both the legacy HR and HTA portfolios. And as Rob will discuss in more detail, we achieved sequential occupancy absorption in line with expectations. The cash leasing spreads, retention, and absorption are especially impressive given high scheduled lease expirations in the quarter. Over 1.6 million square feet of same-store leases expired, and over 2 million square feet across the total portfolio. Yesterday, we announced a JV agreement with KKR at a 6.6% cap rate that will generate near-term proceeds of $300 million and provide a source of additional long-term capital. In addition, we're in process on separate transactions that are expected to generate an additional $300 million of proceeds in the next 90 days. These transactions are expected to price in the six and a half to six and three quarters range. The total proceeds of $600 million will be used to fund existing capital commitments as well as leveraged neutral share repurchases. Applying approximately 50 to 55% of the excess proceeds to share repurchase will maintain debt to EBITDA within our target range of six to six and a half times. Last week, the board authorized a new $500 million share repurchase program. In April, 3 million shares were bought for $42 million under the previous repurchase authorization. The average price was just over $14 per share, which represents an applied cap of 8% and FFO yield of approximately 11%. Given the current disconnect between our stock price and private valuations, recycling capital into leveraged neutral share repurchases generates significant accretion and shareholder value. It also accelerates efforts to improve dividend coverage. Second quarter and four-year guidance does not reflect the KKRJV additional $300 million of transactions, or associated leveraged neutral share repurchases. Guidance will be updated at the end of the second quarter once the final timing and economics of these transactions are known. I'll now turn it over to Rob for more details on our leasing momentum.