Healthcare Realty Trust - Q2 2023

Transcript

Operator (participant)

Good morning or good afternoon all, 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. Ron, please go ahead when you are ready.

Ron Hubbard (VP Investor Relations)

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, Kris 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.

Todd Meredith (CEO)

Thank you, Ron, 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 5s. 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 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 Kris and Rob to discuss our leasing momentum and growth outlook. Now I'll turn it over to Kris.

Kris Douglas (EVP and CFO)

Thanks, Todd. Our second quarter operating performance reflects the stabilities, stability investors have come to know and appreciate from the medical outpatient business. 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 2022 and included in merger-related cost. Trailing twelve-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 5 basis points from last quarter. The improvement was driven by future contractual increases of 3% for the 1 million sq ft of leases that commenced in the quarter. Cash leasing spreads in the quarter also averaged 3%. What is striking is that there are 6 markets with spreads between 5.6% and 17.8%. For example, Seattle had spreads of 8.7% on over 130,000 sq ft 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 legacy HR's current multi-tenant occupancy of 87.7% is 100 basis points higher than legacy HTA'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 sq ft 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 trend 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. A few comments on the updated guidance. FFO guidance for the year was adjusted to $1.57-$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 million-$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 EBITDA to be in our target range of 6x-6.5x. The strengthened balance sheet will position us well to capitalize on accelerating same-store and FFO growth in 2024, as the strong leasing activity we're seeing boosts occupancy. I will now turn it over to Rob for more color on leasing and investment activities.

Rob Hull (EVP and COO)

Thanks, Kris. First, I'd like to touch on the increased disposition volumes that Kris mentioned and provide a quick update on the transaction market. The $300 million currently under contract or LOI, is expected to close throughout the balance of this year. These sales should be characterized as portfolio cleanup. The properties have lower growth potential and are in areas with little opportunity to build out market scale. As examples, about half of these sales are represented by non-MOB properties. Of the MOBs, most are not part of a cluster. Annual escalators for the group average about 40 basis lower than HR's total portfolio. We expect these sales to generate a blended cap rate in the mid sixes. At this level of pricing, this disposition activity reflects a rare moment when we can achieve meaningful portfolio refinement at accretive levels.

The transaction market for MOBs continues to be driven by debt costs, with some of the larger lenders increasing allocations in the space. All in, lending rates remain around 6%. These rates have steadily held cap rates for core MOB product in the low 6s, with higher quality assets pricing below 6. Now, turning to our leasing activity. New executed leases have increased each month since the beginning of the year, when our leasing teams became fully engaged. New leases of 376,000 sq ft were signed in the second quarter, up nearly 60% from the first. Tours are strong, positioning us for further gains in new leasing activity in the coming quarters. A disproportionate share of these new leases were completed in the legacy HTA multi-tenant portfolio.

This is a strong indication that the benefits of our third-party brokerage model are beginning to come through. Where we are really seeing the advantage of it advantages of increased scale is in our 15 largest markets. In these markets, the merger more than doubled the amount of Healthcare Realty's square footage covered by each of our brokerage teams. Such scale provides them with many more options to meet tenant needs. In the quarter, we saw an outsized number of our new leases come from these top 15 markets. For the total portfolio, our executed new leases that are in build-out represent almost 160 basis points of future occupancy. This has expanded 40 basis points from last quarter. The majority of these leases are expected to take occupancy by the end of this year.

Regarding broader demand for space, we've seen tremendous volume over the past couple of quarters from third-party physician tenants. We are also seeing increased demand from health systems. The for-profit systems have recently reported improving results, driven by strong outpatient volume and stabilizing labor costs. For example, HCA and Tenet both just reported a second straight quarter of elevated outpatient surgical volumes. We are hearing similar trends among the not-for-profit systems. Looking ahead, we expect health systems to play a greater role in driving our new leasing volumes higher. Where we have already seen increased engagement from health systems is around development. Our development and redevelopment activity totals $339 million of active projects. We added one new development and two new redevelopments this quarter.

In Scottsdale, we formed a joint venture with a national developer for an 80% pre-leased, 101,000 sq ft MOB, adjacent to a growing HonorHealth campus. The developer saw us as the obvious choice to partner with on this project, given our significant market presence post-merger. We also commenced 2 redevelopment projects. One is in Charlotte with Novant Health, and the other is in Washington, D.C., near where we own 3 MOBs on a Inova campus. Both redevelopments came from the HCA portfolio. Across both our leasing and investment opportunities, we are pleased with how much upside potential we see in the HCA portfolio. I'll turn it back over to Todd.

Todd Meredith (CEO)

Thank you, Rob. I want to round out our prepared remarks underscoring how leasing momentum is poised to accelerate our growth in 2024. As Rob just described, new leasing volume was especially encouraging in the second quarter. 376,000 sq ft of new leases is the highest volume we've executed since the merger, and this volume has risen steadily since January. Where it's really picking up momentum is the HTA multi-tenant portfolio, with over 200 basis points of leased versus occupied and an improvement of 60 basis points over first quarter. Since our merger closed last year, we're seeing two primary drivers elevating our new leasing volume: market scale and relationships. With an average of 29 buildings in our top 15 markets, Healthcare Realty is the obvious first call for providers and brokers. We do a lot of repeat business with providers.

As health systems grow their outpatient services, they know we are the most likely owner and developer to be able to immediately address their needs. With our scale, we do far more leasing transactions than any other owner in these markets. This gives us deeper market knowledge and insight that drives both occupancy and pricing power. Scale also makes us the top priority for our brokerage teams. As Rob indicated, the merger more than doubled their portfolios with Healthcare Realty. We are often their most reliable and lucrative client, motivating them to bring more healthcare providers to our buildings. On this note, we're hosting an Investor Day in Raleigh on October fifth to highlight how market scale and relationships drive leasing momentum, occupancy gains, and rent growth. Those who join will have a chance to tour properties, meet our brokers, and hear from our health system partners.

Healthcare Realty's bright outlook for 2024 growth is largely built on our leasing momentum. We have a tremendous amount of operational upside created by the merger combination. Record new leasing volume will bolster occupancy moving into 2024, especially in the legacy HTA portfolio. We expect absorption gains to ramp up to 100-200 basis points through the course of 2024. This has the potential to boost Healthcare Realty's same-store NOI growth to the 4%-6% range, which can translate to even more at the FFO per share level. With that, Adam, we're now ready to shift to the Q&A portion.

Operator (participant)

Thank you. As a reminder, if you'd like to ask a question today, please press Star followed by 1 on your telephone keypad to enter the queue. When preparing to ask your question, please ensure your headset's fully plugged in and unmuted locally. That's Star followed by 1 to ask a question today. The first question comes from Austin Wurschmidt from KeyBanc Capital Markets. Austin, your line is open. Please go ahead.

Austin Wurschmidt (Senior Equity Research Analyst)

Great. Thank you. Just breaking down the change to your same-store NOI guidance, was there any change to the same-store revenue growth outlook for 2023, or was expenses the sole driver of the 50 basis points decrease to same-store NOI guidance?

Todd Meredith (CEO)

Yeah, no, it's, it's really all isolated towards the, towards the expense side, which you can see, through the, updated guidance on our margin, as well as then through to the, to the bottom line, same-store NOI growth.

Austin Wurschmidt (Senior Equity Research Analyst)

Got it. You, you highlighted that a lot of the leasing you're seeing is in the legacy HTA portfolio, but I'm curious if those HTA cash leasing spreads are weighing on the combined portfolio. You know, when do you expect the cash leasing spread to kind of accelerate back to that mid 3% range or, or better?

Todd Meredith (CEO)

Yeah, it's obviously. That's that's sort of the work that we have in front of us. I will point out that we've had an interesting sort of observation. If you look at on versus off campus, we've, we've actually seen the cash leasing spreads at the HTA in the HTA portfolio be just as strong. In fact, this quarter was a little stronger than the HR on campus, both in the mid to high 3s. Really, it's the off campus is trending, if you look at maybe the first six months of this year, kind of trending in the high 1s, almost 2%. We're just seeing a little bit softer in the off, and that's true, you know, really in the HTA portfolio as well as, as HR.

We're really not seeing anything in the HTA portfolio that would prevent us from continuing to, you know, really push those cash leasing spreads.

Austin Wurschmidt (Senior Equity Research Analyst)

Do you expect an acceleration in the back half of the year or 2024, on the combined portfolio?

Todd Meredith (CEO)

You know, I think our view is that 3-4 range is very, very consistent. You know, we obviously end up doing a lot of volume each quarter, and even as Kris pointed out, some real highlights in a few markets where we had really strong cash leasing spreads. With the volume that we do, it, it, it can be difficult to certainly, you know, have all of your leases move to that high end and push you, you know, outside or even above the 3-4 range. I think our view is 3-4 is still a range that we're, we're comfortable in and think we can continue to perform in.

Austin Wurschmidt (Senior Equity Research Analyst)

Got it. Thank you.

Operator (participant)

The next question comes from Michael Griffin, from Citi. Michael, please go ahead. Your line is open.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. Maybe just asking on operations real quick. I'm curious if guidance has any baked-in sort of conservatism in it for this year, and then kind of as you look to that 3%-4% kind of growth range, how achievable you think that is going into next year?

Todd Meredith (CEO)

Yeah. No, I mean, in terms of, of the guidance, we're, we're trying to, you know, bring it a little bit tighter based off of where we're seeing things, and, and what we're experiencing right now on the, on the labor side, as well as what we're, we're seeing on the, on the interest rate, side. You know, I, I think one of the things that we also took into account as we started to look at where the margins are and overall store NOI, is what we may experience here in the third quarter as it relates to seasonal utilities, given the heat wave that's coming through.

That- that's kind of a, another piece that we're trying to take into account that, you know, depending on how all that plays out through the remainder of this quarter, could, you know, shift you a little bit better than, than maybe what we are, are planning as of right now. We'll have to kind of wait and see how that, that plays out over the next couple of months. I think I just want to clarify, you mentioned 3%-4%. That's our cash leasing spread expectation, but when we, we talk about same store, we're talking 2%-3% this year, and then I mentioned next year, really looking at that 4%-6% range.

Michael Griffin (Senior Equity Research Analyst)

Gotcha. No, that's helpful. Then just turning to the dispositions target, did anything change in terms of those non-core dispositions that you highlighted relative to last quarter? You know, were they not performing up to expectations, or any clarity around that would be helpful.

Todd Meredith (CEO)

No, I would say it's very consistent with what we reported last quarter, which was that, you know, based off of, of what we were seeing, where we saw, you know, our, our, our, our stock trading on an implied cap basis, that we were gonna be leaning into that, that non-strategic asset sales. That's what we've done, and we're, we're making great progress there with the $300 million that we already have under, under contract or LOI.

Michael Griffin (Senior Equity Research Analyst)

Great. That's it for me. Thanks for the time.

Operator (participant)

The next question comes from Juan Sanabria, from BMO Capital Markets. Juan, your line is open. Please go ahead.

Juan Sanabria (Managing Director)

Hi, good morning. Just a question, I guess, on that, leased pipeline and the spread between the leased rate and the occupancy rate. What has that historically been, and with the revised guidance, where do you expect occupancy to end the year?

Todd Meredith (CEO)

Yeah, Juan, I would say that historically, and, you know, obviously, it's relative on history, but it's something that at Healthcare Realty, we've, we've really tracked for a couple, I guess, since, since COVID, really, if you think about it. It was tracking probably around 100 basis points, plus or minus, a little lower, really, coming out of COVID, and then it expanded out a little bit as supply chains and so forth extended. I'd call it 100 basis points or less. As we mentioned, I think 160 basis points overall in the multi-tenant portfolio now, and then, within the HTA portfolio, actually over 200 basis points. That's where clearly we're seeing more of that potential.

We, we obviously lay out in our components of expected FFO and our disclosure, where we see occupancy moving, so we certainly see it. Yet we still have our 50 to 100 basis points in the multi-tenant side. That gets diluted down a little bit when you mix in the single tenant. I think our view is the, the success on the leasing momentum, the 376,000 of executed leases, it's really gonna come down to, as Rob said, getting most of those in build-out done by the end of the year. It could be, you know, within that 50 to 100 in the multi-tenant, but either way, we feel like that is really building, and we think that will show up in, in a combination of, if not the fourth quarter, certainly rolling into the first quarter.

Certainly still looking at that 50 basis points-100 basis points improvement at that pace on the multi-tenant side.

Juan Sanabria (Managing Director)

That 50 basis points-100 basis points is kind of a year-end, that net absorption number?

Todd Meredith (CEO)

Yes.

Juan Sanabria (Managing Director)

Is it that number or an average? Because you're running, I think, at 35 basis points year-to-date.

Todd Meredith (CEO)

I mean, really, we're looking at rolling into that sort of by year-end. Obviously, you know, whether that hits exactly at year-end, whether it hits, you know, in December or end of December, you know, it, it, it will show up in the end of the year. I think our, our view is, again, it's just gonna come down to the pace of build-out, some of these. Most of them, as Rob said, we expect a lot of these leases to be done by year-end. Whether or not that hits exactly, you know, by December 31st or not, we see it rolling in to getting to that pace as we round the year, at the year-end.

Rob Hull (EVP and COO)

I, I would add to that, Todd, Juan, I'd, I'd add to that, that, you know, we're really focused on the new leasing activity. Was just talked that it was strong this quarter, and if you look at that level of new leasing activity and the projected move-out kind of that we see going forward, you know, you get to that 50-100 basis points. We're at-- we feel like we're at that run rate now.

If you look at the strength of the tours that we've seen this year, and the level that we have, kind of averaged this year, we think that supports a lot of momentum moving into 2024 and moving us to that level, of new leasing that will set us up to accomplish that 100 basis points-200 basis points of, of absorption. That's really where, where we're focused, is looking, looking to 2024.

Juan Sanabria (Managing Director)

Just as a follow-up, could you comment on what, if anything, is assumed in guidance with regards to the JV? You mentioned the process has now started and/or a buyback that seems to be a, a focal point for proceeds.

Todd Meredith (CEO)

Sure. I, I'll touch on the JV, Juan. We certainly don't have anything in guidance related to that for this, for this calendar year. So that's something that we'll, as we make progress on that process, we'll incorporate to our guidance for 2024. So assume nothing for this year. You know, we think it'll certainly take the balance of the year to work through that. You know, whether a closing happens this year or into early next year is not critical to that, to that guidance either way, and we'll incorporate that then. Then I think in terms of excess proceeds from asset sales, to your point, I think as Kris said, the first stop will be certainly debt repayment.

It's the easy place to very quickly have that be, you know, the least amount of dilution, but frankly, could potentially even be accretive there. Then we'll look opportunistically, certainly at the, at share repurchase as well. We obviously had the board reauthorize a large amount, a larger amount in June, and certainly, as we have excess proceeds, we'll be evaluating that to compare that to sort of debt repayment versus other choices, funding choices that we'll have.

Juan Sanabria (Managing Director)

Thank you.

Todd Meredith (CEO)

Thanks.

Operator (participant)

The next question comes from Steven Valiquette from Barclays. Steven, your line is open. Please go ahead.

Steven Valiquette (Managing Director)

Thanks. Hello, everyone. One of 2 questions here, just around the guidance. Appreciate all the details around the revision, but maybe just, you know, with the FFO guidance going down about $0.04 at the midpoint, it wasn't really crystal clear how much of that, it could be broken down into the higher operating costs versus higher interest expense. Yeah, I think the increase in the normalized G&A, you know, only brings it up by, you know, less than $0.01 or something like that. I wonder if there's any further breakdown. Also with the dispositions, if you're gonna immediately, you know, redeploy those proceeds into debt reduction, just trying to figure out just, you know, any sort of quantification of the $0.04 by all the components might be helpful if you're able to give some color on that. Thanks.

Todd Meredith (CEO)

I think the way to think about it, the big pieces of it are, you know, interest expense with higher average SOFR. That's really a big change from what we had last quarter. When we were looking at it last quarter, you know, it was looking like SOFR was gonna decline through the balance of the year going into next year. As a result, now, compared to what we were looking at in the spring, it's. We're looking at about 60 basis point, a little bit more increase in the average SOFR rate in the back half of the year. That's the, one of the first items. Second is, is labor inflation. It's running through a couple of different ways.

You know, as we already talked about, it's running through in the same-store portfolio in our margin, as well as in the same-store NOI decline, that adjustment that we did. Then you mentioned, you know, the other piece of that rolling through the G&A. Then the kind of the last big piece is non-cash, you know, straight line rent, which we're adjusting to really be in line with what we're seeing so far for the year, as well as the additional dispositions through the balance of the year.

You know, the dispositions on a cash basis really aren't gonna have a big impact, given the fact of if you just look at where our all-in kind of line cost is right now with that increased SOFR, we're in the, you know, 6.25, maybe a little bit, little bit above that. We're looking at being able to sell, you know, cap rates on a cash basis, and that's 6.5. Really not, not much impact from that. But there is some, some straight line rent that also plays through. Those are, those are kind of all the, the big, the big, larger pieces that make up the change.

Steven Valiquette (Managing Director)

Okay. Appreciate the extra color. Thanks.

Operator (participant)

The next question comes from Connor Siversky from Wells Fargo. Connor, your line is open. Please go ahead.

Suzzane Ballard (Analyst)

Hey, good afternoon. Hey, Suzanne, for Connor today. Thanks for taking the question, guys. Just a follow-up to the capital allocation and guidance questions. In the context of the heightened dispositions and the lowered guide, how should we be thinking about the dividend going into 2024?

Todd Meredith (CEO)

Yeah, I think on the dividend, Chris touched on it in prepared remarks. Certainly, our view is that we may be, you know, sort of in this current level of just over 100% for the balance of the year, and we're comfortable that the momentum we're seeing going into 2024 on the operational upside will, will put us back in a position below 100% on the payout. Certainly, you know, it's, it's early to say, but the macro environment has had, obviously, a tremendous impact on, on, you know, the overall picture. We do see, like many, a, a better picture of that looking ahead to 2024. We, we see that as a potential tailwind. Obviously, we'll revisit that after, you know, multiple Fed meetings and, and how we look at guidance going into 2024.

I think our view from all of that is that we see the dividend as being sustainable for sure, and something that we can tolerate a little over 100 for a bit while we capture this upside and really drive it but well below 100% next year.

Suzzane Ballard (Analyst)

Great. Just a quick follow-up. Can you just give us an update on the M&A environment following the updated guide for acquisitions and dispositions? How is the cap rate environment kind of influencing your appetite for deals at the moment?

Rob Hull (EVP and COO)

Yeah, I mean, I think, what we're seeing on the, on the MOB transaction market right now, you know, we're seeing cap rates kind of stable for core assets in that, you know, loose sixes range. We have seen some, some high-quality deals that have dipped below that. Generally, though, you know, certainly volumes are down, but we're seeing some decent activity there. We do see opportunity as, as these lenders kinda get back into the space that we think that transaction volume, you know, will continue to be where it is and move up throughout the balance of the year and in the next as interest rates are projected to come down. I think there's still an appetite out there for the for the product.

Just you've got an opportunity for some folks to kind of get in and, and achieve the higher, the higher IRRs that they're targeting. Right now, we are seeing some folks that are gonna sit on the sidelines, but, but still continuing to underwrite the space, looking for the right opportunities and, and looking for their moment. Still, still a very attractive space.

Todd Meredith (CEO)

I think maybe Rob mentioned this in his prepared remarks, but I think the lender environment is key to that. We are seeing, you know, like probably a lot of sectors, we're seeing a lot of interest in MOB from buyers who may even just say, "I'll do it all cash," and maybe do a little less volume for the year, but go all cash because we see a better lending environment in the future. Even on top of that, we are seeing some of the major lenders, the bigger banks, back in the space, and not dependent upon the regional banks. There's some encouraging signs there that those lenders want to be in the MOB space.

I think it goes back to simply the stability, you know, just the reliability of the MOB space, and that's a big contrast to some other sectors that are, that are facing much tougher times. It's not just general office. You know, there was an article in The Wall Street Journal about apartments even. We, we certainly see lenders really seeking out the stability and safety of the MOB sector, which is helping the transaction market.

Suzzane Ballard (Analyst)

Appreciate the color. Thanks, guys.

Operator (participant)

As a reminder, that's star followed by one on your telephone keypad to enter the queue. The next question comes from Mike Mueller from JP Morgan. Mike, please go ahead. Your line is open.

Mike Mueller (Analyst)

Yeah, hi. I apologize for any background noise here. Can you comment on what's the expected size of the seed portfolio that you'll contribute? Then taking that into consideration, assuming it's a 2024 event, would you anticipate being a net seller again in 2024?

Todd Meredith (CEO)

Mike, I would say, no change from what we said last quarter on the size of a, of a seed portfolio. We sort of loosely laid out $500 million-$1 billion. I would say that's certainly the target. Obviously, in this kind of market, and as we engage with potential JV partners, you know, that can move around, as you would expect. So I would still say that's sort of the range we're thinking about. I would also add, you know, certainly we're looking at a, a structure that would probably lead us to be a, a smaller piece, you know, maybe 20%-30%. Again, that's a flexible thing that will evolve through the process. Sorry, what was your, your last question? Oh, our, our net seller position currently, will it, will it continue into 2024?

I mean, obviously, that's largely dependent on the macro environment.

Mike Mueller (Analyst)

Yeah.

Todd Meredith (CEO)

It depends where, depends where our cost of capital is. It depends, you know, how things are moving for us. But I think, you know, we're gonna be very careful here and prudent here in terms of where our cost of capital is relative to where we can reinvest. But I think the JV certainly gives us in addition to asset sales, an attractive source of capital that will have a lot of options to, to, you know, pursue all those different redeployment options, which is, you know, everything from share repurchase to development funding, debt repayment, all of those. We're, we're pursuing those, those for now, and I think that will continue into 2024 until we see something different.

Mike Mueller (Analyst)

Okay, thanks.

Todd Meredith (CEO)

Thanks.

Operator (participant)

The next question is from John Pawlowski from Green Street. John, your line is open. Please go ahead.

John Pawlowski (Managing Director)

Thanks. Kris, if the expense pressures you're seeing persist, curious if there is risk to the 4%-6% guidance for same store next year?

Kris Douglas (EVP and CFO)

Yeah, we'll just have to see how quickly it, it comes down, and, and how much we're able to, to recover as a pass-through, through the structures of the leases. You know, as we get further along and we see how it's-- how it's adjusting, then, you know, we'll, we'll, we'll analyze that as, as we start to put our, our expectations and formal guidance together for, for next year.

John Pawlowski (Managing Director)

Okay. Setting aside guidance, just, maybe you could elaborate on the expense pressures. Does it seem like a kind of structural change to the intermediate-term growth of the expense profile of the business, or is it more transitory in your mind?

Todd Meredith (CEO)

Yeah. Yeah, I'm, I'm, I'm wary of using that word because what, what we saw from Fed over the last few years. I can speak a little bit to the trends. What I can say that, that, you know, as I mentioned right now, it, it still seems to be mostly on the labor side, is what we're seeing. You know, it is coming down, so I, I wanna make that clear, but it's just not coming down quite as quickly. Year-over-year in the first quarter, labor in terms of personnel and janitorial, was up almost 14%. You know, in the second quarter, it came down, but it was still year-over-year up 10%.

We're making progress, but it, it just hasn't, you know, come back to, to full historical levels. As we continue to, to pass, you know, just difficult comps and, and things, we, we do feel like we'll start to, to see that trend lower. We are making, you know, some great progress in, in other, other portions of the, of the expense structure, that I think can, can help offset that. We'll, we'll continue to monitor that and work through that through the balance of the year.

John Pawlowski (Managing Director)

Okay. Last question from me. Where are you aiming to get debt to EBITDA down to by end of the year?

Todd Meredith (CEO)

Yeah. Our goal is to, to be in that, in our range of 6-6.5, you know, which, which is kind of where we are today. We expect that that will probably be at the, you know, closer to the high end of that range by the end of the year, but then trending down through next year as we have, have more, you know, growth in terms of, of cash flow. As well as we did talk about last quarter, we had a couple of things that we're not booking income on right now that we're working on potential sale and repayment, ones, you know, sales assets as well as another mezz loan that will be repaid. That would be additional, proceeds that can pay down debt, without a, a loss of income.

That has a, a pretty meaningful impact when, when that occurs, which will likely be late this year, moving into, moving into early next year. But yeah, I would say for the end of the year, still expectation is to be, to be in that range of 6-6.5.

John Pawlowski (Managing Director)

Okay, thanks for taking the question.

Operator (participant)

Another final reminder, that's star followed by one on your telephone keypad to ask a question today. As we have no further questions, I'll hand the call back to the management team for any concluding remarks.

Todd Meredith (CEO)

Thank you, Adam. Thank you, everybody, for joining us this morning. We look forward to seeing many of you in Raleigh on October fifth, in our Investor Day. A reminder should be coming out soon. If you did not get one and are interested, please reach out to Ron, we'll make sure you get an invitation. Thank you, everybody. Have a great day.

Operator (participant)

This concludes today's call. Thank you very much for your attendance. You may now disconnect your-