Healthcare Realty Trust - Earnings Call - Q3 2018
November 2, 2018
Transcript
Speaker 0
Good morning and welcome to the Healthcare Realty Third Quarter Financial Results Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Todd Meredith, President and CEO. Please go ahead.
Speaker 1
Thank you. Joining me on the call today are Rob Hull, Chris Douglas, Bethany Mancini and Carla Baca. After Ms. Baca reads the disclaimer, I'll provide some initial comments followed by Ms. Mancini with an update on health care trends.
Then Mr. Hole will discuss investment activity. And Chris Douglas will review financial and operating results before we move to Q and A. Carla?
Speaker 2
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 a Form 10 ks filed with the SEC for the year ended December 3137, and in subsequently filed Form 10 Qs. 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, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution, FADs, 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 third quarter ended September 3038. The company's earnings press release, supplemental information, Forms 10 Q and 10 ks are available on the company's website.
Speaker 1
Thank you, Carla. Healthcare Realty's third quarter results and positive operating fundamentals continue to exemplify the intrinsic value of our medical office portfolio. The company's same store metrics consistently outpaced norms for the sector, anchored by steady tenant demand, solid tenant retention, and rising rental rates. The strength of our medical office properties lies in their integral location on leading hospital campuses, where higher acuity patients drive the need for specialists, and concentration is high in top markets where thriving population centers ensure increasing demand for healthcare services. As the MOB transaction market has gained momentum in recent years, we have remained sober and purposeful in our investing.
We view Healthcare Realty's relative valuation as a reflection of our commitment to sustainable growth and careful management of risk. Quality, not quantity, has led us to an enviable balance of higher growth and lower risk. With today's market dynamics, our focus is on extending our competitive advantage through operational performance and continuous improvement of our portfolio through recycling of assets, an often underappreciated but effective form of long term value creation. We have no interest in chasing large portfolios at historically steep pricing with subpar growth merely for the sake of buying assets. As cost of capital has risen in recent quarters, experience compels us to be more patient and prudent, targeting investments where we can better control quality and avoid performance diluting assets often embedded in larger portfolios.
Much of our recent acquisition activity has encompassed redevelopment potential that has expanded our development pipeline, generating a store of future value that can be garnered for years to come. Our development pace is somewhat tempered by our adherence to an on campus focus where supply is constrained, rent growth is demonstrably higher, and risk is lower as a result of perpetual demand for more specialized hospital based tenants. Although off campus health care delivery has gained attention, most MOB investors have gravitated toward on campus investments as they achieve scale and lower their cost of capital. Off campus properties are much easier to accumulate, but bear many costly and probable risks that play out over time, namely slower growth, lower tenant retention, and difficulty backfilling vacancies, which experience leads to longer downtime, rent roll downs, and costlier capital and tenant improvements. While we tend to avoid off campus properties for these reasons, they do serve a clinical role, meeting the rising demand for low acuity care and improving population health across markets, but not to the detriment of on campus services, where health systems are actively centralizing and expanding their more complex inpatient and outpatient care.
This optimization of services across different settings will effectively meet patient demand, ease cost pressures, and bolster profit margins. The company's investment strategy has been consistent over twenty five years, honed through hands on experience and acumen gained over multiple lease cycles, both on and off campus. We see growth potential and lasting value creation across our portfolio through operational know how, disciplined investing, and adept portfolio management. With outpatient care shaping the future of an industry that exceeds 18% of GDP and is projected to grow 5.5% annually, Healthcare Realty is well positioned to deliver steady growth with a low risk profile in the years ahead. Stephanie?
Speaker 3
The spotlight on the healthcare sector shifted this quarter more toward hospital performance, provider consolidation and market expansion and away from public health policy, which has been relatively quiet as the midterm election nears. Hospitals and physicians are focused on balancing cost containment and tighter reimbursement while meeting the aging population's demand for greater health care services. The strength of a hospital is critical when Health Care Realty considers an investment. We look beyond just credit ratings to the hospital's underlying operating fundamentals. Over 90% of health care realty's NOI from on campus MOBs is associated with hospitals ranking above the median of the nation's 4,800 hospitals when measured on net patient revenue, occupancy, population growth and density, case mix index, and surgical mix.
Healthcare Realty has generally avoided investments on the campuses of rural, for profit, and stand alone hospitals, often located in sluggish markets, which in today's health care environment are contending with lower inpatient volumes and declining profit margins. These troubled hospitals often drive national headline perceptions of the sector. In contrast, not for profit hospitals in markets with favorable demographics are generating positive growth in revenues per inpatient admission, along with a steady rise in their surgical cases and outpatient services. Health systems across our portfolio and investment markets are building new inpatient towers and moving forward to expand capacity. In the past five years specifically, 40% of HealthCare Realty's hospital partners completed, have underway or are planning an inpatient expansion.
Nationally, acute care hospital construction in 2018 will be the strongest in five years with $20,000,000,000 in completions. Hospitals currently have under construction $50,000,000,000 and another $20,000,000,000 are in the planning phase. With an eye toward expansion, more hospital leaders are asserting their need to capitalize on core strengths and profitable services in their markets in order to accelerate revenue growth, both inpatient and outpatient, while also controlling costs. Off campus facilities offer multiple points of access throughout communities for patients with lower acuity needs, while on campus facilities are moving toward higher acuity services with better margins. 80% of health care realty's MOBs are located within two fifty yards of a hospital.
And 84% of our physician tenants are specialists. In our experience, this translates into valuable tenant retention and higher renewal rates. Medicare policy continues to support higher reimbursement for on campus services as the Center for Medicare and Medicaid Services just finalized their 2019 rates yesterday and extended their 2018 policy to lower payments to off campus hospital outpatient departments to 40% of their on campus rates and closer to the physician office level. This policy should further motivate hospitals to streamline care in off campus settings and centralize higher acuity services on campus, reinforcing the relative value and stability of on campus outpatient care. Thirty years ago many thought the rise in ambulatory surgery centers would put hospitals out of business.
On average, over half of hospital revenues are now outpatient, partly attributable to a 50% increase in hospital ownership of ASCs over the past six years. The resiliency of this sector combined with the rising tide of healthcare demand will ensure its profitability and breadth of potential for lasting investments. Rob?
Speaker 4
Our investment efforts this year have been balanced, redeploying $65,500,000 of proceeds from asset sales into $74,500,000 of new investment with better long term growth potential. Acquisition activity was intentionally muted during the quarter. We purchased a 17,000 square foot MOB on 1.7 acres in Denver for $4,200,000 at a six percent first year yield. The building is adjacent to CHI's St. Anthony Hospital where the company owns six other buildings.
This property gives us control of a contiguous 14.7 acre site at the front entrance to the hospital, securing a sizable future redevelopment opportunity. We continue to successfully identify one and two building opportunities in markets where we already have a presence. The company has under contract two properties totaling $37,300,000 scheduled to close by year end, bringing us to $112,000,000 in new investments for the year on the upper end of our guidance range. Overall, the acquisition environment remains active with several portfolios in the market. For better asset quality, pricing is expected to be in the low to mid-5s and occasionally below five, consistent with levels over the past twelve to eighteen months.
Implied cap rates for public healthcare REITs owning meaningful MOB portfolios currently range from 5.8% to 6.4%. Healthcare Realty's implied cap rate of around 5.8% gives us one of the lowest cost of capital relative to our public peers, a clear advantage in most circumstances. Nevertheless, we are not inclined to raise incremental capital given that valuations for most quality properties remain below our current implied cap rate. As a result, our approach to fund future acquisitions with disposition proceeds remains sensible during this period of disconnect between public and private valuations. We will continue to evaluate the relationship between our implied cap rate and market asset pricing as we establish future acquisition levels.
Turning to dispositions, we sold one off campus MOB in St. Louis for $9,800,000 at a cap rate of 4.3%. With this sale, year to date dispositions totaled $65,500,000 at a blended cap rate of 13.7%. Our disposition activity for the balance of the year will range from 20,000,000 to $50,000,000 at a projected blended cap rate between 5.57%. This range represents up to six transactions, one or two of which could slide into early next year.
Disposing of these properties comprised primarily of off campus MOBs located in smaller markets and one inpatient rehab facility continues our disciplined strategy of improving the growth profile of our portfolio by reinvesting proceeds in more desirable properties. On the development front, the company is making steady progress on the construction of its 151,000 square foot MOB on UW Medicine's Valley Medical Center campus in Seattle. The building is 60% leased and demand for the remaining 40% is strong. Our current pipeline of prospective tenants totals more than two times the remaining space in the building. This level of activity is promising and is why last year we purchased an additional property adjacent to the campus.
This 33,000 square foot MOB under utilizes a four acre site that could accommodate a 150,000 square foot redevelopment. Measured development remains a key component to our long term investing strategy. We expect 50,000,000 to $100,000,000 of development starts each year on average, primarily derived from our embedded development and redevelopment pipeline made up of over 1,500,000 square feet and $750,000,000 development potential in locations that are largely in our control. I am pleased with the patience and discipline our team has demonstrated throughout the year, positioning the company well in a shifting environment for attractive investment opportunities when they arise. Chris?
Speaker 1
Core fundamentals such as leasing performance, operating leverage and internal revenue growth remain on a positive track, generating third quarter same store NOI growth of 3.1% over the same period in 2017. Normalized FFO in the third quarter was $48,200,000 or $0.39 per share. Normalized FFO decreased sequentially $800,000 $500,000 for net dispositions in the second quarter and $300,000 from reduced straight line rent. As we ordinarily see sequential Q2 to Q3 results, NOI was flat due to a $1,400,000 increase in seasonal utilities, offset by increased operating expense recoveries and contractual rent escalators. Looking forward, third quarter seasonal utility expenses typically reverse in the fourth quarter, historically leading to NOI growth of approximately 7 and $50,000 to $850,000 from third quarter to fourth quarter.
This anticipated expense reversal combined with robust cash leasing spreads, escalators and retention signals a positive trajectory in coming quarters. Same store performance in Q3 was reliably strong with NOI from the same store portfolio growing 2.9% on a trailing twelve month basis. NOI for the 15 single tenant net lease assets increased 4.1% with the higher than normal growth primarily a result of two non annual rent increases over 5% in the 2017 and one asset with free rent in early twenty seventeen. These two items create a favorable comparison in the current trailing twelve month period, but we expect this benefit will normalize over the next three to four quarters and bring NOI growth closer to the single tenant net lease average in place escalator of 2.4%. Performance of the same store multi tenant properties was also sound with NOI increasing 2.7% on a trailing twelve month basis due to operating leverage generated by revenue growth of 2.6% and a modest 2.3% increase in operating expenses.
It is worth noting multi tenant same store revenue growth for the trailing twelve months would have been 20 basis points higher, but for changes in rent concessions and legacy property lease guarantees, which represent one percent and zero point two percent of revenue respectively, highlighting how changes in even small categories can impact overall growth percentages. When controlling for these items, trailing twelve month NOI growth would have been 3%. Our internal growth continues to be propelled by solid contractual increases in cash leasing spreads. Future contractual increases were 3.76% for leases commencing in the quarter, which helped boost average in place contractual increases to 2.88% compared to 2.78% a year ago. Cash leasing spreads were 3.8% with approximately 85% of the 96 renewals having cash leasing spreads equal to or greater than three.
Our ability to achieve superior rent growth on both new and renewal leases reflects the value of owning well located and affiliated properties with low fungibility. We continue to dispose of properties with below average revenue drivers and rotate into properties that allow us to bolster cash leasing spreads and annual increases. Thus far in 2018, the weighted average in place contractual escalator for properties we sold was 2.4%, well under our in place average. This rotation allows us to accelerate NOI growth over time even if there is temporary dilution due to lower initial cap rates. This strategy is especially effective for spurring safe growth in the midst of a disconnect between public and private cap rates.
Additionally, by using proceeds from dispositions to fund investments, we've been able to maintain a healthy balance sheet. Leverage remains low at 5.1 times with no significant near term maturities. Year to date FFO payout ratio is 77% and FAD payout is approximately 100%. Excluding the same unusual items I mentioned last quarter, TI overage to be reimbursed by tenants, dollars per move in ready suites and delayed acquisition capital, year to date FAD payout ratio would have been 95%. We expect the full year to follow a similar pattern and our internal growth to improve the FAD payout ratio in 2019.
With ample liquidity, low leverage and capital from a healthy pipeline of dispositions, we remain committed to our proven strategy of targeting investments that will further our ability to generate NOI growth at the high end of the sector. Thank you, Chris. Gary, that concludes our prepared remarks. We're ready to begin the question and answer period.
Speaker 0
We will now begin the question and answer session. The first question comes from Vikram Malhotra with Morgan Stanley. Please go ahead.
Speaker 5
Thanks for taking the questions. In your opening remarks, you kind of alluded to the fact that you'd stay away from pricey portfolios and really focus on the one offs, quality portfolio core quality assets. Does that say that of the two large portfolios out there, Landmark and C and L, that's something you would not be looking at?
Speaker 1
Generally, yes, that is true. We've certainly looked at them. We certainly look at everything. And I would say that in both of those portfolios, there's maybe individual assets that we certainly would find attractive. But it's the challenge of the larger portfolios that it's often accompanied by too many properties that don't fit.
So from our standpoint, those portfolios are not a fit.
Speaker 5
Okay. And then just a commentary on the FAD payout. I understand there were a lot of one time items, and the number would have been 95%. Something, I guess, we've been talking about now, you know, throughout the year. When do you see sort of this the the FAD payout coming down to a level where you you can actually raise the dividend?
Because it's been several years, we're obviously late in the cycle, 95% certainly better than 100%, but it doesn't give you a lot of room. I'm just wondering if you look out over the next twelve months, if you can give us a sense of the range, where do you think you can get the payout to?
Speaker 1
Victor, this is Chris. As we've talked about, FAD payout ratio this year is pretty similar to what it was last year. A lot of that has to do with some of the one time items that I talked about, as well as the fact of the rotation of if you look at all the assets we sold in the first half of the year, they were all single tenants, so don't have much capital associated with them. And then you we're reinvesting in multi tenant properties that we think have better value long term. I think we expect to be able to drive payout down in 2019 and continue to drive that in the years ahead.
I will point out though that we're we are going to make what we think are the right prudent long term decisions, even if it does mean a slightly higher payout ratio in the near term. For example, this year we had a couple of leases where we signed longer term extensions on renewals than we typically do. These were ten and twelve year leases. And the reason we did that was to position these properties for potential sale in the years ahead. With those longer term leases, even with the same TI per square foot commitments, it increases your spend.
But we think it will certainly pay for itself in the end when we potentially sell those properties at higher values and see greater gains. So we're not going to pass up good long term decisions just looking at the payout ratio on a short term basis.
Speaker 5
Okay. And just last one for me. So you have an asset in Garland, Texas, which I know we've talked briefly a bit about. There was a hospital right next to that that that did shut down, and I believe the Garland asset was part of a larger portfolio. Can you give us an update what's the status of that asset, like what's the occupancy and maybe is that one of your disposition candidates?
Speaker 1
Sure, Vikram. That hospital did close actually in February. And so the hospital's been closed for a while. We really have been sort of at about 56% occupancy recently, so that hasn't changed dramatically. We do expect it will move probably closer to 40% over the next year or so.
So really kind of where we're at is obviously looking at them as potential dispositions. We have gained some improvements on the ground lease in terms of ability to lease the non medical tenants by virtue of the hospital closing. And also we're looking at working with Baylor to purchase the fee simple interest. So obviously working towards improving the marketability of those assets. I would say that the NOI from those properties is about $1,000,000 So while it's an important piece to look at in terms of the disposition strategy, it's obviously not a material amount of NOI.
Speaker 5
Great, thank you. The
Speaker 0
next question comes from Chad Vanacore with Stifel. Please go ahead.
Speaker 6
Good morning. So given
Speaker 4
that
Speaker 6
the transaction market is hot and valuations are pretty high, is there somewhere in your portfolio where you can harvest stabilized assets where valuations have run up significantly? Well, I think, Chad, if you look
Speaker 1
at what Rob described, the dispositions for the remainder of the year should be in that between what 05/1957, I think Rob certainly there are certain assets that do fall into that category. We're not out looking to sell some of our top assets to show that they're worth a 5% cap or less. I mean, I don't think that really is necessary. I think there's plenty of other transactions that support very strong valuations. And I think for us, it's more just balancing what investments we see that are attractive and how can we match that with assets that we're selling that make for some attractive proceeds to reinvest and improve the profile of the portfolio.
Speaker 6
Okay. And then just one other question. Given next year's lease accounting changes, moving capitalized leases to the expense line, how do you expect that shift to actually impact FFO next year?
Speaker 1
It's really not going to have much impact for us because we were already expensing the majority of our internal leasing costs. So they're already in our G and A. So no material impact for us.
Speaker 6
All right. That's it. Thanks.
Speaker 1
Thank you.
Speaker 0
The next question comes from Jordan Sadler with KeyBanc Capital Markets. Please go ahead.
Speaker 7
Thanks. Good morning. Not to beat a dead horse. I think there's been a couple questions in this vein a little bit so far. But I think, you know, the investors are probably scratching their heads.
I know we are with the underperformance in the group, medical office building focused REITs versus health care REITs more broadly year to date. I'm sure you guys are doing the same given what seems to be, you know, good fundamentals. But now you're trading, you know, probably, you know, something look looks like a discount to NAV about 10%. And you've talked about your, you know, your cost of capital kinda going away from you relative to where assets are priced. So what are the plans to narrow that gap versus NAV or capitalize on the opportunity that exists?
Or do you just sit tight?
Speaker 1
Well, I think the obvious thing is that we certainly benefit from having a strong portfolio. So I think the contrast here is that you have a lot of folks who are struggling with their operations, maybe not as much in the MOB sector. I think the good news is the MOB sector, as you pointed out, is really performing well for everyone. We think certainly we're outpacing that group. But I think our view is that we have the ability to wait.
We have the ability to rely on our portfolio. We don't think this will last forever. I think whether it's the privates or the publics, we've all had a rise in the cost of capital. For the privates, there's usually a delayed effect. And I think the issue we're all looking at, and this is not just health care or MOBs, it's all real estate.
There's just a huge amount of capital that's been raised on the private side that I think is keeping that pressure, keeping cap rates low, and obviously an interest in the MOB sector specifically for all the attributes that it brings. And so I think we just have to obviously watch that play out. But in the end, the private folks, their cost of debt has risen just like ours has. And so I think you just have to have the portfolio to be patient and wait. And we think we're well positioned to do that.
Speaker 7
And just wait it out.
Speaker 1
I mean, there's certainly things that we can do, and we are doing, in terms of selling assets into that trend. I mean, there's no doubt we're doing that, taking advantage of that. We'll continue to do that. And we'll be selective with investments. I mean, if we can sell some things that are attractive cap rates relatively into that type of environment and we can rotate it into really strong assets, we're going to do that.
The level of that as you saw this year at $100,000,000 plus or minus is certainly down from maybe a normal year of 200 to $300,000,000 but still allows us to remain active.
Speaker 7
Okay. I guess the other sort of question I would have, mean, it seems like there there is some kind of a disconnect, right, privates versus public. So and and you don't wanna sell your high quality, but you you guys have talked about your single you know, liking multi tenant to like better a lot better than single tenant. I mean, there an opportunity? I mean, you guys still have quite a
Speaker 5
bit
Speaker 7
invested in the in certain single tenant assets and some of them you still want to hold. But is there an opportunity to do some monetization in that portfolio?
Speaker 1
I think we have been. That certainly will be where we will lean when we're selling assets. That typically is where we focus. Most of what you've seen, as think Chris said, most of this year has been single tenant. And for the balance of this year we have an inpatient rehab facility and some other off campus and single tenant.
So I think to your point, we're certainly predisposed to go that direction. And I think you will see our multi tenant continue to incrementally rise. I mean the good news is we're only I think maybe 10% or less of our NOI is from single tenant. So there's not a lot of room left to change that. And we're not looking to get to 100 just for principle.
I think it's more about the assets individually and evaluating those situations case by case.
Speaker 7
And any thoughts on I mean, doesn't sound like you're thinking strategic alternatives here at all, but what are your thoughts on MUTA and opting out?
Speaker 1
Sure. I think on that, I think what's important there is we understand the ramifications of having that option. And obviously, if folks that have that option because they're incorporated in Maryland, there's certainly a penalty to exercising that. So we're obviously aware of that. And our board, I think, first and foremost, would want to have investors and shareholders know we don't view that some great defensive option.
We know there's a lot of negative ramifications of using that. So we're certainly aware of it, evaluating it, but don't really consider that as a very viable option in terms of a use of that.
Speaker 7
So why not just take it off the table?
Speaker 1
Well, certainly something we're evaluating. I think the important thing is we didn't go looking for that. We didn't opt into that. It was something that came to those who were incorporated in Maryland. So certainly, we understand that and are taking a look at that.
Speaker 7
That's fair. Thank you for the Sure.
Speaker 0
The next question comes from Jonathan Hughes with Raymond James. Please go ahead.
Speaker 8
Hey. Good morning. Thanks for the time and the earlier commentary. Looking at your second generation TIs on a on a per square foot per year basis, It looks like they're, you know, running maybe 50% above the the 2,015 amount. And I know there was a onetime item in there last quarter that you you mentioned earlier in Vikram's question.
But even outside of that, it looks like it's still up significantly over the inflation adjusted increase I would have expected. Has the leasing that's been completed this year occurred at older buildings that maybe had some deferred TIs? Were they more exposed to competitive new supply pressures? So I realize that seems unlikely given developments pretty measured. Just has the cost of acquisition at least just gone up?
Just curious to hear your thoughts there.
Speaker 1
No, I wouldn't say it's gone up. If you look at just the last five quarters, it's going to bounce around in any particular period. We typically say we think on renewals, you should expect somewhere in the range of 1.5 to $2 And we've had a couple of quarters even outside of that. We had third quarter twenty seventeen was $1.38 2018 was 2.48 And that did have a specific lease or two on the $2.48 that I talked about last quarter, where we did agree to some higher commitments per square foot for some non MOB space that we're looking to potentially sell. So we're not seeing anything that I would say is outsized.
And we think that what we're experiencing is right in the range of what we would expect.
Speaker 8
Okay. But, I mean, I I was looking at the, you know, the stuff from three years ago and that second gen TI per square foot per year on, you know, those renewals is more like a buck to a buck and a half. So, I mean, again, the increase just seems kind of outsized. I was just trying to understand that.
Speaker 9
Yes. You would have to look at
Speaker 1
the specifics of what's going on in that specific period versus this specific period as well as where those leases are. It can be in different parts of the country and different markets. As a result of that, the cost on a percentage of NOI can be different. But generally what we've seen in terms of time and inflation and growth in that metric is that it's been
Speaker 4
fairly consistent.
Speaker 1
I think the other thing I would add is that
Speaker 5
if you
Speaker 1
look at the limited disclosure that's out there for companies that are in the MOB business, our number was, what, 1.5 0 per foot per lease year for renewals this quarter. And I think HTA was $1.5 HTA was $1.55 HCP was $2.22 this quarter. So it's not as though our number on commitments on second generation TI are in fact lower than the other two that disclose something on that. So again, it does move around. But I would say we've been, even over a longer term average, we're very much in line with the peers on that for the disclosure that's out there.
We've looked at, it's only the three of us, us, HTA and HCP that actually even provide that information. We think that is key to be able to compare across portfolios. But we've looked at that over a three point five, four year period and it stayed in that 1.5 to $2 range. I think the average across the three of us was like $1.7 and with the low between us, I think HTA were both around $1.55 $1.6 and HCP was slightly higher, like $1.801.0.85 dollars But all within a pretty tight range.
Speaker 8
Okay. That's helpful. Yeah. I mean, your disclosure is great. So I I I do really appreciate all all the data you give there.
And then just one more for me. You know, looking ahead to to next year, about 20% of your square footage leases expire or not expire or mature. Can we expect a similar recurring CapEx spend on those? Are there any outliers in there that we should be aware of as we look ahead? Thanks.
Speaker 1
Yeah, generally our expectation is that tenant retention and renewals will be similar. We do have one space down in Dallas that's a fitness facility that we may convert a portion of that fitness facility into more clinical use. And as part of that you would be kind of maybe tearing some out and starting from scratch. So it could be up a little bit. But generally, yes, we feel like it should continue to be in the range of what we have seen historically.
Speaker 8
Okay. That's it for me. I'll jump off. Thanks for taking my questions.
Speaker 0
Your next question comes from Rich Anderson with Mizuho Securities. Please go ahead.
Speaker 9
Hey, thanks. Good morning, everyone.
Speaker 1
Good morning.
Speaker 9
Chris, you mentioned just on the lease accounting that you already expensed it. Can tell you me how much that number actually is that's baked into your G and A?
Speaker 1
Yes. Well, it depends on what portion you're wanting to get into. We look at just the lease incentive portion. And that runs I think it was runs from kind of $750,000,000 to $1,000,000 But if you take our entire leasing platform, you're probably in the $2,500,000 range.
Speaker 9
Including lease incentive?
Speaker 1
Yes. Not the annual. That's on an annual basis. And I can follow-up with you with more specifics. That's just kind of going off of top of my head memory.
Speaker 9
Okay. No, it's fine. I just want kind of just rationalize a little bit. Did you mention, Todd or Rob or whoever, how deep your disposition pipeline is in terms of what you view as the non core element of your portfolio?
Speaker 4
Rich. I'm not sure I mentioned that, but I think we look at it as the bottom 5% of the portfolio. We're always when we work our way through that bottom 5% as the portfolio evolves, it's probably going be another 5%. But we think that sales of around 50,000,000 to $100,000,000 per year is appropriate for us. And if we see an opportunity where we could increase that because there's a good opportunity to reinvest it into a quality asset with good long term growth potential, would do that.
I'd also say that if go ahead.
Speaker 9
I was going say up it if something materializes
Speaker 4
Yes, the yes.
Speaker 9
I was just curious, Todd, you opened up the commentary at your, you know, quality over quantity and, you know, over I think everyone is in agreement with that and understands it. But what to to what degree, are you almost having to say that, I'm gonna be a little cynic because that's what always do. Because of where your stock is trading. In other words, you kinda have to sit on the sidelines. So, you know, this is, you know, has we're kinda backing in to this thesis.
You've never been in the type to be accumulators, and I'm not suggesting that. But I mean, are are you wishing you had this stock to to utilize because there's stuff out there that you would normally go after, but you just can't?
Speaker 1
You know, it is. I heard somebody else, I can't remember who it was on their call, say something similar that there really hasn't been as much, maybe quality, I can't remember if it was HTA, but I would agree with that statement that we just haven't seen this year the depth of quality that we saw in the past few years. And it's not to say that the portfolios are bad or we're not commenting that they're not decent portfolios. But they're certainly not the level of what we're looking for in terms of growth profile, the on campus, all the things we look for. And so I would say maybe there's an asset or two here or there that we'd have loved to have been able to participate in.
The challenge of course is the bigger portfolios, there's just too many things that don't fit. And we've even made some attempts here and there to see if we can't pull an asset out here or there. But that's obviously not to be expected in a pretty robust environment where there's strong bids for big portfolios. So I think our view is no, we haven't missed a lot. I think we're watching for that just like everyone is.
And certainly, of course, we would love to have our stock be at a better place and be able to use that. But I think the good news is it's been an environment where we haven't missed a lot as a result of it.
Speaker 9
Okay. And then lastly, you talked a little bit about the hospital closure impact on one of your assets. And I think perhaps some people worry somewhat about the medical office business being tethered to the hospital industry that's subject to a lot of consolidation and what have you. Specifically to Baylor Memorial Hermann, I know that there's not a whole lot of crossover, know, Baylor being in Dallas, Memorial being in Houston primarily. But do you when you look at that, do you have any issues that you've of rise to the surface that you have to be watchful of as a consequence of that merger, should it happen?
Speaker 1
No, we really don't. I think as you pointed out, they really don't have geographic overlap. Mean, they're tangential and certainly improve, I think, the competitive position of the combined entities. I think it's a very strong merger for those two entities. I think it will give them a lot of strength in the state of Texas in terms of, especially their insurance side.
I think that's really the key play there, is that not only obviously giving them some leverage with commercial payers, but also increasing their own insurance product that they have. Scott and White really brought an insurance product play to Baylor, and now they can expand that to a broader geographic region. So I think we see that as a positive. Would say we only have really one campus in the Woodlands where we're associated with Memorial Hermann. So that's certainly, don't see any issue there.
And then otherwise, in the Dallas Fort Worth area or Austin, we really don't see any issues. So we just see it as generally a positive.
Speaker 4
Okay, great. That's all I
Speaker 10
have. Thanks. The
Speaker 0
next question comes from Michael Mueller with JPMorgan. Please go ahead.
Speaker 10
Yeah, hi. The going back to dispositions, the 20,000,000 to $50,000,000 by year end, I think the range was 5.5 to 7,000,000 If you do all 50,000,000 where in that range do you end up? Is it in the middle someplace?
Speaker 4
Yes, it's going to be right at the midpoint of that, Mike.
Speaker 10
Got it. And then going on your comment about 50,000,000 to $100,000,000 of go forward dispositions per year, I mean, how much of the portfolio is left where it would fall into the 6.5 or seven cap bucket as opposed to where you're going see cap rates on dispositions drift down to the 5s? What's left that's high cap rate?
Speaker 4
Yeah, I mean, Mike, think if you inside of our supplemental we've got a section portfolio make up of non MOB bucket, makes up about 2.5% of our NOI. I think that's where generally disposition of those assets are going to kind of fall into that higher cap rate range that you mentioned. We've got a couple of inpatient rehab facilities in there and one remaining skilled nursing facility. Those are probably going be in that higher range that you mentioned.
Speaker 1
But I guess what you're pointing to on that, Rob, is not that entire section that we would think we would sell. Out of that portion of the portfolio, there's two or three buildings, and that's what makes up
Speaker 4
the Yes, two point that's correct.
Speaker 10
Okay. And then one other question. On the 50 to 100 development starts per year, does that include expansion work or redevelopment? Or is that just new starts?
Speaker 4
No, it does include that. We include redevelopment and expansion work with our development expectations.
Speaker 10
So the
Speaker 4
deal that we did in Charlotte was 38,000 square foot expansion that would be included in there.
Speaker 10
Got it. Okay. Okay, that's it. Thank you.
Speaker 0
The next question comes from John Kim with BMO. Please go ahead.
Speaker 11
Good morning. I want to know how sustainable the escalators on leases commenced are at 3.76%. Is that really just a one off? Or is it something that you could sustain going forward?
Speaker 1
Yeah, no, I think that that's higher than what we would tell people to expect for a long term average. What we've been doing is kind of trending up close to three. There's some markets that you obviously can't get three, but there's some markets obviously if you're able to get 3.78 as a blend, we're able to get 3.5 or four. But if we can kind of get our overall escalators running around three, maybe slightly over on an average, I think that would be a great long term run rate.
Speaker 11
On your redevelopment opportunity associated with your Denver acquisition,
Speaker 5
did you need to acquire this asset to get the
Speaker 11
ability to develop on-site given it's adjacent to a number of other buildings? And then also can you just discuss
Speaker 4
No, no. That asset is adjacent to two properties that we purchased in the second quarter, total 13 acres. We did not need this property to develop on that site. However, having this property, it's an additional 1.7 acres, it does enhance the development opportunity and allow us to do some things that will enhance the positioning with the hospital. So it's an important piece.
Speaker 1
And it consolidated some easements for traffic as well as utilities and so forth that just makes it easier to control that whole site.
Speaker 11
And what do think the timing is? Is it something medium term to long term, or could it be
Speaker 4
Yeah, that's more medium to long term, I would say. We look at that as a long term opportunity inside of that embedded development pipeline that I mentioned, that's $750,000,000 It's really a long term pipeline where we control the sites and the process.
Speaker 11
Okay. And then Todd, I think you've been very consistent with focusing on on campus MOBs and you're really talking about, or discussed earlier, the risks with off campus. But acknowledge that there is a purpose and tenant demand and seems like investor demand for that asset class. I'm wondering if it's something that you have looked at or maybe potentially pursued owning off campus in the joint venture structure, or some other structure where you can benefit from your relationships?
Speaker 1
Sure. I think certainly that's a consideration. We've thought about that. I think the difficulty is we're certainly predisposed towards the on campus, just given our position, our history, what we know. And I think that's what people know us for.
We have off campus properties that we think are attractive. Certainly some of the risks I pointed out are still there, and we have to monitor those carefully and manage the portfolio accordingly. But I would say that certainly that's a possibility. Think our view would be that there's going to be other people, just frankly, that are more aggressive in off campus. They don't see maybe the same degree of risk, they're not going to price it the same.
I think it's probably low likelihood that we would go down that path. But I do think, to your point, we might actually and it's what we've done selectively where we've done some new investments off campus it usually is driven by a relationship situation where we're working with an existing partner, or maybe there's a portfolio where you have the same health system and you're doing some on campus and a little bit of off, we're okay with some of that. I think we just look at it as trying to price it accordingly, and then managing the risk appropriately once you own this.
Speaker 6
That's great. Thank you. Sure.
Speaker 0
The next question comes from Daniel Bernstein with Capital One. Please go ahead.
Speaker 12
Hi, good morning.
Speaker 1
Good morning.
Speaker 12
I wanted to dive a little bit more into the renewals. Retention rate is very high. Are you seeing and I think earlier in your call, talked a little bit about longer lease terms. So I wanted to get some more color on that in terms of are you seeing a trend towards longer lease terms, even if that means a little bit more CapEx upfront? And maybe is there any difference in that between renewals with physician groups versus individual hospital tenants?
Speaker 1
Dan, this is Chris. No, I mean, the comments that I made in terms of the longer term, that was frankly more driven by us in terms of a strategic positioning of being able to set those assets up for potential disposition. It was not driven as much as coming from the tenant. I would say I don't think there's specific cases, anecdotes that you could say, you know, kind of one way or the other on physician tenants versus hospitals. But I don't feel like there's been a material change in what we're hearing, across the country of average of people wanting to go shorter or longer.
We're certainly comfortable staying in that kind of average of three to four years on a renewal, given how consistent our tenant retention has been. And we'll just really analyze it from what the needs are on the individual deals.
Speaker 5
Okay.
Speaker 12
And then the other question I had was on development. We heard from a number of other REITs and other sectors about decreasing investment yields, compression of investment yields on development because of labor costs and even some delays in construction and deliveries. How are the factors that are out there that affect development impacting how much development you want to do and what kind of yields you're requiring in your ability to do more development?
Speaker 4
I think we continue to look at development and the yields that we get there in relation to where stabilized assets are trading. We've said that we were targeting 100 to 200 basis points above where those yields are. We're finding with the developments that we're doing that we're still able to achieve those yields, those stabilized yields in that range. Certainly with some of the rising costs out there you are seeing certain cases where that may be a little more difficult but you're also getting some good increases in rents and good markets that are going along with that. You're able to sustain some of those yields.
I'd also say that where you might see that more impactful is that developments that are more build to suit type developments, 100% lease type developments where the tenant has a lot more control in terms of the yields that you're generating on those. And that's typically not the type of development that we're doing. We're going onto campuses, leading hospitals and growing markets and we're working with the systems to put space on their campus that they can utilize to help grow their campus. So that entails some space that you're leaving to lease up and generate this higher return. We think that we can continue to hit the yields that we're targeting 100 to 200 basis points above stabilized assets.
Speaker 1
And Dan, I would say, to Rob's point, we've seen maybe two or three specific cases that were essentially build to suit, 100% leased to health systems, where the cap rates on those deals and these are two plus years of construction, so you're taking some risk in terms of time of delivery. And we're seeing cap rates on those push to the 5% level. There's certainly some examples of that. One that I can think of was in California, another was in North Carolina. So it's not just California.
So I would say you are seeing, as Rob said, more in these build to suit type situations. And it has compressed towards acquisition prices.
Speaker 12
Okay. That helps. And I haven't heard you guys talk anything about buybacks versus actual acquisitions or development as an option given the cost of capital, given where your stock trades relative to private values? And just wanted to hear some reiteration of those thoughts, good or bad.
Speaker 1
Sure. I think for us we'd certainly if there was a prolonged and deeper discount to NAV, that might be a more relevant discussion. Not saying we wouldn't consider it, we absolutely would at some point. I think our view is as long as we have some attractive investments that make sense at decent returns that fit with our portfolio well and we can dispose of assets and invest in those, I think that works for us. But obviously in a prolonged period and a deeper discount, that's something we'd look at and consider.
And we are the assets that we are buying are pretty close. The yields we're getting on those are pretty close to what our implied cap rate is. And so there's not a clear signal of, hey, we can't find anything that we were interested in buying that's close to that, that would say a buyback is an obvious More compelling. More compelling alternative.
Speaker 12
Right, so if you're trading in the mid-6s or something like that, unimplied yield then becomes okay,
Speaker 5
that's good.
Speaker 12
That's all I have, thank you.
Speaker 0
The next question comes from Tayo Okusanya with Jefferies. Please go ahead.
Speaker 9
Hey, this is Dawson Cato on for Tayo. Just one quick question for me as we look into 2019. Are there any purchase options that we should be aware of that we've seen in the past?
Speaker 1
We have some disclosure in our Q on all of our purchase options. There are four that are currently and have been outstanding for multiple years. Those are kind of perpetual. Their fair market value could be exercised at any time. There's one additional that comes into that same category that's fair market value that becomes available in 2017.
It's related 2019. I mean in 2019, excuse me. And becomes available next year. It's related to an inpatient rehab facility that is actually on the campus of a hospital, and it's the ground lessor who has that option. So that's the only new one that comes available, but not the fixed price purchase options like you saw earlier in 2018.
Speaker 9
Great, that's it for me. Thank you.
Speaker 0
The next question comes from Lucas Hartwich with Green Street Advisors. Please go ahead.
Speaker 10
Thanks. Good morning, guys.
Speaker 6
Good morning.
Speaker 10
On the 20% of leases that roll next year, can you talk about where those rents are relative to market?
Speaker 1
Yes, I think in general, with us having 15% to 20% of our leases rolling in a year, feel like we're always pretty tight to market. And you've kind of seen that with our cash leasing spreads over the four to five years. So our anticipation is, as you probably heard me say before, is that we should be able to grow rents in that 3% to 4% on a cash leasing basis. We've been doing better than that over the last three to four years. But still, if I'm looking at long term average, that's what I would expect.
And that's what, at this point, we're projecting and expecting going into next year as well.
Speaker 10
Great. And then there's a decent sized balance on the line. I'm just curious if there are any plans that turn that out?
Speaker 1
Not at this point. We're comfortable especially with our liquidity and the fact that we're looking at really recycling our dispositions into our acquisitions. So we're not looking like we need a ton additional capacity. But that is something that we always consider, as well as we're always kind of watching swaps as well in terms of potentially managing our interest rate exposure. But no plans currently.
Speaker 10
Great, thank you.
Speaker 0
Showing no further questions, this concludes our question and answer session. I would like to turn the conference back over to Todd Meredith for any closing remarks.
Speaker 1
Thank you. We appreciate everybody joining the call this morning. And we will be around this afternoon or the rest of the day today for any follow-up. And hopefully we will see many of you soon. Thank you.
Speaker 0
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
