Healthcare Realty Trust - Q3 2024

Transcript

Operator (participant)

Good morning. Thank you for attending the Healthcare Realty Third Quarter 2024 earnings conference call. My name is Bridget, and I'll be your moderator for today. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host, Ron Hubbard, Vice President of Investor Relations with Healthcare Realty. Thank you, Ron. You may proceed.

Ron Hubbard (VP of Investor Relations)

Thank you for joining us today for Healthcare Realty's third quarter 2024 earnings conference call. A reminder that, except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in the company's Form 10-K filed with the SEC for the year ended at December 31, 2023, and other SEC filings. 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 September 30, 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.

Todd Meredith (CEO)

Thank you, Ron. And thank you, everyone, for being with us today. Joining me for our prepared remarks is Austen Helfrich, our interim CFO. Also here with us and available for Q&A are Rob Hull, our Chief Operating Officer, and Ryan Crowley, our Chief Investment Officer. I will start by highlighting key quarterly results, leasing trends, and operational metrics. Then I'll turn the call over to Austen to walk through capital allocation, the balance sheet, and guidance. Healthcare Realty had a strong third quarter. We reported normalized FFO per share of $0.39, at the high end of our expectations. With these results up 1.2%, we are pleased to return to year-over-year growth. MOB market fundamentals are strong, with demand for outpatient space outstripping supply. We are benefiting from the secular tailwinds of aging demographics and the shift in care to outpatient settings.

Taking advantage of this backdrop, I'm proud of our leasing team for producing their fifth consecutive quarter of over 400,000 sq ft of new signed leases in the multi-tenant portfolio. I'm also pleased to report our team delivered another quarter of strong multi-tenant absorption, totaling 159,000 sq ft, or 49 basis points. This occupancy gain was driven by 565,000 sq ft of new lease commencements, coupled with strong tenant retention of over 80%. This is tremendous execution by all members of our team. We've gained 164 basis points of occupancy over the last four quarters. With one quarter to go in our published five-quarter occupancy bridge, we are on pace to be at the high end of our 150-200 basis point goal. NOI growth was also solid in the third quarter. We achieved same-store property year-over-year growth of 3.1%.

Future contractual escalators for leases commencing were 3.1%, and cash leasing spreads were 3.9%. NOI growth also benefited from continued tailwinds from our expense management program, with same-store expenses down 1.5% year-over-year. While we expect expenses to increase in the fourth quarter on a year-over-year basis, we're seeing a steady return to a more normal expense pattern versus the high inflationary environment of the last several years. For total multi-tenant properties, NOI growth was 3.5% in the third quarter. Although we had significant absorption in the quarter, the full potential economics were not realized due to the relative timing of earlier move-outs versus later move-ins. While timing differences are not uncommon, they were more pronounced than usual this quarter. We expect NOI growth to accelerate as timing differences moderate and free rent burns off. Before I turn it over, I'd like to briefly touch on our recently announced leadership changes.

We made the changes to build on the operational success of the last year and to more closely align our leadership with our 2025 growth initiatives. These changes will extend Healthcare Realty's operational momentum and further increase focus on execution, acceleration of growth, and accretive capital allocation. In just the first few weeks, it's been invigorating to see the fresh perspectives and intensity the team has brought to their new roles. Now I'll turn it over to Austen.

Austen Helfrich (Interim CFO)

Thank you, Todd, and good morning, everyone. Let me start by saying that I'm excited about my new role as Interim CFO and look forward to working with the investor and analyst community. We are pleased with the value created through JV contributions and asset sales this year. Through October, proceeds totaled $875 million. Based on this success, we are increasing our full-year proceeds range to $1.05 billion-$1.15 billion, up $100 million at the midpoint. Since our last call, we've repurchased over $150 million of additional shares, bringing year-to-date repurchases to nearly $450 million at a weighted average share price of $16.48. On a leveraged neutral basis, this represents a reinvestment spread to the company of over 100 basis points, a highly accretive outcome for earnings, cash flow, and NAV. As we look ahead, there is currently a deep and liquid market for medical outpatient buildings.

HR has ample access to that market via third-party asset sales and its joint venture partnerships. We will target the highest long-term risk-adjusted returns for shareholders through a dynamic capital allocation framework, which will always take into account the valuation and future growth embedded in our own portfolio. Turning to the balance sheet, in October, we used proceeds from asset sales to fully repay the unsecured term loan set to mature in July of 2025. Including this debt repayment, quarter-end net debt to adjusted EBITDA would have been 6.6x. We expect leverage to decline to 6.5x at the end of 2024 and continue to move lower in 2025, driven by our organic growth. Finally, as of the end of the quarter, we had approximately $1.3 billion of availability under our credit facility, providing substantial financial flexibility.

With almost 350,000 sq ft of multi-tenant absorption year-to-date, we are investing significant capital in new leasing at very high risk-adjusted returns. As Todd mentioned, this new leasing activity is only beginning to produce a corresponding NOI benefit. Due to the timing mismatch between capital spend and cash rent from new leasing, our payout ratio was 106% in the quarter. Excluding the impact of absorption capital, our payout ratio would have been 98%. Over the course of 2025, we expect our payout ratio to decline below 100% and approach 90% adjusted for absorption capital. Now I'd like to provide an update on the Steward bankruptcy process, which is unfolding in real time. In recent days, we have gained additional clarity. As a reminder, our total exposure to Steward leases is approximately $27 million of annual NOI across 593,000 sq ft.

We have secured or have high visibility into leases with new tenants for approximately $17 million of annual NOI, or nearly two-thirds of our total exposure. This includes $12 million in new direct leases with Boston Medical Center and Brown University Health. These solid investment-grade nonprofit systems represent fantastic upgrades in credit quality, as well as new health system partnerships. The remaining $10 million of annual NOI represents leases that were not accepted by new operators or where we do not have visibility on near-term replacement leases. The loss of this NOI will begin November 1st, and we are assuming that this will continue through 2025. Backfilling space will take time as we work with new tenants and operators to program and build out space. While it's still very early, we are encouraged by the long-term opportunity to recover approximately half of this NOI through our leasing efforts.

In summary, we have clarity on almost two-thirds of the annual Steward NOI, with a longer-term opportunity to recover over 80% of the $27 million of current NOI, with greatly improved credit quality and tenant diversification. Turning to guidance, we have narrowed our 2024 normalized FFO per share range to $1.55-$1.56, including the November and December impact from Steward that I just covered. Our core business is performing extremely well. This performance is generating a number of tailwinds into 2025, including the benefits of absorption and accretive capital allocation. I look forward to meeting with many of you over the next two months at conferences. With that, I will now turn it back to the operator to open the line for questions. Operator.

Operator (participant)

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press Star followed by 1 on your telephone keypad. If for any reason you would like to remove that question, please press Star followed by 2. Again, to ask a question, press Star 1. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking a question. We will pause here briefly as questions are registered. The first question comes from the line of Nick Yulico with Scotiabank. Nick, your line is now open. Nick, your line is now open.

Todd Meredith (CEO)

Sounds like maybe we lost him.

Operator (participant)

Absolutely. The next question comes from the line of Austin Wurschmidt with KeyBank Capital Markets. Austin, your line is now open.

Austin Wurschmidt (Analyst)

Yeah, thanks. Good morning, everybody. Todd, just wanted to go back and make sure I understand the multi-tenant same-store NOI growth guidance and kind of move-in, move-out dynamic you discussed. I guess, can you just marry the timing impact you mentioned with the comment about net absorption kind of exceeding your goals and whether this is a quarter-end occupancy versus average occupancy difference, or if there's something else that we're missing here and just speak to kind of what went on there this quarter?

Todd Meredith (CEO)

Yeah, it's a good question, good observation. Austin, I think you hit it pretty well. We actually spent a fair bit of the quarter below where we ended. Sorry, we spent a fair bit of the third quarter below in occupancy in the multi-tenant portfolio where we finished the second quarter, and then it rebounded strongly in September. And so obviously, as you point out, the average is really the story there. It was well below where we ended. So we really saw a strong pickup in September. Obviously, that bodes well for the fourth quarter, but more importantly, 2025. You also have free rent, which I mentioned. That's obviously not in same store, but that's something also in terms of thinking about how it translates to the FFO line as well, that you've got free rent burning off as well.

So, really, from a true cash perspective, we view a lot of what you see perhaps in the third quarter really starting to contribute in early 2025.

Austin Wurschmidt (Analyst)

So we should really start to think more about the fact that contractual increases are in that high 2% range or in the mid 3%, I think, on cash leasing spreads, and then occupancy should just be the other piece, and that should really be the drivers of base revenue growth moving forward.

Todd Meredith (CEO)

I think that's exactly right. That's well said. I think the other thing you saw, just the dynamic when you're having an inflection point around expenses, we've had declining expenses. Well, that's also dragged down, which is a good thing, reimbursements of expenses as well. So you saw a little softness in revenue overall due to that. But that's something that we think will begin to normalize in the fourth quarter and going forward. So I think you got base rent correct there.

Austin Wurschmidt (Analyst)

And then just last one for me. On backfilling the Steward space, can you give us a sense on timing of the leases that account for, I think you said, two-thirds of the $27 million of NOI, when you'd expect those to commence?

Austen Helfrich (Interim CFO)

Yeah. Hey, Austin. Good morning. It's Austen. Maybe to break up the two buckets, starting with the $17 million that you referenced, we would expect those leases to commence at the end of the Steward lease timing. So no real timing mismatch there that you need to think about. And then obviously, just to kind of close the loop on that, on the $10 million of NOI impact that I mentioned, obviously, when we're thinking about the fourth quarter in 2025, we do want to make sure to be clear that there will be a timing lag as we work to re-tenant that space just due to it's now basically going to enter the new leasing pipeline. So we've got to tour, negotiate new leases, build out space. So just to be clear on those two different components.

Austin Wurschmidt (Analyst)

Understood. Thank you.

Todd Meredith (CEO)

Thanks, Austin.

Operator (participant)

This question line of Juan Sanabria with BMO Capital Markets. Juan, your line is now open.

Juan Sanabria (Analyst)

Hi, good morning. Thank you. Just on the multi-tenant same-store NOI guidance, maybe I'm being a little bit picky, but just curious on why that guidance was brought back or brought down, I should say.

Todd Meredith (CEO)

Yeah. I think Juan, really, if you just look at sort of where we are year-to-date and then you think about the fourth quarter, the guide we had before, just given the lag in the third quarter, the timing difference, it would suggest something that would be really out of line or out of expectation for the fourth quarter. So we just wanted to sort of right-size that relative to what we're seeing in the fourth quarter. So clearly, we still see acceleration going on and that growth rate picking up, as I mentioned. It's just you have this lag effect. So really just bringing it in line with where we are year-to-date versus what makes sense for the fourth quarter.

Juan Sanabria (Analyst)

So the leases just starting later than you would have initially hoped?

Todd Meredith (CEO)

Not necessarily than we hoped. It's just timing of move-outs. So we had move-outs really skewed to the beginning of the quarter. So again, we experienced that sort of drag intra-quarter and then a really strong rebound and obviously net absorption. We were very positive, but a lot of that coming late in the quarter in September. So again, this can have, we had a similar but much more muted pattern like that in the prior quarter. It was just much more pronounced this quarter. And that's just going to vary quarter to quarter on timing. It's not every quarter is the same. There can just be timing differences. So it obviously has an impact in a given quarter.

Austen Helfrich (Interim CFO)

Juan, I think you really have to differentiate on that point as well as how free rent is flowing through that. Obviously, the leases signed in September that Todd referenced caused the significant increase in absorption in the third quarter. Obviously, there's going to be some free rent carryover into the fourth quarter that's going to impact that cash NOI number. Obviously, GAAP FFO is a little bit of a different story, and we will start to see that benefit through straight-line rent in the fourth quarter. I just want to tease out that nuance as well.

Juan Sanabria (Analyst)

Gotcha. And then just curious, G&A came down. I guess, what drove that, and should we then expect a higher number in 2025 or a bigger increase as that's kind of normalized out, or hoping you could tease that out a little bit as we think about turning the calendar over?

Austen Helfrich (Interim CFO)

Yeah, that's a great question, Juan. If you look at our expense growth year-to-date, that's primarily the result of actions taken by management to control G&A into 2024. I think it is a good assumption for you to assume that our current run rate base is a reasonable jumping-off point, and here, we're going to be thinking more about normal wage inflation, normal G&A inflation as you start to think about modeling 2025.

Juan Sanabria (Analyst)

Thank you.

Todd Meredith (CEO)

Thanks, Juan. Thank you.

Operator (participant)

Thank you, Juan. The next question comes from the line of John Kilichowski with Wells Fargo. John, your line is now open.

John Kilichowski (Analyst)

Hi, thank you. Maybe if we could just turn to the capital activity in the quarter. You said you paid down the rest of your term loan. And based on the upsize of the disposition activity, does that imply about $100 million of further debt buybacks here, assuming sort of flat stock repurchases?

Todd Meredith (CEO)

Yeah. Hey, good morning. I think that you are correct. We did pay down the $100 million of remaining unsecured term loan that would have matured in July of 2025, really with an eye to starting to decrease that 2025 debt maturity. I think based on the increased guidance that we gave around the proceeds as well as our year-end guidance to be back at six and a half times, I think your debt paydown calculations are in the realm. I would say just to marry that, one thing I mentioned in my prepared remarks that I would stress on that point is the disposition market and the liquidity in the medical outpatient market right now is very good.

And so we will remain, whether it's thinking about all of the capital allocation options available to us, we will remain very flexible in how we're thinking about the opportunities that we have.

John Kilichowski (Analyst)

Okay, so it sounds like with that $100 million, roughly, it's the revolver at a 579 is the best course of action for that, or is there other opportunities for that capital?

Todd Meredith (CEO)

No. As far as debt paydown, you are right in your thinking on the revolver.

John Kilichowski (Analyst)

Okay. And then maybe next, there was a $47 million credit loss reserve in the quarter. Is there anything you could give us on that?

Todd Meredith (CEO)

Yeah. The $47 million of credit loss was related to the final write-down of a mezz loan in Houston. We have not been accruing any income for that mezz loan since the first quarter of 2023, so nothing to really take out from an NOI perspective. That was a loan that HTA had made that we inherited, and this was the final impairment on that loan due to loan maturity and actions by the first lienholders.

John Kilichowski (Analyst)

Okay. Thank you. And then just last one for me. The final $10 million entering the new leasing pipeline of NOI, could you just walk us through maybe normal cadence of what an asset that hits that new pipeline looks like in terms of timing to touring and the TI process and typical lease-up? Is there any sort of asset so unique that it's hard to sort of put a timeframe around it?

Todd Meredith (CEO)

Yeah. John, I think it's a good question. Austen touched on it broadly. I would say what we're looking at and where the opportunities lie for that opportunity to lease up and recover sort of $5 million, as Austen described, it really follows, I think, the normal course of what Rob has described for some time that it typically takes us a few months, call it four months, to get from a tour to lease execution. And then on average, it's a very wide distribution, but on average, about six months to build out space. Obviously, that can vary depending on the acuity of the space. But I would say this looks a lot like that in terms of the spaces and opportunities we have.

So again, that's why I think when you heard Austen talk about the timing, we're essentially saying that $10 million is probably partial impact in the fourth quarter of this year, which is in our guidance, and then the remainder would continue in our current estimate in 2025. Obviously, that timeframe I just laid out would put you at the back end of 2025 for some of the early ones to start kicking in. So that's how we're thinking about it. Obviously, you can have a lot of different circumstances with free rent, which could kind of add to that a little bit. So again, that's why we're saying we think for now a lot of that recovery in terms of cash flow and FFO persists through much of 2025. But it doesn't, it does not have a unique character relative to everything else we're doing.

We're very encouraged by the space. There's a very significant portion of that space in Florida in some really great buildings, the front door of a strong hospital. It's an A-plus rated hospital, according to the Green Street research. And so we're very bullish that we have a new operator coming in. We really have a chance to get in there and work with those tenants and create, meet that demand. So a lot of encouraging signs, but again, just sort of that timeframe that it takes to lease up multi-tenant space. And it was previously master lease. So obviously, you're going from a master lease to multi-tenant.

John Kilichowski (Analyst)

Got it. Thank you.

Todd Meredith (CEO)

Thanks, John.

Operator (participant)

Thank you, John. The next question comes from the line of Michael Griffin with Citi. Michael, your line is now open.

Michael Griffin (Analyst)

Great. Thanks. I'm wondering if you've noticed whether or not you have a greater ability to push rents or get tenants to sign longer leases, given what seems like continued solid demand and minimal new options from a supply perspective?

Todd Meredith (CEO)

This is Todd, and maybe Rob, you can jump in too. I would say, generally speaking, you're seeing really healthy cash leasing spreads. We were at 3.9% this quarter, very strong and healthy. Obviously, we have a wide distribution under that, but as you've heard us emphasize for some time, we're very focused on occupancy gain, so that's really our big initiative right now is to really push that and not be indifferent on price, but be very sensitive to gaining occupancy. I do think you're seeing some ability to push term, as you just pointed out. I think the negotiation position is strengthening, as you just described, with a lot of limited supply, so it is a very encouraging backdrop, which I alluded to in my remarks, but again, we're pushing occupancy here. We can show you plenty of examples where we're getting double-digit cash leasing spreads.

But when you look across the volume of the activity we're doing, being in that high end of our typical 3%-4% range, I think shows some strength. And I think as we continue to improve occupancy, you can certainly see an opportunity to turn to a little more on pushing more on the rate. But right now, our focus is occupancy.

Michael Griffin (Analyst)

Appreciate the color there, Todd, and then just maybe switching to sort of the capital allocation front. I think you guys have done a good job kind of narrowing the discount to NAV with the share buybacks so far this year, but given there's probably more limited accretion from those at this juncture, and Austen, I think you talked about a pretty liquid and open transaction market, have you started seeing deal activity from an acquisition perspective pickup, or are cap rates a little bit too narrow relative to where your cost of capital is today to execute on some of those deals?

Austen Helfrich (Interim CFO)

Yeah. Thanks, Michael. That's a great question. As you alluded to, we're really pleased with the activity we've had year-to-date. Obviously, the share buybacks have been highly accretive. I think to your point, the market for medical outpatient right now is significantly different than where we were 12 months ago. I think the depth of the market, obviously, as everyone knows, as cap rates improve, it naturally brings more sellers to the market. In terms of how we're thinking about that vis-à-vis capital allocation, I would go back to my earlier point around the dynamic framework. And I think the way that we look at it is really we have a range of options available to us. So I'll start kind of going with that high-level comment, Michael, of we've talked about the absorption targets for the year, 500,000 sq ft.

Obviously, we're funding significant absorption capital right now, which is great for shareholders. It's obviously a very high incremental IRR. I think in terms of other opportunities available to us, we do have access to the KKR venture, which obviously comes with a fee structure as well that is compelling for us. What I would stress is that we have a myriad of options, whether it's what we believe about the future growth rate of our own business, private market valuations, ability to reinvest into the current portfolio, or external growth. So we will continue to look across all of those and allocate capital based on the best available and highest available risk-adjusted return.

Michael Griffin (Analyst)

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

Todd Meredith (CEO)

Thanks, Michael.

Operator (participant)

Thank you, Michael. The next question comes from the line of Rich Anderson with Wedbush. Rich, your line is now open.

Richard Anderson (Analyst)

Thanks. Good morning, everyone. So on the occupancy bridge, you're making good progress there. And you, Todd, you referred to a move to a rate focus perhaps next year. Might we expect sort of a similar sort of communication style about this next phase for Healthcare Realty? You've achieved perhaps, God willing, your occupancy goals for the end of this year. Could there be a bridge or a ski lift or something to get to a higher kind of rate? What's the thought process about communicating the future because it seems it's reasonably worked reasonably well for you this year?

Todd Meredith (CEO)

Right. Right. And obviously, we thought it was important here, basically this time last year, to put out some expectations. So we joke about our five-quarter plan, which just throws everybody off from an annual plan. But I do think it was really important. I would say next year, we will always be transparent about our goals for occupancy. And you've seen us for a long time provide a lot of detail around what we call our components of expected FFO, along with our FFO guidance. So we'll always be very clear about what those type of operating metrics are. I'm not sure we need to go through the same ski lift diagram each time, but I think we will be abundantly transparent and clear about what our expectations are around occupancy for 2025. It's early. Austen's getting in, digging into things. The team is.

We will look at exactly how we will do that and bring that out in February. It's certainly not something we're thinking now, we're going to put out a five-quarter plan for including next year. I think we've built a really good track record this year to show that we're keeping the new leasing pace up above 400,000, as we've said, for five quarters. Obviously, we're now delivering occupancy gains, absorption gains each quarter. That will be a continued story in 2025. Absolutely. And I think you're right. It's going to be a communication effort that we will make to describe our expectations around occupancy versus rate growth. I think 2025, just to be candid, still has a lot of occupancy growth in it. So we will continue to focus on that.

But rate is always part of the picture, whether it's as big of an emphasis next year or the following, it will be out there. So we'll be very transparent, but haven't really put together our 2025 pages yet.

Richard Anderson (Analyst)

Do you sense that tenants, though, are getting more and more conditioned to a higher, we've talked about this for years, a higher rate environment, a rental rate environment for them, or are they still sort of pushing back, even though, despite some of the anecdotal evidence that you've seen in terms of releasing spreads?

Todd Meredith (CEO)

Sure. Yeah. I think this segment, medical outpatient, has certainly matured and has shifted maybe along that curve of maturity towards other more traditional sectors that have been at it a longer time and seen those kind of moves. I don't think maybe where you're going is a much more cyclical business like some others where you really capture incredible cash leasing spreads when it's good, and then you kind of come down when things are softer. I do think one of the hallmarks of this subsector is just the stability. So I think it's still very much about that long-term stability, and we're not seeing any behavioral differences in that profile in the business. You can look at things like the employment numbers in the space and just see that steady, rock-solid year-over-year growth in that 3-plus% range over a long time frame.

So I think that drives a lot of it. But I do think you're right. With supply down, I think Michael asked earlier, with supply down, financing costs as well as construction costs way up, it just limits supply, and it does give you advantage. So I think there will be positive trends to the upside, partly because of those dynamics, plus the maturation of the subsector. But I don't think we're suddenly going to look like the boom-bust of some other more cyclical sectors. But it's very encouraging. I think pricing power is something. And obviously, one of our strategies is to move towards where we think the puck's going in terms of demographic growth, strong health systems, using our strategy and markets and clusters to take advantage of that and maximize.

Austen Helfrich (Interim CFO)

One thing I don't want to lose sight of, sorry, just to hop in really quick, one thing I don't want to lose sight of in the cash leasing spread discussion is also the increase in the retention rate that we've had this year. So I think to that question, you do have to look at it. There are multiple levers to that question, not just cash leasing spread. And I think from a capital standpoint, obviously, increasing retention, enormous benefit versus new leasing as we think about absorption. So there is a bit of, I think there are multiple levers and gauges there that we're looking at in terms of how that supply-demand dynamic impacts the business, not simply cash leasing spread. I just wanted to add that to the question.

Richard Anderson (Analyst)

Second question is you talked about multiple sort of avenues to future growth. Your stock is now just perhaps a hair below, at least, consensus estimates for net asset value. So are we moving away from buybacks and into a pivot with the JVs where maybe you're selling less into them and buying alongside with them? I mean, how quickly could that evolve vis-à-vis the previous schedule or the previous plan to sell assets and buyback stock?

Todd Meredith (CEO)

Yeah. Rich, I think maybe just one comment just overarching, then I'll let Austen jump in. I do think a change you're going to hear from Austen specifically, but all of us, is a different framework that's much more dynamic rather than saying, "Oh, on a static basis, we've reached a certain price," and whether it's the consensus or it's a forward view. We're going to be much more dynamic, and we can do a range of things. Obviously, we may allocate more heavily depending on where we see things. But I would say we're taking a much more dynamic view than just saying, "Oh, we've hit the number. We'll stop this. We'll start that." I think it's looking across all those ranges of activities and returns and balancing where that opportunity lies. Absolutely, you're right.

We are taking a close look at that sort of pivot concept where can we start moving capital accretively into a JV program that has that fee structure that's more advantageous. But we've got to. That's competing against, as Austen said, very high double-digit type returns into redevelopment of our own properties, lease-up capital for absorption, so we look at all those things, obviously, the stock repurchase idea as well, so Austen, sorry if you have anything to add there.

Austen Helfrich (Interim CFO)

No, I think that's great.

Richard Anderson (Analyst)

Last question for me is, with all the management change and perhaps other changes ahead, Todd, you mentioned a fresh perspective. How much of these changes will be strategic, and how much of them will be more communicative? In other words, what are the intentions of the management changes that are underway or have been completed in terms of what the company looks like on a go-forward basis? Thanks.

Todd Meredith (CEO)

Sure. I don't think it's overly complicated. I think it's just simply, in the case of Rob, who we put into the Chief Operating Officer role, Rob was really spending his time on leasing. That was his main focus, even though his title was really around investments. And so it was really just aligning Rob's leadership and having clear, definitive leadership around that in his role and his title and his responsibilities. And that's really serving what he's been focused on, but more importantly, where we're going. So I think you will see a very high focus clearly from Rob, as well as the whole team, around that operational growth. And that's clearly driving a lot of our growth this year. And then on the capital allocation side, really elevating Ryan to the Chief Investment Officer role.

He's been with us quite a long time, just a great guy who's been deep into this space for a long time, knows lots of the parties to get deals done. He's been deeply involved in our JVs, our disposition transactions, which he will continue to lead. So just getting him in that seat and really leading the charge around not only acquisitions and redevelopment, but also the disposition and JV strategy. Clear leadership there with his team. And then Julie in the administrative role, really taking on some strategic healthcare, excuse me, human resource efforts that we really want to bring to the table to really elevate Healthcare Realty to a best-in-class organization. We think we're really good, but we can always improve and really attracting the best talent and retaining that talent. So those are some of the key things. And then Austen, part of it is communication.

I think Austen brings a different perspective to the CFO role, but also as a former longtime buy-side guy, he brings a very different perspective, style of communication, view. But also, I think all of this team has really brought a rigor around how can we do more things that will improve our ability to predict and drive growth over the course of the future. I don't think we're talking, Rich, about transformational shifts away from the business we're in. We're still very much medical outpatient-focused, and so it is strategic, but I would say it's much more operational and focus-oriented rather than completely changing the business.

Richard Anderson (Analyst)

Very good. Thanks very much, everyone.

Todd Meredith (CEO)

Thanks, Rich.

Operator (participant)

Thank you, Rich. The next question comes from the line of Jonathan Hughes with Raymond James. Jonathan, your line is now open.

Jonathan Hughes (Analyst)

Hi. Good morning. Was hoping you could clarify how the Steward Massachusetts catch-up rent received this month will be treated in 4Q multi-tenant NOI growth. Would that be excluded as I think the negative impact was left out in the second quarter?

Austen Helfrich (Interim CFO)

Really good question, Jonathan. Let me answer it from a kind of overall perspective, and then I'll drill down to your specific question. We do expect to have a positive reserve release related to Steward in the fourth quarter. You're probably talking about under $500,000 related to the dynamic you just referenced, Jonathan, on the payments from BMC and Brown University Health. What I would say is in the fourth quarter, or sorry, in the second quarter, we did include the negative impact of those reserves against FFO per share. That was almost $0.01 from $0.39 to $0.38 in the second quarter. So it'll probably include that back out in normalized FFO per share in the fourth quarter. I don't have a specific answer for you on the same sort of cash number. Probably something we'll exclude or look at giving you both ways.

I think it's probably, honestly, Jonathan, a bigger question around how we're going to show the core performance of the portfolio in the fourth quarter vis-à-vis some of the, obviously, impact of Steward in November and December. So we'll come back to you on that. But we're going to try to provide, I think, very good clarity into the core portfolio and then, obviously, give you the Steward impact as well.

Todd Meredith (CEO)

And Jonathan, I would say, yeah, if you look back at the second quarter, we showed it both ways. And I think that's probably a safe assumption, as Austen's saying.

Jonathan Hughes (Analyst)

Okay. That's helpful. And I assume Florida would be treated similarly, right, and roped in with Massachusetts?

Austen Helfrich (Interim CFO)

Yes. That's a fair comment. I think to the extent we had catch-up payments in Florida, we would treat it the same way. I would say, just to re-emphasize what I said earlier, this is very much live. I mean, this is happening this week. So we're giving you our best current view and trying to box what the ultimate outcome is. I would say, yes, theoretically, if we had the same in Florida, we would do that as well.

Jonathan Hughes (Analyst)

Really fluid. So look forward to hearing more about it as it evolves. I have just one more on the dividend. I know it was just declared yesterday, and you did talk about the visibility into reaching a 90% payout ratio. But I was hoping you could talk about that reported payout ratio versus an absorption capital adjusted payout ratio. I think absorption capital was really mentioned for the first time last quarter. So I guess my question is, why the change in how you're looking at payout ratio or maybe looking at it with another metric since I don't really recall hearing absorption capital mentioned until recently?

Todd Meredith (CEO)

Sure. Jonathan, I'll hit it high level, and then Austen can add to it maybe, if necessary, follow up if you have follow-ups. I think it's really just saying, "Okay. Yes, we certainly understand, and we provide a payout ratio calculation," or we show the math, show the two numbers that you can divide and get the ratio. In this quarter, that's 106%, as Austen referenced. And that's come down sharply, substantially. And I think you've seen generally a good trend line on that. And just trying to really look forward and say, "How is management? How is our board looking at where we're headed? Is this sustainable, this dividend?" And our belief, based on the forward look, is absolutely, it's a sustainable dividend, and we can grow into it.

In fact, we can get to a payout ratio that is quite good going forward as the throughput of all this absorption capital converts to, obviously, NOI and then FFO per share. So it's really saying, "How are we looking at that, and where are we headed?" is the idea. Obviously, if we were just in a steady state, it would be a very different framework. It wouldn't make a lot of sense. So I think our view is just trying to help people better understand where we see that going in the future. Is that helpful?

Jonathan Hughes (Analyst)

Okay. Yeah, that is helpful. So the absorption capital, just to be clear, that's leasing commissions, right? So with your portfolio turning, those are cash expenses.

Todd Meredith (CEO)

It's basically taking the absorption gain of the quarter, so that 159,000 sq ft or kind of what we expect through the year on a smoothed basis, and then applying what we're spending on new leasing, both in the way of TI and commissions. It's a combination. Just in rough math, if you look at our disclosure around our commitments, you're talking about $9 a sq ft per lease year. You take the average lease term of new leases, and you get close to $70. It's kind of looking at that incremental, only the incremental, not all new leasing, just the incremental absorption at that cost of commissions and TI and saying, "Hey, if you take this out and just look at where we are, here's where it calculates." In the future, we should get more NOI that will come as a result of all that leasing.

Jonathan Hughes (Analyst)

Got it. That's helpful. Thank you for the time.

Todd Meredith (CEO)

Thanks, Jonathan.

Operator (participant)

Thank you, Jonathan. The next question comes from a line of Omotayo Okusanya with Deutsche Bank. Omotayo, your line is now open.

Omotayo Okusanya (Analyst)

Hi. Yes. Good morning, everyone. I just wanted to talk a little bit about kind of long-term growth for the overall portfolio. Again, clearly, with some of your kind of cash NOI numbers steadily improving, things are moving in the right direction. But if I recall correctly, kind of post the merger, there was a viewpoint that the merged portfolio could kind of generate like 5-ish% same-store cash NOI growth, if I'm recalling that correctly. And can you just walk us through a little bit of the building blocks that could eventually get you to that number, if you still believe in that number, and how soon that could potentially happen?

Todd Meredith (CEO)

Sure. Tayo, good question. I think that kind of sort of adds to some of the questions we've talked about, same-store growth this quarter, next quarter versus next year in the future. The number you're talking about, we talked about 4-5% growth potential post-merger. That was really built around the idea of occupancy gain. And the idea is that you can't have occupancy gain forever, but we saw a long runway post-merger to continue driving our multi-tenant occupancy higher. And you're seeing that. You're seeing that come through in terms of all the occupancy and net absorption gain this year.

What we're spending a lot of time talking about here is, "Hey, that's all great, and it's starting to, we're seeing that path to that converting to actual same-store growth, especially as we look towards 2025." We're not putting out guidance for what we think exactly the growth rate will be in 2025 at this point. We'll do that in February. Our view is that, yes, you can see much higher levels of same-store growth when you have that level of occupancy improvement kicking in. That's a multi-year concept, but obviously, it's not a forever long-term growth rate concept because at some point, you begin to normalize at an occupancy level and maybe have less, if any, occupancy gain.

So it is an opportunity that we see to accelerate growth based on occupancy gain in addition to the underlying fundamentals, which are sort of very strong rent escalators that are in that neighborhood of the high twos, plus cash leasing spreads and so forth, good expense management, all the other normal fundamentals. So it's the normal fundamentals plus occupancy gain is the short answer to your question.

Omotayo Okusanya (Analyst)

That's helpful. Thank you. And then a second question just around capital allocation. Again, I appreciate the comments made earlier on that you would really kind of allocate capital based on where would create the most kind of earnings accretion or shareholder value. And I guess when you do kind of think about acquisitions versus development versus stock buybacks today, I mean, if you're kind of ranking all those potential kind of uses of capital, how do you kind of think about the best use of capital today versus maybe some other alternative uses?

Austen Helfrich (Interim CFO)

Hey, it's Austen. I'll just go back through. I think the best way to answer this is probably to go back through some of the opportunities that I mentioned earlier that we have available to us. I think, obviously, if you're talking about rank ordering, Tayo, the number one place to start has to be absorption capital. Just the returns that we get on TI and LCs and building capital targeting absorption, whether that be through the higher renewal rate or new leasing, is by far the best return available to us today. I think as you go through the remaining options, there's a number of factors you have to consider, which is, most importantly, one, where is our stock price? Number two, where are valuations in the private market? I talked about a deep and liquid market.

Everyone can see where the cap rate on dispositions has been year to date. So I think that's a very good reflection of what's going on in the private market. But I'll also tell you it's very fluid right now. I think everyone on this call is aware that interest rates just went up, I don't know, 60-70 basis points in a couple of weeks. So obviously, we're paying attention to all of that. You've seen what we've done year to date through capital allocation, which can give you some sense. I also referenced earlier the $16.48 as the average share price, and I gave a little bit of my view into what our reinvestment spread on that is. So all of that, I think, can help you triangulate to those thoughts.

But in terms of what we're going to do from here, I think my message would be we have good access to capital. We have a lot of opportunity to accretively redeploy that internally. And as far as all the other options, it depends on a myriad of factors how we'll kind of rank order those at any given time.

Omotayo Okusanya (Analyst)

That's helpful. And if you can just indulge me one more, just in terms of rates rising, how do we kind of think about upcoming debt maturities and as well as swap expirations kind of in 2025 and even possibly 2026?

Austen Helfrich (Interim CFO)

That's such a great question, Tayo. Thanks for asking it. Obviously, as we look to 2025, maturity off that $100 million of unsecured term loan is a great start on our 2025 maturities. Our next maturity is the unsecured, the $250 million of unsecured bonds that are due in May. I think to some of the earlier question that I got around debt paydown, obviously, we are looking to pay down more debt to bring our leverage back to six and a half times by the end of the year. And the number one opportunity to do that is the revolver. So we do expect to enter 2025 with additional capacity on the revolver, which gives us great flexibility in terms of options for that 2025 unsecured maturity.

I would say, to your point, Tayo, as we look at the current rate environment and that May unsecured maturity, we will continue to be very fluid and opportunistic in how we look at that. But I think the great news for us in the near term is we do have a lot of flexibility because of where our revolver will be going into 2025. From a swap perspective, I think it's a great callout that we do have $75 million of unswapped term loans outstanding, and the remainder of our swap expirations really starts in 2026. So it's a great question, Tayo. All something we are actively thinking about. We're trying to set ourselves up for maximum flexibility heading into 2025. And then, obviously, I did reference an intent to continue to delever through 2025. So it's something we're very focused on and appreciate the question.

Omotayo Okusanya (Analyst)

Thank you.

Austen Helfrich (Interim CFO)

Thank you.

Todd Meredith (CEO)

Thanks, Tayo.

Operator (participant)

Thank you, Omotayo. The next question comes from the line of Mike Mueller with JP Morgan. Mike, your line is now open.

Mike Mueller (Analyst)

Yeah. Hi. I guess one quick question first. Can you give a little more color on why you're just recapturing five of the remaining 10 million from Steward? Is it issues with certain buildings? Is it rents above market or something else? Can you just kind of help put that in context?

Todd Meredith (CEO)

Sure. Good question, Mike. I think the core answer is simply you have a number of dynamics going on. We've got, what, 22 buildings across the whole Steward exposure for that $27 million. And so you're going from multi-tenant to, sorry, from single-tenant to multi-tenant in many cases. So you're clearly going to have some difference in a general vacancy factor, if you will, if you think about that from a modeling standpoint. So our expectation isn't to go right back to 100%. And that can go across multiple assets. So it's sort of a part of that. There's some small rate differences here and there that we may see. We've conservatively assumed in our backfill as well. You also had a couple of campuses close in Massachusetts where we didn't have a lot of exposure, but frankly, you have low expectations there that much is going to happen.

We're actually having some positive conversations with those assets, but long-term, those are probably sales where you're not replacing the NOI per se, or at least not a one-for-one basis through an asset sale. So there's just some things that we're factoring in. We don't know for sure now exactly how that will play out, but we're trying to be very conservative and assume that realistically, what do we think we can get back to in a timeframe that people can think about from the standpoint of modeling and building in expectations.

Mike Mueller (Analyst)

Got it. Okay. And then I guess based on what you see today, what do you think the likelihood is that you won't be in that seller again next year?

Todd Meredith (CEO)

Yeah. The broad question, Mike. That probably goes back again to where Austin was on capital allocation. Again, we're just going to be opportunistic. We clearly have some capital needs each year to fund, whether it's development or redevelopment, this absorption capital, so forth, debt paydown, potential share repurchases, all the different options that we have. So I think for us, we certainly currently see it as more attractive to be meeting those needs with asset sales, but we're going to continue to be opportunistic and look at that. So again, we talked earlier about, are we looking at a pivot to acquisitions through a JV? It's on the menu, but obviously, we're not going to commit at this point to where that lines up in a rank order sense.

So look, where we are today, we're still looking at this as a very strong MOB market where we can tap into that liquidity. That's where we're at today. I think 2025 could be very different. We all had sort of everybody was excited about rates coming down, and then it backed up on us, and that could change just as quickly with an election and all the things that come with that. So not really committing to what we think 2025 looks like. I think generally, as Austin pointed out, we're very encouraged about the MOB market and the liquidity there, the access to that, and our ability to generate attractive pricing on proceeds. So we'll obviously refine that as we provide guidance in early 2025.

Mike Mueller (Analyst)

Got it. Okay. Thanks.

Todd Meredith (CEO)

Thanks, Mike.

Operator (participant)

Thank you, Mike. The next question comes from the line of Emily Buechler with Green Street. Emily, your line is now open.

Emily Buechler (Analyst)

Yes. Thank you for the time. I just have a quick question on first-generation TI. So what is causing the $12 million increase from the previous expectation of $35 million?

Austen Helfrich (Interim CFO)

Hey, Emily. It's Austen. I think the simple answer is just the absorption that we've done year to date and where that is. I don't know there's anything really more complicated to it other than just part and parcel with the absorption.

Emily Buechler (Analyst)

Okay. And then one more on move-outs. So outside of Steward, are there any known move-outs in upcoming lease expirations later this year or early next year that will lead to a temporary drag on occupancy?

Todd Meredith (CEO)

No, I don't think anything to call out at this time, Emily.

Emily Buechler (Analyst)

Okay. Thank you guys very much for the time. That's it for me.

Todd Meredith (CEO)

Thanks, Emily.

Operator (participant)

Thank you, Emily. The next question comes from the line of Nick Yulico with Scotiabank. Nick, your line is now open.

Nick Yulico (Analyst)

Yeah. Thanks, sir, for the technical difficulties earlier. In terms of the maintenance capital expenditures, they've trended down a bit in recent quarters as a percentage of NOI. Can you just give us a feel for how to think about that impact next year? Are you still kind of running higher than normal as a percentage of NOI on that CapEx right now? And it could come down next year?

Austen Helfrich (Interim CFO)

I'll provide a little bit of context here, but I think we're going to save 2025 guidance until February. I would say that, obviously, that is going to be tied into our absorption targets for next year. So I think you've heard Todd be optimistic and the team be optimistic around continuing to grow occupancy in the portfolio, which obviously has a capital requirement. I do think what you have seen this year to your earlier point is a real focus when you look into the maintenance CapEx and kind of dive into that. I think you've seen a real focus on efficiency within the building capital as well. But I think generally, as you look forward, it's going to be tied to absorption. So as we continue to drive absorption, that will obviously have a corresponding impact with the maintenance capital.

What I would also generally add is what Todd mentioned, which is we are at this period where we are seeing only the very early benefits to NOI of that absorption, and so it is a disproportional impact in the near term, which is why we are trying to provide additional insight with this payout ratio excluding absorption capital.

Nick Yulico (Analyst)

Okay. Thanks, Austen. Second question is just as we think about the signed leasing activity, you've been running on the multi-tenant, you've been running over 400,000 sq ft for five quarters now, and you've been getting some 50 basis points roughly of absorption last two quarters. As we're thinking about just kind of going forward, is there anything unusual about that pace? I mean, is there just a catch-up element in those numbers that we shouldn't sort of extrapolate and assume going forward for a leasing pace or absorption?

Todd Meredith (CEO)

No. Good question, Nick. I would say no. It's much more about getting up on plane. And now, as you said, we've been doing that for five quarters, and we've got a page that shows back to 2023 where we were really more in the ramp-up mode getting to that level. And I think, if anything, not to put too much pressure on Rob here, but we have high expectations that we can sustain that. In fact, how can we elevate that is really the focus. And so we're very bullish on continued demand. It kind of goes to the core of the question about demand for space. So we're driving that. We're looking to keep that and improve it and grow it in terms of the run rate.

So it's not something. It's easier said than done, but the team's hard at work trying to drive that volume of new leasing demand.

Austen Helfrich (Interim CFO)

And I think I'll just add to that that we've been on a pace at about that level. And I think it kind of comes back to the expirations that we see for 2024 is what we saw. And then we look at 2025 and say, "Okay, we have a certain number of expirations." Historically, we've had a move-out rate of kind of mid to high 20s. And so certainly, looking at the new leasing required to not only backfill that, but then hit our absorption targets is the pace we've been on. And as Todd said, as we look out to 2025, trying to improve upon that and push that a little higher so that we can capture the absorption targets that we set for 2025. But I think it comes down to expirations, historical move-out rates, and then setting volume based on that.

Nick Yulico (Analyst)

Okay. Thanks, guys.

Todd Meredith (CEO)

Thanks, Nick. Glad you circled back.

Operator (participant)

Thank you, Nick. There are no additional questions waiting at this time. I would like to pass the conference over to the management team for closing remarks.

Todd Meredith (CEO)

Thank you, Bridget. And thank you, everybody, for joining us again today. And we look forward to seeing many of you soon at various conferences. Hope everybody has a great day. Thank you.

Operator (participant)

That concludes the Healthcare Realty Third Quarter 2024 Earnings Conference Call. Thank you for your participation and enjoy the rest of your day.