Healthcare Realty Trust - Q4 2023

Transcript

Operator (participant)

Good morning or good afternoon all, and welcome to the Healthcare Realty Trust Q4 Earnings Conference Call. My name is Adam, and I will be your operator for today. If you'd like to ask a question during the Q&A portion of today's call, you may do so by pressing star followed by one on your telephone keypad. I will now hand the floor to Ron Hubbard, Vice President of Investor Relations, to begin. So Ron, please go ahead when you are ready.

Ron Hubbard (VP of Investor Relations)

Thank you for joining us today for Healthcare Realty's Q4 2023 earnings conference call. Joining me on the call today are Todd Meredith, Kris Douglas, and Rob Hull. A reminder that except for the historical information contained within, the matter discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks, and uncertainties. These risks are more specifically discussed in the company's Form 10-K filed with the SEC for the year ended December 31, 2023. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matter 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 December 31, 2023. 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 (President and CEO)

Thank you, Ron, and thank you everyone for joining us this morning. Healthcare Realty generated solid quarterly results, meeting or exceeding expectations on several key metrics. Normalized FFO of $0.39 per share for the Q4 was steady and in line with our expectations. Same-store growth for the quarter and year was in the upper half of our guidance range. You will recall we published a bridge last quarter outlining our expectations for multi-tenant occupancy and NOI growth, starting with the Q4. We are pleased to report over 50 basis points of positive absorption at the very top end of our expected range for the multi-tenant properties. NOI growth accelerated above the high end of our range to 3.3% for all multi-tenant properties, not just same-store.

These strong Q4 results were achieved through the focus and incredible efforts of our leasing and operations teams. Looking forward, we see a couple areas where we can keep improving. First, retention. We made incremental progress on tenant retention, achieving just over 78% in the Q4, compared to 77.6% in the Q3. What's significant is that retention at the legacy HTA properties was in line with the HR portfolio, and we see the ability to push retention higher to more than 80%. A second opportunity for improvement is operating expenses. The Q4 came in better than expected at just over 4% growth. That's in part due to lower property taxes. We see more opportunity to reduce expense growth to the 3% level in 2024.

Together, higher retention and lower expenses will help us reach the upper end of our 2024 goals. What I'm most excited about is our new leasing momentum. Our leasing team signed new leases totaling 425,000 sq ft in the Q4. This marks three consecutive quarters, averaging over 400,000 sq ft. The strong pace of new signed leases is what fueled the occupancy gains in our bridge and forecast for 2024. As we look more broadly at what will drive our 2024 growth, we are seeing an uptick in demand from both health systems and independent physician groups. On top of this, supply has steadily tightened, which provides a favorable backdrop for leasing momentum and occupancy gains. What it comes down to is more tenants chasing fewer MOBs. To illustrate this point, look at replacement rents today versus 2019.

Construction costs have escalated at an annual average of more than 7% over the last five years. Couple this with much higher financing costs, and you have a recipe for much higher replacement rents. Back in 2019, typical MOB development costs were about $350/sq ft in a place like Dallas. Required yields were in the low 6s, putting net rents around $22/sq ft. five years later, equivalent MOB development costs are approaching $500/sq ft, and rent yields are now around 8%. That means replacement rents are approaching $40. So replacement rents have increased more than 80% in five years or more than 12% annually. This limits new supply and sets us up to improve occupancy and rates in existing buildings.

At Healthcare Realty, we're laser focused on maximizing occupancy gains in 2024, with rate acceleration to follow. Now I'll turn it over to Kris for an overview of our financial and operational results. Kris.

Kris Douglas (EVP and CFO)

Thanks, Todd. It was a solid Q4 with normalized FFO per share of $0.39. FFO dollars were $2.7 million higher than the Q3. The sequential improvement was the result of a $3.1 million reduction in interest expense from asset sales that were used to repay the line. This was offset by a $4.2 million reduction in NOI from dispositions. Additionally, operating expenses net of recoveries were down $3.7 million sequentially. The reduction in operating expenses was primarily from the reversal of Q3 seasonal utilities, as well as lower property taxes. The lower taxes was the result of successful appeals and lower rates, especially in Texas. Approximately $2.4 million of the property tax benefit was related to prior periods and will not repeat in future quarters.

The lower property taxes contributed to improved operating expenses. Operating expense growth was 4.1% for the quarter, which was down from 4.8% in the Q3 and 5.3% in the Q2. Same-store revenue fundamentals also improved. Year-over-year quarterly same-store NOI growth was 2.7%, up 40 basis points from last quarter. Revenue growth of 3.2% was driven by a 3% increase in revenue per occupied square foot, and a 20 basis point improvement in average occupancy. Cash leasing spreads in the quarter averaged 3.3%. We ended the year with total portfolio in-place rent escalators of 2.81%. This is up 15 basis points since the Q1 of 2023. The improvement was driven two ways.

First, from higher escalators for new and renewal leases, which averaged 2.95%. This was well above expiring leases, especially for legacy HTA escalators that were averaging 2.5%. Second, was addition by subtraction. The average escalator of properties sold during 2023 was 1.9%, significantly below the rest of the portfolio. Sequential same-store occupancy increased 65,000 sq ft, or 20 basis points to 89.2%. Even more impressive, total portfolio multi-tenant occupancy increased 175,000 sq ft sequentially. The strong leasing volumes contributed to an increase in maintenance CapEx. Total maintenance CapEx for the year was 18% of NOI, or $152 million. This was in the middle of our guidance range for the year. The FAD payout ratio was over 100% for the year.

With anticipated strong absorption in 2024, the payout ratio is likely to remain elevated as we invest in tenant build-outs. We are comfortable the payout ratio will come back down as we fully realize the NOI from the positive absorption. Net debt to adjusted EBITDA at December 31st was 6.4x, within our target range. Net debt was lower as the line of credit was fully repaid at year-end from $338 million of asset sales in the quarter. Looking ahead, normalized FFO guidance is $1.52-$1.58 per share for 2024, and $0.38-$0.39 for the Q1. Guidance and the major assumptions are outlined on page six of the supplemental we released this morning.

To provide context for guidance, we walked forward the major drivers from an annualized Q4 FFO run rate of $1.52 per share. The run rate adjusted for out-of-period items, such as the property tax appeals. The major growth driver in 2024 will be internal operations. Multi-tenant absorption is projected to be 100-150 basis points and generate $21 million-$29 million of growth in cash NOI. Single tenant cash NOI growth is projected to be ±1%, which is below in-place escalators of 2.5% because of two general office expirations. A government services tenant vacated the end of their lease in January. The building sits at the front door of CommonSpirit's St. Anthony Hospital in Denver.

When we purchased this property in 2018, the plan was to raze the building and redevelop the parcel. We are working with the hospital on the long-term redevelopment plans and expect to demo the building later this year. The lease for the other property will expire at the end of January. We are marketing the building with a goal of selling the property before year-end. We have not projected any new rent or sale proceeds from either property in 2024, so any progress on these fronts would be upside. G&A expenses are projected to increase $5.8 million at the midpoint. The increase is primarily related to returning to run rate incentive compensation levels, as materially lower performance-based compensation in 2023 is creating a tough comp.

The other major headwind is a $200 million interest rate swap with a 1.21% fixed rate that expired in January. In preparation for the expiration, we executed new interest rate swaps during the Q4 at an average rate of 4.71%. The new swaps will cost $7 million more annually. There are no acquisitions assumed in guidance. We are projecting $150 million-$250 million of dispositions to match fund our capital needs during the year. The multi-tenant absorption in our guidance is consistent with the occupancy and NOI bridge we introduced last quarter. As Rob will discuss in more detail, an updated occupancy bridge is included on page 21 of our investor presentation.

It shows that we expect sustained positive momentum on occupancy absorption through 2024. This will help drive accelerating NOI growth and generate a strong FFO exit velocity going into 2025. I will now turn it over to Rob for more detail on our leasing progress.

Rob Hull (EVP and COO)

Thanks, Kris. Healthcare Realty posted another strong quarter of leasing activity. New signed leases totaled 425,000 sq ft that were 13,000 sq ft greater than our Q4 projection. For the year, our team signed 449 new lease deals for a total of almost 1.5 million sq ft. Approximately 60% of these came from the legacy HTA portfolio, which represents slightly over half of our multi-tenant portfolio. In addition, 226 renewals totaling 1.2 million sq ft were signed during the quarter, bringing total renewals for the year to 817, that totaled 4.2 million sq ft. Our leasing team, under the leadership of Amy Polley, Senior VP of Leasing, did an extraordinary job of driving momentum in 2023.

I want to commend Amy and her team for their hard work and tenacity. Strong leasing throughout the year culminated in 518,000 sq ft of multi-tenant lease commencements in the Q4. Combined with lower sequential move-outs, multi-tenant occupancy jumped 53 basis points. This equates to 175,000 sq ft of net absorption. This level is at the upper end of the range we provided in the multi-tenant occupancy and NOI bridge, published in November of last year. On the disposition front, Healthcare Realty sold 19 properties for $656 million at an average cap rate of 6.6% during the year. These were largely non-core assets with 34% non-MOB and 63% single-tenant. We also fully exited smaller markets like Sebring, Florida, and Evansville, Indiana.

What I like most is we improved the growth profile of the portfolio by selling properties with annual escalators averaging 1.9% versus 2.8% for the broader portfolio. While MOB operating fundamentals remain healthy, the transaction market continues to be governed by interest rate volatility. Until we see stable rates over a longer period of time, we expect lower transaction volumes and smaller deal sizes. For now, we see MOBs trading in a range of 6%-7%, with the higher quality properties in the low to mid-6%. Turning to expectations for 2024, Healthcare Realty's outlook for leasing is strong. Our new lease pipeline remains robust at 1.5 million sq ft and provides visibility into several quarters of leasing volume. Across the country, new MOB development starts have been trending down over the past 12 months.

In the Q4, they were down by over 40% year-over-year. This trend has been driven by tightening credit markets, and as Todd mentioned, a healthy increase in construction costs over the past five years. At the same time, occupancy across MOBs has continued to climb. Additionally, we are seeing increased health system demand for space as volumes and financial measures improve. Recently, a couple of for-profit hospital operators reported a 3.6% year-over-year increase in outpatient surgical cases, and hospital operating margins steadily improved throughout 2023. Positive supply-demand fundamentals and improving hospital performance will serve as tailwinds for our 2024 absorption goals. We updated our multi-tenant occupancy and NOI bridge in our recently published investor presentation. The primary change is to the starting occupancy, reflecting the sale of some highly occupied properties during the Q4 and the completion of a development.

It is also worth noting that we expect absorption during the H2 of 2024 to be stronger than in the first. These are shaped by two seasonal patterns. First, we have about 2.7 million sq ft of expirations in the H1 of the year versus 2.1 million in the second. Even with a consistent renewal rate, we expect more move-outs in the H1 of the year versus the second. Second, new lease commencements have historically been lower in the H1 of the year versus the second. As a result, we expect net absorption in the H2 of the year to be about 200,000 sq ft greater than the first.

We are reiterating our expectation for 100 basis points-150 basis points of occupancy gain in 2024, on top of the 53 basis points of absorption this quarter. Our leasing team is off to a great start this year. They are energized by growing demand for healthcare services and a tightening supply-demand backdrop. Looking ahead, I'm confident in our ability to drive absorption that translates into multi-tenant NOI growth of 4.5%-5.5% in the H2 of 2024. Now, I'll turn it back to Todd for some final comments.

Todd Meredith (President and CEO)

Thank you, Rob. Before we begin our Q&A, I'll touch on capital allocation and our outlook for 2024. We exceeded our own disposition expectations in 2023. We sold $656 million at a cap rate of 6.6% for the year, with over half occurring in the Q4. What's significant is these sales improved the quality and growth profile of our portfolio. Looking ahead, we're shifting to a more routine annual pace of portfolio optimization. In 2024, we expect dispositions of $150 million-$250 million, which will fund capital obligations, including redevelopment and developments. Beyond this, we're pursuing accretive capital allocation opportunistically. We continue to work towards strategic JV partnerships that diversify our capital sources and extend our ability to meet long-term provider demand. In our initial 2024 guidance, we've conservatively assumed no JV transactions.

Finally, our outlook for 2024. We've updated our occupancy bridge and our occupancy and NOI bridge. Building on the strong absorption in the Q4, we expect healthy occupancy gains and NOI growth in 2024, consistent with what we communicated last quarter. For FFO guidance, robust multi-tenant absorption and NOI growth is the primary driver that moves us into the upper half of our guidance range. For Healthcare Realty, sustained operational growth in 2024 will set the table for attractive FFO and FAD growth in 2025. Operator, we're now ready to begin the Q&A period.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question today, please press star followed by one on your telephone keypad now to enter the queue. When preparing to ask your question, please ensure you are unmuted locally. Our first question comes from Michael Griffin from Citi. Michael, please go ahead. Your line is open.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. Yeah, Todd, maybe I can go back to your comments on the dividend first. I, I think if you look at, at guidance for both normalized FFO and CapEx, it implies about 107% payout ratio for 2024. I know the guidance has been, been elevated for some time, and, and you talked about maybe being able to grow into a healthier payout ratio. But, but at some point, you know, could, could a potential cut be warranted? And, and any color around that would be helpful.

Todd Meredith (President and CEO)

Sure. Michael, we've certainly said that for a while, that we think that as we ramp up our absorption and invest in TI, that we'll certainly see that capital spend continue. So as Kris described in his remarks, we expect a similar payout ratio in 2024 as 2023, kind of in that 107%-110% range. And, you know, we're comfortable with that because we know we're investing the capital that will generate the NOI, that will flow through to FFO and FAD afterwards. And so we really see 2025 as an important transition in that. So we're very bullish on what we see. Obviously, we'd love it to happen sooner, like everyone, but we think, you know, the key is that operational improvement and investing in that capital to generate the NOI.

So our view is we feel very comfortable, as Kris remarked, that we can get there in 2025, and so certainly we're not thinking about a cut. The board is not thinking about that at this point. And, obviously, you know, we can't control all market conditions, but our view is operationally, we can deliver the NOI that will improve that ratio.

Michael Griffin (Senior Equity Research Analyst)

Yeah. And just to follow up on that, I mean, what kind of payout ratio are you comfortable with? And, you know, how long would you kinda have to keep that as is until you would grow into the cash flows?

Todd Meredith (President and CEO)

Yeah, I mean, I think our view is that, again, 2024 looks a lot like 2023 in terms of the payout ratio, but we think 2025 starts to, you know, drive towards that covered dividend level. And obviously, what we'd like long term, obviously, is drive much lower than that, you know, into the 90% or even below 90% level. So that's certainly the path that we see. We know it's, you know, we'd love to see it sooner, but we think that starts to take shape in 2025.

Michael Griffin (Senior Equity Research Analyst)

Gotcha. And then just maybe one on the JV or disposition front. I know, I think at your Investor Day back in October, you laid out about $400 million-$500 million of funding, you know, seed funding into joint ventures. First, is your guidance now that sort of pivoted away from that? I guess, what changed between then and now? Is it a function of where cap rates are, interest rate volatility? You know, that seems like kind of a large pivot in a shorter amount of time. So just curious what your thinking on that was.

Todd Meredith (President and CEO)

Yeah, I wouldn't describe that we're turning away from that in terms of scale. I think what we've talked about, you know, in recent times since Investor Day, whether it was earnings or NAREIT with folks, is that, you know, clearly, as Rob described, the cap rate environment, there is a lot of interest rate volatility and financing challenges that go to that. And so our view is we've not been in a hurry. Obviously, we've had very a large amount of dispositions that have more than covered what we needed on capital. So our view is there's no reason to hurry. We want to be more strategic and patient than too rushed on that. And time is certainly serving us well, because I think as we turned into 2024, we've seen a pickup in how things are going.

Obviously, we're all navigating, you know, interest rate volatility. But our view is, we, we see a couple of transactions, maybe rather than one, but we still think over time, we will, we will generate proceeds that kind of are in that, you know, call it $300 million-$500 million range. It just may take a couple of transactions of a couple of different styles that, for us, are strategic and helpful. Some may be more core, you know, investment-oriented, some may be more, you know, value add, development, redevelopment-oriented. So we, we still see that coming together, just, just being patient here as we kind of navigate interest rate volatility.

Michael Griffin (Senior Equity Research Analyst)

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

Todd Meredith (President and CEO)

Thanks, Michael.

Operator (participant)

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

Connor Siversky (Director and Senior Equity Research Analyst)

Good morning. Thank you for the time. One question on the leasing pipeline. In the NAREIT presentation, you had the number at 1.7 million sq ft. It looks like in the new presentation now you have a range of 1.4 million sq ft-1.7 million sq ft. I'm just curious what's driving the change there, or whether that's just a function of having more visibility into the Q4 expectations?

Todd Meredith (President and CEO)

Yeah, I think that pipeline, I mean, it moves around all the time. I mean, things come in and out of there, and it's... We think that the range that we put in the investor presentation of the 1.4 million sq ft-1.7 million sq ft is reflective of where we think that pipeline will kind of bounce around. We do think that it does provide us good visibility, as you said, into the coming quarters of expectations for new leasing. And the way we think about it is that it, in that range that we provide it, the 1.4 million sq ft-1.7 million sq ft, you know, we think that that provides good visibility in several quarters worth of new signed leasing activity. So we're comfortable that the activity that we're seeing and that we laid out in there that it's that that pipeline supports our assumptions for 2024.

Connor Siversky (Director and Senior Equity Research Analyst)

Okay, thanks for that. In consideration of expirations through 2024, almost 6 million sq ft, am I right to think about maybe a 300,000 sq ft-400,000 sq ft number per quarter as a reasonable target to keep that NOI ratio in the same place?

Todd Meredith (President and CEO)

Yeah, I think on the, in terms of the expirations, I mean, the way that we look at it is that, you know, we've got, we've got more expirations in the H1 of the year. And so we are expecting more move-outs there. And so that combined with, you know, typically the lease commitments, commencements that we see are lighter in the H1 of the year is the way that we see that the absorption number, because of that, will be lighter in the H1 of the year than the second.

So I think what's causing that increase in expirations or move-outs that we modeled in the bridge, it's generally from the higher expectation for expirations and the corresponding renewal rate that we've applied to that.

Connor Siversky (Director and Senior Equity Research Analyst)

Okay. And last one for me, just on the office assets and the SNF sold during Q4, could you provide the full NOI contribution from those assets? Just, you know, to save me from doing the math, if you could provide the average cap rate on the MOB sold during the quarter, that would be appreciated.

Todd Meredith (President and CEO)

Yeah, I don't have the specific number in front of me, but I can give you the cap rates. So effectively, you know, we were about 6.3-6.4 for everything sold in the Q4. The SNFs, you know, we weren't recognizing any income, so those were, you know, zero. You know, we did have some office that were up on the upper end. So if you take those, those extremes out on either side, it ends up being about half of the, of the, of the total proceeds. And the MOBs end up, the that cap rate ends up being in the high sixes, 6.8-6.9 range.

Connor Siversky (Director and Senior Equity Research Analyst)

Great. Thank you for the color.

Todd Meredith (President and CEO)

Got it.

Operator (participant)

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

Juan Sanabria (Managing Director)

Hi, good morning. I just wanted to ask about G&A. Just curious if you could talk about the size of the increase and the thoughts behind that. I seem to recall that post HTA, the G&A was maybe sacrificed a little bit in terms of compensation to kind of hit some of the numbers, but it seems like that maybe was just a temporary phenomenon. Is kind of that the right way to think about it?

Todd Meredith (President and CEO)

Yeah, Juan, really, it's not a change in the target numbers in compensation. It's really the fact that 2023 and even 2022 were softer in terms of the actual results for incentive comp, and therefore, you end up with a lower number in the actual periods. And then really, 2024, what we have in our guidance is simply returning to, you know, in essence, the accrued target of the incentive program. So it's just comparing kinda target levels to under target levels in the prior years, not a big change of any sort in the actual comp programs or you know, all in amounts. So it's really, as Kris described it, really just a tough comparison and, you know, just it's the accrual you always put in place for your comp program compared to the actual results in the prior years.

Juan Sanabria (Managing Director)

Okay. But the 10% growth isn't factoring in any sort of investments in the platform or technologies, just the comp and getting back to how the average hurdle rate that you were below. Is that fair then?

Kris Douglas (EVP and CFO)

I mean, there certainly is investment going on inside of our platform. You know, we've brought on some good, solid people that we think are helping us as it relates to some of the analytics and some of the portfolio strategy and things we're doing. But I would say that that's not the major difference, what's driving the change. It really has to do with what Todd was talking about, of kind of returning to normalized incentive comp. The midpoint is $5.8 million, that's the increase. It ends up being about, it's around $4 million or so that is getting back to that normalized incentive comp range.

And so the balance of the difference is just, you know, growth in G&A for the things you're talking about. That ends up being more of like a 3% growth on a year-over-year basis. So really, the main difference has to do with what, what Todd was talking about, of that, returning to the run rate on the performance compensation.

Juan Sanabria (Managing Director)

Very helpful. Thanks. And then, I just wanted to kind of try to square things as the message has evolved over the last few quarters. If I look back to the Q1 of 2024, you kind of talked about a baseline 2024 FFO growth of 5%-7%, and same-store NOI growth of 4%-6% for the whole company, not just multi-tenant. I guess it sounds like there's some single-tenant expirations that maybe weren't factored in there, and may have been a bit of a surprise. But just curious if you could try to talk through, you know, what's changed over the course of the year. Because the leasing pipeline you guys have been talking about has been robust for a while. You started to see some of that benefits come through in the Q4.

Just if you could just kind of square those two, that'd be super helpful, as we're definitely getting asked that on our end.

Todd Meredith (President and CEO)

Sure. Juan, I think just big picture, we, you know, a year ago did talk about that 4%-6% growth. And I think what you're seeing in our bridge that we laid out last quarter, and sort of reiterated and updated this quarter, is really getting that multi-tenant throughout the year, as Rob described it. You know, obviously ramping up in the, in the H2, just some of that due to expiration patterns, some of that being, being due to the leasing that we really ramped up in 2023. You saw it started to come through in in the Q4, and, and really continuing to contribute throughout 2024. So it's putting all those pieces together to get to... At the back half of the year, we show, you know, growth that starts to get into that 5% range, ±.

Obviously, we'd love to do it sooner. You know, one of the challenges probably that has changed a little bit since a year ago is, you know, operating expenses have been a little more stubborn. We're making great headway, some nice progress this quarter, but we're certainly projecting continued improvement on that going in. And again, a ramp up or maybe a ramp down in the rate of growth in operating expenses. So, you know, some of it is just, you know, obviously knowing more detail and specificity as we've approached it, but we see the momentum and really driving towards that same goal, that 4%-6% multi-tenant growth goal, and getting there throughout the course, and really by the end of 2024.

Juan Sanabria (Managing Director)

Okay. And then just one last quick follow-up. Sorry. You guys were saying that the absorption for the quarter was at the high end, but occupancy came in below on the multi-tenant side. Could you just help us square that, those two comments?

Todd Meredith (President and CEO)

Yeah, if you look in our, whether it's our supplemental or our earnings press release, we laid this out very clearly, that really, it's on page five of the, four of the supplemental. And really, the delta was, I think Rob touched on this in his remarks, the properties we sold in the Q4, that were part of that calculation, that starting occupancy, when you sold those that had higher occupancy in those particular cases, it brought down the starting point. And also, we completed a development. So when you layer those things in, your starting occupancy actually came down a bit. So actually, the delta is still very much the 53 basis points and 175,000 sq ft of absorption.

So the occupancy, the starting occupancy that we projected in the bridge last time, obviously, had to be adjusted for those transactions, the sales and the development completion. And that's something that, you know, you're always adjusting as your portfolio evolves. So we tried to make that as clear as possible, to show that, you know, the starting point is just different, and the change is still, obviously at the top end of the range.

Juan Sanabria (Managing Director)

Super helpful. Thanks, and appreciate it.

Todd Meredith (President and CEO)

Thanks, Juan.

Operator (participant)

The next question is from Mike Mueller from JPMorgan. Mike, your line is open. Please go ahead.

Mike Mueller (Senior Equity Research Analyst)

Yeah. Hi. A couple occupancy leasing questions. I guess, you finished the year multi-tenant 85.2%, and just kind of given the commentary about the timing of move-outs versus commencements and stuff, is it safe to say that in, at least in one Q, occupancy dips from 85.2% before going up, or, or does it just kind of head up regardless of that from year-end?

Todd Meredith (President and CEO)

I would say that, you know, we think that occupancy is gonna move up from here. Those are our expectations. We don't expect to see a dip moving from Q4 to Q1. So just not gonna be at the same pace [crosstalk] that you saw in the Q4. Yeah. So it could be, you know, it could be a slight positive as opposed to the significant, you know, positive absorption we saw in the Q4.

Mike Mueller (Senior Equity Research Analyst)

Got it. Okay. And then, I guess on the lease side, the 87.2, I think it was, at year-end, give or take, for the lease rate. You, you've mapped out in the presentation where you think physical occupancy is going. Do you expect the lease rate to climb higher as well? Or is what you're seeing on the occupancy side, just the commencement of, you know, what's embedded in that lease rate?

Todd Meredith (President and CEO)

Yeah, I think that the what we're seeing in terms of lease commencements sort of moving forward, I would expect that the those two would move. You know, right now we've got about 210 basis points of difference between the two, 87.2 and 85.2. And I would expect that those two would move together as occupancy moves up. I don't see in the near term that the delta between the two getting much smaller.

Mike Mueller (Senior Equity Research Analyst)

Got it. Okay. So, new leasing's in there as well. Okay, that was it. Thank you.

Todd Meredith (President and CEO)

Thanks, Mike.

Operator (participant)

As a reminder, that's star one on your telephone keypad to enter the queue. The next question comes from Michael Gorman from BTIG. Michael, your line is open. Please go ahead.

Michael Gorman (Managing Director and REIT Analyst)

Yeah, thanks. Good morning. Just wanted to maybe synthesize some of the questions here. Obviously, one of the questions on the dividend, and then thinking about the 2024 outlook earlier last year, and as we start to think about how 2024 plays out in going into 2025. I just want to make sure if I'm doing my math correctly, the implication here is that if you kind of move towards dividend coverage in 2025, it's kinda in that 6%-8% FAD growth in 2025 is what would be implied. I know you're not giving guidance, but like, is that the way to think about how 2024 plays out? Is that the run rate by the end of the year is gonna be such that, that kind of mid or even upper single digits FAD growth is, is what we're looking at in the, in the out years?

Todd Meredith (President and CEO)

Mike, I would say you're directionally, you know, headed the right way. I think it's early to be calling that for sure for 2025. You know, an earlier question was asked about, you know, we're obviously very bullish on our multi-tenant side, and our single tenant side is fine. The retention rates are as strong, but backfilling single tenant vacates, you know, have typically a lag effect. And so, you know, we don't have perfect visibility into expirations, for single tenant, as an example, in 2025. So it's early to call, you know, the net number, if you will, but you're right in terms of what the implied math, implied dividend coverage would suggest in terms of the growth potential in 2025.

So we're certainly bullish on that and see a very strong uptick going into 2025. Now, like everyone, you know, we're watching interest rates, we're looking at all that, but, you know, we've brought our variable rate exposure down significantly. We don't have big maturities in 2024. So, you know, from what we can see, we can see that exit velocity of 2024 being quite strong, as you said.

Michael Gorman (Managing Director and REIT Analyst)

Okay, great. And then maybe just helping me out on that, as you think about that, I mean, exiting 2024, you see a lot of strong absorption, a lot of leasing momentum. So obviously, the NOI coming online is a benefit. Should we expect a normalization in CapEx as a percentage of NOI as well as we get towards the back half of 2024? So if I'm thinking about the guidance of $140-$160, is that gonna be front-end weighted as we think about the CapEx bill this year?

Todd Meredith (President and CEO)

You know, I think it really depends on the ultimate timing of being able to sustain additional new, you know, new leasing, moving forward to the back half of the year and even moving into 2025. But we are certainly seeing a bit of an escalation right now. You know, we ended up for the year, I think it was 18.4% of NOI that we spent on maintenance CapEx. You know, I would say that what we're sending for 2024 is a similar amount. But even if you stay to that level, just because you start getting the additional NOI from all of the leasing that occurred late in 2023 and then all the way through 2024, it still drives a benefit.

So, you know, I think that to your earlier question of can we see, you know, much stronger growth in FAD? I think the answer is yes, even without assuming a significant decline in your maintenance CapEx as a percentage of NOI. I would still say that, you know, I would think that, you know, if we get back to a regular, call it 15% of leases that are expiring every year, that's probably the percentage of NOI that you're talking about of spending on maintenance CapEx. So, you know, if we do see some normalization, it's gonna be a, you know, to that degree, it's not like we're assuming that maintenance CapEx number is gonna be cut in half or something.

Michael Gorman (Managing Director and REIT Analyst)

Okay, great. And then maybe just last one for me. Just on the JV, obviously, being conservative, not including that in guidance, how should we think about that conservatism? So if I look at the bridge in your release this morning, is the kind of $5.5 million-$7.5 million of dilution from additional dispositions, is that in place of the JV? Is that the conservatism or I'm just trying to understand the potential benefit if the JVs do come to fruition over the course of the year. Does that take the place of those dispositions, or is it coming through fee income, or how does that play out?

Todd Meredith (President and CEO)

No, I wouldn't necessarily say it's a substitute. I think I would, I would continue to expect the disposition. Some of that is just our normal course, you know, portfolio optimization, and I think that level is not an unreasonable run rate for us going forward. Call it $200 million ±. The JV, really, the way to think about that would be maybe two ways. One would be to simply say, hey, we have proceeds. We can, we can buy back stock. We could, you know, obviously pay off debt, you know, some combination of that for, for a leverage neutral impact, and that would be accretive. Obviously, timing is the key point there. You know, how much of that do you get in a year?

And then maybe the other way to think about the positive would be maybe somewhat related, but would be to say, hey, if we did anything that involved our redevelopments or developments, it would certainly reduce capital spend that we would have, and then you would enhance your return on what dollars you do continue to commit to, smaller dollars that you do commit to, to those projects. So again, timing being a key impact there. So it, it's really sort of what do you do with the proceeds from the joint venture structures, and what's the timing of that? And so obviously, since we're not, you know, giving specific direction on that, we're keeping it out of guidance, and then we will certainly update and layer that in as we progress and have more specifics on that.

Michael Gorman (Managing Director and REIT Analyst)

Okay, thank you.

Todd Meredith (President and CEO)

Thanks, Mike.

Operator (participant)

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

John Pawlowski (Managing Director)

Thanks for the time. I wanna go back to Ron's question on what's changed between now and last May, when you signaled total same-store growth from 4%-6%. And I don't really care about guidance and things changed, but more concerned about a structural shift in the pricing power in the portfolio and stickiness of tenants. And so I pointed to expenses being more challenging, but it feels like the divide between 3% same-store growth and 4%-6% previously signaled is much more, it's much bigger than just expenses. So can you Todd, can you just expand on that? What, what's changed in terms of retention of tenants with the multi-tenant or single-tenant? What's changed in the portfolio? Because it's a big shift.

Todd Meredith (President and CEO)

Yeah, I think the way to think about it is, obviously all the different pieces that go into same-store growth. The occupancy piece, I think probably one of the key things was really talking about same-store versus total multi-tenant. Obviously, what we see a lot of upside in is even some assets that aren't in same-store, and those will, you know, over time, roll into same-store. So they could, you know, actually come back in and increase same-store. But we have assets in our redevelopment side, our development side, that generate a lot of upside. And so that's really why we put the bridge together to really illustrate how all of our multi-tenant properties do get into that range.

You know, over time, that may become really the same store, but, but it's gonna be a matter of when those projects roll or when those properties roll into to same store. But beyond that, at the edges, I've talked about some of the challenges have been retention as well. It's subtle, but it's an important difference. We're running currently, I think for the year, we were at about 79%. For the quarter, we're about 78%. You know, that really needs to hit 80% and, and really get up there to kinda drive fully the, the, the positive source, and that'll get us that 4-6. We've been somewhat conservative in what we have in our bridge.

We're not assuming a huge change in that retention, but that would be a bonus or a plus to what we see there that would push it further. Obviously, I mentioned we already talked about operating expenses. The one other one that I think we're touching on, but maybe not in the right context here, is the single-tenant side. And that certainly is what was lower for us in 2023 and also expected in 2024, simply because of those two properties that Kris talked about. So those growing at about 1% is below the escalators that are in place in the single-tenant portfolio of about 2.5. And so that difference is a little bit of a drag on that.

So again, we may, you know, be able to address some of that. As Kris said, we're looking to sell one of the assets. The other is a redevelopment play. And so, you know, as those evolve and we are able to work out some improvement, we've conservatively assumed those go to zero. But if we can generate additional growth out of those, some leasing out of those or a sale, that will help. So there's some conservatism there, but I would say that's another piece to the puzzle.

John Pawlowski (Managing Director)

Okay, I appreciate all that. Todd, second question on balance sheet and just how you're managing the duration of the debt. So average amongst the maturity of, or average years of maturity, about four years. You've got $1 billion of interest rate swaps expiring in the next three-ish years. Should we expect this type of duration on the balance sheet to remain pretty similar, or are you more open to issuing longer-term unsecured debt and taking refinancing risk off the table?

Kris Douglas (EVP and CFO)

Yeah, no, I think. This is Kris. I'll jump in on that. Yeah, with everything that's gone on in the last couple of years related to interest rates, you know, going up and the volatility, everything associated with that, we obviously haven't issued any any new long-term debt. But that is always on the table. We're always looking at that, and it certainly has improved from where we were, you know, call it four or five months ago. But then you got to look at your use of proceeds. And so if we were to do something like that right now, you know, we don't really have a matching use of proceeds to be able to redeploy those accretively.

But we certainly would anticipate as we move forward that we'd be looking at, you know, at long-term debt as a source of financing and refinancing of expiring debt.

Yeah, our first debt or unsecured bond maturity is next summer, so 2025. So certainly as we get closer to that, we'll be keeping an eye on that opportunity to extend that maturity and duration, as you said.

John Pawlowski (Managing Director)

Okay. Thanks for the time.

Todd Meredith (President and CEO)

Thanks, John.

Operator (participant)

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

Todd Meredith (President and CEO)

Thank you, Adam, and thank you everybody for joining us this morning. We will be available for your follow-up and questions, and we look forward to seeing many of you at some upcoming conferences. Everybody, have a great day. Thank you.

Operator (participant)

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