Healthpeak Properties, Inc. (NYSE:PEAK) Q1 2023 Earnings Call Transcript

Healthpeak Properties, Inc. (NYSE:PEAK) Q1 2023 Earnings Call Transcript April 28, 2023

Operator: Good morning, and welcome to the Healthpeak Properties, Inc. First Quarter Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Andrew Johns, Senior Vice President, Investor Relations. Please go ahead.

Andrew Johns: Welcome to Healthpeak’s first quarter 2023 financial results conference call. Today’s conference call will contain certain forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our expectations. A discussion of risks and risk factors is included in our press release and detailed in our filings with the SEC. We do not undertake a duty to update any forward-looking statements. Certain non-GAAP financial measures will be discussed on this call. In an exhibit of the 8-K furnished with the SEC yesterday, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measures in accordance with Reg G requirements.

The exhibit is also available on our website at healthpeak.com. I will turn the call over to our President and Chief Executive Officer, Scott Brinker.

Scott Brinker: Thanks, Andrew. Good morning, and welcome to Healthpeak’s first quarter earnings call. Joining me today for prepared remarks are Pete Scott, our CFO; and Scott Bohn, our CDO. The senior team will be available for Q&A. Starting this quarter, we moved up our earnings call cadence by almost a full week, made possible by the strong systems we’ve put in place and our streamlined processes. Over the course of the calendar year, this gives the team an extra three to four weeks to focus on value-add real estate activities. After a strong fourth quarter to close out last year, 2023 is also a solid start despite the market backdrop. We affirmed full year FFO guidance and increased full year AFFO guidance, which puts our payout ratio in the 80% range.

Same-store growth was strong in each business segment, blending to 5.5% for the quarter, and our balance sheet is in great shape with 5.4x leverage. Outpatient Medical continues to produce best-in-sector growth despite evermore challenging comps, driven by the quality of the portfolio and platform. CCRCs performing strongly on a cash basis, in particular, with entry fee receipts at an all-time high for the first quarter. I want to make a few comments on life science. For the past 20 years, I’ve invested in an asset managed nearly every variation of health care real estate. I’ve seen firsthand the pluses and minuses of each and believe life science falls on the favorable end of the continuum. I say that based on secular demand, the impact of innovation, barriers to entry and core submarkets, competitive advantage of incumbents, high operating margins and net cash flow growth over time.

It’s a business driven by the aging population and the desire for improved health to things that aren’t going away. At the same time, we fully acknowledge that any business runs in cycles, in fact, despite the market exuberance in the past few years, we correctly underwrote the growth would slow, and we position ourselves accordingly. No new development starts in the past 18 months, no material operating acquisitions in more than 24 months. Very few lease maturities this year are next due to proactive early renewals, and we didn’t compromise on asset quality during the boom. The reality is that not every drug candidate will succeed and biotechs don’t raise 10 years of cash up front. It’s a given that some companies won’t make it and none of this is a surprise to us.

We built our portfolio around these realities. For example, one aspect of our cluster strategy is that growing tenants in our portfolio can take space when another tenant contracts, whether through a direct lease or sublease. It’s often done proactively, powered by our robust asset management. Scott Bohn will share recent examples. For several reasons, we see the pullback in sentiment is a huge opportunity for current and potential Healthpeak shareholders. One, we have a relatively small amount of near-term lease roll. And when we do have availability, we continue to sign leases. Two, new development starts will be very low across the sector for the foreseeable future. Three, higher borrowing costs and delayed lease-up will create acquisition opportunities in the coming years.

And four, we have a big land bank with strong progress on entitlements. When fundamentals turn, which they inevitably will, we expect to be in great shape to capitalize. Recall, we were patient with our land at the Cove and the Shore until market conditions were right, then generated huge returns for shareholders, perhaps goes without saying, but the best opportunities come out of downturns. Now a few Board of Director updates. First, congratulations to Kathy Sandstrom on being elected at our new chairperson. Kathy has been an independent member of our Board since 2018 and brings a wealth of real estate, capital markets and governance expertise. She was previously a senior executive at Heitman, an important public and private real estate investor.

An enormous thank you to Brian Cartwright for his five successful years as Chairman, while we dramatically improved the Company and portfolio. Brian will remain an independent member of our Board and a highly valued adviser to me personally. And I would like to formally welcome Jim Connor to our Board. Jim has a strong track record of creating internal and external growth as CEO of Duke Realty, in addition to development and outpatient medical experience that will contribute to the execution of our strategic plan. Finally, we are pleased to report that we received the highest possible quality scores from ISS for the E, the S and the G in our recent proxy statement. I’ll turn it to Scott Bohn for commentary on life science fundamentals.

Scott Bohn: Thanks, Scott. Before I dive in, I want to touch on a few important topics. First, much like landlords analyze tenant credit, tenants are now doing the same with landlords. With record demand and minimal availability in recent years, tenants didn’t always have the luxury of thoughtfully selecting the real estate assets or partners of choice and many had to settle with what was available. Today, tenants have more ability to select a landlord that has the financial capability and operating credibility in the market as well as the one that has the ability to provide pathways to growth within its portfolio. Healthpeak is exceptionally well positioned to capture the demand from these tenants. Second, with increased supply and softening demand, there will inevitably be pressure on deal economics.

However, purpose-built space in the best submarkets that is owned by large incumbents like Healthpeak will continue to perform secondary locations with lower quality projects and sponsorship. Third, we proactively manage our portfolio, leveraging our scale and tenant relationships to provide real estate solutions for our tenants while enhancing our portfolio credit profile. A very recent example of this is how we proactively downsized Adverum footprint and simultaneously backfilled the 40,000 square foot space with Revolution Medicines, a $2.4 billion market cap company, that has raised over $600 million in two equity offerings in the past nine months. RevMed enter Healthpeak’s portfolio in 2015, initially taking a 42,000 square foot building and has grown to over 140,000 square feet across four buildings.

Finally, while the IPO market has generally remained closed, we’ve seen continued activity and positive signs from the other funding sources. Public biopharma R&D is at record levels, VC fundraising remains strong, and the secondary equity market remains open for those with good data. Moving to the portfolio in our core markets. Pete will discuss the financial results in detail, but I will note that we had a solid leasing quarter with 311,000 square feet of leases executed with a positive 55% cash re-leasing spread on renewals. We delivered the final lab space at our 101 CambridgePark Drive development and the building is now fully placed into service capping off another successful Health peak development project. Now getting into the markets, starting in Greater Boston.

We have only one 22,000 square foot space rolling through year-end 2024 in the entire portfolio. Our only vacancy is in a 49% owned building, where we recently executed a lease on a portion of that space at a triple-digit rental rate and have activity on the remaining space. Moving to San Diego. Our 2.6 million square-foot operating portfolio is 100% leased. Only 200,000 square feet matures over the next 18 months, and we’ve already addressed nearly 1/3 of those maturities. We have commenced marketing on our gateway development following a lease rejection as part of the bankruptcy proceedings. The project was designed to accommodate a singular multi-tenant use and a great visibility of the 85 freeway. Finally, to South San Francisco, where we enjoy dominant market share of approximately 40%.

We have assembled a portfolio in South San Francisco that is built to accommodate tenants of all sizes and maturity levels from brand-new Class A space to small 2,500 square foot Class B spaces. This holistic portfolio approach with different price points catering to the needs of a wide variety of tenants creates an ecosystem that no one can match in this important market. Through 2022 and early 2023, over 78% of Healthpeak’s leasing in South San Francisco has been with existing tenants. Additionally, over the past two years, Healthpeak’s share of total executed leases has approached 50% of the market total, highlighting the importance of our deep tenant relationships and portfolio scale in the South San Francisco market. Now a quick update on our top three priority campuses in South San Francisco.

At Oyster Point, we have completed leasing on 87% of the recent expiration. This quarter, we placed our only vacancy at the Canvas, a 68,000 square foot building that expired at the end of 2022 into redevelopment. The space has 20-year-old improvements, so we’ll need some capital as we work to release it. The balance of the near-term expirations, which totaled 320,000 square feet, don’t expire until late this year and early 2024, and we’ll go into redevelopment at that time. So we are marketing and are in active negotiations on a portion, but still generally too early to be signing leases. At our Pointe Grand redevelopment, which we have derisked with our strategic JV and we have leased 53% or 185,000 square feet of the active redevelopment space.

We’ve executed three leases at the campus between December and March, totaling over 130,000 square feet, two in very late 2022 and one last month with a weighted average lease rate on those deals of just under $90 per square foot. Additionally, we are in active negotiations with prospective tenants on portions of the remaining space. At our Vantage project, we have pre-leased a full building totaling 45% of the first phase to Astellas and have recently executed an LOI with an existing portfolio of tenants for a 23,000 square foot full floor space, bringing the project over 50% committed. Wrapping up with supply in South San Francisco, competitive new supply delivering in 2023 totaled 800,000 square feet, of which 71% is pre-leased. There’s another 1.7 million square feet delivering in 2024, 26% of which is conversion space that will be less competitive to our purpose-built product.

It’s critical to understand that the unleased space delivering in 2023 and 2024 resides only five projects and two of those are conversions. We have consistently competed successfully with these same projects over the past 12 to 18 months while leasing up our Shore Nexus and Vantage projects. Lease-up at Healthpeak these projects have continuously outpaced the competition, and we expect the same to continue. With that, I’ll turn it over to Pete to cover financial results.

Peter Scott: Thanks, Scott. Despite the challenging market backdrop we have started the year on a strong note. For the first quarter, we reported FFO as adjusted of $0.42 per share, AFFO of $0.38 per share and total portfolio same-store growth of 5.5%. Notably, our FFO as adjusted this quarter was impacted by $0.02 of onetime straight-line rent write-offs. Per our policy, we do not add this back to FFO as adjusted. Let me provide a little more color on segment performance. In life sciences, we finished the quarter with an occupancy rate of 98% and and same-store growth was a very solid 6.3%. The drivers of same-store growth were contractual rent bumps, positive mark-to-market and lower free rent, partially offset by a known vacate of a non-life science user at our 8,000 Marina building, which is adjacent to the shore.

Turning to medical office. We had another great quarter with same-store growth of 3.7% and we finished the quarter with an occupancy rate of 91%. Same-store growth was driven by strong in-place lease escalators and our Medical City Dallas campus, which continues to exceed our expectations. Finishing with CCRCs. Same-store growth for the quarter was a very healthy 9.5%. Cash and rep sales of $29 million set a first quarter record. The strong start to the year allowed us to increase our full year NRAP guidance to $107 million at the midpoint that is $27 million or $0.05 per share greater than what is forecast in FFO and AFFO. Last item on our financial results. For the first quarter, our Board declared a dividend of $0.30 per share. This equates to an AFFO payout ratio of less than 80%, the lowest reported payout ratio at Healthpeak in over a decade.

That is a good segue to our balance sheet, which we believe continues to be a competitive advantage. Our net debt to EBITDA is 5.4x. We have liquidity of $2.5 billion. We have limited floating rate debt exposure at 5%. We have no bonds maturing until 2025. Our development pipeline is fully funded, and we have no additional asset sales in our forecast. We have approximately $150 million of annual retained earnings, and we have stable ratings from both S&P and Moody’s. Turning now to our 2023 guidance. We are reaffirming our FFO as adjusted range of $1.70 to $1.76 per share. We are increasing our AFFO range by $0.01 to $1.46 to $1.52 per share. And we are increasing our blended cash same-store growth by 25 basis points to 3% to 4.5%. Let me expand on some important items underlying our guidance.

We see $0.03 of benefits from the following items: $0.01 from the 50 basis point increase in medical office same-store growth and the $2.3 million letter of credit at Gateway, $0.01 due to earlier-than-anticipated revenue recognition at our Hayden campus in Boston and $0.01 from the combined impact of lower interest expense and higher interest income. Our FFO as adjusted, the positive $0.03 increase is offset by a $0.03 decrease in straight-line rents, inclusive of the onetime write-off I previously mentioned. For AFFO, we were able to increase guidance by $0.01, while maintaining a level of conservatism as it’s still early in the year. As a reminder, AFFO is not impacted by non-cash items, including straight-line rent and revenue recognition.

Please refer to Page 36 of our supplemental for additional detail on our guidance. A couple of quick items before turning to Q&A. On the Sorrento Therapeutics operating leases, we have been paid rent in full through April. Although not guaranteed, we could receive additional rent as their strategic alternatives process is expected to run through July, with the rents received year-to-date, combined with the potential for additional rent payments and the letters of credit, there is minimal financial impact to 2023, regardless of whether the leases are accepted or projected. On the Kodiak leases, we have been paid rent in full through April. Due to our proactive subleasing, our annual net exposure is only $3 million across 40,000 square feet at 35 Cambridge Park Drive.

I walked the space last week, and it is an A+ condition. If the leases are rejected, we are confident in our ability to re-lease the space on favorable terms. With that, operator, let’s open the line for Q&A.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. Our first question comes from Juan Sanabria, BMO Capital Markets.

Unidentified Analyst: It’s Eric on for Juan. Just starting with life sciences. Just a question on occupancy, and I appreciate your color and the remarks. Was it just the one move out that drove the decline in 1Q ’23? And then what’s assumed in guidance for the balance of ’23? Is there any other large move-outs that beyond to be aware of?

Peter Scott: It’s Pete here. I’ll take that. Please send our regards to Juan. We did end 2022 at 99% occupancy and in a multi-tenant portfolio, kind of hard to go up from there. Occupancy did decline modestly in the first quarter. But if you put it into context, 50 basis points of an occupancy decline is actually around 50,000 square feet within our portfolio. And if you equate that to the size of our leases, that’s really just one lease. Our guidance for the year did assume occupancy would decline a bit in 2023. As I mentioned, it’s hard to go up from that 99% number. And then as I did mention in our prepared remarks, we did have an expected tenant vacate at our 8,000 Marina project over in Brisbane, and that’s adjacent to the shore, and it was a non-life science user, and we’re evaluating converting that space to lab, and that was certainly expected. So with regards to occupancy generally, that’s probably the best way to answer that question.

Operator: Next question comes from Michael Carrol with RBC Capital Markets. Please go ahead.

Michael Carroll: How built out is the Sorrento Gateway development today did Sorrento Therapeutics already start its TI build? Or does a new tenant or potential new tenants still have a big required TI package that they need to put into that asset to make it usable?

Peter Scott: Mike, it’s Pete here. Again, as we said in our prepared remarks, that building was designed for either a single tenant or multitenant users there. We were probably around three months from delivering that when Sorrento filed for bankruptcy. And so we have pushed out the date with regards to the initial occupancy in our supplemental to mid 2024 at this point in time. It’s hard to comment on any additional TIs that may have to go into that if we had to build out additional lab space on individual floors at this point in time. But I think we look at the location of that right off the 805, we feel quite good about our prospects there. It’s just going to take a little bit more time. So hard to comment on any additional TIs at this point, but the building is progressing.

We should get additional rents as well. The rents there in the low 5s per month, which is an off rental rate in today’s market. So I think 8.5% the return on cost that we had underwritten is still a good number.

Michael Carroll: Okay. And then how much activity has there been? I know this probably just happens. I’m not sure how long you’ve had to show it. So how much activity has there been? And just kind of getting back to the underwritten rents, I mean, is it fair to assume that the TI package is required to go into the building is significantly smaller. So more attractive and more like a second-gen prebuilt lab than just a ground-up development that — where a tenant needs a pretty big cash outlay to go into the asset?

Scott Brinker: I’m not sure I followed the question in its entirety, but it’s a space that is probably three months from being fully built out and ready for occupancy it was designed for that user. So if we end up multi-tenanting, we may have to take some time to build out the TIs in a little bit different way. But it’s a purpose-built lab building. So I’m not sure I followed the second question.

Michael Carroll: Yes. Just I think that it is harder for tenants today to lease development projects because there’s a big TI commitment that they have to put in. And if it’s a second-gen prebuilt lab, then there’s less cash outlay. So there’s more interest and correct me if I’m wrong on that statement.

Scott Brinker: Oh, I see what you’re saying. No, there wouldn’t be necessarily a TI requirement for many new tenant, I mean, this project is fully funded and ready for occupancy.

Operator: Next question comes from Nick Yulico from Scotiabank. Please go ahead.

Nick Yulico: I was hoping to get an update on if we — on your tenant watch list, you may not want to call it a watch list, but if we put aside Sorento and Kodiak, is there a way for you to just quantify a level of the life science rents right now that you are keeping an eye on from a tenant base?

Peter Scott: Yes. Nick, it’s Pete. I’m not going to comment on specific tenants, but I will say that our overall tenant risk profile has actually improved quarter over quarter. And I think that is a pretty key takeaway alongside of our guidance updates that we released on this call. We’ve had a few tenants raise capital over the last month or so. Scott Bohn also talked about the Adverum RevMed transaction that proactive lease termination that we completed. And then one of our tenants, Sarah, and I saw you put that in your note, thank you for doing that, did have their drug approved yesterday as well, and they’re collecting a pretty significant milestone payment on that. I will also say that our disclosure is, we think, pretty good, and we did add cash balances to our top tenants within the supplemental this quarter. So like I said, I think the big key takeaway alongside our guidance updates is that our tenant risk profile has improved a little bit.

Scott Brinker: The only thing I would add is, Nick, it’s Scott. When you look at our life science portfolio, we’re essentially in the three core markets, but we’re also essentially in five core submarkets. So you can tour our portfolio awfully quickly. In the last two or three weeks alone, Pete, Scott and myself, the team, I’ve seen the vast majority physically of the space that is either vacant today or could be vacant if there was an issue with a tenant, and it’s all in good shape. So, there’s a number of factors that have to be considered when evaluating credit of tenants. And for sure, there’s been a lot more good news over the past few months than bad news. But the qualitative aspect is important to the real estate is a really good shape.

And these are core submarkets where we have meaningful market share. We’re not trying to compete in every submarket across the U.S. We’re in five core submarkets, south San Francisco, Torrey Pine, Sorento Meso, West Cambridge and Lexington. I mean that’s our footprint. We have huge market share in each of those local core submarkets that puts us in off in good shape when buildings become available.

Nick Yulico: Okay. And then second question is just on South San Francisco. If you could talk a little bit about the impact that some lease space is having in the market and in your own portfolio as well. I know like Graphite Bio put 85,000 square feet of sublease space at the nexus on grand. Anything else you talk about of meaningful sublease space in your existing portfolio and then how just the overall increase in sublease space in that submarket is impacting maybe rents or overall trends in that market?

Scott Bohn: It’s Scott Bohn. Yes, there’s certainly been an uptick in sublease space in all the markets, it’s still at manageable levels. I think sublease space, it’s important to note, has its own challenges, and it’s not always directly competitive to a direct deal with the landlord. There’s a few things to think about, so generally, no TI allowances, so any incoming sub tenant is going to be coming out of pocket for any modifications to the space. And with those modifications, they also face restoration obligations at the end of the sublease that are additional costs. And I think most importantly, there’s typically not a recognition of a sublease in the event of a master lease termination, meaning sub tenant is taking the credit risk of the sub lessor on their mission-critical facilities.

I think one other note I would make is that subleases have historically been contributors to our leasing success. We provided our team the ability to build relationships with subtenants and oftentimes take them direct at the expiration of a sublease leasing directly to a subtenant at the end of the sublease. It’s been advantageous. It’s often with very little downtime, very little capital if you just look at the Cove of the 1 million square feet here, 200,000 square feet of tenants were former subtenants within the project. So, I think sublease space can certainly pull from leasing demand in the short term. But if you look at it over the long term, it provides an opportunity for us from a leasing perspective.

Operator: Next question comes from Vikram Malhotra with Mizuho. Please go ahead.

Vikram Malhotra: So I just wanted to step back and you talked about some sublease space. You talked about the move-outs you’ve outlined going to year-end with Amgen and then the risk profile that your view is it’s lower Q-over-Q. Can you sort of at a higher level, just talk about the earnings power or trajectory if you were to take slightly long-term view, I’m not looking for a specific guidance for next year, but I’m just trying to understand the guardrails with all the moving pieces given how big of a space Amgen is, would you give us some building blocks to think about the same-store growth profile of the life science segment into ’24?

Scott Brinker: Maybe I’ll start with it, I am sure Pete has some thoughts as well on earnings. But when I step back, it’s a pretty challenging capital markets over the past couple of quarters and really it dates back to 2022 at least in the biotech sector and despite the business being pretty capital-intensive. I mean, to challenged capital markets, you see our occupancy still at 98%. Our leasing volume continues to be strong. It’d be hard to pay a tougher financing environment for tenants. And yet, we just had 6.3% same-store growth and we’re 98% occupancy. So that makes us feel pretty good about our market position and the fundamentals of the business haven’t changed in terms of the aging population, desire for improved health.

I mean, the science isn’t going backwards. It only builds on itself, probably gets even faster in terms of the improvement with AI, if the odds of success on drug development increase with AI, which they almost certainly will, that’s only going to cause more funding to come into the business. So, there’s plenty of reasons to be positive that this 25% mark-to-market that we have across the portfolio over the next decade, that should still be achievable. It’s not an ideal leasing environment today, but when you think about fundamental demand drivers, it’s all there. And our market position is fantastic to capture it relationships, the team, the buildings, the locations, we were at the coast here in South San Francisco all week. I mean it’s a special place.

We’ve got landlords using our building to market at tenants. That’s no joke. I mean, it’s — what Scott and the team created here is pretty is pretty unique. So life science, I think, is going to continue to produce strong growth and you think about the supply, maybe it doesn’t go to zero in terms of new starts over the next year, but pretty close. So the supply/demand outlook over the next three to five years should actually be quite favorable from what we would have said two years ago. CCRC business, it’s only 10% of what we do, but it continues to perform. There’s still significant occupancy upside and NOI to recapture. And then the medical office platform continues to perform. It’s at 90%, so maybe not dramatic upside, but if it can continue to generate that 3% to 4% same-store growth, that’s off the attractive base of earnings growth for the Company.

So Pete, anything you’d add?

Peter Scott: Yes. The only couple of things I would add is, obviously, we’re not putting out 2024 guidance today. But I do like the question that you’re asking, Vikram, because we have a diversified portfolio and a great balance sheet bolted on to it. I’m sure we’ll talk about medical office and CCRCs at some point on this call. But we did put out this NOI growth trajectory for the next three years in our NAREIT deck about six months ago, and we still feel good about that NOI growth trajectory, the timing of when the Gateway project will work its way into our earnings has been pushed back a little bit. But the overall growth story, we still feel very good about. And then with regards to Amgen, in particular, in that Oyster Point campus, as Scott Bohn mentioned, we have re-leased pretty much the majority, the vast, vast majority of the leases that have expired there.

We did put one building into redevelopment. And then we have three buildings that we will get the leases back over the next year, couple the end of this year and then some the beginning of next year as well. And we did put out a full set of assumptions on how we think we will release those and the timing of that. And I think we still feel good about those assumptions. And we will look to update that in future presentations as well because we do get some questions on what’s going to happen with that campus. But from where we sit today, we feel quite good.

Vikram Malhotra: Okay. That’s helpful. And I just want to — maybe just try to get a bit more flavor of the — you mentioned the credit profile and your minds have improved over Q-over-Q. But last June NAREIT, if I remember correctly, you had thrown out a number I think the watch list at that time, you had estimated around 4% to 5% of NOI, and that’s kind of when you had pushed out development lease-up schedules, et cetera, which obviously didn’t got refined during the second quarter. Our work suggests today and not from an NOI but from a square footage perspective, that risk is probably in that still 5-ish percent range of square feet. Would you be able to just comment is that in your — without — if you don’t want to share a number, is that number in the ballpark? Is it much higher, much lower given your comments around Q-over-Q, your risk profile has been lowered.

Scott Brinker: Yes. Vikram, I appreciate your support and report and all the time we put into it. I mean we define things a little bit differently. We obviously have access to data that not everybody would have both public and private. So I don’t want to talk about specifics, but I think Pete’s point that quarter-over-quarter, the risk profile has definitely gone down is an important one, and that includes a lot of good news over the past two to three weeks alone, with companies raising capital doing licensing agreements. So I mean it’s a company-by-company analysis obviously, that we’re doing, and we feel better where we sit today than we would have even two weeks ago.

Operator: Next question comes from Michael Griffin with Citi. Please go ahead.

Michael Griffin: Maybe going back to the Sorento development, I mean you talked about it being used for single or multi-tenant potential use. But correct me if I’m wrong, was the building initially built for one tenant like maybe you can set up the floors differently from TI packages. But is there anything structurally different with the building, what precludes you from multi-tenanting here?

Scott Bohn: No, I would say — Michael, it’s Scott Bohn. The core shell of the building was certainly designed to be single or multi-tenant. So the TIs for the previous deal, we’re built a single tenant, but you’re able to flex those to multi-tenant and the building structure itself and can go multi-tenant very easily.

Michael Griffin: Okay. Cool. And then just back to San Francisco supply, I think, Scott, in your prepared remarks, you mentioned about 800,000 square feet coming online in 2023, that’s competitive. I mean do you have a sense if like these proposals, I think the mayors proposing some buildings in CBD, the office towers converted to lab space. I mean that stuff seems like it’s going to be a tough or lift than the conversion down to Peninsula, but any sense of like how big this the supply market is like how the market might be misinterpreting that headline number when really they just need to probably look under the hood a bit.

Scott Bohn: Sorry, Michael, in the city of San Francisco.

Michael Griffin: I presume that when you look at a market supply report for life science in San Francisco, it accounts for both the CBD and the Peninsula. Now there are probably submarket reports, but I imagine if you type in a broker name in San Francisco Life Science, the whole number will come up. It effectively like how often and wall am are different, but they’d probably be lumped into the same MSA supply.

Scott Bohn: Yes, 100%. I mean, I think you’ll see the headline numbers are always going to be much larger and not all of that is competitive to our footprint. So we’re not overly focused on that. We look at really what is truly competitive to our products within our submarkets, AS Scott mentioned, really in five submarkets, and that’s where we focus. When you look at San Francisco CBD, for example, I mean, there’s talk at least the mayor mentioned inversions to life sciences, those are challenging down there. So, I don’t look at those as something that’s on our radar, we truly competitive.

Michael Griffin: And then a quick one, I could sneak in on MOBs. It looks like guidance was raised kind of on the strength of Med City Dallas. I feel like people almost forget about that business sometimes, but it is steady state and produce solid results. I mean what are your expectations throughout the rest of the year, do we maybe see another guidance increase, if operating results are better than anticipated. And it’s my opinion that if we do get a really severe downturn medical office could be a really good place to be potentially.

Peter Scott: Yes. Griff, we agree with you. It’s Pete here, and then maybe I’ll let Tom Klaritch chime in. But we do look forward to touring Medical City Dallas with you in about 2.5 weeks from now. That campus continues to exceed our expectations and certainly is open with regards to our same-store numbers. But the segment generally is performing well. Obviously, we increased our guidance for that segment this quarter by 50 basis points. We like to keep a little bit in the tank as well. If you go back and historically look, in MOBs, we have been able to increase guidance as the year progresses on multiple occasions. So we feel good about that from where we sit today right now. There is a little bit of volatility with the MCD ad rent component. So, we’re going to be a little bit more conservative at the beginning of the year. But Tom, Klaritch, why don’t you give a little sense for what you’re seeing within the segment overall?

Tom Klaritch: I think if you look, our escalators continue to perform well, where we average about 3%, a lot of that is driven by our fixed escalators that are averaging 2.8%. Obviously, CPI escalators will fluctuate here and there, but they’re doing well. We had a good quarter for mark-to-market on renewals at 4.1%. We tend to see mark-to-market kind of — the bulk it’s in that 2% to 4% range, but then you always have a number of leases that are above that number that are below it. And this quarter, we had a lot more above it than below it. So that worked out well for us. And parking continues to get back to and sometimes above pre-pandemic levels. So we saw a little bit of a bump from that. So overall, most of the major metrics for us have been positive. And as Pete said, Medical City continues to perform the way it has been, we might have some room there, too.

Operator: Next question comes from Steve Valiquette with Barclays. Please go ahead.

Steve Valiquette: Two topics here quickly. On the meds, I know you just kind of talked about this, but I wanted to ask about the for whether it’s portfolio or just development pipeline on one quarter, does that make a trend, just with overall health systems really seeing a major resurgence in their operating performance year-to-date in 2023. Has that led to any more invigorated discussions on development opportunities? Or is it too soon for just further evolution on that? And maybe answer that first, and then I’ll ask have a follow-up.

Tom Klaritch: Okay. Yes, this is Tom. Certainly, we’re in discussions. We have the HCA development program. There’s a number of buildings in that pipeline. HCA just announced on top of having excellent results with almost every major metric being up, they’re going to invest about $4.6 billion in capital into their portfolio. So as they do that and expand med towers and services, we certainly would see the need for more medical office space. And you mentioned the health systems tenant reported great results. UHS reported great results. So that continues on for the year, we’d certainly expect to see good development opportunities. And one thing we were encouraged by is, costs seem to be stabilizing in some instances even coming down some.

We have our Savanna development down in Georgia, and we got about 85% of that bought out and the cost actually came in lower than our base case, and we were able to remove some assumed escalators that were going to be in there. So it improves the return on that project by at least 25 basis points. And hopefully, as we finish the project up, we can get even a little better return out of it.

Steve Valiquette: Okay. Great. That’s helpful. Quick question for Pete on a different topic here. I know there’s obviously a lot of moving parts within the full year outlook, but with the increase in the same-store cash NOI growth guidance for the year, but the FFO guidance remaining unchanged. It wasn’t clear. Was there a specific variable that explains the delta between the two? Or is it just that a 25 basis point increase in SS NOI growth is still absorbed in the pre-existing full year FFO guidance range?

Peter Scott: Yes. Good question, and I’m glad you brought it up, Steve. We did increase our AFFO guidance by $0.01. And one of the drivers of that is picking up our same-store guidance within MOBs, 50 basis points and then 25 basis points overall for our blended same-store. AFFO is not impacted by those straight-line rent write-offs. So the reason we just reaffirmed FFO as adjusted at this point is because we did have those $0.02 impacts to FFO as adjusted, and we didn’t have to take that impact into AFFO. So that’s really the reason for that.

Operator: Next question comes from Connor Siversky with Wells Fargo Securities. Please go ahead.

Connor Siversky: Last earnings call, it was mentioned that movements in cap rates were such that you could see a more favorable return profile and acquisitions at some point this year, perhaps versus development projects. So in consideration of the share price coming off of it since then and muted activity during the first quarter, I mean, are you seeing enough movement in caps that you would feel more comfortable taking an aggressive posture through the balance of 2023?

Scott Brinker: I wouldn’t say aggressive cost here, not at today’s cost of capital, but our view on development hasn’t really changed. Tom did mention that the margin at least development costs are maybe starting to stabilize, if not come down in certain cases. So that’s encouraging. We are making strong progress on entitlements in West Cambridge, South San Francisco and in San Diego. So, several million square feet of development that at some point, the returns will make sense, but our view is development at the right point in the cycle can be spectacular. And at the wrong point in the cycle, it can be pretty rough. So we’re not doing a lot of development right now, but we’re preparing to do a lot of development. So I think that’s important to keep in mind that we do have that land bank and development expertise when the timing makes sense.

But yes, the comment is that it could be a rough couple of years in the real estate market, especially on the private side. Now it depends on what happens with the financing environment. But today, it’s pretty ugly in terms of lack of liquidity, banks really not lending, certainly not at portfolio level quantums. LTV is down interest rates significantly higher. So I wouldn’t be surprised to see return targets to move quite a bit higher. It’s just nothing is getting done right now. Well, I shouldn’t say nothing, but pretty close to nothing. There’s a select trade now and then, but anything material in scale and it requires financing would be near impossible to get done today. So we are optimistic that this downturn is going to lead to opportunities, but obviously, we will need our cost of capital to move up, which we think it will.

I mean the sentiment overshoots in both directions, it always does. So it’s nothing that we’re complaining about. It’s just a reality. The sentiment is way worse than the reality. And there will be a point in the cycle when the opposite is true and have a really strong cost of capital. And my guess is there’ll be quite a few things to acquire. We toward some stuff in the last two or three weeks alone in our core markets that sitting vacant because it’s, on one hand, maybe not a sponsor that has the right footprint, the right relationships or scale to really fill the building that we feel like with the Healthpeak sponsorship over time, buildings like that would probably lease up. So there could be some unique opportunities over the next year or two you see.

Connor Siversky: Okay. That’s really helpful. Quickly on leasing activity in TIs. I mean, we’ve heard some chatter that TIs have come up significantly from the start of the year, particularly in life science, though, it looks like the numbers peak posted in Q1 seemed pretty reasonable. I’m just wondering what the expectation is for TIs going forward on a square foot basis?

Scott Bohn: Sure, Connor. So I think you made a good point. At least as we’ve executed recently, we’ve held our TIs as a percentage of rent pretty low at sub-10% of rents. You do have some tenants is pretty deal specific. They’re typically not smaller deals. You have tenants asking for higher landlord contribution to preserve cash. And depending on the deal of the space and the tenant credit, at times we can get comfortable with that when it’s appropriate. And I think we focused on making sure those build-outs are highly generic and reusable to make sure if we’re putting in additional capital on any deal that’s going to be space that we can use over the next 10 to 20 years from a build-out perspective. So it’s hard to give exact TIs because every deal is different, every space is different. I’ll probably stop there.

Connor Siversky: Got it. Well, we’ll just work on the guidance number — with the guidance number then. I’ll leave it there.

Operator: Next question comes from Ronald Kamdem with Morgan Stanley. Please go ahead.

Ronald Kamdem: Great. Just a couple of quick ones. Going back to the comments on the life sciences funding, I think the question earlier was trying to get at, just sort of the funding environment. And as your thinking is your view that sort of the companies with sort of the right products, there’s still sort of funding to be had there? Just trying to get a sense of just — we’re hearing that there’s a lot of companies that will need funding in the next six to nine months. Just in your mind, how are you guys thinking about how those gaps get filled?

Peter Scott: Yes. Ronald, it’s Pete here. I would say, if you think about some of the first quarter statistics. The secondary equity market, which is a big market for our tenants to raise capital, there were over 30 follow-on offerings were think about $4.5 billion of proceeds for biotech companies. And actually, within our portfolio, tenants raised about $1 billion. And if you have good data and some good readouts that you can raise capital off of you certainly can even in the volatile markets that we’re in right now. Venture capital fundraising, we get a lot of questions on that. Fundraising for venture capital is actually it was around $6 billion in the first quarter. Now from a deployment perspective, so the venture capital is investing into companies, that number was at $4 billion.

So we’re seeing a little bit of a pause or a delay in those funds getting invested into companies. But $4 billion is still pretty healthy. And then from an M&A perspective, there have been some pretty big deals that have been announced, Merck did a deal, GSK did a deal as well. I think the premiums on those were 75% to 100%. And we’ve continued to say that pharma has a pretty big war chest that we think they will continue to put to work in acquisitions or licensing deals with biotech companies. So despite the volatile capital markets, we are seeing capital raising occurring at a healthy pace. It’s obviously down a little bit relative to where it was a year or two ago. What are we looking for going forward? Obviously, the IPO market would be something that we’d like to see improve.

There is a pretty big backlog we’ve been told of companies that are trying to go public. But just at this moment in time, it’s more challenging. So we’d like to see that improve and generally, I think we feel like if the capital markets volatility does subside, interest rates normalize a little bit, that it should be a more improved environment going forward.

Ronald Kamdem: Great. Super helpful. And then just moving on to just a quick update on CCRCs I don’t know if it’s been asked about, clearly, with the capital markets where they are, it’s probably hard to get a transaction. You talked about nothing was imminent, but just curious what — where we stand there, how you guys are thinking about the CCRC business and a potential sale?

Scott Brinker: Yes. There’s no real update. It’s a challenging capital markets to do anything strategic with that business, and it does have significant scale, seen some smaller things get done, but nothing remotely as big as the CCRC portfolio. We’ve had some outreach, but just not an opportune time to sell it. In the interim, it continues to perform really well. It’s a good portfolio, a great partner. It’s got a really strong team here that’s asset managing. Performance has been good. Occupancy is up more than 200 basis points year-over-year. The NOI growth is strong on a cash basis. It’s fantastic on a cash NOI basis, we’re essentially back to 2019 NOI levels and yet we still have a lot of upside to recapture in terms of occupancy.

So there’s still some cost pressure for sure, the labor market has improved. It’s a pretty low bar. It’s still challenging, but contract labor is down about 70%. Our rate growth this year for existing residents was around 10%. Some of those are midyear based on anniversary dates. So not all of that will show up in our RevPAR growth, but 10% is pretty strong. So yes, I mean, we like the business. It’s just not a perfect fit for where we see Healthpeak 5 to 10 years from now. But unless we get a great price for it, we’ll just hold it. We’ve got a great team managing it and they’re good assets, and they’re obviously performing.

Operator: Next question comes from Tayo Okusanya with Credit Suisse. Please go ahead.

Tayo Okusanya: And again, congrats on a very solid quarter. I wanted to go back to the capital allocation question. Just again, clearly, again, no one is kind of happy with your cost of capital today, most especially you. But if you don’t see a lot of improvement near term, how does one kind of think about acquisitions versus development versus redevelopment versus stock buyback versus debt buyback? Like how would you kind of think through those kind of five options to kind of allocate capital and what are you more likely to do at least likely to do?

Scott Brinker: Yes, redevelopment is first on the list. The returns there are strongest in comparison to acquisition or development and the return profile is lower risk given we already know the asset in submarket so well, and the turnaround time is a lot lower than a new development in terms of your — the risk of your time period that you’re trying to underwrite. So that’s our best use of capital today. We don’t want to overreact when market sentiment reacts. But obviously, if there was a sustained differential between our own cost of capital and acquisition cap rates and once we have cleared and what those even are right and there’s a building in the financing market. We could always consider stock buybacks through asset sales, but we’d certainly not lever up to do that.

That’s not high in our priority list right now. It’s not a great time to sell assets realistically and we don’t have to. So our preference is to not do that. But if there was a point in time where acquisition cap rates and we’re clearly below our cost of capital and our implied trading ratios and the financing market was available to buyers. And yes, I mean, of course, we consider that, but that’s not on the table today, tie out development. Well, I think I covered it earlier, but that’s not something that we’d consider starting in today’s marketplace. But a year from now, two years from now, it could be, but we’re happy to sit on the land and the entitlements until the timing makes sense. There’s no urgency there.

Tayo Okusanya: Got you. And then a follow-up question on the life sciences side. Just kind of given everything that’s happening within the space or just the overall concerns people have. Any thoughts about diversifying more within life sciences, and specifically, I think about things like, again, doing more of the agri farmer stuff in North Carolina, possibly going to a new market or even doing more of the kind of academic university-based life sciences stuff. Just kind of curious if there’s any thoughts to move in those directions, and whether the returns in those areas would be potentially attractive to PEAK.

Scott Brinker: Yes. I mean the life science title for the business is a pretty broad title. Our business today is more biotech, biopharma focused. And for that, I see us sticking into three core markets, at least for now. If you look far enough the future, I suppose there could be enough scale that it could be interesting to us. But if you think about R&D, that could be something different than just for-profit biotech companies. There’s an awful lot of R&D happening in nonprofit health systems and for-profit health systems like HCA. We toured a number of them recently, including our own portfolio, lab space and medical building that would rival what we have here in South San Francisco. So I could see us doing things like that within the “life science” bucket.

But in terms of for-profit biotech, I don’t see us strain outside of the three core markets in the near future. We just have such huge competitive advantage. And that’s where the depth of demand is, and frankly, there’ll always be.

Operator: Next question comes from John Pawlowski with Green Street. Please go ahead.

John Pawlowski: I have a follow-up question on South San Francisco. Scott, I appreciate the comments on the amount of supply coming online this year and next year. Just curious, how you think through a reasonable scenario and decline in market rents and decline in market occupancy? So given the amount of supply in the way in the next two years, if demand doesn’t get meaningfully worse or meaningfully better from here, where do you think market rents and market occupancy in South San Francisco head to?

Scott Bohn: Yes. I mean I think hard to tell right now. I think when you look at those, again, as I mentioned, you look at the supply that’s coming on that we do as competitive to our project, it’s really only in five products. Two of those are conversions, which aren’t going to compete as well our purpose built to I think that with our portfolio and the demand we see from within our own portfolio, we do a lot of — the majority of our leasing that we do, especially in our development, 90% of our leasing when you go back to the Cove, the Shore and Nexus and now Vantage has come from within our portfolio. So, I think we’re able to capture the higher rents than some other landlords may be able to. We — a lot of those deals come from tenants with existing leases in place.

So, we’re growing a tenant, say, from 50,000 square feet to 100,000 square feet, right? And so, we’re letting them out our lease on the back end which we’re able to blend in the economics to keep the rents probably higher. So hard to tell on where exactly it goes depending on demand, but I think we’re confident that we’ll be able to certainly outperform and capture the high end of market rent.

Scott Brinker: Yes. I mean you just got one project that’s an outlier that changes the “market occupancy” and 900,000 feet goes under development. That’s obviously intended to be a multiyear lease up. So how do you treat something like that in terms of market occupancy? I think that’s an important consideration, and obviously, to fill something that big. I mean, you’re going to need a lot of large tenants, a lot of the space we have right now. Frankly, it’s perfect for what the market is looking for, Series A companies, 20,000 to 30,000 feet lower OpEx, quicker time to get into the building. We’re in a pretty good competitive position given today’s demand to continue leasing space.

John Pawlowski: Okay. Understood. Could you comment on the trajectory of your mark to — what you think is a reasonable mark-to-market in your South San Francisco portfolio this year? Like what are you seeing on the ground right now? Is that mark-to-market kind of collapsing each month as fundamental deteriorate? Any comments there would be helpful.

Scott Brinker: Yes. I mean the only reason it’s going down and it’s still in that 25% range for the portfolio. South San Francisco has always been on the lower end of the range plus more on the higher end because of the Amgen leases. That’s a huge amount of space that’s essentially at market, and that’s included in our number. When they burn off over the next year or so, that will actually be a benefit the mark-to-market on the remaining portfolio. So it’s still in that range. But keep in mind, we’ve had several quarters in a row now of 30%, 40%, 50% mark-to-market. And as that row through the portfolio, obviously, the mark-to-market on what remains is going to start to decline. And we said all along, our lease rollover in ’22, ’23 and ’24 is relatively small as a percentage of the portfolio and the mark-to-market just happened to be lower in those years.

It’s not a static number. It’s going to jump around from quarter-to-quarter and year-to-year. Our biggest mark-to-markets actually take place in 2025 and thereafter, which could end up being great timing. There is a point when people were kind of disappointed that we couldn’t get to our mark-to-market quicker. And as it turns out, having a really low lease maturity profile this year and next is a huge competitive advantage.

John Pawlowski: Okay. I appreciate it. Last one for me for Tom Klaritch. I’m just looking through your market level occupancy on Page 28 of the medical office. I’m just curious, a few of these big markets are kind of stuck in the mid-80% occupancy range, Denver, Nashville, Houston and a few of them actually went down quarter-over-quarter. Could you just help me understand why vacancy in some of these markets is so high? And what’s structurally different on the ground in terms of demand and supply in these markets versus the rest of the portfolio?

Tom Klaritch: Yes. Typically, it’s because of really developments in many cases. In Houston, we just built a new building that was 130,000 feet. That’s not yet stabilized, so that’s brought the occupancy down some there. We bought a building in Denver, a year ago, Pinnacle that was — we bought it at 7% occupancy. It’s up to 50%, and it actually leased to close to 90%. So some of it is just because there’s, there’s leasing out there that’s not yet commenced in some cases. Some of it is because we put a non-stabilized asset into play. And some of them we have redevelopment. So for example, we have two redevelopments we’re working on in Denver that are close to 100% leased, but they’re not fully occupied yet. In fact, one of those redevelopments, we were able to add some square footage.

So, we don’t — we increase the actual capacity in that building. So there’s a variety of reasons for it. But some of the — most of the big reasons are the non-stabilized developments and redevelopments.

Operator: Next question comes from Mike Mueller, JPMorgan. Please go ahead.

Mike Mueller: Two quick life sciences as well. One being a follow-up from a prior question, I guess in terms of the lease mark-to-market that you had this quarter, 55%, how do you see that trending even though I know the rules are a little bit more limited. How do you see that trending in the balance of the year? And then can you remind us what portion of your tenant roster in life sciences is more tech as opposed to life science?

Scott Brinker: I think the first one — the last one first. We have almost no tech. So, I mean, it’s low single digits. We purposely stayed away from the office market. So that’s an easy question. The first question you asked, we won’t speculate on mark-to-market. It depends on exactly which tenant renews and those are chunky leases. So depending upon which one does or which one does not, it could move the number pretty materially. So that is going to bounce around quarter-to-quarter. So we’re not going to give you a specific target or projection for that.

Operator: Next question comes from Josh Dennerlein with BOA. Please go ahead.

Josh Dennerlein: Just thinking about the life science guide and just your results for 1Q, it looks like you did 6.3 on the same-store on a cash basis. And then the guide you kept at 3% to 4.5% for the year. I guess, how are you thinking about the cadence? And could you remind us what like the typical rent bump is for — on an annual basis for the…

Peter Scott: Yes. It’s Pete here. When you think about the rent bumps, I’ll take the last part first, when you blend the three markets, our rent bumps are in the 3.2 to 3.3 range. And most of our same-store growth this year is driven by those rent bumps because as we said last quarter and we’ll just repeat again on this call. When you’re at 99% or 98% occupancy, it’s hard to get same-store benefit from increasing occupancy at those levels. So the majority of our growth is coming from those escalators. With regards to the 6.3 in the first quarter, as you note, yes, that is meaningfully ahead of our full year guidance range. The 55% mark-to-market, that will get spread out over the balance of the year, and then a couple of other items I do think are important to mention.

We don’t have clarity on the Sorrento operating leases that certainly could swing the second half of 2023. I wish I could give you guys perfect information on that. We’d like perfect information on it. We just don’t have it at this point in time. And then also another item as we get towards the back half of the year with regards to the Adverum, RevMed, proactive lease termination. There will be some downtime as we get to the back half of the year. Again, this is a great positive a 10- to 12-year benefit for us as a company and for our segment, but we do have a little bit of downtime, and we incorporate that stuff into our guidance as well. So we feel good about reaffirming the 3% to 4.5%. Obviously, we’re still early in the year. We will maintain some level of cushion as well within our numbers.

It’s more volatile within life sciences today that has been the last couple of years. But again, we had a great first quarter, and we feel good about reaffirming guidance for the balance of the year.

Josh Dennerlein: Okay. That’s great color. Maybe just one follow-up on that. I guess what are the assumptions that get you to the low end of the life science same-store guide?

Peter Scott: Yes. I don’t know if I want to get into assumptions for high and low. I would say — as I mentioned, there is a little bit of cushion still within those numbers with regards to a variety of things, right? We think about cushion as — could be three different items. It could be a proactive lease termination and some downtime. It could be at then some revenue recognition as a result of some development projects, delivering a month or later or it could be bad debt, right? I know everyone likes to talk about the third I wanted to take that in reverse order. So I don’t know that I want to say what’s going to be some options I just sort of keep it up. We feel good about the 3% to 4.5% that we reaffirmed.

Operator: The next question comes from Nick Yulico with Scotiabank. Please go ahead.

Nick Yulico: I just wanted to follow up on Sorrento and the operating leases. I think its 210,000 square feet, a fair amount of space. And so, I guess I’m just wondering at this point, how you’re thinking about the need of Sorrento for all that space versus some of it. And then if you could also just talk about it, if they were to reject the operating leases, what do you think the mail would be like for that possible downtime et cetera?

Scott Brinker: Yes. Nick, on the first one, I mean, the Company is in bankruptcy. So, it’s not like you just pick up the phone and call their CEO and ask what our outlook is. There’s quite a few people involved in that process. So, we’re not going to speculate on what they’re saying behind those doors. But we’re also on the creditors committee and in some cases preview to certain information that’s just not public we say we’re not going to share that. We don’t have clarity yet on whether they’re going to accept or reject, but you would expect us to be doing some contingency planning either way. So, we’ll see what they end up doing. But yes, we’re obviously thinking about alternatives.

Nick Yulico: Okay. And then if you had — if they do reject some of the space, I mean, how would that work from a re-leasing repositioning standpoint, those buildings?

Scott Brinker: Yes. So it depends on which building, but it’s all part of the same campus essentially directors placed with the Gateway development, it’s spectacular location. Sorrento Mace is a big submarket, and we think we’ve kept the best footprint in all Sorrento Mace the visibility and accessibility. Those are buildings that are, in some cases, already built out life lab in other cases, could accommodate a range of uses and pretty flexible. So each building is a little bit different. And we have a different game plan for each. But we got a big presence in that local market. We’ve got a fantastic team and great relationships. So, if there’s demand out there, I think, Mike and the guys were behind the list of those capturing it.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Scott Brinker for any closing remarks. Please go ahead.

Scott Brinker: Thank you for joining today, and have a great weekend.

Operator: This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.