Physicians Realty Trust (NYSE:DOC) Q1 2023 Earnings Call Transcript May 4, 2023

Physicians Realty Trust reports earnings inline with expectations. Reported EPS is $0.04 EPS, expectations were $0.04.

Operator: Greetings and welcome to the Physicians Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Page, SVP, General Counsel. Please go ahead.

Brad Page: Thank you. Good morning and welcome to the Physicians Realty Trust’s first quarter 2023 earnings conference call and webcast. Joining me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; Mark Theine, Executive Vice President, Asset Management; John Lucey, Chief Accounting and Administrative Officer; Lori Becker, Senior Vice President, Controller. During this call, John Thomas will provide a summary of the company’s activities and performance for the first quarter of 2023 and our year-to-date performance as well as our strategic focus for the remainder of the year. Jeff Theiler will review our financial results for the first quarter of 2023, and Mark Theine will provide a summary of our operations for the first quarter.

Today’s call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect view of management regarding current expectations and projections about future events and are based on information currently available to us. These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties. You should not rely on them as predictions of future events. Our forward-looking statements depend on assumptions, data, and methods that may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that transactions and events described will happen as described or that they will happen at all. For more detailed description of risks and other important factors that could cause our actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission.

With that, I would now like to turn the call over to the company’s CEO, John Thomas, John?

John Thomas: Thank you, Brad. Physicians Realty Trust provides real estate capital to healthcare providers that specialize in outpatient medical services. We provide this capital in a number of ways. We acquire outpatient medical real estate designed to facilitate surgery, oncology, and other specialty services required by patients in high demand and the physician patient encounters ancillary to these medical services. We financed the development of these types of buildings. And we finance the transformation of buildings that may have become out of date as is, but provide a low cost option for transforming to host these medical services and meet the demands of our growinG&Aging US population. Our facilities and providers we partner with around the country provide accessed care for the entire population in the markets where we are located, not just the finite small percentage of seniors that can pay for and want senior housing.

For years, the fundamental case for owning outpatient medical facilities has been strong, but is now stronger than ever. First, healthcare providers benefit from undeniable demographic tailwinds currently and that will dramatically increase demand for services in both the near and long-term. Second, due to Medicare’s Progressive Payment System and Part C modernization, providers are incentivized to provide care at the lowest possible cost consistent with the clinical science available at the time to treat the patient safely and effectively. Third, current expense pressures are temporary and correctable. These pressures are caused by the unique combination of real time inflation and backward looking payer revenue rates that are set based on past costs rather than current or future expected costs.

Each of these factors incentivizes health systems to move patients out of the inpatient hospital setting and into newer, lower cost outpatient sites of care as a means of improving their margin on services provided. These trends have been known and visible for years and have only accelerated in the post-COVID world. Time and time again, buildings hosting outpatient medical services have proven to be resilient and an essential class of real estate. When one of our clients chooses to reduce their space at the end of their lease, is not due to a top — it is not due to a desire to work from home, the result of slowing demand or a consequence of a rapid rise in interest rates. Rather, our non-renewals are driven by unique and specific situations like physician retirements or a change in practice ownership.

These are not structural trends or challenges. Our real estate is necessary for physicians and health systems to deliver their mission to meet ever increasing demand. Unlike other real estate asset classes faced with declining demand for space. Revenue from outpatient medical services grew 8% in 2022, in comparison inpatient revenues experienced no growth. High construction costs and the limited supply growth have allowed us to meaningfully increase rental rates in most markets and we expect to see that trend continue. The opportunity for new acquisition investments remains low for now as private investors make short-term wages on medical office cap rates returning to 2020 levels even at the cost of negative leverage. We believe that patience is a virtue and we will benefit from outsized growth and acquisition opportunities with our dry powder when market cap rates and the long-term cost of capital reach equilibrium.

We do see a growing number of opportunities to finance new outpatient medical investments in our active pipeline in discussions now exceeds $300 million. We’re proud of the two projects we started this past quarter, including our first on balance sheet development and expect to start several new projects later this year. We’re excited to share that we’ve executed contractual commitments related to a $40 million medical office development located in the high growth at Atlanta Server of Beaufort Georgia. The 97,000 square foot outpatient medical facility, which includes an ambulatory surgery center, is 100% pre-leased on 10-year triple net lease terms with 91% leased directly to Northside Hospital, an investment-grade quality health system. The site also allows for an additional 100,000 square foot medical facility in the future, where we will have the development rights to build.

Northside Hospital and affiliated physicians have executed leases based on a 6.2% yield on cost to deliver the project with 3% risk escalators on all lease agreements. Physicians that lease space and provide services in the building have contributed 44 some of the capital to develop this building. This investment increases our long standing partnership with Northside Hospital and is a direct reflection of DOC’s strong relationships with health systems, we want to work with a long-term partner who knows healthcare first. Before our next earnings call, we will celebrate the 10th anniversary of an of our initial public offering. We appreciate your support, the support of all the families that work for and with DOC, and the investment-grade credit and high quality providers that partner with us meet the healthcare needs and the communities we serve.

We look forward to the next 10 years and beyond. We believe we have the highest occupancy, the best balance sheet, and the best strategy for outsized growth well into the next 10 years and beyond. Quarter one was uneventful until we lost George Chapman, who passed away unexpectedly and well before his time. George made Healthcare REIT the powerhouse that it is today. I can’t count the number of senior executives and professionals at public and private REITs and otherwise, that owe their careers to George’s inspiration and mentorship. I can name at least three public REIT CEOs who are our stewards and direct beneficiaries of George’s leadership. But more important than all the financial and business success, George was motivated most by his love for his family, Toledo, The Art, Cornell [ph] and the University of Toledo and taking care of seniors in advancing access to healthcare services for all regardless of their ability to pay.

I believe George is looking down on all of us asking us how we are going to work to expand access to care to all, expanding senior housing to more, and providing professional opportunities to the youth of Toledo and everywhere to meet these objectives. George, we miss you . We at DOC are committed to your passion and mission. Jeff will now share comments on our financial results of Q1 2023 and Mark will discuss our operating results. Jeff?

Jeff Theiler: Thank you, John. In the first quarter of 2023, the company generated normalized funds from operations of $60.3 million or $0.24 per share. Our normalized funds available for distribution were $59.7 million, an increase of 3% over the comparable quarter of last year and our FAD per share was $0.24. The portfolio showed consistent operations with same-store NOI across our entire MOB portfolio increasing at 1.0%. This is below our long-term expectations for the portfolio. As we’ve discussed over the past two quarters, we anticipate this metric returning to our long-term expectations in the back half of the year as our repositioning properties start to roll back online. Our renewal spreads for the full MOB portfolio were negative 0.7% as one renewal had an outsized effect on an otherwise strong period of lease.

Despite this, we still anticipate averaging positive mid-single-digit leasing spreads over the entire year, in line with our previous guidance. Across the portfolio, we continue to see evidence that our existing rents are under the current market rates, which allows for additional pricing power on new and renewal leases. Additionally, the historic rise in construction costs and uncertainty in asset pricing have been significant hurdles for new medical office development. Which we believe will enhance our ability to retain tenants. On the acquisitions front, we are starting to deploy capital, but in a careful manner. Our new investments have been concentrated on development projects with healthcare partners that have been in planning for multiple years.

Encouragingly, the acquisition pipeline that we are actively negotiating has picked up significantly since the beginning of the year. We believe this will enable us to generate accretive external growth in the second half of the year. In order to reduce debt, existing debt and allow ourselves to be prepared for these future opportunities. We strengthened the balance sheet with $66 million of equity issued on the ATM in the beginning of the first quarter. We had previously disclosed this activity on our last earnings call. We feel that we are in an excellent position from a capital perspective at 5.3 times consolidated debt to EBITDA. Finally, we remain on track for our overall G&A guidance. A quick reminder to our analysts and investors that our G&A is always seasonally higher in the first quarter and we expect it to moderate going forward.

With that, I’ll turn it over to Mark to walk through some additional operational details. Mark?

Mark Theine: Thanks Jeff. To best capitalize on the opportunity we have within our portfolio, we are occasionally better served by transitioning space from 1 physician organization to another. These decisions are made to improve the overall financial health and value of our buildings over the long-term, but generally have a short-term impact on our net operating income. Among other benefits, these strategic efforts have served to dramatically improve the credit profile of our portfolio. This is especially relevant in today’s environment where higher operating expenses are offsetting revenue gains for health systems. DOC’s portfolio remains well-insulated from these pressures by the underlying credit quality of our tenants, 67% of which are investment grade quality.

Better yet, 90% of our investment-grade tenants have a credit rating of A minus or higher. This means that these tenants would need to be downgraded several times before they could potentially lose their investment-grade status. Our commitment to credit quality remains unmatched by our peers and we believe this strategy will pay dividends for our shareholders in any economic environment. MOB same-store NOI growth was 1% during the quarter, our 20th consecutive quarter of positive same-store growth. Headline performance in the period was adversely affected by a unique situation at a single location in our portfolio. Specifically, our asset management team was faced with a physician group tenant that had a reduced need for real estate and an in place plan to consolidate locations.

We made the decision to move aggressively to retain at least part of their space in our building as a means of preserving the healthcare ecosystem of the asset, and we are already in discussions with several potential providers to lease space not renewed by this tenant. Overall, this asset represents less than 1% of the same-store pool. Conversely, the 14 building landmark portfolio joined the same-store pool this quarter. As expected from such a high quality portfolio, occupancy is up 50 basis points since our acquisition and the portfolio grew cash NOI by 4.1% year-over-year. In total, the portfolio is exceeding our underwriting expectations and is representative of the quality facilities and tenant at the center of DOC’s investment criteria.

First quarter renewal spreads were impacted by the same scenario I just discussed during our same-store commentary with headline spreads totaling negative 0.7%. Excluding this one asset, renewal spreads for the quarter were positive 10.1%. In total, our leasing team completed 367,000 square feet of leasing activity this quarter including 289,000 square feet of lease renewals and a 72% retention rate. The great work this quarter by our leasing team to reprice lease renewals at today’s fair market value with a 10.1% leasing spread should not be overlooked by one lease. Additionally, this leasing activity offers strong compounding growth for the future as approximately 60% lease assigned this quarter contain annual rent escalations of 3% or more.

Looking back to the 2018 to 2021 time period, only 25% of our leasing activity on average contained annual rent escalations of 3% or more. Despite the short-term impact of a few vacancies in the portfolio, we believe the long-term value opportunity for our portfolio is fully intact as outpatient services drive retention and market pressures continue to increase triple net rental rates. Our team is focused on unlocking the full value of our portfolio through aggressive leasing initiatives, exceptional property management and smart capital improvement investments. Before turning the call back to JT and opening for questions, I’d like to quickly say congratulations to John Sweet, the Founder of DOC for earning the 2022 Lifetime Award from Healthcare Real Estate Insights.

The award was presented in January at the Revista Medical Real Estate Investment Forum. John has always been known by hospital executives, brokers, developers, and investors for his witty sense of humor, unwavering integrity, and creativity in structuring investment transactions. As we celebrate the company’s 10th anniversary this July, we cannot be happier to honor John for his career and contributions to the medical office industry, and we recognize as mentorship and friendship to all of us at DOC. Congratulations, John. With that, I’ll turn the call back over to JT.

John Thomas: Thank you, Mark. Thank you, Jeff. We’ll now take questions.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from Austin Wurschmidt with KeyBanc Capital Markets Inc.

Operator: Our next question comes from Juan Sanabria, BMO Capital Markets.

Operator: Our next question comes from Ronald Camden with Morgan Stanley.

Operator: Our next question comes from Michael Carroll with RBC Capital Markets.

Operator: Our next question comes from Michael Griffin with Citi.

Operator: Our next question comes from John Pawlowski with Green Street.

Operator: Our next question comes from Mike Miller with JPMorgan.

Operator: Our next question comes from Tayo Okusanya with Credit Suisse.

Operator: Our next question comes from Josh Dennerlein with Bank of America.

Operator: Our next question comes from Steven Valiquette with Barclays.

Operator: We are closing our question-and-answer session. Now, I would like to turn the floor back over to John Thomas for closing comments. Please go ahead.

John Thomas : Thanks again everybody for joining us today. We look forward to me seeing you at NAREIT and future investment conferences and speaking to you again in August. Thanks.

Operator: This concludes today’s conference call. You may now disconnect your lines. Thank you for your participation, and have a great day.