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Executives

David Emery - Chairman and CEO

Scott Holmes - CFO

Doug Whitman - COO

Bethany Mancini - Corporate Communications

Gabrielle Andres - Corporate Communications

Analysts

Jerry Doctrow - Stifel Nicolaus

Chris Haley - Wachovia

Steve Swett - KBW

Rob Mains - Morgan Keegan

Rosemary Pugh - Green Street

Healthcare Realty Trust Inc. (HR) Q3 2008 Earnings Call November 11, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the Healthcare Realty Trust third quarter results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions would be given at that time. (Operator Instructions)

I'll now like to turn the conference to your host for today, Mr. David Emery. Mr. Emery, you may begin.

David Emery

Thank you. Good morning, everyone. Joining us today on the call are Scott Holmes, Chief Financial Officer, Doug Whitman, Chief Operating Officer and Bethany Mancini and Gabrielle Andres in Communications. I will ask Ms. Andres to now read the disclaimer.

Gabrielle Andres

Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the Form 10-K filed with the SEC for the year ended December 31, 2007 and the Form 10-Q filed with the SEC for the quarter ended September 30, 2008. 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.

Matters discussed in this call may also contain certain non-GAAP financial measures, such as funds from operations, FFO or FFO per share, funds available for distribution, FAD or FAD per share. A reconciliation of these measures to the most comparable GAAP financial measures maybe found in the company's earnings press release for the third quarter ended September 30, 2008. The company's earnings press release, supplemental information, Forms 10-Q and 10-K, are available on the company's website.

David?

David Emery

Thank you. First a few general comments. Over the last several months the heightened market volatility and financial turmoil have certainly created an environment where REITs are finding it more difficult and expensive to access the debt funding.

Healthcare Realty is fortunate in its conservative capital position, liquidity and market valuation place the company in a good position to execute its business plan and to fund commitments.

The company has no 2009 maturities. $400 million revolver matures in 2010 and its $300 million 8 1/8% notes mature in May of 2011. At quarter end the company's leverage ratio was just 37%, with available borrowing capacity of $332 million on its unsecured credit facility.

Despite the looming recession, Healthcare REIT valuations have lead all REIT sectors during this year, as the investors have sought equities that are historically immune to declining economic activity. Given the expansion of cap rates in the past month, some healthcare REITs are still able to make accretive investments with their relative cost of equity.

Given all of the uncertainty and outlook for the economy, I think it's important to be mindful of the positive real estate fundamentals that drive Healthcare Realty's core investment strategy.

Over 75% of the company's outpatient facilities are located on or adjacent to hospital campuses and our physician tenants provide patient services that drive the majority of hospitals inpatient admissions.

Historically, 118 people per thousand are admitted to the hospital each year, a number which has remained relatively constant over the last six decades. With the reality per or the average person now visiting his or her physician 3.3 times per year, physicians and diagnostic practices are at the front gate of these statistics.

Almost every business is affected by recession. Physician practices and clinical services have historically seen less impact during economic downturns. Of course, professionals who are more dependent on elective procedures will be affected to some degree. We do not expect to see any roll down in rents or decreases in tenancy should the recession worsen.

Our recent lease renewal rates are at the highest level they have ever been, up 6% in the third quarter. The low risk nature of the company's portfolio of properties is bolstered by the average physician's revenues, covering rent and estimated eight to ten times and the fact that our average tenant occupancy is only 3,500 square feet per tenant.

As expected, the exit of the leveraged buyer from the acquisition market has provided the company with opportunities to purchase facilities that add value to our existing portfolio. As disclosed last evening, the company is under contract to purchase 15 facilities for $162 million from the largest healthcare provider in North Carolina, owning 23 hospitals and managing approximately 5,000 patient beds in the metropolitan Charlotte area.

The Carolinas HealthCare System portfolio has an average occupancy of over 90%, with rental increases exceeding 3% annually. After the stabilization of a new owned campus MOB, the portfolio is expected to yield approximately 8%. Working with this top tier health system initiates a productive new relationship with additional long-term investment opportunities on the horizon.

With the gradual increase and attractively priced offerings in the acquisition market, we have slowed the expansion of our future development pipeline. In fact, we've recently sold the development site in Illinois for approximately $800,000 gain. Our current developments are on track with two medical facilities in Colorado opening during the quarter. Mr. Whitman will have some additional comments shortly.

I'm pleased with our progress this year and the outlook for our plans. Healthcare Realty's conservative and simple capital structure is exacting investment standards and the company's long-term, low risk business perspective should serve us well during these uncertain times.

Now, I'm going to ask Ms. Mancini to give us an overview of healthcare which we like to do every quarter. Ms. Mancini?

Bethany Mancini

Thank you, David. With rising uncertainty in the economy, the usual increase in the number of negative healthcare headlines has begun to taint the public view of recent hospital company earnings, despite mostly stable earnings report for the third quarter. Public hospital companies have largely reported earnings in line with expectations and even with seasonal pressure on admissions and continued high bad debt expense, hospital operations and earnings have not shown signs of a negative downward trend for the sector.

The most recent release of data from the American Hospital Association showed that US community hospitals enjoyed record profits in 2007, posting $43 billion more in revenue than expenses and creating the largest single-year jump in profit margins in at least 15 years. Operating revenue at community hospitals topped $600 billion for the first time, increasing 6%.

The Bureau of Labor Statistics reported last week that while non-farm payrolls continue to fall in 2008, healthcare employment expanded by 26,000 jobs last month and by 348,000 jobs over the past 12 months. We would expect that even with some impact on operations as a result of the recession, healthcare will remain a profitable, largely-need driven business, an essential part of our economy, as evidenced by its stability over time and throughout numerous economic cycles and rising federal budget deficits.

However, the outlook for community hospitals access to the municipal bond market has turned negative with the uncertainty in the debt market and the higher cost of financing. Combined with losses to investment portfolios but not-for-profits have previously relied on for cash reserves. Healthcare Realty's capital may prove more attractive as an alternative source for well-managed health systems to fund capital projects and expansion initiatives.

It has been our experience that physician demand for office space on or near hospital campus is largely recession- proof, determined by whether or not the hospital is positioned with solid market share and can evolve to meet the demands of positive demographics in a growing population in its community.

Our strategic on-campus facilities are critical to patient care and provider revenues, with physician tenants willing to pay a premium for on-campus office space. Such physician practices are mostly immune to changes inpatient's elective procedure patterns and instead follow consistent historical growth trends.

Physician offices also remain one of the lowest cost settings for care, preferred by insurers to more costly inpatient settings and supported by growth in public and private reimbursement.

Government spending on Medicare and Medicaid has remained positive providers in 2008, and should continue to support healthcare spending and patient access to coverage and services in 2009. Next year, acute care hospitals will receive on average 4.7% higher payments, and the CMS recently issued final rulings for hospital outpatient department rates increasing on average 4.1% in 2009 better than expected and also for physician rates increasing 1.1% as expected under the Medicare legislation passed in July.

The increase to physicians will last through the end of 2009 after which it is again scheduled to be cut by 20%, although Congress is expected to address the physician payment formula in the second half of '09, either in another short-term fix or possibly a longer-term fix that could involve initiatives, aimed at improving efficiency in primary care, while targeting Medicare Advantage payments to help fund the higher physician payments.

Healthcare reform will likely be a centerpiece of the domestic policy agenda for the Democratic Congress and new President in 2009. There will be proposals for sweeping change to provide universal insurance coverage, expansion of federal programs, regulation of insurers and government subsidies.

However, significant budget and economic constraints will most likely limit these efforts to smaller and more incremental legislation, aimed at decreasing the level of the uninsured.

One of the first items for consideration could be higher federal match funding for state Medicaid programs, included as part of an economic stimulus package. Coverage could also be expanded under Medicare SCHIP when it comes up for renewal in March.

Major healthcare reforms are expected to continue to support the private health insurance market and allow healthcare providers to benefit from stable patient demand, in an aging population in the near future. Even with the continued growth in Medicare and Medicaid spending, the majority of healthcare spending remains financed by the private sector.

We expect the medical office and outpatient sectors to continue to be attractive to investors for its private pay characteristics and positive healthcare fundamentals. As healthcare services improve with technology, the population ages and both public and private payers emphasize lower cost settings.

We expect Healthcare Realty's outpatient facilities and new developments will remain vital as hospital systems growth strategies. David?

David Emery

Thank you, Bethany. Now on to Scott, for some discussion about the numbers.

Scott Holmes

Thank you, David. Before addressing operating results for the third quarter, I would like to note that the company's Form 10-Q which contains financial statements and related footnotes and managements discussion and analysis of results of operations, liquidity, capital resources, and other matters was filed yesterday afternoon.

At the same time, information was furnished on Form 8-K to supplement the Form 10-Q disclosures specifically regarding real estate investments, construction and progress and developments, lease maturities , joint venture investments, same facility growth and other corporate information.

FFO per diluted share for the third quarter was $0.38 even with the previous quarter before a one-time $765,000 charge related to a litigation expense settlement. After the charge, FFO as reported was $0.36 per diluted share.

Operating results for the third quarter of 2008 include three other items of note. First, the company recognized $2 million in gains resulting from the repurchase of the company's senior unsecured notes.

Secondly, the company recorded a non-cash impairment charge of $1.6 million on a non-core patient accounts receivable asset which the company acquired in 2005 in the releasing and debt restructuring of a facility. This impairment charge essentially eliminates any remaining balance of the patient receivable asset.

In the end, the company received more in cash collections than it paid in cash in 2005 to obtain the patient receivables. Lastly, property operating expenses were elevated in the third quarter by seasonal increases in utility expenses which increased by nearly $900,000 over the second quarter of 2008, excluding new properties acquired during the quarter.

FAD per diluted share for the third quarter was $0.44, as compared to $0.43 in the second quarter of 2008. A reconciliation of all items included in the FAD calculation and a reconciliation of FFO can be found on the last page of the earnings press release furnished yesterday afternoon.

A thorough discussion of operating results for the three and nine month period ended September 30, 2008, can be found in management's discussion and analysis of the results of operations included in the Form 10-Q filed yesterday afternoon.

Regarding the balance sheet and capital structure. An equity offering of 8,050,000 shares was completed in late September, with proceeds of $196 million. The proceeds were anticipated to fund recent pending acquisitions with some view towards the likelihood of the Carolinas HealthCare System portfolio acquisition.

Company management continues to focus on and appreciate the simplicity and strength of its balance sheet. At September 30 2008, the company's leverage ratio was 36.7%, the lowest among major healthcare REITs. Considering current market dislocations, it seems appropriate to comment further about liquidity, commitments and funding sources.

Last month, the company exercised its option to extend the expiration date of the unsecured credit facility for one year from January 2009 to January 2010. The same terms and covenants in the facility remain in effect during the extension period, and those covenants are standard for facility of this type.

Pricing on the unsecured credit facility continues through the extension period at LIBOR plus 90 basis points, effectively about 2.5% today. The company was in compliance with all covenants by a comfortable margin at the time of the extension and expects to remain fully compliant through the extension period.

We plan to renew the facility some time in 2009 when market conditions weren't moving forward with that effort. Company management is scheduled to meet on December 10th with its bank group, as well as several potential new participants to update them regarding company progress and plans and to discuss the renewal of the facility.

The company has no other maturities of long-term debt until 2011, and then not until 2014. The company's funding commitments through 2010 for development activities include its existing construction-in-progress total of approximately $112 million, $60 million of that amount being for the Honolulu development on which we intend to obtain project-level mortgage funding.

We plan to fund the remaining $52 million of development commitments through 2010, with incremental equity offerings. Funding for expected acquisitions totals approximately $237 million, which will be offset, in part, by about $60 million in cash inflows from anticipated dispositions of assets. We expect this activity to flow through the unsecured credit facility, which has a balance outstanding today of $103 million.

Increasing the facility for the acquisitions totaling $237 million and decreasing the facility for the $60 million of cash inflows from dispositions would leave the $400 million facility with an estimated balance of $280 million in late 2009. This estimate ignores the possibility of any other unanticipated dispositions, additional project-level financing or equity offerings other than to fund developments.

We expect the company's approach to future funding will provide adequate dry powder on the unsecured credit facility, while comfortably meeting funding commitments and leaving the company well positioned and flexible for 2009 and 2010. I think it is salient to note that $1.7 billion of the company's real estate assets are currently unencumbered.

That concludes my prepared comments. David?

David Emery

All right. Thank you, Scott. Now, to Mr. Whitman, to talk about development activity and acquisitions. Doug?

Doug Whitman

Thank you, David. Before I provide an update on our development and acquisition activity, I would like to comment on the operations of our existing portfolio. Our portfolio of outpatient medical facilities has shown stability and even growth amid the economic turmoil. The occupancy for our stabilized properties remains steady this quarter at 91%. Compared to the third quarter of 2007, our same-store NOI for master lease properties increased by 3.3% and by 2.4% for our owned and managed facilities.

The weighted average rental rate for our owned and managed properties increased for the fourth straight quarter, with rent on existing leases increasing 3% and on renewing leases by 6%. While leases maturing in 2009 represent 22% of revenues, this expiration bulge is comprised of over 425 leases, each averaging only 4400 square feet. The expirations are related to the many acquisitions we did in 2004 like Baylor, Ascension and MedStar, and the five-year leases that were signed at the time.

Nearly three-fourths of 2009 expiring leases are in our owned and managed portfolio. We feel confident that the vast majority of those leases will renew at favorable rates because 85% of them are in on-campus properties or 72% of them are with hospital tenants like Baylor or Ascension. The characteristics of the aspiring leases in terms of tenant makeup and location of properties should provide security that our core portfolio operations will remain stable.

We continue to believe that developing quality properties on or adjacent to acute care hospitals and growing markets will be a key component of our ongoing investment activity. With the completion of our project in Colorado Springs, we now have five buildings in the lease-up phase. The three properties that we opened in 2007 all on Baylor campuses continue to lease in line with our expectations.

The leasing activity for our Colorado project is evolving as expected, with multiple discussions ongoing with potential tenants, some with full floor requirements. Additionally, the completion this summer of a second acute care hospital nearby has spurred increased interest in the buildings.

Our development pipeline currently has seven properties in CIP, representing over 760,000 square feet of outpatient space and an investment of approximately $230 million. The Arizona project will open next month and we expect to have a surgery center tenant in place. Due to favorable weather, one of our Texas developments is ahead of schedule and we have come to terms with the 20,000 square foot tenant.

Construction continues on our other projects in Illinois, Texas and Hawaii, and we have signed letters of intent for an imaging center and several physician offices. All the projects in CIP are on schedule and should be completed by the end of 2010.

Notwithstanding our commitment to development as a key component of our future growth, we have in light of changing economic conditions taken a critical look at our development pipeline and have decided not to pursue four projects that were previously in our shadow pipeline. We sold a parcel of land for a gain near Chicago and abandoned the purchase of three other parcels in Georgia and Illinois. While there was a compelling development story for each of these sites, we thought it was prudent to defer these developments until there is better visibility of future economic conditions.

The current difficulty many of real estate investors face in securing financing has changed the acquisition environment. In several recent portfolio transactions where we have been involved, most of the finalists have been healthcare REITs. We too have benefited from this change landscape and at September, we completed a nearly $200 million equity offering to fund several acquisitions.

In addition to our nearly $60 million acquisition in Dallas this summer, we have closed on $29 million of MOB purchases in the Des Moines market, in conjunction with a new JV partner. The four buildings we acquired totaled over 180,000 square feet and are 100% occupied.

Together with this JV partner, we will also invest in the six building outpatient campus that is being developed near two new acute care hospitals. This campus 80% pre-leased will be completed over the next few months and will represent a $55 million investment.

Last week, we signed a contract to acquire 103,000 square foot MOB in Indianapolis for $28.1 million. This property is 100% occupied by three tenants on a long term triple-net leases and is adjacent to an Ascension Hospital. We have also signed a contract to buyout our partner in a joint venture, that had previously invested on five on campus MOBs in the Pacific Northwest.

We will purchase our partners 25% ownership interest for that $18 million and will consolidate approximately $62 million of existing debt. That debt has a blended rate of 5.8% with no maturities until 2015. All of these acquisitions, totaling nearly $190 million are immediately accretive with yields within our target range of 7% to 8%.

Finally, as David mentioned earlier, we have signed a contract to purchase a 15 building portfolio, totaling nearly 760,000 square feet from Carolinas HealthCare System in Charlotte, North Carolina, for a total consideration of about $162 million. It is the largest healthcare system in the Carolinas, the third largest public healthcare system in the country and maintains a double A minus credit rating from S&P.

This portfolio represents a mix of on and off-campus assets on three hospital campuses around Charlotte. It will be 90% occupied at closing, with the health system leasing 71% of the portfolio on long-term net leases averaging 10 years. The initial yield on this portfolio currently below 7% reflects its size, the quality of the assets and the health systems leasing three quarters of the space.

With additional leasing, coupled with base rent increases of over 3%, we expect this yield to increase to nearly 8% by year three. Much of that additional leasing will occur at one of the portfolios larger properties which will open in December. This property is located on the campus, whose hospital is doubling in size and adding several new clinical programs. We expect this building to be fully leased by 2010.

With the lack of credit and financial turbulence likely reducing the number of transactions for the next several months, judging the direction of cap rates will be increasingly difficult. In pending debt maturities for many recently active MOB buyers may result in some messy transactions.

The inherent fundamentals of outpatient medical facilities, strong occupancy, stable tenancy, lack of fundability, will likely insulate those buyers for a time, but cannot forestall upcoming maturities. Accordingly, we expect cap rates will generally trend upward.

In conclusion, the quality and stability of our existing portfolio as evidenced by our occupancy, rental rate growth and tenant retention are tremendous assets in a period of economic uncertainty. We will work diligently to insure that performance continues.

We will pursue future investments both developments and acquisitions selectively, being careful to balance the ability to add quality assets to our portfolio with the need to preserve capital and financial flexibility. David?

David Emery

Thank you, Doug. Now Operator, I think we are ready to begin the question-and-answer period.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jerry Doctrow of Stifel Nicolaus. Your line is open.

Jerry Doctrow - Stifel Nicolaus

Thanks. Well, good morning, everybody.

David Emery

Good morning.

Jerry Doctrow - Stifel Nicolaus

I just had a couple things. What was the litigation that was in the quarter?

David Emery

That's the one that's been going on for a number of years regarding the HealthSouth derivative lawsuit kind of thing.

Jerry Doctrow - Stifel Nicolaus

Okay.

David Emery

Going on, and it was just a difference in insurance reimbursement with the insurance coverage.

Jerry Doctrow - Stifel Nicolaus

Lease-up, I think, Doug touched on this, but, we didn't see much movement in the lease-up percentages second quarter and third quarter. You're comfortable things are on track and it's just sort of lumpy leases or?

David Emery

Jerry, it's, after all these years it's not necessarily quarter-to-quarter. Just when you suspect that you're not making much traction, something comes up. As long as you have the good location and you've got the compelling kind of force behind it, in the end it works out. I don't think it's -- it is will that ever lease the system, usually a matter of time.

Jerry Doctrow - Stifel Nicolaus

You're comfortable with the progress that your target dates are fully leased-up?

David Emery

We've not seen anything to give us any indication that there's any slow up in interest or activity.

Jerry Doctrow - Stifel Nicolaus

Okay. And then, just a couple questions about sort of capital. I think if I understood what Doug was saying, you've got kind of $190 million of kind of acquisitions pending, some of which have assumed debt and then there's the 162, I think it is for Carolina, and Scott was saying that, since later in '09, you'll have 280 still available on the line, that 280 takes into account all of those acquisitions that Doug was talking about, as well as your asset sales?

David Emery

That's correct.

Doug Whitman

That 190 Jerry, we've already closed on a number of those so that's not future funding. Some of those have already been funded.

Jerry Doctrow - Stifel Nicolaus

Okay.

David Emery

No, the fundings that Scott gave you was the ins and outs and all of those things. We tried to do that to give everybody kind of a final number on the in because there are a lot of moving pieces.

Jerry Doctrow - Stifel Nicolaus

I was just trying to make sure that we got everything in there, we do.

David Emery

Sure.

Jerry Doctrow - Stifel Nicolaus

Obviously you extend the line. You don't have maturities until 11. Scott, I think, was saying that you would pursue equity offerings potentially through 2010 to fund a piece of that. I was just trying to clarify, you actually then made a comment, or is that JV sales or are you just sort of making a general statement that assuming the market would come back, you would prefer to do equity.

David Emery

Well, I think Scott can comment, but I think it's a general sense that you have to have a general view of the way you think what things are going to unfold and I think from the standpoint of incremental equity, we're talking about small aftermarket kind of offerings or those kind of things to kind of match fund that. Obviously if that doesn't play out that way, then we have other alternatives of mortgage debt or otherwise. Scott?

Scott Holmes

No, that's correct. We can be a little more flexible with market conditions and equity offerings with respect to development funding since they do take place over a period of time.

Jerry Doctrow - Stifel Nicolaus

So you don't need an equity offering. It's just that would be your game plan to sort of go forward?

David Emery

Yes. That's just the overall game plan.

Jerry Doctrow - Stifel Nicolaus

Okay. One last question and I'll jump off. In this environment, assuming you found sort of a juicy acquisition that was a couple hundred million dollars, would you be comfortable sort of running the line up further or would you do, you would do more or putting on a little more debt on mortgage? I was trying to figure out just what your appetite is?

David Emery

Well, based on the market the last two or three days, I think we would probably be somewhat renaissance to do much of anything, but I think if there's some normalcy in the equity market, it all kind of depends upon what it is, where it is, how important it is to our strategy, those kind of things.

I think we would probably air on the side of not doing anything unless it's overly compelling until there is a clearer picture regarding the debt markets and the equity markets. It's just not enough benefit to take capital and funding risk at this point in time. I guess to some degree we hope that there's not one of those as you describe it juicy opportunities, at least in the near term until we get more into '09.

As you've heard me say, I do expect in late '09 and '10, as Doug alluded to, there are a lot of what we consider to be maturities related to acquisitions that have occurred over the last two to three years, and so we have some sense that the market is only going to improve for us and those acquisitions in '09 and '010. So the Carolinas acquisition is not something just because of its availability is I think you know enough about the intricate nature of our strategy.

The Carolinas acquisition is very similar to Baylor that we did several years ago and any time you have an opportunity to affiliate yourself with an organization such as Carolinas and for the future businesses that for tends, then that's something that you obviously want to do. I think we were fortunate in that there had been enough recession of the interest from the leverage buyer that it leads us basically acquire this at a fairly beneficial accretion.

Jerry Doctrow - Stifel Nicolaus

One last one, Doug I think mentioned the rent increases on roles that you've been getting is about 6%, on some of the stuff upcoming do you think that's sort of a good number to assume?

David Emery

We don't have anything to indicate otherwise, Jerry, but quarter-to-quarter that jumps up and down. It's run 4%, 5%.

Doug Whitman

It will generally range between 4.5% to 6%, the last couple quarters we've been at the upper end of the range.

Jerry Doctrow - Stifel Nicolaus

Okay. Thanks.

David Emery

That's not to say next quarter it won't be 4% or 3.5%, but it's positive and in this environment, that's good.

Jerry Doctrow - Stifel Nicolaus

Okay. Thanks.

Operator

Thank you. Our next question comes from Chris Haley of Wachovia. Your line is open.

Chris Haley - Wachovia

Good morning.

David Emery

Good morning.

Chris Haley - Wachovia

David, you mentioned that one of the projects in the CHS deal was a development project. Could you offer the size of that project?

David Emery

Doug, what is it?

Doug Whitman

It's about 140,000 square feet, so it's doing final TI build-out. I mean CHS will complete the development. I mean the core and shell is done and they are just doing interior space and they will take occupancy in December.

Chris Haley - Wachovia

And the dollar amount, Doug?

Doug Whitman

For that particular asset? I don't have it with me. I can get back to that.

David Emery

We can probably do that I guess.

Chris Haley - Wachovia

So that project you think will be initially purchased, so basically a pre-sale that will not be capitalizing any costs associated with that when you close? I'm trying to estimate and calculate what income is driven impact there will be from the $190 million from CHS and whether or not some of that is related to an unstabilized asset that will include capitalization.

David Emery

Well, I think the build-out is underway and I think the incremental business, there will be some TI out over the next, I don't know, 12 months or 24 months for the rest of the space. But in the main, I think they are going to take something like nearly 60%, 70% of the building.

Doug Whitman

It's substantially leased. It's not a speck building by any means.

Chris Haley - Wachovia

I'm sorry what was the square footage?

Doug Whitman

About 140,000 square feet.

Chris Haley - Wachovia

Okay. In the purchase and sale agreement, as part of your 10-Q, there is some information but maybe you could help me clarify. They offer a base rent with an operating expense reimbursement figure, which would translate to a little over an 8% yield based upon per square foot numbers. In your comments you mentioned that this would be purchased at an under a 7% rate which I would assume to be a cash base number, not a GAAP based number.

David Emery

It is cash based and it's based upon the fact that you still have some vacancy in some properties and more directly in the new building that's being finished in December.

Chris Haley - Wachovia

On your under 7% yield is your denominator in that calculation, the 190 million?

David Emery

The 162 million.

Chris Haley - Wachovia

162 million., are the rents being paid by the non-CHS and its affiliates tenants lower than the rent being paid by CHS?

Doug Whitman

In some instances and some buildings yes and in some buildings no, there are non-CHS tenants scattered throughout the majority of the buildings in the portfolio, so we're inheriting or taking assignment of some existing leases and CHS will sign new leases at market in some of the other properties.

Chris Haley - Wachovia

Related to that when you think about capital allocation given the commitments you've got for your development pipeline plus the acquisitions made, and you've also re purchased some of your debt and continue to do so in the fourth quarter, how do you think about the relative returns of those allocations and the magnitude of those allocations?

David Emery

Well, I think in general, on the last one regarding the debt, I think that's just been something where from time to time, there's been small parcels over the years that we have been offered where you get yields that are 8% and in some cases have been 10.5%. We don't have any particular program or initiative particularly as you say in light of the capital markets to aggressively buy any of that.

I don't even know that we have anything in the offering or we are even looking at it. Secondly, as far as development, I think as Doug said, we don't feel it's prudent to execute any additional activities in that area, although we are constantly making ourselves aware of opportunities.

Probably it would be my expectation on development that we will see in a capital constrained market for the hospital systems more opportunities for on-campus development.

Anything that we would probably do on the development front would have to take into view the capital markets and take into view kind of the shall we say lease up time or accretion of that development opportunity.

As far as acquisitions, I just refer you to what I said to Jerry that we probably are more inclined not to be buying additional properties unless there's some kind of compelling fundamental story and we feel like that it's accretive on a long-term perspective with the cost of equity kind of being the guide there rather than the incremental cost of debt.

Chris Haley - Wachovia

Thank you. Last question has to do with the decision to issue a small amount of restricted shares this month?

David Emery

Yes.

Chris Haley - Wachovia

Could you offer some color behind that decision?

David Emery

That release is part of basically over the last four years and it's basically every year, all of the officer s have what we refer to as just a memo account, and to some degree, from time to time, we have made releases from that, but this release is the first one that we've had in four years, and it's a composite of employee retention and just the progress the company has made over thousand four years, etcetera. There's no other particular triggering event.

Chris Haley - Wachovia

These are helping the dispersion of these shares.

David Emery

Just among the officers.

Chris Haley - Wachovia

Okay. Thank you.

Operator

Our next question comes from Steve Swett of KBW. Your line is open.

Steve Swett - KBW

Hi, David. How are you?

David Emery

Good morning.

Steve Swett - KBW

Scott, maybe these questions are for you. The litigation expense in the quarter, is that resolve the issue now, so that essentially, that cost will be gone going forward?

Scott Holmes

We think so. If you'll go to footnote 6 in the Q, footnote 6 of the financial statement there's a discussion about this event which I would refer you to, but for now we have an agreement in place that this should put an end to it and there shouldn't be anymore going forward.

Steve Swett - KBW

Okay, and then on the land gain, I think that was referenced, is that something that you think gets booked in the fourth quarter?

Scott Holmes

That was in the third quarter.

Steve Swett - KBW

It was actually in the third quarter.

Scott Holmes

Yes.

Steve Swett - KBW

Then on the acquisition?

Scott Holmes

Footnote.

Steve Swett - KBW

Sorry.

Scott Holmes

I guess that hasn't closed yet. I guess that will be in the fourth quarter.

Steve Swett - KBW

Okay.

Scott Holmes

Yes, it's disclosed but it's a fourth quarter event not a third quarter event.

Steve Swett - KBW

The utility expenses, you mentioned I think about $900,000 in the third quarter, so that essentially gets backed out as you go into fourth quarter?

Scott Holmes

No, I certainly hope so.

Steve Swett - KBW

Okay.

David Emery

Usually, those things are seasonal up and down from time to time. Sometimes there's catch ups and reconciliations and so on and so fourth. We don't have any broad kind of thing and all of a sudden utilities are going through the roof right now.

Steve Swett - KBW

One final question on the acquisitions to make sure I have the number right. Scott, you said 237 of net acquisitions pending and I guess that includes the 162 which leaves 75 million, and I'm having trouble with the deals that were itemized coming up with which 75 million those may be.

Scott Holmes

There's also the matter of how much of the acquisition is the assumption of debt and how much is cash to be paid out. My approach, my numbers are reflecting cash since we're talking about cash flows.

Steve Swett - KBW

I'm sorry. The $55 million pending joint venture investment, the $28 million on the contract in Indianapolis and the $18 million buyout of the JV, those are the three other deals that are outstanding; is that right?

Scott Holmes

That's correct.

Steve Swett - KBW

Okay. All right, thanks.

Operator

Thank you. Our next question comes from Rob Mains of Morgan Keegan. Your line is open.

Rob Mains - Morgan Keegan

Thanks. Good morning.

David Emery

Good morning.

Rob Mains - Morgan Keegan

Scott, I got on just as you were wrapping up with the litigation discussion. Did you say the number there is 775,000, did I hear?

Scott Holmes

765,000

Rob Mains - Morgan Keegan

765. If I were to get kind of a normalized FFO number, I would take out that, the gain on the repurchase debt and the impairment?

Scott Holmes

Yes. I would adjust somewhat for the increase in utilities expense in the third quarter as well.

Rob Mains - Morgan Keegan

Was that increase, was that just seasonally because of air-conditioning use or was there something else going on?

Scott Holmes

No, it's the hot summer months.

Rob Mains - Morgan Keegan

Okay.

Doug Whitman

There was oil at $147 a barrel.

Rob Mains - Morgan Keegan

Right.

Scott Holmes

A combination of the two.

Rob Mains - Morgan Keegan

A question on the line, I wrote down there's 103 out on the line now; is that correct?

Scott Holmes

That's right.

Rob Mains - Morgan Keegan

You had 237 of acquisitions and then you have 60 million coming in, so the 280 million figure, that would be the amount that you'd have out on the line at the end of '09, correct?

Scott Holmes

Or toward the end of '09, yes.

Rob Mains - Morgan Keegan

The remaining, the availability would be obviously what's left.

Scott Holmes

The difference there.

Rob Mains - Morgan Keegan

Jerry asked my question on acquisitions. When you look at the same-store NOI growth numbers, the master lease stuff, that was a stronger number than has been in recent quarters. I would assume that that's going to probably be in the high two range long term?

David Emery

I think we are going to probably average 2.5 to 3.

Rob Mains - Morgan Keegan

All right, that's all I had. Thanks.

David Emery

Thank you.

Operator

Our next question comes from Rosemary Pugh of Green Street. Your line is open.

Rosemary Pugh - Green Street

Good morning, everybody.

David Emery

Good morning.

Rosemary Pugh - Green Street

Regarding the Colorado MOBs placed in service in the third quarter, we understand from industry sources that you are open to leasing space in the building to non-medical office tenants, I am interested in what is driving this decision and how it changes the economics of the project?

David Emery

We have been approached by a number of non-medical tenants. There are two buildings there, Rosemary, and I think given the fact that there's a lack of available space in that market that it would be prudent for us to not turn away any tenants and the dollars and everything to build a building obviously increases peoples alternative choices so on and so fourth. Anybody that is in the market, it's an opportunity, but that's just we've been asked if we would consider that and the answer is yes.

Rosemary Pugh - Green Street

What would be the difference in the rent you could charge for an office?

David Emery

Probably no difference, even maybe a little bit more, at least based upon the inquiries we've had.

Rosemary Pugh - Green Street

You have four property operating agreements expiring in the fourth quarter and that represents about $5 million in annual rent. What are the prospects for renewal for these property operating agreements and what is the underlying occupancy of these properties?

Doug Whitman

The underlying occupancy for the properties is 100%. They're all full. We don't expect to renew those property operating agreements. They are all in the same hospital campus in Southern California and we have, one of the agreements expired earlier this year in the summer and we have been increasing the rental rates on the physicians by 15% to 20%, 25% to bring those up to market and we've been successful in doing so.

To the extent those operating agreements expire, we will be increasing rental rates on the actual tenants. We've been successful in doing so. The campus is completely full. There is no other, it's a developed urban area, there are a few alternatives for lack of fund's ability, so I think over time we'll be able to get those properties, the NOI back to where it was.

Rosemary Pugh - Green Street

What is the short-term NOI impact?

Doug Whitman

I don't have that number off the top of my head. I'd have to get back to you on that.

Scott Holmes

The amount of income support from the sponsors under the POAs, Rosemary, is in the neighborhood of about 2.8 million or so. We would be working to replace that most immediately in the short run. We expect that until there are leases that are in place renewed, there may be some short-term pain on that but it wouldn't be the full amount of the lease support.

Rosemary Pugh - Green Street

2.8 million is the number you're expecting?

Scott Holmes

That's my estimate. I don't know the exact number off the top of my head.

Rosemary Pugh - Green Street

Of lost NOI next year.

David Emery

No, we don't know what the loss will be until we have lease renewals that will offset the 2.8.

Scott Holmes

Right.

Rosemary Pugh - Green Street

Okay and the hospital is tenants?

David Emery

Yes.

Rosemary Pugh - Green Street

Okay. Thank you very much.

Operator

Thank you. Our next question is a follow-up question from Steve Swett of KBW. Your line is open.

Steve Swett - KBW

I'm sorry. My question has been answered.

Operator

(Operator Instructions). I'm showing no more questions or comments at this time.

David Emery

All right, very good, operator. We appreciate everyone being on the call and most of us will be around today if there's any need for any follow-up, please give us a call. Have a good day.

Operator

Thank you, ladies and gentlemen, for joining today's conference. You may all disconnect and have a wonderful day.

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Source: Healthcare Realty Trust Inc. Q3 2008 Earnings Call Transcript
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