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Healthcare Realty Trust Inc. (NYSE:HR)

Q4 2008 Earnings Call

February 24, 2009 10:00 am ET

Executives

David Emery – Chairman and Chief Executive Officer

Scott Holmes – Chief Financial Officer

Doug Whitman – Chief Operating Officer

Bethany Mancini – Corporate Communications

Gabrielle Andres – Corporate Communications

Analysts

Rob Mains – Morgan Keegan & Company

Tayo Okusanya – UBS

[Connor Feneti] – Deutsche Bank

[Doug Sanfisto]

Jerry Doctrow – Stifel Nicolaus & Co.

Stephen Swett – Keefe, Bruyette & Woods

Michael Mueller – JP Morgan

Rosemary Pugh – Green Street

[Ben Lentz]

Operator

Welcome to the Healthcare Realty Trust fourth quarter results conference call. (Operator Instructions) I would now like to turn the conference over to your host, David Emery. Sir, you may begin.

David Emery

Joining us on the call today are Scott Holmes Chief Financial Officer, Doug Whitman Chief Operating Officer and Bethany Mancini and Gabrielle Andres in our communications. Ms. Andres will now read the disclaimer.

Gabrielle Andres

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 our Form 10-K filed with the SEC for the year ended December 31, 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.

The 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 fourth quarter ended December 31, 2008. The company's earnings press release, supplemental information and Form 10-K are available on the company's website.

David Emery

Healthcare Realty Trust completed a productive fourth quarter. As our core portfolio continued to perform well, with stable occupancy and increases in renewal rental rates and property level in line. Despite difficult economy, outpatient medical office continues to be resilient having sound operating fundamentals that continue to follow the broader context of positive historical growth trends.

Since 1972, through six recessions, physician office employment has grown annually by approximately 4.8% compared with the national private employment growth rate of only 1.8%. We view healthcare employment as the best indicator of demand for facility utilization and our managing our expectations of lease rates and the time necessary to lease up new buildings.

Excluding government and education, healthcare was the only industry to experience a significant increase in employment throughout 2008, and even in January 2009 when national unemployment reached its highest rate in 16 years. The healthcare industry added 19,000 jobs in January versus the national loss of some 598,000 non-farm jobs.

Physician office employment grew 3% over the last 12 months, which was slightly higher than the prior year's growth rate. Healthcare real estate remains a business that is driven by the increasing number of clinical services demanded from hospitals by physicians and ultimately the consumers rather than economic trends.

Heightened sensitivity to the current economic climate has prompted leasing concerns across most sectors of real estate. Having developed several hundred million dollars in outpatient facilities over the last ten years, it has been our experience that leasing is usually ruled by randomness and medical office has historically not been subject to the same economic cycle seen in general office. Furthermore, the low fundability nature of MOBs enhances the prospects for success.

Leasing activity for prior facilities and stabilization continues to be positive. This month our recently opened Colorado Springs project received a letter of intent for 20,000 square feet from a national outpatient center. And another in tenant expressed interest in leasing the entire second building.

The Scottsdale project is experiencing similar activity as discussions are underway with a tenant for 15,000 square foot surgery center along with offices for several physician groups. We expect to see continued interest in our new facilities.

Hospital company initiatives are centered on physician recruitment for improving operations in gaining market share. And according to a survey by the American Hospital Association, 31% of all hospitals are cutting their capital budgets by 50% or more this year as they content with lower endowment values.

In this environment, Healthcare Realty's capital may prove to be a more attractive alternate source for well managed health systems to fund project and initiatives critical to their operations, physician relationships and growth.

Regarding acquisitions, in December we were pleased to close on a 15 building portfolio with the largest healthcare provider in North Carolina, Carolina's Health System. This acquisition represents another bellwether investment relationship for Healthcare Realty with potential for strong rental rate growth and additional long-term investments.

We have begun to see a number of outpatient portfolios coming to market. With any capital deployment by HR will likely remain tempered in the near-term. It is our intent to take advantage of compelling opportunities for acquisition as long as such opportunities enable us to maintain our conservative balance sheet metrics and augment our existing portfolio.

To enhance liquidity for future investments, management is pursuing sources for secured financing on its existing stabilized assets and redeploying capital from typical asset sales. Additionally, credit markets have recently shown tentative signs of improvement, which should be a catalyst for equities in the months to come.

Lastly, we have ongoing dialogue with the participants in our credit facility, along with other banks, and have been pleased with their intentions regarding the renewal of our line of credit later this year. With Healthcare Realty's conservative and simple capital structure, strong portfolio performance and exacting investment standards, we believe our long-term low risk business profile should maintain underlying shareholder value even in these uncertain times.

Now I'd like to turn it over to Ms. Mancini to give us the update on transient healthcare that we try to do every quarter. Bethany?

Bethany Mancini

Demand for healthcare in the U.S. remains strong despite the weakened stated of the economy. The practice patterns of patients and provides continue to drive increases in national healthcare spending, employment and funding. Approximately $1 in $5 of the U.S. economy is spent on healthcare services, according to the latest data on national healthcare expenditures.

In 2007, healthcare spending grew 6.1% to $2.2 trillion growing at a slower rater than previous years mainly due to changes in pharmaceutical practices but still expanding faster than the overall economy reaching 16.2% of GDP versus 16% in 2006. GDP had slowed in the struggling economy while healthcare spending trends have remained relatively recession proof.

The breakdown on spending among various service sectors stayed largely the same as the prior year with hospital and physician services comprising the majority of total spending at 52%. Hospital services growth accelerated slightly in 2007 up 7.3% and physician services rose 6.5% even with the rate of growth in the previous year.

Hospital companies are releasing fourth quarter earnings mostly in line with expectations reporting reasonable operating trends for the current economic environment. Strong cash flows in revenue growth were driven mainly by solid price increases while bad debt expenses remained flat to lower than in recent years.

Bad debt expense could increase as unemployment rises, although federal assistance should help the uninsured. While hospital companies are reporting soft admissions volume, outpatient and surgical volumes have increased with operators attributing the growth to diligent physician recruiting and marketing efforts.

Rating agencies have lowered their outlook for the healthcare industry citing investment losses, uncompensated care and few patients. However, standard employers affirmed its original rating for 83% of healthcare providers under its credit review underscoring the sector's long-term resilience and noted that smaller and less credit worthy providers were often those struggling, even before the recession began.

We would expect that even with some impact on providers operations as a result of the recession, healthcare will remain a profitable largely need driven business and an essential part of our economy as evidenced by its stability over time and its rising employment throughout numerous economic cycles.

Government funding of Medicare and Medicaid has remained positive for healthcare providers in 2009 and should continue to support healthcare services, particularly as the federal government seeks to address the problems of rising costs, uninsured patients, and state budget cuts.

For the fiscal year 2009, a future hospital's Medicare payments increased on average 4.7%, hospital outpatient department rates increased 4.1%, and physician rates increased 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 scheduled to be cut by 20% but should be reversed by congress in the second half of this year as it has been in recent years.

Medicare and Medicaid represented 46% of all healthcare funding in 2007 and comprised approximately 4.2% of GDP in 2008. With the aging population and rising per capita healthcare costs, government healthcare funding is expected to increase to 6% of GDP by 2019 and the Medicare trust fund could become solvent as early as 2016.

The continuing rise in healthcare costs and government funding at the same time as the uninsured population is expanding, has made healthcare reform the centerpiece of the domestic policy agenda for the democratic congress and new president in 2009.

Calls for widespread reforms this year will likely include proposals for universal insurance coverage through expansion of federal programs, regulation of insurers and employer and individual mandates. Reforms could also target improving healthcare value by expanding primary care options, pay for performance mandates and comparative effectiveness research.

The third area of reform should involve financing initiative targeting waste and fraud and abuse, increasing transparency of physician industry relationships, changing the tax code and more. While there seems to be a consensus that healthcare reform is needed, significant budget, economical and political constraints will most likely limit these efforts to smaller more incremental legislation aimed at decreasing the level of the uninsured while managing costs over time.

Such legislation was recently passed with the economic stimulus bill, which provided $140 billion in higher Medicaid match funding to state, subsidies for unemployment COBRA premiums and health IT funding. In addition to the recent renewal of SCHIP which expanded the federal healthcare program by $33 billion for an additional four million children over the next five years.

President Obama will release his proposed for the fiscal year 2010 later this week, and it remains to be seen how his intent to expand insurance coverage and access to healthcare services will be balanced by efforts to curb rising healthcare costs.

Reforms are expected to continue to support the private health insurance market and allow providers the benefit from less uncompensated care and increase their services to an aging population in the near future. Even with the anticipated growth in federal funding, the majority of healthcare spending should remain financed by the private sector.

We expect medical office and outpatient real estate to continue to be attractive to investors for its private pay characteristics and positive healthcare fundamentals. And as healthcare services improve with technology and heightened patient demand in both public and private payers emphasize lower cost settings, we anticipate Healthcare Realty's outpatient facilities and new develop will remain vital to hospital systems growth strategy.

David Emery

Now I would like to ask Mr. Holmes to give us an overview of the numbers and make comments on other financial activities.

Scott Holmes

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

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

FFO per diluted share for the fourth quarter of 2008 computed according to the NAREIT definition was $0.49 per share. There are six one-time or unusual items reflected in fourth quarter FFO that warrant discussion. Before the six items, FFO per diluted share was $0.38. FAD per diluted share for the fourth quarter was $0.54 compared to $0.44 in the third quarter of 2008.

A reconciliation of all items included in the calculation of FAD for the quarter, as well as a reconciliation of FFO, can be found on the last page of the earnings press release furnished yesterday afternoon. For the full year 2008, the dividend payout ratio based on FFO was 94.5% and based on FAD was 82.8%.

The six one-time or unusual items in the fourth quarter are these. First, a property operating agreement termination fee of $7.2 million increased FFO in the fourth quarter. During the quarter, the company entered into agreements with a sponsoring hospital system to terminate the property operating agreement and sell to them the medical office building. The sponsor had a longstanding interest in purchasing this property in Cheyenne, Wyoming.

The cash payment from the sponsor to the company to terminate the POA was $7.2 million. The property was moved to assets held for sale in the company's year end balance sheet and the related operating results, including the POA termination fee, are included in discontinued operations in the company's statement of income. The properties sold in early February resulting in cash proceeds to the company of $21.4 million and the first quarter 2009 gain on sale of approximately $5.6 million.

Second, gains from the repurchase of senior unsecured notes in the fourth quarter totaled $2.1 million. Consistent with the prior quarter, the company made a limited number of repurchases of its own senior unsecured notes. The aggregate face amount repurchased during the quarter was $16.1 million. Given the uncertainty in the capital markets, it is unlikely that the company will make additional senior note repurchases.

Third, the company recorded bad debt expense totaling $1.5 million in the fourth quarter relating to additional rent receivables on four properties from one operator that had been in dispute for an extended period.

Fourth, included in discontinued operations is a non-cash impairment charge of $800,000 relating to two properties that were placed in assets held for sale in February 2007 that are not yet sold. Management concluded that the carrying amount of these properties should be reduced.

Fifth, included in the line item interest and other income net, in the fourth quarter is $800,000 of prior year straight-line rental income from an equity method joint venture. Because the company recorded the income as part of its equity income in the JV, this amount is included in the line item interest and other income net.

Lastly, in February the company refunded $950,000 to an insurance carrier and reversed a $325,000 accrual in the fourth quarter to resolve a disputed insurance coverage matter related to litigation legal fees. This $1.3 million of expense was included in property operating Expense.

The $6.5 million net effect of these six items accounts for the increase in FFO in the fourth quarter. One additional comment regarding fourth quarter operations is to note that GMA was $400,000 lower than the previous quarter in line with our expectations.

Looking forward to 2009, average quarterly GMA is anticipated to be in the range of about $5.8 to $6.2 million and will fluctuate from quarter-to-quarter. For example, in the first quarter of each year, GMA tends to be higher than average because of expenses related to year end reporting and the required annual non-cash charge under FASB statement 123R for employee stock purchase plan.

A more complete discussion of operating results for 2008 can be found in Management's Discussion and Analysis of the results of operations included in the Form 10-K filed yesterday afternoon. To date, portfolio operations showed no immediate cause for concern with respect to the potential impacts of this difficult economy.

The two litmus test indicators of trouble would be a decrease in occupancy or growth in rents receivable from tenants. The company has not experienced any growth in the amount of its rents receivable from tenants. In fact, both in dollar terms and as a percent of revenue, rents receivable from tenants have decreased in 2008 compared to a year ago.

Occupancy in the company's stabilized portfolio held steady through the fourth quarter at 91% consistent with the rest of 2008, further, rent increases on leases renewing in the fourth quarter ranged from 3.6% to 11.8% for a weighted average fourth quarter renewal rate increase of 6.4%.

Healthcare Realty Trust has not observed any signs of deterioration in the credit [inaudible] of tenants, the ability of the company to renew leases, or the ability of its portfolio to maintain present cash flows. Regarding the balance sheet and capital structure, at December 31, 2008 the company's leverage ratio was 45%, which continues to be among the lowest of the healthcare REITs. The company maintains a simple but strong capital structure and remains in compliance with all debt covenants.

The unsecured credit facility matures January 2010. Pricing on the unsecured facility is LIBOR plus 90 basis points effectively about 1.4% today. On December 10th, company management met with its bank

group and six potential new bank participants to discuss company progress and plans and the future renewal of the facility.

Feedback from the banks and our existing facility, as well as the perspective new banks, has been positive. Management intends to renew the unsecured credit facility around mid-year as debt market conditions cautiously show early signs of improvement. Given the positive indications from existing and new banks, we do not anticipate any material renewal hurdles.

At the present time, the unsecured credit facility has a balance outstanding of $323 million. Over the remainder of 2009, we anticipate the facility balance will be decreased by proceeds from the disposition of assets and proceeds from secure debt financing. The facility balance would be increased by the funding of CIP and properties and stabilization throughout the year.

Depending on the level of proceeds from asset dispositions and secure debt financing, the year end balance on the facility could be as low as about $150 million to as high as about $325 million if we continue to explore opportunities to place secure debt on a portion of the company's $1.9 billion of unencumbered assets. The company has the capacity under debt covenants to incur up to approximately $400 million in additional non-recourse debt.

Management has identified several pools of asset and is in discussions with several potential secured lenders. If needed, other potential sources of liquidity could include joint venture financing and credit lease financing on leases with highly rated tenants.

We expect the company's approach will provide adequate drive power on the unsecured credit facility throughout 2009 while reasonably meeting funding commitment. The company has no other near-term debt maturities with its senior notes maturing in 2011 and 2014.

And that concludes my prepared comments.

David Emery

Now we'd like to go to Mr. Whitman who'll give us more specific information regarding the recent investments and development activities.

Doug Whitman

Before I provide an update on our acquisition and development activity, I would like to comment on the operations of our existing portfolios. Despite the worsening economic recession, our portfolio of outpatient medical facilities is showing stability and even growth. The occupancy for our stabilized properties remained steady in the fourth quarter at 91%.

Compared to the fourth quarter of 2007, our same store NOI for master lease properties increased by 2.9% and by 3% for our owned and managed facilities. The weighted average rental rate for our owned and managed properties increased for the fifth straight quarter with rent on existing leases increasing 3.1% and on renewing leases by 6.4%.

For the year, the weighted average NOI per square foot in our owned and managed portfolio increased by 4.3%. While growth of this nature may sound counterintuitive during a recession that worsened throughout 2008, we believe it is further evidence of the stability of healthcare spending.

Secular trends and demographics, including positive growth and medical office employment, show rising demand for outpatient medical services, and Washington D.C. continues to demonstrate its desire to allocate ever greater amounts of federal dollars to healthcare.

Against this positive backdrop of healthcare employment and spending, we look ahead at 2009 when about 450 of the company's leases, with an average lease size of only 4,235 square feet, expired. The expirations are mostly related to acquisitions we closed in 2004, such as Baylor, Ascension and MedStar, and the five-year leases that were signed at the time.

Nearly three-fourths of the square footage related to these leases are in the owned and managed portfolio. We view this as an opportunity and expect that the leases will renew at favorable rates because 86% of them are an on-campus property, with nearly half being with hospital tenants like Baylor or Ascension. The characteristics of the expiring leases, in terms of tenant makeup and location of property, should provide securities that our core portfolio operations will remain stable.

Now some comments on our acquisition activity. During 2006 and 2007, prices for outpatient medical facilities reached record levels, and the company, unable to find accretive acquisition opportunities, mostly watched from the sideline.

In the second half of 2008, the acquisition landscape changed dramatically as we found several high quality properties to purchase at accretive prices. In 2008, we acquired 27 real estate properties, representing 1.6 million square feet, for a total investment of $335.6 million. Most of this acquisition activity occurred in the fourth quarter on the heels of our nearly $200 million equity offering in late September.

During the quarter, we acquired a 103,000 square foot medical office building in Indianapolis that is fully leased by three tenants on long-term, triple net leases. This property is adjacent to an Ascension Hospital on the city's north side.

We also purchased the remaining equity membership interest in a joint venture, which owns five on-campus medical office buildings in Washington State. In January, in conjunction with this transaction, we acquired the remaining membership interest in a joint venture, which owns a 62,000 square foot, fully leased on-campus MOB in Oregon.

We purchased the remaining interest for $4.4 million and assumed outstanding debts of approximately $12.8 million, baring interest at 5.91% and maturing in 2021. At the end of the fourth quarter, we completed our purchase of a 15 building portfolio totaling nearly 760,000 square feet from Carolina's healthcare system in Charlotte, North Carolina. It is the largest health care system in the Carolinas, the third largest public healthcare system in the country, and maintains an AA- credit rating.

The portfolio represents a mix of on and off campus assets from three hospital campuses around Charlotte. It is 90% occupied with a health system leasing 71% of the portfolio on long-term net leases averaging ten years.

With additional leasing at a newly completed building, coupled with annual base rent increases of 3%, we expect the yield on this Charlotte portfolio to increase to nearly 8% near the end of the second year. We are already having preliminary discussions with Carolina's healthcare on other investment opportunities as the system looks to grow in its primary service area and deploy capital more efficiently.

Finally, we acquired an 80% interest in a joint venture that purchased four outpatient medical facilities in the Des Moines area. With that joint venture partner, we have begun development of a non-campus medical office portfolio representing an investment of approximately $72 million, of which we have already provided $42.2 million in financing.

This project entails construction of six outpatient facilities, which are about 70% pre-leased. We anticipate funding the remainder of the project over the next 15 months. We have an option to purchase five of these buildings at a market cap rate upon each building completion, and achieving full occupancy. The sixth building will be acquired by the tenant upon completion later in 2009.

The lack of available credit and ongoing financial turbulence will likely limit the number of MOB transactions in the near future. We have begun to see cap rates increase somewhat, although the decline in deal volume will hamper any transparency in rate. We are certainly seeing an increased number of attractive acquisition opportunities, diversified in geography, deal size, and type of seller, but the frenzied competition to complete transactions has vanished.

Some comments about our development. With the completion of our project in Scottsdale, Arizona in December, we now have seven buildings, representing about 725,000 square feet, and the lease up phase. In addition, we have four buildings representing approximately 488,000 square feet in CIP. All of them have seen leasing activity throughout the fourth quarter and into 2009.

Over the past few months we have received signed NOIs for over 55,000 square feet including NOI for over 20,000 square feet in Colorado Springs from a prominent multi-specialty group. We have had material ongoing discussion with over 275,000 square feet of potential tenant representing nearly a quarter of our developing pipeline.

These negotiations include four ambulatory surgery centers, three imaging centers, three orthopedic practices, a large oncology group and three multi-specialty physician practices. This leasing activity, which seems counter to the conventional wisdom that tenant's interest in new developments has evaporated, is due in part to the dissimilar nature of the markets we're building in and with healthcare employment in general.

As the national unemployment rate surged to 7.6% last month, in the markets where we're developing the unemployment rate was just above 6%. While hospitals and physician offices have added 144,000 and 73,000 jobs respectively, nationally businesses have shed 3.6 million jobs since December 2007 when the recession began.

While leasing any real estate project in the current environment is certainly challenging, the macro trends in healthcare plus the relative economic strength of the market where we're developing should result in successful projects.

Furthermore, we have an extensive experience in medical office development. Over the past decade we've developed nearly one million square feet of space and our current activities are tracking historical patterns. As we've said before, leasing medical office space does not occur in an orderly linear manner and our development budgets have always assumed a conservative lease up period.

In conclusion, the quality and stability of our existing portfolio, as evidence by our occupancy and rental rate growth, are valuable assets in a period of economic uncertainty. We will pursue future investments selectively being careful to balance the ability to add quality assets to our portfolio with the need to preserve capital and financial flexibility.

We are pleased with the ongoing positive performance of our portfolio and expect that 2009 will be a year in which that progress will continue.

David Emery

Now operator we are ready for the question and answer period.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rob Mains.

Rob Mains – Morgan Keegan &Company

Couple questions, first of all, you mentioned the secured debt environment, could you describe a little bit how that looks right now for medical office buildings? I know that the agencies are still active in senior housing just want a sense as to what you're seeing for medical offices.

David Emery

Rob, the backdrop is that from mostly the secured financing is the insurance company market. They're about the only people in that sector providing secured financing. On medical office buildings historically for many decades, delinquencies and defaults medical office building has the lowest rate of any real estate type or class in the United States.

So, most life insurance companies know that MOBs in the past have had a very low correlation regarding economic trends so on and so forth. We have had a high level of interest, I think because of that. Also I think because the quality portfolio obviously the rent growth is a good backdrop for that.

I would say as far as rates we are kind of seeing quotes right at 7% with terms that are seven to ten years something like that. So we began to kind of stir on that, as you know, a little bit in the fall. We're pleased with the level of discussion we're having on that.

Rob Mains – Morgan Keegan &Company

Okay. Then the one MOB that was scheduled for 2010 in Texas, could you go into your thoughts behind into putting that off for now?

Doug Whitman

The one that we changed the land held for development.

Rob Mains – Morgan Keegan &Company

Yes.

Doug Whitman

Okay. It was two parcels contiguous to each other. We bought the front and back parcels we opted to develop the back parcel first, and just merely holding onto the front parcel, which is probably the better parcel in the long run until the environment improves a little bit and we complete the one in the back.

We have every intention of developing it. This empty parcel will actually now will then be the same which in between the hospital, which is across the street, and also where we bought a building in 2007 and our new development. So this empty parcel in the middle sort of completes the canvas.

Rob Mains – Morgan Keegan &Company

Okay. So it is clearly just a postponement.

Doug Whitman

Correct. Yes.

Operator

Your next question comes from Tayo Okusanya – UBS

Tayo Okusanya – UBS

Just a couple of questions, in regards to the lease up project, I know you talked about in January you're starting to see some activity and some interest for the Texas project, but in regards to Colorado, the NOI changing so much to negative 437 during the quarter from negative 98 in 3Q.

Could you talk about what caused that difference? Then on the Texas project as well, although there was no increase in occupancy, the NOI actually went up pretty well almost doubled on a quarterly basis. What's going on there as well?

Doug Whitman

I'll take the Texas ones first. Leases have been signed and they show up in the supplemental data as a signed lease so the tenant may not have actually taken occupancy as the space is still billed out. And so when tenants actually take occupancy of their space and pay rent you will see the NOI increase, even though the lease number may not have changed. Conversely on the Colorado property, you're seeing a full quarter of operating expenses on that building when it opened in the third quarter. I think it opened during the period.

Tayo Okusanya – UBS

And then next question in regards to acquisition activity out there, although there is not a lot, can you give us a sense of what you've seen cap rate wise?

Doug Whitman

That's a big question. Cap rates wise it's a bit out spread, it's fairly wide. We have told our folks start some discussions at the 8% to 9% rage and see if they call you back, and in many instances they still are. So the cap rate will just depend a little bit on the nature of the seller and whether he or she has debt maturity or what his or her circumstances are, but I think we're certainly creeping higher.

If it's a stellar portfolio sold by a hospital you might still get 7, 7%, but I warrant off kind of thing is certainly going to be much higher. So this I think the range of cap rate now has exploded and I think our previous efforts to get cap rate.com going or supported by all this activity.

Operator

Your next question comes from [Connor Feneti] – Deutsche Bank.

[Connor Feneti] – Deutsche Bank

I just had one quick question, have you guys had any conversation with any of the tenants about 2009 rents or expirations?

David Emery

Well as a process we have a perspective renewal schedule on each building and we discuss those. Physicians like to hear about their rents a long time ahead of time so I would say we've already had discussions with most of our tenants about any renewals that are happening in '09.

To the best of my knowledge, we have not had any indication that there are any issues regarding any of those renewals, and when we have those discussions we do tell them what the rent is going to be not just the fact that we need to sit down and negotiate or talk. So right now we're keeping our fingers crossed but everything seems to be tracking historical patterns.

[Connor Feneti] – Deutsche Bank

Okay. And then regards to rent growth you except low single digits or flat to last year? Or excuse me to where '08 leases were signed?

David Emery

No. We expect that probably we will eke out about the same amount to 3%, 4%, 5% in that range because we haven't really received any indication that it may be otherwise. And to some degree and one of the overall thing from the standpoint of the economy is that people tend to stay a little more stay put during this kind of environment so that actually might help us on renewal rates.

Operator

Your next question comes from [Doug Sanfisto]

[Doug Sanfisto]

Just a couple of questions, and I may have missed this. But it looks like the underlying occupancy in the nine properties under the operating agreements fell by about 10%. Can you just talk about what's driving that decline and your outlook for those assets going forward? I mean I know that you guys are receiving 100% on an economic basis, but nonetheless.

Scott Holmes

Well this is Scott. I think probably what's happened is there's just been no drop but we've seen some properties that are no longer covered by TOA that have dropped out of the mix. So of the properties that remain that are covered by TOA, they has been no decrease in the occupancy in those.

We're just looking at a different sub set of properties. Now the ones that expired at the end of the year were very highly occupied, so they're now out of the mix.

[Doug Sanfisto]

And are you anticipating the ones that are still in that mix getting leased up over the next 12 months?

David Emery

Well they are in essence already highly leased so a lot of times the property operating agreements on hospitals it's kind of a two-edged sword. The hospital is not necessarily interested increasing rent as much as we were. So a lot of times to some degree it's to our advantage even though there's some interim pain for us to not elect to renew some of these POAs even it we want to.

So to some degree with some interim kind of pain, but our experience that we've had on the particular campus that I think applies to this question is we had one, what's that Scott a year ago, year and a half ago?

Scott Holmes

Middle of '07.

David Emery

Yes, '07 that expired and we've actually during that period of time the rents are pretty much now back to where they were before. We were even able to increase some rent to 24%, 26%. So to some degree it's a little bit of anomaly that, because there is a difference between the POA and the underlying, it doesn't necessarily reflect that there's any in essence basic economic difference.

[Doug Sanfisto]

And then can you just talk a bit further about the conversations that you've had with some banks surrounding the credit facility, and if you have any thoughts on where the spread will go. And if not or if you don't want to discuss it right now, should we just simply expect it to be fairly consistent with the increases that we've seen recently from some of the other non-healthcare focused regions?

David Emery

The crystal ball here is kind of foggy. I think, as far as the talk that we've had with some people who are even in the market now and with some of the banks who are considering those renewals and those kind of things, I think there's a general backdrop that there may be some issues from some banks to some banks because of mergers and acquisitions and some of those kind of those things.

But we're pretty fortunate on that front and that we don't have anybody who's kind of like crippled their size or doubled their size because of that. So to some degree pricing, I don't really know because there really hasn't been any data point. But I think, as far as terms and conditions, Scott you have anything to add?

Scott Holmes

I think the ones that are in the market now, the terms and conditions are fairly consistent with where they have been. We're kind of hearing generally speaking in the LIBOR plus 300 plus basis point range. I don't know if that's going to be the final answer on any of these or not, but that's the noise we're hearing, and we're currently at LIBOR plus 90. So that would be for us, if it were 300 that would be a little over 200 basis point increase in the rate.

David Emery

If you have some other color you could share with us, we'd appreciate that.

[Doug Sanfisto]

I think that the 300 basis point range is actually pretty consistent with what we've seen thus far. And I guess just lastly, can you just help us understand your view on the dividends since, based on our sort of numbers it remains slightly unfunded and given the appearance focus on maintaining liquidity, have you had any discussions with the board, and also what are your thoughts on the cash stock payout?

David Emery

Well I'll take the last one first, cash stock. We don't really see issuing stock at these levels has been anything that's in our particular case would be beneficial for anyone. On the first part of your question, I think the premise that you use as being uncovered I think is incorrect. I think we do a quarterly cash flow statement monthly.

I think we're probably only read I think that does that and that's in accordance with GAAP and FASB 95. And that basically is the tool that we use to measure dividend policy and otherwise and so that's kind of our guide as to coverage and those kind of things.

As far as discussion with the board, we have the discussion every quarter regarding forecast and coverage and all those kind of things, and there has not been any discussion about any change in the dividend policy.

Operator

Your next question comes from Jerry Doctrow.

Jerry Doctrow – Stifel Nicolaus & Co

Just a couple of things, David, there's an item in the K about master leases, which I think you've touched on maybe in general. But just like to understand a little bit more about your rational for letting them expire? And you suggest, I think by some language in there, that you could see some dip in income initially and then rebound. Just any sense of quantity what kind of magnitude we're talking about there.

David Emery

Doug, do you want to respond to that?

Doug Whitman

Well some of master leases that have expired are multi-tenanted facilities so we are now just the landlord too, but we're previously the sub tenant, and as those leases roll we have begun to increase, sort of like what we do when the POA expires, increase those underlying rents, which have been kept part officially low.

And we've had good luck I know in a couple instances in Florida where that's happened, where properties underlying rents are now increasing quite a bit. I don't know if it's a magnitude yet off top of my head we can keep look that up and follow up, Jerry.

David Emery

Well, Jerry in general we really don't want to have any master leased buildings that are sub tenanted. We think that if there's any credit enhancements you might get from somebody who is master leasing the building is offset by opportunity and growth. And so I think you'll find anytime we have the opportunity to get out from under a master lease that has sub tenant income, we would try to do so.

Jerry Doctrow – Stifel Nicolaus & Co

And again, just that line sort of saying that you might see some short-term impact.

David Emery

I think that's just a normal affect, but obviously we're owning the building for a long time and we certainly have a fairly high degree of correlation regarding the stickiness of tenants and our ability to increase rent over the last seven or eight years I guess it is. We've been able to increase rents basically the rents now are about 135% of where they were in 2000, and compared to general office, which is about 102% of where they were in 2000.

So in that kind of backdrop, I think that getting control of the sub tenancy in the long run is the right thing to do, even though there's some interim kind of pain related to that because you can't change the rent immediately. But also we have the benefit that we have short-term leases. So we don't have any master lease building that's got sub tenants in it on 10 or 15-year leases.

Jerry Doctrow – Stifel Nicolaus & Co

And what you're losing is sort of just the rent on whatever that unoccupied portion is before you can raise the rent?

David Emery

No. It's more related to the rent differential.

Doug Whitman

It's not vacant space.

David Emery

It's not vacant space. In other words, the hospital, as you heard me say, would give them the rent or would give them space. So to some degree the only imperative there are under is the star clause that they have to charge market rent. But that's also a band, so you can kind of guess which end of the market rent band they are at, which is the lower end.

Jerry Doctrow – Stifel Nicolaus & Co

But you don't expect to see a meaningful hit, like am I going to see $0.02, $0.03 pop off earnings as you begin to roll these buildings over or is it just not that material.

David Emery

No it's not a material thing. It's real muddy, Jerry, but it's not material.

Jerry Doctrow – Stifel Nicolaus & Co

In terms just asset sales, you've now got $90 million on assets held for sale. There's some additional stuff you identify as potentially going. I guess the two questions here are do you have a sense of what total sales might be in '09. And can you just give us a little color on I mean I know these things are covered by prior agreements, but what sort of cap rates and stuff you're selling the existing assets for.

David Emery

Doug?

Doug Whitman

They range, I think, typically in the 7% to 8% of some of these sales, the Cheyenne one that we recently completed, that was done at a market rate and a very aggressive cap rate. They wanted that property so they paid up for it. So again, it just depends kind of on the motivation of the seller.

David Emery

And the size, Jerry, has a lot to do with it. Some of these properties have some vacancy in them and they sell and the cap rate's a little bit distorted.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay. And then just I'm assuming we should expect the whole $90 million that you've got assets held for sale to go some markup from book on those. And then you identified another $19 million or so that you expect to be exercised in '08. Is something on that order [inaudible] kind of projection of what kind of sales levels you might achieve?

David Emery

Well, it kind of depends, Jerry, on which ones actually do sell. Sometimes these things have to go into held for sale because the purchase option's been exercised and there are gross investments or fair value, whichever is higher. So, if it's a fair value it would reflect current cap rates, so my guess would be that it's unlikely that all of the items in held for sale will be sold. But I suspect at least half of them maybe three quarters of them will be. It's hard to say right now with any degree of accuracy.

Doug Whitman

Some of the people that exercised may not be able to follow through on their commitment.

David Emery

Exactly. And we can't really gauge that too well.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay. And you just move them as soon as if they're specified dollars and the sale; it's just that they're covered by agreements so you move them into held for sale?

David Emery

Correct. And if they sell they'll be gone, if they don't sell and lessee is not able to get the financing and so forth so the probability drops to a low level then we may be in a position of moving those back into the portfolio.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay. And last just on some of the renewals releasing again, you sort of touched on this in general terms. So of the percentage of the stuff that you've got, I think it's like 22% or so, the leases roll in '09. You've indicated you expect a fairly high renewal rate on that.

I was just wondering if either based on past experience of your sense from discussions already, you can give this a sense of what percentage of that is renewal, what percentage of that might be releasing. I think on releasing you've got a little bit higher rent increases, so just trying to get a little bit more color of what's going on in there.

David Emery

Jerry, just from a profit statistical standpoint, it would not surprise me that we probably approach 100% of the renewals in this kind of environment, but I think if your kind of asking a modeling kind of question, you might se 10%, 15% as a release, Doug I don't know what do you think?

Doug Whitman

Yes. Because so many of these properties are on campus and have such a heavy hospital [inaudible] I think that you will see that in our renewal percentage.

David Emery

Right, 86% of these, Jerry, are on campus so it would surprise me if we don't do 100% of those.

Jerry Doctrow – Stifel Nicolaus & Co

And do we know how much square footage we're talking about in that space as opposed to sort of dollars of leases.

David Emery

Doug got his calculator out. You mean just the amount of square footage.

Jerry Doctrow – Stifel Nicolaus & Co

Right, that's being released.

David Emery

That's up for …

Jerry Doctrow – Stifel Nicolaus & Co

It's up for renewal right?

David Emery

It's up for renewal.

Doug Whitman

It's about two million feet

David Emery

Two million feet, but the average lease size is 4,235 feet so that's manageable.

Jerry Doctrow – Stifel Nicolaus & Co

I think one of your competitors has about $10 a square foot on TI for renewals, $30 per square foot on releasing NTI, your numbers sort of in that ballpark, below, above?

David Emery

No. I would say that our usual…

Doug Whitman

Their shopping Expo and we're shopping at Home Depot.

David Emery

I'd say that our usual experience is on release it's about $1 a foot a year I guess, something like that for renewals.

Jerry Doctrow – Stifel Nicolaus & Co

So, but you're signing five-year renewals or something like that typically.

David Emery

Well, they're three to five. I think we're trying to keep them as short as we can so we're trying to get the average down to three and a half or four. As far as re-letting space, as you know Jerry you've been on some of these tours, a lot of the times when you relent the space to another physician it's not like going from an insurance agency to a lawyer's office where you have to tear it all out and start over.

So to some degree the space is useable in high degree to the next tenant. We may have to change, put a sink in a certain exam room or some kind of something like that, but even the releasing is not big numbers.

Operator

Your next question comes from Stephen Swett – KBW.

Stephen Swett – Keefe, Bruyette & Woods

A question for Doug, I looked through the 10-K but I didn't see it anywhere. Can you just be specific on the Carolina acquisition, the size and the closing date?

Doug Whitman

The closing date was December 29th and dollar amounts?

Stephen Swett – Keefe, Bruyette & Woods

Yes, dollar amount.

Doug Whitman

One hundred and six-two million dollars.

Stephen Swett – Keefe, Bruyette & Woods

Scott, on your discussions on the line renewal, have the banks indicated that they'd like to see that balance paid down or is that just a non-issue for them?

Scott Holmes

That's been a non-issue. There's been no discussion about that.

Stephen Swett – Keefe, Bruyette & Woods

Okay. And you said the renewal should happen sometime around mid-year?

Scott Holmes

Yes, that would be my guess. We don't want to wait too long but we would like for the markets to clear as much as they can. And I would point you Steve to your footnote four to the audited financial statements has a pretty thorough discussion about the Carolina's portfolio in it.

Operator

Your next question comes from Michael Mueller – JP Morgan.

Michael Mueller – JP Morgan

Following up on some of Jerry's questions from before, looking at the POAs looking at the master leases burning off. I know you had tried to address it saying the '09 expirations, 7 of the 14 won't be material. When we combine that with say the five POAs that burned off plus the other expected one in 2009, can you still make that same blanket statement that NOI, you're not really going to see it miss a beat.

David Emery

Let me correct you, we didn't tell you we wouldn't miss a beat.

Michael Mueller – JP Morgan

Okay, well how significant of a quarterly…

David Emery

Well, that depends upon which lease it is, how much we can renew it for and the timing of those. So if you want to take the number and divide it by 24 and average it out you can do that. I don't know if there's a particular number we'd come up with.

Doug Whitman

If you took away as an example in Fountain Valley, California where we had one POA expire in the middle of 2007, the rent that we've been able to negotiate with the tenants who are now not covered by the POA those rate increases have been on average 21%.

And the other four Fountain Valley properties, which at the time were still covered by the POA, have all now since expired, was only about 10%. So you can see as those leases roll we're able to get a doubling of the renewal percentage.

Just by way of example, in the Fountain Valley portfolio over half the space will turn between 2009 and 2010 so it'll take up to a couple years to kind of claw back, but throughout they year we'll be able to make new steps toward getting back to where we were.

Michael Mueller – JP Morgan

Okay. And if you're comp growth has been running I think it was close to 3% in the fourth quarter, is the short-term impact of this enough to take it down to zero to one to two. I'm still trying to get a better handle of the short-term impact understanding that it takes an year or two to get to breakeven?

Doug Whitman

The yield on the Fountain Valley stuff even with all the POAs gone the yield on that portfolio when blended was over eight. It's just the underlying tenants, even with their below market rates is still generating an eight. It didn't disappear off a cliff into zero.

David Emery

If you need more on that we can drill down on it, Mike, just give us a call.

Michael Mueller – JP Morgan

Last question, in terms of the secured debt pricing, not necessarily pricing, but the amount raised, now Scott, you talked, I guess you backed into it with the line balance being at a certain level by year end. What's a rough expectation about how much do you think you had raised on the secured debt side? Do you think it's $50 million, $100, million $150 million?

David Emery

Well I don't really know, I guess our feel is it's probably between $50 and $100 will be fairly pro forma. It's just depends on the level of interests. One portfolio we have is 71% occupied by AA rated credit. In this environment that's probably going to be something that we can do. That itself would be close to $100 million, I don't really know, but I think $50 to $100 might be in the amount. Scott, is that what you…

Scott Holmes

I'd say $50 to $150. That would be my expected range.

Operator

Your next question comes from Rosemary Pugh – Green Street

Rosemary Pugh – Green Street

First question is it true that most of your rent escalations are CPI driven, and what does this mean for your near-term?

Doug Whitman

I would not say that most are, I'd some of them are, a lot of them are fixed percentage increases.

Rosemary Pugh – Green Street

So what percentages are CPI's driven?

Doug Whitman

I don't know off the top of my head, I'd have to look it up. Rosemary, we'll get back to you on that number.

Rosemary Pugh – Green Street

HealthSouth has been paying $2.5 million in replacement rent for three inpatient rehabilitation facilities sold in '05 and the lease term for this rent payment ends in mid-2009. So my question is what are the prospects for you to get this replacement rent that was rolled into other leases renewed?

Doug Whitman

It is very good. We have identified a different facility in southwest United States that will replicate about 50% of that replacement revenue and that will start sometime this year. We have another facility that will probably start in early 2010 that will probably pick up the remaining balance.

Rosemary Pugh – Green Street

So these are new acquisitions?

Doug Whitman

Yes. They are new facilities for us and new facilities to the health system.

Rosemary Pugh – Green Street

So you'll be acquiring them later in the year?

Doug Whitman

Yes.

Rosemary Pugh – Green Street

What is the expected yield on the construction project you funded with $42 million loan if you decide to purchase the building and if you don't? You mentioned that there is an exit fee and it wasn't specified the amount, just trying to understand the returns on this project, can you give us?

Doug Whitman

Currently we're providing construction financing to the developer on those and if we choose not to purchase the facility at our option, we are merely paid the construction interest on that. I think if we opt to purchase facility, it would be at a market cap rate and we recently actually closed on first of the five that we're eligible to and its yield up into the mid to high eight fully leased.

Rosemary Pugh – Green Street

Can you give us any background on the credit profile of the joint venture partner?

Doug Whitman

Joint venture partner is a local developer in the Des Moines area, probably launched in the credit profile a tenant, which is Mercy Health System which is part of CHI system.

Operator

You have a follow up from Rob Mains.

Rob Mains – Morgan Keegan & Company

A couple of quick numbers questions, Scott. First of all the bad debt that you incurred in the quarter, is that the end, there is nothing recurring there that we should go back to a kind of normal level in 2009?

Scott Holmes

That's correct. It's bad debt expense, it's not going to recur, and it won't have any effect on the level of income that we've been recording.

Rob Mains – Morgan Keegan & Company

Then the other question on another of the one-time items, the streamline rent income that you realized in the quarter that fell into the interest and other bucket, your interest and other bucket was still up, the mound was still up excluding that from the third to the fourth quarter. Was that the spike in the interest rate you got earlier into the year or is there something else going on that we should be looking at a higher level going forward?

Scott Holmes

I'll have to dig into that question and answer that offline, Rob. Right off the top of my head, I don't recall anything specific going on there. That's the line that has lease guarantee income and all kinds of stuff going through it, I'll look at that and chat with you offline about it.

Operator

Your next question comes from [Ben Lentz].

[Ben Lentz]

Just on the POAs again, sorry to belabor this point. My understanding of the underlying theoretical foundation of how it works was confused a little bit in Jerry's question. When you say you don't really get any of the loss in vacancy when the master lease or the POA is expired, does that mean the hospital covers the vacant portion after the master lease is gone or do you actually have vacancy?

David Emery

No. The interesting thing here is most all these buildings are nearly 100% occupied.

[Ben Lentz]

Is it just the Katrina buildings that drag it down to the 64%?

David Emery

No. It's different properties in different places but a lot of it just has to do with the hospital from a standpoint. I guess maybe I'm wrong, some buildings we have hospitals sometime say don't lease that floor because we want to keep that floor open for recruitment or special things or whatever, sometimes those factors involve. A lot of times it's just related to the difference in rent.

[Ben Lentz]

My understanding was that the rent per square foot paid in the POA would probably be less than you would get from the tenant but you are going to get a lot more vacancy because they are not 100% occupied. From the comments that you said to Jerry now I thought that maybe that wasn't true that the hospital would cover the vacant portion and the rents would actually be below what is implied in the POA.

That is where I'm confused. Do you have a vacancy loss when one of these master leases or the POAs is terminated? Do you receive 30% vacancy because it's only 70% occupied?

Doug Whitman

It's going to vary by building. The ones that expired in California at the end of December, there were four of them that expired, their average occupancy in those buildings were 90% plus. So even though the POA expired, it did not leave a bunch of vacant space generating no income.

[Ben Lentz]

The ones that are going to expire in 2009 are 64% occupied?

Doug Whitman

The one that expires in 2009 is 100% full. The ones that have vacancies don't expire until 2016 or 2017.

[Ben Lentz]

So when you use the footnote of the nine properties that are in there that is not referring to the ones that are expiring.

Doug Whitman

No. Those are the ones that are still in existence.

[Ben Lentz]

So they're going to go for the long-term so the near-term impact we'd see in nine and ten is going to be deminimus and that's where your comment to Jerry came from.

David Emery

Yes, that's right. I apologize for the confusion.

Doug Whitman

Part of it's looking back and part of it is looking forward.

Operator

You have a follow-up from Rosemary Pugh – Green Street

Rosemary Pugh – Green Street

What was the gain over undepreciated book value on the Cheyenne sale? The Wyoming MOB that you sold?

David Emery

Let me reach into my bag of tricks and answer that. The gain was about $5.6 million and the investment was around $20 million and the proceeds in total were around $21 so I'd say about $1 million.

Operator

I'm showing no more questions at this time, sir.

David Emery

Well, we appreciate everyone being on the call today and all of us will be around today if there needs to be any follow up questions or any clarifications. With that, we bid you good day.

Operator

Ladies and gentlemen, this does conclude today's conference. You may now disconnect.

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Source: Healthcare Realty Trust Inc. Q4 2008 Earnings Call Transcript
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