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Executives

David R. Emery - Chairman and Chief Executive Officer

Scott W. Holmes - Chief Financial Officer

B. Douglas Whitman II - Chief Operating Officer

Bethany Mancini - Corporate Communications

Gabrielle Andres - Corporate Communications

Analysts

Rich Anderson – BMO Capital Markets

Jerry Doctrow - Stifel Nicolaus & Co.

Robert Mains - Morgan, Keegan & Co.

Michael Mueller - J.P. Morgan

Jim Sullivan – Green Street Advisors

David Aubuchon - Robert W. Baird & Co.

Healthcare Realty Trust, Inc. (HR) Q2 2009 Earnings Call August 11, 2009 10:00 AM ET

Operator

Welcome to the Healthcare Realty Trust’s second quarter financial results conference call. (Operator Instructions) Now, I would like to turn the conference over to Mr. David R. Emery. Mr. Emery please go ahead.

David Emery

Good morning everyone. Joining us on the call today are Scott Holmes, Chief Financial Officer; Doug Whitman Chief Operating Officer and Bethany Mancini and Gabrielle Andres in communications. Now, Ms. Andres will 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, and the Form 10-Q filed with the SEC for the quarter ended June 30, 2009. 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 may be found in the company's earnings press release for the second quarter ended June 30, 2009. The company's earnings press release, supplemental information, Form 10-Q and 10-K are available on the company's website.

David?

David Emery

Thank you. The company had another stable quarter with rental rate increases averaging 7.7% on renewals and an overall occupancy of 91% reinforcing we believe the defensive nature of core portfolio of outpatient and medical office properties.

Our development and acquisition activities continue to be robust with over $300 million of new investments being reviewed and about $175 million under construction. I am particularly pleased with the progress made during the quarter on the renewal of the bank credit facility and the commitment indications we have received. We expect the renewal will proceed smoothly in the coming weeks.

As was recently announced we were delighted with the outcome of the secured financing effort and working with the folks at Holiday Fenoglio Fowler. The company received over $600 million in offers from nearly a dozen lenders. Establishing our relationship with the venerable mortgage lender, TIAA, the company has expanded its funding options for worthy investments in the years to come.

Our solid capital position supports our strategy to increase acquisitions in the coming months. In fact, we believe more activity will occur in future quarters than we have seen in several years. Historically the best investment margins follow an overheated real estate market.

Health insurance reform is still dominating headlines and we expect given the current legislative environment that changes will most likely be incremental and a net positive for our business model which is focused on properties that have lower cost setting for healthcare delivery. Any legislative program that increases the insured populace will result in a need for more physicians and treatment facilities. A recent published report estimated that expanding coverage could generate a need for more than 200 new medical office buildings.

We believe that Healthcare Realty’s facilities will continue to serve a strategic role on hospital campuses particularly as health systems enhance their physician recruitment and outpatient initiatives while looking to preserve capital through investment partnerships. With the continued positive performance of Healthcare Realty’s core portfolio and it strong balance sheet the company is well positioned to execute its growth plans while maintaining its low business risk profile.

Now I would like to turn it over to Ms. Mancini to expand on the trends in healthcare. Bethany?

Bethany Mancini

Thank you David. The healthcare industry continues to prove its stability, even profitability, despite sustained economic pressure, high unemployment and uncertain surround health insurance reform. Hospital companies reported positive earnings for the second quarter with surprisingly stable volume and bad debt expense. Patients continue to follow long-established demand patterns for hospital and physician services which drives the low risk, need driven dynamics of medical office real estate.

The CMS has released its 2010 ruling for Medicare reimbursement to healthcare providers although Congress will likely change these payment rates as part of a health insurance bill later this year. Payments to physicians formulated to decline 21.5% are at the forefront of the Congressional agenda and should end up flat to slightly positive for 2010. Final rulings for Medicare payments to acute care hospitals and other providers are mostly in line or better than proposed rules and put off payment cuts necessary to catch up with over spending for past years now sustained beyond 2011.

The political sensitivity of healthcare is a dynamic that tends to offset reimbursement risk and ensures consistent growth in payments over time. The details of health insurance reform are continuing to be worked out in the Senate Finance Committee and the House committee Health Reform draft has been prepared to take to the floor for a vote in September. While significant debate surrounds the various reforms under consideration, it is likely that the nation’s healthcare spending and the government’s responsibility for funding that spending currently at 46% of $2.2 trillion will keep growing.

If reform is even partially successful, demand for healthcare providers and medical facilities should increase. However, the cost of expanding government insurance coverage could require lower Medicare payments to providers as the government will have to curtail profit margins wherever it can in order to pay for its burgeoning role and payment responsibility.

Hospital groups have promised to lower the rate of spending growth, agreeing to a possible 1.5% reduction to the expected $1.5 trillion in Medicare payments for acute care services over the next 10 years. The government is also focused on reforming the efficiency of the current system, specifically its suppliers, to save costs. Hence the call to mandate provider efficiency and pay per performance, to prohibit physician owned specialty hospitals, to provide additional disclosure by not for profit hospitals and other efforts that could target provider profit margins.

While the likely outcome of insurance legislation is not certain, it seems probable that an increasing number of people will be covered by government plans in 2013 and doctor’s revenues could decline under public regulations offsetting the benefit of higher patient demand. We could also see a shortage of physicians and longer wait times. However, the government is committed to providing incentives for increasing the number of physicians. Medical schools could expect more applicants and foreign doctors could become more prevalent. In fact, other developed countries with nationalized healthcare currently have more physicians per capita than the United States.

Critical to Healthcare Realty’s low business risk profile, our physician tenant’s average more than 8 times in rent coverage, making medical office one of the safest places for investment in healthcare even if profit margins fall.

In the end, while we can see potential for significantly higher demand for medical office space and lower cost of care outpatient settings, Healthcare Realty is also realistic. The pressures on physicians and hospitals will keep expansion efforts measured and slow. We expect our existing facilities and new developments to remain vital to hospital systems’ growth strategy.

All in all it remains probable a health insurance reform bill could pass this year and prove a net positive to the company’s sustainability and growth in 2013 and beyond.

David?

David Emery

Thank you Bethany. Now over to Scott to give us an overview of the numbers and some comments on other financial activity. Scott?

Scott Holmes

The company’s form10Q containing 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 the form 8K to supplement the form 10Q 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 second quarter of 2009 continued according to the NAREIT definition was $0.44. This quarter was subject to certain quarterly fluctuations in certain line items and of course does not reflect the higher capital costs of the refinancing activities currently underway. The effect of refinancing appears to be reflected in the range of published street estimates of FFO for the year 2010.

FAD per diluted share for the second quarter 2009 was $0.48. 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. A more complete discussion of quarterly operating results can be found in management’s discussion and analysis of the results of operations included in the form 10Q filed yesterday afternoon.

Through the first half of 2009 portfolio operating results continued to indicate no cause for concern with respect to negative impacts from this difficult economy. The three leading indicators of trouble in our business would be lower occupancy, increasing delinquencies or erosion in renewal rental rates. All of these indicators remain steady for the company and we credit this result to the uniqueness of our medical office portfolio and its tenant diversity, the average tenant lease being about 4,000 square feet.

Regarding the balance sheet, capital structure and access to the capital markets, the company maintains a simple but strong capital structure and remains in compliance with all debt covenants. At June 30th the leverage ratio was 44.9%. The equity and unsecured debt markets have continued to improve as evidenced by the many offerings in the market in recent weeks. The unsecured debt market is now a viable option to turn out the company’s unsecured credit facility or provide funding for worthy accretive investments.

The company has made meaningful progress in managing its maturities. By the end of next month the company expects to have greatly reduced the outstanding balance on the unsecured credit facility with secured debt proceeds and through entering into a new facility that will mature in September 2012.

Two weeks ago the company announced agreements with one lender for new secured debt totaling $207 million, having a seven year term and 30 year amortization with interest at 7.25%. The secured debt is expected to close by September 30th with proceeds used to pay down the secured credit facility. The loans have two one-year renewal options and the security for these loans is 29 properties with a net book value of $325.1 million and with an overall loan to value of approximately 55%.

Following several months of discussions with banks currently in our unsecured credit facility and with a number of new banks, the company has just launched the renewal of its $400 million facility which matures in January 2010. The renewal is expected to be completed next month and the term of the new facility should be 3 years. We expect the size and the financial covenants to remain the same and the new interest rate to be in the range of 280 basis points over LIBOR. The facility fee should be about 40 basis points and commitment fees about 100 basis points.

The company anticipates all of the banks in the existing facility to be in the new one and that several new banks will be involved. Based on commitments and indications so far, we are comfortable that it will be sized at $400 million or perhaps more. The company has no other near-term debt maturities with its senior notes maturing in 2011 and 2014. Our conservative stance and simple capital structure and our patience with the markets have served us well.

I am very pleased with the progress we made this quarter in managing the balance sheet and we appreciate the confidence shown by the secured lenders and our bank group. We believe their confidence validates the consistent performance and low risk nature of the company’s portfolio.

That concludes my prepared comments. David?

David Emery

Thank you Mr. Holmes. Now on to Mr. Whitman to give us more specific information regarding recent investments and development activity and operations. Douglas?

B. Douglas Whitman II

Before I provide an update on our acquisition and development activity I would like to comment on recent property level operations. Our portfolio of outpatient medical facilities has again this quarter despite the economic downturn shown both resiliency and growth. The statistics for our second quarter operations demonstrate this.

For the quarter the occupancy rate of our stabilized properties remained steady at 91%. Compared to the second quarter of 2008 our same store NOI for master lease properties increased by 3.2% and by 2.4% for our owned and managed facilities. Our focus on increasing our property top line continues to yield results. Rental rates on leases renewed during the second quarter increased by 7.7%. Over the past 12 quarters the average rental rate increase on lease renewals has been 7.3%.

This ability to push rental rates even during the recession can be attributed to several factors; on campus medical office space has two substitutes though demand is more [inaudible]. Our average tenant size is only 4,100 square feet so we have better leverage in lease negotiations and physicians tend to cover their rent 8 to 10 times so occupancy costs are only a modest amount of their practice expenses.

We believe our portfolio comprised primarily of on campus, multi-tenant and outpatient facilities will continue to see solid growth in rental revenue. As I mentioned on the last call, this potential to renew leases at higher rates is why we see the expiration of master leases as only a temporary setback. Six master leases expired during the quarter. One small property was sold. Another small building is vacant and is being marketed.

The other four properties, representing 90% of the expired square footage have existing physician sub-tenants in place. In fact, the rental revenue from these assumed sub-leases is actually 2% higher than the master lease revenue we formerly received. When these sub-leases come up for renewal in the coming quarters we will seek to negotiate increases similar to what we have seen historically in our managed portfolio.

As you may recall we have a large number of leases in our managed properties expire in 2009. We have been very successful in renewing those leases nearly 95% of those tenants still in place. Tenants are staying put and signing new leases. In early July Baylor renewed over 266,000 square feet and we expect this success in these new leases will continue throughout the year.

Now some comments on our acquisition activity. In July the company through its joint venture with a Des Moines based real estate firm acquired a 22,000 square foot medical office building for $3.6 million that is 100% occupied. Later in the month the joint venture also acquired 100% occupied, 63,000 square foot health facility for $21 million. Both properties are in the Des Moines market.

While the second quarter MOB transaction volume across the country was the lowest it has been in 6.5 years we continue to see signs the number and quality of acquisition opportunities are improving. We know that credit constraints continue to limit the nature and number of firms vying for these opportunities. IN addition we will be watching to see if the overhang of healthcare reform has any impact on potential transactions. Will respective buyers be more timid given the uncertainty around the reforms? Will perspective hospital sellers be more aggressive in their efforts to divest MOB’s in an effort to improve their balance sheet and focus management attention on their core business?

Regardless, we expect the renewal of our credit facility and establishing relationships with secured lenders will enhance our ability to take advantage of upcoming acquisition opportunities.

Now some comments about our development activity. Work continues on the four buildings currently under construction with one project finishing this month the others finishing in December or January. Tenant interest in these four projects as well as recently completed projects in the lease-up phase continues to be strong. We signed a 10,000 square foot lease with an imaging center for one of the Texas projects currently under construction. At the other Texas construction project we have a 30,000 square foot lease out for signature in the large multi specialty property.

During this economic downturn we have observed that larger tenants such as the imaging center and multi specialty group have shown the strongest interest in leasing space. We have noted that these tenants have greater resources, both financial and managerial, and have been more aggressive in expanding their practices similar to businesses in other industries that are grabbing market share during the recession. These larger tenants have characteristics like retail anchor tenants. For example they generate lots of foot traffic and patient referrals. We expect they will eventually attract smaller physician groups who should begin to consider relocating or expanding their practices as the economy improves.

Current economic conditions have also impacted many of the development opportunities we are seeing. The recession and recent financial market panic have spurred more hospitals into employing [inaudible] firms and capital to develop campus buildings. We expect to see more on campus development opportunities as hospitals are looking to invest their scarce capital in their core business of providing in inpatient care.

We will continue to pursue future investments selectively being careful to balance the ability to add quality assets to our portfolio with the need to properly allocate capital and maintain financial flexibility. We are pleased with the leasing and operational performance of our portfolio and expect that success to continue.

David?

David Emery

Thank you Doug. Operator, I think we are ready for the question and answer period. If we could open it up for that.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Rich Anderson – BMO Capital Markets.

Rich Anderson – BMO Capital Markets

On the run rate you have been able to achieve on renewals over 7%, I assume you are kind of burning off that opportunity as you roll leases so I was wondering what you see as a timeline for that type of number to maintain itself?

David Emery

The average lease term is 4-5 years so in the abstract you are turning 20% kind of a year which we have historically done. Outside of some blips in different years where you have more like when we buy a large portfolio I don’t see any reason why that would change.

Rich Anderson – BMO Capital Markets

As it relates to your retention rate of 95%, would you be able to comment on what a new lease rate would be relative to that 7%? Is it higher or lower?

David Emery

On the retention?

Rich Anderson – BMO Capital Markets

If you are retaining 95%...

David Emery

You mean are we giving them concessions and stuff?

Rich Anderson – BMO Capital Markets

I was wondering if your retention was lower that might be actually an opportunity because you can get a better number on a new lease. Is that true?

David Emery

You have heard me say before there is one good thing about our portfolio is nobody ever moves. One of the worst things about our portfolio is nobody ever moves. So, I think that it is just a balance.

B. Douglas Whitman II

Remember too this year we have a disproportionate number of hospital occupied spaces. As you may recall in 2004 we did a lot of acquisition activity and a lot of the leases signed at the time with the hospital for their stint was 5 years. So those spaces are coming up for renewal. These are typically going to be the hospital outpatient department, breast imaging, and surgery and so on. Those leases are going to renew at a slightly higher rate than the typical physician practice. So you are going to see a very high number of leases renewed and we expected that.

Rich Anderson – BMO Capital Markets

Scott, on some of the refinancing you are doing I am particularly interested in the secured facility in 2012. I think I have that right, correct?

Scott Holmes

When we renew the unsecured facility it will be a 3-year term so if it closes next month it should expire in September 2012.

Rich Anderson – BMO Capital Markets

I think you went through some of the seasons and such but are you noticing somewhat of a change in terms of where you were prior to this dislocation that is underway right now and whether or not while the rate is more are there other fees behind it that are also a step up from what you had previously?

David Emery

Other than the LIBOR spread which our current facility is 90 over LIBOR and the new one will be 280 basis points over LIBOR. Other than that not really. The upfront fees and commitment fees that we pay to the banks are 1%. That may be higher than it was last time.

Rich Anderson – BMO Capital Markets

Nothing dramatics?

David Emery

Nothing dramatic, no.

Rich Anderson – BMO Capital Markets

You spoke positively about your development exposure and having some success there. I imagine it is a tougher business model in this environment. Is there any design to reduce your development exposure or are you just going to keep going with not a whole lot of a different approach than you might have had in previous years?

David Emery

I think to some degree it is a balance between the margin on acquisition and the margins on development. Our activities going on for probably now three years on that front the emphasis was more driven by the fact it made a lot more sense to development the 9 to 10 than it did to buy at sub six. So I would think there would be a natural more balancing back to previous years. We will continue to do the development as part of what we do. I think we probably get the sense that is going to be a little bit more on-campus, almost build to suit kinds of things for hospitals and we have 2-3 of those kind of under discussion now. I don’t think there will be any difference. We do not see the economy having really any kind of effect.

You have probably heard me say I can’t believe emotionally that any kind of recession doesn’t affect your lease up. But right now we are not really seeing anything that indicates that other than maybe some angst in the smaller tenant but as Doug noted the larger discussions we have are kind of unabated during this recession kind of environment. Emotionally I think otherwise. I think if you take a small physician there is some angst there that might kind of delay the decision process. It seems like the general public press is that the world is going to go on now. We have not seen anything to any large effect on that and don’t expect that to go in a down direction. It should have turned already.

Rich Anderson – BMO Capital Markets

I’m glad to hear the world is going to go on.

David Emery

Well that was in last week’s paper. I don’t know if you noticed it or not.

Rich Anderson – BMO Capital Markets

You mentioned acquisition opportunities potentially cropping up. In term of financing I think Scott mentioned some in the secured market. Is that a more favorable option to you versus common equity?

David Emery

No, not really. It is always a balancing act. I think our loan debt to gross assets percentage we have always felt the lower that is the more it would help to reduce the risk profile. Scott do you have anything to say?

Scott Holmes

I would see either as a candidate. Considering where we are on our leverage, probably the propensity would be to do more debt than equity. At least do debt first. Nothing to say if the equity markets versus a little better than debt we could consider that as one of the possibilities.

Operator

The next question comes from the line of Jerry Doctrow - Stifel Nicolaus & Co.

Jerry Doctrow - Stifel Nicolaus & Co.

I am curious about operating expenses. There was a big improvement in margin this quarter more than we have seen. I was curious if there was anything going on there that is either seasonal or just unusual?

Scott Holmes

No, I think it was mostly just seasonal. I think there are many parts of the country utility expenses are down. The cooler areas. I think it is just sort of brand out kind of noise. I don’t mean to diminish the fact that our folks in the field are not keeping an eye on expenses and managing them appropriately but I think it isn’t as if we implemented some new program where you are only allocated two rolls of toilet paper.

Jerry Doctrow - Stifel Nicolaus & Co.

Should we see it ramping back up a little bit to levels or in between here and what we saw in the first quarter on margin?

David Emery

In the third quarter on utilities and stuff you will see you will have the full effect of July and August and September with the higher utility expense. A lot of municipalities where the property taxes are paid biannually, those come due during that period as well. It is just going to be some seasonal fluctuation.

Jerry Doctrow - Stifel Nicolaus & Co.

Nothing else going on. Okay. Then sort of similar on G&A, I think there was a note in the Q that there was some staff reductions and things with severance. Can you give us a sense of what run rate for G&A might be next quarter?

Scott Holmes

I have said in the past we expect overall on average G&A is going to run around $6 million a quarter. It does fluctuate from quarter-to-quarter and the first quarter of the year is always, I shouldn’t say always, but is normally the biggest quarter just because of the one-time things that hit then. So my best guess going forward would be to consider it somewhere in the vicinity of $6 million a quarter.

Jerry Doctrow - Stifel Nicolaus & Co.

Your lease conversions, I think a couple of you touched on that. Doug you had said something like a 2.1% or something. I was just trying to get a sense of how much added rent from the sub-tenants you picked up specifically in the quarter and whether we are going to see more of that? Candidly the property operating income was more than what we had expected. I think the master lease is playing some impact on that.

Scott Holmes

We had six master leases in the quarter; one we sold and one currently empty although we are marketing it. The others did have tenants in place. Those are the four I indicated the rental revenue we are receiving from the sub-tenants, which I guess now are direct tenants, is actually higher than the masters revenue. So the hospital and physicians are actually making quite a bit of money on their masters.

Jerry Doctrow - Stifel Nicolaus & Co.

In terms of the quarter ballpark for that should we see in terms of dollars and maybe…

B. Douglas Whitman II

I think the number of master leases coming up now in the third and fourth quarter is relatively smaller. We will see two or three. I don’t think you will see as big a difference.

Jerry Doctrow - Stifel Nicolaus & Co.

Are there any of them big enough that came up during that quarter that we will see a move from second or third just because of that stuff or is this a pretty good run rate?

B. Douglas Whitman II

I think it is fairly good.

Jerry Doctrow - Stifel Nicolaus & Co.

On the joint venture, I think you talked about buying a couple…I guess the Iowa joint venture as well as you funded some mortgage investments to them. I was just trying to get a little bit more color on what is that process. Are there more developments coming on line? Are there going to be more acquisitions there? A little bit more color on your ownership interest and that sort of thing. I don’t know if you are modeling that in much detail.

David Emery

We have an outpatient campus. Eventually it will be, I think disclosed in the Q, six properties on an outpatient campus adjacent to Mercy Hospital and Westlake Hospital just west of Des Moines. Our joint venture partner is actually developing and leasing of these facilities. We provide the construction financing and the mortgages which you see in the Q. Once those properties are complete and fully leased we have the option to purchase them and have therefore purchased a few of them. I think there are 2-3 more buildings yet to be built. We should be coming on line throughout 2009 and 2010.

Jerry Doctrow - Stifel Nicolaus & Co.

So are there more under construction right now? That is the mortgage loan?

B. Douglas Whitman II

Yes.

Jerry Doctrow - Stifel Nicolaus & Co.

What do you mean bring them online? Is there an expected sort of yield or cap rate? Are you buying 100% interest or are you buying less than 100% interest?

B. Douglas Whitman II

We are buying an 80% interest. On a couple of them we have also provided debt on them. Our effective ownership is fairly high. The yield on these things, stabilized yield, typically come out 100% leased, is going to be 8.25 or 8.5. These are Middle America, almost by definition, so their cap rates so if these were done in Orange County or Westchester County it might be different.

Jerry Doctrow - Stifel Nicolaus & Co.

The size of chunks we might be thinking of these are like $20 million buildings or $15 million buildings?

B. Douglas Whitman II

Most of them are going to be between $10-20 million.

Jerry Doctrow - Stifel Nicolaus & Co.

You funded like $8.4 million of expansions I think or additions or improvements in the quarter. I just wanted to get a little color there. Are there any sort of major projects going on or is it minor stuff?

B. Douglas Whitman II

We did see some completions, we are continuing on the core projects up there in CIP as well as some TI work has been stabilized in the portfolio with some of the recent activity there.

Jerry Doctrow - Stifel Nicolaus & Co.

I think this is separate from the development that was $8.4 million, so you are not doing a major addition; it is more TI sort of stuff? I think that is the right number.

B. Douglas Whitman II

Yes.

Jerry Doctrow - Stifel Nicolaus & Co.

You had talked about leasing on general being good and that sort of stuff. There was no progress made at least that I saw on the stuff that is in lease up. I know that is kind of lumpy but you are feeling okay about those? I thought the ones you mentioned were in stuff that is still being developed, not in lease up?

B. Douglas Whitman II

Right and we signed Garland which picked up about 51% and others. LOI updating on those, we are conservative. We don’t count LOI in the [SRP] table there. The two leases I referenced, the 10,000 square foot and the 30,000 square foot were actually related to projects above the line up in the CIP group.

Jerry Doctrow - Stifel Nicolaus & Co.

So basically as you have LOI’s out you are feeling comfortable about lease up. Are things slower so we should be thinking is a 2-year lease up working? Or is it now a 3-year lease up? I know some of the stuff like first quarter 2008 and second quarter 2008…

David Emery

I think most all these kind of come out in 2-3 years. We have had discussions about kind of velocity and different discussions. I don’t think anyone thinks that while one or two might change in some velocity, in the end the kind of numbers differential operations wise doesn’t even approach a rounding difference. So to some degree we don’t see anything other than maybe the angst I mentioned a little bit about the smaller tenants but usually at least in the initial phases of these we are not interested in the small podiatrist as much as we are the large imaging center because that kind of sets the tone for the building. To some degree, in my discussions I have not had any feeling that there has been much of a change. I think one of the highlights of the recession is that tenant finished cost is down big time. To some degree if leasing happens to be a little slower or something like that the cost of the building, a lot of that is being offset by tenant finished costs. Some of that stuff is down 20-30% or more.

Jerry Doctrow - Stifel Nicolaus & Co.

If you were going to do equity, would you do continuous? Would you do overnight do you think? Any thought about dividend at this point?

David Emery

The dividend is kind of a reflection of cash flow and currently doesn’t reflect the refinancing of the company so obviously once we kind of get the refinancing and everything done that is going to have an impact on the level of the dividend. Otherwise, as far as efforts and leasing and those kinds of things I think everything seems to be pretty much on keel. We are pleased with working through the refinancing although it is going to be at a much higher cost.

Jerry Doctrow - Stifel Nicolaus & Co.

Equity, no particular preference?

David Emery

I’m sorry, no particular model choice there whether it be the ongoing or otherwise. I think we have obviously kind of had our heads down on the refinance work. It seemed like the equity markets, as you well know, have ballooned here in the last few weeks.

Jerry Doctrow - Stifel Nicolaus & Co.

I thought you were going to take a victory lap for yourself because you were patient enough to wait.

David Emery

I was expecting people like you to give us kudos. I’ll wait and see what your notes say. We have been patient. I think the equity and debt market we have been patient about that. It seems like both of those are coming in our direction. So as Mr. [Wilford] and his group can gen up what we expect to be an increased amount of acquisitions in the offing then I think hopefully we will be able to do size in both debt and equity.

Operator

The next question comes from the line of Robert Mains - Morgan, Keegan & Co.

Robert Mains - Morgan, Keegan & Co.

Scott, one numbers question. Other income was down sequentially about $500,000. I think that is POA burn off. Is that a run rate we should use or is that going to diminish meaningfully going forward?

Scott Holmes

That is probably a reasonable run rate.

Robert Mains - Morgan, Keegan & Co.

Are we correct to assume that as some of your largest development projects come on line there was a question you already handled on the operating income margin on the operating properties that they would have an impact additionally downward on the margins.

David Emery

Yes.

Operator

The next question comes from the line of Michael Mueller - J.P. Morgan

Michael Mueller - J.P. Morgan

On the credit line is there going to be a LIBOR floor on that?

Scott Holmes

No. No LIBOR floor.

Michael Mueller - J.P. Morgan

Secondly, in terms of acquisitions and I think you touched on this a little bit, can you give us a sense do you think on it a sense of a range of initial yield that you are seeing on that $300 million you have been looking at. Then number two, what do you think is kind of triggering the more optimism you have related to seeing acquisitions? What do you think is causing the volume to pick up in terms of what you are seeing or has it?

David Emery

I’ll tackle the cap rate question first. On large portfolios, large on campus, high quality assets, I think you will continue to see cap rates on those in the 7.5 range. High seven or 7.5. On the stuff we are looking at it tends to be more onsie, twosie buildings in the $20-40 million range. Those can still be had for a range of 8-8.5. So 8.25 is midpoint. I think hospitals to the extent they are kind of very much more attuned to their balance sheet to the extent they can divest assets and raise capital and get out from sort of an ongoing capital requirement of maintaining facilities, I think that is attractive to them. I think also part of the offering is also related to people who are or developments who may have done developments for hospitals during a more “abundant” capital period. A lot of those were done on shorter term maturities. We get a sense a lot of it is a little bit of refi. People saying okay the markets have come back and I need to kind of get back in the market with this. That is probably some of that in there also.

Michael Mueller - J.P. Morgan

I know you mentioned a couple of joint venture acquisitions. I am assuming the bulk of what you are looking at from this point going forward is really all owned, 100% owned on balance sheet. Is that fair?

David Emery

Yes.

Michael Mueller - J.P. Morgan

Excluding the CIP assets and the stabilization in process assets, can you give us a sense of where capitalized TI’s and commissions should pencil out for this year on an annualized basis? Again, excluding the development lease up.

David Emery

Why don’t we do that offline to kind of see exactly what number you are looking for.

Operator

The next question comes from the line of Jim Sullivan – Green Street Advisors

Jim Sullivan – Green Street Advisors

On the same store results, you described the same store results as a normalized number. Can you talk about some of the major revenue and expense items at a normalized to get to the 2.4 that was reported?

B. Douglas Whitman II

I don’t remember saying anything about normalized.

Jim Sullivan – Green Street Advisors

In the supplemental your same store number is normalized for same facility NOI growth.

B. Douglas Whitman II

To get same store we take out properties that are no longer in service or have been in service less than a year in an effort to kind of get an apples-to-apples comparison.

Scott Holmes

The more that were sold, the more that were bought and don’t have a comparable period.

Jim Sullivan – Green Street Advisors

So in terms of your portfolio and that calculation the one quarter you exclude properties that fit that description?

B. Douglas Whitman II

Say that again?

Jim Sullivan – Green Street Advisors

Your footnote says that 77% of the portfolio is in the same store calculation. A quarter of the portfolio is excluded.

Scott Holmes

Correct.

Jim Sullivan – Green Street Advisors

Those are which assets again?

Scott Holmes

Basically assets that used to be there that no longer are there or assets that have been in the portfolio less than a year. The Charlotte properties that we purchased in December would not be included nor the Springhill acquisition in December or the Pyramids building last July. Just so we can have a more normalized or equal quarter-to-quarter comparison.

Jim Sullivan – Green Street Advisors

Within the 77% you do include there is no major normalizing revenue expense items?

Scott Holmes

No, it is just more just trying to get buildings that are either in or out.

David Emery

Normalized may not be the right word. How about comparablized.

Jim Sullivan – Green Street Advisors

Following up on the question about the lease up of your development properties. I am curious now that a couple of those buildings have been opened for over two years and still are sort of stocking the 60% range on the lease up. What do you do to fill up that last 30-35%? Is it a matter of rate or are there other things you can do to get that space filled?

B. Douglas Whitman II

It is not a matter of rate. I think again it is a matter of awareness and marketing yourself to working with the hospital in terms of their physician recruitment efforts. Being in discussion with the hospital, because the ones you are referring to are on campus facilities so to the extent the hospital is looking to expand some of its clinical facilities. I know that one of the Baylor properties there they have a large breast imaging center that they are discussing about adding another 11,000 to 12,000 feet to expand. I think it is working with the existing physicians who are in the building on who or whom would you like to see in there that you would like to refer patients to or to receive referrals from. It is just a lot of leg work and getting out there. We are obviously in touch with the brokerage community as well and listening to what they have and what prospects they might be able to bring to us.

Jim Sullivan – Green Street Advisors

On your off campus properties would you ever consider leasing to non-medical uses? Is that an alternative for you?

B. Douglas Whitman II

Yes we would. On our Colorado property we have had some discussions. We are in a good spot in Colorado. It is a great area demographic near other offices and residential areas so we have been approached by general office users saying we need space and you are in the right area. So we have had those discussions. Our first preference would be to go to medical but we would be foolish not to at least have communication with folks who have other interests.

Jim Sullivan – Green Street Advisors

On rent on new leases, if I heard you right, you said you are plus seven on renewals. I am curious what the figure is for space that was re-leased to new tenants?

B. Douglas Whitman II

That includes people who checked the box that said I am staying as well as somebody who moved out and somebody moved in. The new moved in.

David Emery

The new moved in, actually it tends to be higher. I think that is right?

B. Douglas Whitman II

In most cases, yes.

Jim Sullivan – Green Street Advisors

Higher because you are investing capital?

David Emery

No. It is demand a lot of times. You develop a relationship with existing and sometimes to retain them you might not push as much as you would or you could push as much as you would on somebody on a renewal.

Jim Sullivan – Green Street Advisors

On that topic how much do you spend typically per foot on a new tenant versus a situation where you have an existing tenant on spend?

David Emery

To some degree the staying is practically nothing and the new tenant because of the reuse for the facility we kind of reused the facility we don’t really have to go down to green space and come back.

B. Douglas Whitman II

On new tenant it is typically about $2-4 per foot per year of lease. It depends on the condition of the space that is being leased but…

Jim Sullivan – Green Street Advisors

Your average lease term on new leases is what? Three years you said? Or four?

B. Douglas Whitman II

About five.

Jim Sullivan – Green Street Advisors

So you are spending $15-20 or something like that?

Operator

The next question comes from the line of David Aubuchon - Robert W. Baird & Co.

David Aubuchon - Robert W. Baird & Co.

I am curious as to the mindset of the hospital systems and your recent conversations with those folks about the capital raising environment. You touched on it a couple of questions earlier. What is their mindset? Do they feel like the worst is behind them or they are really continuing to kind of scramble to figure out how they are going to finance?

David Emery

You may have heard me say that after our 15 years we have been at it we have never heard any hospital say that things are great. It is always a constant drum beat of it is worse, it is bad, we need more money, send more money kind of thing. To some degree you are never going to hear a hospital say that the new expansion facility we did is not going to cover off the ball and we made it twice what we thought we were going to make. To some degree there is always the muted discussion about how they are doing and it tends to be on the downside.

I don’t know that I have heard anything regarding hospitals in particular. Just the normal insurance reform angst that kind of drives everybody. The capital markets created a lot of angst with them. They have large endowments in investment portfolios so that creates some of that.

B. Douglas Whitman II

I think the rates on tax exempt debt have certainly come down in line with the corporate debt as well. I think it is true it costs more than it did a couple of years ago which is forcing hospitals to operate generally at a relatively low margin and to kind of look carefully at their balance sheet and income statement. My sense is they have access to capital, it just costs more and it is forcing them to take a hard look at their operations.

David Aubuchon - Robert W. Baird & Co.

Have you changed your underwriting standards at all or have you thought about that differently?

B. Douglas Whitman II

No. I think we view that as an opportunity for us to the extent that we can help them with capital avoidance developing a facility for them that allows them to not commit capital. I don’t’ think our underwriting necessarily has changed but as I mentioned earlier I think we will see more of that on campus development opportunity for that reason. I think hospitals are going to be more judicious in how they invest their capital and really understanding and much more comfortable now about employing outside firms to do that for them.

David Aubuchon - Robert W. Baird & Co.

You mentioned the 2-3 developments you are thinking about right now. Have your return expectations changed at all on those?

David Emery

No. I think to some degree some of these things take a long time but the beauty is the time has kind of been in a cycle where costs have actually gone down. So they usually start out at 9 or 10 and then you wind up at 8.5 or 9 just as a normal process. In this environment a lot of people don’t have work and materials and that kind of stuff it has really helped us maintain our yield objectives.

Operator

At this time we show no further questions. Does anyone have any concluding remarks?

David Emery

No. I believe that is it. We will be around for any follow-up questions that anybody may have. With that we appreciate everyone on the call and we will talk to you in November. Good day.

Operator

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

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Source: Healthcare Realty Trust Inc. Q2 2009 Earnings Call Transcript
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