Healthcare Realty Trust's (HR) CEO David Emery on Q2 2016 Results - Earnings Call Transcript

| About: Healthcare Realty (HR)

Healthcare Realty Trust Inc. (NYSE:HR)

Q2 2016 Earnings Conference Call

August 04, 2016 10:00 AM ET

Executives

David Emery - CEO

Carla Baca - Director Corporate Communications

Bethany Mancini - Associate VP Corporate Communications

Todd Meredith - EVP Investments

Douglas Whitman - EVP Corporate Finance

Kris Douglas - EVP and CFO

Analysts

Jordan Sadler - KeyBanc Capital Markets

Chad Vanacore - Stifel

Rich Anderson - Mizuho Securities

Michael Carroll - RBC Capital Markets

Vikram Malhotra - Morgan Stanley

Kevin Tyler - Green Street Advisors

Todd Stender - Wells Fargo

Michael Mueller - JPMorgan

Operator

Good morning. And welcome to the Healthcare Realty Quarterly Analyst conference call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Mr. David Emery, Chairman and Chief Executive Officer. Please go ahead, Sir.

David Emery

Thank you. Good morning, everyone. Joining us today on the call are Douglas Whitman, Todd Meredith, Kris Douglas, Carla Baca and Bethany Mancini. Ms. Baca will now read the disclaimer.

Carla Baca

Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the Form 10-K filed with the SEC for the year ended December 31, 2015 and in subsequent filed Form 10-Q. 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, normalized FFO, FFO per share and normalized FFO 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 2016. The Company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the Company's website. David?

David Emery

Thank you. We're, again, pleased to report a strong quarter. Our steadfast commitment to quality and the on-going refinement of the portfolio continue to produce positive results that validate the Company's long health strategy that is centered on low risk, high intrinsic value properties, and the expanding outpatient medical office sector. Property level operating metrics continue to be robust. Cash leasing spreads and contractual bumps for the second quarter were strong across the portfolio. A solid foundation of internal performance broadens the bandwidth of opportunities and affords the Company not only staying power but the ability to be even more discerning with acquisitions. We continue to be selectively deploying capital, to compliment the Company's inherent advantages and foster low-risk, long-term growth.

Despite the uncertain backdrop of market volatility, we're pleased with a high level of investor interest in our recent equity offering and the support of the lenders who participated in the credit facility renewal providing the Company with fluid access to the capital markets in an accretive manner. The ever-expanding need for healthcare services and the related expansion of medical office real estate supports our time tested and sustainable business model. The prospects for the Company are bright and we expect the quarters and the years ahead to be productive and prosperous. Now, as we do every quarter we're going to ask Ms. Mancini to summarize our views on current events and trends related to the healthcare industries. Bethany?

Bethany Mancini

In addition to the usual election headlines surrounding recently healthcare related news, we're also tracking the latest Medicare cost-saving initiative on the horizon for healthcare spending and provider reimbursement. Last month the Center for Medicare/Medicaid Services or CMS issued its proposed rule for the implementation of Section 603 of the Bipartisan Budget Act of 2015. Starting January 2017, this bill will establish site neutral Medicare payments for hospital-based outpatient services, equalizing payments for the same services offered across outpatient settings at the lower physician office rate. As proposed in its initial, CMS will exempt hospital-based outpatient departments and facilities located on a hospital campus or within 250 yards of the hospital. And as proposed, all off-campus facilities that we're billing for covered services prior to the date of the legislation November 2015. These outpatient departments are expected to be grandfathered in and can continue to bill at the higher hospital based Medicare rates, subject to some limitations.

While the specifics of implementing this regulation remain in flux and exemptions are ill-defined, we are confident that Healthcare Realty's outpatient facilities are positioned quite well in the face of these reimbursement changes. 75% of the Company's outpatient facilities are located on campus or within 250 yards of a hospital and we expect our off-campus facilities to be grandfathered in. With Section 603 neither Congress nor the CMS appeared to be looking to penalize or devalue facilities already in operation. Rather this rule is more forward-looking, intending to curb the proliferation of off-campus hospital outpatient development. The complexity of this reimbursement policy and the ambiguities of regulating off-campus Medicare services underscore the stability and need driven dynamics of on campus investments. We have always found on campus property to have innate value that drives better growth metrics, being integral to the central operations of the health system with greater propensity for tenants to renew and little risk of becoming an orphan asset.

In addition to site neutral Medicare payments, the CMS is also looking to implement more alternative payment model, with several bundled payment demonstration projects underway in selected markets. As part of the broader nationwide shift toward value-based care, their goal is to reward doctors, hospitals, and other providers for quality over quantity of care and to have at least half of traditional Medicare payments go through alternative payment models by 2018. Accordingly market leading health systems and physician groups are proactively pursuing ways to minimize their risk in these payment models through vigorous recruiting, hiring, ramping up IT and data reporting capacity, consolidating resources and expanding outpatient care. All part of an effort to increase market share, capture patients and lower costs, deciding who gets what, where and thereby controlling payments for the full spectrum of care. Healthcare hiring momentum continues to reflect this trend strong across the sector, up on average 3.2% in June over the prior year versus 1.7% job growth in the overall economy.

We see on-going evidence of heightened demand for on campus medical office space by health system seeking opportunity to enhance their physician lead outpatient care and pursue coordinated care incentives. But the move to value base pay will be gradual with only 5% of physician practice revenue currently tied to quality, volume still rule reimbursement in many compensation metrics. Physicians continue to garner solid pay increases, up on average 2.8% in 2015, according to modern healthcare's recent annual compensation survey, citing higher demand for new doctors by the aging population, a shortage of key specialists and the expanding need for primary care. Consolidation of doctor practices into larger groups and groups joining larger health systems have helped to bolster physician pay as well. Overall, owing's portfolio comprises a broad base of physician tenants across mover than 30 specialties affiliated with top credit rated health systems in top MSA markets. As our tenants benefit from relatively lower concentration of Medicare and Medicaid patients and high rent coverage, Healthcare Realty's ability to capitalize on inherent growth in its properties should remain secure despite an uncertain political and regulatory environment. David?

David Emery

Thank you, Bethany. Now to Mr. Meredith for more specific about recent investments and development. Todd?

Todd Meredith

Midway through 2016, we are tracking well on investment activity with a strong outlook for additional investments through the balance of the year. Year-to-date, we've acquired three buildings for $79.9 million. This includes two properties acquired for $41.6 million in the second quarter, a 47,000 square foot on campus MOB in Seattle acquired for $21.6 million in April and a 63,000 square foot on campus MOB in Los Angeles acquired for $20 million in May. The property in Los Angeles is currently 80% occupied and should yield over 6% when fully occupied. In our recent equity offering, we indicated that we expect $150 million of additional acquisitions over the next 12 months. We are currently ahead of schedule working on the acquisition of two properties for $98 million including an MOB in Seattle for $53 million and an MOB in Washington, DC area for $45 million. Both are on track to close in October. These two properties are 100% occupied, located on campus and physically connected to acute care hospitals operated by top 100 health systems including AA plus rated University of Washington Medicine or UW Medicine in Seattle and AA plus rated a nova in the Washington, DC area.

In addition, we have three more on campus properties in Seattle and the Baltimore, DC area that should close by year end for another $35 million to $45 million. All of these properties generate first year cash yields of 5.5% to 6% and are immediately accretive when matched with proceeds from our recent equity offering. With a strong outlook for the balance of the year, we are increasing our 2016 acquisition guidance to $200 million to $250 million. On the disposition front, we expect to sell several properties in the third and fourth quarters. We are decreasing our guidance slightly to $50 million to $75 million due to the timing of certain transactions that could flip into 2017. One property that will likely sell in the fourth quarter is subject to an atypical fixed price purchase option that was recently exercised for $14.9 million. The remaining properties expected to be sold in 2016 are estimated to sell at an average cap rate in the low sixes but our blended cap rate will be skewed higher by the purchase option.

More than just a capital source we view dispositions as part of a broader strategy to continuously improve the growth profile and value of the portfolio, culling properties that no longer fit our objectives because of the lack of health systems alignment, geographic fit, growth potential or relative value. To continue to make headway on several development and redevelopment projects in Nashville construction which recently completed on the core and shale of a 70,000 square foot building expansion and the attached 900 space parking garage will open in September. Tenant improvement projects currently under construction will make way for 67,000 square feet of occupancy gains in the first quarter of 2017. Of the $51.8 million budget, $12.6 million remains to be funded over the next three to four quarters. We also have $23.5 million remaining to be funded at the MOB under construction in Denver that is scheduled to be completed in the second quarter of 2017. In terms of new activity, we recently received a commitment for a 44% of a new 146,000 square foot on campus MOB in Seattle.

Space planning is currently underway that would increase these leasing commitments to over 60%. This will be our fifth MOB associated with UW Medicine and our third MOB on their valley campus where we acquired an MOB in April and expect to acquire a second MOB for $53 million in October. Construction should start in early 2017 and be completed by mid-2018. With a $62 million budget including a contribution to a new 1200 space parking garage the development is estimated to generate a stabilized cash yield in the low sevens [ph]. Nearby in Tacoma, we received a lease commitment for a 20,000 square foot expansion of the 33,000 square foot MOB we acquired for $8.5 million last year. The $9.3 million redevelopment project should get started in first quarter of 2017 and be completed within 12 months. The project is 100% preleased and is estimated to produce a stabilized cash yield in the mid sevens [ph]. We expect to fund about half of the $70 million combined budgets for these two new projects over the next 12 months. These developments and redevelopments exemplify our ability to create value beyond just buying more properties.

They fit appropriately into our strategy of creating follow-on investments with attractive returns delivered at a measured pace and dictated by hospital-driven demand for outpatient capacity. Finding attractive investments and raising cost effective capital does not often coincide. Our currently pipeline includes some of the best individual properties we've seen in some time in terms of location, health systems strength and growth prospects. I'm pleased with our team's ability to uncover these exceptional properties and match fund them quickly with attractive capital, producing accretion, long lasting NOI growth and operational value.

David Emery

Thank you, Todd. Now on to Mr. Whitman to update you regarding our balance sheet in the capital market sector. Doug.

Douglas Whitman

Last week Healthcare Realty completed the renewal of a $700 million revolving credit facility. This new revolver has a four-year term expiring in 2020. The pricing for the new credit facility improved slightly with the rate for drawn funds decreasing 15 basis points to LIBOR plus 100. There were also several beneficial changes to definitions and financial covenants. We had $1.1 billion of commitment from a strong diverse group of banks. 13 banks from our previous revolver renewed joined by one new lender. The second quarter was an active one in terms of equity issuance. We benefited from the confluence of a favorable cost of capital and accretive investment opportunities. We used our ATM program during the second quarter selling 2.4 million shares and generating $75 million in net proceeds. On July 5 we completed a 9.2 million share offering which generated net proceeds of $305 million. Initially, those proceeds have been used to repay the entire $190 million revolver balance and $50 million of the $200 billion term loan.

The equity issued through the ATM and follow on offering, along with the new investments to be funded with that equity will strengthen our balance sheet and debt metrics. Even after we fully funded those investments, our debt to enterprise value will decrease to 23% from about 30%. Debt to undepreciated assets will go to 34% from 40%. Debt to EBIDTA will decline to the mid five [ph]. Recognizing these enhanced metrics our portfolio quality and robust operational performance, S&P recently upgraded us to Triple B, in line with our ratings from Moody's and Fitch. While the impetus for issuing this equity was to fund the acquisitions and developments Todd just described an ancillary benefit is reducing leverage. Going forward, we expect to stay at this lower leveraged level with our debt to undepreciated assets remaining in the low to mid-30% range, debt to EBIDTA continuing in the mid-fives and our fixed charge ratio increasing close to four times. This lower leverage provides not only with added safety but also with financial flexibility and ample dry powder.

David Emery

Thank you, Doug. Now, to Mr. Douglas to give us an overview of results of operations and other financial matters. Kris?

Kris Douglas

First, a few comments about the recently equity offering. Third quarter FFO will be impacted by temporary delusion of approximately $0.02 from the 9.2 million share offering. As we close on future acquisitions and recognize rental income from our redevelopment and development projects funded by the equity offering, FFO is expected to be accretive by approximately $0.03 per share per year. If funded on a leveraged neutral basis the annual accretion would have been approximately $0.04 per share per year. Funding of equity needs - is flexible needs advantage operating results for the quarter 0.7% [ph] over second quarter 2015. While over the same period, normalized FFO per share increased 5% to $0.42. The increase in FFO was driven by trailing 12 months same-store NOI growth of 4.3%. 5.4% for the 135 multi-tenant properties, which comprise 72% of total same-store NOI and 1.6% for the 34 single tenant net lease properties. The higher NOI growth in the multi-tenant properties as compared to the single tenant net lease properties is largely a result of the composition of the annual [ph] escalators.

In the single tenant net lease properties 63% of the leases have CPI-based escalators which grew on average 1.3% in the last 12 months. In contrast, only 4 percent of the multi-tenant properties have CPI-based escalators while 84% have fixed annual increases which have averaged 2.9% over the past 12 months. The higher growth for the multi-tenant properties is further amplified by the fact that the single tenant properties are net leases. So there's no opportunity to create the operating leverage we are generating with the multi-tenant properties. Page 17 of the supplemental provides enhanced disclosure of the contractual rate increases for both the multi-tenant and single tenant net lease properties. Multi-tenant same-store revenue increased 4.5% over the trailing 12 months. The growth was driven by a 3.9% increase in revenue per average occupied square foot combined with a 40 basis points increase in average occupancy to 87.6%. At June 30, sequential quarterly occupancy dropped 10 basis points or about 10,000 square feet due to a 17,000 square foot move out of temporary storage space.

That space was being leased for $500 per month so the drop in occupancy has no real impact on revenue. Operating expenses for the multi-tenant properties increased 3.3% over the trailing 12 months. We continue to see continue to see the effect of a fourth quarter 2015 property tax catch up payment of $2 million, which we discussed on the February 17th conference call. Adjusting for the portion of the 2 million that was related to periods outside the last 12 months, operating expenses would have grown approximately 1.5%, which is below the expected long-term average of 2%. As a reminder, there's typically a seasonal increase in utility expenses in the third quarter, which we expect this year as well, given the recent heat wave across the country. In 2015, seasonal utilities increased $1.4 million in the third quarter over the second quarter. Looking ahead, indicators for favorable revenue growth in the multi-tenant properties remain strong, as seen through the following metrics. Tenant retention in the quarter was 81.2%.

Excluding the 17,000 square foot storage space lease I mentioned earlier, tenant retention was 84%. Future contractual rent increases for leases commencing in the quarter were 3%. These increases are the contractual bumps that will occur in future lease years for 280,000 square feet of multi-tenant same store leases executed in the quarter. The 3% future contractual increases are higher than the 2.9% contractual increase that occurred in the second quarter. As a result, the growth rate of contractual rent increases is gaining momentum. Cash leasing spreads on renewals in the quarter were 6.3%. While the cash leasing spreads can move around quarter to quarter and are higher than the expected long-term trend, the cash leasing spreads on all 228,000 square feet of renewals in 68 separate leases were positive. A testament to the pricing power of on campus MOBs associated with leading health systems. We are pleased with the strong leasing efforts and operational expense controls this quarter, which continue to help drive NOI and FFO growth.

David Emery

Okay. Thank you, Kris. Operator, we are ready to begin the question and hopefully answer period.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] At this time we will pause for a moment to assemble our roster. Our first question will come from Jordan Sadler of KeyBanc Capital Markets. Please go ahead.

Jordan Sadler

Thank you. Good morning. First question, regarding some of the guidance here, there are a couple of tweaks on the investment activity front. Can you talk about the decline or the decrease in the expected disposition volume I would think given the fact that the cap rate environment is - the appetite for assets is high that you might look to increase rather than decrease. Thanks.

David Emery

Sure. Good morning, Jordan. I would say that really the change was really just a tweak based on the sorts of the progress and activity we see on specific deals. And I think as I mentioned in my remarks, it's really not a design to raise proceeds, per se. It's really more of a design of specific properties and looking through the portfolio and look and to optimize performance in the portfolio and just pulling those out that aren't the right fit. So I don't think we see necessarily dispositions slowing down in general. I think just some of those shifting into 2017. So, I think given your point with strong cap rates we're not opposed to keeping the disposition ranges, healthy over the next few quarters.

Jordan Sadler

And just given sort of the focus on the MOB, particularly on campus and more critical facilities and their better growth profile longer term, what are the most current thoughts on the in-patient rehab and surgical?

David Emery

Sure. I mean, I think certainly you see our activity in terms of acquisitions is primarily pretty much exclusively on or adjacent to campus MOBs. So that's really our focus I think in those non-MOB asset types it's really for us just looking at the ones we own and looking at the various factors associated with those particular properties. Certainly something to look at from time to time. And if you were going to sell those properties I think you also need to take into account kind of where you are in the lease cycle and making sure you feel like you can maximize value so you have to kind of look at those on a case-by-case basis.

Jordan Sadler

Okay. You're inferring that you guys have some exposures you'd rather put to bed before you refer some of those is that?

David Emery

I wouldn't say we have a lot of exposure. We did have one, inpatient rehab property that the lease matured this year what we backfill wad new tenant and were able to sign a long-term lease. Obviously we were not look to go dispose of that property in the last year or two just because of the term of the lease remaining. But now, that we've gotten through the lease, we signed a new 20 year lease, we have a lot of time to kind of along at it and decide when or if we would want to sell.

Jordan Sadler

Okay. And then you went through the changes in the cap rate on the guidance for dispose tenant to get the purchase option. Did you give us the number? What's the cap rate on that purchase option property?

David Emery

That one, as I mentioned, all the balance of those dispositions we expect this year are in the low sixes. That one happens to be about 12%. So you can see how that skews. It kind of skews towards that midpoint of, eight, plus or minus.

Jordan Sadler

Any others in the portfolio hanging out there that we should know about that are fixed price purchase options?

David Emery

We have a table in our 10-Q on that. If you look at where we were at the beginning of the year, we had a number of them, three of them, and, actually, this was the only one that came to pass this year. The other two have expired or gone away. We have one in 2017 or a group of properties that have a fixed price in 2017 that's about $49 million, $50 million, but beyond that it's pretty much one in 2021 and then there's a couple in 2025. So it's pretty far out there and pretty small in any near term years.

Jordan Sadler

Okay. Thanks, guys.

David Emery

Sure.

Operator

Our next question will come from Chad Vanacore of Stifel. Please go ahead.

Chad Vanacore

Hey. Good morning, all.

David Emery

Good morning.

Chad Vanacore

So just thinking about tenant retention, I think you mentioned this in the low 80s [ph] right now but excluding one property it would have been sort of mid-80-ish [ph], how should we think about that going forward?

David Emery

You know, we provide guidance with a range of [indiscernible] and any particular quarter it can move around in that. We've actually been for the last 12 months, four quarters, and actually further back, we've been more at the mid to upper end of that range. But anywhere in that range in any particular quarter I think is a reasonable expectation.

Chad Vanacore

All right. Thanks. And then it looks like normalized G&A ticking up a bit from prior expectations. Was that from adding more head count at the corporate level or something else?

David Emery

It's a small amount of head count. Not a lot there. It has a lot to do with just performance that has occurred over the last - over the first two months of the year and what we're seeing through the remainder of the year related to leasing and operating performance incentive payments that are related to that performance.

Chad Vanacore

All right. I think I'll hop back in the queue, thanks.

Operator

Our next question will come from Rich Anderson of Mizuho Securities. Please go ahead.

Rich Anderson

Thanks. Good morning, everybody.

David Emery

Good morning.

Rich Anderson

So I'm going to - I would like my - if I first question is going to be a little bit of a psychological test. So, I'm going to say one word and then if you guys can respond to that word as it relates to your business. Okay? So the word is Trump.

David Emery

No comment. That's right.

Rich Anderson

Well, what I'm trying to get at is administrative, issues related to the Affordable Care Act and all that sort of stuff and if you could comment if any of your peers - your customers have kind of thought about that and are thinking about potential dismantling of the Affordable Care Act.

David Emery

Rich, we don't really hear much along that line. I don't know if anybody else has heard anything in particular. There hasn't been any specificity other than, we're going to get rid of it. But as any kind of program like this that has become systemic in the system is not exactly walking over the wall and flipping the switch and so, I expect that there - if it plays out in that imperative that we're going to do something about it the original perception of what we're going to do about it and what it ends up - winds up in the end several years later are nowhere close to each other.

Rich Anderson

Okay.

Todd Meredith

And I think the other thing Rich, too, to add to that would be, usually changes that do end up occurring, as David said end up being incremental in little small tweaks. And so I think, it's always less than what the grandiose plans, on the stump suggest. I think for us - you see a little sign of that just with some of this macro changes that maybe they're pushing out the implementation of some of that as scheduled that was under recent legislation. So it always will sort of ease in rather than dramatic change and I think that probably continues.

Rich Anderson

Okay. So on to more topical stuff for you. You know, you're developing more now, you're acquiring more now, and I'm curious if that is - what is that a function of? Is it a function of just basic confidence in the business or is your reduced cost of capital making you think more aggressively about investing externally?

David Emery

Well, Rich, I think, firstly, it's just our footprint experience and work we've been doing with all the systems we do work with. That eventually kicks in as being kind of the lead person doing this development stuff and some of the other kind of things. So I think the company is benefiting from that, from the standpoint of deal flow. I don't think we have any signs on the doors around here buy more stuff or develop more stuff. I think it's just responding to that. I think the cost of capital to some degree has some impetus with that because people who own assets they're probably getting the realization that - I don't know if it's going to be any better than this. So I think that's part of it. I don't know, Todd if...

Todd Meredith

Yes. I think the other thing Rich, certainly, the cost of capital plays into that and it affects all the competitors out there. So we certainly benefited from that. I think the most important thing we see and as you saw this quarter was really trying to effectively raise capital quickly to match that. Just given where the markets have been, the volatility. So we don't - again, as David said we're not out trying to suddenly crank up the volume and kind of compete with other folks on volume. I think it's more sticking to go quality. But the deal flow as David said, the quality of what we're seeing has been ticking up lately so we encouraged by it. We want to take advantage of it while we can but more importantly it's are these the right assets to buy or build that will feed into our internal growth profile.

Rich Anderson

Okay. And then my last question is, maybe a tangential response to Section 603. Could be non-grandfathered hospital satellite operations in off-campus settings of course could be actual beneficiaries in the sense that they are a lower cost alternative to CMS and, hence, maybe we'll see more volume from some of these bundling programs? Is that a too farfetched of a thought process?

David Emery

You know, I think maybe after years and years that could begin to play out. I do think, as Bethany mentioned in her remarks, the intent here by CMS is to really curb the proliferation of these off-campus hospital outpatient departments that you would sort of suggest are going after that higher reimbursement. So maybe in the end to your point with more transparency, high deductible plans, the kind of thing that drive patient behavior, you can see a little bit of that. But I think at the end of the day you still have the need for services and we see the general shift being back to the safer environment of the on campus locations, where be focus. So it's at the margin. Obviously our off-campus exposure is fairly small and probably shrinking over time and so it probably doesn't affect too much how we think about underwriting. We're not doing a whole lot off-campus, if any.

Douglas Whitman

I think also, Rich, the question you posed, we have three board members that are key executive operators of big health systems and so we have a very topical daily, hourly almost, feedback on what the thinking is and some of those kind of things so none of those people have given us any - individuals have given us any indication that all of a sudden this is, some kind of wind fall kind of thing that they can advantage. So probably in the abstract it may appear that way but I don't think on a practical basis.

Rich Anderson

Okay. So HTA is more inclining to off-campus in communities. There's really - you can't see any circumstance where HR would go that direction at this point in time?

David Emery

Well, let me give you a long answer. No.

Rich Anderson

Okay. Thank you very much.

David Emery

Yes.

Operator

Our next question will come from Michael Carroll of RBC Capital Markets. Please go ahead.

Michael Carroll

Yes, thanks. Todd, can you maybe talk a little bit about the on-going discussions you're having with hospital systems? How are these systems thinking about growth? Do they still want to grow pretty quickly or are those discussions for new development activities starting to continue to increase?

Todd Meredith

Sure. Mike, they are. I mean, I think we're seeing a lot of, as David described, just having the portfolio we have, the relationships that are embedded in that over all the years, we're certainly seeing a need for outpatient space. And it's measured and I would say the pace of that development, it takes a lot because they're doing a lot of planning as to what exact services they want to plug into those new spaces, and I think because hospitals are dictating more of that and controlling a little bit more of the programming in that then maybe in decades past, it's a longer process. So I think we're seeing a lot of that discussion. I don't think we're suddenly going to be doing, 20 deals a year. That's not the point. I think it is just selectively we're being standard offensive that discussion. And I kind of joke we're doing things in threes around here. We seem to be able to find these situations where we buy or build one or two and then we add one or two. So it is very much an organic process from those kind of discussions. But I don't think we're seeing a huge ramp-up. It's just a nice steady pace.

David Emery

All right. I think that continues through the on-going shift for hospitals to source more of their revenue from the outpatient side of the business. Whether that's expanding existing outpatient programs, adding new outpatient programs, again, I think it's part of that and, as Todd said, they're negotiating their deals with the physicians who are going to be providing services in these outpatient programs. So it is slow deliberate, but the demand I think is steady.

Michael Carroll

And does those activity continue to pick up compared to about a year ago? And is it going to translate into them actually making decisions or is it still a long drawn-out process for them to actually make a decision?

David Emery

It is long and drawn out. I'd say it can take multiple years sometimes from the initial discussions. But I would say you're right, you go back a year ago, we were already seeing some increased discussions about it. So you're starting to see some of that come to fruition and certainly that's the case of this one I mentioned in Seattle and that's how that came about. We've probably been in discussions with them north of 12 months about the idea of acquisitions and some development. So it's just - there's always a good pace of it just driven by the need for these hospitals to shift to outpatient and the increase in patient flow they have, as these systems consolidate. So it's just that steady flow and we're obviously interested in taking advantage of that whether it makes sense for us. We don't want to chase it everywhere but with the right systems and good markets, great demographics we'll pursue those.

Michael Carroll

And how big do you think you can push the development pipeline if you're finding those attractive deals? How large do you want that to grow to?

David Emery

I think for us, having been through some development cycles, be certainly appreciate the need to keep that measured as a percentage of the total assets. I mean, today we're probably in the 1%, 2%, 3% range, if that, in terms of commitments and so forth. So I think for us, less than 5% in terms of our total commitments is probably a conservative range to keep it in. So if you think about us as having $3.5 billion, $4 billion of gross investments, 5% of that or less is probably reasonable to think about.

Michael Carroll

Okay. And then, Doug, in your prepared remarks I believe you mentioned the company is going to o run at a lower leveraged metric kind of going forward. I mean, do you have new leverage goals or is this just kind of a near term type of plan?

Douglas Whitman

No. I mean, it's sort of a long-term. I think long-term objective. Certainly the equity offering on the ATM activity that we did this year got us there maybe sooner than we expected but going forward I think we're comfortable at the leverage level that we're at now, which I guess would imply that going forward we'll be funding investments on a more leveraged neutral basis.

Michael Carroll

Okay, great. Thank you.

Operator

Our next question will come from Vikram Malhotra from Morgan Stanley. Please go ahead.

Vikram Malhotra

Thank you. Just to dig into your relieving spreads, as you look to the portfolio for the last few quarters, if you cut it by quality on or off campus or other metrics, can you give a sense of the range you're seeing on sort of high quality versus maybe what you'd consider lower quality in your portfolio? And so where are you getting the top end of the range in terms of spreads?

David Emery

Yes. Vikram, the spreads we are seeing some differentiation between our on and off, but generally across the board they've been strong. If you look over the last 12 months, I believe we've been averaging about 4.8% for our on campus and about 1.3 % I think it was for our off-campus. This past quarter with having everything be positive is a great step forward in terms of something we've been talking about for the last year or so of really trying to adjust the tails of the curve and being able to get rid of those, those releasing spreads that have been negative really helps to drive your average over time. And there obviously there can be certain markets where in any particular time you might be getting some better results. We actually had I think it was about eight or nine different markets this past quarter where we had double digit cash leasing spreads. So we think that that's a positive indicator of how we're able to drive those cash leasing spreads across the country and not just in one or two specific.

Todd Meredith

Vikram, I would add just this past quarter as an example, that range was basically zero to 33%. So it's a broad range but the key as Kris said is very few, down at the low end, and no negatives. And it's that distribution that really for us - obviously we don't expect 32% very often, but, those are unusual circumstances, but very consistently we're seeing, as Kris said, double digit in multiple markets, many campuses.

Vikram Malhotra

Just sort of as a follow-on in thinking out over the next few years with all the regulatory changes, the push to off - settings that are away from the hospital whether it's on or off, but all that combined sort of is a good case from a volume standpoint for whether it's more development or acquisition opportunities, but what about from internal growth standpoint? Do you expect, given that you've been pruning the portfolio for a while and you've got a largely on-campus portfolio, do you expect sort of the same NOI number to creep up and to be more consistent in the 4% range as opposed to the 3% range?

David Emery

I think, victim Vikram, if you really think about the portfolio, we're obviously getting some boost this year as we continue to see some lease up in the development properties, which are now approaching the same as the rest of the portfolio at nearly 87% occupied. But I think we see sort of a more normal level is still two to four but probably as you're pointing out it's more three to four is kind of where we can expect to be. Our goal, much like Kris described on the cash leasing spread is within the portfolio to have that same portfolio approach of looking at the tails and saying what's driving the upper end of our performance on the NOI level and the revenue level growth - revenue growth level and then what's dragging us and manage the portfolio that way and kind of eliminate the bad tails and increase the good tails and move that average over time. So I think that's kind of how we view it. But three to four is probably a reasonable range in the near future beyond kind of the development boost that we get.

Vikram Malhotra

Okay. And then just last one, of all the product out there, whether it's $2 billion or $4 billion, can you just maybe break that into buckets? What percent you would really like to have in your portfolio? What is sort of maybe we're not crazy about and what is it that we don't want to go after it?

David Emery

You know, Vikram, I would say there's obviously a number of large portfolios that have been sort of circulating out there. Other folks have talked about them. Like others, that's really not something we go after. We may find some portions of those portfolios that are attractive but in general we're not interested in those $500 billion portfolios. I would say that right now what we're seeing is just a healthy flow of individual deals. Sometimes it's one deal, maybe two anywhere $20 million to $80 million, or $100 million and for us it's just a matter of figuring out the fit weapon, does the price work? Is the value there? Is the growth profile there? So I would say for us doing two, three, $400 million a year, that's very manageable. I think beyond that you have to kind of move into a whole different category of bigger deals that are just not of the same quality.

Vikram Malhotra

Thank you.

David Emery

For us it's healthy volume of what we're after and easily abating a reasonable pace of $200 million, $300 million, $400 million a year.

Vikram Malhotra

Great. Thank you very much.

Operator

Our next question will come from Kevin Tyler of Green Street Advisors. Please go ahead.

Kevin Tyler

Thank you. Hey, guys. Going back to the releasing spreads for a second. You mentioned that you're getting higher numbers and they've been running above the longer term average and then you talk about addressing the negatives. But seemingly doing that requires some sort of enhanced spend to push those higher and your capital additions, TI, leasing commissions they have been growing noticeably. So I'm just wondering how you think about the trade-off between this incremental spread and the leasing spread?

Todd Meredith

Yes. The quarterly spend that you see, Kevin, does bounce around and it is up a little bit this quarter. I would remind folks that number is what's spent or accrued to be in that particular period. That may relate to deals that were struck three, four quarters ago that are on - going build out CapEx projects, TI projects or deals that are taking occupancy in a couple quarters. So there's kind of a disconnect between the rate and that's being spent in the quarter versus what you're committing to on the leases that you struck during the quarter. And so I think that's one disconnect you have to kind of watch and that's why that spending will bounce around. We kind of bounce between $8 million and $14 million a quarter on second generation TI. We don't feel like we'll be out of line with our guidance for the year. When you really get down to what are we committing to go on a per square foot per lease year basis, for us on renewals we're spending about $4 on that.

That hasn't changed much at all. It's almost flat from 2015 versus what we've been done so far in 2016 and then on renewals that number is about $1.50, which is not a big change from 2015 either. You blend those together it's about $2.18 a foot per lease year in the first half and all of 2015 we spent $2.19 per foot per lease year so really have not seen a big uptick. It's more just about sort of the nature of spending patterns bouncing around, depending on the quarter.

Kevin Tyler

One clarification, Todd, is the $4 is on new leases?

Todd Meredith

Yes, sorry.

Kevin Tyler

And the other to do is on the renewals.

Todd Meredith

Exactly.

Kevin Tyler

That's the difference.

Todd Meredith

Blends to that $2.18.

Kevin Tyler

I guess if you lump in the leasing commissions and the capital acquisitions to some of the back and beyond math that I've done it looks like the numbers have trended higher since 2013 in aggregate so I guess any color on the overall spend.

Todd Meredith

The leasing volume certainly impacts that. I would say, just if you think about it this way, in the last 12 months if you take second generation TI commissions and CapEx, if you will, if you look at the last 12 months, that number is $40.4 million. That's up 3% over the prior 12 months of $39.1 million. So, again, not a huge change. Maybe if you go back to 13 [ph] it's up a little, a little more than that, but that's right at the midpoint of our guidance for those items for this year.

Kevin Tyler

Okay. Appreciate the color. I just - the other question that I had was on reposition. So that square footage is kind of stuck around the 1 million square feet, give or take, and I was wondering if you can outline some of the strategies that you might be taking to potentially restore some of that occupancy and then is there any kind of forecast you have for that bucket and the size of it going forward? Is it a stable size? Is there properties that are kind of on the cusp of potentially moving in there? How should we think about that?

Todd Meredith

In terms of the reposition, and you're right, it does - it has stayed kind of around that million square feet for a while. And one of the things I will point out on that, it has to do with kind of our definition of same store and the fact that we're looking at trailing 12 month basis. So once an asset has reached occupancy above 60% and positive NOI, it needs - it stays in that reposition for eight quarters before it goes back in. So there are actually some properties inside of the reposition that are already in what we would call back into a stabilized level but have yet to move back into same store just because we're waiting on the time period because we don't want to show an accelerated growth once you put it back in same store, so trying to be cognizant of that.

In terms of just in general, yes, we do look at the breakdown of those assets. Some of them we do look at as long-term holds and we have done some work as I mentioned many are ready to move back into the same store. There are some that we are looking at potentially disposing of. We have sold some over the last year or two out of that bucket of properties and so, it's a mixture kind of between the hold in it.

Kevin Tyler

All right. I appreciate guys. Thanks.

Operator

Our next question will come from Todd Stender of Wells Fargo. Please go ahead.

Todd Stender

Hi guys and thanks for the color and the releasing spreads. Most of my questions revolve around those but just looking at, one of the acquisitions made in the quarter, the LA property, the cap rate out a bit of five-one. It's one of the lowest we've seen across the group that I think Todd you mentioned a stabilized rate in the sixes. So I just want to hear some of the assumptions that going into the underwriting maybe what the lease expiration schedule looks like and maybe timing to get some - to get to some stabilized level.

Todd Meredith

Sure. Yes. Obviously, the 80% occupancy is what's driving that particular cap rate of five-one. So we don't - I mean, we obviously want to put in our disclosure a cap rate that we expect in the first year. So typically in our underwriting, even if we think there is a least up momentum, we will not put all that lease up in one year to sort of get to a better cap rate. We try to be very conservative on that. So, that five-one obviously sort of artificially pulls down the perceived range. I think for us we see that as a cap rate that should be closer to that six once it's stabilized. Realistically, we don't - we're not looking at that happening all in a very short term. I think for us it's a process of probably a couple of years of optimizing that. The seller of that property was not putting a lot of capital. And so, into the property as well as into the tenant improvement.

So, we think once we and we've already seen some signs that spending some money with the tenants is building good will or getting some momentum going. So, we are certain to see some traction but it will take a little while and I think for us, we have long view on that. It's more about the location, the quality of the property. It's the lowest, it's really the only MOB in that particular campus in that area that has much vacancy. So, we like we were positioned for that and certainly like what we see on the ability to push right there as well.

Todd Stender

I was going to ask on the rents and any lease explorations you have coming up?

Todd Meredith

No. Nothing of concern. No significant space that we're concerned about there. I feel very comfortable with the renewals we have.

Todd Stender

Great. Thank you.

Todd Meredith

Sure.

Operator

Our next question will come from Michael Mueller of JPMorgan. Please go ahead.

Michael Mueller

Yes, hi. I like to ask a question on spreads have been answered but I guess turning to development for a second, Todd, you mentioned I think it was about $70 million in new projects coming on for the next couple of years. One, how does the shadow pipeline beyond the current one you're about to start look like and then I may have missed it but did you talk about preleasing on those?

Todd Meredith

I did touch on that. There's two projects. The large one is a new development that is a $62 million budget. 140,000 square foot MOB. We have a commitment for 44% of the building so far and there's a lot of planning underway that we think will take it over 2016 near or around the time we start construction early next year. So that's kind of that general preleasing level. And then, on the other project which is smaller and nine plus million dollar budget, it's really a redevelopment and an expansion of the building we bought last year, that's a 100% prelease. So high levels of leasing there with yields that are in the seven to mid-seven range on those. In terms of additional development, I would say, we've certainly talked about another development in Seattle that's sizeable with a $60 million plus, $67 million budget. That's something that could probably start probably middle part of next year, kind of depends on preleasing I think will sort of see how that goes as we get closer here but we're well underway on planning designing and getting the right various entitlements we need.

So that can be another project in the near term. Certainly, our team, as we talked about earlier sort of activity and interest inquiries from health systems even some development partners that we've worked with before talking about some new development. So I think we see a healthy pipeline beyond what we know that we plan to do in the next 12 to 18 months or at least get started. So it's not unlike the acquisition pipeline just a very robust shadow pipeline if you will.

Michael Mueller

Got it. And one quick follow up. In terms of preleasing, I mean, how do you generally think of for this larger projects? Where you want to be in terms of preleasing levels before you push levels in the ground and go ahead with it.

Todd Meredith

Sure. It's - we don't have an absolutely threshold but I would say, case by case but generally a bare minimum for us would probably be something around where we see NOI breakeven which typically is 35%, 40%, 45%, 50 plus or minus is probably a good way to think about it. But again, it's case by case. There's one in Seattle that we haven't started that sort of in the shadow pipeline. That's one where unbelievably tight market and a lot of big users that need space. So we have a lot of confidence there we would like to obviously see some commitments, a lot of discussion, specific discussions before we get started. So, again, maybe lows of 35%, to 40% but...

David Emery

But and a lot of times the demand is coming from the hospital. That's the candle as to get this project started. So, they often will have one or two or three identified needs. For example, Todd mentioned you have 44% commitment on this one out in Seattle with indications that they could go up to 60% that's because they are still doing their programming and their planning. We certainly got enough I think to do the initial work but what we have seen as this hospitals as the process moves along their space needs increase to their finding ancillary physician groups who want to be a part of this project and are being added. So a lot of this is being demand driven and were just meeting that demand.

Todd Meredith

Also as a process of risk management to some degree if you ring out all of the risk and development, you have an acquisition with a lot more risk. So, to some degree its where is that inflection point that you reward matches the risk and so, closure on campus and you have the affiliation, you probably have the opportunity and less risk and better returns if you're in the 35% to 45% range whereas if you do a big on campus and you wait until you get a 70% or 80% lease, just an abstract comparison then you're down in very low acquisition rates.

Michael Mueller

Got it. Okay. Thank you.

Operator

And ladies and gentleman this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. David Emery for any closing remarks.

David Emery

Right. Thank you everyone for being on the call. And any follow up most specially around today. So, we'll be please to deal with any follow up calls and otherwise, we will be on the call in November. So, have a good rest of the summer. We'll talk to you then, good day.

Operator

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

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