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Healthcare Realty Trust, Inc. (NYSE:HR)

Q2 2008 Earnings Call Transcript

August 5, 2008 10:00 am ET

Executives

David Emery – Chairman and CEO

Gabrielle Andres – Corporate Communications

Bethany Mancini – Corporate Communications

Scott Holmes – EVP and CFO

Doug Whitman – EVP and COO

John Bryant – EVP and General Counsel

Analysts

Rosemary Pugh – Green Street Advisors

Herb Tinger – Morgan Keegan

Chris Haley – Wachovia Capital Markets

Jerry Doctrow – Stifel Nicolaus & Co.

Albert Adriani [ph] – Catapult

Richard Anderson – BMO Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the Healthcare Realty Trust second quarter results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance during the program, please press star then zero on your touchtone telephone.

I would now like to introduce your host for today’s program Mr. David Emery. Please go ahead sir.

David Emery

Thank you. Good morning, everyone. Joining us on the call today is Scott Holmes, Chief Financial Officer; Doug Whitman, Chief Operating Officer; and Bethany Mancini and Gabrielle Andres in Communication. Now we will ask Ms. Andres to read the disclaimer.

Gabrielle Andres

Thank you. Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in the Form 10-K filed with the SEC for the year ended December 31, 2007 and the Form 10-Q filed with the SEC for the quarter ended June 30, 2008. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material.

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 earning press release for the second quarter ended June 30, 2008. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's Web site. David?

David Emery

Thank you. First a few brief comments. During the quarter we continued to progress in expanding the development pipeline and reviewing potential acquisitions to stabilize properties. The company now has about $260 million in medical office under construction and as noted recently we acquired a $59 million office complex in Dallas, Texas. This investment will be immediately accretive with the ability to re-tenant one of the buildings over the next two years with medical tenants at what we expect to see higher rates. While the Dallas investment could be an indication that transaction prices of individual properties are becoming more attractive, we feel that the larger portfolios located on hospital campuses will probably still command a premium providing investment return.

We continued to view the development pipeline as the company’s primary growth driver albeit with longer time lines but we believe once stabilized it should provide better investment returns and higher quality buildings. In the near term, we do not see much influence from micro economic head wins while there has been some speculations that elective procedure volumes might recede in an economic slump. Historically, these procedures have only accounted for about 10% of physicians and outpatient services. So, even if there are some erosions, we do not believe that it would have much impact on our tenants. We view our business model as simply the ownership of a large geographically dispersed portfolio of outpatient and medical properties tenanted by various specialties and financially stable professionals. These practices are not affected by economic cycles. Given the quality and location of the company’s properties and the fact that about 80% of the portfolio has an average tenant size of only 3500 square feet, we believe the company will continue to experience positive, rental rate growth with limited exposure to vacancy or lease concessions. The healthcare industry and the outpatient services in particular have demonstrated over many decades the industry’s resilient nature and its consistent pattern for growth.

Now, I would like to ask Ms. Mancini to give us an update on the trends in healthcare. Bethany?

Bethany Mancini

Thank you, David. Government legislative activity over the past quarter continued to support growth in healthcare spending and patient access to coverage and services. On July 15th, the Congress overruled the President’s veto and passed The Medicare Improvements for Patients and Providers Act of 2008. This legislation provides physicians with a 1.1% increase in Medicare payments for 2009 offsetting a 10.6% cut in increasing spending on physician services by $17 billion over five years. In another spending bill passed by Congress this quarter, six of seven Medicaid cuts that the President had proposed were delayed. While states are being (inaudible) with tighter budgets and spending cuts, 26 states are proposing to increase healthcare coverage for the uninsured.

The current political landscape is undoubtedly favorable to expanding healthcare services, particularly in light of the upcoming elections in the state of the economy. Whatever the outcome of the presidential election in November, the healthcare will likely continue to be viewed and supported by our government as a personal necessity and right. Both presidential candidates are looking to increase coverage of the uninsured which should translate into improved revenue and fewer bad debts for hospitals other widespread reforms are likely set several years out at best with implementation even further out. Where the reforms have started to increase government funds or coverage or private insurance and tax reforms, the politically sensitive nature of providing healthcare to the entire population particularly as it ages should translate into continued stability in growth for facility based healthcare services. Given the inevitable rise in healthcare spending, the government remains focused on lowering long-term healthcare inflation. Recommendations for reform are generally focused on improving technology, quality and cost transparency rather than on limiting provider Medicare payments. The congressional (inaudible) to get it in a recent report, to lower long-term spending growth by increasing consumer accountability through cost and price transparency, making eligibility requirements more stringent, changing incentive for poor providers and consumers to chose lower cost options, setting comparative effectiveness of new treatments and technology, and promoting healthier living. These initiatives if implemented by Congress should assist in lowering long-term healthcare inflations while still providing growth and reimbursements to providers.

The centre for Medicare and Medicaid services recently finalized regulations for 2009 Medicare payment rates for acute care services, inpatient rehab and nursing homes with final rates in line or better than expectations. Inpatient rehab facility payments will be slightly lower although their admissions criteria have been eased. An acute care hospital will receive on average 4.7% higher payment. The remainder of the legislative year should be relatively quiet for healthcare policy with final payment rates being released for hospital outpatient services, originally proposed at an average 3.2% increase for 2009.

The medical office outpatient sector continues to be attractive to investors for its private paying characteristics and positive healthcare fundamentals. As healthcare services improve with technology, the population ages and both public and private players continued to emphasize lower cost spending, we expect our outpatient facilities and new development to remain integral to hospital systems growth strategy.

David Emery

Thank you, Bethany. Now on to Mr. Holmes to give us an overview of the numbers and some comments on other financial activities. Scott?

Scott Holmes

Thank you, David. Before addressing operating results for the second quarter, I would like to direct everyone's attention to the Form 10-Q, which contains financial statements and related footnotes, and management's discussion and analysis of results of operations, liquidity and capital resources and other matters which was filed yesterday afternoon. At the same time, information was furnished on Form 8-K to supplement the disclosures in the Form 10-Q, specifically regarding real estate investments, construction in progress and developments, lease maturities, joint venture investments, same facility growth and other corporate information.

Now a few comments on balance sheet matters. The company continues to maintain a simple capital structure and had no capital market transactions during the second quarter. At June 30, 2008 the company's leverage ratio was 44.9%. The company management continues to focus on its balance sheet strength and simplicity. Having no preferred stock outstanding the company is not affected by the new Standard & Poor's rating methodology for preferred stock. Assuming the company stays within its estimate of $50 million to $100 million per year in new acquisitions, the company does not expect any near-term lead to access the capital markets. With available borrowing capacity on the unsecured credit facility and considering proceeds from asset dispositions the management is comfortable with the company’s financial flexibility and access to funding. Currently unutilized alternative funding sources could include all cash joint ventures arrangements or traditional secured mortgage debt.

Operating results for the second quarter of 2008 were absent in the unusual items of significance. Total revenues increased approximately $900,000 or 1.7% relative to the preceding quarter. Master lease income, while lower in the second quarter on an absolute basis was up slightly after giving effect to the non-recurring first quarter lease termination fee income of about $800,000. Property operating income increased yearly $900,000 or 2.5% in the second quarter. Normalized same facility NOI growth over the second quarter of 2007 at 2.7% for master leased facilities and 2.4% from the managed facilities is consistent with the previous quarters. Rental rate increases on leases renewed during the second quarter ranged from 3.6% to 10.3% or a weighted average of 5.9% while rent increases on in-place leases averaged 3%.

Regarding near-term expirations of property operating agreements, management expects to either renew these agreements or rely on existing subtenants to maintain the cash flow from these properties. Should sponsors not renew these POAs, there will be some short-term paying but we see explorations to be a long-term opportunity to increase rents without the restrictions of the POAs. Occupancy in the POA properties with near-term explorations is currently 96.3%. Property operating income net of property operating expense increased about $200,000 as compared to the previous quarter a result of normal fluctuations.

G&A expense included a small increase in employment related expenses, related to new hires in the development and leasing area and a small decrease in capitalized overhead resulting from developments that have been transferred from construction into the real estate property portfolio. Overall, G&A for the second quarter contains no large or unusual items.

For the second quarter, income from continuing operations and FFO as defined by NERI were approximately $200,000 lower than the immediately preceding quarter. FFO per diluted share for the second quarter was $0.38 less than one half penny per share lower than the preceding quarter. FAD per diluted share for the second quarter was $0.43 as compared to $0.44 in the first quarter of 2008. FAD in the first quarter was $0.01 per share higher than it had been in the previous couple of quarters because the non-recurring lease termination fee income item in the first quarter was cash or as about half of the offsetting non-recurring expense items were non cash. A thorough discussion of operating results for the three and six-month period ended June 30, 2008 can be found in management’s discussion and analysis of the results of operations included in our Form 10-Q filed yesterday afternoon.

That concludes my prepared comments David.

David Emery

Thank you, Scott. Now on to Mr. Whitman who will give us an overview of investment and development activity. Doug?

Doug Whitman

Thank you, David. Investor interest in medical office properties remained solid as many investors remain attracted to the healthcare sector generally and healthcare real estate in particular. While tightening credit conditions have reduced transaction volume in the first half of 2008 by about 13% from last year and changed the types of buyers acquiring assets, cap rates for quality healthcare properties have not seen much adjustment. We generally expect them to be in the low 7% range for assets we will consider.

We remain cautiously optimistic that a slowing economy and tighter credit market conditions will foster a better acquisition environment for REIT in the months to come as there would be fewer leverage buyers competing and more sellers concerned about the ability of buyers to close. As an example of that acquisition environment last week we announced that we acquired two six-storey office buildings and a six-level parking structure in Dallas, Texas for $59.2 million. Baylor healthcare system affiliates and other medical tenants occupy one of the buildings under long-term leases the other building is entirely leased to a single corporate tenant who will vacate when its lease expires in July 2010. Each building contains 146,000 square feet and the parking structure contains 977 parking spaces. Built in 1999, the Class A buildings benefit from a desirable location along the North Central Expressway and their proximity to upscale residential communities, shopping districts, and three of the largest medical campuses in Dallas — Presbyterian Hospital, Medical City Hospital, and Baylor University Medical Center. The immediate submarket has some of the highest occupancy and lease rates in Dallas. This acquisition expands the Company’s existing Dallas/Fort Worth portfolio to more than 2 million square feet.

While we are pleased with our recent purchase of the buildings in Dallas, we remain primarily focused on our development pipeline. The three properties that we opened in 2007 all on Baylor campuses are leasing in line with our expectations. Our development pipeline has 9 properties and CIP representing nearly 1 million square feet of outpatient space and an investment of approximately $260 million. The projects in Colorado and Arizona will open later this year, construction on the Hawaii property which began last winter continues to proceed and we have begun site work for one of the Texas projects. Two others in Illinois and Texas will commence construction later this summer or fall. All the projects currently including CIP should be completed by the end of 2010. In addition to those nine properties, our development pipeline includes another five sites where we either own or control the land. On those sites, we anticipate developing over 725,000 square feet of medical office space the budget totaling nearly $210 million. These projects are still in the free development phase and would if constructed be finished in 2010 or 2011.

Our development pipeline includes a sound mix [ph] of hospital sponsored projects where we are working on a hospital campus and market driven projects where we try compelling demographic and real estate fundamentals and then develop adjacent to a hospital. While the hospital sponsored projects may have a bit more security due to their on-campus nature, that advantage can be offset by hospitals sluggish decision making and the use in tenancy restrictions typically found in hospital ground leases. The market driven projects tend to be a little (inaudible). There is a slight increase in risk by developing adjacent to a hospital campus and not on it but that risk is offset by our ability to move quickly to take advantage of market conditions and the lack of use restrictions that would otherwise impair our ability to lease to desirable tenants like surgery or imaging tenants.

Current economic uncertainty has not yet impacted our development pipelines but despite our conservative leasing assumptions there could be isolated instances or local market conditions adversely affecting leasing efforts. While we are not immune to a slowing economy several factors do help to insulate our sector. Most healthcare spending is non-discretionary, overall demographic trends and patients’ desire for improved healthcare facilities necessitates new construction and the long lead time required to construct hospitals and outpatient facilities complicates timing development to optimal market conditions.

We continued to be pleased with our development projects and pipeline but we also recognize that constructing these properties and leasing them can be a lengthy and choppy process. As I previously noted, development activities does not follow a neatly package schedule. Constructions start dates can be affected by the permitting process, hospital bureaucracy or (inaudible) approval. Leasing is generally not linear but occurs in a random manner for the first two to three years after a building is completed. Despite the apparently irregular time line of developing and leasing medical office buildings, a building's long-term return is impacted more by its quality and location and not whether stabilization occurs sooner or later than originally forecast. We remain confident that our strategy of developing buildings on or adjacent to acute care hospitals in addition to making selective, accretive acquisitions, will provide stable, long-term cash flows from properties and sustain the companies low business risk profile. David?

David Emery

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

Question-and-Answer Session

Operator

Certainly. (Operator instructions) Our first question comes from Rosemary Pugh from Green Street Advisors.

Rosemary Pugh – Green Street Advisors

Yes hello.

David Emery

Good morning.

Rosemary Pugh – Green Street Advisors

Good morning. I (inaudible) learning more about the purchase options that were exercised or agreed to during the last couple of months, can you provide a little bit more detail on that?

David Emery

Rosemary, property purchase options are more fully discussed in the 2007 10-K in footnote 3 to the financial statements and in the trends section of MDNA, and in this form 10-Q you will find information in the footnote 2 to the financial statements and in the liquidity section of MDNA. We continue to experience the occasional exercise of purchase options by (inaudible) but these are options that have been in leases for many years as opposed to anything new that we are doing.

Rosemary Pugh – Green Street Advisors

So, in the case where the tenant paid you $38 million or a building where you had a growth investment of $47 million, why would the tenant have such a favorable purchase option?

Scott Holmes

$47 million?

Rosemary Pugh – Green Street Advisors

$46.8 million I think was the number I saw in the 10-Q.

Scott Holmes

Hold on just a second, let me catch up with you. It was based on a cap rate formula that was put in the lease 12 years ago, so it is what it is.

Rosemary Pugh – Green Street Advisors

Okay and what percentage of leases would include purchase options?

Scott Holmes

Well, that’s in the disclosures that I was talking about. We talked about how many million dollars of investment are subject to purchase options and the leases. So, I would suggest that you read that and if you want to talk about that in more detail, we can do that offline.

Rosemary Pugh – Green Street Advisors

Do you have an estimate on how many of these are valued at or below the total amount invested?

Scott Holmes

We have said that, this is absolutely true; we would expect to incur no loss on the disposal of any asset subject to purchase option. So, we should recover at least our net book investment or more.

Rosemary Pugh – Green Street Advisors

Okay. Then one more question on development returns, in the past you stated that stabilized returns on development projects are about 9% but it looks like in mid supplemental you are extending the period of stabilization from 2 to 3 years for some projects, and I am curious about what the typical IRR or total return on an MOB project would be for you?

David Emery

I think we have been consistent in saying that development, the lease-up period for stabilization is generally two to three years for projects and as we have also said, development returns we target stabilized return of 9% to 10%, some will be a bit higher and some will be a bit lower.

Rosemary Pugh – Green Street Advisors

Can you provide the current percentage leased for the Colorado Springs property, has that opened already or is it about to?

David Emery

It is not open, it is still in construction.

Rosemary Pugh – Green Street Advisors

So, do you have a percent –

David Emery

There are no signed leases.

Rosemary Pugh – Green Street Advisors

Okay, thank you very much.

David Emery

But it is characteristic, there are a lot of discussions going on. A lot of these properties during the construction process have some leasing some will have more than others. We have opened a number of properties over the years that had no pre-leasing or no leasing during construction and started out at zero. So, none of them Rosemary follow any particular pattern.

Rosemary Pugh – Green Street Advisors

Yes, thank you very much.

Operator

Thank you. Our next question comes from Herb Tinger from Morgan Keegan.

Herb Tinger – Morgan Keegan

Thank you. Good morning.

David Emery

Good morning.

Herb Tinger – Morgan Keegan

Couple of questions, regarding the MOB acquisition in Dallas, have you disclosed what kind of a yield you got from that deal?

David Emery

We have not but our target yield as we said on these type of properties is between 7% and 7.5%. This is a very stellar property so although we don’t disclose the particular yields, you can assume that that is probably at the lower end of that range.

Herb Tinger – Morgan Keegan

Okay. Did you say that one of the buildings, a single tenant will vacate it in July ‘09?

Doug Whitman

Right.

David Emery

In 2010. The building was originally built in 1999 for a technology-based company and that company went through several mastications [ph] and I think the buildings were bought by the intermediary that we bought it from. They re-tenanted one of the buildings with medical tenants, which is Baylor and several others. This property is (inaudible) to say that it is in a location that has half medical utilization and so the fortunate thing is that the tenant who is paying rent in the second building is actually not in occupancy. So, we have the advantage that over the two years that should we find the appropriate medical tenant that we would want, we are not stopped from doing anything until July ’10.

Herb Tinger – Morgan Keegan

Okay and the follow up on the previous questions about the outstanding purchase options, of the properties that have outstanding options, are they all MOBs?

Doug Whitman

Typically yes. The vast majority of them would be MOBs.

David Emery

And most of those are ones that were bought many years ago either from hospital systems or otherwise and I think at that period of time it was fairly typical that in those master leases that the hospitals had purchase options.

Herb Tinger – Morgan Keegan

Okay.

David Emery

I can assure you we have not anymore of those in a number of years.

Herb Tinger – Morgan Keegan

Okay. Question on the other income line, can you give some details as to why that rose quite a bit sequentially and is the $5 million that was recorded in Q2 a good run rate going forward?

Scott Holmes

Hold on one second, actually the income level for the current quarter should be a pretty good run rate going forward. We had a couple of things that happened last quarter that dropped that down some. So, comparatively it looks like it is way up but really it is kind of back where it belongs.

Herb Tinger – Morgan Keegan

Okay. A question on the pattern of G&A expense, I think that in the past it tends to be high in the first quarter and then lower in Q2 and Q3, can you explain what’s behind that pattern and do you expect a similar pattern this year as well?

David Emery

One of the culprits for that is FAS 123R which requires a charge or what’s determined to be compensation expense under the FASB statement related to our employee stock purchase plan that is a one-time event that occurs in the first quarter of each year and that runs in the range of $200,000 to $300,000. So, that’s one big ticket item that hits in the first quarter of every year. Other than that no, there is not any particular items, probably shareholder communications kinds of expenses, the Annual Report 10-K, proxy tends to run higher in the first quarter but it is just kind of general bumpiness from quarter to quarter. I expect based on what we have seen in G&A this quarter that this ought to be fairly representative of what G&A would be for the remainder of the year per quarter.

Herb Tinger – Morgan Keegan

Okay, good that explains it. Finally, given the acquisition in Dallas, can you say – will you disclose how much you have got available on your line of credit as of today?

Scott Holmes

As of today, our revolver balance is in the neighborhood of $205 million and we have $400 million of capacity. So, we would have $195 million remaining.

Herb Tinger – Morgan Keegan

Got you. Thank you very much.

Scott Holmes

Yes.

Operator

Thank you. Our next question comes from Chris Haley from Wachovia.

Chris Haley – Wachovia Capital Markets

Good morning.

David Emery

Good morning.

Chris Haley – Wachovia Capital Markets

One of the things if you could help me out in the G&A line first, how much are you currently capitalizing related to your development efforts on an annualized basis?

Scott Holmes

Chris, I have to get back to you on that. I don’t know that answer right off the top of my head. Comes from many sources.

Chris Haley – Wachovia Capital Markets

That would be helpful, maybe a possible disclosure as well would be helpful in the light of the amount of development that is going on and the extension of dates, stabilization dates, would you care to offer your view from an accounting perspective when these properties come off of the lease-up phase and into the stabilization? At what point in time during that two to three-year period you can no longer capitalize associated expenses, is that a year after the project is done technically or –

Scott Holmes

No, from an accounting standpoint, once you are core and shell you kind of have up to a year to continue to capitalize costs. You can capitalize everything that you did up to core and shell but you can continue to capitalize interest expense and certain other overhead kind of cost in the project or up to a year depending on the circumstances. Once your property reaches whatever you consider to be stabilization or you reach the one-year period, whichever occurs first, then you would discontinue the capitalization of costs.

Chris Haley – Wachovia Capital Markets

But in looking at and thank you for looking at your disclosures however most of the projects would be beyond the one-year time period I would assume or are you able to and currently extending the shell build out so that you can maintain the capitalization policy?

Doug Whitman

Basically, our experience has been in the lease-up front two to three years on these type of properties and to just reiterate what Scott said, there is a mix of what you capitalize during the first year but the two or three-year lease-up didn’t really impact the capitalization. It’s a fairly bright line accounting pronouncement so there is not much discretion on exactly what you can capitalize and you can’t capitalize.

Chris Haley – Wachovia Capital Markets

Okay, thank you. The next question has to do with the purchase options. You mentioned that you don’t expect a loss on these investments coming on these options, is that on a gross investment basis or a depreciative basis?

David Emery

I would say that on a net basis, it would have to be compared to net to incorporate a loss.

Chris Haley – Wachovia Capital Markets

So you are speaking a GAAP loss versus an economic loss.

David Emery

Correct.

Chris Haley – Wachovia Capital Markets

Okay. The last question has to do with the master lease income, looking at the run rate going into the second half of the year, would you care to offer any commentary as to the sequential decline first to second quarter, was that related to sales or I am just trying to figure out what the run rate might look like in the second half of the year and what type of impact this activity might have in 2009?

David Emery

The second quarter master lease income would be a good proxy for the run rate going forward. First quarter was higher because we had about $800,000 of a lease termination fee recorded in master lease income in the first quarter and that did not recur in the second quarter.

Chris Haley – Wachovia Capital Markets

Is that the only variant sequentially?

David Emery

Yes.

Chris Haley – Wachovia Capital Markets

Thank you.

David Emery

Thank you.

Operator

Thank you. The next question comes from Jerry Doctrow from Stifel Nicolaus & Company.

Jerry Doctrow – Stifel Nicolaus & Co.

Hi, good morning.

David Emery

Good morning.

Jerry Doctrow – Stifel Nicolaus & Co.

I have a couple of different things. It looks like you actually paid off some of the debt, the long-term debt, if we understood right this 2014 debt, I just didn’t quite understand why that made sense and just wanted to confirm it and maybe what you’re thinking was?

Scott Holmes

Jerry, we had some proceeds coming in from disposition of properties, we had a choice of either paying down the revolver that we would save 3% or 4% interest on or due to the situation in the bond market we could repurchase our own bonds that would yield us somewhere around 7% to 7.5%. So that’s what we chose to do, it’s with a limited number of dollars, it’s not we are getting crazy about, we did buy back a few of our own bonds, both the 2011 issue and the 2014 issue and we’ll save a little bit of interest going forward as a result.

Jerry Doctrow – Stifel Nicolaus & Co.

You bought it at a discount so it is a little bit better deal than what we were thinking, okay.

Scott Holmes

We bought some at a discount, the others sold at a slight – of course the discount yields a gain and then some were at a slight premium which yields a loss and net-net we were about even on gain and loss.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay, let’s see, I don’t know whether I want to too much belay with the asset sales and purchase options, I think what we are trying to sort of get to if we think through the rest of ’08 and maybe into ’09 is what the likely loss of income may be from those two things and you have got the other $38 million I guess I think first quarter ’09, is there more stuff out there that we should be expecting sort of come off and give us a sense on maybe what the yields and things would be.

Scott Holmes

Other than what’s disclosed in the 10-Q we don’t know of anything else that is coming down the pipe.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay and you are not getting any inclination that guys – there are other potential purchase options that could be exercised but you are not getting a sense at your – the hospital systems I guess are inclined to exercise.

Scott Holmes

No, we don’t have any indication of any other pending exercise or purchase options. We do Jerry have one property that we’re kind of hovering on the edge of selling, it is not a purchase option exercise, it is just a decision by the company to sell it and it would be in the neighborhood of about $18 million.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay. Any sense of what the yield might be on that?

Scott Holmes

It will be 9% [ph].

Jerry Doctrow – Stifel Nicolaus & Co.

How about the yield on the $38 million unless it was disclosed and I missed it, the one that is coming off ’09?

Scott Holmes

Hold on a second, that’s in the 7% to 8% range.

Jerry Doctrow – Stifel Nicolaus & Co.

Alright, that’s helpful. There is just a couple of items in the Q that I want to circle back on, one there is this contingent rent on this stuff, Methodist stuff in New Orleans, is there a potential drop in rental income there either because the support agreement goes away or just because the facilities can’t get released up or there is no demand in New Orleans?

Doug Whitman

There is a potential for that. As you know from the disclosures in the Q, that is a loss for you under a property operating agreement and basically the properties were damaged in Hurricane Katrina. The sponsor has decided to quit paying the amounts due under the POA. We continued to accrue those and we have disclosed the amount of that accrual. There was a suit filed in connection with that POA and that goes to trial in October. So, I think there will be a fairly binary outcome from that trial, either the POA will be enforced and the sponsor has the ability to pay or it won’t be in which case we may have a reduction in income as a result.

Jerry Doctrow – Stifel Nicolaus & Co.

Is there any underlying value to the properties there or have you rebuilt them or whatever with insurance proceeds or just what the –

Doug Whitman

Yes, we immediately restored them to operating condition which is our obligation under the POA. So we did do that.

David Emery

But the hospital has not reopened but the salient point of the whole thing Jerry is that the liquid assets of the guarantor here approaches $150 [ph] million. So, it is not like somebody is under strained and can’t pay. I think they simply liked it because of the hurricane, might use that as an opportunity to abrogate their contractual relationship. So, it is just an interpretation of contract and that is pretty clear. So, it is disappointing we have to go through it but –

Jerry Doctrow – Stifel Nicolaus & Co.

But if you lose the loss, it is really, substantially a total loss because the property is really – there is no tenants for the properties basically at this –

David Emery

I think there are some tenants in the property but it would not be at the level that it was before.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay. The other one that is in there is just the health suit I guess is the Capstone litigation and that sort of stuff, just any additional color on that, do you expect any hit from that litigation?

David Emery

No, John Bryant is in the room. John, do you have any comments on that you know –

John Bryant

We will continue to spend money to defend the case; we don’t perceive any material long-term outcome.

Jerry Doctrow – Stifel Nicolaus & Co.

Just the last one David, you already commented on this a little bit, but just color on acquisitions, I think you had said earlier $50 million to $100 million, obviously you are well above $50 million for this year, is it feeling more like the higher end of that range or perhaps even above it if the storage kind of aligned right for you?

David Emery

I would say that the answer to that is yes.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay, alright, thanks.

David Emery

I don’t think there is any deluge but there does seem to be a little percolation of more activity but again it has to kind of do with what kind of properties those are Jerry, there may be a lot cut in the marketplace but it is these larger ones that are on hospital campuses, most likely those are going to be below our target rate, at least that is what we anticipate. We don’t know that but maybe it is probably – there are several in the offing but we’ll just have to wait and see what the pricing is because as you know we have exerted a good bit of discipline over the last two or three years regarding that and I don’t think there has been any C change, there are just opportunity now that is just less kind of leverage bar and so we went from being listed as number 10 to 2nd or 3rd and then Dallas we happened to be number 1.

Jerry Doctrow – Stifel Nicolaus & Co.

Again, just on the use of capital, you were talking at one point about JV maybe Hawaii and that sort of thing, I think Scott said earlier that you don’t see a need for capital raising here, is that JV or anything sort of assumed in that time frame?

David Emery

No, we are pretty good as we go. We don’t really have to do anything in particular. We always look at all of the different options that we might have, that’s all of mosaic development and acquisitions and those kind of things but we are not out saying that we have to do this joint venture in Hawaii or in Seattle to meet our capital budget projection. So, right now we are kind of good to go, if the development stuff pokes up then we would obviously consider all of our options to support that.

Jerry Doctrow – Stifel Nicolaus & Co.

Okay, alright, thanks a lot.

David Emery

You are welcome.

Operator

Thank you. Our next question comes from Albert Adriani [ph] from Catapult.

Albert Adriani – Catapult

Yes, thank you, good morning.

David Emery

Good morning.

Albert Adriani – Catapult

I have a question about, you mentioned in a footnote in your supplemental the property operating agreements and referencing 14 properties at 73% occupied, does that include these New Orleans properties we are talking about or is that a different pool?

David Emery

That includes the New Orleans properties.

Albert Adriani – Catapult

Okay. In the same supplemental where you talk about your construction pipeline that you have an estimated total investment, does that include the capitalized items or is that not included?

David Emery

That includes all costs that are capitalized or expected to be capitalized to the project.

Albert Adriani – Catapult

Okay, great. Then just lastly, a small thing, your economic occupancy went from 90% in Q1 down to 89% which could mean a decrease between 1 basis point and 199 basis points depending on where the rounding is. I am encouraging you to perhaps go to one tenth of a percent to help us determine whether it really is something just small and minor or is there something material going on in occupancy?

David Emery

It is small and minor but we’ll take that under advice.

Albert Adriani – Catapult

Okay, thank you very much.

Operator

Thank you. Our next question comes from Ernest Swett from BMO.

Richard Anderson – BMO Capital Markets

Richard Anderson here. I wonder if I can ask an uncomfortable question.

David Emery

Yes.

Richard Anderson – BMO Capital Markets

It’s not that uncomfortable. David, in your masterful English language you said percolation of activity, I suppose it is distant percolation of activity –

David Emery

Pretty good Rich.

Richard Anderson – BMO Capital Markets

On a serious note, your stock is trading at $30, it is almost $30 a share now, you are getting some love from the street, you are certainly knocking the cover off the ball in terms of year-to-date total returns, so things have really looking good, I wonder if you can comment, you guys, it is not secret, you guys are the darling targets from healthcare REITs in terms of the size of your outpatient medical office building portfolio, if you can comment at all on your appetite, your willingness to consider a phone call from some of your peers to re-discuss getting together with them in a merger transaction.

David Emery

Sure. Obviously our phone number is published. We have not received any of those type calls. We as shareholders and obligation, we would obviously consider anything that we thought made some sense, I think I have made the comment over time that given the simplicity of the portfolio and the valuation of the portfolio we don’t know necessarily how people are enhanced by being part of the necessarily larger operation so to speak. But with that said, we are open, we are business people and we are open to any discussions anybody wants to have but we have not heading those discussions and frankly I don’t know that I expect anybody.

Richard Anderson – BMO Capital Markets

Okay great. That’s all I have.

David Emery

Sure.

Operator

Thank you. It is not showing any further questions at this time.

David Emery

Very good. We appreciate everyone being on the call today. I think most of us will be around today, if there is any follow-up questions, I believe Scott has a couple of people that he needs to follow up with, so we will be around if there is any more additional details that folks need, give us a call and we appreciate your interest and good day.

Operator

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.

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Source: Healthcare Realty Trust, Inc. Q2 2008 Earnings Call Transcript
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