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Healthcare Realty Trust Incorporated (NYSE:HR)

Q3 2012 Earnings Call

November 08, 2012 10:00 am ET

Executives

David R. Emery - Founder, Chairman of the Board, Chief Executive Officer, President and Chairman of Executive Committee

Carla Baca

Bethany Mancini

Douglas Whitman

Todd J. Meredith - Executive Vice President of Investments

Scott W. Holmes - Chief Financial Officer and Executive Vice President

Analysts

Trish Azeez

James Milam - Sandler O'Neill + Partners, L.P., Research Division

Jeff Theiler - Green Street Advisors, Inc., Research Division

Michael Carroll - RBC Capital Markets, LLC, Research Division

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good morning, and welcome to the Healthcare Realty Trust Third Quarter 2012 Results Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mr. David Emery, Chairman and CEO. Please go ahead.

David R. Emery

Thank you. Good morning, everyone. Joining us today on the call today are Scott Holmes; Doug Whitman; Todd Meredith; 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 a Form 10-K filed with the SEC for the year ended December 31, 2011, and a Form 10-Q filed with the SEC for the quarter ended September 30, 2012.

These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material.

The matters discussed in this call may also contain certain non-GAAP financial measures such as: Funds from operations, FFO or FFO per share; funds available for distribution, FAD or FAD per share. A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30, 2012. The Company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website. David?

David R. Emery

Thank you. During the third quarter, we were pleased with the company's progress on multiple fronts. The steady performance of our core portfolio resulted in solid gains in year-over-year same-store NOI growth, leasing momentum in our development properties remained on track, and the company's sale of 9.2 million shares for net proceeds of $201 million, positioned us well to fund ongoing development, a growing acquisition pipeline. Upon closing $50 million in acquisitions by year-end and bringing online the 2 fully leased Mercy Health properties in 2013, these investments will be accretive to FFO. We're pleased to be seeing more low risk, high-quality properties coming to market that meet our criteria and pricing expectation. The company's conservative balance sheet and available line of credit will enable us to take advantage of improving acquisition environment and the rise in hospital-centric outpatient facilities.

We believe that the election and the political debate surrounding implementation of insurance reform will have little impact on the outpatient segment of health care real estate. The alignment of physicians with health systems, in the face of increasing payment and regulatory pressure is already evident and clearly here to stay. Consolidation in the health care industry will require capital and new facilities in cost-effective, centralized locations, which will further the trend towards on-campus outpatient care. Healthcare Realty remains focused on investments that we believe will prosper in this new environment. With 78% of our $3 billion in properties affiliated with 60 hospitals, the company benefits from the high certainty of renewal and a portfolio comprised of 83% multi-tenant, outpatient properties, where an average tenant size of only 4,300 square feet. The underlying credit of our health system partners has become increasingly important. Over the last few years, Healthcare Realty's investment strategy has diligently focused on health system relationships and future growth opportunities, enhancing the intrinsic value of the company's portfolio. The consistent performance of our asset base throughout the economic concession and with its strategic position to expand in the post-reform era, affirms our belief in the company's positive fundamentals and low business risk. We see the future as increasingly bright for the company's prospects, given the size of the industry and the booming demand, and the pressing need for new buildings by hospitals. We believe our investment strategy will continue to produce solid near-term operating results, decreased leverage and make HR a distinctive investment alternative, with strong long-term growth potential. Those are my opening comments this morning, now I'd like to go to Mrs. Mancini to give us views on the current events and trends related to healthcare. Bethany?

Bethany Mancini

Thank you, David. With the election now behind us, the focus in Washington now shifts to the most pressing legislative concerns, namely the federal deficit and the looming 2% sequestration cut, the budget fiscal cliff and force physicians to 27% sustainable growth rate formula or SGR, cut to Medicare rates in January. There is reportedly widespread agreement on Capitol Hill to reverse the physician cut as Congress has done each of the past 10 years. With pressure to curb the federal deficit and find savings to forgo the 2% budget-wide cut in 2013, any long-term solution to the SGR is arguably out reach. Healthcare providers remain hopeful that sequestration will be avoided. And if not, could potentially be offset by annual market basket increases, cost controls and higher acuity casement. The reelection of President Obama and the Democratic control of the Senate likely means continued implementation of health reform, and providers should benefit from this near-term operational visibility. Even so, uncertainty lingers as Congress is now faced with intense pressure to cut spending ahead of another looming fiscal cliff, and the political balance in Congress could raise issues surrounding key provisions and funding of the Affordable Care Act. In addition, many questions remain concerning the creation of health insurance exchanges, states' roles, the expansion of Medicaid coverage, taxes and regulatory changes that could impact the Medicare program and provider reimbursements. As reform-related uncertainty persists going forward, we believe the operational changes that could actually have an impact on medical office real estate, are already underway and should progress unchecked. We saw over a year ago, among Healthcare Realty's tenants, that providers were ready to digest healthcare reform and move on with new strategies to contain costs and improve patient care, a trend which should continue to benefit leasing at our facility.

We believe the risk to Healthcare Realty's tenants of reimbursement policy and fiscal restraint remains low and the advancing shift to physician-directed outpatient care is certainly promising. Outpatient services will play an increasingly critical role going forward, and health systems' needs for medical office space will benefit healthcare real estate regardless of the ultimate outcome of the various parts of health insurance reform. In addition, as of October 1, hospitals must now contend with lower Medicare rates for high-end patient readmission level. This should also further drive hospitals to seek better outcomes in low-cost outpatient settings, and to bring physicians under their employment to ensure compliance among all providers to coordinate patient care, and share risk within their system. Most importantly, as the aging population expands, and the need arises for more healthcare providers, any increase in the number of physicians, with each requiring 1,500 square feet on average of office space, will translate into additional development of medical office facilities. Our buildings are comprised of both hospital outpatients operation and physician offices from over 30 diverse specialties, with each practice varying in Medicare and Medicaid case mix, the average physician office receiving only 30% of revenues from these programs. With limited exposure to public programs and the benefit of high rental expense coverage, we continue to approach tenant reimbursement even in the current political climate from a low-risk perspective. David?

David R. Emery

Well, thank you, Bethany. Now on to Mr. Whitman to give us an update regarding balance sheet, capital markets, et cetera. Doug?

Douglas Whitman

Thank you, David. First, a brief comment on the recent capital markets activity. At the end of the third quarter, the company issued 9.2 million shares in a follow-on equity offering, which generated $201.1 million in net proceeds. We will use this offering to fund the remaining $108.2 million on the 2 build-to-suit healthcare facilities being developed for Mercy Health, and to acquire several outpatient facilities in our acquisition pipeline before year-end. All of these investments will be accretive, the acquisitions, when we close on them, and the Mercy Health projects when they are completed in July and November 2013. The equity offering had the immediate effect of reducing the balance on our line of credit, from $216 million at the end of the second quarter to only $34 million this quarter. As a result of the offering, our leverage ratio fell from 48.1% to 41.7%, and our debt to EBITDA ratio dropped from 7.7x to 6.2x. With our lower leverage and ready access to both the debt and equity markets, we are able to take advantage of an improved acquisition environment to make additional accretive investments. Now I'd like to comment briefly on our portfolio. Same facility NOI for our multi-tenant properties increased 5% year-over-year due to annual rent increases and holding operating expenses per square foot, flat. For both multi-tenant and single-tenant properties, same facility NOI increased 4.2% year-over-year. Sequentially, same facility NOI for the multi-tenant properties dropped 1.5% compared to the second quarter, due to the higher utility cost, typically found in the third quarter. Portfolio occupancy was stable, with occupancy on our same facility properties remaining at 90%. Our tenant retention rate for the third quarter was 85.1%, which is in line with our year-to-date retention rate of 83.9%. Through the first 3 quarters of this year, the on-campus retention rate has been about 8 percentage points better than off-campus renewals. A better on-campus retention rate is typical, and part of the reason we have worked to increase the percentage of properties located on or adjacent to a hospital, to 78%, up from 66% just 2 years ago.

For those leases having an annual rate adjustment in the quarter, the average annual bump was 3.2%. Our cash re-leasing spreads for the third quarter were 0.4%. This number is skewed by 3 large leases that were renewed by the same tenant. Excluding those 3 leases, the re-leasing spread would have been 1.7% for the quarter, which is in line with recent periods. While those 3 leases did not have significant initial re-leasing spreads, the tenant renewed for either 5 or 10 years, increased the amount of square footage it was leasing by 11%, agreed to 3.5% annual rate increases, and we'll get a modest $3.60 per square foot in TI. The overall economics of these leases are very positive. In fact, when one considers all of the facets of a lease renewal: term, square footage, re-leasing spread, future bumps, TI, et cetera, the expected returns on the 103 leases renewed in the third quarter, show an improvement over each of the prior 3 quarters. In our updated Sharpie presentation, which is available on our website, we have added a few new slides. Page 4 of the presentation highlights typical coverage ratios for various healthcare property types. This slide illustrates the significant red cushion, associated with MOBs. Using data from the Medical Group Management Association, we calculate that MOBs have coverage ratios of approximately 9x, which makes sense, given the occupancy costs account for only a tiny fraction of an average physician group's expenses. Page 15 of the presentation provides some detail on the 2 Mercy Health projects. Todd will discuss those -- these 2 investments further in a moment. In addition to these 2 slides, we have provided an additional -- we have provided additional disclosure on Page 20 about the properties included in our non-core bucket, as well as our disposition activity in 2012. This information, including the property's net book value, NOI and square footage, should allow investors to more properly assess the value of this often overlooked part of our portfolio. Finally, we will see many of you at NAREIT in San Diego next week for the opportunity to continue this discussion. And with that, I'd like to turn it over back to Dave.

David R. Emery

Very good. Now on to Mr. Meredith to give some specific information regarding investments and developments. Todd?

Todd J. Meredith

Thank you, David. Leasing in our development properties showed steady progress during the third quarter. Our 12 properties now in stabilization in progress, or SIP, increased to 54% leased, compared to 50% last quarter for the same group of 12 properties. Based on the leasing activity underway, we continue to expect leasing to exceed 60% by year end. We see the consistent pace of lease up over the last 5 quarters continuing into 2013, and we anticipate leasing being in the mid-60s by the end of the first quarter. Our stabilizing properties generated breakeven NOI in the third quarter. Occupancy at these properties was 37%, and as tenants take occupancy of the 54% already leased, NOI will build to over $2 million per quarter by midyear 2013. Several properties will reach stabilization in 2013, and contribute significantly toward the $25 million to $30 million of pro forma annual NOI that will be generated by all 12 properties in stabilization. Early in the third quarter, we completed one remaining property under construction, located in the high-growth submarket of Houston. This property is 46% leased, and we have letters of intent that will increase leasing to over 75% of the building. We funded $25.7 million during the quarter toward 2 existing construction mortgages for facilities that are 100% leased to Mercy Health based in St. Louis. One property is a comprehensive outpatient facility in Oklahoma City, and the other is an orthopedic surgical facility in Springfield, Missouri. Vertical construction has topped out at both facilities. To date, we've funded $94.4 million, and the remaining $108.2 million will be funded in $25 million to $30 million quarterly increments, through completion in July and November of 2013, respectively. We currently generate interest income at 6.75% on our loan balances. We will assume ownership of these facilities through the outstanding loan balances upon completion, after which these properties will yield approximately 8%. These return levels create net asset value, given that similar assets trade for 6% to 7% today. Regarding our ongoing disposition efforts, we sold 5 buildings for $31.3 million in the third quarter. Year-to-date, we've sold 16 properties for approximately $81.4 million. These non-core assets average 41,000 square feet and 60% occupancy, with 84% of the square feet located off-campus, and we acquire -- and were acquired in years past as part of larger portfolios. In the fourth quarter, we expect to sell additional properties for approximately $10 million, putting us over the midpoint of the range of $80 million to $100 million of asset sales that we estimated for 2012.

In November, we entered into an agreement to sell a medical office building located in Brevard County, Florida that if closed, will result in a $7.8 million noncash impairment. Originally acquired 1998, this single tenant property was vacated during 2010. The market has declined rapidly due to NASA's downsizing, which has greatly affected re-leasing efforts. Given that the property produced a net operating loss of $179,000 for the 9-month period through September 30, the sale will be accretive upon closing and reinvestment of the estimated $2.1 million in proceeds. As part of our equity offering in late September, we communicated that we were seeing more acquisition opportunities that meet our criteria, and we would close up to $50 million by year end 2012. Subsequent to the end of the quarter, in October, we acquired 2 properties for $20.4 million. These properties total 86,570 square feet or 94% occupied upon closing, and yield approximately 7.7%. One property is located in Memphis, the other in Edmonds, a suburb of Seattle. Both are well located near properties that we already own, and we intend to close additional acquisitions in the fourth quarter that will bring us closer to the $50 million we indicated previously. Looking ahead to 2013, our current acquisition pipeline is the largest which that we've had in 12 months, at over $200 million, and at a targeted blended cap rate of approximately 7.25%. Our current outlook as an improving investment and if our current outlook of an improving investment environment persists, we will take advantage of investment opportunities, given our lower leverage and the capacity on our credit facility. For an illustration of the quality level of the assets we are pursuing, please see Page 24 of our updated Sharpie presentation, where we've superimposed our acquisition pipeline on the 4 quadrant framework, characterizing our existing portfolio. While most investors are pursuing large, investor-owned portfolios, we find these portfolios usually have disparate properties, lack intrinsic value characteristics and command premium pricing because of size. We continue to focus on individual assets and smaller portfolios, aligned with leading health systems and growth markets that also fit well with our existing properties, meet our fundamental real estate criteria and can be acquired at better pricing. In the long run, these types of properties will increase the quality of our portfolio, generating a reliable cash flow, stable occupancy, steady growth and most importantly, be additive to net asset value. In the near term, we remain focused on driving the leasing momentum in our development properties, selling certain assets and taking advantage of the improving acquisition environment. David?

David R. Emery

Thanks, Todd. Now, on to Mr. Holmes to give us some overview of recent activity of results of operations. Scott?

Scott W. Holmes

Yesterday afternoon, the company filed its form 10-Q, which contains detailed current disclosures about the company, its financial position and results of operations. Concurrently, information was furnished on a Form 8-K to supplement the Form 10-Q disclosures regarding investment activities, leases and occupancy, and other, relevant corporate information.

I have a few brief comments about the operating results. The third quarter was a quiet quarter, with no transaction anomalies or noise impacting the operating results. The normalized FFO per diluted share for the third quarter was $0.33, and normalized FAD was $0.35. There are no normalizing adjustments to FFO or FAD for the third quarter. The dividend payout percentage on normalized FAD for the third quarter is 86%. Consistent with prior years, property operating expenses increased in the third quarter due to seasonally high utility expenses. Utility expenses increased approximately $1 million over the second quarter of 2012, caused by the higher summer temperatures, in line with the typical seasonal increases we have seen in the past. I direct your attention to the section entitled Other Items Impacting Operations in MD&A on Page 30 of the Form 10-Q filed yesterday, for additional information about other matters that could impact operating results for the remainder of 2012.

I continue to be pleased with the performance of the existing property portfolio and the efforts of the leasing and property management teams to deliver consistent and improving property results, giving us a solid backdrop of revenue and NRI growth as we execute on our strategy. David?

David R. Emery

Okay. That concludes our prepared comments. Operator, we are ready to entertain questions, if there's anyone in the queue.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Trish Azeez of BMO Capital Markets.

Trish Azeez

So you've said in the past, that you expected the, the SIP portfolio to reach 50% occupancy by year-end, but it seems that leasing kind of slowed a bit in Q3. And at the current pace, it'll take at least another 3 quarters to reach that target. Can you talk a little bit about your leasing pipeline, and maybe about how the environment differs from what you anticipated 6 months ago?

Todd J. Meredith

Trish, this is Todd. I wouldn't say that we see any change in the trend in our leasing pace. We're actually very comfortable that it's in line with what we've been talking about. The occupancy specifically, which we always mention lags leasing, that always depends upon buildout, the complexity of each tenant, the timing of those, the design and buildout process. So that could be a little less than the 50 by year-end, but doesn't change anything about our leasing. And I think, as it relates to being 2 or 3 quarters behind, I certainly don't think that's the case. As I talked about, we see reaching 50% comfortably next quarter and being in the mid-60s by the end of the following quarter. So nothing that we see, we're -- we've been I think consistent in 3% to 6% a quarter in leasing progress each quarter. So no change there.

Trish Azeez

Okay, and also, you also stated that you were focused on seeing the pre-leasing opportunity through to completion, before you thought about taking on to investments. What are you think -- you need to be, from a pre-leasing percentage perspective that will make you more inclined to backfill your development pipeline with a bit more of a sense of urgency?

Todd J. Meredith

We're certainly not just waiting to hit some specific numbers, that's not the plan. But certainly, as you said, we've talked about making sure we're focused on it, develop it and having a competent level of leasing before we take on more. We're certainly always out there looking at developments, and I think, in terms of new development starts, wouldn't anticipate any necessarily in the first quarter. But probably, getting into the second half, second quarter and second half of the year, you'd see some development starts and by then, as I said, by the end of the first quarter, we're looking at mid-60s for leasing. So we would begin to be comfortable to do that.

Douglas Whitman

And Trish, this is Doug. I think on a lot of the opportunities on the development side that we're seeing nowadays, with hospitals and health systems, begin, were -- tend to develop on-campus, so hospitals are putting outpatient departments, or acquired practices, or some sort of hospital entity in these buildings. And so you -- almost all of these development opportunities are coming baked with a significant amount of pre-leasing. They range all the way from build-to-suits to -- the hospital takes a third, the half of the space. So it's rarely that you'd see a totally spec building.

Operator

The next question comes from James Milam of Sandler O'Neill.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

I know traditionally, we haven't really thought of reimbursement as being a big risk to medical office buildings but I guess I'm curious what are you guys' thoughts are, as you think about being more on campus and more affiliated with hospital systems if reimbursement pressures, as they begin taking physician practices on board, et cetera, if we ought to be looking at reimbursement pressures as they affect hospitals more or do you still think that, that's really a nonissue?

David R. Emery

Well, I think it, that the physicians are still billing separately, then you mean, they're under the same umbrella contract for a payer, maybe now as with the hospital. And so you're getting improved revenues from that angle. But the facility fee versus the professional fee, they're still billing separately on that. So the physicians, are somewhat, yes they're linked, but maybe not as close as you think in terms of the reimbursement on the revenue side.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

And so when you think about the hospital partner or the hospital system, obviously, you guys, in your underwriting, you think about the credit quality and the strength of that system, but you're not concerned, necessarily about the reimbursement environment as it relates to those hospitals?

David R. Emery

No. Not the -- the hospitals with whom we're affiliated are generally, market leaders, they're the first or second largest health system in their market area, service area. Very strong. There's certainly a lot of publicly available data on their financial performance, as well as operational performance. So we're very comfortable with the hospitals with whom we have a relationship and certainly when we enter into a new one, that's one of the, key parts of our due diligence is to make sure that the health system is going to be around, and so.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

Okay, that helps. My second question on the operating properties, obviously very solid same-store NOI growth. Can you just talk a little bit more about what the driver was there, is it, new leases? Or is it improving occupancy, and I guess I'm not sure if the SIP portfolio is considered part of that or not?

David R. Emery

The SIP is not. It's not included in that same-store NOI calculation. Really, the growth on the multi-tenant side, it's just in annual rent increases, we're getting a little over 3% on those, so that kicks in, and again cost expense management, our operating expenses per square foot have remained flat, year-over-year, in the third quarters. So that's -- that those 2 factors kind of combine, that -- for those healthy same-store NOI.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

And is that expense control something that will carry forward into additional quarters, or was that just, a weather-related third quarter?

Scott W. Holmes

Yes. No, I mean, obviously your third quarter utilities is always kind of the big buzz, but no, I think you -- we've consistently kind of kept operating expenses flat. We work very hard on keeping that manageable, and so it's an ongoing thing. It's not just a one -- one event.

David R. Emery

But I think a lot of it is, is -- this is David. I think a lot of it is, is we have a strong focus on the top line, because when you look at the composite of NOI on these buildings, it's a lot easier to work the top line, than it is the bottom line. And we have done, I guess over the last 5, 10 years, we've gotten the bottom line about as much under control as it's kind of possible. So over the last 4, 5 years, we begin to kind of emphasize top line growth, and I think you could see that in some of the numbers, particularly in this quarter and so on and so forth. I think, also we're benefiting from the standpoint of just the secular nature of what we're doing, there's not a lot of extra supply, you have a growing population, all of those kind of things, kind of drive the economics, the rent cushion of 9x, all of those kind of things, gives us a little bit more opportunity to push on the top line, because of the low fungibility of properties, a lot of times there's not a lot of alternative for the tenant to relocate.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

Okay, thanks. And then my last one, you guys made some disclosure about some master leases that are expiring next year, is -- I guess what is the net effect on NOI? Are there underlying tenants there that you'll take over and, I guess that you said that there's vacancy, what kind of leasing interest are you getting in those assets?

David R. Emery

Four of the assets are inpatient rehab facilities, leased by HealthSouth, so we expect HealthSouth to stay in those facilities. The other 2, one is a small clinic in Georgia, we expect the tenant, I think, to stay in there, as just renewed for a single -- they renewed last year for 1 year, and I expect that they will continue to renew. The other building, is a larger building, it's a single tenant building, it's a multi-tenant -- multi-specialty group, we are working with that group and/or other groups, it's in an enviable location. It is an off-campus facility, but we have had several folks interested in the facility, and we expect somebody will pursue that building.

James Milam - Sandler O'Neill + Partners, L.P., Research Division

Okay, so we shouldn't be concerned about any meaningful NOI decreases from at least to the top line, sounds like everything's pretty stable there?

David R. Emery

Yes. I mean, it's --

James Milam - Sandler O'Neill + Partners, L.P., Research Division

You'll be working hard, but ...

David R. Emery

They either sign or they don't. So, I would say the majority of them, you have the HealthSouth, ones we think will be fine, the others, I think -- we're working hard on re-leasing them so, but we'll definitely keep you guys updated on that.

Operator

The next question comes from Jeff Theiler of Green Street Advisors.

Jeff Theiler - Green Street Advisors, Inc., Research Division

My first question relates to your investor presentation. On Page 24, you have a quote up there that says you're increasingly seeing lower risk, high-value properties come to market at attractive pricing levels. I guess my question is kind of, what's driving that increase in supply, and how should we think about pricing going forward if you look at acquisitions?

David R. Emery

Well, that's certainly right, and I think we are just seeing just a little higher volume. It's not a tremendous change in volume, but we're just seeing some more things that fit our criteria and I think it's just a process and we've looked at nearly 400 deals this year, just as you get all these deals, and obviously have been very selective, but just as you dig through those, we're finding some more that fit our criteria, and I think what's driving this is still a lot of folks realizing that these are attractive cap rate levels if you're a seller, there's obviously some tax consequences to think about for some folks at year-end, which is up in the air right now. So we see some of the driving it. We see some of the consolidation that's going on, driving that. Sometimes you have physician investors that might be becoming part of the health system and it's a logical exit point for them in the ownership. So lot of different factors driving that, and I think, in terms of rates, I mentioned, what we're seeing is an average in around the 7 a quarter for the ones that we're pursuing, certainly you see some things, some of the bigger assets in bigger markets and bigger portfolios going well below 7, but as I said, we're looking at individual assets, primarily in small portfolios, that give you that ability to go 7 and closer to 8 in some cases as the ones we just closed last month.

Jeff Theiler - Green Street Advisors, Inc., Research Division

But you think that pricing stays pretty steady, it's not that, there's more of these coming to market, so that the pricing, gets a little more attractive?

Todd J. Meredith

I don't see a huge change, I really don't. I think for us, obviously, it's all relative to your cost of capital, and the spread and the value you can create out of that. So we'll just keep monitoring that. As long as it contributes significantly to NAV, through that spread difference that we see and bigger portfolios like our own, that's well below 7 on the valuation versus being able to buy things at 50 to 100 basis points above that, we'll continue to continue to pursue some of those.

Jeff Theiler - Green Street Advisors, Inc., Research Division

Okay. And then my next question is, in terms of the properties you've disposed of, in the third quarter, can you kind of go over what the occupancy cap rate price per foot is on those properties? I know you break it out for the 9 months, but just the ones in the third quarter?

Scott W. Holmes

I'll have to get back to you specifically on the third quarter on some of those stats. But as you saw in, in any 1 quarter, I don't know that that's the best trend to follow. I would look, probably more as year-to-date, you've got a bigger pool of assets. As you know, if you have a building that's empty, that certainly didn't look very different than a building that's full, and we had a little bit of both in the third quarter. So it's better to look at those year-to-date stats and I think, you're talking 60% occupancy, average size, 41,000 feet. All those kind of stats, I think are pretty relevant to what we're seeing, smaller on average, below par occupancy and as you can -- off-campus, 84% of the square footage being off-campus. So I think that's the themes that you should continue to expect to see.

Jeff Theiler - Green Street Advisors, Inc., Research Division

Okay, and then I just -- kind of the last follow up on that point. So you added those 2 MOBs in Florida. The dispositions that weren't previously characterized, was there a -- or what was the change in thinking there? Is anything notable?

David R. Emery

You're talking about the assets that were not necessarily -- that were stabilized assets?

Jeff Theiler - Green Street Advisors, Inc., Research Division

Yes. Yes, exactly.

David R. Emery

Yes, and I think for us, it's just a coming, a natural culling of the portfolio, and looking through different markets and assets that we think may be are at their, their best possible point, and we don't see a brighter future for them, frankly, in terms of performance or the market. And so we look at exit points that make sense, and that's part of how we look at portfolio. So certainly, as you look at the 16 we've sold, most of them are assets that we consider non-core. Some are maybe in the stabilized portfolio, but we think there's reasons for us to move on. And we've had a couple of those this year, but not too many.

Operator

[Operator Instructions] The next question comes from Michael Carroll of RBC Capital Markets.

Michael Carroll - RBC Capital Markets, LLC, Research Division

Can you guys give us a sense or some color on your stabilized occupancy number? I believe this was the sixth consecutive quarter it's been at 87%. You expect that to improve next year?

David R. Emery

It, I mean it kind of hovers around that 87%. I mean, I think we have forecasted modest improvement in that stabilized portfolio and on the occupancy side. But it's not going to, it's very -- it's a very large portfolio, it's hard to move that percentage significantly up or down, on a short period of time. But no, I think, yes, we forecast it to go up. And certainly, as we add the occupancy of the acquisitions that we've done, for them, they had to be out of the same-store bucket for 5 quarters before they get to go in. And so we do disclose that same-store occupancy was X, and -- but the stuff that we've acquired at an occupancy of Y, just to give you an indication that those numbers are going to go up through the acquisitions, so.

Douglas Whitman

Yes, I think the better number to probably look at is really the, in our presentation, the stabilized -- or the same-store number, which is, "is 90%" as Scott mentioned, and then as Doug said, you have the acquisitions that are more like 94%, 95% in the recent 5 quarters. And then, and then really what's dragging that is just some of these properties that we say are non-core that we're working through, either re-leasing or selling, and those are on average, 52%. So you can see that's really the component that drags it down a little bit.

David R. Emery

And to the extent that those non-core ones are disposed of, that also, will obviously will increase the overall occupancy.

Michael Carroll - RBC Capital Markets, LLC, Research Division

That makes sense. Then how much of your SIP portfolio's still being capitalized? I mean, can you give us a sense of timing on when some of those larger projects will start rolling off?

Todd J. Meredith

Yes. We have 1 property that is still being capitalized, that was capitalized into the third -- in the third quarter, and that will actually roll off, I believe fully next quarter. And that's actually 1 of those items that Scott referenced in our 10-Q that we addressed. The capitalized interest on that particular building that was, I will say is very small. I wanted to say it's about $100,000 per quarter, just because, again we only capitalize the unoccupied portion of buildings that have CO'ed, and that building, the buildings that we're still capitalizing are generally have pretty good occupancy in.

Michael Carroll - RBC Capital Markets, LLC, Research Division

Okay. And then my last question is, I believe you had a couple of purchase options that are now exercisable or turned exercisable this quarter? Has the tenant indicated its plans to you?

Todd J. Meredith

No. I don't think there's any this quarter. There may be next quarter or the quarter after, I'm not sure. We'll get back to you on that, but that's not this quarter or next.

Operator

The next question comes from Michael Mueller of JPMorgan.

Michael W. Mueller - JP Morgan Chase & Co, Research Division

A couple of things. First of all, I missed a couple of numbers from the remarks, I was wondering if you just let me know the NOI run rate on the development pipeline that you thought you were going to be up by mid-2013, and then where it stabilizes?

Todd J. Meredith

The number I mentioned was, when we -- when occupancy catches up with the current leasing number of 54%, we're looking about $2 million, little over $2 million a quarter. And that was the midyear number that you asked. And then, what was the other question?

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Stabilize the --

Todd J. Meredith

Oh the total? Well, again that's the 25 to 30. So if you just said that in the quarters, that's kind of the overall --

Michael W. Mueller - JP Morgan Chase & Co, Research Division

I then, I mean, going to acquisitions for a little bit, I mean, obviously some pretty optimistic comments there about what you seeing. Do you have any preliminary thoughts about how, say what you could see in 2013? How that compares to 2012 similar number, less, more?

Todd J. Meredith

Well, I think the number year-to-date, well not including the ones in October, was $22 million, so it's probably not crazy to say, maybe a little more than 2012. But that's not saying a lot. So we don't really have a target number, it's more about what we're seeing as we go, and how that relates to the ability to find accretive acquisitions and create value through the spread on NAV. So that's really our focus and certainly we'll update everybody each quarter as to what we're seeing, talk about what we've just closed and characterize that a little more.

David R. Emery

I think Mike, this is David, over the years, you've, we've -- kind of consistent. You say that kind of runs $50 million to $100 million. So it can be north of that, and it can be south of that. As Todd said, we're just, we're pretty picky about what we're doing from our attitude, the NAV view. And that is, is that, we can acquire these things north of 7, and our NAV evaluation is below that, then it's additive. So we're not trying to buy a certain amount of stuff, we're just trying to focus on is it additive or not.

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Sure. And then just thinking about capital deployment, when do you think about the development opportunities that you're seeing out there, I mean, does it feel like the pool of opportunities is there, where you're going to have consistent starts over the next few years or is it very selective? I mean, how would you characterize that, what you're seeing on the development side?

Todd J. Meredith

Well I think, back to the comments I just made, I think, to some degree, and I think there's something in our Sharpie presentation a bit -- about our view on development. That is -- that's a real opportunity to get some vigor-ish from the standpoint of NAV. So to some degree, we think that will always be part of what we do. That has to be risk-adjusted, the return has to reflect that. I think our view and outlook is, is that more and more development opportunities are going to kind of the hospital kind of generated or husbanded, in other words this just, it just seems that, rather than us going out and saying this is a hell of a location, why don't we build a building here? I think there are opportunities when you do want to do that, but I think that's probably going to be overweighed by the internal demands for capital within health systems that we're just going to turn to some folks like us to basically say, build this building for us, and we're going to take about anywhere from 50% to 100% of it, I think on balance. And so that's always going to be good for us. And I think we have a good reputation on that front, we've got a lot of it. We've done it with Stellar Systems. So to some degree, we're probably afforded an edge there to the opportunities that come at hand.

Michael W. Mueller - JP Morgan Chase & Co, Research Division

Got you. So the starts for you say the next 5 years are probably going to have a higher pre-lease percentage than the starts over the past 5 --

Todd J. Meredith

Yes, I think that's right. But with that said, that doesn't mean that there's not kind of a golden opportunity that you see, but on the main, I think you're right. I think that would characterize more of how we see it. And that's not because of design, or what we're necessarily trying to do, is just kind of -- that's the tidal flow. That's kind of what's coming at us.

Operator

The next question comes from Daniel Bernstein of Stifel, Nicolaus.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

I have a couple of questions on the construction side. Are you going to have a -- thinking of it in terms of a marked change in how you're going to construct -- do your construction you've been doing, a lot of money in constructing loans, loan to own, where you have a purchase option at the end? If you look at -- what you think of -- thinking about for construction for next year and in the future, being more on-campus and more hospital-driven. Are you looking to do more construction for yourself and less mortgage construction loans out there?

David R. Emery

Dan, this is -- it's probably just something really that depends on how the opportunity comes to us. If a developer has a relationship and we can work with them, or if the hospital wants to go a financing route. We'll look at that. But on the whole, our preference is to do a straight construction process where we're in control of that, and we provide that service and I think hospitals mostly want that. But it's really just however we can get, means to an end is really how we look at it. At the end of the day, we want to own the asset when it's complete and as we lease it up and stabilize it. So that's really the goal, there's no design of, exactly how we go about it. We just look at it case-by-case.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

And do you think construction yields are going to change over the next couple of years relative to what you had been doing, or what your expectations were before? I know with hospitals driving that construction, they're looking for a better deal than they would have 3, or 4, or 5 years ago?

David R. Emery

Well, I think certainly as you see more occupancy as David was describing, you certainly see a little more pressure on those initial yields and so if you have a build-to-suit, sure, you're going to see a lot less of the yield, then it's something you have significant lease-up for us. Given that's appropriate, it's the risk adjustment. So we certainly see that. I don't know that I would say it's tremendously different than years past, I mean, occasionally you'll see a deal that is a little alarming in terms of the rate for a hospital-driven deal, maybe it's the 7 cap which you go, well, I can buy things at 7, so those you really have to underwrite well, and make sure it's worth it. But I'd say 8 to 9 is still a feasible range for developments to extent especially to the extent there's a little development lease-up risk in it that we're comfortable with. If you do build-to-suit, I think you're below 8 but still opportunities well above 7. So not a tremendous change, we'll see as the volume picks up as it probably will over the coming years.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then you've also spoken about your hospital relationships, the strength of that, if more development is coming from this hospital-driven and maybe even asset sales as well, coming more from the hospital-driven market, do you have to build up additional relationships that you don't have now? Do you feel like you have to staff up to do that in any way? Just trying to think about how you might change your business operations for the opportunities in the next couple of years?

Douglas Whitman

No. I don't think, I mean we've really been staffed appropriately for that, for I think a long time. We've always had that type of approach, really, and so I think the good news is, we're staffed for that. We're sort of set up with our as David said, with being, having a very solid reputation in the business that we tend to get the invitation to look at these. So I don't see a tremendous change in how we go about it. I mean obviously, we think about our staffing all the time, and make sure we have it appropriate, but I don't see a material change there.

Daniel M. Bernstein - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then one theoretical question here, on -- you talked about the space you need for physicians, 1,500 square feet per physician, when you build or when you sign a new lease, there's been a lot of talk about the use of nurse practitioners to fill in the space of some physicians, especially with Obamacare clearly, probably going to stay in place, Reelection of the President and Democrats keeping control of the Senate, do you see the potential for additional demand coming from Obamacare? And really being more from nurse practitioners than just physician groups itself?

David R. Emery

Well, I think that's a good point. I think that you've heard us comment before the ability to just turn the dial and produce more doctors is not very easy. The system just does not -- is not that capable of that. So I think, when you look through the flow, then it kind of gets down to exam rooms and it kind of gets down to the patient flow. So you got more patients to some degree, you can only run so many people through a certain amount of exam rooms and times and waiting rooms and all those kind of things. So I would say, probably just on the abstract theory, that the wind is probably at our back on that, that there's going to be a little bit more demand for space, but I don't think it's going to be some simple formula that thereby it says, we're going to have a gazillion more people with insurance, and therefore then, we're going to have to double the inventory of MOBs. That's not going to be the case. So I think it's going to be at the margin, and I think the nurse practitioners and physician extenders and some of those kind of things, I think also physician offices taking on a little bit more of the diagnostic procedures, taking a little bit more of the clinical procedures, all of those things are good for us. And so, it's certainly not a contraction kind of thing, as far as that's concerned. Bethany?

Bethany Mancini

Yes, I think that we've seen consistently throughout the recession an increase in office employment for physicians. Not just not physicians, but their office employees have been on the rise for a while now. And that should continue and continue to support net of office space, but like David said, I don't think we see some watershed events that, all of a sudden, we're going to have all of this need for new space. But it certainly will be consistently on the rise, and we think that's good for HR.

Operator

At this time, I am showing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Emery for any closing remarks.

David R. Emery

Very good. Thank you, everyone, for being on the call today. And as Doug said, we hope to see many of you in San Diego next week. So with that said, that concludes the call. Thank you.

Operator

The conference is now concluded. Thank today for attending today's presentation. You may now disconnect.

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