Yahoo Finance Healthcare Realty Trust Incorporated (NYSE:HR) Q1 2024 Earnings Call Transcript
Healthcare Realty Trust Incorporated (NYSE:HR) Q1 2024 Earnings Call Transcript May 7, 2024
Healthcare Realty Trust Incorporated misses on earnings expectations. Reported EPS is $-0.81916 EPS, expectations were $0.38. Healthcare Realty Trust Incorporated isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for joining us today for Healthcare Realty's First Quarter -- hello and welcome to the Healthcare Realty First Quarter Earnings Conference Call. My name is Elliott, and I'll be coordinating your call today. [Operator Instructions]. I'd now like to hand over to Ron Hubbard, the floor is yours. Please go ahead.
Ronald Hubbard: Thank you for joining us today for Healthcare Realty's First Quarter 2024 Earnings Conference Call. Joining me on the call today are Todd Meredith, Kris Douglas and Rob Hull. A reminder that 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 company's Form 10-K filed with the SEC for the year ended December 31, 2023. 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 or FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution or FAD, net operating income NOI, EBITDA and adjusted EBITDA.
A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the quarter ended March 31, 2024. The company's earnings press release, supplemental information and Form 10-K are available on the company's website. I'll now turn the call over to Todd.
Todd Meredith: Thank you, Ron. Healthcare Realty is pleased to report strong first quarter results. FFO per share was at the top half of our expected range as were most of our key operating metrics. Solid NOI growth was driven by robust cash leasing spreads, improved tenant retention, positive multi-tenant absorption and tight operating expense controls. Most importantly, we're focused on 2 top priorities: capital allocation and operational momentum. First, our top near-term priority is accretive capital allocation. Our express goal is to accelerate FFO growth and improve dividend coverage as quickly as possible. More specifically, we intend to use proceeds from JVs and asset sales to repurchase stock on a leverage-neutral basis as long as the company trades at a substantial discount to NAV.
As a major first step, yesterday, we announced a strategic relationship with KKR that is expected to generate proceeds of $300 million within the next 60 days. And there is more KKR capital behind this initial JV seed portfolio, which I'll cover in more detail later. We also expect another $300 million of proceeds in the next 90 days from separate transactions. And in April, we repurchased $42 million of stock at very accretive levels. The average price represents an 8% implied cap rate, which compares favorably to expected JV and asset sale cap rates in the 6.5% to 6.75% range. Our second priority is operational momentum. This is primarily about increasing multi-tenant occupancy. Occupancy gains in the first quarter were on track with expectations that we communicated in our multi-tenant bridge.
New leasing volumes remain elevated, and we expect absorption to gain momentum in the second quarter and into the second half of 2024. Many of you will recall, we initially published our bridge 2 quarters ago. We expected absorption to increase by 150 to 200 basis points over 5 quarters, through the end of '24. Two quarters in, we have generated 70 basis points of absorption, which is exactly on track with our plan. I'm particularly pleased with the diligent effort and focus of our leasing and operations teams. Our leasing team has produced new leasing volume of more than 400,000 square feet in each of the last 3 quarters. This quarterly pace is an important indicator of our ability to continue elevating multi-tenant occupancy. Our operations team is focused on accelerating NOI growth by quickly converting new leases to occupancy and controlling operating expenses.
Total multi-tenant NOI grew 2.8% in the first quarter, well above 2023 growth of 2.3%. Looking ahead, we're on track to achieve the 4.4% to 5.5% multi-tenant NOI growth published in our bridge for the second half of 2024. Our leasing confidence is boosted by the constructive backdrop for MOB supply and demand. Aging demographics and strong patient utilization are pushing demand steadily higher. Hospitals and providers are initiating more and more outpatient expansion plans. At the same time, a sharp rise in construction and financing costs has severely limited development starts. These tailwinds translate to positive absorption and rising rental rates. Typical replacement net rents are pushing $40, setting up for multi-tenant occupancy gains and robust rate increases for average net rents at existing buildings that are in the low $20 range.
Now I'll turn it over to Kris to discuss financial and operating results.
James Douglas: Thanks, Todd. The year is off to a great start on operational and capital allocation efforts. Normalized FFO per share of $0.39 was at the upper end of our guidance range for the quarter. Net income for the quarter was impacted by a $250 million goodwill write-off. This noncash accounting impairment was driven by the current macroeconomic environment and does not speak to the durability or growth potential of our assets. In fact, same-store cash NOI growth accelerated in the first quarter to 3%, up from 2.7% last quarter. Cash NOI margins improved 30 basis points year-over-year as a result of holding operating expense growth below our average in-place rent escalators of 2.8%. First quarter operating expenses increased 1.7%.
This was a significant improvement compared to 4.1% in the fourth quarter and 4.3% for full year '23. Disciplined and proactive efforts, especially on property taxes and labor costs helped to control operating expenses. The successful property tax appeals in the fourth quarter resulted in first quarter year-over-year property tax increases of just 1.1%. Labor costs increased 2.7% in the first quarter compared to 10% in the fourth quarter and 9.5% for full year '23. The improvement was achieved through rightsizing and staffing and rebidding service contracts, particularly in markets with scale. We don't expect the 1.7% growth in the first quarter to be our new run rate, but we are on track to beat the full year expense growth assumptions in the occupancy and NOI bridge.
Revenue drivers were also strong in the first quarter. Cash leasing spreads were pushed to 3.7%, up from 3.3% last quarter. Initiatives to retain tenants were successful as tenant retention improved significantly from 78% in the fourth quarter to 85% in the first. Notably, the 85% was consistent in both the legacy HR and HTA portfolios. And as Rob will discuss in more detail, we achieved sequential occupancy absorption in line with expectations. The cash leasing spreads, retention and absorption are especially impressive given high scheduled lease expirations in the quarter. Over 1.6 million square feet of same-store leases expired and over 2 million square feet across the total portfolio. Yesterday, we announced a JV agreement with KKR at a 6.6% cap rate that will generate near-term proceeds of $300 million and provide a source of additional long-term capital.
In addition, we are in process on separate transactions that are expected to generate an additional $300 million of proceeds in the next 90 days. These transactions are expected to price in the 6.5% to 6.75% range. The total proceeds of $600 million will be used to fund existing capital commitments as well as leverage neutral share repurchases. Applying approximately 50% to 55% of the excess proceeds to share repurchase will maintain debt to EBITDA within our target range of 6 to 6.5x. Last week, the Board authorized a new $500 million share repurchase program. In April, 3 million shares were bought for $42 million under the previous repurchase authorization. The average price was just over $14 per share, which represents an implied cap of 8% and FFO yield of approximately 11%.
Given the current disconnect between our stock price and private valuations, recycling capital and to leverage neutral share repurchases, generate significant accretion and shareholder value. It also accelerates efforts to improve dividend coverage. Second quarter and full year guidance does not reflect the KKR JV additional $300 million of transactions or associated leverage neutral share repurchases. Guidance will be updated at the end of the second quarter once the final timing and economics of these transactions are known. I'll now turn it over to Rob for more details on our leasing momentum.
Robert Hull: Thanks, Kris. I will focus my comments today on multi-tenant occupancy gains and leasing momentum, which are right on track with our bridge. For the first quarter, multi-tenant occupancy improved 57,000 square feet or 17 basis points. Combined with our fourth quarter, we have achieved 70 basis points of absorption. This puts us on pace to deliver the 150 to 200 basis points of multi-tenant occupancy gains we communicated last November in our 5-quarter bridge. It's worth noting that occupancy has increased by 130 basis points at the legacy HTA assets in the last 2 quarters. Our progress this quarter was driven by strong new lease commitments totaling 480,000 square feet. Move-outs were elevated due to high scheduled lease expirations of 1.6 million square feet in the first quarter.
This was nearly double the volume of expirations in the previous quarter. Although volume was high, the move-out percentage was in line with our expectations. For the remainder of 2024, our expiration schedule averages just over 1 million square feet per quarter. This is about 60% less than the first quarter. So we expect fewer move-outs through the balance of the year. Turning to lease momentum. Our new lease pipeline remains robust at 1.7 million square feet, the top end of our historical range. The pipeline gives us visibility into future activity and positions us well to achieve projected absorption gains outlined in our multi-tenant bridge. Total signed not occupied leases or SNO in the multi-tenant portfolio remained solid, representing an additional 170 basis points of future occupancy.
The legacy HTA multi-tenant properties have 190 basis points of SNO. We expect the SNO pipeline to increase as we maintain our new signed lease volumes and move-outs moderate to lower levels moving forward. Our strong leasing activity is supported by favorable supply and demand fundamentals. Occupancy across the sector is climbing, and new medical outpatient building starts are continuing to decelerate. This quarter, we saw the largest year-over-year decline in starts since the pandemic. Health System top line revenue and operating margins continued to improve. Providers are seeing increasing admission rates and growing outpatient revenues. And healthcare employment remains robust, increasing at a rate more than 2.5x the rate of total job growth.
The combination of rising demand and limited supply is creating a nice tailwind for leasing. New signed leases in the first quarter totaled approximately 440,000 square feet. What is noteworthy is this marks our third consecutive quarter above $400,000. Included in this activity were meaningful gains across our development and redevelopment projects. The combined lease percentage for these projects is now 70%, up 400 basis points over last quarter. A significant contributor to this increase is a building here in Nashville that came online in the fall, and many of you have visited. A leading orthopedic group signed a lease that increased the building to 88% leased from 50% last quarter. With a fairly complex build-out, including the new surgery center, we expect this tenant to take occupancy in the first quarter of 2025.
I'm proud of the solid occupancy gains and sustained pace of new leasing our team has achieved. Our strong leasing momentum and the constructive supply/demand backdrop is the foundation from which we can produce projected new leasing activity. Coupled against moderating move-outs, we are poised for accelerating multi-tenant absorption in the back half of the year to hit our targeted growth levels. Todd?
Todd Meredith: Thank you, Rob. Let me make a few more specific comments about capital allocation. The company is currently trading at a substantial discount to NAV. So we're focused on maximizing the opportunity to sell or JV assets and repurchase our stock at accretive levels. In terms of generating proceeds, we announced the KKR joint venture yesterday, where HR will contribute 12 properties to the joint venture at a gross asset value of $383 million, representing a cap rate of approximately 6.6%. KKR will make an equity contribution to the JV equal to 80% of the value of the properties, yielding proceeds to HR of probably $300 million. Healthcare Realty will retain a 20% interest, manage the JV and oversee leasing and operations.
HR will also earn various fees for overseeing the JV properties, which is not reflected in the 6.6% cap rate. The property contributions are subject to customary closing conditions and are expected to occur throughout May and June. Asset-level financing is not contemplated for this JV, which simplifies the management of leverage for Healthcare Realty. The 12 JV properties represent a high-quality stabilized MOB portfolio. The properties are located in 7 top markets, including Austin, Seattle, Philadelphia and Los Angeles to name a few. They're located predominantly on or adjacent to leading hospital campuses. And in short, the portfolio looks a lot like Healthcare Realty as a whole. Beyond the initial seed portfolio, KKR has also committed up to $600 million of equity to pursue additional investments in high-quality stabilized assets.
This could increase the potential value of the JV to more than $1 billion. We may contribute more Healthcare Realty properties to the JV or pursue acquisitions depending on market conditions. In the near term, our capital allocation priority is to repurchase stock on a leverage-neutral basis. Separate from the KKR JV, we're working on additional transactions that are expected to generate more than $300 million of proceeds within the next 90 days. We're very encouraged by the level of interest from capital partners and potential buyers. There's a deep pool of equity seeking to increase exposure to the MOB sector, which has been aided by a much improved financing market. As I said at the top, we are focused on our top 2 priorities, capital allocation and operational momentum.
We intend to execute quickly on the accretive capital allocation priorities outlined today. Coupled with multi-tenant occupancy gains and operational momentum, we're making progress toward our goal of accelerating FFO growth and dividend coverage. Operator, we're now ready to move to the Q&A period.
See also
10 Best Cookies and Crackers Stocks to Buy and
13 Best Stocks That Will Always Grow.
To continue reading the Q&A session, please click here.
