Healthpeak Properties, Inc. (DOC) Earnings Call Transcript & Summary

Good morning, and welcome to day 2 of virtual Nareit. My name is Amanda Sweitzer, and I'm Baird's senior research analyst covering the health care REIT sector. I'm really excited to be joined by Healthpeak today, an $18 billion health care REIT focused on their 3 main verticals of life science, medical office and CCRCs. [Operator Instructions] And so with that, I'll turn it over to Tom Herzog, Healthpeak's CEO. He'll introduce the management team and provide any opening remarks.

Thanks, Amanda, and good morning, everyone. On the screen with me today, I've got a few different people, Scott Brinker, our President and CIO; Pete Scott, our CFO; and Tom Klaritch, our Chief Operating Officer, and he also heads up our medical office business. So what I'm going to do is start by sharing my screen. And I'm going to give you an overview of some of the points that we made in an investor presentation that we issued on Monday, along with a couple of press releases. So if I just -- oops, hold on a sec. If I just move forward to the third page, we've got a number of updates that have occurred over the last 4 to 5 weeks, so of since May 5, which was the date of our earnings call. First, we just recently announced a Callan Ridge update where we leased the entire property. That was a project that we had announced in March, and we have already leased the entire property. So that was good news. That has an estimated yield of approximately 9%. And with the strong activity that we've seen in San Diego, we also announced the Sorrento Gateway project, a $120 million development in Sorrento Mesa, and that's expected to yield in the low 8s. From a transactional perspective, we've closed on another $175 million in the last 4 weeks of the $400 million that we had remaining in senior housing. All that pricing that was right directly in line with what our expectation was. And we did complete the debt tender that we had announced for $550 million, and those bonds were maturing in 2025. From an operational perspective, our medical office and life science have been doing very well. They continue to be in line or generally ahead of our expectations. And CCRCs continue to perform as expected. Importantly, our IAM, or independent, assisted and memory care, occupancy has increased in both April and May. SNF occupancy continues to fluctuate, which was as expected for us, but that's a pretty small part of our NOI. Next, let me take you through some updates on our development platform. This page shows the developments that we've completed over about the last 5 years or so, which really is all the developments that we've completed since our inception of a company. We've completed 15 projects with $1.6 billion of cost at a blended yield at about 8% and have created value of somewhere in the vicinity of $1.1 billion. This next slide shows our development pipeline looks a little bit like what you've seen in the sup that we put out every quarter. This particular one includes now Sorrento Gateway and a couple of other revisions, but it shows that we have a percent -- so the $1.3 billion actual amount of the pipeline, it's 57% pre-leased, and that includes the addition of Sorrento Gateway. And we have an estimated yield on these projects of about 7%. I think many of you have probably seen our land bank and densification opportunities across the company. They span all 3 different businesses that we are involved in: life science, MOB and CCRCs. And that $7 billion will keep us busy for the next decade or so, so it's a nice runway for us. All that leads up to a slide that we created that shows the NAV creation that has occurred on the projects that we've completed to date, so the $1.6 billion has produced about $2 a share of NAV. If we take our current active development pipeline of $1.3 billion, we expect that will produce probably $1 per share or maybe a little bit more. And then our remaining land bank and densification opportunities will produce somewhere in the vicinity of a combined $5.50 a share of NAV. And that's at a 200-basis-point spread to cap rates. We've done a lot better than that over the last 5, 6 years, but perhaps, conservatively, at 200 basis points, that put us at $5.50. So this would all occur over a period of about a decade. So again, a nice runway of growth for us in our development pipeline. Next, I'll touch briefly on the MOB historical performance. We alluded to this in the last earnings call that we're going to speak to a study that we were doing to assess on- versus off-campus based on our own portfolio. I think many of you know that we -- since our inception in MOBs, we've had a philosophy or strategy that we would own on-campus assets, and we would do that with #1 or #2 hospitals. That's what was critical to us. This page shows 4 major on-campus portfolios, and we have others. But these 4: Medical City Dallas in Dallas; you got Swedish in Seattle; Sky Ridge in Denver; and Centennial in Nashville. All the kind of orange-ish colored buildings represent the medical office surrounding the hospitals in yellow. These are all major campuses that produce significant NOI. And in total, these 4 campuses alone produce $80 million. It took us probably 1.5 decades to accumulate and grow, so it's not something that could be replicated in today's environment. That gave rise to a study that we wanted to perform, and you can read all these bullets quickly on the screen. But the study was we wanted to look at our own population of assets, and we have a very long and deep data set of information. And we wanted to determine for all the MOBs that we could include in the study because of the length of ownership, what would our returns look like for MOB on-campus versus off-campus affiliated versus off-campus unaffiliated. And the purpose to it was to help instruct us on our strategy going forward. We just completed the restructuring of our company, and we brought it down into the 3 core businesses that I think people are aware of: life science, MOBs and a much smaller portfolio on CCRCs. And we wanted to assess, is our MOB strategy that we've had for a couple of decades almost, is that still the best strategy? So here's what we found after studying the data. It didn't surprise us terribly. But our on-campus -- so this first page shows the annual cash flow, which is the NOI less the AFFO CapEx. That's critical because usually, on-campus assets are a little bit older and can be a little bit higher on the CapEx. So we wanted to have the complete presentation of that. And we did find that on-campus produced a plus 2.3% cash flow growth versus off-campus affiliated at 1.4% and off-campus unaffiliated at minus 1.7%, which we don't own a lot of these, but it was enough to have a statistically significant sample size within this study. The adjacent assets that we hold were in the on-campus -- excuse me, off-campus affiliated. They look a lot more like the on-campus, so that probably impacted the results a bit. It made this category look a little bit better than it would have otherwise. But the bottom line is the on-campus performed better. A couple of other items that we measured was tenant retention, which I think you all know is critical to MOBs, that stickiness. On-campus was at 80%, 75% for off-campus affiliated and 60% -- 68% for off-campus unaffiliated. When you think about the stickiness, the retention, you have to think about the specialists that reside in different property types. On-campus is where the greatest majority of specialists reside. So they can do their rounds in the morning, and then they can attend to their patients in their medical office in the afternoon. We also looked at mark-to-market renewal. And here, on-campus was dramatically stronger: off-campus affiliated at a minus 2.4%; unaffiliated, a minus 2.1%; on-campus at a plus 2.3%. Oftentimes, the off-campus affiliated is going to have a significant negotiation power on the front end. And when it comes time to release -- re-lease the assets, you might lose some mark-to-market growth. So this wasn't terribly surprising to us either. But anyway, the bottom line is that this study did produce the results we expected, but we did want to do it in a very unbiased way as we approach the analysis to instruct our investment in MOBs going forward. So with that, I'll stop my share. And Amanda, turn it to you for Q&A.

Yes. Thanks, Tom. I'd like to start a bit more high level and really the key topic for Healthpeak over the past several years, and that's your portfolio repositioning. And you guys have made a ton of progress. I'm not sure it's fair to ask what's next. But what's next with that process? Should investors expect any additional asset sales after senior housing is complete? And in 3 years, where do you envision the pro forma portfolio be?

Okay. So the what's next part is we just spent the last 5 years jettisoning $18 billion of a $30 billion portfolio. Now we added a lot of billions as well in our strategic businesses of life science and MOBs. So the what's next is to execute on the plan that we already have. And that is to grow these 3 businesses that we have and focus a lot on our development program while continuing to maintain a rock solid BBB+, Baa1 balance sheet. One thing that we will do from a sales perspective is as we complete the final couple of hundred million dollars of senior housing sales, rental senior housing sales that we've already announced, is we do have 1 remaining joint venture with a sovereign investor. And it's not a huge amount of money for us, but we're working with the sovereign to determine should we liquidate that position or do something different. We want to make sure we make right by them because they entered as our partner. They're a very strong partner. So more to come on that one, but we'll see what plays out and what's best for both firms. And as we look at what we'd like our portfolio to look like 3 years from now, that probably a lot like it looks today. We're currently 50% life science, 40% MOBs, 10% CCRCs. 10% is probably the limit that we'll put on CCRCs. There's going to be a lot of natural growth that occurs in life science from our huge densification pipeline. And MOBs, we have a lot of paths to growth as well. So it probably stays maybe that 50-40-10 split, but opportunistically, it could shift around a little bit, so we'll see what plays.

Yes. And I do want to dive into life science and kind of the development pipeline densification opportunities there. On that slide you showed with the value opportunity, what are the underlying assumptions there? And then what are kind of the near-term opportunities to add to the under construction pipeline beyond what you've announced?

Yes. Why don't I start with the first part of that question, Amanda, and just talk about the underlying assumptions. On the completed developments where it's about $2 a share of NAV that we've created, those developments were completed at a blended yield above 8, so the spread to market cap rates today is probably closer to 350 basis points when we look at how much value was created. When you think about the active pipeline, that's probably more like 275 basis points because the yield that we have been able to sign leases at and we project is around 7 1, 7 2. So again, some really strong spreads there. And then going forward, as Tom mentioned, for the land bank as well as the densification opportunities, we assume a 200-basis-point spread there, which may have a little bit of conservatism in it, but it's hard to predict as you're looking out 5, 10 years. As we discussed, this will be a decade-plus.

I can take the second question, Pete, on the sort of what's next. But in March, we announced 2 new projects: 1 in San Diego, 1 in San Francisco. We've now fully pre-leased the building in San Diego. That opens about 18 months from now. And we're getting significant interest in the San Francisco project. And then 2 nights ago, we announced commencement of another project in San Diego, 163,000 feet in the Sorrento Mesa submarket. And we're already getting significant interest on that, a good 18 months before it could possibly deliver. Beyond that, when you think about the 5-plus million square foot land bank and densification opportunity in life science, it really falls into a couple of different categories. We have some just vacant land plus or minus 2.5 million square feet, including entitlements, which we're actively working on. In the first project that is likely to come next would be the first phase of Vantage, which is a 20-acre project in the heart of South San Francisco. It's essentially shovel-ready on 350,000 square feet, just a Class A+ location. That's probably next on the list. And then when you think about the densification opportunity, which is the other bucket where we have existing real estate today, that really depends on the timing of the existing leases rolling over in the churn, of course. And that's going to happen over time. The first opportunity is probably our Pointe Grand campus, again, in the heart of South San Francisco, starting in 2023. But then that could be a 10-year type program where we densify sites as leases roll, especially if they're not renewed. So that's probably the best way to think about what's next and then the time frame for addressing that 5-plus million square foot opportunity.

Now when you talk about the entitlements that you need, what is the process for that? Or what else needs to happen before you can realize that full opportunity that you've lined?

Yes. In some cases, we're seeking additional density. And there are situations where it's being done in tandem with the city itself, increasing density for particular zoning area. And then in other situations, we already have the applicable zoning entitlements, and it's simply a matter of going through the permitting process.

That's helpful. And then sticking with life science. I mean you've continued to achieve leasing activity that's materially above your original budgets. What is your outlook for life science demand for the remainder of the year? And how have space demands from your tenants changed at all post-COVID?

Yes. I mean the growth in demand has been exponential. If you look back even over 10 years in the 3 core markets. For life science, the supply has grown about 50%. It's a pretty big increase in supply, and yet vacancy rates are at all-time lows. Rents over that 10-year period grew mid- to high single digits, and that's only accelerated in 2020 and into '21. 97% of our portfolio is in those 3 core markets for a reason, and rents are up anywhere from 10% to 20% depending upon the submarket over that 12-month period, so it's pretty astounding. It has allowed us to far exceed our underwriting on all of the new developments to date. Hopefully, that continues to be the case. And when we think about how much demand we're seeing in those 3 markets, it's literally at 2 to 3x historical levels. And yes, there's some new supply being delivered but with good reason. There's a lot of demand. And most of what's being delivered over the next 2 years is already substantially pre-leased. That's the case for our portfolio as well at 60% pre-leased for the entire portfolio, even though we only started construction on 3 of the projects in the last 3 months. So we still feel really, really good as an incumbent landlord with the development pipeline over the next 2 years. But we constantly study supply and demand. It's a constant topic of conversation in our investment committee. So we feel fantastic today, but it's something that we'll have to continue to monitor.

Yes. And a question from the audience on life science. Upon stabilization, where do you see your life science development pipeline worth on a price per square foot basis? And where does that compare to some of the transactions that you've seen closed recently?

Yes. Of course, it depends on the market and, therefore, the rental rates, but the Class A projects in the core markets are easily trading into the low 4s today based on the transactions we've seen executed or closed. And with rental rates in South San Francisco quickly approaching the mid- to high 70s, I mean, that's translating into price per unit in terms of stabilized value at $1,500 or more. So it's pretty significant. Replacement cost today, it's obviously going up. Although construction costs aren't as impacted in life sciences, maybe in some of the other sectors, just given the materials that are used for construction, but land prices are going up, for sure. So that -- just as an example, in South San Francisco today with market value of land and today's construction costs, it's at least $1,100 a foot to bring new supply to the marketplace if you had to buy land at market. It's one reason we keep pointing to our $5-plus million land bank and densification opportunity that there may be situations where we go out and buy new land because it's so strategic, but we have all that land sitting on our balance sheet today. And that would be a huge competitive advantage in continuing to grow that business without the need to go acquire land at market.

Yes. That makes sense. And you brought up a point that I do want to hit on because it's kind of the topic. It's your inflation. So two-part question on that. I mean what level of construction costs are you seeing broadly? And how are you mitigating that risk in your under construction pipeline? And then second, in your existing portfolio, are there any kind of inflation risk mitigators that you can point to?

Maybe I'll start with the second part of the question, and I can turn it to Tom Klaritch to go through construction costs. We actually talk a lot about it. It's a good question, Amanda. I mean as you think about a REIT, they have a bottom-like element to it and a stock-like element to it as well. And as we've seen some recent studies, it looks like the correlation between lease term and inflation is maybe not as high as people thought, although there's debates around that topic. As you think about ways that we have some protections in there to help mitigate inflation, we have escalators in our leases within life sciences and medical office, call it, in the 2.5% to 3.5% range. And then we can actually pass through expense increases, a significant chunk of that, to our MOB tenants. And then life sciences is primarily a triple-net lease structure. So almost all expense increases get passed through. And then the company we are today is very different. The weighted average lease term in our segments is probably in the 5- to 6-year range right now between MOBs and life sciences. So the ability to reset those rents happens a lot quicker than, say, a longer-term triple-net type structure where that was primarily what we were about a decade ago. So the company has changed pretty dramatically, and we have this development pipeline as well coming online, which helps provide some nice near-term earnings growth. I'll talk to -- I'll actually pass it to Tom Klaritch to talk about construction costs and some thoughts around that.

Sure. Overall, when we look at 2021, we're anticipating total price increases all-in of about 3% to 6%, depending on the market and the property. There's a lot of discussion right now around steel prices and lumber prices. They've gone up significantly. A lot of that's really occurred in the last 3 months. If you look back over the past year, kind of from the beginning of COVID through the end of the year, pricing was actually flat to down a little because construction really kind of shut off at the beginning of the pandemic. There was an overabundance of supplies, pricing, even labor was down. And then at the end of the year, everything just turned back on immediately. So price -- supply started to get in short supply. Production hasn't caught up yet. So we're seeing surge pricing, especially steel is up probably 40%; lumber, I've heard as high as 60%. And really, lumber, we don't use in our properties for the most part, but pretty minor at least. Steel, probably 9% of the cost of the project. And things to mitigate like you suggested are -- we do enter into GMP contracts. So once we lock in pricing, they're set. We're a fairly large developer. So we work with large contractors, and they have pricing power over some of the subs. So that helps us in many ways. And so far, the projects have yields on them have come in at or above where we underwrote initially, so.

Yes. That's helpful. And then I do want to pivot to capital allocation. As you do kind of finish recycling your senior housing disposition proceeds, what is the makeup of your acquisition pipeline today between your 3 targeted segments? And then how should investors think about the timing of those acquisitions occurring?

I can start. Yes, I would say we're active across all 3 segments. Over the past 2 years, we were particularly active in life science, closing about $2 billion of acquisition, including the big Cambridge Discovery Park last December, almost $700 million at a 5% cap on a cash basis. Pricing is getting more and more expensive, I mean, with good reason. There's a lot of interest in the sector, so it's driving down cap rates. We're not really a buyer at 4% caps for stabilized assets. We're more likely to develop those, including the 3 that we've put under construction this year, but we are still searching for those unique value-add-type opportunities, whether it's densifying a site, redeveloping a particular suite, leasing it up. Those we are still interested in to generate that premium yield, so we remain active there. MOBs, we've closed $420 million to date in 2021 and another $150 million under a hard contract. So more activity in medical office, for sure, because we are trying to balance the longer-term development, earnings and NAV accretion with some short-term earnings accretion. And with our current cost of capital, we feel like we can generate that with high-quality medical office. And we're even seeing some occasional CCRC opportunities, which is unusual, given it's not a huge sector, and about 85% of it is controlled by nonprofits who essentially never sell. So it'd be nice to pick off 1 or 2 of those. It won't become a huge part of our business, but at the yields that they generally trade at, it can be a nice addition, especially from an earnings standpoint.

That's helpful. And then I thought your study on the MOBs was interesting. But as you think about kind of a post-COVID environment and you have more care that's going away, from an inpatient setting, how do you think about the risk of more hospital closures? And as you think about investing in MOBs, how do you choose the right health systems to partner with?

Yes. Our strategy has always been we want to partner with the top 1 and 2 hospital in the market. So our hospitals are really strong. I think over the past 20-plus years, only 1 hospital has closed, and it was something we acquired in a portfolio acquisition. It turns out that it was a pretty good location. So those buildings were still doing pretty well. But we've been pretty fortunate with that strategy and not having hospitals that are really struggling. If you look at a lot of our providers, they're expanding their inpatient campus. If you look at HCA, they're putting hundreds of millions of dollars into these campuses annually, actually billions in some cases. So we really think the on-campus strategy makes a lot of sense. A lot of those services, you hear about moving from inpatient to outpatient will move into our buildings. So a lot of doctors prefer to be on the campus, so they can go back and forth between their inpatients and their office patients. So it's just really a lot more convenient for them. Plus if they're doing an outpatient procedure and there's a complication, you've got all the resources of the hospital right down the hall or across the parking lot. It's easy to just zip the patient into a critical care unit and take care of them, which you can't do as efficiently in an off-campus asset.

Yes. That makes sense. And we probably have time for 1 more question. So I did want to tie all these together. And as investors think about kind of results for the remainder of the year, where do you see the main potential areas of upside to your guidance?

Yes. I can take that. As a reminder, Amanda, we did raise our guidance across the board for all 3 segments in the first quarter. We took life sciences same store up 50 basis points. We took medical office same store up 25 basis points. And we did take up our LCS CCRC NOI projection by about $7.5 million. So we're off to a good start for the year. How does the remainder of the year look? So how do we exceed expectations? In medical office and life sciences, we do forecast bad debt within our guidance, and we're just not seeing it. It was something that when we set the forecast at the beginning of the year, and we always do, we probably have some conservatism there. So perhaps a little bit of upside in those segments. CCRCs, we did publish our April and May occupancy trends, and those are heading in a good direction for us and, I'd say, year-to-date, exceeded our expectations. One thing to keep in mind that we're focusing on our labor costs as well as other items like insurance costs are going up. So our ability to continue to exceed will depend on both those items: occupancy as well as expenses. And then lastly, I would say on the transaction side, we certainly have an opportunity at the high end to -- we can hit the $1.5 billion of acquisitions and beat the midpoint of our guidance.

Perfect. And I think we'll end it there. Thank you all for your time. Appreciate it.

Thank you.

Bye.