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

Good afternoon for most of you, and good morning to the Healthpeak team. For those of you who don't know me, I'm Josh Dennerlein, Bank of America's senior analyst covering the health care REITs. We're certainly pleased to have with us Healthpeak's CEO, Tom Herzog, President and CIO, Scott Brinker; CFO, Pete Scott; and COO, Tom Klaritch. Before I turn it over to Tom, I want to remind everyone that if they want to ask a question, please use the Veracast software to input your questions at the bottom of the screen. Alternatively, I'll also be on Bloomberg, if you would want to message me directly. I'll be looking for your questions, and we'll ask on your behalf. With that, I'll turn it over to Tom for his prepared remarks.

Thanks, Josh, and good morning, everyone. For those of you who are not familiar with Healthpeak, we're a $24 billion enterprise value REIT, focused solely on ownership of life science, medical office and CCRCs, 3 core and vital segments of the health care real estate sector. Our life science portfolio represents about 50% of our NOI and is located in the 3 hot bed markets of San Francisco, Boston and San Diego. Our medical office business is about 40% of our NOI and represents primarily on-campus or affiliated properties with hospitals that are #1 or #2 in their respective markets. Finally, the balance of our portfolio or 10% of our NOI, is comprised of CCRCs where we own 15 high barrier-to-entry communities, each with an average of 500 units located on 50-acre parcels of infill land in strong locations. So with that backdrop, let me provide you with some opening comments. We had stated on our Q2 earnings call that our portfolio is performing well. At that time, our life science same-store was up 7.9% and MOBs, up 3.1%. As we stated on our call, our life science growth will moderate a bit in the second half, however, we still expect some nice growth given current market fundamentals. And for MOBs, we expect performance to remain solid. For CCRCs, which is a small part of our portfolio, at the time of our call, we are seeing some occupancy recovery and an uptick in entry fees, but we're also seeing some fairly significant labor cost pressure. Third quarter to date, we've also noted an increased amount of COVID cases due to the Delta variant. And our portfolio is largely in Florida, but we will see how the rest of the quarter unfolds and report out at our upcoming Q3 earnings call. Turning to our development pipeline. Our development progress remains firmly on track, and our pipeline was 73% pre-leased as of our second quarter call. Plus, we have additional leasing activity that we'll discuss in our upcoming third quarter earnings call. Finishing with acquisitions. As of our second quarter call, year-to-date, we had closed on $700 million of acquisitions, including $640 million of off-market MOBs. Our acquisition pipeline continues to build, and we're seeing opportunities across all 3 of our businesses, ranging from immediately accretive transactions to value-creating developments and covered land places. You may have seen some press last week about an acquisition we made in the Alewife submarket of Boston. This is 1 transaction among a number in that market that we're in the middle of closing. So we'll hold off on providing any details until the -- our upcoming earnings call where we can furnish a comprehensive outline of the entire investment play that we're stepping into. We think this assembly of transactions will be very well received. So everything is progressing well. And with that, Josh, how about I turn it back to you for questions?

Yes. No. Thanks, Tom, for the overview. I'd like to kick off the Q&A with the same question I've been asking all the companies. In your view, Tom, what has been the top reasons that investors should buy your stock today?

When you look at our company, we own 3 vital irreplaceable, high barrier gantry businesses of life science MOB and CCRCs, which combined with our development and densification upside, which is very significant and our conservative balance sheet, offer multiple avenues of embedded accretive growth. And we think that these 3 businesses are going to provide a great deal of competitive edge. Our portfolio and business strategy will provide a way to benefit from the baby boomer demographic tailwinds, really in all 3 of those businesses, with diversification among those 3 businesses that will, in our view, enhance our stability through the inevitable cycles to take advantage of our scale and our inherent business synergies.

Maybe that's a good segue into my next question. Could you maybe expand on the densification opportunities across your portfolio? And kind of where you are in that process? And how long it will maybe take to play out?

Well, it's -- well, I always say that our densification plays out over the next decade plus, some of what we'll be talking about, we're going to announce in our upcoming earnings call in another 5, 6 weeks or so. But the densification of land bank opportunities really represent a significant growth engines for us across all 3 of our businesses, but especially life science and secondarily, in medical office and also some of the CCRCs, where we have those huge campuses. And I think we'll be able to execute into this -- the local supply and demand dynamics, which are going to be favorable in all 3 of these vital health care businesses. In life science alone, we've got 5-plus million square feet spread across all 3 of our major markets, which are San Francisco, Boston and San Diego. And with that land that sits in these densification opportunities, we have a very low cost basis as you can imagine that's going to generate higher returns than if we had purchased the real estate at market or land at market. And equally important, these are really class A main locations where land simply isn't available, certainly not at this scale. So that's life science. For MOBs, we do have some densification opportunities in some of our major campuses with a couple of million square feet available. A big part of this is in our trophy Medical City Dallas campus, where we have a proprietary development program with HCA. And then in CCRCs, like I said, we've got densification opportunities. Those assets, the 15 campuses we have, they sit on the 750 acres of infill land in aggregate and their embedded densification opportunities throughout that.

That's great. And as investors, we're always very concerned about NAV growth, earnings growth. What's the NAV opportunity from this densification? And then how should we think about the earnings growth over this decade. And maybe how do you balance the 2 that might conflict in the near term?

Yes, yes. So as we think about NAV growth, think in terms of easily $5-plus billion of spend where we -- typically, we will be back up. Typically, when we do development in this environment, in life science, we'd be looking at a spread over stabilized cap rates of 150, 200 basis points. But we're talking about land bank that we've already got our cost that's been invested earlier at lower pricing, that's going to increase that spread. And certainly, densification increases it even more. So the NAV opportunity is actually quite good. If we looked over the next decade and took $5 billion plus, it would easily be $4 a share of NAV. If you do that math. Just think in terms of 4-cap stabilized life science asset and developing into, call it, a 6.25% cap, which is a little higher than that spread that I just provided, but certainly not with our land bank and densification. Now that's probably 40% NAV accretive. And so we've got a decade of that type of work in front of us, so there'll be a lot of value creation that occurs there. On the earnings front, really the same math, except when we look at our year 1 funding cost, and that's 70% equity, 30% debt, the way that we've levered our company so that we've got a very safe balance sheet, our year 1 funding cost is lower than what stabilized cap rates would be for this product. So we're picking up probably a solid 250 basis point plus yield benefit. And during the development period, cap in interest, call it, 3% of the weighted average debt cost, and so the drag is not super high, and we get a very nice spread from it. We do use the rollover effect where we complete one project, start another, complete one start another, so the drag continues to roll forward through the pipeline. So you don't get any incremental increase unless you expand the size of the program. So that becomes an increase to our overall earnings growth on an annual basis as we go forward. And again, our big goal is to have strong pipelines that would be in place. That are very strategic in these major clusters that were part of that would spend. Like I said earlier, a decade. So as far as -- I think you said something about balancing the 2. In other words, there's lots of earnings growth, but how do you balance the drag? It's that rollover effect that we look at. And if we're willing to take on a larger development pipeline, we just have to eat a little extra drag on the front end. But coming out the other side with these development projects that have been quite successful, it provides us the opportunity to absorb a little bit of drag because the projects have been so accretive.

And then you mentioned the Boston acquisition, it sounds like there might be more coming. How do you supplement -- it almost feels like you're maybe trying to get a bigger campus in Boston. Like how do you think about acquisitions in complementing your existing campuses and making them bigger?

I could take that, but Scott Brinker, maybe we should -- maybe you should start with that one.

Yes, Josh, we've had the most success when we have significant scale in the local submarket, it can really provide a campus setting with amenities so that these companies can use the real estate as a tool to attract employees. And the bigger the campus, the more flexibility you can provide to the tenants as well, which is a key consideration when they're choosing a landlord. So all things being equal, we do prefer to have a lot of density in a specific submarket. So when we think about acquisitions, the priority would always go, all else being equal, to something that is more proximal, ideally within walking distance. You think about a company that's considering moving an office space because they need a bigger suite, a lot easier on your employees to move to a building that's shot within walking distance of where we've been previously versus relocating across the opposite end of town, especially in these 3 big markets that we're in. You think about the Bay Area, Boston and San Diego, commuting is not an insignificant issue with the team, and employee retention is critical in that business more than any other, perhaps, just given that it's so dependent upon talent and knowledge. So that really is a key consideration for us as we build out this pretty incredible real estate platform.

And going forward, Tom, in your opening remarks, you mentioned that you're 50%, call it, life science, 40% MOBs and balance is CCRCs. How are you thinking about how this evolves in the future? Like is that kind of where it will be? Or do you want to get heavier in life science, heavier in MOBs? Just kind of curious what you're thinking.

We got to see what plays out, what the opportunities are. But I will say that our business will naturally grow faster in life science because when we start talking about spending $0.5 billion a year in life science development for easily 10-plus years, that's a lot of growth just right there from life science. We'll probably have more growth in life science through development then we grow through acquisitions because acquisitions are -- they're expensive, and there aren't that many that come up in the strategic clusters where we want them. So it's probably heavier in development. In MOBs, it's probably -- we'll probably see more accretive opportunities come up with our relationships with health systems and hospitals. So the acquisition side probably is a faster way for us to grow there accretively. And we would only do it with an invitation from the hospital so that we get those off-market transactions that actually can work out quite nicely. At the same time, we have a $75 million to $100 million MOB development program with HCA, and we're building the same program with some others. And in CCRCs the growth will be very small. So as we look forward, I kind of like or we kind of like, I mean, MOB reasonably try to keep pace with life science, but I do see life science probably being the bigger of the 2 businesses as we go forward.

We've got a few audience questions just hoping to weave in. The first one was, do you guys have an opinion on the conversion of traditional office to life science in markets such as Boston?

Yes, we do. Scott, do you want to start with that one?

Yes, I can start with it, Tom. I mean it's certainly possible that some office buildings or industrial buildings could be converted. We have a handful in our own portfolio that do just fine. They happen to be in San Diego for the most part. We have traditionally lower story office buildings, 2 to 3 stories, which makes the conversion a little bit easier. But not all office buildings can be converted. So I mean we have the same view that a number of the other market participants have that it's possible but very few of the buildings end up checking all the boxes that are necessary. I mean even if you're in the right submarket, questions around the physical constraints of an office building in terms of floor-to-floor heights, load-bearing capacity, adequate loading docks, room for generators, et cetera, that most buildings cannot be converted. And if they can, it ends up being at a pretty significant cost because you have your -- the cost basis to acquire the asset in the first place or your historical cost and then the investment that's necessary to convert to lab is quite significant, quite significant. And even then you tend to end up with a building that's compromised in one way or another, so that you can't necessarily offer the flexibility to market to the full range of potential tenants. So a long way of saying, our preference is to own purpose-built lab. On occasion, we find office buildings that will make sense, but most will end up as pretty compromised products, which will probably be most evident when the market environment is not quite as favorable for landlords. Certainly, in today's market, landlords even with conversions are in a great spot because there's just so much demand and excessive supply. But over time, you'd expect that, that could be closer to an equilibrium. And really, it's at that point that we feel like the purpose-built product will be at a huge competitive advantage.

What about using traditional offices, kind of look like a covered land play that you could eventually convert to life science? Like have you seen any of those deals? Or does it not pencil at this point?

Yes. Certainly, that's a possibility. We have some of that, that exists even within our existing portfolio where you have a building that might have been constructed 20, 30 or even 40 years ago, that's just underutilizing the site. It might be a Class A location, but perhaps it was built as 1 or 2 stories when current zoning and/or an entitlement process could yield 5 or 6 stories of purpose-built lab, which obviously comes at a much higher rental rate as well. So we have some of that in the densification, the 5-plus million square feet that Tom mentioned. But from an acquisition standpoint, that's certainly something we look at as well. If you have an older office or industrial building in Class A location in comparison to just acquiring land, which is not yielding anything, at least there's some level of return to help offset your carrying costs. So that is something that we've done historically, and we're certainly looking at a couple of those currently.

Got it. And then I wanted to touch base on what was something you said in the opening remarks, Tom, and even a client question with it. You mentioned in the second half of this year, your guidance was assuming a bit of a moderation. Can you remind us why that is? And then kind of weaving in the client question, I guess some leases rolling in the second half of this year in your life science portfolio. What are you thinking like the mark-to-market on those? And is that playing to the moderation that you're expecting?

Peter or Brinker, do you want to take that one?

Yes, I can start. On the mark-to-market across the portfolio, Josh, I'd say conservatively in the 15% range, but it will move around from quarter-to-quarter depending upon which leases are either renewing or maturing. Last quarter, it was 23%. But that's not necessarily the reason for the slowdown that we've projected in the second half of the year. And keep in mind, we've been -- we came out with 4% to 5% guidance at the beginning of the year, and we steadily increased that each quarter. So the outlook remains extremely favorable. The growth rate remains strong, but we were in the mid- to high 7s here in the first half of the year. We think the second half will be a little bit slower than that. It's mostly because we did 2 proactive early terminations, one in Redwood City in the Bay Area and then one in San Diego, where we had cash flow in-place leases with a couple of years left, we were being paid to rent, but we knew the tenants were moving out. And meanwhile, we had growth tenants on those same campus is looking for more space, and we were able to proactively do an early termination of the existing leasing, bring in this growth tenant in both cases with 10-year leases, 40-ish percent cash mark-to-market. So on a long-term basis, just an economic home run for Healthpeak, but it does come with 6 months of downtime to build out the new TIs, which has an impact on same-store. So it's about 200 basis points in both the third and the fourth quarter that is really the reason for the slowdown.

And then other -- another question from the audience was, where you're estimating your market net effect of rent, particularly in San Diego, but it would be even great to hear Austin and South San Francisco or San Francisco as well?

Yes. I mean market rents continue to climb. We're up at least 10% over the past year, arguably more in the 20% range versus a pre-COVID level. San Diego probably leads the pack at least on a percentage basis, which probably up in the 20% to 25% range. And there are really 3 core submarkets in San Diego, Torrey Pines is the most prestigious, and rental rates are the highest in that submarket, certainly into the 70s today for Class A product, which is being credible for San Diego, so more than $6 per month. South San Francisco, where we're the dominant player and have a huge pipeline. Rents for Class A product are into the, I'd say, low 80s on an annual basis, just to make it apples and apples. And then in Boston, our 2 big submarkets are West Cambridge and Lexington, Waltham. West Cambridge today would be at least $90 per year, arguably close to $100 for Class A product. That's dramatically higher than what we underwrote when we made a big play in West Cambridge over the past years. And then in Lexington, rents are easily into the low 80s for Class A products. So again, just a dramatic change from when we entered those markets over the past 3 years.

Got it. And can you remind us what's rolling within life science, I guess, for next year? Any kind of key leasing risks we should watch or...

No. I mean it's a portfolio that it's very much an operating portfolio. Weighted average lease term is 6 years. So just naturally, there's going to be lease roll in any given year. We've got about 800,000 square feet of leases maturing in both '22 and '23. So that's about 8% of the operating portfolio that's rolling over in any given year. So nothing in particular stands out. And certainly, market fundamentals remain strong. So we should be in a great position from that standpoint. The bigger thing in life science, given you have a lot of single-tenant buildings just by the nature of the work is that even if you do have a successful leasing outcome, unless it's a renewal, and there's no downtime, generally speaking, especially after the second-generation TIs have been exhausted, you do have some downtime to build out the new TI package for the new tenant. So that's probably just the bigger thing that an investor has to keep in mind when it comes to life science, real estate, renewal has no downtime and probably a significant mark-to-market in today's environment. But new leasing would often come with a great mark-to-market but some downtime to build out the TIs.

Great. And maybe swinging gears a little bit to talk about medical office. Tom, you mentioned the HCA development program, and that it sounds like you're working on kind of a similar program with others. Anything you could elaborate on that side? What you're working on and what you're hoping to achieve?

Yes, we had started the HCA program. I guess it's been a solid couple of years plus ago, and these are for typically on-campus MOB properties that HCA wanted to add to existing campuses. And so we worked out of a program with them that allows us to complete development, take a 40% to 50% anchored position in the asset, and they do come in as some nice yields and makes an excellent addition to those campus portfolios for us. We also had hired Justin Hill who had worked with Scott Brinker historically in the past for a number of years. And Justin has done work to build those types of relationships and build those types of programs. He get that in his prior life at Welltower for a good number of years. And so Justin has been with us now for about 2 years or something like that, and he's been working to build that program with some other health systems as well and developers.

Great. And on the operating side for the medical office, what's been the latest on the elective procedures? And where are the buildings kind of on the parking revenue? That seems like a spot of conservatism and maybe they weren't fully backed.

Yes, I want to call Tom Klaritch. He had some bandwidth issues, so I believe Tom will be on telephonically. So Tom, if you can start, go ahead. And if not, then one of us will take it up.

Sure. Can you hear me okay?

Yes.

Great. So the second wave of COVID hitting pretty heavily, and I'm sure you've read about it, where there's a high incidence of COVID patients in the hospitals. We did see some restrictions reimplemented on inpatient procedures, but really no restrictions on how patients receive it, which really is what affects our MOBs. From a partner standpoint, if you look back to the second quarter of 2020 was really our worst quarter, the restrictions on visitors were at their highest at that point in time. If you looked at our run rate, typically, we expect to see about [ $13 million ] a year in parking, so the annualized run rate in 2Q of '20 was about [ $7 million or $8 million ]. That continued to improve throughout the year. Really in '21, it did improve most. But if you look at the first quarter, we're probably annualizing to about $2 million, and it's been growing about $300,000 a quarter since then. We have seen some restrictions on visitors again this year, but luckily they're not as restricted as they it was in 2020. Patients generally are allowed to have 1 visitor coming with them. The last year when basically the patients were taken to the hospital where he's dropping off at somewhere else. Now they're actually in parking and going in with the patients. So we continue to see that improvement but a little cautious, the restrictions started being reimplemented, [ we're going to have some blended outlook ].

Got it. We have a few minutes left, maybe I wanted to switch gears and move Peter into the conversation. It's great to hear what your thoughts on capital spending and returns to your balance sheet as you head into 2022.

Yes. Thanks, Josh. We've positioned our balance sheet as a source of a competitive advantage at PEAK. We have no significant debt maturities until February of 2025. And if you saw on Monday, we actually closed on an upsized $3 billion revolver, which provides us with additional liquidity as well as flexibility. If you also recall, we made the decision about a year ago to take our leverage down 0.5 turn with a target now of 5.5x net debt to EBITDA, which we think firmly puts us as one of the best BBB+, Baa1-rated REITs out there. And we thought this was appropriate to take our leverage down just a little bit as we focused a lot more on development and densification going forward. As you think about funding for that, we probably have $700 million to $800 million of development and redevelopment spend annually. When we adjusted our dividend, that gives us about $150 million annually of retained earnings, which helps us to fund a portion of that. We'll also look at noncore sales, really portfolio pruning of up to $300 million. And then the balance will get funded when we're trading at a premium to NAV in the equity markets and a little bit in the unsecured bond market. So our balance sheet is in great shape. As I said, it's a competitive advantage for us, and it's something that we'll take advantage of going forward.

No, that's great. And maybe I just wanted to touch on the CCRCs a bit. Maybe big picture, Tom, home prices are really rising pretty quickly. Like how does that play out into the CCRC business? Because -- do you think that's one driving those higher entry fees that you're seeing?

Scott, do you want to take it?

Yes. I missed probably the key word when you're talking about the higher entry fee prices, what cause were you pointing to, Josh?

I wasn't sure if that was just driven by rising home prices.

Oh, rising home prices. Yes. I mean, that's fundamentally an important factor in home prices. Nationally, we're obviously up dramatically over the past 18 months. But in Florida, in particular, where we have such a big presence, home prices are up dramatically. And our entry fee average sale price is up about 20% year-over-year. So I mean there's just fundamentally strong demand for that business, but home prices do have a pretty direct impact. It's less of a need-driven decision. It's more of a life style decision given the nature of the resident. And most of them are selling a home before they make the move. So that has certainly provided support for our rental rates and entry fee prices.

Great. Really about just a minute or so left. We've been wrapping up the conversations with 3 rapid fire questions. I was hoping to get your team's response on them. The first one is, which are the following is the greatest challenge facing U.S. public REIT today, a, Fed action and higher rates? B, supply chain issues, which includes labor and logistics? Or c, see flows to nontraded REITs?

I guess, all 3 of them have their elements. I'd probably say Fed action could have the most impact.

Fed action. And then the second question is, over the next 5 years, which markets will outperform the urban coastal markets or Sun belt?

Oh, boy. I would have answered that question Sun Belt a couple of years ago. I think I got to say urban. Maybe there's a recovery, and there's some opportunity on that side.

Excellent. And then the last one is probably a little bit easier for you. For your company's office plans post-pandemic, will you, one, have no change from pre-pandemic? Two, leave it up to the individual teams within the organization? Three, offer hybrid? Or four, go full or no?

No, we're going to go hybrid, and we have a whole plan put together. We have plenty of flexibility for our employees, but also that creates an opportunity for all of our people to come together on a fairly routine basis.

I like that. Most people have been answering hybrid, but you're the first person I've heard say you have a plan.

Yes, we have a plan.

No. We're basically out of time right now. Now I do want to thank you guys, and appreciate the time, and good luck with the rest of the conference.

Thank you, Josh. And for everybody listening, appreciate it.

Thanks, Josh.