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

All right. I guess we should get started. All right. Good. So I'm Nick Yulico, Head of the U.S. REIT research team at Scotiabank, here for our 12:30 session with Healthpeak Properties. I think what I'll do is I'll turn it over to Tom Herzog, CEO of the company, to introduce the rest of the management team here and, I think, go through some prepared remarks about what you're focused on with the company and the message this week.

Yes. Thanks, Nick. Before I get started, I'd like to introduce my team. To my right is Scott Brinker, our President. To my left is Pete Scott, our CFO. Next to him is Tom Klaritch, our Chief Operating Officer; and Scott Bohn, our EVP and Co-Head of Life Science. For those of you who don't know Healthpeak, we're a $24 billion GAV value owner of life science, which is 50% of our portfolio; medical office, which is 40%; and CCRCs, which is the balance. And our portfolio is very much one of differentiated, irreplaceable portfolios. We have an active development pipeline of $1.3 billion, which is 73% pre-leased and an additional 12% under LOI. We prefer to operate with lower leverage with a targeted net debt to EBITDA in the mid-5x. We issued a pretty extensive investor presentation on Monday that I would encourage you to review if you get a chance, a lot of new information. Let me start by taking you through a number of what we call 8-K-able items from the investor deck. And if you have it in front of you, either in the room or out on the webcast, it's Page 3, provides the highlights. As far as leasing activity in life science, we backfilled 107,000 square feet at Hayden relative to the [ Kaleido ] default that we announced last month on our earnings call, with a credit tenant at $79 a square foot and a 38% plus mark-to-market. 101 CambridgePark Drive is now 100% pre-leased with the final lease executed at $112 a foot versus our original underwriting of only $78 a foot. We signed a 147,000 square foot lease at $78 a foot with a credit tenant at our Oyster Point campus, which represents only a 9% mark-to-market, but that was a Rigel lease that we had had in place since 2002. So many, many years of lease escalators had accumulated. So we're just glad to have that at a positive mark-to-market. And 45% of our Vantage Phase 1 is now under LOI with a credit tenant at $86 a foot. In MOBs, leasing volumes remained strong at 365,000 square feet during April and May. And our current retention rate is at about 80%, which by the way is quite important, a lot of people don't know this, but renewals produce about 50% more income than the new leases due to the heavy TIs and the downtime. In CCRCs, May occupancy is up 10 basis points since March and 120 basis points since December. I think most of you know that CCRCs did not have the dramatic decline of rental senior housing. So the recovery has continued to be good and as expected. Leads and tours are exceeding 2019 levels, and we have pricing power with absolutely no discounts at the current date. Net hires have been positive since February, which will reduce our contract labor, and our trailing 12 months nonrefundable entrance fee cash collections have exceeded our earnings amortization by $20 million, which, of course, cash proceeds, future amortization, which drives our FFO. So that's a plus. I n other sections of the deck, we added some operating updates for each of our 3 businesses, including May 31 occupancies across all 3, along with some updates on our development pipeline and a page that provides our next plan development and redevelopment starts. Additionally, we provided a fair amount of new lease -- or excuse me, new life science tenant detail, which we've got a lot of questions around in the biotech sector, plus a leasing and redevelopment update on our Oyster Point campus, which includes financial results. We had first press-released that back in 2019, and now that that's played out, we thought it was a good time to provide a fairly extensive update that you can use to do your modeling. As to the current environment, we're clearly in the middle of an unusual business and economic cycle. So I thought it might be helpful to provide some perspective on how we're seeing things, how it affects development, our business and our funding plans. So for development, that's obviously a critical part of our business. We've been at it for well over 25 years across life science and MOBs. It's a, like I said, a big part of how we create value. It's a long-cycle activity, though. And despite the near-term market pressures, we do intend to maintain a strong pipeline while continuing to take actions to mitigate risk. We estimate construction costs are up 20% year-over-year for the past 12 months and expect they could increase another 10% to 20% during the next year. Fortunately, our $1.25 billion active pipeline is 100% under GMPs, so we have no budget pressures there. The high construction and land costs, supply chain pressures and increased interest rates are impacting development spreads. But the big flip side is it's also likely to impact new supply for both life science and MOBs. Life science and on-campus MOB developments still pencil for us as we have a lot of premium land at very low cost basis. So our spreads continue to be quite strong. And many of the conversion opportunities that you've heard a lot about, there's been a lot of discussion, simply won't work due to the increased conversion costs. So that's a plus, obviously, for us. In South San Francisco, our near-term development and redevelopment plans will be modified in response to recent shifts in the biotech market. Let me give you some examples. In Pointe Grand, we plan to pivot to redevelop these properties as leases turn. This will provide well-located, B+ space, which many biotechs may prefer given the lower price point and especially satisfying needs in the next 12 to 18 months rather than the next 3 years. We're also in initial stages of rehabbing our Oyster Point campus to create near-term A- space. So again, B+ space for Pointe Grand, A- space for Oyster Point. Oyster Point is in a main and main location that's right adjacent to The Cove. It is going to come with some near-term drag in '23 and '24 but has huge FFO accretion in 2025, so a good trade. You might remember, we first outlined the Oyster Point in 2019. I think I may have mentioned that. But that's when we first outlined what those maturities would be and how we had planned to approach them. And now that we have greater insight, I'm able to provide you that update, but also there are some very, very good slides in the presentation if you're wanting to do a pretty specific underwriting of that very large campus. And we expect to capture entitlements and acceleration of our phases at -- Phases 2 and 3 at the Vantage, which is right next door to Pointe Grand, again, a very -- in the heart of South San Francisco location. And that's where we'll be developing our A+ product, so B+ in Pointe Grand, A- in Oyster Point and A+ in Vantage. Feels like the right mix and timing given the current state of the life science market. Next, as we look at life science, MOB and CCRC businesses, just an update. Life science tenant spaces often have strong tenant demand. And we've got embedded 25% plus mark-to-market across that entire portfolio. Pharma and large biotech M&A is starting to heat up or it's heated up a lot. In fact, just last week, Turning Point announced that they were being acquired by Bristol-Myers, which for us is a great credit upgrade. And we're seeing, as we think about life science, we're still very, very bullish on the long-term drug development, which I would say there are very few things in life that are more important to people than their health and especially the health of their families. So especially with the baby boomers coming up, we expect that to be a long-term sustainable business. And for incumbents like Healthpeak, where we have real scale purpose-built campuses, we expect that to be a big competitive advantage. In MOBs, rent escalators have been pretty sticky at that 3% to 3.5% range. But as construction continues to slow dramatically and be curtailed by construction costs and demographics continue to increase, especially for the baby boomers, we see incremental demand and believe that largely on-campus portfolio rental rates are going to continue to expand with turns over time that probably are going to be at least in line with inflation and maybe a bit above on turns. So we feel good about that. In CCRCs, we're the only public REIT to play. And in this unique high barrier to entry senior housing asset class, we're seeing significant tailwinds. The strong housing market has increased our entry fees by 15% just in the last year, and our entry fee cash receipts are up by 40% in the last year due to the higher rates, due to the higher leasing that we've been doing. We've also seen absolutely 0 new supply for CCRCs as replacement costs for this portfolio would be at least 3x our cost basis in these assets, and stabilization is an 8- to 10-year process from inception to stabilization. So that means, especially in infill locations, you just have no new supply. As to liquidity and funding, we plan to recycle capital to avoid high-cost debt and issuing stock at a discount to NAV, which we're at, at the moment, and we see upside to that. But at the moment, we're trading at a discount. Rates are up, but we have no maturities until 2025. And since we concluded our corporate restructuring in senior housing exit a year ago, we've been interested in leveraging our platform with our skilled team and use of strategic JVs, not lots of JVs, but a couple 3 critical JVs to take advantage of the benefits that this can produce. Proceeds from these activities, the JV activities, we believe, will fund in full our life science and HCA development programs without the need for external funding. So with that, I'll say, we're very optimistic about our business and certainly our current strategic position. And Nick, with that, how about we move it to questions?

Great. Yes. Thanks, Tom. I guess let's start with life science because it is very topical right now. You did touch on some of the points you're trying to make there. But I just want to be clear, the company's view on life science as a segment right now, I mean, it's been obviously a very strong demand driver in the last several years. You now have seen a little bit more of capital markets uncertainty for biotech industry. How is that affecting your view of the industry in terms of future tenant demand, if you see some additional credit risk of smaller tenants in the portfolio? And also just kind of relating as well to your decision on Pointe Grand to redevelop and rather than scrape that site, how that all kind of ties together into your firm's view on life science right now?

Scott, I'm going to start and then turn it over to you. I think there are some critical things that I'd want to point out. Keep in mind that life science right now is at 99% occupancy. We end up leasing space before steel even comes out of the ground. We're currently 85% pre-leased or under LOI for our entire development pipeline. And in Pointe Grand, that decision was made more on speed to market than anything. If there's currently a gap in new supply coming to market at that price point, and we can satisfy that need, that made a lot of sense for us to be able to move quickly on that, fill that space up. We've got so much premium land that we have opportunity with across South San Francisco in the Alewife area, Waltham and in certain parts of San Diego that we can certainly take advantage of the opportunity to lease some space up more quickly, have less drag and then move forward more profitably. But Scott, what would be your additions on the other parts of Nick's question?

Well, I mean the public markets are the easiest to follow, it's because you can see the stock prices every day. But if you think about all the capital that actually comes into that sector, the public markets are actually a pretty small percentage of it. It's just one avenue. You also have venture capital, which has continued to be really strong. You have the NIH from the government, which is very steady and has been growing. And then a lot of partnerships and collaborations with bigger companies that really for the last couple of years have slowed down because valuations were so strong in the public markets that companies went public. But even if you aggregate all the capital that was raised in '20 and '21 across the segments like $200 billion. I mean there's a lot of money coming into this sector for a good reason, but less than 20% of that was IPO capital. So it's important, but it's not the only source of capital, and we have regular dialog with a lot of the big venture capital firms and virtually everyone we talk to is either just closed a new round or is in the process of closing a new round. They've had a lot of success in the last decade. And certainly, there's no slowdown in the demand for new and innovative drugs. So they're still bullish. But certainly, the public markets are volatile. I mean everybody in this audience that they focus on that market and you see how volatile it is, sometimes for fundamental reasons and sometimes not. And certainly, the dramatic increase in demand for biotech in '20 and '21. I don't think we thought that was sustainable. We love the business long term, but we didn't think it was growing to the sky. I mean with rents up 20%, that only happens for so long. We do think it's a great business. We think that's very -- the fundamentals in terms of aging population, demand for innovative drugs, it's not going away, but it's going to have it cycles. And realistically, we're more worried over the past 2 or 3 years about just the dramatic potential increase in supply than we were about lack of demand. And between construction costs and maybe a bit of a slowdown in that demand, it could end up being a very positive thing for us if we were to look out over the next 3, 5, 10 years that things can slow down a little bit.

Right. And I think in the situation at Hayden where you had the tenant give back space, you announced this week that you've already re-leased that space, had a higher mark-to-market, I think with the existing tenant in that complex. Maybe I don't know how much more you can talk about that? What drove that? And I guess if there were other tenants giving back space in your portfolio, should we think that there's a lot of demand in the markets that ultimately [indiscernible].

Scott Bohn, do you want to take that one?

Sure. So at Hayden with the backfill, that was to -- as you said, it was an existing tenant who have recently been acquired by $200 billion-plus multinational player. So great credit upgrade, 38% mark-to-market. I think when you think about space potentially coming back, if we were to in the market, there is significant demand for built-out space. Space is ready to go, has very little capital improvement needed. Right now, groups are conserving cash a little bit more. So if you do have spaces that come available within the portfolio, there's plenty of tenants looking to grow and looking to grow in the space that's ready to go and ready and moving ready.

And in terms of development in that sector, you did talk about construction costs going up, rents have been also growing very significantly in the last couple of years. How should we think about the ability to still have the 7% to 8% development yields in lab space for your portfolio?

Yes. I mean maybe just a bit of history too for some context. We've been very active on development for the last, call it, 2015 through 2020 when rents were growing about 10% a year on average, and construction costs were only up at basically inflation, which was low single digits. So anyone who delivered product in that window had a massive gap in terms of return on cost because rents were just growing so much faster than construction costs. In 2021, we remain very active. The active pipeline has been in the $1 billion to $1.5 billion range throughout that period. But we had rents going up in the -- between 15% and 20% range, depending on the submarket, but construction costs were up by a similar amount. So it was more an equilibrium. And our active pipeline today, Nick, it's $1.3 billion. All of it's under Guaranteed Max price contracts, so we don't have any exposure there, and it's 85% pre-leased. So our return on cost is pretty well locked in at a 7%, which is still awfully attractive. If we were to look forward, it feels like construction costs will at least for the balance of 2022 continue to increase. I don't know that if it's a bit quite the 15% to 20% rate that we saw in 2022. It does feel like things are starting to slow down. As interest rates go up, it's harder for new projects to be underwritten and get financed, but market rent growth is slowing down as well. It's not negative. Year-to-date, across our core submarkets, we feel like rents are up low to mid-single digits even in the first 5 months of the year. So that's still a pretty healthy pace. But it might be that in 2022, rent growth is a little bit less than construction cost growth, we'll see, but that feels like kind of the near-term trend. Over time, certainly possible that things could slow down on the construction side quite a bit if that dynamic remains, which for us would be a good thing in terms of less new supply, less new competition because most of what we're going to do over the next decade, virtually all of what we're going to do is on land we already own. So we just have a huge built-in advantage because our cost basis is so much lower than some of the potential new supply.

Can you just talk a little bit more about Pointe Grand and the redev there and the type of products you're offering? And where are you competitive on maybe rents or type of space within that market and decision again to pivot to that type of use?

Sure. So I think, as Tom explained, I mean, we want to build to have a variety of offerings for our client base in South San Francisco. So with Vantage as A+, and Oyster Point as A- product and Pointe Grand as B+, all in A+ locations, right, in the heart of South San Francisco, it's important to have the ability to have a wider offering. So you look at rents at Vantage, a newbuild product that's probably in the high 80s, low 90s, at Pointe Grand, we'd probably be in the low to mid-80s. There's a big difference, though, in operating expenses. From a new product or a new project, you're probably $1 a month or $12 a year at least higher from an operating expense standpoint. And I'm assuming you couple that with the rent, there's quite a bit of savings. There's also a big savings from the TI contribution. So at Pointe Grand, we'll probably be closer to turnkey type builds for tenants, so less out of pocket. When you look at a new development like Vantage, for example, typically in the $175, $185 a foot TI package, the total buildout there for tenants is in the mid-300s. So there's a substantial out-of-pocket for them. So just being able to offer both sides of that to the market going forward.

And in terms of -- Tom, you did mention earlier about how we should think about the financing for development, potential recycling of capital, potential JVs. Could you talk a little bit more about thought process there?

Yes. I'll take that. We've talked pretty consistently about having around $750 million a year of development and redevelopment spend. We think we'll probably hit largely those numbers in the next couple of years. It may dip a little bit as we go through entitlements on Phases 2 and 3 of Vantage in 2023. But we do like that kind of number, and we like that risk-adjusted pipeline coming online. From a funding perspective, and we have some retained earnings, that was one of the reasons why we adjusted our dividend a couple of years ago to more closely fit our portfolio as well as our development objectives. We're going to have debt capacity every single year as well as our EBITDA continues to increase from the portfolios or the developments coming online as well as same-store growth with our existing portfolio. And then we talked about noncore sales to fill the gap for that. I would say noncore sales are probably in the, call it, $100 million to $200 million range. I mean that number is getting lower and lower, the more that we've pruned our portfolio, what Tom mentioned during his prepared remarks on strategic JVs that would be different than noncore sales as the noncore sales will probably come at a higher cap rate, whereas you think about strategic JVs, those funds would come in at a much lower yield than noncore sales. And that's really how we think about funding, not just the development pipeline, but additional CapEx throughout the portfolio.

I want to make sure we have room for questions in the room. Anyone has any? There's a mic where you can just yell. All right. Maybe just turning to the MOB business a little bit. Just talk about kind of latest in terms of tenant demand and then perhaps as well on the transaction side, what you guys are seeing?

Yes. Really on the demand side, our leasing has probably been the strongest in the past 2 years than it's been probably in the past decade. We've been consistently beating our leasing targets. Our occupancy actually has started out about 100 basis points ahead of our expectations for '22. So on the demand side, it's been great. Transaction side, I'll let Scott comment a little bit after me. But we really haven't seen a lot of closing of transactions recently. So it's hard to judge where things are going to be falling out as far as cap rates and stuff. We did a couple of deals kind of in the 5% range, a little north of that, but I think we'll have to wait to some market transactions close to see where we end up. I don't know, Scott, do you have anything to add?

I'd probably just add that there is a distinction between core product that tends to have low or very or no leverage. And that's essentially the area that we play in, 90% on-campus or adjacent to campus. I mean that's a super core product type, but there's just not a whole lot of leverage in that type of an asset class or product type. I think where you'll see the more expansion on cap rates is value-add type off-campus where you're going to have higher leverage, higher yields, and that buyer pool is definitely more impacted by what's happening with interest rates. But our view is, overall, cap rates are likely to go up a bit, how much is to be determined, but you can't ignore what's happening with the risk free rate and with borrowing costs. But to date, at least there's been so much product or capital waiting to deploy that we haven't seen a dramatic increase, but certainly, the direction is for cap rates to move a little bit higher.

I guess I also wanted to ask about the dividend. I mean, how the Board is viewing that? You have a lot of development underway or perhaps more additionally over the next couple of years, we're also in this maybe more uncertain economic environment, but higher dividend yields seem like they're being valued higher in the market right now. So I just love to hear how the Board is thinking about the current dividend and potential growth there?

We've moved to a place where dividend coverage is stronger and stronger. I would put it simply that as AFFO continues to grow, a portion of that growth will go to increasing our dividend. And that is in our sights as we look forward over the next couple of years.

Great. Jack, again, if there's any last questions in the room. I guess last one for me is how you think your asset classes will fare in this higher inflation environment? And maybe you could just touch on each segment and how they offer inflation protection, which is pretty important these days.

Yes. Why don't I start, Scott, and then you also add. When we're looking at MOBs, they're oftentimes thought of as slow growth same-store type assets. That may be partially true, but we've been dealing with inflation that's been slightly sub-2% for, I don't know, it's starting to feel like for about ever and declining cap rates over a couple of decades. So it's kind of hard to use that gauge that MOBs will be slow growth forever. You have to take into account that insurance and government can dictate the movement of reimbursement rates on different procedures along with insurance companies. So that's a reality. But over time, medical costs have to increase with inflation over time. In MOBs, there's a greater and greater push toward outpatient treatment. And as development slows, especially on campus, which requires an invitation from a hospital or health system and yet baby boomers and others are creating greater and greater demand for healthcare, that's going to result in constraint for space, which as leases turn will result in our view, in increased rents over time. It's just inevitable. So we do feel that MOBs will have solid inflation protection, average lease term of, call it, 4, 4.5 years, and we'll participate in that, we're already seeing the fixed rate bumps increasing a little bit, there's been more that are based on CPI. So we think that, that will be a very solid asset class. And there's no question that demand for it's there, you break an arm, you don't wait until COVID's done or the economic cycle changes before you get your arm reset. In life science, the long-term demand for drug development and therapeutics is literally indisputable. So whether there's some slowdown short term, the demand for this by baby boomers and their families will continue. And the scientific advancements are accelerating. And what that means is that long-term increase in the need for space in life science in the 3 core markets where all the talent resides, the VC resides, the major medical institutions that do that research reside is going to cause long-term rent growth in that business. And in CCRCs, there are a whole bunch of different dynamics, but because there's absolutely no new supply in the infill markets, for the healthier senior with the 8- to 10-year length of stay, as I said, no new supply. It's more of a resort style activity. It's for the healthier senior that's got some affluence, those rental rates will grow over time. Housing has increased, that's going to increase nonrefundable entrance fees. So we have 3 classes of assets that are all extremely high barrier to entry. They're absolutely irreplaceable. And the demand for that space is going to continue long term. And they're all related to healthcare with the aging baby boomer. So we feel that in all 3 classes of those assets that, that is a great long-term play. We're very happy with where we're at and how we've positioned our portfolio strategically.

Great. Well, with that, I think we're out of time. Thank you.

Thank you, everybody. Appreciate it.