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

Good morning, and welcome to the Healthpeak Properties and Physicians Realty Trust Conference Call. [Operator Instructions]. Please note that this event is being recorded. I would now like to turn the conference over to Andrew Johns, Senior Vice President, Investor Relations. Please go ahead.

Thank you. Good morning, everyone. If you have not yet downloaded the press release or merger presentation related to this call, they are available on the Healthpeak and Physician Realty's website under Investor Relations. This morning, you'll hear from Scott Brinker, President and CEO of Healthpeak; Peter Scott, CFO of Healthpeak; and John Thomas, President and CEO of Physicians Realty Trust. Today's conference call will contain certain forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our expectations. Factors that could cause actual results to differ including, but are not limited to, the potential benefit of the proposed merger, the expected timing and likelihood of completion of the transaction, including the ability to obtain the requisite approval of Healthpeak and Physician Realty shareholders and the risks that the closing conditions are not satisfied. Please refer to the forward-looking statements notice in Healthpeak and Physicians Realty's 10-K and other SEC filings for information. Finally, this call will contain financial measures. In accordance with Reg G, the company provides a reconciliation in their respective earnings packages. And with that, I'll turn the call over to Scott Brinker.

Thank you, Andrew, and good morning, everyone. Very excited to be here with John to discuss the merger we announced this morning and the significant benefits to both companies. This combination will create the leading real estate platform dedicated to health care discovery and delivery, a large and attractive playing field with strong secular growth. We also announced strong 3Q earnings including another increase to both same-store and earnings guidance. I'm going to ask Pete to summarize our results, then John will do the same for DOC who also announced 3Q results this morning. Then I'll be back on with John to discuss the merger. Pete?

Thanks, Scott. Despite the challenging capital markets environment, we continue to put up solid operating and financial results. I will be brief so we can get back to the merger we announced. For the third quarter, we reported FFO as adjusted of $0.45 per share, AFFO $0.40 per share and total portfolio same-store growth of 6%. Some additional color on segment performance. Starting with outpatient medical. Same-store growth was a solid 3.4%. During the quarter, we signed 2.2 million square feet of leases, including a 20-year extension at our Medical City Dallas campus and 143,000 square feet of leases in Philadelphia. Shifting to lab. Same-store growth was a strong 3.3%. During the quarter, we executed 211,000 square feet of leases, including converting all 196,000 square feet of previously announced LOIs into leases. The significant deals included a 101,000 square foot lease with Client Therapeutics to backfill a 2023 Amgen lease expiration at our Oyster Point campus, a 61,000 square foot lease with Voyager Therapeutics to expand at our Hayden campus in Boston and a 23,000 square foot lease with Astellas at our Vantage development, bringing that project to 52% preleased. All 3 tenants were existing tenants in our portfolio and underscores the severe competitive advantage that incumbent landlords have. Finishing with CCRCs. Our strategic and operational initiatives are producing strong results. Same-store growth for the quarter was an exceptional 32.1%, driven by occupancy gains, reduced labor costs and margin improvement. Turning now to our 2023 guidance. We are increasing our FFO as adjusted and AFFO guidance by $0.02 at the midpoint to $1.77 and $1.53, respectively. Additionally, we are increasing our full-year blended same-store guidance range by 75 basis points to 4.75% at the midpoint. Please refer to Page 38 of our supplemental for additional detail on our guidance. With that, let me turn the call to John.

Thank you, Pete. Before discussing the merger, I want to take a few moments to discuss Physicians Realty Trust's performance during the third quarter of 2023. During this quarter, Physician Realty Trust generated normalized funds from operations of $61.2 million or $0.25 per share. Our normalized funds available for distribution were $60.1 million or $0.24 per share. We paid our third quarter dividend of $0.23 per share on October 18, which represented a payout ratio of 96%. We ended the quarter with a balance sheet in great shape, our consolidated net debt-to-EBITDA ratio of 5.3x and less than 5% of our debt carries a variable rate interest rate. Of our $2 billion of consolidated debt, only about $85 million or 4% matures before 2026. Our revolving line of credit is completely undrawn, providing us with $1.2 billion of near-term liquidity when combined with our nearly $200 million of cash on the balance sheet. Operations remain strong with the leasing team achieving positive absorption of 26,000 square feet and renewal spreads of 6.7%, outpatient medical same-store cash NOI grew 1.5% year-over-year, an improvement from prior quarters as the team works to re-lease the incremental vacancy incurred earlier in the year. New investments were modest at $16.8 million, including the funding of previous loan commitments on outpatient medical facilities under construction. We also remain on track for the G&A guidance of $41 million to $43 million. Our construction team is also managing to the guidance of $24 million to $26 million for recurring capital projects, and we don't expect any surprises there. We're also excited to report that Physicians Realty Trust earned a score of 78 out of 100, representing a 4% year-over-year increase and a Green Star designation in the 2023 GRESB Real Estate Assessment for sustainability reporting. I'll now pass it over to Scott to discuss the merger.

Okay. Thank you, Pete and John. From day 1, the discussion with John focused on whether both companies will be better together than as stand-alone entities. That was the only transaction either side was willing to do, and we accomplished that goal, as the merger is expected to be accretive to both companies from every important angle. Scale, earnings, balance sheet, capabilities, team and relationships. John and I will touch on each of these items. One of the benefits of this transaction that is most exciting to John and me is that we can combine the complementary strengths of the 2 companies, including DOC's internal property management and PEAK's redevelopment and development expertise just to name two. We expect this deal to fundamentally change the power of the combined platform and therefore, our mutual growth opportunity. For the past year since taking on this role at Healthpeak, I've talked about several initiatives we were focused on, including having a larger playing field given the evolving nature of health care delivery, getting closer to our real estate, deepening our relationships and streamlining our operations. This transaction accelerates every item on that list. There's an investor presentation on both company websites, but let me quickly describe the basics. This is a 100% stock merger based on the closing share price of each company as of Friday. Each stock share will be converted into 0.674 shares of newly issued Healthpeak stock. The ownership split will be approximately 77% Healthpeak shareholders and 23% Physicians Realty shareholders. The company's name will be Healthpeak Properties headquartered in Denver with the ticker symbol DOC or DOC. We expect to maintain our dividend at $1.20 per share resulting in an AFFO payout ratio of 80% or below. Closing is expected to occur in the first half of 2024, subject to typical closing conditions, including shareholder votes. Let me clarify, this is not a sale for either company. There's no cash changing hands. This is a relative value trade that we believe is beneficial to both companies. And our transaction structure allows all shareholders to carry forward and participate in the immediate and future value creation. Let me touch on the financial highlights. There is immediate and compelling value creation opportunity that will grow over time. The year 1 run rate synergies should at least $40 million with the potential to reach $60 million by the end of year 2. Any increase in occupancy or rate would be upside to those numbers. We expect the combination to be accretive to stand-alone year 1 AFFO for both companies. We also expect FFO accretion, though that number is subject to GAAP accounting adjustments that will be finalized just prior to closing. We're even more excited about the strategic benefits. First, we've already spent a huge amount of time thinking about the team and platform from top to bottom with a joint mindset that the status quo was never good enough. Both companies have already been operating at a high level. This is an opportunity to quickly go to the next level, combining the complementary talent and strengths of each company. Second, broader and deeper relationships. Together, we'll have relationships with each of the 10 largest health systems in the country, the vast majority of the world's largest biopharmas, an exciting mix of innovative biotechs and regional health systems. Those relationships are the intangible that drives our outperformance. Third is increased operating scale with a combined 40 million square feet of outpatient medical real estate, including concentration in high-growth markets like Dallas, Houston, Nashville, Phoenix and many others. The combined footprint will deepen our competitive advantage in local markets, but we haven't included any of this potential upside in our numbers. Four, we'll retain DOC's internal property management platform and expect to internalize certain markets in our medical and lab portfolios. This will deepen our relationships and augment our local market knowledge. The internalization will also be accretive and we've included those profits in our synergy numbers. Five, improved tenant diversification. The top 10 tenants will represent just 21% of annual base rent. And 7 of those 10 are investment-grade credits. Only 2 tenants will represent more than 1% of our combined base rent. HCA will be our biggest tenant at 9%, and they are the largest for-profit health system in the country. It's also a highly strategic relationship that goes back more than 2 decades. Common Spirit will move from 15% of DOC's stand-alone down to 4% of the combined company. Common Spirit is the largest not-for-profit system in the country and rated A- by S&P. We look forward to supporting the mission of these 2 organizations and many others in the sector in a broader way than we could as stand-alone companies. Sixth, this transaction will help accelerate the integration of our medical and lab operations. Independent of this merger, we're already moving toward a single operating platform, as the daily blocking and tackling of property management, leasing, CapEx, forecasting and accounting has enormous overlap between the 2 segments. We also see more and more of our health systems doing some level of R&D, where we can be a high value-add partner given our capabilities. Seven, increased scale and liquidity for equity investors as both companies will benefit from a larger market cap. Eight, is a bigger, more liquid balance sheet with leverage expected to be in the low 5s at closing and well-staggered debt maturities. The balance sheet will be a competitive advantage as we move forward, positioning the company to go on offense when highly levered owners are searching for answers in this new environment. Nine, lower cost of capital through more efficient G&A and enhanced liquidity, making external growth more accretive. And ten, we'll use the larger portfolio to become more active in recycling capital for our pipeline opportunities, whether through outright sales or private capital joint ventures. Medical and lab remain attractive asset classes to institutional investors and no company will be better positioned to capitalize on their desire for exposure to the sector. Moving to the team and governance. John Thomas will join our Board as Vice Chair and have an active role in strategy, business development and relationships, areas where I've seen firsthand that he excels. John has proven himself time and again as a leading voice in this sector, and it was a driving force for growth at both Healthcare REIT and Physicians Realty. In addition, we're excited to retain the vast majority of the DOC operations and property management teams, many of whom are reimbursed by the tenants. Kathy Sandstrom will continue to be our Chairperson and the Healthpeak Board will be expanded to include 5 directors from physicians Realty, including John and the former U.S. Secretary of Health and Human Services, Tommy G. Thompson. After closing, outpatient medical will represent approximately 50% of the combined company's NOI. Demand exceeds supply in the outpatient sector today and we expect that dynamic to continue given senior population growth and the high cost of new construction. We're also starting to see market rental rates catch up to inflation, which is a positive sign for future NOI growth. That being said, we do not have fixed portfolio allocation targets moving forward. We'll allocate capital based on opportunity and risk-adjusted returns. And we do expect the opportunity set to be significant, driven by 4 major buckets and in no particular order. First is outpatient medical acquisitions from capital-constrained owners or health systems, second is new development with leading health systems, third is distressed acquisition opportunities in life science driven by refinancing challenges or delayed lease-up, and fourth is activating our 5 million square foot life science land bank when fundamentals are favorable. I'm excited for JT to provide his thoughts on the opportunity in front of us.

Thank you, Scott. When John Fleet and Mark Theine asked me to join them just over 10 years ago to create a new public company focused on outpatient medical investment, I was intrigued by the opportunity to work with them to build a new kind of organization with an intense focus on serving the current but more importantly, the future needs of health care providers and their patients as care continues to move from the inpatient setting to the outpatient setting. We didn't have an objective then or now to build a portfolio and sell it. But rather to build an organization built to last for the long term, one that would grow and evolve with clinical science, the needs of an aging U.S. population, and resilient to macro and micro capital market conditions. We wanted a culture to drive those goals and over time, came to capture that culture in the acronym CARE. We communicate and collaborate. We act with integrity. We respect the relationship and we execute consistently. I've had the privilege to work with Scott since 2009 when we were both had the opportunity to work together under a genuine mentor to both of us, George Chapman. We worked with Pete since his days at Barclays and collaborated with him since he joined Healthpeak. We've had the opportunity over the past 10 years to get to know the Healthpeak team and more in recent weeks. We have common and consistent missions, goals and more importantly, culture. Scott has articulated defined, achievable, measurable and objective metrics we can and will achieve together. We are convinced this combination not only furthers our long-term objectives from our humble beginnings 10 years ago, but provides the best-in-class scale and operating platform to achieve together, for our combined providers and the patients they serve far more than we can deliver separately. We are here to serve the best interest of our shareholders and stakeholders, and we believe with all of our analysis and discussions that 1 plus 1 in this context is not only more than 3, but has potential to be much, much more. In addition to Scott's earlier comments, an additional benefit to DOC's existing shareholders as we are merging with the best-in-class lab portfolio with large footprints and lab investment platforms in Cambridge Mass, South San Francisco and San Diego, at an incredibly great valuation in time for investment in the existing lab platform with what we believe is an outsized ROI for years to come. Healthpeak's class A lab facilities are incredible real estate, hosting some of the world's leading scientists, clinicians and discovery, sponsored by and backed by leading pharma, Venture Capital and academic proximity and involvement. The combination of Healthpeak's lab teams and DOC's operational platform further enhances the value of these assets and relationships. I've toured Healthpeak's best-in-class lab in markets and share the vision for the development of existing land owned by Healthpeak in Cambridge and South San Francisco that should generate outsized growth for years to come, focused on lab and community development, but also outpatient medical access. Scott and I led under George Chapman's leadership, a large investment in Cambridge lad real estate in 2010 and working together learned lab real estate investment, development, operations together. The results of that investment speak for themselves. Obviously, Scott has taken that experience and executed consistently as Healthpeak's leader. I'm very excited to partner with him and our collective team to further the combined company's future opportunities in lab and of course, outpatient medical. In conclusion, DOC is not selling an outpatient medical portfolio to Healthpeak. Healthpeak is not selling lab or outpatient facilities to DOC. Rather, we believe we are combining the best of both organizations in an all stock merger of equals that we believe will benefit both shareholder bases and continue the mission, vision and culture of each organization as one. This combination furthers each of our goals to have and build an organization built to last for the long term, one that we grow and evolve with clinical science, the needs of an aging U.S. population and resilient to macro and micro capital market conditions. We believe this combination meets and exceeds all of those objectives. I look forward to working with Scott and our collective team and Board. And as we say at DOC, this is an opportunity to invest in better as Healthpeak, and you'll be able to find us at the New York Stock Exchange under the stock symbol DOC. Thank you. We'll now be happy to take your questions.

[Operator Instructions]. Our first question comes from the line of Michael Griffin with Citigroup.

I'm curious if you can kind of elaborate maybe, Scott, just on the on -- versus off-campus of the combined company. I mean Peak historically has been more on-campus focused, DOC has been more off-campus. So is there going to be a strategy shift in terms of preference there?

Yes. I would just say that the portfolios are really complementary. I mean there's a lot of overlap in the markets themselves, something in the range of 70% market overlap, they have a huge concentration in a lot of our big markets like Dallas and Houston, Phoenix, it's a pretty long list, as well as some new markets like Atlanta. We are higher on-campus. That's been a good strategy over the years. It's produced good results. But I think DOC has high-quality assets in kind of different and complementary way. Certainly, health care is moving more off-campus doesn't mean it's completely moving off-campus, our hospitals are still busy, those on-campus MOBs are still performing. But if you think about the trend in delivery, progressive health systems today have 10 or more outpatient assets for every one hospital in their system with oftentimes a strategic plan to move more towards a 2:1 ratio and just almost by default, most of those new assets are off-campus trying to make care more convenient, more accessible, more affordable. So we still like on-campus real estate, but we think we have to complement it and serve our health system partners more comprehensively and off-campus just has to be part of that strategy. If you look at the segment or the sector in the aggregate, it's probably only 30% on-campus. So it's just not realistic to think that you can be a true partner of choice with health systems if you're only serving that 30% of the real estate footprint.

Got you. That's helpful. And then I'm just curious if you could maybe kind of give us a little color on sort of how these talks came to be a mergers of equals, kind of over time, how did things evolve? Or anything there would be pretty helpful.

Yes. I mean we'll put out the proxy with all of that background information in the next month or 2, Michael, but I'll probably defer that answer until that's made public.

Our next question comes from the line of Austin Wurschmidt with KeyBanc.

I was hoping you could provide some additional detail around the synergy components within the $40 million to $60 million that you flagged. And do you expect it will be accretive immediately upon closing? And can you give us a sense about the magnitude of accretion you expect in the first year?

Yes. Austin, it's Pete here. It's a good question. As we said, we do expect the transaction to be accretive to both AFFO and FFO per share. I will note, and I think everybody knows this at this point, but FFO has a lot of accounting adjustments, including a mark-to-market of the debt, and that won't be finalized until the deal closes. But everything I just said is based on our best estimates as of today. And importantly, those accounting adjustments do not impact AFFO. The accretion of $40 million to $60 million. I think the biggest component of that are compensation savings. There will be some redundancies within both organizations, there's also corporate overhead savings, notably some significant professional fee savings from having 1 public company as opposed to 2. And then the increased NOI from internalizing property management across the portfolio. So those are the biggest pieces. But to answer your initial part of the question, we do expect it to be accretive in year 1.

No, that's helpful. And then I'm just curious, so with the combined companies, the Peak team has kind of highlighted the potential mark-to-market growth opportunity. I think it's in 2025 within the lab space segment and DOC has talked about, I think it's '26 when you've got the significant maturities with an attractive mark-to-market as well. I'm just curious how you thought about sort of how this would dilute that growth in the years ahead and then kind of how you backfill that through some of the other opportunities that you've discussed and highlighted.

Yes, Austin, I'll take a shot at that, and Pete and John may have comments as well. But overall, we view this transaction as augmenting our internal growth profile, certainly making it less volatile more predictable. But in addition to just the initial synergies that Pete just described, our capabilities in serving our clients is going to increase pretty materially, whether it's our development redevelopment capabilities, internal property management, the additional scale in the local markets that just brings us closer to the real estate, closer to our tenants, that should drive better economics. And if you think about the last 10 years in lab versus the last 10 years in medical, it's not necessarily going to repeat itself. I mean, from where we sit, our medical growth over the past decade has been in the mid-2% range, so slightly above inflation. But we have 5- to 6-year lease terms on average, and we are starting to see market rental rates catch up to inflation. There's obviously a lag given that weighted average lease term, but we are starting to see some pretty significant rental rate growth and DOC has been reporting the same -- so I think if you look at the go forward, we're pretty optimistic about the growth rate within outpatient medical. We see demand exceeding supply really across the entire industry, including in our local markets. So it should be a pretty compelling future growth rate that might look different than the 10 years in that medical business.

Our next question comes from the line of Juan Sanabria with BMO Capital Markets.

Congrats on getting the deal done. Just a question on Asset Management, I guess, for Scott Brinker. I mean you guys had tremendous scale, particularly in the lab markets. I'm just curious on kind of why the change of strategy about embracing the internal property management. And if you could dive a little into how should we think about how much NOI that business generates just from a synergy or accretion perspective.

Yes. Happy to take that one Juan. Really in the last year one of the major initiatives that we've been pushing as a leadership team is to bring our company closer to our real estate, closer to our buildings, local markets and relationships and having the internal property management allows us to be that much closer to our tenants in our buildings. And we feel like we're a little bit redundant, maybe one step removed in some cases with third-party property managers and we think we can eliminate that, improve the relationship, improve our local market knowledge and doing it off the back of DOC's existing platform, just allows us to do it faster, it's less execution risk and it will have a higher margin just given we don't have to start from scratch. So it's a pretty significant part of the synergy number that Pete described. Some of that comes immediately because there are a number of markets that we've already identified that we can internalize right away. And then over time, depending upon how it goes, we can increase that number. So it's one of the really interesting and intriguing parts of this merger that it's not only financially accretive in a pretty meaningful way, but it's strategically important, in that it brings us that much closer to our real estate.

Yes. Juan, This is JT, just to add to that, in the 6 largest overlapping markets for outpatient medical, Peak's always had a great, high-performing team and organization, organizational structure and approach to -- on the ground, boots on the ground operation and property management. We have DOC team members in each of those large markets already, so there's just a lot of synergy and scale that's already we can put in place day 1, and we'll be working during the process towards closing to get that plan in place and assume those responsibilities together day 1, and then there's many more markets to come. So just a lot of upside opportunity, both financially, but also as Scott said, to get people just connected to the real estate.

And then just as a follow-up, I guess it's maybe a little 2 part. Is the exchange ratio fixed? Or is that variable? And then is there any planned dispositions or exit of any markets with the combined company?

So the exchange ratio is fixed. And in terms of dispositions, it would only be opportunistic. The balance sheet is in great shape today for both companies. It will be even stronger post-closing. We have a very high-quality portfolio. We toured the vast majority of DOC's portfolio and feel the same. So anything we do would be opportunistic. There's no forced sales as a part of this transaction, given the strength of the balance sheet. But I did make comments in my prepared remarks that we would expect to be more active in capital recycling, so doing things opportunistically, whether it's outright sales or recaps with joint venture partners. We do think that we'll be a partner of choice to the private capital community as well. We already have a number of those relationships, and we think we could have more as we see a significant pipeline opportunity, as I described, really across the lab and medical business, and if the stock is not trading at an accretive level, we could certainly look to recycle assets to capitalize that growth pipeline.

Our next question comes from the line of Vikram Malhotra with Mizuho.

Congrats on the deal. I guess just first one, when 2 of your peers merged, one of the thesis was that this creates a much larger acquisition opportunity set. And theoretically, the AFFO, FAD growth is higher. I think there was a 500, 600 basis point number at that time. Is that part of the rationale here? Do you see a bigger acquisition set and just ultimately higher, you said steadier growth, but I'm curious if you also see higher growth.

Well, certainly, on the external growth front, we do think that our balance sheet will be even more attractive to lenders so our cost of capital should benefit, clearly, our G&A as a percentage of assets will go down, so our cost of capital should improve. Hopefully, the market responds to the strategic benefits of this transaction and our cost of equity improves as well. So certainly, we would expect that the external growth opportunity will be more attractive, given the DOC relationships and the Healthpeak relationships on top of that, improved cost of capital. But that's not part of any of the accretion or synergy numbers that we've outlined, that would be all upside, Vikram.

Okay. That's helpful. I guess just one more, just following up on the whole, I guess, the off- versus on-campus. Part of what you mentioned is that the consumer, the hospitals are going more off-campus. But I guess that could be that has been going on for a while. So I'm just sort of wondering why today? And a part of this, do you still see -- you mentioned disposition. So do you still see a path where more of the dispositions are off-campus weighted?

No, it would just be opportunistic, Vikram, it's not going to be by design. But I think really from day 1, 12 months ago, this management team has described the desire to have a wider playing field. if we're not servicing our tenants and health system partners in the medical business, we're not going to be -- we're not going to find maximum success. And just given the emphasis of their strategy and growth plans, we have to be a participant in that.

Okay. So I guess just to clarify, the dispositions would then still be like more broad-based, including potentially the CCRC that you've always had on that list?

Yes, I would put CCRCs in a totally different bucket. That's a business that is performing well. We think it's a great asset class. We've got a great portfolio and internal team running it as well as a great third-party property manager in LCS. So the feedback and strategy on that portfolio hasn't really changed. When the financing markets make sense, and we get a fair price, that's one that we'd be willing to sell and recapitalize or recycle into our core businesses. But on your specific point about on -- versus off-campus or lab, that will just be completely opportunistic wherever we get the best pricing is where we would look to transact.

Our next question comes from the line of Rich Anderson with Wedbush.

So congrats to everybody. You're making it clear, no one is buying the other and so on. But the fact is Healthpeak is issuing, if my math is right, 168 million shares. If I'm also doing my math right, the implied cap rate on stock is in the, call it, low to mid-7s. And so if you do a cost of equity, if you just do an inverse of your AFFO multiple to keep it simple, it's 9-ish. So I guess the question is you need that $40 million of synergies to be able to talk about accretion. It's without it, it is at least marginally dilutive out of the gate to Healthpeak earnings. Is that a fair mathematical approach?

I'm not sure -- there was a lot there, Rich.

I'll do it again if you want. 168 million shares implied cap rate on DOC of 7.25%, 7.5% something like that. So based on those 2 forces, it's dilutive without the synergies, correct?

Yes. Well, they're very different portfolios. I mean we're not a pure-play medical portfolio today. We have the CCRCs, we have lab and NOI is one metric you could think about, it's certainly one that real estate investors tend to point to, but it's certainly not the only metric. I mean when you think about CapEx and volatility of earnings, but CapEx in particular, DOC, given the nature of their portfolio, just has a very low CapEx burden relative to ours. So that certainly drives a lot of the accretion as well on an AFFO basis, which feels more like a cash economics analysis to us, and I'm not sure if I would agree with your point on -- in terms of AFFO, kind of the true economics of the deal, I think there's probably some accretion even without other synergies, Rich.

Our next question comes from the line of Tayo Okusanya with Deutsche Bank.