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

To the 11:40 a.m. session of Citi's 2024 Global Property CEO Conference. I'm Michael Griffin with Citi Research, and we're pleased to have with us Healthpeak and CEO, Scott Brinker. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions if you do not want to raise your hand. Brinker will turn it over to you to introduce Healthpeak and the team, provide any opening remarks, and then we'll get into Q&A.

Okay. Yes. Thanks for the invitation. Griff if I've got Pete Scott here with me, our CFO. So a quick introduction. We feel like there's enormous value and opportunity in the stock today. Headline is notwithstanding, we're still growing, our same-store 3%, it's translating into earnings growth. It has, and we expect that to continue. We're trading at a dividend yield of 7-plus percent. That's a very well-covered dividend with a very high-quality portfolio and balance sheet. On top of that in terms of upside opportunity, right, the 10-plus percentage I just described is just a baseline even if we don't recapture any of that multiple improvement, but we're trading in the mid-8 on a very high-quality portfolio that the private market still embraces. I don't know exactly what NAV is because the market is still a little bit slow, but my best estimate would be in the low to mid-6s, which is in line with our NAV and that's a 35% or better percent upside opportunity in the stock beyond that baseline that I just described. And then in the deck that we published on Friday, we identified $80 million of NOI upside in the portfolio beyond our 2024 outlook. So that's all upside to our current guidance. And it's a combination of additional synergies from the merger as well as recapturing NOI at 3 of our big life science redevelopments, very well located, made in main type locations, we will recapture the NOI. It's just a matter of time. And then the last point I would make is the power of a great platform. And I feel, and I think objectively could make the case that we had the 2 best outpatient medical platforms in the business between Physician Realty and Healthpeak and by putting them together in a true merger, a true combination we've created without doubt in my mind, the best platform in the outpatient medical business. And I do think that, that will prove to be beneficial for shareholders over time as we drive internal and external growth.

Thanks, that, Brinker. We're starting off each of these roundtable sessions with the same question. What are the top reasons investors should buy Healthpeak's stock today?

I think I maybe already answered that question. So I mean it's the return opportunity, 10% baseline growth expectation with upside for 35% or better the additional $80 million of NOI upside that is not in our numbers that I don't think investors are underwriting as well as the strength of the platform that we've put together through this merger that closed on Friday. Those would be the 3.

Let's start off with the merger. Why does this deal make sense for both DOC and PEAK shareholders? And does this signal a shift towards medical office and away from your life science platform?

Yes. I mean the U.S. spend $5 trillion a year on health care. It's an enormous number. And you think about our plan field includes health systems, physicians and pharmaceuticals. That's 75% of the $5 trillion a year that the health care system in the U.S. spends. So it's an enormous opportunity for us. We think there is significant back-office synergies between the 2 businesses. But in terms of the merger itself, it's clearly accretive to earnings, set AFFO per share by 3% to 4% in 2024 with more upside to capture in the future. It's clearly accretive to our balance sheet because of the synergies, about 0.2 to 0.3 turns on our leverage, which was already strong. Now it's even stronger. And then the benefits of the platform, which I mentioned earlier, which over time, I think, will prove to produce a lot of shareholder value. In terms of outpatient medical, it's always been a big part of our business. And it's a consistent growth business. We have an excellent portfolio and platform and relationships to drive that growth. And fundamentals are accelerating. It's a business that grew in the 2% to 3% range over the previous decade, but that was a different environment. Today, we see that number accelerating our growth, the last 3 years in outpatient medical has been 3.5%. So it maintains that consistent low volatility profile, but at a higher baseline than it has for the previous decade because demand continues to grow as health systems have a mandate to move more of their care to an outpatient setting. It's more profitable for them. It's more convenient and efficient for patients. So that will continue to happen. So demand is strong and supply is as low as it's ever been because of the cost of construction, rental rates on new development today are in the $40 per foot range, plus or minus. The in-place rents in our portfolio is in the low 20s. So it's just an enormous gap between what we charge for Class A space that's in good condition and well located versus what it would take to fill up a new development. And that's creating an enormous opportunity that we think will take advantage of for the foreseeable future. Those dynamics will continue.

How confident are you in realizing the synergies from the merger. You talked about $40 million in year 1, up to an incremental $20 million on top of that in year 2. Could we see any additional synergies realized on top of that?

Yes. I might ask Peter to answer that. But I want to make one additional comment on the merger because life science is still 40% of our business. A lot of the $80 million of upside that I identified earlier in the presentation is in life science so of a 5 million square foot entitled land bank. It's very easy for a year or 2 from now for life science to once again be 50-plus percent of our business. So -- it's in no way a statement about our belief in the life science business. It was simply a decision that we think this combination made us a better company and that there's still a lot of upside to recapture in life science. So Pete, do you want to answer the synergy question.

Yes, sure. Hopefully, you all can hear me. But we're fully confident in the synergies. And to that point, we had $40 million of synergies included in our outlook this year. Previously when we announced the deal, we said we'd have $40 million in year 1. So we hit that $40 million mark and essentially 10 months this year because the deal closed on March 1. The $20 million of synergies for next year. A lot of that will come from internalizing property management. We've already internalized 4 markets so far this year. We've got 5 more slated and more to come next year, and we'll get the full year benefit from that. So highly confident in the $40 million this year and highly confident in the $20 million incremental next year.

And then in terms of the integration, how has it been coming along so far? Was there a lot of overlap between the 2 portfolios in terms of health system relationships or markets? And have you made any new health system relationships or expanded into any new markets as a result of the merger?

Yes. I mean on the integration, Pete just spoke to the synergies. But beyond that, I mean, I couldn't be happy with the level of integration across the company, whether it's technology, forecasting, internalizing property management, which is way ahead of schedule, really on every single level, I'm happy about the level of integration and teamwork between the 2 organizations. We just closed on Friday. We've already internalized property management on 4 markets. I mean, advanced the closing date with 5 more on [ TAP ], and that's a material part of the synergy number. So a financial benefit, but also a strategic benefit of getting our own team more directly in contact with our tenants on a day-to-day basis. We gave combined guidance for the company in early February, a month before the transaction even closed, which I think speaks to the level of integration on the accounting and forecast inside and this is a very different transaction than, say, a public company auction, right, where there's only so much underwriting that can be done and only so much integration that can be done prior to the closing. This was a privately negotiated true merger with 2 companies decided they'd be better as one, and we've been integrating since October, and it explains why we're so far ahead of what you would expect in a traditional public company setting. In terms of relationships, that's one of the major benefits in the transaction. Today, if you look at our outpatient portfolio, 67% of our tenants are health systems. That's 3x what it was 2 decades ago and almost 2x of what it was even a decade ago as more and more of our tenants are health systems directly and not small physician groups. So having those relationships which Physician Realty Trust had in scale and deep relationships is critical to our success moving forward. There wasn't a ton of overlap. There's some big national names like Optum or McKesson where naturally we have overlap. But for the most part, they're new relationships like in Atlanta with Northside, Ascension in Indianapolis, Baylor in Dallas. -- it's mostly new relationships coming into the combined company.

And does the combined platform give you additional scale and competitive advantage to win on new acquisitions?

Competitive advantage across the board, acquisitions, yes, although it's not something we'd be excited about today, given cost of capital, but leasing, development, redevelopment across the board I spoke to earlier, but given how much of our tenancy or health systems, those relationships are what drive opportunity internally and externally in the sector.

And have you identified any properties as a result of the merger that you'd be looking to dispose of? And if so, what do you think the dollar amount could be?

Yes. It's 2 high-quality portfolios. So there's nothing that we have to sell. But given we're trading at an implied mid-8% cap rate and our assets probably trade more in the 6% to 7% range depending on asset quality. We would consider pursuing asset sales, we're actively pursuing it in fact, in one of the use of proceeds could be stock buybacks. So it would be really 2 benefits, accretively recycle capital by buying back stock and improve the quality of the portfolio that remains. So that is something that we're pursuing. And the market is opening up a bit in 2024, especially in outpatient medical. It feels like there's a stronger bid as at least in the private market, investors are attracted to not only the consistent growth but an accelerating growth rate in that segment.

And then maybe just one last one on MOBs before we shift over to life science. You're anticipating about 3% MOB same-store growth for the year, which is slightly above the long-term average, call it, 2.5%. As a result of the merger, could we expect same-store growth to stay above that long-term average level over the next few years?

Yes, that's our expectation. We grew outpatient medical same-store by 2.5% the last decade. But keep in mind, inflation was only 2% during that era. In the last 3 years, we've grown our same-store by 3.5%. So a pretty significant increase, 40% increase. Our guidance this year does include the full DOC portfolio. And the midpoint is 3%. We have a pretty good track record of exceeding our initial guidance. It doesn't mean we will necessarily this year, but our track record is to do so. And that's above trend. There is some occupancy upside, but equally important, we're getting highest escalators we've ever had. Our re-leasing spreads are at the very high end of our historical range and so is our retention. So those are the things that obviously drive earnings growth.

Has there been any more interest on year-end and tying future leases to CPI growth just given the high inflationary environment we were previously in?

Yes. We could consider it. We've tended to go more at the fixed escalators. It's just complicated negotiations to introduce inflation escalators that usually require ceilings and floors and it just -- it has not been worth the negotiation trade-off.

And then maybe switching gears to life science. Despite some concerns that we've seen around elevated supply and tenant health, particularly on the small and private biotech side. The long-term fundamentals seem to remain intact. Are you seeing anything out there that might make you more cautious on that business in the near term?

No. I mean when you look at what drives demand for that business over time, it's really 3 things: capital coming into the business and 2023 was at or near an all-time high in the aggregate, approaching $500 billion of capital. That includes NIH, venture capital, public markets and then R&D off the balance sheet of big pharma. That's critical. The amount of capital coming into the space. Two is the amount of drugs that are being approved in any given year, and we're at or near all-time highs. And if you look at the third thing, which is how many drugs are in the pipeline, clinical trials, we're at all-time highs. As long as those 3 things persist, which they have been even through this down cycle, the demand will be there with the potential for AI to make things even more successful in terms of the discovery phase. I mean, it's the one largest impediment to research funding coming in the sector is the odds of failure are relatively high. And we feel like AI is something that could dramatically improve the odds of success. So we see upside from that for sure. Obviously, the biggest concern has been supply. No real estate sector is immune from new supply, and life science is one of the best segments in all of real estate for the last 10 years. And it drew a lot of interest for obvious reasons, especially as other segments of real estate had their challenges. And what we've been telling investors for the last 2 years is, one, we positioned our portfolio defensively in that we haven't started a new development in the last 2 years. So we don't have a lot of unleased development. We also don't have a whole lot of near-term lease maturities in '23, '24 or '25. So even though the market backdrop is less favorable, we don't have a whole lot of maturities that we're trying to address during that window. And I think that's proven to be a good decision. And then the last thing we've told investors that has proven to be true. And we've heard BioMed and ARE say the same thing, and we agree with it, talk to third-party brokers, they'll tell you the same thing, is that each real estate sector functions a little bit differently in terms of what creates a competitive advantage. And in life science, local scale and relationships are a massive competitive advantage. Why is that? Well, 75% of our leases are typically signed with existing tenants. ARE would probably say the same thing. So our pipeline today is 1.6 million square feet. It's about 3x what it was a year ago. and it's a pretty big increase even from 6 months ago. And 75% of that is existing tenants. So if we were a new entrant with no relationships and no existing footprint, you could cut our pipeline by 75%. That's a very significant competitive advantage, whether it's through the relationship or an in-place lease, that gives us a lot more bargaining power to attract tenants who are looking to take space. And we think that any downturn is going to create winners and losers, and we think that, that competitive advantage of scale and relationships will allow us to emerge as one of the winners here.

What is the typical lag time between capital formation, be it IPOs or VC funding, the lag time to then have these companies look to lease space.

Yes. I mean our best guess is it's probably 2 quarters out, so call it, 6 months is a little bit of a lag time. And you think about the pipeline, Scott just talked about it at 1.6 million square feet, capital raising improved in 2023. It was pretty low in the first half, but it definitely improved in the second half, and we saw that with our internal pipeline growing and probably doubled in size, and it's grown even since then. And year-to-date, secondary equity offerings are pretty significant. I think it's north of $12 billion. I think I saw this morning, there were 4 or 5 additional capital raises by biotech tenants just yesterday as well. So that number is growing at a pretty big clip. As we think about the correlation to that and tenant demand, we certainly see that as benefiting tenant demand as the year progresses and it certainly benefited our pipeline already.

Maybe just switching to markets. Even within core biotech markets, presence in the strongest submarkets matters, I think about Cambridge and Boston or Torrey Pines or Sorrento Mesa in San Diego. With the supply picture where it is, and as you mentioned, Brinker, the kind of increase in newer entrants that we've seen over the past couple of years, how is Peak's life science platform poised to differentiate?

Yes. Well, beyond the existing tenant base that I mentioned earlier, I think it's the scale and at different price points. So we can cater to 10,000-plus users who want Class A space in new development, and we can cater to a 10,000-foot user who wants the lowest price point possible. Our focus has been more on being located in the core submarkets. You can take our entire life science portfolio and 90-plus percent of it is in 5 core submarkets. South San Francisco, Cambridge, Lexington, Sorrento Mesa, and Torrey Pines. It's virtually our entire portfolio is in those 5 submarkets where we're the #1 or #2 market share landlord in those areas. And that's more how we've built business. Some markets where tenants want to be, there's a critical mass of activity and then a platform or a portfolio that allows us to cater to a broad range of tenants at multiple price points, multiple suite sizes, that's proven to be most effective because the Series A company only wants 20,000 square feet. But guess what, if they're successful, then they need [ 50,000 or 100,000 ] and to be able to accommodate that tenant is critical to success in the business, and that's how we built our portfolio as opposed to one beautiful brand-new building in a random location. It's just a totally different dynamic when you're competing for a tenant.

We had a question come in from LiveQA on the recent J&J news. Can you add any additional color on the J&J vacate at your San Francisco campus and expectations for rents and leasing at that property?

Yes. I mean the rents are roughly at market. It's at our [ Shore ] Campus, which is a Class A 600,000 square foot campus. There's no downside in that scenario. There's only upside for us. I mean they had 8 years left on their lease. Sometimes big pharma space has a mix of office. This is high-end lab, they were doing a very specific R&D program. So for company-specific reasons, they've chosen to pull the plug on that program, which it's not great in terms of sentiment. But in terms of economic impact, there is none. The default is they pay us rent for the next 8 years. And the only alternative other than that, that I just described is even better for us. They write us a check that's too big to ignore, and we go try to re-lease the space on top of it. So no economic downside, company-specific reason for pulling out in its purpose-built Class A lab space, it is not office.

And to that end, while you said big pharma is well capitalized from a credit perspective. Is there any update to a potential tenant watch list as it might regard those small private biotech firms, I think about Sorrento Therapeutics last year as an example.

Yes. I mean the tenant watch list continues to improve, is the bottom line. There's still a handful of tenants that we watch. It's a very robust program that we have qualitatively and quantitatively to monitor every tenant in the portfolio. Obviously, there's always going to be some that we have to keep a close eye on. But as a general statement, tenant credit is dramatically better than it was in the past. Part of that is capital raising in the public and private markets, and part of it is M&A and partnerships. And if you think about the drug discovery process in the U.S. today, big pharma ends up selling the drugs, but the actual drug discovery rarely takes place inside of big pharma. It's more than almost 2/3 of their revenue today comes from drugs that were developed by smaller biotech companies. So that process of where the drug discovery takes place versus how it gets sold and marketed continues to accelerate. And that's the -- those are the types of tenants that we cater to.

And from a leasing perspective in terms of life science, how have you seen concessions, whether it be TI dollars or free rent been trending as of recent? And when would you expect them to stabilize?

Yes, Griff, I would say that we feel like they're starting to stabilize enough new supply has come on to the market. And I think the existing under construction projects are going to hit the market pretty soon that -- as we think about rental rates, we think that, that number has stabilized. I mean a couple of years ago, we would probably be in a 25% to 30% plus rent mark-to-market. We've been telling everybody we're in more of that 5% to 10% rent mark-to-market. So rents are certainly not declining. We don't see from this point, and we have pretty good indications on that, given our pipeline right now. I'd say TIs went up the last couple of years. The new phenomenon is like tenants just don't want to come out of pocket a lot of capital, right? They want to preserve as much capital as possible, so I'd say that your typical first-gen TI that used to be $150 a foot is probably $200 to $250 a foot, but we're getting good rental rates for that. So I would say that on both those perspectives, we feel like the net effectives have stabilized at this point and have a little bit of upside going forward. And the other part to that, too, is, look, our portfolio, we do have pockets of vacancy, but our operating portfolio is 96%, 97% leased at this point in time. So tenants that want to be within that operating portfolio are going to have to pay up for that, right? That's a little bit different than some of the other portfolios out there, but we feel like the trends are working better within our portfolio than other companies out there.

And then maybe just on same-store expectations for Life Science for 2024. They came in, I think, a bit lower relative to where you were in 2023. Can you maybe give us some color on what's driving that delta? And is there any way you think you can beat it to the upside?

Yes. I mean, look, I thought 1.5% to 3% was actually pretty good. There are some idiosyncratic things that impact that year-to-year. I mean you're really anchored by your escalators, your escalators typically are in the low 3% across our portfolio. Occupancy, we're expecting it's declining a little bit, about 100 basis points. So that's a drag down. And then free rent. Free rent sometimes helps, sometimes it hurts your same-store growth. I'd say this year, it was a little bit of a headwind, that's really what's driving us to that 1.5% to 3%. Now we do have some conservatism that we set in that number. Every year, we've been very consistent saying that we include a little bit of conservatism when we set guidance at the beginning of the year. So you didn't ask, can we outperform the 1.5% to 3%? I mean we'd certainly like to outperform more to come as we report earnings throughout the year. But that's really what the initial 1.5% to 3% was, which frankly, I thought was quite a good number given market expectations.

Maybe just touching on development and redevelopment initiatives. It seems like new ground-up development might not pencil in today's environment, but it seems like redevelopment is driving incremental yield and upside. Kind of how are you thinking about that in the context of your current portfolio? And where could we see redevelopment grow as a percentage of external growth?

Yes. So in the last 6 months alone, we've entitled about 5 million square feet of our land bank in 2 of the best submarkets in the country, in West Cambridge and South San Francisco. So we wouldn't start those today just given supply-demand fundamentals and cost of capital. But at some point, those would be a huge asset and growth engine for the company. So behind the scenes, like doing the work to prepare ourselves for that opportunity like really strong success in those 2 submarkets that are hard to build in, we have strong relationships in each. And then on redevelopment, there's the 3 big campuses that I mentioned earlier in life science. It's a big part of that $80 million of upside. It's temporary downtime. A lot of that earnings was in 2023. The leases expired. The buildings need to be brought back to market standards, and we'll recapture that NOI. Is there anything beyond that? Yes, we've had an active redevelopment program across our business for a decade plus, including outpatient medical as building's age, and we get a really attractive return on cost. And importantly, we do that all with retained earnings. Given our payout ratio below 80%, we can fund 100% of our CapEx, including all those redevelopments with operating cash flow.

We have a question from the audience.

Yes. I just wanted to go back to Life Science portfolio. Wondering what your current utilization is in the Life Science portfolio? And how do you measure that? And then what are you seeing in terms of renewals in terms of people taking space or relative to where they stood before. And I guess part of that would be, what's your mix of office versus lab space in the...

There a lot of questions there. I'll try to remember everything. The mix of office and lab, I mean the traditional build-out is roughly 50% of lab versus nontechnical space. That really hasn't changed in the last decade. We signed 5 million square feet of leases in the last 4 years, and it's roughly the same build out that it always has been. So that -- we haven't really seen any change there. In terms of utilization, it's more company-specific. Now I don't think anybody is coming to the office 5 days a week anymore, although Pete and I do. But for the most part, that's not happening in corporate America, but the buildings are still utilized given that the science is why they lease the space in the first place. So any situation where the campus isn't being utilized is company-specific where they just don't need the space period. It's not that they're downsizing the amount that they we're making really strong headway on our early renewals. So when I talked about a 1.6 million square foot pipeline today, a material part of that is discussions with tenants about early renewals whether it's '24 or '25 or thereafter. So yes, we're really happy with the trend in tenant showing interest given the capital raising environment, I think they'll now have more confidence to actually make the decision and sign the lease.

And I appreciate the comment on company-specific utilization. But I'm just wondering, do you guys measure that in your portfolio? Turnstile data and some other way.

Yes. I mean we have the same type of tracking in terms of mobile phone utilization, and it continues to improve. It's obviously lower on Mondays and Fridays than it would be during the week, but it's trending in the right direction. In terms of the energy utilization, it's similar, if not higher, a lot of our campuses have amenities in terms of gyms and food and beverage. And those revenues are at or above levels from 2019. So various metrics that we look at to track it, and it's certainly either back to 2019 levels or trending in the right direction.

And maybe in that same line of questioning, is there any worry about a work-from-home hit on some of your medical office properties, just given that there's probably some space that's used administrative or back office needs.

Yes. Very little administrative space. We too are real estate. I've never seen the parking lots busier. Most of us have a hard time getting an appointment with a physician. So it's the opposite problem. The parking lots are packed. I don't see any impact from work from home. The telehealth was viewed as a potential threat in 2020. It's leveled off and now it's just complementary. It brings more people into the system. It makes the physicians more important. It certainly hasn't reduced demand for space. We've only seen that accelerate. So no, we don't have any concern around that.

Yes. The other thing I would add to that is we did add a slide in our latest investor deck around absorption has been going up within outpatient medical and new development starts are coming way down as the financing market is difficult for some of the private developers out there to source to be able to do new development starts that if you think about the net impact of that the last couple of years, occupancy is up over 100 basis points. You compare that to traditional office and it's incomparable, right? We didn't put a slide in our deck on that, but there are certainly slides out there for what's happening with CBD office occupancy rates and the exact opposites happening with outpatient medical.

Maybe we can just finish up with your CCRC platform. What are you seeing from your labor perspective in terms of availability of labor or wage inflation? And do you expect strong fundamentals to continue in 2024?

Yes, the business has continued to perform. We had 15% growth in 2023, a bit lower in 2024, most likely, but still very positive. Most of the labor upside has been recaptured. The contract labor is largely out of the portfolio. But the downside is part of getting rid of contract labor is just paying people more. So there's just a higher baseline rate of growth. Most of our CCRCs are here in Florida, actually, so enormous barriers to entry and strong demand. But labor is a challenge. So even this year, we still expect labor to be up in the 4% range. So lower than the last couple of years, but certainly higher than the historical growth rate. But it's performing well. It's a good portfolio, no new supply, good operator in LCS, who's been an industry leader in that business for 5 decades in a really high-quality internal team managing it. So it's performing fine. If there was ever a time that we could recycle a lot of it without being dilutive, it's something we'd consider just because it doesn't have overlap with our 2 core businesses. But we're in no rush because it's performing really well. We've got a good team.

Great. Well, if there are no other investor questions, I'm going to turn it over to [indiscernible] to do the rapid fire.

What is the best real estate decision for Healthpeak today? Buy, sell, develop, redevelop or pause?

Yes. Well to sell, buy back stock, selective redevelopment and even more selective development.

What will same-store NOI growth be for outpatient medical and life science overall in 2025, not Healthpeak overall?

I think a bit stronger than this year.

Care to put any numbers behind that or just stronger?

Yes, 3, 4-plus percent.

And last one, will there be more fewer or the same number of publicly traded health care REITs 1 year from now?

Yes, I'll say the same.

Thank you very much Healthpeak.