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

Good afternoon, and welcome to the Healthpeak general session. I'm Jim Kammert with Evercore following the company. But more importantly, we have Scott Brinker, CEO; and Pete Scott, CFO, here from the company to lead us to a little discussion. And as you may well know, if you have questions later in the general session, please try to use the microphone so people can hear you remotely, et cetera. And I think what I'll do is turn it over to you, Scott, and you just give us like a general introduction and some general comments and let it roll.

Yes, thanks, Jim, for hosting. Thanks for joining. See some new faces. So I'll give a quick overview of the company, and then we'll turn it to Q&A. But Healthpeak Properties is an S&P 500 company. We're based in Denver, our 2 primary business lines are focused on health care discovery and delivery, which means we invest in life science R&D properties. We've got roughly 12 million square feet of operating real estate focused in the core submarkets of San Francisco, San Diego and Boston, where most of the biotech innovation exists, and we're one of the incumbents. We've been in the sector for 20 years and have a huge footprint, know-how, expertise, relationships to drive leasing volume, and we can come back to that. And our other business is outpatient medical. So we're really participating in the movement of health care from an inpatient basis to an outpatient setting. We have 40 million square feet, concentrated in a lot of the high-growth markets like Nashville and Denver and Southeast Florida and we just got merger with one of our former peers, competitors so that we're now, we think, the largest owner and operator of outpatient medical real estate. And important for me strategically, is that we think we have the best platform. Obviously, we're biased, but in terms of people, process, technology and relationships to drive outperformance, we feel like we now have that. And it's a very solid, consistent business benefiting from the aging population. and the impact of technology and reimbursement, which is allowing more and more health care to be delivered on an outpatient basis. We think that, that trend will continue. It's more convenient for you all. It's for the payers, and it's actually more profitable for the health systems. So sort of every wins from that transition, and we're going to be one of the major players facilitating that through acquisition, through development. And we internally manage our portfolio as one of the strategic things that we accomplished through the merger with Physicians Realty Trust, which closed about 90 days ago, historically, Healthpeak outsourced, a number of services, including property management. And this merger allows us to bring that in-house so that are interacting with our tenants on a daily basis, which was important to me strategically, but it's also financially accretive. We announced first quarter earnings about 30 days ago. It's a very positive report. We increased earnings guidance. Same-store was very strong. mergers are going well. So we feel like the execution continues to be really, really strong across our business. And then in terms of balance sheet. Pete and the team have done a fantastic job. Our debt-to-EBITDA is in the low 5s, very little floating rate debt or near-term debt maturities. in a very low AFFO payout ratio so that our balance sheet and income statement in terms of free cash flow is really in a great spot. And we continue to, we think, outperform on leasing in out 2 major segments, just given the strength of the portfolio, the submarkets that we've chosen and the strength of the relationships. Whether it's with health systems and our outpatient business, the venture capital firms and the biotech tenants, is really driving outperformance. And we got a big pipeline of leasing in both segments that we hope to convert into signed leases in the coming months and just given where the stock has been trading. We've been pretty active, disposing of assets and buying back stock accretively. So we've had a nice run for the last 2 or 3 months so the arbitrage is a little bit smaller than it had, but we still feel like we're trading at a discount to the implied value of our real estate, or the inherent value of the real estate, and we'll continue to take advantage of that arbitrage. And the pipeline is pretty significant on dispositions, which we think will also improve the quality of the remaining portfolio. So we're really optimistic about the things we're working on and continue to execute. So Jim, I'm going to turn it to you for Q&A.

If you touched upon, obviously, the big news among other stories is the merger, and you noted the property level synergies you think you can extract, the internalization of management, et cetera. But how has the integration gone generically because obviously, we have one data point in this sector in the last few years that maybe it didn't go as well as planned, perhaps. But what is Healthpeak doing to capture the synergies and where does that stand relative to your initial kind of expectation time-wise and dollar value?

When we increased earnings a couple of weeks ago, one of the drivers was improved merger synergies versus expectations. The balance was just the operations from the same-store portfolio. But I think our merger, the background, is important because it came together in a way very different from than traditional M&A, which a lot of times involves acquiring a company and a company being purchased. And oftentimes, there's an auction involved. Our deal was different in that we had 2 companies that were perfectly fine to be stand-alone companies on a go-forward basis. But individually and collectively deciding that we could be a better company together. And that allowed us to really do a lot of the integration planning before we even made an announcement, frankly. And certainly, between the announcement and the closing, we've been integrating for 6 months before the deal even closed. We had a huge head start. And it's also -- it truly is a strategic merger, not a purchase in that it's not one company coming in and kind of blowing out the other. It's putting together the best people from each team, the best process from each team. So there's also a lot of continuity. And I think that's been one of the challenges in some of the mergers in our sector historically is that when you don't have that continuity, just given the nature of our business, it's not like a hotel or multifamily where you just got thousands and thousands of nondiscrete tenants, right? We have a very select group of tenants in our life science and our outpatient medical portfolio that we do business with. So if you lose those relationships, the execution risk increases dramatically. Our outpatient portfolio today is almost 2/3 leased to health systems, and they're taking big blocks of space. And if we would have lost the relationships and the connectivity through this merger, it would have had a very detrimental impact to the go forward, but we didn't. And I think that's one reason that we've been able to integrate the company so successfully. And it's not just financial, that is important. Like behind the scenes, the cultural integration has been successful as well. And I think the fact that JT is our Vice Chair. He's here at the meeting this week. A number of his senior leaders are still part of the team. And I think that buy-in makes a huge difference as well. So we're really optimistic about the progress we've made and the platform that we've created together. It really is taking the best of 2 companies and making one even better company.

Do you feel like those tenants, I mean, have they responded favorably? I mean they see you as scale players? Is that part of their strategic plans as well to grow with the scaled the landlords, if you will, and maximize their opportunity from an expansion prior standpoint?

Yes. I mean there could be acquisition opportunities down the road. It's not an economic backdrop or cost of capital that makes acquisition is favorable, but we do see a pretty significant development pipeline. If you think about the ratio of inpatient to outpatient revenue and assets, I mean, today, most "hospitals" derive at least 50% of their revenue on an outpatient basis. And they have a strategic mandate to move as much of their care into an outpatient setting as possible, in order to capture market share and to grow their own profitability, and we're going to be an active participant in that. And there were some situations where the 2 companies competed with one another in the same submarket and did business with the same relationship, and we'll be even better positioned together to capture that opportunity. And then there's a number of markets where Healthpeak did not have a presence where physicians did that we now have access to, but growth market with leading health systems to capture growth opportunities. Atlanta is a good example. ISI did a big property tour a couple of weeks ago that I participated in. And that's a good example of a market where we did not have exposure but physicians did. The northern suburbs of Atlanta, in particular, are growing rapidly and JT and the team have a great relationship with Northside Health, which is the dominant player in North Atlanta. And we're doing a number of project actively or in the potential pipeline, that there's going to be more of that in different markets. That's just one example.

That's an example. Are they -- particularly North side, they really like to do the off-campus now, right? It's in their business model to move those patients, move that service where they see higher -- more visits per patient per annum, et cetera. So that works sort of symbiotic for yourselves.

Yes. If you, too, are one of the new developments, the vast majority of the space is services that would have been provided in the hospital 5 and 10 years ago. But the impact of technology and reimbursement has allowed most of those services to move off-campus into more convenient settings. And that was one thing that order helped us accomplish because we still like our on-campus portfolio. It's performing well. But they tend to be older assets, and most of the growth in health care is off-campus. When you work with the top health systems, they're still investing into their hospital campuses, but the vast majority of their growth is off-campus. And we felt like we had to participate in that growth and just meet the market where it is, again, because consumers demand it and the health systems are focused on it because it's more profitable for them.

Let me talk about lab for a little bit, too, just talk about the other major component of your portfolio. And then as the audience have questions, just please raise your hand and we want to get to your inquiries. But I think you've done a great job of late talking about sort of the record essence of demand on the leasing side across both your existing sort of renewals for the lab side. And obviously, very important to the growth of the company on the development side. So can you just remind us sort of the depth of that? The number of tenants you're speaking with? The number of square feet that you're entertaining in terms of discussions, and help us update on that front.

Yes, I'll turn it to Pete.

Thanks. Great. We're off to share one microphone so that works great. On the lab side, we have a pretty big platform. It's over 12 million square feet and hopefully, growing over time. I would say our tenant relationships, we have about 200 existing tenants. And I think one of the things we're seeing right now in the lab space, I mean it was such a great business for about a decade, up and until a couple of years ago. And then you started to see more and more supply. And capital raising becoming more challenging for our tenants. But what we're seeing today is more and more capital is actually getting raised by our tenants specifically on the biotech side. I'm not talking about the large-cap pharma names. We do have those exposures, but they tend to be larger exposures through M&A. And the 200-tenant relationships is a huge differentiator for us. And what we're seeing today is a lot of those tenants gravitating towards the large incumbent landlords. This might not have been your exact question, Jim, but I think it's an important point to make is tenants are starting to seek out the more well-capitalized landlords, and they're really sticking to the core submarkets. And I think as you saw more and more supply entering the life sciences space, a lot of it was happening in the noncore submarkets. It was office conversions and those assets are having a much harder time leasing up versus what we're experiencing in our core submarkets. So we feel like we are at more of an inflection point right now where we'd like to see positive absorption in the portfolio. And I think some of the other new entrants, it could be a while before they see that kind of lease up, but we feel like we're actually quite well positioned, most importantly because of the scale we have and how many different tenant relationships we have within the portfolio.

And just mathematically, I think you've been talking 2 million square feet, plus or minus, of activity across the portfolio and how that breaks down, geography, used, new tenant?

Sure. We have about 2 million square feet of active discussions we're having with tenant's pipeline. And we think of that as like a couple of different buckets. The most important buckets being those where we have LOI signed or where we're actually in the proposal phase versus touring or active discussions. So of that 2 million square feet, the majority of it, and that's a substantial majority is actually in the LOI as well as proposal discussion phase. So she feel like we've got a high degree of probability of converting a lot of that pipeline into leases over the course of the year. We did say that as of the first quarter call, there was around $450,000 square feet of LOIs. That number has ticked up since the end of the quarter. So again, a much higher degree of confidence once you have an LOI signed. It's 90%, 95% probability that, that turns into leases. So stay tuned as I think we'll have more to disclose on the second quarter call, the progress we've made from a perspective.

Can you just refresh us, what is the order of magnitude of square footage that you feel you need to lease up over the next couple of years within the redevelopment and development pipeline? Maybe put that in context to the representative of annual leasing you've done. So just help the audience get a better sense of what needs to be done, and relate that to what you've accomplished in the past so we can get a little sense of frame on that?

I mean, I'll say -- I'll just take that one. It's kind of in the 1 million to 1.5 million square foot range. Our lease maturity schedule in hindsight was pretty strong, in terms of being defensively positioned for this downturn. The last 2 years, we've not had a lot of lease maturities, and we don't have a whole lot this year. It starts to pick up a little bit in '25 and '26, but still modest by comparison. But we do need to do some renewal leasing, but we're having active discussions. I mean that's part of the 2 million square feet. About half of it is renewal and half of it is new.

Are there any questions from the audience? I'm thinking about -- the other element, obviously, is a concern or I think the perception in the marketplace by the investors is how much capital landlords have to put in on the lab side. Obviously, you had a little bit more of a competitive market. Tenants have a few additional options. How are you addressing that? And you can dock, extract or return, if you had to put more capital into these properties. Are you still able to maintain your yields on these developments? Just trying to get a sense of what's happening there in the dynamic tenant versus landlord relationships power.

Yes. I mean, our public disclosure is really strong on a quarterly basis, and you can look back for 2 years, and our TI and leasing commissions as a percentage of rent has been very modest. Usually, less than 10% for new leasing, less than 5% for us for 2 years now. That being said, for new development or redevelopment, those tend to be closer to turnkey TIs in today's market, but we're still generating strong return on capital, even for those types of transactions. But the day-to-day ordinary leasing, the TIs have actually been very modest by comparison to history or even other real estate sectors. So it's been more on the buildings that are newly developed or being dramatically redeveloped at the TIs have climbed. But the free rent hasn't really moved materially. Leasing commissions haven't really materially.

So that then maybe speaks to the fact that you felt, as you mentioned earlier, the incumbent, the scale of landlords are able to hold their economics and generally hold their market share, if you will, against perhaps the new supply threat seems quite daunting and on the surface but if you peel the onion a little bit, players like [ DOC ] are able to hold your own and maintain your economics.

Yes, I would say a couple of the advantages. I mean, there's a lot of velocity among this tenant base. They may sign a lease for X square feet for 10 years, but there's a very high probability over those 10 years, if not the next 3 to 5 years, they're going to need more space or less space. And if you work with a large incumbent landlord, you have a much higher probability of being able to move around and probably on the same campus or the same submarket, which has a lot of value to these companies. We've worked with the same group of venture capital firms for 2 decades in some cases and have established strong relationships and that credibility goes a long ways as well. And then today's market, just the financial wherewithal that we're going to be there to not only complete the TI, but for the term of the lease. Not all the new entrants can say that. So I think our competitive advantage. And the same is true of the other large incumbents is really multifaceted, and it's proving out. There's a very low likelihood that any of the new entrants would be able to talk about a leasing pipeline that's as large as what we have right now.

And maybe if you could just -- obviously, you've done very focused with your 3 primary markets on the lab side. Would you rank them in terms of the Boston, the suburban market in Boston, San Diego and South San Francisco? Just sort of best to worst and what are the dynamics in those markets just to help us get a frame of what we should be most concerned about and where the opportunities might lie?

Yes. I mean I think we think about the submarkets we're in, they're all like we love our kids equally, right? We don't deal with any less than others. But I would say that the amount of discussions we're having right now, it's probably more heavily weighted towards San Francisco, just purely because that's our largest exposure, especially in South San Francisco. And I would say Boston probably follows after that and then, San Diego. I mean San Diego, we have disposed of a noncore asset in that market, the Poway asset. And we also did a joint venture with breakthrough at our Callan Ridge property there as well. So the size of that portfolio relative to the size of where San Francisco and Boston is right now, just leads you to infer that we're probably having more discussions, especially in San Francisco. Maybe a little bit more equally weighted in Boston because we don't have a ton of availability in San Diego. But I wouldn't say that there's a discernible difference across any of the markets. I'd say if anything, Boston probably had more new submarkets pop up in the last couple of years. The barriers to entry were pretty high in Cambridge as well as in Lexington, and that's why you started to see more and more expansion into new submarkets. So we're really more unproven like Seaport District as well as other areas, Summerville, Watertown, that historically were not large hubs for life sciences that popped up. And I think those are probably the submarkets that will take longer for product to get absorbed in. And you saw a little bit of that in San Diego. It's really mostly Torrey Pines as well as Sorrento Mesa, a little bit in UTC. But you saw a development and some additional submarkets there that, again, if you're not in a core submarket, it's going to take a lot longer to lease up.

Comment on South San Francisco because there's some new faces. South San Francisco is just north of the airport, SFO. It's not the city of San Francisco. So it's a different city. It's even a different county, and it's this 1 mile circle with the San Francisco Bay to the east and the 101 to the West. It's zoned for life science lab and industrial. So there's no office. There's no -- essentially no retail. There's no multifamily. That's all that you can build there and it's 15 million going to 20 million square feet of life science real estate. It's probably the densest cluster of life science innovation in the world, maybe 1 or [ 1A ] with East Cambridge. So it's a very different submarket than San Francisco, when you hear us talk about it, in terms of not only the location but also the politics and then the uses of the real estate. And we're still seeing a lot of demand there. When you think about the talent that's needed to grow a successful biotech company, that talent doesn't reside in Texas. It doesn't reside in Florida. And for the most part, even the successful smaller companies that have good science, they may be founded elsewhere, but as they look to scale their business, just the type of expertise that's necessary. That talent resides in the big 3 markets, including the Bay Area, which is also getting kind of the turbocharger from AI, and we have a number of AI-focused biotech companies in our pipeline that is helping support demand for real estate. So I think just for those who aren't as familiar with our company in South San Francisco, just important to point out that distinction.

Sounds like you've got the leasing pipeline building. So I guess I have to ask Pete how you're going to fund all this or where do you stand on the balance sheet please?

Yes. I mean I think actually it's probably underappreciated about our company is how great of a balance sheet we do have. Scott mentioned in his opener that our net debt to EBITDA is in the low 5s, that's actually below our targets. We've got a very well-covered dividend. It's in the high 70% on AFFO. I know some people like to quote FFO payout ratios. We think we quote it in a more conservative and appropriate way. So we've got retained earnings of a couple of hundred million dollars every year that we can reinvest into our properties. And that will, first and foremost, go into the redevelopments that we're doing right now. We've got a couple of large campuses that we are redeveloping, including one large one in South San Francisco. So the balance sheet is in great shape. Our disposition pipeline is strong. We'll have more to report on our second call but that just gives us additional cash that we can delever balance sheet even more, have dry powder for acquisition opportunities for development opportunities. There might be distressed opportunities, although it will be more limited in the core submarkets, but we certainly could look at distressed opportunities on the lab side. So we're -- our balance sheet is in great shape, limited debt maturities over the next couple of years. So we will have some debt maturities to have to deal with, specifically $800 million next year, but it's in 2 different tranches. So we're sitting in a pretty enviable position right now, Jim, is the way that we look at it. So capital is not the issue for us. I think it's a matter of getting lab leasing done and continuing to get that discount to NAV. And when you look at our FFO multiple, where that is today relative to where our longer-term averages are. I mean that's what we're focused on is eliminating that disconnect. And I think on the lab leasing side, as we get deals done and disclose, we feel like that disconnect should go away.

Sticking on the lab, but you haven't really mentioned or maybe you could, if it would possible. Sort of some of the indicators of that demand sort of renewing itself, if you will, attend capital raising among the biotech world, R&D financing. Just some of those metrics that maybe you should keep in mind of as your indications of demand for the lab space.

Yes. I mean, the R&D in the sector comes from a diverse set of sources both public or private whether it's NIH, university-focused endowments, off the balance sheet of the big biopharmas. And then obviously, the kind of venture capital-backed or IPO biotechs. So it's $400 billion a year of R&D that comes into the sector in the U.S. It's an enormous number. It continues to grow. The vast majority of that is pretty sticky, whether it's the NIH or R&D funding from big pharma. The piece that moves around the biggest, and it's only -- it's less than 20% of the total, but it moves the needle on leasing because it's the amount that the biotech companies are raising, venture capital, IPO, secondaries. Even though it's the minority of the total capital, it's the vast majority of where the innovation and growth is taking place. And you look at even in today's market, the revenue that's generated from "big pharma", more than half of it is from drugs that were discovered by biotech companies. And that number is only growing. So you think about where the R&D is actually taking place, who needs the heavy lab space. It's primarily from the biotech portion of the market. And that group is dependent on venture capital, IPO, secondary market to fund their business. Their pre-revenue for sure. They need to have successful science that allows them to raise more money. And as that slowed down over the previous 2 years, we saw an obvious decline in demand. And as the market has come back over the past 2 quarters, we've seen a very direct correlation with capital raising going back up and our leasing pipeline really taking off. And it's roughly 3x what it would have been a year ago. So it's been a pretty dramatic change that's tied to the capital raising.

Running up to about 2 minutes left. Do we have any questions from the audience? Going once? Just -- I think we can probably close it out there unless you want to make any closing comments or wrap up for the audience benefit?

Well, thanks for hosting us. We still see compelling value in the stock. We've been not only selling assets but buying back shares. So we're a buyer of this company as well. We hope the recent success continues. We definitely are optimistic about our future so thank you.

Thank you.