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

Thank you for joining us on Day 2 of the BofA Healthcare Conference. My name is Farrell Granath, and I am the health care REIT analyst with Jeff Spector and the BofA REITs team. I'm joined today by John Thomas, who is currently the Vice Chair of the Board of Healthpeak Properties. He is currently -- or he was previously the President and CEO of Physicians Realty Trust until its merger with Healthpeak in 2024. I'll pass it over to John for some opening remarks, and I'll follow-up with some questions.

Thanks for having me, Farrell, and thanks for showing up. It's great health care conference. We don't always get a big participation. But Healthpeak is a $25 billion or so real estate investment trust focused exclusively on, primarily 2 areas of health care, outpatient medical, which is about 60% of our business. And we're the largest owner of outpatient medical facilities in the world, if you will. About 10% of our business is senior housing, which is an area that Healthpeak historically has had a fairly large presence in, but has been selling that off over time. It performs very well. We're very happy to have it. But at some point in the future, right time, right price, we'll move out of that area of health care. And then the last part of our business, about 30% of our business is life science and lab in the 3 core markets of Cambridge, Boston, South San Francisco and then San Diego. We're the second -- are third largest owner of lab, life sciences facilities in the world as well.

Great. And given that we're at a health care conference and DOC owns, develops and manages real estate. Can you explain how Healthpeak specifically fits inside the health care ecosystem?

Yes, it's a great question. So again, why I'm at a health care conference. Well, a bunch of -- a lot of our clients are here presenting. So I'm here both underwriting and sourcing new business for us. HCA is our largest single tenant, but it's only about 4% of our business. But HCA, again, largest health system -- largest for-profit health system in the country is our largest tenant. CommonSpirit, the largest nonprofit health system in the country is our second biggest tenant across the spectrum. So I came out of -- I was hired and got into this business, was hired by a guy named George Chapman, who started or was part of and led health care REIT for a number of years, the oldest company in the health care space, in the real estate space. And when he recruited me to join them, I was General Counsel of the Baylor Health Care System in Dallas. And there are a lot of John Thomases in the world, and I didn't really know why he was recruiting me because I was in a health care system as General Counsel. I was not a real estate person or in a REIT or a developer or anything like that. And he said the real estate part of our business is easy is I want to have somebody who understands what's going on inside our buildings. That's what makes our buildings valuable, and that's what makes our investments valuable. And so he convinced me to move to Toledo, Ohio and go to work in that space. But it was my health care knowledge and my health care experience, and I did a lot of policy work and I still do a lot of policy work in Washington that was valuable to him. And so I've worked with George for a number of years to help grow their outpatient medical business until I had the opportunity in 2013 to do the craziest thing of all time is join a couple of guys who had a small amount of business in the outpatient medical space, 18 buildings, 500,000 square feet and maybe $10 million NOI, and we went public with one employee in 2013. That was Physicians Realty Trust. We were able to get the stock symbol, DOC, D-O-C, which is still our stock symbol even after the merger. And then we grew that business from, like I said, $100 million of value at the IPO to $6 billion at the time of the merger. And when we merged with Healthpeak, the premise was our business was and today is still great, our underlying business. We collected 99% of our rent during the pandemic, true cash rent. We send an invoice out, we got paid. And that's the whole idea of investing in health care real estate is it's recession-resilient, it's pandemic resilient now. We can prove that. And for 20 years, it's been the 1 of 2 areas of commercial real estate that has grown NOI for 20 straight years. No other -- manufactured housing, I was going to ask you if you even knew what the other one was. Manufactured housing is the other one, which is totally irrelevant for this discussion. But the whole idea of investing in health care real estate and particularly outpatient medical and lab, and we'll talk about that, it's just the consistency, the reliability. In a recession, you may not go to a mall, in a pandemic, you may not go to senior housing, you may not go to a movie. But if your child is sick or you're sick, your mother is sick, you're going to take them to the doctor and the doctor needs space to provide that care, they're going to pay their rent. And like I said, it's just one of the most -- it's not an area where we have fast growth, we just have consistent, reliable growth and we have for 20 straight years.

Great. And you were just touching on it, especially with your past experience, can you explain how your outpatient medical portfolio has relationships within the health care system itself?

Yes. So we -- how do we have relationships? And part of our core values is respect the relationship. We've grown our business. Again, we went from $100 million to $6 billion at Physicians and Healthpeak, again, has a similar legacy where HCA actually built its own REIT inside of itself 25 years ago and then Healthpeak bought that 25 years ago. So we have this genesis, again, that's kind of my personal story, but actually our corporate stories, we have this genesis of really kind of spinning out of or having these direct relationships with health systems and then doing a lot of repeat business with those health systems. So Healthpeak's in our 10 largest markets are the markets you would think of and fast-growing markets still today. Atlanta is our biggest -- one of our biggest markets, Dallas, where I was with Baylor, Houston, Phoenix, Seattle, Minneapolis, again, markets that are still growing. And our clients are the health systems in those markets and the dominant health systems in those markets. So in Atlanta, it's Northside Hospital. In Dallas, we actually have large relationships with HCA, Baylor and Presbyterian THR in that market. But at Physicians, like HCA in the Healthpeak deal 25 years ago, Physicians in 2016, we did a $750 million transaction with CommonSpirit -- what's now known as CommonSpirit, CHI. We bought 50 buildings in 12 markets. They needed capital. We needed assets. It was the largest single transaction ever in this space between a REIT and a health system. And again, the next year, that relationship went so well. The next year, we bought another $200 million of assets from them. And so we got $1 billion of assets with CommonSpirit. We've got probably $4 billion -- $3 billion of assets with HCA and all the other markets. And for both of those, we continue to grow with new development. And so we've got a $300 million to $400 million development pipeline with those health systems, not just those 2, but they are part of that number. And again, outpatient medical continues to grow. Population -- somebody quoted yesterday that population of 65 and older is going to be 20% of our population by 2030. Every day, 12,000 people turn 65. So that demand is 8% to 10% just mathematically, no matter what happens with Washington or commercial payers or anything else. The demand and growth in health care services and the need for those health care services are growing every day.

And so on the topic of the supply and the demand, what is keeping other outpatient medical properties from just building their own and developing or partnering with you and expanding?

Yes, great question. So I'll give you a couple of different statistics, but it's -- to answer your question, so the average rent across our 42 million square feet of outpatient medical space, the average rent today in our portfolio is about $23 a foot, triple net. We're about 93% occupied. To build new in this market between the past few years, inflation, construction costs, cost of capital, the average rent for a similar building today that we would want to own in a health system and a physician would want to rent and the patients would want to go to is closer to $35 to $40. And again, the buildings that we're building for health systems are demand-driven, meaning they don't have an entry point, and access point in a demographic that they -- a suburban market that they want to be in. So they lead with an outpatient medical building. But today, that costs them $35 to $40 a foot depending upon the market in Atlanta, getting in that higher end range. Phoenix is a similar price point as well, while our in-place buildings and rent is $12 cheaper. So unless you want to -- unless you have a growth need or a demand-driven need to be in a specific location, you're going to stay in the building you are at $23 versus move next door for $35, right? It's just the right economic decision. In the meantime, as a landlord, we want to raise our rents as much as we can, obviously, and in a balanced way because we want to continue to grow with those health systems. So getting a 5% or 10% renewal and kind of a mark-to-market is pretty common now. And for -- as I said, the business has been so great for 20 years, but this is the first time in my 20 years in the business where we could grow rents more than 2% to 3%. We're growing rents 5% to 10%. And the health systems are -- and the physicians may not want to pay that, as we were talking about before is your apartment search, but at the same time, that's a more economical decision for them to make than it is to go to a new, which used to be our competitor, right? And so retention is very high, 80% to 90%. It's been very strong in the last 6, 8 quarters. And our average mark-to-market has been 5% to 10% every quarter in the last 8 quarters. And the other key point about our business that's been differentiated in the last years, which I think will continue for a long time is, as I said, rents have grown 2% to 3% contractually, annual increases for the last 20 years. Now we're moving everybody from 2% to 3% to 3% to 4%. And that's just the gift that keeps on giving because we don't sign overnight leases, we sign 5-year leases and 10-year leases. So if we can sign a new lease, we mark-to-market up 5%, and we can raise the increases in those leases from 2% to 3% or 3% to 3.5%, it's just compounding growth over time.

Great. And I guess now switching gears to lab portfolio, and I'm sure many people are very focused on the biotech and biopharma area. But can you give a little bit of detail around the supply and demand landscape? And more importantly, how is DOC's differentiated approach in capturing that demand?

Great question. So as I mentioned before, we're in the 3 key submarkets, core markets for lab real estate in the lab business, Boston, primarily Cambridge, West Cambridge, South San Francisco and San Diego. For 10 years, maybe 15 years, lab was -- I said -- talked about how great outpatient medical has been for 20 straight years, lab is one of the best markets -- best asset classes to be in, in real estate from 2009 until 2021. And again, part of that was just the demand and the investment as a country we were making, but as an investment of private capital that we're making in innovation and research, and we've got the best scientists in the world, particularly concentrated in those 3 markets. We take a very concentrated approach to kind of a campus community. Interestingly enough, lawyers, which I used to be one, and business people will get all cranky about IP and secrecy and everything else, the scientists want to collaborate with scientists. And we have whiteboards in parks, and we have amenities in these buildings that just facilitate collaboration. And so scientists from 2 different organizations, it could be -- I'm just making up names, but these are some of our tenants, Amgen and some start-up biotech firm, go down, have lunch, they're really struggling with the problem and they just start talking about, hey, what can I do to kind of go to the next step with my science. So it's very collaborative. And so those campuses facilitate that and they facilitate demand from the scientists to, hey, I want to be in those buildings in that amenity. We have golf simulators, we have bowling alleys, we have bars, we have kind of these great facilities. And one of the things about lab buildings is you have -- we have over 1 million mice in our buildings on purpose. We have pigs in our buildings. We have all this very sophisticated space. That's why this real estate is so expensive. But we also have places for the scientists to compete, and they want to be there. So these campus communities really facilitate that and the recruitment of businesses to pay our-very-expensive rent. These are very expensive buildings to build. The air in this building -- this building probably -- well, casinos probably replaced their air a good bit more than most commercial office buildings. But our air in our lab buildings is replaced every 30 seconds. So they're very sophisticated real estate. It's not the back office for Amgen or Bristol-Myers or Novo Nordisk, one of our biggest tenants in our buildings, it's not the back office accounting space. This is where innovation is. It's where -- when they buy a small biotech where they're trying to increase their revenue because of the patent cliffs coming in '27, '28. It's where they want to be and where they collaborate. And again, we have -- we're about 85% occupied in lab. So long-winded, when the lab business was so good for so long, the pandemic fueled a huge need for more lab space to cure COVID and other things or try to find vaccines for COVID and other things like that, that so many people kind of piled into the lab business. That when we came out of COVID, we all of a sudden had an oversupply and a lot of construction by people who've never been in the lab business. And again, these buildings are $1,000 to $1,500 a foot to build, and there was a lot of spec buildings built in our 3 markets and other markets that created an oversupply of the need for lab. And so that has caused at least a temporary, and I'm sure it's temporary, but a temporary kind of slowdown in the ability to recruit tenants. Our retention is just fine, but to recruit new tenants and then because the biotech market, and I've been sitting in these conferences for these last 2 days, the amount of capital, again, private capital going into a biotech start-up has slowed down because of what's going on in the federal government. And so we've got this oversupply of lab real estate all of a sudden in those 3 markets, in particular, and the ability to recruit new tenants and the lack of capital coming in to invest in those tenants has slowed down. We don't have any NIH-funded tenants, but tenants 10 years from now are NIH funded. So somebody gets NIH funding, major medical university, they prove their science, so they go out and get private funding, and that's when they need our space. And so right now, there's a slowdown of the future supply if NIH gets cut or they slow down in -- the government slows down in research funding. But it's a very temporary thing. Long term, this country has got a dominant position, the dominant position in life science and innovation. And it's just a matter of time before the lab business, the real estate lab business picks up even more. We pay a 7% dividend based on our current stock price. It's crazy. We have a low multiple because of this kind of depressed lab market, even though it's 30% of our business. But if you want to play life science and invest in a very safe, diverse real estate investment, but you want to be investing in life science, buy our stock, you get paid 7% to wait for the market to return. Our payout ratio is 70% of our cash flow. REITs have to distribute all their cash flow. And we pay -- about 70% of our cash flow goes to our dividend -- to our shareholders. Today's stock price is 7%. Our cash flow is growing 3%. You're literally getting paid 10% in asset-backed cash flow return today, if you invest in us, while you wait for the biotech and the high returns you get in biotech to pick back up in time.

So a lot to unpack there, a few points. But first, when you were discussing about the oversupply in the lab space, can you give a little bit of detail on -- I've always seen the word zombie buildings, and I've driven around through some of the key markets and have seen big beautiful brand-new buildings that remain empty. So can you explain either what those are and maybe either why DOC is or is not within that segment?

Yes, happy to. So one of the smart decisions that Scott Brinker and the Healthpeak -- our CEO and the Healthpeak leadership team did was 3 years ago, they did see this glut of new entrants into the market, into the business. Office developers, 3 years ago, you couldn't -- offices were completely empty from work from home. And there's still a lot of empty office buildings in Manhattan and Boston from traditional corporate office environment, work from home. San Francisco, same thing, South San Francisco, same thing. San Diego, same thing. And so office owners said, hey, lab is great. Look at the last 10 years, what -- growing rents 5% to 10% every year in the lab business. And so a lot of new entrants got into the lab office building development or tried to take their building and said, I can't convert it to residential, like a lot of people are doing, UDR, you mentioned. But what I can do is convert my building -- my office building into a lab building. It looks just the same. The problem with that is, for lab, you've got gases in the walls, you've got all this extra stuff, for that replacing the air every 30 seconds. You got to have places for mice, vivariums, you got to have places for pigs and you got to have 14 feet of shelf -- space between the ceiling and the floor plates. And so a lot of office -- traditional office owners either try to develop new lab to "lab buildings" or convert empty buildings, zombie buildings into lab, and it's just not working. And so a lot of the statistics about how much "due supply" there is in Boston, for example. If you can look at some stats that say, there's 15 million square feet of new development or lab space in the Boston market, today, there's about 60 million square feet that's occupied, and you see 15 million "coming online". Well, there's not that -- there's not much demand for 15 million square feet. And a lot of that, like maybe 13 million square feet of that number is either office buildings trying to convert to lab or office owners trying to build new buildings and make them -- call them lab. And it's really not a competitive space. So the real blood, if you will, I hate to use that word, but the real excess supply in Boston is more like 2 million square feet. We're 95% occupied in Boston. The other 2 big incumbent lab companies are highly occupied in Boston as well. You see stragglers, the new entrants in the market that either trying to convert buildings, repurpose buildings or build new buildings and call them lab who don't have the experience, who don't have the capital. So they got these buildings built. They don't have money for TI. TI in our buildings is $400 to $500 a foot. Got 1 million square feet, $400 to $500 a foot of just TI is pretty expensive. We have the capital to provide that. Brokers won't even go to those buildings. So they're zombie buildings for a number of reasons, but basically, they're empty, they're going to be empty for a long time. They're not going to be lab ever. So they really aren't competitive supply to us. As I said, we're 95% occupied in Boston. If we need more space for a tenant, we can go buy, we can either or we can -- what we've been doing is providing some loans to those new developers who got into the space, ran out of money, can't provide TI, can't pay leasing commissions as we talked about, which is important. So we've been loaning some money in some very specific circumstances because we see the demand coming back. And so then we have an entry point to buy that building, once the new lease is signed. We provide the happy money, the TI, once the lease is signed, and then we can grow our business that way.

Great. And also, you've already touched on NIH funding and your exposure, but I guess, generally, that's been a big topic in these panels about macro regulatory issues. Can you also address it in anything that would be a tailwind or a headwind in the outpatient medical field? And also, how is it impacting how tenants are looking to either sign or make decisions in executing leases?

So as I mentioned before, we got a lot of construction going on right now. And the health systems who came out of the pandemic realized that one thing they probably didn't have enough of was outpatient medical space. During the pandemic, as I mentioned, we were 99% -- we collected 99% of our rent, but we were 95% occupied. If you were sick, you went to the doctor. We did a consumer survey. We hired a firm to go out and do this, an independent firm in our 5 biggest markets and said if you're sick, where are you going to take your child or where do you want to go get that care? And 77% of the people said, I want to go somewhere at least a mile away from a hospital because the perception was all the COVID people are in the hospital. If my child injures their knee or arm or whatever or my mother has a heart issue, I don't want to take them to the hospital because that's where the COVID people are. And so there was -- there's been this growing demand for outpatient medical space for years. COVID really accelerated that because people were like, why am I going to the hospital unless I'm like in a car accident or have trauma or have a major transplant issue. The care in hospitals, government policy and commercial insurers have been pushing care out of the hospitals since 1982 when the prospective payment system was created before you were born. And it's been an evolution. So now there's much more care provided in an outpatient setting there than there is in an inpatient setting. And the pandemic really accelerated that because consumers didn't want to go anywhere near a hospital. And so the construction we're doing is there's some on-campus with new hospitals with Northside in particular, CommonSpirit or HonorHealth in Scottsdale. But where the real demand there is for new locations in demographic areas, strong demographics, commercially insured, high Medicare populations, where we can build outpatient facilities, kind of build the demand for that area and then hospitals will follow up with an inpatient facility if they need one to meet that demand. And so as I said before, the demographics, 12,000 people turning 65 every day, 20% of the population is going to be over 65 by 2030. The growth in the top line revenue of health care is 8% a year. It's just math. And the government does everything they can to shift that number, but the real shift is to incentivize care to be pushed to the outpatient setting, cheaper, newer facilities we're building and the care can be provided there safely and frankly, better and higher quality. And so that's where the demand is. So government policy, Medicaid is important, ensuring everybody in the population is important. But the services that we're providing, that our health care system are providing, where they make their money is commercial insurance and they can make money on Medicare. Medicare growth, again, continues regardless just because of the aging population. I mean you're legally entitled to that benefit once you get to that age. So more and more people are becoming insured just from that aspect alone. And that's just driving the demand for more outpatient real estate in particular.

And then in the lab space, obviously, with a bit of the overhang of the funding, how is that impacting how perhaps tenants are thinking about executing leases or with the renewals or signing of leases, how is that? Are you getting new entrants, current tenants? I guess, like what's the general...

Yes. So it's all about the capital markets and for new demand in lab space. I mentioned the cutback in NIH funding is not directly hurting us. The real debate around NIH funding is the overhead factor, the indirect part of the grants. The direct cost in a grant has not been slowing down. It's really a debate about trying to carve back the 50% and 70% kind of indirect cost overhead factor that go along with these grants. But the direct cost is still getting funded. Rent is a direct cost. So future tenants for our buildings that are doing science in Boston, San Diego, South San Francisco, they're still getting their research dollars. They're still getting dollars included in that, that pays the rent. Again, as I said, that's not really part of our focus of our business. It's when they advance their science and get private funding, is when they come knocking on our door and when we're recruiting them to move into our buildings. So last year, we signed more leases than we've ever signed. And the kicking point for that -- we have about 11 million, 12 million square feet of lab business. But the kicking point for that was the capital markets, the IPO market was slow to come about, but the capital markets generally, the amount of venture capital funding was better in 2024 than it was in 2019. So it's kind of been a 5-year inflection point. That drove a lot of leasing for us. This year with all the rhetoric or however you want to put it, around lab and how much we're going to invest through the NIH and how much we're going to fund the FDA to approve drugs and through clinical trials has slowed down the capital fuel in venture capital and otherwise. We still have a good leasing pipeline. It's not as strong as it was last year, but we still have a good leasing pipeline where people are looking for space. They need to expand, they need to grow. And again, they're looking at our buildings because the zombie buildings owners can't actually fund the TI that they need to build out their space, in particular. And we just have these dominant positions, particularly in San Francisco and Boston to provide that space for them. And so it's really fueled by the capital markets. Once the capital markets open back up, more funding into round A, round B IPOs for those tenants of ours, those biotech firms that are working through their science, they hit their scientific milestones, they get more money. When they get more money, they need more space. And it's just a perpetual reliable kind of connection between capital markets funding and the growth in the lab space that's needed for those tenants.

I think our last question here. So looking ahead, if you could quickly go through the growth avenues for Healthpeak for 2025 and beyond.

So again, we're 85% occupied in our lab business. So the real growth for us is leasing the last 15% of our space. At some point in the not-too-distant past, we were 100% occupied. There's probably $60 million to $75 million a year in rent NOI, if we lease up that last 15% space. So there's real organic growth just sitting there to be had. We just need a little bit of momentum in the capital markets behind biotech, maybe eliminate some of the rhetoric in Washington. And I got one more point about that in a second, to help generate, we need some IPOs of biotechs. In 2027, 2028, we have a huge patent cliff pipeline or cliff for the major pharmas that have to replace that revenue. They got to replace it by buying some of our tenants who have proven out their science and getting their Phase III commercialization approvals from the FDA. So that's the big growth driver there. As I said, we're very strategically investing in some of these zombie buildings, if you will, through loans and other capital, happy money to help those tenants, those landlords provide the money to tenants that need the space where we don't have the space available to give them. That's another area of growth for us. On the outpatient side, it's just -- again, we've got the largest portfolio or largest platform today in the world. We've got the best platform from a service perspective. We -- our own employees take care of the tenants who come into those buildings, take care of the patients to get to the care that they need. So we continue to grow that business, primarily through construction, new development with our health system clients, 90% to 100% pre-leased buildings. And then kind of when interest rates and other things converge, we'll start acquiring more buildings as well. Just we're best positioned to grow in those 3 ways. The point I wanted to make about the government is it's a really good point yesterday that captured my attention more than anything in the lunch panel with the health policy experts was, NIH funding, FDA funding, there's only so much the administration can do to cut it back if Congress has funded it. I mean there's a very clear Supreme Court case about this. Once Congress funds it, the administration has to distribute it that way. And so if we go -- if we pass the legislation that congress is funding, that's fine. Most of our hospital systems, HCA and Tenet yesterday said, it's not as bad as we thought it was going to be with Medicaid, in fact, it's better than we thought it would be. So that's really not an issue for us and our health systems. But if the life science business, NIH funding, FDA funding that comes out of appropriations, comes through a continued resolution versus this Congress actually cutting those dollars back, then we actually -- Washington is growing the amount of funding going into life science, growing into NIH. And it's just a matter of the administration distributing the dollars that are legally required to do. I think those are very positive catalysts for our clients, our future clients and innovation in the United States.

Well, that's a great place to end. So thank you, everyone. Thank you, John.

Thank you. Thanks, Farrell. Thanks, everybody.