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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Physicians Realty Trust First Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode, a question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Bradley Page, General Counsel.
Thank you. Good morning, and welcome to the Physicians Realty Trust first quarter 2018 earnings conference call and webcast. With me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; John Lucey, Chief Accounting and Administrative Officer; Mark Theine, Senior Vice President, Asset and Investment Management; and Daniel Klein, Deputy Chief Investment Officer.
During this call, John Thomas will provide a summary of the company’s activity during the first quarter of 2018 and year-to-date as well as our strategic focus. Jeff Theiler will review the financial results for the first quarter of 2018 and our thoughts for the remainder of the year. Mark Theine will provide a summary of our operations for the first quarter of 2018. Following that, we will open the call for questions.
Today’s call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. They are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe our assumptions are reasonable, our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations and those anticipated or implied in such forward-looking statements. For more detailed description of potential risks, please refer to our filings with the Securities and Exchange Commission.
With that, I would now like to turn the call over to the company’s CEO, John Thomas.
Thank you, Brad. Thank you, everyone, for joining us this morning. Physicians Realty Trust delivered a very solid and steady performance during the first three months of 2018. Medical office has been and, we believe, will remain the best-performing health care real estate asset class over the long term and is perhaps the best noncyclical real estate there is. As expected, the capital markets have transitioned away from public REIT equity this year driven by material increases in the 10-year U.S. Treasury interest rate just as the tax reform legislation was enacted at the end of 2017. Nevertheless, the underlying performance of our medical office facilities is outstanding as we delivered another strong quarter of same-store NOI growth and excellent results from operations.
We’re very pleased with the three acquisitions completed just the beginning of 2018, two of which were previously announced and a third completed in April that was included in our modest acquisition guidance expectations for 2018. We’re also making great progress with our asset disposition and recycling plans and expect to have more details to report later this quarter.
As you know, Physicians Realty Trust has been a fast-growing REIT that, in just under five years, has built a $4 billion portfolio of medical office facilities. Our focus has been on outpatient care leased to the largest and highest-quality health care providers, especially those providers with investment grade quality balance sheets.
Eight of our top 10 tenants have an annual base revenue and an investment grade rating and the other two have very strong balance sheets without a credit agency report. [indiscernible] these types of credit rating facilities and high-quality providers that are attracting the most capital and, thus, still high prices, primarily with private equity investors. Private equity have raised billions of dollars of new funds for real estate investment in 2018 and cumulatively have hundreds of billions of dollars of total undeployed commitments, many of which are seeking medical office investment.
There are several portfolios of medical office buildings currently in the market and one single core facility leased to a very large health system anchored in the top 10 MSA. The process and market rumors are that these assets will price in range similar to 2017, with many expecting the high-profile acquisition to price in the mid-4 cap range. We are still evaluating all potential opportunities, but also don’t see enough value to deploy our capital in these high-profiled auctioned deals.
We have always made all market relationship-driven acquisitions a priority and are proud of the portfolio that we have built in that fashion. Two of the three acquisitions completed this year added to existing health care provider relationships and the buildings were developed by and purchased from sellers with which we have had existing long-term relationships. The third facility, a 72,000 square foot medical office facility in Fredericksburg, Virginia, is affiliated with the Mary Washington Health System, increases our penetration in the Mid-Atlantic Northern Virginia DC market with a health system we have known for many years.
While pricing is strong and the cost of capital that we source from the public markets remain tight, we will continue to be very selective in this environment. We have an outstanding portfolio with approximately 14 million square feet that is 96% occupied. We expect to grow our cash flow this year and have no compelling need to grow our total assets in this capital market environment.
We have, from the beginning, been consistent with our strategy of building a REIT focused on the future of health care delivery, that is a portfolio of health care clients in their facilities where they provide care to patients, young and old, primarily on an outpatient setting where quality tends to be higher and the cost is lower. Our outpatient care facilities tend to have high levels of rate leverage and our provider clients are generating higher margins in those buildings than they can in their inpatient facilities or long-term post-acute care settings.
We entered 2018 with a very strong balance sheet and intend to keep it that way. Jeff will provide more details in a minute, but we believe the strength of our creditworthy tenants, our industry-leading occupancy and our average lease term and the credit and geographic diversity of our portfolio creates short-term visions and long-term value, value which deserves and will eventually receive recognition by the credit agencies and the public debt and equity investors, translating into enhanced value for our current stakeholders.
As announced earlier this year, we do expect to prune our portfolio in this market and use the proceeds to fund acquisitions to-date and pay down debt. We are pleased with where we are in that process and do believe we will have more to share in the near term as we complete several potential transactions. We’re also exploring other capital and strategic relationships that we believe can benefit Physicians Realty and our long-term commitment to our shareholders.
We do not believe we should offer our long-term strategy or our focus on acquiring the highest-quality medical office facilities nor have we changed our opinion about development. We remain quite comfortable with our risk-adjusted return benefits of partnering with the best developers in the medical office space who have embedded health system relationships that take years to foster and blossom. Where a health system doesn’t have such a relationship, we are comfortable introducing our outstanding development partners to them and help them optimize their real estate strategy to fit their needs. We believe this win-win strategy enhances our long-term opportunities and the scope of our options and make us the preferred long-term owner of medical office facilities by health systems and the best medical office developers in the United States.
Jeff will now discuss our financial results and Mark Theine will provide more color on our portfolio management and results. Then, we’ll be happy to answer your questions. Jeff?
Thank you, John. In the first quarter of 2018, the company generated funds from operations of $49.0 million or $0.26 per share. Our normalized funds from operations were also $49.0 million and $0.26 per share. Our normalized funds available for distribution were $43 million or $0.23 per share.
While we continue to maintain active dialogue with health system executives and other sellers in the marketplace, our overall investment volumes slowed from its usual pace as we adjusted the required returns in our underwriting to our current cost of capital. As John mentioned, we continue to see a strong interest in the sector by private capital sources, which is maintaining relatively high MOB asset pricing despite recent weakness in publicly traded health care REIT share prices.
We did invest $107.8 million in the quarter, most of which was comprised of the previously announced $71 million Hazelwood Medical Commons building in Maplewood, Minnesota, which is primarily leased to the investment grade-rated HealthEast System; and the $28 million Lee’s Hill Medical Plaza, which is primarily leased to the investment grade-rated Mary Washington Health System.
While we are pleased with these investments, looking forward into 2018, we see more opportunity on the disposition side of the capital equation. We will work over the coming year to prune noncore assets and take advantage of the sellers’ market to improve the overall quality of our portfolio. We are in the final stages of negotiation on a 15-building portfolio sale and remain open to additional sales at the right price. Proceeds from the current assets held for sale as well as any future sales will first be used to pay down our line of credit and fund any future acquisitions and then potentially to repurchase stock.
In terms of capital activity, we had a fairly quiet quarter. We issued $5.5 million of stock in the ATM early in the quarter, but stopped quickly when the capital markets turned against us. Our investments in the first part of the year were largely funded with our $850 million revolving line of credit, which had $222 million outstanding as of the end of the quarter. We remain committed to maintaining a strong balance sheet and ended the quarter with debt-to-enterprise value of 35% and net debt-to-EBITDA of 5.8x. Aside from our revolving line of credit, 99% of our debt is at a fixed interest rate or is completely hedged and our next significant debt maturity is in 2023.
Our existing portfolio remains highly occupied with 96.6% of our space leased, including 52% leased by investment grade-rated health systems or their subsidiaries. Our same-store portfolio performed well, growing at 2.6%, primarily driven by contractual rental rate increases. We work hard to keep our capital expenditures low and we’re able to limit them to roughly 6% of our NOI, enabling us to return more cash to our shareholders.
G&A expense for the quarter was elevated, mostly due to the immediate expensing of restricted share grants for the full year of 2018. We expect this to trend closer to $7 million per quarter for the remainder of the year. We are not changing our G&A guidance for the full year of $27 million to $29 million. As we look at the rest of 2018, we will be disciplined in our investment selection and focused on improving our portfolio through operations. We will also, when appropriate, engage in thoughtful and value-enhancing disposition activity.
I will now turn the call over to Mark to walk through some of our operating statistics. Mark?
Thanks, Jeff. The first quarter of 2018 represented stable and consistent growth for Physicians Realty Trust. Our relationship-centric approach to asset management continues to enhance the value of our portfolio, resulting in higher revenues for the quarter, strong internal growth and a continued commitment to operational excellence.
Our portfolio is an industry-leading 96.6% leased with an average remaining term of 8.2 years. This unparalleled figure illustrates our ability to attract and lease space to additional physicians within our facilities, contributing to a robust referral ecosystem that helps our health care partners reach their clinical and business goals as well as increase community access to care. We believe this commitment not only provides our shareholders reliable dividend income and strong earnings growth potential, but also benefits the health system that trust us to operate their facilities. Our dedicated asset management team, led by VP of Asset Management, Mark Dukes, continues to focus on creating greater operational efficiencies, which benefit our health care partners as well.
As a result of these efforts, the 215-property same-store portfolio generated cash NOI growth of 2.6%. This increase was driven by year-over-year 1.4% reduction in operating expenses and a 1.3% increase in cash revenues. Reduced expenses are primarily attributable to a decrease in aggregate real estate taxes, insurance, parking lot repair expenses compared to the prior period. These expense savings also resulted in lower recovery income as tenants under those leases represented less than 3% of our annualized base rent.
I’ll now talk – I will now turn to an update on leasing activity, a team led by VP of Leasing, Amy Hall. As we entered 2018, only 70,000 square feet of leases across our portfolio had scheduled expirations in the first quarter. This limited number of scheduled expirations resulted in reduced leasing volumes for the quarter.
In total, we completed 169,000 square feet of leasing activity, including 36,000 square feet of new leases and 132,000 square feet of lease renewals. These numbers include several early lease renewals initially scheduled for later in 2018. The average lease term for new deals executed in the quarter was 6.9 years and the average term for lease renewals signed in the quarter was 7.9 years.
These leases contained an average annual rent escalator of 2.4%. Our leasing team remains focused on creating built-in internal growth through annual rent escalators. To-date, nearly 25% of our leases have annual rent increases up 3% or better. In the first quarter, rent concessions, including TI and leasing commissions, remained very low, with $0.98 per square foot per year invested in lease renewals and $2.29 per square foot per year invested in new leases.
In total, we invested $4.2 million in capital expenditures or just 5.9% of the portfolio cash NOI. When compared with our peers, this relatively low capital expenditure investment is driven primarily by low lease expiration schedule during the year, ultimately delivering significant cash flow directly to FAD.
Releasing spreads. Our lease renewals in the first quarter were down 2.8%, primarily driven by two leases which represented nearly 1/3 of lease renewals in the quarter. First, a 10,000 square foot surgery center, which was expected to enter into a new lease at closing, was delayed by the health care partner’s internal approval process.
Our acquisition underwriting anticipated the rental rate for this lease resetting from $31 triple net to $25 triple net with an 8-year lease term commencing upon closing and 2.5% annual rent increases. Both closing negotiations resulted in an agreement to execute the new lease at $27.50 per square foot. These terms outperformed our underwriting estimates by $2.50 per square foot, but still resulted in a negative leasing spread.
The second lease contributing to this quarter’s releasing spread was a 31,000 square foot renewal at a noncampus MOB in Maine, in which the hospital committed to taking 100% of the facility by entering into a new 16-year master lease. This long-term commitment by the hospital system demonstrates the mission-critical nature and superior quality of the facility.
These attributes contributed to the hospital requesting only $375,000 in tenant improvement or $0.50 per square foot per year on their renewal as they committed the master lease and the entire building in exchange for rent 5% below their current rate. This MOB is an excellent example of the compounding power of long-term rent growth with limited capital investment required, which we believe is the key to unlocking lasting portfolio value.
Despite the trying period and the REIT cycle, our operations team continues to outperform and the fundamental qualities of our portfolio remains solid. We are investing this time widely to deepen our health care partner relationships, enhance operation efficiencies, prune noncore assets and ultimately focus on driving internal growth.
With that, Tina, we would now like to open the call for questions.
Thank you. [Operator Instructions] Our first question comes from the line of Jordan Sadler from KeyBanc Capital Markets. Please proceed with your question.
Thanks. Good morning. Why don’t you dig in a little bit to the for sale assets and just broader thoughts on your positioning and processes as you look forward for the rest of this year, given your comments on where the capital markets are and just having reviewing your portfolio? So I’d love to understand sort of the size and value here, the thought process and what’s being sold.
Jordan, good morning this is JT. Nothing surprising. It’s just we’re five years in the life of the company. We’ve acquired a lot of assets. For a period, we’re acquiring about a building a week and the – while the capital markets were open and supportive. So a lot of the assets are smaller, more rural, may have more physicians – tend to be more of a physician tenant base than a health system tenant base. So just an overall continued refocus on the quality and the size of buildings in the larger markets and help this investment grade tenant base. There’s outstanding medical office facilities in what we’re kind of in the buckets that we’ve identified for sale and that we’ve been approached by other private investors to purchase. So good quality buildings, but not long-term contributors to our shareholder value.
Total expected realized value and cap rates?
I think we talked about 5% of the portfolio, $200 million to $300 million kind of total proceeds potentially. I don’t know that we’ll do that large of a transaction or multiple transactions to get to there. Medical office is trading in the mid-6s.
And is that consistent with the portfolio that is currently under contract?
Yes. Yes.
Okay. And then, just commentary on what’s on the market currently, what you’re seeing? I think you alluded to cap rates that are potentially consistent with last year. And I thought – would just love any color on the quality of what’s being offered relative to last year and your – from your perspective and then – and the buyer pool.
Yes. There’s – I mentioned there’s one kind of high-profile, very core asset in a core market and a heavy concentration of health care providers that is attracting capital from all over the world, frankly, buyers all over the world. We do expect that to trade in line or even perhaps even more aggressively than the highest profile assets that we and others acquired last year. The portfolios that are out there, kind of nice enough, I mean, kind of $500 million-ish ballpark kind of portfolio so...
And then, just one on the asset side, the LTACHs. Any commentary on what’s happening with the coverage there sequentially? It looks like it dipped.
Yes. Jordan, it’s Jeff. As you know, we’re not in the LTACH business and so we’d certainly be open to selling those assets at the right price. Obviously, there’s been changes in the reimbursement rules, specifically around the site-neutral payment rules that would be phased in, so kind of like everybody else is LTACH covered have increased a little bit. I think for the first time actually in a long time, there’s some positive news on that front where there’s a delay in further phasing in of those site-neutral rules then there’s also this talk about eliminating the 25% rule, which would be a good benefit for the industry and for our buildings as well. So I think we’ve got good momentum, hopefully, in the LTACH business and coverages, but certainly we’re still open to getting out of those assets at the right price.
Our next question comes from the line of Jonathan Hughes from Raymond James.
Jeff, I think I heard you earlier say you guys raised equity via the ATM in the quarter, but that you guys are trading 9% or so below consensus NAV on average. Can you just talk about how you look at that cost of capital and why you chose to raise equity flow NAV? I think I caught that correctly.
Yes, Jonathan. So we raised like $5 million at the very, very beginning of the quarter. So that was when our stock was kind of trading at 17s, high 17s a little bit. So certainly, as the stock price deteriorated, we cut off the ATM program.
Okay. All right. That’s fair then. And then, looking at the same-store operating expense, they were down year-over-year, but trended up pretty significantly sequentially. Can you just talk about what drove that increase?
Sure, Jon. This is Mark. Sequentially, first quarter, we do the TAM reimbursement and reconciliation process. So there was some adjustments there as we trued-up the final 2017 TAM reconciliation process. And then, in first quarter, we had a little bit of weather there from additional funds and snow expenses that drove it up just a little bit, but for the most part, as you know, our portfolio is triple net leased and the majority of those expenses pass through under those leases.
Okay. Fair enough. And then, there’s just one more and I’ll jump off. But FFO per share was a little below what I was expecting with the difference not driven by the acquisition timing, so maybe there are bigger issues on my side. But I would find it helpful and I’m sure others would, too, but have you given any thought to maybe giving some components of FFO guidance, maybe not explicit per share guidance, but at least some parameters to kind of help frame estimates?
Yes, Jon, we try to. I mean, we give some of the guidance that we have the answers to, right? So like G&A for example, we try to give a full year guidance number for that, which I think, if you look at this quarter, that’s likely one of the reasons that the FFO probably didn’t meet your estimate. It was – we had some kind of unusual G&A this quarter, which we don’t expect to recur over the next three quarters.
In terms of acquisition guidance, we used to give it when we felt comfortable with our cost of capital and had good visibility on what we could acquire. In this environment, it’s just really hard to give it. And that’s really the only thing. I mean, aside from that, the rest of our portfolio, we think, should be pretty steady and stable. So it’s – I mean, we try to give what we can and what we feel we have good visibility on, but we also – to the extent we don’t have visibility on something, it’s hard to give a guidance.
Our next question comes from the line of Juan Sanabria from Bank of America.
This is Kevin on for Juan. I just had to get an update on Trios. Is that still trending toward a July midyear comeback?
Yes.
Go ahead. I’m sorry.
No. Go ahead, Kevin.
Yes. I was going to say, secondly, on development, have you guys seen any increase in activity for your partners within development? And if there are any, I guess, increasing opportunity to kind of do any more mezz lending in ‘18 or ‘19?
Yes, Kevin. So Trios, we do see some light at the end of the tunnel. The core process is – there is somewhat of a big schedule now that, if they stick to that schedule, the sale out of the bankruptcy court to RegionalCare would occur in the third quarter. And so we’re still targeting kind of October 1 as the rent commitment under our revised lease with RegionalCare, but again, we can’t control that. We’re certainly pushing the core – pushing all the other parties to stay on that schedule. So kind of our best guess is October 1 and hopefully that may be a little conservative.
On the – I’m sorry, Kevin, what was the question? Oh, development. Yes. I’m sorry. So we are – yes, our development partners are out working with several health systems and kind of predevelopment planning for some nice facilities to be anchored by those health systems. So nothing imminent, but we would expect to have the opportunity to participate in the capital stock with those developers and then the long-term opportunity to acquire those buildings from the back end at our option has been our strategy. So we’re seeing an uptick in planning, so maybe late ‘18, early ‘19, kind of starts with kind of 2020 delivery, our ultimate opportunity on those assets.
Our next question comes from the line of Michael Carroll from RBC Capital Markets.
John, can you talk a little bit about what RCCH’s plan is in Kennewick and Pasco? I know that they just acquired another acquisition or hospital right across, I guess, town in that area. Do they just want to build scale? So should we view that as a positive that it’s more likely that they take the Trios system out of bankruptcy?
Yes, that’s exactly right, Mike. And so they’ve acquired that facility. They’ve had a clinical affiliation with University of Washington, so I don’t want to oversell that as a balance sheet from the University of Washington Medical Center system. It’s really RegionalCare and their asset and their credit, but they’re looking to build a regional system in that market, which we think is a very positive thing. They’re very capable operators and well-capitalized. So we’re pretty excited about working with them and just kind of want to move forward.
We always like to remind people that this building never went dark. The physicians have been in the building, seeing patients every day throughout this process. And I think coming out of the back end, the balance sheet will be dried and there will be credit behind the balance sheet and we’ll have a good tenant going forward.
And has there been a delay in the timing? And I believe last quarter, it was July. Is it just typical delays in the core process that is pushing it back to October?
Yes. It’s just the branding nature of bankruptcy court and what happens in that process. So we didn’t see a fixed schedule before. We had hoped that the court would push through the process a little quicker, but now we see a big schedule and see light at the end of the tunnel.
Okay. Great. And then, can you talk a little bit about the investment market and where cap rates have been trending? I know you put some in your prepared remarks and it seems like cap rates are still fairly low. I mean, who are the buyers out there that are still pretty aggressively bidding on this product?
Yes. Again, it’s well-capitalized private equity and its operators that had been in the market for years. So the kind of companies that are private equity-backed operators out of Chicago are part of the biggest buyers, but there are others. And capital is really coming from all over the world.
And are there more assets that you want to put in your for sale bucket? I know you added 8 this quarter. Does that correlate with the size of the sales that you had mentioned in your prepared remarks? Or should you expect – or should we expect more assets to come into that that’s slated for disposition bucket?
Yes, that’s right. So I’d like to say 5% or so of the total portfolio, but we’re talking about smaller assets primarily, so take more of those to get to 5% from a value perspective. So when I talk about 5%, it’s $200 million to $300 million in valuation. Again, if we’re looking at smaller rural market assets, it will take more of those to get to those kind of numbers. But we’ve been approached kind of off-market and would likely market some of these buildings to the investors we know that are looking for these types of smaller assets with a little higher yield. But again, the yields we’re looking at and the cap rates we’re looking at are all – for the most part, are all better than what we thought before, so accretive on a per dollar basis.
And should we expect that to be sold this year? And I know – maybe one last one for me real quick is on the Foundation. Is there any update on those sales?
Yes. So the – we’re excited that the San Antonio Foundation facility has fully completed their repayment plan and have been current on rent now for almost 18 months – 16 months. So now we’re being more aggressive. They’re being more aggressive. The physicians there are in discussions about capitalizing their ability to buy the hospital back from us. And so that’s progressing pretty well now.
El Paso is now – is on their 13th consecutive month since – of timely and full rent payments. They are still working through kind of opportunity to pay the back rent from 2016. So again, likewise, their operations have hit to a point and a steady-state that there are discussions with them about buying the building back from us are more aggressive. And we think both are actionable in this year and, hopefully, sooner than later.
Our next question comes from the line of Drew Babin from Robert W. Baird.
This is Alex Kubicek on for Drew. We’re kind of just looking for a little more detail on that small land acquisition you guys made in Scottsdale. It sounds like you already acquired the facility. Wondering if there’s any expansion or development opportunity there and what really prompted that move?
No. It was just a second component to an acquisition we did with HonorHealth. Great client and it continues to expand their outreach kind of all around the Phoenix market. So it was just a second piece of the deal that we did with HonorHealth.
Got it. That makes sense. And just another follow-up. Have you guys like considered making a move to fix at least the portion of your revolver balance? I noticed that interest rate jumped about 30 basis points from last quarter. And as you guys continue to pull out in this environment, what are your guys thoughts going forward on using derivatives or loans to make that more fixed?
That’s a good question. It’s Jeff. So we had just over $200 million, $220 million outstanding on the line at the end of the quarter. As we noted in the earnings release, we’ve got some buildings that we intend to dispose of in the near term. So we’re going to use those proceeds to pay down the line versus kind of fix out the interest rate on that. So I’d imagine that, that line balance decreases over the year. And as such, we have kind of a minimal amount of variable rate debt. The term loan – the $250 million term loan, we’ve already fixed the interest rate when we did that deal. So that’s at a 2.87% interest rate, I believe. So we like having a little bit of variable because we’re going to end up paying it down with dispositions.
Our next question comes from the line of Chad Vanacore from Stifel.
This is Tao for Chad. It looks like you were almost halfway through your 2018 lease expirations. What is the retention rate like for the quarter? And I may have missed this, but what kind of releasing spread do you see? And what about rent concession and TI for the quarter?
Sure. Tao, this is Mark. So our retention rate for the quarter was 69% as disclosed in our supplement and that was primarily attributable to 12,000 square feet at the mid-coast buildings that I mentioned in our prepared remarks. That faces immediately release from taken over by the hospital, but in our staff becomes added as a nonrenewal and then immediately released, so it has no net absorption impact. So excluding that one space of 12,000 square feet, our retention rate [indiscernible] 78%. And again, our leases continue with [indiscernible] for 3% escalators in our rents when we come up a renewal.
Got you. And I have a follow-up on NOI growth. You did 2.6% this quarter. What is the same-store NOI growth if you include the Kennewick asset?
Sure. If you included Kennewick in our same-store, as we’ve talked about that building extensively, it’s about $1 million impact for quarter. So same-store would be flat there if you included that one. And then, if you included our held for sale and placed for disposition assets, things sort of actually improve 50 basis points positive there. But consistent with our methodology to exclude the held for sale and placed for dispositions, we do not include that even though it would actually help the number.
That’s helpful. And on the balance sheet, you mentioned that you have like $220 million balance on the revolver. Do you expect to pay that down through dispositions later in the year? Or do you think of replacing that with small permanent capital [indiscernible]?
No. I think, right now, we intend on paying that down with disposition.
Okay. And one last technical detail and I’ll hop off. So on Page 11 of the supplemental, so in addition to the 15 held for sale assets, there are also 8 properties listed under the other category. So what are those?
They are primarily the Foundation assets. They’ve been on there for a number of quarters yet. So those are assets that we are actively in negotiations with and trying to dispose of. But I personally don’t have a timetable on that right now, but we’re working towards selling those assets.
So no guidance on timing for those, right?
No. We can’t give good guidance on timing right now.
Our final question comes from the line of Daniel Bernstein from Capital One Securities.
I just wanted to go back to the new leases for quarter. You indicated that the rent bumps were about 2.4% and I know you guys generally push for 3%. So has anything changed in terms of whether it’s become more or less challenging design, new tenants in those 3% bumps or whether you need to put some more CapEx TI, free rent? I’m just wondering what the tenant consolidation in the hospital space where anything has become more challenging or just very specific to those leases and you still think 3% is the right number going forward for releasing spreads.
Yes [indiscernible]. I think 3% is available. And again, in both of those situations, there was kind of long-term – one’s a health system with our party have a long-term lease, part of the building. So it’s really a win-win because we put less CapEx into the lease. So all of the things being equal, it’s a very strong long-term extension with low CapEx and low CapEx over the next 15 years. So 3% is achievable.
Construction costs, deal tariffs and everything else and demand, particularly in the southeast with the hurricane and the flood rebuilding, the cost of new construction, new development is going up to a point where we think we may be able to start pushing rents in our existing buildings at a better pace. I think some of our competitors are seeing similar opportunities as well.
Okay. Any concerns on your part in terms of real estate taxes? Or is that really just – I’ve seen some place – some states wanting to offset the President Trump congressional tax cuts by increasing taxes on business and real estate. Do you have any concerns about that? Or is that all kind of picked up as far as the triple net structure?
Yes. So on one hand, it’s all part of the triple net pass through. On the other, it’s a very important factor, particularly in underwriting and acquisitions, because in the end, the tenant can only pay so much for the occupancy of their space. And again, the less we’re paying in distributor and real estate taxes, the more triple net ramp we can collect.
So very important factor in underwriting. Some of the transactions last year – not in buildings that we bought, but in all buildings – they were selling at high prices and the real estate tax assessment is likely going to go and we have to be prepared to manage through that. But a very important question and something that we’re on top of and aggressively challenge.
Okay. Yes. We might want to talk some more about that offline.
Yes.
And then, one last question. KentuckyOne, the Catholic Health system’s assets near and around Louisville, is there anything new on that in terms of sale of those assets? And any or no impact on your properties?
No impact on our properties. We’ve been in discussions at a very high level with Blue Mountain, who’s publicly entered into an agreement with CHI about the Louisville hospitals. They keep us appraised of the process and progress, but it’s been slow. So we expect that the transaction to be 2018, but we’re – there’s no set timetable.
Same thing – well, you didn’t ask this question, but similarly on the Dignity Health CHI merger, again, what we understand and what we’re told by the C-Suite of both organizations is that, that will – that is progressing. They fully expect it to close, but it’s more likely at the end of the year to – for that merger to be completed.
Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to John Thomas for closing remarks.
Thank you, everyone, for joining us today. As you’ve heard, we believe we have a very steady and strong portfolio of medical office facilities that are performing well. This morning, the DOC team was recognized by the Milwaukee Sentinel Journal as one of the best places to work in Milwaukee. We’re very proud of our team – great team culture as we believe that delivers great service to our clients and great results for our shareholders. I’d like to recognize and appreciate that recognition.
And thank you. I look forward to seeing you at NAREIT.
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.