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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Healthcare Realty Third Quarter Financial Results Conference Call. [Operator Instructions].
Please note this event is being recorded. I would now like to turn the conference over to Todd Meredith, President and CEO. Please go ahead.
Thank you. Joining me on the call today are Rob Hull, Kris Douglas, Bethany Mancini and Carla Baca. After Ms. Baca reads the disclaimer, I'll provide some initial comments, followed by Ms. Mancini with an update on healthcare policy and trends, then Mr. Hull will discuss investment activity and Kris Douglas will review financial and operating results before we move to Q&A. Carla?
Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involved estimates, assumptions, risks and uncertainties. These risks are more specifically discussed in our Form 10-K filed with the SEC for the year ended December 31. 2017, and in subsequently filed Form 10-Qs. These forward-looking statements represent the company's judgment as of the date of this call. The company disclaims any obligation to update this forward-looking material. The matters discussed in this call may also contain certain non-GAAP financial measures such as funds from operations, FFO, normalized FFO, FFO per share, normalized FFO per share, funds available for distribution FAD, net operating income, NOI, EBIDTA and adjusted EBITDA.
A reconciliation of these measures to the most comparable GAAP financial measures may be found in the company's earnings press release for the third quarter ended September 30, 2018. The company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the company's website.
Thank you, Carla. Healthcare Realty's third quarter results and positive operating fundamentals continued to exemplify the intrinsic value of our medical office portfolio. The company's same-store metrics consistently outpaced norms for the sector, anchored by steady tenant demand, solid tenant retention and rising rental rates. The strength of our medical office properties lies in their integral locations on leading hospital campuses, where higher acuity patients drive the need for specialists and concentration is high in top markets, where thriving population centers ensure increasing demand for healthcare services.
As the MOB transaction market has gained momentum in recent years, we have remained sober and purposeful in our investing. We view Healthcare Realty's relative valuation as a reflection of our commitment to sustainable growth and careful management of risk. Quality, not quantity, has led us to an enviable balance of higher growth and lower risk. With today's market dynamics, our focus is on extending our competitive advantage through operational performance and continuous improvement of our portfolio through recycling of assets, an often underappreciated but effective form of long-term value creation. We have no interest in chasing large portfolios at historically steep pricing with subpar growth merely for the sake of buying assets. As cost of capital has risen in recent quarters, experience compels us to be more patient and prudent, targeting investments where we can better control quality and avoid performance diluting assets often embedded in larger portfolios.
Much of our recent acquisition activity has encompassed redevelopment potential that has expanded our development pipeline, generating a store of future value that can be garnered for years to come. Our development pace is somewhat tempered by our adherence to an on-campus focus, where supply is constrained, rent growth is demonstratively higher and risk is lower as a result of perpetual demand for more specialized hospital-based tenants.
Although off-campus healthcare delivery has gained attention, most MOB investors have gravitated toward on-campus investments as they achieve scale and lower their cost of capital. Off-campus properties are much easier to accumulate, but there are many costly and probable risks that play out over time; namely slower growth, lower tenant retention and difficulty backfilling vacancies, which in our experience leads to longer downtime, rent roll-down, and costlier capital and tenant improvements.
While we tend to avoid off-campus properties for these reasons, they do serve a clinical role, meeting the rising demand for low-acuity care and improving population health across markets, but not to the detriment of on-campus services where health systems are actively centralizing and expanding their more complex inpatient and outpatient care. This optimization of services across different settings will effectively meet patient demand, ease cost pressures and bolster profit margins.
The company's investment strategy has been consistent over 25 years, honed through hands-on experience and acumen gained over multiple lease cycles, both on and off-campus. We see growth potential and lasting value creation across our portfolio through operational knowhow, disciplined investing and adept portfolio management. With outpatient care shaping the future of an industry that exceeds 18% of GDP and is projected to grow 5.5% annually, Healthcare Realty is well-positioned to deliver steady growth with a low-risk profile in years ahead. Bethany?
The spotlight on the healthcare sector shifted this quarter, more toward hospital performance, provider consolidation and market expansion, and away from public health policy which has been relatively quiet as the midterm election nears. Hospitals and physicians are focused on balancing cost containment and tighter reimbursement, while meeting the aging population's demand for greater healthcare services.
The strength of a hospital is critical when Healthcare Realty considers an investment. We look beyond just credit rating to the hospital's underlying operating fundamentals. Over 90% of Healthcare Realty's NOI from on-campus MOBs is associated with hospitals ranking above the median of the nation's 4,800 hospitals, when measured on net patient revenue, occupancy, population growth in density, case mix index and surgical mix.
Healthcare Realty has generally avoided investments on the campuses of rural, for-profit and standalone hospitals, often located in sluggish markets which in today's healthcare environment are contending with lower inpatient volumes and declining profit margins. These troubled hospitals often drive national headline perceptions of the sector.
In contrast, non-for-profit hospitals in markets with favorable demographics are generating positive growth in revenues per inpatient admission, along with a steady rise in their surgical cases and outpatient services. Health systems across our portfolio in investment markets are building new inpatient towers and moving forward to expand capacity. In the past 5 years specifically, 40% of Healthcare Realty's hospital partners completed, have underway or are planning an inpatient expansion. Nationally acute care hospital construction in 2018 will be the strongest in 5 years, with $20 billion in completions. Hospitals currently have under construction $50 billion and another $20 billion are in the planning phase.
With an eye toward expansion, more hospital leaders are asserting their need to capitalize on core strengths and profitable services in their markets in order to accelerate revenue growth, both inpatient and outpatient, while also controlling costs. Off-campus facilities offer multiple points of access throughout communities for patients with lower acuity needs, while on-campus facilities are moving towards higher acuity services with better margins. 80% of Healthcare Realty's MOBs are located within 250 yards of a hospital and 84% of our physician tenants are specialists. In our experience this translates into valuable tenant retention and higher renewal rates.
Medicare policy continues to support higher reimbursement for on-campus services, as the Center for Medicare and Medicaid Services just finalized their 2019 rates yesterday and extended their 2018 policy to lower payments to off-campus hospital outpatient departments to 40% of their on-campus rate and closer to the physician office level. This policy should further motivate hospitals to streamline care in off-campus settings and centralize higher acuity services on campus, reinforcing the relative value and stability of on-campus outpatient care. 30 years ago, many thought the rise in ambulatory surgery centers would put hospitals out of business. On average, over half of hospital revenues are now outpatient, partly attributable to a 50% increase in hospital ownership of ASCs over the past 6 years. The resiliency of this sector, combined with the rising tide of healthcare demand, will ensure its profitability and breadth of potential for lasting investment. Rob?
Our investment efforts this year have been balanced, redeploying $55.5 million of proceeds from asset sales into $74.5 million of new investments with better long-term growth potential. Acquisition activity was intentionally muted during the quarter. We purchased a 17,000 square foot MOB on 1.7 acres in Denver for $4.2 million at a 6% first-year yield. The building is adjacent to CHI's St. Anthony Hospital, where the company owns 6 other buildings. This property gives us control of a contiguous 14.7 acre site at the front entrance to the hospital, securing a sizable future redevelopment opportunity.
We continue to successfully identify 1- and 2-building opportunities in markets where we already have a presence. The company has under contract 2 properties totaling $37.3 million scheduled to close by year-end, bringing us to $112 million in new investments for the year, on the upper end of our guidance range.
Overall, the acquisition environment remains active, with several portfolios in the market. For better asset quality, pricing is expected to be in the low to mid 5s and occasionally below 5, consistent with levels over the past 12 to 18 months. Implied cap rates for public healthcare REITs owning meaningful MOB portfolios currently range from 5.8% to 6.4%. Healthcare Realty's implied cap rate of around 5.8% gives us one of the lowest costs of capital relative to our public peers, a clear advantage in most circumstances. Nevertheless, we are not inclined to raise incremental capital, given that valuations for most quality properties remain below our current implied cap rate.
As a result, our approach to fund future acquisitions with disposition proceeds remains sensible during this period of disconnect between public and private valuations. We will continue to evaluate the relationship between our implied cap rate and market asset pricing, as we establish future acquisition levels.
Turning to dispositions, we sold 1 off-campus MOB in Saint Louis for $9.8 million at a cap rate of 4.3%. With this sale, year-to-date dispositions total $65.5 million at a blended cap rate of 13.7%. Our disposition activity for the balance of the year will range from $20 million to $50 million at a projected blended cap rate between 5.5% and 7%. This range represents up to 6 transactions, 1 or 2 of which could slide into early next year. Disposing of these properties, comprised primarily of off-campus MOBs located in smaller markets and 1 in-patient rehab facility, continues our disciplined strategy of improving the growth profile of our portfolio by reinvesting proceeds in more desirable properties.
On the development front, the company is making steady progress on the construction of its 151,000 square foot MOB on UW Medicine's Valley Medical Center campus in Seattle. The building is 60% leased and demand for the remaining 40% is strong. Our current pipeline of perspective tenants totals more than 2x the remaining space in the building. This level of activity is promising and it's why last year we purchased an additional property adjacent to the campus. This 33,000 square foot MOB underutilizes the 4-acre site that could accommodate a 150,000 square foot redevelopment.
Measured development remains a key component to our long-term investing strategy. We expect $50 million to $100 million of development starts each year, on average, primarily derived from our embedded development and redevelopment pipeline made up of over 1.5 million square feet and $750 million development potential in locations that are largely in our control.
I am pleased with the patience and discipline our team has demonstrated throughout the year, positioning the company well in a shifting environment for attractive investment opportunities when they arise. Kris?
Core fundamentals such as leasing performance, operating leverage and internal revenue growth remain on a positive track, generating third quarter same-store NOI growth of 3.1% over the same period in 2017. Normalized FFO in the third quarter was $48.2 million or $0.39 per share. Normalized FFO decreased sequentially $800,000, $500,000 from net dispositions in the second quarter and $300,000 from reduced straight-line rent. As we ordinarily see in sequential Q2 to Q3 results, NOI was flat due to a $1.4 million increase in seasonal utilities offset by increased operating expense recoveries and contractual rent escalators. Looking forward, third quarter seasonal utility expenses typically reverse in the fourth quarter, historically leading to NOI growth of approximately $750,000 to $850,000 from third quarter to fourth quarter. This anticipated expense reversal combined with robust cash leasing spreads, escalators and retention; signals a positive trajectory in coming quarters.
Same-store performance in Q3 was reliably strong, with NOI from the same-store portfolio growing 2.9% on a trailing 12-month basis. NOI for the 15 single-tenant net lease assets increased 4.1% with a higher-than-normal growth primarily a result of two non-annual rent increases over 5% in the fourth quarter of 2017 and 1 asset with free rent in early 2017. These two items create a favorable comparison in the current trailing 12-month period. But we expect this benefit will normalize over the next 3 to 4 quarters and bring NOI growth closer to the single-tenant net lease average in-place escalator of 2.4%.
Performance of the same-store multitenant properties was also sound, with NOI increasing 2.7% on a trailing 12-month basis, due to operating leverage generated by revenue growth of 2.6% and a modest 2.3% increase in operating expenses. It is worth noting multitenant same-store revenue growth for the trailing 12 months would have been 20 basis points higher, but for changes in rent concessions and legacy property lease guarantees, which represent 1% and 0.2% of revenue, respectively; highlighting how changes in even small categories can impact overall growth percentages. When controlling for these items, trailing 12-month NOI growth would have been 3%.
Our internal growth continues to be propelled by solid contractual increases in cash leasing spreads. Future contractual increases were 3.76% for leases commencing in the quarter, which helped boost average in-place contractual increases to 2.88%, compared to 2.78% a year ago. Cash leasing spreads were 3.8%, with approximately 85% of the 96 renewals having cash leasing spreads equal to or greater than 3. Our ability to achieve superior rent growth on both new and renewal leases reflects the value of owning well-located and affiliated properties with low fungibility.
We continue to dispose of properties with below average revenue drivers and rotate into properties that allow us to bolster cash leasing spreads and annual increases. Thus far in 2018, the weighted average in place contractual escalator for properties we sold was 2.4%, well under our in-place average. This rotation allows us to accelerate NOI growth over time, even if there is temporary dilution due to lower initial cap rates. This strategy is especially effective for spurring safe growth in the midst of a disconnect between public and private cap rates.
Additionally, by using proceeds from dispositions to fund investments, we have been able to maintain a healthy balance sheet. Leverage remains low at 5.1x with no significant near-term maturities. Year-to-date FFO payout ratio is 77% and FAB payout is approximately 100%. Excluding the same unusual items I mentioned last quarter, TI to be reimbursed by tenants, dollars per move-in ready suites and delayed acquisition capital; year-to-date FAB payout ratio would have been 95%. We expect the full year to follow a similar pattern and our internal growth to improve the FAB payout ratio in 2019.
With ample liquidity, low leverage and capital from a healthy pipeline of dispositions, we remain committed to our proven strategy of targeting investments that will further our ability to generate NOI growth at the high end of the sector.
Thank you, Kris. Gary that concludes our prepared remarks. We're ready to begin the question-and-answer period.
[Operator Instructions]. The first question comes from Vikram Malhotra with Morgan Stanley.
Thanks for taking the questions. In your opening remarks, you kind of alluded to the fact that you'd stay away from pricey portfolios and really focus on the one-off quality assets. Does that say that of the 2 large portfolios out there, Landmark and CNL, that's something you would not be looking at?
Generally, yes. That is true. We've certainly looked at them. We certainly look at everything and I would say that in both of those portfolios there's maybe individual assets that we certainly would find attractive. But it's the challenge of the larger portfolios is that it's often accompanied by too many properties that don't fit. So from our standpoint, those portfolios are not a fit.
Okay, and then just the commentary on the FAD payout, I understand there were a lot of one-time items and the number would have been 95%. Something I guess we've been talking about now throughout the year, when do you see sort of the FAD payout coming down to level where you can actually raise the dividend? Because it's been several years. We're obviously late in the cycle. 95% is certainly better than 100%, but it doesn't give you a lot of room. So I'm just wondering if you look out over the next 12 months, if you can give us a sense of the range. Where do you think you can get the payout to?
Vikram, this is Kris. As we've talked about, the FAB payout ratio this year is pretty similar to what it was last year. A lot of that has to do with some of the one-time items that I talked about, as well as the fact of the rotation. If you look at all the assets we sold in the first half of the year, they were all single tenants who don't have much capital associated with them. And then we're reinvesting in multitenant properties that we think have better value long term. I think we expect to be able to drive payout down in '19 and continue to drive that in the years ahead. I will point out though that we are going to make what we think are the right prudent long-term decisions, even if it does mean a slightly higher payout ratio in the near term. For example, this year we had a couple of leases where we signed longer-term extensions on renewals than we typically do. These were 10 and 12-year leases, and the reason we did that was to position these properties for potential sale in the years ahead. With those longer-term leases, even with the same TI per square foot commitments, it increases your spend. But we think it will certainly pay for itself in the end when we potentially sell those properties at higher values and see greater gains. So we're not going to pass up good long-term decisions just looking at that payout ratio on a short-term basis.
Okay, and just last one from me, so you have an asset in Garland, Texas, which I know we've talked briefly a bit about. There was a hospital right next to it that did shut down and I believe the Garland asset was part of a larger portfolio. Can you give us an update? What's the status of that asset? What's the occupancy and maybe is that one of your disposition candidates?
Sure, Vikram. That hospital did close actually in February of this year and so the hospital has been closed for a while. We really have been sort of at about 56% occupancy recently. So that hasn't changed dramatically. We do expect it will move probably closer to 40% over the next year or so. So really kind of where we're at is obviously looking at them as potential dispositions. We have gained some improvements on the ground lease in terms of ability to lease to non-medical tenants by virtue of the hospital closing and also we're looking at working with Baylor to purchase the fee-simple interest, so obviously working towards improving the marketability of those assets. I would say that the NOI from those properties is about $1 million. So while it's an important piece to look at in terms of the disposition strategy, it's obviously not a material amount of NOI.
The next question comes from Chad Vanacore with Stifel.
So given that the [indiscernible] that market is hot and valuation is pretty high, is there somewhere in your portfolio where you can harvest stabilized assets where valuations have run up significantly?
Well I think, Chad, if you look at what Rob described, I mean the dispositions for the remainder of the year should be between 5.5% and 7%, I think Rob said. So certainly there are certain assets that do fall into that category. We're not out looking to sell some of our top assets to show that they're worth a 5 cap or less. I mean I don't think that really is necessary. I think there's plenty of other transactions that support very strong valuations. And I think for us it's more just balancing what investments we see that are attractive and how can we match that with assets that we're selling that make for some attractive proceeds to reinvest and improve the profile of the portfolio.
Okay, and then just one other question, given next year's lease accounting changing, moving capitalized leases to the expense line; how do you expect that shift to actually impact FFO next year?
It's really not going to have much impact for us, because we were already expensing the majority of our internal leasing costs. So they're already in our G&A, so no material impact for us.
The next question comes from Jordan Sadler with KeyBanc Capital Markets.
Not to beat a dead horse, I think there's been a couple questions in this vein a little bit so far. But I think the investors are probably scratching their heads -- I know we are -- with the underperformance in the group medical office building focused REITs versus healthcare REITs more broadly year-to-date. I'm sure you guys are doing the same, given what seems to be good fundamentals. But now you're trading probably something that looks like a discount to NAV about 10%, and you've talked about your cost to capital kind of going away from you relative to where assets are priced. So what are the plans to narrow that gap versus NAV or capitalize on the opportunity that exists, or do you just sit tight?
Well, I think the obvious thing is that we certainly benefit from having a strong portfolio. So I think the contrast here is that you have a lot of folks who are struggling with their operations, maybe not as much in the MOB sector. I think the good news is the MOB sector, as you pointed out, is really performing well for everyone. We think certainly we're outpacing that group. But I think our view is that we have the ability to wait. We have the ability to rely on our portfolio. We don't think this will last forever. I think whether it's the privates or the publics, we've all had a rise in the cost of capital. For the privates, there's usually a delayed effect. And I think the issue we're all looking at and this is not just healthcare or MOBs -- it's all real estate -- there's just a huge amount of capital that's been raised on the private side that I think is keeping that pressure, keeping cap rates low, and obviously an interest in the MOB sector specifically for all the attributes that it brings. And so I think we just have to obviously watch that play out. But in the end, the private folks, their cost of debt has risen just like ours has. And so I think you just have to have the portfolio to be patient and wait. And we think we're well-positioned to do that.
And just wait it out?
I mean there's certainly things that we can do and we are doing in terms of selling assets into that trend. I mean there's no doubt we're doing that and taking advantage of that. We'll continue to do that. And we'll be selective with investments. I mean if we can sell some things that are attractive cap rates relatively into that type of environment and we can rotate it into really strong assets, we're going to do that. The level of that, as you saw this year at $100 million plus or minus, is certainly down from maybe a normal year of $200 million to $300 million. But it still allows us to remain active.
Okay, I guess the other sort of question I would have, I mean it seems like there is some kind of a disconnect, right, privates versus publics? And you don't want to sell your high quality, but yet you guys have talked about you're liking multitenant a lot better than single tenant. I mean is there an opportunity? I mean you guys still have a quite a bit invested in certain single tenant assets and some of them you still want to hold. But is there an opportunity to do some monetization in that portfolio?
I think we have been and we still -- that certainly will be where we will lean when we're selling assets. That typically is where we focus. Most of what you've seen is I think Kris said most of this year has been single tenant and for the balance of this year we have an inpatient rehab facility and some other off-campus and single tenant. So I think to your point, we're certainly predisposed to go that direction and I think you will see our multitenant continue to incrementally rise. I mean the good news is we're only I think maybe 10% or less of our NOI is from single tenant. So there's not a lot of room left to change that and we're not looking to get to 100 just for principle. I think it's more about the assets individually and evaluating the situations case by case.
And any thoughts on -- I mean it doesn't sound like you're thinking strategic alternatives here at all; but what are your thoughts on MUTA and opting out?
Sure, you know I think on that, I think what's important there is we understand the ramifications of having that option and obviously if folks that have that option because they're incorporated in Maryland, there's certainly a penalty to exercising that. So we're obviously aware of that. And our board I think first and foremost would want to have investors and shareholders know we don't view that as some great defensive option. We know there's a lot of negative ramifications of using that. So we're certainly aware of it, evaluating it, but don't really consider that as a very viable option in terms of the use of that.
So why not just take it off the table?
Well it's certainly something we've evaluating. I mean I think the important thing is we didn't go looking for that. We didn't opt into that. It was something that came to those who were incorporated in Maryland. So certainly we understand that and are taking a look at that.
The next question comes from the Jonathan Hughes with Raymond James.
Looking at your second-generation TIs on a per-square-foot per-year basis, it looks like they're running maybe 50% above the 2015 amount. And I know there was a one-time item in there last quarter that you mentioned earlier in Vikram's question. But even outside of that, it looks like it's still up significantly over the inflation adjusted increase I would have expected. Has the leasing that's been completed this year occurred at older buildings that maybe had some deferred TIs? Were they more exposed to competitive new supply pressures, though I realize that seems unlikely given developments [indiscernible]? Has the cost of acquisition of leases just gone up? I'm just curious to hear your thoughts there.
No, I wouldn't say it's gone up. If you look at just the last 5 quarters, it's going to bounce around in any particular period. We typically say we think on renewals you should expect somewhere in the range of $1.50 to $2.00 and we've had a couple of quarters even outside of that. We had third quarter of '17, it was $1.38. Second quarter of '18 was $2.48. And that did have a specific lease or two on the $2.48 that I talked about last quarter, where we did agree to some higher commitments per square foot for some non-MOB space that we were looking to potentially sell. So we're not seeing anything that I would say is outsized. And we think that what we're experiencing is right in the range of what we would expect.
Okay, but I mean I was looking at the stuff from three years ago, and that second-gen TI per square foot per year on those renewals was more like $1.00 to $1.50. So I mean again, the increase just seems kind of outsized. So I was just trying to understand that.
Yes, you would have to look at the specifics of what's going on in that specific period versus this specific period, and as well as where those leases are. It can be in different parts of the country and different markets. And as a result of that, the cost on a percentage of NOI can be different. But generally what we've seen in terms of time and inflation and growth in that metric is that it's been fairly consistent.
I think the other thing I would add is that if you look at the limited disclosure that's out there for companies that are in the MOB business, I mean our number was what-- $1.50 per foot per lease year for renewals this quarter. And I think HTA was $1.50?
HTA was $1.55. HTP was $2.22 this quarter.
So it's not as though are number on commitments, on second-generation TI are high. They're in fact, lower than the other two that disclosed something on that. So again, it does move around. But I would say we've been -- even over a longer-term average, we're very much in line with the peers on that for the disclosure that's out there.
Yes, we've looked at -- it's only the 3 of us: us, HTA and HTP that actually even provide that information. We think that is key to be able to compare across portfolios But we've looked at that over a 3 1/2-4-year period, and it stayed in that $1.50 to $2 range. I think the average across the 3 of us was $1.70 and with the low between us, I think HTA, we're both around $1.55 to $1.60. And HTP was slightly higher, like $1.80-1.85, but all within a pretty tight range.
Okay, that's helpful, yes. I mean your disclosure is great. So I do really appreciate all the data you give there. And then just one more from me, looking ahead to next year about 20% of your square footage leases mature. Can we expect a similar recurrent CapEx spend on those? Are there any outliers in there that we should be aware of as we look ahead?
Yes, generally our expectation is that tenant retention and renewals will be similar. We do have one space down in Dallas that's a fitness facility that we may convert a portion of that fitness facility into more clinical use. And as part of that, you would be maybe tearing some out and starting from scratch. So it could be up a little bit. But generally, yes, we feel like it should continue to be in the range of what we have seen historically.
The next question comes from Rich Anderson with Mizuho Securities.
Kris, you mentioned just on the lease accounting that you're already expensing. Can you just tell me how much that number actually is that's baked into your G&A?
Yes, well, it depends on what portion you're wanting to get into. We look at just the lease incentive portion and that runs -- I think it runs from kind of $750,000 to $1 million. But if you take our entire leasing platform, you're probably in the $2.5 million range.
Including lease incentive?
Yes.
And that's annual?
That's on an annual basis. Now I can follow up with you with more specifics. That's just kind of going off of the top of my head, memory.
Okay. No, that's fine. I just want to kind of just rationalize it a little bit. Did you mention, Todd or Rob or whoever, how deep your disposition pipeline is in terms of what you view is the non-core element of your portfolio?
Yes, Rich, I'm not sure I mentioned that. But I think we look at it as the bottom 5% of the portfolio. We're always -- when we work our way through that, that bottom 5% as the portfolio evolves there's probably going to be another 5%. But we think that sales of around $50 million to $100 million per year is appropriate for us. And if we see an opportunity where we can increase that because there's a good opportunity to reinvest it into a quality asset with good long-term growth potential, we would do that. I'd also say-- go ahead.
I was going to say up it if something material--
Yes, yes, yes.
Okay, I was just curious, Todd, you opened up with the commentary, your quality over quantity and I think everyone is in agreement with that and understands it. But to what degree are you almost having to say that -- so I'm going to be a little cynic because that's what I always do -- because of where your stock is trading? In other words, you kind of have to sit on the sideline, so this has -- we're kind of backing into the thesis. You've never been the type to be accumulators and I'm not suggesting that. But I mean, are you wishing you had the stock to utilize because there's stuff out there that you would normally go after but you just can't?
I heard somebody else -- I can't remember who it was -- on their call say something similar that there really hasn't been as much maybe quality -- I can't remember if it was HTA. But I would agree with that statement that we just haven't seen this year the depth of quality that we saw in the past few years. And it's not to say that the portfolios are bad or we're not commenting that they're not decent portfolios. But they're certainly not the level of what we're looking for in terms of growth profile, the on-campus; all the things we look for. And so I would say maybe there's an asset or two here or there that we'd have loved to have been able to purchase paid in. The challenge of course is the bigger portfolios, there's just too many things that don't fit and we've even made some attempts here and there to see if we can't pull an asset out here or there. But that's obviously not to be expected in a pretty robust environment where there's strong bids for big portfolios. So I think our view is no, we haven't missed a lot. I think we're watching for that, just like everyone is. And of course we would love to have our stock be at a better place and be able to use that. But I think the good news is it's been an environment where we haven't missed a lot as a result of it.
Okay, and then lastly you talked a little bit about the hospital closure impact on one of your assets. And I think perhaps some people worry somewhat about the medical office business being tethered to the hospital industry that's subject to a lot of consolidation and what have you. Specifically the Baylor Memorial Hermann, I mean I know that there's not a whole lot of crossover, Baylor being in Dallas and Memorial being in Houston, primarily. But when you look at that, do you have any issues that sort of rise to the surface that you have to be watchful of as a consequence of that merger, should it happen?
No, we really don't. I think as you pointed out, they really don't have geographic overlap. I mean they're tangential and certainly improve, I think, the competitive position of the combined entities. I think it's a very strong merger for those two entities. I think it will give them a lot of strength in the state of Texas in terms of especially their insurance side. I think that's really the key play there is that not only obviously giving them some leverage with commercial payers, but also increasing their own insurance product that they have. Scott & White really brought an insurance product play to Baylor and now they can expand that to a broader geographic region. So I think we see that as a positive. I would say we only have really one campus in the Woodlands where we're associated with Memorial Hermann. So that certainly-- don't see any issue there. And then otherwise in the Dallas/Fort Worth area or Austin, we really don't see any issues. So we just see it as generally a positive.
The next question comes from Michael Mueller with JP Morgan.
Going back to dispositions, the $20 million to $50 million by year-end, I think the range was 5.5 to 7. If you do all 50, I mean where in that range do you end up? Is it in the middle someplace?
Yes, it's going to be right at the midpoint of that, Mike.
Got it. And then going on your comment about $50 million to $100 million of go-forward dispositions per year, I mean how much of the portfolio is left where it would fall into the 6.5 or 7 cap bucket as opposed to we're going see cap rates on dispositions drift down to the 5s I mean, so what's left is high cap rate?
Yes, I mean Mike, I think if you inside of our supplemental, we've got a section of portfolio makeup that's non-MOB bucket. It makes up about 2.5% of our NOI. I think that's where generally the disposition of those assets are going to kind of fall into that higher cap rate range that you mentioned. We've got a couple of inpatient rehab facilities in there and one remaining skilled nursing facility. So those are probably going to be in that higher range that you mentioned.
But I guess that what you're pointing to on that, Rob, it's not that entire section that we would think we would sell, but out of that portion of the portfolio there's 2 or 3 buildings and that's what makes up the 2.5%?
Yes, that's correct.
Okay. And then one other question on the $50 million to $100 million development starts per year, does that include expansion work or redevelopment or is that just new starts?
No, it does include that. We include redevelopment and expansion work with our development expectations. So the deal that we did in Charlotte was a 38,000 square foot expansion that would be included in there.
The next question comes from John Kim with BMO. Please go ahead.
I wanted to know how sustainable the escalators on leases commenced are at 3.76%. Was that really just a one-off or is it something that you could sustain going forward?
Yes, no, I think that that's higher than what we would tell people to expect for a long-term average. What we've been doing is kind of trending up close to 3. There's some markets that you obviously can't get 3. But there's some markets obviously if you're able to get 3.78 as a blend, where we're able to get 3.5 or 4. But if we can kind of get our overall escalators running around 3, maybe slightly over on an average, I think that would be a great long-term run rate.
On your redevelopment opportunity, those stated with your Denver acquisition, did you need to acquire this asset to get the ability to develop on site, given it's adjacent to a number of your buildings? And then also can you just--
No, that asset is adjacent to two properties that we purchased in the second quarter, a total of 13 acres. We did not need this property to develop on that site. However, having this property, this additional 1.7 acres, it does enhance the development opportunity and allow us to do some things that will enhance the positioning with the hospital. So it's an important piece.
And it consolidated some easement that were -- some easements for traffic as well as utilities and so forth. It just makes it easier to control that whole site.
And what do you think the timing is? Is this it something medium-term to long-term or could it be--
You know, that's more medium-to-long term I would say. I mean we look at that as long-term opportunity and inside of that embedded development pipeline that I mentioned of $750 million. It's really a long-term pipeline where we control the sites and the process.
Okay, and then Todd, I think you've been very consistent with focusing on on-campus MOBs and you're really talking about or discussed earlier the risk with off-campus, but acknowledged that there is a purpose and tenant demand and it seems like investor demand for that asset class. I'm wondering if it's something that you have looked at or maybe potentially pursued owning off-campus in the joint venture structure or some other structure where you can benefit from your relationship.
Sure. You know, I think certainly that's a consideration. We've thought about that. I think the difficulty is we're certainly predisposed towards the on-campus, just given our position, our history, what we know and I think that's what people know us for. It's not to say -- I mean we have off-campus properties that we think are attractive. Certainly some of the risks that I pointed out are still there and we have to monitor those carefully and manage the portfolio accordingly. But I would say that certainly that's a possibility. I think our view would be that there's going to be other people just frankly that are more aggressive in off-campus. They don't see maybe the same degree of risk and they're not going to price it the same. I think it's probably low likelihood that we would go down that path. But I do think, to your point, we might actually here -- and it's what we've done selectively where we've done some new investments off-campus. It usually is driven by a relationship situation, where we're working with an existing partner or maybe there's a portfolio where you have the same health system and you're doing some on-campus and a little bit of off. We're okay with some of that. I think we just look at it as trying to price it accordingly and then managing the risk appropriately once you own those.
The next question comes from Daniel Bernstein with Capital One. Please go ahead.
I wanted to dive a little bit more into the renewals. Retention rate is very high. I think earlier you'll recall you talked a little bit about longer lease terms. So I wanted to get some more color on that in terms of are you seeing a trend towards longer lease terms, even if that means a little bit more CapEx up front. And maybe is there any difference in that between renewals with physician groups versus individual hospital tenants?
Dan, this is Kris. No, I mean the comments that I made in terms of the longer term that was frankly more driven by us, in terms of a strategic positioning of being able to set those assets up for potential disposition. It was not driven as much as coming from the tenant. I would say I don't think -- there's specific cases, anecdotes that you could say kind of one way or the other on physician tenants versus hospitals. But I don't feel like there's been a material change in what we're hearing across the country of average of people wanting to go shorter or longer. We're certainly comfortable staying in that kind of average of 3 to 4 years on a renewal, given how consistent our tenant retention has been. And we'll just really analyze it from what the needs are on the individual deals.
Okay, and then the other question I had was on development. We heard from a number of other REITs in other sectors about decreasing investment yields, compression with investment yields on development because of labor costs and even some delays in construction and deliveries. How are the factors that are out there that affect development impacting how much development you want to do, and what kind of yields you're requiring and your ability to do more development?
You know I think we continue to look at development and the yields that we get there in relation to where stabilized assets are trading. We've said that we're targeting 100 to 200 basis points above where those yield are. We're finding with the developments that we're doing that we're still able to achieve those yields, those stabilized yields in that range. Certainly with some of the rising costs out there, you are seeing certain cases where that may be a little more difficult. But you're also getting some good increases in rents in good markets that are going along with that. So you're able to sustain some of those yields. I'd also say that where you might see that more impactful is that developments that are more build-to-suit type developments, 100% lease type developments where the tenant has a lot more control in terms of the yields that you're generating on those. And that's typically not the type of development that we're doing. We're going on to campuses of leading hospitals in growing markets and we're working with the systems to put space on their campus that they can utilize to help grow their campus. And so that entails some space that you're leaving to lease up and generate those higher returns. So we think that we can continue to hit the yields that we're targeting, 100 to 200 basis points above stabilized assets.
And Dan, I would say to Rob's point, we've seen maybe 2 or 3 specific cases that were essentially build-to-suit, 100% leased to health systems where the cap rates on those deals -- and these are 2-plus years of construction, so you're taking some risk in terms of time of delivery -- and we're seeing cap rates on those push to the 5% level. There's certainly some examples of that. And one that I can think of was in California. Another was in North Carolina. So it's not just California. So I would say you are seeing it, as Rob said, more on these build-to-suit type situations. And it has compressed towards acquisition prices.
Okay, that helps, and I haven't heard you guys talk anything about buybacks versus actual acquisitions or development as an option given the cost of capital, given where your stock trades relative to private values. And I just wanted to hear some reiteration of those thoughts, good or bad.
Sure. I think for us we'd certainly, if there was a prolonged and deeper discount to NAV that might be a more relevant discussion. I'm not saying we wouldn't consider it. We absolutely would at some point. I think our view is as long as we have some attractive investments that make sense at decent returns that fit with our portfolio well and we can dispose of assets and invest in those, I think that works for us. But obviously in a prolonged period and a deeper discount, it's something we'd look at and consider.
And the assets that we are buying are pretty close. The yields we're getting on those are pretty close to what our implied cap rate is. And so there's not a clear signal of, hey, we can't find anything that we were interested in buying that's close to that that would say a buyback is an obvious more compelling alternative.
So if you're trading in the mid 6s or something like that?
Right.
Implied yield then becomes -- okay, that's good. That's all I have.
The next question comes from Tayo Okusanya with Jefferies.
Hey, this is Austin Caito on for Tayo. Just one quick question from me as we look into 2019, are there any purchase options that we should be aware of that we've seen in the past?
We have some disclosure in our Q on all of our purchase options. There are 4 that are currently and have been outstanding for multiple years. Those are kind of perpetual. Their fair market value could be exercised at any time. There's one additional that comes into that same category that's fair market value that becomes available in 2019. And it becomes available next year. It's related to an inpatient rehab facility that is actually on the campus of a hospital and it's the ground lessor who has that option. So that's the only new one that comes available, but not the fixed price purchase options like you saw earlier in 2018.
The next question comes from Lukas Hartwich with Green Street Advisors.
On the 20% of leases that roll next year, can you talk about where those rents are relative to market?
Yes, I think in general with us having 15% to 20% of our leases rolling in a year, we feel like we're always pretty tight to market and you've kind of seen that with our cash leasing spreads over the last 4 to 5 years. So our anticipation is as you probably heard me say before is that we should be able to grow rents in that 3% to 4% on a cash leasing basis. We've been doing better than that over the last 3 to 4 years. But still if I'm looking at a long-term average that's what I would expect and that's what at this point we're projecting and expecting going into next year as well.
Great, and then there's a decent-sized balance on the line. I'm just curious if there are any plans that term that out.
Not at this point. We're comfortable with this, especially with our liquidity and the fact of we're looking at really recycling our dispositions into our acquisitions. So we're not looking like we need a ton of additional capacity. But that is something that we always consider, as well as we're always kind of watching swaps as well in terms of potentially managing our interest rate exposure, but no plans currently.
Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Todd Meredith for any closing remarks.
Thank you. We appreciate everybody joining the call this morning and we will be around this afternoon or the rest of the day today for any follow-up and hopefully we will see many of you soon. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.