DOC - Physicians Realty Trust (DOC) Q4 2022 Earnings Call Transcript
Physicians Realty Trust (DOC)
Q4 2022 Earnings Conference Call
February 22, 2023 10:00 AM ET
Company Participants
Brad Page - Senior Vice President, General Counsel
John Thomas - Chief Executive Officer
Jeff Theiler - Chief Financial Officer
Mark Theine - Executive Vice President, Asset Management
Conference Call Participants
Juan Sanabria - BMO Capital Markets
Joshua Dennerlein - Bank of America
Tayo Okusanya - Credit Suisse
Michael Griffin - Citi
Ronald Camden - Morgan Stanley
Michael Carroll - RBC
Dave Rodgers - Baird
Steven Valiquette - Barclays
Mike Miller - JPMorgan
Presentation
Operator
Greetings and welcome to the Physicians Realty Trust Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Brad Page. Thank you, Mr. Page. You may begin.
Brad Page
Thank you, Maria. Good morning and welcome to the Physicians Realty Trust fourth quarter 2022 earnings conference call and webcast. Joining me today are John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; Mark Theine, Executive Vice President, Asset Management; John Lucey, Chief Accounting and Administrative Officer; Lori Becker, Senior Vice President and Controller; and Dan Klein, Deputy Chief Investment Officer.
During this call, John Thomas will provide a summary of the company's activities and performance for the fourth quarter of 2022 and year-to-date performance in 2023, as well as our strategic focus for the remainder of 2023. Jeff Theiler will review our financial results for the fourth quarter of 2022, and Mark Theine will provide a summary of our operations for the fourth quarter.
Today's call will contain forward-looking statements made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. They reflect view of management regarding current expectations and projections about future events and are based on information currently available to us.
These forward-looking statements are not guarantees of future performance and involve numerous risks and uncertainties. You should not rely on them as predictions of future events. Our forward-looking statements depend on assumptions, data and methods that may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that transactions and events described will happen as described or that they will happen at all. For more detailed description of risks and other important factors that could cause our actual results to differ from those contained in any forward-looking statements, please refer to our filings with the Securities and Exchange Commission.
With that, I'd now like to turn the call over to the company's CEO, John Thomas, John?
John Thomas
Thank you, Brad. Physicians Realty Trust demonstrated resilience throughout 2022 and enters 2023 from a position of strength. Our assets are performing well, demand for our space remained strong, and our balance sheet is well-positioned for outsized external growth. We're proud of our achievements during the year, including attainment of the highest annual Fed, funds available for distribution for share in the history of the company. The cash growth is supported by record leasing performance. For the year, we executed leases totaling more than one million rentable square feet including over 800,000 feet of renewals and an average spread of 6%. Retention remained strong as 77% and more than 60% of our executed leases had an average annual escalator at 3% or greater.
We remain focused on creating long-term value on behalf of our shareholders. This can occasionally require the selective non-renewal of leases when we believe that the space can be re-let to stronger health system tenants. While this has the effect of hurting total occupancy and same-store NOI growth in the short-term, we believe that these decisions result in a stronger portfolio that delivers superior cash flow growth in the future.
During 2022, we increase the amount of space leased to investment grade quality tenants from 65% to almost 67%. And we believe that we continue to have the highest portfolio leased rate of any public medical office building investor.
The rapidly changing interest rate environment required us to be disciplined when evaluating external growth opportunities during 2022. Still, we were able to add to shareholders -- add value to shareholders through the transaction we did choose to pursue.
In July, we opportunistically sold disposed of our three Great Falls Montana medical facilities at a 4.7% cap rate, generating a $54 million game and an outstanding 16% unlevered IRR. We match this transaction with a $160 million of new investments in 2022 highlighted by our $82 million acquisition of the Calco Medical Center in Brooklyn, New York, at a 5.5% stabilized cash yield.
We also continue to work with several health systems to move development and redevelopment projects forward that we expect to proceed in 2023 and generate rent in 2024.
Our financial achievements were matched by our accomplishments as they relate to corporate responsibility in 2022. We made measurable progress toward our goal being a sustainable -- sustainability leader across all real estate industry sectors.
For the year, we invested in 31 projects totaling $5.6 million that will directly reduce the energy footprint of our facilities, while also enhancing the desirability of these assets to tenants.
Thoughtful investments like these are a critical part of our long-term sustainability objectives, including our goal announced in 2021 to reduce our portfolio's greenhouse gas emissions by 40% by 2030, over our 2018 baseline.
Social accomplishments in 2022 include 902 hours of volunteer work, individually and corporately, to the communities we serve, which exceeded our 600-hour goal by over 50%.
Doc also provided more than $408,000 to philanthropic fundraising and in-kind donations to community and healthcare provider organizations, benefiting their research and mission initiatives.
In addition, in 2022, we earned recognition for Modern Healthcare as One of the Best Places to Work in Healthcare for the second year in a row, and Top Workplaces Honors from the Milwaukee Journal Sentinel in our headquarters for the fifth year in a row.
Our ESG efforts continue to receive recognition at asset and corporate levels. During 2022, Doc assets were certified by IREM under their Certified Sustainable Property program, bring our aggregate count to 38 properties with this designation.
Separately, we earned 16 new ENERGY STAR property certifications under their recently relaunched medical office building program, bringing our certification count to 26 and qualifying Doc as a premier member of the Certification Nation's efforts.
We're also proud to share that we were named to Bloomberg's Gender Equity Index in January of 2023 as a first-time submitter, distinguishing our work in gender equity in enhanced public disclosure. We're thankful to have been recognized in each of these ways and remain committed to maintaining our status as a leader within the healthcare REIT sector on matters of ESG.
In a few minutes, Jeff will discuss the strength of our balance sheet and Mark Theine will provide more details on our operating results. Before that, I'd like to take a moment to speak toward our expectations for the year ahead.
In 2023, we have set ambitious goals to increase our occupancy at market rate and continue seeking medical office acquisitions and development opportunities. Our development financing pipeline is more extensive than ever, with more than $200 million at cost of opportunities under evaluation and exclusive negotiation. We expect to proceed with many of these opportunities and are targeting stabilized project yields in the 7% to 8% range.
The acquisition market has not yet stabilized with current and capital market conditions. On market transactions are working around the high six cap rate. Still, with low volumes and a limited financing market. We do not believe the market is reached equilibrium, with our weighted average cost of capital, or the markets cost of capital growth generally.
In conclusion, DPhysicians Realty Trust in 2023 with a strong, stable and proven portfolio. Our balance sheet is strong and we remain disciplined and capital deployment, patiently waiting for acquisition and development opportunities that will be accretive to our long term financial goals. We celebrate our 10th anniversary this summer, and we are proud that we have built this company to last for decades to come.
I will now turn the discussion over to Jeff. Jeff?
Jeff Theiler
Thank you, John. In the fourth quarter of 2022, the company generated normalized funds from operations of $61.5 million or $0.26 per share. Our normalized funds available for distribution were $57.9 million, an increase of 5.4% over the comparable quarter of last year, and our FAD per share was $0.24.
2022, our normalize FAD was $242 million, an increase of 10.6% over 2021, and our full year FAD per share was $1.1. Releasing spreads remain strong this quarter at 7%. And we expect the broader economic environment to support our efforts to roll the portfolio's rent up over time.
On the expense side, we're protected from stubbornly high inflation by our standard triple net lease structure, in which we recover 84% of all operating expenses, which is about 20 percentage points higher than our peer group. Well year-over-year same store NOI growth was below expectations at 1.5% due to the movement – due to the move outs discussed earlier in the year. We see positive results on a sequential basis with quarter-over-quarter same store NOI growing by 1.3%.
On the acquisitions front, we had projected minimal acquisition activity in the fourth quarter, and saw that play out with just a handful of strategic transactions taking place, along with some funding on existing loans, patients continues to be the theme here.
While cap rates have drifted significantly higher. We are not yet seeing a high volume of deals that meet our quality thresholds at pricing that makes sense in this capital environment. Our cost of capital is extremely competitive right now. So it isn't that we are competing against cheaper capital. Instead, we see this as the usual delay that happens when sellers have to adjust to pricing that is less advantageous than they could have received several months ago.
Therefore, we are reluctant to put out acquisition guidance at this time. We believe that either cap rates will adjust to historical norms based on current debt costs or we will see improvements in our cost of capital that will create opportunities in the current market environment.
We are in constant dialogue with potential sellers and health system partners, and believe we will be in an excellent position to grow the company's earnings substantially. When this bid ask spread closes.
We took steps to bolster our balance sheet further by issuing $74 million of equity in the fourth quarter on the ATM along with another $66 million on the ATM in January. This place is our balance sheet on a debt to EBITDA run rate of 5.2 times on a consolidated basis, and provides plenty of dry powder for us to utilize at the right time.
Finally, a few updates to our 2023 guidance. We expect G&A to increase by about 4.5% at the midpoint to a range of $41 million to $43 million. Current capital expenditures are expected to increase modestly by about 5% at the midpoint to a range of $24 million to $26 million. As we continue to see tenants trade TI dollars for lower renewal spreads. As mentioned earlier, acquisition guidance will be withheld until we have more visibility on how cap rates and capital costs evolve in 2023.
With that, I'll turn it over to Mark to walk through some additional operational details. Mark?
Mark Theine
Thanks, Jeff. Our tenured asset management, leasing and capital projects teams are united in our focus to serve our healthcare partners. While growing cash flow for our stakeholders. We contributed to these goals in 2022 by delivering record renewal spreads, maintaining retention, and efficiently prioritizing capital project investments in this inflationary environment. These successes are the direct results of our commitments to outstanding customer service and in line with our care core values.
Despite the difficult macro environment, we delivered record full year renewal spreads of 6% while maintaining retention of 77%. Importantly, these results were achieved without offering excessive incentives. With full year renewal TI's totaling just $0.80 per square foot per year. This efficiency was matched by our capital projects team, who deployed $23.9 million of recurring CapEx in 2022, representing $1.48 per square foot.
During the fourth quarter, we continued our positive momentum by achieving renewals spreads of 7% on 141,000 square feet of volume, with leasing costs totaling $0.45 per square foot per year. In addition, new leases totaling 42,000 square feet commenced during the quarter at an average rate of $18.64.
Tenant improvement costs on new leases totaling $3.89 per square foot per year remain well within industry averages, demonstrating our commitment to bottom line effective rent rather than headline rate. The weighted average annual rent escalator on this quarters 182,000 square feet of leasing totaled 2.9%, a significant increase against the portfolio average of 2.4%
MOB same-store NOI growth was 1.5% in the fourth quarter, below our historical 2% to 3% growth rate due to the 30 basis point decline in occupancy from the vacancies we discussed last quarter. In total, this 51,000 square feet of lost occupancy across 13.5 million square foot same-store portfolio is largely explained by activity at two specific buildings.
First, same-store occupancy continues to be impacted by the strategic non-renewal of suites and an MOB in Minnesota to allow for the construction of a brand new ASC that is currently under construction and leased to the dominant investment grade health system in the market. The new 21,000 square foot surgery center is expected to be completed and paying rent during the third quarter of 2023.
Second, 22,000 square feet of vacancy is attributable to an MOB in Pennsylvania, where our historical physician tenants were employed by a hospital and relocated to the hospitals-owned medical office facility at the end of the lease term. We are making several investments to improve this space. And we have partnered with the local brokerage team with strong healthcare relationships.
Overall, we do not view the small amount of negative net absorption to be indicative of market conditions or our potential for internal growth, but rather one-off events that will have a short-term impact on the portfolio.
Excluding these two assets, MOB same-store NOI growth would have been 2%. Well, we don't typically highlight our sequential same-store results, the 1.3% growth in NOI, stable occupancy in 0.5% reduction in operating expenses show positive progress in the impact of our team's efforts. This is our 19th consecutive quarter of positive same-store NOI cash growth.
Again, we enter 2023 with strong leasing momentum. The macro leasing environment continues to offer an advantage to existing medical office inventory, with quality space in move in condition due to the cost and time required for new construction, especially in markets like Phoenix, Nashville, Atlanta and Dallas where Doc has a strong presence.
At the beginning of the year, our leasing and marketing teams launched a comprehensive campaign to increase online exposure of our properties, target key brokers and market influencers and leverage the relationships and knowledge of our in-house property management team. Just two months into the year, our efforts are already yielding results, as tours of vacant space are up nearly 30% year-over-year, and we are trading proposals on over 162,000 square feet of vacant space in the portfolio.
Our leasing and property management teams have a busy calendar of broker open houses to showcase our portfolio and demonstrate new virtual reality technology, which allows prospective tenants to visualize a customized suite and finishes before commencing expensive construction.
We have dedicated approximately 60% of our 2023 recurring capital budget of 24 million to 26 million to leasing initiatives that include renovating vacant suites, tenant improvement allowances to retain and attract healthcare providers and general building renovations where there's a strong leasing activity due to the supply and demand of physicians in the market. Through these collective efforts, we believe that there's opportunity for an increase in total portfolio occupancy in the back half of the year.
Following a typical three to six months, it takes to design construct and commence a new lease. We expect this positive momentum to also appear in lease renewals, while 2023 scheduled expiration volume remains small at 4.5% of the consolidated portfolio. The market conditions that help contribute to our success in 2022 remain intact.
For the full year, we expect renewal spreads to be in the mid single-digits compared to the long-term MOB industry expectations of 2% to 3%. And we anticipate retention to be in line with our historical average of 75%.
To conclude, we anticipate that our operational initiatives will lead to improve same-store NOI growth beginning of the third quarter of 2023. While below target same-store performance is frustrating in the short-term. We believe that long-term value is maximized through thoughtful portfolio management, intelligent capital investments and aggressive leasing initiatives. The thesis for medical office is as strong as ever, and we're excited to execute on behalf of our stakeholders in 2023.
With that, I'll turn the call back over to John.
John Thomas
Thank you, Mark. Maria, we're now ready for questions.
Question-and-Answer Session
Operator
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Juan Sanabria with BMO Capital Markets. Please go ahead.
Juan Sanabria
Hi. Good morning, and thanks for the time. Just hoping to talk a little bit more about the leasing efforts and the occupancy upside. Can you quantify how much occupancy upside you expect? I think, you said in the back half of the year and would that really be driven by filling current vacancy, or is it more incremental new leasing of space that has been sitting vacant for a bit, and given the -- you give the piece parts of re-lease spreads and occupancy a bit? What is the expectations for same-store NOI for 2023?
Jeff Theiler
Hey, Juan thanks a lot. This is JT. I think our ambitious goals this year around both vacancy and really non-renewing lower quality credit tenants with higher quality health system tenants who need to expand into space in their building. So it's 95% to 96% somewhere in that number is full occupancy, and so our ambitious goal is just to hit those numbers, and so positive accretion for the year, and our compensation goals are tied to that as well.
So, we're, you know, we think that's very achievable, somewhere in that range, and same-store is a number that is impacted by a small percentage, very small percentage of move out, some of which we caused on our own in sequential quarters and it takes a couple of more quarters to backfill that space with both leases signed, but also more importantly, completing the TI and the commencement of those leases.
So, back after the year, we have expectations for good, solid return to our same-store growth numbers that are historical. First half the year, we're burdened by the decisions we made, we think the right decisions in the third and fourth quarter of 2022.
Juan Sanabria
Okay. And then I was just hoping for some color on the transactions market and where you see that the bid-ask spreads, maybe in terms of cap rates of where sellers are still holding on what you think is realistic, given your capital costs are generally higher capital across the market.
John Thomas
Yeah. Great question. And we're seeing a significant movement in cap rates, they're just not many transactions occurring. Sellers are just holding on, hopeful that we returned to the glory days of 2020 and 2019 from cap rate perspective. But transactions are occurring in the mid-sixes. And we think we have a great cost of capital in the current environment, but that cost of capital still expects needs high sixes to mid-sevens cap rates, depending upon the annual increase reserves in the rents and things like that to execute.
So, we think there's a good opportunity in the back half of the year assuming that market reaches equilibrium in that range. But in the current environment, we're just not seeing many trades that right quality, right credit, right location that we want to buy, in the mid-sixes. So we want to see those cap rates move up. And, like Jeff said, we've got a balance sheet loaded to execute once we reach equal equilibrium. It's my word in cap rates with market cost of capital.
Juan Sanabria
Thanks John.
John Thomas
Next one.
Operator
Your next question comes from Joshua Dennerlein with Bank of America. Please go ahead.
Joshua Dennerlein
Yes. Hey, guys. I just wanted to follow up on some of your opening remarks on the lease escalators. I think you said you -- for you just signed in 4Q, I think, 2.9%, up from 2.4% in the in-place portfolio. I guess how are the current conversations going for leases renewing in 2023? Are you able to push a little bit more aggressively on the go-forward leases?
John Thomas
Hey, Josh, great question. That's one of the things that just kind of understated in our comments.
[Technical Difficulty]
Joshua Dennerlein
Hello?
Operator
Sir, you may proceed.
John Thomas
Maria, can they -- can you hear us?
Joshua Dennerlein
Yes.
Operator
Yes. I can…
John Thomas
Hey, Josh, can you hear us okay?
Joshua Dennerlein
Yeah. Went out, basically, right when you started talking.
John Thomas
Oh, the best comments I've ever made on an earnings call.
Joshua Dennerlein
That's what I figured. All the good stuff.
John Thomas
Yes, exactly. Shoot, the stock would have gone up 20%. No, just kidding. Hey, Josh, what I was saying was, I think 60% or more of our leases in the fourth quarter, we renewed with -- average annual increase was over 3% or 3% or more.
And the compounding effect of that is probably the best thing we can do in our leases and just moving our, kind of, average annual escalator up from 2.4%. I think we're up to 2.5% now, and we continue to move that up. So those conversations continue to be strong.
And we continue to have a, kind of, some negotiating power in the average annual increase sort of to move those up beyond historical averages. And our leasing team, led by Amy Hall and her team, are doing a great job, kind of focus on not only in the renewal rate, which again, for last year, was 6% or more, but also that average annual increase.
So, we try to get CPI, we try to get floors in that CPI increaser, but just moving that number up has a long term compounding effect. We don't sign one-night leases or two -- or 30-day leases or even one year leases. We signed five years or more increase -- re-leases and extensions on existing leases. And that average increase was a really important part of our strategy to grow in a way over the time.
Joshua Dennerlein
Okay. Appreciate that color. And then, maybe one big picture question for me. Any kind of, like, changes you're seeing with health systems in the current environment kind of coming out of COVID? I know they did have labor pressures. Just some challenges on that front. Like, anything they're looking to do differently that might help your business or hurt it a little bit? Just trying to get a sense of the landscape.
John Thomas
Yes. Since 1982, there's been a push by Medicare and payers to move more care out of the hospital into outpatient settings. And I think health systems realized during COVID, they don't have enough outpatient space available for the kind of demand in their markets. And so, what we're seeing differently from health system is a more intensive strategy to open new outpatient locations, in strong democratic locations and that's what's leading to a lot of development opportunities for us.
All health systems, investment grade and otherwise had challenges in 2022 with inflation and labor shortages and stress of labor and things like that. We're starting to see that stabilize. And the revenue side or the reimbursement side of healthcare is always a lagging indicator, not a lagging indicator, lagging impact on their P&L statements. And so, expenses, a real time revenue, take reimbursement rates, take time to catch up with inflationary pressures. And so we're starting to see -- starting to see stability there, but at the same time, reimbursement increases kind of catch up with inflation. So, lots of lots of ways to go. But the US healthcare economy this year is going to be $3.5 trillion. So there's lots of lots of money in the system, lots of intensive efforts to move more care to the outpatient setting which is more profitable and at the same time, some stability in the labor market.
Joshua Dennerlein
Appreciate that. Thank you.
John Thomas
Thank you.
Operator
Your next question comes from Tayo Okusanya with Credit Suisse. Please go ahead.
Tayo Okusanya
Yeah, good morning, everyone. Question on internal growth. I think everything that's happening on the top line is pretty impressive, even with some of the deliberate occupancy drag, but with OpEx, I think you're getting the same store OpEx growth was 9.8%. Could you just talk a little bit about efforts to kind of mitigate some of the OpEx increases going forward, and specifically is part of that just because of again, your triple net leases, but not everything is passed through at this point? Jeff, I believe you mentioned, you had like an 84% reimbursement rate. Could you just talk a little bit about again how ultimately some of the OpEx growth gets mitigated going forward for better same store NOI growth performance?
Jeff Theiler
Yeah, thank you, Tayo. I’m going to ask Mark to respond to that.
Mark Theine
Yeah, good morning, Tayo. So you point out our operating expenses in the fourth quarter were up 9.8%. It's definitely higher than historical norms. But one thing kind of below the surface that's really pushing it up this quarter is some one time insurance costs are insurance in the quarter was up 1.2 million over the prior year. And again, those are some one time costs in the quarter. But you know, one of the things we really appreciate about our portfolio is just you know, as alluded to is that we're 95% occupied and highly triple net lease. So, our operating expense recoveries were actually up 10.3% to offset that increase.
What our asset management team is really focused on is controllable expenses, and you know, where we've got the ability to impact long term, the operating expenses of the portfolio. And if you look specifically at controllable operating expenses in the quarter, those are up about 5%, 5.5%. So, that's a pretty good run rate and great work by our asset management team in this inflationary environment to really focus on those controllable expenses, which exclude insurance and taxes.
Tayo Okusanya
That’s helpful. And the continued investments in real estate technology again, I think you guys put like 0.5 million into that again this year, this quarter. Could you just talk a little bit about again, your ultimate return on investment that you're looking for how this is going to help you guy, you know, in lower operating expenses, just again, as you just kind of look at more investments on the technology side. What exactly you kind of expect to get out of that?
Jeff Theiler
Hey, Tayo. This is Jeff. Good question. So what we think we'll get a good return out of that investment just on a monetary basis. But really, the investment is also designed to help us stay in front of the latest technology, the latest real estate technology. And to your point, I mean, help us manage our operating expenses going forward.
So we think it is going to be a good return on the investment side. But it also gives us front row access to all these new companies that are coming out with innovative real estate solutions, and really helps us be at the forefront of, having the best possible management of our properties and keep our operating expenses low for our tenants and which, you know, of course helps the company itself.
Tayo Okusanya
Are you partnering with any of those companies at this point and seeing any kind of result?
Jeff Theiler
You know, Tayo I think it's JT– I think, I think part of the opportunity, you know, in this PropTech investment we made is to work with other REITs to kind of identify and benefit from some of the best IT minds out there. So I don't think our shareholders are looking for us to create our own IT platform.
I think benefit is we're investing alongside other REITs and other institutional real estate owners to kind of develop IT tools that we will benefit from and at the same time, have a great IRR or return on investment from those – that direct investment. So, we haven't seen anything directly but we get to explore these tools, which is part of the opportunity that are under development or that are kind of leading-edge technology. So, we'll see some long term benefits eventually.
Tayo Okusanya
Right. And then one more for me if you can indulge me, just some capital allocation question. So some of the recent equity issuances again, what again are going to be the use of the funds, especially this kind of given the issuance of that your current kind of implied cap rate. And lastly, how do we think about the dividend outlook going forward, given like the 96% EFFO payout ratio?
John Thomas
Yes, Jeff?
Jeff Theiler
I’d be happy. Hey, Tayo so – yes, we did some equity issuance on the ATM, we're trading at an implied cap rate in the mid 6% range. That's consistent with where we've seen Class A medical office buildings being marketed. We haven't seen many transactions closing still. And cap rates have really only been moving in one direction which is up, so we thought it was prudent to strengthen our balance sheet at these levels, which we think is going give us a great opportunity when the market stabilizes at what we think the right numbers are to really be an active investor and to really generate strong earnings accretion, which is a certainly a departure from the previous times when cap rates were so low, it's hard to generate earnings accretion, we think we're going to be able to get best-in-class, Class A MOB's at really good pricing.
So, we feel good about the strengthening of the balance sheet. You know, obviously in the meantime, it also pays down our variable rate debt, which is seems to – also seem to be only moving in one direction, which is higher with the Feds increases. So, we think it's a smart capital allocation decision.
Tayo Okusanya
Great. Thank you.
John Thomas
Thanks Tayo.
Jeff Theiler
Thanks Tayo.
Operator
Our next question comes from Michael Griffin with Citi. Please go ahead.
Michael Griffin
Great. Thanks. Maybe to follow-up on Tayo's last question there related to the equity issuance. I mean you talked about being disciplined in 2022, patients continues to be a theme, you mentioned a competitive cost of capital. You why the equity issuance now, I guess, just given the sense that it's at a pretty notable discount to what consensus NAV is that, you seem like you're fine from a balance sheet perspective, it seems like the capital markets are going to be pretty muted for the near-term. Why did it make sense now and why not maybe put it off for until capital markets activity improves?
Jeff Theiler
Hey Mike, I'll take that. Yes, look, I think we're running at the low end of our leverage range, right, which -- we've put our leverage range out at 5.5% to 6%. Certainly, one can argue that the capital markets have been very choppy over the last few months. I mean, certainly we've had a good month in the capital markets overall, or good year-to-date, I should say. But that's not guaranteed by any stretch.
So, really, the idea it's kind of a -- it's not a discount to where we're trading on an implied cap rate versus where we'd be buying assets today if they were closing. So, I think it makes sense to have that optionality to kind of build that dry powder now, such that if the capital markets freeze up for some reason, we're still going to be in a position to grow and grow when others can't.
Michael Griffin
Right, so it seems that in your view, it's relative on an implied cap rate basis, maybe investors should be thinking about it on that basis relative to premium or discount to NAV, am I reading that correctly?
Jeff Theiler
Yes, I think that -- I mean they go hand-in-hand, right. But yes, I think that's how we're thinking about it. Our implied cap rate versus where assets are trading in the -- are being marketed right now, I should say.
Michael Griffin
Okay, cool. And then maybe one for Mark. I know you talked about selective non-renewal of certain leases. You mentioned the MOBs in Minnesota and Pennsylvania as examples. I get the long-term strategic rationale behind this, but I just want to clarify are -- is there any potential for additional strategic non-renewals that could impact occupancy in 2023 and any additional color on that would be helpful?
Mark Theine
Yes, certainly. So, again, we strategically did not renew two leases to -- in Minnesota to bring in an investment-grade tenant. So, that's going to create great long-term value for the company, for the portfolio, for shareholders. And we're going to continue to look at opportunities always to replace existing tenants with investment-grade quality, great long-term tenants. So, it does create a near-term drag on our same-store results, which is frustrating, but it provides the right long-term value and we will always look for those opportunities in 2023 and years after that. So, the good news is our leasing team has done a fantastic job this year of already commencing conversations on 162,000 square feet of new leases and taking space.
Now, not all that will get done, but those are good conversations to start the year. And we feel good about filling vacant spaces throughout 2023 and really growing our net absorption.
Michael Griffin
All right, that's it for me. Thanks for the time.
Mark Theine
Appreciate it.
Operator
Our next question comes from Ronald Camden with Morgan Stanley. Please go ahead.
Ronald Camden
Hey, just two quick ones. Staying on the balance sheet. So, the -- if I look at the $66 million plus or minus equity issuance post Q, just trying to get a sense of what that was put towards? And sort of the related question to that is, so if I annualized your interest costs for Q, I get to sort of an $80 million number. Is that sort of the right ballpark, or it's some debt get paid down? Hopefully that makes sense.
Jeff Theiler
It does. Hey, Ron, it's Jeff. So yeah, we put that towards paying down the revolving line of credit. So, obviously we're – we expect eventually to redeploy those proceeds into acquisitions, but in the meantime, we pay down the line of credit with it. So it'll bring the interest expense down a bit.
Ronald Camden
Got it. And then just on the acquisition, I know you guys are not providing guidance given sort of what you've talked about and – can you talk a little bit more about just what the competition is like why are cap rate thing so tight, who's sort of stepping up and still buying here and why haven't we seen sort of more widening? Thanks.
John Thomas
Yeah, it's JT. I think – I think it's just a seller's holding out and hoping. So essentially hope, conflicts with, rising interest rates on short term loans that were used to acquire for four cap, five cap assets in 2017 to 2020 range. But, I think – I think until we see kind of more distress on the ownership side of the capital side, medical office billings. We won't see a lot of trades occurring. So it's moving in the right direction. It just takes time for the market to kind of – kind of rationalize between cost of capital and it's been a 20 year bull run, and in medical office, and the 10 year treasury, and kind of other things. So it's – it just takes time for the – when interest rates rise 400 500 basis points like they have in the last six to nine months. It just takes time for them – in the kind of the market to reconcile itself. So it'll get there and, we expect to – we expect a pretty good backup – backup – back half of the year. But the market is going to get there.
Ronald Camden
Got it. That's it for me. Thanks so much.
John Thomas
Yeah. Thanks.
Operator
Next question comes from Michael Carroll with RBC. Please go ahead.
Michael Carroll
Yeah. Thanks. JT, just staying on the MOB private market valuations, I think you highlighted that assets were being marketed in the mid 6% cap rate right now. Is that a fair valuation or do you think it needs to go higher from that mid 6% type cap rate?
John Thomas
Yeah, Mike, great question. I think that's when they're marketed that rate. Almost by definition, that means the price should be better – from a – shouldn't move up from that range. And so, frankly, the fact that assets are even marketed, above six is a dramatic change from where they were marketed six months ago, and they still need to move a little higher. So, we're waiting patiently. We're not – we're not out of the market, as far as, you know, exploring opportunities. But, when we – when we make an offer on a Class A asset that we're really excited about it's – it's going to be higher than, mid 6%.
Michael Carroll
So we're thinking more of like a high 6%, are we talking about 7% type range, or I guess, like mid 6%, obviously, pretty wide range? I mean, are we talking higher than that?
John Thomas
Yeah. Generally, and we're IRR investors. So, depends on the annual increases where they are market rents and things like that. So it's a combination of factors, but from a cap rate perspective, just the market generally is – it's we're seeing trades very few. But we are seeing trades in the mid 6s on assets that if they were trading, let's just call it seven. We would be pretty excited about it moving in the right direction. So it's just few and far between, but we think the market is moving in the right direction, as a buyer, in a long-term investment.
Michael Carroll
Okay. And what's the appropriate IRR target? I mean, trying to translate this from a cap rate to an IRR. I mean, are we talking about 8% plus IRR?
Jeff Theiler
Yes, I think, that's a fair way to think about.
Michael Carroll
Okay. And then are these high quality MOBs so like off campus affiliated with a major health system. Is that what we're generally talking about here?
John Thomas
Yes. And we're very transparent. That's all we buy. And so that's what we're talking about. So you can get lower quality at a higher rate. You can do other asset classes at a higher rate. But right now for Class A assets and that's and I think, in part that's where we see development kind of leading the way for the next several years is health systems really we're looking for new strategic locations. And we're working with several right now on kind of helping them develop those locations and getting in a more attractive yield in the current cost capital environment.
Michael Carroll
Okay. And then I know earlier in your prepared remarks and through some of these questions, you talked about selectively not renewing some tenants if you think that there's a better tenant that could take that space. I mean, are we talking about some of the things that you already did or are there additional leases that you plan on doing this with in 2023?
John Thomas
That's a great question. So it was about -- we have 16 million square feet, and we're talking about 40,000 square feet where we did that last year and we're already backfilling that space. It just takes time for the new leases to commence post TI. There will be a little bit of that in the first quarter of this year, but it's -- when the tenant has too much space, I mean, that's almost worse than having the tenant kind of renew a lease and occupy space that we think there's a better market rates for -- out there for to compete for that space.
So, we have a little bit of that in the first quarter of this year. But it's not a lot across 60 million square feet. But in short-term, it's negative; long-term, it’s very beneficial to the company.
Michael Carroll
Okay. Great. Thank you.
Operator
Our next question comes from Dave Rodgers with Baird. Please go ahead.
Dave Rodgers
Oh, yes, good morning. Just a couple of follow-ups on investments. I think the first would be around the development funding pipeline 200 million that you talked about. I think this was a similar number to where you started last year. Maybe give us a sense of kind of how it kind of wound up in 2022 versus that expectation, I think was probably lower, but just to give us your own assessment of that. And then I guess what gives you confidence in that number for this year and debt markets maybe part of that?
The second would be maybe a follow-up to Mike's question just a minute ago. In terms of the investment activity that you expect to accelerate in the second half, is that because you're seeing more RFPs on the market, more packages coming out? Is it more hope or you're actually seeing good amount of activity that would lead you to be able to close activity or close acquisitions in the second half of the year?
John Thomas
Dave, those are all great questions. Hope is not a strategy or we not depend upon RFPs to find assets or work with health systems. Those tend to be auction type processes where there's always some low bidder that you don't want to compete with. Not that we couldn't. And so I think the 200 million is active discussions with health systems. Last year when both supply chain and inflation was going up, you couldn't get a construction, a contractor to give you a quote on contract to build a building that was good for more than a day. I mean, historically you get a bid and 90 days later, 180 days later, it was still a good number.
So last year, a lot of the projects we're working on are still there and that's the confidence in that $200 million number is some of those projects that are carrying over, and we the health system that positions, we're waiting on some stability, stabilization in the construction, and also the timeline with supply chain and other things that are beyond everybody's control.
And so, numbers are coming in today, we're proceeding with some projects that we thought would begins construction in the fourth quarter, but the tenant, the capital, us, the contractors, all have more stability today than we had three months ago. And frankly, that's going to create much more long-term value for us by that short delay in those -- on those projects.
So we'll be breaking ground in the next 30 days on projects that we've been working on for a couple of years. So we feel really confident in that number going forward and we see a lot of more opportunity in that space.
Dave Rodgers
All right, great. Thank you.
Operator
Your next question comes from Steven Valiquette with Barclays. Please go ahead.
Steven Valiquette
Great. Thanks. Good morning, everybody. So, I guess not to get too granular on the same-store OpEx that was up 9.8% in the fourth quarter, but I guess to flip the narrative around here a little bit with the one-time insurance cause that you mentioned you absorbed in the fourth quarter that makes the favorable 0.5% sequential decline in OpEx, I should be little more impressive. So I guess with the assumption that the insurance costs were probably up sequentially in 4Q versus 3Q just remind us, which cost categories actually improved the most sequentially. And then also, were there any seasonal factors worth mentioning one way or the other that may impact that favorable sequential comparison on the OpEx? Thanks.
Mark Theine
Yeah, Steven. This is Mark. Thanks for pointing that out. I should have mentioned that earlier, but we've done a great job sequentially keeping our operating expenses actually declined a little bit. Contributing to that sequential change utilities was a large contributor quarter-over-quarter and actually a decrease in holding that relatively flat and same with general maintenance category there, year-over-year those were -- those two categories were up about 700,000 and 600,000. But quarter-over-quarter, we did a great job with our asset management team to keep those flat.
I think we're also seeing the results of some of our ESG efforts in the utility expense from LED upgrades things like that, where we've made wise capital investments, and we're starting to see that reduction in the operating expenses from some of those projects that we completed this year.
Steven Valiquette
Okay. And you mentioned that you don't normally do those sequential comparisons, but again, I guess the reason why you don't do that as they're just some seasonality factors that just mucks that out sometimes, just curious any reminders on any seasonal factors on sequential comparisons either 4Q to 1Q, or just any other times throughout the year as far as any obvious ones that stick out?
Mark Theine
Yeah, the obvious ones would be snow removal and markets -- North Dakota was hit pretty hard with our snow removal costs in the fourth quarter, but really don't have a lot of seasonality in our operating expenses outside those obvious ones. And again, our highly occupied triple net lease portfolio help insulate the overall NOI same-store numbers there. But, clearly, we watch that carefully for our healthcare tenants and partners, because it's the overall occupancy cost that matters when we talk to them about lease renewals.
Steven Valiquette
Got it. Okay. All right. Thanks.
Operator
The next question comes from Mike Miller with JPMorgan. Please, go ahead.
Mike Miller
Yes. Hi. So, for two questions. The first one, on the $200 million of development funding that's under discussion, I guess, if all that comes to fruition, how much capital do you think could go out the door in 2023 and generate a return on it? That's the first question.
Second one is what's the return profile on piecing these smaller condos together, like in Atlanta, versus a typical building acquisition that you would make?
John Thomas
I can't help but laugh at the second question, because it's a great question. Actually, it's -- the long term return profile there is much better than about anything else we do. It just -- it's just taking time. It's a very strategic location.
For some reason, 20 years ago -- 25 years ago, physicians and hospitals thought condo projects for the right way to build buildings and invest in buildings. And in this particular case, a kind that was built in a incredibly strategic location, across the street from three health systems.
And so, we're really excited about the long term -- and maybe the -- maybe the best, kind of, IRR cash yield we'll ever get from individual investments. It just takes time to accumulate the condos over time. So, a great question. We know it looks odd, but at the same time, on the back end, we're going to have fantastic returns from those investments.
On the on the development, that's a good question. It takes 18 months to build these buildings. So the ones under construction or about to begin construction, those will -- it just plays out over time, over the 18 month construction cycle. So of that $200 million -- for your model averaged out over 18 months, but it's something like that.
So it's -- and frankly, that's the projects we know we will probably finance this year, or contractually commit to financing this year. And we're working on others. So I think there's -- I think there are opportunities for kind of outsized investment on the development side.
Mike Miller
Got it. Okay. Thank you
Operator
There are no further questions at this time. I would like to turn the floor back over to John Thomas for closing comments. Please, go ahead.
John Thomas
Yes, Maria. Thank you. And thanks, everyone for joining us on the call today. We're really excited about 2023. It's a different markets and at a different time. But we think a 20-year bull run and seller's market has turned into outsized opportunity for DOC, Physicians Realty Trust this year, and we look forward to seeing you at some of the investor conferences coming up soon. Thank you.
Operator
-- concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation. Have a great day.
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Physicians Realty Trust (DOC) Q4 2022 Earnings Call Transcript