Interview Transcript:
BRAD THOMAS: Hello everyone. This is Brad Thomas with iREIT. I’m back again with another CEO Roundtable. Today, I’m honored and pleased to be joined with John Thomas. We’re not related, but I am a shareholder. We may be related actually, but we just haven’t gone that far back.
But John, thanks for joining us today.
JOHN THOMAS: Yeah, thanks for having us Brad.
BRAD THOMAS: John is with Physicians Realty, ticker symbol, of course, is easy to recognize and remember, is (DOC). That’s “DOC.” So John, let’s talk about COVID-19 first. I know we spoke right at the end of the first quarter, now we’re in the second quarter. So, what’s happened in the latest quarter, positively for the company? I’ve seen some really good trends.
JOHN THOMAS: Yeah. I think we finished the end of the quarter with really positive results from actually one of the best quarters we’ve ever had, financially. Kind of ironic. But we didn’t grow during the quarter. We were very conservative, have a strong balance sheet – a great balance sheet – but we ended the quarter right at 98% cash collections from our tenant base. I think that led the industry, and I think one of the best in REIT-land, generally – but it certainly led the Healthcare REIT industry. And I think it’s a tribute to the investment grade tenant base that we have the strong, large physician groups that we have, and really just the client relationships that we have, as well.
So, as the quarter played out in April, a lot of the practices were shut down. A lot of the outpatient surgery facilities were shut down. And they weren’t shut down because they weren’t able to provide care, but they had to be shut down – by the government, and by the systems, generally – to ration Personal Protective Equipment. And that certainly had a big impact on the surgery centers in particular, who do scheduled care.
I think there’s a misnomer in the general press – the investment community generally – about “shutting down elective surgeries.” When I think of elective surgeries, you think about plastic surgery, things that you may, or may not, ever need to have done. The real issue’s about scheduled care, and care that you could defer and delay. So what happened was – in April, a lot of our practices delayed a lot of care, at the request of the government, because of rationing of PPE masks, and gowns, and things like that. But all that care came back in – in May, and June, and July – as those restrictions were loosened.
And then in July, when we saw a ramp back up – or spike of cases – in a lot of markets that we’re in: the Southwest, and the South in particular – by that point, the practices were able to stockpile PPE. So the system didn’t have to shut down scheduled surgery. It just put the surgery in a place that would – away from where the COVID patients were. So, inpatient facilities were preserved for taking care of COVID patients. And then the outpatient care facilities – which is what we primarily invest in – were able to take care of the rest of the population if you will – the rest of the healthcare needs of the population.
So, again – in the end, a strong quarter for us. Stock prices reacted strongly to that just this past week. And just this week, we announced Fitch investment grade rating that’s one notch higher than our rating from the other agencies. We think we deserve a higher rating from the other agencies, but anyway, Fitch certainly recognized that. And I think our strong cash collections reflected that.
BRAD THOMAS: Yeah. Well, I’ve had a couple questions, John, with some of our current subscribers – and two of those questions really resonate around technology, and how technology is impacting positively to the medical space. But what negative impacts could you see, or what do you see, in regards to the Teledoc – telemedicine? Is that a trend that you think could potentially be disruptive to your sector?
JOHN THOMAS: You know, it could be disruptive to the need for clinical office space, certainly. But I think the net net that we believe is a very positive for the healthcare industry, and for the physician community in particular: creates a lot of efficiency, it’s a very convenient service for patients, a very low-cost option for payers. We’ve had the technology for years, and three years ago, we really studied – kinda thought about this strategically, and said, “What parts of our business could be impacted by a rise in telehealth – and other technologies – that would reduce the need for the patient to actually physically go to a Medical Office Building, like we own?” And there are certain specialties that can be very disrupted by telehealth: psychiatry – that’s one you really can do a lot, through the telehealth vehicle, versus going to an office setting.
Where we have always focused our attention but really (unintelligible) three years ago, is we focused investments in procedural based medicine. So oncology facilities that do radiation, surgical facilities, and specialties that are highly focused on surgical procedures, like orthopedics, general surgeons, spine surgeons, and things like that. It’s that encounter that can’t be disrupted by telehealth – but what can be done is the follow-up visits, and some of the pre-visits can be done telehealth. So it’s very efficient for the provider, and now they’re going to get paid for it. Until COVID, there really was no payment model for telehealth. Now they’re getting paid for it. Now it’s very efficient for them. It allows them to spend more time in the OR, take care of more patients, if you will. And, so we see it as a net net positive.
The last thing I wanted to share about telehealth in particular, is a lot of clinical offices or medical offices in modern design have not taken into account: the need for a physician to have a HIPAA-compliant room in their office to communicate with patients. That typically is non in-person in the clinic room, or in a clinic setting, the exam room. So we think a lot of our physicians will need to restructure some of the space in their offices to provide for that telehealth, HIPAA-compliant room, which would create some efficiency for them. And then at the same time, generate more revenue, which is EBITDAR for us.
BRAD THOMAS: Yeah, and along those same lines, this is another subscriber question – really had to do with: do you see any opportunities out there where you could provide capital, i.e., loans that could potentially could be incorporated into lease structures for financing more technology for the physicians? Are you seeing an increased demand in that, or is that something that you all consider when you negotiate with a physician’s practice, in terms of providing them capital – other than the brick and mortar capital?
JOHN THOMAS: Yeah, exactly. So, tenant improvement allowances often allow for – and they often facilitate – investments in equipment, medical equipment in the practice, as well as internet and other technology that can be incorporated into the physical plan of those offices. In that example I was just giving you about – we haven’t had those kind of requests yet, but we think tenants will be looking to install greater technology capability, telecommunication, internet capability, 5G capability. And we certainly would be happy to work with our tenants to facilitate that. We’ve looked at this for several years as well, as: “Could we just plug a better internet pipeline into our buildings, and then charge $0.10 more rent?” – or something like that. And I think now there may be more opportunity to do that, than ever before.
While I think some telehealth, certainly, will happen from home, so it will happen from vacation homes – we’ve had surgeons tell us that they’ve been so busy, and they were like: they couldn’t do anything in April. And then they were so busy in May, June, and July – that now they still want to go have some summer vacation, but they can bill telehealth follow-up visits with their surgical patients – from their vacation house. But the vast majority of that’s going to be done back in the office, once people get on a more normal routine, just create more efficiency.
BRAD THOMAS: So let’s talk about – in terms of – have you guys gone on offense yet, or are you still playing defense? What do you see in terms of growth opportunities, primarily in acquisitions out there? Are you still actively seeking new opportunities, or just staying on the sideline?
JOHN THOMAS: Yeah, I mean we’re being conservative and cautious, but we’ve got the strongest balance sheet we’ve ever had. Our debt to EBITDA is lower than it’s ever been. Our stock has rebounded pretty well after April. In particular, we started being able to prove out the rent collections that we were getting, and the stability of our portfolio, and stability of our underlying tenants. We were all stressed at one level or another, but bottom line is: the stock price has been strong.
We raised a lot on the ATM, and so we’ve got a lot of dry powder. We’re looking for opportunities right now, and think we’ll make some investments this quarter, and some in the fourth quarter. Hard to predict how much yet, but what we’ve seen is pre-COVID pricing for Medical Office – on a cap rate basis, if you will – it’s still where trades are occurring. But at the same time, the quality of the credit, and the quality of the underlying real estate – balanced with that pricing – is what we’re looking for. So, being very picky, being very conservative, but we will start acquiring assets, soon.
BRAD THOMAS: So in terms of cap rates, I know the Duke deal portfolio sell, set the bar in terms of pricing. Where are you seeing pricing today? Is it low 5%s – in that range? Or what’s the market looking like today, in terms of pricing?
JOHN THOMAS: Yeah, so the market’s been looking at pre-COVID, and talking very bluntly about today or directly about today. But pre-COVID, best-in-class assets were trading at a 5.25%, low 5%s to mid-5%s ranges. And that’s still the pricing today. We’ve got our pipeline surely focused on about a 5.5% to 6% first year cash yield cap rates. And so we’re finding opportunities there. Not huge volumes of opportunities, but we’re finding attractive opportunities in that range. And so I think for now, the cap rates will stay in that range between 5%, low 5%s to 6%, for higher quality investment grade, high-quality physician group tenants. Again – once again, just like 2008, 2009 – Medical Office has proven the resiliency of the asset class – even now, more than ever, in this pandemic.
BRAD THOMAS: Well, of course, one thing that differentiates your company from some of the direct peers is the longer-term leases, and investment grade operators or tenants. Do you see an opportunity in this COVID environment to conduct some sale-leasebacks? Do you see that – is there any more opportunity out there – with direct financing – with some of these hospital systems?
JOHN THOMAS: Yeah. We’re seeing more – in the near term, we’re seeing more short-term demand for new development opportunities, directly with the health systems. We’re getting involved in discussions with several right now, who were planning some things, stalled with COVID – and then, now, have to ramp back up those plans – they may have tweaked a little bit, ’cause I think people are learning what they need in a Medical Office Building, on or off campus, that may be different than pre-COVID. So we’re incorporating some of that, and we anticipate there’ll be some hospital monetizations to restore capital accounts, capital balances – as they’ve been impacted, both on their stock endowments and investments.
But also, COVID’s had a huge hit on the expense side, in particular. And then, its hospitals had to shut down the scheduled surgery, and elective surgery – during April and March. That was a big hit to revenue, which – that revenue can come back, as we talked about before, but they’ve already burdened the expenses from COVID – so, it’s gonna be a tough year for hospitals. No, I mean, it’s obvious from all the financial data, all you’re seeing from the reports – a lot of them are being supplemented pretty heavily by the government, and that’s showing up in positive cash flow. But we do expect some hospital monetizations – in 2021. And that’s what we’re really planning for.
BRAD THOMAS: Ok. And I guess, forward looking, using analysts’ consensus, we see about 6% growth in – excuse me, 3% in 2021. 6%, this is our consensus analysts in ’20. So, and so our model looks pretty good in terms of future. But looking back at the historical trends since you listed shares, you started out with a – I know we’ve talked about this in the past – your payout ratio was practically 100% when you listed, but you’ve gradually been able to get that payout ratio down, to a really more manageable level. How do you feel about that payout ratio today, especially in this COVID-19 environment?
JOHN THOMAS: Yeah. I mean, we’re preserving cash. We don’t need to cut the dividend by any means. We had the best FAD margin again this past quarter we’ve ever had. And that was a tribute to a loaded lease roll. Which again, you mentioned, we have those long-term leases, which again, requires very little CapEx to keep tenants happy and in the building – lease commissions and things like that, that you encounter with a lot of lease roll.
And then, we think we can continue to widen that spread, as we can get back to some accretive growth – again, cautiously, in the near term, but more aggressively in 2021. So, we’ve got good coverage today. We anticipate to continue to grow that coverage, and should position us well for a dividend increase in the future. But we think there’s a lot of top line growth. We think the most important number is the bottom-line growth with our FAD growth. And we’re well positioned to continue to grow FAD, much stronger.
BRAD THOMAS: Great. Well, John, I think that’s about all my questions here. I want to thank you again for jumping on this call. Hope everybody’s safe there, and look forward to seeing you here: I guess the next one will be the Virtual Nareit. But hopefully we’ll see you in person soon, but wish you the best. And thank you again for joining us today.
JOHN THOMAS: Thanks for your time, Brad. Hope all your family is safe as well, and look forward to seeing you in person soon – in the next Zoom.
BRAD THOMAS: Thank you.
JOHN THOMAS: Thank you, Brad.
Happy Investing
Brad Thomas is Senior Research Analyst at iREIT and CEO of Wide Moat Research LLC. With over 30 years of real estate experience, he is also long-time Editor of Forbes Real Estate Investor, a monthly subscription-based newsletter that dives deep into the vast world of profitable properties, and since 2021, he has served as an adjunct professor at New York University.
Thomas has also been featured on or in Forbes magazine, Kiplinger's, U.S. News and World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. And he was the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020 and 2021 based on both page views and number of followers.
Thomas is the recently-published author of The Intelligent REIT Investor Guide (2021), co-author of The Intelligent REIT Investor (2016), and he wrote The Trump Factor: Unlocking The Secrets Behind The Trump Empire (2016) - all available on Amazon.
Thomas received a bachelor of science in business/economics from Presbyterian College and is married with five wonderful kids.
