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Healthcare Realty Trust  (NYSE:HR)
Q4 2018 Earnings Conference Call
Feb. 14, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the Healthcare Realty Trust Fourth Quarter Financial Results Conference Call. (Operator Instructions) Please note this event is being recorded. At this time, I would like to turn the conference over to Todd Meredith, CEO. Please go ahead.

Todd Meredith -- President and Chief Executive Officer

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 a few opening remarks followed by Ms. Mancini with an update on Healthcare trends, Mr. Douglas will review operating and financial results and then Mr. Hull will finish with a discussion on investment activity before we move to Q&A. Carla?

Carla Baca -- Director, Corporate Communications

Except for the historical information contained within, the matters discussed in this call may contain forward-looking statements that involve 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 2018 and in subsequently filed Form 10-Q. 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, EBITDA 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 fourth quarter ended December 31st, 2018. The Company's earnings press release, supplemental information, Forms 10-Q and 10-K are available on the Company's website.

Todd Meredith -- President and Chief Executive Officer

Thank you, Carla. A shift in capital cost during 2018 changed the investment outlook for most REITs, including Healthcare Realty. We were fortunate to enter 2018 with a strong balance sheet and a well-positioned portfolio, which afforded us the patience to rely on the performance of our existing portfolio and avoid capital issuance. We deliberately matched targeted asset sales with selective new investments, improving the safety of the Company's portfolio and increasing the potential for higher growth. Importantly, in a period of rising capital costs, we held leverage at the low end of our projected range throughout the year.

The Company's 2018 investments remain centered on existing health system relationships and markets, expanding our presence in attractive MSAs such as Seattle and Denver. Dispositions consisted of non-MOB properties, including a few legacy in-patient facilities and also some MOBs in less desirable markets affiliated with weaker, for-profit hospital operators, reducing our already modest exposure to both CHA and tenants. Healthcare Realty's medical office portfolio performed superbly in 2018 with same-store NOI growth averaging right at 3%, well above most MOB portfolios.

This performance was bolstered by strong underlying fundamentals, high tenant retention, positive rent bumps and cash leasing spreads and steady occupancy, telling signs of robust demand for medical office space. Health systems continue to shift care to lower cost outpatient settings and expand their physician networks to meet rising utilization from an aging population while adapting to reimbursement and cost pressures. Healthcare Realty's FFO per share improved in 2018, primarily from internal growth offset in part by higher interest rates and the sales of several legacy assets at unfavorable cap rates earlier in the year. Funds available for distribution were in line with dividends paid for the year.

While we could have reduced certain capital expenditures to increase dividend coverage in the short term, we chose to make strategic investments that would create value in the years ahead. We do expect to make incremental progress on dividend coverage in 2019 and steadily moving forward. As we entered 2019, our investment outlook is much brighter than a year ago when a pullback in public equity prices drove a gap relative to steady private asset valuations. That gap has narrowed substantially and with the growing number of quality individual properties under consideration, as many as we've seen in some time, we currently see a more constructive environment for external growth.

We also continue to pursue a measured pace of development and redevelopment, a proven avenue to generate long-term value for shareholders and health systems as they expand their outpatient capabilities. The majority of these opportunities will come from our embedded pipeline estimated at more than $750 million, where we have more insight into demand for medical office space and a greater ability to control the development decision-making process.

With the steadier economic backdrop, improved capital markets and momentum in our acquisition and development pipeline, we expect 2019 external growth to be more robust than last year. These investments play an important role in delivering accretion over time, especially when they are additive to internal growth and reinforce the safety investors expect for medical office buildings. Bethany?

Bethany Mancini -- Associate Vice President, Corporate Communications

The healthcare environment in 2018 showed signs of stability and growth, providers and hospital companies position themselves to take advantage of favorable demographic shift in emerging market demand. The need for physician services and outpatient facilities continues to rise. Outpatient care increasingly represents one of the best solutions for health systems, doctors, insurers, government programs and patients alike. It offers lower cost, better margins and enhanced access to care across market. The nation's healthcare spending reflects the importance of hospital and physician services comprising approximately 53% of the $3.5 trillion in annual US healthcare expenditures.

Healthcare Realty remains committed to investing in medical office facilities aligned with investment-grade health system. In our experience, it matters greatly who you invest with, who has the means to navigate the stresses as well as opportunities of today's healthcare environment. Larger regional health systems and their hospitals that are well located operate on average at positive profit margins amid a landscape of smaller independent hospitals that are struggling to remain relevant and profitable. Such hospitals are looking to partner with larger systems as are physician groups, many of whom are seeking to align with dominant health systems in their market.

Scale and market share lead to higher payer rates, lower cost, expansion of outpatient services, less financial risk and improved performance. Outpatient revenues for hospitals nationally have reached approximately half of total hospital revenues and are projected to surpass in-patient care. Employment also continues to rise in ambulatory care settings and physician offices. This trend benefits Healthcare Realty's MOBs and development initiatives and the credit quality of our hospital-centric tenants. Regulatory and reimbursement volatility also impacts who we partner with. Scale and growth provide health systems and physicians a significant buffer against reimbursement pressures.

Larger systems are expected to be able to better adapt when alternative payment models and value-based care eventually overtake fee for service and drive future reimbursement. The status of healthcare legislation is mostly stalemated for now. With a divided Congress, any major healthcare initiative is most likely off the table this year except for the appeal of the Texas Federal Court ruling last December that declared the Affordable Care Act unconstitutional. The ACA currently stands in effect, however, for the duration of the lengthy appeals process. As we approach the 2020 election, we expect political rhetoric to ramp up around Medicare and ACA.

But the forefront of health policy action this year is expected to remain at the state level and with the Trump administration focused on improving insurance markets and containing pharmaceutical cost. CMS continues to refine and expand Medicare's site neutral policy, commonly referred to as 603, first introduced in 2015. These policies are intended to curtail rising healthcare costs by lowering payments for services in hospital-based off campus facilities to bring them in line with physician payments for the same services. As of January 1st, 2019, CMS is no longer grandfathering higher rates for clinical visits in off-campus facilities.

We estimate this ruling will reduce Medicare payments over the next two years for off-campus hospital outpatient care by approximately 3% to 5%, suggesting weaker reimbursement and reduce tenants stickiness ahead for off-campus hospital-based outpatient facilities. With the lowest exposure to off-campus properties among its peers, Healthcare Realty is more insulated from these site neutral initiatives. In our experience, the attraction of on-campus MOBs to clinical providers is about more than reimbursement rates, it is the symbiotic relationship tenants have with the adjacent hospital.

It means greater accessibility to save outpatient services for a higher acuity patient base and it means valuable efficiency for specialist to coordinate advanced patient care, diagnostic imaging and surgery. The need driven dynamics inherent to on-campus medical office facilities foster stable occupancy and steady internal growth for Healthcare Realty as we continue to invest in this sector. Kris?

Kris Douglas -- Executive Vice President and Chief Financial Officer

The fourth quarter of 2018 much like the year was defined by the continued strong performance of our same-store properties. As expected, normalized FFO for the fourth quarter increased $900,000 over the third quarter of 2018 to $49.1 million, primarily due to the reversal of third quarter seasonal utilities and normalized FFO per share improved to $0.40. For full year 2018, normalized FFO grew 7.2% to $195.3 million and FFO per share increased 2.7% to $1.57. These results reflect our continued success harnessing operational efficiencies. As evidenced, total trailing 12-month same-store revenue and NOI increased 2.7% and 2.9% respectively.

And quarterly, year-over-year NOI improved 3.6%. Single tenant same-store NOI increased 3.3% on a trailing 12-month basis, tracking higher than the weighted average in-place contractual escalator of 2.45% due to the benefit of two leases with non-annual escalators in late 2017. The benefit of these non-annual escalators will dissipate over the next year. Also in 2019, there are two single tenant net lease expirations. In July, a lease with Encompass for an inpatient rehab facility will expire. The annual rent is approximately $2.2 million. The facility is located on a UPMC acute care hospital campus in Erie, Pennsylvania. We do not expect Encompass to renew the lease but UPMC has expressed interest in purchasing the building for redevelopment.

The second expiring in August is an inpatient rehab facility in Los Angeles operated by an acute care hospital. The rehab facility is located on an acute care campus, where we also own five MOBs. The hospital has a renewal option that if they exercise, the rent will be greater than or equal to the existing annual rent of $2.5 million. The hospital has exercised two previous renewal options for this facility. The multi-tenant portfolio continued to perform well in 2018 with annual same-store NOI 2.9% higher than 2017. Revenue and revenue per occupied square foot increased 2.7% and 2.8% respectively over the prior year. Operating expenses increased 2.5%, which is at the high-end of our historical range due to 5.3% growth in property taxes primarily in Texas. If property taxes had grown at a more long-term norm, operating expenses would have increased 1.9% and NOI would have been north of 3% further demonstrating the health of our underlying portfolio.

Our ability to drive revenue growth is a result of a continued emphasis on in-place contractual increases and cash leasing spreads. For leases commencing in the fourth quarter, weighted average future annual contractual increases are 3.18%, driving the average in-place contractual rent increase up to 2.91% from 2.72% two years ago. Spreads in the fourth quarter were down 0.5% and for the year were up 3.4%. Two leases totaling 50,000 square feet caused this quarter's dip in spreads. A tenant in Des Moines, Iowa, exercised a renewal option with a stated renewal rate. This negative spread renewal option was known at the time of the acquisition and accounted for in our purchase price. With the other lease, we negotiated an early renewal of a major tenant in an off-campus building in new Memphis to obtain a longer-term and higher annual escalators.

Without these two deals, spreads were 3.8% for the quarter, which is in line with our long-term expectations. This strong performance combined with tenant retention of 83% for the quarter and 84% for the year demonstrates the sustainability of our internal growth model. In 2019, we have 2.7 million square feet of multi-tenant leases expiring, which affords us the opportunity to continue improving revenue drivers. One notable expiration in July of 2019, that I mentioned last quarter, is a 111,000 square foot fitness center that occupies approximately half of an MOB on the main downtown Baylor Campus in Dallas. The hospital no longer desires to be in the business of operating a fitness center but wants to maintain wellness services on the campus and recommended an experienced operator they have worked with on other projects, who is interested in leasing up to half the space.

We're also exploring redevelopment options for clinical use with medical office rates in the building more than 50% higher than the current fitness center rate. Even with this expansion, we expect portfoliowide tenant retention north of 80% for 2019, bolstered by the fact that 89% of the multi-tenant leases maturing are located in on-campus buildings. For the fourth quarter, the FFO payout ratio was 77%. FAD for the fourth quarter and the year was equal to dividends paid. Excluding unusual items we discussed in previous quarters totaling $9 million for the year, the 2018 FAD payout ratio would have been 94%. These items include dollars for move-in ready suites and delayed acquisition capital as well as investments to position assets for future sale.

Debt-to-EBITDA at the end of the quarter was 5.1x consistent with recent results and at the lower end of our target guidance of 5x to 5.5x. Looking ahead, our strong internal growth and liquidity provide a solid footing to pursue external investments through properties that deliver reliable returns. Rob?

Robert Hull -- Executive Vice President, Investments

During 2018, we saw a strong private bid for MOBs, including several large portfolios. While for much of the year, the public markets remained disconnected from these private valuations, Healthcare Realty was able to make attractive investments. We acquired eight buildings, a portion of which were value-oriented for $111.5 million at a blended first-year yield of 5.7% and funded $35.6 million toward four development and redevelopment projects.

Acquisitions were intentionally balanced with $98.7 million of dispositions. Sales in the first half of the year totaled $55.8 million, including seven buildings subject to a fixed price purchase option and five rural skilled nursing facilities. In the second half of the year, sales totaled $42.9 million at an average cap rate of 6.3%, comprised of two on-campus MOBs in second tier markets associated with four profit hospitals. one in-patient rehab facility and one off-campus MOB. Our investment activity for the year illustrates a continued rotation into higher quality properties with greater growth potential. During the fourth quarter, acquisitions totaled $37 million at an estimated first year yield of 5.1%.

In Chicago, we purchased a 15,000 square foot surgery center suite on the first floor of a previously acquired MOB for $5.1 million at an expected first year yield of 5.9%. Healthcare Realty's investment now totals $34.2 million in the 114,000 square foot building, which is 94% occupied and attached to Ascension's 318-bed St. Alexius Medical Center. Last year, Ascension continued its expansion and commitment to the Chicago MSA with the acquisition of Presence Health adding 12 hospitals to its network. In Nashville, we purchased our corporate headquarters for $31.9 million at an estimated first year yield of 5%. We occupy 34% of the 109,000 square-foot building, which is 78% leased. Ownership of the property gives us greater control over occupancy cost. As our lease expiration was approaching, rent was projected to increase significantly, likely more than 60% if we chose to relocate into new construction.

Additionally, the building is estimated to yield more than 6% once it reaches stabilized occupancy, propelled by institutional ownership and Midtown, Nashville's increasingly tight office market. For 2019, we're initially targeting new acquisitions of $150 million to $200 million at cap rates in the low to mid-5s, primarily made up of stabilized buildings with some room for additional value investing. Our current investment pipeline is healthy with $47 million under contract and negotiations under way for a few additional MOBs.

Turning to development. I'll point you to Page 13 of the supplemental for new disclosure about the expected timing of cash NOI and occupancy as a ramp up to the current lease percentage of our projects. Development remains a path to owning some of the best MOBs. We continue to target $50 million to $100 million in new development starts for the year, largely driven by our $750 million embedded pipeline. Currently, we're planning a few projects expected to start later this year. As is often the case with on-campus developments, timing of starts can shift with hospital priorities and physician recruitment. Dispositions during the quarter provided a source of fund for investment.

We sold two MOBs and one in-patient rehab facility for $33 million at a blended cap rate of 6.9%. The two MOBs were located in slower growing markets on tenant and community health campuses. The sale of the inpatient rehab facility further reduced our exposure to this asset class bringing it to 2% of NOI today versus 8% three years ago.

During 2019, we expect sales of $75 million to $125 million at a combined cap rate range of 6% to 7.5%. With the opportunity to increase volume, should we see a compelling use of proceeds. Looking across all of our investment activities including acquisitions, development and dispositions, we are pleased with the early momentum we have generated coming into 2019.

Todd Meredith -- President and Chief Executive Officer

Thank you, Rob. Operator, that concludes our prepared remarks. We're ready to begin the question-and-answer period.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question today will come from Chad Vanacore of Stifel. Please go ahead.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

Can you help us square our outlook for the transaction market in 2019? I think you implied that the acquisition environment was losing but your cap rate guidance implies 25 basis points tighter at the midpoint year-over-year. So are you seeing more M&A opportunities though(ph) pricing remains elevated?

Robert Hull -- Executive Vice President, Investments

Yes. I think what we're seeing is a good pipeline of individual opportunities. You know, the past few years have been really dominated by portfolios in the market and this year, we're seeing some good individual opportunities, high quality. And on average, we're seeing them in the low to mid-5. So I think where we've seen some slight increases in cap rates has really been in the off-campus and the lower quality assets. So it's not typically an area where we play in. So our cap rate range really is indicative of the assets that we're pursuing.

Todd Meredith -- President and Chief Executive Officer

Chad, I would also add that as Rob mentioned in his remarks a few things that we did in terms of acquisitions in '18 had a bit of a value component such that the occupancy was a little less than stabilized and I think that also impacted our cap rate and our guidance for '18 and I think really if you look at the individual market, we haven't seen much of a change for the good quality assets as Rob said.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

Todd, is it fair to say you're basically focused on stabilized assets in 2019?

Todd Meredith -- President and Chief Executive Officer

Generally. We're OK with adding some assets that might have a little less occupancy if we see it in a strong market, somewhere we have experience and some insight into the ability to lease up that asset. So it's not that we're shy about doing some of that. I think just sort of what we see in our pipeline may have a little more tilt toward that stabilized side but it wouldn't surprise us to also be acquiring a few things that might have a little room for a lease up as well.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

And next question on your outlook, you've got the high end of cash leasing spreads that's reduced for 2019 from 2018, so came in at lower end of the range. What do you see out there that's driving that range lower in 2019? And I might add it looks like you've got a decent size of rent renewals slated for 2019?

Todd Meredith -- President and Chief Executive Officer

Yes. You know, if you look at our guidance for cash leasing spreads of 3% to 4%, you would've heard us kind of talk about that range for many years that we think that that's the appropriate long-term range for cash leasing spreads and the final results are really going to depend on the mix of kind of the tails of the distribution in terms of how many that you're able to generate that are greater than 4% versus those that may be zero to negative. In this quarter, we did have negative spreads in the quarter because we had little bit more on that bottom tail. But assuming that that bottom tail stays kind of like it was for the year and 2018 maybe 10% of your renewals then our expectations is that for the long-term, 3% to 4% spreads are certainly achievable.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

All right. And you mentioned this quarter having lower cash leasing spread and that's related to two leases essentially. So what market conditions led to kind of a rent roll-down there?

Kris Douglas -- Executive Vice President and Chief Financial Officer

On those two, there were specific situations. One of them actually had a stated renewal rate embedded inside of their option, renewal option. And that was known when we bought the facility, and was reflected in our cap rate, which was higher anticipating the exercise that renewal would roll down. The second was at an off-campus building, it was a major tenant where you want to make sure you are managing your lease role in that type of situation. And so we actually executed that renewal a couple of years early and locked that tenant in for a longer-term as well as higher bumps. So I would say it's not specific to market conditions it's more of just individual circumstances.

Todd Meredith -- President and Chief Executive Officer

And Chad, I would say that if you do pull those two specific or unique deals out, we looked at all the other renewal activity in those particular markets for '18 but also going back to '17 and actually saw some very strong, above 4% type of cash leasing spreads. So we don't think it's indicative of the market broadly. it's unique to what Kris described.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

Got it. Is there anything like that in 2019, which you'd just consider in our guidance?

Kris Douglas -- Executive Vice President and Chief Financial Officer

No. As I said, in any particular quarter you're going to have some negatives, some zeros and negatives. And it really have to do with your overall average is going to be the mix of that. We think that 10% kind of like we have for the year is not unreasonable. We've looked at it over the last four, five years and we've kind of averaged in that 5% to 10%. Every lease is not going to roll up all the time but it's about managing your exposure to those potential roll-downs and being able to take advantage of specific circumstances, where you may be able to get some higher than average spreads as well.

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

Got it. Thanks for the questions.

Operator

Our next question will come from John Kim of BMO Capital Markets. Please go ahead.

John Kim -- BMO Capital Markets -- Analyst

Good morning. I had a question on your guidance. Your same-store NOI growth was sector-leading and looks like think that's going to continue this year. However, your FFO growth has lagged same-store for each of the last three years for various reasons. Looking to FFO growth for 2019, do you see any events that may be dilutionary(ph) to your organic growth?

Kris Douglas -- Executive Vice President and Chief Financial Officer

No, as you look at 2019, as you mentioned, we've had a couple of things over the last couple of years that have impacted our FFO growth including, as Rob mentioned, the purchase options in '18 as well as the skilled nursing facilities that we sold. As you look at those, we actually sold them pretty close to the middle of the year in '18. So there will still be some impact that rolls through in 2019 as a result of those dispositions. Beyond that, I would say it's just kind of a typical mix of acquisitions to disposition cap rates that Rob has gone through. Nothing material in terms of the averages like we saw in '18, but you will continue to have that as you recycle assets into better properties that have better long-term growth.

Todd Meredith -- President and Chief Executive Officer

And I think the other situation that Kris mentioned was this lease in Dallas that -- again it's not huge relative to the total picture for the Company. But it's certainly the timing of how that plays out when we're able to backfill the operator on that fitness center and how quickly we can redevelop some of the additional space could also have an impact. But aside from those things, I think we see a strong year as you've described.

John Kim -- BMO Capital Markets -- Analyst

I'm not sure if you touched upon this in your prepared remarks but this year you have 21% of your leases expiring, which was an increase from what you reported last quarter for this year. Were those short-term leases that got extended and are part of this figure now?

Kris Douglas -- Executive Vice President and Chief Financial Officer

Yes. And you'll see that every year as you roll from third quarter to fourth quarter just from the distribution of leases, you end up with some that you signed that are one year, maybe even a little less as well as some that are going to be on the longer term. But on average, our renewals are running kind of in that 3% to 4% range and our new leases are running in the five to seven year range.

John Kim -- BMO Capital Markets -- Analyst

Okay. And than finally on the site neutral implementation this year, how long do you think that takes to play out as far as reduced tenant retention and demand for off-campus?

Todd Meredith -- President and Chief Executive Officer

Well, in our view, as Bethany described, 3% to 5% impact on just their Medicare payments is probably pretty small initially because Medicare might be 25% to 30%, a third of their business. It, obviously, could vary depending on their service lines. So it's not a huge impact. I think it does take a while to play out. I think the incentives though that are out there is exactly how this drives behavior and what we saw was when there was this opportunity to buy physician practices, roll them into a different billing structure at a higher rate. That's what Medicare or CMS saw several years ago and said, we're seeing a spike in this activity, which is kind of arbitraging reimbursement and that's what they looked at to try of curve with this change, as we call it 603. And I think again, it will probably be more about curbing incremental development and arbitrage on these reimbursement levels. But it's not going to necessarily make everybody abandon that strategy. There's still other reasons to be in different locations distributed throughout A community with those type of services. So it's really just at the margin, the incentives and where you might see more or less activity and we think at the margin that should be favorable to on-campus.

John Kim -- BMO Capital Markets -- Analyst

Great. Thank you.

Operator

Our next question will come from Jordan Sadler of KeyBanc Capital Markets. Please go ahead.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

I had a question on the acquisition environment, just follow-up for you Rob. So what is the change at the margin that you feel like you're seeing in the environment this year as we sort of look forward that gives you a little bit more confidence that you could double the acquisition volume?

Robert Hull -- Executive Vice President, Investments

Yes. I think as we entered 2019, and just looking at your pipeline, and it's a healthy pipeline and we've got some properties, I mentioned $47 million worth of properties under contract. Right now, we're having good dialogue on a few others. And we haven't seen that level of volume this early in the year in quite some time. The last two years has been more portfolio driven in terms of the volumes out there and we're seeing more individual properties that fit well in our criteria. So it gives me confidence that this early in the year, we're off to a strong start and make me optimistic on the year.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Okay. And what's sort of the catalyst there that you're -- do you shake in a couple of these loose because of pricing? Or is there a fund life that's up?

Robert Hull -- Executive Vice President, Investments

I think pricing has remained consistent year-to-year in the low to mid-5s. I think you're seeing some sellers come out and say OK there's some stabilization in the market in terms of cap rates and so I think they're taking the opportunity to say, hey, we've got a window here after we've had a number of portfolios in the marketplace that have really dominated the interest of the buyers. And so now -- you don't have that right now. And I think they see a window to take advantage of some of the strong pricing that's out there and some of the money that's out there to make trade on their asset.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Okay. And then just -- I'll stick with you for a second here on your crown acquisition this quarter of the headquarters building. The 5% cap, is that on in-place NOI including your in-place rent? Or is that a reflection of the potential 60% mark?

Robert Hull -- Executive Vice President, Investments

Yes, that's on the in-place and it includes our potential rent. The building's 78% leased and we see an opportunity to stabilize the building and take the 6% north of 6%. You know, the Nashville market right now is one of the strongest in the country and you know it got low unemployment, low vacancy rate in our market and rents have been escalating in a cliff(ph). So we think it's a good opportunity to take advantage of that.

Todd Meredith -- President and Chief Executive Officer

But I will say that the -- to your question, I think Jordan the 5% cap does not include a 60% markup to our rent to be clear. But we do see rent to push, as Rob said, overtime as we can stabilize the building and return it to a stabilized level.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Okay. What are you guys paying on a per foot basis these days?

Todd Meredith -- President and Chief Executive Officer

We're right at $28 gross.

Robert Hull -- Executive Vice President, Investments

With parking, go up $30 gross.

Todd Meredith -- President and Chief Executive Officer

And new buildings in Nashville Class A office are easily over $40 approaching mid-40s.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

That makes sense. And then I only have Kris out here. Kris, any impact from -- I didn't see or hear anything on the lease accounting changes. Anything -- you're expecting to see anything in 2019?

Kris Douglas -- Executive Vice President and Chief Financial Officer

No. We're already expensing our internal leasing cost. So we're not going to have any additional lease expense related to the change in the lease accounting.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Good. That's just perfect. One more follow up just on this expiration you talked about in July at Baylor, the fitness center. Is that one of the single tenant leases representative of the 153,000 or is that in the multi-tenant bucket?

Kris Douglas -- Executive Vice President and Chief Financial Officer

No. That's in the multitenant.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Okay. And how much capital would you have to throw with that to get the 50% increase in rent you think?

Kris Douglas -- Executive Vice President and Chief Financial Officer

Rob, you?

Robert Hull -- Executive Vice President, Investments

Yes, you know, we look at it as a redevelopment. So typically, you're going to go in and you're going to repurpose those suites and so you're looking at a gut and a repurpose. So you'll probably end up $60 to $100 a foot range to get that ramp.

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Okay. Thanks, guys.

Operator

Our next question will come from Kevin Egan of Morgan Stanley. Please go ahead.

Kevin Egan -- Morgan Stanley -- Analyst

Hi, thanks for taking my call. This is Kevin on for Vikram. Just a quick question in terms of the CapEx expectations for this year and perhaps the next couple years? Just in terms of the number of new leases that are rolling this year, is there a reason to think that maybe you could be at the higher end of that CapEx expectation, again, like you were in 2018? Or was basically the 2018 CapEx, was that kind of perhaps CapEx you were investing in anticipation for the leases rolling in for '19?

Todd Meredith -- President and Chief Executive Officer

Yes. We do have a bit more roll and so that plays into kind of the range that we have put together. I will point out that in our actual spend for '18, there were also some unusual items that I've mentioned, including some capital for some speckly space that we did spend about $4 million in '18. But a bigger piece is that we actually had some properties that we were positioning for a potential disposal in the years ahead in '19/'20 and beyond where we signed longer than average lease terms approaching 11 years on renewals compared to our typical average of more of three to four years. And as a result, the dollars on the CapEx were higher. So we spent about $6.4 million related to those leases in 2018. So that's what pushed our second gen TI up to and above the original expectation that we had had for the year. We don't have that level of spend in terms of positioning assets expected in 2019 and that's part of what has given us the confidence in the guidance ranges that you have laid out for 2019.

Kevin Egan -- Morgan Stanley -- Analyst

Okay. Sounds good. Thank a lot.

Operator

Our next question will come from Jonathan Hughes of Raymond James. Please go ahead.

Jonathan Hughes -- Raymond James & Associates -- Analyst

Thanks for the time and the commentary. On the acquisition volume guidance, I'm sorry to keep pressing on this after we talked about it a while with Chad and Jordan, but my question would be is the acceleration in deal activity a reflection of your improved cost of capital and would have been lower had you issued guidance, say, two months ago? Why not maybe just go out with flat acquisition guidance from last year and surprise to the upside. Just trying to understand the mechanics there.

Kris Douglas -- Executive Vice President and Chief Financial Officer

Well, I would add that it certainly has helped to see the stock price and, obviously, debt cost come down a bit, but stock price go up a bit. But I would say most of what we're looking at in the pipeline was really there, come at late(ph) in the year and before really the recent rally. So yes, it may help you a little bit with confidence on those but I would say it was really more about criteria and controlling quality by looking at individual properties versus some of the larger portfolios, as Rob said, that seem to be really kind of consuming the mind share over the last year or two.

So it's really more a function of sticking to our criteria and just seeing more that fits rather than just price. And again, we don't really see a big shift. Rob mentioned low to mid-5% and if you look at our last year, you pull out may be a value-oriented 1% or 2%, you'd find the same level of cap rate and the same would be true for '17 if you pulled out a larger portfolio that we did in Atlanta. The rest of them would be sort of low to mid-5%. So we're not really seeing a lot of change in cap rate or just say, hey, we can pay more. It's more about the quality and the flow of individual properties.

Jonathan Hughes -- Raymond James & Associates -- Analyst

Okay. That's helpful. And then turning to the CapEx. The second generation CapEx guidance in redevelopment spend guidance, we had the Dallas lease in the second gen bucket that comes out of FAD and it sounds like maybe that's actually baked into the redevelopment spend but not in FAD. I just want to make sure that if Dallas is in fact in that redevelopment guidance?

Todd Meredith -- President and Chief Executive Officer

Not at this point. It's that lease expires closer to the midpoint of the year, and as I mentioned in my prepared remarks, we are working with a new operator who may come in and operate about half of that space. And any TI associated with that would be more in our second gen spend. If we did do a larger redevelopment of the space, that would fall into the redevelopment capital. But we have not determined that we're doing that at this point and we have not earmarked those dollars and if they did occur, they would be back-end loaded in '19 and wouldn't materially shift our redevelopment capital budget.

Jonathan Hughes -- Raymond James & Associates -- Analyst

Okay. That's great. And then just one more. I think Rob you might have mentioned, you locked in a tenant for a longer lease in this past quarter kind of drove the negative spread there, but you got higher bumps. But just the longer lease term kind of struck me as something you don't normally do. I'm just curious there you're still sticking with that kind of more shorter-term lease strategy even though that obviously comes with more frequent leasing commissions that detract from your ultimate FAD.

Todd Meredith -- President and Chief Executive Officer

Yes. That property is actually an off-campus asset. And so I would say, we do manage our lease roll a bit different in those in terms of your risk, because especially given the size of that potential tenant, more of a unanchored tenant in that off-campus building that we wanted to make sure that we had kind of locked them up for a longer term. So I would say, no, there's no change in kind of our leasing strategy. But you do have to look at it a bit differently on those off-campus situations versus the on-campus. We still have very many of the off-campus. So you don't hear us talking about it very much, but we do kind of look at those a bit differently.

Jonathan Hughes -- Raymond James & Associates -- Analyst

Okay. That's great. That's all I had. Thanks for the time.

Operator

Our next question will come from Daniel Bernstein of Capital One. Please go ahead.

Daniel Bernstein -- Capital One Securities -- Analyst

Good morning. I know you just said you don't have many off-campus assets. But have you seen with the 603 site neutral rules, any shifts in like LOIs or inquiries for on-campus space versus the off-campus? Just trying to get a sense of -- if there's any leading indicators of change in behavior?

Todd Meredith -- President and Chief Executive Officer

Not yet, Dan. I think it's early. This went in effect January 1, unless there's a particular plan in place in their looking outlook. You see, you'd have to catch them at the right moment when they're out looking and, obviously, any expiration that could come up could be an interesting indicator and we haven't seen that yet either. So I think it'll play out. Maybe, we'll get some indications this year. Again, we don't have a whole lot of, but maybe to your point, we see a little of the benefit in some of our on-campus assets.

Daniel Bernstein -- Capital One Securities -- Analyst

Okay. So we'll have to just wait and see. And then you also talked about, if you took out a few items from last year additional CapEx, your payout ratio would be around 94%. Is that kind of a target we should think about for later this year going into 2020, as to where you think your payout ratio will be or where you want it to be?

Todd Meredith -- President and Chief Executive Officer

We certainly think we'll make a little progress in '19, but we do, as Kris, mentioned, have an elevated amount of leases rolling that certainly we don't necessarily expect to spend more per foot per lease here, but when you just multiply it by that many square feet it adds up, and it's in our guidance. And so we see that, obviously, applying some continued pressure there on the payout ratio. And we also expect to invest, make a couple of investments in one of the areas, that Kris mentioned, the make-ready suites. We've seen some nice traction there with some leasing of those types of suites. So we continue to do some of that. So we'll see some progress. I think certainly mid-90s, we'd like to move that direction. And then in 2020, we'd certainly like to move even lower than that. So that's sort of the path we see. But I think it will be more incremental in 2019 and better in 2020.

Daniel Bernstein -- Capital One Securities -- Analyst

Okay. And then, just to go back to the acquisition side. Have you seen a change in the composition of sellers and buyers? And by that I mean, the REITs have generally been pretty active on the MOB side. There's been some indications they're going to continue to be active. Obviously, you increased your guidance as well. So are you coming across more REITs as competition? And then same thing on the seller side, has there been any change in that composition as well?

Robert Hull -- Executive Vice President, Investments

I think certainly the REITs have come back into the space, into the market, last year early on, most of the transactions were purchased by or the properties were purchased by the private buyers. And then late in the year you saw the REITs enter into the space again with a couple of large transactions that were announced by some of the other REITs. I think that for 2019, I mean, I think we'll continue to see similar competitors out there bidding on properties, both REITs and the private side. I don't see that letting up in favor of one or the other. So really not much change.

Daniel Bernstein -- Capital One Securities -- Analyst

Okay. And hospitals aren't monetizing assets any more than they had been in the past, just same type of seller composition?

Robert Hull -- Executive Vice President, Investments

No, I mean, I think it's the same story, Dan. I mean, I think you hear about certain hospitals thinking about monetizing. Occasionally, you'll have one that comes out and sells assets. But nothing that seems to be any different than the past few years.

Daniel Bernstein -- Capital One Securities -- Analyst

All right. I appreciate all for taking my questions. Thank you.

Operator

Our next question will come from Todd Stender of Wells Fargo. Please go ahead.

Todd Stender -- Wells Fargo. -- Analyst

Hi. Thanks. My, I guess, biggest question is the dividend. I know you kind of start to flesh(ph) it out there. But the payout ratio, just as we're looking at, is inching toward a 100% and if you're still buying in the fives and selling in the sixes, you've got pretty good lease roll this year, which is good. Your rent spreads are positive, but it's going to take some TI spends. So just wanted to see if you could flesh it out a little bit more on how you're going to improve the dividend? I think it's a tall task.

Todd Meredith -- President and Chief Executive Officer

Sure. Thanks, Todd. I think the main driver, obviously, is internal growth as you mentioned, same-store. Acquisitions, obviously, can help but as you said, those spreads can be fairly thin relative to cost capital and, obviously, the sort of lower yields and dispositions as a source of funding. We do see that gap coming down between -- rotation between acquisition and disposition based on the market and also what we might be selling versus what we experienced in 2018. So that will be certainly a source of improvement. We had quite an impact from these higher cap rates in '18 that we shouldn't see repeat to that level or that volume in '19 and '20.

So that will certainly help. And then I think, as Kris described earlier, we certainly -- even though we have the elevated lease roll, we see overall maintenance CapEx really being more in line with this past year. So it shouldn't be elevating necessarily. So if you put all that together, I think you can see modest progress in '19 and then obviously in 2020 is where we see more progress being able to be made. And I think the other sort of wildcard in there, and somebody touched on it earlier, is the acquisition volume, and certainly the cap rates on that. We certainly have indicated a better acquisition outlook this year than last, by the numbers almost double of potential. But we also see an ability to potentially move that up as the year progresses. If it doesn't, that's fine too but there is the chance that we could see a bigger year just based on the pipeline that Rob was articulating. So all those things I think add up to some modest improvement in '19 and more in 2020.

Kris Douglas -- Executive Vice President and Chief Financial Officer

And Todd, the only thing I would add there is if you actually go back four, five years, if you look at our FAD payout ratio, we were well over 100%. So we've actually been moving it down in the last year or two because of some of the dispositions and a couple of other items that we discussed. Yeah, it's kind of taken a bit of a pause and didn't have the same trajectory down that we've had but some of that has been decisions that we made to invest capital that is flowing through FAD, but does have future value, so you can really look at that as investment capital but it does put a bit of a pressure on the short term potentially on your payout ratio. But we still think it's the right long-term decisions to drive overall value.

Todd Stender -- Wells Fargo. -- Analyst

All right. That's helpful. And then just back to acquiring your headquarters.You got $32 million into it. How much you're going to put in as far as CapEx to drive occupancy higher? And who's going to manage the building?

Todd Meredith -- President and Chief Executive Officer

We will manage it internally. We do have quite a bit of property here in Nashville and think that we can handle that. We're already doing that. And in terms of capital, certainly we have some CapEx, some planned acquisition capital is how we categorize it that we certainly plan to spend to improve the building, make some noticeable changes. Some of that's visible, some of that's more infrastructure related. And we think that's been somewhat deferred by the prior owner. So we're looking forward to some of those improvements certainly impacted sort of our decision as to whether we were staying or going. So buying the building solved that for us. So probably a few million dollars -- up to a few million dollars over a couple of years for those types of items and then obviously as the leasing occurs, there would be additional TI dollars or commissions related to that.

Kris Douglas -- Executive Vice President and Chief Financial Officer

And Todd that capital is taken into account in terms of our cap rate.

Todd Meredith -- President and Chief Executive Officer

Yes...

Kris Douglas -- Executive Vice President and Chief Financial Officer

And so it's -- we fully load it and bake it to the cap rate that we disclose.

Todd Stender -- Wells Fargo. -- Analyst

Okay. Thank you.

Operator

(Operator Instructions) Our next question will come from Lukas Hartwich of Green Street Advisors. Please go ahead.

Lukas Hartwich -- Green Street Advisors -- Analyst

Thanks. Hi, good morning. Was the headquarter purchase off-market or was that a marketed deal?

Kris Douglas -- Executive Vice President and Chief Financial Officer

Off-market.

Lukas Hartwich -- Green Street Advisors -- Analyst

Okay. And then another just quick one. And I know it's small, but it looks like the preleasing on the Charlotte redevelopment came down a bit. What drove that?

Robert Hull -- Executive Vice President, Investments

Yes. Lukas, if you notice in the disclosure, we changed the square footage that was associated with that development. Previously, we were showing 204,000 square feet, which is the size of the total building and that leasing percentage was 87%, last quarter was associated with all 204,000. What we've done this quarter is we've isolated disclosure to just the redevelopment piece, the 38,000 of additional square footage that we're adding, which is where all the capital is being spent. And so the 81% is reflective of the lease percentage of that 38,000 square feet.

Todd Meredith -- President and Chief Executive Officer

And no change. So there was no difference in leasing from last time. Just the segmenting as Rob said.

Lukas Hartwich -- Green Street Advisors -- Analyst

Got it. Thank you.

Operator

Ladies and gentlemen, at this time we will conclude our question-and-answer session. I'd like to turn the conference back over to Todd Meredith for any closing remarks.

Todd Meredith -- President and Chief Executive Officer

Okay. Thank you everybody for joining the call this morning. We'll be available for follow up if you have any additional questions and we hope you have a great day. Thank you.

Operator

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.

Duration: 60 minutes

Call participants:

Todd Meredith -- President and Chief Executive Officer

Carla Baca -- Director, Corporate Communications

Bethany Mancini -- Associate Vice President, Corporate Communications

Kris Douglas -- Executive Vice President and Chief Financial Officer

Robert Hull -- Executive Vice President, Investments

Chad Vanacore -- Stifel, Nicolaus & Company -- Analyst

John Kim -- BMO Capital Markets -- Analyst

Jordan Sadler -- KeyBanc Capital Markets -- Analyst

Kevin Egan -- Morgan Stanley -- Analyst

Jonathan Hughes -- Raymond James & Associates -- Analyst

Daniel Bernstein -- Capital One Securities -- Analyst

Todd Stender -- Wells Fargo. -- Analyst

Lukas Hartwich -- Green Street Advisors -- Analyst

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