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Physicians Realty Trust (NYSE:DOC)
Q4 2018 Earnings Conference Call
Feb. 27, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Greetings and welcome to Physicians Realty Trust's Fourth Quarter and Year End 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, during the conference, please press "*0" on your telephone keypad. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Bradley Page, Senior Vice President, General Counsel. Thank you. You may begin.

Bradley Page -- Senior Vice President, General Counsel

Thank you, Rob. Good morning and welcome to the Physicians Realty Trust Fourth Quarter and Full Year 2018 Earnings Conference Call and Webcast. With me today are: John Thomas, Chief Executive Officer; Jeff Theiler, Chief Financial Officer; Deeni Taylor, Chief Investment Officer; John Lucey, Chief Accounting and Administrative Officer; Mark Theine, Executive Vice President of Asset and Investment Management; and Lauri Becker, Senior Vice President and Controller.

During this call, John Thomas will provide a summary of the company's activities and performance for the fourth quarter of 2018 and the year ended 2018, as well as our strategic focus for 2019. Jeff Theiler will review our financial results for the fourth quarter of 2018 and year ended 2018 and will provide our thoughts for 2019. Mark Theine will provide a summary of our operations for the fourth quarter of 2018. Following that, we will open the call for questions.

Today's call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. They are based on the current beliefs of management and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although we believe our assumptions are reasonable, our forward-looking statements are not guarantees of future performance. Our actual results could differ materially from our current expectations and those anticipated or implied in such forward-looking statements. For a more detailed description of potential risks, please refer to our filings with the Securities and Exchange Commission.

With that, I would now like to turn the call over to the company's CEO, John Thomas.

John Thomas -- Chief Executive Officer

Thank you, Brad. Good morning and thank you for joining us today. This time last year, we told you we expected 2018 would be a year to recycle capital, to place an extraordinary focus on operations, and to position Physicians Realty Trust for 2019 and beyond. We executed on that plan through the work of our talented team, as we focused on investing better.

Our goals were largely accomplished through the selling of $220 million of older, less strategically valuable properties throughout the year. Those proceeds were reinvested in the four highest-quality properties in the country occupied by high-quality health system clients in existing relationships.

No property better represents this focus on quality than the North Side Medical Midtown medical office building located in the Midtown neighborhood of Atlanta. This 165,000 square foot facility is fully leased through and occupied by Northside Physicians' outpatient services and affiliated medical professionals. This property was nationally recognized by Healthcare Real Estate Insights, our industry's leading trade publication, with a 2018 HREI Insights Award for the Best New Medical Office Building of the Year. This achievement marks the fourth such HREI award winner in our portfolio and we are proud Northside Hospital selected DOC to own that building.

In 2018, we evaluated every facet of our organization with a goal to increase revenue and decrease expenses and we accomplished our specific financial goals by 150%. Away from the income statement, our team worked together to define the DOC difference through our mission, vision, and value statements. These efforts illustrate who we are and how we deliver results to our people, our shareholders, our providers, and our clients.

DOC's on a mission to help medical providers, developers, and shareholders provide better healthcare, better communities, and better returns. We are dedicated to making a difference in the lives of our team members, investors, healthcare partners, and those who visit our properties. We do this by offering broader and deeper healthcare expertise than any other REIT, by crafting solutions that benefit all parties, and by leveraging our long-standing industry connections to source and sustain the highest quality facilities and tenants in the industry.

We articulated our core values with the acronym "CARE." We collaborate and communicate with internal and external stakeholders, we act with integrity, we respect the client relationship, and we execute consistently. By driving our organization to make decisions and manage our investments with care, we will fulfill our mission and achieve our vision.

We'd also like to share more about Physicians Realty Trust's commitment to sustainability and the ESG. We have developed a G2 sustainability philosophy, a practical approach in which being green through our capital initiatives equates to a green cash result with cost savings over time. This outlook ensures the integrity and the economic viability, operational efficiency, natural resource conservation, and social responsibility within our network nationwide portfolio.

In 2018, DOC spend approximately $2.8 million on sustainability-driven capital expenditure projects within the portfolio. These efforts include LED retrofits, building automation system upgrades, and façade replacements, resulting in both immediate and long-term energy savings. The company also consolidated telecommunication bills, which reduced cost and created cash management efficiencies.

In 2018, Physicians Realty Trust was certified by the independent analysts at Great Places to Work. We also earned a spot on the Milwaukee Journal Sentinel's 2018 list of Wisconsin's top workplaces.

The diversity of our employee base remains a top priority for our company. I'm proud to share that women and minorities comprise 23% of our leadership team and 57% of our larger team. On our Board of Trustees, 29% of the independent trustees are a woman or a minority.

Because of our commitment to our CARE core values, the company provided over $180,000.00 in philanthropic support to charitable causes nationwide while participating in meaningful volunteer opportunities with our team.

We are proud of our ESG progress in 2018, but understand that we can always do more. We will continue to invest in initiatives that improve our overall sustainability performance and support our long-term goals.

With this attention to detail and invest-in-better mentality, we ended the year with a high-quality portfolio of medical office facilities. As of December 31, 2018, approximately 96% of our 13.6 million square feet is leased, with 90% of our space on campus or affiliated with a healthcare system and an average lease term of 7.9 years. This focus on quality extends to our tenants, with 57% of our leases being signed by investment-grade quality entities or their affiliates, a metric that leads the medical office space. It's these tenant relationships that are the catalyst for Physicians Realty Trust growth.

By working with the best health systems in the best markets, our opportunity for organic growth is second to none. In the past, we had funded new development conservatively. Moving forward, we believe we can generate higher returns by increasing capital allocations to new developments. This strategy includes backing the best healthcare developers who have projects pre-leased at high rates to high-quality health systems. Projects like Northside Medical Midtown in Atlanta is a prime example of this hospital-driven, self-development model. We support these efforts as well.

Today, we mentioned the closure of the El Paso surgical hospital. In December, we learned that the operator of the hospital announced they were closing at the end of the year. The hospital was very successful for many years and while the facility had challenges in 2018, the ownership, including Physicians, invested millions of dollars to recruit and employ new physicians in the market, open new services, and upgrade the facility over the last few years. The facility never missed a rent payment but, surprisingly, closed with three weeks' notice and has not yet paid its December rent.

Most of the key physicians were both owners of the tenant and employees. Fortunately, the physician tenants were quickly reemployed by a wholly owned subsidiary of Sierra Providence, Tenet Healthcare's wholly owned subsidiary in El Paso, and we executed a new 10-year lease on the facility at terms better than the existing lease.

We have a number of national healthcare systems actively evaluating and interested in either leasing or purchasing the now vacant hospital. We have received and are evaluating offers to purchase and/or lease the facility and are confident we will have a new tenant in the facility in the near-term. While a disappointing surprise, the strength of this location in the healthcare market and the physicians historically aligned with the facility we believe will allow us to quickly address the situation.

Also, as noted in our press release this morning, we are proud to announce three promotions. Our Board of Trustees has promoted Mark Theine to Executive Vice President of Asset Management, recognizing his strong leadership and growth as a leader in the company. Mark's career began when he was hired by our founder, John Sweet, to help build and run the private company that is the predecessor company to DOC and became an original officer of DOC as a senior vice president upon completion of our IPO.

Mark is responsible for managing the daily operations of our portfolio, which has grown from 19 buildings and 500,000 square feet at the time of the IPO to over 250 buildings and almost 14 million square feet today. In the beginning, he managed a handful of internal employees and third-party property managers and, today, due to our growth, directly or indirectly manages over 100 people.

In addition, the Board promoted and expanded the responsibilities of John Lucey, recognizing his contributions as our Chief Accounting and Administrative Officer. John joined our organization immediately following our IPO as our principal accounting officer and his leadership and ability to scale our team as we have experienced significant growth has been critical to our success. John leads our accounting, SEC and public company reporting, human resources, information technology professionals, and oversees other administrative responsibilities as well.

Among many of John's accomplishments was his decision to hire, mentor, and develop Laurie P. Becker, who rose quickly through the organization. We are pleased to announce Laurie has been promoted to Senior Vice President and Controller. Laurie will continue to report to John Lucey across his many responsibilities, with a direct focus on accounting and SEC reporting.

With that, I'll turn it over to Jeff.

Jeff Theiler -- Chief Financial Officer

Thank you, John. In the fourth quarter of 2018, the company generated funds from operations of $49.9 million or $0.27 per share. Our normalized funds from operations were also $49.9 million and $0.27 per share. Our normalized funds available for distribution were $44.7 million or $0.24 per share, representing an increase of $1.2 million after adjusting for last quarter's one-time benefit from the lease termination fee.

For the full year of 2018, the company generated funds from operations of $1.08 per share, an increase of $0.04 over 2017, and funds available for distribution of $0.94 per share, an increase of $0.01 over 2017. This represents the fifth consecutive year of per share FAD growth, a 38% increase, overall, from 2014's $0.68 per share return.

Our fourth quarter investments were limited to $9.8 million of funded mezzanine loans, which will generate a weighted average yield of 8.3%. The company's full-year acquisitions were largely funded by the disposition of 34 non-core assets, with $220 million of proceeds used to acquire $252 million of Class A real estate, highlighted by the $82 million Northside Medical Midtown MOB.

It's common knowledge that 2018 was a very difficult year for external growth for medical office building REITs. Our cost of capital was constrained by our share price, which was much lower than warranted for the entire year. In addition, we faced very aggressive bidders for medical office buildings in the private market, both from private equity buyers, who have recognized medical office as a core asset class and, therefore, have lowered their required returns for owning it, and by the large diversified public healthcare REITs, who are rapidly diversifying away from the ever-worsening senior housing industry.

Against this backdrop, DOC focused on making significant operational improvements in asset management by directly hiring property managers in Ohio and Kentucky and positioning itself with premier health systems and development groups to partner on their most important facilities going forward.

It was because of this work in 2018 that we can now predict $200 million to $400 million of off-market transactions at cap rates between 5.5% and 6.25%, assuming our cost of capital remains favorable. Importantly, the pricing on these transactions does not reflect lower asset quality but rather a recommitment to the off-market and partner-driven growth strategy that has cemented DOC as the MOB owner of choice during the past five years. This proven strategy will enable DOC to build concentration with key health systems and widen our existing lead in investment-grade tenancy, while we reward our shareholders with earnings accretion.

We still maintain six assets in our "slated for disposition" bucket, with a net book value of $98 million. These assets are 78% leased and are performing well but we have determined that they no longer fit our core strategy, so we will dispose of them if and when we can get to the right price. Two of these assets were classified as "held for sale" last quarter because of a signed purchase contract but the buyer was unable to secure the necessary financing so they have been removed from that category this quarter.

We had very little capital markets activity in the fourth quarter, with just a small amount, $2.4 million, issued on the ATM. Our balance sheet remains strong, with less than $77 million of debt maturing over the next four years, all of which are existing mortgages with a weighted average interest rate of 4.1%. Our net debt to adjusted EBITDA RE is 5.6 times and our debt to total capitalization is less than 34%, providing lots of flexibility.

Our portfolio remains highly leased at 96% of total DOA and 53% of the space is leased to investment-grade rated health systems or their subsidiaries. Each of these metrics lead the MOB REIT universe. Northside Hospital, our third-largest tenant at 3.5% of portfolio DOA, does not currently issue public debt but would most certainly be investment-grade rated if they did.

Our 96% leased same-store portfolio generated cash NOI growth of 1.3%, excluding the six properties slated for disposition. If we included these properties, the NOI growth would be 1.9%. G&A expense was $6.7 million for the quarter, bringing our total 2018 G&A to $28.8 million, within the expected range announced at the end of last year.

Connected in our earnings release and John's address in his prepared remarks, the tenant transition that we are working through at our El Paso specialty hospital and MOB. We have already released the MOB at comparable lease rates and have been working with many interested parties for the hospital asset. But until we are able to finalize a new lease, we will experience a drag on FFO and FAD of approximately $800,000.00 per quarter.

In terms of 2019 projections, we've already mentioned the $200 million to $400 million of off-market investments at cap rates of 5.5% to 6.25%, although the timing of those investments is uncertain. We also anticipate G&A expense of $31 million to $33 million, which, like 2018, will be temporarily elevated in Q1 due to expensing of stock bonuses and then tail back down. We anticipate CapEx will be less than 10% of NOI again, as we seek to maximize the amount of rent that flows through to the bottom line for our shareholders.

We don't utilize a repositioning bucket for underperforming assets so it is difficult to predict our overall same-store NOI growth for 2019, as that number will be influenced by the speed at which we finalize a tenant replacement in El Paso, but we continue to expect 2% to 3% of cash NOI growth on a long-term basis.

I will now turn the call over to Mark to walk through some of our operating statistics in more detail. Mark?

Mark D. Theine -- Senior Vice President, Asset and Investment Management

Thanks, Jeff. We started 2018 with key objectives for the operations team, including driving organic growth through proactive asset management, improving the quality of our portfolio, and expanding our property management platform.

As we look back at last year, we have achieved these key goals. In 2018, same-store NOI growth for the full year was 3.1% or 1.9% if the one-time termination fee at the Fox Valley MOB is excluded. As Jeff mentioned, fourth quarter same-store NOI growth was 1.3%, driven by a 1.8% increase in rental revenues, 20% increase in operating expense recoveries, and offset by an 18% increase in operating expenses. This larger than usual year-over-year increase in operating expenses is attributable to the rise in real estate taxes at the Baylor Cancer Center, as well as MOBs in Austin and Houston. The increase in operating expense recoveries to offset this rise in taxes demonstrates the inflated nature of our cash flow from triple net leases.

In 2018, we significantly improved the long-term quality of our portfolio by selling 34 older and smaller assets. These properties averaged 31,000 square feet each, were 82% leased, 25 years old, and only had 27% investment-grade rated tenants. We recycled the capital from the sale of these assets into four new properties totaling 620,000 square feet. These new acquisitions averaged 155,000 square feet each, were 96% leased and only 5 years old, with limited CapEx needed in the future. Three of the four 2018 acquisitions were with existing tenants in the portfolio, demonstrating DOC's position as their preferred real estate owner.

Stepping back and reviewing our progress over the last few years, we have improved the quality of our portfolio substantially through both acquisitions and dispositions, including the disposition of nearly half of the legacy IPO portfolio. Simply stated, DOC's portfolio transformation is real. Three years ago, 26% of our tenants were investment-grade rated, compared with 53% today, and 84% of our Top 10 tenancy is investment-grade rated. We believe these new investments will provide outstanding returns for years to come and reflect the standard of exceptional quality for our acquisitions in the future.

Speaking of our Top 10 tenants, we would like to congratulate Catholic Health Initiatives and Dignity Health on completing their merger and rebranding under the new name, Common Spirit Health, effective February 1st.

Turning to our portfolio, in 2018, we completed over 1 million square feet of leasing activity. In the fourth quarter, specifically, we completed 270,000 square feet of leasing activity, with positive leasing spreads of 3.9%. In total, we completed 146,000 square feet of lease renewals, with an average lease term of 8.8 years, resulting in a tenant retention rate of 53%. The retention rate, however, was 77% in Q4 if you exclude the El Paso specialty hospital that John previously mentioned. We also completed almost 125,000 square feet of new leases, with an average lease term of 11.8 years.

We continue to see strong leasing momentum from our hospital partners for new space and the ability to push rent and annual rent escalators in lease renewals. In fact, 90% of our leasing activity in 2018 contained an average rent escalator of 2.5% or greater.

We are proud to report that fourth quarter rent concessions were low, with no free rent and very little TI required to renew our existing healthcare provider partners. Approximately 60% of the leases renewed in the quarter did not require any TI and the remaining 40% averaged $1.57 per square foot per year. Tenant improvements for new leases were approximately $2.29 per square foot per year during the quarter.

In 2018, we invested a total of $19.8 million in tenant improvements, recurring CapEx, and leasing commissions, or just 7% of the portfolio's cash NOI. The low investment capital expenditures relative to our peers is driven primarily by the physical quality of our buildings we have bought, attention to deferred maintenance, and our low lease expirations scheduled during the year.

In 2019, we expect capital investment to continue to trend on course at approximately $4 million to $5 million per quarter.

As we begin 2019, we have built a high-quality portfolio, operated by exceptional asset management and leasing teams that continue to deliver bottom line results. We successfully expanded these teams recently by replacing third-party property managers and directly hiring managers to the DOC team in Kentucky and Ohio, markets representing approximately 1.1 million square feet or 15% of our multitenant portfolio.

As always, our commitment to relationships and service excellence for our healthcare partners nationwide is the trademark of the DOC difference, ultimately driving tenant retention, cost efficiencies, and profitable, consistent growth for our shareholders.

With that, I'll turn the call back to John.

John T. Thomas -- Chief Executive Officer

Thank you, Mark. We'll now take your questions.

Questions and Answers:

Operator

At this time, we will be conducting a question-and-answer session. If you'd like to ask a question, please press "*1" on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press "*2" if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing "*". One moment, please, while we poll for questions.

Our first question comes from Michael Carroll with RBC Capital Markets. Please proceed with your question.

Michael Carroll -- RBC Capital Markets -- Analyst

Yeah, thanks. First, I want to talk a little bit about the El Paso move out and why did the system decide to shut down its operations and is that normal versus trying to sell the practice? I'm assuming that they were just not very profitable in 2018.

John T. Thomas -- Chief Executive Officer

Yeah, Mike, it's hard to explain. It was a surprise to us, as we said in my comments. We had about three weeks' notice. And, as I said, they had never missed a rent payment and the hospital had been very successful for a very long time. So, the physicians that were employed there and were also part owners were as surprised as we were. So, can't explain the decision but it was made and, like I said, working with the physicians, quickly moved both their employment and the lease to the medical office facility that they occupied to Tenet Healthcare and have a lot of interest in the facility. So, not a great situation but we think it's short-term.

Michael Carroll -- RBC Capital Markets -- Analyst

Yeah. So, it's encouraging that you got the MOB released so quickly. I guess, can you talk a little bit about the interest in the property? I know you mentioned that you may sell or release it. Why do you think you can do it so quickly and do you think you'll be able to get this done at similar value and/or rate as the prior lease?

John T. Thomas -- Chief Executive Officer

Yeah, we do believe that. And three national healthcare operators are actively touring it, evaluating it, looking at data and due diligence from us, and building a business pro forma around it. El Paso is still a growing community. It's fairly tightly bedded on any kind of bed-to-population standard. And, more importantly, this facility has 10 ORs. It was primarily a surgical hospital and the orthopedic surgeons who were part owners and employees who are still there in the community want to come back and start practicing in it again. So, it's a very desirable location and place, particularly for physicians and efficiency for both inpatient and outpatient surgery.

Michael Carroll -- RBC Capital Markets -- Analyst

Is the hospital physically opened right now? And if it's not open, is that an issue in terms of trying to sell it or release it?

John T. Thomas -- Chief Executive Officer

No, it's secured and locked up and we're taking care of it, obviously, but whoever -- if one of the other hospitals in the community opens it, they can open it under their license and do it pretty quickly. If somebody wanted to come in on a de novo basis, it would take a little more time but still wouldn't take too much time. So, the hospital could be up and operating within days, depending on which hospital operator decides to lease it from us.

Michael Carroll -- RBC Capital Markets -- Analyst

Great. Thanks. And, finally, I guess, John, can you provide some comments on the new reimbursement change that was enacted on January 1st related to the Section 603 assets? I know that DOC has been pretty optimistic on those properties over the past few years. Does that new payment schedule alter your view on those properties?

John T. Thomas -- Chief Executive Officer

No, we still are attracted to off-campus outpatient care facilities, particularly if they are leased to a credit-quality health system, which is what 603 is all about. The AHA, the number of hospitals that are suing CMS over the payment cut, because it's directly contrary to the plain language of Section 603, there's a bipartisan letter that came out of the Senate with, I think, 70 or 80 signatures. I don't think they have any problem addressing the situation if they have to do it legislatively. But bottom line is we underwrite every facility based on what its current revenue and what its current reimbursement rates look like. We're not dependent upon just the statute and the regulatory protection as the basis for our decision. It's really about what are the services there, how much revenue are they generating.

As you said, physicians in non-hospitals can be successful in locations like that. So, it's a nice addition with the grandfathered status and we think it's particularly valuable for the long-term renewal rates of the hospitals in those locations to protect that grandfathered status. So, bottom line is we still underwrite every facility and monitor every facility on our current basis based upon what CMS is paying them.

Michael Carroll -- RBC Capital Markets -- Analyst

Okay. Great. Thank you.

Operator

Our next question comes from Jonathan Hughes with Raymond James. Please proceed with your question.

Jonathan Hughes -- Raymond James -- Analyst

Hey, good morning. So, it sounds like El Paso tenant clearly wasn't on the watch list and that was unexpected. Are there any other tenants on the watch list that lease large spaces with expirations over the next few years?

John T. Thomas -- Chief Executive Officer

Jonathan, I think our watch list and issues that we've had to deal with in the past is healthier than ever and stronger than ever. We certainly evaluate -- when we brought in and created the credit watch group and underwriting team that reports to Jeff, one of the things that they went back and did is went through all our leases and started tracking down financials and monitoring that and have visibility on the vast majority of all of our tenants, particularly all of our large tenants of any size. So, that's been a very helpful team to build and they're doing a great job. So, again, still working through the sale of the hospital in El Paso and probably a change of ownership in San Antonio, which will be an enhancement overall, but those issues have been largely taking care of themselves.

Jonathan Hughes -- Raymond James -- Analyst

Okay. And then on the G&A guidance, maybe a question for Jeff. I think that includes some vesting of maybe restricted shares in the first quarter and that goes back down through the rest of the year. I think we saw the same thing last year. Is this going to be a recurring item that we should be modeling in 2020 and beyond?

Jeffrey N. Theiler -- Chief Financial Officer

Jonathan, yeah, that's a great question. And you should be modeling that each year. I think you'll see a very similar pattern.

Jonathan Hughes -- Raymond James -- Analyst

Okay. All right. And now on the acquisition guidance, expected pricing there is in the high 5% to 6% cap rate range, a little higher from deals in this past year, and you mentioned that's a reflection of your relationship network. But maybe on the marketed deals that I assume you still evaluate, have you seen any change in seller pricing there on the MOBs over the past 6-9 months as interest rates have stabilized higher?

John T. Thomas -- Chief Executive Officer

I'd say we haven't seen a meaningful change, Jonathan. I think the four that have traded haven't measured up on a quality basis to, say, the Duke portfolio and there are some high-quality portfolios floating around right now. We'll see what those print at. But, for the most part, I think Jeff's dead on. We're seeing lots of great opportunities with our relationships at the cap rates that you suggested.

Jonathan Hughes -- Raymond James -- Analyst

Okay. Any interest in large portfolios out there?

John T. Thomas -- Chief Executive Officer

You know, Jonathan, we look at everything and evaluate everything that's on the market, but we tend to stay off-market and that's where we find the best value and have the best opportunities with our relationships.

Jonathan Hughes -- Raymond James -- Analyst

Okay. Fair enough. And then just one more. So, you used the ATM during the fourth quarter. Do you plan to utilize that, in addition to capital recycling from the "slated for disposition" bucket, to fund the external growth guidance?

Jeffrey N. Theiler -- Chief Financial Officer

Hey, Jonathan, it's Jeff. Certainly, we're going to look at both of those sources as we look to fund the pipeline. We're probably pretty near target leverage right now. So, it's going to depend a little bit on how fast we can generate these acquisitions and the interest that we can get in selling our properties slated for disposition. As we talked about, these are good properties and so we are looking for good pricing on them. So, that's going to factor into what sources of capital we're able to tap.

Jonathan Hughes -- Raymond James -- Analyst

Okay. That's it for me. Appreciate the color.

Jeffrey N. Theiler -- Chief Financial Officer

Thanks, Jonathan.

Operator

Our next question comes from Drew Babin with Robert W. Baird. Please proceed with your question.

Drew Babin -- Robert W. Baird and Company -- Analyst

Hey, good morning. Quick follow-up on the G&A front for Jeff. I know that the changes in lease accounting, you're expensing more property management type costs that you might have capitalized last year. I guess, can you quantify that impact to G&A and kind of confirm that that's sort of an AFFO-neutral change.

Jeffrey N. Theiler -- Chief Financial Officer

Yeah, Drew, I mean, so that is an AFFO-neutral change. As a practical matter, we didn't have a ton of G&A that we were capitalizing in that manner. We started to try to work toward this guidance implementation earlier. So, most of the G&A that you see is kind of an increase in the cost of running the company, increase in salaries and benefits for the best-in-class staff that we have. So, there's some benefit from capitalization but it's not a lot.

Drew Babin -- Robert W. Baird and Company -- Analyst

Okay. And I guess a related question as well. On the CapEx front, I think you mentioned in the prepared remarks that it would remain, I think, less than 10% of NOI. Looking at your 2018 results, it looked like it was maybe 7%. So, I guess, throwing the 10% out there, is that just sort of a general range? Do you expect the per square foot cost to rise significantly in 2019 or should they stay relatively consistent?

Mark D. Theine -- Senior Vice President, Asset and Investment Management

Hey, Drew, this is Mark Theine. Jeff threw out the 10% number but we're really working to manage our CapEx efficiently and be in the $4 million to $5 million per quarter in 2019.

Drew Babin -- Robert W. Baird and Company -- Analyst

Okay. That's helpful. And just one more from me on the $200 million to $400 million of investment guidance. Does that include any mezzanine or development-type fixed income investments or is that just pure property acquisitions?

Jeffrey N. Theiler -- Chief Financial Officer

Yeah, so that's going to be -- I guess that would be inclusive of acquisitions, some take-out type deals, and limited development. If we do mezzanine loans, you're going to see interest rates that are well above that range. Typically, our mezzanine rates of return are kind of in the 8% to 9% range.

Drew Babin -- Robert W. Baird and Company -- Analyst

Okay. That's all helpful. Thank you.

John T. Thomas -- Chief Executive Officer

Thanks, Drew.

Operator

Our next question comes from Jordan Sadler with KeyBank Capital Markets. Please proceed with your question.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Good morning. First question, regarding the acquisition guidance here, just drilling down. Is there line of sight to the $200 million to $400 million that you offered up a specific range?

John T. Thomas -- Chief Executive Officer

Yeah, Jordan, we've got a pretty good pipeline we're working on so line of sight to the midpoint of that number and expect that to appear pretty quickly.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

So, for modeling purposes, mid-year timing kind of works?

Jeffrey N. Theiler -- Chief Financial Officer

Yeah, I think that's right, Jordan.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Okay. And, Jeff, while I have you, the funding, you touched on it here, but what's embedded in the guidance in terms of funding and leverage for 2019?

Jeffrey N. Theiler -- Chief Financial Officer

Yeah, so, embedded in the leverage, I guess -- or, as I mentioned, we're at or near our target leverage. Right? So, you consider that to be 65% equity, 35% debt or so. So, for modeling purposes, that might be an easy way to do it -- 65% equity. The wild card is whether or not we're able to reach agreement on some of these assets slated for disposition. That will obviously affect the amount of equity issued.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

The dispos, are they solely related to the six assets in that bucket and does that bucket include El Paso?

Jeffrey N. Theiler -- Chief Financial Officer

So, the assets slated for disposition include the foundation El Paso asset, not the El Paso specialty hospital. That's not in there right now. We don't think it will be. So, those are assets, they've been in there for a few quarters now, and we just determined they're non-core and are looking to sell them. But, again, as you heard in our same-store remarks, I mean, they're performing well so there's not a huge -- we're not willing to take any price. We're willing to sell them at the right price.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Okay. They've been hanging out here for a while so I'm just curious. Is there an expectation this is a 2019 event or it's just we'll see what happens?

Jeffrey N. Theiler -- Chief Financial Officer

I mean, we thought we had -- we were close to selling two of them. We think we'll be close to selling two of them again, probably sooner rather than later. But, again, we're evaluating all prices that come in.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Okay. And just to clarify on the El Paso specialty hospital, did you -- I thought you mentioned in the prepared remarks that you may sell the asset. Is that right or did I mishear that?

John T. Thomas -- Chief Executive Officer

Yeah. At least three of the suitors, if you will, who are interested in the facility have inquired about a purchase or a lease. So, we're evaluating those options. We've received written offers that we're evaluating but our primary desire is to lease the facility again. The operators that are evaluating and interested in it are high-quality tenants that we would like to have a relationship with.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

And how should we think about the timing of the releasing and the two different pieces?

John T. Thomas -- Chief Executive Officer

Yeah. I mean, we think it's quick but it's hard to predict. But we think it's quick.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

First half or second?

John T. Thomas -- Chief Executive Officer

I think we'll have it resolved first half, it's just a matter of how quickly we can get them back in there and get it open and operating. It can be quick, just depending upon which one of the operators we end working a deal out with.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Okay. Lastly, on this term loan in Columbus that you've done in the first quarter, the $15 million, can you shed a little bit of light on that? One of your other investments here, you provided more color on this development loan, I'm just curious about the one that's in Columbus. It seems to have a little bit less detail in the release.

John T. Thomas -- Chief Executive Officer

Yeah, it's one of our large healthcare developer client relationships who took down some land and is in the process of finalizing the plans, has a lease with an investment-grade tenant. So, at this point, you can view it as a short-term bridge to the bigger development project. But we're evaluating whether or not we'll participate or work that deal out with him on the second project but, in the near term, it's a good investment and well-secured.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Is it an MOB?

John T. Thomas -- Chief Executive Officer

It's a large healthcare tenant.

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Okay. All right. Thank you.

Operator

Our next question comes from Vikram Malhotra with Morgan Stanley. Please proceed with your question.

Vikram Malhotra -- Morgan Stanley -- Analyst

Thanks for taking the questions. In your prepared remarks, you referenced taking some of the management internal to the DOC team. Just wondering, some of your peers have focused or emphasized the internal management and they outlined some savings and margin growth opportunities. I'm just wondering, does this signal or is this something you're looking to expand, in terms of doing more internal management?

John T. Thomas -- Chief Executive Officer

Yeah, Vikram, this is J.T. We're gonna continue to, in markets where it makes sense and where we have scale and we can gain those efficiencies. And there are some other markets where we're planning to head in that direction in the near term. I don't think we'll ever find it -- in some markets, it's better to work with our third-party partners, like we already do. They're the ones with the existing health system relationships and have brought us into those relationships with them and they're great partners. They do a great job. And in markets where we have scale and otherwise, it's our relationships that we're primarily working through, we're going to continue to in-house where we can.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. Just post the merger, the CHI-Dignity merger, can you maybe update us and provide your thoughts on is there potential rationalization post-merger? Are there candidates for disposition as you've now gone through the portfolio for a while, something, I guess, you may have thought about post the acquisition of CHI portfolio?

John T. Thomas -- Chief Executive Officer

Yeah. Great question. The short answer is no. They don't overlap in any markets today and we had lots of dialogue with them throughout their process of merging and getting their thoughts on which markets are going to support the best and where there might be some markets that they want to exit. So, as of today, we don't have any knowledge of any particular market that they plan to exit and we had pretty detailed conversations with them about this. As you know, CHI started the process of selling Kentucky One before they completed the merger with Dignity. So, they are continuing to process that sale. It's kind of unrelated to the Dignity merger.

We've got great relationships with Dignity and the combined C Suite there has a heavy component of the Dignity Health team but a lot of our CHI leadership that we work directly with are continuing on in critical roles in the organization. So, we're really excited about it. We think it's going to strengthen their balance sheet and strengthen their operations and strengthen the overall coverage of our facilities across the country.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. And then just on the development side, given the capabilities, some of your peers, maybe the more diversified ones, have outlined pipelines and partnerships with various systems, some of them stretching a couple of years. I'm just sort of wondering, can you kind of lay out opportunities over the next, call it, two years and what we can think of in terms of development contribution?

John T. Thomas -- Chief Executive Officer

Yeah, I won't put a dollar value on it but the clients that we have where we've done this consistently over the last couple of years and now that we're funding some development projects more directly with developers, we think the pipeline is pretty significant. I think we announced the one project today. That's with an existing developer relationship and an existing national credit-rated tenant and we think there's a pipeline with that development company and that particular tenant but there's also others, from Phoenix to Texas and other markets where we're actively working with the health systems. And we'll continue to invest in Georgia, where we have fantastic relationships and see more economic growth and opportunity there.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. And then just, last one, just to get a sense of the closure that you announced and then you're back, obviously, pretty quickly. But just given the surprise, in terms of you mentioned they were paying rent, never missed a payment, and suddenly decided to close, what does this mean for both underwriting but, more importantly, just monitoring? You have a new team, a credit team in place. And just what sort of information do you get? Describe some of the interactions that you have with the tenants just to sort of have some sort of heads up that it's not just going to shut down one fine day.

John T. Thomas -- Chief Executive Officer

Yeah, it's a great question, Vikram. We always evaluate that kind of situation. We've only had a small handful over the five-year life of the company. But, in all candor, we'd been working with that tenant, evaluating and monitoring them, and had been given every assurance that they were kind of continuing on and committed to the facility and the market. And then they did a 180 within weeks and closed. So, it's hard to explain how to change that result in that particular situation. But, like I said, the upside opportunity with the other operators that are interested in that facility are better.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. And this was in December, I believe. Correct?

John T. Thomas -- Chief Executive Officer

Yes.

Vikram Malhotra -- Morgan Stanley -- Analyst

Okay. Great. Thanks, guys.

John T. Thomas -- Chief Executive Officer

Thanks, Vikram.

Operator

Our next question comes from John Kim with BMO Capital Markets. Please proceed with your question.

John Kim -- BMO Capital Markets -- Analyst

Good morning. I'm just going to follow up on the El Paso discussion. I know you said you were surprised when they decided to close but now that you've had some time to examine it, what do you think happened? I know they had recent new ownership at the hospital but I'm wondering if there was also new competition in the area or there were reimbursement challenges or maybe something else.

John T. Thomas -- Chief Executive Officer

John, if I had a rational explanation for the decision, I would share it with you. I mean, best way to summarize it is that it's a national operator who had one facility in the market and decided to exit the market and do it on a moment's notice. We really had three weeks of notice before they closed the doors. So, it was no expectation at all. The physicians who were employed there and were part owners of the hospital had no notice either. And, like I said, it was a quick turnaround. That is a very strong healthcare market and there are two large, national operators that are there and they're very strong and tough competition for anybody. So, it may have been that they didn't think they could compete with them but they had for a long time and had been very successful for a long time. We really can't explain the situation but, like I said, we've got four good operators that we think will step in there.

John Kim -- BMO Capital Markets -- Analyst

And on the $800,000.00 per quarter impact, should we not assume there's a termination fee you can collect? And then is it realistic that this would translate into an annualized impact? Because even if you do lease it, it may take some time for a new hospital to come in and take physical occupancy.

John T. Thomas -- Chief Executive Officer

Yeah, I think we wouldn't anticipate a termination fee. We are pursuing, in their liquidation process, claims, but they're liquidating so we'll have to see how that plays out. But the reason we did quantify it by quarter, in particular, is we think it could be a quick turnaround resolution, but it depends upon which operator we end up working an arrangement out with. And it could be temporary, it could bleed into the year depending upon the ability to get the facility relicensed or brought under one of the existing licenses in town and we think that's a strong likelihood.

John Kim -- BMO Capital Markets -- Analyst

Okay. And then, Jeff, on your prepared remarks, you mentioned on the dispositions, they no longer fit your strategy. And I was wondering if you could provide some color on what those characteristics are.

Jeffrey N. Theiler -- Chief Financial Officer

Yeah. So, the disposition bucket includes one small building in Florida that it's just kind of away from the rest of our operations and it's a little bit isolated. So, that's the reason that one is in there. The other ones are in the foundation assets. Certainly, they are some of the first assets that we bought in the history of the company and we've been diversifying away from these surgical hospitals. And then there's an associated MOB with each surgical hospital so it kind of makes sense to sell those as a group. So, those are the reasons that they don't meet our strategy any more.

John Kim -- BMO Capital Markets -- Analyst

Got it. Okay. Thank you.

Jeffrey N. Theiler -- Chief Financial Officer

Thanks.

Operator

Our next question comes from Chad Vanacore with Stifel. Please proceed with your question.

Chad Vanacore -- Stifel Nicolaus -- Analyst

All right. Thanks. So, just one quick clarification on the retenanting of the El Paso assets. And so it looks like Tenet Healthcare but they're only renting about a third of the space. What was the makeup of the former tenants and why are we leasing only a third of this space or is there more to come?

John T. Thomas -- Chief Executive Officer

Yeah, Chad, so it's two buildings. One's a surgical hospital and one's a medical office building. And to be clear, the medical office building is not on the campus. It's an off-campus building that, primarily, the orthopedic surgeons who were employed by the hospital and were part owners of that hospital occupied at the time this occurred. So, we just turned around, they stayed right where they were, and changed their employment to Tenet and then Tenet signed a new lease on that building. So, the impact of this decision, about one-third of it was the MOB and that's what's been released. So, now we're working through with hospital operators who are interested in leasing and/or buying the hospital facility. It's a surgical hospital so not a huge building.

Chad Vanacore -- Stifel Nicolaus -- Analyst

I understand. Got it. Yeah. Just needed that clarification. And then just one other question from me. Sequential occupancy dropped in the fourth quarter a little bit. Were there any other vacancies that came up in 4Q that haven't been retenanted?

Mark D. Theine -- Senior Vice President, Asset and Investment Management

Chad, this is Mark. We actually had a positive net absorption for the fourth quarter, a small number if you exclude that El Paso hospital, but the drop in occupancy that you're referencing is a direct correlation to the El Paso facility.

Chad Vanacore -- Stifel Nicolaus -- Analyst

Okay. Perfect. That's it for me. Thanks.

Mark D. Theine -- Senior Vice President, Asset and Investment Management

Thanks, Chad.

Operator

Our next question comes from Daniel Bernstein with Capital One. Please proceed with your question.

Daniel Bernstein -- Capital One -- Analyst

Hi, good morning. Not to ask another question on El Paso but I feel like I have to. You said you weren't going to pursue a lease termination fee and I just wanted to understand. Did you not have something in there that was contractual? And, typically, in your leases, what's the typical length that somebody has to go ahead and give you notification?

John T. Thomas -- Chief Executive Officer

Yeah. So, to be clear, they didn't honor their lease, the terms or the financial terms, once they decided to close. So, we will pursue claims and I said I wouldn't expect a lease termination fee. This has been a long-term facility, been well-operated. This operator bought the operator who built it and ran it for a very long time with the physicians there and we owned it before they were involved. So, the relationship with that operator -- we didn't have anything extraordinary, credit enhancements, or guarantees from that operator standing behind that lease that they purchased from another party. We typically do and we typically get -- particularly if we're making a new investment with a new operator, we would get those kind of credit enhancements. It's a case by case basis. You don't have it with every facility.

Daniel Bernstein -- Capital One -- Analyst

Okay. You didn't have any escrows or money you could tap to that lease termination fee then?

John T. Thomas -- Chief Executive Officer

The tenant is liquidating. So, as they collect receivables, we're making claims against those receivables like their other creditors.

Daniel Bernstein -- Capital One -- Analyst

Okay. And then you made a comment earlier about escalators at 2.5% or greater. I just wanted to -- maybe if you could remind us how much of that is CPI versus fixed rate?

John T. Thomas -- Chief Executive Officer

A very small percentage of CPI. We've been working those into some leases in this environment. But the vast majority are fixed. And even if there's a CPI, there would be a floor and probably a ceiling banding around that CPI adjustment.

Daniel Bernstein -- Capital One -- Analyst

Okay. That's all I have. Thanks.

Operator

Ladies and gentlemen, we've reached the end of the question-and-answer session. At this time, I'd like to turn the call back to John Thomas for closing comments.

John T. Thomas -- Chief Executive Officer

Yeah. Thank you very much for joining us today. I know there are a number of investor conferences over the next few weeks. We look forward to seeing you at those meetings. Thank you for your time.

Operator

This concludes today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

Duration: 55 minutes

Call participants:

Bradley D. Page -- Senior Vice President, General Counsel

John T. Thomas -- Chief Executive Officer

Jeffrey N. Theiler -- Chief Financial Officer

Mark D. Theine -- Senior Vice President, Asset and Investment Management

Michael Carroll -- RBC Capital Markets -- Analyst

Jonathan Hughes -- Raymond James -- Analyst

Drew Babin -- Robert W. Baird and Company -- Analyst

Jordan Sadler -- KeyBank Capital Markets -- Analyst

Vikram Malhotra -- Morgan Stanley -- Analyst

John Kim -- BMO Capital Markets -- Analyst

Chad Vanacore -- Stifel Nicolaus -- Analyst

Daniel Bernstein -- Capital One -- Analyst

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