Executive Summary / Key Takeaways

• Healthcare Realty is executing a strategic turnaround focused on operational excellence, portfolio refinement through targeted asset sales, and significant balance sheet deleveraging to enhance long-term value.
• Operational momentum is strong, evidenced by record leasing activity, improving tenant retention, and consistent multi-tenant occupancy gains, driving accelerating NOI growth.
• The company is prioritizing high-return internal investments in leasing capital (TI/commissions) and directing proceeds from non-core asset sales towards debt reduction to lower leverage and improve financial flexibility.
• While facing near-term headwinds from deleveraging and tenant bankruptcies (Steward, Prospect), management has reaffirmed 2025 guidance and expects to achieve full dividend coverage by late 2025 or early 2026.
• HR's pure-play focus on outpatient medical real estate positions it to capitalize on powerful demographic tailwinds and the ongoing shift to lower-cost care settings, offering a differentiated investment opportunity within the healthcare REIT sector.

Setting the Scene: A Pure-Play Focus in a Dynamic Healthcare Landscape

Healthcare Realty Trust Incorporated operates as a specialized real estate investment trust, singularly focused on the ownership, management, and development of medical outpatient buildings (MOBs) across the United States. This pure-play strategy distinguishes it within the broader healthcare real estate sector, aiming to be the preferred equity investment for outpatient medical exposure and the landlord of choice for health systems. The company's portfolio, comprising hundreds of consolidated properties and interests in numerous joint ventures across dozens of states, totals millions of square feet, often strategically located on or adjacent to hospital campuses.

The outpatient medical market benefits from robust underlying fundamentals driven by powerful secular tailwinds. Aging demographics are a primary catalyst, with the over-65 population, the largest users of healthcare services, expected to grow significantly faster than the general U.S. population over the next decade. Simultaneously, healthcare systems are increasingly shifting patient care to lower-cost outpatient settings, fueling demand for well-located MOB space. This demand is currently outpacing new supply, which remains constrained by rising construction costs and limited availability of suitable sites, creating a favorable environment for landlords like Healthcare Realty.

Within this landscape, Healthcare Realty positions itself through its scale, leasing model, and deep tenant relationships. While competitors like Welltower (WELL) and Ventas (VTR) offer broader healthcare real estate exposure including senior housing and life sciences, HR's singular focus on MOBs allows for specialized operational expertise. A recent industry report notably assigned HR's on-campus portfolio an A+ rating, suggesting a resilient positioning. Although HR's overall market share is smaller than diversified giants like Welltower, its concentration in core outpatient markets and ability to drive operational efficiencies are key competitive factors. The company's operational approach, including empowering local teams and leveraging technology for financial discipline and efficiency, supports its competitive standing, aiming to improve NOI margins from the low 60% area. While specific details on proprietary technology are not disclosed, the focus on improving systems and processes for efficiency and faster project cycles (like streamlined development processes leading to lower costs per square foot and faster new builds) represents a form of technological and operational differentiation.

The Turnaround Story: Building Momentum Through Operational Excellence

Following a significant merger in 2022, Healthcare Realty embarked on a strategic turnaround to integrate assets and enhance performance. This effort has yielded tangible operational momentum over the past year. The leasing team has achieved record levels of new signed leases, consistently exceeding 400,000 square feet in the multi-tenant portfolio for multiple consecutive quarters. This robust activity, coupled with a material improvement in tenant retention rates (reaching approximately 85% in recent quarters, up from the mid-to-high 70s), is translating directly into occupancy gains.

Multi-tenant occupancy has seen consistent sequential improvement, with net absorption gains measured in basis points each quarter. Management noted exceeding the top end of their initial absorption targets in 2024, highlighting the effectiveness of their leasing efforts. This operational success is further supported by diligent expense control. Property operating expenses have seen year-over-year decreases in recent periods, and general and administrative expenses have also declined, reflecting management's focus on efficiency. This combination of rising occupancy and controlled costs is driving margin expansion and accelerating NOI growth.

Recent financial results reflect these dynamics. For the three months ended March 31, 2025, total revenues were $298.977 million, down from $326.805 million in the prior year, primarily impacted by strategic dispositions. Despite this, Normalized FFO attributable to common stockholders was $137.722 million, resulting in Normalized FFO per diluted common share of $0.39, consistent with the prior year period. Same-Store Cash NOI growth was 2.3% in Q1 2025, impacted by seasonal expenses and a difficult prior-year comparison, but management expects material acceleration throughout the remainder of the year. The company acknowledges that elevated spending on tenant improvements and leasing commissions, necessary for driving this absorption, impacts near-term reported payout ratios, but views this as high-return, revenue-enhancing capital crucial for future cash flow growth.

Strategic Execution: Portfolio Refinement and Balance Sheet Strength

A core pillar of Healthcare Realty's strategy is the ongoing refinement of its portfolio and strengthening of its balance sheet. The company is actively recycling capital through targeted asset sales and joint venture contributions. In 2024, this effort generated nearly $1.3 billion in proceeds, used for share repurchases and debt reduction. For 2025, the company has guided to $400 million to $500 million in non-core asset sales. These targeted properties are strategically selected from markets with slower population growth, less scale for HR, and operating margins below the portfolio average, aiming to enhance overall portfolio quality and maximize long-term NOI growth potential. Management emphasizes selling these assets outright rather than contributing them to joint ventures, although JVs remain a valuable tool for capital sourcing and potential future growth through acquisitions.

The primary use of proceeds from these dispositions, after funding essential leasing capital, is significant debt reduction. This is a key priority aimed at lowering overall leverage and extending debt duration. As of March 31, 2025, net debt to adjusted EBITDA stood at 6.4 times. The company's goal is to reduce this to a range of 6.0 to 6.25 times by year-end 2025 through the execution of its disposition plan. Recent actions include repaying term loans and accessing the unsecured credit facility to address maturing senior notes. This focus on balance sheet strength is viewed as essential for achieving a lower cost of capital and greater financial flexibility, positioning the company for future accretive opportunities.

Outlook, Guidance, and Risks

Healthcare Realty has reaffirmed its Normalized FFO per share guidance for the full year 2025 in the range of $1.56 to $1.60. This outlook is underpinned by expectations for continued operational momentum, including 75 to 125 basis points of same-store absorption by year-end and a material acceleration in same-store cash NOI growth throughout the year. Management anticipates sequential occupancy growth building through 2025, with most gains realized in the second half. Key assumptions supporting this guidance include sustained robust demand for outpatient space, effective expense management, and the impact of planned asset dispositions and debt reduction. Notably, the guidance assumes no revenue contribution from the Prospect Medical portfolio in 2025 due to the ongoing bankruptcy process.

The company is targeting achieving full dividend coverage by the fourth quarter of 2025 or early 2026. This is expected to be an outcome of the strategic plan's execution, driven by core NOI growth, capital efficiency, and a lower lease expiration schedule in 2025 compared to 2024. While the near-term deleveraging process presents a modest earnings headwind due to the difference in interest rates on paid-off debt versus sale proceeds, management believes this is the necessary path to a stronger financial profile and enhanced long-term growth.

Despite the positive momentum, key risks remain. The bankruptcies of Steward Health and Prospect Medical continue to impact results, although management is making progress on backfilling the affected Steward space and expects to recover a significant portion of that lost NOI over time. The early stage of the Prospect bankruptcy introduces uncertainty regarding future revenue recovery from those leases. Interest rate volatility poses a risk to the cost and availability of capital, potentially impacting refinancing efforts and acquisition/development activity. Policy changes in healthcare could also indirectly affect tenant viability and demand. Furthermore, competitive pressures from larger, more diversified REITs and the potential for technological advancements like telemedicine to alter demand dynamics represent ongoing considerations. HR's smaller scale and potential technological gaps compared to some peers could make it more vulnerable if these trends accelerate.

Conclusion

Healthcare Realty is actively engaged in a strategic transformation aimed at unlocking value for shareholders. By focusing intensely on operational execution to drive leasing and occupancy gains, refining its portfolio through targeted dispositions, and prioritizing balance sheet strength through debt reduction, the company is building a more stable and efficient platform. While facing near-term challenges from tenant bankruptcies and the financial impact of deleveraging, the reaffirmed 2025 guidance and clear path to dividend coverage underscore management's confidence in the strategy. As a pure-play MOB REIT, Healthcare Realty is uniquely positioned to benefit from powerful demographic and healthcare delivery trends. Continued execution on its strategic priorities, particularly sustained absorption and successful deleveraging, will be critical factors for investors to monitor as the company works towards its goal of improved earnings growth, a stronger multiple, and enhanced shareholder value.