Fitch Affirms and Withdraws Physicians Realty Trust's Ratings; Outlook Stable

Fitch Ratings has affirmed and withdrawn the Long-Term Issuer Default Ratings (IDR) of Physicians Realty Trust (NYSE: DOC) and its operating partnership, Physicians Realty L.P., including the unsecured debt ratings at 'BBB'.

The Rating Outlook prior to the withdrawal is Stable.

The ratings and the Stable Outlook reflected the issuer's conservative financial policy, durable cashflows generated by its medical office building (MOB) portfolio, solid liquidity profile, and strong contingent liquidity as measured by UA/UD relative to broader REIT peers. These strengths are offset by DOC's less established and less frequent access to unsecured debt capital markets relative to higher-rated diversified healthcare REIT peers and DOC's limited financial flexibility via higher but a sustainable adjusted funds from operations (AFFO) payout ratio.

Fitch has chosen to withdraw Physicians Realty Trust's ratings for commercial reasons.

Key Rating Drivers

Conservative Financial Metrics: The ratings reflected Fitch's expectation that leverage (net debt before preferred to recurring operating EBITDA after distributions to/from associates and minorities) would sustain around 5.5x through the cycle. DOC maintains adequate headroom for leverage to sustain below 6.0x, the level which Fitch views as more consistent with a lower IDR. Fitch estimates DOC's leverage at 3Q22 was 5.8x.

Fitch expects DOC to remain a modest net acquirer even if cap rates for MOBs trend higher. Fitch views DOC's approach to investments favorably, as the issuer avoids bidding wars by sourcing the majority of its acquisitions directly through relationships with owners and brokers. While this results in substantially more upfront effort and longer lead times, it allows DOC to exercise control and provides the issuer with more visibility and predictability in its investment pipeline.

Durable, Predictable Rental Cash Flows: A primary tenet of the ratings was the expectation that DOC's portfolio will deliver durable operating cash flows. MOBs generally, and DOC's assets specifically, benefit from secular demand drivers and long tenor-leases with, in a significant portion of DOC's portfolio, highly rated health systems and/or rents that are well-covered by underlying cashflows. These factors reduce the risk of meaningful credit-related declines in EBITDA during the life of the lease.

Healthy Portfolio Mix: DOC's portfolio is split between MOBs on hospital campuses and those located off-campus as well as between single tenant and multi-tenant buildings. Demand for off-campus health care real estate is supported by secular shifts in the provision of care to non-hospital, outpatient settings. However, Fitch believes that while care will continue to move off-campus over time, the degree to which off-campus MOBs capture that benefit may be mitigated in part by competing in a much larger real estate market than the finite number of on-campus options.

Fitch expects single-tenant and off-campus MOBs could face higher renewal risk at lease expiration than multi-tenant and on-campus MOBs, unless they benefit from significant anchoring features. Examples of qualitative anchoring features may include being located in buildings or on campuses with other tenants that create campus synergies. Quantitative anchoring features may include financial incentives, such as tenant improvements with significant remaining useful lives or benefiting from higher Medicare rates.

Diversified Tenant Base: DOC does not have any material health system concentration (greater than 5%) after CommonSpirit Health (15% of annualized base rent at 3Q22). Approximately 30% of DOC's rents at 3Q22 come from its top 10 tenants, which is well diversified relative to other health care REITs. Additionally, 59% of DOC's tenants are 'investment grade' per its disclosures, though Fitch notes that not all contractual counterparties are the rated parent and could be with unrated subsidiaries. DOC does not disclose tenant lease coverage ratios, but Fitch views the generally higher rent coverage for all MOBs relative to other health care real estate property types as an indication of the lower relative lease default and lease renewal risk.

Establishing Capital Markets Presence: DOC has demonstrated access to relatively diversified capital sources through public and private placement bonds and multiple common stock offerings and an active at-the-market (ATM) program. However, Fitch views DOC's relative access to capital as less established with the issuer's smaller capitalization making it less relevant to debt and equity investors during less liquid capital market environments relative to larger REIT peers.

Derivation Summary

DOC's ratings reflect the issuers high quality, geographically diversified portfolio of MOBs that generate durable cashflows. DOC's portfolio of health system affiliated on- and off-campus MOBs benefit from secular health care spending growth as well as from the shift of medical procedures to outpatient and community-based settings.

DOC and MOB peer Healthcare Realty Trust (BBB/Stable) have comparable MOB portfolios and benefit from strong contingent liquidity as measured by unencumbered assets relative to unsecured debt as compared to peers. However, their financial flexibility is limited when considering the higher AFFO payout ratios that limit the extent to which the issuers can retain FCF.

Fitch rates DOC's peers Omega Healthcare Investors (BBB-/Stable), National Health Investors, Inc. (BBB-/Stable), Sabra Healthcare REIT, Inc. (BBB-/Stable), and CareTrust REIT (BB+/Stable), all of which have significant exposure to skilled nursing facilities (SNF) and senior housing, both sectors that face significant headwinds. Additionally, Fitch rates both Healthpeak Properties and Ventas, Inc. 'BBB+'/Outlook Stable, as they have diversified healthcare real estate portfolios and above average access to capital relative to other REITs.

Fitch rates the IDRs of the parent REIT and subsidiary operating partnership on a consolidated basis using the weak parent/strong subsidiary approach and open access and control factors - based on the entities operating as a single enterprise with strong legal and operational ties.

Key Assumptions

Low-single digit annual SSNOI growth, driven primarily by fixed contractual rent increases and positive cash releasing spreads;

Annual net acquisition spend between $0 and $200 million in 2023-2025;

Unsecured revolving credit facility maturing in 2025 refinanced prior to maturity;

No equity issuances in 2023 and 2024 and $80 million of equity issued in 2025.

RATING SENSITIVITIES

Prior to Fitch's withdrawal of ratings, the following factors, individually or collectively, could have led to a positive rating action/upgrade:

Fitch's expectation of net debt to recurring operating EBITDA sustaining below 5.0x;

Demonstrated consistent access to unsecured debt capital and frequency of issuance on par with higher rated REIT issuers.

Prior to Fitch's withdrawal of ratings, the following factors, individually or collectively, could have led to negative rating action/downgrade:

Fitch's expectation of net debt to recurring operating EBITDA sustaining above 6.0x;

Fitch's expectation of REIT fixed-charge coverage (recurring operating EBITDA adjusted for straight line rents and maintenance capex relative to interest and preferred dividends) sustaining below 3.0x;

UA/UD sustaining below 2.0x based on a stressed capitalization rate of 8.5%;

Fitch's expectation of AFFO payout ratio sustaining at or above 100%;

Material and sustained declines in same-store net operating income indicating lower asset quality.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Solid Liquidity Profile: Fitch estimates DOC's sources of liquidity (unrestricted cash, availability under the revolving credit facility, as well as retained cash flow from operations) cover its uses (debt maturities, committed development expenditures and maintenance capex) through 2024.

DOC maintained $738 million of capacity on its $1.0 billion unsecured revolving credit facility at Sept. 30, 2022.The strength of DOC's liquidity profile is driven by the lack of meaningful near-term debt maturities until 2025. Fitch notes, however, that debt maturities are concentrated in a 10-month window beginning in March 2027 when 47% of current non-mortgage and non-JV debt amounts outstanding mature. Fitch expects these amounts will become more manageable as the issuer continues to grow and ladder out its debt maturities.

Contingent Liquidity: The financeability of the underlying real estate is a core tenet of investment-grade REIT ratings. MOBs generally benefit from strong access to contingent liquidity sources, including a multitude of durable mortgage capital sources as well as more pro-cyclical bank mortgage and CMBS market. DOC's UA/UD was 2.6x at 2Q21. Fitch was unable to update this ratio by capitalizing unencumbered NOI but estimates it likely remains at levels appropriate for the rating given the amount of unsecured debt as a percentage of total debt and undepreciated assets as a percentage of total debt went from 87% and 28% at 2Q21 to 85% and 32% at 3Q22 respectively. Fitch notes that investment-grade REITs rated by Fitch typically have UA/UD ratios around 2.0x.

High Dividend Payout Ratio: DOC's AFFO payout ratio has historically ranged from 90% to over 100% and was 89% for the quarter ended Sept. 30, 2022, which Fitch views to be high but sustainable given the predictability of the cashflows.

Issuer Profile

Physicians Realty Trust (NYSE: DOC) is a real estate investment trust that focuses on MOBs including those located on and off-campus.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg