Welltower Inc. (NYSE:WELL) Q3 2023 Earnings Call Transcript

Welltower Inc. (NYSE:WELL) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Thank you for standing by, and welcome to the Welltower Third Quarter 2023 Earnings Conference Call. I would now like to welcome Matt McQueen, General Counsel to begin the call. Matt, over to you.

Matthew McQueen: Thank you, and good morning. As a reminder, certain statements made during this call may be deemed forward-looking statements in the meaning of the Private Securities Litigation Reform Act. Although Welltower believes any forward-looking statements are based on reasonable assumptions, the company can give no assurances that its projected results will be attained. Factors that could cause actual results to differ materially from those in the forward-looking statements are detailed in the company’s filings with the SEC. And with that, I’ll turn the call over to Shankh.

Shankh Mitra: Thank you, Matt, and good morning, everyone. I’ll review our third quarter results and capital allocation activities. John will provide an update on performance of our Senior Housing Operating and Outpatient Medical Portfolios. And Tim will walk you through our triple-net businesses, balance sheet highlights and revised guidance. Nikhil is also participate in the Q&A session of the call. Against a backdrop of increasingly uncertain macroeconomic outlook, I’m pleased to report another strong operating results with which continue to exceed our expectations. Our Senior Housing portfolio posted another quarter of exceptional revenue growth, which continues to approximate double-digit levels, driven by both strong pricing power and occupancy build.

We are delighted to report that occupancy growth not only accelerated through Q3, but also that September occupancy gains marked the highest level we’ve seen over the last 2 years. From a pricing standpoint, we continue to achieve outsized rate increases as reflected by nearly 7% growth in RevPAR or unit revenue. As you may recall, we previously mentioned that last year, one of our largest operator pull forward its typical January increase to September 2022. This year, the same operator elected to maintain its historical cadence of rate increases and will therefore wait until January of 2024 to push through rate increases. As a result, reported pricing of Q3 this year may appear lower than what we are experiencing in the business and it bears repeating that our operators’ pricing power remains strong.

The story on the expense side is similar to that of our top line and result continues to outperform our elevated expectations. We reported 2.4% expense per occupied room growth or unit expense growth, the lowest reported export growth in the company’s recorded history. This is largely driven by a 2.7% increase in compensation per occupied room, which represents a substantial step down in recent quarters. This combination of strong revenue and controlled expense growth has generated 333 basis points of same-store margin expansion, yet another record for the company as it marks the highest level of quarterly margin improvement in our recorded history. And our shop NOI margin of 25.6% is the highest level of profitability we achieved since pre-COVID.

NOI growth for the quarter came in 26.1%, our fourth consecutive quarter of 20% plus NOI growth and the second highest level of growth in the company’s recorded history. While we are pleased that margins are moving in the right direction, we are also mindful that our profitability remains significantly below pre-COVID levels and below where we believe the industry can attract external capital investment on a long-term basis. Our managers strive to deliver a superior product, experience and provide valuable choices for our retired seniors. Our product remains highly affordable at the high-end while we operate in the U.S. and the U.K. and they should continue to focus on highly differentiated services, even if that means rate increases need to remain at the elevated levels.

As I’ve said many times, cutting corners is not in our DNA. We recommend that our operating partners serve fewer residents well than serve more of them poorly. As a result, one of our key items to focus is to work with the right operator to improve the customer and the employee experience. We believe that doing so will improve the experience of all [technical difficulty] all of our stakeholders. Conversely, we will be very disappointed if our operators take the path of lease resistance, which ultimately will impact resident and employee satisfaction. We continue to focus on the delta of RevPOR minus ExpPOR as the single most important operating metric to optimize. While it is too early to comment on anything specific relative to 2024, as I sit here today, I can believe — I believe that the delta of RevPOR minus ExpPOR can expand, which we need to get to a sustainable level of margin.

From a product standpoint, AL continues to outperform IL and from a geographic standpoint, Canada finally caught up to the level of growth that U.S and U.K were experiencing. We have further retailing to do in our Canadian business with a new operating platform being launched in next few weeks. And going forward, we believe both of our international businesses will have been significant contributors to our earnings growth in ’24 and ’25. From a capital allocation standpoint, we have never been busier. Last quarter we spoke about a pipeline of $2.3 billion. We closed $1.4 billion in Q3, and roughly another $900 million in October. Additionally, we have another $1 billion of deals just about to cross the finish line. Beyond these billion dollars of investments under contract, our pipeline remains large and near-term actionable.

But the execution of these deals will depend on our access to capital. The extremely challenged debt and equity market in this higher for longer rate environment suggests that this trend will continue and perhaps will get better in ’24. We’ll continue to see credit evaporate from our investment universe and are selectively pursuing great opportunities in both whole stack and med stack levels with highly favorable last dollar exposure. These opportunities have potential to achieve equity returns with basis and credit downside protection typically seen in low leverage transactions. We’re seeing opportunities across product types and geographies with equity investments in U.S senior housing, and credit investment on the SNF [ph] side, making up the large stewards [ph] of opportunities that we’re constantly being pinned on.

I want to remind you that we have a three dimensional lens through which we measured investment opportunities: risk, reward and duration. Given the substantial rise of real rates over the last 90 days, we have recalibrated the thresholds of these three thresholds higher. In other words, for the same risk we need higher returns today than we did 90 days ago or we can do deals with a similar return profile, but with a much lower risk and so forth. Where student of history and markets and cannot find many times when a lot of good has come out of a period of highly — sharply higher real rates. If real rates continue to grow — grind higher, we’ll continue to calibrate our three guideposts higher. So far, we have no problem achieving these three calibrations as sellers understand the markets have changed, and will remain the best at many times, the only hope for liquidity.

From a balance sheet perspective, amidst growing macroeconomic, fiscal and geopolitical uncertainty, we’re pleased to have reduced our net debt to adjusted EBITDA to one of the lowest levels in our recorded history, which also represent nearly 2x decline from just 12 months ago. Our balance sheet strength and flexibility gives us opportunity to remain on offence, or provides shelter if the economic environment meaningfully what sits next week. We don’t have a clue which direction the wind will blow. But I’m delighted that we don’t need fair weather to meet our obligations or growth. As you all know, a wall of debt maturity and commercial real estate sector is coming exactly at a time when debt capital is evaporating from the market. We will not be surprised if significant dilutive capital is raised, or otherwise a lot of keys will need to be returned to the lenders.

I’m certainly grateful to Tim and our best of class — best-in-class capital markets team for keeping us ahead of the cadence that Nikhil and I can spend on as we look to capitalize on the best environment for investments that we have ever seen. Year-end is shaping up to be extremely busy. And Q1 also looks promising if we continue to have access to growth capital. At the risk of sounding like a broken record, I want to reiterate, that will only grow externally, if and only if, we can grow value accretively on a partial [ph] basis for existing shareholders. I hope that you as our shareholders are as excited as I am about our operating results and capital allocation activities. But interestingly, those are not the most exciting things — exciting areas inside Welltower today.

What truly galvanizes us are the exciting prospects of John’s operating platform, and especially the digital transformation of senior housing industry. As we have discussed ad nauseam, we refuse to accept the lack of 21st century business process and technology infrastructure of the primarily people driven business where individual community — communities are on their own island. We have made tremendous strides in last 90 days on the technology backbone of what Welltower 3.0 may look like, and how far we can raise the bar for resident and employee experience. Welltower’s engine room is buzzing with pilots and scaling, and traditional technology solutions like from ERP and CRM to advanced technology solutions around robotics and artificial intelligence.

Our goal is to elevate the community experience by delighting the customer and their families and simplify and enhance the employee experience, all of which should lead to occupancy and NOI growth. Then, and only then, do we have to have a shot at earning a long-term sustainable return for our owners, which has been less than satisfactory over the last decade. My partners and I are truly inspired and are hopeful that we’re turning the corner to achieve multiyear double-digit compounding growth rate. While supply and demand backdrop is squarely in our favor, we’re far more focused on the value at alpha from our platform with you as our fellow owners have funded to build with our blood, sweat and tears. And with that, I’ll pass the call over to John.

John Burkart: Thank you, Shankh. I know that it sounds like a broken record, but again, another great quarter. Our total portfolio generated 14.1% same-store NOI growth over the prior year’s quarter led by the senior housing operating portfolio with 26.1% year-over-year growth. We are methodically moving forward focused on the customer and employee experience and that is driving results. We started with brute force effectively relying on our raw labor to identify issues and opportunities. We continue to improve the systems and processes and organize the data to make data driven decisions to improve the business, and we’re just at the beginning. The medical office portfolios third quarter same-store NOI growth was 3.4% over the prior year’s quarter, same-store occupancy was 95%, while retention remains extremely strong across the portfolio at nearly 93%.

The 26.1% third quarter year-over-year NOI increase in our same-store senior housing operating portfolio was a function of 9.8% revenue growth driven by the combination of 6.9% RevPOR growth, 220 basis points of average occupancy gain and moderating expense growth. Expenses remain in control coming in at 5.1% for the quarter over the prior year’s quarter. The strong revenue growth and expense growth led to substantial margin expansion of 330 basis points. As Shankh has mentioned many times, the marginal increase in expenses as occupancy continues to grow over 80% is relatively low for obvious reasons. Many of the expenses are fixed. Each property has an Executive Director, Head Chef, Maintenance Director regardless of the occupancy level. The bulk of maintenance utility and many other costs are largely factored in at 80% occupancy.

As a result, our Expense POR or Expense Per Occupied Room continues to remain low, enabling the business to improve the margins. As Shankh mentioned, our ExpPOR growth for the quarter was 2.4%, the lowest in our recorded history. All three of our regions continue to show strong same-store revenue growth, starting with the U.S at 9.6%, and Canada and the U.K growing at 9.7% and 12.9%, respectively. The strong revenue growth in each region combined with the expense controls have led to fantastic NOI growth in the U.S., Canada and the U.K., of 25.4%, 27.1% and 37%, respectively. The management transitions continue to perform above expectations. We are grateful to our operating partners, who are working so hard to ensure that we achieve the improved operations that we set out to accomplish in our journey to operational excellence.

Our operators continue to do an amazing job of managing through the complexities of the business to provide a superior customer and employee experience. Many of our senior customers were born in the 1930s. The Depression. They have worked hard and sacrifice all their life and now they deserve to enjoy the fruits of their labor. The product and services remain very affordable to a large segment of the population who have purchased and paid off their homes years ago, and are now at a point where they can sell their home, live off their assets enjoying a good quality of life during their golden years, which they deserve. Our focus with our operating partners on improving the customer and employee experience benefits all stakeholders. For example, our focus on materially reducing agency labor improves both the customer and employee experience, as both are benefited by permanent high-quality employees compared to the random agency employees lacking relationships with our customers and knowledge of the community systems and processes.

Additionally, eliminating the agency or middlemen enables us to ensure the hard working people at our communities receive a fair compensation package with vacation and benefits as well as competitive pay, and our shareholders benefit from the reduced leakage to the agency company owners. Care is the essence of the service provided and ensuring employees can deliver outstanding care is one of our top priorities. Our operating platform efficiencies will increase the time available for care and reduce the stress on our employees. For example, at one site, one of my team members worked at, the Executive Director spends over 3 hours per move-in inputting the documents into the antiquated systems. The CRM, [indiscernible] and Care modules are disparate systems.

Our platform has all the documents in E-Form and the modules are fully integrated, reducing the potential for errors and saving time, which enables the site leader to focus on the customers and employees, not paperwork. We continue to make substantial progress on our platform and the related rollout. I’m grateful for the engagement and participation by the leadership of our operators who are actively working with us to ensure the success of the platform. More to come in 2024. I will now turn the call over to Tim.

Tim McHugh: Thank you, John. My comments today will focus on our third quarter 2023 results. The performance of our triple-net investment segments in the quarter, our capital activity, a balance sheet and liquidity update, and finally our updated full year 2023 outlook. Welltower reported third quarter net income attributable to common stockholders of $0.24 per diluted share and normalized funds from operations of $0.92 per diluted share, representing 10.4% year-over-year growth, or 16.5% growth after adjusting for HHS and the year-over-year impact from changes in FX rates and higher base rates and floating rate debt. We also reported total portfolio same-store NOI growth of 14.1% year-over-year. Now turning to the performance of our triple-net properties in the quarter.

As a reminder, our triple-net lease portfolio coverage and occupancy stats are reported [indiscernible]. So these statistics reflect the trailing 12 months ending 6/30/2023. In our senior housing triple-net portfolio, same-store NOI increased 3.9% year-over-year and trailing 12-month EBITDA coverage is .93x. In the quarter, we agreed to convert 11 StoryPoint assets and triple-net lease to RIDEA, which will bring their regionally focused managed portfolio up to 55 Midwestern properties in the fourth quarter. Next, same-store NOI and our long-term post acute [ph] portfolio grew 5.3% year-over-year, and trailing 12-month EBITDA coverage was 1.44x. Turning to capital activity. We closed on $1.4 billion of acquisitions and loans in the quarter, led by $618 million of senior housing operating investments.

As a reminder, the Revera PSP joint venture online that was announced last quarter will close by geography in three distinct phases. The U.K portion closed in 21Q and the U.S portion close this quarter, resulting in $75 million of net investment. And the Canadian portion is expected to close by year-end. In the quarter, we continue to issue through our ATM to fund ongoing investment spend and position the balance sheet for future opportunities. We raised gross proceeds of $1.9 billion, at an average price of approximately $81 per share, allowing us to fully fund year-to-date investment activity and also extinguish $290 million of debt in the quarter. This capital activity along with continued growth across our business segments including the continued post-COVID recovery within our senior housing operating business, help drive net debt to adjusted EBITDA to 5.14x at quarter end which represents 1.8x of deleveraging versus one year ago.

We expect net debt to adjusted EBITDA to settle in the mid 5s on a pro forma basis post near-term investment activity, and it continued to trend downward in future quarters, as a recovery in our senior housing operating portfolio continues to drive organic cash flow higher. Additionally, filing this intra and post-quarter capital activity, including $900 million of gross investments closed to date in October, we have a current cash and cash equivalents balance of $2 billion, along with full capacity on our $4 million revolving line of credit and $624 million in remaining expected proceeds from near-term dispositions and loan pay downs, representing approximately $6.6 billion in near-term available liquidity. Lastly, moving to our full year guidance.

Last night we updated our previously issued full year 2023 outlook for net income attributable to common stockholders to a range of $0.91 to $0.95 per diluted share and normalized FFO of $3.59 to $3.63 per diluted share, were $3.61 per share at the midpoint. Our normalized — updated normalized FFO per share guidance represents a $0.055 increase at the midpoint of our previously updated guidance. This increasing guidance is reflective of a $0.03 increase from higher expected full year senior housing operating NOI, a $0.035 increase from capital allocation activity, which assumes no further investment year beyond what is close the date, and this increases are partially offset by combined penny drag on increase in expected full year G&A and stronger dollar.

Underlying this FFO guidance is an increased estimate of total portfolio year-over-year at the same-store NOI growth of 11.5% to 13.5%, driven by subsegment growth of outpatient medical, 2.5% to 3%, long-term post-acute 4% to 5%, senior housing triple-net of 1.5% to 2.5%, and finally, increased senior housing operating growth of 23% to 26%. The midpoint of which is driven by continued better-than-expected expense trends, along with revenue growth of approximately 9.8% year-over-year. Underlying this revenue growth is an expectation of approximately 240 basis points of year-over-year average occupancy increase and rent growth of approximately 6.7%. And with that, I’ll hand the call back over to Shankh.

Shankh Mitra: Thank you, Tim. I want to conclude by turning your attention to three items that may not seem as important or exciting for our near-term results. On a combined basis, they may actually serve as a drag on our Q4. But nonetheless, it’s extremely important to underscore as far as our stabilized or run rate earnings is concerned. First, we have convinced our partner StoryPoint to convert 11 properties from triple-net to RIDEA structure. 9 of these properties ran a historic lease structure with other operators, and 2 of them are recent acquisitions. StoryPoint is one of our best operators and a current RIDEA operator has cleaned up these billings, improved staffing, service quality and invested significant capital. These properties have gained 500 basis points of occupancy since beginning of the year to 70% in September, report is up 15% since they took over, RevPOR of the new movements in 2023 is up another 12% from the average of 2023 numbers.

This is setting up the stage for significant cash flow growth in ’24 and beyond. Debt to equity conversion at the bottom of the cycle, perhaps the most value accretive transaction we can complete today. As we have experienced in our recent legend conversion, we can expect to breakeven in 12 to 15 months relative to our previous contractual rent, and then our shareholders will get all the upside afterwards. This obviously will work only if you have great assets run by great managers and we are right about the trajectory of the cash flow. And that is the bet I’m willing to take at this point in the recovery cycle. We consider to — we continue to seek additional opportunities to achieve similar outcomes when they check the boxes of great assets and operator quality and when we can expand the pie with our partner so that we can attain a win-win solution, an outcome for a long-term basis.

Second, Kisco, one of our strongest operating partner, measured by margin, occupancy and other operating metrics, recently marched with another one of our operators, Balfour. Balfour, now a affiliate of Kisco, maintains a dominant position in the Denver [ph] metro area also has [indiscernible] buildings nearing completion in Brookline, in Boston MSA and Georgetown in D.C., both properties opening in 2024. We thank Schonbrun and Susan Juroe for their partnership at Balfour and wish them all the best for the next phase of their lives and welcome Andy Kohlberg and his team to take over the stewardship and growth of these communities. Like StoryPoint communities above, this transaction will be significantly accretive to our stabilized earnings and cash flow growth.

Last but not least, when the final stages of Project Transformer, the transaction, which I described to you last quarter, with our teams working really hard with Matthew and Frederic at Cogir. Our brand launch is coming up in the next few weeks, and people are on both sides are working at a frenetic phase to achieve seamless transition. This is yet another transaction like the others above, which will look back at in ’24 and ’25 and feel really proud to have completed as they have added to our earnings and cash flow growth despite some near-term friction and the tremendous workload for the combined team. Speaking of earnings and cash flow growth, I would like you to provide a report card on the previous large transactions to Avery and Oakmont from Signature and Sunrise that we discussed with you in Q2.

Both Avery and Oakmont have grown occupancy of approximately 300 basis points since transitions have begun. We, at Welltower, remain focused on the long-term price of getting this business to an elevated level of customer and employee experience and generating earnings per share that is substantially higher than where we came from. To sum it up, the powerful recovery in senior housing operating business, the rollout of our operating platform and a significantly accretive capital deployment are all setting us up for an accelerating earnings and cash flow trajectory for ’24 and ’25. With that, I’ll open the call up for questions.

Operator: [Operator Instructions] Our first question comes from the line of Vikram Malhotra from Mizuho. Please go ahead.

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Q&A Session

Vikram Malhotra: Good morning. Thanks for taking the question. I guess the sort of great opportunity on the external growth front, we have — yesterday, we saw two of your peers merge, and I was hoping you could sort of give us a sense of as that process was explored, have you been — is that something that’s been of interest to you or could be of interest to you? And can you compare and contrast that line sort of entity deal with your sort of more granular approach going forward?

Shankh Mitra: So Vikram, I don’t comment on other people’s deals. It seems like it’s a great outcome for both of them. We were not engaged, and we will not be engaged in that process, just to be specific. As we said many times, what works for us is one asset at a time transactions even if we do, when we do portfolios, Nikhil is finishing up a portfolio transaction right now of 10 assets that we have gotten. We have picked from a collection of 80, 90-plus assets. So it’s sort of — we’re very, very focused on going deep than going broad in our markets. And we genuinely believe in small transactions with one asset at a time. I believe there are median size of assets, transactions that we have done in the last 3 years, which constitute this $12 million-or-so of assets we’ve bought is like $30 million.

That’s what we like, that works for us, and that’s what will continue. We have no [indiscernible] opportunities. I mean what we see today, the market is, I will not be surprised, you guys will recall that we had talked about a few years ago, there will be potentially $30 billion of opportunities. As we sit here today, we can say the TAM is actually bigger than that, given how much loans that coming due, how much of floating rate debts are rolling over. So we have no problem growing the company as long as we have access to capital and we can do it on a per share [ph] basis. But large M&A is something that I’ve never liked. I’m not saying I’ll never do it. But frankly speaking, it’s just not much interest to us. And specifically answer to your question, we’re not engaged and will not engage in the process that you mentioned.

Operator: Our next question comes from the line of Connor Siversky with Wells Fargo. Please go ahead.

Connor Siversky: Good morning out there. Thanks for taking the questions. I’ve got a three part one for you guys here. But on the Cogir transaction, can you offer a sense as to what occupancy levels look like in the properties earmarked to be managed by the operator in the future? And then is there a way to quantify the NOI upside potential from this transaction and ultimately, the transition of those properties? And finally, is that Regency case study outlined in the deck a good example to gauge what that NOI potential could look like for the broader Cogir portfolio?

Shankh Mitra: Connor, you were talking about, if I understand your question correctly, the Cogir transaction if you’re talking about the properties that Cogir is taking over from Revera, the property occupancy is roughly around 80%. And we think that, as you know, Cogir obviously runs their properties well north of 90% occupancy and 40% margin, and I think we’ll get there. What was the other part of the question, sorry, I missed that?

Connor Siversky: So you outlined that Regency case study in the deck for those — I think you were in British Columbia near Alberta. Is that a good example to use as a gauge for the NOI potential of the broader Cogir portfolio?

Shankh Mitra: Yes. I think you will see in this particular portfolio that we’re talking about, the transition portfolio, Regency portfolio, Regency was a very well-run portfolio. This Cogir still has been able to get that margins, I believe, from around, call it, take up 40% to about 50%. In this particular case, I believe that the improvement will be better and will go from — margins will go from, call it, say, up 20% to 40%. So I think we should see better enhancement in this particular case than the Regency example.

Connor Siversky: Great. Thank you.

Operator: Our next question comes from the line of Juan Sanabria with BMO Capital Markets. Please go ahead.

Juan Sanabria: Hi, good morning. Thank you. Impressive occupancy acceleration into September. Just curious what the early indications are for revenue increases to existing customers. I’m assuming some of the rate letters, apologies, have gone out already. So just curious how that year-over-year delta is looking for rent increases to existing customers? Thanks.

Shankh Mitra: Juan, as you know, we’re sort of finalizing that as we speak, right? That’s the discussion we are in. As I’ve mentioned in my prepared remarks that we expect that to be very strong like last couple of years and that’s where we are. We are not there yet from a purely finalization standpoint. But I continue to believe that we’ll achieve — a customer is expecting an elevated level of service, costs are not coming down any place, the business overall for the industry, not just for us, remain at a suboptimal level of margins where you can attract capital to the business. So all these things putting together, I think you will see strong rate growth. What exactly that is, is too early to say, but I continue to expect that will be very strong.

Operator: Our next question comes from the line of Jonathan Hughes with Raymond James. Please go ahead.

Jonathan Hughes: Hi. Good morning. Thanks for the time. Shankh, could you just clarify the any comments you gave in your prepared remarks where you said that the Kisco, Balfour merger might be a drag on the fourth quarter? I didn’t quite understand why that might be the case? And then maybe one more, if I could sneak it in, the SHO portfolio outperformed that typical seasonality in the third quarter. I think that’s expected to continue into year-end. Is that driven more so by the U.K. related changing same-store pool, something else? Just any additional color there would be great. Thanks.

Shankh Mitra: Let me try the first one. So I did not say that specific transaction might be a drag on the fourth quarter. I said the three things that I described together could be a drag on the fourth quarter. But combined, all of them should be a significant driver of growth on 20 — for ’25 or just call it, stabilized earnings. That’s the point I was trying to drive, not specifically about Kisco and Balfour.

Tim McHugh: And on your question on the seasonality in the business, you’re correct. We continue to outperform the historical seasonality, and we are not seeing major differences between our transition portfolio. As Shankh mentioned, we are actually seeing very strong occupancy gains in the transition portfolio probably greater than what we’ve seen in the core portfolio.

Shankh Mitra: Jonathan, just the core portfolio, as you know, sequential occupancy growth was around 150 basis points and the transition portfolio, the two, I talked about was the majority of the transition we did in Q2. The occupancy growth in from signature to Avery and Sunrise to Oakmont, both portfolios achieved a sequential occupancy growth of roughly 300 basis points. So almost double of what the same-store did.

Operator: [Indiscernible] with Scotiabank. Please go ahead.