Welltower Inc. (NYSE:WELL) Q4 2022 Earnings Call Transcript

Welltower Inc. (NYSE:WELL) Q4 2022 Earnings Call Transcript February 16, 2023

Operator: Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Welltower Fourth Quarter Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Matt McQueen, General Counsel. Please go ahead.

Matt 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 statement are detailed in the Company’s filings with the SEC. And with that, I’ll hand the call over to Shankh.

Shankh Mitra: Thank you, Matt, and good morning, everyone. I will review fourth quarter and the year and describe high-level business trends and our capital allocation priorities. John will provide an update on operational performance of our SHO and MOB portfolios. And Tim will walk you through our triple-net business, balance sheet highlights and 2023 full year guidance. Nikhil, our newly appointed CIO, is also on the call to answer questions. While we are happy to bring back full year guidance after three years, I’ll point out that many macro and business uncertainties remain. I would recommend investors and analysts to focus on 2023 exit run rate to understand the earnings power of this platform and not overly emphasize the calendar year guidance.

I have mixed emotions as I reflect back on 2022. As I’ve described to you in my prior calls, our results frankly underwound our expectation during the first half of the year. While we don’t like to fix that on short-term stock performance as we believe, an appropriate window to gauge our performance is at least three to five years, you should so to measure that for generating an unsatisfactory return — total return in 2022. But remember, a stock is a fractional ownership of a business and not a ticker. We view our fellow investors as partners for the long haul and continuously strive to improve the prospects for long-term compounding of this business. In spite of some of the headwinds that we experienced in 2022, my team and I are pleased with the underlying improvements we have seen in this platform and our talent base, resulting in a strong rebound of performance in fourth quarter and farther improving momentum being carried into 2023.

Our recent progress is only the tip of the iceberg of many of our initiatives, will truly manifest themselves in the year — next year or two, which I’ll go in a minute. While overall macro headwinds persist, we have seen a considerable improvement in the key indicators of the unit economics of the business as reflected by expense per occupied room or EXPOR or revenue per occupied room, or REVPOR. On the expense front, we have seen significant progress on addressing certain challenges we have faced over first year plus, most notably on the agency and temp labor situation. In fact, export has moderated to — in Q4 to 3.4% driven largely by a deceleration in compensation per occupied room or COMPOR to 2.6%, the lowest level we have seen in our recorded history.

At the same time, REVPOR, again, the revenue per occupied room, remain a consistent bright spot for us, increasing 7.5% in Q4, a clear reflection of strong pricing power resulting from our premier locations, product and operator base. As I mentioned on our last call, one of our largest operators pulled forward January rental increases in Q4. Even without that, our Q4 REVPOR would have exceeded 6% plus, reflecting a broad-based strength across our portfolio. And while we achieved record REVPOR growth in 2022 of 5.5%, we expect to surpass this level of growth in 2023. While we achieved an impressive 19% SHOP NOI growth in 2022 and expect circa 20% NOI growth in 2023, I believe we’re only at the beginning of a multiyear double-digit NOI growth, resulting from a long runway of occupancy gain, rate growth and operating margin expansion.

And despite significant macro uncertainty already weighing on the fundamentals of many other sectors, our confidence in future growth of our business is supported by the need-based nature of our asset class along with a favorable demand-supply backdrop, which is getting better every single day. I’m pleased to report that 2023 is already off to a great start with January move-ins up 16% of our ’19 levels, representing a meaningful acceleration from the fourth quarter. Forward-looking indicators are also showing promise in January with our total volume — tour volume across our senior housing operating portfolio is up 25% year-over-year. I would be completely remiss to ignore perhaps one of the most important milestones in the 53-year history of our company, and that is the Private Letter Ruling we received, which permits us to both own and self manage independent living assets.

The PLR provides us significant flexibility in operating our assets, and its timing coincides almost perfectly with the build-out of our industry-leading operating and asset management platform, which John and his team have been tirelessly working on. We remain optimistic that farther investment in our platform will not only result in a better margin profile of our assets, but also will meaningfully benefit the third-party operating partners across the senior living spectrum, who we choose to do business with in the future. We continue to see a tremendous opportunity to professionalize and modernize the operating side of senior living business, following our instinct where there’s mystery, there’s margin. And our PLR gives a significant ammunition to accelerate the pace for what Welltower 3.0 might look like.

I want to thank Mike Garst, our tax team and many others whose efforts have led to this game-changing achievement. Before turning to investing environment, I want to highlight the addition of Retirement Unlimited, or RUI, to Welltower’s roster of exceptional operating partner. RUI is one of the best operating performing senior housing operator in the East Coast with the highest program quality programming and care standards. RUI has consistently maintained occupancy levels at north of 90% and with hardly any use of agency lever over past few years. We announced today that RUI has assumed the management of our first community together in Alexandria, Virginia, with plans to meaningfully grow our relationship in near term through acquisitions, transition and development.

We are extremely excited and humbled to partner with the Fralin and Waldron families and RUI’s all star President, Doris-Ellie Sullivan, and welcome them to Welltower family. In terms of other growth partners, it was exactly a year ago when we announced our partnership with David and Simon Reuben, along with their acquisition of Avery Healthcare in the UK. As you know, Reuben Brothers is one of the most sophisticated, forward-thinking and well-capitalized global investors with the reputation of attracting best-in-class talent and technology platform. Our thesis was validated when Reuben Brothers attracted Lorna Rose, one of the most well respected operating — senior housing operating executive in UK to join Avery as the company’s CEO view in December.

Lorna has spent 25 years in the industry and was most recently with Barchester, one of the UK’s largest senior housing platforms. Next, on the capital allocation side, we have rarely seen a favorable environment across all our product types in all three countries we do business with in. There are 20-plus-billion of exit cue for core real estate funds and then perhaps even a longer one for non-traded REITs. This along with the challenging debt market, give us an enormous advantage to buy the right product at the right location at the right basis. Please note that while we are underrunning by more than $0.5 billion of EBITDA from pre-pandemic levels, we just reported debt metrics that are better than Q4 of 2019, along with more than $5 billion of near-term liquidity — available liquidity.

We have many avenues to access and deploy capital that I’ve described before, and we remain busy on all fronts. But our North Star remains consistent and simple. We strive to create per share value for our existing owners by compounding over a long period of time within our circle of competence, which we define as the area where we can assess and allocate capital with house odds rather than gambler’s odds. With that, I’ll pass it over to John.

John Burkart: Thank you, Shankh. I’m excited about our operating performance this quarter and the acceleration in growth, which we’ve witnessed. My first conference call at Welltower was in Q2 of July 2021. Total portfolio same-store NOI was a negative 7.1%. Since that call, the portfolio’s performance has continued to improve. In 2022, despite challenges, growth was in the range of 7% to 9% for the Q1 through Q3. However, in Q4, we accelerated a 12.9% portfolio NOI growth driven by senior housing operating business with NOI growth of 28.1%, despite all the challenges of the current economy. This amazing performance is a result of both the fantastic supply-demand dynamics of the senior housing sector and aggressive asset management.

I continue to see many opportunities to professionalize the business, which are being proven out through various initiatives as noted in the case studies we presented in the slide deck and clearly come through the financials when looking at the massive improvement in agency labor, which I’ll outline in a moment. It is this abundance of opportunity, the opportunity of applying proven industry solutions to the senior housing industry, which led me to chat to my friend, Jerry Davis, and engage Jerry as a Strategic Advisor. As many of you know, during my multifamily days, Jerry was my counterpart at UDR, one of the largest multifamily REITs with the national platform of 60,000 apartment homes. Jerry spent 30 years in various roles at UDR and nearly 15 overseeing all the company’s operations before retiring in 2021.

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He and I have always shared similar views that the operational excellence requires a focus on people, processes, data and technology, which, if well done, results in a superior experience for both residents and employees and ultimately drives stronger financial performance. We have made substantial headway over the past 1.5-year in enhancing our management capabilities, and Jerry’s expertise will accelerate that progress. He’ll focus his efforts on specific opportunities while I’ll continue to build the broader operating platform from asset management and operations to capital, resource management, renovation, et cetera, as Welltower transforms the business. Jerry will help us to continue accelerate — continue to accelerate change in the senior housing industry.

Our work together will not simply be additive, it will be exponential, J squared. Now, I’ll provide some insight into our operating business, starting with the medical office portfolio. In the fourth quarter, same-store NOI growth for our outpatient medical business was 2.1% over the prior year’s quarter. Same-store occupancy was steady throughout the year at nearly 95%, while retention remains extremely strong across the portfolio at 93% for the second straight quarter and nearly 92% for the entire year. This robust retention rate helps us drive improved lease rates and continued strong re-leasing rates. Turning to our senior housing operating portfolio. The 28.1% fourth quarter NOI increase over the prior year’s quarter was driven by revenue growth of 10.3% for the period.

Year-over-year margin growth of 320 basis points was also the strongest of the year. All three regions showed strong revenue growth, starting with Canada at 6.6%, the U.S. and the UK, an impressive 10.6% and 19.2%, respectively. Revenue growth in the quarter was driven by a 200 basis-point increase in average occupancy and another quarter of healthy pricing power with REVPOR growth of 7.5%, which, as Shankh mentioned, is the highest we’ve ever witnessed. Sequentially, portfolio average occupancy continued to improve with a gain of 20 basis points during the period. Turning to expenses. Agency use has obviously been a key factor in 2022 expenses. However, in Q4 2022, just as Tim had mentioned many times, agency expense is acting as an expense deflator.

Agency in our same-store portfolio is down 44% year-over-year in Q4 ’22. We often quote agency as a percentage of compensation. So looking at it that way, in Q4 of 2021, agency expense was 6.9% of compensation and in Q4 of 2022, it was 3.7%. Regardless of how you look at agency, the expense is declining in the U.S. and Canada, where over 90% of our senior housing portfolio is located. The UK is still impacted by overall labor shortage as well as some rigid staffing models, which have led to lower occupancy properties being overstaffed. Management in the UK is slowly adjusting to a dynamic staffing model, ensuring appropriate staffing at various levels of occupancy. Overall, COMPOR, the compensation per occupied room, which represents about 60% of the expense per occupied room, increased only 2.6% in the fourth quarter compared to the prior year’s quarter, which is the lowest growth rate in over five years.

This moderating COMPOR growth helped drive the deceleration in overall expense growth, despite continued inflationary pressures in several line items, including food and utilities, which rose 10.5% and 10%, respectively, in the fourth quarter of 2022 on a per occupied room basis compared to the prior year’s quarter. Food and utilities represent roughly 12% of expense per occupied room. The combination of 7.5% REVPOR growth, the highest in over five years with a 3.4% expense POR growth led to remarkable growth rate in net operating income per occupied unit of 25%. Regarding our operating platform, we continue to be on pace to pilot our first module in Q1 ’23, with several other modules in the works. I must say that I’m purposefully not giving out the details as they’re proprietary.

However, I will say that I’m proud of the creative accomplishments of the Welltower team and I’m grateful for the wonderful operators that we are partnering with on these first modules. The successes that we have had through aggressive asset management, as noted in the slide deck, are the result of brute force and prove the opportunity. Operational excellence is achieved by a focus on people, processes, data and technology, and that is exactly what the team has done and the various initiatives that are outlined in three case studies on agency labor reduction, revenue management and care revenue. We will continue to leverage our team to drive results, yet the greatest opportunity will be realized as we roll out the operating platform in the coming years.

Finally, I would like to thank our operators and all their employees and the Welltower employees for making these results possible. Our teamwork has clearly paid off, leading to improved resident and employee experiences and stronger overall results. I’ll now turn the call over to Tim.

Tim McHugh: Thank you, John. My comments today will focus on the fourth quarter 2022 results, the performance of our triple-net investment segment in the quarter, our capital activity, our balance sheet liquidity update, and finally, our outlook for the year ahead. Welltower reported fourth quarter normalized funds from operations of $0.83 per diluted share, representing 7% year-over-year growth after adjusting for prior period government grants and FX headwinds. We also reported total portfolio same-store NOI growth in the quarter of 12.9% year-over-year. Before getting into our segment results, I want to provide an update on our recently closed ProMedica restructure and the go-forward reporting treatment. In late December, we announced the closing of our restructure joint venture with ProMedica Health System and our newly formed joint venture with Integra Health.

The ProMedica Health System JV consisting of 58 private pay assisted living assets will continue to be operated under a lease with ProMedica Health System and it is now part of our senior housing triple-net reporting segment. The Integra Health joint venture, consisting of 147 skilled nursing properties, comprised of a property joint venture and a master lease with Integra Health. The lease commenced upon closing in December adds to the first tranche of the property JV with Integra acquiring 15% of Welltower’s stake in 54 of the assets for $73 million. As previously expected, subsequent to year-end, the second tranche of assets closed in January, Integra acquired 15% interest in another 31 assets for $74 million. The remaining 52 assets are expected to close in the second half of the year.

As for the underlying operations, the subleasing of the portfolio is progressing in line with expectations. 75% of the beds have already transition management with the remainder of the portfolio waiting on state specific approvals. We will continue to update the market as the progress of management transitions in addition to underlying property level fundamentals. Now turning to the performance of the rest of our triple net properties in the quarter. As a reminder, our triple-net lease portfolio coverage and occupancy stats reported a quarter in arrears. These statistics reflect the trailing 12 months ending 9/30/2022. In our senior housing triple-net portfolio, same-store NOI increased 4.3% year-over-year and trailing 12-month EBITDA coverage was 0.86 times in the quarter.

Next, same-store NOI in our long-term post-acute portfolio grew 4% year-over-year and trailing 12-month EBITDA coverage was 1.34 times in the quarter. Turning to capital market activity. In the quarter, we settled $1.5 billion of previously raised equity through our forward ATM program, helping to bring debt to EBITDA down to 6.3 times at year-end, a substantial decrease of nearly 7 times at year-end 2021 and below pre-COVID levels of Q4 2019. For the year, we settled a total of $3.7 billion of equity to fund $3.7 billion of net investment activity, allowing us to continue to deploy capital into a desiccated private market while materially delevering the balance sheet. Looking forward, we ended the year with $722 million of cash, full capacity on our $4 billion revolving line of credit and $383 million in expected proceeds from near-term dispositions and loan pay-downs, representing $5.1 billion in near-term available liquidity.

Before moving on to our 2023 guidance, I wanted to add more context to Shankh’s earlier commentary around the opportunity provided to our company by last year’s Private Letter Ruling. Nearly 14 years ago, Welltower structured first day of management agreement, giving a direct economic exposure to senior housing operations. Over the last five-plus years, we built a better and stronger alignment within this contractual structure, ultimately reaching a point in 2021, where we can generate meaningful ROI through centralized human capital and technology investment at Welltower. We hired John Burkart and started to build the team around him. The PLR we received last year allowed us to meaningfully accelerate that effort as the ROI friction is entirely removed under self-management.

This Welltower platform investment is evident through G&A. With greater than 80% of our expected year-over-year increase in overhead costs being driven by technology investment and new position additions in ’22 and ’23, focused primarily on asset management, data analytics and technology. We continue to believe that the opportunity to both modernize operations and drive efficiencies through scale in our business is vast and creates a sustainably strong cash flow tailwind when combined with the demographic-driven demand of the next decade plus. Lastly, moving to our full year guidance, which we are reintroducing for the first time since COVID uncertainty began impacting our business in March of 2020. Last night, we provided an outlook for 2023 of net income attributable to common stockholders of $0.57 to $0.75 per diluted share and normalized FFO of $3.35 to $3.53 per diluted share or $3.54 at the midpoint.

As mentioned in the release, our 2023 guidance contemplates no adjustments for other government grants we receive in the year. So, after adjusting for $0.07 of nonrecurring government grants received in 2022, we are guiding for 5% year-over-year growth. This year-over-year increase in FFO is composed of $0.36 from growth in our senior housing operating portfolio and $0.03 from growth across the rest of our segments. These are offset by $0.04 of prior mentioned higher G&A and Welltower platform costs and $0.19 of floating rate interest and foreign exchange headwinds. Underlying this FFO guidance is estimated total portfolio year-over-year same-store NOI growth of 8% to 13%, driven by subsegment growth of outpatient medical, 2% to 3%, long-term post-cute 2% to 3%, and senior housing triple-net of 1% to 3%, and finally, senior housing operating growth of 15% to 24%, the midpoint of which is driven by revenue growth of approximately 9.5%.

Underlying this revenue growth is an expectation of approximately 230 basis points of year-over-year average occupancy increase and rent growth of approximately 6.25. And with that, I’ll hand the call back over to Shankh.

Shankh Mitra: Thank you, Tim. While we ended 2022 on a positive note, it was also a year of sheer grit and perseverance from our team. As we face different challenges in our business, be it the expense pressure, development cost pressure or ProMedica, we remain steadfast in our belief that our job as stewards of our shareholders’ capital is to solve problems when we encounter on this journey and not rip the band aid off and give away potential future upside to private equity — to profit from either because, one, it is the easiest thing to do instead of working things out or two, the feeling on instant gratification as Wall Street tends to cheer such decisions. We see too many market participants mix up short-term volatility with long-term risk apartment capital loss.

As our partners in the business, our investors can count on us to take tough road to deliver strongest returns we believe are achievable when we face challenges. This is evident in the build-out of our operating platform and our transaction with ProMedica and Integra. To paraphrase Mr. Munger, you can rest assured that we have a deferred gratification gene imprinted all over our culture, and we remind ourselves every day that big money is made not in buying and selling, but in winning. Lastly, I’m extremely delighted to see many of my partners recently appointed to the executive and senior management roles within the organization, developing the business fighting it together in the trenches, and I’m convinced that we have the deepest bench strength along with the longest runway as I look across the real estate space.

Supplementing this talent is our unmatched data and machine learning capabilities, which allows us to efficiently and cost effectively evaluate new investments as well as reinvestment in our portfolio. In addition to our strength of our existing team, we continue to attract best-in-class talent from outside the industry who share our belief that the future of our business may look very different from the past. Simply said, we want to attract talent that comes from the industries with high standards. And to that point, I could not be happier that John has convinced Jerry Davis to join our team. As you all know from his many years in multifamily sector, Jerry has one of the sharpest operating minds in real estate. I have known and admired Jerry for 15 years and cannot be more excited to work with him and learn from him.

I’m more convinced than ever that John along with Jerry will have an exponential impact and transform this industry. If you are or know someone of that operating caliber and more importantly have an outsider’s mindset from a related or frankly unrelated industry who wants to join the formidable team of J squared, please let us know. Welltower is wide open for business, not only for asset acquisition but also for talent acquisition. With that, I’ll open the call up for questions.

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Q&A Session

Operator: We’ll take our first question from Jonathan Hughes at Raymond James.

Jonathan Hughes: I just wanted to ask about the increasing operator relationships. Obviously, we just saw another one yesterday with RUI and you talked about more opportunities — or expected opportunities in the future. But I’m wondering what the landscape looks like after three years of these pandemic headwinds? How many high-quality operators remain as an opportunity that you don’t already have a relationship with and what’s the size of those individual opportunities? Are they smaller or larger in terms of investment volume than the relationships established over the past few years? Thanks.

Shankh Mitra: Yes. Jonathan, you asked a very, very good question. So, as I think about — if your question is specific to senior housing industry, I see that — obviously, we have most of the operating partners that want to do business which we already do business with. So expansion of new operating partners is less of a focus and going deep rather than going broad is our focus. We are looking for striving for regional density with our existing partners across the different countries, right? Now, we have, I mentioned before that we have — there are operating partners in the business, there are operators in the business that we have admired for a very long period of time. And this is a long dating process. It takes a long time for both parties to understand how we can add value to each other, right?

Capital is a commodity. Just capital, us bringing capital to an operating partner, frankly speaking, in any relationship is not enough. And for our perspective, so we bring in data analytics and other operating platform initiatives that John is doing to the equation. At the same time, we want to understand whether these operating partners are thinking about the business or where the business is going 10, 20 years from now, not where the business was 10, 20 years ago, right? There’s a significant mind shift that is needed in the business. And frankly speaking, as I mentioned a few minutes ago, we need higher standards, higher standards of employee engagement, higher standards of customer service and higher standard of how we treat capital and what we — and how we deliver results for the capital.

And those are the type of operating partners and business partners that we’re looking for, and we’re grateful that we have a fundamentally a fantastic roster of these people to drive business with. Now going to the second part of your question, from an investment volume standpoint, I want to reemphasize, you’re going to see a majority of the investment volume with existing partners as well as sort of the partners that we have already announced in the last couple of — two, three years.

Operator: We’ll take our next question from Michael Griffin at Citi.

Michael Griffin: Maybe just on transaction activity. I mean, Shankh, I know you’ve always talked about how you’re an unlevered IRR focused investor. I’m curious if you’ve seen any change and maybe hurdle or return rates that might get you more excited about one property type relative to another. I know you seem pretty positive in your opening comments, but any additional clarity there would be helpful.