Welltower - Q1 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen. Welcome to the Welltower First Quarter 2023 Earnings Release Conference Call and Webcast. At this time, all participants are in a listen-only mode. Please be advised that this call is being recorded. After the speaker's prepared remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star one on your telephone. If you would like to withdraw your question, please press the pound key. Just a reminder, we do ask that you please limit yourself to one question initially. Now at this time, I'd like to turn the call over to Mr. Matt McQueen, General Counsel. Please go ahead, sir.

Matt McQueen (General Counsel)

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. With that, I'll turn the call over to Shankh for his remarks.

Shankh Mitra (CEO)

Thank you, Matt. Good morning, everyone. I'll review our Q1 results and describe high-level business trends and our capital allocation priorities. John will provide an update on the performance of our senior housing operating and outpatient medical portfolio. Tim will walk you through triple net businesses, balance sheet highlights, and revised guidance. Nikhil is also on the call to answer questions. We're pleased to report another strong quarter with results that exceeded our expectations. Our strong performance was once again driven by outsized growth in our senior housing operating portfolio, which generated 23.4% same-store NOI growth, with both revenue and expense trends continuing to move in the right direction. In fact, we produced our fifth consecutive quarter of double-digit organic revenue growth on the back of strong pricing power and occupancy build, with each coming slightly better than expected.

Perhaps equally, if not more encouraging, is the margin expansion story, which is being driven by a significant improvement on the cost side. While we generated strong revenue growth in 2020, these gains were largely offset by pressure across the expense stack, which ultimately resulted in lost year in terms of per share growth. We are delighted by the progress made on various expense items, but particularly pleased by the sharp decline in agency labor or temporary staffing across the portfolio. Over the past few quarters, we have noted the headway our operating partners have made in net hiring as jail employment rates have been weakening. This has ultimately translated into a meaningful reduction of prohibitively expensive temporary staffing, which with cost declining over 50% versus the Q1 of last year.

Though we still have a long way to go to eradicate this problem, which is largely attributed to community leadership challenges, we believe that this trend, along with strong pricing power, will continue to be a tailwind for further margin expansion. From a product and geographic standpoint, while assisted living continue to outperform independent living, IL pricing is starting to strengthen. This is reflected in our Canadian portfolio, which is finally rebounding after a disappointing couple of years. We have seen standout performance from our operating partner, Cogir, which has returned to almost 40% margin for the first time since COVID. We're grateful to our partner, Mathieu Duguay, and his team for their hard work and dedication. Sticking with our international team, our U.K. portfolio continues to produce strong revenue growth, and we're starting to see some green shoots on the cost side.

During our call, I expressed my enthusiasm around the appointment of Lorna Rose as the CEO of our largest UK operator, Avery. Lorna is already making significant impact with a strong commercial acumen and impeccable leadership skills. We expect our UK portfolio to be a strong source of growth as we look at 2024 and beyond. Returning to the U.S., our largest operator, Sunrise, continues to produce strong top and bottom-line results. There is meaningful embedded upside to this incredibly well-located and virtually impossible to replicate portfolio, which sits at mid-70s occupancy today. Also, during our last call, I mentioned that we expect meaningful step function growth from a large regionally concentrated portfolio of StoryPoint. I am pleased to report that Dan and his team has started the year off with a bang as their no-excuse culture and relentless focus on performance is paying off significantly.

Last but not least, Oakmont. A year and a half ago, we moved six well-located California properties to Oakmont, and at that time, Courtney Siegel, Oakmont's CEO, made me a promise that her team would lease up this portfolio in two years. I'm pleased to report that the portfolio today sits at 86% occupancy, while NOI has gone up 13 times since then. Courtney has set a simple performance-driven culture at Oakmont. If you are not 95% occupied, you are not performing. I'm confident that I will be able to soon report to you that this portfolio has reached 90-plus% occupancy level. Pursuit of high standard is prerequisite of high performance. Last year, I described to you that we, as capital allocators, strive to create per share value by compounding over a long period of time.

By doing what's right in the long term for our continuing shareholders may result in short-term pain. Our proactive portfolio management efforts, which includes transition of properties to our strongest operators, is an example of this philosophy. I encourage you to take a look at the case studies within our business update presentation for more details on Oakmont's success and the other key operators, including Peace Capital, which has created substantial value for our shareholders. Following the transition of a portfolio of skilled nursing facilities two years ago. By operating these facilities more efficiently from an expense perspective while increasing quality mix, Peace has been able to improve EBITDA by more than 75% relative to the pre-COVID levels. This point is further underscored by our COVID class of acquisitions and our further efforts to transition other assets over the past few years.

We're just beginning to capture significant embedded NOI from these properties as they return to their pre-COVID NOI levels and higher. In fact, we have achieved 20% of that incremental NOI in the past quarter alone. Shifting to the operating platform and asset management initiatives. As you have come to know, at Welltower, we vehemently reject mediocrity and are in relentless pursuit of high standards. We continue to believe that there's an opportunity to recognize meaningful cash flow from our own portfolio as we optimize location, product, price point, and operators using our data analytics platform, Alpha. To further add to this multidimensional optimization problem using machine learning, our operating platform initiatives are now becoming more tangible, moving from drawing boards to pilots.

While a few weeks don't make a trend, we are optimistic that John and his team are on the verge of some real creative breakthrough. More on that in coming quarters. In terms of recent operating conditions, while I don't like to fixate on short-term trends, I want to mention the consistent rise in demand for our seniors product in Q1. Tour volumes are up roughly 20% in the quarter, partially attributed to an easier comparison period last year due to Omicron variant, also because of great organic demand as we enter another year of significant growth of the 80 plus population. Leads and tours have picked up further in April. While we remain confident in the prospect of business, I'd be remiss not to acknowledge the rising macroeconomic uncertainty as we approach the summer and fall leasing season.

We're encouraged by what we are seeing so far, which admittedly is also the seasonally slowest point in the year. We need to see what market gives us during the all-important upcoming leasing season. The need-driven nature of our product gives me hope that we will outperform majority of the asset classes, not just real estate, but it is also important for you to understand that we have no delusion of certainty. Moving to capital allocation. Since our last call, U.S. banking sector has started to show some significant signs of strength, resulting in material decline in trade flow in the economy. No one is rooting for macroeconomic uncertainty, the current backdrop has certainly created a further expansion to our already attractive set of capital deployment opportunities.

We remain disciplined and will not risk the enterprise that we built with blood, sweat, and tears, but we remain optimistic that we'll be able to grow our portfolio with all the well-located asset at a highly favorable basis and in-place cash flow. To illustrate that point further, we acquired $529 million of assets during Q1 at a great basis and in-place cash flow. The K Street medical office building that we acquired in D.C. perhaps tells you how favorable the investment environment has become. We continue to see underwriting standards tightening meaningfully, leverage levels decline, and banks are now requiring more commercial deposits and more recourse. As a low-leveraged buyer, this backdrop is very beneficial for us.

Our pipeline today is robust with opportunities to deploy capital across senior housing in all three countries, outpatient medical in the U.S., and debt opportunities on the skilled side. Our team remains active and yet highly disciplined and price-conscious as always. From a balance sheet standpoint, I wanted to quickly highlight the continued progress we made in terms of leverage and liquidity under Tim's leadership. He will get into more details, but I'm very pleased with significant deleveraging that we have achieved in past year with net debt to EBITDA falling almost a turn to 6.3, with further organic deleveraging going forward.

Our ability to source over $1 billion of capital this year in the midst of a very challenging capital markets environment is a testament to the confidence entrusted in us by the banking community, the lenders, our investors, and our other partners. With approximately $700 million of cash on the books and undrawn line of credit, we are not only positioned to endure further capital markets volatility, but also to deploy capital as opportunities arise. To summarize our optimism regarding the long-term growth trajectory of the business remains firmly intact. Topline growth remains strong, expenses are moderating, and our external growth opportunities continue to expand. All the while, John and his team are making progress in turning our vision of creating a world-class operating platform into a reality.

With that, I will turn it over to him for an update on the operational element of the business and build out of the platform. John?

John F. Burkart (COO)

Thank you, Shankh. Another great quarter. 11% same-store NOI growth over the prior year's quarter, led by the senior housing operating portfolio with 23.4% year-over-year growth. These results speak for themselves. They're great. I'll provide limited color this quarter. Medical office portfolio's Q1 same-store NOI growth was 1.6% over the prior year's quarter. As our guidance outlines, we expect the MOB portfolio to deliver between 2% and 3% same-store NOI growth in 2023. Therefore, we expect the remaining three quarters to be well above the Q1 number. Same-store occupancy was 94.9%, while retention remains extremely strong across the portfolio at 91.4%. The 23.4% Q1 NOI increase in our senior housing operating portfolio was a function of the 10% revenue growth and continued expense control for the period.

I want to remind everyone that last quarter's revenue growth was driven in part by an operator pulling forward rental increases. Excluding that specific operator, revenue growth in Q1 would have been 10.8%, a 130 basis point increase over the growth for Q4 2022 for the comparable portfolio. All three of our regions continue to show strong revenue growth, starting with Canada at 7.7%, and the U.S. and U.K. growing 9.3% and 17.4% respectively. Revenue growth for the quarter was driven by a 240 basis point increase in average occupancy and another quarter of healthy pricing power with RevPOR growth of 6.8%.

The 10 basis point increase in sequential occupancy during the Q1, a period that has historically seen an occupancy decline due to seasonal factors, reflects the continued increased demand for senior housing as we move into the all-important spring and summer leasing season. Turning to expenses, agency use continues to decline, leading to a 53% expense decrease year-over-year for the same-store portfolio in the Q1 of 2023. Welltower's continued aggressive asset management is keeping expenses in check, enabling margin expansion. During the Q1, the operating margin expanded 240 basis points over the prior year's quarter. Regarding our operating platform, I'm very pleased with the progress the teams have made. We are executing rapidly as planned. As many of you know, I'm somewhat secretive about the details of our platform for proprietary reasons.

I will say that one of the challenges our operators in the pilot are having is keeping up with the increased qualified leads. A very good problem to have. We're at the very beginning of this process. All lights are green at this time. I'm very excited about the future. I'm grateful for the diversity of operational experience, engagement, and enthusiasm of those operators who understand how the platform will transform the business, lead to consolidation, and great success for the operators who leverage our best-in-class platform to improve the delivery of service to our customers, the quality of life of the employees, and returns for our owners. I will now turn the call over to Tim.

Tim McHugh (CFO)

Thank you, John. My comments today will focus on our Q1 2023 results, performance of our triple net investment segments in the quarter, our capital activity, a balance sheet liquidity update, and finally, our updated full year 2023 outlook. Welltower reported Q1 net income attributable to common stockholders of $0.05 per diluted share and normalized funds from operations of $0.85 per diluted share, representing a 4% year-over-year growth and 13% growth after adjusting for the year-over-year impact from a stronger dollar and higher base rates on floating rate debt. We also reported total portfolio same-store NOI growth of 11% year-over-year. 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 a quarter in arrears, so these statistics reflect the trailing twelve months ending 12/31/2022. In our senior housing triple net portfolio, same-store NOI increased 0.2% year-over-year, and trailing twelve-month EBITDA coverage was 0.86 times in the quarter. Same-store NOI in our long-term post-acute portfolio grew 4.2% year-over-year, and trailing twelve-month EBITDA coverage was 1.33 times. Turning to capital market activity. In the quarter, we raised $413 million through our ATM program, which helped fund accretive investment activity during the quarter and maintained debt to EBITDA at 6.31 times at quarter end, a substantial decrease from 7.1 times at 3/31/2022.

In March, we swapped $350 million of our $1 billion 2027 floating rate term loan to a fixed rate of 5.335% through March of 2024, bringing floating rate debt to 13.6% of total debt and just 4% of consolidated enterprise value as of quarter end. We ended the quarter with $639 million of cash, full capacity on our $4 billion revolving line of credit, and $393 million of expected proceeds from near-term dispositions and loan paydowns, representing $5 billion in near-term available liquidity. Over the last 12 months, we've seen leverage meaningfully improve from its post-COVID peak reached in the Q1 of 2022.

As our senior housing operating NOI has started to recover, we've experienced beginning stages of a cash flow growth driven deleveraging. We've amplified this organic leverage reduction with a disciplined approach to capitalization of our external growth pipeline. The result of this approach is a balance sheet that, in its current form, is poised to be substantially lower levered than it was pre-COVID as we continue to see senior housing operating NOI recover. Lastly, moving to our full year guidance. Last night, we updated our previously issued full year 2023 outlook, the net income attributable to common stockholders, to a range of $0.57-$0.72 per diluted share. Normalized FFO of $3.39-$3.54 per diluted share, or $3.465 at the midpoint.

Our updated normalized FFO guidance represents a two and a half cent increase in the midpoint from our previously issued guidance. This increase in guidance is reflective of $0.02 of fundamental outperformance, mainly from our senior housing operating segment, roughly half a penny of which is from subsidies received in Q1, and a half cent from investment activity completed in Q1. Underlying this FFO guidance is an increased estimate of total portfolio year-over-year same store NOI growth of 9%-13%, driven by sub-segment growth of outpatient medical 2%-3%, long-term post-acute 3%-4%, senior housing triple net 1%-3%. Finally, increased senior housing operating growth of 17%-24% year-over-year.

The midpoint of which is driven by better than expected expense trends to start the year, along with year-over-year growth expectations of revenue, approximately 9.5%. Underlying this revenue growth is expectation of approximately 230 basis points of year-over-year average occupancy increase and rent growth from approximately 6.3%. With that, I'll hand the call back over to Shankh.

Shankh Mitra (CEO)

Thank you, Tim. While we're very pleased with our quarterly results and our improved outlook, it's a bittersweet moment for us in Toledo as we mourn the passing of George Chapman. George was the former Chairman and CEO of Health Care REIT, Welltower's predecessor company, and a gifted person and a visionary in the healthcare real estate space, and perhaps above all, an incredibly kind and generous individual. During his many years at Health Care REIT, George not only served as a leader of the company, but was also a mentor and teacher to numerous individuals across the real estate space. He was raised in the Toledo area and always sought opportunities to give back to the community, including his high school in Maumee and through his service on various boards to strengthen the Northeast Ohio region.

We are deeply appreciative of all he has done for us, and he'll be missed dearly. Lastly, before we get into Q&A, I wanted to highlight a document which we posted on our website last evening, which is also part of our shareholder letter published a couple of weeks ago. This document contains a set of ground rules or shared principles which form Welltower's philosophical foundation for long-term compounding through capital allocation, risk mitigation, and culture amongst other factors. Ultimately, and most importantly, who we seek as our long-term investor partners as we execute our mission of delivering to them superior absolute and relative total shareholder returns. I will now open up the call for questions.

Operator (participant)

Thank you very much. Ladies and gentlemen, at this time, any questions, please press star one. If you find your question has already been addressed, you can remove yourself from the queue by pressing the pound key. Just a reminder, we ask that you please limit yourself to one question initially. We'll take our first question this morning from Derek Johnston of Deutsche Bank.

Derek Johnston (Lead Analyst)

Hey, everybody. Good morning. Can you share your thoughts on further transitions and potential consolidation of operators within the portfolio? 'Cause in your case studies, you know, we were most impressed with Kisco. Are there opportunities to expand this relationship from seven or eight communities like you did with the Kensington? You know, look, we ask, you know, given all operators are not operationally equal, is there a plan or potential for further accretive transitions?

Shankh Mitra (CEO)

Derek, you asked a lot of questions, so I think I'll try to remember and answer the question. Kisco is one of our best operating partners, and there are very significant opportunities to grow with Kisco. Whether that's through transition, that's through acquisition, that's through development, obviously, there's no question that they have absolutely hit it out of the park. We're having all these conversations going on. As I've mentioned on last quarter's call, I believe, that we finally have figured out, hopefully, how to do transitions very accretively as you know, sort of your words, but I think that's a, that's a good one. I think I've given some examples of, you know, in my script and on Oakmont. Let me give you another example.

Probably last year this time, we announced a large set of acquisitions with our partner, StoryPoint, and the first tranche of that acquisition closed in Q3. Let's think about it. These properties, the first tranche, there's 18 properties that StoryPoint took over from the existing operator. At that point, at end of Q2, it had 74% occupancy, call it circa six and a half million, $6.4 million of NOI, annualized NOI. Nine months later, they started taking this over in July. You would think that through transition and all of those, you know, obviously moving this asset, NOI, that it'll be a great win if occupancy and NOI held. Nine months later today, not today, end of March, you know, in the quarter end, occupancy was 82%, NOI was $16.2 million.

That tells you what a great operator with significant focus can do. It is my belief that now you got, you know, obviously John and his team and with our, you know, premium operating partners who have done this many times over, during the most difficult time of COVID, has figured out how to do this extremely well and accretively. I gave you a bunch of examples. We obviously provided more case studies. We do think there is significant opportunities to enhance our portfolio by what I said, optimizing four things, right? It's an optimization problem, which is location, product, price point, and operator, right? That's what, you know, obviously Swagat and Kevin and the team are trying to constantly do, and we're executing that with our premium operating partners.

Operator (participant)

Thank you. We go next now to Connor Siversky at Wells Fargo.

Connor Siversky (Director and Senior Equity Research Analyst)

Good morning out there. Thanks for having me on the call. Question on labor for me? Can appreciate that Welltower, the operator base, has made a lot of headway on improving labor sourcing methods across the portfolio, and then the positive trends related to agency usage. I'm curious, what does the training schedule look like for a new hire in a senior housing facility? Can you provide any color or number as to what turnover levels look like currently compared to, say, this time last year? What your expectations or goals are related to that turnover metric looking forward?

John F. Burkart (COO)

Yeah, I'll answer that. Couple things there. One is, things are going fantastic. We've fundamentally changed how we looked at or how the operators look at personnel and effectively created a hiring funnel to move people through that process. The training is dependent upon position, but can take from a few weeks to, you know, a couple of months in some jurisdictions as far as certain requirements that are there. One of the things that I wanna bring up that's pretty important, it's a subtle piece, but it's pretty important. We appreciate the agency stepping in when necessary to provide some assistance, but it's obviously both disruptive and not very efficient.

As we move forward and we reduce agency and create a group of steady long-term employees, that substantially improves the quality of life for our residents. It improves our effectiveness and our efficiency. The benefits are not just reduced expense. The benefits will come through via increased occupancy, increased RevPOR, et cetera. As far as for the turnover, the turnover at this point in time is going down. We have numerous initiatives to improve the quality of life for our employees as well. I've mentioned in the past, we are focused on that. We're looking through the lens of the employees. They're very hardworking people, and making sure that they have what they need really for the whole aspect of their employment, whether it be things as simple as parking to break rooms to time off, et cetera.

We've put a lot of effort into that. We continue to put effort into that. That's a very positive area. Thank you for the question.

Operator (participant)

Thank you. We go next now to Vikram Malhotra at Mizuho.

Vikram Malhotra (Managing Director)

Thanks for taking the question. Shankh or Tim, I have a broad two-part question surrounding investments. Just maybe first, you know, one of your peers had some challenges with the debt investment. They had to convert that, so there's some headwinds there. If you could maybe give us some color on your loan book, and particularly the investment you made with HC-One, I think a couple of years ago, if correct me, maybe it was over $700 million. I just want to understand the structuring, you know, perhaps kind of the time you underwrote that, and just maybe give us an update on the status.

Just related to investments, Shankh, you have very unique cost to capital, relative cost to capital today in a world where equity and debt is very, very hard to get, a lot of fear in the market. I'm just wondering, can you broadly give us color on where you're greedy in terms of capital structure or type of property? Thank you.

Shankh Mitra (CEO)

Let me try to address both of those question, and Nikhil will jump in if I miss anything, okay? Let's just start with the second question first. We are always greedy when others are fearful, as you know. Where we're finding opportunities, as I mentioned on my prepared remarks, that we have a substantial actionable pipeline in seniors housing in all three countries. This is the first time we're seeing opportunities not just in U.S., but also in Canada and U.K. We're very optimistic about senior housing opportunities in all three countries, and we are seeing substantial opportunities, albeit small deals. As you know, Vikram, we're very focused on individual buying individual assets, small transactions, in outpatient medical in the U.S., right?

We're seeing across capital structure, we're seeing opportunities on the debt side in the skilled side of the business. That's sort of where we're seeing opportunities. First question, debt book. If you think about that debt book, you should think about that debt book in three different buckets. Before I get into it, I'll remind you that majority of these loans, right, just call it 80% of the book was originated after COVID. We try to, as we have discussed in many of these cases, let's just talk about three buckets and you'll understand. The first bucket is HC-One. You have specific question, I'll get to it. The second bucket is our partnership with Related, and as I've mentioned in previous calls, these developments are structured as a participating mezz, right?

That's the second bucket. Those are majority of the loans if you go beyond that, the average size of the loan is like $12 million, right? Let's just talk one at a time. We are very much focused on not just debt, but also last dollar basis of every debt, and possibly, as in majority of these cases, an equity feature that, you know, attached to that debt. Let's talk about one at a time. We talked about the Related development pipeline, that's obviously structured as a participating mezz. By definition, that's equity-like structure. Second HC-One, if you go back and see what we said when we did that is a whole loan. That is a senior loan. Unlike a lot of the things that you see, it is not a mezzanine loan.

There is no senior in front of us. We are the senior. The last pound basis of that loan is 32,000 pounds per, you know, per debt, which tells you how low leverage that loan is. To your question, you know, if we had to take that over, which is we have no intention of, but if we had to take that over, there is no senior loan that sits in front of us, right? Understand our last dollar basis, you know what the values are in U.K., that sort of gives you a sense of what it is. More importantly, if you go back and see what I said when we did the loan, we have actually a substantial amount of equity behind that in terms of warrants, right? You go to the last one, there are some, you know, pure debt.

There's a lot of participating pref, participating mezz. That's sort of the convention of the loan book. We don't lend anywhere where we don't think the last dollar is not significantly beneficial to us. We hope the people who borrow from us will do substantially well. From the equity participating nature of many of this loan, we'll participate with them, not just get a return on and off our capital. Hopefully, that's what's helpful for you.

Tim McHugh (CFO)

I think I'll just quickly add on the two related projects that I've delivered, New York and San Francisco. New York Senior Housing opened in January of this year. Four months in, occupancy is beyond where we underwrote at the end of the first year. San Francisco, which has been open for about a year, is also ahead of underwriting both

Shankh Mitra (CEO)

Rates are substantially above what we underwrote.

Tim McHugh (CFO)

Exactly.

Operator (participant)

Thank you. We'll go next now to John Pawlowski at Green Street.

John Pawlowski (Managing Director)

Thanks for the time. Shankh, you made the comment recently that if John and team are successful with their initiatives, that the pace of improvement in expense growth will intensify from here. Just curious, if some of the early operating initiatives you're currently working on were flowing through the cost structure of the business in recent quarters, how much lower would Expense Per Occupied Room growth been relative to, like, the 3.5% reported growth in recent quarters?

Shankh Mitra (CEO)

I'm gonna answer that question in two parts. First is asset management initiative, and that asset management initiative that John has with his team, that you are seeing the impact on the agency labor and replacing that agency labor with permanent employees. John mentioned many other, you know, sort of initiative that's going on to attract and retain talent, which would continue to reduce that number. The other side of that, your question is the operating platform question. There today, John is entirely focused on top line. You know, we are seeing some signs of, as I mentioned on my prepared remarks, that we've just moved on a few places from drawing board to pilot, and we're seeing some significant successes on leads and other situations that, you know, obviously, we're not prepared to talk about it.

That you're gonna see on top line, not on the expenses yet. He will get to the expenses, but he's focused on the big ball today, on the revenue side.

Operator (participant)

Thank you. We'll go next now to Michael Griffin at Citi.

Michael Griffin (Senior Equity Research Analyst)

Great, thanks. Maybe turning back to capital allocation, I'd just like to get some color, you know, maybe around the MOB acquisitions. Seems like it's pretty opportunistic. You know, I believe y'all were selling MOBs back in summer of 2020 when people were buying. Maybe some color around, you know, you list the initial yields here. The occupancy, at least for the K Street one, seem kinda low. Maybe Nikhil, in your underwriting, are you assuming maybe a stabilized, you know, high 80s, low 90s occupancy? Shak, as a capital allocator, if we go back to your Q3 prepared remarks about those five sources of capital, does any one of those, whether it's debt or equity, you know, selling assets, does anyone screen as more attractive right now? Thank you.

Shankh Mitra (CEO)

Okay. Nikhil will walk you through the MOB acquisition that we did in the quarter. Let me just answer some of the other questions you asked. You know, as you think about it, the five sources of capital, we have accessed three of them this quarter, right? We have done public equity, we've done private equity, right? We have sold assets and took capital and very attractive, obviously, returns. You can see it, you know, as an example on slide 12, the case studies that we put together on some of those assets on how we significantly maximize value there. We still have some participation left in that transaction. The other thing was debt, but that was on the secured side. As you think about menu of capital, don't just think this is public equity and public debt, right?

Obviously the good, very good source of capital and has been for us. Also think about private source of capital, whether it's joint venture, asset sales, and private source of debt. Senior housing is a housing business, we have substantial portfolio, under-leveraged portfolio in U.S. and in Canada, with a very significant agency support, right? This quarter in U.S., we have executed one transaction. As you think about capital, think about menu of options. Depending on what that menu of option, how it is priced on a given day, we execute and think and only think through that use of capital as it relates to what are the returns of that as we deploy the capital back on an unlevered IRR basis.

Michael Griffin (Senior Equity Research Analyst)

From the perspective of a long-term return. That's just how we invest capital. Nikhil?

Shankh Mitra (CEO)

Yeah. I think, Don, to answer your question on the MOBs, if you look at the K Street, that's roughly 20% of the capital we deployed towards medical office this quarter. K Street, we're buying it at less than half of replacement cost with a 6.6% in-place yield at low 80s occupancy. We've underwritten this to be beyond an 8% stabilized yield with occupancy with a, you know, nine in front of it. I mean, just think about the quality of the real estate, right? I mean, it's three blocks from the Metro station. It's two blocks from The George Washington University Hospital. You've got some great parking.

I mean, it's as high quality of an asset as you can get, and, you know, we're getting it with very healthy in-place yield with a lot of upside. The other two portfolios, they're core as they get. They've got healthy lease terms, high occupancy above 95% and very good association with great health systems.

Operator (participant)

Thank you. We'll go next now to Joshua Dennerlein of Bank of America.

Joshua Dennerlein (Head of Business and Information Services Equity Research)

Thanks everyone. Tim, you mentioned there's more de-levering ahead. Just curious if you could kind of expand on those comments and how we should think about the trajectory of that de-leveraging?

Tim McHugh (CFO)

Yeah, Josh, thanks. As we've talked about in the past, there's kind of two prongs in which we get the balance sheet back to the range, pre-COVID range, target range of 5.5 to six times leverage. The main one is just seeing NOI recover back to pre-COVID levels. We've been pretty clear in that shouldn't be taken as a stated goal of where NOI and those assets sit, just more so, you know, a marker on the ground of where NOI actually was in those assets, and then what the impact both on earnings and leverage would be just to get it back to that level. Obviously we plan to take it well and well beyond that. Think about our current leverage profile.

Part of our de-leveraging from 7.1 last year has been driven by the kind of beginning stages of that NOI recovery. As we've capitalized our external growth pipeline, we've continued to be pretty disciplined about the way that we've capitalized it via equity. We've driven down current leverage much faster than it would've if it had just been purely through organic cash flow recovery. Now sitting at 6.3 times leverage this quarter. If you were to layer on kind of just a recovery of NOI back to pre-COVID levels, you'd get down to around five times flat. That's kind of the comment on seeing expectation that if you just take our current capital structure and we do nothing, and you continue to see NOI recover back to pre-COVID levels, you'll see us get to a leverage level that's well below where we would have been, or where we were pre-COVID.

Operator (participant)

Thank you. We go next now to Steve Sakwa at Evercore ISI.

Steve Sakwa (Senior Managing Director)

Great. Thanks. Shankh, I was wondering if you could maybe just talk about, you know, the pricing power trends that you're seeing in senior housing and, you know, maybe some of the feedback you're getting from the operators, vis-a-vis kind of the residents and how you see that pricing maybe trending, you know, into the second half of the year, and does that continue into 2024?

Shankh Mitra (CEO)

John, you want to take that?

John F. Burkart (COO)

Yeah. No. Glad to take that. What we're seeing is tremendous strength in the across the board. The feedback from the operators is very positive. What's going on is people are appreciating that the environment that they have, they're appreciating the social environment, and the demand is strong, and it's quite affordable. Obviously, it's an asset play for the assisted and memory care living. The expectations as to how this plays out, we have nothing that we're seeing would indicate that it's not gonna continue with great strength for the foreseeable future. It's a supply/demand situation at one point, and obviously demand is substantial and supply is very limited going forward.

Shankh Mitra (CEO)

I'll just add, one point of color perhaps. First thing is, Steve, as I mentioned, as you think about pricing power, the initial phase of pricing power has been that our cost has been going up. Obviously, to bring back these communities, to a profitable level, or the only way this will actually continue to serve the community if they are profitable, right, over a long period of time, is to increase pricing. As I mentioned in last call, that you will see the next 12 to 18 months handover from pricing because cost has gone up to pricing power because we have no rooms to sell, right? That handover will come.

you know, the second point is just understand that we're not focused on absolute level of pricing, but we're focused on the difference, the delta between RevPOR and ExpPOR. That's what drives P&L, right? Keep those two in mind, and you will see, where, you know, where our focus has been and continue to will be. As we think, you know, just understand our portfolio, you know, is roughly speaking half and half on an average basis in an average year is January versus throughout the year, right? We continue to, as we roll these leases and market rent continues to go up, we expect that pricing will continue to remain strong.

Operator (participant)

Thank you. The next now to Michael Mueller of JPMorgan.

Michael Mueller (Senior Equity Research Analyst)

Your current development pipeline, it looks like it's about 15% outpatient medical office and the balance in senior housing. I guess as you think about anticipated starts over the next few years, do you see that mix shifting dramatically between those buckets?

Shankh Mitra (CEO)

Actually, if you look at into that senior housing bucket, you will see the majority of the new capital outlay has been on the wellness side of the house rather than on the senior housing side of the house. I expect that will absolutely continue. Medical office, majority obviously all of our medical office, I shouldn't say majority. All of our medical office development have been 100% pre-leased, yield on cost development, we're not exposed to the cost risk. Some hits in different quarters. You saw a bunch of them hit this quarter, which we have been working on for many, many years. We should not expect anything different going forward. Majority of that, what is showing up as senior housing development are actually on the wellness side of the house.

Senior housing development as seniors product is very, very hard to make numbers work today. We're not that focused on that side of the house unless it is a very special project in a very special location, such as some of the Related projects that Nikhil talked about.

Operator (participant)

Got it. Okay. Thank you. Thank you. We go next now to Michael Carroll of RBC Capital Markets.

Michael Carroll (Managing Director)

Yeah, thanks. If a seniors housing operator wants to access Welltower's platform, what do they have to do? I mean, do they need to sign some type of exclusive agreement, or will you help any operator that manages your specific assets? Just one last thought. Are these different levels of services that you provide operators? If you have an exclusive agreement, they can kind of fully tap your platform, and if they just manage an asset, then you kind of are offering them help, but maybe not allowing them fully accessing your data.

Shankh Mitra (CEO)

We're not gonna get on this call about contractual agreements and what kind of different levels of service and situations that might be going. We'll just focus on the fact that we have a aligned interest with our operators, as always said for years and years, that the RIDEA 3.0 or other structures are all about syncing and swimming together, right? You know. There is substantial upside to many of this portfolio for us, but also for our operating partners. You know, we have different types of arrangements with different people. We're not gonna obviously get into on this call. Understand at the end of the day, the goals are very simple, right? We're trying to create a very good environment for our residents.

We're trying to create an environment for our employees to stay and to lower turnover, resident satisfaction, employee satisfaction, and frankly, owner satisfaction. That's the goal. If we can match those goals, it'll be great for us, and it'll be great for our operating partners.

Operator (participant)

Thank you. The next now to Austin Wurschmidt at KeyBanc.

Austin Wurschmidt (Senior REIT Analyst)

Great. Thank you. Shankh, you highlighted a robust investment pipeline with opportunities across all your regions. I know you're return driven as you consistently highlight, but given the pricing power you're seeing in IL and Canada or the acceleration in growth you highlighted in the UK heading into 2024, are returns more attractive in those regions today, or, and are you considering kind of leaning in, I guess, more international versus, domestically in the senior housing side?

Shankh Mitra (CEO)

I wish the answer to your question was yes, but the answer is no. Canada is a very tight market with very significant, you know, few handful of owners, handful of banks, and very significant CMHC presence. Returns in Canada usually are pretty tight. We're seeing opportunities to create value through our great operating partners that's there. U.K., we're actually now starting to see very significant returns. We made one investment in U.K. this quarter, like last quarter, and we're seeing that. U.K. returns are good, but actually very good. I will tell you the vast majority of opportunities are in the U.S. You know, frankly speaking, it's such a deep and robust, you know, pipeline that you can pick your spots and make some significant returns.

As we're seeing, you know, the unlevered IRRs in the senior space today without getting into which country, you know, which return for which country. Roughly speaking, I'll say close to double digit. We're seeing opportunities that are in the double digit. Medical office today, our IR opportunities are, you know, 8.5+, I would say. Obviously, we're very focused on, you know, sort of participating debt structures in the SNF side where we can create high-teen returns, despite using some debt and some equity-like features that I talked about in probably in the high teens. That's kind of our focus.

We're purely return driven, we're purely basis driven. All we are trying to do is we're trying to figure out where can we add value, not through just financial capital, but those four things I talked about. It's an optimization problem, right? It's an optimization problem of location, product, price point, and operator. That's how you make money in this business. That's how we're trying to create value.

Operator (participant)

Thank you. We go next now to Steven Valiquette at Barclays.

Steven Valiquette (Managing Director of Equity Research Analyst)

Thanks. Good morning. Just to follow up on your earlier comments on the senior housing pricing power for the rest of 2023 and into 2024, I think you kinda suggested for us to maybe not focus as much on the absolute price increases at this stage, but just more on the spread between RevPOR versus ExPOR. I guess really the question is, without giving any specific guidance, can you just give us maybe just a general sense or range of what you know, might be targeting for the spread between RevPOR versus ExpPOR over the next few years? Is 200-300 basis points a reasonable assumption, you know, the trend you've seen over the past several quarters, or should we think more conservatively at this stage, you know, when thinking beyond 2023? Thanks.

Shankh Mitra (CEO)

Thank you, Steve. Good morning. I was trying to add value, added color to the question that previously was asked. Tim already gave you our view of RevPOR increase as we sit today, right? 6.3% increase that we talked about. I was trying to provide more color as we think about long term. Long term, we're focused on the spread between RevPOR and ExpPOR. By no means I'm trying to say that we're seeing anything in that, you know, sort of, around us that says that pricing power is cooling down. In fact, it's the opposite, and I think John probably mentioned that.

All I was trying to point out that long term, without thinking about is it 6%, is it 12%, is it 3%, the way you're gonna get the P&L right, which is ultimately what we are focused on, is the spread between that RevPOR and ExpPOR, right? That's what I was trying to answer. We do think that we'll see significant pricing power continue as I mentioned, half of our portfolio gets renewed at different points in the anniversary cycle, and street trade continues to go up. Hope that's helpful.

Operator (participant)

Thank you. We go next now to Omotayo Okusanya at Deutsche Bank.

Omotayo Okusanya (Equity Research Analyst)

Thanks. I'm just turning to the guidance. I wanna make sure I'm understanding this right. In terms of the, you know, the NAREIT FFO guidance range coming down, you know, there's various normalized items, expenses, that are, you know, being added back to your normalized FFO. A lot of that's the transaction costs, promotes, you know, I know you guys break this out, but just trying to understand, you know, what's driving that. It's a pretty regular line item going back for the last year. You know, how we should think about, you know, is this still gonna be other transaction costs hitting the P&L for the rest of the year, but it's just not in your NAREIT FFO guidance right now? Thanks.

Tim McHugh (CFO)

Yeah. Thanks, Nick. The transaction costs you're referencing, so other expenses, which are predominantly transaction costs, just think about that being as it's described in the footnote, non-non-capitalizable transaction costs. A lot of that tends to be dead deal costs. It's tough to predict kind of how that comes through. We're a pretty active firm. I'd say that stepped up a bit this quarter just because of, you know, as we've talked about and as Shankh kind of highlighted on a few prior calls, you know, our underwriting standards have picked up a bit, and we've seen costs increase. You think about some developments that we've gotten beyond kind of early stage development spend, and, you know, we think in a fairly disciplined manner, have walked away from.

As we kind of look forward, similar to the way we don't kind of guide to acquisition costs, we try to have a pretty flexible framework as to how we think about our acquisition volume. Flexible framework is how we think about investing dollars. The same goes for, you know, as we pursue things with the intent to move forward. If we end up not moving forward with them, they could end up coming through this line item. It's not something that we've made decisions on right now, or else it'd be coming through this quarter.

Operator (participant)

Thank you. We'll go next now to Ronald Kamdem at Morgan Stanley.

Ronald Kamdem (Head Managing Director)

Great. Thanks. Just the presentation sort of highlighted that the outsized occupancy gains was in AL and in other parts of the business. Just a little bit more color on sort of the IL versus AL difference would be helpful, 'cause some of the NIC data suggests IL was accelerating, and I think you mentioned that as well, would be helpful. Then the follow-up was, you know, post the PLR ruling, just what are the updated thoughts and vision in terms of having an in-house sort of operating platform, and any color on timing costs would be helpful. Thank you.

Shankh Mitra (CEO)

Let me try to take the first one. John why don't you take the second one? As I mentioned on my prepared remarks, assisted living continued to significantly outperform independent living. The only thing I was trying to highlight that after underperformance, independent living is starting to pick up, particularly in Canada, that's what we are seeing starting to come through our Canadian numbers, right? If you just look at an absolute performance between the two, there's no question that assisted living has been outperforming. If economic continues to weaken, my, you know, on a given rolling 12-18 month period, my guess is that it will continue to outperform very significantly given the need-driven nature of the business.

John F. Burkart (COO)

Regarding the self-management of the PLR, I want everyone to keep in mind, our focus is, it always has been, on driving results. That is the number one most important thing. Whether we're managing directly or whether we're asset managing and our partners are managing, is less the point, and it's more about getting the results. With that said, I think it's probable that we end up in some form of self-management this year. I would say as far as the costs go, what's happening right now is we're working very quickly on the technology aspect and data analytics aspect of the operating platform. That really is just swapping out. For, you know, our operators have modules, they're paying for those modules, and now we're switching them to our modules.

That is close to a net zero on the cost side. There are a few other costs as we improve things, which will provide some more clarity going forward. None of these are really big numbers. I wouldn't worry about that in the sense of, you know, very big surprises. It's just really changing out and getting improved improved modules going forward. Hopefully, that's helpful.

Operator (participant)

Thank you. The next now to Michael Griffin at Citi.

Michael Griffin (Senior Equity Research Analyst)

Great. Appreciate the follow-up. Just a quick one. I noticed in your investor presentation, I think it's slide seven, last quarter it said the comp pool growth decelerated at 2.6%. I know it's kind of nitpicky, and I didn't see anything on the slide in the current deck. I don't know, maybe Matthew or someone, if you just clarify if there's that number available, that would be helpful.

Tim McHugh (CFO)

Yeah, Michael. What we provided is the pool change. I think one thing you're noting is that we've seen kind of ExpPOR pick up from Q4 to Q1. We gave the number on what Q1 would have been based on the Q4 pool, as you noted in the footnote. Then just on the pickup in general from the reported same-store number in Q4, Q1, it's actually 'cause we continue to expand the same-store pool. You've got 95% of our operational properties that we've owned for more than four quarters in our same-store pool now. A lot of the transitions that came in were from the U.K.

U.K., we've just seen expense growth run higher than the rest of the portfolio, largely driven by utilities, which we've talked about a lot in this call. Some of the increase you're seeing just in Q1 is from that mix shift and inclusion of more U.K. properties.

Shankh Mitra (CEO)

UK is at the sort of the earlier stages of normalizing labor costs. It's the addition of UK that it makes it look like the compo has gone up. If you look at on a same-store basis of, you know, not the same-store basis, but the same pool of Q4, you will see it was relatively, you know, same.

Operator (participant)

Thank you. The next now to Juan Sanabria at BMO Capital Markets.

Juan Sanabria (Managing Director and Senior U.S. Real Estate Analyst)

Hi, just a big picture question. Curious if you guys could comment on overall seniors housing penetration. Talking to some of the privates and just reading some of the trade racks, it seems like acuity levels have gone up and maybe seniors are waiting to come in. Just I guess, are you seeing that? What does that mean for the business? What are your thoughts about overall penetration rates and the ability to effectuate that through marketing or what have you, as part of this new data-driven platform and efforts?

Shankh Mitra (CEO)

I'll try to, I'll try to address first part of your question. Acuity actually went up, I would say in 2020, right? If you didn't absolutely need it, you would avoid the product pre-vaccine. We obviously have seen acuity gone up in 2020, but since then, we have seen acuity sort of normalize. I'm not sure that I subscribe to this idea that acuity across the board for the industry has going up. In fact, you know, someone just asked earlier in the question pool about Kisco. I was with the Kisco team last week and, you know, Kisco CEO were talking to me that acuity, they have seen acuity actually gone down, right?

You know, probably gone down for some, gone up for some, but I do believe that acuity has normalized from that, 2020, peak levels as we have seen, vaccine come into play. You want to answer the second part?

John F. Burkart (COO)

Yeah. I'll just add a little bit. You know, obviously, as I said, supply demand incredibly favorable. We've said it many times. You get to the next piece, which is penetration, which you're talking about. I actually see penetration increasing. What we're seeing is the seniors desire, the loneliness and the desire for social, you know, safe, active location, as well as the cost of care. The cost of care has continually gone up. We all know that. Labor for care has been a challenge. Where you see that the most is in home care. We've had people move into our properties because they can't afford or cannot get the level of care. Their costs actually net go down, which is a benefit.

I see that playing itself out over the next couple of years, so we get the benefit of supply demand. Additionally, we get the benefit of penetration. Then finally, the platform will drive greater market share, and we'll get that benefit as well. I see a very, very favorable future going forward.

Operator (participant)

Thank you. We'll take our final question this morning from Vikram Malhotra at Mizuho.

Michael Griffin (Senior Equity Research Analyst)

Thanks for the follow-up. Just two clarifications. Tim, I guess, in your last call, you had mentioned in the guide you were keeping the temp usage as a percent of total intact or flat through the year in your guide. With what you've seen in Q1, are you changing that, in terms of it being lower? Second, in the medical office side, I think the OpEx went up, you know, maybe 7% or 8%. I'm just wondering, was there anything one time in that number?

Tim McHugh (CFO)

Yes. I'll start with your first question on senior housing, and John can add any color on the MOB side. For senior housing, yeah, you're correct. We came in, our Q1 results were better than expected as far as how agency came down. Of course, some of that benefit gets netted out with full-time employees coming on. Net, we ended up in a more favorable spot for compensation. As I kinda noted in my guidance outlook, that's largely what's moving our outlook for the year. Is just a better trend coming out of Q1 on expenses, with that being the main piece. The assumption revenue kinda holds given that we're moving into the revenue building months as we speak.

Then on the MOB, you know, as I mentioned in my prepared remarks, we're expecting guidances between 2% and 3%. So that is a timing issue for Q1, and it'll reverse as we go through Q2, Q3 and Q4.

Operator (participant)

Thank you. Ladies and gentlemen, that will bring us to the conclusion of the Welltower Q1 2023 earnings release conference call. We'd like to thank you all so much for joining us this morning and wish you all a great remainder of your day. Goodbye