Welltower - Q3 2023

Transcript

Operator (participant)

Thank you for standing by, and welcome to the Welltower Q3 2023 earnings conference call. I would now like to welcome Matt McQueen, General Counsel, to begin the call. Matt, over to you.

Matt McQueen (Chief Legal Officer and General Counsel)

Thank you and good morning. As a reminder, certain statements made during this call may be deemed forward-looking, 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.

Shankh Mitra (CEO)

Thank you, Matt, and good morning, everyone. I'll review our Q3 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 will also participate in the Q&A section 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're delighted to report that occupancy growth not only accelerated through Q3, but also that September occupancy gains marked the highest level we have seen over the last two years.

From a pricing standpoint, we continue to achieve outsized rate increases, as reflected by nearly 7% growth in RevPOR or unit revenue. As you may recall, we previously mentioned that last year, one of our largest operator pulled 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 2024 to push through rate increases. As a result, reported pricing of Q3 this year may appear lower than what we're 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 ExpOR 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. Our sharp 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%+ 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're 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 where 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, of all of our stakeholders. Conversely, we'll be very disappointed if our operators take the path of least resistance, which ultimately will impact resident and employee satisfaction. We continue to focus on the delta of RevPOR minus ExpOR as the single most important operating metric to optimize. While it is too early to comment on anything specific related to 2024, as I sit here today, I believe that the delta of RevPOR minus ExpOR 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 our new operating platform being launched in the next few weeks. And going forward, we believe both of our international businesses will have these significant contributors to our earnings growth in 2024 and 2025. 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 $1 billion 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 markets in this higher for longer rate environment suggest that this counter-trend will continue and perhaps will get better in 2024. We are continuing 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 side, making up the large worth of opportunities that we're constantly being pinged on.

I want to remind you that we have a three-dimensional lens through which we measure investment opportunities: risk, reward, and duration. Given the substantial rise of real rates over the last 90 days, we have recalibrated these 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. We're students 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 grind higher, we'll continue to calibrate our three guideposts higher.

So far, we have no problem achieving these recalibrations as sellers understand the markets have changed, and we remain their best, at many times, the only hope for liquidity. From a balance sheet perspective, amidst a 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 a two-time decline from just 12 months ago. Our balance sheet strength and flexibility gives us opportunity to remain on offense or provide shelter if the economic environment meaningfully worsens 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 grow.

As you all know, a wall of debt maturity in 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 am suddenly grateful to Tim and our 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 we will only grow externally if and only if we can grow value accretively on a per share 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 twenty-first century business process and technology infrastructure of this primarily people-driven business, where individual communities are on their own island.

We have made tremendous strides in the 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 around traditional technology solutions like 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 perhaps 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 multi-year double-digit compounding growth rate.

While supply and demand backdrop is clearly in our favor, we're far more focused on the value add alpha from our platform, which you, as our fellow owners, have funded to build with our blood, sweat, and tears. With that, I'll pass the call over to John.

John Burkart (EVP and COO)

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 portfolio's Q3 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% Q3 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 per occupied room continues to remain low, enabling the business to improve the margins. As Shankh mentioned, our ExpOR 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 sacrificed 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 hardworking 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 three hours per move-in inputting the documents into the antiquated systems. The CRM, rent roll, and care modules are disparate systems. Our platform has all the documents in eForm, 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 (EVP and CFO)

Thank you, John. My comments today will focus on our Q3 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 Q3 net income attributable to common stockholders of $0.24 per diluted share, and normalized funds from operations of $0.92 per diluted share, representing a 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 on 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 a quarter in arrears, so these statistics reflect the trailing twelve months, ending June 30th, 2023. In our senior housing triple net portfolio, same-store NOI increased 3.9% year-over-year, and trailing twelve-month EBITDAR coverage was 0.93x. In the quarter, we agreed to convert 11 StoryPoint assets from triple net lease to RIDEA, which will bring their regionally focused managed portfolio up to 55 Midwestern properties in the Q4. Next, same-store NOI in our long-term post-acute portfolio grew 5.3% year-over-year, and trailing twelve-month EBITDAR 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 unwind that was announced last quarter, will close by geography in three distinct phases. The U.K. portion closed in Q2, and the U.S. portion closed 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, helped drive net debt to adjusted EBITDA to 5.14x at quarter end, which represents 1.8 turns 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 to continue to trend downward in future quarters as the recovery in our senior housing operating portfolio continues to drive organic cash flow higher.

Additionally, following 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 billion revolving line of credit and $624 million in remaining expected proceeds from near-term dispositions and loan paydowns, 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-$0.95 per diluted share, and normalized FFO of $3.59-$3.63 per diluted share, or $3.61 per share at the midpoint.

Our updated normalized FFO per share guidance represents a $0.055 increase at the midpoint from our previously updated guidance. This increase in 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 in the year beyond what is closed to date. These increases are partially offset by a combined $0.01 drag from an increase in expected full-year G&A and stronger dollar.

Underlying this FFO guidance is an increased estimate of total portfolio year-over-year, same-store NOI growth of 11.5%-13.5%, driven by sub-segment growth of outpatient medical, 2.5%-3%, long-term post-acute, 4%-5%, senior housing triple net, 1.5%-2.5%, and finally, increased senior housing operating growth of 23%-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%. With that, I'll hand the call back over to Shankh.

Shankh Mitra (CEO)

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 that 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 our RIDEA structure. Nine of these properties were in a historic lease structure with other operators, and two of them are recent acquisitions. StoryPoint is one of our best operators, and a current RIDEA operator, has cleaned up these buildings, 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.

RevPOR is up 15% since they took over. RevPOR of the new managements in 2023 is up another 12% from the average of 2023 numbers. This is setting up the stage for significant cash flow growth in 2024 and beyond. Debt-to-equity conversion at the bottom of the cycle are perhaps the most value accretive transaction we can complete today. As we have experienced in our recent Legend conversion, we can expect to break even in 12-15 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 who are right about the trajectory of the cash flow. That is the bet I'm willing to take at this point in the recovery cycle.

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 and outcome for a long-term basis. Second, Kisco, one of our strongest operating partner, measured by margin, occupancy, and other operating metrics, recently merged with another one of our operators, Balfour. Balfour, now a Kisco, affiliate of Kisco, maintains a dominant position in the Denver metro area, also has trophy buildings nearing completions in Brookline, in Boston MSA, and Georgetown in D.C., both properties opening in 2024.

We thank Michael 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, we're in the final stages of Project Transformer, the transaction which I described to you last quarter, with our teams working really hard with Mathieu and Frédéric at Cogir. Our brand launch is coming up in the next few weeks, and people are on both sides of working at a frenetic pace to achieve seamless transition.

This is yet another transaction, transaction like the others above, which we look back at in 2024 and 2025 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 began. We at Welltower remain focused on the long-term prize 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 the significantly accretive capital deployment, are all setting us up for an accelerating earnings and cash flow trajectory for 2024 and 2025. With that, I'll open the call up for questions.

Operator (participant)

At this time, I'd like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll ask that you limit yourself to one question, please. We'll pause for just a moment to compile any questions. Again, if you'd like to ask a question, please press star one on your telephone keypad now. Our first question comes from the line of Vikram Malhotra from Mizuho. Please go ahead.

Vikram Malhotra (Managing Director)

Good morning. Thanks for taking the question. I guess, the sort of great opportunity on the external growth front. We have, you know, yesterday we saw two of your peers merge, and I was hoping you could sort of give us a sense of, you know, as that process was explored, you know, 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 (CEO)

So, Vikram, I don't comment on other people's deals. 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 picked from a collection of 80, 90+ 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 the median size of assets transactions that we have done in the last three years, which constitute this $12 billion or so of assets we bought, is like $30 million. That's what we like, that works for us, and that's what we continue. We have no dearth of opportunities. I mean, it's what we see today, the market is, I will not be surprised, and you guys 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, you know, loans that are coming due, how much of floating rate debts are rolling over.

So we have no problem growing the company, you know, as long as we have access to capital, and we can do it on a partial basis. But, you know, 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 of 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 (participant)

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

Connor Siversky (Director and Senior Equity Research Analyst)

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 (CEO)

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, you know, 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 question? Sorry, I missed that.

Connor Siversky (Director and Senior Equity Research Analyst)

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

Shankh Mitra (CEO)

Yeah, 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, say 40% to about 50%. In this particular case, I believe that the improvement will be better, and margins will go from, call it, say 20%-40%. So I think we should see better enhancement in this particular case than the Regency example.

Connor Siversky (Director and Senior Equity Research Analyst)

Great. Thank you.

Operator (participant)

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

Juan Sanabria (Managing Director)

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 late 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 (CEO)

So Juan, as you know, we're sort of finalizing that as we speak, right? That's the discussion we're in. As I mentioned in my prepared remarks, that we expect that to be very strong, like last couple of years. And, and that's where we are. We're 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'll be very strong.

Operator (participant)

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

Jonathan Hughes (Equity Research Analyst)

Hi, good morning. Thanks for the time. Shankh, could you just clarify the ending comments you gave in your prepared remarks where you said that the Kisco, Balfour merger might be a drag on the Q4? I didn't quite understand why that might be the case. Then maybe one more, if I could sneak it in. The SHO portfolio, you know, outperformed that typical seasonality in the Q3. I think that's expected to continue into year-end. You know, is that driven more so by the U.K., you know, related changing same-store pool, something else? Just, any additional color there would be great. Thanks.

Shankh Mitra (CEO)

Let me try the first one. So I did not say that specific transaction might be a drag on the Q4. I said the three things that I described together could be a drag on the Q4, but combined, all of them should be a significant driver of growth on 2024 for 2025, or just call it stabilized earnings. That's the point I was trying to drive, not specifically about Kisco and Balfour.

Tim McHugh (EVP and CFO)

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've actually seen very strong occupancy gains in the transition portfolio, probably greater than what we've seen in the core portfolio.

Shankh Mitra (CEO)

Jonathan, just, the core portfolio, as you know, sequential occupancy growth was around 150 basis points. The transition portfolio, the two I talked about, which 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 (participant)

With Scotiabank. Please go ahead.

Nick Yulico (Managing Director)

Thanks. Yeah, I was hoping to get maybe a little bit of a preview about, you know, how G&A could trend over the next year. You know, I know this year, you know, there was the build-out of John's group, and just trying to understand, you know, like, how far along that is and, you know, how that could affect, you know, G&A growth over the next year.

Shankh Mitra (CEO)

Nick, as I mentioned early in the year, I think if you go back to Q4 call, we have at least another year of elevated G&A increase as a build-out of the platform. So you should, we have come long, but we have a long ways to go. So G&A versus NOI, just a geography of where you see expenses versus revenue. So we do believe that the platform build-out is paying off, and started to pay off in spades. But from a purely, just looking purely at P&L item, we would expect that another year of build-out, at least another year of build-out.

Operator (participant)

Our next question comes from the line of Michael Griffin with Citi. Please go ahead.

Nick Joseph (Head of US Real Estate and Lodging Research Team)

Thanks. It's actually, Nick Joseph here with Michael. Shankh, I recognize you said, you're not engaged, you won't be engaged. But last year, you reportedly got involved in a similar public-to-public M&A situation within the medical office space. You know, you talked in the past a lot about being an IR buyer and cost-based focused, and that you look at everything. So just curious, in this situation, you know, or more broadly, is it kind of the current valuation and underwritten returns aren't sufficient against the other opportunities that you're seeing? Is it something about medical office that's keeping you on the sidelines here?

Shankh Mitra (CEO)

So, first thing, I mentioned that I don't comment on other people's deals, so I have nothing underwritten, so I can't even comment on what the underwritten returns looks like. But specifically to medical office, I think I provided some color, last quarter that, you know, we're unsure at this point where the long-term inflation land. And because we're unsure, we are unsure of at this point to make a huge bet on a asset class that we don't know what the growth profile versus the long-term inflation looks like, right? So that is a very important point. We are finding opportunities where we think we can small opportunities, where we can do value add. We're buying assets at 70%-80% occupancy and leasing up, and so that we can see the growth rate higher.

But from a stabilized 95%, call it, you know, occupied medical office with a 2.5% increase or whatever it is, the traditional medical office, which provides a good, long-term stable growth for institutional investors, is not interesting for us. For that one reason, and the second reason is it's always, it's relative opportunities is the question, right? If that's the only thing that was available to us, it'd be a different conversation. We're easily taking off, you know, a low double-digit, plus unlevered IRR opportunities in the senior living side, assuming that we don't add much value, and I'm pretty positive we'll add value. So it's just a question of relative opportunities of where we see the world today, and that's why we have no interest.

By no means that suggests that we don't think it's a good deal or not a good deal. I have no idea what the deal is because I'm not engaged in it, and as I specifically mentioned, we'll not because of the reasons I just pointed out to you.

Operator (participant)

Our next question comes from the line of Joshua Dennerlein with Bank of America. Please go ahead.

Joshua Dennerlein (Senior Equity Research Analyst of REITs)

Yeah. Hey, guys. I have a question on the transitions. Shankh, you mentioned you've been very active in terms of proactive portfolio management, and you've achieved a lot of early success recently with Avery and Oakmont. How have these operators driven such strong results so quickly, and just how would you encourage us to think about future transitions in the portfolio?

Shankh Mitra (CEO)

Yeah, I'm not going to answer the first question, Josh, obviously on a public call. I mean, there are things called trade secrets that you don't want us to divulge on a public company call, but we'll say that this doesn't happen, like, on automatically. As I've said before, we have learned, we have done a lot of transitions over the last, call it five, seven years that I've been doing this, and we have learned our lessons from, frankly, old, you know, old school way of losing money. We have learned what we have done wrong. We have gotten better. Then sort of we've learned how to stop bleeding, and then finally, we have gotten the other side of, you know, how do we - how we can make an impact, what the prep work you need to do on systems and processes.

And frankly, that's what John taught us, right? So it's just, it's an evolution. It's a process that we have gotten over the last few years, and I'm very, very happy that we're there. Now, from the point of view of, you know, transitions, is it the last transition? Would we do 1,000 more transitions? It just depends on the performance. We're trying to optimize our performance. I may have said it many, many times that this is a business, in our opinion, in our humble opinion, it's a business of optimizing location, product, price point, and operator. Right? So we'll keep optimizing it until we think that we, we're done. And, you know, and that's kind of where we are. It's a journey, you know, it's a journey I've written about that I'm willing to do, even if we take short-term hits.

It appears, at least from near-term results—no guarantee of the future—that we have achieved how to even mitigate that short-term hit.

Operator (participant)

Our next question comes from a line of Rich Anderson with Wedbush. Please go ahead.

Rich Anderson (Managing Director)

Hey, good morning, everyone. So I want to talk, and perhaps to John, on the rate number that you mentioned, the RevPOR number of 7%, and specifically the sustainability of that type of growth. It's always been my view that there was some sort of implied ceiling of growing rents for people that are 85 years old, and that at some point along the way, that there's just a way of doing business. Now, I don't know that there's a real, you know, ceiling of some sort, but it always seemed to me that was the case. Correct me if I'm wrong. Number two, though, maybe it involves unpacking the rent. Maybe it's rent between rent and care, and so that, you know, kind of muddies the conversation.

I wonder if you could comment at any level about how rate might grow in the future, considering, you know, what I think would be some pushback for the reasons I just described.

Shankh Mitra (CEO)

Rich, let me try to start then, and John, you know, you sort of finish anything that I haven't added. So I think your conversation that you have is a reasonable if you think about a long-term tenant in the middle of the market, right? So you have to think about the customer you're talking about. Our rate increases because we have sold majority of our mid-market product. Our U.K. and U.S. portfolio is primarily focused on very high-end customer, very wealthy customer, and the product remains incredibly affordable to them. And at that level, we haven't seen any pushback. The second point you have to consider, Rich, is we have never raised rates like you have seen in other asset classes, multifamily, storage, others, 20%, 25%.

You know, we have never raised that, right? So just sort of rates remains high single digit, you know, whatever, like 8%, 9%, 10% is sort of what we have done. So it's much more sustainable than you, you think. But put that aside, just understand, put all of those comments in the context of average length of stay. You're talking about an average length of stay of 20 months. So we might be here talking about for the third year of increase of x%, but just understand, the person who got the first year of increase, he or she is gone, right? She's no longer in the community. So if you put all of those together, you will see that if you provide... The very important point, if you provide the differentiated services at the highest level, your customer is willing to pay you.

Now, we are, as I've said many, many times, we're not focused on an individual number called a RevPOR or rate, right? We're focused on very much of a delta between RevPOR and ExpOR, and that's what we are focused on. I've said that last year and the year before, and we shall see what the market gives us, right? I have no idea what the market will give us. If there's a pushback, we will adjust, but we haven't seen any yet.

John Burkart (EVP and COO)

Yeah, no, I fully agree. It's the difference between RevPOR and ExpOR. And I think you're probably, Rich, thinking about multi-family, where people are there for years and years and years, and it's a very different situation here.

Operator (participant)

Our next question comes from Jim Kammert with Evercore ISI. Please go ahead.

Jim Kammert (Managing Director)

Hi, good morning. Thank you. I certainly appreciate the operating leverage embedded in the SHO portfolio. I was just wondering if you could provide a little more color, sort of regarding labor trends for the general staffing there and what conviction you have in the ability to really continue to sustain pretty attractive or capitated growth of those expenses. I mean, are you getting longer tenure, so it's lower turnover and lower recruitment costs, or just a better labor talent pool? And again, I'm just thinking more beyond the chef and the general manager, you know, how, what levers are contributing to a nice profile in terms of growth on the expenses for labor?

Shankh Mitra (CEO)

Jim, you are correct that we are seeing turnover is coming down significantly. We are seeing that overall availability of employees who wants to be part of our business and part of the communities is increasing significantly. And we're seeing that our operating partners are getting better using technology and other resources to attract talent and keeping them in the business, right? So that's sort of, it's whenever you get hit by a crisis, people figure out ways to do things better. Every crisis makes a business better if it survives, right? And that's what we are seeing. And what conviction do we have that, you know, that, that RevPOR minus ExpOR journey can continue very significantly. For a specific line item on a specific things, on a specific quarter, we have no idea.

I said this million times, our goal here is not to predict the future. Our goal is to see what market gives us and do better than market. We'll see what market gives us.

John Burkart (EVP and COO)

I would just add, you know, in my comments, my focus is on productivity. So, you know, we want our employees to be paid well. We want to happy employees and happy customers. We also want to increase productivity of the business so that we can manage to accomplish all of that. So that's really the, I think, the take-home point.

Operator (participant)

Our next question comes from the line of Mike Mueller with JPMorgan. Please go ahead.

Mike Mueller (Senior Equity Research Analyst)

Yeah, curious, how are you thinking about, I guess, senior housing development today, and how do you see starts potentially trending over the next couple of years?

Shankh Mitra (CEO)

Yeah, Mike, I'm just gonna be repetitive here. I was asked this question at the NIC conference about a week ago or 10 days ago, whenever that was. I'll repeat what I said on that panel. I think if you're a debt provider in senior housing today, you have better luck going to Vegas. And if you're an equity provider in senior housing development today, you have better luck buying lottery. I hope that tells you what my view of senior housing development is. I don't even understand why there is any start, like more than zero, because the economics doesn't make any sense given where construction cost is, where capital cost is, and where the margin of the business is. It should not have any starts, and it seems like it's going there.

I think any starts that you are seeing, people are still playing with other people's money, and, you know, and that's coming down, closing down pretty quickly, and I think you will continue to see it's moving down. Mike, did I miss any of, any other part of your question?

Mike Mueller (Senior Equity Research Analyst)

No, that was it. Thank you.

Thank you.

Operator (participant)

Our next question comes from the line of Michael Carroll with RBC. Please go ahead.

Michael Carroll (Managing Director)

Yeah, thanks. Given the dislocation that we're seeing in the private market, is it harder for operators that are having liquidity issues to provide the same level of care versus your operators that presumably don't have these issues? I mean, are you seeing that in the marketplace at all right now? And if not, do you expect that this will become a bigger storyline over the next several quarters?

Shankh Mitra (CEO)

I can't speak for other people, Mike. You know, I will tell you that, we have our operators, our operating partners are doing extremely well, and we are getting hit left, right, and center with new operating partner who wants to be part of our story. So whether that's because they're inspired to do what John is doing, our data journey or, you know, we're trying to professionalize the business on the digital transformation journey, or they are having troubles on their own end, or both, I have no idea. But I could tell you that we have literally. I mean, it is, we have seen really good investment opportunities, but we have never seen anything like what we are seeing today. Whether that's because of a pull or a push, I have no idea.

We're seeing operators from all parts of the country, in all three countries we do business with, is calling us to be part of it, this well-capitalized, extraordinarily well-capitalized platform, but also the part of being part of John's platform.

Operator (participant)

Our next question comes from the line of Ron Kamdem with Morgan Stanley. Please go ahead.

Ronald Kamdem (Managing Director and Head of US REITs and CRE Research)

Hey, great. Just a big picture one. So I was looking at the presentation, the NOI, the incremental NOI build. I noticed that you guys added a bar here that looks like another $172 million. And, you know, I'm tying back to your comments about the focus on RevPOR versus ExpOR. It's clearly a margin benefit here. So I was wondering if you could talk about that, you know, why add that to the deck? Where is this? Is it? Are we supposed to read into it, just more confidence in the ability to get back to pre-COVID margins? Is the question.

Tim McHugh (EVP and CFO)

Yeah, Ron, so we added that to the deck through conversations with both investors and analysts alike. That they were looking at it and interpreting the stabilized point to be reflective of 88% occupancy and 31% margins, when in fact, with the rent growth we've seen since Q4 2019, basically, we're ignoring that rent growth or with it, we're baking in around 29% margin. So what we wanted to do is just SHO getting back to just the NOI level on today's rents means that you're getting to, you know, margins that are 200 basis points plus below where we were margin-wise, in Q4 2019.

What that final bar does is it just shows you getting back to 88% occupancy, 31% margins in pre-COVID levels, at today's Q3 2023 realized rents, where NOI would be.

Shankh Mitra (CEO)

Ron, I've said this before, I'll repeat it again. If that's all we go back to, you know, Q4 of 2019 level or pre-COVID level, I would be very, very disappointed. If you have done this in Q4 of 2019, you would remember, those were not the greatest days of this business, right? So we, we were getting hit for 4+ years at this point, and through a supply cycle. That is not a high point like a lot of other businesses are, and we're very disappointed that's, that's all we get back to.

Operator (participant)

Our next question comes from the line of Jamie Feldman with Wells Fargo. Please go ahead.

Jamie Feldman (Managing Director and Head of REIT Research)

Great. Thanks for taking my question. I'm here with Connor. How should we think about funding assumptions for the next tranche of acquisitions? And then also, how does the quality of the assets you're looking at compare to the quality of your existing portfolio? Or put differently, how do you assure investors that you aren't moving up the risk curve to chase a return profile?

Shankh Mitra (CEO)

I don't want to assure investors of anything. I, you know, I think investors are aware of our track record, and you guys do a very good job of visiting our properties, so you can see it. The chasing the risk curve to get investment might happen when things are really, really tight. It is an exactly opposite environment, Jamie. When those environments have occurred in the past, we were massive sellers of assets. We don't chase risk curves to get return. That's just not what we do. Now, going back to our actual, the crux of your question is, frankly speaking, the initial part of COVID, what we are noticing was sort of a lot of broken cash flows, right? Assets were 60%, 70% occupied.

You know, new development, brand-new assets, three-year, four-year, you know, two-year-old assets, but broken cash flow, because that's normal for a business that had, you know, breaks even at 60% occupancy, and your marginal sort of, return, if you will, or your marginal or incremental margins, sort of go hockey stick. It's normal for that period of time, given how much occupancy we lost during COVID, to have those kind of assets. Great assets, broken cash flow because of, where the occupancy is and how margins work in this business. That was two years ago. Two years ago, that's what sort of we were seeing. Today, we are seeing broken capital structure.

Assets are generating the cash flow that it should be generating at 80% occupancy, 82% occupancy, where the industry is, call it, you know, 6%, 6.5%, whatever it is, the cash flow yield, that's not the problem. The problem is the underlying leverage, which is now so far plus 350, 400, is at 9%. That's the problem. And those loans are coming to you. You are upside down on a cash flow basis, and you're upside down on a leverage basis. And those are the ones that are transacting today....

So frankly speaking, the number of trophy buildings, number of high quality, high, high quality buildings, which core investors own, you know, the core real estate owners own, that we have seen in last, call it six months, even last four months, I haven't seen the four years before that, right? And so the quality of opportunities are going up pretty significantly, but it is up to you to decide, you know, what is the quality of assets you are buying. And, you know, we give assets, you can, you can go and visit them, and I think you will come to the same conclusion. Did I miss any part of the question?

Tim McHugh (EVP and CFO)

Jamie, on your funding question, in my prepared remarks, I spoke to kind of a liquidity build, and that's as of October 30th. We talked about $900 million in investments, just quarter-to-date closed in October, billion-dollar pipeline ahead of us, up to $2 billion in cash, and $6.6 billion in total available liquidity to fund that.

Operator (participant)

Our next question comes from Austin Wurschmidt with KeyBanc Capital Markets. Please go ahead.

Austin Wurschmidt (Senior REIT Analyst of Equity Research)

Great. Thanks. Shank, you were crystal clear with your thoughts on why development doesn't make sense broadly in senior housing today, but you did expand the development pipeline. I think it was up $600 million this quarter. Roughly $300 million of that was in senior housing, and clearly, you know, you have a cost of capital advantage today. But I mean, is that what gives you the comfort moving forward with these projects? And then I'm curious, are developers coming to you to partner on future projects that can't sort of access construction financing? And how does that opportunity set compare versus acquisitions?

Shankh Mitra (CEO)

So I think if I understand correctly, Nikhil, correct me if I'm wrong, all our development starts are either fully 100% leased, medical office developments that we have long-term, tail or long-term contracts with our existing clients, or they are wellness housing development. I do not believe that we have started any senior housing development. I don't remember when the last time we actually started a senior housing development. So because of they all reported in the same bucket, Austin, but they're not senior housing development. They are what in the, you know, what we call wellness housing, which is age-restricted and age-targeted apartments.

Operator (participant)

Our next question comes from Juan Sanabria with BMO Capital Markets. Please go ahead.

Juan Sanabria (Managing Director)

Hi, it's Juan here with one still. Just a quick question on the investment pipeline. Could you give a breakdown of kind of what you're looking at? And where do you think you see or where are stabilized yields there for what you're targeting in the major group groups?

Shankh Mitra (CEO)

Yeah. So the pipeline today is, as I said, I don't know, Nikhil, but it's like 80%+ would be senior housing.

Juan Sanabria (Managing Director)

Yeah, that's right.

Shankh Mitra (CEO)

Mostly, I would say, equity in senior living, and probably even 90%. But vast majority is senior living and core equity opportunities in senior living. Just because of the size, it's just a lot of it is in U.S., and we just closed a large transaction in Canada. So if I think about, remember it correctly, it's almost entirely, not entirely, but majority is U.S. senior housing, and there are some credit opportunities in the skill set. I don't remember any transaction, a pipeline about any MOBs, but do you know anything?

Juan Sanabria (Managing Director)

Nothing meaningful.

Shankh Mitra (CEO)

Okay. And, stabilized yields, I would say in the senior living today, we're targeting, close to eight on a stabilized basis and going in. I think I said last call, we're seeing sort of opportunities that, you know, starting at six, ending at eight, and given the rise of real rates, we're seeing better than that today. Frankly, we have graduated our, return expectations higher. So that's sort of where we are transacting. But, you know, we're not a yield buyer. We're still happy to buy, one percent yield if we think that's the right basis and the right assets. But generally speaking, those are the kind of opportunities we're seeing.

Operator (participant)

Our final question comes from the line of Vikram Malhotra with Mizuho. Please go ahead.

Vikram Malhotra (Managing Director)

Thanks for taking the follow-up. Nikhil or Shankh, can you just update us on the Integra process? Where - how are those assets been performing? And, you know, by extension, are there additional opportunities? I just asked that because you had earlier outlined upon stabilization, you might look to sell some of that. So it would just be helpful to get an update on Integra. Thanks.

Tim McHugh (EVP and CFO)

Yeah, Vikram. So, we're pleased with the performance that we're seeing. In the last quarter, I talked about the first 133 out of the 147 buildings that I transitioned. In the last quarter, those buildings produced roughly $70 million of positive EBITDARM, compared to negative $90 million for the three months prior to the transition. Now, fast forward another quarter, those same buildings in the second quarter generated $127 million of EBITDARM. So in the six months since transition, you're seeing a cash flow swing of, you know, $215+ million, and obviously, every month continues to be better than the prior month. So if you look at June, and you annualize that, you're roughly $170 million, which is north of the rent, right?

So here we are, six months in. When we had underwritten this, we thought it would take us much longer, you know, 18 months, give or take, to get to this point. So we are incredibly pleased with the performance, but we think there is still a long ways to go. So, you know, your point about exiting upon stabilization, we're happy with the progress, but we're far from stabilization.

Operator (participant)

This concludes the Welltower Q3 conference call. Thank you for joining.