Welltower - Q4 2022
February 16, 2023
Transcript
Operator (participant)
Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Welltower fourth quarter earnings call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number 1 on your telephone keypad. If you would like to withdraw your question, press star 1 again. At this time, I would like to turn the conference over to Matthew McQueen, General Counsel. Please go ahead.
Matthew McQueen (General Counsel)
Thank you. 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 hand the call over to Shankh.
Shankh Mitra (CEO)
Thank you, Matt. Good morning, everyone. I will review fourth quarter and the year and describe high-level business trends and our capital allocation priorities. John will provide an update on operational performance of our SHO and MOB portfolios, and Tim will walk you through our triple-net business, balance sheet highlights, and 2023 full-year guidance. Nikhil, our newly appointed CIO, is also on the call to answer questions. While we're happy to bring back full-year guidance after 3 years, I'll point out there are many macro and business uncertainties remain. I would recommend investors and analysts to focus on 2023 exit run rate to understand the earnings power of this platform and not overly emphasize the calendar year guidance. I have mixed emotions as I reflect back on 2022.
As I've described during my prior calls, our results frankly underwhelmed our expectation during the first half of the year. While we don't like to fixate on short-term stock performance as we believe an appropriate window to gauge our performance is at least three to five years, you should throw tomatoes at us for generating an unsatisfactory return, total return in 2022. Remember, a stock is a fractional ownership of a business and not a ticker. We view our fellow investors as partners for the long haul and continuously strive to improve the prospects for long-term compounding of this business.
In spite of some of the headwinds that we experienced in 2022, my team and I are pleased with the underlying improvements we have seen in this platform and our talent base, resulting in a strong rebound of performance in fourth quarter and further improving momentum being carried into 2023. Our recent progress is only the tip of the iceberg of many of our initiatives will truly manifest themselves in the next year or two, which I'll go in a minute. While overall macro headwinds persist, we have seen a considerable improvement in the key indicators of the unit economics of the business, as reflected by Expense Per Occupied Room or ExPOR, or Revenue Per Occupied Room or RevPOR.
On the expense front, we have seen significant progress on addressing certain challenges we have faced over past year plus, most notably on the agency and temp labor situation. In fact, ExPOR has moderated to in Q4 to 3.4%, driven largely by a deceleration in Compensation Per Occupied Room or CompPOR to 2.6%, the lowest level we have seen in our recorded history. At the same time, RevPOR, again, the Revenue Per Occupied Room remained a consistent bright spot for us, increasing 7.5% in Q4, a clear reflection of strong pricing power resulting from our premier locations, product, and operator base. As I mentioned on our last call, one of our largest operators pulled forward January rent increases in Q4.
Even without that, our Q4 RevPOR would have exceeded 6% plus and reflecting a broad-based trend across our portfolio. While we achieved record RevPOR growth in 2022 of 5.5%, we expect to surpass this level of growth in 2023. While we achieved an impressive 19% SHOP NOI growth in 2022 and expect circa 20% NOI growth in 2023, I believe we're only at the beginning of a multi-year double-digit NOI growth resulting from a long runway of occupancy gain, rate growth, and operating margin expansion. Despite significant macro uncertainty already weighing on the fundamentals of many other sectors, our confidence in future growth of our business is supported by the need-based nature of our asset class, along with a favorable demand supply backdrop, which is getting better every single day.
I'm pleased to report that 2023 is already off to a great start with January move-ins are up 16% over 2019 levels, representing a meaningful acceleration from the fourth quarter. Forward-looking indicators are also showing promise in January with our total tour volume across our senior housing operating portfolio is up 25% year-over-year. I would be completely remiss to ignore perhaps one of the most important milestones in the 53-year history of our company. That is the Private Letter Ruling we received, which permits us to both own and self-manage independent living assets. The PLR provides us significant flexibility in operating our assets, and its timing coincides almost perfectly with the build-out of our industry-leading operating and asset management platform, which John and his team have been tirelessly working on.
We remain optimistic that further investment in our platform will not only result in a better margin profile of our assets. Also will meaningfully benefit the third-party operating partners across the senior living spectrum who we choose to do business with in the future. We continue to see a tremendous opportunity to professionalize and modernize the operating side of senior living business following our instinct where there is mystery, there is margin. Our PLR gives us significant ammunition to accelerate the pace for what Welltower 3.0 might look like. I want to thank Mike Gerst, our tax team, and many others whose efforts have led to this game-changing achievement. Before turning to investing environment, I want to highlight the addition of Retirement Unlimited, or RUI, to Welltower's roster of exceptional operating partners.
RUI is one of the best performing senior housing operator in the East Coast with the highest quality programming and care standards. RUI has consistently maintained occupancy levels at north of 90% and with hardly any use of agency labor over past few years. We announced today that RUI has assumed the management of our first community together in Alexandria, Virginia, with plans to meaningfully grow our relationship in near term through acquisitions, transition, and development. We're extremely excited and humbled to partner with the Fralin and Waldron families and RUI's all-star President, Doris-Ellie Sullivan, and welcome them to our Welltower family. In terms of other growth partners, it was exactly a year ago when we announced our partnership with David and Simon Reuben, along with their acquisition of Avery Healthcare in the U.K.
As you know, Reuben Brothers is one of the most sophisticated, forward-thinking, and well-capitalized global investors with a reputation of attracting best-in-class talent and technology platforms. Our thesis was validated when Reuben Brothers attracted Lorna Rose, one of the most well-respected senior housing operating executive in U.K., to join Avery as the company CEO in December. Lorna has spent 25 years in the industry and was most recently with Barchester, one of the U.K.'s largest senior housing platform. On the capital allocation side, we have rarely seen a favorable environment across all our product types in all three countries we do business in. There are $20-plus billion of exit queue for all real estate funds and perhaps even a longer one for non-traded REITs.
This, along with the challenging debt market, give us an enormous advantage to buy the right product at the right location at the right basis. Please note that while we are underearning by more than half a billion dollars of EBITDA from pre-pandemic levels, we just reported debt metrics that are better than Q4 of 2019, along with more than $5 billion of available liquidity. We have many avenues to access and deploy capital that I've described before, we remain busy on all fronts. Our North Star remains consistent and simple. We strive to create per share value for our existing owners by compounding over a long period of time within our circle of competence, which we define as the area where we can assess and allocate capital with house odds rather than gambler's odds. With that, I'll pass it over to John.
John Burkart (EVP and COO)
Thank you, Shankh. I'm excited about our operating performance this quarter and the acceleration in growth which we've witnessed. My first conference call at Welltower was in Q2 of July 2021. Total portfolio same-store NOI was a negative 7.1%. Since that call, the portfolio's performance has continued to improve. In 2022, despite challenges, growth was in the range of 7%-9% for the Q1 through Q3. In Q4, we accelerated to 12.9% portfolio NOI growth, driven by senior housing operating business with NOI growth of 28.1%, despite all the challenges of the current economy. This amazing performance is a result of both the fantastic supply-demand dynamics of the senior housing sector and aggressive asset management.
I continue to see many opportunities to professionalize the business, which are being proven out through various initiatives as noted in the case studies we presented in the slide deck, and clearly come through the financials when looking at the massive improvement in agency labor, which I'll outline in a moment. It is this abundance of opportunity, the opportunity of applying proven industry solutions to the senior housing industry, which led me to reach out to my friend Jerry Davis and engage Jerry as a strategic advisor. As many of you know, during my multifamily days, Jerry was my counterpart at UDR, one of the largest multifamily REITs with a national platform of 60,000 apartment homes. Jerry spent 30 years in various roles at UDR and nearly 15 overseeing all the company's operations before retiring in 2021.
He and I have always shared similar views that the operational excellence requires a focus on people, processes, data, and technology, which, if well done, results in a superior experience for both residents and employees and ultimately drives stronger financial performance. We have made substantial headway over the past year and a half in enhancing our management capabilities. Jerry's expertise will accelerate that progress. He'll focus his efforts on specific opportunities, while I'll continue to build the broader operating platform from asset management and operations to capital, resource management, renovation, et cetera, as Welltower transforms the business. Jerry will help us to continue to accelerate change in the senior housing industry. Our work together will not simply be additive, it will be exponential. J squared. I'll provide some insight into our operating business, starting with the medical office portfolio.
In the fourth quarter, same-store NOI growth for our outpatient medical business was 2.1% over the prior year's quarter. Same-store occupancy was steady throughout the year at nearly 95%, while retention remains extremely strong across the portfolio at 93% for the second straight quarter and nearly 92% for the entire year. This robust retention rate helps us drive improved lease rates and continued strong re-leasing rates. Turning to our senior housing operating portfolio, the 28.1% fourth quarter NOI increase over the prior year's quarter was driven by revenue growth of 10.3% for the period. Year-over-year margin growth of 320 basis points was also the strongest of the year.
All three regions showed strong revenue growth, starting with Canada at 6.6%, the U.S. and the U.K. an impressive 10.6 and 19.2% respectively. Revenue growth in the quarter was driven by a 200 basis point increase in average occupancy and another quarter of healthy pricing power with RevPOR growth of 7.5%, which as Shankh mentioned, is the highest we've ever witnessed. Sequentially, portfolio average occupancy continued to improve with a gain of 20 basis points during the period. Turning to expenses, agency use has obviously been a key factor in 2022 expenses. However, in Q4, 2022, just as Tim has mentioned many times, agency expense is acting as an expense deflator. Agency in our same-store portfolio is down 44% year-over-year in Q4 2022.
We often quote agency as a percentage of compensation. Looking at it that way, in Q4 of 2021, agency expense was 6.9% of compensation, and in Q4 of 2022, it was 3.7%. Regardless of how you look at agency, the expense is declining in the U.S. and Canada, where over 90% of our senior housing portfolio is located. The U.K. is still impacted by overall labor shortage, as well as some rigid staffing models, which have led to lower occupancy properties being overstaffed. Management in the U.K. is slowly adjusting to a dynamic staffing model, ensuring appropriate staffing at various levels of occupancy.
Overall, CompPOR, or compensation per occupied room, which represents about 60% of the expense per occupied room, increased only 2.6% in the fourth quarter compared to the prior year's quarter, which is the lowest growth rate in over five years. This moderating CompPOR growth helped drive the deceleration in overall expense growth despite continued inflationary pressures in several line items, including food and utilities, which rose 10.5% and 10% respectively in the fourth quarter of 2022 on a per occupied room basis compared to the prior year's quarter. Food and utilities represent roughly 12% of expense per occupied room. The combination of 7.5% RevPOR growth, the highest in over five years, with a 3.4% expense core growth led to remarkable growth rate in net operating income per occupied unit of 25%.
Regarding our operating platform, we continue to be on pace to pilot our first module in Q1 2023 with several other modules in the works. I must say that I'm purposefully not giving out the details as they are proprietary. I will say that I'm proud of the creative accomplishments of the Welltower team, and I'm grateful for the wonderful operators that we are partnering with on these first modules. The successes that we have had through aggressive asset management, as noted in the slide deck, are the result of brute force and prove the opportunity. Operational excellence is achieved by a focus on people, processes, data, and technology, and that is exactly what the team has done in the various initiatives that are outlined in three case studies on agency labor reduction, revenue management, and care revenue.
We will continue to leverage our team to drive results, yet the greatest opportunity will be realized as we roll out the operating platform in the coming years. I would like to thank our operators and all their employees and the Welltower employees for making these results possible. Our teamwork is clearly paying off, leading to improved resident and employee experiences and stronger overall results. I'll now turn the call over to Tim.
Tim McHugh (EVP and CFO)
Thank you, John. My comments today will focus on the fourth quarter 2022 results, the performance of our triple-net investment segment in the quarter, our capital activity, a balance sheet liquidity update, and finally, our outlook for the year ahead. Welltower reported fourth quarter normalized funds from operations of $0.83 per diluted share, representing 7% year-over-year growth after adjusting for prior period government grants and FX headwinds. We also reported total portfolio same-store NOI growth in the quarter of 12.9% year-over-year. Before getting into our segment results, I wanted to provide an update on our recently closed ProMedica restructure and the go-forward reporting treatment. In late December, we announced the closing of our restructured joint venture with ProMedica Health System and our newly formed joint venture with Integra Health.
The ProMedica Health System JV, consisting of 58 private pay assisted living assets, will continue to be operated under lease with ProMedica Health System and is now part of our senior housing triple-net reporting segment. The Integra Health Joint Venture, consisting of 147 skilled nursing properties, is comprised of a property joint venture and a master lease with Integra Health. The lease commenced upon closing in December as did the first tranche of the property JV, with Integra requiring 15% of Welltower's stake in 54 of the assets for $73 million. As previously expected, subsequent to year-end, the second tranche of assets closed in January, as Integra acquired a 15% interest in another 31 assets for $74 million. The remaining 62 assets are expected to close in the second half of the year.
As for the underlying operations, the subleasing of the portfolio is progressing in line with expectations. 75% of the beds have already transitioned management, with the remainder of the portfolio waiting on state-specific approvals. We will continue to update the market as the progress of management transitions in addition to underlying property level fundamentals. Turning to the performance of the rest of our triple-net properties in the quarter. As a reminder, our triple-net lease portfolio coverage and occupancy stats are reported according to arrears. These statistics reflect the trailing 12 months ending 9/30/2022. In our senior housing triple-net portfolio, same-store NOI increased 4.3% year-over-year, and trailing 12-month EBITDAR coverage was 0.86 times in the quarter.
Next, same-store NOI in our long-term post-acute portfolio grew 4% year-over-year, and trailing 12-month EBITDAR coverage was 1.34 times in the quarter. Turning to capital market activity. In the quarter, we settled $1.5 billion of previously raised equity through our forward ATM program, helping to bring debt to EBITDAR down to 6.31 times at year-end. A substantial decrease from nearly 7 times at year-end 2021 and below pre-COVID levels of Q4 2019. For the year, we settled a total of $3.7 billion of equity to fund $3.7 billion of net investment activity, allowing us to continue to deploy capital into a desiccated private market while materially de-levering the balance sheet.
Looking forward, we ended the year with $722 million of cash, full capacity on our $4 billion revolving line of credit, and $383 million in expected proceeds from near-term dispositions and loan paydowns, representing $5.1 billion in near-term available liquidity. Before moving on to our 2023 guidance, I wanted to add more context to Shankh's earlier commentary around the opportunity provided to our company by last year's Private Letter Ruling. Nearly 14 years ago, Welltower struck its first RIDEA management agreement, giving it direct economic exposure to senior housing operations. Over the last five-plus years, we've built a better and stronger alignment within this contractual structure, ultimately reaching a point in 2021 where we could generate meaningful ROI through centralized human capital and technology investment at Welltower.
We hired John Burkart and started to build a team around him. The PLR we received last year allowed us to meaningfully accelerate that effort as the ROI friction is entirely removed under self-management. This Welltower platform investment is evident through G&A, with greater than 80% of our expected year-over-year increase in overhead costs being driven by technology investment and new position additions in 2022 and 2023, focused primarily on asset management, data analytics, and technology. We continue to believe that the opportunity to both modernize operations and drive efficiencies through scale in our business is vast and creates a sustainably strong cash flow tailwind when combined with the demographic driven demand of the next decade plus. Lastly, moving to our full year guidance, which we're reintroducing for the first time since COVID uncertainty began impacting our business in March of 2020.
Last night, we provided an outlook for 2023 of net income attributed to common stockholders of $0.57-$0.75 per diluted share and normalized FFO of $3.35-$3.53 per diluted share, or $3.54 at the midpoint. As mentioned in the release, our 2023 guidance contemplates no HHS funds or other government grants we received in the year. After adjusting for $0.07 of non-recurring government grants received in 2022, we are guiding for 5% year-over-year growth. This year-over-year increase in FFO is composed of $0.36 from growth in our senior housing operating portfolio and $0.03 from growth across the rest of our segments.
These are offset by $0.04 of prior mentioned higher G&A and Welltower platform costs, and $0.19 of floating rate interest and foreign exchange headwinds. Underlying this FFO guidance is estimated total portfolio year-over-year same store NOI growth of 8%-13%, driven by subsequent growth of outpatient medical, 2%-3%, long-term post-acute, 2%-3%, and senior housing triple-net of 1%-3%. Finally, Seniors Housing Operating growth of 15%-24%. The midpoint of which is driven by revenue growth of approximately 9.5%. Underlying this revenue growth is an expectation of approximately 230 basis points of year-over-year average occupancy increase and rent growth of approximately 6.25%. With that, I will hand the call back over to Shankh.
Shankh Mitra (CEO)
Thank you, Tim. While we ended 2022 on a positive note, it was also a year of sheer grit and perseverance from our team. As we face different challenges in our business, be it the expense pressure, development cost pressure, or ProMedica, we remain steadfast in our belief that our job as stewards of our shareholders' capital is to solve problems when we encounter on this journey, and not to rip the Band-Aid off and give away potential future upside to private equity to profit, to profit from either because, one, it is the easiest thing to do instead of working things out, or two, the feeling of instant gratification as Wall Street tends to cheer such decisions. We see too many market participants mix up short-term volatility with long-term risk of permanent capital loss.
As our partners in the business, our investors can count on us to take tough road to deliver strongest returns we believe are achievable when we face challenges. This is evident in the build-out of our operating platform and our transaction with ProMedica and Integra. To paraphrase Mr. Munger, you can rest assured that we have a deferred gratification gene imprinted on all over our culture. We remind ourselves every day that big money is made not in buying and selling, but in waiting. Lastly, I'm extremely delighted to see many of my partners recently appointed to the executive and senior management roles within the organization. We grew up in the business fighting it together in the trenches, and I'm convinced that we have the deepest bench strength along with the longest runway as I look across the real estate space.
Supplementing this talent is our unmatched data and machine learning capabilities, which allows us to efficiently and cost effectively evaluate new investments as well as reinvestments in our portfolio. In addition to our strength of our existing team, we continue to attract best in class talent from outside the industry who share our belief that the future of our business may look very different from the past. Simply said, we want to attract talent that comes from the industries with higher standards. To that point, I could not be happier that John has convinced Jerry Davis to join our team. As you all know from his many years in multifamily sector, Jerry has one of the sharpest operating minds in real estate. I have known and admired Jerry for 15 years and cannot be more excited to work with him and learn from him.
I am more convinced than ever that John, along with Jerry, will have an exponential impact and transform this industry. If you are or know someone of that operating caliber, and more importantly, have an outsider's mindset from a related or frankly unrelated industry who wants to join the formidable team of J squared, please let us know. Welltower is wide open for business, not only for asset acquisition, but also for talent acquisition. With that, I'll open the call up for questions.
Operator (participant)
Thank you. At this time, I would like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We ask that you please limit yourself to one question to allow everyone an opportunity to ask a question. We'll take our first question from Jonathan Hughes at Raymond James.
Jonathan Hughes (Managing Director)
Hey, good morning.
Shankh Mitra (CEO)
Good morning.
Jonathan Hughes (Managing Director)
Morning, Shankh. I just wanted to ask about the increasing operator relationships. Obviously, we just saw another one yesterday with RUI. You talked about more opportunities or expected opportunities in the future. You know, I'm wondering what the landscape looks like after, you know, three years of these pandemic headwinds. How many high-quality operators remain as an opportunity that you don't already have a relationship with? You know, what's the size of those individual opportunities? Are they smaller or larger in terms of investment volume, you know, than the, than the relationships established over the past few years? Thanks.
Shankh Mitra (CEO)
Yeah. Jonathan, you asked a very, very good question. As I think about if your question is specific to senior housing industry, I see that, you know, obviously, we have most of the operating partners that we want to do business with, we already do business with. Expansion of new operating partners is less of a focus, and going deep rather than going broad is our focus. We are looking for, striving for regional density with our existing partners across, you know, the different country, right? Now, we have, I mentioned before that there are operating partners in the business that operate us in the business that we have admired for a very long period of time. This is a long dating process. It takes a long time for both parties to understand how we can add value to each other, right?
Capital is a commodity. Just capital, us bringing capital to an operating partner, frankly speaking, in any relationship is not enough. For our perspective, so we bring in data analytics and other, you know, operating platform initiatives that John is doing to the equation. At the same time, we want to understand whether these operating partners are thinking about the business of where the business is going 10, 20 years from now, not where the business was 10 to 2 years from, you know, 10, 20 years ago, right? There's a significant mind shift that is needed in the business. Frankly speaking, as I mentioned a few minutes ago, we need higher standards. Higher standards of employee engagement, higher standards of customer service, and higher standard of how we treat capital and you know, how we deliver results for the capital.
Those are the type of operating partners and business partners that we're looking for, and we're grateful that, you know, we have a fundamentally a fantastic roster of these people to drive business with. Going to the second part of your question, from an investment volume standpoint, I want to reemphasize, you're gonna see majority of the investment volume with existing partners as well as sort of the, you know, partners that we have already announced in the last couple of two, three years.
Operator (participant)
We'll take our next question from Michael Griffin at Citi.
Michael Griffin (Senior Equity Research Analyst)
Great, thanks. Maybe just on transaction activity. I mean, Shankh, I know you've always talked about how you're an unlevered IRR-focused investor. I'm curious if you've seen any change in maybe hurdle or return rates that might get you more excited about one property type relative to another. I know you seemed pretty positive in your opening comments, but any additional clarity there would be helpful.
Shankh Mitra (CEO)
Michael, if you think about different times give us opportunities for different types of product. You have seen us buy and sell every product that we own in last, call it, say, seven years, eight years under the leadership of this team, right? Because different times you get opportunities to buy different product at a very favorable basis. This might be the first time we're seeing across all our product types, across the three countries that we do business with, and we're seeing opportunities, right? This is a very, very disruptive time. From not only from debt side, but also from equity side. The people we normally compete against, right?
The core funds, the non-traded REITs and others, everybody is facing very significant flow, you know, outflow, you know, either because of the denominatory effect that you see in pension fund world as well as institutional world, or you know, some other reasons such as not availability of debt and other situations. We're seeing across all product types, we're seeing very significant opportunities in, I mean, you know, and frankly speaking, an ability to achieve IRRs that we haven't seen in some of the product types, frankly, forever.
Operator (participant)
We'll move next to Jeff Dennerlein at Bank of America.
Josh Dennerlein (Senior Equity Research Analyst)
Hey, hey guys, I guess Jeff and I merged. It's Josh Dennerlein here. Yeah, no, I appreciate all the color on the asset management platform. I'm just kind of curious how we should be thinking about kind of is this like the full investment year and then payoffs start happening in 2024? Is there anything kind of built into guidance as far as like a payoff? Kinda how are we thinking about that J squared run rate for returns?
John Burkart (EVP and COO)
Yeah, I'll start, and just Tim may wanna comment. I'm not, definitely for clarity, not commenting on Tim's guidance. You know, I think what we're seeing and what we're trying to SHO is the returns are already coming through. You know, I mean, you look at what's going on from an aggressive asset management perspective, you see that in the agency move and what the team has done, which is tremendous amount of blocking and tackling. The additional work that we're doing really relates to scaling those things. Partly why, you know, we included that in the deck is I came in and I had a view of things, you know, from my gut, you might say, so to speak, and I probed around and got confirmation.
We started workflows, and now that that's proving out, and that's what we wanted to SHO because that is critical. We were right. There is tremendous opportunity here. The more I got into it, the more opportunity I see. When you look at, you know, J squared and this exponential opportunity, it's huge. I, you know, my view is where I'm working right now is across the whole platform, as I mentioned, and Jerry will be able to focus in on individual items and execute at, you know, highest of all levels, which will speed up our process. You know, bottom line is we're already delivering, you know, numbers. It'll continue for the many, many years, and it'll ultimately relate to significant margin improvement across the board.
Tim McHugh (EVP and CFO)
I'll just add on cost. You know, we look at this as an investment, right, on the human capital side and on the technology side. You know that we run our platform very efficiently, and we don't take the cost lightly as far as any further investment. We think there's a lot of return here on investment. You know, there is a bit of a lag between, you know, dollars in and hires in that return. On a go-forward basis, I'd expect us to be very prudent about it and continue to be SHO high return before dollars are spent.
Operator (participant)
We'll move to our next question from Mike Mueller at JPMorgan.
Mike Mueller (Analyst)
Yeah, hi. I'm curious, what's the range of margins that you think the SHO Business could operate at full occupancy and to use your term, when it's fully professionalized?
Shankh Mitra (CEO)
Mike, I'll just not gonna sit here and try to speculate what might or might not happen, but I will repeat what I said before. If you went back to pre-COVID occupancy and pre-COVID margin, I will be really disappointed. If that's where we end, we'll be disappointed.
Operator (participant)
We'll go next to Derek Johnston at Deutsche Bank.
Derek Johnston (Lead Analyst)
Hi, everybody. Good morning. You know, in addition to the REIT community, you know, a lot of generalist investors are closely following Welltower. I know we touched on it in the opening, but can you expand on this favorable Private Letter Ruling with the IRS? I think around 45,000 independent living units, you know, are not really being designated as healthcare facilities and/or subject to RIDEA. You know, what does that mean, right? Importantly, you know, how the decision may drive further earnings growth, especially given the beefed up asset management platform. Thanks.
John Burkart (EVP and COO)
Yeah, I'll touch on that. What it means, I think the easiest way to look at it is if you just go back and read history a little bit and you look at the multifamily world when everyone kind of came together in the mid-90s when I started where I was at. What you saw is this move from fee managers to owner-operators was a fundamental shift. What I think a lot of people missed was there was a basic economics behind that. In essence, as a fee manager, you get paid a percentage, let's say 5%, to collect $1, and that means you wouldn't spend more than 5 cents to collect $1. As an owner-operator, you were paid $1 to collect $1. In that sense, you would spend 99 cents to collect $1.
That fundamental shift enabled us as owner-operators to move much, much faster and changed how we looked at the world, whether it be investing in websites, technology, et cetera, or bringing things in-house, marketing in-house, et cetera. All these things enabled a tremendous improvement in margins, and that's what it ultimately means, is it will allow us to step into that business and have tremendous impact on the margins. More than that, I would say I break the business down into three components overall. There's a real estate or multifamily component, there's what I call the hospitality component, which relates to meals, housekeeping activities, and then there's a care component.
Our various residential businesses have one to three of those parts. As we step in and we address the real estate as well as this hospitality component at our independent living, we'll be able to take those best practices and move those into the assisted living, which we're obviously not managing. If we find better ways, more effective ways to deliver higher quality meal service, et cetera, that will all be pushed out through our platform. No different than what we're doing right now in our case study on revenue management, how we push that out to one of the assisted living properties. The same concept will apply. This is pretty huge, and it'll impact our whole overall residential platform.
Shankh Mitra (CEO)
I'll just add, Derek, one thing to that. As I mentioned before, we're working towards regional density, going deep and not going broad with our existing partners, right? Think about it, you know, I don't know, but just you will see the future is with our select operating partners, strategic partners, we're gonna have bigger density or higher density and a bigger scale in a market. With our investment in the technology platform, in the operating platform, with our operating partners' ability to execute on the ground, I think, you know, again, this is gonna be not only a great win for our owners, our, you know, and our assets, but also a great win for the select operative partners that we'll choose to do business with going forward.
This is a very much of a focus on win-win, and that's the way, you know, business gotta be.
Operator (participant)
We'll take our next question from Michael Carroll at RBC Capital Markets.
Michael Carroll (Director)
Yeah, thanks. How has Welltower's relationship changed with its existing independent living operators since the PLR announcement? I mean, are they more willing to work with Welltower given certain goals or targets or has there been any noticeable change since that was announced?
Shankh Mitra (CEO)
The forward-thinking ones who are thinking about where the business needs to go 10 years from now, you know, 5 years from now, 15 years from now, has come forward and want to participate in building out the platform together. The ones that are holding on to the notion of what the business was in the 90s are clearly realizing their future is not with us.
Operator (participant)
Next, we'll go to Ronald Kamdem at Morgan Stanley.
Speaker 17
Hey. Yeah, you have Adam on for Ron. Good morning, guys. Just wanted to ask about the ProMedica and Integra assets. Wondering, you know, kind of with the new, with the new operators in place there for some of them, if you could kinda comment on the rent coverage. I'm not sure if it was in the supplemental. I know there were some changes there in terms of the reporting structure. I'd love to just hear about the rent coverage. I think it'll be helpful for investors, kind of given the, given the kind of the prior history there.
John Burkart (EVP and COO)
Look, I think, with the new operators, you know, we've transitioned to at least 16 operators so far, you know, by the time the dust settled, it'll be north of 20 operators. You know, all these transitions have happened over the last month and a half. It's, it's too soon to have numbers and performance, you know, conversations about their performance. Overall, transitions have been smooth. In the upcoming months, we'll have better data to share on performance trends. For now, the focus has been on getting the buildings in the right hand. As you'll see, you know, with 16 to 20 operators, that the focus has been very deep and very, you know, sharpshooter-esque, where you want to find for every single asset the right operator. That's been the top priority so far.
Operator (participant)
We'll go next to Steve Sakwa with Evercore ISI.
Steve Sakwa (Senior Managing Director)
Yeah, thanks. Good morning. Shankh, I was just wondering if you could talk a little bit more about the investment opportunities that you're sort of seeing out there and sort of the distress in the system. You guys were obviously very active last year, and I'm just curious, you know, what it takes to sort of shake the tree and, you know, how the returns might have changed, kind of looking forward on the, on the new deals.
Shankh Mitra (CEO)
Yeah, Steve, I don't think I have much to add. Maybe Nikhil has something to add after I'm done. I'll just tell you that this is sort of the only time I've seen where there's opportunity in all three product types across all three countries, right? You usually don't see that's driven by last couple of years have been primarily debt-driven, right? We have seen a lot of opportunities in the IRRs. You know, we have done senior housing, you know, 9%, call it, take a 9%, some higher, some lower, but call it around say 9%. You know, historically, I've said, you know, medical office is an interesting of, you know, business to buy or interesting space to invest around, call it 7-plus unlevered IRR. Finally, we're seeing opportunities in the 8-plus level.
On the wellness side where, you know, the cap rates have been very, very tight, IRRs have been in the 6s. We're finally seeing they're in the high 7s, right? That's sort of, I would say, where the different investment landscape, where we're seeing opportunities, but depends on, you know, some are obviously higher. We're still seeing some double-digit opportunities. I will tell you the other thing is, because it's not just debt-driven, but also equity-driven, most of the stuff that we have bought in last couple of years were fundamentally focused on right location, right product, right basis, and we have bought lots of assets with no cash flow, negative cash flow. Finally, we're seeing, because people have to transact, right, what's happening, we're seeing opportunities that with very good bases with very good locations.
Assets are also starting to come with cash flow. That's sort of, I will say, the slight change and nuance of the investment landscape. I don't know, Nikhil, you wanna add anything?
Nikhil Chaudhri (CIO)
Yeah, I think the other thing I'll add is we just go through a lot of pain and effort to try and be the highest quality counterparty for someone to deal with. You know, whether it is the speed of execution, whether it is, you know, across the timeframe of a transaction, sticking with what we started off saying initially the deal was. In times like these, it just makes us the preferred counterparty. There's a lot of recognition for that across the street, and it's times like these that we really are able to shine. We're excited about our pipeline for the year.
Operator (participant)
We'll take our next question from Rich Anderson at SMBC.
Rich Anderson (Managing Director)
Hey, thanks. Good morning, everyone. If I could.
Shankh Mitra (CEO)
Good morning, Rich.
Rich Anderson (Managing Director)
Good morning. On the PLR, very, very interesting, indeed. I just have some thoughts around it. Does this mean that, you know, we should see sort of a pace of investment from you guys to bring managers in-house for what you have, you know, currently? How much of the IL portfolio that you have today didn't qualify, and will there be kinda changes there to, you know, have them pass the test so that they also can qualify for the PLR ruling? Thanks.
Shankh Mitra (CEO)
I'll take the second part. Think about, we have independent living that are standalone. For example, Holiday Retirement portfolio as well as our Canada portfolio. That's roughly, I would say, two-thirds to three-fourths of the independent living that we own that obviously qualifies. How this relates to, you know, when independent living is as a part of the continuum, we will figure that out. Most importantly, I want to focus on what I said before, that you will see with our forward-thinking select operators who have density, you will see that we will, building out the platform, right? John has mentioned very clearly that he's building out the platform with our best operators, right? This is not a question of what part we'll do in-house versus in what part we'll do with our operator.
We have also another 15,000-20,000 units in the wellness housing sector there, which obviously we always could have done in-house, right? This is finding the right balance of regional density with all the product that's around that region and bringing in-house where we have the density or keeping it outside when our partners have density. The game is not to who does what. This is not a fight of, you know, just because we do something, we'll do it better. The main goal is with our operating partners, build this, you know, operating platform to the highest quality technology and systems and processes and data to deliver the best outcome for our residents as well as, you know, frankly, employee experience. John, you wanna add anything to that?
John Burkart (EVP and COO)
Yeah. I mean, that's said perfectly, and I would just add in the sense of the speed, you know, you can only imagine we're moving, and we have been moving extremely fast to address the opportunities that we see. We'll definitely build on success. It's not. Exactly what Shankh's saying. It's not about going out and trying to control everything. It's about creating success that drives value to all the various stakeholders. That's where our heads are at. And, you know, in the end, there'll be a little bit of a lag in the sense of where we spend money on G&A versus where we start to offset that because of reduced fees, 'cause we're just moving it like the multifamily, moving the property management services onto the book.
Little bit of a lag there, but ultimately it'll offset, and then the improvement will be in margins.
Operator (participant)
We'll go next to Juan Sanabria at BMO.
Juan Sanabria (Managing Director)
Hi. Good morning. Just wanted to hit on the SHOP same store, same store NOI growth guidance. Shankh, I think you were mentioning in your opening remarks about the exit run rate and focusing on that, so maybe hoping you could provide a little color there. And should we assume that there's any incremental transitions in 2023? You mentioned RUI having a growing going forward through transitions as well. Just curious if you could maybe just comment on those two moving pieces.
John Burkart (EVP and COO)
Yeah. Thanks, Juan. On the transition piece, we'll start with that. There's not a contemplation of further transitions in our guidance. Our first quarter has about 85% of our open and operating buildings as of 12/31. Our first quarter has 85% of that same store, and that grows to mid-nineties. On average, you kind of have 90% of the open and operating as-assets in that pool.
Shankh Mitra (CEO)
What was the first question?
Juan Sanabria (Managing Director)
The cadence or the exit run rate.
Shankh Mitra (CEO)
If you think about it, we're building occupancy, right? You know that Q1 is sort of the weaker point in the occupancy spectrum, and you build occupancy. Occupancy growth happens through spring and summer. Your occupancy build on an average basis, you get closer to sort of that Q3, Q4 level, where you will get a better, you know, revenue, if you will, right? Sort of in that, in that annual journey. Think about expenses, which are also coming down. Right. You have, you know, you probably have a better, significantly better exit run rate in Q4 than Q1, right? Following both revenue as well as expenses. Think about how, you know, other situation that I've described before, I think the last call, maybe the one before, is how RevPAR builds, right?
You move your rents on a bunch of people at the beginning of the year, as well as, you know, for our portfolio, just call it half and half. We also have a very large operator who moved in Q4, but just think through how that plays out. You chase that, you know, in-place rent through your market rent, which is also going up for the year. If you think about from an occupancy, from rates, from expense improvements, which is, you know, we're glad that agency cost is down from, call it 7 to sub 4. We're very unhappy it's still sub 4. It should be significantly lower than that. If you think through all of the main drivers, you're gonna get a much higher exit run rate in Q4 than Q1.
Operator (participant)
We'll move next to John Pawlowski at Green Street.
John Pawlowski (Managing Director)
Hey, thanks for the time. John Burkart, could you just give me a sense for how much more pushback your operators are seeing on rent increases today than in recent quarters, where they've had no issue pushing rents? If there's any segments of the portfolio that are starting to hit a wall on just in terms of absolute rents, any color there would be appreciated?
John Burkart (EVP and COO)
Yeah, no, glad to. I'm not aware of any pushback. Now, it's not to say, of course, when a rent increase goes out, there's not a discussion, but in the sense of defining pushback as a market response to that, no, I'm not aware of that. I think the our partners have done a phenomenal job of communicating, you know, the increases and the reasons behind those increases. And I think our residents, you know, understand that they don't wanna see important services and care cut. They wanna have, you know, what they paid for, the best of that. And we're just not aware of any issues there.
Shankh Mitra (CEO)
As John, as I mentioned, I expect rent, you know, RevPAR increase to be better in 2023 than 2022. We'll see what the market gives us, but as we sit here today, we think the pricing environment is getting better.
John Burkart (EVP and COO)
Audra?
Operator (participant)
We'll move next to Vikram Malhotra with Mizuho.
Vikram Malhotra (Managing Director)
Thanks for taking the question. Just maybe building upon the pricing part, maybe Shankh or John, if you can just, you know, elaborate. You talked about the exit run rate, earnings run rate, sort of as a guide to the earnings power. Can you talk about, you know, both on pricing and say, CapEx? If you see, you know, inflation come in, your costs come in, you know, your maybe ability to push higher rates, you said near term is not hampered. You know, as you see inflation come in, but occupancy is still low, can you just give us some context on how you see pricing power evolving until occupancy recovers?
Similarly, CapEx-wise, you know, after 2, 3 years of COVID, what do you need to invest from a run rate standpoint, maybe % of NOI? Is there a uptick needed, you know, over the next few years on CapEx? Thanks.
Shankh Mitra (CEO)
Let me try that. First on the CapEx, I do not believe other than inflationary changes, anything changed from a CapEx standpoint, right? Just understand that we bought predominantly in last 2, 3 years, new assets. We bought 1 or 2 portfolio as a value add portfolio, and when we bought it, for example, the Holiday portfolio, we told you exactly what we underwrote to spend on CapEx, right? We bought it in extremely cheap basis, and we told you exactly what the CapEx needs are and how we plan to invest.
From that perspective, you know, as you think about going forward, I do not believe outside those couple of value add investments that we have done, and we report-told you otherwise when we have done it, we do not believe the business' CapEx needs outside the, you know, sort of inflationary increases that are happening, anything has changed. Now, I think John has a very large plan, a very big plan to reamenitize the portfolio and, you know, sort of fundamentally changing what the value proposition might look like. Obviously, we'll do that if he thinks that we're getting fantastic return on that incremental investment. From a regular CapEx perspective, I don't think anything has changed.
From a pricing power standpoint, I don't think what else I can add other than to what I said to John's question and the earlier question, which is we're feeling very good about the pricing power across all our countries and across all our product types. As you know, that Canada has been a laggard. Feels like Canada is starting to catch up. U.K. and U.S. has been strong and continue to be strong. You know, we're feeling pretty good. John, you want to add anything to that?
John Burkart (EVP and COO)
Yeah. I mean, again, I would just say on the value add side, this is purely opportunistic. I mean, I just look at the world and see, you know, our portfolio is positioned so well to come with another layer of value add opportunities because of the age of the portfolio, which are really the highest returns because the infrastructure is all in great shape. You're talking about, you know, what some people would call fluff and buff, but re-amenitize, you know, enhancing the units a little bit and really, you know, improving that value proposition and getting paid very well for it. Very much similar to, you know, what many of the multi have done. But that's all enhanced the returns.
Shankh Mitra (CEO)
Vikram, I missed one part of your question. I'll just tell you that from a pricing power standpoint, this is something I mentioned in the last call, that despite our average occupancy of the portfolio call it, say, 80%, a significant part of the portfolio, call it, give or take half of the portfolio, 45% of the portfolio is up in that, you know, high 80s, mid to high 80% occupancy. There, the pricing power changes to, you know, I'm raising price because I have no rooms to sell, right? There is a dynamic that's going on, and we will increasingly will get to the point as we move average occupancy for the portfolio, more and more properties within the bucket, but you will get to that pricing power, because frankly you have no rooms to sell.
That transition is happening and will continue to happen in 2023.
Operator (participant)
We'll take a follow-up from Michael Griffin at Citi.
Michael Griffin (Senior Equity Research Analyst)
Hey, thanks. I just wanted a clarifying question. I don't recall if I heard this earlier, but just on the assets that are continued to be operated by ProMedica, the assisted living and the memory care, what is the coverage on those? Do you happen to have that info handy?
Tim McHugh (EVP and CFO)
Yeah. Those are covered one time in EBITDA basis.
Operator (participant)
We'll go next to Derek Johnston at Deutsche Bank.
Derek Johnston (Lead Analyst)
I won't make a habit of it, but, you know, on staffing levels, you know, at 80% occupancy in senior housing, I believe that's near fully staffed, and please correct me if I'm wrong. You know, the question is, you know, what are you modeling or including in guidance for 23 relative to agency labor as a percentage of labor expenses? You know, do you view this as possible low-hanging fruit, to get back to pre-pandemic levels of agency, you know, especially as John and the team increase property level accountability?
Shankh Mitra (CEO)
Yeah. Let me try to take part of that, Tim will take part of that question. We do not view this as a low-hanging fruit, but we do view this as a fruit that can be plucked, right? There's a lot of effort that's going on. Tim will tell you what's modeled. Frankly, I don't know. But I will tell you that agency labor is a function of, frankly, weak management. That's just what it is, weak leadership. We're working with our best-in-class operators to get the right people in the right place so that, you know, we should, over a period of time, see that improvement. As I've said, coming below 4% is an achievement when you start from 9.
By no means I want you to think that I'm actually happy with that number. That number needs to be substantially lower. We need to really get full-time employees in the communities. This is not just a question of cost, but also, as John alluded to, it's also a question of culture and the customer experience.
Tim McHugh (EVP and CFO)
And, from a modeling perspective, we're essentially the high 3s% of compensation. Pretty flat from where we came out of 2022.
Operator (participant)
We'll move next to John Pawlowski at Green Street.
John Pawlowski (Managing Director)
Thanks. I just have 1 follow-up on the Private Letter Ruling. I guess, what else needs to happen internally in terms of people, systems, technology before you're actually able to self-operate a substantial amount of IL units? I'm just curious how quickly we could actually see Welltower operate these assets.
John Burkart (EVP and COO)
Yeah. I'll comment on what would need to happen, but not necessarily the speed at which, you know. If you look at it, I mean, one way to look at it is really just to simplify the world a lot and to say, you know, what would happen, you know, when a company, you know, from my past experience, you know, when two companies merge, you look and say, "Okay, if I step into their systems and start to fly the plane with what they have, that can happen pretty fast, right? You know, that's not that complex. The timing of it can be faster if we want it to be faster by stepping in that way.
Obviously, what, you know, going back to what we're building, as I've mentioned previously, we're using largely existing modules. There's some creative stuff going on right now with the team, but generally it's existing modules that are out there. That doesn't take that long either. The speed can go, you know, fairly fast. The bigger issue is, you know, we're focused on success, and we're focused on, you know, working with people to deliver the success. It's not about us necessarily doing it's about us, you know, delivering success for all the stakeholders. That's where my mind is at. The speed could go pretty fast.
Operator (participant)
And that-
Shankh Mitra (CEO)
It will not surprise me to see that we start to self-manage some assets, some IL assets in calendar year 2023.
Operator (participant)
That does conclude today's question and answer session. I'll turn the conference back over to management for any closing remarks. That does conclude today's conference call. You may now disconnect.