American Healthcare REIT, Inc. (AHR) Earnings Call Transcript & Summary

So welcome, everybody, to the 11:00 a.m. company presentation for American Healthcare REIT. My name is Austin Wurschmidt. I'm the covering analyst at KeyBanc Capital Markets for the health care, residential and lodging REITs. Here in a moment, I'm going to hand it over to Danny Prosky, President and CEO of American Healthcare REIT to introduce his team and provide a quick overview and background on the company. We'll then follow up with some question-and-answer session and then towards the end, I will open it up to the floor for any questions anyone may have. Danny?

Thanks, Austin. Good morning, everyone. Thank you for joining us. Hopefully, you came to hear us and not just to get a good seat for Essex who's coming up next. I'm Danny Prosky, I'm the President and CEO of American Healthcare REIT. With me are Brian Peay, our Chief Financial Officer, to your left and then Gabe Willhite, our Chief Operating Officer, to your right. American Healthcare REIT was formed in the fall of 2021 through a Tri-Party merger. It was a merger between 2 public non-traded REITs that were launched one in 2013 and one in 2016 as well as our management platform. So we formed the REIT and recently conducted an IPO. We raised about $770 million on February 7 and 100% of that was used to pay down floating rate variable floating short-term debt. So we are clinical. We focus on clinical health care real estate. We're diversified. So clinical means the type of real estate where patients are being seen by providers. We primarily focus in medical outpatient buildings and long-term care, which can be skilled nursing, assisted living as well as our integrated senior health campuses, also known as our Trilogy investment, which is our biggest differentiator. We like the diversified strategy within health care. We like it from an asset management perspective. I think it really proved itself out during COVID, where about 1/3 of our portfolio was medical outpatient, did very well during COVID. We actually grew our occupancy in 2020 as opposed to our long-term care side of the business, which struggled during COVID, like the industry as a whole, mainly because people couldn't move in for an extended period of time. We also like it from an acquisitions perspective. We're able to look at the best risk-adjusted returns that are available at any particular point in time and focus on that type of assets. So we don't have predetermined percentages that we focus on. We look at what are the best opportunities at that point in time. For example, on medical office with outpatient, depending on what you're calling it nowadays, we acquired most of those early on in our life cycle, call it from 2013 to 2016. Cap rates compressed significantly on medical outpatient over the last few years. So we've actually been net sellers over the last few years because cap rates remained stubbornly low for that asset class. And we focus a lot more on growing our long-term care portfolio. A couple of things to differentiate us from some of the other non-traded REITs, some of the other traded REITs, excuse me. Our size, we're about $4.5 billion in assets based on purchase price, kind of a midsize health care REIT. We like that size from a growth perspective. We don't need to do multibillion-dollar deals to grow our portfolio. We can grow using one-off transactions and still have a substantial effect on the overall portfolio. We also are differentiated because we have a significant portion of our investment base in RIDEA or managed assets. We're about 60% managed versus leased and most of that is within our Trilogy portfolio, integrated senior health campuses, which are a mix of assisted living, skilled nursing, memory care and a little bit of independent living. Focuses on a higher acuity resident, a lot of -- they're mostly purpose-built buildings newer, nicer they tend to be the best assets in their markets and Trilogy operates in 4 states, Southern Michigan, Northern Kentucky, Ohio and Indiana. So they're our largest investment by far and they're also our best-performing operator by far. We did file a new set of slides yesterday, just prior to NAREIT. A lot of it is information we put out publicly before. I think that the most relevant slides are the earlier slides in the deck that show -- give you an update on occupancies and then a summary of our first quarter results. Occupancies continue to do very, very well this year as they've done in 2022 and '23. I think we're beyond COVID recovery at this point. I think most of our occupancy growth now is coming from the dislocation between supply and demand that we're seeing right now. We've got the baby boomers, will start turning 80 very, very soon. That's really where you start seeing a lot of demand for long-term care within our space, both assisted living and skilled nursing. And we've seen very, very little new construction over the last 6 years. New construction dropped in 2018 and 2019. That was mainly lender-driven. Lenders thought that there was too much new development going on and they turned to spigot off. And then in 2020 and 2021, we had COVID, new development really slowed down. And in the last 2 years, the lenders are out there, they're lending, but they're charging much higher interest rates and they're providing much lower proceeds. And of course, they've tightened their lending restrictions as well, right when construction costs have gone through the roof. So new construction starts over the last few years are back down to kind of 2010 levels as a percentage of total product out there. And we feel very, very strongly that over the next 3 to 5 years, this will continue. We're going to see increased demand for long-term care just because of the aging of the baby boomers, right when we've seen very little new development coming out of the ground, very few new beds opening up over the next 3 to 5 years. So I think that's why we've seen such good occupancy growth. Our margin growth has been good. RevPOR has been good. Expense growth has kind of slowed back to kind of pre-COVID levels. It was very, very high during COVID, as you can imagine, a lot of that was wages. So I've been in the space for 32 years. In my opinion, this is the best environment I've ever seen. Health care rates typically relied on external growth to grow their earnings, and we still look to do external growth. We're doing some of that. But I think the vast majority of our earnings growth is going to be more organic over the next 3 to 5 years. We hope and expect to see margin improvement and RevPOR growth to continue to improve over what we've seen in the last few years. So unless Brian or Gabe, unless you want to add anything, why don't we give it back to Austin for Q&A.

That's a great intro there. And I want to go back to kind of your comment a little bit on the integrated senior health campuses and really kind of -- you touched on it a little bit, but why does the integrated senior health campuses. Why is it an attractive business to you? And why does it differentiate you versus the other health care REITs?

So we like the model, but we really like the operating Trilogy, in our opinion, is the best-in-class operator. If you look at their performance, I'm not just talking about financial, I'm talking about outcomes because that's really what it's more and more about, right? This is a health -- we're in the health care real estate business. We all want to get bottom line, it's obviously very important, but we really want a good quality outcomes because it's always been important, right, without good quality outcomes, without less recidivism, without good patient care, your assets just aren't going to perform well in the long term. That's even more important today as we move more, more the value-based care, and we're seeing it not just on Medicare Advantage, we're seeing it on regular Medicare and Medicaid and private insurance as well. So Trilogy is always excelled with that. They built this company over 25 years. We've owned them for a little over 8 year but Trilogy has been around since 1999. They've been growing incrementally in their 4-state footprint. They started out as pure skilled nursing, realized that they were -- their residents were leaving and typically moving into AL and they said, hey, why not capture that business. So 20 years ago, they decided to expand into AL and IL as well. That's become a bigger and bigger part of the business. They do a great job. First question we get about Trilogy, and we still get it, although not as much as, well, isn't that a CCRC? And the answer is no. These are not CCRCs. CCRCs tend to be larger. They tend to be primarily independent living focused, kind of most people move into IL and then if they need AL or skilled that's available. And then specifically an entrance fee model as well. Trilogy as well as the rest of our buildings, none of them have an entrance fee model. Trilogy is higher acuity typically kind of a 50-50 split between skilled nursing and private pay AL and IL and they actually tend to see residents to move more the other direction. Typically, their admits on the skill side come directly from hospitals. It's a post-hospitalization model for the most part, average length of stay there is less than 30 days and about 42% of their AL residents come directly from skilled and 70% of their AL residents have spent time in a Trilogy Skilled Facility. So either they came directly or they got better, went home somewhere down the line and required AL or desired IL and look at our Trilogy facility. So they do a very good job moving residents back and forth depending on the means. They're very efficient. They're not only they're newer and nicer, but they'll have a single kitchen to serve both wings of the building. And it is two separate wings. There's a skilled wing and an AL, IL wing with separate entrances, separate dining rooms, but they share a kitchen, they share administrative staff, they share maintenance staff and they even share clinical staff. So if -- one of the reasons they look so good for the RA mandate or the total the Care Mandate is because they're able to move care providers back and forth across a different sides of the facility. So it's a great model. You need patients to build a company like Trilogy, you can't do it overnight. Trilogy is not going to go out and buy 10 or 20 buildings and convert them to their model. It's not what they do. They occasionally do an acquisition, but they're much more likely to grow through development. And we develop anywhere for 2 to 4 assets a year is pretty typical.

So you talked about some of the efficiencies of this model and why you like it? Why is this attractive to residents that come and stay in your buildings?

I think for quite a few reasons. They're typically -- the average age of Trilogy facility is about 9 years. So they're just nice, right? You look at -- I've visited a lot of skilled nursing facilities in my career. And this is not what a Trilogy asset does not look like a typical skilled nursing asset. They're very nice. It looks like a nice AL facility, which it really is. Their outcomes are better. Right now, they've got a higher 5-star rating, that's become more and more important. Residents want to be in Trilogy facilities, both on the skill side and on the AL and IL side. It's -- I think it also -- if you look at the AL and IL side of the business, people get an extra sense of security, having the skilled nursing available on site. And by the way, a lot of Trilogy's IL business is on villas which are on adjacent land. They're not within the building itself. But it still have access to all the Trilogy services, right? They have access to the dining, they have access to activities, even though they have their own club house, where a lot of the activities take place. If they need rehab, it's available right there. Typically, they can walk to it. That's how close these facilities are or they'll have a golf cart if they need it. It gives them an extra level of security being adjacent to the skilled nursing services. And I think that is a big attractive to the AL and IL residents at Trilogy.

So maybe when you think about you being one of the only REITs that really has that operating exposure to skilled nursing, how do you manage the risk of that large net exposure across the company? And what's sort of risk reward or opportunity that you see both in the near term and over time?

Yes, I think -- so that does differentiate us a little bit because we have a higher percentage of our RIDEA assets in skilled it, right? Everybody who's got RIDEA has some skill, whether it's a CCRC, a lot of Ensign. They've got AL. We've got a lot of AL providers that have a skilled component. So it's not like we're the only one that have it, but it's a larger percentage for us. I think it's a little bit of a misunderstanding as far as what the risk. Frankly, from a liability risk, I don't think you're in any worse position with skilled in AL. Gabe, I don't know if you want to chime in, but we look at this all the time. I believe that the cost per incident may actually be a little bit lower for a skilled facility than an AL facility. Correct me if I'm wrong there. You do get a higher -- a lot more of your income from Medicare and Medicaid. It's very important that you manage that and make sure that you are billing at a correct rate, which Trilogy is very, very good at. They are conservative as far as their billing. But we really don't view -- if you look at that 8.5 years of track record we have with Trilogy, we've had no issues at all from a liability perspective, whether it's been through reimbursement or through PL/GL. So we feel really good about it.

Yes. I totally agree. And I think on the PL/GL side, that's where people will get a little bit distracted by it. I think in the assisted living space already today, you're seeing higher acuity than you did 3 years ago for sure. And with that higher acuity, people are generally associating maybe a higher PL/GL spend. The most important thing for the entire equation is not -- is by far the operator and the quality that they are committed to. That's the way to manage the risk. If I have the best PL/GL program in the world and the worst operator in the world, I'm still in a bad spot. So partnering with somebody like Trilogy, who's been doing it for a long time, who's committed to a higher quality standard than is typically seen in the industry is probably the best way to manage the risk.

Yes. So this is not something we expect to do in the future with additional skilled operators. We were very happy to do with Trilogy. I have known Trilogy for over 20 years when I was at Health Peak, we had portfolio with Trilogy. So I've known the company and the founder since the early 2000s. We view them as a best-in-class operator and we're very happy to do -- we did the transaction with Trilogy, but it's not something we necessarily look to do with other skilled operators.

Yes. So recently, there was the passage of the minimum staffing laws that's currently being challenged. But just from Trilogy's perspective, can you talk about if things are to move forward as a law for mandate currently states, how Trilogy is positioned, you think relative to the industry?

So I'll let maybe Gabe talk about specifics at Trilogy, since he does a real good job with it. But overall, they're in great shape. And the reason they're in great shape is they already have a high acuity model to begin with. They've got higher 5-star rating, et cetera. They focus more on short-term post-hospitalization residents versus long-term Medicaid residents. So they have a higher staffing ratio already. If you look at Trilogy's staffing ratios, they look really good. The problem with a mandate, along with many other things, it doesn't differentiate between the different types of skilled nursing facilities and they're all different. So if you've got a lot of long terms that are lower acuity, you're probably going to have lower staffing, it's going to be harder for you to meet that mandate. Trilogy is in very good shape, Gabe I'll let you give specifics.

Yes. So the proposed staffing rule for skilled nursing is 3.48 hours per patient day. It means you need to provide that level of direct care every day on average for the month. At Trilogy, they already are exceeding that. They're typical run rate is about 3.8 hours per day. So they're almost 10% higher than what the requirement is already partially because what Danny said, it's a higher acuity partially because their commitment to excellence means we need an excellent experience for employees. An excellent experience for employees will drive outcomes within your facility. So Trilogy retention is about half of -- or about double what the industry average is. Turnover is about half of what the industry average is. They've got training programs where they train their nurses within. The CNA component of the proposed rule is 2.45 hours a day that you need to find a CNA to provide in your setting. At Trilogy, they've created a CNA training program and they've got regional scale to do this where they can have trainers in specific regions of their portfolio to go out and train people who have come in and started working at Trilogy in a different level, maybe they even came from maintenance or hospitality and they want to become CNA certified. Trilogy will do that for them, and they're on pace to train 1,000 people to serve that function just this year. And that's something that scalable and repeatable for years to come. So there are -- if we -- the more we talk about Trilogy as an operator, I think the more you peel back the layers and you hear kind of these anecdotal things where in almost every operational category you can think of, they figured out a way or they're further ahead than everybody else in optimizing it and partially because they're really good and partially because they've been doing it for 30 years. And you learn from the mistakes as you go and you just get better. And once you do it better in one facility, you're 130, you can roll it out to the rest of them and optimize the performance.

So what is it? I mean, labor has clearly been a challenge for the industry through COVID, coming out of COVID. How did Trilogy fare, I guess, through that period? And what have they done to stand out relative to the industry overall to the point that they're already there from a nursing hours perspective?

Yes. So they were an advantage because of what Gabe mentioned about their turnover, their turnover is about 42% a year. I think the industry is closer to 100%. What Trilogy was able to do is, is they formed what's called Flex Force. And they -- back when COVID hit, you kind of saw what was happening with agency nursing. Trilogy realized early on that, hey, we cannot just rely an outside agency, so they create their own in-house agency. So they've got a team of 100-plus nurses located around the 4-state region where they operate. They are paid a little bit more than regular Trilogy nurse, but maybe 10%, 15% more, not 2x to 3x. And they're available to -- and by the way, when I say travel, we're talking about driving for the most part, something they need to go on a plane and get a hotel necessarily. They will go on an as-needed basis to cover any kind of shifts where there's a shortfall. And because of that Trilogy has relied on outside agency nursing since the height in COVID, I think in 2020, maybe early 2021. And that -- not only is it better from a cost perspective, but it's better from a labor perspective as well. You don't have the animosity between the existing staff who has to train the temporary staff and then the temporary nurse is making 2x, 3x times what they make. The nurse that shows up as part of the Trilogy family, knows the Trilogy systems, knows where everything is, that travel nurse could show up, it'd be productive immediately. It's not like they need to be taught what to do. But they're able to do that because of their size and scale and regional concentration. So it's that as well as their culture. They are able to promote people. Trilogy expands annually, right. They add new campuses, they expand their campuses. They're able to provide growth for employees. So you may the administrator and training program, which is a 12 to 18-month program. And then when you finish that program, you're going to have an opportunity, right? Maybe there'll be a new campus opening up where you can come in there as an Assistant Administrator, maybe administration of your building will move over to the new campus, which is pretty typical and you can take over that existing campus. There's a lot of opportunities to grow every time we talk to Trilogy lot of times we'll go and see a new campus and you meet the staff. If someone who started out -- I mean, sometimes it started busting cables 30 years ago. And now they're an Assisted Administrator. They've gone -- they've done through all the training. They've worked on several facilities. They don't necessarily have to get up and move their family, right? They've got facilities that have been driving distance. And it's just a great opportunity and Trilogy has been able to take advantage of that.

And one more point on that before we leave it because I think I don't want to get lost. So we get a lot of questions about the regional concentration at Trilogy and being in the Midwest and picking Indiana, Kentucky, Ohio and Michigan, where they focus. And that would probably not be on anybody's list of raise your hand of your market to enter and say this is the most ideal market with the highest median income, high home prices, everything like that. I understand that. But what you have at Trilogy is an operator that's got the scale and concentration within a region that unlocks those opportunities that derisks it in a way that if you just focus purely on geography and state, you're going to miss the point that having this presence also concentrated and one spot allows you to have a Flex Force that can travel allows you to train EDs from within your system that have been with the program for 20 years and open up new buildings, allows you to have a SWAT team that goes out and opens up your new developments and can do the sales all from the mother ship that's 2 hours away from most of your locations. And that is a significant advantage and one that's probably not repeatable if you try to have a national footprint.

Maybe that's a good segue just talking about the fact that Trilogy draws from various payer sources, one of which is on federal government and state reimbursement. Maybe just talk about the reimbursement landscape and just how you guys feel about the states that they operate in and then just more broadly?

Sure. So it's a wide range, right? And we actually publish our rate. We talked about RevPOR and the AL, IL side, but on the skill side, we actually show the daily rates, which is typically how you look at it from a skilled perspective. So they've got Medicare or Medicare Advantage. They've got Medicaid. They've got a lot of private pay, a lot of private insurance within their skill. They've got a much higher quality mix in industry as a whole. And it's been a good environment for the last few years, not just because the reimbursement increases have been strong, both at the federal and state levels, but because we've seen a movement away from typical reimbursement a, we have PDPM, right, which has been very good for Trilogy, but you've seen them move towards value-based care. And Trilogy just been able to because they've got better staffing, they got better outcomes, less recidivism. They've been able to increase their rates at a much faster pace than the typical increases that we've seen across the industry. And even on Medicare Advantage, which is typically a little bit lower rate than regular Medicare a shorter length of stay. If they don't like the Medicare advantage rate with any particular insurer or system, they'll opt of it. They won't participate in it. And they'll still get a lot of residents because people demand Trilogy and the Medicare Advantage systems will our networks will negotiate with Trilogy outside of network. But they're -- they're able to pick and choose who they want to work with, and they only work with those networks that reimburse them accordingly.

So you guys have a majority stake within Trilogy. Can you just speak to as the real estate owners, the importance of that investment? And then maybe also talk a little bit about this purchase option that you have to acquire the remaining stake within the operator?

Yes. So our ownership structure on Trilogy is a little bit atypical. It's a RIDEA structure. There is an EIK called Trilogy Management Services. However, they don't really manage for other owners with the exception of what they need to do in order to maintain EIK status. They manage pretty much for us. There's a Board that we control. We have an investment committee that we run every 6 weeks. We are very, very close. Trilogy is not a typical kind of vendor-client relationship that you see within RIDEA. It's much more of a -- they look at us as a capital partner. It's really help -- their senior management team has an STIP short-term incentive plan and a long-term incentive plan, very similar to the ones we have. The STIP is based on meeting metrics, such as budget, et cetera. The LTIP is meaning F is a 3-year look back on FFO growth, margins, et cetera, very similar to what we have in our plans. So they are really focused on bottom line of Trilogy. Clearly good care comes first but they are incentivized to focus on overall company performance and not just top line revenue. As far as the purchase option, we own 76% of Trilogy, we own in a joint venture structure, along with another week called NorthStar Healthcare Income. They're in liquidation mode. Their goal is to liquidate the company by the end of next year. So about a little more than 6 months ago, we entered into a purchase option agreement with them to buy out the 24% that we do not own. That has a fixed price. I mean, the price has increased a little bit over time, but it's a fixed dollar number. It's not a cap on an NOI or anything like that. We have a lot of flexibility there, not just on time. As I mentioned, we've got well over a year to exercise that a year in 4 months. We until September of next year. We can do it through cash, preferred. We can do it through a combination of those 2 things. Our goal, we intend to exercise that purchase option at some point. It is very accretive to our earnings. We want to own 100% Trilogy. The price is fixed. So all of the growth at Trilogy will enter to us regardless of when we exercise that purchase option. That being said, as Brian will tell you, as Brian is getting over [indiscernible]. We did this IPO, we raised a lot of money. We dropped our debt multiple down into the low 6s, which is kind of where we want to be. We're not interested just turning around and borrowing and having that multiple go back up. So we are going continue to call our portfolio, we continue to expose medical outpatient buildings to the market. Most of what we sell is kind of the smaller off-campus stuff they're less excited about. Our EBITDA growth has been very, very strong. If you take a look at the slides that we posted, we've shown very growth over the last year so far this year. And our hope and expectation is that will continue. And we expect that we will be able to buy out that 24% and maybe we issue more shares this year or next year. Our expectations will exercise that purchase option, and we will do so without just levering up.

Great. We're quickly running out of time here, actually, and time flies when you're talking to health care real estate. So I would like to open it up to anybody that does have any questions from the audience. Maybe we'll talk a little bit more broadly on just capital allocation here because you hit on, obviously, one of the main priorities, which is the Trilogy purchase option. But given where your cost of capital is, how are you thinking about capital allocation? And what's really the most attractive to you beyond the purchase option?

Yes. So clearly, our capital is limited, right? I mean our expectation is our stock will re-rate in the future as we continue to meet our earnings guidance and maybe even exceed it, which is our hope. That being said, we have to look at what the best risk adjustment return opportunities are for us today. Right now, those are within Trilogy, not just the purchase option, but I mentioned the Trilogy villas. We continue until we've got 5 projects that we started on building with Trilogy villas. These are duplexes that are adjacent. We already own the land. These are adjacent to Trilogy facilities. They're very, very popular. They lease up. It's about 12 months build, so they build them quickly and they lease up immediately. They're typically leased prior to construction being complete and the yields on those meet our criteria as far as they exceed our cost of capital. So we're doing some of those Trilogy expansions, Trilogy campuses are built to be expanded if there's demand. So if you've got a building where the AL is full with the waiting list or the skilled is full with the waiting list. It's very easy to add on to the wings. The wings basically end and you can add on to them. So we continue to do those. Those exceed by a wide margin, our cost of capital. We do -- we have built out a lot of Trilogy campuses over the last few years. Construction costs have gone up. The yields on those still exceed our cost of capital with a pretty good margin. That being said, they take longer to build, and they take longer to fill up. So there's a little bit higher risk than say the IL villas. So I think we're planning on slowing down the new campus development. We'll probably instead of doing 2 to 4 a year, we can see us do in 1 year for the time being until either our cost of capital comes down or the returns increased back to where they were prior to the increasing construction costs. As long as we have so many opportunities within Trilogy outside of new campus development, you'll probably see us focus more on those.

Maybe just sneak in the last one here. Just kind of curious where the dividend fits within sort of your capital allocation? And then how are you thinking about the balance sheet in general from a leverage perspective and certainly, the IPO drop down leverage, but where you'd like to be over time?

I thought it was just here for window dressing. Yes. So fair point. The dividend is not quite fully covered in 2024. We anticipate that with the organic earnings growth that's embedded in our portfolio that it will be covered in 2025.

Yes, after AFFO.

Yes, after AFFO. On NFFO, it's fully covered. So the thought was did make sense to cut the dividend in 2024 simply to go back and raise it out in 2025. As Danny had mentioned, we were very mindful of the balance sheet. We worked very hard to get our debt-to-EBITDA down in the 6s. We're quite comfortable in the mid-5s to low 6s times. And so we're protective of that. We know that the best traded REITs have the highest multiple that have low leverage. It's also important to be able to grow externally. But at our current cost of capital, we're not anticipating doing a lot of that. The thought is that we will rerate and that the stock will be a better reflection of the true value of our portfolio. And we're in a little bit of a proven phase, which we fully understand, and our numbers, hopefully, will speak for themselves.

Well, I want to thank everybody for coming today. I don't know if you have any closing remarks that you'd like, but I'll pass it back to you Danny.

I just want to thank everybody for coming. Got a little bit over our time, but we appreciate it. I appreciate your interest in American Healthcare REIT. We look forward to a very good rest of 2024 and '25, and look forward to seeing everybody at the next NAREIT.