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

All right. Thank you, everyone, for joining for the American Healthcare REIT Roundtable. My name is Farrell Granath, and I'm the co-lead for healthcare REITs alongside Jeff Spector for the BofA REIT team. I'm joined here today with AHR, President and CEO, Danny Prosky, who can introduce his team and kick it off with an overview.

All right. Well, thank you very much, Farrell, and thank you, everybody, for sticking around for -- I think, at the last session. I'm not quite sure. I'm Danny Prosky. I'm the President and CEO of American Healthcare REIT. With me up here is Brian Peay, our Chief Financial Officer; and then Alan Peterson, our VP of Investor Relations. I think most people here know who we are by now. We IPO-ed about 1.5 years ago. BofA led our IPO, probably why they gave us such a nice room. We appreciate it. Thank you for our meetings. We're a midsized but growing diversified health care REIT. I think what really separates us the most is our investment in Trilogy, which is more than half of our NOI. It's an integrated senior health campus model, mix of skilled nursing assisted living, independent living. I think most people here probably are familiar with Trilogy. A lot of you may have been out to see it already. I think as opposed to just explaining the entire company, I think the one theme I've been leaving everybody with, not just at this meeting, but on other calls I've been on is that I've been in this business 33 years since 1992. This is by far the best operating environment I've ever seen. I think almost everybody will agree with that. I've never seen REITs be able to put up these types of organic earning growth numbers. Those of us that have a significant exposure to managed long-term care, companies like Ventas, Welltower, us, we're 75% RIDEA. We've shown outsized growth over the last couple of years because of just the imbalance between supply and demand. Baby boomers start turning 80 next year. The growth in demand for long-term care is going to continue to explode probably for 15 years. New supply has been very, very stale. I mean new construction starts over the last 7 years have been very low as a percentage of existing stock. We monitor that every quarter when the [indiscernible] comes out with their data. It seems like construction starts still haven't really moved up. I imagine they will eventually. But I think we've got a multiyear runway where demand is going to continue to outstrip supply. For that reason, RevPOR growth should exceed export growth. Occupancy should continue to increase. Margins should continue to improve as well as NOI, which those things drive. So very bullish on our firm and on the space for the next 5-plus years. With that, I'll probably open it up to questions.

All right. And as a reminder, please jump in with any questions. This is supposed to be open. And if anything, a little casual end of the day, [indiscernible]

No hold.

Let's focus on occupancy. So at the end of the second quarter, you're coming in with spot occupancy about 87.5%. Hopefully, I wrote that down correctly. I'm curious, what are you seeing in terms of the acceleration, especially now that we are within the peak leasing season or coming to the end of the peak leasing season. Have you continued to see acceleration through the quarter?

Yes. So I would -- we've been publicly stated at this meeting and other conversations that June was a very strong month. So if you look at our Trilogy had a very strong Q1, mainly because of flu, right? It was good for Trilogy. Their skilled nursing side of the business showed very strong growth in Q1. Rest of the SHOP portfolio, we actually saw a little bit of a drop -- we firmly believe that's flu related with a much stronger flu season. I think we've gotten a little lazy as far as infection control after COVID, we did a really good job there. Flu came roaring back this year. I think we continue to see a slight drop in occupancy in April, turn around in May. June was very strong, and we already put out our -- obviously, our Q2 numbers. July and August were very strong. We feel very positive about the growth we've seen so far in July and August. Obviously, too soon to say in September. But we haven't given any guidance yet for what we expect by the end of Q3, but I think our numbers as well as everybody else should be really good for Q3.

Can you remind those that maybe aren't as familiar with within Trilogy, any additional frictional vacancy due to the SNF aspect of the business?

Yes. So Trilogy has a mix of AL/IL and skilled nursing, roughly 50% skilled, roughly 50% AL/IL, not exactly. But on the AL/IL side, it's very similar to the rest of our SHOP portfolio. I get the question all the time, well, how high can occupancy go? What can margins get to? They're going to continue to move up. I don't know how high and how fast. I don't see why we can't get into the mid-90s, maybe even higher when we have buildings already now that are well above 95%. It's going to continue to drive up margin. I don't know exactly at what point, but I expect continued improvement, not just because of occupancy, but because of RevPOR growth as well and change in mix. On the skilled side, Trilogy, it's a short-stay model, right? Mostly Medicare, Medicare Advantage. There is a Medicaid component. It's small and shrinking. They don't -- Trilogy doesn't accept new Medicaid patients. The Medicaid beds that they offer are really a service to their Medicare as well as their AL residents where they know that, hey, if for whatever reason, I time out of Medicare or I run out of money, there should be a Medicaid bed available to them. They'll have one wing that's Medicaid beds with double occupancy. No guarantee. They don't make any promises, but they try to make those beds available on an as-needed basis. For that reason, because it's a much -- the average length of stay at Trilogy is 3 to 4 weeks on the Medicare side, on the post-acute side, mostly hospital discharge patients, you're always going to want some -- you're going to want some availability there. You don't want to take it up to 98%, 99%. You want beds available to accept especially Medicare, which is the highest daily rate. So what is the optimal occupancy for Trilogy on the skilled side? Probably 92%, 93% is my best guess. They have assets that are 100%. Now fortunately, for Trilogy, because they are so big and have such a good concentration of assets, this facility may be full, but there's probably another 15 miles away that has availability. So they can offer -- they centralize their admissions. They work closely with hospital discharge departments in order to accommodate those discharges. And they may not have availability here, but they probably have one not too far away. So that's the important thing is that they have that availability for those higher-paying Medicare as well as the higher-paying Medicare Advantage. Not all Medicare Advantage payments are the same. Some pay more, some pay less. They clearly give priority to those with the higher rates.

And that's a great segue into -- on this last quarter, you spoke about your Medicare Advantage resin stays is now up to 7.2%. And I'm curious, how does that compare to previous trends? And where can you see that going? Are you seeing an increased demand or the ability to bring in the payer mix of more Medicare Advantage?

So clearly, Medicare -- I mean, if you look at Medicare Advantage versus Medicare overall, you got more people on Med Advantage now than in regular Medicare. Trilogy still has a higher mix of standard Medicare because they get preferential treatment to standard Medicare. Now, the Medicare Advantage side has been growing and the RevPOR growth has been very strong there because, a, they're able to push contract rate because they have enough market power in their markets. to tell the insurers, hey, if you want to admit into Trilogy, you need to pay at least this amount. If it's below that, we're just not going to accept your residents. And by the way, if it's between that amount and a higher number, we'll give you a benefit's available. But if it's not, it's -- you're going to get -- we're not going to get preferential treatment over someone that pays a higher rate. So the insurers are forced to push their rates up because their insureds demand access to Trilogy facilities. Just like they want access to certain doctors. They want to be in Trilogy facilities. They are newer, nicer, better outcomes, less recidivism, probably near their home than other options. So for that reason, you've seen a higher -- an increase in Medicare Advantage days and a drop in private pay as well as Medicaid days. Now the private pay Trilogy tends to be lower acuity as opposed to Medicare and Medicare Advantage. So the rate is kind of in between a Medicaid rate and a Medicare Advantage rate. I expect that trend will probably continue as Medicare Advantage rates get closer and closer to Medicare rates based on our contracts.

I'll pause if anyone has questions on that. I think that's a really interesting part of your business that you're able to potentially...

Medicare Advantage and your ability -- like your success in pushing Trilogy's success in pushing up rates, like how far can you push that? Because you're really negotiating like, hey, you want versus end up coming back to the hospital. It's going to cost you way more. like how far do you think you can see those rates increase?

Well, pressure on -- for example, there have been some articles in the news about certain Medicare Advantage providers whose 5-star ratings under pressure. And signing a contract with Trilogy is one way to improve those 5-star numbers. Trilogy has higher staffing, better outcomes, but certainly better 5-star ratings than pretty much anybody out there. So that has helped us. I think it's the availability that really helps us as occupancy grows, as availability of beds become scarce, they're going to find that if they don't pay a good enough rate, they're not going to have access to Trilogy even if they have a contract. I think all those things combine to help Trilogy push up the rates. And so Medicare Advantage, it's always going to be a percentage of Medicare. So -- but maybe it used to be 85% and maybe that percentage moves up to 92%, 93%. The higher it is, the more likely they are to be able to admit into a Trilogy facility.

And you won a big Medicare Advantage contract with a provider.

We do.

Is there opportunity to do that with the other large providers?

I think it's not just new contracts. I think it's improvement on existing contracts. Those things combined. We have a lot of contracts. Some are national, some are regional, some are by state, some are just by building. But scarcity allows us to push those rates up. So -- and by the way, we will sometimes negotiate outside of the contract. If we don't have a contract, we'll take your resident, but this is the rate you need to pay. We will do that as well. So it's really just adjusting your mix based on what makes the most sense.

And then in terms, we were just speaking about the RevPOR potential within Trilogy. Can you also address that in your SHOP portfolio and where you currently are today in your occupancy and where you can see that going?

Yes. So if you look at the trend in our supplemental, you can see that if you look at, call it, '23 or '24, huge increase in occupancy in our SHOP portfolio as well as Trilogy. Trilogy did really well as well. I think in one quarter, we had 600 basis points of increase, give or take. RevPOR increased as well, but not as much. Last year -- this year over last year, you saw a shift there. Yes, occupancy increased over the prior year, but RevPOR grew tremendously. So what you've seen is you've seen a focus -- occupancy is important, but we've been -- as occupancy increases, we've been focusing more and more on the revenue per occupied bed, less incentives as far as paying outside like a place from mom, outside places like that, no more free first month rent, no more -- no initial payment when you move in, facility fee, et cetera, things like that. So we've been much more -- we've been asking our operators to focus much more on RevPOR as opposed to occupancy, and you can see that in the results.

You guys recently changed [indiscernible].

Yes. So the question there is -- so Trilogy is our largest and best operator. They've got the best systems in place. And it's not just on the financial performance side, it's also on the quality of care side, which I think is just as important, if not more so. But now that we own 100% of Trilogy and now that we've converted Trilogy's LTIP from cash-based to stock-based, so effective January 1 of this year, we had to get shareholder approval for this. They're getting their LTIP, which is -- so their compensation program is very similar to ours. It's an STIP based on kind of meeting your budget, and it's an LTIP based on 3-year performance that we set in advance. Now it's pays in stock. So whatever the stock price was on January 1, that's set, any appreciation, they get the benefit of that. So they are now incentivized to focus not just on the performance of Trilogy, they're really incentivized to focus on overall AHR performance. So we're utilizing them more and more. It's not like this is new. We have an operator summit every spring. Trilogy has been a big part of that summit for the last several years as far as their ability to improve employee satisfaction, employee retention, reduce reliance on agency nursing, reduce overtime. I think they've had a huge impact on helping the rest of our operators improve performance, and you've seen that in your numbers. But now they're incentivized even more. So revenue management is just one example where they brought it in-house. They use much more of a kind of an airline hotel model as far as resetting the rates daily, differentiating between quality of rooms. So a bedroom with a view is going to go for more than a 1-bedroom without a view, things like that. So those rates aren't set at the facility, they're set at corporate. I think you'll see us be able to utilize more of those types of systems with the rest of our operators. Those are the things we're trying to do, and we can do that now that we own 100% of Trilogy. Anything I missed, Brian on that? I know that's -- there's a lot to unpack there.

Yes. I mean, look, the lowest hanging fruit is global purchasing, right? That's pretty obvious. But the fact of the matter is that Trilogy's platform is of tremendous value to our existing shop operators. And our shop operators, in a lot of cases, think of themselves as many Trilogy's and they are hoping to deploy Trilogy's best practices and become like the next Trilogy. So it's a great opportunity for us.

Is it accepted widely across operators to take on this new dynamic?

Yes. So some operators are more open to it, others not as much. We have a regional approach. Most of our operators are regional. We like that. We think the performance is better when they're near the assets. We don't have any of the -- we don't have like Brookdale or anybody like that in our portfolio. We do have one that's pretty national that we started out as a regional and they got bought by this national firm. They've done a great job. We've actually given them more business. So I'm not saying we'd never look at someone bigger. I think the smaller shops are probably more open to it than the larger shops. They have a bigger back office. They have better systems in place. But I've been to these -- I go to these operator symposiums. I use the EF Hutton analogy when Trilogy speaks, people listen. The performance speaks for itself.

So I guess, generally across your portfolio, how much of potentially dynamic pricing is already rolled out across all the operators?

I think it's in stages, right? And I think the days of -- well, here's your rate sheet January 1, this is your rate sheet for the rest of the year, you're seeing less of that. Now the rate sheet changes monthly or weekly or quarterly because as you grow your occupancy, you should be looking at your rate. If you're at 99%, 100% with the wait list, maybe your street rate should be higher. So I think everybody is doing a better job with that. Certainly, our management contracts provide incentive for people to focus on bottom line performance, not just top line revenue or occupancy.

I guess there's also been a key focus on operating leverage, especially once you pass that 90% occupancy. And I was wondering if you can give any more context of what you in your business are able to see when it comes to bottom line incremental NOI.

Yes. So that's -- we get that question in every meeting practically. How high can you take occupancy? How much incremental margin do you have? Obviously, there's not a line where once you pass this line, your incremental margin goes from A to B. It's a spectrum. So clearly, with higher occupancy, your incremental margin grows. If you're going from 99% to 100%, I mean, how much additional costs are you incurring? Your fixed costs are fixed. Are utilities and maintenance costs going to go up, food costs a little bit? I mean the vast majority of that is probably going to drop to the bottom line. So -- and it depends a lot on the level of service. Obviously, independent living, much higher margin, much higher incremental margin than skilled nursing. And assisted living is somewhere in between. Now I can give you my estimate. I don't know exactly what it is. I think on independent living, it's probably -- as your occupancy is high, it's probably very high. It's 85%, maybe 90%, maybe higher. On AL, it's probably 60%, 65%. On skilled, it's probably 30%, 35%. Remember, skilled, it's a much higher daily rate, but you're bringing in a higher acuity resident, they're going to need more care. You bring in a new skilled patient, you're going to need to care for that patient. It's not like you could just spread it across everything. So lower incremental margin, but a much higher daily or monthly rate, however you want to look at it. So bottom line NOI may actually be higher even though the margin is much lower.

[indiscernible]

Well, I mean, on the -- the U.S. Yes. So on the Medicare and Medicaid is government reimbursement. As far as affordability, we typically think about it more on the senior housing side versus the skilled nursing side. I mean we do have private pay within skilled nursing. Typical private pay resident is someone who ran out of Medicare, wants a couple of extra days, so they pay privately to stay a little bit longer. Sometimes, they're a long-term resident who needs to run out of money before they can go on Medicaid. It's a mix. On the AL/IL side, yes, the monthly rate is going up. It's going up faster than inflation. I expect that to continue just based on supply and demand. I would argue that depending on your level of need, $5,500, $6,000 a month might sound high. But if you need assisted living, you're going to need -- you can stay home and you can continue to pay your property taxes and your -- maybe if you have a mortgage, your mortgage, your maintenance, your insurance, your utilities, your food costs. If you need help, if you need care, if you need someone to check in on you 2, 3 times a week for an hour, that might be affordable. If you need somebody there 8 hours a day, 7 days a week, that gets expensive. So I don't necessarily think it's an option to just -- well, AL is too expensive. I'm going to stay home. If you could stay home, you'd stay home. Nobody wants to be in assisted living. Maybe you move in with a loved one or some other friend, that guess -- that's a possibility, too. But it's need-based. It's not like, yes, it's $500 a month too expensive, so I'm not going to do it. If you can avoid it, you probably avoid it regardless of the price. I think it's more affordable. If you look at the cost of staying home, that's not cheap either.

[indiscernible].

Yes. So we would not have done this deal with another operator. I've known Trilogy since about 2000 when I was at Healthpeak, which then was called Healthcare Property Investors. It was a long time ago. They were actually a tenant of ours. We own 7 other buildings. We own 7 buildings and they were our tenant. So I've known Randy Bufford, the founder for a very, very long time. Their model, they built it right. They did it incrementally over almost 30 years. They stuck to their knitting, their levels of service, their geography, which I think has been a key component of how they built it. They didn't say, well, we want to be in 40 states. They started out in Kentucky, went in Indiana, in Ohio, then Michigan, and now we're adding Wisconsin. They've always focused on the care component first, which we've worked very hard to push out that mantra to the rest of our base of operators. Yes, we like to meet budget. Yes, we like NOI growth. But quality outcomes has to come first. If you cannot provide good quality care, you're going to pay a price in the long term, even if short-term earnings look better. People talk about, oh, it's RIDEA SNF. Isn't there a higher risk? Well, we haven't seen it. We've owned them for 10 years. The -- they do a much better job handling any PLGO claims than anybody else. The performance is there. And their focus on employee satisfaction, employee retention, quality patient care. Their employee turnover is in the low 40s, typically 40% to 45% a year. That sounds high. Industry average is 80% to 100%. A big part of their success is their employee experience. And that's another thing that we've used to export to the rest of our operators -- thing that we've used to export to the rest of our operators and for [indiscernible] employees, 100% turnover a year is tough to deal with.

And yes, there's a very high correlation between employee satisfaction, employee retention and resident satisfaction. As you can imagine, seeing the same caregiver over and over and over has a huge impact on that resident's experience.

[indiscernible]

And we don't pressure them. We don't tell them, oh, look, guys, your margin needs to be higher. So do this. Quality patient care comes first.

[indiscernible]. It seems like the number of nurses that we have is too low in the next 4, 5 years.

Yes. So the question was regarding labor, how are they dealing with, I think, primarily with the nursing staff. So of course, labor was a big problem 2, 3, 4 years ago, right? Post-COVID, they're used to 40%, 45% turnover. They were running probably in the 70s. I'm not sure how high they got, but much higher than they were used to. We saw it at AHR. We have almost -- we have very little turnover normally, but it picked up post COVID. The labor situation has been good the last 1.5 years, knock on wood. We're back to kind of your normal 3% annual raises. That being said, it's -- when you ask what the #1 issue is in this industry, it's labor. Even during COVID, labor was the #1 issue. It wasn't COVID. So it's very important that we be the place that people want to work. And I think they've done a good job of that. Our retention -- our turnover is mostly at the lower wage levels. It's not at the nursing staff. It's certainly not at the administrative level, where a lot of the employees are very, very long term. It's more at the lower wages, it's maintenance, food service, things like that. It's going to be an issue, but I think Trilogy is better positioned to deal with it than virtually any other operator.

I think like the differential between like working at McDonald's versus working Trilogy like on the lower end, does that grow?

I think it's -- that's been a big factor in the turnover there. If we're paying someone $17 an hour and McDonald's will pay $20, that person is going to look at that as an option.

Do you feel like that's what's happened?

No, I think that was a big problem 3, 4 years ago. We had to raise rates significantly on the low end. I don't think that's as much of a problem as it was in 2022 and 2023.

It seems like now they're starting to pay like a decent premium.

Yes. And I think -- look, overall, I think it's -- I'm not sure if we pay a big premium. But I mean, McDonald's needs to pay more than Trilogy in order to attract employees. I would rather work at Trilogy in foodservice than I would at McDonald's in foodservice. I think most people would agree with that.

One of the really interesting things about Trilogy too is that the opportunities that exist there. What I mean by that is you may come into a Trilogy facility, start your employment there in the kitchen, but you have higher aspirations for your career. Well, Trilogy trains thousands of CNAs every single year. And that really creates tremendous loyalty for those people. You've given that person a whole new path for their career. And similarly, because of that regional densification of the Trilogy models, there are opportunities for growth, maybe not in your campus, but 1 campus over or 2 campuses over. Let's say, you're a young and up-and-coming Executive Director, but you're an assistant and your Executive Director is not going anywhere. Well, guess what, we just finished building another campus, and we're going to open it up, and we'd like to offer you the opportunity to be the Executive Director over there. So the turnover that we talk about at 40% is really at the lower levels. The higher levels see the opportunity that's available to them within Trilogy, all of which is creating that employee satisfaction and that stickiness.

Yes. When we offer tours at Trilogy. We have one next week, which I think is already fully booked. But Alan can arrange that, anybody wants to go out to see Trilogy facilities. Biggest investors in our firm are typically those that went out and visited Trilogy and understand the story. I cannot -- I've seen a lot of -- I've been many, many Trilogy tours. You hear the same story over and over again. You meet the Head of Marketing or the ED or the Assistant ED. I started out as a food server 25 years ago or I started out doing maintenance 30 years ago. I cannot tell you how many times I've heard that story. If you're ambitious and you want to work hard and you want to learn, you have opportunities there. And just as Brian mentioned, anytime Trilogy opens up a new campus, which we do 2 to 4 a year, creates a lot of growth opportunities within Trilogy. You don't need -- if you want to be promoted and grow your career, you don't need to leave Trilogy. There are opportunities in Trilogy to do so. Yes.

[indiscernible]

So we're very comfortable. We do about $150 million a year on average of development at Trilogy. And that's a combination of 2 to 4 new campuses, several campus expansion projects and probably 4 or 5 villa projects per year. We're very comfortable at that rate. Could we push for more? We probably could. But what we don't want to do is grow Trilogy to the point where it becomes detrimental to their overall business. Every time they open up a campus, they do shift staff around, as Brian mentioned, creates a lot of opportunity. They have a SWAT team that kind of comes in for the first couple of months to get things going. But do they really want to open 8 campuses a year? I'm not sure that's such a good idea. I think Trilogy would agree. They're compensated based on their overall performance. Their goal is to maximize that performance. Growing too big, too fast probably doesn't help that.

And then in terms on your external growth and the acquisitions, can you address your current pipeline and if you've made any progress from what you were just announcing on the Q2 earnings call?

Yes. So our stock got to the point late last year where it made sense to take a look at outside acquisitions. Congratulations goes to our investments team. They've done a great job in the last 9 months, really growing that pipeline. We -- at the end of Q1, we talked about what we've closed, and we said we had well over $300 million in the pipeline. We closed a lot of that in Q2 or at the end of -- at the beginning of Q3. We came out at earnings and said, hey, despite the fact that we closed all these deals, we still have well over $300 million in our pipeline. I think, Alan, we just announced -- we updated that to over $350 million. Those are awarded transactions, not necessarily under contract. Deals that we feel we're likely to close, but there's no guarantee. No guarantee we'll close them this year. Some may go into next year. However, if we're saying over $350 million, we wouldn't say that unless we were very comfortable that we could meet or exceed that number in addition to what we already closed so far this year. So we did $650 million last year. Most of that was buying out Trilogy, that $500 million piece that we did not yet own. The other 2 large transactions were deals where we were the mezz lender. We were able to take over that real estate and the cost of our mezz at a fraction of replacement cost. A lot of the stuff we're doing this year is also deals that we didn't really have to compete for the 2 Trilogy deals that we closed -- well, 3 really with the lease buyout are all deals that we were the likely buyer there, and we really didn't have to compete with anybody else on the outside. And we have a lot of SHOP growth within our pipeline, a lot of one-off deals, small portfolios, newer, larger, higher-quality assets. That's really what we're focusing on, assets that will provide good organic earnings growth into '27, '28, '29 and '30. That's what we want to do is we want to continue this runway of strong organic earnings growth, really, which I think our investors are looking for.

Can you give us the sense of the average volumes?

Well, there's -- I can give you a range, right? So there are deals where we are 92%, 94%, not even 95% occupied. Our investment team is usually underwrite it down to 92%, 93% if it's above that, which I think, is a level of conservatism they're used to in the past. I'm not sure it's necessary today. I -- they are so conservative that I would be shocked if we don't beat the underwriting on every deal they've done this year. We're -- I really like deals that are newer, just opened are maybe 70%, 75% occupied. The current yield is obviously not going to be high in those deals. However, the price per unit will be very attractive. And I have a high level of confidence in our operating partners that they will fill those up quickly. We've seen them do that already. I think it's a combination of having confidence in the operating partners we have as well as the overall environment we're in. We are in a very positive environment. Demand growth is outpacing supply growth. So I think on those deals, even though the going yield may not be as high, I expect that the stabilized deal will probably be a little bit higher than the assets we're buying today that are currently stabilized. Either way, I expect RevPOR growth to outpace export growth regardless, whether it's well occupied or not as well occupied. If you're asking me what the average is, it's probably in the mid- to high 80s.

And what is your appetite in terms of acquiring larger portfolios versus having either smaller portfolios or ones you deal?

Yes. So we would do larger deals as well. Those tend to be more aggressive from a pricing perspective. You got a different type of competitor out there, as you can imagine. We've looked at some. We bid on one, a very large high-quality deal a couple of months ago. Very expensive, very high price per unit. It was 96% occupied. We got outbid as we expected. But we're okay with that. As much as we like the portfolio, we felt that it probably would not be additive to organic earnings growth in the outer years, unlike the stuff that's currently in our pipeline today as well as the stuff that we already own. So we're looking at some larger transactions. I'm not saying we don't need to do larger deals at our size. We are very comfortable growing the way we've been growing for the last couple of years, doing smaller deals. It doesn't mean we won't do larger deals as well.

Do you think 2026 is really the turn of external growth where you could see that volume continue to increase all the way through?

It's hard to predict what happens next year. Look, we can increase our volume, no problem. We just need to pay more, right? I mean, we're not going to compromise on quality, but we could be more aggressive on pricing if we so chose. I mean, based on where our cost of capital is today, I mean, we probably have the second best cost of capital in our space. We can be very competitive. We haven't found the need to do that, but we can if we want. We're going to have strong earnings growth if we do no acquisitions. We can stop acquiring today for the next 3 years, we can do no new external growth, and we're still going to have strong earnings growth just based on the in-place organic earnings at our facilities. So there's no pressure for us to do external growth, but we intend to keep doing it.

Do you feel like underwriting assumptions are conservative, too aggressive?

I honestly think we're probably being too conservative today. I mean, we're still underwriting 3% rent growth. That's not -- that's too conservative. Brian and I talk about this all the time. We'll get our underwriting sheet. And I look at price per unit, I look at what stabilized yield is in-place yield, et cetera. And then I see trailing 12 cap rate versus forward 12 -- sorry, trailing 3 cap rate versus forward 12. Oftentimes, the forward 12 is lower than trailing 3 because they're currently 95% and our underwriting team assumes it drops to 93%. I get while we did that in the past, I don't necessarily think you need to do that today. So I think we'll probably have them get a little bit more realistic on a go-forward basis just because of where things stand today. And what we're seeing, we used to be -- we almost always replace the operator with one of our favorite group of operators. It used to be first 3 to 6 months, you see a drop in performance. Anytime you make a switch like that. We're not seeing that now. Usually, performance improves within a month. So I think we need to probably adjust our underwriting a little bit.

But having said that, I don't think that it's resulting in us being able to buy less property than we need and should be buying today. But if we can beat up these underwriting as hard as we are and it still pencils, I think these are really good deals.

Why do you think like -- because it just seems like in general, senior housing buyers all kind of have this like 3% growth and you have this -- like why do you think -- is it just because they've been burned in the past.

Well, most of our investment team has been around a long time. It's not -- these are not newbies. And yes, they've been -- in 2014, if you underwrote 3%, you may not have been getting it because there's so much new supply hitting the market. So it's just -- it's a conservative bent that everybody has gotten used to that probably needs to be looked at.

Yes. It's easy to forget that there was so much supply back in 2012 through '16, '17, number one. Number two, inflation wasn't what it is right now. And so underwriting a 3%, it wasn't a guarantee you're going to get it.

All right. And now we're on to our 3 rapid-fire questions.

Do you think something [indiscernible] what they are?

Do you want more?

In Ohio, the lawsuit that went [indiscernible] Medicaid. Do you still have problems through?

Yes. Yes, a big part of our Medicaid Advantage is value-based payments, and that's growing and that's here to stay. So Ohio had a situation where they set their reimbursement in a certain way. Then when it kind of made the payments, they treated it differently. There was a lawsuit. It wasn't -- we weren't involved in the lawsuit. It was some other operators that said, well, this is what you said you would do. This is what you need to do. They won the lawsuit. There will be -- they'll probably appeal it or who knows what they'll do. There will be some retroactive payments due to Trilogy. We have an estimate for '23. I assume we'll have -- we'll get some money back for '24 and maybe '25. Would not be surprised if they -- these rules change all the time, right? -- part of the problem with billing for these value-add payments is you have to understand how it's -- and they change all the time. Different states have different criteria and they change them all the time. You have to be able to track it and bill it, which is hard to do. Trilogy can do it because of their size and scale. It's harder for other operators. So they may very well go ahead and say, okay, well, now we're changing the rules, just to be clear, this is how we're paying. And it's based on staffing. It's based on 5-star rating. It's based on recidivism. It's based on all kinds of different things. So -- and it changes. So I think we'll probably see some benefit from that. We are not assuming we get some permanent increase in reimbursement. If it happens, great. But we didn't report it someone else did. So we didn't go out there and say, "Oh, look at all the money we're getting yet. I did see the report on that this morning. I think he probably picked it up at Nick's my guess.

So you don't think there going to be an increase in the actual [indiscernible] is that true?

Maybe I think it's going to continue to trend up, but I don't think there's going to be this hit this positive effect that's going to be there long term. And maybe, but we don't basically forecast for that.

All right. Speedy. When the Fed starts to cut, do you expect borrowing rates for long-term debt to decline, stay flat or potentially rise?

I think they've already declined, assuming that's going to happen. There's other things affecting long-term rates just besides what the federal funds rate is. I think it's much more a function of is there a recession, what is growth? What is the employment number? What is the employment situation like? I think they'll stay around where they are. I don't expect a big -- unless we have a recession, I don't think they'll go down considerably. I'd love to hear your opinion.

Yes, yes. I think, obviously, we have seen the movement in the 10-year. I think that's been constructive. I would be willing to bet that the banks are going to get a little bit more aggressive on lending next year. And as a result, spreads are going to come in. So I think generally, there will be lower long-term cost of borrowing.

All right. Last year, the majority of companies stated that they are ramping up spending on AI initiatives. How would you characterize your plans over the next year, a higher, flat or lower spend?

Higher.

I can't spell AI.

Do you believe same-store NOI for your sector will be higher, lower or the same next year for the sector?

Same-store NOI in total?

Yes.

Higher.

That sounds good. All right. Thank you so much.

All right. Thanks.