Welltower Inc. (WELL) Earnings Call Transcript & Summary

Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph with Michael Griffin with Citi Research, and we're pleased to have with us Welltower and -- CEO, Shankh Mitra. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions. Shankh, I'll turn it over to you to introduce the company and team, provide any opening remarks, tell the audience the top reasons that investors should buy your stock today, and then we'll get into Q&A.

Is this thing -- okay. I'll quickly introduce the company. Welltower is a health care REIT, which operates in 3 countries, we invested in 4 different types of product. Majority of the business is in senior living, outpatient medical a little bit of skilled nursing and a lot of age-restricted and age-targeted apartments. With me today from my left, John Burkart, our COO. To my right, Tim McHugh, our CFO; and to Tim's right is Nikhil Chaudhri, our Chief Investment Officer. And Tim will tell you the reason you should buy our stock or not.

We talked about this a bit in our call a few weeks ago, but I think it was a good setup for how we think about why Welltower is a compelling investment opportunity. First and foremost, it's the supply-demand backdrop. So in our core business, '24 is a very attractive year relative to '23 and it's only getting better in '25 and '26. I'm sure we'll go a bit further into that, today. Second is digital transformation and process optimization that John is leading at the property level. So great kind of macro drivers of the business and in addition to that, a lot of micro upside. Third is kind of with that number two is the amount of portfolio optimization we've been doing in our senior housing operating portfolio, mainly through transitioning to new operators, new operating agreements, so creating better alignment. First and foremost, this is having a positive impact mainly on our employees and residents at the property level. And following that, we expect significant financial improvement. For -- on the external growth side, we've had an extremely kind of targeted and disciplined approach to external growth, a lot of structural reasons why there's a pretty attractive window right now to take everything we're doing internally, the 2,000-plus properties we do own and continue to add to the portfolio in a very value-accretive way. And then lastly, is the balance sheet. So we've done a lot of work over the last couple of years. As you all know, COVID kind of had a big impact on the cash flows in our business. Most noticeably in debt-to-EBITDA metrics. And we have very quickly put the balance sheet in a much better position, not just recovering from COVID, but putting us actually in a stronger position than pre-COVID with a lot of further room to run the EBITDA side. So how I think about this and talked to many of you around it is, I think we continue to hopefully make the right choices for the long term in the business and having the balance sheet in the right spot continues to allow us to make the right long-term choices.

Thanks for that, Tim. Shankh, you talked recently on the last earnings call about the 5 pillars of growth. I wonder if you can start by maybe unpacking these a bit and how you see the importance of each pillar as it pertains to Welltower's growth strategy and value proposition.

I think Tim just walked you through that 5 pillar. I will just say that if you -- look, the beta of the business is very interesting. The business, last decade looking at -- the demand growth has been very anemic. Supply growth has been very significant. And finally coming through a supply cycle with no lending prior to COVID, lending coming down very significantly and getting absolutely destroyed through COVID, we're in a very good sort of demand-supply backdrop. But within that demand-supply backlog that I'm really excited about is what John is doing and fundamentally changing value proposition of many of these communities, digital transformation. The stuff that you guys take for granted, even for your local deli hasn't happened in the senior housing business, right? So those are the kind of stuff that we're talking about, nothing rocket science. Most of it was very basic technology transformation, just hasn't happened in this business. So that's what we are going through. And frankly speaking, as we are optimizing our own product and loan portfolio, we're reloading the gun, buying [ broken ] assets at a significant discount to replacement cost. So that's what we're doing, and we have a balance sheet to support that. But if you just put all of this together, what are we trying to achieve is very simply, most real estate companies over a long period of time are not long-term compounders. Some of them are, but many of them are not. And I think this -- well, after many, many years of tremendous hard work, we think we have positioned this company to be a very significant long-term compound. That's what the bottom line is.

And maybe just turning to operators for a bit. There's a bifurcation in performance between your various operators. What are the better ones done to manage labor and other expenses while also driving revenue? And was this based on factors like acuity, geography? Or is it culture within the operators?

Yes. So -- yes, as you can see there's a difference in operators in how they approach the business, in how they function, how they...

John, your mic might not be on.

I don't think we have...

Yes, I don't think we have an on button. There you go. Now it's on. Sorry. Anyway, there's a difference in how they approach the business, how they look at it. The highest-level operators are really focused on the customer experience, employee experience and then trying to figure out how to optimize that and ultimately drive value. So they're going to look at the processes at the sites, just like I do and say, "Okay, how do we optimize this? How do we ultimately make it work best for the customer, but at the same time, drive value down to the bottom line," which oftentimes, there's things in the business that are old school, how they're set up, whether it be receptionist at front desk and these types of things that can get shifted to improve the efficiency. There's no reason to have vendor calls going through a receptionist instead of to the maintenance team or sales calls going through receptionist instead of directly to the sales team. So there's changes that are made, and we're with them all down the way to help enlighten them on some of the opportunities and help them roll this stuff out.

Maybe to that end, John, and I realize you can probably only keep this high level as opposed to offering specifics. But can you maybe highlight any of the initiatives that you've done on the operating side that has helped your partners staff up some of these facilities?

Yes. When you say specifically staff up, so there's a lot of initiatives, but to staff up, the -- this old-school way of looking at labor as being abundance of labor. And in reality, that's not the case. And so we look at it and say the sales funnel that you would have for a customer is the same that you have for labor. And so changing the way people look at labor from a staffing perspective and how you respond to 2 top people, the best people that apply for jobs, you have to answer the phone right away. You have to respond right away. It's -- again, it's a sales process. If you wait like a lot of people do, they let the resumes pile up. The good people are gone, and you're left with something less than that. So really helping them to understand how to compete in the modern world for the best talent and helping them work through systems so they get that set up so they can respond rapidly. There's a speed-to-lead concept in sales. It's the same speed-to-lead concept in staffing. And those that have done it have had fantastic results. It's really fantastic results, shocking and those that don't, you can see it.

And then maybe just on -- touching on occupancy for a bit. It seems like the narrative a few years ago was this post-pandemic bounce back in occupancy, which is driven by pent-up demand. But based on the absorption trends we've been seeing that have been pretty strong for the past couple of years, it seems like that's going to be expected going forward. So is this expected growth in occupancy, a function of demographic shifts finally kicking in from a demand standpoint and limited supply? Or are there other factors at play?

If you look back on our earnings call transcript, you will see that I have said it for years that I don't believe there's a thing called pent-up demand in senior living. You need the product when you need it. And if you don't, find it or you find other ways to satisfy it or not, right? So you just -- maybe got 6 months of pent-up demand, 3 months of pent-up demand, 9 months of pent-up demand but there's no concept of pent-up demand for a longer period of time. Fundamentally, it's just the demand-supply. I mean you've got no new product coming to the market. You've got an aging population. So it's not that more complicated than that, right? So within that, obviously, there's a question of market share, right? So that's a different conversation. But overall, system occupancy is increasing for everybody. It's just a function of there's more demand than supply.

At what point do you see supply starting to come back? I mean, obviously, the financing markets are holding it back and everything else, but the forward demand is very much there. So you think it would attract capital eventually?

Now you are trying to -- asking me to speculate. So I will give you an example that we just went through a recap with one of our joint venture partner. We had a handful of development assets, they were lease up, development loans on -- and you guys understand our balance sheet and the strength of our balance sheet and the amount of cash we carry on the balance sheet. Lenders, U.S. regional banks refused to roll that loan for Welltower. That tells you what happens if you're just a developer, right? We'll tell you, we have worked on the development projects in places like Cupertino. Places like the prime most location in Boston, 7-years fight, we finally got it. We updated our model with SOFR plus 350, 400 and the model blows up, right? Cost of construction is 50% higher. Cost of financing is where it is today. Forget about a quick second that whether you can get it or not. Even in locations like Cupertino, we can make it work. So -- and it's not because we have high cost of capital, market capital cost is what it is. And so that sort of tells you that senior development in senior living is just not an economic venture. Majority of the products that if you look at, traded in the last 3 years, they traded at $0.60, $0.70 on $1. Why would you build something for $1 and unless you can make a profit, right? So I think who knows what's going to happen in the future. But we know that equity and debt both are not available today. What we also know that the senior living development platform that have been built has been dismantled. Any of the names that you know, I'm not going to get on this call and tell you like the names. I don't want to personally be insulting to people, but a lot of people developed a lot of product last cycle that just have never leased. Those people have no work. So those have been dismantled. So first, you need to see the formation of human capital. Once formation and human capital happens that if you actually have financial capital, then you're going to see for an average location for us is a 2- to 3-year of predevelopment work. I'm talking about an average suburban New Jersey, suburban Seattle kind of location. I'm not talking about West Manhattan, Central Boston, Brooklyn, not that kind of location, an average location. And you need a couple of years of construction. So it feels like it's probably -- it's too late to get a development cycle as far as this decade is concerned. What happens after that? Who knows?

How do you think that plays into capital flows into the space from acquisitions, either IRR or discount to replacement cost?

Capital, understand the history of capital in this space for the last 10 years is very, very bleak, right? Owners haven't made money in the last 10 years, you've got a huge supply cycle, which was the problem. Then what you got is COVID, where your NOI fell 40%, 50%, something like that. As you were just trying to recover from it, your underlying rates went from 3.5%, 4% to 8%, 9%, 10%, right? So you got a hit in every possible way. And on top of that, loans in senior living, majority of, if not all of them have personal guarantees or they're too Freddie-Fannie. You know that you can't default on Freddie-Fannie and ever be loaned money again. So there is a lot of issues, structural issues of what happened in the last 10 years. And markets don't change. They have real memory of is this is the asset class -- I don't know one asset class where people have lost more money in the last, say, 5, 7 years than senior living. And that's not going to change. I mean, put office aside. Okay. I don't know much about office. I don't want to comment on that. I'm just saying this has been an area where people have lost a lot of money. So institutional memory is like your bank is not going to loan to a senior housing acquisition. Just not going to happen.

Shankh, you've been very vocal in the past about bringing in talent from industries with high standards. With that, John, you continue to grow and invest in the operating platform. How is your experience historically as a multifamily operator been applied? And how can you best capitalize from your previous knowledge for multifamily and apply it to the growth opportunity you see within senior housing?

You'll ask John, so he will answer the question I can't answer you. I will just tell you that I'm disgusted by the low standard of senior living business, right? What's acceptable, and the excuse culture of this business just blows my mind. So which is why I made the comment that I only bring people from industries of high standards and he's the best of them all.

Yes. So you're saying -- you're asking how my prior experience applies, I guess. And ultimately, there's a lot of crossover, right? They're are residential properties. There's also business crossover, just basic standards, basic mathematics, bringing a new look at the world looking how we -- again, I keep saying about focus on the customer experience, focus on the employee experience. You didn't hear that talked about very much previously. People do focus on care, which is critical, and that is the #1 item, the service, the product that we provide, our properties provide, but the other aspects of it are important as well. So bringing that to the table, I think, has been quite beneficial, building a team that has experience from multifamily, from hospitality and other areas is also very beneficial. Of course, our product type touches the residential. It touches the hospitality side and then, of course, care as well. So bringing that all together and getting experts is driving results. And you had a second question, I apologize, I forgot what that was.

No. It was just kind of the long-term growth trajectory that you see in senior housing. I believe in the past, you've compared it to what multifamily was like back in the '70s. So just kind of taking that prior experience and applying it to your role today.

Yes. I mean, Tim, obviously gives guidance. So I don't give guidance. But to comment or to go back on my prior experience, yes, I see huge opportunity in the margin of this business because we're just at the very beginning, not at the end of really looking and saying, "How do we optimize every aspect of this business to drive greater value to the customers. And in doing that, that will dramatically improve the margin." I've mentioned comments like revenue management, which, to be very clear, what I'm speaking about in the base is just properly pricing units. I have a unit that has a drop-dead view of a lake, why is it priced the same as a unit with a garbage dumpster view. That's just fixing that. That's not anything else beyond that. There's just basic things like that. There's numerous other aspects. I've commented publicly about the marketing cost, almost 3% of revenue. And in the multi-world, it's closer to 60 basis points. The sales process is different. But on the marketing process, you're bringing in leads. So why is it so expensive? And what are the opportunities to solve for that? There's just a lot of different pieces that can get fixed that are pretty exciting. It's a lot of -- exciting to me, I should say. I think for most -- everyone in this room, it would bore the heck out of you, and you would just go, it's time to go get a drink. But the reality is these are just blocking and tackling, nuts and bolts and just going after it.

Not just you look at this and just say, comparing to other industries, what it can be. We look at our portfolio, look at our best operators and look at their occupancy and margins, which are substantially higher than average, right? So you don't have to be a rocket scientist to figure out can we get the whole portfolio there, just what you need is a real digital transformation of this business, real processes, real systems. So the outcomes, the realm of outcomes are just not this wide. So we're making a lot of progress, but we think we have a long ways to go in this area.

Shankh, where do you think margins can get to in the portfolio over a long period of time?

I have been doing this for a long time. You are not going to get me to answer that question. But we can help you think about that, just understand that assuming there's demand, put that demand-supply question aside, frictional vacancy is a pure financial calculation, depends on what's your turnover? And how quickly can you turn a unit, right? So what's the basic standard of -- in our industry of how long it takes to turn a unit versus what John and Jerry are used to, let's just say that's a fraction. So if there is demand, we're not going to -- in this question, we're not addressing the demand-supply question, which we talked about, you guys understand that. Then frictional vacancy should be a lot lower than historically it has been. So you should be able to fill a product that alone changes sort of your -- what your margin should be. About the opportunities of rate, we're also -- let's get into not think about the opportunities of amenity-based pricing, right? In a senior living building, usually, all the units are priced the same. I actually have examples in my portfolio in places like Manhattan and Boston, as you go up, the price come down. I've never seen anything like this in my life. That's how this business operates, right? Everything is sort of on a yellow post-it, people sort of do what feels right. So there are many, many examples of that. We'll be talking for next 2 hours, if John starts to give you example of some of the stuff we have seen. But those are the things that we are fixing, and we think there is future, there's a lot -- not [indiscernible] future. There's a lot of margin opportunities as we get these buildings full. And as we provide a value proposition that the customers like and they're willing to pay for it. But margin question in this conversation is much less about cost. There are significant cost opportunities. And those that I call $1 bills, right? We'll take $1 bills. But the revenue opportunity is $20 bills. That's what we are after.

Maybe just a question on the data analytics platform. You've obviously highlighted your investment in it. It's pretty integral to the growth strategy going forward. I was wondering if you can provide any examples of the way this investment has enhanced your portfolio quality and been able to improve margins.

We have provided examples. There is a slide on our investor deck, at least it used to be, probably still there, that our data analytics, our Chief Data Officer and Chief Data Scientist, they came to us 2 years ago and said, "These guys predict rent, and they're extremely good at it." What should be the rent in a given location, and they got very, very good at it. So there was an example of 6 buildings that were run by an operator, and they said, "You should get -- if you move it to an operator A from operator B, you should be able to get 20-plus-percent higher price," right? Just the -- changing the service model and we said, "Okay, well, let's try." I think we have given an update every quarter on that portfolio, 6 buildings, not going to change our lives. But we have gone in those -- that portfolio from 63% occupancy to low 90s occupancy, $1 million of annualized EBITDA to $17 million of annualized NOI. It's just an example. I can give you many, many examples. We think most people misunderstand real estate as a business, right? You will hear in this conference that real estate is a business of location, location, location. We fundamentally reject that idea. We think real estate is a business of location, product price point and our business there's a 4-dimension called operate as a service model. And it's an optimization game. It's not a maximization game. You will see that -- see tremendous amount of variability in the same location, depending on the product. right, product in our business could be -- is it IL? Is it AL, right? That's one product? Is it studio? Is it one bedroom? Is it 2-bedroom? That's another way to think about product. So depending on location, product, obviously, price point and the operator overlay, it could change your outcome as much as 30% on the bottom-line NOI. So that's what we use -- it's a good example of -- that's what we use and many other things using that platform.

John, it feels like in our investor conversations broadly, the main pushback is the stock is expensive, right? So it's -- from a multiple perspective, it can be relative. Sometimes it will be NAV. But ultimately, right, if we're thinking about kind of new investors to the stock, everyone says, "Okay, senior housing looks great. Welltower is doing very well. The stock is expensive right now." You've talked about compounding cash growth. You've talked about not wanting to give that multiple away or that cost of capital way as a buyer, right? So you've been disciplined there. But how do you address that kind of pushback, right? I mean I recognize it's a good problem to have, but ultimately, to attract more capital, how do you think about kind of that relative valuation or even absolute valuation?

It is not my job to address what multiple my stock should trade at, right? So I don't address that question. But if you really want to -- I'm an investor, I'm not a deal junkie. If you really want to get into a conversation with me on valuation of a company. I will tell you that go run an IRR model or do a DCF model, you'll come to the conclusion yourself, right? So it's a lazy way to look at a company's stock on near-term multiple, particularly for a compounder that's compounding rate forever and really bottom line, finally, in a big way. You're making it -- if the stock is expensive, are implicitly making a call that this company is close to its stabilized occupancy. And if that's your view that the frictional vacancy of this business is close to where it should -- where it is today, then you're right, it is an expensive stock. If it is not, the conversation is, if we think we can take the frictional vacancy to a much lower level, then the stock is really cheap. That's your call. That's just not my call, right? I know what I would do is very simply, I look at what I buy and sell. If I sell a stock to buy properties, I do it for the same calculation. What I think is the frictional vacancy is, and what I think the margins can get to. In these both cases apply same amount of CapEx depending on the age of the property and everything and say, is there a IRR trade between the 2, under the same assumption, which is, in our case, we never assume that exit rates will be lower. We'll get a higher exit multiple. We have to make the IRR entirely on the cash flow. And under the same assumption on a daily basis, if it looks like that we can buy something to -- by obviously issuing the stock or issuing -- selling another asset, we'll do it. If not, we won't. That's just as simple as it gets. But you cannot think about the way you think about an apartment company for Welltower today. Or I -- just taking any -- I don't know all these companies you guys cover, but it seems like a majority of them are close to that stable occupancy level. You can't do that, right? Think about the majority of the profitability in this business is after 80% occupancy, right? You breakeven at 60%, your toughest point in the margin sort of equation is when you are 80%, 82% occupied because that's why you're fully staffed. And -- your incremental margin goes hockey stick from there. You have to think about like you think about an industrial company, not industrial estate company, an industrial company, right? So it's an incremental margin question. So how far that incremental margin goes, depending on how far do you think occupancy could be pushed? And how far do you think rates could be pushed? So it's just a question of you're making an implicit bet whether you are -- you're bullish on the stock or making an implicit bet on a simple fact, which is what's the frictional vacancy. And I think that's what most people don't understand.

Shankh, as a capital allocator. You've talked about finding opportunities up and down the capital stack, both in terms of discount to replacement costs and unlevered IRRs. We have this wall of debt maturities coming due over the next 2 years that you've talked about many times, how best can Welltower capitalize on these opportunities? And what does the pipeline look like in the year ahead?

Nikhil, do you want to take that?

I think the pipeline, as John mentioned on the call, we've been busier than we ever have, right? I mean, usually, what you see is transaction activities pick up in the back half of the year and you close a bunch of stuff, as motion looking to start of fresh into the new year. And so -- then usually, it takes a while in the first and second quarter to define incremental transactions, negotiate and you start to see things closing in the back half of year. This year, it's not the same. This year, a lot of the counterparties that were transacted with in the back half of last year, we're in conversations with them to do incremental transactions. So we're busier than we've ever been and...

Sorry, is his mic working? I can't really -- okay.

Too far?

Maybe I might be -- yes. All right. Sorry about that.

Better?

Yes.

Yes. So just to quickly catch you up on what I said that this year started off busier than most years have, and a lot of that is driven by repeat activity with folks that we transacted with in the back half of last year. And from an opportunity set perspective, you've got roughly $16 billion of seniors housing debt coming due in the next 2 years. And from a recapitalization perspective, Fannie-Freddie have provided roughly $1.5 billion to $2 billion a year. And so obviously, there's not enough there to recap the debt that's coming due. We've all talked about regional banks not wanting to put out an incremental capital. So there is a massive gap between the capital that's needed and the capital that's available. And similarly, on the equity side, there is -- Shankh has mentioned this before, folks have not made money in this business for the most part. And so there is a fair amount of hesitancy even if you can transact without debt, there's a lot of PTSD for equity and equity is not coming back anytime soon. So we're in a unique spot where we have found a way to make money in this business. We have access to capital, and we're able to cherrypick assets in markets where we have a lot of conviction, in markets where we have assets that are performing really well and name our price. If that price works for the sellers, we transact. If not, we move on. But the opportunity set continues to be overwhelming and the opportunities are great.

And Nikhil -- sorry, Shankh, were you going to say something?

No.

Nikhil, maybe sticking with you. When you're looking to underwrite new investment opportunities, how have you seen return hurdles change? And do any of the property types, be it wellness housing, IL, AL or SNF, screen more attractively now?

Yes. Well, I think our focus continues to be, as I look today at the pipeline, it's essentially all seniors housing. We had a large transaction in the wellness space that was really 5 years in the making. And so there's been a lot of conversation about that. But there's just not that much products to acquire in that space. And this one took us 5 years to unlock. From a return expectations perspective, what you've had is we're buying assets at $0.65, $0.70 compared to replacement costs. We're buying them pretty close to debt value. But what you've had happen is as the industry performance has improved, at the same basis when 2 years ago, the industry occupancy was 70%, you were getting no going-in yield. Today, you're at a 6%, 6.5%, high 5s depending on what specific assets you're looking at. But because of the recovery in the industry, you're going-in point is much better. And -- but from a discount replacement cost perspective, we're in a pretty similar place. And so you put all that in the blender to calculate the IRR. We're not assuming any cap rate compression, we're assuming cap rates are in line with where they are today. We're not assuming performance beyond pandemic recovery. We're not assuming John Burkart adding any incremental value. And despite all of that, in seniors housing, you were able to hit 10%, 11% type of unlevered IRRs. And then you asked the question about SNFs. There were credit investors. There the thinking is we need multiple layers of protection. We need to be in the right state, the right basis. And in addition to all that, have the right operator and incremental credit protection beyond what's available in the confines of the deal. So incremental guarantees from individuals, from entities, it's a true credit investment.

Maybe just a question on the balance sheet for Tim. You've done a good job managing the balance sheet. Obviously, bringing leverage down to about 5x from about 6.5x a year ago. Is the plan to maintain leverage at current levels or reduce it further? And under what circumstances could you look to take leverage higher again?

Yes. So leverage will continue to come down just because of the natural recovery in NOI [indiscernible]. So both from -- I think, the consistent theme is we think there's tailwinds that continue to bring NOI back to where it was pre-COVID. And certainly beyond that, over the coming years, given all the reasons we kind of talk through today. So with that, you'll see from a cash flow coverage perspective, so debt-to-EBITDA fixed charge, et cetera, continue to see better metrics going forward. And I think, as I said earlier, I don't think it's a question of what would make us bring leverage back up. I think it's just what the balance sheet being in the right spot allows us to do is make the right decision for what's going to drive long-term value, whether that's access to equity capital or debt capital, it means that all options are open, and that's why we've continued to kind of approach investments with the discipline we've had as far as how we funded them.

Great. Well, if there are no other questions from investors, I've got my 3 rapid fire to end the session. What is the best real estate decision today, buy, sell, develop, redevelop or pause?

Buy.

What is the expectation for same-store growth for 2025 for the shop industry overall?

Not going to answer.

And will there be more, fewer or the same number of publicly-traded health care REITs a year from now?

Same or more.

Great. Thank you very much.