Welltower Inc.

Good morning, ladies and gentlemen, and welcome to the first quarter 2019 WellTower earnings conference call. My name is Nicole, and I will be your operator today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. If at any time during the call you require assistance, please press star followed by zero, and an operator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. Now I'd like to turn the call over to Tim Hughes, Senior Vice President of Corporate Finance. Please go ahead, sir.

Thank you, Nicole. Good morning, everyone. And thank you for joining us today to discuss Welltower's first quarter 2019 results. Along the safe harbor, you'll hear prepared remarks from Tom DeRosa, CEO, Sean Mitra, Chief Investment Officer, and John Goody, CFO. Before we begin, let me remind you that certain statements made during this conference call may be deemed forward-looking statements in the meaning of the Private Securities Litigation Reform Act of 1995. Although Welltower believes results projected in any forward-looking statements are based on reasonable assumptions, the company can give no assurances that its projected results will be attained. Factors and risks that could cause actual results to differ materially from those in the forward-looking statements are detailed in this morning's press release, from time to time in the company's filings with the SEC. If you did not receive a copy of the press release this morning, you may access it via the company's website at welltower.com. And with that, I will hand the call over to Tom for his remarks on the quarter.

Thanks, Tim. I'm pleased to report a strong quarter, completely in line with the expectations we laid out for you at our Investor Day last December. These results are the product of consistent growth across all of our business segments, in particular, seniors housing, where performance is being driven by an ongoing stabilization of occupancy, which Well Tower began to benefit from in 2018. We expect this to continue through the rest of the year. We also continue to benefit from excellent access to capital. which allowed us to both fund our contractual investment pipeline and position the balance sheet for opportunistic investments going forward, locking in long-term value creation for our shareholders. Our differentiated strategy and approach to capital allocation has resulted in a total of $2 billion in new investments, closed or announced, since the start of 2019, bringing accretive new investment volume to over $6 billion since early 2018. This is enabling Well Tower to deliver the earnings growth we report to you today. Simply put, we run Well Tower to deliver sustainable and reliable growth to our shareholders. Our results demonstrate that our strategy works. Shank Mitra will now give you a closer look at our operating performance in the quarter, as well as our new investment activity.

Shank. Thank you, Tom, and good morning, everyone. I will now review our quarterly operating results, provide additional details on performance, trends, and recent investment activity. At our investor day in December, we gave you a detailed look into our view of senior housing supply and how adjusted competition units and year-to-open inventory shock impacts our best-in-class portfolio within our specific micro-markets. While pundits proclaimed supply headwinds for years to come using their gut feel, as it suits their story at a given moment, our data analytics team of statisticians and computer scientists armed with machine learning, not gut feelings, informed our prediction of the turn in our operating trends that I have discussed with you over the last three quarters. However, I have to admit, our first quarter sharp results exceeded our expectations in all three main drivers, rate, occupancy, and labor cost. Same store and wine for the shop portfolio is up 3% year over year, driven by 60 basis points of occupancy growth, 2.9% rate growth, partially offset by 3.6% labor cost growth. These are the best fundamental results we have seen in a long time. Sequential results are even more encouraging. Sequential revenue growth of 0.4% in a usually seasonally weak first quarter is one of the best we have seen in years and is driven by both strong rate and occupancy. More interestingly, this quarter, for the first time in five years, we saw sequential revenue per occupied room growth of 3.3% outpaced compensation for occupied room growth of 2.8%, resulting in a positive spread of 50 basis points. One of the most underappreciated aspects of our company is the strength and diversity of our senior housing operating platform, which has 23 operators in three countries. In any operating business, growth is not always a straight line as many of us wish it was. However, due to significant diversity of our operating partners across geographies and acuity spectrums, that volatility is softened in the aggregate. Over the last few years, we have routinely seen parts of our portfolio results that resembles the challenges of the industry at large. But these operators have consistently been pulled up by other operating partners who serve a completely different customer need in another part of the country. Having said that, this quarter we experienced broad strengths across a majority of our operators. Exceptional UK results are driven by significant asset management efforts by our UK team headed by Justin Skiver, a deep negative comp in prior years, and the lease up of a couple of low occupancy assets. We expect UK results to normalize as we move through the year. On the other hand, the Canadian platform, facing a tough comparison year, is expected to normalize upwards as the year progresses. We continue to be encouraged by our U.S. portfolio this quarter. NOI is up 2.2% year over year, driven by 40 basis points of occupancy increase, 2.8% rate growth, and particularly encouraging 3.8% compensation for occupied room growth. We have seen broad-based trends across larger and smaller markets. From a product type perspective, our industry-leading assisted living and memory care portfolio drove results with 4% NOI growth. While a handful of quarters does not make a trend, we are cautiously optimistic that our portfolio is positioned for significant cash flow growth for years to come. While results were in line in our other lines of businesses, I want to highlight a few things to help you understand the trend. First, in our senior housing triple net segment, the reduction of coverage is driven primarily by the removal of StoryPoint portfolio, which we sold in the quarter and somewhat by Brookdale underperformance. As you know, we consider StoryPoint to be one of our best and most strategic operating partners. Yet, we sold these assets at an offer we could not refuse. We sold these 20-year-plus old assets at a 4.6% yield at an unlevered IRR of almost 19% for our eight-plus years of ownership, which achieved an NOI CAGR of 7.2% in face of significant headwinds. We continue to grow with StoryPoint through a new RIDEA joint venture with two brand new assets that we just bought, several in development, and are transitioning many more communities to Dan and Brian that we believe will see cash flow growth similar to that experience in the portfolio that we just sold. While we are not working on any lease restructuring in our senior housing triple net portfolio at this moment, we have plans for every asset and frankly, we'll be happy to get back many of these assets so that we can transfer them to the operators like StoryPoint so that you, as our shareholders, can enjoy significant upside. Secondly, Our post-acute portfolio decline in coverage is driven by a handful of LTACs we own, which is less than 1% of our asset base. Skilled nursing licensed assets, which constitute a vast majority of our post-acute bucket, either in the traditional sense or in the short-stay category, are stabilizing, as I have described in our last quarter earnings call and you subsequently heard from Genesis. While makeshift is still a headwind, we're encouraged by occupancy growth, recent reimbursement announcements, and upcoming PDPM implementation in Q4. Third, we're very happy with the capital deployment plan in our Prometica HCR Medicare assets. ProMedica HR manual care team is working diligently with our data analytics team to prioritize capital deployment. We have 45 assets slated to go through this CapEx program in the next two to four months. And last, as I have no noteworthy update for the outpatient medical operating results, we're very encouraged by 2.1% net rent increase in the quarter and the dramatic changes that Keith and Ryan are making in that platform to position us for growth next year and beyond. On the capital deployment side, we're busier than ever. We have closed $778 million of investments so far this year and have significantly more that are closing in coming months. These investments have been made both in senior housing as well as medical office segments. In senior housing segments, we continue to grow with our existing partners such as Chelsea and Discovery. We are very excited about our new joint venture RIDEA relationship with Frontier Management that we established this quarter. Portland, Oregon-based Frontier is one of the finest operators in the higher equity segment of the senior housing business. Greg Roderick, who is the CEO and majority owner of Frontier, is a third generation operator and leads one of the most operationally focused teams that we have seen in this industry. We have significant plans for growth with this team in near future. As we continue to acquire attractive assets with great operating partners or health systems, we will fund this capital need through disposition and common equity. we expect the parting yield on disposition will be similar, very similar to the initial yield on acquisition. But our thesis is to drive higher total return or IRR in that trade through higher growth rate and lower CapEx. Whether through disposition or common equity, we only allocate capital when we believe this thesis holds. However, there can be timing difference when the capital is raised and an acquisition is closed. This timing difference, which has no impact on our run rate earnings, can impact quarterly earnings. But we're willing to make that trade-off in order to minimize balance sheet risk and lock in long-term value creation as Tom described. We are not interested in rolling the dice in this volatile capital market by playing short-term game. short-term earnings gain, but rather driving long-term cash flow and NAV growth. Beyond our significant organic acquisition machine, we are beginning to see the emergence of value-add opportunities. By definition, these transactions are not accretive to cash flow day one, but they come at a significant discount on core real estate valuation metrics, such as price per door or price per foot, and will drive significant IRR and NAV growth. We believe our acquisition of South Bay Portfolio with Discovery that we closed subsequent to the quarter end fits in this bucket. We are exploring a few opportunities in the medical office space in this category as well. We are looking for the right opportunity, but we very much like the idea of what these assets can become in hands of Keith and team. In summary, we are very encouraged by accelerating prospect of both internal and external growth opportunities. This will be a very busy year for us on all fronts. With that, I'll pass it on to John Goody, our CFO.

John? Thank you, Sean, and good morning, everyone. It's my pleasure to provide you with the financial highlights of our first quarter 2019. As you have just heard from my colleagues, Q1 has been another successful and very active quarter for Welltower, further highlighting our differentiated portfolio and corporate capabilities. During the quarter, we completed $367 million of gross investments, including $259 million of high-quality acquisitions at a blended yield of 6.3%, with twice that value already closed to date in Q2. We also completed $612 million of dispositions in the quarter at a blended yield of 6.7%. In addition, we received $14 million in loan payoffs. Q1 was especially active for Welltower on the balance sheet and capital raising front. During the quarter, we successfully raised $538 million of gross proceeds from our common equity issuance via our DRIP and ATM programs at an average price of $74.69 per share. In addition, we elected to affect the mandatory conversion of all our outstanding 6.5% Series 1 cumulative convertible perpetual preferred stock into common stock of the firm. During the quarter, we successfully accessed the senior unsecured notes market, issuing an aggregate $1.05 billion across five- and ten-year tenors, using the proceeds to redeem an aggregate $1.05 billion of existing notes due in 2019 and 2020. In doing so, we increased our average debt maturity profile by six months to 8.1 years at the quarter end. Finally, we initiated an up to $1 billion unsecured commercial paper program, providing us with an alternative source for short-term financing. In summary, Wellpower continues to enjoy excellent access to a plurality of capital sources to fund and pre-fund our acquisition pipeline and future growth opportunities. Our Q1 2019 closing balance sheet position was strong, with $249 million of cash and equivalents and $2.6 billion of capacity under our primary unsecured credit facility. Our leverage metrics improved from last quarter with net debt to adjusted EBITDA falling to 5.47 times. Moving on to earnings, today we're able to report a normalized first quarter 2019 FFO result of $1.02 per share representing growth of 3% over Q1 2018. As in the past, we do not include one-off income items such as lease modification or loan repayment fees in our normalised numbers. Our overall Q1 same-store NOI growth was an encouraging 3.1% for the quarter, with all our segments recording solid growth. Senior housing operating same-store NOI grew by 3.0% in the quarter, with the UK delivering a standout result. Senior housing triple net grew by 4%, outpatient medical grew by 2.3%, and long-term post-acute grew by 3.2%. I'd now like to turn to our guidance for the full year 2019. We are reaffirming our expected normalized FFO range of $4.10 to $4.25 per share, and our previously announced expected average blended same-store NOI growth of approximately 1.25 to 2.25%, with growth expected in all our business segments. We are also reaffirming our segmental guidance of senior housing operating, approximately 0.5 to 2%, senior housing triple net, approximately 3 to 3.5%, outpatient medical, approximately 1.75 to 2.25%, health systems, approximately 1.375%, and long-term post-acute care, approximately 2 to 2.5%. As usual, our guidance includes only announced acquisitions and includes all disposals anticipated in 2019. Finally, on May 28, 2019, WorldTower will pay its 192nd consecutive cash dividend, being 87 cents per share. This represents a current annualized dividend yield of approximately 4.8%. With that, I'll hand back to Tom for final comments. Tom.

Thanks, John. Now, Nicole, please open up the line for Q&A.

Ladies and gentlemen, if you'd like to ask a question, please press star then one on your telephone keypad. To withdraw a question, please press the pound key. Please limit your questions to one question and a related follow-up so that all callers may ask their questions. You may re-enter the queue after by pressing star 1 again. We will pause for a moment to compile the Q&A roster. The first question comes from the line of Daniel Bernstein with Capital One.

Good morning. Hi, good quarter. I wanted to expand on the comments about value add opportunities that you first opened up your comments with. What sectors are you seeing that in and maybe what is causing those opportunities to pop up? Is that private equity pulling back? Is it simply developers have kind of hit the end of their line on their development funding and now need to go ahead and sell assets? I just want to kind of understand kind of the scope and extend to that.

Good question, Dan. I'd say it's all of the above. We're seeing opportunities across all of the sectors that we have focused in historically. there are value-add opportunities we see outside of our portfolio, and we've talked about value-add opportunities we see inside the portfolio. Shank, you want to expand on that?

Yeah, I think, Dan, you were right. You know, what happened is if you think about, you know, we think about supply as it impacts, you know, operating portfolio, right, operating results. And also, you think about supply, you think about a lot of inventory that you can either acquire or inventory that people have built, you know, people who are not from this business, you know, think about multi-family developers, people have never been into an operating business, have built and now they can lease out, right? So that's sort of the point they're hitting a wall. So you can buy these things that, you know, 40, 50, 60% occupancy at a very, very good price per door. I'm talking about seniors housing. And, you know, you can do very well with them. On the medical office, there are few and far between. As I said, we're looking at a couple of opportunities, a great price per foot. And, you know, the ownership of some of these buildings either have changed their strategic, you know, objective or they just, you know, could not maintain the capital structure that will require ongoing investment like we do in our portfolio and great owners, other great owners do in their portfolio. So we're seeing that. More in seniors housing, but we have some significant opportunities in medical office as well.

Okay. Will those opportunities require a significant amount of CapEx, or is it more of an operational improvement that needs to happen? Just trying to understand. You know, you've got to create it from day one. I'm just trying to understand, you know, how much you need to put in, how long is that going to take? Yep.

So if you buy 60% leased senior housing, portfolio is not going to be a creative day one. We know that. Some of these assets are newly built, so you don't have to do anything. Some of these assets are older that you need to bring in operational improvement and refresh the physical plans. So it can be both. So if we do require, if some of these things require CapEx, that will be part of our underwriting, right? We're not going to think, okay, if you think about what we do with the four Sunrise assets we bought from S&H, it was a great value-add opportunity. We put capital and we underwrote as a part of it. So it can be both. We are seeing, you know, the one portfolio we did with Discovery, it's a newly built portfolio. So you don't have to put any CapEx in it. And we're seeing opportunities that we do. We think both.

And if the value add is bringing in one of our operators into a, let's just say, less than optimally managed portfolio of senior housing assets, understand that's not like flipping on a switch. It takes some time. There's always going to be some level of disruption. And we're seeing many opportunities like that where we're seeing assets that the types of assets that Shank was referring to, or actually our operators are seeing assets in their markets that are struggling, where they know that their management template could significantly turn the performance around. So it's coming from lots of different directions, Dan.

One more quick question, if I could. I just wanted to ask about how you saw the flu impact in the season. I know it's just a quarter and there's normal seasonality, but the flu season did start late. It's ending late. How did that impact 1Q, and how do you see that rolling through your same store numbers as we get into the second quarter?

So I'll just start and then Mercedes will add color to that. So first is that, you know, we're very encouraged by, as I said, we're seeing in rate growth, occupancy growth, as well as first time in the expense growth. So I would not characterize our first quarter results are driven by flu. Having said that, you know, we have, as I said, we expect UK to normalize down and Canada to normalize up as we go through the year. We have high hopes for the rest of the year, as you have seen. But Mercedes, you want to comment on flu?

Just on flu specifically, I would say that it's been a slightly longer flu season than we traditionally see. Having said that, we haven't had any reports from any of our operators of particular impacts that is noteworthy.

Okay. Appreciate it. Thank you. I'll hop off.

Your next question comes from the line of Vikram Malhotra with Morgan Stanley.

Thanks for taking the question. So, Shank, I just want to get more color on sort of the value add, not only product, but just thinking about geography as well. Obviously, I know you focused more on micro markets and sub markets, but as these opportunities come about, how should we think about sort of your focus on, you know, the traditional coastal markets that you have focused on versus maybe newer markets or newer opportunities in new markets?

Yeah, Vikram, it's a very good question. So we're seeing these opportunities across all markets. As you know, that we don't focus on just what the headline major MSA looks like. We're focused on On micro markets, we believe there are seniors that you need to take care of in every market. It just needs to be the right price point. And as you're getting into the investment, it needs to be the right price per door. So as you can see, that even in a Michigan-Ohio portfolio in StoryPoint, we sold the assets at 19% unlevered IRR. I want to repeat, it's unlevered IRR. So you can make significant amount of money if it's the right assets with the right basis with the right operator. So no change of template. Across the US we're seeing these kind of opportunities. We're seeing sort of emergence of certain opportunities in UK. We're seeing certain emergence of opportunities in Canada. We're interested in all three of our countries across all product.

But what I would add to that, Vic, is that when you see us go outside of the core coastal markets or the major metro markets in Canada and the UK. It's very operator specific. We cannot underscore enough the operating excellence of companies like StoryPoint who face tremendous competition from new supply and have outperformed consistently because of their focus on operations. These are not real estate developers that are trying to participate in what's considered a new, new sector of real estate. These are people that come from really the health and technology sectors who have a differentiated product, again, in not first-tier markets, and they perform consistently. That's who we align ourselves with.

That makes sense. And then just second question, we've obviously seen you be fairly active on the MOB side, but maybe Tom and Sean, can you sort of remind us or update us? You've talked in the past about opportunities with health systems and sort of opportunities both that could be specific to health systems but also touch senior housing. So could you maybe update us on what sort of opportunities you're seeing with health systems and tie that back to the ProMedica deal?

I will just talk about the medical office aspect of your question and then Tom will add on the health system side. If you look at, we have seen, as we have described in last call-up 18 months, really we have seen sort of an air pocket in that aspect, that part of the capital markets. where um you know the cap rates have become more reasonable and we have done a lot of transactions as we told you that we need to hit you know give or take seven percent unlevered iraq to do any transactions so we're still seeing opportunities to do that um and there's many ways to get there but we're focused on unlevered not levered returns and if you know those pricing changes then you will see that we will get out of the market again like we have two to three years prior to that.

What I'll say about health systems is that when I came here or I came into the CEO spot here five years ago, I came with a knowledge and relationships about the large non-for-profit health systems. I have been engaging in that space over the last five years, initially by myself, and then I brought other people to the company like Shank and Mark Shaver who have helped really develop the dialogue and relationship. And the one thing I will tell you, as major health systems start to consider their futures They are thinking much more outside of the acute care hospital space about where they will meet their customers. And I'm saying, I said that word specifically, not necessarily patients, because patients means that you are sick. Where they will meet their customers as their models evolve more towards patients health and wellness of the population, rather treating sick people in acute care hospital beds, which is simply not sustainable. So that is leading to multi-level discussions with major health systems. And what I can tell you is it takes a lot of time to develop these relationships. This does not happen overnight. and we're making very good progress. Great, thank you.

Your next question comes from the line of Jordan Sadler with KeyBank Capital.

Thanks, good morning. Morning. Wanted to just start on the same store performance and particularly relative to the guidance. It seems like you guys came in very strong, particularly relative to the guidance and particularly within the senior housing operating portfolio. Can you maybe just comment on sort of what the expectation is that's embedded in the rest of the year's performance for the overall portfolio, but shop in particular?

Yeah, so as you know, by policy, we do not update segment level guidance for the year. We are, you are right Jordan, that we are very excited about the same store performance really in the shop, but also medical office also outperformed as well. So we are excited about what, you know, sort of the year will shape up, but it's too early to change overall same store guidance. But just remember that we do not change segment level guidance through the year.

I was just going to say, is there something we should be looking at that will soften up the trajectory? So in other words, you did 3% in the shop portfolio in the quarter versus your guide of one and a quarter. But as I look out to the next three quarters, is there something either comp-wise on the revenue or expense line item that should cause a meaningful slowdown that I may not be focused on?

I'm not gonna comment on that. That will be giving you guidance. I would say that we are just focused on different three countries. I expect UK will normalize down. Canada will normalize up. And I expect continued, I'm very, very encouraged by the U.S. performance. Just focus on what I said on sequential basis, right? First time in five years, we saw rep for growth that outpaced comp for growth, right? If you just think about that, what that does is, For the P&L rest of the year, I will leave you to that math. But I will just say, answer to your question, I don't see anything that dramatically slows down the performance of the shop portfolio, except the UK and UK dynamic that I just described.

Okay. That's helpful. And then could you maybe just talk about the character of the story point buyer, just so we get an idea of who's out there, chasing assets like this?

I can't because of NDA, but I can tell you that everybody and anybody. You know, we are in the public markets are focused that we know when, you know, many participants are focused and when the business exactly turns, which quarter, which year, private buyers are not. They're seeing, you know, a multi-year trend that's coming, and people are excited to deploy capital. So, you know, from private equity to all the institutional investors that you're seeing, everybody's interested in the asset class. But, you know, this is obviously there's an operating aspect of the business, so people are trying to partner with the right types of operating partners or people like us.

Okay, my last one. It's just regarding the provision you took in the quarter. Is that something based on something that's already happened? I just was confused by the footnote. It's an $18.7 million charge related to a planned restructuring of seniors housing triple net.

Is this on at new or old? At Jordan, it's John. Is that exhibit, you're looking at the exhibit two? It's your normalizing adjustment.

Yeah, correct.

Yeah, I mean, that was a provision for a loan. We've taken a provision for a loan loss on a restructuring of a couple of triple net buildings that were in special purpose entities.

That was your point, Jordan? That was, yes, that occurred during the quarter and there was no, the income impact and that restructuring was felt during the quarter.

Okay, so that was just another, like a conversion? When you say restructuring?

No, this was a provision. This is a provision in case something happens, right?

So this is a provision on the law. It's a provision against the loan that we've provided for a non-full recovery on.

And then we did not recognize interest income on that loan in the quarter. Oh, gotcha.

Okay.

Thank you.

Your next question comes from the line of Chad Vandercorp with Steeple.

All right. Thanks. Good morning, all. Good morning. Good morning. All right, since we touched on StoryPoint a couple times, you know, it looks like you sold the TripleNet portfolio, but you actually expanded your RIDEA relationship there. So could you tell us what was the coverage on the TripleNet portfolio, and then what was the rationale behind selling it? Did the operator have a purchase option? Did you want to reduce Michigan exposure if it's something else there?

Yep. So we did not expand on RIDEA portfolio. We created a new RIDEA joint venture.

All right, thanks for clarification.

So that's sort of first one. Second is the coverage was almost 1.7 times. The reason to sell those particular assets is what I told you in my prepared remarks. If you can hit 20-plus years old buildings, you can hit a 4.6% yield to get to a 19% unlevered IRR. You do that all day. Every asset is for sale at a price. So, you know, we sold the assets because we thought we got the fantastic value. There's nothing to do with it.

Did you go to the operator or did the operator come to you?

No, we got an unsolicited offer.

Okay. All right. And then just thinking about the shop portfolio, you've got Brookdale Assets. It looks like you transitioned about 18 of those. What's the expectation of performance there? What's left to also transition there?

So I'm glad you asked that question. Our same store pool for shop portfolio has not changed. It was 473 assets. It is still 473 assets. The total number of shop assets changed to 599. Why? Because the restructuring of Brookdale that we talked about, you know, last summer got done, finally got done, some of the assets in California and other places this quarter. So you saw those transactions, those transitions from Brookdale to Pegasus happen this quarter, actually on 2-1. So that changed the overall number of show assets. But I want to reemphasize again that our same store pool did not change. What is the expectation? We told you that, you know, we're pretty happy when we did the Brookdale transition. We transitioned the assets so that we have good coverage, right? Our EBITDA coverage for the Brookdale assets is not the 1.3 times. Having said that, I don't want to talk specifically about Brookdale. Any assets, we have an operating portfolio. Just think about it, just our idea portfolio has 23 operators. Our triple net portfolio has several operators. There are assets that can be maximized, the value can be maximized in different operators. So we have plans for every one of these assets. And I went through this in detail two quarters ago, how we think about it, how we look at it. We're more than happy to transition any of these assets if we need to. Brookdale is now about 2.5%. our total operating, our total income. So it is very, very manageable. That's its cover. And we think that Brookdale under the current leadership is turning the business around. If not, we have other operators to do, you know, to transition that too, as we have done USC last year.

Chad, we have 10 more buildings from the transition portfolio to transition from Brookdale to other operators. We expect that to be done over the next two quarters.

All right. Thanks, Tim. And then just one more question on there, which is you have 10 more buildings. Is that outside of you had a restructuring agreement? I think it's about $5 million or so of rent. Is that outside that? And then when would you expect that to be affected?

So these are still part of the original restructuring plan. There's been no further assets added to that since then. the original transaction. So it's just a matter of, we gave that as kind of a pro forma when fully transitioned, what the difference in income would be and assets are just the last 10 assets from that originally described transaction.

All right. And I just want to speak one more question in here, which is labor costs looked like they were down quarter of a quarter, you know, shop. That seems to be the opposite of the breadth of the senior housing market is seeing. So what's the contributor there, and then what's the expectation going forward through 2019?

Labor cost is not down, Chad. Labor cost is up significantly. That trajectory for the first time we saw is on the mend. So if you look at what I talked about, that if you, in the first quarter, sequentially from the first quarter.

One sec there. You know, OPEX, you know, from 2019, last quarter to this quarter, it looks like it was up like 0.4%, which is flattish, right? And that probably shouldn't be the expectation there going forward, right?

I'm sorry, I don't understand the question. All right. Occupied unit, the labor cost is up 2.8%. Sequentially, quarter over quarter.

Okay.

And the rate is up 3.3%. You understand what I'm saying? Labor costs is still up significantly year over year.

I'm talking about- Should we expect, you've got rate going up much higher than OpEx and- Not much higher.

Let's just be dramatic.

That's a pretty good portion of growth right there.

First time in five years we got a positive spread. I'll take it, but just let's not be dramatic. It's It's 50 basis points. But look, as we talked about, labor cost has been increasing in our portfolio five plus percent on an occupied room basis for the last five plus years. I mean, now you see markets. I'll give you an example. Let's just talk about New Jersey, where labor cost is a problem. New Jersey is not. slated to be $15 market until 2021. If you look at our portfolio across the board, it's $15 plus today. So maybe the regulatory side in many aspects hasn't changed, but the actual labor market because of competition has already moved there. They call that I talked about some of the regulatory driven change, which is the 15 move to the $15, Let's talk about California. L.A. has hit $15 last summer. San Francisco has hit $15 last summer. L.A. is doing that this summer. So after that, you're going to get more of a market-driven increase rather than just a big move from 11 to 15, which on a percentage basis is a big number. So I'm not suggesting the labor cost is not going to be a problem. All I'm saying is I'm happy that finally the curve has been on the mend for the first time. Too early to comment whether that continues or not.

All right. So there is a good quarter on that side of the expenses, but maybe change is going forward. We'll see. All right. Well, thanks for your time. I appreciate it. Thanks, Jeff.

Your next question comes from the line of John Kim with BMO Capital Markets.

Thank you. The occupancy gap between senior housing, triple net, and shop has widened over the past year. I think a year ago it was basically the same. And I'm wondering if this is a reflection of the quality difference between the two portfolios, the difference in capex spend, and what do you think happens as the year progresses?

So, look, I mean, we have our shop portfolio in bigger markets, you know, in better locations. Generally, that's true. And we also have some really good operators in the triple net portfolio, right? We talked about different operators over a period of time. I think it's just different, you know, if you think about a recovery, this is fundamentally a local business. Different parts of the country is participating in the recovery in different times. So I wouldn't suggest there is fundamentally something different about senior housing business. We're encouraged by the first quarter results, but this is not yet the time to take a victory lap. But we do think if you think about a longer period of time, we think that you will see improvement in both sides of the house.

Okay. And then on the supply in a three- and five-mile ring around your assets, I know that's not really how you look at it, but it has increased sequentially. And I'm just wondering how much of a headwind do you think this will be this year, given you have maintained your guidance this year?

I think your question has the answer, John. That's not how we look at it. We gave you how we look at it, which is adjusted competition unit and year-to-open shock. And we described that we expect, you know, roughly 15% to 20% reduction this year. and walked you through the details of that on Investor Day, we still expect that. Now, what happens is delays happen, some 18 flows into 19, and then 19 flows into 20. So obviously, all of these things can be stretched out. But as you can see from our results, the thesis that we had directionally is playing out.

But did that level of supply increase surprise you, just given it? It seems like it's impacting your markets more than the national average.

Again, we don't look at it that way. The way we look at it, it's actually down, which is on an ACU and yet to open way. We're not surprised.

Got it. Okay. Thank you.

Your next question comes from the line of Kyron Ford with MUSG Securities.

Hi. Good morning. One second. appreciated your decision to over-equitize the balance sheet again this quarter and keep your powder dry. Just was wondering if the capital markets stay open, will you continue this strategy, and how do you expect leverage to trend over the balance of the year?

Karen, I'll take the leverage side first. At the beginning of our investor day, we talked about keeping leverage flat throughout the year. We've obviously taken it down significantly. As a just quick note on that, at the time of the investor day, we spoke about that from a debt diva perspective. And as it was not part of our plan to convert our preferreds, In the first quarter, given where our stock was trading, we were given the opportunity to force a conversion on those, and we did. So we now expect our leverage on a less preferred basis to come down significantly during the year, as it already has.

And, Dan, I'll just add to that, you know, you think about the impact when you – when you actually raise capital, whether through disposition or ATM, versus you close an acquisition, there's a gap, not because we did not know what we'll do with the capital, but because it takes time. So we generally think about match fund when we sign the PSA, but you think about there's diligence after that. And if you think about a medical office building, you have to think about a role for a process which a health system is on the side of. They don't respond in seven days because we like to close the deal. On the senior housing side, you have to think about, just look at some of the Koji and Pegasus transactions. In California, it takes six, nine months for you to get the license transfer. So these are the reasons that things change. We're not looking at either a stock or an asset to say, you know, that's a pretty good level, let's just do that. We are doing a match one basis that difference of timing comes from all these things that are just part of life. if you do real estate transactions. I hope that helps you to understand. We do match fund. We're not looking at our stock or not looking at a price of an asset and say, that looks pretty good, let's just do it. We are match funding, but when you sell a stock on a given day, you got the money that day. When you got the license, ultimately in California to transfer to close a deal, that probably takes six months. We're not going to roll the dice to think whether capital markets will be six months from now.

Just to finish that, we expect leverage to come back up as we close on our under-contract pipeline, not more than expected. And then on ATM, as Shaq said, we've got nothing planned as of now, but you should expect us to continue to match fund as we see opportunities, and we're very optimistic on that front right now.

Understood. No, that's helpful. A second question is on the ProMedica HCR continuing integration. I think you said on your comments that you're happy with the way that's going. Can you give us any metrics on that front? Can you talk about what trends are in occupancy, margin, or synergies, just to flesh that out a little bit?

Well, I think you heard about many of those on our investor day. directly from Randy and Steve, so I'm not going to get into too much. I was trying not to do it. I'll just give you one so that you are happy that your question was answered. We're looking at occupancy, both on the skilled side as well as on the Arden Court side, which is the senior housing part of Promenica Deal occupancy up in both sides of the house. In skilled, it's up 100-plus basis points. and it's in the senior housing side. It's close to that, but less than 100 basis points. But I'll just leave it at that. And, you know, these things take time, and we are focused on what the long term looks like, but we're happy, very happy with how the short term has played out, whether that's on the reimbursement side or on the cost side, on the synergy side. So we are excited about it. And obviously, as you know, the part of our thesis was, you know, these assets we bought at a very, very low basis That was capital start. And I touched on that, that finally that program, you know, it takes time to do these things. Finally that program is on the way. We have 45 assets or so, actually really exactly 45 assets to go through that program in the next three to four months. So we're very, very excited what will happen. And some of them are complete reno. Some of them are patch-ups, cover peels. Some of them are in between. So it's just going through a whole series of renovation program. both on the skilled side as well as on the senior housing side.

I appreciate your answering the question.

Thank you.

Our next question comes from the line of Lucas Hardwich with Green Street Advisors.

Thanks. Hey, guys, just a quick one for me. On the story point sale, was there a near-term rent reset or something like that that explains the low cap rate?

No, it doesn't.

All right. That was it. Thank you.

Your next question comes from the line of Michael Carroll with RBC Capital Markets.

Yeah, thanks. I wanted to touch on the long-term post-acute coverage ratios. And, Shank, I believe you mentioned that the sequential drop related to the LTACs, which is a small part of the portfolio. Can you kind of go through what's actually happening with those LTACs? And it seems like it had to be a pretty big drop to impact coverage that much.

Yeah, because you can see what's happening in the LTRAC industry that would suggest that you are right about your assumption.

So what's the plans with the LTRAC? Is that something that you guys are going to have to address here in the near term, or do you expect that they have some things that they can pull to help improve the results, or what's the outlook with that part of the portfolio?

I wanted to comment on that, but as you know, that we are, it's a very, very small part of our portfolio, right? We own a handful of assets. We look at everything from a total return perspective, and if we have to address, we'll address. But I just want to remind you again that it is a very, very small part of our portfolio. That's why I wanted to have the differentiation. Post-acute is now less than 10% of our overall cash flow. From a value perspective, it's much lower than that, but less than 10% of our cash flow. Primarily, that is, you know, skilled nursing licensed businesses, which means also Genesis Rehab, Short Stay, which is technically skilled nursing, but obviously it's a completely different business, but also traditional skilled nursing. That's primarily what that bucket is. But the handful of LTACs that we own, we're thinking about, you know, how to maximize value there.

Okay, great. And then just touch on last question on the value-add projects that you're looking at. What size of the pipeline does the value-add represent right now?

I couldn't even tell you what the pipeline size looks like. We just don't do business that way. So, you know, everything is a function of total return. And if we see opportunities that are great, we'll do it. If that's 100% of the pipeline or 5% of the pipeline, we're not trying to sort of put those things in the bucket.

All right, great. Thanks.

Our next question comes from the line of Nick Ulico with Scotiabank.

Oh, thanks. I just want to go back to the shop same store pool just to clarification. I think you said the pool did not change this quarter versus the fourth quarter. Is that right?

Yes, I did.

Okay. So what I'm confused about is then if I look at the supplemental, why did the numbers change now versus the fourth quarter in terms of revenue and expenses for that pool?

I'm not sure I understand the question because there was growth. It's a different quarter.

No, I just mean if you look at the historical results of the same store pool in the fourth quarter supplemental versus in this supplemental, those numbers are different. The revenue, the expenses, and some NOI, and so I'm just wondering if there was a change in accounting or if there's something else. Since this is supposed to be the same pool, this looks a little strange.

There was no change in accounting. They're exactly the same 473 assets. The only thing you have to think about the change is FX. Remember, we own assets outside the United States.

Okay.

But, Nick, you do raise a very important question that, you know, just sort of I hear a lot of noise. in recent months about our same-store policy and our same-store. I mean, there's just a lot of wasted time on it. So I would like John to address that question. John?

Yes, certainly. I think, Nick, you know, we essentially disclose two same-store parameters. One is the one that we spend all our time talking about. That's our non-GAF. sort of supplemental disclosure that is essentially our economic participation in those same store buildings. And what do I mean by that? I mean that it is prorated for our ownership position. As you know, with our 23 RIDEA partners, we often have joint venturing agreements, so we're not 100% owner of those buildings and therefore not 100% owner of the income stream. Whereas for our GAAP, disclosure, we are required also under GAAP to do a consolidated view. So we have to take all of the buildings where we have greater than a 50% ownership, consolidate that, and then report that on a 100% basis. So we actually have two different pools. which is why you see two different numbers between the supplemental sort of business view that we use and we talk about with you because we believe that's the one that drives our view of how we're performing and should drive your view on how we're performing versus the gap which is essentially a mathematical equation that we have to produce to comply with our gap accounting requirements. So that's why that's different. Sometimes that number is above, sometimes it's below. you know, it doesn't have necessarily a consistent trend over time.

Okay, thank you.

Your next question comes from the line of Todd Stindler with Wells Fargo.

Hi, thanks. Just to drill into the Chelsea acquisition, obviously shows you still have an appetite for triple net, but can you share some of the decision behind that? I guess not going into RIDEA? Is it the growth trajectory, labor costs, and maybe just some of the rent coverage and underwriting? Thanks.

So, Mike, if you look at, I believe two quarters ago, I addressed this issue holistically on our earnings call. We completely believe in the triple net business. I cannot emphasize that enough that we're sitting here trying to say right here is the only way to go. Structure is secondary. Primary focus is the quality of assets, the quality of markets, and an alignment with an operator. Several ways you can get to that alignment. You can do it in what we call RIDEA 3.0. Obviously, it's a different bells and whistles on a normal RIDEA contract, which makes it very, very different. You can also do it on a triple lease structure. and we obviously have different bells and whistles around it. So we continue to believe in that business, and we think Chelsea is a good operator, and we're going to continue to grow that business.

And, Sean, how about the rent coverage it was underwritten at, and how about maybe the CapEx responsibilities of Chelsea? Thanks.

Yeah, so rent coverage it was underwritten at. Roughly, what we do is when we underwrite a new triple net assets, we're underwriting at a north of 1.5 times EBITDA basis or 1.2 times EBITDA basis. As you know, I believe in our investor day, we talked about that some of the assets that we're buying, that a billion dollar pool has an average age of four and a half years. Some of the Chelsea assets that we're buying, they're just developed. So, if you think about it, from that perspective, the NOI, the VDARM, is still ramping up. But the stabilized coverage, we believe, will be in that range that I described.

Thank you.

Our next question comes from the line of Stephen Veliketti with Barclays.

Great, thanks. Good morning, everybody. Congrats on these results. So there's been a lot of big picture questions so far. I guess I have another one here for either Tom or for Shank. Basically over the past month or so, the Medicare rate updates for 2020 from CMS have been pretty strong for most healthcare facilities business models. So I guess I'm curious to hear whether it feels like this has helped keep momentum going with health systems and other partners just regarding development projects and other transaction activity in that context. And also conversely, maybe more importantly, My guess is that Medicare-for-all proposals and discussions are probably way too preliminary to give anyone pause or hesitation on development or planned projects. I'm wondering if you're just able to corroborate that view as well. Thanks.

Yeah, Steve, I would definitely agree with you on the Medicare-for-all point. That is not driving progress. the strategic thinking at the health systems today. You know, I think it's very early, and I sit on the side of I think it's a completely something that would not work, but we will get into that at another time, but I'm going to have Mark Shaver, who spends a lot of time with the health systems, comment on your earlier point.

Yes, Steve, thanks, Mark. You know, I think we track pretty closely what's happening at CMS. In fact, Tom and I were just at a session with Administrator Verma maybe two weeks ago. And I think we, you know, the country holistically is moving more towards valuable PDPM that Sean alluded to on our post-acute side, the new CMS reforms last week around primary care. We feel it's moving in the right direction. But just like all of our businesses, In certain markets, value is accelerating, and in certain markets, fee-for-service and the traditional commercial business are very important. So we continue to work with the health systems in different markets that we think are progressive, understand where value is going, but also understand reimbursement under the traditional form as well. And as Tom mentioned, we're working pretty closely with the systems on alternative sites of care and lower cost venues of care. Everything that we do is outside the four walls of the hospital, which we think bodes well for how reimbursement is moving in the country.

Okay. I appreciate the color. Thanks. Thanks.

The next question comes from the line of Nick Joseph.

Thanks. I just want to clarify one question on guidance. In terms of the segment, same story on the line, do you plan to update that throughout the year?

No, Nick, I addressed that before on this call. By policy, we don't do that. We don't update segment-level same-store guidance. We will update, if necessary, the total guidance for the same-store pool. And, you know, honestly, you can look at the trends and you can come to your own conclusion. The problem of updating guidance in segments is that overemphasizing any segment, we don't have a favorite children among the segments. As a buyer of wealth, our stock, you get to buy all of them. So we are trying to de-emphasize any part of our portfolio and have you focus on are we good capital allocators? Are we good manager of the portfolio? Those are the decisions. But if you look at the numbers and the trajectory and sequential, you should be able to get pretty close to what those numbers look like.

Right, but why give segment-level guidance and then not update it throughout the year if you're going to update other line items of guidance?

Because we don't want you to emphasize on any particular segment. We will update the total if it's necessary. We do think that creates you to keep, you know, market to focus too much on one segment versus other when we as the manager of the business don't focus on one particular segment. versus others. Thanks.

Your next question comes from the lineup. Rich Anderson with SMBC MECO.

Hey, thanks. Good morning, everyone. Hello? Is this mic on? Okay. So, Shankar, I know you don't want to talk about ProMedica in advance of, you know, the real numbers coming out, but I just want to make sure I understand the starting point as we get closer to the time where you have some more real-time info. The 1A coverage that was identified when you did the deal, I think, was really, if you look at the math, was really something higher than that or should be based on, I think, a function of the 80-20 joint venture on the real estate. Am I thinking about that correctly? Absolutely. about how the coverage is in reality from a real cash flow perspective?

I'm not sure I completely understand the question. I will give you two answers which hopefully will help you to get to the answer. One is Karen has been able to get me to talk about it, so I actually gave some real time sort of feedback on how the portfolio is performing. And I don't want to repeat myself, but I did say that occupancies are both on the skills side as well as on the senior housing side. And we're just starting the CapEx program, which we think will dramatically change these businesses. Going back to your question, 20%, we have 80% ownership in the real estate, and our partner Prometica is the 20% owner, and our cash flow is, or rather their cash flow is subordinate to our cash flow. And that's how the coverage is calculated.

Okay, okay. Maybe I'll take it a little bit more offline later.

And then the second question is... Yeah, no, I want you to go back, and Rich, by the way, welcome back. You can go back to the call we did when we did the deal, and I walked through line by line of how that is calculated. But anyway, regardless, welcome back. Thanks.

Second question is on medical office. I think I recall you saying something about cap rates drifting up and it got you guys more interested in doing deals on the outpatient medical, and you obviously did with CNL very early this year. Is that an observation that you would agree with, that there has been a trickle-up on cap rates that have made the asset class more interesting to you. Just some clarity on that, please.

Yes, Rich. We think the cap rates, you know, I forgot, but two years ago or 18 months ago, I can keep the track of time, got to an unsustainable level. And since, obviously, it has gotten to a level, they definitely have trickled up. I think I mentioned that probably last three calls, every call we have done, not just TNL, we have done so far two plus billion dollars of medical office acquisition in the last 12 months. So they have come to a level where we think that IRR now makes sense. We kind of give you a guidance that we think we need to hit a 7% IRR to get to a transaction. It's still there. But as I said, if they go down again because people want to be aggressive again, then we'll get out of the market again.

Right. So what does that say about this investment in particular? To what degree is the over-under, that cap rate still trickle up following the closing of the transaction and perhaps making the investment you made less effervescent or something? Do you worry about that going forward?

I don't. No, I don't. We're trying to get to total return. We're not a buyer or seller of any assets on a cap rate. We are not trying to top tick the market, bottom tick the market. We're trying to get to a total return, an IRR, and fund it through capital, whether equity or assets, but the total return will be lower, right? So that's sort of what we're trying to drive value. That's the difference. I don't, you know.

But if the cap rates go up and your IR calculation on the terminal value change and, you know, that's the part of the concern perhaps you, I guess you don't have.

No, we don't because we will continue to deploy capital. And remember, that would be a concern if we debt finance the deals. We're not debt financing the deals, right? We're equity financing the deal. So even if that's the case, A, we will continue to deploy capital. We hope that happens. And if it does happen, if it doesn't happen, then we'll just wouldn't do it. You understand my question is if it is a finance transaction, the value of what we just bought on a spot basis does not matter. We locked in a difference of a total return on what we bought versus what we sold.

Okay. Got it. Thanks very much. Thank you.

As a reminder, ladies and gentlemen, if you'd like to ask a question, please press star, then 1 on your telephone keypad. Please limit your question to one question and a related follow-up so that all callers may ask their question. The next question comes from the line of Sarah Tan with JP Morgan. Hi.

Good morning, everyone. I'm on for Michael Muller. Just had one question regarding the development pipeline. I think last quarter you guys talked about the $3 billion development pipeline locked up across the seven different projects. Could we get an update on which other projects have been underway?

I will just say I think you probably may start. It's not seven different projects. It's seven different operating partners. And I'll just say many of that you will start to see later this So let's just – today's call is not the appropriate time, but more to come.

Okay. Thank you so much.

Your next question comes from the line of Tayu Okasanya with Jefferies.

Hi. This is Austin Cato. I'm for Tayu. Thanks for taking the question. I guess just to follow up to that, I saw that The New York development project was pushed out. The conversion date, another quarter. And at the investor day, the expectation was that construction was done by 1Q. And just curious, any new updates with that project?

Yeah, I mean, everything seems to be proceeding according to plan, both in terms of cost and timeline up to this point. So there's no real updates to it.

I don't know where there's been no announcement. of any change.

I don't know where you saw that. I mean, our expectation is still pretty much what it was during the investor day.

Yeah. Okay, great. Thank you.

Thank you.

Yes, this is Tayo. Could I also actually ask one more follow-up question?

Go ahead, Tayo.

Yes, it's actually more around, again, your data analytics platform. Again, I think you guys really put that on display during the investor day. And I'm just kind of curious, just kind of given the micro-level analysis that you do, if your data analytics platform is telling you anything different about operating trends today versus, you know, your investor day, whether across, you know, senior housing or any of your other business segments?

Our data analytics platform did give us that insight, which is why we started talking about, you know, three quarters ago that the business is turning. when the topic du jour was it's gonna be really bad for next five years, that's what I hear. So it's hard to talk about stuff that already happened and take a victory lap. That's just not a display of humility, I would say. But as you can see, these people are very, very good and they have called that turn. And you are seeing the results, you're seeing that turn in the results. From December to today, we're making, 10, 15, 20 year decisions. I mean, like from December to today, we don't change our views like that.

But remember, we're not making a call on the industry sector with our data analytics. This is very specific to the Welltower portfolio, our operators and the locations of our assets. As you learned at our investor day, we do look at the country on a micro market basis. So we have been managing our portfolio over the last five years and making tough decisions that always didn't reflect well in quarterly performance. But they were the right decisions for the long term. And that is what you're starting to see flow through our results. So, yes, our data analytics gives us what we believe to be unique and proprietary insights into the way we run our business. But, again, we are not, do not think our results and what we're seeing in our portfolio is a call on the senior housing industry changing. Gotcha.

I appreciate the explanation. Thank you. Thank you very much.

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