Welltower Inc.

Hello, my name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Welltower third quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star 1 again. In the interest of time, we ask that you limit your questions to 1. I would now like to turn the call over to Mr. Matt McQueen, General Counsel. Please go ahead, sir.

Thank you, and good morning. As a reminder, certain statements made during this call may be deemed forward-looking statements in the meaning of the Private Securities Litigation Reform Act. Although Welltower believes any forward-looking statements are based on reasonable assumptions, the company can give no assurances that its projected results will be attained. Factors that could cause actual results to differ materially from those in the forward-looking statements are detailed in the company's filings with the SEC. And with that, I'll hand the call over to Sean for his remarks.

Thank you, Matt, and good morning, everyone. Today, I would like to describe our capital allocation priorities for Medica's senior care transaction and the rapidly evolving capital markets environment. I will also review some high-level business trends before handling the call over to John. will provide details on operational trends and a brief update on our operating platform. I'm very pleased with the progress we have made since we last spoke 90 days ago. Despite a flattish earnings trend on a sequential basis, driven by several exogenous headwinds, including effects, interest rate, and utility expenses, our underlying business is actually improving meaningfully and setting up for the coil spring recovery that we hope for. In our senior housing operating business, Same-store revenue is up 10.8% year-over-year, driven by strong occupancy gains and, most importantly, pricing power. 5.3% same-store rate growth is the best we have seen in our recorded history, and I want to remind everyone that we're compounding already industry-leading rate growth from last year. From these early trends, I believe you will see a further improvement in Q4, which will create a strong setup for 2023. However, perhaps what I'm most excited about is the progress we're making on the labor front, with compensation per occupied unit is up 4.3% year over year, the lowest level of growth we have reported since the beginning of pandemic. Our operating partners are experiencing a significant surge in applications, which has translated into strong increase in net hiring. In fact, in September, total portfolio monthly contract labor spend was the lowest since August of 2021, and subsequently improved in October. We believe this trend will continue into year end outside the normal pickup agency use during the holiday season and well into the next year. We strongly believe the labor market is changing for the better, and it will help our sector to be a total standout amongst all real estate sectors next year on a relative basis. SHO portfolio same-store NOI growth was 17.6% in the quarter led by U.S., which posted third quarter of 20 plus percent growth. And assisted living product type reported same store NOI growth of an impressive 25.1%. Let me highlight three operating partners for you that provide further insight into why I'm so pleased with our progress over the last 90 days. Number one, Oakmont. As you recall, we transitioned 10 top California assets to Oakmont in August. While we expected some initial disruption to occupancy NOI during the transition, in actuality, we recognized an immediate benefit due to remarkable performance from Courtney's team. These assets have experienced a slight increase of NOI and occupancy, despite challenges that are normally incurred during a transition. This is the first time I've seen a transition with no negative P&L impact, apart from the six assets we transitioned to Oakmont last year. I expect these properties, as well as the other assets that we transition to Oakmont, to add significantly to our 2023 growth. If you are visiting San Francisco this month for NARIT conference, I recommend you to join our property tour and experience firsthand the remarkable job this team has done. To my earlier point on shift of labor market during the summer, open positions across Oakmont platform was 16% of total jobs. It is down to low single digit at this point. Number two, StoryPoint. StoryPoint is one of our best operating partners, perhaps will be the source of biggest NY swing next year. We have a billion dollars of investment with low occupancy properties, which is generating approximately 2.7% yield in Q3. StoryPoint made remarkable improvement in the top line on both occupancy and rates, but the properties have not generated significant NOI in 2022, as these properties were just over the breakeven occupancy and agency cost was very detrimental. Their open positions are now down more than 50% through the end of October, and we expect 80% reduction of agency by end of this month. We believe that stabilized NOI for this group of portfolio is about circa $80 million, which will be substantially achieved in 2024. While we'll not close this gap in 2023, I expect we'll make significant strides next year and will be over the half-year way mark. We cannot be more pleased with the execution then and the team has pulled off. Number three, Sunrise. Sunrise is our largest operator. Due to a national presence, Sunrise experienced significant labor challenges and has had to rely on contract labor for the last many quarters. Jack and his team has made remarkable progress in this area over the last 60 days. Contract labor down 52% from year-to-date run rate, and I believe Sunrise will be the biggest contributor to contract labor improvement in the coming months and quarters. Given strong rates Sunrise benefit from in these incredibly well-located wild-tar buildings, we should see extremely strong and wide growth contribution from Sunrise. While we are very encouraged by the strengths and our fourth quarter guidance of 21% growth at the midpoint, I'll remind you that we are at the very early inning of senior housing recovery. will remain as excited as ever about the growth prospects in coming years, and the 80-plus population growth will continue to accelerate, and as new construction in the sector will come to near a standstill. In fact, 2023 should see 4.5% increase in 80-plus population. As you may have observed, only 2,700 units got started in Q3, and frankly, I don't even understand how these people will make any money in development. While new developments should continue to come down, assuming people want to develop to make any money, another interesting phenomenon we're observing is that the thousands of units are being taken offline, either because of obsolescence or because of higher and better use like behavioral health. As of 9.30, almost 15,000 units were taken offline on a TTM basis. I also want to highlight consistent and steady performance of our outpatient medical group under Ryan's leadership, Our retention rate for the quarter is a remarkable 92.7%, and rents rates are ticking up into the mid-threes. For both new and renewal leases, I'm pleased that our weighted average escalators are now above 3%. I'm also pleased that the low interest rate environment and the wall of capital that drove two to low 2% escalators seems to be a thing of the past. Kelsey Siebold, which is our largest MLB tenant, and also represents a very significant portion of our development pipeline, was acquired by UnitedHealth during the summer. The significant credit upgrade of our largest tenant and our development client represents a meaningful value creation for our shareholders. The most significant change we observed in this, however, in the MOB space is the remarkable widening of cap rates. I've said like a broken record for a long time that MOB cap rates made no sense to us, given where the forward view of inflation was relative to underlying growth rate of the cash flow. I'm pleased to see other capital sources are now waking up to the ugly realities of real return on capital in this inflationary environment. There was nothing wrong with this asset class except price, and I'm relieved to see that has finally changed. Billions of dollars of transactions were consummated at low cap rates, often with short-term floating rate debt. The party is over with capital structure and cash flow as many of these vehicles are now upside down. We'll be observing this place closely in the coming months and quarter. Now I would like to discuss our recent restructuring of a lease with ProMedica Health System. I'm not going to bore you with the details of our fundamental thesis of this investment in 2018. I laid it out clearly when we did this transaction. We didn't predict COVID and its impact on the cash flow portfolio and, frankly, were underwhelmed by the execution. But the fundamental investment thesis of the original transaction should still protect our shareholders' capital. That basis and appropriate structure are critical to any real estate investment. While we have historically relied on our operators' ability to drive cash flow and thus yield, we never make real estate investment decisions based on yield. We believe success in real estate investment over a long period of time is a function of right basis and staying power. If you own an apartment in New York City for $400,000, while everybody owns an equivalent apartment for $1 million, you can still charge rent for that unit and generate strong returns. That is such a simple, yet perhaps one of the most overlooked concepts on Wall Street. The cacophony of noise around ProMedica's negative EBITDA coverage over the last few months have reached a fever pitch. And we honestly understand and empathize with this Pavlovian response as the history of healthcare REIT sector is full of remedies such as massive rent cuts or disposal of assets at fire sale prices that result in significant value destruction to shareholders. Even though I'm personally humbled by the cash flow deterioration in the ProMedica portfolio, Let me repeat that we are not experiencing a rent cut on a cash basis, and our investors are the beneficiary of a satisfactory total return to date. And that goes back to our incredibly favorable basis and structure. To continue my previous metaphor, Manhattan apartment rent might come down from $5,000 to $4,000 in a bad year, but we never hypothetically even charge $4,000 as we bought our unit at such a low price. That is why our rent is now going up, not down, after this transaction. And I continue to believe it remains below market and will be a source of future value creation. As I mentioned in our last call, ProMedica has made significant strides in reducing its operating losses, which are farther narrowed in the last 90 days, through both occupancy gains and lower labor costs, contract labor costs particularly. Integra or its parent entity, which we have done multiple transactions previously, has successfully executed many turnarounds, including those involving HCR assets that we've sold it to them in the last couple of years, and is well positioned to return these assets to its previous glory using a regional operative strategy, just like they have done over the last couple of years. We are looking through Integra's parent entity and the owner for the downside protection through subordination of their equity as well as significant other guarantees and will subsequently share significant value creation with us. But I cannot overemphasize that the fundamental idea of below market rent basis equals to below market rent is not about Prometica. It is about our belief how we invest and protect our shareholders' capital. If a business has demand growth and you can own it for significantly less than what it costs to build, In a low leverage capital structure, it is challenging for me to see how we lose money in most scenarios. We remain partner with ProMedica, albeit on a much smaller scale, and will be delighted to see the significant credit improvement of an important institution in Toledo. Finally, let's discuss the current capital markets environment, which excites me to no end. Before I go into what we might do in the future, Let's discuss what we have done in the past under this leadership team. If we go back and read all our comments about capital deployment in the last few years, you will notice a few attributes. One, we're unlevered RR buyers and we underwrite significant cap rate expansion at exit. Hence, the recent rate increase don't fluster us just as we have never chased low rates down under the guise of low cost of capital. Our unrelenting focus on basis relative replacement cost, and as a result, we seriously dislike low cap rates in stabilized occupancy scenarios. Nothing has happened so far, even in this turbulent capital market backdrop, that require us to change how we invest capital. We are experiencing historic volatility in the treasury market with every part of the yield curve inverted right now, with significantly the most important 2 to 10 curve is as inverted as it was during Paul Volcker's time 40 years ago. One approach for us would be to ride out this storm in a shelter and do nothing. But those of you who know us well know we're unlikely to do so. We maintain a very favorable capital position and a war chest due to our extremely talented capital markets team under the leadership of Tim. Despite our unfavorable public cost of capital on a spot basis. Today, we have no darts of global institutions who want to partner with us. And let me remind you again, a simple capital allocation framework I've described to you before. Every company effectively has four choices of raising capital. One, tapping internal cash flow. Two, issuing debt. Three, issuing equity. And four, disposition of existing assets. It also has five essential choices of deploying that capital. One, investing in existing assets. Two, acquisitions. Three, buying debt at a discount. Four, paying a dividend. And five, buying stock at a discount. You can loosely call the first set of choices as selling, but the right description would be sourcing or raising capital. You can loosely call the second set of choices as buying, but perhaps the correct description would be deployment of capital. Following the same line of thinking, loosely speaking, consistently buying low and selling high creates value for shareholders. In a more wholesome and thoughtful description, optimizing these choices from this menu of sources and uses in a tax efficient manner creates meaningful value for continuing shareholders on a partial basis. Our goal is to maximize partial value and partial cash flow, not to become the biggest or the most revolutionary. Our capital allocation team on both sides of the balance sheet is poised to pounce on this great menu of opportunities, while the most volatile interest rate environment in four decades has put in front of us. And at the same time, John's team is just getting started on the journey of cash flow and platform optimization. With that, I'll pass it over to John. John?