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spk24: 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.
spk15: 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.
spk22: 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?
spk03: Thank you, Sean. I'll provide some insight into our operating business, starting with the medical office portfolio. In the third quarter, same-store NOI growth for our outpatient medical business was 1.4% over the prior year's quarter, which was below trend due to some timing issues on tenant improvements, delay in move-ins, and higher utility expenses. We continue to see strong retention levels at 93% in the quarter and accelerating renewal rates in the marketplace. Turning to our senior housing operating portfolio, the recovery in this sector continues. As Shank mentioned, revenue in our same-store portfolio came in at 10.8% in the third quarter compared to the prior year's quarter. All three regions showed strong revenue growth, starting with Canada at 4.4%, the U.S. and U.K. growing at an impressive 11.6% and 18.9% respectively. Revenue growth for the quarter was driven by a 390 basis point increase in occupancy and another quarter of healthy pricing power with REVPOR growth of 5.3%, as Sean mentioned, the highest we've witnessed. Sequentially, the portfolio occupancy continued to improve with a gain of 110 basis points during the quarter. While expenses remain a challenge, our operators continue to control expense per occupied rooms, The comp four, or compensation product by Groom, only grew at 4.3% in the third quarter over the prior year's quarter, the lowest growth rate since 2019. Expense four grew at a rate of 3.7% in the third quarter on a year-over-year basis, well below our REV4 growth of 5.3%, driving an expansion of 130 basis points on a year-over-year basis in our margin. As our operators have pivoted from the COVID state to normalized operations, and as labor and materials have become more available, we have aggressively addressed maintenance that was delayed during COVID, which resulted in slightly elevated repairs and maintenance expense during the quarter. Overall, the quarter's occupancy gains, strong REV4, and expense controls enabled the senior housing operating portfolio to deliver 17.6% year-over-year same-store NOI growth in the period, led by the U.S. with over 20% year-over-year growth, while Canada NOI grew at 6.3% and the U.K. was up 9.8%. Going forward, we expect the operating portfolio to continue to deliver outside NOI growth, with each geography expected to experience accelerating NOI growth in the fourth quarter. As we look forward to what many believe will be a weaker labor market in 2023, It's important to realize that labor as an expense represents about 60% of our total expenses. Additionally, nurses are only about 5% of the labor force at the communities. And although there are other more specialized positions at the communities, most of the positions require skills that are transferable from other sectors of the economy, allowing us to benefit from a softer labor market, as Sean noted. Our operating platform, we continue to quickly move forward on plans to pilot our first module in early 2023 with several other modules in the works. Like all technology rollouts, it's about people, processes, data, and then technology. So it's not about flipping a switch. It takes teamwork. The results will show up over time. Our meetings with our operators have been very productive as we bring together their skills and experience with our own to build a better future for the industry. Finally, I would like to thank our operators and their employees for making these results possible. It's been a full sprint since the beginning of COVID, and they have addressed one challenge after the next. We are finally at a point where it seems like there's light at the end of the tunnel. Occupancy continues to rise. Net hiring is occurring month after month. Rev4 continues to outpace Expense4, which will drive further margin expansion and so much more. We wish to thank everyone and wish them a wonderful Thanksgiving, and thank you for your hard work. I'll now turn the call over to Tim.
spk25: Thank you, John. My comments today will focus on our third quarter 2022 results, the performance of our triple net investment segments in the quarter, our capital activity, a balance sheet and liquidity update, and finally our outlook for the fourth quarter. Wellcower reported third quarter normalized funds and operations of $0.84 per diluted share. representing 6.2% growth over the prior year period when adjusting for HHS funds received and changes in FX rates, marking our second consecutive quarter of year-over-year growth since the start of the pandemic. We also reported our second consecutive quarter positive total portfolio same-store and Y growth with 7.2% year-over-year growth. Turning to our triple net lease portfolios. As a reminder, our triple net lease portfolio coverage and occupancy stats reported a quarter in arrears, So these statistics reflect the trailing 12 months ending 6-30-2022. In our senior housing triple net portfolio, same-store NOI increased 1.6% year-over-year, below the low end of our guidance range, which is primarily timing-related. Trailing 12-month EBITDA coverage is 0.83 times the quarter. Next, same-store NOI in our long-term post-acute portfolio grew 3.1% year-over-year, and trailing 12-month EBITDA coverage 1.31 times. And lastly, health systems. which is comprised of our joint venture with ProMedica Health System, had same-story NOI growth of positive 2.75% year-over-year, and trailing 12-month EBITDARM and EBITDARM coverages were negative 0.01 and negative 0.6, respectively, as operations continue to be impacted by high agency utilization costs in the second quarter relative to the prior year. Putting these coverage figures in context of our announcement last night, Trilling 12-month ProMedica Senior Care EBIT arm coverage of negative 0.01 implies trilling 12-month EBIT arm of negative 1.6 million relative to $168 million of cash rent paid in the trilling 12-month period ending 6-30-2022. The transition of the skilled nursing business will bring the remaining ProMedica Senior Care EBIT arm back to profitability with the trilling 12-month coverage of nearly two times relative to the remaining rent from the 58 assisted living facilities that will continue to operate. Thus, the transition to Integra Health has a dual benefit, providing us a well-capitalized and strategic partner to focus on the skilled nursing properties while also leaving ProMedica Senior Care in a substantially better financial state following the transaction. Turn to capital market activity. In the quarter, we continue to enhance our balance sheet strength by utilizing our ATM program to raise approximately $760 million of forward equity at an average price of $80.12. We settled 9.1 million shares for total proceeds of $842 million to fund $1 billion of net investment activity, leaving $1.5 billion of unsettled forward ATM as of 9.30. Post-quarter end, we settled additional ATM proceeds to fund investment activity and pay down $850 million of total debt, $817 million of which was floating rate. Post-debt paydown, we have the full $4.0 billion of available borrowing capacity and our line of credit and no unsecured maturities until 2024. We expect to finish the fourth quarter with consolidated net debt to EBITDA below 6.5 times for the first time since 2020. From a liquidity perspective, in addition to the $4 billion we've passed in the line of credit, we have $1 billion of cash and forward equity and $580 million remaining near-term dispositions and loan paydown proceeds and a 4.6 yield, representing $5.6 billion of total near-term liquidity. Lastly, moving to our fourth quarter outlook, Last night, we provided an outlook for the fourth quarter of net income attributable to common stockholders of $0.08 to $0.13 per diluted share and normalized FFO of $0.80 to $0.85 per diluted share, or $0.82 and a half cents in the midpoint. As mentioned in the release, our fourth quarter guidance contemplates no HHS funds to be received in the fourth quarter. So after adjusting for $0.01 and a half cents of non-recurring items, including HHS funds received in the third quarter, we're effectively flat for sequential FFO. The sequential change is composed of two cents from sequential increases in senior housing operating portfolio and one cent from sequential increases in outpatient medical and senior housing triple net. These are offset by three cents of interest expense and foreign exchange headwinds. Underlying this FFO guidance is estimated total portfolio year-over-year same-store NOI growth of 8.5% to 10.5%, driven by subsegment growth of outpatient medical, 1.5% to 2.5%, long-term post-acute, 2.5% to 3.5%, senior housing triple net, 5% to 6%, and finally, senior housing operating growth of 18.5% to 23.5%, driven by revenue growth of approximately 9.5% year-over-year. Underlying this revenue growth is an expectation of approximately 200 basis points of year-over-year average occupancy increase and rent growth of approximately 7%. And with that, I'll hand the call back over to Sean.
spk22: Thanks, Tim. One of my mentors, Peter Kaufman, often says, life is not about predicting, it's about positioning. Did we predict that Prometica ZBDR coverage will turn negative? Absolutely not. But we positioned for it and structured as such. Did we know COVID will happen and availability of credit in senior housing sector will weaken? No, but we positioned for it. We own more than 11,000 units of age-restricted and age-targeted apartments that will benefit from government agency backstop financing at very attractive pricing from which we can generate a couple of billions of dollars of proceeds. Did we predict that our stock will be in the low 60s and we'll lose our access to equity capital? No, we didn't. But we positioned for it and raised $3.28 billion of capital and an average price of $86.55 this year. We have no idea if rates are going back down or going back up. and how ugly the capital markets environment might turn before it gets better. We're laser focused on what we can control and have an incredible organization that is rallying to take advantage of the opportunities with house odds as opposed to gamblers' odds. I cannot be more excited about the period of unprecedented par share value creation that we are embarking on for our existing owners. And with that, I'll open the call up for questions.
spk24: At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. In the interest of time, we ask that you please limit your questions to one. Your first question comes from the line of Bikram Mahaltra with Zuhal.
spk11: Morning. Thanks so much for taking the question. Just a quick two-parter here. One, you know, you talked a lot about pricing power. You gave the examples across operators on how pricing and labor is improving. Just how sustainable is this across your regions, maybe within the U.S., but also globally? And then can you just add on to that any early signs that the elevated flu is impacting fundamentals? Thank you.
spk22: I'll take the pricing part, John, if you take the flu. That's great. So from a pricing part standpoint, Vikram, if you just look at what we said at the beginning of the year, nothing really changed. except if you think about what happens is in the industry, at least for our portfolio, you've got a lot of renewals in the beginning of the year, and this year we got very strong pricing, obviously. And given that there's a gap between where market rent is as well as where your renewal rates are, obviously with the rents that are rolling off, there's a gap over a period of the year that sort of, you know, sort of comes down, right? That's sort of what happens. in the normal year. What we have said this year, given that market rents have been rising at a faster rate than annual rates, first time, honestly, in like a decade, so we have seen that gap close down pretty meaningfully, and you're seeing report increases are actually getting better through the year. You add on top of that that we are seeing some early renewals for next year in that sort of call it another 10-ish percent range, and we expect that obviously we'll do similar type of pricing increases as we come to next year, you will see that pricing power will continue to hold up and rep or rate increases will continue to hold up. So, we're pretty excited about it. But remember, pricing power also comes in many forms and substances, right? So, you have occupancy of the portfolio and many parts of the portfolio is getting to a point, overall portfolio might still be at 80% occupancy, but there is segments of the portfolio is well above high 80s and 90% occupancy, where it starts to get pretty meaningful pricing power because you have no units to sell anymore, right? So as we get into that environment more and more, I believe that you will see sustainable pricing power. I have no crystal ball on exactly what the macroeconomic environment would be next year, but as we sit here today, we feel very good about pricing.
spk03: Yeah, on your question regarding the flu, I most certainly can't predict the future, but what I can say is that the COVID protocols, I think, will mitigate the situation within our communities. They're still in place. I was at one of the properties very recently, and I'm waiting in line to get in, wash hands, temperature check, wear a mask, et cetera. And I'm in a line with employees, any vendor, all of us. That's the protocol. It's a safe, thoughtful protocol. Um, and so my expectation is that that will have a very positive impact in the communities, you know, how the flu season goes in the US and otherwise I don't, I can't predict that, but I do think the COVID protocols will be very positive going forward.
spk24: The next question comes from the line of Derek Johnston with Deutsche Bank.
spk14: Hi everybody. Good morning. Um, can we discuss the newly authorized $3 billion in share repurchase program. How do you feel about the shares at current levels and I guess the possible timing of execution given the announcement comes in conjunction with earnings which seems unique. Thanks.
spk22: Good morning, Derek. I think I laid out pretty clearly what our possible capital deployment opportunities look like. Buying back shares is one of them and Frankly speaking, as you know how we think, we are unlevered IRR buyers, and we look at everything from that lens, or you can look at from the basis lens, and you will see that we find our stock to be very, very attractively priced, and we'll measure that against every other opportunities we have. I cannot predict on timing. We just don't do that, as you know. But you know how we think. We think through a lens of basis, through replacement cost, and we think through an eye of a total unlevered IRR. And if you do those calculations, you will come to perhaps the same conclusion that we have come to.
spk24: Your next question comes from the line of John Polosky with Green Street.
spk06: Thanks for the time. John Burkhart, as operations recover in the shop portfolio, In between AL versus IL, do you expect structurally different margins between the two businesses once fundamental is fully stabilized?
spk03: You know, there naturally are different margins starting out, but do I think that the end point will change? I think what we're doing with the operating platform will change that across the board, and because AL, you know, has perhaps one might say more opportunity. though the impact might be slightly greater there. But I think the whole business is going in the right direction at this point in time, and I think we're benefiting across the board.
spk22: John, you didn't ask for my opinion. My two cents on this topic is that you will see more improvement in L than IL, but you'll see improvement in both.
spk21: But you asked the right person that question.
spk24: Yeah, next question comes from on the line of Wendy Ma with Evercore.
spk19: Hi, good morning. Thank you for taking my question. So could you please give us some color about the moving trend of different senior housing project types like LAL and the senior apartments? And also given the current slowdown of the housing transaction market, have you observed any slowdown of your independent living moving?
spk22: I'm not sure I completely followed that question, but I think you asked about the moving trends in the senior apartment business. If I heard that correctly, I will tell you that. Go ahead, Wendy.
spk19: And also, sorry, can you give some color for different senior housing types like IL, AL, and also the senior apartments?
spk22: Yep. Okay. So I think I understand the question now. So, look, I mean, if you think about it from a product-type perspective, as I mentioned, that the assisted living is going through probably the most robust recovery, perhaps for nothing other than the fact that it is the most need-based environment. It's least susceptible to a macroeconomic environment. You know, when you need it, you need the product when you need it. And obviously, it also fails farther, so it has more rooms to climb back up. So that's where you're seeing the most, you know, sort of robust recovery. As I mentioned, the NOI growth in that sector for the quarter was 25 plus percent, right? So that's sort of it. Let's just then talk about the senior department business. That business has been as good of a business as any business I've seen. It's been very strong through COVID. It's been very, very strong. You know, through times, I mean, our portfolio is at 95-plus percent occupancy. As you know, we operate in the mid-market portion of that business, which is very dependent on Social Security and everything else. And you've got a massive COLA increase next year, which we also think will be very beneficial for the pricing power increase in that business next year. Independent living, you are obviously independent living did not fall as far as assisted living. and it's coming back more slowly. But I personally think that's a good business when you combine that with other property types. And I think obviously Canada, which is our majority of our independent living exposure, has been so hard to recover. But as John noted, that we are starting to see improvement there.
spk24: Your next question comes from the line of Dan Bernstein with Capital One.
spk04: Hey, good morning. I just wanted to kind of expand on your comments about the upside down, I guess, private buyers in the MOV space. Just trying to understand there a little bit more if lenders are actually foreclosing on assets and maybe if you are already seeing some opportunities there to buy assets at a better IRR. And maybe on a related question, do your comments also apply to senior counseling and skilled nursing, where I believe there are some upside-down loans as well?
spk22: Yeah. So, Dan, we haven't seen lenders foreclosing on medical office loans yet. But my comment was, you know, it's sort of called the convexity of the situation, right? When you have very, very low rates, and people buy in cap rates that are, you know, in that environment makes sense. And then treasury card moves 200, 300 basis points. And now your treasury cards, you know, sitting on top of or above the cap rates that you are paid. That's a pre or upside down convexity situation. And that's the comment I was making. You know, it takes time for lenders to foreclose. It takes time, but we are starting to see some meaningful, increase in the cap rates there, which is interesting. We're not yet to talk about whether we are going to look at that and execute on that yet. We have lots of opportunities that we see on a relative basis. We talked about obviously senior housing is one of those. Nothing changed. I specifically pointed out MLBs because that has changed. Senior housing as an opportunity was there for the last 18 months when executing on it. Nothing changed there. right, and continues to be super attractive. On top of that, to the earlier question Derek asked, now our stock is really attractive. So, you know, we look at every opportunity and think about what's the unlevered RR on a risk-adjusted basis and what's the sort of execution risk as well as, obviously, the frictional cost that comes with the execution risk. But is the space finally first time in years has become interesting? The answer is yes, but it's interesting at a price, and that price is likely a lot lower than most Wall Street things.
spk24: Your next question comes from the line of Ronald Camden with Morgan Stanley.
spk12: Hey, just one two-parter. Just looking back at the slide in the deck on the long-term $543 million embedded NOI, my question is just on On that $230 million that comes from getting back to 4Q19 NOI levels, your comment sounds like you're pretty constructive on sort of margin improvement, especially with sort of the acceleration you saw in revenues relative to expenses this quarter. If you just remind us, how are you thinking about the margins of that $230 million versus sort of the 4Q19 level as part one? And if I could sneak in a part two, which is just on the Prometica consideration, that half a billion, how much of that is the 15% stake that they're giving up, and how much of that is sort of the working capital? Sorry, thank you.
spk25: Yeah, I'll start with the first comment on the margin side. The assumption is we get back to pre-COVID levels, so no assumption on change in margins. assuming it back to pre-COVID level profitability and operating margins of about 30.8% across the portfolio.
spk20: On the consideration, it's roughly half and half.
spk24: Your next question comes from the line of Michael Carroll with RBC Capital Markets.
spk10: Yeah, I just wanted to touch on the new SNF, JV. I know you just kind of highlighted the rough size of the operating reserves ProMedica is going to be providing. But how is that going to be distributed to the new operators? Are they simply earmarked to fund near-term cash flow losses during the transitions? And what happens if these new operators don't actually need to access those reserves?
spk22: So the reserves are earmarked for the operating losses, working capital losses, And, you know, that reserve will go to them to improve the quality of the portfolio.
spk20: So, you know. Yeah, I think if they do a good job and don't need them all, that's good for them, right? So they share the risk and they get the benefit if they're saving.
spk24: Your next question comes from the line of K.O. with Credit Suisse.
spk13: Hi, yes. Good morning. Again, congrats on the quarter and the transition. I've been covering this place 15 years. I don't think I've ever seen a rent restructuring where the rents went up. So that's pretty cool to see. In regards to Integra, and again, this idea that they're going to be subleasing a lot of the assets to regional operators, just curious a little bit again, Your mantra in the past has always been to be as close to the operator as you possibly can. You're actually even on the board at ProMedica. How is that relationship going to be with these subcontracted operators, and how do you manage that to ensure you continue to get operational excellence out of them?
spk22: Taio, extraordinary good question, and thank you for your comment there. I'll just add one thing to that. Not only the rent is going up, the previous tenant is living close to half a million dollars on the table to make sure that these properties are taken care of going forward. So we thank our partner for that. So I'll just add to that question of why we didn't go and find the operators. Our mantra is to get close to the operators, but that's in the senior housing business. I fundamentally believe in the expertise And we have worked with Integra and its parent company on many of these transactions before. There's no question that they are significantly better in the skilled nursing business than we ever were and will ever be, right? So we are sharing and for creating that value I've mentioned in my script that we're sharing very significant upside that they can create with them. In return, they're providing us the downside protection, which is very important for us. So you think about it, you got to do in life what you are best at, right? You know, think about from an op standpoint, we think we understand operations of, you know, senior living, the wellness housing business, as well as MLB business. And we want to partner with people who we fundamentally believe, on the other hand, are very good in other businesses. And that's what you're saying. Fundamentally, it is, you know, sort of, Going through the decision making is going to the people who are the best at the, you know, what they're good at. At the same time, it sort of cut the risk reward in terms of who creates value. It's just as simple as that. As I've said before, you know, you can see the value still remains a very attractive basis, which you can get to. You know the total rent. You know what market sort of rent, you know, sort of constant of skill nursing business is. and you can divide to get to a value, and you will see that value is still extraordinarily attractive, and thus the rent is extraordinarily attractive and remains below market. So there will be, hopefully, a lot of upside as the regional operators bring this portfolio back to its previous glory, which we actually, this is not a guess, right? We have, Mikhail, how many assets we have transacted, X Manicare assets we have transacted with Integra and its parents? About 21 assets. 21 assets, right? We have seen them doing it, And we are going on an execution path that we have seen in the last couple of years. So hopefully there's a lot of value to be created, you know, for residents, for employees, for capital, and that will be shared between the two parties. But it is fundamentally the belief of, you know, they're giving us the downside protection for which they should enjoy very significant upside that they create. On the other hand, you know, for us, it's all about where we sit in the risk reward spectrum. So it's a win-win-win for all three priorities. ProMedica wants to focus on its core business and wants to be in the higher margin business, and that's the leadership that they are taking that forward. It's a very significant improvement in their credit. For World Tower, it's obviously a great day for some value realization, as well as obviously taking this portfolio to the hands where we can create another round of very significant upstep of values. For Integra, they're coming in at a very attractive basis, and obviously they're creating the value that they will share the upside with us. So it's a win-win-win on all fronts.
spk24: Your next question comes from the line of Mike Mueller with J.P. Morgan.
spk05: Yeah, hi. We appreciate the expanded development disclosure, but what's the timeframe that you see for ramping the developments from you know, the 1.6% initial yield to the 7% stabilized yields.
spk25: Yeah, Michael, I appreciate recognition that we're trying to help with just the ramp or the kind of trajectory of how that cash flow comes through. And it depends on, you know, type of development. So you think about our, where a lot of our starts have been as of late is more in the senior apartments, wellness housing side. And there you're talking about, you know, more 12-, 18-month type ramps towards stabilization. And on the traditional senior housing side, it's more of that 24-, 36-month ramp. And that's where more of the lower yields, negative yields, come in the first 12 months.
spk24: Your next question comes from the line of Nick Ulico with Scotiabank.
spk23: Thanks. Good morning, everyone. I just want to go back to ProMedica. Clearly, you know, strong pricing you got there and the cash rent going up is attractive. So I want to see, though, if you could let us know the gap impact, because I didn't see any mention of, you know, lease escalators for the new arrangement. You had them previously. So just trying to understand the FFO impact from this. And separately, I don't know if you're going to be filing details on the new lease, but if you had anything you can share right now in terms of escalators, financial covenants, CapEx requirements, because those were specific, very sort of onerous conditions of the last lease with ProMedica, which kind of strengthened, I think, the whole process you went through. So any detail there would be helpful. Thanks.
spk22: Very good question. The escalators remain the same, 2.75%. And the gap impact, as we mentioned, will be roughly neutral to slightly accretive. One of the leases are remaining the same lease. The manicure, not the hard-end court senior living lease is going to 10 years, so you have a negative gap impact there. So net-net, you will be roughly neutral to site lead today.
spk24: Your next question comes from the line of Austin Works, made with KeyBank.
spk02: Yeah, hi, good morning. I'm curious, you know, first off, if there were other partners you approach for the new ProMedica joint venture, how do we think about, you know, you going from a health system investment with feeders into these assets to the more regional operator approach? And then just lastly, I'm curious, kind of going back to 2016, 2017, wasn't the plan to ultimately exit the SNF business? And so curious how you think about the strategic direction of that segment of the portfolio.
spk22: So can you please repeat the first part of your question again?
spk02: Yeah, I was just curious if you approached any other partners beyond just Integra for the new joint venture.
spk22: So, look, it is no secret that we have been thinking about in the industry that we have been thinking about this particular portfolio for a long time. We have been approached by at least five parties who are interested in doing this transaction similar or higher value, similar or higher structures. We went with a partner that we know very well where we felt the execution risk is much lower. But I think if you have heard that you have correctly heard that we have been approached by many groups Because these assets are not only very attractive assets, they have very good history, but also the basis remains very, very attractive. Going back to 2016, 17, I think your question was to exit the SIP business. I have very clearly laid out two years ago when I took over as a CEO, we have a very simple strategy that we want to make money on a risk-adjusted basis on a par share basis for existing shareholders. That's the strategy. And it's a very simple strategy. Whether it's skilled nursing, whether it's medical office, whether it's senior departments, whether it's senior housing, whether it's debt, equity, value-add, development, opportunistic, we'll go anywhere we can find opportunities to make money on a partial basis for existing shareholders. That's the simple strategy.
spk24: Your next question comes from the line of Juan Sanabria with BMO Capital Markets.
spk08: Hi, good morning. Shaka, I was just hoping you could talk to maybe opportunities you see outside of the U.S. given the unusually strong U.S. dollar and whether that presents a wider opportunity set for potential acquisitions.
spk22: One extraordinarily good question. As you know, we get really excited about basis and we're at USD. We raise capital in USD. Our expenses are mostly in USD. Capital structure is in USD. And we think about basis in terms of USD. And as you can figure out, UK on a US dollar basis has never looked more attractive. And Canada also looks pretty attractive. But UK particularly, given what happens to the currency situation, looks extraordinarily attractive. You add on top of that, that you don't have a super functioning debt market in UK. Like you have the agency support in US and Canada. It's a very, very interesting market. I have never seen UK opportunities as cheap as it looks today from the eye of a US dollar investor. And that probably perhaps goes for any asset class, anything, even for shoppers. So you're picking up the right thing. We're absolutely thinking about it.
spk24: Your next question comes from the line of Rich Anderson with SMBC.
spk01: Hey, thanks. Good morning. Congrats on the ProMedica Integra transaction. The market seems to be rewarding you for that resolution. But the way I look at it is you kind of married ProMedica in 2018, but you signed a prenup, and that protected your downside. And all this is based on basis, and it's all clear and understood. But now you're selling 15% to Integra, What happens to basis for that 15%? In other words, 85% I assume stays put, but are you upping your basis and eliminating some of that quote-unquote prenup component so that if there is a disruption going forward with Integra and its regional partners that you still have an equal amount of protection should something go wrong here? Because a transition isn't a
spk22: silver bullet it usually it sometimes works but sometimes not so just want to get a gauge in the future in terms of how you're protected going forward thanks yeah so our basis remains the same and you can do the calculation on again you have the total rent you know what the give or take you know yield is in the business right and you can get to the total value rent divided by the yield, it will get you the value. You can divide that by the total number of beds and you will see Integra's basis is also very attractive, right? So our basis remains attractive. Remember what we sold to Integra is what we got for ProMedica for nothing, right? So it's important for you to understand the nuances of what's happening here. So our basis remains very attractive. Obviously, we got the support for the operator who is living and living, as I mentioned, leaving close to half a billion dollars on the table. We created another structure where that 15%, which Integra is paying for, remains subordinated. That further lowers our net basis, which is the first time when I remember I talked about that. That condition remains. We have obviously other guarantees in place, as I said. And if that's not the case, remember in the last question I said that people want these assets because they're very well-located assets. And they're at very good location and they're very attractive basis. So we don't see, as I said, look, anything can happen, Rich. But as I've mentioned before, four years ago on this topic, that low basis, well-located assets that have demand that's held in low-level structure, it's hard to see how we lose money. Anything can happen, right? Anything is possible. But if you think about we have to live within the realms of probabilities, not possibilities, it looks pretty good to me.
spk24: Your next question comes from the line of Michael Griffin with Citi.
spk07: Thanks. It's Nick Joseph here with Michael. You've talked a lot about the opportunity for improvements and modernization in senior housing, but when you look at the skilled side, and I recognize it's a very different business, more regulatory considerations and everything like that, but are there opportunities to improve either the operations or share best practices from a well perspective that maybe could help coverage going forward?
spk22: Nick first, congratulations for getting the top job. We have been a big fan of yours for a long time and obviously thank you for your question on the call today. So look, I've mentioned very, very clearly that we do not consider ourselves a skilled nursing expert. If we did, then we would not bring in our partners in this deal who we consider knows the business better than we do. So I will leave that to our partner to execute the strategy, which we have mentioned, you know, as Nikhil just mentioned, that we have done just from this portfolio 21 assets before. We leave it to them to maximize. You know, where in this case is sort of a structural protection is what we are after, not maximizing value through operators. That's what they're bringing to the table in this case. And we remain focused on our core businesses where, you know, whether it's senior living, whether it's wellness housing or medical office, and that's where John is spending all his time.
spk24: Your next question comes from the line of Stephen Veliquette with Barclays.
spk16: Great. Thanks. Good morning. Yeah, just sticking with ProMedica for a minute here. You know, I guess one of the expected operational synergies from ProMedica acquiring the Medicare SNF assets in the first place was likely centered around you know, good flow of patient referrals from Prometica hospitals into at least some of the ManorCare SNFs, you know, where it made sense geographically. I guess I'm curious, you know, with hindsight, did that part of the strategy play out the way everyone thought it would? And maybe just perhaps the underwhelming execution that you alluded to, Sean, was just more a function of, you know, just tough industry dynamics for SNFs overall. And also under the new agreement then, does Prometica, you know, patient referrals, you to the SNFs under Integra as operating controls stay intact going forward, or as part of the strategy for Integra to turn things around is really to maybe widen and expand the Medicare post-acute referral sources to improve the occupancy.
spk22: Let me try to address your question, Steve, and then Nikhil, you jump in. First is the fundamentally, the strategic part of the patient flow point that you mentioned has not played out and has it not played out because we walked directly into a very tough environment of COVID or has it not played out because the idea, you know, we couldn't execute or Prometica could not execute. I don't know the answer to that question. Hindsight is 20-20, right? But there's no question that it hasn't played out and that leadership at Prometica firsthand will tell you that they're underwhelmed with the execution as well. So no question it hasn't played out And the second, but if you think about, again, I would recommend you, it's hard to say things, easy to say things sort of looking back. I would like you to go back and to the call where I've described why we did this transaction. And we'll see how much we emphasize that we fundamentally think if everything goes away, what we still have is the basis, right? Think about, Steve, as I mentioned, that, you know, you have a two-bedroom apartment in New York City. where it cost everybody a million bucks, but you bought something for $400,000 during GFC, you don't need to charge the rent that everybody else is charging. That is the fundamental idea of how you make money in real estate without taking a lot of risk, right? And that's what we saw, and that has played out, I hopefully will agree, in this transaction. Nikhil, you want to add anything to the second part of the question?
spk20: Yeah, I think from a clinical programming perspective, I think this portfolio, ManorCare ProMedica, has always been good at providing good clinical programs. And they work closely with hospitals across different markets, whether it's for medical hospitals or not, in creating programming that serves the need for local hospitals. And that programming stays in place. And obviously, as new operators come in, they'll decide if they want to keep that in place, scale that back, enhance it. But this whole platform has been known to have incredible clinical programming, and that stays in place.
spk24: Your next question comes from the line of Dave Rogers with Baird.
spk09: Yeah, maybe for John Burkhart. You know, John, as you obviously grow occupancy in the shop portfolio, you have more and more assets that are likely now at kind of stabilized occupancy. Can you talk about the margins at the stabilized assets and if they've stabilized to pre-COVID levels and then any delay between the occupancy stabilization and margin that you're witnessing in that larger group of assets?
spk03: Yeah, let me just give you... an interesting piece of data. One of our operators that has very high occupancy in the 95s actually had expenses going backwards. And so you see some tremendous margin improvement there. The whole portfolio is going that way and no doubt that the higher occupancy levels, as Sean mentioned, was pushing, able to push rent or achieve higher rent, which is again then driving better margins. But on the expense side, they continue to see opportunities to improve as we go forward and move out of the situation during COVID. As I mentioned in my prepared remarks, one of the situations during COVID was there's a challenge to get some maintenance done, get people into the buildings, et cetera, et cetera. So our numbers today even reflect some elevated maintenance expenses, which will be reduced over the coming quarters and, again, provide a stronger run rate. So, yes, things are going very good. They're going good at all levels. As Sean mentioned, we have maybe four buckets of assets with different levels of occupancy across the board. And at the top occupancy assets, we're achieving fantastic margins As you get down the rung, obviously that's not the case, but we're continuing to improve occupancy and things are all looking forward. So hopefully that answers your question.
spk24: Your next question comes from the line of Joshua Dinnerline with Bank of America.
spk00: Yeah, no, appreciate all the color on ProMedica. Maybe one question on the senior housing side for the ProMedica. Was there any discussion of potentially moving that to another operator? Or you guys felt pretty comfortable with how they're performing?
spk22: As Tim mentioned, those assets actually generate a decent amount of profitability for them. And ProMedica, that is part of ProMedica's strategic, obviously, plan. And those are, as you know, are high margin businesses, and they have been even before COVID. And we expect they will continue to come back to, you know, remember pre-COVID, these assets on mid-82% occupancy was generating high 30% margin, right? So I expect as you sort of come back from the COVID and get that occupancy stabilized, frankly speaking, I will venture a guess, that would be the best sort of margin part from all of ProMedica's businesses. So, look, I mean, that's where we stand today, and there's no reason to believe that those assets will not. As you can see, you know, as part of this recovery from these occupancy levels in the business, margins are coming back. I'm not happy with where margins are today, and we're seeing, obviously, a lot of signs of improvement that we discussed, but the margin of this business should come back to a much higher level, and ProMedica should enjoy that, you know, like everybody else in the business.
spk24: At this time, there are no further questions. This concludes today's conference. You may now disconnect.
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