Ready. I guess we're starting.
All right. Good afternoon, everyone. My name is Ron Kamden. I'm the Head of U.S. REITs and Commercial Real Estate Research at Morgan Stanley. I'm thrilled to be hosting AHR in this company presentation. We think they have a really interesting story. Hopefully, as you get to know the company, you can sort of think of your own questions. We'll try to take some questions at the end. Maybe why don't we just start going through down the line, just maybe your name and what you do at the company, just so everybody's familiar. Start with you.
Yes. Good morning. I'm Brian Peay, and I'm the CFO. And I just celebrated my ninth anniversary at the company.
Hi, everybody. I'm Danny Prosky. I'm the President and CEO. And I was one of the founders back in 2006.
Everyone, my name's Gabe Willhite. I'm the Chief Operating Officer at AHR .
Alan Peterson. I head up investor relations for AHR .
Great. Why don't we start with you, Danny? Just a quick, for those in the room that may not know the company, may not be familiar with the story, just talk about who is AHR , what do you guys really do?
Thanks, Ron. AHR, we actually IPO'd about 16 months ago. Even though we've only been around as a publicly traded company for about a year and four months, we've been together originally as a management team going back to since 2006. Long convoluted story. I won't bore you with the details. We've been in the health care business a very long time. I myself actually started my first health care REIT, publicly traded company in Denver called American Health Properties back in 1992. American Healthcare REIT, we are kind of a mid-sized health care REIT. We've got about $6 billion of equity market cap, about $7 billion of enterprise value, about 300 buildings. We focus on clinical health care real estate. Clinical means where patients are being seen by providers.
I think what's most unique about us is that we have a very large percentage of managed real estate versus leased real estate. I'm sure a lot of you are familiar with the term RIDEA. About 70% of our portfolio is RIDEA, meaning we don't have a tenant. We have a management company that operates it for us. In lieu of rent, we actually get to keep the bottom line earnings. That is the reason we've had such outsized growth over the last two years. This has been a fantastic time period in the last two years for senior housing in particular, which is what our RIDEA portfolio encompasses. It's SHOP, Senior Housing Operating Portfolios, as well as integrated senior health campuses that have long-term care, including skilled nursing, assisted living, and independent living.
We're in a position right now where the baby boomers are just about to start turning 80. The oldest baby boomers will turn 80 next year. We have a 15-year period of very rapid growth in demand for that over 80 cohort, which is the dominant residence for our types of facilities. We are at the end of a six-year period where we've seen very few new construction starts. Starting in 2018, we saw construction for assisted living drop precipitously. It has remained very, very low since then. We've had COVID. We've had a rapid increase in construction costs. We've had an increase in interest rates. All of those things have come together to cause a fast reduction in the amount of new projects being started right when we're entering a period where we're seeing very high growth in demand.
We've had double-digit same-store NOI growth for the last couple of years. We feel very comfortable that we have a multi-year period ahead of us where our industry, not just us, but those of us who operate long-term care facilities, are going to see outsized growth.
Great. When I think about sort of senior housing, out of all the sectors I cover, we see sort of the best supply-demand fundamentals. I think you would agree with this that it feels like the year is off to the best start that we've seen in quite a while. I guess my question is, just can you sort of talk about why having more of an exposure to managed versus leased is such a big advantage in this marketplace? Because when I think about some of your peers, you guys are at 70%. Everybody else is at 60% or 50% or lower. Maybe just talk about that advantage in this environment.
Thanks, Ron. Traditionally, health care REITs, going back to the 1990s when I started, were really kind of spread investors, right? It was a 100% lease structure, mostly senior housing, some hospitals. You would basically have a 15-year bond net lease to a tenant with annual rent increases that were typically CPI-based, or they would have a fixed 2%-3% rent bump. Over time, you started seeing them get into medical office buildings, which my firm started doing in the mid-1990s, which was a little bit more dynamic, shorter-term leases, more potential for growth. Starting about 20 years ago, the rules changed, and REITs were allowed to actually own the real estate and have a company operate it on their behalf. There is good and bad for that, right? There were times where they were overbuilding within senior housing.
It actually had a negative impact on bottom line earnings, which hurt the REITs. There are times like now where demand for health care real estate, demand for services is outstripping supply. You're seeing that the good times roll on. We're benefiting from that right now. There are a lot of our competitors out there that have a very high percentage of leased assets going back to how things used to operate historically. That's great. Their tenants are generating higher earnings. They've got better rent coverage, which is good. Their bottom line earnings are still growing 2%, 2.5%, 3% a year because that's what the leases call for. The additional earnings being generated, those assets are going to the tenant as opposed to the landlord.
We fortunately are in a situation today where the vast majority of our portfolio is not operated that way. Those growing profits are coming to us as opposed to the non-existing tenants.
Excellent. We are going to double-click a little bit to try to understand the company and the portfolio better. In the managed segment, one of your biggest segments and operators is Trilogy. We have actually had the chance to go visit some of their facilities. We have seen it in action. Maybe can you talk about how is Trilogy unique and sort of the competitive advantage that the company has in the market?
Yeah. That is probably the biggest differentiating factor within our company is that we have a significant portion of our NOI, about 60% currently, under the management of one operator, a company called Trilogy. They are based in Louisville, Kentucky. They operate about 130 of our assets. Fortunately, they are not only our biggest operator, but in our minds, our best operator. Those assets have a unique quality to them as well. We refer to those as integrated senior health campuses, which is a mix of skilled nursing, assisted living, and independent living. All of that is under one rooftop. Usually, those are buildings anywhere from 100-125 units. In many of our campuses, we have independent living villas on adjacent land that are part of the campus as well. It is a higher acuity model. A significant component of the business is skilled nursing.
Probably about 50% of their beds are skilled nursing beds. That number has been shrinking over time as a percentage because as we have grown Trilogy, we have added a lot more assisted living and independent living versus skilled nursing. Now, the first question I usually get from people who are not familiar with Trilogy is, is not that a CCRC, a continuing care retirement community? Our answer to that is no. These are not CCRCs. CCRCs tend to be much larger. They could be hundreds of units. They tend to be heavily independent living. They are really designed for a continuum of care where people come into independent living. If they need more care, they can move into assisted living or memory care. Those are usually just kind of adjunct components to the campus. It is really primarily independent living.
Oh, by the way, CCRCs very often have an entrance fee type model, which none of our assets have. Trilogy, the continuum tends to go more in the other direction with Trilogy. Yes, people come into IL or AL and at some point may need skilled nursing and will come over to the skilled nursing side maybe just for a period of time. You are much more likely to see people come into skilled nursing. The majority of admissions into Trilogy facilities are hospital discharge residents. They come directly from the hospital to the skilled nursing side of the business of Trilogy. The vast majority end up going home. Some of them get better, but they are not ready to go home or they need more care. They will oftentimes move in directly to a Trilogy AL or IL unit.
If you look at Trilogy's AL business, about 30% of their residents came directly from the skilled side of the business. About 70%, which includes that 30%, spent time in a Trilogy skilled bed. Either they went home later on, needed more care, and came back to a Trilogy AL or IL unit, or they came directly from the skilled side of the business. They do bring people directly into AL and IL, and especially the villas. They do not market 100% from the skilled side. They are very active at marketing the business outside of people coming from skilled. You see a lot of people being admitted into skilled and then moving on to AL or IL.
Interesting. Trilogy is sort of the big sort of growth driver for the company at about 60% of the NOI, as you mentioned. Another piece of it is also just the senior housing operating portfolio, which we refer to as SHOP. What we have seen in the public markets is that operators matter. The performance of that business is really dependent on the operator. Maybe can you talk about what your secret sauce has been? How have you guys been able to sort of have success in that business?
Yeah. So I'll start out and maybe hand it over to Gabe to talk about our operating partners. SHOP has been, SHOP is about 11%-12% of our NOI today, growing very rapidly because that's been the fastest growing segment of our business. As fast as Trilogy has grown, the SHOP business has grown even faster. I think we had 30% same-store NOI growth Q1 this year versus Q1 last year. That growth has been, I think we were running 60% at one point last year. It's been very, very outsized. That's a combination of occupancy growth, which was very strong last year and continues to move in the right direction, and rent per growth. As we've grown occupancy, we've been able to grow revenue-occupied room at a very nice clip, which has obviously impacted margin and NOI.
That is where we're, if you look at our acquisitions pipeline, 100% of our pipeline is in those managed segments, either Trilogy or SHOP, and primarily SHOP. You're going to see that continue to be the area that we focus on growing. In our minds, that is by far the best risk-adjusted return in today's market. As a matter of fact, we've been reducing our exposure to outpatient medical buildings over the last three years. We've been selling those off, primarily the smaller buildings that we are less excited about owning long-term and reinvesting in Trilogy and SHOP. Maybe I'll let Gabe talk a little bit about our operating partners and our strategy there.
Yeah. I think maybe we have more conviction in this than others. I think you're spot on, Ron, that the operator in a senior housing investment, if I had to pick between best real estate, best market, or best operator, I would pick best operator every time. It would be the top priority. What we're trying to do is build a stable of operators in different regions with regional concentration and regional headquarters. Why are we doing that? Because we saw it works so well at Trilogy. Trilogy has 130 properties in four states, a big concentration in the Midwest. What's good about that is that the Trilogy CEO can make it to every single building within a day and does and regularly sees them all. I do not know why long-distance relationships do not work. In senior housing, long-distance relationships do not work as well.
The closer you are to the proximity of the headquarters of the operator, the better the performance of the asset. It's a cultural thing. It's a pride thing. It's an accountability thing. There's a lot that goes into it. We have tried to establish those relationships across the country. What that means is that we use more regional operators and smaller operators than other people do. We think that they have the ability to drive performance, control the culture of the buildings. What we lose with that is a little bit of the scale and sometimes the sophistication and the resources of big operators. What we have now with Trilogy is kind of AHR 2.0, Trilogy 2.0, 3.0, 4.0. I don't know.
We have the ability to leverage Trilogy's platform because they're essentially a captive operator for us to help support the regional operators and the rest of our portfolio. Trilogy has an incentive fee that's part of their management contract that's based on AHR stock compensation to the operator. Trilogy is financially incentivized to provide back-office support, even on a private label basis, for key initiatives and strategies that smaller regional operators wouldn't be able to execute on without the support of some big operator behind them. I think it's a real differentiator. It's something that's really started to take off in the last year as Trilogy has participated in our annual operator summits to share best practices and help our operators grow and continue to get better.
Excellent. Okay. The setup is senior housing fundamentals are attractive. You've got Trilogy, which is a great operator. You've got the SHOP business where you've got the right operators. I guess can you just tell us what was performance like in 2024? Maybe talk about what you've sort of guided for 2025. How did this all sort of play out in the numbers?
Yeah, sure. 2024 performance was very strong. Frankly, it led us to believe that the business will continue to grow. Danny pointed out some of the reasons why. Obviously, the demand is dramatic, and there has been no new supply. 2025 guidance was arrived at. Obviously, we start the budgeting processes in typically August or in September. We do not ultimately conclude on that until November. The good news is you have got a little bit of time because you are going to meet out that guidance to the street in your Q4 earnings announcements. You have got a little bit of 2025. You have got January put to bed. You know what is going to happen.
I thought we were not overly conservative on our 2025 guidance where we're talking about Trilogy's same-store NOI growth is probably in the low teens, maybe 13%-14% at the midpoint. Our SHOP same-store NOI growth is going to be in the low 20%. We didn't feel like that was conservative. Yet the beginning of the year of 2025 was really strong for us, even with the flu. In fact, in some cases, there was much written about a terrible flu season. The flu created occupancy in our skilled nursing beds at Trilogy. It hurt the senior housing side. People were moving. They were not moving in. There was some mortality, certainly. Ultimately, we felt good about those numbers that we came out with 2025 guidance with, let's see, $1.60. That's our revised.
$1.58 per NFFO per share was our midpoint of our guidance. Yet with everything that happened in the first quarter, we did not have a choice. We had to raise guidance again. Now those are the numbers that I sort of described. We were $1. What were we at? $1.50, $1.64 was our most.
No, I'm thinking last year.
Oh, last year we ended up at $1.41.
Yeah. So from $1.41- $1.61 is the new midpoint. So pretty dramatic growth in earnings per share. And by the way, embedded in that was a dramatic decrease in our leverage as well. So when we went public, our debt to EBITDA was in the nine range. We used IPO proceeds to pay it down. We got into the 7x range. And now we're at 4.5x . So with that dramatic earnings growth and deleveraging, we accomplished quite a lot.
Great. When I think about, okay, you've got a business that's organically growing double digits or more. When I think about the rest of the REIT market growing at 3%, that's interesting. The other part of the value creation is really capital allocation. What are you spending your dollars on? I think you talked about on the earnings call an acquisition pipeline of $300 million. Just was curious if you could just tell us a little bit more about that. What do you expect to close? What's in those investments? How do you guys think about sort of the external growth at this point?
Thanks, Ron. Back in our last earnings call, which was in late February, we announced—no, I'm sorry, it was in May, excuse me. We announced that we'd closed on about $80 million so far this year, and we had north of $300 million in the pipeline. Now, six weeks have gone by. As you can imagine, the pipeline, it's a dynamic pipeline, so we're always adding to it. You can take that with how you wish to take it. Our expectation is we'll close all of it, or at least the majority of it, this year. What we're looking for is we are growing. We are focusing on that 70% of our portfolio that is REIT data, that is managed, that we feel is the best risk-adjusted returns. We've been net sellers of outpatient medical.
We haven't been growing our net lease piece of our portfolio. It's quite small. It's only about 7%. What we're really also trying to do is improve the overall quality as we do it. We've been selectively disposing of assets. We've sold some outpatient medical. We've sold a few long-term care facilities. They tend to be smaller and older. We're focusing on larger, newer buildings. The vast majority of what's in our pipeline has been built in the last eight years, much of it in the last five years, buying it at well below replacement cost. Replacement cost has continued to tick up over the last five years, significantly during COVID, of course. We're able to, not just us, but you're still able to find deals out there well below replacement cost. Obviously, we'd like for them to be accretive.
We're not just looking at deals that provide a high going-in yield that's a spread above our cost of capital. We're really looking for deals that will provide us future growth, not just this year, but into the next several years. It's a mix. We've got some stabilized buildings that are high 80s, low 90s. We've got a few buildings in that pipeline that just recently opened and are in the 60s and 70s from an occupancy perspective. We feel that with our operators, we'll be able to bring those up to a much higher level of occupancy fairly quickly. In almost every situation, we are replacing operators as we add to our portfolio. Not always. In a few instances, it's our operators bringing us the deal, right? We've got seven regional operators that we really like.
We'll be adding to that number, as we discussed on our earnings call, with a couple of new ones that we've identified a long time ago that we've been looking for opportunities to grow with, and we've now found them. In some cases, our operators come to us with a deal that they already operate that's owned by someone else who's looking to get out. They'll ask us, "Hey, will you take a look at this building? Would you consider buying it?" because they'd rather we buy it than someone else because, A, I think we get along pretty well, and B, we're going to keep them on as the operator as opposed to another buyer who may operate it themselves or bring in some other operator. We feel really good.
I think historically, if you look at the buildings we took over over the last couple of years, they have a good track record of filling up at a nice pace. We expect to be able to do that even better on these because they are newer, nicer, and the market just continues to move more and more in our favor as the baby boomers continue to age and as that lack of new supply becomes even more pronounced.
I'll just add two quick things to make sure we level set. When we talk about pipeline, these are not assets that we're tracking and that we're following and that we're bidding on. These are assets that we've already won the bid. So they're either under LOI, they're under contract, or there was no bidding process at all. In fact, 40% of that pipeline are assets that were not broadly marketed. So we either had the inside track with the operator in several cases or that they were not broadly exposed to a bidding war process.
Great. Just staying with you, just the funding, right? I think you talked a little bit earlier about sort of the balance sheet. How do you guys think about sort of sources of capital and sort of balance sheet discipline as you fund this pipeline?
Yeah, that's a great question. We fought very hard to get our leverage to where it is right now. I don't think there's any reason. I mean, I would anticipate our debt to EBITDA will probably get a little bit better just because of the earnings growth that we have embedded. When we look at sources, and we are going to fight to keep the balance sheet in good shape. I don't see it going. If anything, directionally, it's going to get better, not worse. I think if you think about that pipeline and how we pay for it, our AFFO payout ratio, which is after maintenance capex, is pretty attractive. It's in the high 70%-low 80%. That means that there is retained earnings. That's the cheapest cost of capital. That's the cheapest form of capital that you can access.
Retained earnings will be part of it. Danny mentioned that we're selling some smaller, maybe off-campus outpatient medical buildings that are probably growth constrained. They're going to be slower growth than what we're redeploying into. That's a great source of proceeds for us to utilize. We have an ATM program that we kicked off a couple of quarters ago. We are very price sensitive. If we can get a decent price, we're a small portion of the daily volume that's happening in the stock. That's a great source of equity because it's a very cheap way to access equity capital.
The bottom line is we have an attractive cost of equity right now. I think you'll see us utilize that heavily towards these acquisitions.
Great. It's not all good news, right? There's got to be some pushback to the story. I think you guys have sort of shown that you're in sort of the right industry with the right supply-demand fundamentals. There's clearly a very operationally intensive industry, and you've proven you've been able to execute. We've gotten a lot of questions from investors about the news surrounding Medicaid and Medicare recently. I guess my question to you is, can you help clarify how you view this news flow and potential risk to your business?
Okay. Yeah. Clearly, Trilogy, in particular, because of the skilled side of their business, relies on Medicare and Medicaid for a significant chunk of their revenue, less so than most skilled operators. Trilogy has a much higher quality mix. They have a lot more private pay, private insurance than a typical skilled operator. Still, they cater to seniors, and oftentimes seniors are going to be using Medicare and Medicaid. We got a lot of questions on that starting several months ago when it first became an issue. Our response was kind of threefold. Number one, we have no idea what's going to happen. Yes, we have a much clearer picture today. There is a bill that the House passed. No guarantee that will be the final bill. At least I think there's a little bit clearer indication of which direction they're going.
Our second response was, and by the way, the issue was Medicaid, not Medicare. I mean, the federal government was very clear they're not touching Medicare. It was really Medicaid that was the issue. Now, we felt very strongly that any changes to Medicaid would not affect seniors. It would be primarily focused on work requirements for younger people, things along fraud and abuse, trying to reduce that. I think the bill has proven that out. If you look at what's in there, there's really nothing in there that has any kind of detrimental effect to the skilled nursing business. There is a cap on increasing bed taxes, which is fine with us. We didn't expect any increase in bed taxes anyway. We feel very comfortable that we're going to have very limited effect.
That being said, Trilogy has, like I said, a very high-quality mix, which means they rely less on Medicaid revenue than a typical skilled operator. It's less than 20% of their revenue. They're able to play with that mix if they need to. If they needed to reduce their Medicaid beds, they could very easily do that. We feel really good about the recent legislation and don't think it's going to have any impact on our operations.
On that point, because that's an important one, Danny, and this is probably the most overlooked thing in the entire company, people are looking at Trilogy as part of the business that's skilled nursing and government reimbursement and assuming an inflation-linked rate increase in that business for the foreseeable future and implying some sort of cap on NOI growth because of it. Because Trilogy serves a high volume of post-acute residents, not just Medicaid residents, and also has Medicare Advantage plans residents that are in their buildings, they've got opportunities and levers to drive rate growth that others don't. That's by adjusting their Q-mix, adjusting the resident mix that's even coming through in the government reimbursement side of the business. That's how we were able to deliver 5+% rate growth in the skilled nursing side in the face of lower than that number of inflation, right?
That's going to continue even beyond 2025 and 2026. As census goes up, as occupancy goes up in Trilogy's facilities, Trilogy is going to continue to optimize the resident mix and the residents that they care for. I expect inflation to be the floor, not the ceiling on where rates will grow for that part of the business.
Yeah. So you combine that with the move towards value-based care, which Trilogy excels in, where you see operators provide better care, get better reimbursement. That's been a big part of the strong rev port growth at Trilogy over the last year and a half as well.
No question about it.
Yeah.
Excellent. Any questions in the room? Anything that we can answer? I think we got two and a half minutes. Yep, we got one up there. Maybe, I do not know if this is webcast. Do you want to use the mic? Thank you so much for your question.
You mentioned a lot of rate growth, and that's been the primary driver for NOI. Is there any rate sensitivity that you're seeing, or is there sort of a peak on how much rate growth you're able to see from your client base?
Yeah. First of all, I would say it's a combination of rate growth, expense control, and occupancy growth, of course. I think you have to look at the different buckets. Clearly, with the skilled side of the business, you're going to always have Medicare and Medicaid, and you can't just say, "Well, I'm full. I'm going to raise rates," right? You can change your mix, as Gabe mentioned, continue to focus on value-based care. Trilogy is the best provider typically in all of their markets. Not only do they have the best real estate, but they've got the best quality outcomes. They've got a much higher staffing ratio than is typical in their markets.
All the things that are required in order to be able to take advantage, not just of Medicare and Medicare Advantage value-based care, but Medicaid value-based care, which is active in all four of the states they operate in, they are well set up to do that because you not only have to provide the care, but you have to be sophisticated enough and able to bill for it, which is actually quite difficult. If that's going to continue, now, are they going to continue to generate the same kinds of increases they've been able to generate last year? They may not be able to do that. I think, as Gabe mentioned, we expect that they will continue to be able to outpace inflation as far as their ability to grow revenue.
Now, on the private pay side of the business, which is Trilogy's AL, IL, part of their skilled, as well as our SHOP business, it's a supply and demand issue. As there's more and more demand and less supply, as we've seen occupancy increase, we're better able to not just increase rates for people who are in the building, but increase the street rate, which is really probably the most critical thing because even if you're limited as far as your ability to increase rates on people that are there today, it doesn't mean you can't increase the rates on people that are moving in. At some point, the market may say, "Hey, look, there just aren't enough people who are able to pay these rates." I'm not saying it can go on forever.
The way we see it, we expect rev port growth to exceed export growth for the foreseeable future. If expenses are growing at 3% a year, which is kind of what we're seeing, we're back down to kind of typical expense growth across our entire managed portfolio, we expect rev port growth to exceed that. Now, will it be 4%, 4.5%, 5%? I think it's going to depend on the market and the building. I think between a continued increase in occupancy and continuation of rev port growth exceeding export growth, we feel very comfortable that the growth is going to be outsized for the next several years.
Great. I want to thank the AHR management team for joining us. Any other follow-up questions, feel free to reach out to us. Thanks so much.
Thanks, everybody.
Yep. Thank you, guys.