Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph, with Michael Griffin, with Citi Research, and we're pleased to have with us Welltower and CEO Shankh Mitra. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC 2024 to submit any questions. Shankh, I'll turn it over to you to introduce the company and team, provide any opening remarks, tell the audience the top reasons an investor should buy your stock today, and then we'll get into Q&A.
Okay. I'll quickly introduce the company. Welltower is a healthcare REIT which operates in three countries, where we're invested in four different types of product. Majority of the business is in senior living, outpatient medical, a little bit of skilled nursing, and a lot of age-restricted and age-targeted apartments. With me today, from my left, John Burkart, our COO. To my right, Tim McHugh, our CFO, and to Tim's right is Nikhil Chaudhri, our Chief Investment Officer. And Tim will tell you the reason you should buy our stock or not.
Oh, forgot the mic. You know, we talked about this a bit in our call a few weeks ago, but I think it was a good setup for how we think about why Welltower is a compelling investment opportunity. First and foremost, it's the supply-demand backdrop. So in our core business, 2024 is a very attractive year relative to 2023, and it's only getting better in 2025 and 2026. I'm sure we'll go a bit further into that today. Second is digital transformation and process optimization that John's leading at the property level. So great kind of macro drivers of the business, and in addition to that, a lot of micro upside.
Third is, kind of with that number two, is the amount of portfolio optimization we've been doing in our senior housing operating portfolio, mainly through transitioning, well, to new operators, new operating agreements, so creating better alignment. First and foremost, this is having a positive impact immediately on our employees and residents at the property level, and following that, we expect significant financial improvement. Four, on the external growth side, so we've had an extremely kind of targeted, and disciplined approach to external growth. A lot of structural reasons why there's a pretty attractive window right now to take everything we're doing internally, the 2,000-plus properties we do own, and continue to add to the portfolio in a very value- ac cretive way. And then lastly is the balance sheet. So we've done a lot of work over the last couple of years.
As you all know, COVID kinda had a big impact on the cash flows in our business. Most noticeably in debt-to-EBITDA metrics, and we have very quickly put the balance sheet in a much better position, not just recovering from COVID, but putting us actually in a stronger position than pre-COVID, with a lot of further room to run the EBITDA side. So how I think about this and talk to many of you around it is, I think we continue to hopefully make the right choices for the long term in the business, and having the balance sheet in the right spot continues to allow us to make the right long-term choices.
Thanks for that, Tim. Shankh, you talked recently on the last earnings call about the five pillars of growth. I wonder if you can start by maybe unpacking these a bit, and how you see the importance of each pillar as it pertains to Welltower's growth strategy and value proposition.
I think Tim just walked you through that five pillar. I will just say that if you look, the beta of the business is very interesting. The business last decade, looking at the demand growth has been very anemic, supply growth has been very significant. And finally, coming through a supply cycle with no lending, prior to COVID, lending coming down very significantly and getting absolutely destroyed through COVID. We're in a very good sort of demand-supply backdrop, but within that demand-supply backdrop that I'm really excited about is what John is doing and fundamentally changing value proposition of many of these communities, digital transformation. The stuff that you guys take for granted, even for your local deli, hasn't happened in the senior housing business, right? So those are the kind of stuff that we're talking about.
Nothing rocket science, most of it with very basic technology transformation, just hasn't happened in this business. So that's what we are going through. Frankly speaking, as we are optimizing our own product and own portfolio, we're reloading the gun, buying broken assets at a significant discount to replacement cost. So that's what we're doing, and we have a balance sheet to support that. But if you just put all of this together, you know, what are we trying to achieve is very simply, you know, most real estate companies over a long period of times are not long-term compounders. Some of them are, but many of them are not. And I think this, well, after many, many years of tremendous hard work, we think we have positioned this company to be a very significant long-term compounder.
That's what the bottom line is.
Then maybe just turning to operators for a bit. There's a bifurcation in performance between your various operators. What have the better ones done to, you know, manage labor and other expenses while also driving revenue? You know, is this based on factors like acuity, geography, or is it culture within the operators?
Yeah. So we, there's a-
... John, your mic might not be on.
I don't think we have-
Yeah, I don't think we have an on button. Oh, there you go. Now it's on. Sorry. Anyway, there's a difference in how they approach the business, how they look at it. The highest level operators are really focused on the customer experience, employee experience, and then trying to figure out how to optimize that and ultimately drive value. So they're gonna look at the processes at the sites, just like I do, and say: Okay, how do we optimize this? How do we ultimately make it work best for the customer, but at the same time, drive value down to the bottom line? Which oftentimes there's things in the business that are old school, you know, how they're set up, whether it be receptionists at front desk and these types of things that can get shifted to improve the efficiency.
There's no reason to have vendor calls going through a receptionist instead of to the maintenance team, or sales calls going through a receptionist instead of directly to the sales team. So there's changes that are made, and we're with them all the way, all down the way to help enlighten them on some of the opportunities and help them roll this stuff out.
Maybe to that end, John, and I, I realize you can probably only keep this high level as opposed to offering, specifics, but can you maybe highlight any of the initiatives that you've done on the operating side that has helped your partners staff up some of these facilities?
Yeah. You know, when you say specifically staff up, so there's a lot of initiatives, but to staff up, there's old school way of looking at labor as being a you know, a abundance of labor, and in reality, that's not the case. And so we look at it and say, the sales funnel that you would have for a customer is the same that you have for labor. And so changing the way people look at labor from staffing perspective, and how you respond to top people, the best people that apply for jobs, you have to answer the phone right away. You have to respond right away. It's, again, it's a sales process.
If you wait, like a lot of people do, they let the resumes pile up, the good people are gone, and you're left with something less than that. So really helping them to understand how to compete in the modern world for the best talent, and helping them work through systems so they get that set up so they can respond rapidly. You know, there's a speed to lead concept in sales. It's the same speed to lead concept in staffing. And those that have done it have had fantastic results, truly fantastic results. Shocking. And those that don't, you can see it.
Then maybe just on touching on occupancy for a bit. It seems like the narrative a few years ago was this post-pandemic bounce back in occupancy, which was driven by pent-up demand. But, you know, based on the absorption trends we've been seeing that have been, you know, pretty strong for the past couple of years, it seems like that's going to be expected going forward. So is this expected growth in occupancy a function of demographic shifts finally kicking in from a demand standpoint and limited supply, or are there other factors at play?
If you look back on our earnings call transcript, you will see that I have said it for years, that I don't believe there's a thing called pent-up demand in senior living. You need the product when you need it, and if you don't find it, or you find other ways to satisfy it or not, right? So you just maybe got six months of pent-up demand, three months of pent-up demand, nine months of pent-up demand, but there's no concept of pent-up demand for a longer period of time. Fundamentally, it's just the demand supply. I mean, you got no new product coming to the market. You got an aging population, so it's not that more complicated than that, right? So within that, obviously, there's a question of market share, right? So that's a different conversation, but overall, system occupancy is increasing for everybody.
It's just a function of there's more demand than supply.
At what point do you see supply starting to come back? I mean, obviously, the financing markets are holding it back and everything else, but the forward demand is very much there, so you would think it would attract capital eventually.
Now, you are trying to ask me to speculate. So I will give you an example, that we just went through a recap with one of our joint venture partner. We had handful of development assets or lease up or development loans on, and you guys understand our balance sheet and the strength of our balance sheet and the amount of cash we carry on the balance sheet. The lenders, U.S. regional banks, refuse to roll that loan for Welltower. That tells you what happens if you are just a developer, right? We'll tell you, we have worked on development projects in places like Cupertino. This is like the prime most location in Boston. Seven years fight, we finally got it. We updated the model with 4 plus 350, 400, and the model blew up, right? Cost of construction is 50% higher.
Cost of financing is, you know, where it is today. Forget about for a quick second that whether you can get it or not. Even in locations like Cupertino, we can make it work. So... And it's not because we have high cost of capital. Market capital cost is what it is. And, so that sort of tells you that senior development in senior living is just not an economic venture. Majority of the products that if you look at traded in last three years, they traded at 60-70 cents on the dollar. Why would you build something for a dollar and unless you can make a profit, right? So I think, you know, who knows what's gonna happen in the future, but we know that equity and debt both are not available today. What we also know that the senior living-...
You know, development platform that have been built has been dismantled. You know, any of the names that you know, I'm not gonna get on this call and tell you, like, the names. I don't want to personally be insulting to people, but a lot of people developed a lot of product last, you know, cycle that just have never leased. Those people have no work, so theirs have been dismantled. So first, you need to see the formation of human capital. Once formation of human capital happens, that if you actually have financial capital, then you're gonna see for an average location for us is a 2-3-year pre-development work. I'm talking about an average suburban New Jersey, suburban Seattle kind of location. I'm not talking about West LA, Manhattan, you know, center of Boston, Brookline, not that kind of location, an average location.
And you need to in a couple of years of construction. So it feels like it's probably it's too late to get a development cycle as far as this decade is concerned. What happens after that? Who knows?
How do you think that plays into capital flows into the space from acquisitions, either IRR or discount to replacement cost?
understand the history of capital in this space for the last 10 years is very, very bleak, right? Owners haven't made money in the last 10 years. You've got a huge supply cycle, which was the problem. Then what you got is COVID, where, you know, your NOI fell 40%, 50%, something like that. As you were just trying to recover from it, your underlying rates went from 3.5%-4% to 8%-9%-10%, right? So you got hit in every possible way. And, on top of that, loans in senior living, majority of, if not all of them, have personal guarantees or they're to Freddie, Fannie. You know that you can't default on Freddie, Fannie and ever be loaned money again.
So there is a lot of issues, structural issues of what happened in the last 10 years. And, you know, markets don't change. They have real memory of, this is the asset class. I don't know one asset class where people have lost more money in the last, say, 5, 7 years than senior living, and that's not gonna change. I mean, put office aside. Okay, I don't know much about office. I don't want to comment that. I'm just saying this has been an area where people have lost a lot of money, so institutional memory is like, you know, your bank is not gonna loan to a senior housing acquisition. Just not gonna happen.
Shankh, you've been very vocal in the past about bringing in talent from industries with high standards. You know, with that, John, you know, you continue to grow and invest in the operating platform. How has your experience historically as a multifamily operator been applied, and how can you best capitalize from your previous knowledge from multifamily, and apply it to the growth opportunity you see within senior housing?
You asked John, so he will answer the question. I can't answer you. I will just tell you that I'm disgusted by the low standard of senior living business, right? What's acceptable and the excuse culture of this business, it just blows my mind. So which is why I made the comment that, you know, I only bring people from industries of high standards, and he's the best of them all.
Yeah, so you're saying, you're asking how my prior experience applies, I guess. Ultimately, you know, there's a lot of crossover, right? They're residential properties. There's also business crossover, just basic standards, basic mathematics, bringing a new look at the world, looking how we've... Again, I keep saying, but focus on the customer experience, focus on the employee experience. You didn't hear that talked about very much previously. People do focus on care, which is critical, and that is the number one item, that the service, the product that we provide, our properties provide, but the other aspects of it are important as well. So bringing that to the table, I think, has been quite beneficial. Building a team that has experience from multifamily, from hospitality and other areas is also very beneficial.
Of course, our product type touches the residential, it touches the hospitality side, and then, of course, care as well. So bringing that all together and getting experts is driving results. And you had a second question. I apologize. I forgot what that was.
No, it was just kind of the long-term growth trajectory that you see in senior housing. I believe in the past, you've compared it to what multifamily was like back in the seventies.
Yeah.
So just kind of taking that prior experience and applying it to your role today.
Yeah. I mean, Tim obviously gives guidance, so I don't give guidance, but to comment or to, you know, to go back on my prior experience, yeah, I see huge opportunity in the margin of this business because we're just at the very beginning, not at the end, of really looking and saying: How do we optimize every aspect of this business to drive greater value to the customers? And in doing that, that will dramatically improve the margin. I've mentioned comments like revenue management, which, to be very clear, what I'm speaking about in the base is just properly pricing units. If I have a unit that has a drop-dead view of a lake, why is it priced the same as a unit with a garbage dumpster view? That's just fixing that. That's not anything else beyond that.
There's just basic things like that. There's numerous other aspects. I've commented publicly about the marketing cost, you know, almost 3% of revenue, and in the multi-world, it's closer to 60 basis points. The sales process is different, but on the marketing process, you're bringing in leads. So why is it so expensive, and what are the opportunities to solve for that? There's just a lot of different pieces that can get fixed that are pretty exciting. It's a lot of exciting to me, I should say. I think for most everyone in this room, it'd bore the heck out of you, and you'd just go, "It's time to go get a drink." But the reality is, these are just, you know, blocking and tackling, nuts and bolts and just going after it.
... Not just you. You look at this and just say, comparing to other industries, what it can be. We look at our portfolio, look at our best operators, and look at their occupancy and margins, which are substantially higher than average, right? So you don't have to be a rocket scientist to figure out, you know, can we get the whole portfolio there? It just, what you need is a real digital transformation of this business, real processes, real systems, so the outcomes, the realm of outcomes, are just not this wide. So, you know, we're making a lot of progress, but we think we have a long ways to go, let me say.
Shank, where do you think margins can get to in the portfolio over a long period of time?
I have been doing this for a long time. You're not gonna get me answer that question.
All right.
But, uh-
I had to ask.
We can help you think about that. Just understand that, assuming there's demand, put that demand, supply question aside, frictional vacancy is a pure financial calculation, depends on what's your turnover and how quickly can you turn a unit, right? So, you know, what's the basic standard of in our industry of how long it takes to turn a unit versus what John and Jerry are used to? Let's just say that's a fraction. So if there is demand, we're not gonna, you know, in this question, we're not addressing the demand supply question, which we talked about. You guys understand that. Then frictional vacancy should be a lot lower than historically it has been. So you should be able to fill your product. That alone changes sort of your, what your margin should be. We have the opportunities of rate.
We're also, you know, let's get into not think about the opportunities of amenity-based pricing, right? In a senior living building, usually all the units are priced the same. I actually have examples in my portfolio in places like Manhattan and Boston, as you go up, the price come down. I've never seen anything like this in my life. That's how this business operates, right? Everything is sort of on a yellow postage. People sort of do what feels right. So, you know, there are many, many examples of that. You know, we'll be talking for next two hours if John starts to give you example of some of the stuff we have seen. But those are the things that we are fixing, and we think there is future. There's a lot, not human future.
There's a lot of margin opportunities as we get these buildings full and as we provide a value proposition that the customers like, and they're willing to pay for it. But margin question in this conversation is much less about cost. There are significant cost opportunities, and those that I call the dollar bills, right? We'll take dollar bills, but the revenue opportunity is 20 dollar bills. That's what we are after.
Maybe just a question on the data analytics platform. You've obviously highlighted your investment in it. It's pretty integral to the growth strategy going forward. I was wondering if you can provide any examples of the way this investment has enhanced your portfolio quality and been able to improve margins?
We have provided examples. There is a slide on our investor deck, at least used to be, probably still there, that our data analytics, our Chief Data Officer and Chief Data Scientist, they came to us two years ago and said, "You know, these guys predict rent, and they're extremely good at it. What should be the rent in a given location?" And they got very, very good at it. So there was an example of six buildings that were run by an operator, and they said, "You should get, if you move it to an operator A from operator B, you should be able to get 20%+ higher price, right?
Just the changing the, you know, service model." And we said, "Okay, well, let's try." I think we have given update every quarter on that portfolio, 6 buildings, not gonna change our lives. But we have gone in those for that portfolio from 63% occupancy to low 90s occupancy, $1 million of annualized EBITDA to $17 million of annualized NOI. It's just an example. I can give you many, many examples. We think most people misunderstand real estate as a business, right? You will hear in this conference that real estate is a business of location, location, location. We fundamentally reject that idea. We think real estate is a business of location, product, price point, and then our business is a fourth dimension called Operator-as-a-Service model. And it's an optimization game, it's not a maximization game.
You will see that tremendous amount of variability in the same location, depending on the product, right? Product in our business could be, is it IL? Is it AL, right? That's one product. Is it studio? Is it one bedroom? Is it two bedroom? That's another way to think about product. So depending on location, product, obviously, price point, and the operator overlay, it could change your outcome as much as 30% on the bottom line, NOI. So that's what we use. This is a good example of that's what we use, and many other things using that platform.
Shank, it feels like in our investor conversations broadly, the main pushback is the stock is expensive, right? So it's from a multiple perspective, it can be relative, sometimes it'll be NAV, but ultimately, right, if we're thinking about kind of new investors to the stock, everyone says, "Okay, senior housing looks great. Welltower has done very well. The stock is expensive right now." You've talked about compounding cash growth, you've talked about not wanting to give that multiple away or that cost of capital away as a buyer, right? So you've been disciplined there. But how do you address that kind of pushback, right? I mean, I recognize it's a good problem to have, but ultimately, to attract more capital, how do you think about kind of that relative valuation or even absolute valuation?
... It is not my job to address what multiple my stock should trade at, right? So I don't address that question. But if you really want to, I'm an investor, I'm not a deal junkie. If you really want to get into a conversation with me on valuation of a company, I will tell you that go run an IRR model or do a DCF model. You'll come to the conclusion yourself, right? So the, it's a lazy way to look at a company's stock on near-term multiple, particularly for a compounder that's compounding, you know, rate forever and really bottom line, finally, in a big way, you are making a, if the stock is expensive, you are implicitly making a call that this company is close to its, you know, stabilized occupancy.
And if that's, that's your view, that the frictional vacancy of this business is close to where it should, where it is today, then you're right, it is an expensive stock. If it is not, the conversation is, if we, if we think we can take the frictional vacancy into a much lower level, then the stock is really cheap. That's your call. That's just not my call, right? I know what I would do is very simply, I look at what I buy and sell. If I sell the stock to buy properties, I do it for the same calculation. What I think is the frictional vacancy is, and what I think the margins can get to in this both cases, apply same amount of CapEx, depending on the age of the property and everything, and say, is there an IRR trade between the two?
Under the same assumption, which is in our case, we never assume that, you know, exit rates will be lower, we'll get a higher exit multiple. We have to make the IRR entirely on the cash flow. And under the same assumption on a daily basis, if it looks like that we can buy something to, by, you know, obviously issuing the stock or issuing, selling another asset, we'll do it. If not, we won't. That's just as simple as it gets. But you cannot think about the way you think about an apartment company for Welltower today, or just pick any. I don't know all these companies you guys cover, but it seems like majority of them are close to that stable occupancy level. You can't do that, right?
Think about the majority of the profitability in this business is after 80% occupancy, right? You break even at 60, your toughest point in the margin sort of equation is when you are 80%, 82% occupied, because that's where you're fully staffed. And your incremental margin goes hockey stick from there. You have to think about, like, you think about an industrial company, not industrial real estate company, an industrial company, right? So it's an incremental margin question. So how far that incremental margin goes, depending on how far do you think occupancy could be pushed and how far do you think rates could be pushed. So it's just a question of you're making an implicit bet, whether you are, you're bullish on the stock or you're bearish on the stock. You're making an implicit bet on a simple fact, which is: What's the frictional vacancy?
I think that's what most people don't understand.
Shankh, as a capital allocator, you've talked about finding opportunities up and down the capital stack, both in terms of discount to replacement costs and unlevered IRRs. We have this wall of debt maturities coming due over the next two years that you've talked about many times. How best can Welltower capitalize on these opportunities? And what does the pipeline look like in the year ahead?
Nikhil, you want to take that?
Yeah, look, I think, the pipeline, as Shankh mentioned on the call, you know, we've been busier than we ever have, right? I mean, usually what you see is transaction activities pick up in the back half of the year, and you close a bunch of stuff, you know, as folks are looking to start afresh into the new year. And so then usually it takes a while in the first and second quarter to find incremental transactions, negotiate, and you start to see things closing in the back half of the year. This year is not the same. This year, a lot of the counterparties that we transacted with in the back half of last year, we're in conversations with them to do incremental transactions. So we're busier than we've ever been. And-
Sorry, is his mic working? I can't really... Okay.
Too far?
Maybe, yeah, mine is... Yeah.
All right.
Sorry about that.
That better?
Yep.
So just to quickly catch you up on what I said, that, you know, this year started off busier than most years have, and a lot of that is driven by repeat activity with folks that we transacted with in the back half of last year. And, you know, from a opportunity set perspective, you've got roughly $16 billion of seniors housing debt coming due in the next two years. And, from a, you know, recapitalization perspective, you know, Fannie and Freddie have provided roughly $1.5 billion-$2 billion a year. And so obviously, there's not enough there to recap the debt that's coming due. We've all talked about regional banks not wanting to put out an incremental capital. So there is a massive gap between the capital that's needed and the capital that's available.
And similarly, on the equity side, there is, Shankh mentioned this before, folks have not made money in this business for the most part, and so there is a fair amount of hesitancy, even if you, you know, can transact without debt, there's a lot of PTSD for equity, and equity is not coming back anytime soon. So we're in a unique spot where we have found a way to make money in this business. We have access to capital, and we're able to, you know, cherry-pick assets in markets where we have a lot of conviction, in markets where we have assets that are performing really well and name our price. If that price works for the sellers, we transact. If not, we move on. But the opportunity set continues to be overwhelming, and the opportunities are great.
And Nikhil... Oh, sorry, Shankh, are you gonna say something?
No.
Nikhil, maybe sticking with you. When you're looking to underwrite new investment opportunities, how have you seen return hurdles change? And do any of the property types, be it wellness, housing, IL, AL, or SNF, screen more attractively now?
... Yeah, look, I think our focus continues to be, as I look today at the pipeline, it's essentially all seniors housing. You know, we had a large transaction in the wellness space that was really five years in the making. And so, you know, there's been a lot of conversation about that, but there's just not that much product to acquire in that space, and this one took us five years to unlock. From a return expectations perspective, you know, what you've had is, we're buying assets at $0.65-$0.70 compared to replacement costs. We're buying them pretty close to debt value. But what you've had happen is, as the industry performance has improved, you know, at the same basis, when two years ago, the industry occupancy was 70%, you were getting no going in yield.
Today, you're, you know, at a 6, 6.5, high 5s, depending on what specific asset you're looking at. But because of the recovery in the industry, your going in point is much better. And but, but from a discount replacement cost perspective, we're in a pretty similar place. And so you put all that in the blender to calculate the IRR. We're not assuming any cap rate compression. We're assuming cap rates are in line with where they are today. We're not assuming, you know, performance beyond a pandemic recovery. We're not assuming, you know, John Burkart adding any incremental value. And despite all of that, in seniors housing, you were able to hit, you know, 10, 11% type of unlevered IRRs. And, and, you know, then you asked a question about SNFs. You know, there were credit investors.
There, the thinking is we need multiple layers of protection. We need to be in the right state, the right basis, and in addition to all that, have the right operator and incremental credit protection beyond what's available in the confines of the deal. So incremental guarantees from individuals, from entities, it's a true credit investment.
Maybe just a question on the balance sheet for Tim. You've done a good job managing the balance sheet, obviously, you know, bringing leverage down to about 5x from about 6.5x a year ago. Is the plan to maintain leverage at current levels or reduce it further? And under what circumstances could you look to take leverage higher again?
Yeah, so leverage will continue to come down just because of the natural recovery in NOI, it's going to occur. So both from... You know, I think the consistent theme is we think there's tailwinds that continue to bring NOI back to where it was pre-COVID. And, certainly beyond that, over the coming years, given all the reasons we kind of talked through today. So with that, you'll see my cash flow coverage perspective, so debt to EBITDA, fixed charge, et cetera, you'll continue to see better metrics going forward. And I think, as I said earlier, I don't think it's a question of what would, what would make us bring leverage back up.
I think it's just what the balance sheet being in the right spot allows us to do, is make the right decision for what's gonna drive long-term value, whether that's access to equity capital or debt capital. It means that all options are open, and that's why we've continued to kind of approach investments with the discipline we've had as far as how we've funded them.
Great. Well, if there are no other questions from investors, I've got my three rapid fire to end the session. What is the best real estate decision today: buy, sell, develop, redevelop, or pause?
Buy.
What is the expectation for same store growth for 2025 for the SHOP industry overall?
Not gonna answer.
Will there be more, fewer, or the same number of publicly traded healthcare REITs a year from now?
Same or more.
Great. Thank you very much.