Senior living expenses rose sharply in the third quarter of 2021, but operators working with real estate investment trust Welltower (NYSE: WELL) also benefited from historically strong revenue growth, and they are driving rate to keep margins in check.
In fact, Welltower posted the strongest sequential revenue growth in the company’s history last quarter, with rate and occupancy increases resulting in a 3.5% rise in same-store topline revenue.
“Despite mediocre bottom-line results, we cannot be happier with the overall results of the quarter,” CEO Shankh Mitra said Friday on the Toledo, Ohio-based company’s Q3 2021 earnings call.
Looking ahead, Mitra is even more bullish, seeing signs that labor challenges are easing and the overall operating environment is improving, which bodes well for longer-term financial performance. Welltower plans to achieve additional gains through an effort, led by recently named COO John Burkart, to “modernize” operations.
“It is my firm belief that our margin will be higher than the pre-Covid margin, on a stabilized basis,” Mitra said.
Welltower’s leaders also are excited about maximizing the upside of new investments, including four senior living portfolios that the company recently acquired for $1.3 billion. The REIT has a strong pipeline of additional senior housing opportunities, and Mitra foresees that the current aggressive investment period will last even longer than he initially anticipated.
Welltower already is the largest senior housing owner in the United States, with more than 780 properties in its senior housing operating (SHO) portfolio and about 350 in its triple-net portfolio.
Expense and revenue tug-of-war
The senior living expense stack was hit by “a perfect storm” in Q3, Mitra said on Friday’s call.
The “confluence of extraordinary costs” included rising expenses in labor, insurance, utility, repair and maintenance, and other areas, he said.
Labor headwinds have been particularly forceful across the U.S. economy, as workers left their jobs in droves over the summer, while wages have been spiking and labor unrest has been building.
Within senior living, additional labor complications arose. As the delta variant caused a surge in Covid-19 infections outside of senior living communities, workers more frequently called in sick — either because they tested positive or out of caution, if they were even mildly ill, Mitra said. And, senior living staff were logging more paid time off than usual, eager to take advantage of easing travel restrictions after more than a year of exhausting work.
Consequently, many senior living providers turned to agency labor, which costs two to three times as much, Mitra noted.
“We have seen some operators where contract labor cost has gone up 10x in six months,” he said.
The rise in contract labor resulted in a $9 million SHO impact in the quarter, Welltower noted in its earnings release. The SHO margin dropped 50 basis points sequentially to 21%.
But while expenses were a severe drag, topline performance was strong, thanks to the “dual benefit” of occupancy and rate growth, Mitra said.
SHO same-store revenue increased 3.5% sequentially; and for the U.S. and U.K. portfolios, year-over-year revenue growth turned positive for the first time since the pandemic started.
In the U.S. SHO portfolio, occupancy growth was “solid,” increasing 260 basis points sequentially, BMO Capital Markets analysts noted. Overall, SHO portfolio spot occupancy increased about 210 basis points sequentially, to 76.7%.
Consumers recognized that high resident and staff vaccination rates made senior living communities safe havens, driving demand even in the midst of the delta surge, Mitra said.
Furthermore, the rise in single-family home values and the strong performance of the stock market are providing older adults with the purchasing power for a senior living move, even in the midst of an inflationary environment. And in light of the pandemic, consumers also are more focused on the quality of care and services and shopping less on price, Mitra said.
Welltower’s senior living operators are therefore aggressively increasing rates. They are in the process of enacting annual bumps for in-place residents, but they are also touting the strength of their service offerings to drive rates for new residents, and the “street” rate is generally moving up 1.5x to 2x faster than the “renewal” rate, Mitra said.
The full benefit of rate increases has not yet been realized, as the renewal rates typically take effect after the first of the year. So, Welltower’s leaders are anticipating further momentum in the first quarter of 2022.
Storm gives way to green shoots
Mitra and other Welltower execs are not only optimistic about rate growth but are hopeful that the labor crunch is easing, as enhanced unemployment benefits have been phased out, the latest Covid-19 surge is dissipating, and in-person school has resumed.
“Although I expect we will still see some continued pressure for several months, I’m hearing green shoots as our operators are making comments such as, ‘the peak labor challenge has passed,’ or ‘we’ve seen a substantial pickup in applications,’ or ‘new hires outnumber the employees leaving 2.5 to one,’ and even ‘we’re currently fully staffed at almost all of our communities,’” Burkart said.
Demand also remains “unprecedented,” judging by October and early November sales trends.
“We have never seen this kind of momentum, that’s all I’m willing to say,” Mitra commented.
Mitra and Burkart are planning to build on these tailwinds by pursuing operational innovations. Burkart joined Welltower as COO in June 2021, coming from multifamily REIT Essex Property Trust (NYSE: ESS).
“While the focus on care has been and continues to be very high, I believe that similar to the multifamily industry 20 to 30 years ago, there [is] an opportunity to modernize our seniors housing business and improve the effectiveness and efficiency of the operations,” he said.
Though tight-lipped about his plans, he identified targeted community renovations, digital transformation and revenue management as areas of focus.
As one example, he described leveraging Welltower’s data analytics to evaluate how a market has priced certain types of units over time. Applying this approach to one highrise property revealed “substantial variations in demand versus pricing” that is leading Welltower to change prices on certain units by as much as $1,000 a month.
Torrid dealmaking pace continues
In conjunction with its earnings release, Welltower announced acquisitions of four senior living portfolios, representing a pro rata investment of $1.3 billion. These are just the latest transactions in a remarkably acquisitive period for the REIT.
With marquee deals such as the $1.6 billion purchase of 86 Atria Senior Living/Holiday Retirement properties, Welltower has completed $5.6 billion in gross investments since October 2020.
Mitra elaborated on some of the latest senior housing additions during Friday’s call.
One deal involved 14 communities operated by Tucson, Arizona-based Watermark Retirement. Welltower anticipates achieving a double-digit unlevered internal rate of return (IRR) on this deal by executing a “higher and better use strategy,” Mitra said.
In other words, these communities are located in desirable micromarkets and present opportunities for strategic expansion or repositioning. For example, one community in the Bellevue, Washington area includes a piece of residential-zoned land where Welltower could develop a vertical senior living or wellness-focused property; or, the REIT could sell the land to a multifamily developer.
Such a real estate value-add strategy is enabled by the addition of Burkart and the hire of Mike Ferry as SVP and head of global development. These leaders and their teams have brought the needed expertise to Welltower, which has struggled in the past to execute on these types of opportunities, Mitra said.
Another of the new acquisitions involves five communities in the Mid-Atlantic and Southeast, with an average age of three years. Mitra said that Welltower will in the future disclose the identity of the “extraordinary” operator and developer of the communities.
“Here is a teaser — this team has executed flawlessly even during this challenging Q3 without any agency labor. That gives you a sense of their operating prowess,” he said.
Dealmaking at the moment is largely being driven by sellers coming up on debt maturities, so they prize the certainty of a close highly, Mitra said, noting that Welltower can execute these types of deals with speed and certainty, thanks largely to its data analytics capabilities and the company’s roster of high-quality operators.
The third-quarter labor challenges have caused a significant number of owners to seek an exit from senior housing, continuing the churn that began during the pandemic, according to Mitra. The conditions continue to be ripe for Welltower to execute on its investment strategy of acquiring in the right micro-markets with the right operators and at the right discount to replacement cost.
“I remain very optimistic that this trend of acquisition at these kinds of prices will continue — frankly, longer than I thought,” Mitra said.
And, Welltower certainly has the dry powder to keep executing deals, as Stifel analysts noted.
“With $303 million of unrestricted cash on the balance sheet, $4.0 billion of availability liquidity (WELL just expanded credit facility), and no material senior unsecured note maturities until 2024, WELL’s liquidity position is very strong. We assume that the cash will be redeployed into acquisitions over the next year or two,” they wrote.
Mitra’s optimism in the midst of current challenges seemed to resonate with investors on Friday, as the REIT’s share price climbed 5.32% to end the day at $84.64.
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