Improvements in senior housing fundamentals for Welltower (NYSE: WELL) are creating a “strong setup for 2023,” according to CEO and Chief Investment Officer Shankh Mitra.
Specifically, Welltower’s senior housing operators demonstrated historically strong pricing power in Q3 2022, and Mitra is even more excited about positive workforce trends.
“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,” he said Tuesday on the Q3 earnings call for the real estate investment trust (REIT).
In addition, Mitra is “excited to no end” by opportunities created by current capital market conditions.
Welltower also announced the creation of a new joint venture with Integra Health, to transition 147 skilled nursing assets previously operated by ProMedica. This deal resolves concerns related to coverage on these properties and increases rent paid to Welltower by about 4%, with ProMedica also contributing nearly $500 million in a working capital consideration.
While still not happy with where margins stand today, Mitra and other Welltower executives conveyed a bullish outlook, as have other senior living leaders in recent earnings calls. And investors seemed pleased by Welltower’s recent progress and the forecast for 2023, with shares trading up 8.22% at the end of regular trading Tuesday. This was despite fourth quarter guidance for normalized funds from operations (FFO) of $0.825 per share being below analysts’ consensus of $0.84 per share, as BMO Capital Markets analysts pointed out in an investor note.
Historic senior housing data points
Headwinds blew in Q3 2022, including interest rate and utility expenses, but Mitra singled out a few positive metrics to showcase improving senior housing fundamentals.
In the seniors housing operating (SHO) portfolio, same-store revenue per occupied room (RevPOR) increased 5.3% year-over-year, representing the best growth in Welltower’s recorded history.
At the same time, a 4.3% year-over-year increase in compensation per occupied room was the lowest level of growth since the start of the pandemic.
As these dynamics imply, net operating income (NOI) is trending strongly in the right direction, led by a 25.1% same-store increase for SHO assisted living assets. Overall, U.S. SHO communities posted 20%-plus NOI growth in the quarter.
With expenses up 3.7% year-over-year in Q3, margins expanded 130 basis points.
These trends should continue into the fourth quarter and 2023, Welltower’s leaders believe.
On the pricing front, Mitra pointed to the fact that market rents have been rising faster than annual rates for the first time in about a decade. And he emphasized that “pricing power comes in many forms and substances,” including from improved occupancy rates. As more communities reach and surpass 80% occupancy, their pricing power will increase.
“As we get into that environment more and more, I believe that you will see sustainable pricing power,” he said. “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.”
The good feelings extend to the labor situation. Mitra described a “significant surge” in applications across the operating portfolio. In September 2022, total portfolio contract labor was at its lowest level since August 2021, and numbers improved further in October.
“We believe this trend will continue into year-end, outside the normal pickup [in] agency use during the holiday season, and well into the next year,” he said.
Oakmont Senior Living is one Welltower operating partner achieving gains. Across the Oakmont platform, open positions ran to 16% of total jobs over the summer, but that figure is now down to the low single digits. Mitra also touted improvements at 10 California assets that transitioned to Oakmont in August.
“These assets have experienced a slight increase of NOI and occupancy despite challenges that are normally incurred during a transition,” Mitra said. “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.”
A softer labor market coupled with rate increases should be reflected in improving margins, particularly considering that labor accounts for 60% of total expenses, Welltower COO John Burkart noted. Welltower’s pre-pandemic operating margin was roughly 30.8% across the portfolio.
The promise of strong margins was one reason why ProMedica retained its 58 Arden Courts senior living properties, even as the health system agreed to give up its 15% stake in the 147 skilled nursing facilities that are being transitioned to a new JV between Welltower and Integra Health.
In fact, Mitra said he would “venture a guess” that the senior living assets will post the strongest margins across all of ProMedica’s businesses.
Executing on the operational improvements to drive margin in the SNFs will be left to Integra and regional affiliates, which will sublease the former ProMedica properties. This is unlike the Welltower senior housing portfolio, where margin improvement will not only be tied to higher occupancy and normalizing expenses but to operational efficiencies that Burkart’s team is focused on identifying and implementing.
“There’s no question that they are significantly better in the skilled nursing business than we are and will ever be,” Mitra said, referring to Integra. “ … Think about it from an op standpoint; we think we understand operations of senior living, the wellness housing business as well as MOB business.”
The first module of a tech-forward senior living operating platform developed by Welltower is slated for a pilot in early 2023. Burkart and Mitra said assisted living has more obvious upside from a margin standpoint than independent living. But “the whole business is going in the right direction at this point in time,” Burkart said.
“One of our operators that has very high occupancy, in the 95% [range], actually had expenses going backwards,” he said. “And so you see some tremendous margin improvement there. The whole portfolio is going that way.”
Turbulent capital markets
Capital markets are in a period of “historic volatility,” with “every part of the yield curve inverted right now,” Mitra observed.
“One approach for us would be to ride out the storm in a shelter and do nothing,” he said. “But those of you [who] know us well know we’re unlikely to do so.”
Indeed, Mitra said the current capital markets environment “excites me to no end.”
As an unlevered IRR buyer that underwrites significant cap rate expansion at exit and is “unrelenting” in focusing on relative replacement cost, Welltower is not bothered by interest rate increases and is positioned to continue its investment strategy, he said.
“We maintain a fairly favorable capital position and a war chest due to our extremely talented capital markets team under the leadership of Tim [McHugh],” Mitra said. “Despite our unfavorable public cost of capital on a spot basis, today, we have no dearth of global institutions who want to partner with us.”
Welltower is eyeing overseas markets in particular, with the United Kingdom especially attractive due to the strong dollar.
“I have never seen U.K. opportunities as cheap as [they look] today for the U.S. dollar investor,” he said.
Welltower has $301 million of cash on the balance sheet and roughly $3.8 billion of available liquidity, Stifel analysts pointed out in an investor note issued Monday.
“Our capital allocation team on both sides of the balance sheet is poised to pounce on this great menu of opportunities, which the most volatile interest rate environment in four decades has put in front of us,” Mitra said.
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