Welltower Inc (WELL) — Q2 2015 Earnings Call Transcript

Thank you, Holly. Good morning, everyone, and thank you for joining us today for HCN’s second quarter 2015 conference call. If you did not receive a copy of the news release distributed this morning, you may access it via the company’s website at hcreit.com. We are holding a live webcast of today’s call, which may be accessed through the company’s website. Before we begin, let me remind you that certain statements made during this conference call may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although HCN believes results projected in any forward-looking statements are based on reasonable assumptions, the company can give no assurance that its projected results will be attained. Factors and risks that could cause actual results to differ materially from those in the forward-looking statements are detailed in the news release and, from time to time, in the company’s filings with the SEC. I will now turn the call over to Tom DeRosa, CEO of Health Care REIT. Tom?

Thank you, Jeff, and good morning. One of the things I'm excited about coming to work every day is that HCN is part of a solution to a big problem. Today, healthcare delivery is faced with a mandate to drive down costs and deliver better outcomes. It sounds like a great idea, right? As they say, easier said than done, this mandate cannot be met unless we can drive patients from acute care hospitals into lower acuity settings. You may have seen Mount Sinai hospital’s ad in last week’s New York Times that stated, 'If our beds are filled, it means we fail.' What does that mean? It means that one of the top hospital systems in the world recognizes that their old business model is not sustainable. If they, like many hospitals, continue to bear low acuity, uninsured, and cognitively impaired elderly patients, their historic business models simply won’t work. Better real estate solutions are needed. In many of the metro markets of the U.S., the UK, and Canada, where our company is concentrated, we simply do not have adequate post-acute and outpatient care for the broader population and senior care communities to keep our aging population well and avoid unnecessary hospital stays. HCN has established itself as the preeminent capital partner to drive the most effective healthcare real estate solutions. I’m proud to announce that one of the largest and certainly most respected real estate investors in the world has chosen HCN as its partner to establish its initial investment position in healthcare real estate. The Canada Pension Plan Investment Board, commonly known as CPP, has entered into a joint venture partnership with HCN to acquire a superb portfolio of medical office buildings largely located in the famous Golden Triangle of Beverly Hills, California, one of the most valued locations in the world to hold any category of real estate. While nearly all of our new investment volume this outstanding opportunity was sourced not from a broker-led auction, but from an existing relationship that was looking for liquidity and saw the benefits of taking HCN shares. CPP’s decision to co-invest in this portfolio underscores the high institutional investment grade quality of the real estate and further validates the unique investment proposition that HCN offers to our shareholders. We are excited to welcome CPP to the HCN family.

Thank you, Tom. I’m pleased to report accelerating internal growth with same store earnings up 3.2%. The operating portfolio in the U.S. led the way with outstanding 5.2% same-store growth in the second consecutive quarter. Our footprint is paying off. For years, we targeted large metros that have superior growth in population, jobs, and housing values. Today we have 8% market share in the top 10 MSAs, compared to less than 4% share in all other markets, clear evidence of our concentration in large markets. The big metros are more transparent, more liquid and deliver better results. Our same-store growth in large markets continues to be substantially higher than our smaller markets. Modern physical plans and premium operating partners further differentiate us. Shifting to the operating portfolio in the UK, until this year it’s been tremendous growth -- with double-digit same store growth. The severe flu season this year caused a big spike in move outs and a decline in earnings. Census is moving back up and we expect strong results in the UK to resume within a few quarters. Same store earnings in the overall operating portfolio were 3.3%. Rental rates were up 3.2% and occupancy increased by 10 basis points. Move-ins continue to be strong and move-outs have normalized, setting a stage for census to move higher. To that point, occupancy is up 60 basis points since our earlier May earnings call. Triple net senior living continued its excellent performance. Same-store earnings were up 3.4%. The superior growth was driven by active asset management, in particular, the Merrill Gardens properties that we converted to a lease with large escalators and the CCRCs that we converted from entry fee to rental. Moving to development, we’ve opened 22 properties in the past two years. They are 700 basis points ahead of underwriting on occupancy and $7 million ahead on NOI. Meanwhile, new supply in our local markets measured as a percentage of existing inventory is less than half the number provided by NSG. We’re also seeing and hearing about 10 plus percent increases in development costs since the beginning of the year. This should help to limit new supply. Turning to post-acute long-term care, our rental income is growing consistently. Same store earnings were up 3.1%, payment coverage was flat and remains at secure levels. Next up is outpatient medical, where again the takeaway is steady, predictable growth. Same store earnings increased 2.6%. We’re seeing minimal new supply and growing demand for outpatient services. Digging deeper, our asset benchmarks favorably on key indicators like occupancy, age, hospital affiliation, lease rollover, and NOI per flip. These assets are poised to deliver steady earnings growth for years to come.

Thanks, Scott and good morning everyone. You just heard Tom and Scott talk about our recent investment success in an environment where there is greater uncertainty about our cost of capital due to recent pressures on our stock price and the future direction of interest rates. So from a financial perspective, how do we balance your desire for us to be more prudent in the current environment, with the hope that we continue to invest accretively to grow our portfolio and future earnings? The answer is that you should expect us to do the following; emphasize investing with our existing partners and off-market transactions, maintain the strength of our balance sheet, and maximize our financial flexibility by accruing funding investments and leveraging additional sources of capital such as JV partnerships and dispositions when appropriate. We successfully adhered to these principles so I’d like to lead you with three specific takeaways this quarter. First, we pre-emptively raised the capital needed to fund the investments completed year-to-date. Second, we’ve done so while further strengthening our balance sheet and credit metrics, resulting in nice momentum with the rating agencies; and third, we moderated our pace of investments and retained significant liquidity which will allow us to selectively capitalize on acquisition opportunities moving into the second half of the year. I’ll begin with my detailed remarks with some perspective on our second quarter financial performance and enhancements to our disclosure. Normalized FFO came in at $1.09 and normalized FAD was $0.95 for the second quarter, representing sequential increases of $0.05 and $0.03 respectively. These are solid sequential improvements in the light of raising $3.1 billion of capital year-to-date through a combination of equity, debt, and disposition proceeds, which were used to fund the $2.9 billion in growth investments completed during the first half of the year. I think our most important financial message this quarter ties directly to something Tom talked about in his earlier remarks that is, we will not sacrifice the balance sheet in an effort to drive short-term earnings growth. More specifically, our net debt to book capitalization has declined nearly 5 full percentage points over the last five quarters to the current 38%. In terms of dividends, we will pay our 177th consecutive quarterly cash dividend on August 20th of $0.825 per share, an annual rate of $3.30. This represents a 3.8% increase over the dividends paid last year and a current dividend yield of 4.7%. In terms of our supplemental package, we made a few noticeable enhancements this quarter in response to investor and analyst feedback. First, on page 13, we’ve added back disclosure in our unstable portfolio around the time of projected future development funding and growth investment balances. On page 14, you can see that we have provided our pro-rata share of beds, units, and square footage data to allow you to more accurately calculate those numbers on an NOI basis. Lastly, on pages 22 and 24, we have added our Canadian portfolio performance to both the NOI and NOI reconciliations.

Hi. Good morning.

Good morning.

Just in terms of the guidance – you held the guidance – and if I read right, it sounded like the UK operating portfolio isn’t set to accelerate, starting to play in the second half of the year, if I read your comments correctly. So where are you seeing offsetting upside in the portfolio that’s kind of keeping you in the range?

I’m Scott Brinker, I’ll start. The U.S. continues to be really strong, with five plus percent growth in the first two quarters and that’s roughly three quarters of the operating portfolio, so that’s by far the most significant driver. I would say that UK actually is improving; census is definitely moving back up, it’s just that we need to climb out of a pretty big hole because of the flu from the first quarter that extended into April. So, we’re going in the right direction each quarter moving forward is going to improve. It already is; it’s just will take a while with that growth rate to turn positive, but I would say 2016 is the latest based on current trends. Our U.S. same store growth is quite encouraging and I think speaks to some of the concerns about supply coming into the markets. We maintain that in the markets where our portfolio is concentrated there is not a supply issue. With five plus percent same store sales growth in the U.S. portfolio, which is the overwhelming majority of our asset portfolio, I think this should help to direct some of those concerns.

The same is true in the UK; two-thirds of our operating income comes from the greater market, which I think is the most favorable supply-demand market of any in our entire portfolio. We own very modern assets, so there is no question that we will be happy we own these assets over time; they just had a really bad flu season.

Good morning. So, on the MOB deal with CPC, how would you characterize those assets being in Beverly Hills; are they kind of like cosmetic type surgery, just thinking of the demographic there in Beverly Hills?

Well, good question, Rich. As you might imagine, lots of plastic surgeons and dermatologists to the stars.

Okay. And to the CEOs of the companies?

Well, we can all use a little refreshment sometimes.

But the bigger question is, do you think that having the CPP as a partner, and I don't speak for them but this may be their first investment in healthcare, do you think this is kind of a first salvo for them in terms of medical office? Do you see them being a partner and having this relationship grow specifically in medical office or outside of medical office and other healthcare areas?

Rich, the way I’d answer that question is, I would say they -- we first met them over a year ago. It was, I believe, July of last year, early July, and I would say they have spent maybe more time underwriting HCN than they actually spent underwriting this investment opportunity. This is not a one time find a joint venture partner to finance a deal. This is all about HCN being CPP’s partner to enter a new class of real estate investment. A lot of diligence went into this process, both with respect to HCN as well as the assets. This is an asset portfolio that anyone would invest in. The locations are outstanding, and we actually see some upside even in the retail portion that’s associated with these assets, which can be upgraded gradually over time and be in character with the luxury retailers that are one block away. This is very significant because I think it also says that the most sophisticated real estate investor in the world is now looking to healthcare real estate. I think it validates what we do.

Yeah. But do you see more in the way of transaction activity in medical office specifically vis-à-vis this relationship, or just generally – is this a signal that we should be expecting more to come?

I think – one of the things that we’ve talked about, Rich, is that I think – we made in my comments -- I think the outpatient medical infrastructure in the major metros in this country is inadequate to meet the needs of driving patient populations out of the hospital. So, when you think about the scale of capital that will be needed to address that, having a partner like CPP is very important for us. They would consider other investments other than medical office in healthcare. We’ll see how this plays out over time, but their decision was more of a broad decision to enter this space with us.

This is Scott Brinker speaking. We don’t have a ton in those areas in the middle part of the country that are heavily dependent on natural resources. So, Toronto, Montreal, Ottawa, Vancouver – those cities are not as impacted by natural resources. That being said, the Canadian economy is very much tied with what happens in the U.S., and I would say it’s more stable than the U.S., just given how they finance things and the way their banks work. But as a general comment, we like the Canadian market because we own very, very low acuity and mostly senior apartments in Canada. This is a very independent living portfolio, and it’s a nice complement to what we do elsewhere, and it’s very stable. So long life – stay, very high occupancies, very high margins, but it’s not going to grow at 5% - 6% year; it’s more in the 3% to 4% range, very steady and stable. We see significant opportunities over time to then add services, particularly assisted living and memory care.

Just from a financial perspective, we very much hedge the currency rates, obviously the Canadian dollar has been weak against the US dollar, but it’s a reminder really for everybody that 90% of our balance sheet risks are hedged and that 75% of our earnings are hedged. So we are not really in the business of taking any currency risks.

Good morning, Tom. Had a follow-up question on the CPPIP joint venture; can you discuss what the fees paid to you by them are, either for asset management, leasing, or transaction-related fees?

We’ve agreed not to disclose fees with our partner. I would say that we’re taking advantage of our platform and it improves the return profile for us, but it is still a very attractive way for CPP to enter the space, because it takes a lot of expertise to do what we do.

But they will be paying some kind of fees to you?

They will. Yes.

Okay. And as far as sourcing new MOB acquisitions, do they have any right of first offers?

They do in Southern California. It’s limited by time or investment amount, but I would say separate from what’s in the legal contracts we have every intention to substantially grow our partnership with CPP.

But at the same time, John, we’ll be looking to grow with PSP as well. So there are two major joint venture partners now, and they both – the institutions have a good relationship, and we’ll be looking for ways to grow with both of them.

Yeah, PSP is a good precedent; it took us a year of working with them before they chose us as their partner on the Revera portfolio which is a company that they wholly own. That was three years ago, and in the interim three years, we’ve now closed on three separate projects with them.

Hi guys. Good morning. Just wanted to ask about the regrowth upside in Regal relative to the rest of your Canadian asset?

It’s Scott Brinker; I’ll take that. First, we’re doing it with our existing partner, Revera, which is the second biggest senior living provider in Canada, so there should be some economies of scale. Regal is a relatively small company with around 25 homes. So we are expecting some upside there. The way we structured the deal is that while we will maintain our pro-rata shares of all the upside, we will have a fixed 4% increase in NOI through this preferred return for the first five years, starting at a 6.1% yield. It’s a very attractive initial yield plus growth at a minimum, and then we capture the upside as well. The Regal portfolio is in the top markets in Canada. We are creating critical mass in the major metro areas in the Canadian market, which we feel good about for the long-term growth prospects for this portfolio.

So on the construction activity side, does that change the equation for operators and capital expanding for them?

No, we are seated directly. The projects we’re funding on our balance sheet have exposure to 100 projects at various levels of construction in the U.S. and the UK. If it costs 10% more today than it did six months ago, that probably does impact the number of new projects that are put under construction.