Welltower Inc (WELL) — Q1 2017 Earnings Call Transcript

Thank you, Holly. Good morning, everyone and thank you for joining us today to discuss Welltower's first quarter 2017 results. Following my brief introduction, you will hear prepared remarks from Tom DeRosa, CEO; Mercedes Kerr, EVP, Business and Relationship Management; Shankh Mitra, SVP, Finance and Investments; and Scott Estes, CFO. 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 Welltower believes results projected in any forward-looking statements are based on reasonable assumptions, the Company can give no assurances as 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 this morning's press release and from time to time in the Company's filings with the SEC. If you did not receive a copy of the press release this morning, you may access it via the Company's website at welltower.com. Before handing the call over to Tom DeRosa, I want to highlight three significant points regarding our first quarter 2017 results. First, we disposed of over $1.1 billion in non-core assets, bringing our private tape as a percentage of revenue to 93.1%, and using proceeds to retire $1.1 billion of high-rate secured debt and preferred securities. Second, this balance sheet-focused capital allocation reduced net debt to book capitalization to 35.8% and net debt to EBITDA to 5.26%; nearly half-turn reduction from just a year ago. And third, we reported 2.2% total portfolio same-store NOI growth for the quarter, and we are reaffirming our guidance of 2% to 3% total portfolio same-store growth for 2017, which, as a reminder, does not include any benefit from the leap year adjustment. And with that, I will hand the call over to Tom for some remarks on the quarter. Tom?

Thanks, Tim. We were pleased with our first-quarter results; predictable and on-track characterize this quarter. Words that may sound boring to some but speak of the stable growth that an A-quality premium portfolio of healthcare real estate assets provides. The effective new supply coupled with little differentiation in cap rates for A versus B assets has made us a net seller of senior housing assets this quarter. We have taken that capital and redeployed it behind the Welltower family of operators and reduced the leverage to historic low levels. Welltower's senior housing presence in dynamic metro markets on the east and west coasts, as well as in Canada and the UK, continue to provide a significant competitive performance advantage. We continue to reinvent the way we run our business with a focus on integration, efficiency, and data. This contributes to continued decreases in our G&A costs. We look to model the most successful growth companies of tomorrow and not bloat inefficient structures of yesterday. Our unique focus on investing only in premium assets has given our senior housing operators crucial pricing power and resilient organic performance that tells a very different story from national trends. Our leap year adjusted RevPAR was up over 5% despite a number of issues seen in Q1 like elevated and prolonged flu seasons. Shankh and Mercedes will offer more detailed comments on senior housing supply but we are hearing that non-recourse construction financing is more limited than we've seen in years, which may dampen the level of building we've seen in many markets. This leads us to believe that supply issues impacting the senior housing industry may start to moderate. Mercedes will offer some comments on the investment environment, but I will say that today discipline is a hallmark of our investment strategy. There are many lessons learned from the asset aggregation period of our past that today guide how we deploy our shareholders' capital. We will continue to refine our portfolio by shedding non-core assets where we do not see an adequate return on CapEx dollars and reinvest that capital in the next generation of senior housing assets that will become effective partners to the major health systems in the top markets in which Welltower is concentrated. Now over to you, Mercedes.

Thank you, Tom. I will start today by describing our first-quarter 2017 investment activity and follow with some market perspectives, as well as an update on our value-enhancing initiative. During the first three months of 2017, we completed $217 million of new investments, all with existing Welltower partners, including new prospective senior living and Avery Healthcare. These follow-on transactions consist of recently constructed buildings and include $104 million in new acquisitions at a blended yield of 6.4%. We also placed nine development properties into service during the quarter with a total value of $186 million and a yield of 7%. Our ability to add recently constructed assets to our portfolio at attractive stabilized yields is especially valuable given our disposition strategy. As you heard in the first quarter, our dispositions totaled $1.1 billion and yielded 6.6%. These dispositions included a combination of loan payout, outright sales, and the completion of the previously announced monetization of a 75% interest in 11 Brookdale assets into our Cindat/Union Life joint venture for $268.5 million. Scott Estes will describe our uses of proceeds in more detail. To echo Tom's opening comments, Welltower's investment dispositions this quarter highlight our disciplined capital allocation and spending. On the investments front, we're pursuing earnings in NAV accretive opportunities, which are often off-market while at the same time we're careful to reject those deals that don't offer adequate risk-adjusted returns for our shareholders. Our disposition strategy is designed to improve portfolio quality while selectively capturing the benefit of buyer demand and attractive market pricing. Speaking of market pricing; it’s fair to say that cap rates remain aggressive, especially for widely marketed portfolios. Our focus on off-market deals and repeat business through our operator partnerships keeps us mostly out of that fray, but as owners, we are observing these trends with great interest as local and foreign institutional investors show a growing appetite for healthcare assets with a premium on quality portfolios like ours. Regarding new supplies, we continue to monitor changes in occupancy and operating metrics which may result from new competition, but we remain optimistic about our portfolio's resilience and are encouraged by the slowdown in construction financing and starts in recent quarters. As you know, starts peaked in the third quarter of 2015 and are continuing to moderate. Non-recourse construction financing has become scarce in the last six to nine months and spreads have widened by 50 to 75 basis points along with the increase in LIBOR. This has resulted in an overall cost increase of as much as 150 basis points. While starts data is volatile from quarter to quarter, we continue to believe that we will see a dampening from construction cost increases as we look into the second half of the year. In addition to anecdotal and evidence of these trends, the year-end senior housing industry report published by CBRE has detailed discussions on the topic for anyone looking for more color. I want to end by sharing a few examples of our most recent asset management initiatives. First, we're helping operators implement industry-leading systems to better match staffing levels to current census and acuity, and to improve billing accuracy for the services provided. These tools are tailored to fit each operating platform and should have a meaningful impact on revenues. On the expense side, we have previously talked about our savings resulting from group purchasing of property insurance. We're now looking to expand into other products such as health and wellness benefits coverage. And finally, we're leveraging our outpatient medical team's experience to reduce maintenance expenses in our senior housing communities. These projects use the scale and intellect of the Welltower platform to drive sustainable improvements and cash flow. We're excited about the possibilities, and we will post to you on our progress. Now I'm going to turn the call over to Shankh, who is going to discuss portfolio performance.

Thank you, Mercedes, and good morning, everyone. I will now review our quarterly results with an emphasis on our senior housing business and focus on some geographic detail that many of you have recently asked about. Our overall same-store NOI increased 2.1% year-over-year. The triple-net portfolio continues to produce stable and reliable performance. Our senior housing triple-net segment grew 3.2% and the long-term post-acute portfolio grew 3.4%. Growth remains healthy, and payments remain secured. Same-store NOI for the outpatient medical portfolio grew 2.4%; all three of these business segments are in line with our expectations that we described to you in the year-end call in February. As a reminder, we don't include fee-related income in our same-store metrics. We believe this provides a more accurate picture of underlying performance. Our senior housing operating segment reported growth of 0.9%, which is above our initial budget for the quarter. The headline results are partly lower due to the leap year effect—sales in 2016 benefited those operators that bill residents on a per diem basis adjusting for one extra day's NOI in Q1 of 2016; on a comparable basis, Q1 '17 shows same-store NOI grew 1.9% despite a 90 basis points decline in occupancy. Revenue increased by 2.3% due to a 4.1% increase in RevPAR on a leap year adjusted basis. Strong pricing power is the hallmark of Class A real estate and long-term value preservation. Operating expenses increased 3% for shop; adjusting for the leap year, same-store expenses were up 3.5%. Labor expense remains elevated, but the growth rate is down from recent highs. 2016 UK living wage growth is still impacting Q1 numbers, but we expect overall operating expenses to moderate for the rest of the year in the UK. Overall, senior housing demand and supply remains largely healthy, with pockets of imbalance due to heightened deliveries in certain markets. We have seen overall industry occupancy drop as new deliveries lease up. It is important to understand that move-outs in the quarter were elevated due to a heightened and prolonged flu season. Much has been written about this topic with a focus on overall population data from the CDC. If you look at the 65-plus segment of the population as we do, outpatient visits due to flu increased 70% from last year and were 35.5% higher than the epic 2017 flu season. The hospitalization rate in this segment almost quadrupled from last year but was 50% lower than 2015. While the debt due to flu is almost up 4x over last year, it is still a lot lower than 2015. How do the stats translate into our business? Quality operators learned valuable lessons in 2015 and were much better prepared to deal with a bad flu season this year. These precautions have led to many more temporary resident bans to protect our resident population. For example, what we observed in the New York metro region. While we saw strong demand that manifested in over 5% RevPAR growth in the New York MSA, admissions bans in a handful of our communities contributed to an occupancy decline of 280 basis points, resulting in flattish NOI growth in this market, which usually ranks among our top markets quarter-after-quarter in NOI growth. We think these admissions bans will prove beneficial to the rest of the year's results as they have held to protect our resident population, providing us a base to build upon as we enter the traditional moving season in late Q2 into Q3. In markets where we did not experience these occupancy headwinds, our continued strong pricing power manifested into strong NOI growth in markets like D.C., Southern California, Toronto, and London. Our core market versus non-core market performance spread narrowed this quarter relative to last year. Other markets remained relatively flat, but core market growth receded from mid-single digit growth due to flu situations in New York and New England. We expect core market growth to pick up in the second half as we rebuild occupancy. It is important to note that we also observed an interesting divergence in our IL versus AL performance from last year. While same-store NOI growth in our IL communities was higher than that of AL communities primarily due to lower expense growth in IL, we observed a higher occupancy decline in IL versus AL. While one quarter does not make a trend, we will continue to keep a close eye on this topic. In conclusion, our operating metrics met our expectations in Q1 with the exception of the outpatient medical portfolio, which outperformed our initial expectations. We are excited about the year and the prospect of our operating performance. We believe our operating portfolio provides significant total return or unlevered IRR opportunity driven by three levers: occupancy upside, rate growth, and normalized expense trends. We believe our sustained rate growth in the face of new supply exhibits not only the quality of real estate that we own but also the value propositions senior living provides for its growing need-based resident population. While regulatory buyers may dominate the mindshare in the very short-term, we are confident our asset class in general, and Welltower in particular, offers a unique opportunity for medium and long-term investors. This is particularly interesting as investors think about comparing our portfolio to many core group asset classes with mid-90% occupancy levels at a time when the economy is essentially at full employment. We hope as our growth rate starts to reaccelerate in the second half of the year relative to the first half and shows resilient growth in the next couple of years, the public markets will share the enthusiasm we encounter every day from the world's most astute private investors. With that, I'll pass it over to Scott Estes, our CFO. Scott?

Alright, thanks, Shankh, and good morning, everybody. From a financial perspective, we're off to a solid start to the year as we continue to demonstrate the capital allocation discipline that we've been articulating over the past year. As we continue to enhance the quality of our portfolio, our corporate finance team has ensured that our balance sheet has made commensurate improvement as well. I'll start off by emphasizing three specific first-quarter financial highlights. First, we generated over $1.1 billion in disposition proceeds during the quarter, which were used to repay both secured debt and preferred stock, leaving us with limited debt maturities throughout the remainder of the year. Second, we significantly strengthened our balance sheet through these pay-offs, resulting in enhanced credit metrics and a reduction in undepreciated book leverage to 35.8%, its lowest level in nearly five years. And third, we dramatically improved the operational efficiency of our platform as first-quarter G&A declined by more than 30% from the comparable quarter last year. Most importantly, our stronger balance sheet and nearly $3 billion in current liquidity will allow us to remain both disciplined and opportunistic regarding any incremental investments, dispositions, and capital raises throughout the remainder of the year. I'll begin my detailed remarks with some perspective on our first-quarter financial results, our dividend, and changes to our supplement and earnings presentation. We started off the year with solid financial results relative to our expectations, generating normalized FFO of $1.05 per share versus $1.13 per share last year. Earnings declined as expected, due to the nearly $4 billion in dispositions completed since the beginning of 2016 and our efforts to reduce leverage by nearly four full percentage points over the last 12 months. As a reminder, we're no longer providing an official FFO per year calculation this year but are providing additional detail regarding straight-line rent, CapEx, non-cash interest expense, and stock-based compensation at the bottom of exhibit 2 in our earnings release. Our G&A came in at $31 million for the first quarter, representing a significant year-over-year reduction from $46 million in Q1 '17, as we continue to enhance our operational efficiency. Based on the strong start to the year, we're tracking at or slightly below our initial G&A guidance of $135 million for the full year. We recognized significant gains on asset sales of $244 million during the quarter, which was partially offset by small impairments and a few held-for-sale properties and an unconsolidated entity. We also recognized charges related to our secured debt extinguishments and preferred stock redemption. In 2017, we began capitalizing most transaction costs, which is why you see a zero in that line in the income statement this quarter; but I would note that the $11.7 million in other expenses includes some transaction costs primarily from deals that occurred in 2016, as well as severance costs. Moving onto dividends, we'll pay our 184th consecutive quarterly cash dividend on May 22 of $0.87 per share, representing a current dividend yield of 5%. We made several changes to our supplement this quarter to simplify and streamline its presentation. On page 6, based on analyst and investor feedback, we reverted the presentation of our triple-net payment coverage stratification back to a chart format. One notable addition made this quarter is on page 18, where we now provide additional detail on our debt broken out by local currencies, as well as related hedges. Turning now to our liquidity picture and balance sheet; I think the most significant capital event this quarter was the $1.1 billion in proceeds generated from dispositions, alongside $65 million in loan pay-offs and over $1 billion of property sales, which included $244 million in gains. We used the majority of the proceeds to repay $806 million of secured debt at a blended rate of 5.6% during the quarter, which lowered the average rate on our remaining secured debt to 3.7%. We also redeemed all 11.5 million shares of our 6.5% Series J preferred stock during the quarter, valued at $288 million; and in terms of equity, we generated approximately $112 million in proceeds under our equity programs during the quarter. As a result, we have nearly $3 billion of current liquidity based on $2.5 billion of credit line availability and nearly $400 million in cash on our balance sheet. Our significant secured debt and preferred stock pay-offs allowed us to significantly enhance our balance sheet metrics during the first quarter. As of March 31, our net debt to undepreciated book capitalization declined 35.8%, representing a 116 basis points sequential improvement from year-end, while net debt to enterprise value declined to 28.8%. Our net debt to adjusted EBITDA improved to 5.26x, while our adjusted interest in fixed charge coverage for the quarter increased to 4.3x and 3.5x respectively. Our secured debt declined to only 9.6% of total asset at quarter-end, representing a significant 240 basis points decline from the previous quarter. I’ll conclude my comments today with an update on the key assumptions driving our 2017 guidance. First, in terms of same-store NOI growth based on the solid first-quarter results generated across our portfolio, we are maintaining our blended growth forecast of 2% to 3% for the full year. In terms of our investment expectations, there are no acquisitions other than that which was completed during the first quarter for our 2017 guidance. Our guidance does include an additional $265 million in development funding on projects currently underway, and an additional $375 million in development conversions at a projected blended stabilized yield of 7.9%. In terms of our full-year disposition forecast, we continue to anticipate a total of $2 billion in disposition proceeds at a blended yield of 7.6% based on $1.1 billion completed to-date and $900 million of incremental proceeds throughout the remainder of the year. Finally, as a result of these assumptions, we are maintaining our normalized FFO guidance of $4.15 to $4.25 per diluted share. So in conclusion, our enhanced balance sheet and $3 billion in current liquidity as a result of our capital allocation discipline continues to provide us with maximum financial flexibility in the current environment. So at this point, I will turn it back to you, Tom, for some closing comments.

Thanks, Scott. So let's talk about the deal of the week. We were quite pleased to see the excitement generated by Duke's decision to sell its medical office portfolio. In our almost 50 years in this business, we have never seen such enthusiasm for healthcare real estate. Should we all be surprised? No. Revised data indicates the value of hospital and medical office real estate in the U.S. to be $1 trillion. And by the way, 82% of this real estate is owned by health systems and physician groups, with only 10% held by REITs and 8% by institutional investors. Over $600 billion of that is attributable to hospital brick and mortar, and the balance is MOBs. You should know that the majority of this hospital real estate was built around a fee-for-service model; so if it takes 10 days to fix a hip fracture, the hospital submitted a bill to the payer and got its cost reimbursed plus the margin. That model requires a lot of real estate. Today, however, we are moving to a value-based model; if it takes you 10 days to fix a hip but the payer will only reimburse the hospital for the equivalent of a two-day stay, the hospital must eat those 8 days. As the focus increasingly shifts to outcomes, underperforming hospitals will be under further pressure. You should not be surprised that 52% of U.S. hospitals lost money last year. Like many malls, strip centers, and suburban offices; much of the hospital real estate in this country is obsolete, and health systems are looking to evolve their real estate footprint while they invest heavily in other areas like technology. The shift in patient demand is being reflected in real estate demand as the spread between hospital cap rates and MOBs continues to widen. A new generation of outpatient medical real estate connected to lower acuity settings like senior housing and modern post-acute care needs to be built in order to facilitate the transition to value-based healthcare. This is a huge opportunity, perhaps the most compelling opportunity the real estate industry has seen in decades. So, the enthusiasm for Duke's healthcare asset is yet another indication that we are finally being recognized as an institutional investment class. If only a small portion of the 82% of this real estate transitions to REITs and other institutional investors, it's tens of billions of dollars in investment opportunity. No company is better positioned than Welltower to take advantage of this opportunity, so stay tuned. Now, Holly, open up the line for questions.

Good morning, thanks. I wanted to ask you just quickly. It sounds like there is no change in your— or you said there is no change in your full-year outlook for same-store NOI, but I was just wondering, was there any change in the composition of getting to that? And I guess specifically, are you still in that kind of 1% to 3% change growth in your— in the same-store shop NOI for the year?

This is Scott Estes. You are correct; there is no change to any of the components of the build-up for the same-store NOI.

Okay, thank you. And then Tom, I'm just wondering; I know it's only past the house but the potential changes in the ACA—does that give you any changes in the way you think about being in the post-acute business and I guess particularly some of the changes that we’re talking about for Medicaid?

Yes, you know, it's still very early to tell. I think some of the proposed rhetoric coming out from CMS was initially perceived as negative. Actually, it could easily be positive; I think we just have to stay tuned. You know, I come back to the fact that we need to move to lowering healthcare costs and improving outcomes. The real estate footprint I just talked about is limiting the ability to reduce costs in healthcare delivery, and I think the proposal for the repeal of Obamacare is very much focused on improving outcomes, reducing costs, and doing that by increasing competition. And I do believe this will drive more of this hospital real estate to shut down. We cannot afford to keep the lights on in hospitals that are continuing to lose money in this country, and I think that's going to drive a lot of services to other lower-acuity settings like post-acute care, seniors housing, and medical office buildings, which really will become primary sites of care versus the traditional acute care hospital.

Great. Okay, thank you for that. I appreciate it.

Hi, good morning. Do you have any update on John Hopkins and how you expect that really—how you expect the first year of that venture to evolve and then maybe any updates on progress with other systems with similar ventures?

Sure, this is Mercedes Kerr. The conversations that we're having with John Hopkins Center are primarily around two topics: research and collaboration, clinical collaboration. Both of those conversations are active and starting to see more tangibility regarding the kinds of projects or specific implementations that we might seek to collaborate on together. We're working on the research project that we've talked about before, which has to do with outcomes and quality measures and indicators for senior housing, as well as collaboration primarily in some of the markets they are expanding into, for example, D.C. So, nothing particular that I can share beyond that today, but just I suppose giving you a little bit of comfort around the fact that these lead publications are going in the right direction and turning into more tangible projects for us together. With respect to other health systems, the same is true. Conversations that were a little bit more general or conceptual in the past year are now turning into much more specific, tangible opportunities that we are pursuing, and we hope to have something to talk about yet this year.

Thanks. And in some other questions, you commented about higher loan costs for developers kind of helping the supply picture as you look into '18; are you thinking about capitalizing on the balance sheet that you have as you look forward and maybe kind of re-accelerating senior housing development into that, maybe declerations looking into '18 and '19?

No. You know, we are not— we're setting as we go forward with respect to development. We see a lot of opportunities, especially from our existing operators, and there are some certain operators that grow more through development, while others grow through acquisitions. So I don't see any radical changes regarding our approach there.

It's Shankh; I will just add that if you look at—you know, if your question is specifically about filling the void for the construction lending, as you know, we're not a lender, we have no ambition to be a lender, but we do think that finally the construction costs are going to go up. As Mercedes said, with LIBOR also on the spread; so that's something very interesting. We're observing that costs are going up. We recently heard from a big bank that one of the construction loans, which was priced at LIBOR plus 300, they could not syndicate it. So we're pretty excited about what the industry is going; you know, there probably has been too much development that should not have happened but we're excited about where the industry is going and we'll continue to pursue opportunities like we have seen in New York, where there's core development.

Great, thanks.

Thanks, good morning. Just trying to sort of put together just a couple of the pieces on sort of—you know, the targeted markets and the discussions you guys have been leading, Tom, for the last year or so, and you know, I understand a lot of the new investment which is relatively modest is with existing partners. But when I see cities like Rawley, Lancaster, Warsaw, etc.; I know you're—to some extent at the mercy of where your partners are expanding; but how do you think that just—how are you guys affecting a more targeted strategy to really build where you think—where there’s great potential?

So, Josh, I would say that our investment strategy is very much built around our operators. These operators are largely concentrated in major markets, but because they all share a focus on the premium part of the market, there are many smaller markets—Rawley is a fantastic market, it is a high-growth market, it behaves like a major metro market in a state where it is not easy to build because North Carolina is a certificate of need state. So, we are not redlining some of the smaller markets, particularly in the South or even in the Midwest because there are towns, whether it is Michigan or Madison, Wisconsin that behave a lot like the types of major markets that have the same drivers in terms of job growth and population growth. In summary, Josh, I’d say we're focused on deploying capital behind the partners. If there are partners that do not have that focus, those are likely the assets that you have seen us sell or will sell in the future. And we will, again, continue to be laser-focused on deploying capital into markets where you see positive demographic factors.

Yes, and the one thing that I would add to that is; some of the conversations we’re having with health systems do center around development. It's not the bulk of it, but there will be some element of that, and those are conversations that we are driving, that will potentially involve seniors housing as a component. But my point is to say that we are actually on the forefront of being proactive and trying to select our markets and select our partners. So that—you know, on one hand, we’re receptive and responsive to our operators, and on the other hand, we’re also trying to help guide the conversation with the data and other relationships that we can bring to bear.

And one more point I'd like to make, Josh, this is Justin Skiver; is that the distinction between triple-net and our ideas is important in that a lot of the deals that you’re referencing are triple-net based structures as opposed to ideas where we would expect a steeper higher growth from the portfolio than triple-net.

Okay, that makes sense as well. And then just a second question, just trying to figure out the calculation on this VPR impacts; you know, just taking an apples-to-apples comp to the others, and I understand the shop impact is about 100 basis points, just sort of finger in the air that makes a lot of sense when last in the quarter; but these are the rate impact, it was 180 basis points, but the OpEx impact was only 50 basis points; so what drives the difference in leap year impacts on the different parts of the NOI?

Josh, it's Shankh. If you think about expenses, roughly half of the expenses are fixed and half of the expenses are floating. So only that portion of the expenses—which you have floating labor cost and others—are impacted. But if you have a fixed expense category, that will not be impacted. On the revenue basis, obviously, we’re only looking at the 29th day of February last year, and if you charge on a per diem basis, you're billing revenue. So if you charge on a monthly basis, you have no difference. It is only impacted on some operators that charge on a per diem basis on the revenue side and on the expense side it's only impacted by the cost of the expense category.

That makes a lot of sense. So the OpEx of 50 basis points makes a ton of sense, that 50, 56 and floating; but again, I guess I'm just struggling with the rate; if you're charging on a per diem basis, why would rate be as much as 180 basis points, right? Because I'm assuming not everyone is even charging on a per diem.

Yes, because where you see the most impact is in higher entry markets like Boston and New York, that's why the rates are much higher. So when you get that operator in those—in New England and New York markets, where you have much higher average rates, that impacts the overall report than if you just compare it to our overall portfolio; it’s not just those markets. For example, I told you—New York report was 5%. So you have one day of change in New York where you have an operator who charges on a per diem basis that has a bigger impact.

Right, so it's really a mixed issue as well.

Yes, it's a market mix issue.

Thanks. Tom, can you give us a little bit more color on the plans for future dispositions? Is there anything else we should expect that you could sell outside of the $2 billion that's included in guidance?

Michael, we are – we look at our portfolio over the long-term and we're always trying to stay ahead of where we might see changes in a market that might impact performance. So it's hard to give you a specific number, we're also opportunistic. If someone is willing to pay us a cap rate on assets that for a variety of reasons may be very strategic for them but are not so strategic for us, we'll take advantage of that. So I often say, both in my personal life and in my business life, real estate is always for sale. So I think you have to be opportunistic, and I think over the long-term this protects the shareholder.

Okay. And can you talk about—I believe on previous calls you highlighted that Genesis had some purchase options that they could exercise in 2017; should we expect that tenants exercise these purchase options, and how you're thinking about that portfolio going forward?

Michael, that's a very good question. As we mentioned, Genesis had some purchase options; as you might recall, it was part of our portfolio that expired on March 31, and we're pretty excited because their purchase options were priced at a certain cap rate, and the cap rates on those assets have come down significantly since then. So what happened is—Genesis’s credit has significantly improved in the last nine months, so we're currently negotiating three term sheets with various buyers. So we're hopeful that you will see further reduction in Genesis concentration as we go through this year, but more to come on that, stay tuned.

Great. And is there a timing on these term sheets or are those completed yet, or is that just kind of still in the negotiation process?

It's in the negotiation phase; too early to comment, but as I said, stay tuned, there will be more to come on this topic.

Thanks. Good morning. So just wanted to get to the shop portfolio; the 0.9% first-quarter same-store NOI growth was underwhelming relative to your nearest REIT peers. I guess what you're saying can’t be viewed as a trend maybe for the full year; but looking back at your comments last quarter, you were expecting flattish occupancy and you got a 90 basis point reduction in occupancy this quarter. Was that in your expectations? And how much of the performance caused you to think a little bit about tweaking down the guidance for same-store this year?

Rich, that's a very good question. So if you think about what we said last call about flattish occupancy, we talked about the whole year, not Q1. So Q1—if you think about, as I mentioned in my prepared remarks; Q1 same-store NOI growth for the shop portfolio is actually higher, not lower. So what is the difference? First thing is the revenue growth—it is underwhelming, as you said for sure, but if you look at the revenue growth, it's actually higher than most peers I believe. So we've got slightly lower occupancy, but we got much better rates, and we have no desire to decrease same-store NOI guidance for the year; we do not change the guidance quarter-to-quarter on different segments, but I think we’re trying to tell you we are more excited, not less, about that particular business and as we throw—think about the entire year.

Well, we were certainly interested in that portfolio; I think everybody was interested in that portfolio, and they ran a very competitive process. I don't really know any other details, Rich, regarding who was in the process, but there must have been lots of players to drive the price to where it eventually settled. And I think that's a positive for our industry and this property type.

Maybe I could ask it this way; I know this is a medical office, and just a general focus on lower cost environment is your bread and butter investment approach for the hearing now. Let's call it 4.5% to 5%; I don’t know—we can argue with the numbers but how many—how does that compare to the value you see and what you're looking at? In other words, if let's just say the numbers are around 5%, if you’re looking at medical office in—the conversations you're having, how many basis points is that lower than what your dialogues are starting?

We've never seen cap rates at that level. And if cap rates have been at that level, they've been situations that we have not participated in.

Yes, I guess let me add a little bit to that. We've been successful in acquiring at more favorable cap rates, let me put it that way. And with respect to this portfolio, I mean I would tell you I think it’s—there were a lot of overlaps with ours and, certainly, we were very interested both in terms of market concentrations, as well as tenant roster. It’s probably the second-best portfolio out there after our portfolios of medical office buildings, and so we were very keenly interested. But there's a point where naturally it needs to make sense for our shareholders and we need to know that it will be accretive. Considering that we have a very successful property management platform which tends to operate at a far higher margin, frankly, than anything we've seen out there comparatively. You know, we thought that we did a good job of underwriting it and then remaining disciplined about it.

And I would say that it is—it's our strategy in the future to build our medical office, outpatient medical business through the relationships that we have formed with the major health systems. So as we keep telling you, stay tuned for that. We don't have anything to announce to you today, but those relationships we believe will bear fruit over time, and we’d rather build our asset portfolio in that way than in participating in major marketed auctions—whether that would be in the senior housing space— and you know you’ve not seen us build our senior housing asset base through auctions. We've done it through our relationships, and that's what we're trying to duplicate in the outpatient medical business.

So it's 4.5%—100 basis points lower than your radar right now? 50 basis points lower? 75?

I'd say there are deals trading at 5%—probably 50 basis points higher we've seen.

That's fair; we haven't seen the 5% reach until now.

Good enough. Thanks very much.

Alright, Rich.

Thank you. So just—Shankh, going back on your comments on IL and AL, I thought it was interesting; you mentioned the performance was a little better in IL, but certain metrics were better in the other category. I'm just wondering given all the supply in AL and limited supply in IL, what do you think is driving sort of this difference? And what are the implications going forward in terms of your preference for IL versus AL?

Vikram, I think that's a great question. As I said, one quarter does not make a trend. I will tell you that not only was occupancy better in AL, but also the revenue growth was better in AL. So does that mean that we have a better preference for AL versus IL today? The answer is no. We have a preference for the best quality real estate in the best market run by the best operator, and that wherever we find that opportunity—whether it's IL versus AL—we do not think about that any differently. It depends on that particular asset in the particular sub-market run by the operator, and we think about a lot of—sort of supply ways coming. As you know, as we've marked into the IL space today, and we absolutely love independent living as a business. It is a relatively more cyclical business, and we have to be mindful of that as we—at a time when the economy is essentially at full employment, so we do think about that. And the other point I would tell you is, despite all of the talk of the supply, our AL portfolio is in very, very good markets and they are need-based products; so obviously, the care component of it—we cannot overemphasize the importance of operators in this business. So we’re starting to see some differentiation, but it's too early to comment.

Okay, thanks. Then just a second question; can you give us some more color and maybe some perspective on the UK; one of your peers has at least decided in part to move away. Just how are your recent developments that have come online? How are they performing, and what are your expectations for future opportunities in that market?

Hello, we've traditionally limited our partnerships to our peers, which has helped us avoid some structural issues that have been seen in the healthcare sector previously. We have a dedicated team in London and recently opened around 15 buildings, all of which are seeing strong occupancy rates. We're very satisfied with our partners at Sunrise Grade for their success in attracting tenants to these locations. Occupancy levels and growth are encouraging, making us cautiously optimistic about the market's trajectory there. Notably, when comparing the average age of buildings in the UK, which is around 20 years, we are introducing high-quality, new developments in thriving markets. We are pleased with our performance this quarter and have positive expectations for the remainder of the year.

Okay. And if I can clarify just on pricing in the UK, you talked about in the U.S. being flattish. Any notable changes in the UK?

Well, the UK had some structural cost increases, as you know. Shankh noted the National Living Wage which has been escalating quite quickly, although it has started to temper. Because of that, the whole industry has had to push pricing up; and the pricing industry-wide has obviously stuck; across the industry, we're very lucky that we’re very highly privately pay-focused, so we’re in the business-to-consumer market in some ways, rather than some of our peers operations, which are receiving large amounts of government reimbursement. On average, the private sector has been pushing rate in the UK between sort of 4% to 6% per market rate; and I’d say that's the average for our partners in the market.

Great, thank you.

Hi, good morning. Thanks for the time. Just going back to one of the earlier questions on skilled nursing, you said you've been focused on kind of the newest operator trends which to me talk towards Genesis' focus on the short-term rehab and that clearly seems to be one of the focal points in terms of potential pressures from CMS' new initiative. So just wondering if that changes your thinking on how you are focused with your remaining post-acute portfolio. Are you still committed to being exposed to Genesis in their short-term therapy business over the long-term?

This is Bryan Hickman. I guess I'll answer your question in two parts. First, to talk a little bit about our thoughts on the CMS rule that came out. For CMS' initial estimates of the impact of the proposed rule are modest with changes in payments to for-profits and freestanding facilities at minus 1.1% and minus 0.5%, respectively. This is yet at the high single-digit cost of Medicare revenue that some are suggesting may be significantly overstated. Second, the ACA, the skilled nursing industry's lobbying group has been involved in the design of this payment reform package with that several years with input from providers across the industry. So, CMS did not create this proposal in a vacuum. We've been hearing from several of our operators that the proposed rule contains provisions that will help operators deliver care more efficiently. For example, the increase in the allowance for utilization of concurrent and group therapy seems like a positive, especially when you consider that in the context of our Genesis PowerBack properties which are highly rehab-focused. Finally, the consensus on the pre-rule is that it's long way from implementation and there is going to be commenting over the next several months of the year. An analogic credit is the revision to the long-term care regulation which CMS implemented in late 2016; those were originally proposed in early 2015. So that also has played out over about 18 months, and further more operators had ample opportunity to provide commentary directly to CMS regarding changes. So we expect to see that play out similarly. As for our PowerBack portfolio, we believe that has been a good investment for us, and we continue to invest with Genesis. We have a construction start that began with them in the Philadelphia metro market, a PowerBack property, and then one that's coming online on the New Jersey side of their operations this year.

So Juan, I think as Bryan stated, we're going to continue to look to invest in the next generation of post-acute care assets, whether that will be with Genesis or maybe there will be some other operators that are bringing this next generation of post-acute care to the market. It is very clear to us, because of the amount of time we spend with the major academic and super-regional health systems that this is an area that is keenly important to them, so we are working with these health systems to try and refine the infrastructure that post-acute care can be delivered effectively. It's always going to be a volatile space to be in, and we want to make sure that we can continue to invest, albeit never going to be a big piece of our business but invest in a way that we will be getting an adequate return on the capital that we will deploy towards this space.

Just one question on the senior housing side, we've heard that Holiday may be looking to transition some of their independent living assets that are facing more supply—sorry, assisted living assets facing a supply to independent living. Do you think that creates a shadow supply that may not be disclosed or highlighted in the mixed data in the independent living bucket that payers are watching? Are you seeing that trend at all?

No, I have to—this is—I’ll speculate a little bit, but I'd have to tell you this; this is prime where the exception in the rule there. Frequently, conversations are based—you know that are responsive to the market. For example, we might take some units in a building and convert them to memory care. If we decide that there is a lot of demand to be met and that we could get a nice return on those sort of conversion dollars that we invest into a property; things like that are happening frequently. But to have whole clause changes when you are taking a portfolio and converting it from assisted living to independent is not common. I have not seen that happening in any widespread way at all, and we don’t expect for it to happen.

Thanks, Mercedes.

Good morning, everyone. I just have a quick question about senior housing. I think in general, there is this sense out there that things will get better soon based on slower delivery later on in the year or everyone taking a look at some of that. But if you do look at mixed forecasts, you know they do still call for decline in occupancy and tough kind of NOI outlook all the way up until 2018. So, I guess how do you kind of reconcile some of this kind of optimism that things turn around very soon versus saying it could still be another 18 months of tough outlook?

Tayo, it's Shankh. Your definition of soon may not exactly match our definition of soon. You talked about—we talked about emphasizing medium to long-term. That's question number one. But I will give you some numbers where I want you to focus on—not the whole industry, but our portfolio. So, if you go back and calculate quarter-after-quarter, we give you a three-mile, five-mile sort of radius and how it impacts our portfolio, right? Let's just talk about a broader picture, 5-mile. In Q3 of 2015, our total NOI that was impacted by supply was $83 million. That was the total. It peaked in Q2 of 2016 at about $90 million, and today that is $73 million. So, I’m talking about just our portfolio. You saw a spike up and now it's coming down. So, you know, we can sit here and talk about the NIC data and how that all relates to the whole industry. Obviously, you know we share enthusiasm for our sector, but we are particularly talking about how our portfolio will perform, which we think will do better.

Tayo, this is Tim Lordan. The only thing I would add to that is; one of the reasons we're optimistic about the balance of the year is, you know the rate growth in our portfolio. The rate of rate growth continues to exceed what we see in the NIC data, and that rate growth has been there consistently. That's not something that's new for us this quarter. So, that continued rate growth combined with what Shankh mentioned earlier—that there's a slight deceleration in the rate of increase of labor—drives our optimism.

That's helpful. And then this quarter it didn't seem like you announced any new relationships with some of your investments that you've done. I was just kind of curious if that is deliberate in regards—you have been much more selective in regards to who you’re partnering up with, but more of a cast of—you just see a lot of opportunities with your existing relationships?

Well, you know we have 17 RIDEA operators in our portfolio. You know, you hear us use this term—the Welltower family of operators. You know, Tayo, I think we have a pretty strong bench. There will be on the margin. You saw us add a new operator to that group last year. I think there are maybe a few left, but we are focused on putting capital behind this very skilled group of operators that have dominant positions in the markets that are important to us. So, I wouldn't see us—I would doubt that you will see us add 25 operators next year.

And I thought we have always been very selective. So, we’re not—you know particularly selective now. We have always been selective, and that's not changed.

Got you.

So, I was thinking about same-store shop NOI performance and we've talked about revenue and occupancy. But what were some of the issues that led to higher OpEx in the quarter, and what happened in Iowa in particular?

So, Chad, I think you have two questions. First is not—quarter OpEx was actually pretty favorable. It's pretty inline with what we expected. So, I’m not sure you know what you're thinking about behind that question. It's pretty inline with what would be expected as the same issues we have faced. Labor remains an issue; however, we expect, as we said, we’re seeing it moderating. U.K. has an impact, as John Goodey talked about. So that's sort of one thing. I yield, there was no specific—we saw a favorable revenue trend in AL versus IL, but we saw a favorable expense trend in IL versus AL, and that's what drove the NOI difference in those two property types.

Just thinking about the midpoint of same-store NOI guidance for the year, you did 2.2% of first quarter, so the midpoint figure is 2.5%. That would imply some improvement through the year. So, what segments would be the primary driver of that improvement if you hit it?

Shop.

You will see improvement in shop as we sort of discussed here.

Alright, is there anything that could really move the needle on the outpatient medical portion?

Outpatient medical has been relatively steady within our portfolio. It continues to produce a very favorable and predictable growth for us. I mean quarter-to-quarter things change, but we don’t see massive changes in that portfolio.

Yeah, that's around 95% occupancy and 80% retention is a good forecast. So, we’re pretty much maxing out our portfolio occupancy as we have for some time in that part of the business.

Alright, thanks Scott, and I will hop back in the queue.

Thank you, good morning. I wanted to follow-up on the MOB portfolio trade this week. So, the one thing that seems to have surprised everybody was the price at which it traded. You guys as well as your peers. But at the same time, I guess, Tom, as you were wrapping up your remarks, you mentioned to stay tuned. So, I'm just curious; do you expect more sellers to put assets on the market as a result of this pricing? Or how should we be reading into that? I think there's just been an acceleration or pick-up in the number of players looking to buy MOB assets and then that was demonstrated in this price, and I'm just curious what brings the supply to bear?

So, Jordan, if you’re a buyer that needs to find assets in auctions, this was the action of all auctions in the MOB space, because we don't know of another portfolio of that size and diversity that is available. It's hard—it's not on our radar screen. When I said stay tuned, Jordan, it goes back to a point that I made on another question. We will build our medical office portfolio organically, which means that we’re not sitting waiting for some big portfolio trade, not to say if one comes out we won't be hanging around the hoop. But I will tell you that we believe that the major health systems that we have aligned ourselves with across our business—we realize they cannot own all of their real estate for the long-term. You heard me talk about that 82% of this real estate is still owned by these health systems. They have significant capital needs, for example, in technology that will allow them to remain competitive. If they don't invest in technology and continue to sit there and think they need to own all of their real estate, they will become less and less relevant. So, we believe that we will mine medical office investments and development opportunities through the same way we’ve done it in the senior housing space by picking our partners and being a trusted partner. I moderated a panel last month at a research conference, where I brought not only Chris Winkle from Sunrise assisted living but also Mark Shaver who is head of Strategy for the Johns Hopkins health system. And actually, Mark looked at the audience and said, I have to tell you, we own too much real estate, and you know, you probably haven't heard someone at that level publicly state that. And basically said—and like you will see Tom owning some of our real estate at some point in the future. I think that's the way we're going to grow this business, and it's important that their medical office footprint is going to be connected to our senior housing and post-acute care portfolio. That's the future of this company. That's why I am so excited about our business. I think this is one of the biggest opportunities that the real estate industry has seen in decades. So, that's why I say stay tuned. I don't have anything to announce to you.

Okay. That's helpful. How do you gauge? You guys mentioned, I don't know if you are seeing fictitious, but you know the portfolio that traded was the second highest-quality portfolio next to yours. How do you gauge portfolio quality?

By age, by occupancy, by operating margin, by retention by the tenant rosters; so on just about every mark that you might be thinking about when you consider an outpatient medical portfolio, we outrank.

On-campus versus off; does that...

We talk about affiliations too. Be careful with that; it’s affiliated or not affiliated, you should care about, and our portfolio is 95% affiliated with health systems.

Okay. Thank you very much.

Hey guys, it's been a long call. But I wanted to ask one question in particular. On your senior housing business, your full-year guidance is 1.5% NOI which is comparable to the 0.9% for 1Q. So, you've talked about it a little bit on this call on different questions, but can you help me better understand the comment that you are more excited, not less as you think about that particular guidance range as it relates to what you reported for 1Q?

Michael, it’s Shankh. So, as you know, we do not update our guidance on a quarterly basis for different segments of the business, but you heard me right that the 0.9% which we reported as the growth is comparable to 1.5% to 3%. So, Tim, I think cleared that and we are more excited about that segment of the business because of the first-quarter beat that we had relative to our expectations. And it's driven by what we see in the rate trend as well as the expense trends.

Okay, and then what do you make of the country breakout just to go little deeper into; the slightly negative print for U.S. excluding leap year or 1% leap year adjusted, you know as I think somebody else said earlier was a little underwhelming. So, just curious how you thought about that part of it; I assume that part too was also largely in line with your expectations.

It was; if you think about on a country basis, it was largely in line with our expectations, and we expect the U.S. to perform as we look through the rest of the year. Again, I would recommend to you one thing; obviously, we're excited about our U.S. portfolio; we think that performance will get better, but as we want you to think about our whole portfolio, not just parts of the portfolio because different parts of our portfolio came together purely because our strategic allocation, capital allocation decisions are right. So different points in the cycle, you will see different countries will react differently. IL and AL will react differently, but that's how we think about our capital allocation as a portfolio rather than one particular product type or one particular country.

Sure. But then just overall, as it relates to the 1.5% to 3%, it sounds like it's mostly on the rate side to drive that sort of the three quarters of the rest of the year from 0.9% up to the 1.5% to 3%.

That's right, Michael.

Okay. Thanks.