Welltower Inc (WELL) — Q4 2022 Earnings Call Transcript

Thank you, and good morning. As a reminder, certain statements made during this call may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Although Welltower believes any forward-looking statements are based on reasonable assumptions, the Company can give no assurances that its projected results will be attained. Factors that could cause actual results to differ materially from those in the forward-looking statement are detailed in the Company's filings with the SEC. And with that, I'll hand the call over to Shankh.

Thank you, Matt, and good morning, everyone. I will review the fourth quarter and the year and describe high-level business trends and our capital allocation priorities. John will provide an update on the operational performance of our SHO and MOB portfolios. Tim will walk you through our triple-net business, balance sheet highlights, and 2023 full year guidance. Nikhil, our newly appointed CIO, is also on the call to answer questions. While we are happy to bring back full year guidance after three years, I'll point out that many macro and business uncertainties remain. I would recommend investors and analysts to focus on 2023 exit run rate to understand the earnings power of this platform and not overly emphasize the calendar year guidance. I have mixed emotions as I reflect back on 2022. As I've described to you in my prior calls, our results frankly underwound our expectation during the first half of the year. While we don't like to fixate on short-term stock performance, as we believe an appropriate window to gauge our performance is at least three to five years, our total return in 2022 was unsatisfactory. But remember, a stock is a fractional ownership of a business and not just a ticker. We view our fellow investors as partners for the long haul and continuously strive to improve the prospects for long-term compounding of this business. In spite of some of the headwinds that we experienced in 2022, my team and I are pleased with the underlying improvements we have seen in this platform and our talent base, resulting in a strong rebound of performance in the fourth quarter and improving momentum being carried into 2023. Our recent progress is only the tip of the iceberg; many of our initiatives will truly manifest themselves in the next year or two, which I'll cover shortly. While overall macro headwinds persist, we have seen considerable improvement in the key indicators of the unit economics of the business as reflected by expense per occupied room (EXPOR) and revenue per occupied room (REVPOR). On the expense front, we have seen significant progress on addressing certain challenges we faced over the past year, most notably the agency and temp labor situation. In fact, EXPOR has moderated in Q4 to 3.4%, driven largely by a deceleration in compensation per occupied room (COMPOR) to 2.6%, the lowest level we have seen in our recorded history. At the same time, REVPOR remains a consistent bright spot for us, increasing 7.5% in Q4, a clear reflection of strong pricing power resulting from our premier locations, product, and operator base. As I mentioned on our last call, one of our largest operators pulled forward January rental increases in Q4. Even without that, our Q4 REVPOR would have exceeded 6%, reflecting broad-based strength across our portfolio. And while we achieved record REVPOR growth in 2022 of 5.5%, we expect to surpass this level of growth in 2023. While we achieved impressive 19% SHOP NOI growth in 2022 and expect around 20% NOI growth in 2023, I believe we're only at the beginning of a multiyear double-digit NOI growth, driven by a long runway of occupancy gains, rate growth, and operating margin expansion. Despite significant macro uncertainty already weighing on the fundamentals of many other sectors, our confidence in the future growth of our business is supported by the need-based nature of our asset class along with a favorable demand-supply backdrop, which is improving every day. I'm pleased to report that 2023 is already off to a great start, with January move-ins up 16% compared to our '19 levels, representing a meaningful acceleration from the fourth quarter. Forward-looking indicators are also promising with our total tour volume across our senior housing operating portfolio up 25% year-over-year. I would be remiss not to highlight one of the most significant milestones in the 53-year history of our company, the Private Letter Ruling we received, which permits us to both own and self-manage independent living assets. The PLR provides us with significant flexibility in operating our assets, coinciding almost perfectly with the build-out of our industry-leading operating and asset management platform, which John and his team have been tirelessly working on. We remain optimistic that further investments in our platform will not only result in a better margin profile for our assets but also significantly benefit the third-party operating partners across the senior living spectrum, with whom we choose to partner in the future. We continue to see a tremendous opportunity to professionalize and modernize the operating side of the senior living business, following our instinct that where there’s mystery, there’s margin. Our PLR gives significant ammunition to accelerate the pace of what Welltower 3.0 might look like. I want to thank Mike Garst, our tax team, and many others whose efforts have led to this game-changing achievement. Before turning to the investing environment, I want to highlight the addition of Retirement Unlimited, or RUI, to Welltower's roster of exceptional operating partners. RUI is one of the top-performing senior housing operators on the East Coast, known for the highest program quality and care standards. RUI has consistently maintained occupancy levels above 90% with minimal use of agency labor over the past few years. We announced today that RUI has assumed the management of our first community together in Alexandria, Virginia, with plans to significantly grow our relationship in the near term through acquisitions, transitions, and development. We are extremely excited and humbled to partner with the Fralin and Waldron families and RUI’s stellar President, Doris-Ellie Sullivan, and welcome them to the Welltower family. In terms of other growth partners, we announced a year ago our partnership with David and Simon Reuben, along with their acquisition of Avery Healthcare in the UK. As you know, Reuben Brothers are among the most sophisticated, forward-thinking, and well-capitalized global investors with a reputation for attracting best-in-class talent and technology platforms. Our thesis was validated when Reuben Brothers attracted Lorna Rose, one of the most respected senior housing operating executives in the UK, to join Avery as the company’s CEO in December. Lorna has spent 25 years in the industry and was most recently with Barchester, one of the UK's largest senior housing platforms. Next, on the capital allocation side, we have rarely seen a favorable environment across all our product types in all three countries where we operate. There are over $20 billion of exit capital for core real estate funds, and potentially even more for non-traded REITs. This, along with the challenging debt market, gives us an enormous advantage to acquire the right product at the right location and right basis. Note that while we are underrunning by more than $0.5 billion of EBITDA from pre-pandemic levels, we reported debt metrics that are better than Q4 of 2019, along with more than $5 billion of near-term available liquidity. We have many avenues to access and deploy capital that I've described before, and we remain active on all fronts. Our North Star remains consistent and simple: to create per-share value for our existing owners by compounding over the long term within our circle of competence, which we define as the area where we can assess and allocate capital with favorable odds rather than gambler’s odds. With that, I'll pass it over to John.

Thank you, Shankh. I'm excited about our operating performance this quarter and the acceleration in growth that we've witnessed. My first conference call at Welltower was in Q2 of July 2021, where total portfolio same-store NOI was negative 7.1%. Since that call, the portfolio's performance has continued to improve. In 2022, despite challenges, growth was in the range of 7% to 9% for Q1 through Q3. However, in Q4, we accelerated to 12.9% portfolio NOI growth driven by our senior housing operating business, which had NOI growth of 28.1%, despite the current economic challenges. This amazing performance results from both the favorable supply-demand dynamics of the senior housing sector and aggressive asset management. I continue to see many opportunities to professionalize the business, proven through various initiatives noted in the case studies we presented in the slide deck, and this is evident in the massive improvement in agency labor, which I'll outline shortly. It is this abundance of opportunity, the chance to apply proven industry solutions to the senior housing sector, that led me to engage Jerry Davis as a Strategic Advisor. As many of you know, during my multifamily days, Jerry was my counterpart at UDR, one of the largest multifamily REITs with a national platform of 60,000 apartment homes. Jerry spent 30 years in various roles at UDR and nearly 15 overseeing all company operations before retiring in 2021. He and I have always shared similar views about operational excellence requiring a focus on people, processes, data, and technology, which, if executed correctly, leads to a superior experience for residents and employees, ultimately driving stronger financial performance. We have made substantial headway over the past 1.5 years in enhancing our management capabilities, and Jerry's expertise will accelerate that progress. He will focus his efforts on specific opportunities while I continue to build the broader operating platform from asset management and operations to capital, resource management, renovation, etc., as Welltower transforms the business. Jerry will continue to help us accelerate change within the senior housing industry. Now, let me provide some insight into our operating business, starting with the medical office portfolio. In the fourth quarter, same-store NOI growth for our outpatient medical business was 2.1% over the prior year's quarter. Same-store occupancy was steady throughout the year at nearly 95%, while retention remains extremely strong across the portfolio at 93% for the second consecutive quarter and nearly 92% for the entire year. This robust retention rate helps us drive improved lease rates and continued strong re-leasing rates. Turning to our senior housing operating portfolio, the 28.1% fourth quarter NOI increase over the prior year's quarter was driven by revenue growth of 10.3% for the period. Year-over-year margin growth of 320 basis points was also the strongest of the year. All three regions showed strong revenue growth, starting with Canada at 6.6%, the U.S. at an impressive 10.6%, and the UK at 19.2%. Revenue growth in the quarter was driven by a 200 basis-point increase in average occupancy and another quarter of healthy pricing power with REVPOR growth of 7.5%, which, as Shankh mentioned, is the highest we've ever witnessed. Sequentially, portfolio average occupancy continued to improve with a gain of 20 basis points during the period. Regarding expenses, agency use has been a significant factor in 2022 expenses. However, in Q4 2022, just as Tim has mentioned many times, the agency expense is acting as an expense deflator. Agency use in our same-store portfolio is down 44% year-over-year in Q4 '22. We often quote agency as a percentage of compensation, so looking at it that way, in Q4 of 2021, agency expense was 6.9% of compensation and in Q4 of 2022, it was 3.7%. Regardless of how you view agency use, the expense is declining in the U.S. and Canada, where over 90% of our senior housing portfolio is located. The UK is still impacted by an overall labor shortage as well as some rigid staffing models, which have led to lower occupancy properties being overstaffed. Management in the UK is slowly adjusting to a dynamic staffing model, ensuring appropriate staffing at various levels of occupancy. Overall, COMPOR, the compensation per occupied room, which represents about 60% of the expense per occupied room, increased only 2.6% in the fourth quarter compared to the prior year's quarter, which is the lowest growth rate in over five years. This moderating COMPOR growth drove the deceleration in overall expense growth, despite continued inflationary pressures in several line items, including food and utilities, which rose 10.5% and 10%, respectively, in the fourth quarter of 2022 on a per occupied room basis compared to the prior year's quarter. Food and utilities represent roughly 12% of expense per occupied room. The combination of 7.5% REVPOR growth, the highest in over five years with a 3.4% expense POR growth led to remarkable growth in net operating income per occupied unit of 25%. Regarding our operating platform, we continue to be on pace to pilot our first module in Q1 '23, with several other modules in the works. I'm proud of the creative accomplishments of the Welltower team and grateful for the excellent operators that we are partnering with on these first modules. The successes we have had through aggressive asset management, as noted in the slide deck, result from brute force and prove the opportunity. Operational excellence is achieved through a focus on people, processes, data, and technology, and that is exactly what the team has done, particularly with initiatives outlined in three case studies on agency labor reduction, revenue management, and care revenue. We will continue to leverage our team to drive results; however, we believe the greatest opportunity will be realized as we roll out the operating platform in the coming years. Finally, I would like to thank our operators and all their employees and the Welltower employees for making these results possible. Our teamwork has clearly paid off, leading to improved resident and employee experiences and stronger overall results. I'll now turn the call over to Tim.

Thank you, John. My comments today will focus on the fourth quarter 2022 results, the performance of our triple-net investment segment in the quarter, our capital activity, balance sheet liquidity update, and finally, our outlook for the year ahead. Welltower reported fourth quarter normalized funds from operations of $0.83 per diluted share, representing 7% year-over-year growth after adjusting for prior period government grants and FX headwinds. We also reported total portfolio same-store NOI growth in the quarter of 12.9% year-over-year. Before getting into our segment results, I want to provide an update on our recently closed ProMedica restructure and the go-forward reporting treatment. In late December, we announced the closing of our joint venture restructure with ProMedica Health System and our newly formed joint venture with Integra Health. The ProMedica Health System JV, consisting of 58 private pay assisted living assets, will continue to be operated under a lease with ProMedica Health System and is now part of our senior housing triple-net reporting segment. The Integra Health joint venture, consisting of 147 skilled nursing properties, includes a property joint venture and a master lease with Integra Health. The lease commenced upon closing in December and adds to the first tranche of the property JV with Integra acquiring 15% of Welltower's stake in 54 of the assets for $73 million. As previously expected, subsequent to year-end, the second tranche of assets closed in January; Integra acquired a 15% interest in another 31 assets for $74 million. The remaining 52 assets are expected to close in the second half of the year. As for the underlying operations, subleasing of the portfolio is progressing in line with expectations. 75% of the beds have already transitioned management with the remainder awaiting state-specific approvals. We will continue to update the market as management transitions progress, in addition to property-level fundamentals. Now turning to the performance of the rest of our triple-net properties in the quarter. As a reminder, our triple-net lease portfolio coverage and occupancy stats are reported a quarter in arrears. These statistics reflect the trailing 12 months ending 9/30/2022. In our senior housing triple-net portfolio, same-store NOI increased 4.3% year-over-year, and trailing 12-month EBITDA coverage was 0.86 times in the quarter. Next, same-store NOI in our long-term post-acute portfolio grew 4% year-over-year, and trailing 12-month EBITDA coverage was 1.34 times in the quarter. Turning to capital market activity, we settled $1.5 billion of previously raised equity through our forward ATM program in the quarter, helping to bring debt to EBITDA down to 6.3 times at year-end, a substantial decrease of nearly 7 times compared to year-end 2021, and below pre-COVID levels of Q4 2019. For the year, we settled a total of $3.7 billion of equity to fund $3.7 billion of net investment activity, allowing us to continue deploying capital into a challenging private market while materially deleveraging the balance sheet. Looking forward, we ended the year with $722 million in cash, full capacity on our $4 billion revolving line of credit, and $383 million in expected proceeds from near-term dispositions and loan pay-downs, representing $5.1 billion in near-term available liquidity. Before moving on to our 2023 guidance, I wanted to add context to Shankh's earlier commentary regarding the opportunity provided by last year's Private Letter Ruling. Nearly 14 years ago, Welltower structured its first management agreement, giving direct economic exposure to senior housing operations. Over the past five-plus years, we built a better and stronger alignment within this contractual structure, reaching a point in 2021 where we can generate meaningful ROI through centralized human capital and technology investment at Welltower. We hired John Burkart and started to assemble the team around him. The PLR we received last year allowed us to significantly accelerate that effort as the ROI friction is entirely removed under self-management. This Welltower platform investment is evident through G&A, with over 80% of our expected year-over-year increase in overhead costs driven by technology investment and new positions in '22 and '23, focused primarily on asset management, data analytics, and technology. We continue to believe that the opportunity to modernize operations and drive efficiencies through scale in our business is vast, creating a sustainably strong cash flow tailwind, especially considering the demographic-driven demand of the next decade. Lastly, moving to our full year guidance, which we are reintroducing for the first time since COVID uncertainty began impacting our business in March of 2020. Last night, we provided an outlook for 2023 of net income attributable to common stockholders of $0.57 to $0.75 per diluted share and normalized FFO of $3.35 to $3.53 per diluted share, or $3.54 at the midpoint. As mentioned in the release, our 2023 guidance contemplates no adjustments for other government grants we receive in the year. After adjusting for $0.07 of nonrecurring government grants received in 2022, we are guiding for a 5% year-over-year growth. This increase in FFO comes from $0.36 growth in our senior housing operating portfolio and $0.03 from growth across the rest of our segments. These are offset by $0.04 of prior mentioned higher G&A and Welltower platform costs, and $0.19 of floating rate interest and foreign exchange headwinds. Underlying this FFO guidance is estimated total portfolio year-over-year same-store NOI growth of 8% to 13%, driven by subsegment growth of outpatient medical at 2% to 3%, long-term post-acute at 2% to 3%, and senior housing triple-net of 1% to 3%. Finally, senior housing operating growth is expected to be between 15% to 24%, with the midpoint driven by revenue growth of approximately 9.5%. Underlying this revenue growth is an expectation of approximately 230 basis points of year-over-year average occupancy increase and rent growth of approximately 6.25. And with that, I'll hand the call back over to Shankh.

Thank you, Tim. While we finished 2022 on a positive note, it was also a year that required great determination and perseverance from our team. As we encounter various challenges in our business, whether they relate to expense pressures, development costs, or ProMedica, we are committed to addressing these issues rather than opting for the easy path of relinquishing potential future gains to private equity, which might be tempting for quick profits and is often celebrated by Wall Street. Many market participants confuse short-term volatility with the long-term risk of capital loss. Our investors can trust us to navigate these tough challenges to deliver the best possible returns. This commitment is shown in the development of our operating platform and our transaction with ProMedica and Integra. To paraphrase Mr. Munger, we understand that lasting success comes from being patient and focused on winning rather than constantly buying and selling. I am also thrilled to see many of my colleagues step into executive and senior management roles, further developing our business together. I believe we possess unmatched talent and a strong foundation in the real estate sector. Our advanced data and machine learning capabilities enable us to assess new investments efficiently while reinvesting in our portfolio. We are also attracting exceptional talent from outside the industry who believe our future may differ significantly from the past. We're eager to bring in individuals with high standards, and I am particularly pleased that John has successfully recruited Jerry Davis to our team. With his extensive experience in the multifamily sector, Jerry is known for his sharp operational insights in real estate. After knowing and respecting Jerry for 15 years, I am excited to collaborate with him and learn from him. I firmly believe that John and Jerry will have a remarkable impact on transforming our industry. If you know someone of that caliber, particularly with an outsider's perspective from a related or unrelated field, who wants to join our strong team, please reach out to us. Welltower is fully open for business, both in terms of acquiring assets and attracting talent. Now, I'll open the call for questions.

I just wanted to ask about the increasing operator relationships. Obviously, we saw another one yesterday with RUI, and you've talked about expected opportunities in the future. But I’m wondering what the landscape looks like after three years of these pandemic headwinds? How many high-quality operators remain as opportunities that you don't already have a relationship with, and what’s the size of those individual opportunities? Are they smaller or larger in terms of investment volume than the relationships established over the past few years? Thanks.

Yes, Jonathan, you asked a very good question. If your question pertains specifically to the senior housing industry, I see that we have already established relationships with most of the operating partners we want to collaborate with. Consequently, expanding our network with new partners isn’t a primary focus; instead, we are concentrating on strengthening existing relationships. We aim to achieve regional density with our current partners across various countries. As I mentioned earlier, there are operating partners in the industry that we have respected for quite some time. This is a lengthy process that requires both parties to understand how we can mutually benefit from each other. Capital is readily available, and simply providing capital to an operating partner is not sufficient from our viewpoint. We incorporate data analytics and operational platform initiatives into the mix. Additionally, we seek to understand how these operating partners perceive the business and its direction over the next 10 to 20 years, rather than reflecting on where it stood a decade or two ago. A significant mindset shift is essential within the industry. We also require higher standards of employee engagement, customer service, and capital management to achieve desired outcomes. These are the types of partners we aspire to work with, and we are thankful to have a remarkable group of individuals driving our business forward. Regarding your second question, I want to highlight that most of our investment volume will stem from our current partners and those we've formed relationships with in the past two to three years.

Maybe just on transaction activity. I mean, Shankh, I know you've always talked about how you're an unlevered IRR-focused investor. I'm curious if you've seen any change in maybe hurdle or return rates that might get you more excited about one property type relative to another. I know you seem pretty positive in your opening comments, but any additional clarity there would be helpful.

Michael, different times bring different opportunities for various property types. You’ve seen us buy and sell across all products we own in the last seven or eight years under the leadership of this team. Different times provide opportunities to acquire different products at a favorable basis. This might be the first time we’re seeing opportunities across all product types in all three countries where we operate. This is a very disruptive time, driven not only by debt but by equity issues as well. Our competitors—core funds, non-traded REITs, and others—are facing significant outflows due to the denominator effect seen in the pension and institutional worlds or due to a lack of available debt and other challenges. So, we’re seeing significant opportunities across all product types, and honestly, we are able to achieve IRRs that we haven’t seen in some of these product types for a very long time.

I appreciate all the details on the asset management platform. I’m just curious how we should think about this being the full investment year, and then payoffs start happening in 2024? Is there anything built into guidance regarding a payoff? And how are we thinking about the J squared run rate for returns?

Yes. I'll start, and Tim may want to comment as well. For clarity, I'm not commenting on Tim's guidance. What we're seeing and trying to show is that returns are already coming through. If you look at the aggressive asset management perspective, you see that in the agency move and what the team has done, which is an incredible amount of blocking and tackling. The additional work we're doing relates to scaling those efforts. We wanted to demonstrate that because it’s critical. We were right; there is an enormous opportunity here. The more I’ve gotten into this, the more opportunities I’ve noticed. When you consider J squared, this exponential opportunity is huge. My focus is across the entire platform, as I mentioned, and Jerry will be able to concentrate on individual items and execute at the highest level, which will expedite our process. So the bottom line is we’re already delivering results. This will continue for many years and is set to drive significant margin improvements across the board.

I'll just add on cost. We view this as an investment on the human capital side and on the technology side. We run our platform very efficiently, and we don't take costs lightly as we add any further investments. However, we believe there is a significant return here on investment. There is a bit of a lag between dollars spent and returns realized, but moving forward, I expect us to be very prudent and continue demonstrating high returns for the dollars we invest.

Hi. I’m curious what's the range of margins that you think the SHO business could operate at full occupancy, and to use your term, when it’s fully professionalized?

Mike, I’m not going to speculate on what might or might not happen, but I will repeat what I've said before. If we return to pre-COVID occupancy and pre-COVID margins, I will be severely disappointed.

In addition to the REIT community, many generalist investors are closely following Welltower. I know we touched on it in the opening, but can you elaborate on the favorable Private Letter Ruling with the IRS? I think about 45,000 independent living units are not really being classified as healthcare facilities and are not subject to RDEA. What does that imply? Additionally, how does this decision contribute to further earnings growth, particularly considering the enhanced asset platform? Thank you.

Yes. I'll touch on that. To put it simply, going back and looking at the history a bit, when you look at the multifamily world in the mid-'90s, you saw the move from fee managers to owner operators, which was a fundamental shift. What many people missed was the underlying economics behind that. Essentially, as a fee manager, you get paid a percentage, let’s say, 5%, to collect $1; as an owner operator, you pay $1 to collect $1. This fundamental shift enabled us as owner operators to move much faster and changed our approach to investing in technology, marketing, etc. This PLR allows us to step into that business and have a substantial impact on margins. I break the business down into three components: a real estate or multifamily component, a hospitality component relating to meals and housekeeping, and a care component. As we enter the independent living sector with best practices, we will be able to push improvements into assisted living, addressing both the real estate and hospitality aspects, thus enhancing our overall platform.

I want to add one more point to that, Derek. As I mentioned earlier, we are focusing on regional density and deepening our relationships with select operating partners. So, you will see that, with our strategic partners, we are working toward achieving higher density and scale in the market. Our investment in technology and operating platforms will enable us to execute effectively on the ground, resulting in mutually beneficial outcomes for our shareholders and our chosen operating partners moving forward. This focus on collaboration is key.

How has Welltower's relationship changed with its existing independent living operators since the PLR announcement? Are they more willing to work with Welltower now, given certain goals or targets, or has there been a noticeable change since the announcement?

Those who think forward and consider where the business needs to go 10, 5, or even 15 years from now have reached out and expressed a desire to participate in building the platform together. The ones who cling to the notion of what the business was in the ‘90s are clearly realizing their future is not with us.

Hey, Adam on for Ron. Good morning, guys. I just wanted to ask about the ProMedica, Integra assets. Wondering if you could comment on rent coverage with the new operators in place for some of them; if you could provide helpful insights for investors given the prior history there.

I think we've transitioned to at least 16 operators so far. By the time the dust settles, our total will be over 20 operators. However, all these transitions have happened within the last month to month and a half. It’s too soon to provide numbers or performance conversations regarding their performance, but overall, transitions have gone smoothly. Our focus has been on ensuring that each asset is placed in the right hands. That has been our top priority so far.

Shankh, I was wondering if you could talk a little more about the investment opportunities you're observing? What are the distress levels in the system? You guys have been quite active last year. I'm curious about what it takes to shake the tree and how the returns may have evolved for new deals going forward.

Steve, I don't have much to add. Perhaps Nikhil can add something after I finish. I just want to say that this is the only time I've seen opportunities across all three product types in all three countries. You usually don't see that. This environment has been primarily driven by debt. We've noticed opportunities in IRR with senior housing around 9%, some higher, some lower, but generally around 9%. Historically, medical offices have been interesting businesses to invest in with IRRs at around 7-plus; now, we're seeing opportunities around 8-plus. Finally, in wellness, where cap rates have been tight, we’re noticing IRRs in the high-7s. This outlines the different investment landscapes we see, but of course, some opportunities are higher. We continue to observe some double-digit opportunities. Most significantly, because the environment is not just debt-driven but also equity-driven, we are witnessing the emergence of assets with good cash flows and solid basis for acquisition.

Additionally, we exert tremendous effort to be the highest quality counterparty for every deal. Whether through speed of execution or the timeline of a transaction, we maintain our established deal framework. In these trying times, it positions us as the preferred counterparty, leading to increased recognition in the market, and it's periods like these where we're particularly able to shine. We’re very excited about our pipeline for the year.

On the PLR, very interesting. I’d like your thoughts: does this mean we will see a pace of investment from you to bring managers in-house for what you currently have? How much of the IL portfolio that you have today didn’t qualify? Will there be changes to have them pass the test to qualify for the PLR ruling? Thanks.

As for the second part, think about our independent living at a standalone, for example, Holiday Atria portfolio and our portfolio in Canada. That is roughly 2/3 to 3/4 of the independent living we own that qualifies. In relation to what we self-manage versus what we work with partners on, we'll navigate that. The focus is not on determining who does what but on building out the platform with best operators. John has stated clearly that he aims to develop the platform with our best operators. It's about striking the right balance regarding density for all available products in our region, and bringing in-house operations where we have the density versus keeping them outside when partners have more density. The objective is not merely who controls what; rather, it’s about working with our operating partners to create this platform, utilizing the highest-quality technology, systems, processes, and data, to achieve the best outcomes for our residents and employee experiences. John, do you want to elaborate on that?

What Shankh said is spot on. I would just add that the speed at which we move is influenced by factors like organizational readiness. We have been moving rapidly to tackle opportunities we observe. Our aim is to achieve success—driving value for various stakeholders. So, while timing is a consideration, the ultimate goal is executing with excellence.

I wanted to touch on the SHO same-store NOI growth guidance. Shankh, I believe you mentioned in your opening statements about the exit run rate and focusing on that. So I would appreciate a little clarification on that? Should we anticipate any gradual transitions in 2023? You mentioned RUI will roll out with further transitions as well. So any insights you could provide on those two moving pieces would be useful.

Sure, Juan. So, regarding the transitions, we don’t plan on additional transitions in our guidance. Our first quarter has about 85% of our open and operating buildings as of 12/31. It shows that average to mid-90s in the same-store during the first quarter. What was your first question?

The cadence of the exit run rate.

Yes. So, if you think about it, we're building occupancy. Q1 is when occupancy typically dips, so we will build occupancy through the spring and summer. Your average occupancy builds peak in Q3 and Q4 levels, leading to stronger revenue during the year. Now, consider the expenses which are improving, right? So, you will likely see a significantly better exit run rate in Q4 compared to Q1. Furthermore, consider how REVPOR develops. We’ll increase rents for some at the start of the year and continue that approach for the rest of the portfolio throughout the year. Given that we have a large operator already moving in Q4, this sets us up nicely for pricing power throughout 2023. Therefore, as we move the average occupancy for the portfolio, we will enhance pricing power in response. We are aware of the significant opportunity ahead, and our efforts will result in enhanced margins.

John Burkart, could you provide a sense of how much pushback your operators are seeing on rent increases today compared to previous quarters, and if there are any segments of the portfolio starting to feel constrained in terms of absolute rents? Any clarity here would be appreciated.

I’m not aware of any pushback. While it’s standard for rent increases to invite some discussion, I wouldn’t define any of it as pushback. Our partners have done an exceptional job communicating the reasons for rent increases, and it appears our residents comprehend the value provided in maintaining services and care. Therefore, we have not encountered significant resistance.

Additionally, as I’ve mentioned, I expect REVPOR increase to be better in '23 than '22, which gives you an idea of positive pricing trends.

Building on the topic of pricing power, could you elaborate on how both pricing and CapEx are evolving in light of inflation? How do you see pricing power developing until occupancy recovers? Similarly, after years of COVID, what is the anticipated run rate for CapEx as a percentage of NOI? Is there an uptick expected over the next few years in CapEx?

Regarding CapEx, I do not believe any changes other than inflationary adjustments will occur. We have primarily purchased new assets in the past few years, with one or two value-add purchases. We communicated exactly what CapEx spending would be when we bought the Holiday Atria portfolio. We purchased at an extremely favorable basis. Therefore, we don't see CapEx needs changing outside of inflationary increases. For pricing power, there’s nothing significant – as I previously stated, we are positive on pricing power across our countries and product types, with Canada showing signs of catching up.

I will say that our portfolio is ideally positioned to capitalize on value-add opportunities due to asset age, which allows us to see excellent returns as we invest in enhancements for higher standards in various offerings. This means we will evaluate how we can enhance our existing asset value proposition as we roll out these improvements.

I want to add that we have about 45% of our portfolio at higher occupancy rates, which allows for increased pricing leverage, the more we stabilize occupancy. Therefore, more of our properties will start to experience pricing power as occupancy levels rise. This transition is ongoing and will accelerate in ‘23.

Could you clarify on the assets that ProMedica continues to operate, focusing on assisted living and memory care? If you happen to have that handy, what’s the coverage on those?

Yes. Those are covered one-time on an EBITDA basis.

On staffing levels, at 80% occupancy in senior housing, I believe that's around fully staffed; please correct me if I'm wrong. Can you share what you're modeling for guidance in '23 regarding agency labor as a percentage of labor expenses? And do you consider this a low-hanging fruit to return to pre-pandemic agency levels, especially as John and the team enhance accountability?

We do not see this as low-hanging fruit, but we believe this is fruit that can be plucked. Significant efforts are underway. Tim can address what’s modeled. However, agency labor reflects weak management, which we're working to improve with our best operators to ensure proper staffing remains a focus. Coming below 4% is an achievement as we began at 9%. Still, I am not satisfied with that figure – it needs to be significantly lower.

From a modeling perspective, we are looking at the high-3s as a percentage of compensation, so it's relatively flat from where we ended 2022.

I have a follow-up on the Private Letter Ruling. What internal adjustments regarding people, systems, or technology are needed before you're ready to self-operate a significant number of IL units? How quickly could we potentially see Welltower manage these assets?

Yes. I will say, what’s necessary can be simplified. The timeline is essential but not too complex. We could step into systems of our existing partners and fly the plane using their framework fairly quickly. Our focus is to ensure success, and we will collaborate effectively with people to achieve it. Timing could happen very soon.

It wouldn’t surprise me if we start to self-manage some IL assets in the calendar year 2023.