IRS Rules Independent Living Not Health Care, Lets REIT Self-Manage IL Assets

Senior living REIT Welltower is shifting to a self-managed operating platform for 45,000 independent living units in its Senior Housing Operations (SHO) portfolio.

The Toledo, OH-based REIT said in a Q4 earnings call last week it has obtained a “favorable ruling” from the IRS that gives the company wider latitude to self-manage most of its IL portfolio.

In what the Internal Revenue Service calls a private letter ruling (PLR), the IRS gave Welltower “significant flexibility” to self-manage more than 45K units that make up about three-quarters of the company’s independent living portfolio.

The letter specifies that the independent communities are not classified as health care facilities, and therefore are not required to be leased to a third-party operator or taxable subsidiary as required under the REIT Investment Diversification and Empowerment Act (RIDEA), Senior Housing News reported.

During the REIT’s Q4 earnings call, Welltower COO John Burkart said the strategic shift to self-managed properties is comparable to the multifamily sector in the mid-90s—when multifamily players shifted from fee managers to owner-operators who had the ability to “move much faster, and it changed how we looked at the world,” he said.

“All of these things enabled a tremendous improvement in margins,” Burkart said, during the earnings call. “It will allow us to step into that business and have a tremendous impact on the margins.”

The transition of its IL assets to a self-managed operating platform has been in the works at Welltower since the middle of 2021, when Burkhart joined the REIT as COO after 25 years with Essex Property Trust, a multifamily REIT, most recently as the Essex COO.

Burkhart, who took over platform-wide operations responsibilities at Welltower and adopted a data-driven approach to drive platform efficiencies, initiated the strategic shift to self-managed operations.

Welltower disclosed during last week’s earnings call that it has hired Jerry Davis, who spent 30 years as a top executive with multifamily REIT UDR, to develop and implement the new operating platform for its independent living assets.

Welltower is planning to initiate the self-managed program with a pilot program involving a select group of operators, with preliminary results from the pilot program expected later this year. The REIT said it wants to develop best practices that can be expanded to operators of its assisted living assets.

“We remain optimistic that [this]will not only result in a better margin profile of our assets, but also meaningfully benefit the third-party operating partners and others across the senior living spectrum,” CEO Shankh Mitra said.

Mitra said Welltower’s goal for the new business model is to exceed the company’s pre-pandemic operating margin for its SHO portfolio, which was about 31%. The REIT reported that its operating margins rose to 22.8% in the fourth quarter from the 22% reported in Q3.

“I believe we’re only at the beginning of multi-year, double-digit NOI growth resulting from a runway of occupancy gain, rate growth and operating margin expansion,” the Welltower CEO said.

In its Q4 results, Welltower reported that same-store revenue growth exceeded 10% for four consecutive quarters in 2022, with same-store NOI for the REIT’s Senior Housing Operating (SHO) portfolio rising 28% over Q4 2021.

Occupancy rates in the SHO portfolio ticked up to 79.1% in the fourth quarter from the Q3 2022 level of 78.9%.