The seniors’ housing property sector has long been known as a steady, solid, and safe investment. But a recent series of blockbuster acquisition deals is transforming the sector, with some of the industry’s largest ownership groups pursuing new—and riskier—growth opportunities.
Since the middle of 2010, health care and seniors’ housing real estate investment trusts (REITs) have announced more than $20 billion in consolidations and partnerships—a significant surge from the $2.9 billion in deals done in 2009 and the $1.8 billion in 2008, according to Irving Levin Associates, a health care acquisition research firm based in Norwalk, Connecticut.
"This is probably the most dynamic sector really within real estate," says Debra Cafaro, chief executive of Chicago-based Ventas Inc., which through recent acquisitions has become the largest owner of seniors’ housing in the United States.
Health care–oriented REITs accounted for more than half the value of all REIT acquisitions from July 2009 through December 2010, according to Green Street Advisors, a Newport Beach, California–based REIT research firm. The primary deal makers—Ventas, Health Care REIT, and HCP Inc.—have used advantageous capital environments to buy up hundreds of seniors’ housing properties, from retirement communities to assisted living facilities. The REITs expect to capitalize on America’s rapidly expanding elderly population, but some of the deals also represent a shift in growth strategy—from merely owning and leasing seniors’ facilities to more directly managing and profiting from their operations.
Traditionally, health care facilities have been owned and operated by the same company. The new trend, thanks to a change in federal REIT laws, is to split up those duties—health care REITs owning and managing the properties while separate health care operators continue to run the facilities under contract. Under this structure, REITs can potentially generate higher profits than they could through leases, but with the tradeoff that growth and profitability are more connected to the risky ups and downs of the general economy.
"REITs have been aggressively pursuing this structure because they see the potential for higher growth," says Jeff Theiler, a Green Street Advisors research analyst who specializes in health care.
A year ago, billion-dollar acquisitions in seniors’ housing would have been unthinkable, according to Chris Macke, a senior real estate strategist for the CoStar Group, based in Washington, D.C. But they are quickly becoming the norm. For instance:
Ventas agreed in February to acquire Newport Beach, California–based Nationwide Health Properties for $5.8 billion in stock plus $1.6 billion in assumed debt, basically doubling the size of Ventas and vaulting it past Long Beach, California–based HCP to become the largest health care REIT, with a stock market value of $17 billion.
Health Care REIT, based in Toledo, Ohio, in February acquired the real estate of Kennett Square, Pennsylvania–based Genesis HealthCare in a $2.4 billion deal, picking up 147 short-term rehabilitation and longer-term assisted living facilities in 11 states.
HCP in December announced the acquisition of Toledo, Ohio–based HCR ManorCare, one of the largest U.S. nursing home and post–hospital care companies with 338 properties, for $6.1 billion.
Ventas last fall agreed to acquire Louisville, Kentucky–based Atria Senior Living Group and its 118 seniors’ communities in a deal valued at $3.1 billion.
Seniors’ housing executives and analysts cite several reasons for the recent spike in blockbuster deals.
First, REITs have cash to spend. Health care REITs have been the model for stable, low-risk returns in the stock market, earning an average of 14.5 percent annually during the past five years, easily outperforming all other major REIT sectors such as residential (6.8 percent) and retail (–1.1 percent), according to the National Association of Real Estate Investment Trusts. This growth has given REITs easier access to capital, with both stocks that are trading at higher-than-usual premiums and lower borrowing costs. In 2009 and 2010, health care REITs raised more money in stock offerings—$47.4 billion—than in the previous four years combined.
"Health care REITs are getting a lot more interest by the investor class, and that’s allowing them to do things they haven’t been able to do before," says W. Aaron Conley, president of Third Act Solutions, a real estate financial advisory firm in South Carolina specializing in seniors’ housing, and also a vice chairman of ULI’s Senior Housing Council.
Another reason for the increased interest in seniors’ housing is demographics, because more baby boomers are reaching retirement age. The elderly population—those age 65 and older—is expected to jump 36 percent from 2010 to 2020, to 54.8 million people, according to the U.S. Census Bureau. In addition, the number of people age 85 and older—the key nursing home demographic—is growing at three times the rate of the general population, to 6.6 million people by the end of this decade.
One other major factor fueling some of the mega-acquisitions is the one generating some buzz in the industry—a change in federal tax law that is leading to a new level of strategic diversification.
In 2008, Congress passed the REIT Investment Diversification and Empowerment Act (RIDEA), which makes it easier for health care property owners to establish taxable subsidiaries to oversee operations of their facilities, such as by hiring an independent contractor. This made operation of health care facilities more like that of hotels and shopping malls, which have been allowed to indirectly operate their properties for more than a decade.
After the law was passed, the recession hit, pushing the stock market lower and quieting the acquisition market. But several recent deals have taken advantage of the RIDEA structure, including Ventas’s deal for Atria, as well as several partnerships announced by Health Care REIT that total more than $2 billion. "The flurry of deals we have seen in senior housing have mostly been done using this structure," says Jerry Doctrow, who specializes in health care real estate as managing director at the Stifel Nicolaus investment firm in Baltimore.
The main advantage of the RIDEA structure is the ability it provides to tap new sources of revenue. Traditionally, health care REITs lease their seniors’ housing operations through a triple-net lease, in which the operators are responsible for paying property expenses such as taxes, insurance, and facility maintenance. This creates a fixed, stable level of revenue for the REIT. Under RIDEA, REITs take on those property expenses, which frees them to both charge rent and potentially generate additional revenue streams off the properties, such as with a retail outlet. This can lead to higher incomes.
For instance, Health Care REIT’s RIDEA deals are estimated to generate internal rates of return of 10.5 to 12 percent, compared with 10 percent yields for standard triple-net leases, according to Green Street Advisors.
The main disadvantage of the RIDEA structure is increased risk through exposure to a down cycle of the economy and potential cuts in Medicare and Medicaid reimbursements, both of which could hurt seniors’ housing operations. Nevertheless, seniors’ housing executives believe they can manage these risks, partly because this segment of the industry has traditionally been "somewhat resistant to economic downturns" through the involvement of solid operators, says Scott Estes, chief financial officer of Health Care REIT.
One result of RIDEA has been that more seniors’ facility owner/operators have become willing to sell because they can shed their property expenses while still running their facilities. "In this [RIDEA] structure, you can sell the assets but . . . never have to take your name off the door, so it’s not destructive to your brand," says Conley.
Looking ahead, all the factors triggering the surge in seniors’ housing deals show no signs of abating. For instance, health care REITs are on pace so far this year to raise a record amount of total capital—$65 billion—from stock offerings and debt financing. In addition, some market dynamics could add to the deal-making momentum.
For one thing, the seniors market faces a shortage of new developments because total construction—comprising nursing care, assisted living, and independent living units—dropped about 25 percent in 2010 in the largest 31 metropolitan areas, according to the National Investment Center, a Maryland-based market research firm focused on seniors’ housing. This means acquisitions will remain a primary way to expand property portfolios.
For another thing, health care real estate is a highly fragmented market, with REITs owning less than 10 percent of the roughly $700 billion in health care assets in the country. This suggests plenty of room for more consolidation.
In fact, Doctrow predicts, "There is a lot more investment activity and consolidation to come."