Their ability to raise capital easily, assemble large portfolios and generate healthy returns makes them significant players.
By Jane Adler
Having acquired a large number of properties over the last several years, non-traded real estate investment trusts (REITs) have cemented their position in the seniors housing ecosystem. As publicly owned companies whose shares are not traded on a securities exchange, non-traded REITs are ratcheting up the competition with the publicly traded REITs for the best buildings.
At the same time, the non-traded REITs have served as property aggregators for their publicly traded competitors as demonstrated by a recent series of big transactions.
With their ability to quickly raise cash from retail investors through broker/dealer networks, non-traded REITs have provided an important source of capital for the sector.
But some observers say they are overpaying for properties and bidding up prices. The lack of new properties for purchase has also pushed non-traded REITs into the development arena as a way to invest their capital.
Rising interest rates could eventually impact their ability to raise funds as returns for other investments improve. A rise in cap rates could also make it more difficult to assemble portfolios at prices that can generate healthy returns when the portfolio is liquidated, typically after a hold period of about seven years.
Despite the uncertainty, non-traded REITs will likely remain an important participant in the seniors housing market. “Non-traded REITs will continue to aggregate large portfolios and potentially sell them as bulk transactions,” says Rick Swartz, executive managing director and national head of senior housing at Cushman & Wakefield in Boston. “They will continue to be significant players in the seniors housing capital market.”
Non-traded REITs of all types are growing quickly. They raised $19.6 billion in 2013, double the amount of 2012, according to investment bank Robert A. Stanger & Co. of Shrewsbury, New Jersey. The bank forecasts that non-traded REITs will raise $20 billion in 2014.
Broker-dealers, which trade securities for their own account or on behalf of their customers, and registered representatives typically sell non-traded REITs for $10 per share to investors.
Retail investors who seek higher yields but remain skittish about the stock market view non-traded REITs as a popular alternative. Non-traded REITs provide annual returns that generally range from 6 percent to 10 percent, experts say.
The large fundraising volume of non-traded REITs is also driven by so-called liquidity events. When the REIT sells its portfolio, merges with another entity, or goes public, investors often plow sale proceeds back into the market.
Pending regulatory changes could dampen the ability of non-traded REITs to raise funds, however. The sector has come under scrutiny for high fees (front-end fees can be as high as 15 percent) and new rules that would require non-traded REITs to disclose charges on client statements.
Healthcare is hot
While non-traded REITs typically specialize in a property niche, healthcare real estate has been at the top of their wish list lately. Like other investors, non-traded REITs recognize that older people make up an increasing share of the U.S. population and that healthcare services are expanding. Existing seniors housing properties have also performed well.
In 2011, non-traded REITs made seniors housing acquisitions totaling $461 million based on deals valued at $2.5 million or more, according to New York-based Real Capital Analytics. By 2013, acquisitions by non-traded REITs totaled $1.5 billion. Non-traded REITs were on track to top that total in 2014 with acquisitions through mid-August of $1 billion.
In one of the biggest transactions of 2014, non-traded REIT sponsor NorthStar Realty Finance agreed in August to acquire the non-traded Griffin-American Healthcare REIT II for $3.4 billion. NorthStar declined to comment to Seniors Housing Business on the purchase or its plans for the portfolio, which includes medical office buildings and seniors housing properties. The deal is slated to close in the fourth quarter.
In June, Ventas Inc. (NYSE:VTR) agreed to buy American Capital Healthcare Trust Inc. (ARC) for $2.6 billion. ARC was launched in 2011 as a non-traded REIT and was listed last April on the NASDAQ exchange.
“Capital availability in healthcare real estate is robust,” says Daniel Bernstein, an analyst at Baltimore-based Stifel Financial Corp. Long-term debt is readily available at a low cost, and a wide range of investors are competing for properties, he adds, noting that non-traded REITs have been more aggressive buying medical office properties than seniors housing facilities.
American Realty Capital (ARC) Healthcare Trust II was launched in August 2013. The $2 billion fund is allocating 40 percent of its portfolio to seniors housing, 40 percent to medical office buildings and 20 percent to hospitals. “We are an aggregator,” says Ross Sanders, vice president at New York-based ARC Healthcare Trust. “We have a reputation for getting deals done.”
The REIT favors private pay assisted living and memory care properties, but also invests in skilled nursing facilities. A robust pipeline of properties consists of nearly 50 assets, including 10 skilled nursing facilities, 20 assisted living/memory care buildings and a rental continuing care retirement community.
“We like the necessity-driven nature of the healthcare housing products,” says Todd Jensen, chief investment officer and executive vice president at ARC Healthcare Trust.
ARC targets medium-sized regional operators. Examples include Frontier Management, a group in Portland, Ore., and the Arbor Co. in Atlanta. “Our investments are geographically diverse,” notes Jensen.
With fundraising for the second healthcare fund drawing to a close, Jensen says that ARC plans to launch a third REIT this fall after it wins approval by the U.S. Securities and Exchange Commission.
Investment strategies vary
A relative newcomer to the non-traded REIT space, Orlando-based Sentio Healthcare Properties Inc. also prefers to acquire properties owned by smaller regional operators. Sentio was launched in 2012, but had previously operated under the name of Cornerstone REIT. In February 2013, the New York investment firm KKR provided $150 million in equity to Sentio for expansion.
Sentio typically enters into a joint venture RIDEA agreement with its operating partners. In 2008, Congress enacted the REIT Investment Diversification and Empowerment Act (RIDEA), which enables REITs to participate in the operating cash flow of an asset. For example, Sentio recently acquired two assisted living properties in the Boston area from Senior Living Residences of Massachusetts (SLR), Compass on the Bay for $11.7 million, and Standish Village for $15.55 million. Privately held, SLR was established in 1990 and manages properties in New England.
“They’ve never had an institutional capital partner before,” says Scott Larche, senior vice president and founding partner at Sentio. “SLR is typical of the operators we like.”
SLR contributed 5 percent of the capital to the joint venture, and Sentio provided the remainder. “They can participate in the upside of the portfolio,” says Larche.
Competition for well-located properties is intense, notes Larche, and buildings openly marketed through brokers are selling at excellent prices. “There’s a huge demand for assets,” he says.
Alternatively, Sentio prefers to cultivate relationships with operators and then purchase properties before they’re offered on the open market. The company also seeks properties in the lease-up stage. “We try to negotiate pricing that allows us to take some risk in exchange for outsize returns,” says Larche.
Taking calculated risks
Amid intense competition for existing high-grade properties, non-traded REITs have edged into the development business. Sentio announced in February a development deal for a 108-unit assisted living building in the Villages in Central Florida. The project, called Buffalo Crossing at the Villages, is slated to open in the spring of 2015.
Sentio partnered with KR Management, based in the Tampa area, to develop the property. They manage six properties in Florida and already have a track record of developing properties at the Villages, an enclave for seniors with a population of about 50,000. Larche likes the location of the new facility because it’s actually within the confines of the Villages.
Orlando-based CNL Healthcare Properties Inc. has developed two new seniors housing properties and has three more under way. The non-traded REIT was launched in 2011 and made its first acquisition in 2012. The portfolio’s target allocation is 50 percent seniors housing and 25 percent medical facilities, with the balance in hospital properties. The sponsor is CNL Financial Group, which has launched several other REITs that invest in healthcare properties.
In July, CNL acquired seven seniors housing communities in Texas and one in Illinois for $187.2 million. The seller was developer South Bay Partners, which will develop another community in a joint venture with CNL — a $38.2 million independent living facility in Katy, Texas.
“We saw an opportunity to do new development with this operator,” says Kevin Maddron, senior managing director at CNL.
He likes new development for several reasons. New projects are more desirable and help keep the portfolio from aging. Development also allows the REIT to create an asset with an attractive yield that would be hard to match through the acquisition of an existing property, especially when competing with the big publicly traded REITs. Lastly, new development is a way to expand business with an operator.
“New development helps us to stay competitive,” says Maddron, adding that he’s somewhat cautious about new development, which accounts for less than 5 percent of the REIT’s portfolio. Even so, he thinks new development will be controlled in part by cautious lenders. “We look carefully at each individual market to make sure it’s not a huge risk,” he says.
What’s ahead for non-traded REITs? CNL’s Maddron expects to continue to raise money for the next two years and then hold the portfolio for several more years, bringing the total life cycle of the REIT to about seven years.
He notes that the life cycle of non-traded REITs has been compressed over the last decade because of their ability to quickly raise and invest capital. “It’s not unusual to see REITs exit the market after four or five years,” he says.
Sentio plans to invest the $150 million from KKR and then explore its options. “We have a lot of flexibility,” says Larche. The REIT just completed a $10 million buyback of shares, offering investors some liquidity. “It was well received,” says Larche.
Rising interest rates could be a concern going forward. “That’s the million dollar question,” says Larche. Obviously an increase in interest rates could impact the ability of non-traded REITs to raise capital, but Larche notes that rising rates could also help seniors who rely on savings for income.
“If the financial situation of our residents improves, that’s good for us,” he says, explaining that the RIDEA partnerships allow the REIT to share in operating income.
The irony is that long-term interest rates have been falling slowly for much of 2014. As of Aug. 29, the 10-year Treasury yield registered 2.34 percent, down from 3 percent at the start of the year.
While interest rates are low, Larche plans to lock in long-term debt. “That will be an asset to the portfolio,” he says.
Putting the sector in perspective, Larche notes that non-traded REITs still have a lot of capital to spend and don’t carry much debt. “We have a nice pipeline of opportunities. This is a fun time for us.”