Rising volume of property sales and high-profile mergers demonstrate how owners and operators are aligning interests.
By John Nelson
After experiencing a 35 percent surge in property and portfolio sales in 2013, the U.S. seniors housing industry is off to a blockbuster start in 2014. Billion-dollar mergers like the Emeritus Corp. and Brookdale Senior Living agreement are also changing the landscape for investors and operators alike.
Approximately $13.6 billion in one-off and portfolio transactions closed during 2013, compared with $10.1 billion in 2012, according to the National Investment Center for the Seniors Housing & Care Industry (NIC) and Real Capital Analytics (RCA). The data is based on closed deals $2.5 million and above.
The lion’s share of the acquisition activity in the space — roughly 58 percent — came from real estate investment trusts (REITs) and other public buyers. While still dominant, the market share for REIT acquisitions has dropped from 2011, when they accounted for approximately 89 percent of acquisition activity, according to Bill Kauffman, senior research analyst at NIC. Kauffman expects REITs to remain active this year.
“As far as the pipeline for 2014, the REITs are ready to make acquisitions, but it will depend on the availability of capital and the pricing of properties,” says Kauffman. “But all indications are the REITs have access to the capital they need, and all signs point to another active year, barring any economic meltdown.”
Today’s seniors housing market features a wide array of buyers — from local and regional operators to private equity firms to publicly traded and non-traded REITs. The assemblage of buyers looking to increase their market share coupled with the limited amount of available properties positions seniors housing as being more of a seller’s market.
“It’s our impression that there are a tremendous amount of private equity firms, as well as traded and non-traded REITs, looking for an opportunity to deploy their capital,” says Matthew Whitlock, senior vice president of seniors housing services at CBRE. “It’s very much a seller’s market.”
Public buyers are tweaking their acquisition criteria in order to compete for available properties, as they are contractually obligated to pay a dividend on their money, according to Ben Firestone, managing director of Blueprint Healthcare Real Estate Advisors, a seniors housing and healthcare real estate advisory firm based in Chicago.
“If those dollars that they raised are not deployed into investments, then in the case of the specialized senior care real estate, there’s no return on those dollars,” says Firestone. “They’re absolutely motivated to invest.”
The historically low cap rates in the seniors housing industry are beneficial to sellers looking to dispose of their assets. Cap rates for independent living and assisted living properties dipped into the low-8 percent range in the second half of 2013, while cap rates for skilled nursing facilities were in the high-11 percent range, according to Marcus & Millichap Research Services.
The current low cap rate environment and the looming threat of an interest rate hike should seemingly put pressure on owners to bring their properties to market, but most industry experts believe that any increase in cap rates or interest rates will be counterbalanced by an increase in rental rates, and therefore net operating income (NOI).
The fragmented nature of seniors housing has opened up opportunities for every type of buyer to participate in merger and acquisition activity. Many mid-size capital providers are pursuing regional portfolios as part of their investment strategy, according to Kevin Maddron, senior managing director of fund management for CNL Financial Group. (Maddron oversees seniors housing and healthcare investment and asset management activities for the firm.)
For example, Fundamental Long Term Care Holdings LLC, a mid-size operator of high-acuity properties, recently purchased a three-property portfolio of skilled nursing facilities from NHI for $18.5 million.
“Mergers and acquisition activity in 2014 will come from both smaller operators and larger REITs,” says Maddron. “With the introduction of new capital providers not previously in the sector, and a greater acceptance and understanding of the asset class, the need for product will drive opportunity for the smaller, regional operator.”
Justin Hutchens, CEO of Murfreesboro, Tenn.-based National Health Investors, agrees with Maddron and says private equity firms are also coming back to the space.
“Both the REITs and private equity firms — and operators using other forms of financing — will be active,” says Hutchens. “But there's plenty of room for everyone.”
One of the most significant mergers to date in the seniors housing industry is the $2.8 billion merger between Brentwood, Tenn.-based Brookdale Senior Living Inc. and Seattle-based Emeritus Corp., two publicly traded seniors housing operators.
The merger spans all assets of the seniors housing care continuum, from independent living to hospice care. The merger expanded Brookdale’s footprint to 10 new states, mostly concentrated on the West Coast and Northeast.
The merger will bring more than 500 Emeritus communities into Brookdale’s portfolio. After the deal closes, which should culminate in the third quarter, Brookdale will own 112,700 units in 1,161 communities in 46 states.
Robert Mains and Daniel Bernstein, research analysts at Stifel, a full-service brokerage and investment banking firm based in St. Louis, suspect that the perceived void of available seniors housing portfolios for sale will only increase after the merger agreement.
The analysts also say the merger presents some clear benefits for the two companies.
“We see cross-selling opportunities, more negotiating strength with vendors, likely cost-of-capital advantages, and an increased market presence contributing to, and possibly exceeding, the benefits the companies provided,” write Mains and Bernstein in their analysis of the merger.
The analysts do see the merger affecting large healthcare REITs because a number of them derive revenue from both Emeritus and Brookdale. Also, the Brookdale/Emeritus portfolio of properties post-merger won’t contribute to the earnings of those REITs.
Smaller buyers are essentially unaffected by the merger because they have had better operating results than national companies due to better knowledge of local markets, says Mains and Bernstein. “We do not see the Brookdale/Emeritus merger changing that.”
Another significant merger agreement struck in recent months was Health Care REIT’s $4.3 billion acquisition of a 20 percent stake in Sunrise Senior Living. The acquisition included a portfolio of 120 wholly owned properties and five assets owned in joint ventures with third parties.
The Sunrise portfolio spans 10,000 units and is concentrated in Southern California, Chicago, Philadelphia, Boston and Washington, D.C., as well as international assets in London and Montreal. The average age of the assets is eight years and the average monthly rental rates nearly double the industry average, according to Health Care REIT.
“We were attracted to the quality of the operating company, as well as the superb quality of the physical plants and major metro infill locations,” says Scott Brinker, executive vice president of investments at Health Care REIT. “We also view Sunrise as a platform for growth, including acquisitions and new development.”
The deal closed in the summer of 2013. In February 2014, Health Care REIT agreed to recapitalize Sunrise to where the REIT's stake in the company will increase from 20 to 24 percent. Revera Inc., a Canadian seniors housing operator, will own the remaining interest in Sunrise.
Health Care REIT and Revera are going to buy out affiliates of private equity firms Kohlberg Kravis Roberts & Co LP, Beecken Petty O’Keefe & Co. and CoastWood Senior Housing Partners LLC. The transaction total for the buyout was not disclosed.
Portfolio sales abound
Since the second half of 2013, significant portfolio acquisitions have occurred that have aligned the interests of the buyers with the properties’ operators. Among the major portfolio transactions in recent months:
- Newcastle Investment Corp. bought 52 Holiday Retirement properties for $1 billion.
- National Health Investors acquired 25 independent living facilities from Holiday for $491 million.
- CNL Healthcare Properties purchased a portfolio of 12 seniors housing communities in the states of Idaho, Montana, Nevada and Oregon for approximately $302 million.
- American Realty Capital bought a Southeast portfolio of assisted living facilities for $143 million.
- Capital Health Group LLC acquired seven communities in Utah and Nevada for $96.6 million.
- Capital Senior Living purchased four facilities in South Carolina and Indiana for $64.9 million.
When considering portfolio transactions, many investors look first at the quality of the operator. “While not directly involved in the transaction, the residents are a third-party group who are a very important part of the equation that the buyer needs to focus on. And the way to focus on them is through the operator,” says Mark Burkemper, vice president of the transactions group at Harrison Street Real Estate Capital, a Chicago-based real estate investment management firm.
A healthy relationship between the operator and investor is vital in today’s market, and it can lead to future opportunities for acquisitions for the investor. Investors oftentimes use portfolio transactions to strengthen their relationships with a specific operator.
In July 2013, NHI purchased 17 properties — 14 through another REIT and three from the operator, Bickford Senior Living — for $135 million. The transaction was a way to expand the company’s RIDEA partnership with Bickford.
“It was an existing joint venture that we utilized to make the acquisition. It put NHI in a position to where we now own 85 percent of about three quarters of Bickford's operations,” says NHI’s Hutchens. “From an alignment standpoint, it was important that we had as much exposure to them as possible since we have operating risk [through the RIDEA structure].”
Operators can benefit from a long-standing relationship as well. Ventas REIT, which recently purchased 26 Holiday Retirement communities for $790 million, says its portfolio acquisitions presented an opportunity to bring in Atria Senior Living to manage the communities.
“We saw opportunities to change the management, increasing Atria’s footprint and taking advantage of their size, scale and expertise, which we believe gives us a competitive advantage,” says Lori Wittman, senior vice president of capital markets and investor relations at Ventas REIT.
In addition to aligning their interests with strong operators, portfolio investors are also looking for a way to mitigate the risk of purchasing a single asset. If a buyer purchases an asset and experiences adverse conditions in that market, there are no built-in safeguards from those conditions like there are in portfolios.
“If there should be an operational shortfall of one property, there is geographic diversity and potentially acuity level diversity, so a portfolio may have a lot of inherent mitigants to the risk profile of a single asset,” explains CBRE’s Whitlock.
Geographic barriers to entry are vital when determining the viability of an acquisition of a regional portfolio acquisition because of the risk profile.
Harrison Street Real Estate Capital purchased a portfolio of six Class A assets in Long Island, N.Y., which has high barriers to entry, for approximately $380 million. The 915 assets were 80 percent assisted living and 20 percent memory care.
“It was right down the fairway for Harrison Street. It had high barriers to entry, it was an extremely high-quality operator and the buildings have all remained full since our purchase,” says Burkemper. “We feel like we’re going to be proud owners of that portfolio for almost forever.”
Skilled nursing outlook
Skilled nursing properties are usually panned as high-risk due to the reimbursement structure and the high-acuity nature of the facilities. These properties have historically been a tough sale for investors.
“Skilled nursing is not something our investors are looking for us to acquire. We have some concern with the reimbursement model, and it’s just not something we are focusing on right now,” says Burkemper. “We’re seeing some REITs divesting their skilled nursing facilities to get out of that exposure to government pay.”
Cap rates are also markedly higher than independent and assisted living due to the risk profile of the projects. Blueprint’s Firestone says the cap rates for skilled nursing properties have remained relatively unchanged in the past 10 years.
“The cap rates haven’t moved respective of interest rate volatility or even investor demand,” says Firestone.
Even though skilled nursing properties are seen as high-risk, industry professionals are expecting a groundswell of investor demand for the products because of the potential return on investment. REITs like NHI are even testing the waters.
Says NHI’s CEO Hutchens, “NHI will continue to evaluate potential skilled nursing investments and we’ll make some opportunistically. It’s not our primary focus. It's certainly something that we look at and if it’s a high-quality opportunity that meets our underwriting criteria, we'll be happy to entertain new investments.”
Omega Healthcare Investors Inc., a seniors housing REIT based in Hunt Valley, Md., recently closed a $525 million sale-leaseback of 56 skilled nursing facilities with Ark Holding Co. Inc., which operates the properties.
The transaction occurred in connection with the merger of Ark Holding Co. by 4 West Holdings, an affiliate of Health Care Navigator. Private equity firm Behrmann Capital previously owned Ark Holding Co.
The portfolio is concentrated in the Southeast with 39 facilities located in the region. The remaining properties are located in the Pacific Northwest (seven), Texas (nine) and Indiana (one). Like Omega Healthcare Investors, Health Care REIT is also eyeing select skilled nursing facilities for acquisitions.
“We are making targeted, strategic investments into the skilled nursing sector through our triple-net lease relationship with Genesis, who we consider to be the leading platform in the sector,” says Brinker of Health Care REIT.
The “crowding out effect” with so many buyers in the independent living and assisted living spaces isn’t responsible for the upward shift in demand for skilled nursing facilities. The increase has more to do with REITs like NHI, Omega and Health Care REIT that are looking for ways to deploy their capital in high-growth assets.
“Three years ago, the big three REITs (HCP, Health Care REIT and Ventas REIT) never would’ve looked at a skilled nursing portfolio because they’re trying to reduce their exposure to pen stroke risk and diversify their income stream away from reimbursement risk,” says Firestone. (Pen stroke risk refers to the uncertainty of government reimbursements due to potential legislation.)
“Because of the conditions now, REITs are wanting to go back into the market and chase the yield in order to continue to grow earnings,” adds Firestone.
Says CBRE’s Whitlock, “We look at the skilled nursing marketplace, and for those people willing to accept the risk associated with a higher return, there will be a tremendous amount of opportunity. The market looks very bright.”