Since 2009, the company has made $1.2 billion in investments and diversified the portfolio by leveraging its relationships with top-tier operators.
By Matt Valley
From a portfolio diversification standpoint, the recent acquisition by National Health Investors Inc. (NHI) of 25 independent living communities from an affiliate of Holiday Retirement for $491 million was transformational.
The sale-leaseback deal, which included 2,841 units in 12 states, filled in a missing piece of the puzzle for the Murfreesboro, Tenn.-based REIT that specializes in seniors housing, skilled nursing and other asset healthcare classes in secondary markets. “It gave us an independent living concentration that we really didn’t have previously,” says Justin Hutchens, president and CEO of NHI. “We had assisted living, we had skilled nursing, we had acute hospitals, but we had very little independent living.”
As a result of the acquisition, seniors housing now accounts for 49 percent of NHI’s revenues across the portfolio, up from 35 percent prior to the deal. That’s significant because seniors housing is private pay, whereas skilled nursing depends on government reimbursement.
NHI boasts a geographically diversified portfolio with approximately 168 properties in 30 states, including 91 seniors housing communities, 71 skilled nursing facilities, four hospitals and two medical office buildings.
Since 2009, NHI has made more than $1.2 billion in healthcare real estate investments. The 39-year-old Hutchens is the architect of that growth. In 2009, he joined NHI as president and COO, and as part of a succession plan was appointed CEO in March 2011. Prior to working at NHI, Hutchens acquired 15 years of senior care operations experience. He previously served as senior vice president and COO of Summerville Senior Living and executive vice president and COO of Emeritus Senior Living.
With a market cap of approximately $2 billion, NHI is a small healthcare REIT. The company was incorporated and publicly listed in 1991. In addition to specializing in sale-leaseback transactions, NHI provides mezzanine financing, construction financing and will selectively enter joint venture deals through the REIT Investment Diversification and Empowerment Act of 2007 (RIDEA), which allows REITs to own both real estate and operations.
Seniors Housing Business (SHB) recently spoke with Hutchens about the strategic outlook for the company, the state of healthcare REITs and how he got into the business.
SHB: What is NHI’s value proposition? As a smaller player in the healthcare REIT universe, how does NHI stand out?
Hutchens: We currently have 28 customers, and all but one are operators. Eleven of those customers have done repeat business with us over the past five years primarily due to a relationship approach. We have flexibility in terms of our structure to meet the needs of the operators. The smallest deal we’ve done in the last five years was $850,000, and our largest was $491 million.
The $850,000 deal was a mezzanine loan used to finance the conversion of assisted living beds to skilled nursing beds on a campus. The $491 million transaction was the purchase of 25 independent living facilities from an affiliate of Holiday Retirement. In both cases, we were meeting the need of a customer. They were opportunities that were referred to us directly, and they got to deal with the decision-maker on the front end. We’re a smaller-sized company, so you don’t have a bureaucracy to deal with. My background is in operations, so customers are dealing with someone who has been in their shoes.
SHB: Which of your customers is the only one that isn’t an operator?
Hutchens: It’s Capital Funding Group, a HUD lender that is one of our borrowers.
SHB: Can you give us a breakdown of NHI’s sources of revenue?
Hutchens: Leaseback revenues account for 79.2 percent of all company revenues, followed by RIDEA joint ventures (13.2 percent), loans (5.1 percent), and REIT dividends (2.5 percent).
SHB: NHI wants to be in growing markets. Are you referring to population growth, income growth, or all the above?
Hutchens: Primarily we are looking at the demographic of persons 85 years old and above. If you look below that age group (seniors in theirs 70s), you can see what the market demand will be down the road.
SHB: Which markets today fit your criteria for growth?
Hutchens: We are in 30 states. There is no particular state that we are enamored with more than another because we drill down into the local market. Seniors housing is generally a five-mile radius business. So, we’re looking at the local market fundamentals, the quality of the property and the overall strength of the operators.
SHB: Where is your concentration of properties?
Hutchens: We have concentrations in Texas, Tennessee, Florida and California. We have properties all over the Midwest.
SHB: Why do you prefer to invest in seniors housing properties in secondary markets?
Hutchens: The yields are a little higher and they generally attract less competition because the institutional money chases primary markets.
SHB: How aggressively did NHI have to compete to acquire the 25 properties for $491 million from an affiliate of Holiday Retirement?
Hutchens: I would say because Holiday had closed a large deal just before our deal, the market price was established. (Newcastle Investment Corp. announced in November 2013 that it had agreed to acquire a portfolio of 52 seniors housing properties from affiliates of Holiday Retirement for approximately $1 billion.)
Holiday had a clear, exact market comparable. So, that made it easier to negotiate on both sides. We had identified Holiday as a priority relationship a few years ago. We had been working with them to try to get a deal done together. I wasn’t surprised at all with any of the pricing. We’re thrilled to be a capital partner to Holiday.
SHB: Did the $491 million deal with the affiliate of Holiday Retirement put NHI on the map, or do you feel that NHI had already raised its profile in the marketplace?
Hutchens: Before 2009, we were off the radar screen for many years. Every year since then we’ve been gradually becoming more active with our investment activity and generating more awareness in the marketplace of our capabilities. Two transactions last year helped take us to a new level. One was a $135 million RIDEA transaction with Bickford Senior Living, where we expanded that relationship. The other was the $491 million leaseback transaction with Holiday. I do feel as though we are more on the radar screen, which is helping to bring us opportunities that are under review.
SHB: As you have pointed out, the purchase of the 25 independent living properties from an affiliate of Holiday Retirement was driven by the need to diversify NHI’s holdings. It’s one thing to say you want to diversify, but how did you do it?
Hutchens: We had to establish relationships with seniors housing operators that we previously didn’t have. Part of what helped us to get started is that I had been actively involved as an operator with the Assisted Living Federation of America before joining NHI. Bickford Senior Living, for instance, was one of our first investments when I joined in 2009. I had been a colleague with that company for years.
Emeritus Senior Living was another relationship that we accessed in 2009. Over time, we’ve had a good experience getting to know new operators that focus on private pay, and we have managed to be a capital partner for them.
SHB: Does being a good operator equate to being a large operator?
Hutchens: I will give you the pros and cons of both. The advantage of size is experience in many different markets and the ability to benchmark and implement best practices. Big operators have sophisticated systems because they have had to learn how to manage across multiple facilities. Then there is the issue of balance sheet credit. Bigger companies offer better credit support for lenders and for REITs.
But what I like about the smaller and regional companies is that you have ownership that is close to the customer. You have a management team that has a vested interest in the outcome of the business. They are very committed to operations and being competitive and taking care of the customers’ needs.
SHB: You have a rich background in operations. What is it about operations that you have learned most that you try to apply to your current role?
Hutchens: I’ve learned that operations continually evolve. If they are not evolving, you are not going to be successful. It’s important to be responsive to your customers’ needs and the needs of your workforce. In this job, I find it very interesting to work with several operators and observe many best practices. When you are an operator, you assume at times that you are the best at what you do. You might be in certain categories, but it’s been a great experience to observe best practices among other operators out there in the industry.
SHB: Can you give me an example of the evolution of operators?
Hutchens: When the assisted living industry started in the late 1990s, there was an assumption among developers that if you build it, they will come. The developers were driving a lot of the growth. There was a lack of operating experience because the industry was so new. To be successful, operators had to put in a sales force. They had to put in a lead bank tracking system (similar to Salesforce.com). They had to be sophisticated from the standpoint of market pricing. None of that was anticipated on the front end. Several companies failed due to their lack of responsiveness to that need. Now you look across the industry years later and it’s just a regular part of a business plan.
SHB: With annual returns of 20 percent during the past 10 years, NHI has consistently outperformed the broader REIT index. What accounts for that strong performance?
Hutchens: There are a few reasons. In 2009, we had no debt. So, we started our growth plan with a pristine balance sheet that we have been able to grow and expand with a low cost of capital. As a smaller company, it doesn’t take much acquisition volume to move the needle. Combine that growth opportunity with the fact that our portfolio has industry-leading lease-service coverage ratios (LSCR). Our weighted average LSCR is 2.92 across the whole portfolio. The marketplace also gives us credit for having low leverage on the balance sheet. The downside risk is minimal, plus we’ve had the growth. I believe that’s why we have been outperforming the sector as a whole.
SHB: The healthcare REIT sector as a whole posted a total annual return of 20.3 percent in 2012, but recorded a negative 7 percent total annual return in 2013, according to NAREIT. Why was there such a sharp falloff?
Hutchens: Healthcare REITs had a really nice run-up over the years. They finally reached a valuation level where the market just felt that they were fairly valued. So, you had a little bit of stabilization of the stock prices.
In early 2013, there was also a tremendous amount of liquidity chasing high-yield investment opportunities. When the Federal Reserve announced last April that it was going to consider tapering its bond-buying program, the threat of interest rates going up caused liquidity to leave the space, which ultimately caused the stocks to fall back.
Since then, the valuations have been relatively stable. In most cases, the analysts feel as though the healthcare REITs are fairly valued, if not fully valued.
SHB: NHI has made $1.2 billion of investments since 2009. What do you see as your biggest challenge?
Hutchens: The ongoing challenge will be to manage the balance sheet so that we can get the best execution on debt and equity, and keep our cost of capital as low as possible, while pursuing high-quality investments in what is becoming an increasingly competitive environment.
SHB: Hasn’t it always been competitive?
Hutchens: It’s increasingly competitive because there is an onset of new REITs that are participating in healthcare investments. Private equity has come back to invest in seniors housing in particular. There is tons of demand, but there is also more competition. The companies that will be the most successful will be the ones that manage their balance sheet most efficiently to keep their cost of capital low, which gives you an advantage when you are bidding on assets.
SHB: Can we expect to see a similar level of investment over the next five years?
Hutchens: I wouldn’t be surprised to see a similar pace that we have had over the past five years if market conditions permit it, but there is no telling what might happen in the future.
SHB: How did you get started in the seniors housing industry?
Hutchens: When I was pursuing my undergraduate degree at the University of Northern Colorado, I worked as a resident assistant at an intermediate care facility in Greeley, Colo. An intermediate care facility is a level between assisted living and skilled nursing. So, I worked at a true entry-level position and worked my way up through the industry. I changed my major from business to human services because of that job. When I earned my master’s degree in management (from Regis University in Denver) that rounded out my business background.
SHB: NHI is a publicly traded company that has to report earnings quarterly. Is it easy to get detached from the industry?
Hutchens: Certainly I’m in a different role than when I was working on the operations side of the business. But that operating background has really helped our underwriting in many ways, particularly in identifying operators’ motives for being in the business. I’m proud that we work with operators who wake up every morning with their primary concern being caring for people.
SHB: If they don’t wake up every day thinking of caring for people, what’s the net effect?
Hutchens: The industry in the late 1990s was more focused on growth than on the primary need, which was caring for seniors. Many companies made growth their number one priority, and responding to customers’ needs number two, and they didn’t make it. The number one priority is to take care of your residents, take care of your workforce, and then you will have opportunities to grow.