Several partnerships between REIT owners and operators have generated solid returns so far, but this 'tool' has yet to be battle tested.
By Jane Adler
About four years ago, the big healthcare REITs embraced a new type of partnership that quickly became so popular it seemed like it might replace many traditional lease arrangements.
Known by the acronym RIDEA — REIT Investment Diversification and Empowerment Act — the partnerships allowed REITs to participate in the operating cash flow of an asset. The structure gave REITs growth and earnings potential above traditional rent escalators in triple-net leases.
At the same time, building operators got access to a stable source of capital available for recapitalization and expansion opportunities.
Fast forward several years and it seems unlikely that RIDEA partnerships will become vastly more prevalent than they are today. While the deals are performing as expected, joint venture partners say RIDEA structures aren’t appropriate in many situations.
Industry observers also note that RIDEA ventures haven’t been tested during an industry downturn, which could impact returns and diminish their appeal.
Guarding against the potential downside, REITs are limiting the percentage of a portfolio held in a RIDEA structure. Meanwhile, operators and REITs alike are carefully choosing partners and working to establish best practices.
“RIDEA is accepted now as another tool in the toolbox to offer operators,” says Justin Hutchens, CEO and president at National Health Investors Inc. (NYSE: NHI), a healthcare REIT based in Murfreesboro, Tenn. “RIDEA is part of the regular course of business.”
RIDEA was enacted by Congress in 2008 in response to the severe downturn in commercial real estate and was designed to give REITs a new way to generate income. The big REITs such as Health Care REIT (NYSE: HCN) and Ventas (NYSE:VTR) adopted RIDEA partnerships, accounting for a huge wave of seniors housing acquisitions.
HCN established RIDEA ventures with a number of regional seniors housing operators, including such well known names as Benchmark Senior Living, Belmont Village Senior Living, Merrill Gardens, Brookdale Senior Living and Silverado Senior Living.
Fairly characteristic of HCN’s partners, Belmont has 19 of its 25 properties in a RIDEA structure. Belmont uses RIDEA funds to recapitalize communities and to help develop new ones. The company opened a new assisted living and memory care building in Austin, Texas, last April. Another new project opens soon in Houston.
“We are pleased to have a partner who understands our sector and is a long-term player in the sector,” says Patricia Will, co-founder and president of Houston-based Belmont Village.
HCN currently holds 334 properties in RIDEA partnerships, or about 30 percent of its portfolio. Ventas has about 34 percent of its portfolio in RIDEA partnerships with operators such as Atria and Sunrise.
The sector’s other large REIT, HCP (NYSE:HCP) hasn’t used RIDEA structures as much as the other two big seniors housing REITs and has only 3.8 percent of its investments in the partnerships, though it recently announced a deal with Brookdale.
In general, the REITs are content with no more than approximately 30 percent of their portfolios in RIDEA partnerships, according to George Skoufis, director of New York-based Standard & Poor’s. “That’s their comfort zone,” he says.
RIDEA partnerships are generating healthy returns, however. NHI, for example, has a RIDEA partnership with Bickford Senior Living. The venture began in 2012 with 10 properties and last year was expanded with the addition of 17 other properties. Two new projects have been built since then and a third new project will open this year, bringing the total number of buildings held in the RIDEA partnership to 30 — a $200 million investment by NHI.
Typical of RIDEA deals, the operator, in this case Bickford, maintained a slice of the ownership, thereby aligning the interests of both the REIT and the operator –– one of the advantages of the structure. Bickford owns 15 percent of the real estate and operations, while NHI holds 85 percent. Bickford also serves as the property manager for which it earns a fee.
“We wanted to partner with Bickford for the purposes of development,” says Hutchens at NHI. “We also wanted to share in the cash flow stream from operations.”
While a triple-net lease typically generates an annual return to the REIT of 3 percent, NHI’s RIDEA structure with Bickford has resulted in net operating income growth of 4.5 percent year-over-year, according to Hutchens. He expects double-digit returns on the new development, and an average return from the portfolio over the long term of 6 percent.
“By and large, RIDEA structures have worked,” says Rob Mains, research analyst for the investment banking firm Stifel Financial Corp. He adds that Ventas and HCN, the most prominent RIDEA practitioners, consistently report net operating income growth of 4 to 7 percent for RIDEA properties, compared with 2 to 4 percent for the remainder of their portfolios.
At HCN, for example, net operating income performance for its 270 RIDEA properties in the portfolio for at least 15 months grew 8.1 percent year-over-year in the first quarter of 2014. That compares to NOI growth of 3.3 percent at its 273 triple-net seniors housing projects. The triple-net properties accounted for 27 percent of the annualized net asset value per share, while the RIDEA partnerships contributed 34 percent of the total.
To generate big returns, properties suitable for RIDEA deals are carefully selected. In April 2014, HCP announced a partnership with Brookdale Senior Living. The companies are creating a new joint venture to own and operate 14 continuing care communities, a portfolio valued at $1.2 billion.
As part of the transaction, the companies are also amending leases on 202 HCP-owned seniors housing communities currently operated by Emeritus, which is being acquired by Brookdale in
a deal expected to close in the third quarter.
The 202 properties will be split into two portfolios; 153 projects will have triple-net leases and 49 will be converted to a RIDEA structure. The properties in the RIDEA partnership have an occupancy of 80 percent and were chosen for their “attractive future growth profile,” according to a press release issued jointly by Brookdale and HCP.
A similar scenario is in progress at Merrill Gardens, a seniors housing operator and developer with 12 new properties underway –– assisted living projects that should generate healthy growth rates.
The new buildings will likely be included in Merrill Gardens’ RIDEA partnership with HCN, according to Bill Pettit, president and chief operating officer at Merrill Gardens, Seattle. “The RIDEA venture is an efficient capital structure for us.”
Unlike traditional financing vehicles with a time horizon of seven to 10 years, RIDEA structures are long-term partnerships, Pettit notes.
“It’s a learning process.” Operators accustomed to making their own decisions must include the REITs in the decision-making process. In return, REITs have to understand that they’re now in an operating business. “Both parties are on the same side of the table,” says Pettit.
Other operators agree. “RIDEAs work well when there’s an alignment of interests,” says Will of Belmont Village.
RIDEA partnerships are also benefitting from the fact that seniors housing is currently enjoying a sweet spot. Seniors housing occupancies in the first quarter rose 80 basis points from a year earlier to 89.8 percent, according to the National Investment Center for the Seniors Housing & Care Industry (NIC). That occupancy rate was based on a survey of the 100 largest metropolitan markets. The rate rent growth at seniors housing communities in the first quarter was 1.6 percent.
However, RIDEA partnerships are more subject to volatility than triple-net leases, says Skoufis at Standard & Poor’s. An increase in the supply of seniors housing that results in rising vacancies could slow gains. “We are reaching a period where growth rates will moderate,” he says.
RIDEA partners are adjusting their business models in response. Sabra Health Care REIT (Nasdaq: SBRA) partners with First Phoenix, a Minneapolis-based developer and operator with 10 new assisted living and memory care facilities underway. “RIDEA works under the right circumstances,” says Rick Matros, chairman and CEO at Sabra, Irvine, Calif.
First Phoenix designed a new prototype building with self-sufficient neighborhoods, each with its own common living areas. The product is well suited to the needs of today’s frail assisted living resident, says Matros. He adds that the resident-centric building offers Sabra downside protection because the property will be in demand.
“This new product is suited to how the seniors housing business is changing,” says Matros, citing rising acuity levels (sickness) among residents.
Despite confidence in his business model, Matros is still cautious, and like other REIT executives, doesn’t want too much RIDEA exposure. Only 10 of Sabra’s 130 properties are in the RIDEA partnership. “It’s a super-tiny percent of net operating income,” says Matros, who doesn’t plan to hold more than 20 percent of the portfolio in RIDEA partnerships.
Other downside protections are being put in place. Orlando-based CNL Healthcare Properties holds a portfolio of 76 properties, about 70 percent of which are seniors housing projects. About 60 percent of the seniors housing properties are in RIDEA structures, according to Joe Johnson, CFO at CNL.
Some of the company’s operating partners include Prestige Senior Living and MorningStar Senior Living.
RIDEA partnerships include new properties such as HarborChase of Villages Crossing, a 95-unit assisted living and memory care in Lady Lake, Fla., that opened in January. The property developer and manager is Harbor Retirement Associates based in Vero Beach, Fla.
CNL includes a management fee subordination clause in its RIDEA agreements. A portion of the management fee is forfeited if the manager misses the NOI target; though the manager receives an incentive bonus if NOI outperforms expectations.
“We get some downside protection and the operator gets some upside incentive,” says Johnson. “Our interests are aligned.”