Transaction Volume Tumbles Again

Downward trend that started in late 2016 continued through 2017 as REITs became sellers rather than buyers of seniors housing.

By Jeff Shaw

The fast and furious days of seniors housing property and portfolio sales have officially faded.

The total volume of annual sales fell 32.3 percent from 2015 to 2016, according to Real Capital Analytics (RCA). That trend continued in 2017, with deal volume slumping 31.6 percent compared with the prior year. (RCA’s sales data is based on property and portfolio sales $2.5 million and above across the United States.)

Based on RCA’s preliminary totals, transaction volume in the seniors housing space totaled $11.7 billion in 2017, compared with $14.6 billion in 2016 and $18.4 billion in 2015. Leading up to that peak in 2015, sales volume had been on a steady year-over-year climb since the Great Recession.

Despite the slowdown in the volume of property trading hands, Jim Costello, senior vice president at RCA, notes that the seniors housing industry is still strong.

“It’s not like the market’s collapsing,” says Costello. “Prices are still very competitive. Cap rates are at record lows. There are still investors looking to get into the sector. It’s a great economic story.”

The main source of this recent decline has been general inactivity by the major seniors housing REITs due to a combination of depressed stock prices, high rates of new development, increasing interest rates and a struggling skilled nursing sector. 

REITs accounted for 42 percent of transaction volume in both 2014 and 2015, but only 26 percent in 2016 and 15 percent in 2017. Private buyers now account for the bulk of transactions (48 percent in 2017), followed by institutional investors (30 percent).

What’s more, for the first time in many years, the major REITs were net sellers in 2017. The pendulum swing has been quite dramatic. In 2015, REITs bought $7.7 billion in seniors housing properties and sold $907 million, so they purchased $6.1 billion more than they sold. In 2017, REITs sold $4.8 billion and bought $1.7 billion, meaning they sold $3.1 billion more than they bought.

The REITs have been especially active on selling assets in the skilled nursing sector. Three of the year’s biggest transactions involved REITs selling off large portfolios of skilled nursing facilities:

  • Ventas sold its entire portfolio of 36 Kindred Healthcare communities for $700 million. Kindred bought the facilities before it sold them again as part of the company’s planned exit from the skilled nursing sector. The deal was announced in late 2016, but closed in 2017.
  • As part of a larger $930 million sale, Welltower sold its 75 percent interest in 28 skilled nursing facilities to a Chinese joint venture between Cindat Capital Management Limited and Union Life Insurance. This deal was also announced in 2016, but closed in 2017.
  • Sabra Health Care REIT has announced its intentions to divest its entire portfolio of skilled nursing facilities leased to Genesis Healthcare Inc. Those sales are ongoing, but several were completed or announced in 2017.
  • HCP announced in November it plans to sell six Brookdale-
    operated properties for an estimated $275 million. The REIT also plans to sell its remaining 40 percent stake in a joint venture to Columbia Pacific Advisors for $332 million. 

The joint venture — RIDEA II — owns 49 seniors housing properties, of which Brookdale operates 46. Those deals had not yet closed at year’s end, but are examples of the trend. HCP no longer participates in skilled nursing, having spun off its entire portfolio into a separate REIT in 2016.

What’s holding back REITs?

Although Welltower and Ventas declined to be interviewed for this article, HCP confirmed some of the prevailing explanation for slow REIT investment activity.

“We slowed our acquisitions starting in 2016. There are a couple of factors influencing this,” says Kendall Young, senior managing director of seniors housing properties for HCP. “First, we have been more selective on our acquisitions in part due to new supply. Second, we have been focused on the execution of asset sales and transitions from our announced Brookdale transactions.”

On the few acquisitions HCP made, the determining factors were the growth potential of the specific market, “including both new supply and long-term demand characteristics,” adds Young.

Stock prices have slumped in recent months, and all of the “Big Three” REITs, are well below their recent peaks.

  • HCP’s stock price closed at $21.77 per share on Feb. 14, down from $30.42 a year earlier and a five-year peak of $49.53 on May 13, 2013.
  • Welltower’s share price closed at $54.15 on Feb. 14, down from $65.58 a year earlier and a five-year peak of $84.31 on Jan. 12, 2015.
  • The share price of Ventas stock closed at $49.62 on Feb. 14, down from $61.68 a year earlier and a five-year peak of $93.26 on May 13, 2013.

“If the REITs are trading at a premium, they have tremendous access to capital. That’s what was reflected in 2013 through 2016,” says Peter Martin, managing director with JMP Securities, a San Francisco-based financial services firm. “When their stocks are below their averages, they no longer have endless access to capital.”

Martin also noted that the high rate of development is perhaps causing some buyers to hesitate. With an estimated 50,000 new units under construction, strong consumer demand is the only thing keeping occupancy rates from dipping even further. (The overall occupancy rate for seniors housing stood at a “relatively weak” 88.8 percent at the end of 2017, according to the National Investment Center for Seniors Housing & Care.)

“Demand has been much higher than we expected, partially because the housing industry is so strong,” says Martin. “The equity in homes is the purchasing power, and our parents can sell their house at peak pricing right now.”

This is in contrast to previous market peaks, Martin says, because consumer awareness of private-pay seniors housing has gone from below 30 percent in the late 1990s to above 90 percent now. Previously, even independent and assisted living were considered to be “the nursing home,” but most consumers now understand the difference.

A silver lining of low REIT activity is that other types of buyers now get to kick the tires on prospective deals that were previously snatched up almost exclusively by REITs.

“The private buyer has a better look at things just because you don’t have the dominant rush of the REITs,” says Martin. “Slowly but surely, other institutional investors — hedge funds, high-net-worth individuals — are now getting involved because the deals are now making it to their desks.”

Have cap rates hit the floor?

At the end of 2017, the overall seniors housing capitalization rate for the industry hit a record low of 6.5 percent (with independent living below that number and skilled nursing above it), according to the RCA data. The cap rate is the expected annual return on a newly acquired asset based on the property’s annual net operating income relative to the purchase price.

“Simply put, cap rates have bottomed out,” says Martin. “The market is now anticipating at least two interest rate increases in 2018. Investment spreads will compress quickly, which will necessitate cap rates to move up.”

New Senior Investment Group’s recent purchase of a nine-property portfolio of Holiday Retirement properties at a 5.1 percent cap rate is a potential indication that rates will not compress any further, says Martin.

He also notes that REITs slowing their acquisition volume is often a precursor to cap rates increasing. The obligation of publicly traded companies to generate high returns for investors causes them to pull back on their buying activity before other investor types.

Costello of RCA doesn’t go as far as to suggest cap rates have hit their lowest point, saying “there’s room for a little more compression in the short term.” However, he does agree they’re part of the reason for the slowdown in transactions.

“Low cap rates put expectations of buyers and sellers further apart,” says Costello. “There’s good, steady, ongoing yield, but buyers are hesitant to keep bidding with the same aggressiveness of the past few years. The cap rates might go up a little bit, so buyers have to be more conservative. The sector is not collapsing, but it takes longer for buyers and sellers to get comfortable with a transaction.”

However, one factor could continue to keep cap rates low, according to Jeff Erhardt, managing director with Maryland-based seniors housing investor Capital Healthcare Investments. The company is the healthcare investment vehicle for publicly traded REIT MTGE Investment Corp.

As development costs continue to rise, notes Erhardt, the “build versus buy” equation still can push many owners to buy, regardless of low returns.

“You are seeing those costs to develop increase pretty significantly, mostly driven by labor and the cost of raw materials,” says Erhardt. “Land costs are going up, and it’s taking longer for properties to lease up. As construction costs per unit continue to increase and oversupply issues increase, it may start to make buying existing product more attractive.”

Despite not being a publicly traded REIT, Erhardt reports that Capital Healthcare Investments is also sharpening its pencil when it comes to what it chooses to buy.

“Our underwriting has gotten significantly more conservative. We are a landlord, so our leases are being written more conservatively. We’re still looking at acquisitions, but at a much more conservative valuation.”

Previewing 2018

When asked to look into their crystal balls for 2018, the sources all said not to expect any drastic changes compared with 2017.

Historically low cap rates and a high cost of capital for the REITs should keep transaction volume around its current level, according to Costello.

“Until sellers are compelled to sell for some reason — such as not being able to refinance or return capital to investors — there may not be much of a reason to sell. They’ll just hold on and wait and see how it goes.”

Erhardt also expects 2018 to be on pace with 2017, but he has seen some early signs of potential resurgence.

“There’s been a lot of product coming to market so far. There have been some big portfolios launched, driven by REIT divestitures. We’ve talked to the investment banker community and they all seem to be very bullish on 2018.”

HCP’s Young predicts 2018 will be a similar but “active” year, with private equity and foreign capital “bridging the gap left by the REITs.”

According to RCA, although foreign capital has fallen in terms of total percentage of the investment market (from 12 percent in 2015 to 6 percent in both 2016 and 2017), foreign investors are still net buyers and therefore increasing their stake in U.S. seniors housing. “They’ve been increasing their overall exposure to the sector,” says Costello.

In fact, in a deal that could have drastically changed the outlook on 2017, Chinese investor Zhonghong Zhuoye reportedly offered to buy Brookdale, the largest owner and operator of seniors housing in the United States, for $3 billion. The deal later fell apart when the Chinese bank funding the acquisition put its financing on hold.

“I notice at industry conferences there are more foreign funds looking at the space,” says JMP’s Martin. “We’re heading more toward the bottom of the cycle — we’ve already rolled past the top — so foreign capital doing due diligence right now would be very smart.”

Martin says new construction would have to slow before market fundamentals could boost rents and occupancies to stable rates. That said, despite the many headwinds facing the industry, the eventual demographic wave of Baby Boomers reaching the appropriate age for seniors housing makes it a perpetually enticing real estate investment option.

“For the future, it’s really going to depend on how patient someone’s capital is going to be. Given that demographics are going to get better over the next decade, investors just have to decide how long they’re willing to wait to meet occupancy and cash-flow goals.”