The use of RIDEA structures in REIT acquisitions is becoming more commonplace in the senior housing sector as a model that helps drive long-term growth, and analysts say the days of healthcare REITs enjoying healthy margins are far from over.
“We see the RIDEA structure as a way for the REITs to remain competitive within the acquisition marketplace, and further benefit by the long-term profitability of the individual properties,” says Matthew Whitlock, a senior vice president at real estate broker CBRE’s National Senior Housing Group. “While initial returns may be below that of a traditional REIT lease structure, RIDEA does allow the REIT to participate in the upside of the property in future years.”
A recent Forbes column implied that Ventas’ days of enjoying “unusually high” margins are over as supply of senior living assets catches up to demand. The columnists cited a net operating profit after tax (NOPAT) margin that shrunk from a peak of 72% in 2003 to a low of 8% in 2011 along with a “rapidly declining” return on investment capital (ROIC).
However, the industry’s solid fundamentals, including increased occupancy, indicate the ‘Big 3’ REITs (HCP, Inc., Ventas, Inc., and Health Care REIT) can safely expect to enjoy healthy margins for the foreseeable future, according to some analysts.
One reason why REIT are seeing certain margins decline is because they’ve incorporated RIDEA structures into their portfolios instead of exclusively utilizing triple-net leases. Rather than contractual escalators with a triple-net lease that allow for a set amount of annual revenue, RIDEA agreements allow REIT landlords to share rewards with an asset’s manager if the property outperforms.
“It’s not that there’s more cost pressure—they’re concentrating in a different asset class that has less margins but better growth potential for NOI (net operating income),” says Jeff Theiler, an analyst with Green Street Advisors.
It’s a riskier structure, he says, but it has greater potential upside.
“REITs right now think it’s a great environment for senior housing, and they’re willing to take that risk to capture outsized growth,” says Theiler. “The downside is a scenario where the senior housing sector doesn’t grow at that magnitude or has negative growth, and that will flow through to the REITs’ performance.”
That inherent risk means most REITs probably won’t start buying up distressed properties, despite upside potential. Instead, RIDEA structures are predominantly deployed when a REIT sees future benefit from either the stabilization of operations—perhaps a high-quality asset still in lease-up phase—or the improvement of margins through a management change or capital expenditures, says Whitlock.
“The [largest three REITs] are not going to change their pattern and dip into distressed assets—it has not been their [practice] to do that,” says Daniel Bernstein, an analyst with Stifel Nicolaus. “They’d rather let private equity take the risk on distressed assets.”
A perfect example, he says, is the troubled Sunwest portfolio that was acquired in a joint venture between The Blackstone Group and Emeritus and then bought by HCP for $1.73 billion after the assets were mostly stabilized, but still had some additional upside.
“If we can achieve RIDEA-like NOI growth without the RIDEA operating risk, that’s first prize. And obviously, we are able to achieve that in a very, very significant measure with our October 31, 2012, closing on the Blackstone JV with Emeritus,”James Flaherty, chairman and CEO of HCP, Inc., said during a fourth quarter earnings call. “We may do some more of that, we may do some more RIDEA, but it will all be in the context of looking at risk-adjusted returns.”
Senior Housing Properties Trust’s president and CEO David Hegarty called his REIT’s RIDEA portfolio its ‘most value-creating opportunity’ during the Citi Global Property CEO Conference in early March.
The independent living sector was particularly hard-hit when the housing market crashed, Hegarty recounted. In September 2011, SNH agreed to purchase a portfolio of nine Vi properties that had been about 94% occupied prior to the economic recession before dropping to a low of just under 84% occupancy.
“We bought them when they were a little over 85% occupancy and we have no reason to believe they can’t get back up to [those] low- to mid-90% occupancy levels,” Hegarty said. SNH’s operating partner, Five Star Quality Care, is now managing the portfolio, and in 2013 Hegarty says the REIT will be “pumping CapEx into the properties and bringing them up to be extremely competitive—if not top of the market.”
The CapEx strategy has a good chance of success.
“RIDEA in general has paid off pretty well, because seniors housing growth has been pretty great over the past several quarters,” says Theiler. “It seems that growth versus safety is paying off for these guys, and it could continue.”
Ultimately, Bernstein doesn’t believe the Big 3 REITs’ operating margins and earnings ability will be compromised in the next 12 to 24 months, especially with rising pressure on occupancy rates.
“I don’t see any reason why seniors housing margins would deteriorate [for REITs] on a same-store basis,” he says. “From our point of view, the fundamentals of seniors housing are very strong, and we wouldn’t expect anything but either flat or increasing margins.”
Written by Alyssa Gerace