Inside Trilogy’s $1 Billion Deal

The implications of the $1.125 billion acquisition of Trilogy Health Services LLC are becoming clearer, suggesting a potential change in the REIT landscape making deals more competitive and potentially constraining cap rates.

Trilogy was acquired by Griffin American Healthcare REIT III, Inc. in a joint venture with NorthStar Healthcare Income, Inc., the companies announced last week. As such, Griffin American will own 70% of the joint venture and act as its manager, while NorthStar Healthcare—a public, non-traded REIT—will own 30%. Trilogy leadership will maintain an investment of about $24 million in the company.

The deal means Griffin American purchased the operating company outright, whereas a competing bid from Health Care REIT (NYSE: HCN) honed in on Trilogy’s real estate, Scott Estes, executive vice president and CFO of HCN, said during the Bank of America 2015 Global Real Estate Conference last week.

“Our bid on the real estate was RIDEA, whereas Griffin bought the whole company,” Estes said.

Though the deal was a joint op co/prop co transaction, only some of Trilogy’s 96 operated senior living communities were also owned by the company. Only 53 properties were purchased outright, while the remainder are leased, some with purchase options, according to a filing with the SEC. Twenty Trilogy properties remain in HCN’s hands, Estes said.

The acquisition also signals the end of a joint venture between Trilogy and post-acute and transitional care provider Mainstreet, which had invested in the operations of 15 Trilogy facilities, Adlai Chester, Mainstreet’s CFO, tells SHN. Last year, Mainstreet forged a $1.4 billion partnership with HCN.

“As part of this transaction, Mainstreet will be stepping away from the joint venture with Trilogy,” Chester said, but he noted that capital will be redeployed amongst Mainstreet’s operating partners in the future, including possibly Trilogy and others. The joint venture will cease in conjunction with the closing of the transaction, which is expected to close by the end of the year and is subject to customary closing conditions and third-party approvals.

Given that the deal involved a failed bid from HCN and a successful outcome for the smaller-cap REITs, the deal also could represent a shift in the industry in terms of what type of investors could be involved in major transactions. With the “Big Three” REITs’ cost-of-capital advantage eroding and the potential for an interest rate hike, public, non-traded REITs and smaller entities might be driving more deal-making, said Kevin Tyler, an analyst with Green Street Advisors.

“Publicly traded health care REITs have seen their cost-of-capital advantage vanish in recent months, leaving more room in bidding tents for non-traded counterparts,” Tyler said. “The public REITs are incented to grow their portfolios when shares trade above net asset value (NAV), which has been the case for the last four to five years. Today, the stocks trade in line with NAV, removing the sizable cost-of-capital advantage that resulted from issuing stock above NAV to fund acquisitions.”

Green Street is not alone in these observations. At this point, many of the operator-owned portfolios in the sector have been acquired by REITS, which has caused further competition between the publicly traded and non-public health care REITs, according to Brown Gibbons Lang & Company, a middle market investment bank based in Cleveland, Ohio.

This competition, in turn, has contributed to lower cap rates, according to BGL. The cap rate for the recent acquisition of four skilled nursing facilities in Maryland by Sabra Health Care REIT, Inc. (Nasdaq: SBRA) in June, for example, was 8.5%. Meanwhile, the cap rate on the Trilogy transaction was 7.35%, a “premium cap rate for post acute,” Mike Hargrave, principal with health care real estate data service Revista, tells SHN.

Written by Kourtney Liepelt

Pictured: Stonecroft Health Campus in Bloomington, Indiana, a Trilogy/HCN property.