New Senior Housing REIT Deal Structure Brings Upside, But Risks as Well

One of the hottest topics in senior housing is the new RIDEA structure available to REITs looking to make acquisitions. The structure allows operators and the REITs to share both the operating profits of the facilities and also any downside, should performance deteriorate.

RIDEA, which comes from and is an acronym for the REIT Investment Diversification and Empowerment Act of 2007, became eligible for health care REITs when Congress passed the Housing and Economic Recovery Act of 2008.  The provisions of the bill give health care REITs the ability to buy and sell assets more effectively, than the traditional triple-net lease structure.

But a RIDEA transaction requires a level of trust between both parties since everyone’s interests are aligned for a long period of time.

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“I wouldn’t have done this with just any REIT,” said Loren Shook, president of Silverado at the National Investment Center for Seniors Housing event in Washington, DC. “This is a long term marriage and you really have to have ultimate confidence in your partner.”

In February, Shook’s company announced a $298 million joint venture with Health Care REIT (NYSE:HCN) that combined 18 senior housing communities across the country. As part of the deal, Health Care REIT owns 95%, with Silverado owning the remaining 5% interest in the partnership. Silverado will continue to operate the facilities under a long term management contract with incentives based on the the future performance of the properties.

Prior to the deal, Shook said the two companies had worked together for years and stressed how important the long term relationship was for Silverado. The partnership also provided Silverado the ability to monetize what it had built over the years without taking the company public.

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“It enabled us to get public company capital without going through the pain of actually doing it,” he said.

Plus, the backing of Health Care REIT’s balance sheet and low cost of capital allows Silverado to acquire communities without incurring a large amount of debt.  At the end of the 2Q 2011, Health Care REIT had access to a $2 billion line of credit and over $328 million of cash to continue to grow its portfolio. But the fact that Shook and his team will have ownership in the future of the company was key.

“Very important to us [to own] and have the ability to buy in,” he said. “Feels like it’s 100% owned by us.”

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Other companies, like CNL Lifestyle Properties, have decided to use the RIDEA structure as well, with Sunrise Senior Living (NYSE:SRZ). The $630 million deal was structured as a joint venture involving 29 Sunrise communities, with CNL owning 60% and SRZ the remaining 40%. Sunrise also entered into a long-term management contract of the properties and has the right to purchase CNL’s interest at the end of the third year.

The relationship between CNL and SRZ isn’t new; it started almost 10 years ago with Marriott Senior Living. When the company wanted to exit, they worked out a deal with CNL to purchase the business.

“Sunrise took the management contracts and it was a beautiful thing,” said Sharon Yester, Head of Asset Management for CNL Financial Group. “Because of the legacy relationship with Sunrise, [the joint venture] was a natural fit because of the trust built up over the years.”

The joint venture is the first deal for CNL after it was forced to exit the business due to a non-compete after it sold CNL Retirement Properties for $5.3 billion in October 2006 to Health Care Property Investors. During an interview with SHN, Yester made it clear there are more deals to come.

“There are several other Sunrise type of deals available out there today,” she said.

Downside Risks

While the RIDEA structure gives REITs the ability to share in the upside of the operating income from the property, they can also share in the downside. The fact that it’s different from the way things have been done in the past raises red flags for those like Ted Bigman, Managing Director of Morgan Stanley Investment Management.

“Healthcare REITs have changed their colors,” he said during a different panel during the NIC event. “It’s not the [the traditional] triple net lease. Now they’re the owner of the upside and the downside. The market has not quite come to grips yet about what that means.”

The deals are making some investors a little uneasy and many are watching how the deals perform closely as REITs manage and protect against any associated risks with the operations. The risks are exactly why everyone on the panel stressed the importance of the operators.

“HCN views these as long term partnerships,” said Chuck Herman, CIO of Health Care REIT. “[We want to work with those] committed to the industry and are among the pioneers in the business with a real state in the industry itself.”

Because everyone in a RIDEA structure retains ownership, all interests should be properly aligned.

“Ownership by the people making decisions helps ensure that they’re going to have a consistent outlook on what we’re trying to accomplish,” Herman said. “The meaningful ownership going forward makes sure all of the interests are aligned.”

CNL stressed the importance of finding the right operators and how they’re essential to making the deals work over the long term.  When asked to describe what they’re looking for, Yester said they’re not looking just for the operator who is only in it to make a nickel.

“We want [operators] who are passionate about their operations because they will deliver everyday to the residents and investors, that’s what we want,” she said.

Written by John Yedinak