Senior Housing RIDEA Deals a Lasting Trend, Messy Divorces Unlikely

Although real estate investment trusts (REITs) face higher risks when entering into a RIDEA structure with senior housing operators, it’s risk that’s well thought out, and the management structure will become increasingly important going forward, analysts say.

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.

These types of deals are becoming more popular, with companies like Silverado entering into a $298 million joint venture with Health Care REIT (NYSE:HCN) that combined 18 senior housing communities across the country.

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Others like HCP, Inc. (NYSE:HCP) have used the management structure with Brookdale Senior Living earlier this year, with Brookdale operating and acquiring 10% interest in 21 HCP-owned communities.

The structure is attractive to REITs because it allows them to share in the property’s profits from operations, different from the traditional triple net lease structure, where operators provide fixed payments regardless of how the property performs.

Operators also benefit by tapping into a lower cost of capital through the REITs, making the relationship mutually beneficial.

“If the marriage works, it gives the REIT higher internal growth, and those operators that have teamed with the REIT are in a much more advantageous position in terms of doing consolidation with properties because they’ve got a financial partner with a lower cost of capital,” said Jerry Doctrow, an analyst with Stifel, Nicolaus, & Co.

Sometimes relationships can get rocky, though, and for the REIT, the downside to these joint ventures is the risk of a variable performance.

“The REIT is arguably taking a greater risk,” Doctrow told SHN. “If the occupancy declines, if the rates decline, if operating expenses go up, you’re not going to get the same income you would have expected.”

In the RIDEA management structure, REITs are more dependent on the housing market and the economy compared to a traditional triple net lease, he added.

In order to minimize this risk, REITs generally limit how much equity interest they have with the operator, with many shares ranging between 5% and 10%, although there are some exceptions.

Earlier this year, Sunrise Senior Living, Inc. (NYSE: SRZ) completed the recapitalization of seven communities it owns in a joint venture with CNL Income Partners. The deal is structured as a RIDEA joint venture with 68% owned by CNL Income Partners and approximately 32% by Sunrise.

In order to protect their interests, REITs are very careful to select both the operators they’re working with, and the properties for which they’re using the management structure, said Doctrow; most only do a partnership with properties that have significant upside.

These factors are all considered when forming the contract between a REIT’s taxable subsidiary and an unaffiliated, third-party operator, because once the contract is in place, it’s not easy to back out of it.

“The manager is not guaranteeing performance; most of the contracts include some types of remedies, which vary from contract to contract, where you may be able to go back and transfer properties to a new manager,” Doctrow explained.

It’s the REIT that’s taking the operating risk, he emphasized, as they generally can’t remove a manager without “very clear cause.”

“The marriages are carefully considered. The details of each management agreement are not always totally laid out, but it’s not always that easy just to have a divorce,” he said.

He said that in these structures, the REITs are committed to their operators, unless there’s “extreme underperformance.”

However, as with other real estate, investing in properties is generally long-term for REITs, and they know up front there will be upsides and downsides.

Overall, Doctrow says Stifel Nicolaus’ view on RIDEA management structures is generally positive.

The risks in senior housing aren’t that great, and the properties performed relatively well even during the downturn, he said; the REITs’ selectivity regarding which operators and properties they’re working with are the key to whether or not it will be a successful outcome.

“Short of the operator filing bankruptcy, your’e going to get your rent,” said Doctrow. “You’re taking on risk, and the risk of variability on the income is definitely greater, but it’s more a matter of market risk than it is the risk of the sort of structure.”

Written by Alyssa Gerace

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