Brookdale Merger Endangers Healthcare REITs’ Growth Potential

Healthcare REITs may start losing their competitive edge as a result of more harm than benefit stemming from the Emeritus-Brookdale merger announced last week.

Historically, high credit ratings have given these REITs access to lower costs of capital, says global ratings giant Fitch in its outlook on the acquisition.

But real estate investment trusts focused on health care and senior housing are facing a changing landscape—and potential diminished growth—as a result of the merger, Fitch says in its analysis. The deal might put downward pressure on both ratings and operating profit margins.

“While we expected operator consolidation, we believed it would be larger operators acquiring smaller, private, regional operators rather than a merger between larger peers,” notes the recent Fitch Ratings commentary.

The merger is likely to spur further consolidation among tenants of healthcare REITs, says Fitch, which is expected to impact the credit ratings of those REITs.

“Generally speaking, [the merger] is probably a negative for their credit, but to the extent it’s a big negative, that remains to be seen,” Britton Costa, a Fitch analyst who covers REITs, told SHN.

HCP (BBB+), Ventas (BBB+), and Health Care REIT (BBB)—collectively known as the “Big Three” healthcare REITs—are all landlords of properties managed by Brookdale and Emeritus. Post-merger, Brookdale will represent 21% of HCP’s revenues; 7% of Ventas’ revenues; and 7% of Health Care REIT’s investments.

“For the rated REITs that are landlords to the combined company, Fitch expects the merger will enhance coverage modestly while also boosting concentration, which is a negative for credit quality,” says the commentary.

However, there are also credit-positive factors the combined Brookdale-Emeritus company will present, including synergies among the companies both in terms of revenue and expense.

“A healthier tenant will be a credit positive as it reduces cash flow volatility stemming from a previous bankruptcy,” says the Fitch commentary. “The transaction may also allow the REITs to push rents over the longer term, although their ability to do so remains uncertain.”

But Brookdale’s size and scale following deal closing will give the operator more power as a tenant.

“Larger, more concentrated tenants have significant leverage when negotiating lease renewals given the pooling of assets into master leases,” says Fitch. “The downside potential from material tenant concentration will continue to be a focal point for healthcare REIT ratings.”

Another factor: Brookdale intends to exercise purchase options and reacquire between $2.3-2.8 billion of properties.

“The lost revenues in any one year is less of a credit concern than the potential effects on healthcare REITs’ share prices, which have been closely linked to growth expectations,” says Fitch. “A rise in the cost of equity due to lower growth expectations could hinder REITs’ ability and willingness to raise equity capital to maintain or improve credit metrics.”

While the Brookdale-Emeritus merger doesn’t necessarily put consolidation pressure on the industry, it does change the dynamics of the senior housing real estate acquisition environment, Costa says.

“Over the past few years we’ve seen Ventas and Health Care REIT acquiring a lot of senior housing assets through the RIDEA structure. Now we’re going to have an operator that’s been very vocal about reacquiring their real estate,” he says. “That changes a little bit of the market and adds a new player to the market with operators reacquiring properties.”