After a year of record transaction volume across senior living, the “Big Three” senior housing REITs now are taking aim at a different asset class by allocating more resources through very different strategies.
With chatter that blockbuster portfolio transactions in senior housing are harder to come by, HCP Inc. (NYSE: HCP), Welltower Inc. (NYSE: HCN) and Ventas (NYSE: VTR) are placing bets on higher yields in the hospital system space. But while Ventas has staked its claim with the “beachhead” investment in hospitals by acquiring Ardent for $1.75 billion, the CEO of Welltower is talking about putting acute hospitals “out of business.”
Leaders from the “Big Three” REITs recently spoke with Senior Housing News to weigh in on the hospital asset class and what the new focus means for senior housing.
The Last Frontier
The shift in focus for REITs comes at a time when the role of the hospital within the U.S. health care system is evolving, due in large part to Affordable Care Act reforms that incentivize more coordinated care across the continuum and reward provider groups that can place patients in the lowest-cost settings as rapidly as possible.
Welltower CEO and President Thomas J. DeRosa sees a changing acute care landscape and anticipates that hospital systems will undergo a transformation with the help of REITs investing more in the space—and in his estimation the days may be numbered for the acute care hospital as we know it.
“I think that hospital systems are just starting to recognize that their models have to change,” Thomas J. DeRosa, CEO and president of Welltower Inc., told SHN. “The next 50 years will look very different than the last 50 years. Our goal is to put the traditional acute care business out of business. The days of keeping the beds filled in an acute care hospital are over.”
Fitch Ratings also views the shift to more capital dedicated in the space as a natural progression for REITs seeking the next sector with high yields, calling hospitals the “last frontier that pencils out.”
At the same time, hospital systems are consolidating, influenced by recent mergers among the largest commercial insurance companies, such as the acquisition of Humana Inc., the fourth-largest health insurer by revenue, by Aetna Inc., the third-largest insurer. With REITs investing more in sector, consolidation is likely to increase at a faster pace.
“There are a lot of incentives for hospital consolidation,” Britton Costa, director of U.S. REITs Corporate Ratings with Fitch Ratings, told SHN. “Now that REITs are potentially willing to allocate capital toward it, they can serve as the grease in the transaction if they’re able to finance the majority of a merger with the real estate early on.”
Consolidation may also further accelerate as REITs take on a larger role, says Costa, who anticipates that more systems will converge amid health care changes.
“REITs have been deploying more capital to the hospital space to the extent that during a merger, the acquiring company could finance the portfolio transaction at the time of the announcement or shortly thereafter,” Britton told SHN. “It could allow for more transactions. In the past, an operator would have to finance the transaction, be it through their bank facility or bridge facility, and then sell the real estate to leasebacks over time.”
Lauralee Martin, CEO and president of California-based HCP Inc., agrees that consolidation in the sector is happening due to health care law changes as rules from the Affordable Care Act continue to come into play, and the Centers for Medicare & Medicaid Services (CMS) implements alternative payment methods.
“Hospital systems are consolidating because they need to negotiate with the payer systems as well as the consumer’s choice,” Martin told SHN. “As transparency around that comes into play, there a battle, a focus on market share and being the No. 1 or No. 2 system in any given market. Consolidation is definitely going on and [hospital systems] want to make sure they have the specialties in the different areas.”
Hospital systems are also consolidating because the landscape of acute care is undergoing a transformation, according to DeRosa.
“We think there are too many acute care hospital buildings that are outmoded to deliver health care today,” DeRosa told SHN. “The future of health care and acute care is outpatient, not inpatient. The future is about moving people out of the high-cost beds and partnering with other providers of health care services that can offer a better outcome at a lower cost. We have to move away from a health care system that sees the acute care hospital bed as the central point.”
Diverging Big 3 Strategies
While large-cap REITs are engaging with hospital systems, they vary in their approach to the acute care part of the continuum.
Ventas CEO and Chairman Debra Cafaro has spoken frequently of the REIT’s aggressive strategy in the hospital system space, noting several contributing factors.
“We see a tremendous opportunity to grow in the large, fragmented and rapidly consolidating $1 trillion domestic hospital segment,” Cafaro said in a statement to SHN. “We believe that several key trends benefit hospitals, including attractive demographics, policy tailwinds such as the Affordable Care Act and Medicaid expansion and an improving economy.”
Earlier this year, Ventas massively increased its stake in the hospital sector by purchasing Ardent Health Services, Inc., one of the largest for-profit hospital companies in the country, for $1.75 billion.
“Our recent acquisition of Ardent, a top 10 U.S. hospital operator, is the leading edge of our investment program in this highly fragmented market,” Cafaro said. “By providing capital to high quality hospitals and health systems in attractive markets, we will help care providers fulfill their core missions and improve efficiency in health care.”
HCP has a very focused approach to hospital systems, with 14% of its portfolio dedicated to the medical office sector and 4% to hospitals. Of its medical offices, roughly 80% of these assets are on hospital campuses and 95% are affiliated with hospital systems. By comparison, 19% of Ventas’ portfolio consists of medical office buildings and 2% is made up of specialty hospitals.
While their investment exposures may be different, HCP and Ventas have similar views when it comes to what makes the space attractive.
“We favor the medical office portion of the hospital systems, particularly when the medical office is on campus,” Martin told SHN. “As we see hospital systems today navigating the changes in health care reimbursement, the ACA’s impact, we see them strategically focused on their acute hospital as sort of their heart and center. If they are going to monetize something—which is where REITs come into play—they are more comfortable monetizing their medical office portfolios than their acute care hospitals.”
Given this perspective, it makes sense that instead of going after the heart of acute care—the hospital—HCP has a significant portfolio in specialty hospitals, senior living and medical offices that surround and are integrated into hospital campuses. However, Martin also told SHN the REIT wouldn’t rule out acute hospital investments in the future.
Specialty hospitals and medical offices may become more favorable than traditional acute hospitals as they are generally lower-cost settings. Like HCP, Welltower similarly sees more opportunities in the surrounding campuses.
“We stop at the front door of the hospital,” DeRosa told SHN. “What we are looking to do is partner with hospital systems to build, own and manage the outpatient system to bring in a broader population to those major acute acute settings.”
Still Bullish on Senior Housing
Despite a heavier concentration and more capital being diverted into hospital system assets, senior housing providers shouldn’t be concerned, the Big 3 leaders say. They agree that with 10,000 baby boomers turning 65 every day, there will be plenty of demand for years to come, and all are firm that they will continue to invest heavily in the sector.
Speaking at a recent forum in Chicago, Cafaro noted that Ventas is still optimistic about senior housing down the line, particularly given the opportunity to increase market penetration. She pointed to the fact that less than 10% of seniors live in senior living communities.
“We are very bullish on senior housing for the long term,” Cafaro told the forum.
Welltower also balks at concerns of oversupply or overbuilding in senior housing, adding that it’s best to look at the sector by regional real estate markets.
“The headlines of oversupply and overbuilding in senior housing are misleading because you have to look at specific market,” DeRosa told SHN. “If you are focused to the urban core of the market, those areas are not overbuilt. We are still deploying capital to the best-in-class operators in the Welltower senior housing family who are bringing the beds to treat people to the places where people live.”
HCP’s Martin warns that overbuilding is something to watch, but agrees that looking at specific markets is the best way to detect oversupply. And she delivered a very direct message of reassurance to senior housing providers.
“Senior housing operators should feel that they remain a very sought after investment asset class by REITs,” said Martin.
Written by Amy Baxter