Have senior housing real estate investments trusts (REITs) reached their RIDEA max?
We posed this question back in 2013, when RIDEA exposure already seemed at the high-end of its range. Evidently, the max exposure had not been reached, if recent transactions by the ‘Big Three’ health care REITs—Welltower Inc. (NYSE: HCN), Ventas Inc. (NYSE: VTR) and HCP Inc. (NYSE: HCP)—are any indication.
Upon completion of its recent $1.15 billion senior housing portfolio acquisition on the West Coast, Welltower’s RIDEA NOI share will jump to a proportion above 40%, executives at the company said during a recent quarterly earnings call with analysts. In 2013, 34% of Welltower’s—then known as Health Care REIT—NOI came from RIDEA-strucutred assets. By comparison triple-net leased properties accounted for 27% of NOI in 2013, and was 27.6% of NOI by the end of the second quarter of 2016.
Similarly, Chicago-based Ventas Inc. (NYSE: VTR) has jumped up its RIDEA exposure within its senior housing assets. Three years ago, Ventas’ RIDEA assets made up 29% of the overall portfolio’s NOI. Today, the portfolio share stands at 32% of NOI stemming from RIDEA assets, according to a recent supplemental.
In comparison, HCP Inc. (NYSE: HCP), which recently decided to spin out its skilled nursing assets into a separate, publicly-traded REIT called Quality Care Properties (QCP), has a much lower RIDEA exposure in its current portfolio. Its senior housing operating assets accounted for 14% of its overall portfolio as of June 2016. While HCP’s RIDEA share is around half of its industry peers, just 3.4% of its total portfolio in 2013 was made up of RIDEA-strucutred properties. Once its skilled nursing spin is complete, that figure will increase to 17%, according to a recent investor presentation. HCP’s triple-net senior housing portfolio share will be 37% post-spin.
No doubt about it—senior housing REITs are betting more on RIDEA-structured assets as profit winner—but is getting involved in the operations really riskier?
Market Strength, Competitive Advantages
When recently questioned by analysts how the RIDEA-leaning portfolios would fare if faced with a future, hypothetical economic downturn, executives from Ventas and Welltower mounted similar defenses—by touting the strength of their operating partners and value of their Class-A senior housing assets.
“We don’t think it elevates the risk profile, because we have very seasoned operators and an infrastructure to manage RIDEA assets that’s unparalleled and we feel much more comfortable in our ability to manage our RIDEA assets than we might with certain triple-net, just by the nature of how the ownership is structured,” Scott Estes, executive vice president and chief financial officer at Welltower, said during a recent quarterly earnings call. “…Not that we would say that triple-net is necessarily riskier, but we think we know how to manage risk and enhance value through a RIDEA structure better than anybody.”
Ventas CEO and chairman Deb Cafaro also took a similar question in stride, largely brushing off any additional risks from the increased RIDEA share. Even during the Great Recession, senior housing remained a reliable asset and remained profitable, she said during a second quarter earnings call. That underlying reliability, coupled with REIT’s capital advantages over the past several years, has kept Ventas bullish on senior housing, RIDEA-structured assets included.
“We’re in a Goldilocks environment for REITs in general, and Ventas in particular,” Cafaro said while discussing the company’s advantages in the public markets, improved cost of capital and strength of the core businesses. “We have been in this slow-growth economy for a while. What I would say is that in the financial crisis and recession, senior housing was the only real estate asset class that continued to show NOI growth.”
The Big 3 have seen tremendous growth since they started utilizing RIDEA structures in their senior housing portfolios. While they were able to weather the storm of the financial crisis nearly a decade ago, they have continued to change risk profiles by upping the RIDEA share. Not only is the risk profile different, but there’s a new threat on the horizon: oversupply in certain markets.
“RIDEA brings in additional revenue growth opportunities, but also more risk,” John Kim, analysts with BMO Capital Markets, told SHN. “Higher growth has helped improve the cost of capital for the REITs. “The companies have been very successful on it since implementation. They have worked on best practices. They have addressed some low hanging fruit, they’ve utilized their scale advantage. The success and growth has been there. The question going forward, with new supply in the market, can they replicate the success?”
Generally, RIDEA may carry more risk as a structure in periods of operational pressure. However, in some of the tightest housing markets across the country, operational strength is more likely to be buoyed by demand. The bigger REITs, which select their markets very carefully and have the capital to penetrate even those with the highest barriers-to-entry, are therefore somewhat shielded in certain cities from operational risk compared to other markets.
“RIDEA definitely injects more risk than triple net lease, but if you’re buying the right asset in the right market, the overall return profile in senior housing business should be the same in regard to lease structure,” Kevin Tyler, analyst with Green Street Advisors, told SHN. “Risk might be shared equally.”
The strongest housing markets where the biggest REITs have made monster acquisitions over the past few years may also influence lease structure. Markets that have a higher barrier to entry, such as Welltower’s latest claims in San Francisco and New York City, may be stabler overall in terms of the operating power of the assets. Welltower’s $1.15 billion West Coast portfolio includes 19 properties currently operated by Vintage Senior Living.
“REITs are selective when they are laying capital,” Tyler said. “The Vintage deal, albeit a RIDEA structure, is in high barrier markets. Those are the kind of assets they want to own and have ownership in the operations. Whereas the economics of a triple-net lease might make more sense in a tertiary market, should they have a choice. You can insulate yourself by owning operations in the right markets.”
However, not all REITs are seeing the same upsides. National Health Investors, Inc. (NYSE: NHI), a smaller senior housing REIT with a market value of approximately $2.2 billion at the end of 2015, recently moved to reduce its RIDEA exposure, and therefore risk profile. The company is converting a 32-property portfolio with Bickford Senior Living from a RIDEA-structured asset to a triple net lease. NHI will buy Bickford’s share of the real estate, and Bickford will buy NHI’s interest in the operations.
“They go from being a joint venture partner to a tenant,” NHI CEO Eric Mendelsohn told SHN upon the transition announcement.
The unusual move was seemingly not based on any operational challenges. Instead, executives said the conversion would simplify the relationship with Bickford going forward into new developments, as well as reduce the REIT’s overall risk. Executives noted they did not see much difference in the rewards between RIDEA and triple net lease.
Others say the conversion brings the “risk-averse” NHI in line with its other portfolio asset structures.
“In RIDEA, it’s helpful to have a large presence and scale to have it work well,” Kim said. “NHI, generally speaking, is a relatively risk-averse company. …It makes sense to be more aligned to the rest of their portfolio to go to triple net.”
Written by Amy Baxter