Senior housing real estate investments trusts (REITs) have pulled back their acquisition activity since the end of 2015, and transactions during the first six months of the year tanked as a result. However, rebounding share prices are returning the capital advantage to the biggest players in the industry, and may help deal volume pick up at the tail end of the year.
And there are signs that this may already be coming to pass: A few billion-dollar-plus acquisitions announced in the third quarter of the year could signal that REITs are ready to reclaim the aggressive acquisition strategies they have cultivated over the last few years, particularly the “Big 3” players—Ventas Inc. (NYSE: VTR), Welltower Inc. (NYSE: HCN) and HCP Inc. (NYSE: HCP). But others believe new market headwinds could mean a slower return to normal in terms of transaction volume.
Cost of Capital Improves
Higher cost of capital kept senior housing REITs sidelined on dealmaking for several quarters, largely caused by lower share prices. Following a dip in the stock market at the beginning of the year, REITs seriously tapered off their M&A activity in the first and second quarter. During the second quarter of 2016, there were only 76 deals, which totaled $1.6 billion—the first time in which senior housing deals dipped below 100 transactions since the second quarter of 2013.
While stocks have recovered losses from the start of the year, other market conditions could make for a slow M&A recovery. Elements at play, including the Fed’s continued conservative interest rate environment, have helped REITs recover, as well.
“Cost of capital has improved,” John Kim, analyst at BMO Capital Markets, told SHN. “Cost of debt has come down and the share prices have mostly gone up pretty significantly this year. While the cost of capital has improved, the REITs have been more selective on acquisitions compared to how they might have been two or three years ago.”
Instead of making major acquisitions in 2016, REITs have actually looked to pare down their portfolios and offload noncore assets during the first half of 2016, according to Britton Costa, analyst with Fitch Ratings. Others have sought out alternative strategies to recapture shareholder value, such as HCP Inc.’s (NYSE: HCP) decision to spin off its skilled nursing assets into a separate, publicly-traded REIT, announced in May.
“The three biggest buyers over the last three years are all looking to sell at the same time,” Costa told SHN. “Transactions have been low because there are more sellers than buyers. Why are health care REITs looking to sell? For one, they were adjusting to their cost of capital.”
The higher cost of capital impacted the public players more so than others, but the Big 3 have seen a steady favorable trend in their cost of capital at the end of 2016, according to data from the National Investment Center for Seniors Housing & Care (NIC).
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Cost of capital was not the only culprit in the backseat position of the REITs. The potential for disruptive oversupply in certain markets has added to the pullback.
“Right now, the market is concerned about new supply in senior housing,” Kim told SHN. “A couple years ago, there wasn’t as much supply, large acquisitions were accepted. Today, they are more scrutinized.”
Indeed, recent data reflects that new units that have come on line this year have put a damper on the market.
“The pace of absorption has slowed in the past six months from 4,200 units in the fourth quarter to 1,200 in the second quarter,” Beth Burnham Mace, chief economist for the National Investment Center for Seniors Housing & Care (NIC), recently wrote in National Real Estate Investor (NREI).
Some of the absorption slowdown was due to seasonal changes, including a late flu season and “higher-than-normal disease incidence” reported by the Centers for Disease Control and Prevention (CDC), according to NIC.
“Even so, the increase of only 1,200 units was surprising, because the housing market remains on an upward trajectory in terms of the velocity of sales, home prices and low mortgage interest rates,” Mace wrote. “These factors provide a supportive backdrop for potential seniors housing residents as they try to sell their homes.”
However, the real estate market can’t be painted with too broad of a brush, and those looking for more granular insight into the health of certain locations can look to WalletHub’s recent findings of the top real estate markets and those that are still struggling.
Several of the best performing real estate markets—including the top three—lie in Texas, with Frisco, McKinney and Richardson, Texas, named as the best markets across 300 U.S. cities. Meanwhile, Newark, New Jersey; Paterson, New Jersey; and Detroit, Michigan, were among the worst performing, according to WalletHub.
Rebound in Sight?
Even with improved cost of capital, it may take some time for transactions to bounce back up from the REIT side, according to Bill Kauffman, a senior research analysts with NIC.
“In addition to a bounce back in premium since the first-quarter turmoil … the public REITs were not affected [by the Brexit vote] on June 24 to the same degree as the rest of the stock market, which is a positive for their investors and potentially for their deal-making going forward,” Kauffman wrote in a recent blog post. “And in fact, we already have started to see a little pickup in the third quarter. But we will have to see how the next few months play out as there is usually a lag between changes in the cost of capital and actual deal closing for the time period.”
Others agree that even with a recapture of capital advantage, REITs aren’t really being aggressive in terms of new deals, except for a few recent outliers. Ventas recently announced a $1.5 billion acquisition in the life sciences sector, while Welltower inked a $1.15 billion seniors housing portfolio acquisition on the West Coast.
“The REITs have seen a pretty significant improvement in their share prices this year, and that’s directly tied to their cost of capital,” Michael Knott, director of U.S. REIT research with real estate investment firm Green Street Advisors, told SHN. “In theory, it should have increased their interest in returning to being more aggressive acquirers. …But interestingly, you haven’t seen that as much; you’ve seen a reasonable discipline by REITs.”
Written by Amy Baxter