After a year marked by up-and-down transaction volume, senior housing real estate investment trusts (REITs) may be gearing up for a buying rebound in 2017—but don’t expect them to acquire Brookdale Senior Living (NYSE: BKD).
That’s one prediction for what the year ahead will hold for the big three health care REITs, Ventas Inc. (NYSE: VTR), HCP Inc. (NYSE: HCP) and Welltower (NYSE: HCN). Along with an unruly regulatory environment and rising interest rates, these companies are likely to feel pressures across certain asset classes, meaning they will have to tailor their strategies to get through some choppy weather.
The nation’s largest senior living provider, Brentwood, Tennessee-based Brookdale, is a major tenant for the big three REITs, and is a likely candidate for a takeover. After suffering from operational challenges and with net losses rising more than 50% at the end of 2016, Brookdale appears ripe for the picking—but the REITs themselves aren’t biting.
Many potential buyers have been rumored to be in talks to buy Brookdale, including private equity firm The Blackstone Group, as well as senior housing REIT Ventas Inc. (NYSE: VTR). Ventas, along with HCP Inc., denied being in talks to buy Brookdale publicly in investor presentations in early March, and both have made moves to divest some Brookdale assets.
Amid the swirling rumors, Brookdale’s ongoing challenges—and REITs’ attempts to distance themselves from the provider—are weighing on the industry as the REITs continue to have some exposure to the troubled company.
“I’ve heard the saying that rising tides lift all ships, but what we are seeing with Brookdale is as Brookdale sinks, everyone else is sinking,” Brad Thomas, editor of subscription-based Forbes Real Estate Investor, told Senior Housing News.
Several possible reasons for why REITs are unlikely to buy Brookdale have been floated, including the need for all of Brookdale’s major landlords to sign off on a potential deal. At one time, it was rumored that two of the “Big 3” health care REITs were attempting to make a big play for Brookdale, but no deal materialized. Attempting a full buyout again could have a similar result.
However, even if the REIT is not planning to buy out some or all of Brookdale, Ventas could be eyeing another senior housing grab, according to Thomas.
New Senior Investment Group (NYSE: SNR), a REIT with a portfolio dominated by private pay senior housing assets, could be a potential buy, according to Thomas, who sees its discounted value as an attractive purchase.
Ventas CEO Debra Cafaro was conspicuously mum about the REIT’s plans to make senior housing acquisitions in 2017 during a recent quarterly earnings call. Instead, Ventas was looking hungrily toward its new asset class—life sciences and medical office buildings—in forward-looking statements. Cafaro discussed acquisition and growth opportunities in this sector and the acute care hospital space.
Regulatory and Rate Impacts
In 2016, health care REITs were historically quiet on the acquisitions front in senior housing, according to NIC data, and were hit by rising interest rates. As the Federal Reserve gears up to raise interest rates up to three—and even potentially four—times in 2017, health care REITs are taking a hit in share price values.
However, the rate environment is likely to have less of an impact in 2017 than previous years.
“Most of [the impact] has already been priced into the market,” Thomas said. “There will be nothing near what we saw in 2013, when there was a substantial pullback when the Fed first started talking about a rate increase. In terms of fundamentals for REITs, this has minimal impact, if any.”
Historically, rising interest rates have hit REITs hard, with an immediate shock to share prices. Long term, however, REITs tend to do better overall when the interest rate environment returns to normal, according to NAREIT.
At the same time, economic fundamentals are predicted to improve in 2017, including GDP growth, Fitch Ratings predicts. REITs also could be poised for greater attention from investors after gaining recognition as their own indexed category. Faster interest rate hikes from the Fed are also indications of the economy’s strength.
An area of uncertainty lies in the Obamacare repeal and replace legislation. Republicans recently put forth their health care replacement plan, The American Health Care Act.
“In health care, we do think uncertainty will continue, and there’s increased discussion around the Affordable Care Act repeal and replace [plan] and what that means,” Britton Costa, analyst with credit rating firm Fitch Ratings, told SHN. “…Uncertainty increases risk—that will make big transactions a little bit tougher.”
As the bill undergoes debate in Congress, it’s unclear what financial and clinical impact the law will have on senior housing, if any. Skilled nursing, which has been ravaged by regulatory and operational hurdles, is more likely to see a steep impact, and this too could affect REIT activity this year.
Skilled Nursing Sell-Off
While REITs’ acquisitions were down in 2016, substantial sell-offs and spin-offs occurred, mainly focused on skilled nursing assets.
HCP made major moves to distance its core portfolio from its skilled nursing assets by spinning them off into a separate, independent REIT, Quality Care Properties (NYSE: QCP). That follows a SNF spin-off executed by Ventas in 2015. Welltower perhaps made the biggest waves among its peers in terms of repositioning its portfolio by increasing its disposition target to $4.1 billion, up from a previous guidance of $1.3 billion.
However, REITs had other reasons to sell assets in addition to skilled nursing challenges, Britton Costa, analyst with credit rating firm Fitch Ratings, told Senior Housing News. REITs experienced weak share prices throughout the year and higher cost of capital, reducing their purchasing power. Selling assets enabled REITs to delever and counter that weakness.
Compared to the senior housing sector, skilled nursing is still facing major headwinds in 2017, and could be in store for more challenges as Obamacare repeal and replacement legislation makes it way through Congress.
“Skilled nursing is under more pressure than any other sector,” Thomas said. “The biggest catalyst is going to be the repeal of Obamacare and how it’s going to impact Medicare and Medicaid under skilled nursing categories. Senior housing has its supply and demand issues, but I think we are able to call the bottom of that. We can’t call the bottom on skilled nursing.”
With a reduced exposure to SNFs and more streamlined overall portfolios going forward, REITs may have regained some advantages that will allow them to be more acquisitive.
“Our expectation is for health care REITs, in terms of acquisitions, to pick up in 2017,” Costa said. “2016 was a pretty telling year in terms of the volume of dispositions that we saw.”
However, the portfolio rationalization efforts are ongoing, so don’t expect REITs to stop shedding assets even as they shift to a more accretive position, Christopher Honn, senior managing director of senior housing & healthcare at Berkadia, told SHN.
Going forward, “REITs will still selectively sell properties,” he said.
Written by Amy Baxter