Welltower Bullish on Senior Housing JVs After Stellar Results

Welltower Inc. (NYSE: HCN) wants to expand its joint ventures with operating partners, to capture some of the financial upside from communities that are outperforming their local markets. But don’t expect the real estate investment trust (REIT) to partner with Brookdale Senior Living (NYSE: BKD) on these types of JVs, at least any time soon.

Toledo, Ohio-based Welltower, one of the largest senior housing real estate owners in the nation, on Tuesday posted strong financial results for the third quarter of 2017. Its funds from operations of $1.08 per share and revenue of $1.09 billion beat analyst expectations, and the REIT increased its same-store net operating income (SSNOI) guidance. The performance of its senior housing operating portfolio (SHOP) shone especially bright.

In a move that could provide a template for how Welltower will go about increasing its currently high-performing SHOP portfolio, the REIT converted Fort Worth, Texas-based Sagora Senior Living from a strictly triple-net leased tenant to a RIDEA operating partner in the third quarter.

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On the triple-net lease side of the ledger, coverage ticked down on Welltower’s portfolio of senior housing and skilled nursing facilities (SNFs). But this could change by the end of the year, given disposition activity underway.

The REIT already has disposed of about $1.4 billion in assets this year, and this should reach $2.4 billion by the end of the year or early 2018, according to updated guidance. In addition, Welltower is in the midst of hammering out a transaction involving skilled nursing giant Genesis HealthCare (NYSE: GEN), which could drive the dollar figure for total dispositions even higher than $2.4 billion.

Genesis, which has experienced steady share price erosion over the past year, is not the only HCN tenant in rough waters at the moment. Brentwood, Tennessee-based Brookdale saw its share price tumble Tuesday after its own third-quarter earnings call. For the time being, Welltower believes it is in a comfortable position with Brookdale but is not pursuing growth with the behemoth operator, HCN executives said Tuesday morning on a call with analysts.

Best of both worlds

Welltower’s SHOP portfolio consists of ventures in which the company is not just collecting rent but has a stake in the operations of its communities, through structures such as RIDEA. It has about 500 properties in the SHOP portfolio, compared to about 420 in its triple-net lease senior housing portfolio.

The performance of the SHOP properties in Q3 was “surprisingly strong,” analysts with Green Street Advisors wrote in a note issued Tuesday.

In particular, they highlighted the plus-4% growth pace of same-store net operating income for the SHOP portfolio. This was the strongest pace of the year and the strongest seen since early 2016.

“Welltower delivered impressive senior housing results, which speaks to the quality of its real estate, operators and asset management capabilities,” Green Street analyst Michael Knott told Senior Housing News. “The company is set up well for the long term on the strength of its senior housing platform.”

The SHOP portfolio also gained a bit of scale in the third quarter thanks to the addition of 14 Sagora Senior Living properties. Three of these, located in Houston and San Antonio, were newly acquired in the quarter for $166 million. The other 11 were previously triple-net leased, but because they had higher than average lease coverage and “outsize growth,” they were transitioned into the RIDEA joint venture, HCN execs said.

“We started this relationship [with Sagora] in 2010,” Executive Vice President of Business Development Mercedes Kerr said. “This triple-net lease structure was somewhat an incubator process … These were 11 properties which stood out from an otherwise consistent, solid portfolio as a group of properties with outsized growth.”

Welltower is “built” around owning RIDEA assets, and this type of conversion play might be repeated, according to CEO Tom DeRosa.

“You will continue to see us look for operators we’ll incubate in a triple-net format to transition ultimately to a RIDEA structure, and see us move away from relationships we can’t transition into a RIDEA structure in the future,” he said.

This process could be facilitated by tools developed in conjunction with Sagora and other RIDEA partners, such as better alignment features in management contracts and better structured incentives to mitigate volatility, Kerr told Senior Housing News.

While looking for RIDEA opportunities, Welltower is not planning to transition its whole triple-net portfolio to joint ventures and will remain opportunistic in its M&A approach. There is no “systemic plan to buy triple-net to convert to RIDEA,” Kerr told SHN.

Generally, as with Sagora, assets that steadily perform in line with market averages are likely to be triple-net leased, while top performers will be good JV candidates.

“A lot of industry debate is RIDEA versus triple-net,” said Shankh Mitra, senior vice president-investments. “[With Sagora], we’ve combined the best of both worlds.”

As for whether the SHOP performance suggests that the worst is over related to oversupply and other senior living industry headwinds, Mitra said that new supply will continue to affect operations into 2018. Beyond that, he did not want to predict into next year, except to express confidence that the Welltower portfolio would continue to outperform the industry as a whole.

The Brookdale play

About 7.2% of Welltower’s NOI is derived from its portfolio of 147 Brookdale properties. Brookdale’s share price has fallen precipitously since its acquisition of rival Emeritus Corp. in 2014, and despite some improvements in operational metrics, it posted a $413 million loss for the third-quarter of 2017.

“We’re cheering for Brookdale, we hope they can turn their business around,” DeRosa said Tuesday. “Their issues affect the view of the entire industry.”

However, as things currently stand, Brookdale is not an operator that Welltower is considering as a JV partner.

“Never say never, but they’re not one of the operators I was referring to beforehand, that we’ll grow out of the triple-net lease to RIDEA longer term,” DeRosa said. “They’re a very different situation for us, always have been. We’re not looking for growth opportunities there.”

The Brookdale lease structures and the quality of the underlying real estate give Welltower a lot of “optionality” when it comes to optimizing shareholder value relative to this portfolio, he added.

Rent coverage for the Brookdale properties is actually above average for the Welltower triple-net portfolio overall, Kerr noted. Additionally, about two-thirds of the portfolio is in California, Washington or a certificate-of-need state, and Welltower has “excellent” operators in every region that could step in and manage a Brookdale community if the need should arise.

Last week, Brookdale and its largest REIT landlord, HCP Inc. (NYSE: HCP), announced a complex deal, under which HCP gave up its consent rights. This means that if Brookdale wants to execute a large-scale change-of-ownership transaction—which it is rumored to be pursuing—HCP will not have to grant its permission. However, Welltower retains its consent rights, as does Chicago-based REIT Ventas Inc. (NYSE: VTR).

As of market close on Tuesday, HCN shares were up 0.85%, at $68.59.

Written by Tim Mullaney

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