Eric Mendelsohn, CEO and President of National Health Investors (NYSE: NHI), might seem to be a study in contradictions.
On the one hand, he is a self-professed “contrarian investor” who is bullish on skilled nursing while others view this as a beleaguered sector. Yet, he also describes the investment approach of NHI, a Murfreesboro, Tennessee-based real estate investment trust (REIT), as very conservative.
One thing is clear: Mendelsohn is relying on the history of the senior housing and care industry to be his guide. He recently sat down with Senior Housing News during NHI’s Music City Symposium in Nashville, and while he covered a range of topics—from NHI’s overall acquisition strategy, to its position on rent escalators, to his take on ideal operator size—he repeatedly pointed to what has worked well, and what has not, in the past.
Oversupply has been an ongoing concern in senior housing, do you see the situation getting better any time soon? I’ve been hearing that the tide should start to turn around mid-2019?
Mendelsohn: I think we’re starting to see it already. We’re getting lots of calls from developers who have been turned down by banks, and that’s an early indicator. When banks turn off the spigot of money, then developers start looking for secondary sources, either more equity or a REIT or a pension fund, who may not be as savvy as a bank and as regulated as a bank.
So, that call volume tells me, and my conversations with other banks tells me, that things are slowing down. So I definitely think by the end of this year we should see a slowdown in construction. All the new product that’s coming on in the next 12 months will probably be the last hurrah.
Do you see opportunities for NHI to acquire distressed properties, where occupancy has suffered due to all the new competition?
As a REIT, we need to be careful. I love distress as much as the next investor, but we have to be mindful that we have to pay a dividend, so buying a failed development is tricky. We did exactly that in New Hampshire earlier this year, with a loan. So, we have a first mortgage, we’re getting current payments on it, and the property is filling up according to our predictions. But that’s what you’ll likely see more of, more developments that are built, that are half full, with lackluster performance, that can be purchased at a deep discount.
You’ve said that you want NHI to be the ‘REIT of choice’ for regional operators. How do you define what makes a regional operator? Do they have to be in multiple states?
When I say region, I’m thinking of a cluster that makes sense, like the Midwest or Southeast. Our Bickford [Senior Living] relationship is a great example. They want to be able to drive to their buildings, or for their people to be able to drive to all their buildings, in one day. That tells me that the operator has their finger on the pulse of their buildings, they know their residents, they know their employees, they’re very aware fo the performance of the buildings, and that’s important to us.
You just added Comfort Care Senior Living as a new operating partner, and they’re only in Michigan. Do you see that company as having the potential to grow throughout the region?
Yes, they’re very entrepreneurial and eager to grow more in Michgan and surrounding states. Ideally, when I say regional operator, I mean someone who doesn’t have far-flung locations that get ignored, and has a tight grasp on their operations and performance.
Does that mean you’re not looking to grow your relationship with the national operators in NHI’s portfolio? Holiday Retirement, for example.
Holiday’s a great example. They have buildings all over the country. They have a national platform. They’re going through lots of changes that need to be observed and tracked, so the jury is still out on them. I would consider doing deals with national operators, but having a background with a national operator, I know that there are lots of things to be wary of.
How big is too big? Do you think there’s a size where the advantages of scale get outweighed by the drawbacks?
All I can do is point to history, and history has not treated companies above 300 buildings well.
NHI owns more than 70 SNFs versus nearly 150 senior housing properties. How are you thinking about those two asset classes going forward? Seems like skilled nursing is pretty challenged?
Maybe. I’m a contrarian investor. Our view of skilled nursing is skewed by the fact that we have NHC and Ensign as two of our largest tenants, and their stocks are trading at an all-time high. From where I sit, skilled nursing is doing great. I view the Genesis and ManorCare situations as specific to those operators and self-inflicted due to higher leverage and poor management choices. We just bought two skilled nursing buildings two months ago and we’re thrilled, and I would buy more if I could find any that would fit in that narrow box.
What is Ensign doing to drive its success?
I don’t think they would mind if I told you that I’m impressed with their culture. They’re very tuned in to what’s going on in the buildings. They’re also very proactive, and this goes for NHC as well, with regulators. They have a lot of outreach to payer sources, managed care sources, and I don’t see that happening a lot with other skilled nursing operators. I think those two things distinguish them.
We’re seeing more health systems tying up with senior living and care providers. Are you seeing more health systems and payers at the table for senior living and care deals?
Not in a way that moves the needle. But I think it’s a great idea. I can tell you that there is a continuum of care that can be assembled when you have a hospital and skilled nursing and assisted living group that all work together to move residents and patients back and forth based on their level of need. I think there are plenty of patients who can recuperate in assisted living as opposed to a skilled nursing or hospital setting. There are economic benefits for that and also social benefits for that. If you’re able to recuperate in assisted living, you’ll be happier, it’s less medical.
Does NHI still have an interest in behavioral health? I believe you’ve said that you’d like to play more in that market.
We’re still chasing those deals. They’re few and far between, and they’re very competitive, so stay tuned.
Are you interested mainly because you see growing demand for behavioral health? Do you see synergies with senior housing and care?
No doubt about it. There’s geri-psych. If you cross a line in memory care where you’re unable to reside there for your own safety, you would move to a geri-psych facility. We’re seeing that in our TrustPoint building, that’s owned by Acadia [Healthcare]. Acadia’s a large, publicly traded behavioral health company that’s based here in Franklin, a suburb of Nashville. So, we have a really good view into what goes on in those buildings, because we own two of them. We’d love to own more. I think the referral capability between memory care and geri-psych could be something worth exploring.
One of your goals when you became CEO was growing NHI’s West Coast presence, are you making progress on that?
Part of that strategy was hiring someone in the west. We hired Michelle Kelly from Welltower, and she offices in Denver. So, she’s our West Coast person now, and she just started six months ago. So, ask me that question in a year, and we’ll see how she’s doing.
How much capital do you anticipate deploying on acquisitions this year? I believe in the past you’ve said $300 million to $500 million would be typical?
This year is going to be a tough year. I would lower that to $200 million to $400 million. We’re at the end of June, and I think we’re at just over $100 million. So our guidance is pretty clear that we’ll make our numbers based on what we’ve done, but it’s going to be a challenging year. Most REITs are net sellers, we’re one of the only REITs that is a net buyer.
We still have a very favorable cost of capital. Our stock has held up and we’re able to get favorable financing from banks at low interst rates because we’re low levered. We are primarily a relationship REIT, so we have access to off-market deals that our clients bring to us. That allows us to keep growing, some years more than others, but I would say that’s our secret sauce.
Are you looking to pick up any of those properties that the other REITs are divesting?
Those are really private equity deals. They only make sense if you can use high leverage, and only make sense if you believe that when you sell, you’ll make your money. As a REIT, we need current pay. That means you do a deal and someone pays you a rent or mortgage right away, and I turn that into a dividend for our shareholders. Private equity doesn’t have to worry about that.
So the REITs by and large are disposing of underperforming assets?
I would just say there’s value-add, or upside. Look at Apollo, [which] just bought some properties from HCP. That’s a perfect example.
Here’s something you said about rent escalators back in 2016, I’m wondering if you still believe this: “I wouldn’t be surprised if we came across a property that was fully valued, highly occupied and in a competitive market, and we would agree to [escalators] between 2% and 3%, rather than 3% to 4%, just so that going forward the operator has enough breathing room to make the cash flow they should get from taking the risk as an operator.”
I still believe that. I want to say the Bickford deal we just did has 2.5% escalators at some point. It might have a couple years of 3% and then it flips to 2%. So, that’s a good example of that.
As to why operators need the breathing room, is it due to the tough competitive environment right now?
History tells us that perhaps 3% or 3.5% escalators are too much. And in a low-inflation environment, it’s unrealistic to assume that resident rents can move up that quickly.
Where do you stand on RIDEA versus triple-net leases? Other REITs, like Welltower, have been talking up the benefits of RIDEA. But NHI recently converted a Bickford portfolio from RIDEA to triple-net.
I have a preference for leases. I think RIDEA is fine if you have an operator who is well-capitalized and incentivized and aligned with the REIT on running the property in a profitable environment. I think that the idea of owning a building and hiring a for-fee manager is going to end badly. Those managers will not be incentivized, those managers will just walk away or put their b-team on the property because they have no incentive to improve everything.
So, if you prefer triple-net and you’re willing to go lower on escalators, that seems very conservative to me. Is that fair?
It is. We are a conservative REIT. History has taught us that that works well. Our stock price performance and dividend increases have been consistently good over the past 15 years because of it.
Written by Tim Mullaney