Some of the nation’s largest senior housing landlords are changing or reconsidering their leases with independent living giant Holiday Retirement.

National Health Investors (NYSE: NHI) has inked a new lease agreement with tenant Holiday in a move meant to position the operator for long-term success, the Mufreesboro, Tennessee-based real estate investment trust (REIT) announced Tuesday, in conjunction with its Q3 2018 earnings results. Sabra Health Care REIT (Nasdaq: SBRA) is also considering Holiday-related changes, the company stated in announcing its own Q3 earnings on Tuesday.

NHI is entering into a lease amendment and guaranty release with its tenant, Holiday Retirement. At its core, the agreement extends the term of the lease to 2035, increases the portfolio’s required minimum capital expenditure per unit and gives NHI a stronger pro forma lease coverage ratio for next year. NHI currently leases 25 independent living communities to Holiday, which makes up 14% of the REIT’s cash revenue. But the Holiday portfolio could also shrink in the months ahead, as both the REIT and its tenant are considering selling as many as five properties.

The new lease amendment gives NHI a consideration of approximately $65.8 million in cash or property from Holiday, which includes the forfeiture of half of the operator’s roughly $21.2 million security deposit. Among other conditions, the agreement sets Holiday’s rent at $31.5 million as of Jan. 1, as opposed to the $39 million it previously was set to pay. Annual escalators, not to exceed 3%, will start on Nov. 1, 2020.

The new lease agreement represents what could be the final step toward helping Holiday Retirement get off the REIT’s “worry list,” according to NHI President and CEO Eric Mendelsohn (pictured above).

“I made no secret that Holiday was on our worry list, and that we were concerned about the financial performance of the buildings and the guarantor entity as a result of the change in the management model and headquarters relocation,” Mendelsohn said during the company’s third-quarter earnings call Tuesday. “We are satisfied this transaction will position our portfolio to perform well, and take it off the worry list. NHI is all about crafting unique financial solutions to promote operator-focused, long-term success, and this transaction is a good example of that approach.”

As Mendelsohn referenced on Tuesday’s call, Holiday has seen its fair share of operational changes in recent times. The operator in 2017 dropped its long-time management model in favor of a more traditional one. Then, just a few months later, the company moved its headquarters from Lake Oswego, Oregon, to Winter Park, Florida — a decision made in part to trim costs and shrink the size of Holiday’s corporate team.

But now the dust seems to have settled, especially with regard to some of Holiday’s different collaborators, including New Senior Investment Group (NYSE: SNR). And NHI has seen occupancy improvements with its Holiday properties as of late, with the portfolio’s average occupancy rate at 89.2% in the third quarter. That’s higher than the portfolio’s occupancy rate of 88.8% in the second quarter of this year.

“The change in management model went well, and as a result the buildings are run in a more customary manner, with a professional executive director instead of live-in managers,” Mendelsohn said. “Having visited Holiday’s headquarters recently, I can tell you the team is motivated, cohesive and focused.”

If the amended lease works as intended, Holiday would have more flexibility to grow, and therefore positively impact the operator’s relationships with some of its other landlords, such as Ventas (NYSE: VTR) and Sabra Health Care REIT (Nasdaq: SBRA), according to Mendelsohn.

“This could be something that all those parties look at and study,” he said. “We try to craft a win-win for both sides, and I think this puts Holiday in a position where they could actually grow the company now, and we’d love that for them.”

Sabra questions Fortress’ intentions

As Mendelsohn alluded to, Sabra is debating various options for its own 21-community Holiday portfolio.

Most likely, these leased properties would switch into a managed agreement in the near future, Sabra CEO Rick Matros said Tuesday on the company’s Q3 earnings call.

The issue is that Holiday is facing high rent escalators on its leases, and not just with Sabra. Several REITs were “all sort of complicit” in creating challenging lease structures that now are burdensome for Holiday, Matros said. That’s because there was a flurry of dealmaking with Holiday several years ago, in which several REITs acquired properties and put in place similarly high escalators — in Sabra’s case, they were at 4% and now are at 3.5%.

Holiday’s current management team has done an admirable job of making the recent large-scale operational changes while these escalators have been in place, Matros said. However, while Holiday needs additional breathing room, he does not believe that simply lowering the escalators or cutting rents would be wise.

“Part of that has nothing to do with the Holiday management team, who we think highly of, but none of us really have any sense of what Fortress’ agenda is as it pertains to Holiday,” Matros said, referring to Holiday’s private equity owner. “So, in terms of making a long-term commitment relative to extending the lease with new escalators, we’re not willing to take that gamble.”

Although flipping to a management agreement is likely, other options are on the table as well, including transitioning the Holiday portfolio to a different operator.

“We’ll make a decision shortly,” Matros said.

Another REIT, New Senior Investment Group (NYSE: SNR), recently converted its 51-property Holiday portfolio to a managed agreement. Currently, New Senior itself is managed and advised by an affiliate of Fortress, but is in the process of internalizing its operations.

Written by Tim Regan and Tim Mullaney