‘Unprecedented’ Market Dynamics Hurt Ventas’ Senior Housing Portfolio

Ventas’ (NYSE: VTR) senior housing portfolio (SHOP) performance has lagged throughout 2019. That performance took a turn for the worse in the third quarter of 2019.

A combination of market dynamics, particularly on pricing, surprised Ventas’ operating partners in Q3. Those conditions worsened over the course of the quarter, with occupancy taking a “precipitous leg down” at the end of September, Ventas CEO Debra Cafaro said Friday on an the earnings call for the Chicago-based real estate investment trust.

Overall, the dynamics at play were “pretty unprecedented,” CFO Bob Probst said on the call.

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Any reversal of Ventas’ SHOP fortunes will likely happen after 2020, as the portfolio’s performance took a dip in the third quarter of 2019 as a result of unexpected pricing pressures from new inventory that has come online in recent years.

The problems were concentrated in assisted living, and particularly in secondary and tertiary markets. Lake Oswego, Oregon-based operator Eclipse Senior Living (ESL) was hit particularly hard. Excluding Eclipse, Ventas’ SHOP NOI would have increased 100 basis points.

Unlike other operators, Eclipse’s year-over-year numbers throughout 2019 have reflected some “noise” related to the fact that it is a portfolio of transitioned assets: ESL was founded in late 2017 and took over a portfolio of about 80 properties formerly operated by Elmcroft Senior Living in early 2018. Since that time, Eclipse has grown its portfolio with Ventas, which maintains a 34% ownership stake in the operating company.

Eclipse’s challenges in Q3 stemmed in part from its footprint in the secondary and tertiary markets that experienced the greatest pricing pressures in the quarter, Cafaro said. In addition, Eclipse has been in the process of implementing a new pricing model for assets that it has taken over, adding another variable to the tough market conditions.

The Chicago-based health care real estate investment trust (REIT) reported funds from operations (FFO) of $0.96 per share. This beat analysts’ predictions by two cents but marked a three-cent drop, year-over-year.

Ventas reported total Q3 revenue of $983.2 million, a 4.7% increase year-over-year. Rental income, however, increased from $384 million in Q3 2018 to $408.3 million in Q3 2019. Much of that income growth came from new investments, such as Ventas’ $1.8 billion acquisition in June of Canadian provider Le Groupe Maurice. Cafaro touted Canada as one of Ventas’ strongest senior housing markets, and Ventas is working with Le Groupe Maurice to expand within that country.

Based on the performance of its SHOP portfolio, Ventas lowered its 2019 guidance for FFO to between $3.81 and $3.85 per share, from the previous range of between $3.80 and $3.86 per share.

A ‘cumulative effect’

As it has throughout the year, Ventas’ SHOP performance remained the outlier in its overall portfolio. The SHOP portfolio represents about 25% of the overall enterprise.

After a 2.2% decline in the second quarter, same-store SHOP net operating income (NOI) performance dropped another 5% in Q3, year-over year. This nearly wiped out the combined NOI growth of Ventas’ medical office and R&I segments, and the REIT recorded only a 0.1% increase in overall NOI in the quarter.

Occupancy across the SHOP portfolio increased by 70 basis points versus Q3 2018, to 86.7%. But Ventas’ operators did not experience an expected seasonal lift and the occupancy gap widened materially in September, ending the month approximately 115 basis points lower than a year ago.

Meanwhile, price competition with new supply drove wider re-leasing spreads year-over-year, Ventas CFO Bob Probst said during the earnings call.

As for why pricing became more aggressive than anticipated, Ventas did not offer a definitive answer. Capital One analyst Daniel Bernstein suggested that senior housing communities that opened in the last three years might still be struggling to reach stabilization as they are hitting their covenants on construction loans, propelling them to offer deeper rent concessions.

A combination of factors are at play, and no single owner or operator is a bad actor, Cafaro said.

Although Probst expressed confidence with Ventas’ SHOP occupancy rate, an analyst’s note from Green Street Advisors noted that this is the 17th straight quarter of year-over-year occupancy declines.

“Unfortunately, the supply/demand imbalance hits not only occupancy, but also rents, which continue to eke out only slightly positive gains year-over-year,” the note read.

Operating expenses grew a modest 1.1% in the second quarter, and Ventas’ operators continue to manage staffing and drive efficiencies. The REIT reaffirmed its view that full-year operating expenses will increase in the 2% range, given a tight labor market.

“If the economy continues to perform as is and there is continued wage pressure, we’ll need to run the same playbook. We give credit to our operators for maintaining [expenses] and keeping it below the rate of inflation,” Probst said.

Ventas sees the weakened SHOP performance continuing into the fourth quarter, and both Cafaro and Probst said the focus now is on closing out 2019 as strongly as possible given the market conditions. The REIT is already in discussions with its operating partners reviewing options for pushing rates and entertaining the possibility of selective dispositions of underperforming assets.

“Even our boots-on-the-ground operators were surprised by the quickness of the change,” Probst said.

Workforce pressures and new supply are challenges faced by senior living providers nationwide and are not unique to Ventas’ portfolio. Still, Green Street raised concerns about the REITs’ performance relative to its peers.

“Ventas’ SHOP portfolio performance has lagged the industry, as well as some peers, for several quarters now, so it’s not clear how much of the bad news is company specific,” Green Street’s note read.

(As of press time, Ventas did not respond to a request from SHN to respond to Green Street’s comments. We will update this story if and when Ventas does.)

The poor SHOP performance reminded Cafaro that, even at this stage in her career, she can be surprised.

“It’s amazing to be at this stage and grade and still be learning good lessons,” she said. “I would say that again, we’ve always been known over long periods of time to be reliable and to be forthright. And those are values we hold dear.”

Cafaro added that Ventas needs to remain disciplined in its reporting, even as stakeholders and analysts ask for more detailed information on when a turnaround of its senior housing portfolio may take hold.

“We have to be more disciplined to make sure we have all the inputs that we believe are necessary to have confidence in what we are telling you. And that lesson is reinforced by today,” she said.

No timetable on a rebound

Ventas’ belief that its SHOP struggles will continue in Q4 led analysts on the call to ask when the REIT expected to stabilize performance and how it would impact its 2020 guidance. Despite repeated questioning from analysts, Cafaro and Probst declined to offer guidance.

“We want to address the 2020 guidance and its components in the first quarter. We want some key underpinnings in place including our budget, rate levers, and expenses and see where we end the year. We want to give [guidance] when it is reliable,” Cafaro said.

Probst allowed that Ventas’ SHOP performance in the fourth quarter will dictate its initial 2020 guidance.

The SHOP performance left analysts cautious about what to expect from Ventas in the fourth quarter and beyond.

“Reports of deeper loss in occupancy and revenues, management comments about not expecting growth until after 2020 as well as implications of even weaker performance in [Q4] may temper that enthusiasm and even flatten the long term five-year outlook for the portfolio,” Stifel analyst Chad Vanacore wrote in a note to investors.

The earnings report sent Ventas stock trading down nearly 9% on Friday, closing at $66 per share.

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