Real estate investment trusts (REITs) might soon feel “buyer’s remorse” over recent decisions to bulk up their senior housing operating portfolios, according to Eric Mendelsohn, CEO of National Health Investors (NYSE: NHI).
In recent years, several factors drove some REITs to go big on RIDEA. With new supply, labor and other challenges squeezing their net operating income, senior housing operators have struggled with sizable rent escalators under triple-net leases, prompting some conversions to RIDEA. After years of building up sophisticated asset management platforms, REITs are increasingly confident in their operational chops. And property owners and management companies both tout the alignment of interests when they share financial risk and upside related to operations.
But Murfreesboro, Tennessee-based NHI has not gotten on the RIDEA bandwagon. Mendelsohn — who previously spent nearly a decade in operations with Emeritus Corp. — warns that operating company financials do not translate well to the quarterly reporting demanded of public REITs. And, a different approach to triple-net leases can still create aligned interests while lessening to risk to operators that they will be replaced if performance starts to suffer, he told Senior Housing News during a recent interview at the American Seniors Housing Association (ASHA) conference in Palm Springs, California.
The following has been edited for length and clarity:
You’re expecting some “turbulence” in 2020, which could bring opportunities for NHI?
I think that the turnover that’s happening with some of the REIT tenants and operators is surfacing a lot of the issues that have been brewing for the past 24 months. I think there are some operators that aren’t doing as well as they could be. And I think some of the REITs might regret going 100% operational in RIDEA.
Operating revenues and NOI don’t always line up well [quarter to quarter] if you’re a public company — I learned that at Emeritus. So, there could be buyer’s remorse, and that could mean opportunities.
That’s part of what you’re seeing with some of the operator replacements: Let’s not blame the real estate right away, let’s see if another operator can do better. And then if they can’t, then we’ll sell the buildings.
It seems to me that any operator will still struggle with the big headwinds right now, like controlling labor expenses.
You’re absolutely right. A new operator isn’t going to change the labor situation — except maybe turnover. I can tell you that. We have seen that a better operating culture and a better operating manager will stem the tide of turnover because they’re listening to employees and making better hires.
But where you’re going to find the difference is revenue. Bring in a pharmacy, bring in a physical therapist, be better at Facebook, at advertising, electronic media, beat out a Place for Mom. That’s one of my favorite topics, lessen A Place for Mom expense. We notice that right away. If someone is completely reliant on A Place for Mom, that is an opportunity to start training salespeople, being more rigorous on their visits to referral sources, being better with follow up.
The new CEO at A Place for Mom has been talking about improving the relationship with senior living providers.
I’ll believe it when I see it.
You said some REITs might have buyer’s remorse on RIDEA. But we’re hearing complaints about triple-net leases from operators, particularly that escalators are too high.
NHI has been doing things like new leases that have escalators that are much lower than 3%, and often CPI-based. Conceivably, you have a year or two, if CPI is negative, that your escalators are little to none.
We have a habit of being very conservative in our underwriting, in that we will only pay for in-place cash flow. That means we lose out on a lot of deals where a private equity fund or some other more speculative buyer will be willing to buy into a broker’s story that the future will be better, and you should pay me for better now. We don’t do that. We will pay for what it’s worth in the moment based on the history, and then set up the earn-out if you can improve the operation and make more value. We’re willing to cut a check and give the operator a piece of that.
Are there circumstances when you could see doing RIDEA?
I can see doing it when you get a great bargain on the property and there’s a lot of visible upside. But there aren’t a lot of deals like that right now.
When Silverado got replaced by its REIT partner, Welltower, I think light bulbs went off for some people, and they thought —
Wow, that can happen to a high-quality operator. I didn’t think that was possible.
Right. Maybe it created some concern that this could happen to them. Do you think operators are right to be concerned?
They should be very concerned. That’s the downside of RIDEA. Operators think that RIDEA doesn’t have a lot of pressure because there’s no lease, but you don’t control the property. The REIT isn’t happy with us, they can make a change. That’s their right.
Are you worried about current geopolitical and economic uncertainty?
The election could really be a gamechanger. I know our industry is mostly private pay, but people who run a skilled nursing facility are very concerned about what changes might come.
I’m not sure that there isn’t a recession around the corner, and while that’ll help our labor costs — that’s kind of a silver lining — it also will burden all these buildings that need access to wealthy retirees, who won’t feel so flush.
If you watched the last Democratic debate, Pete Buttigieg said that he would support an assisted living stipend. So, my ears perked up at that, because if they’re going to presumably increase Medicaid payments or expand it, government regulation can’t be far behind. Once you have a government payer source, they feel the need to regulate how that money gets spent.
What types of senior living are you bullish or bearish on?
Bullish on CCRCs, bullish on skilled nursing. Bullish on independent living, because I feel that the demographic wave that is brewing, the first customers will be in their late 70s, and that’s an IL customer.
Are you worried about active adult as an IL competitor?
Not really. I think that’s an interesting product. I think people are not as active as the builders imagine. I’m interested to see what they come up with. I think that the product could be something that influences independent living and assisted living in terms of design, activities and services.
If the economy does go into a recession, does that change your thinking on IL?
Good question. IL took a beating during the last recession, but the last recession was the most brutal recession we’ve had in decades. So, assuming this is more of a garden-variety recession, I would expect the demographic wave to overpower any softness due to the recession.
Are you bearish on assisted living and memory care?
I’m less excited about AL and much less excited about standalone memory care.
That’s because of the ongoing oversupply in standalone memory care?
Right. And oversupply also in AL. I love the product, but people have to stop building new buildings. Let’s absorb what we have.
On the CCRC side, we’re seeing experiments with new rental models, smaller and urban CCRCs, are you interested in all those iterations?
I love it. Let’s figure that out. There will be winners and losers. I think any time you have new designs and new operating models, that’s good for our industry.
You like the CCRC model because of the continuum of care?
I think that’s great. Especially if there’s skilled nursing. People don’t want to think about skilled nursing because it’s not sexy, but boy, when you need it, it’s good to have it available.
When everyone else was running away from skilled nursing, we were running toward it. Now, everyone’s running toward it.
Skilled nursing was in dire straits a few years ago. What changed, that now people are running toward it?
Why now? I think people figured out they were overreacting and overly bearish. Two years ago, Genesis was falling apart and ManorCare was falling apart. In my mind, market sentiment shifted because of the Welltower-ProMedica deal.
That’s interesting. There was some skepticism over aspects of that deal, including the footprint of ManorCare versus ProMedica.
I agree. There was a lot of Monday morning quarterbacking, hand-wringing. But so far, so good.
I don’t think Welltower has reported much on the results yet. Even without that, the fact that the deal happened, and the theory they advanced about health system integration, was enough to change sentiment?
We hear deal prices are very high. Do you expect a slow acquisition year for the REITs again?
We did over $300 million last year. I know for Welltower that’s not a lot, but for us, that’s a pretty good year. We’re expecting to have a similar year. We’re off to a $150 million first quarter. You do that every quarter, that’s a really good year.
What’s keeping you up at night?
Lease purchase options and lease maturities.
We just had the Brookdale transaction; there’s a good example of buildings walking out the door.
How many other purchase options are you looking at?
We have two more this year that are medical office or hospital related.
At any given time, we just have one or two, and they move around. Sometimes people don’t really want to sell, but it’s an opportunity to monetize equity or lower escalators or just make a deal.
How many lease maturities?
This year, thankfully, not much.