A variety of partnerships and lease structures present many options for landlords and tenants to both benefit.
By Jeff Shaw
In the retail real estate world, triple-net leases are king. Under this standard agreement, the tenant is responsible for all expenses — taxes, insurance, maintenance, utilities and rent to the owner.
But seniors housing is a very different type of real estate. In retail, if a tenant fails, the owner simply finds a new one. For senior living, there’s a human element at play both for the employees and the residents of a community. It’s a highly operations-intensive business, where a management company can’t just be swapped out on short notice.
If an operator is replaced, what happens to the residents who live there and the care staff that serves them?
For this reason, there’s a wide variety of joint-venture partnerships between owners and operators, standard lease structures and alternate structures that make sure that the landlord and the manager keep their interests aligned. There’s simply more at stake when frail seniors get involved. Because of this, both the capital providers and the boots-on-the-ground operators are looking for partners, not simply landlords or tenants.
“The sheer volume of retail space compared to the seniors housing industry has dictated a standard lease structure, just like office, industrial and other industries,” notes Michael Stoller, CEO of Massachusetts-based owner-operator LCB Senior Living. “Seniors housing is a smaller industry with specialized and complex buildings versus those more common to retail.”
“And each operator has its own building design and footprint, so there are significant differences,” continues Stoller. “There is not yet, if there will ever be, a standard or conventional building that would more easily align itself to a standard retail or office building leasing company to enter the market.”
That isn’t to say that triple-net leases are unheard of in the seniors housing space. LTC Properties, a California-based REIT focused on senior living and healthcare properties, has a portfolio built on 82 percent triple-net leases.
As an example of a typical LTC lease, the company bought a skilled nursing center in the Kansas City metro in 2019. The tenant entered into a 12-year lease with 2 percent annual rent escalators, plus two five-year renewal options.
Clint Malin, the company’s co-president and chief investment officer, says triple-net leases allow the REIT to essentially stay out of the operator’s way and let them do what they do best.
“In this structure, operators control their own destiny because capital providers are non-intrusive,” says Malin. “Operators are solely in control of running their businesses as they see fit. Another inherent incentive is the ability of an operator to capture 100 percent of the upside of the business above and beyond their lease payments.”
This type of lease structure is just one of an array of options for seniors housing. Owners and operators should consider all options to decide what’s best for each individual property, says Malin.
“In retail, it’s typical to have multiple tenants occupying space within a given building or project. Therefore, leasing is a common and logical choice in such a circumstance. However, in seniors housing, it’s the complete opposite whereby the entire building is used for a single purpose by a single tenant or operator.
“This uniqueness lends to a wide array of ownership and financing options, including triple-net leases. Each operator and owner will have its own specific preferences as there are no right or wrong choices, just multiple options affording both owners and operators diversification strategies in ownership, financing and operations,” concludes Malin.
Furthermore, Malin notes that property ownership can be capital intensive; therefore, as operators grow their companies, lease financing is a capital diversification strategy to help operating companies achieve growth objectives.
“Sometimes triple-net is the perfect structure, whereas another time maybe some type of structured finance solution makes more sense.”
Stoller adds that another reason for the variety is that “the industry has not significantly consolidated yet,” noting that “one of the nice things about a young industry is there are still some pockets of opportunity for local new entrants to the industry.”
However, these new entrants likely will use a local lender and won’t have access to REIT money until they’ve become more established.
The REIT Investment Diversification and Empowerment Act (RIDEA) was passed by Congress in 2008 in response to the severe downturn in commercial real estate and was designed to give REITs a new way to generate income.
Rather than a true lease structure, RIDEA agreements are a partnership whereby owners receive some of the operational income from a property and operators get access to a stable source of capital available for recapitalization and expansion opportunities.
While many were — and still are — hesitant to enact these agreements, some of the REITs have embraced them to a high degree.
The exemplar of the RIDEA strategy in recent years is Welltower (NYSE: WELL), the largest REIT in the seniors housing space by both units and market cap ($36.8 billion as of Jan. 7). While a September business update from the company said 23 percent of its portfolio is triple-net seniors housing leases, the company made several massive purchases in 2021, often closing a RIDEA agreement with the operator as part of the deal.
• In November, Welltower closed on the $580 million acquisition of eight rental and six entrance-fee communities in “attractive markets across the United States,” including Bellevue, Wash.; Dana Point, Calif.; and Alexandria, Va. Watermark Retirement Communities will operate the communities under a RIDEA agreement.
• At the same time that deal was announced, Welltower also acquired three properties in “fast-growing micro markets in the Midwest” for $119 million. New Perspective will operate the assets under a RIDEA contract.
• Also in November, Welltower announced plans to build two communities with Kisco Senior Living for $325 million, with Kisco operating the properties under a RIDEA agreement upon completion.
• In July, Welltower announced a development partnership with Oakmont Management Group, and started a RIDEA agreement with the operator as part of that plan.
• In June, as part of a three-company deal where Atria Senior Living acquired the operations business of Holiday Retirement, Welltower agreed to purchase the 86 communities that Holiday owned for approximately $1.6 billion. Atria will manage the properties under “a highly incentivized and strongly aligned enhanced RIDEA management contract based on both top and bottom-line financial metrics.”
While 2021 was a banner year for Welltower and RIDEA, it wasn’t the REIT’s first rodeo. In 2018, Welltower moved its entire portfolio of Brandywine Living-operated communities to a RIDEA structure. That same year, Welltower moved 37 Brookdale Senior Living communities to a new operator — Pegasus Senior Living — under a RIDEA agreement.
All the press releases regarding those transactions focus much more strongly on the partnership aspect than one would see in a typical landlord-tenant relationship. Referring to the Holiday/Atria deal, Welltower CEO Shankh Mitra commented at the time: “Through a highly incentivized and aligned management contract, we have created tremendous upside opportunity for stakeholders of both Welltower and Atria.”
Merrill Gardens, a Seattle-based owner-operator, has shifted its entire portfolio over to RIDEA structures, according to Bill Pettit, president of R.D. Merrill Co., parent company of Merrill Gardens.
“Under this structure, the REIT forms a joint venture with the operator for tax purposes by which we own a common interest in both the real estate and the operational cash flow,” says Pettit. “We used to have a few buildings in triple-net leases, but abandoned that structure years ago.”
Pettit notes that Merrill Gardens prefers to hold on to its communities for the long term while using a moderate level of financial leverage, which makes RIDEA ideal for the company. Additionally, a RIDEA venture protects the operator amid economic downturns such as during the COVID-19 pandemic.
“If you are a short-term investor driven by a focus on maximizing IRR (internal rate of return) through short to intermediate holdings, then a lease structure can work well,” says Pettit. “We just do not believe they are ideal for conservative portfolio investors who understand the need for flexible solutions in down cycles where cash flows are likely to suffer in the seniors housing model.”
“Fundamentally, we want the lessor and lessee on the same side of the table in down cycles,” concludes Pettit.
He also adds that a wide variety of landlord-tenant relationship options are necessary in seniors housing, as it is “one of the most complicated operating models in commercial real estate.”
Skin in the game
Perhaps more than in any other type of real estate, seniors housing operators often have at least some level of ownership stake in the properties, whether through a RIDEA agreement or simply a joint venture with a capital provider.
LCB is one of those operators. Stoller notes that the company invests alongside its third-party equity investors for both acquisitions and developments.
“As these investments mature, we recapitalize and continue in the ownership group with the new partner,” says Stoller. “We invest a portion of our proceeds from the sale. In this structure we continue to operate as manager and as managing member of the new partnership.”
This type of partnership allows LCB to share in quarterly and annual cash distributions, resulting in “a direct alignment of interests driving performance and returns” between all parties, says Stoller.
Though LTC prefers the triple-net structure for the bulk of its portfolio, it has participated in some hybrid agreements. Under these deals, the property and the operations are split into two separate entities. The operator will have a stake in the real estate, but still operate the community under a triple-net lease.
“Recognizing operators’ interest in real estate ownership, we’ve entered into some creative investments,” says Malin.