REITs sell off portfolios while other investors pursue distressed assets amid record-low occupancy.
By Jeff Shaw
When the COVID-19 outbreak hit the U.S. with full force last March, investors in the seniors housing sector had some difficult decisions to make.
With the occupancy rate at private-pay seniors housing falling to a record-low 80.7 percent in the fourth quarter of 2020, according to the National Investment Center for Seniors Housing & Care, the question that quickly arose in the marketplace was whether it was better to sell off properties, buy assets strategically or hold onto them until the storm passes.
For many of the big real estate investment trusts (REITs), the answer was clear: It was time to sell.
Welltower (NYSE: WELL), the largest REIT in seniors housing by both portfolio size and market cap, sold off $2 billion in seniors housing real estate in 2020. Joe Weisenburger, a senior vice president with Welltower, explained the company’s strategy during an investment panel at France Media’s InterFace Seniors Housing Investment, Development & Operations conference, held virtually in December.
On Feb. 28, 2020, Welltower’s stock was trading at $89.99 per share, pointed out Weisenburger. “The pandemic hits, and by March 20 our share price had dropped to $33.22. Needless to say, at that point in time the company went into conservation mode and tried to fortress our balance sheet. Through this process we had the ability to liquidate assets.”
“When you’re selling into a troubled market, you’re going to have to sell some assets that maybe you’d want to keep,” continued Weisenburger. “You just figure out which ones are sellable. We sold some portfolios that quite honestly we would’ve liked to have kept.”
Healthpeak Properties (NYSE: PEAK), the third-largest REIT in the seniors housing sector, enacted a similar plan. In a November investor presentation, the company revealed it was in the midst of $4.5 billion in seniors housing dispositions. In its presentation, Healthpeak noted that it was actively marketing the majority of its remaining seniors housing portfolio for sale.
Meanwhile, all of the Big Three seniors housing REITs — Welltower, Healthpeak and Ventas (NYSE: VTR) — are plowing billions into the life sciences and medical office sectors, which have continued to grow during the pandemic.
Of course, you can’t have a seller without a buyer, so some investors must be taking the opposite position of the REITs.
In December, Blue Moon Capital Partners joined up with Áegis Living to buy 10 properties that Healthpeak owned and Áegis operated for $350 million. Blue Moon “sees value in all three approaches” — buying, selling or holding — but decided to acquire that portfolio because “we valued the unique Áegis Living operating model in communities they’ve managed for many years,” according to Kathryn Sweeney, co-founder and managing partner with the investment firm.
“Our fundamental commitment to the seniors housing sector is unchanged in the face and aftermath of COVID,” says Sweeney. “Clearly we needed to make some adjustments to cash flow plans and exit activities. However, we are even more bullish on the sector as the pandemic has served to further separate the longstanding, committed operators in the space performing quality services from those that entered the sector for the favorable demographic metrics.”
In fact, Blue Moon plans to stay active on the buying front for a few reasons. Because construction screeched to a halt during the pandemic, pent-up demand will result in a bounceback in occupancy rates after COVID-19 becomes a thing of the past, says Sweeney.
“With a significant slowdown in new supply, combined with the strong senior demographic growth, we expect to see occupancies and rental rate increases that restore profitability to pre-pandemic levels.”
Additionally, Sweeney expects to see “private equity tourists” leave seniors housing as the difficult operational environment continues. “These are investors previously attracted by the favorable demographics, but without the long-term commitment to the segment.”
“We will be on the lookout for opportunities reflecting some stress among other operators seeking to exit the business, where we can purchase those assets and grow with more established operators,” adds Sweeney.
Sellers hold their ground
An emerging bid-ask gap is slowing transaction volume. Despite struggling with occupancy, many sellers are not compromising on their prices.
“Pricing for stabilized communities hasn’t changed that much,” said Kevin Carden, senior vice president of acquisitions for REDICO, speaking on that same InterFace panel in December. “The Welltower portfolio that was sold earlier in the pandemic — that was very strong pricing. Most other stabilized deals in independent living and assisted living have continued to trade at strong prices.”
Since many buyers expect a lower price due to pandemic issues and low occupancy, this has led to a gap between buyer and seller expectations.
“A lot of people are looking for pre-pandemic pricing,” added Weisenburger. “More deals got pulled from the market than ones we were able to transact.”
This is despite the fact that he expects a slow recovery once the vaccine has become widespread.
“When it’s time to recover — and it could be second or third quarter of this year — all communities will be filling back up at the same time. Lease-up is going to take longer than in a normal cycle.”
Carden said that his acquisition pipeline “looks okay,” but was quick to note that were it not during a pandemic, the unusually low deal volume would have him “panicking.”
“I’m still getting a flow of deals in, and there are deals we will transact if we can come to terms with the seller. I’m hopeful that it gets better. If I had this pipeline and there wasn’t a pandemic, I’d be freaking out.”
Buyers’ acquisition strategies also can differ. For example,
REDICO generally looks to hold an asset for five years before selling it, while Welltower has a 10-year time horizon.
There may be signs that pricing will come down in the near future for buyers, according to Isaac Dole, founder and CEO with Birchwood Health Care Partners, who also spoke on the InterFace panel.
“When it comes to pricing and structure, it has everything to do with seller motivation. With nicer assets and nicer markets, it’s highly competitive right now.”
But that seller motivation may be changing. Dole noted that “there are some exhausted operators out there.”
“For mom-and-pops or even regional operators with an outlier in their portfolio that is just a thorn in their side, there’s strong motivation [to sell]. They’ll accept lower prices if you can increase the certainty of closing. If you’ve closed with them before, if you’re putting up a strong deposit, if you have a tight transaction timeline, if there’s credibility there, price is less of a factor than certainty and speed of execution.”
There could also be long-term fallout from the influx of government relief funds, added Dole. Because of constantly shifting reporting requirements, potential sellers may think their bank accounts are full but not realize that much of that money will need to be paid back.
“It’s pretty challenging to navigate, and some will have to return millions and millions of dollars next year. It’s creating a false sense of security.
“When the tide goes out, it’s going to leave some cracks in the operational capabilities of many people. You’re going to have a long slog to rebuilding census. It’s not going to be an easy process.”
Capital markets complicate
COVID-19 created another wrinkle for investors, as sourcing acquisition financing has become more difficult.
Lenders are decreasing the amount of leverage they’re willing to offer while increasing recourse requirements, according to Curtis King, a senior vice president at HJ Sims, who also spoke on the InterFace panel.
He suggested that 2021 might be a year in which lenders are “more or less treading water.”
“One thing about being a lender is that you’re concerned about your ability to get paid currently and making sure the borrower can make debt service,” he said. “How long is it going to take to get to the point where we’ll feel the positive impacts of the vaccine in terms of occupancy and overall revenue rate increases? It is going to be very tough to get debt financing to acquire turnaround projects that require occupancy increases.”
“We’re still seeing a lot of sponsors out there looking for higher leverage solutions, but those solutions aren’t necessarily there,” concluded King. “It’s being driven by the lenders not comfortable with the same leverage they were pre-COVID.”
Although it hasn’t happened much yet, the current low occupancy across the industry will inevitably result in some borrowers not being able to make their mortgage payments, said Weisenburger.
“How long will the lenders be patient? People are going to start to trip more and more covenants. To date, they’ve been allowed to defer, but at some point ¬— probably in 2021 — banks are going to start getting their hands tied. The chickens have to come back to roost.”
Of course, distressed assets create attractive value-add acquisition opportunities for savvy investors.
“Lenders are kicking the can down the road with troubled assets,” said Carden. “When that stops, I expect the transaction flow will increase quite a bit.”
Some lenders have stopped working in the seniors housing space altogether during the pandemic.
One step borrowers can take to help survive the pandemic is to be open and honest with their lenders, said King.
“If you have a lender you’re working with, communicate with them, discuss how things will improve and make them understand it’s a short-term disruption. You do have some patient lenders that are staying in this space long term, that will be patient and will work with you.”
Despite the many obstacles the seniors housing industry currently faces, most investors maintain a positive outlook on future of seniors housing. “The vaccine is here,” said Dole. “Census will rebuild eventually.”