REITs Keep a Sunny Disposition

by Jeff Shaw

By Jeff Shaw

By many metrics, it has been a slow couple of years for REITs immersed in the seniors housing segment. 

The volume of acquisitions and dispositions by REITs in 2022 was the lowest in at least a decade, according to MSCI Real Assets. The expectation is that 2023 is going to be another down year for transaction volume. 

Publicly traded investors made approximately $2.5 million in acquisitions and dispositions in 2022, dropping from $12.7 billion in 2021. As recently as 2015 that number was over $15 billion.

But the factors leading to this depressed acquisitions and dispositions activity — a rapid increase in interest rates over the last year and depressed stock prices — are largely temporary. And if the tenor of recent earnings calls is any indication, they are extremely optimistic about the trends in the industry right now.

Both Welltower (NYSE: WELL) and Ventas (NYSE: VTR) — the two largest owners of seniors housing in the United States with a market cap of $43.7 billion and $17.5 billion, respectively — provided extremely sunny outlooks on their second-quarter earnings calls.

“The key drivers of this business — occupancy, rate and expenses — all came in better than expected this quarter, supported by accelerating demand of our product and plummeting new deliveries,” said Shankh Mitra, CEO of Welltower. “All in all, we have finally exceeded $1 billion of annualized net operating income (NOI) in our seniors housing segment for the first time since COVID, and believe we have a ton of growth left in the tank.”

Debra Cafaro, CEO of Ventas, was similarly optimistic, praising “strong results of broad-based property NOI growth across our diverse portfolio.”

“We continue to benefit from the multi-year growth and recovery cycle underway in seniors housing,” she said. “Notably, our U.S. assisted living portfolio grew NOI 32 percent year over year.”

M&A market remains stagnant

If the outlook for seniors housing is so positive, why has transaction activity been reduced to a trickle?

“The simple answer is that interest rates increased while seller expectations did not change,” says Eric Mendelsohn, president and CEO of National Health Investors (NYSE: NHI). The REIT is the 11th largest owner of U.S. seniors housing with 10,734 units in its portfolio as of June 1, according to the American Seniors Housing Association (ASHA).

“We were not net buyers in 2021 or 2022 as the valuations did not make much sense to us. We were active sellers and took advantage of the market to sell nearly $350 million of seniors housing properties that had very low single-digit NOI yields.

“We were fortunate to sell when we did as the market slowed significantly in the second half of 2022 due primarily to the increase in interest rates without a corresponding change in seller expectations. We are still seeing that in 2023. With the regional banking crisis and the emerging belief that interest rates are going to stay higher for longer, we do think that we will be more active in the market and be able to buy at more attractive valuations in the second half of 2023 and into 2024.”

Matthew Gourmand, senior vice president at Omega Healthcare Investors (NYSE: OHI), echoes Mendelsohn’s concerns about the bid-ask gap. Omega is the 21st largest owner of U.S. seniors housing, with 8,031 units in its portfolio as of June 1, according to ASHA.

“It was primarily due to a disconnect between prices sellers were looking for and what the market would support,” says Gourmand. “We saw a meaningful tick-up in financing costs, as interest rates increased dramatically, and we did not see a commensurate resetting of prices to reflect this new paradigm. The situation is improving, as external factors have forced some sellers on a select basis to face the reality of the market — but we’re not yet seeing it across the board.”

“Given the higher yields we’re able to achieve in the skilled nursing industry, we’ve often struggled to rationalize the yields being sought for [private-pay] seniors housing portfolios,” continues Gourmand. “However, we continue to look for quality portfolios at fair prices, as demonstrated by the sizable Brookdale-operated portfolio we acquired during the pandemic.”

(Omega bought 24 Brookdale-operated communities from Healthpeak Properties in 2021 for $510 million. The move was part of Healthpeak’s move away from the seniors housing industry during the pandemic.)

Sabra Health Care REIT (NASDAQ: SBRA), the industry’s 19th largest owner with 8,746 units in its portfolio as of June 1, per ASHA, definitely recognizes the slowdown in transactions. After executing $400 million in deals in 2022, CEO Rick Matros reports that the company has completed $140 million in acquisitions and dispositions so far this year.

“The issue is the capital markets changed so dramatically and so rapidly that it turned everything upside down, on top of recovery of occupancy taking longer than expected,” says Talya Nevo-Hacohen, Sabra’s chief investment officer. “One of the biggest issues is: What’s available to buy these days? There’s a lot of product underwater on debt. The motivation for most sellers is they’ve run out of room on their debt — either because of a loan maturity or they are breaching debt covenants — so they have to move.”

However, LTC Properties (NYSE: LTC) — the 33rd largest seniors housing owner in the country with 5,687 units in its portfolio as of June 1, per ASHA — bucks the trend of low transaction volume.

“In late 2022, LTC set the stage for 2023, its strongest investment year since 2015, sourcing nearly $260 million of investments consisting of both loans and owned properties driven by relationship-based transactions,” says Wendy Simpson, CEO of LTC. “We remain patient with an eye on investment opportunities in 2024.”

Seizing the opportunity

While equity REITs are investors, and therefore usually associated with buying and selling properties, a time of depressed transactions doesn’t necessarily mean there’s no activity among those companies. Many are taking this time to set themselves up for long-term success when the acquisitions market rebounds.

As an example, Sabra worked with lenders to convert all its remaining floating-rate debt to fixed-rate debt to better handle any further interest rate hikes coming down the line. Matros estimates the move will save the company $14 million to $15 million in debt service annually.

“We fixed everything at just under 4 percent and we’re set through 2028. Rates are still going to go up a bit, so everyone with variable-rate financing is going to be paying more. If rates come back down to 3 percent, we’ll have different financing options at that point.”

Matros adds that the strong relationship between Sabra and its lenders has enabled the company to lock in a rate at a time when the future is so unpredictable.

“We have two dozen banks in our credit facility. It’s a billion-
dollar line of credit that can expand to $2.5 billion. We have really strong relationships with our lenders. It’s in their best interest for us to have a strong balance sheet, so they’re pretty amenable to fixing the interest rates.”

Many REITs are also using this time to strengthen their operational partnerships, or switch out operators on underperforming properties.

“The pandemic showed the difference between good and excellent operators,” says Matros. “There are those that before the pandemic did a nice job and that was okay, but their performance became an issue during the pandemic.”

For its part, LTC is in the midst of working with Brookdale on the third-party lease agreement between the two companies.

“We are making good headway on our Brookdale portfolio, whose master lease expires at the end of this year,” says Simpson. “Most recently, Brookdale re-leased 10 of the properties in the portfolio from us in Kansas and Colorado, and we are actively engaged in re-leasing or selling the remaining 25 properties.”

For its part, NHI took advantage of low stock prices to repurchase $152 million in stock. NHI’s stock price closed at $50.54 per share on Friday, Sept. 8, down from $54.62 one year earlier.

“We are in a strong position to fund growth because our leverage remains low and we estimate that we have well over $100 million in debt capacity to finance acquisitions without the need to issue any equity,” says Mendelsohn. “We are hopeful that as we start to grow the company again that our stock price reacts favorably and that we can get back to our traditional financing mix.”

NHI also is able to capitalize on the high interest rates and lack of active lenders. The company provides loans as an alternative financing source. As Mendelsohn puts it, NHI is “ready to fill the financing void as increased rates and the regional banking crisis are pushing many capital providers to the sidelines.”

Sabra’s Nevo-Hacohen says that as long as the general economic environment continues to discourage acquisitions, REITs will continue to issue loans with increased frequency, often acting as the mezzanine lender in a structured financing.

“But REITs are going to be careful because what they want is to be paid back and get their interest rate. It’s a great way to make an accretive investment if you make sure you managed the risk of having your principal repaid.”

Matros adds that Sabra does issue loans, but usually only to its operator partners. “It’s just another aspect of being a good capital partner.”

Simpson notes that seniors housing REITs are not all the same, and to expect a wide variety of different strategies during these challenging times.

“Across our peer group, you’ll likely see myriad reactions to external forces. Some remain in a wait-and-see mode, while others are seeing opportunities.”

Gourmand is confident that the near-term future is bright for seniors housing and that transaction volume will soon return.

“Sellers are starting to accept reasonable prices. My sense is that there are more opportunities to come.”

You may also like