Giant owners and operators go on a buying spree in 2014, but the opportunities for more megadeals are dwindling.
By Bendix Anderson
In the first quarter of 2015, Omega Healthcare Investors Inc. will finalize its $3 billion acquisition of Aviv REIT Inc. The signed contracts will help put the finishing touches on a memorable 2014 on the mergers and acquisitions front.
Publicly traded seniors housing companies announced at least five large transactions to merge with, or acquire, their peers in 2014. The smallest of these M&A deals was valued at close to $1 billion.
M&A activity among publicly traded companies in the seniors housing space nearly reached $10.5 billion in 2014. (That doesn’t include the billions of dollars companies spent on acquiring portfolios and single assets.)
“I was impressed with the scale of the transactions,” says Matthew Whitlock, senior vice president for National Senior Housing Services at CBRE. “It’s rock’n’roll these days.”
Strong motives to merge
The combination of low interest rates and eager buyers paved the way for large seniors housing transactions in 2014.
Investors are attracted to seniors housing because of healthy occupancy rates and favorable demographics, which has driven up the stock prices of healthcare real estate investment trusts (REITs).
At the end of 2014, healthcare REIT stocks were trading at an average premium of 20 percent to their net asset value (NAV), according to Charlottesville, Va.-based SNL Financial. That’s much higher than the premium enjoyed by other REITs.
Self storage and manufactured housing REITs traded at premiums less than 15 percent to their NAV at the end of 2014. Meanwhile, hotel, apartment, retail and office REITs traded at premiums under 5 percent to their NAV.
High stock prices give healthcare REITs tremendous access to capital — and the money is crying out to be spent.
“That’s a signal from the public market to be aggressive on the acquisition front,” says Kevin Tyler, REIT healthcare analyst for Newport Beach, Calif.-based Green Street Advisors.
High prices tempt potential sellers. “If you are going to agree to be acquired, what better time?” says Jason Lail, manager of real estate research for SNL Financial.
Larger companies can adapt to the new federal regulatory environment more easily than smaller companies and are better equipped to navigate the complexities of healthcare reform, say industry experts.
The system will reward companies that can successfully integrate their information systems in order to mine large quantities of data. That’s because a growing number of healthcare companies now receive reimbursements based on the clinical outcomes of the care they provide.
“You need a tool that can measure outcomes,” says Beth Mace, chief economist for the National Investment Center for Seniors Housing & Care in Annapolis, Md. Size will make the task easier.
Over the last decade, most M&A deals involving seniors housing companies turned out well, according to Lail. “As a whole, the buyers in these deals outperformed the S&P 500 and the broader REIT market one year afterward.”
For example, a year after Ventas bought Nationwide Health Properties Inc. in 2001, its stock price was up 22 percent. That’s about twice the return of the SNL Equity REIT Index over the same period and more than five times the return on the S&P 500.
The $4.2 billion merger between Health Care REIT (HCN) and Sunrise Senior Living has worked to HCN’s advantage since the deal closed in 2013.
“HCN is clearly benefiting from scale and admin-istrative efficiencies related to adding properties to its large and still growing seniors housing platform,” says James Shanahan, an equity research analyst for St. Louis, Mo.-based Edward Jones.
Top deals in 2014
Over the last decade, the same three publicly traded healthcare REITs — HCN, Ventas and HCP — bulked up. “It’s the Big Three that are making the great majority of acquisitions,” says SNL’s Lail.
The biggest REITs did not disappoint in 2014, announcing four giant deals to acquire other seniors housing companies. HCN paid nearly $1 billion for HealthLease Properties Real Estate Investment Trust, a Canadian REIT, including assumed debt. Ventas agreed to pay $2.6 billion, including assumed debt, for American Realty Capital Healthcare Trust.
The big REITs also made dramatic investments in seniors housing properties and companies in foreign countries this past summer.
In August 2014, Ventas spent close to $1 billion to buy 29 senior living communities in Canada from Holiday Retirement. That same month, HCN bought a portfolio of 11 seniors housing communities from Gracewell Healthcare in the U.K. for £153 million (approximately US$257 million).
Arguably the most high profile M&A deal of 2014 wasn’t between two REITs, but rather between two publicly traded companies. In August 2014, Brookdale Senior Living Inc. completed its $2 billion acquisition of Emeritus Corp. Brookdale’s portfolio now includes 1,100 seniors housing communities in 46 states.
“They are setting themselves up to offer a full range of senior living options,” says CBRE’s Whitlock. The merger also gives Brookdale new economies of scale, he says.
To complete the merger, Brookdale absorbed hundreds of communities owned by Emeritus and hundreds more that Emeritus managed. Many of these properties are owned by other companies and leased by the former Emeritus.
“I was impressed with Brookdale’s capacity to understand and negotiate all the Emeritus leasehold interests,” says Whitlock. “As these mergers become larger, they involve an exponentially larger set of negotiations.”
Not all of the big acquisitions in 2014 followed the script of large companies gobbling up smaller companies. In December, National Health Investors (NHI), a smaller REIT, spent nearly $500 million to buy eight continuing care retirement communities (CCRCs)
from HCN.
The properties are in four states and total 1,671 units. Charlotte, N.C.-based Senior Living Communities LLC, will continue to manage the assets under a 15-year master lease.
“HCN unloaded a portfolio it had been looking to get out of for a long time,” says Green Street’s Tyler. Health Care REIT has become less interested in entrance-fee CCRC properties over the years. However, the deal shows that new buyers like NHI are once again becoming attracted to the CCRC model.
“It shows the market demand for CCRCs, which has been out of favor,” says Tyler. “The seniors market is looking for ways to grow.”
The skilled nursing facilities segment of seniors housing also recorded a giant deal in 2014. On Oct. 31, Omega Healthcare Investors announced that it would buy Aviv REIT for $3 billion, including the assumption of debt.
When the deal was announced, Aviv traded at a steep premium to its NAV, which made the acquisition expensive for Omega. The deal made sense for Omega because it was trading at an even steeper premium to its NAV.
The two portfolios of properties also covered two different geographical areas. “Omega was able to buy another operator with minimal overlap,” says Tyler.
Omega’s market cap as of Dec. 26 was $5 billion, while Aviv’s was $1.67 billion, so Omega will grow significantly as a result of the deal expected to close in the first quarter of 2015.
In December 2014, Northstar Realty Finance Corp. completed the largest M&A deal of the year in the healthcare real estate space. Northstar paid $4 billion, including assumed debt, for Griffin-American Healthcare REIT II Inc., a non-traded REIT.
Northstar now owns a portfolio of healthcare properties valued at $5.8 billion. For many years, Northstar operated as a mortgage REIT that originated loans for a wide variety of commercial real estate properties.
Stiff competition for quality assets
A wide range of buyers are likely to invest in seniors housing through 2015, keeping property prices high and capitalization rates low.
“Barring unforeseen global events, I would be surprised if transaction activity did not continue to be robust,” says Whitlock. He expects the volume of lending and buying in 2015 to potentially exceed the level of activity in 2014, even though 2014 set a high bar.
U.S. seniors housing transactions totaled $19.4 billion over the 12-month period that ended Sept. 30, 2014, up sharply from $14.2 billion the prior year, according to Real Capital Analytics. That figure includes both M&A transactions and sales of single properties and portfolios.
But the giant merger and acquisitions deals announced in 2014 may be difficult to repeat in 2015. “How much longer can this last?” asks Green Street’s Tyler.
The challenge for the largest seniors housing companies is that there are relatively few options available that provide an opportunity to grow significantly. “There are not that many large targets left to acquire,” says Whitlock.
If new opportunities to acquire portfolios or companies do not emerge, the biggest REITs may be constrained to slower growth, which includes relying on rent increases at existing properties and embarking on new ground-up development.
“You’re pretty much stuck with organic growth of 2 to 3 percent a year,” says John Roberts, director of research and an equity research analyst at Louisville, Ky.-based Hilliard Lyons.
The largest seniors housing companies have been doing their best to grow their NAV at a rate
of about 10 percent a year, according to Tyler. That kind of growth may be difficult for the largest seniors housing companies to deliver in 2015.
The biggest three REITs are unlikely to buy each other. The big three operate in very different ways that are unlikely to mesh well together. Their portfolios overlap. The stock prices of the big three REITs all trade at a similar premium to NAV, so that it’s not clear which REIT should buy and which should sell, according to Lail.
Among the smaller and mid-sized REITs, several of the potential targets are now too expensive to be attractive — though it’s always possible that the REITs will find a way to make a deal work. “There is always a chance that Ventas buys a smaller healthcare REIT,” says SNL’s Lail.
Looking across the pond and beyond
To keep growing, the largest seniors housing companies are kicking the tires in other countries to see what they like. “They aren’t limited to growing in the U.S.,” says Lail.
The demand for seniors housing in Europe and Japan is strong and is likely to become stronger. Top U.S. seniors housing companies have already made considerable investments in English-speaking countries like Canada and the United Kingdom.
“There are more opportunities overseas for U.S. seniors housing companies,” confirms Mace.
Large seniors housing companies may also find opportunities to grow by purchasing large portfolios of properties from private equity funds. “Private equity players are looking to create portfolios to be able to sell to larger companies,” says Mace.
Private equity funds typically sell their properties a few years after acquiring them. By selling the assets as a portfolio rather than one at a time, sellers can often boost the sales price by as much as 20 percent, according to NIC.
New development projects can help the top three REITs grow to some degree, but none of them have a large development pipeline, says Lail.
HCN, for example, had a pipeline of projects under development valued at a total of $331 million in the third quarter of 2014, according to SNL Financial. That might sound like a lot, but it’s tiny compared to the company’s market capitalization of $25 billion.
HCP also had a relatively small development pipeline valued at a total of $117 million compared to its much larger market capitalization of $21 billion. Ventas had a pipeline of just $18 million compared to its $21 billion capitalization.