|In the latest in a series of dialogues with key players regarding the current capital environment in the seniors housing and care industry, Michael Hargrave, vice president of NIC MAP®, recently interviewed Omotayo Okusanya (“Tayo”), Managing Director in the Equity Research Department at Jefferies, and Senior Analyst responsible for coverage of Real Estate Investment Trusts (REITs).
NIC: Over the past few years, HCREITs have made significant acquisitions using the Taxable REIT Subsidiary/RIDEA structure. This structure allows REITs to participate in the underlying NOI/cash flow of assets through a third party manager to the REIT. While this structure provides flexibility and the potential for cash flow growth, it also comes with more risks. In particular, NOI streams and CAPEX spending become more important to monitor and predict. Thus far, how have the HCREITs, as a whole, been performing under this structure? Have there been any surprises to date and what risks warrant monitoring as we move forward, in your opinion?
Okusanya: The use of the RIDEA structure by HCREITs has been embraced by investors and companies, such as Ventas and Health Care REIT, that have increased exposure to RIDEA, and have seen their stocks experience multiple expansion. Given 1) expectations of an improving housing market, and 2) U.S population demographics, it is likely that demand for seniors housing grows over the next few years. This suggests seniors housing operators should be able to drive occupancy and rents. In such an environment, underlying NOI/cash flows can easily grow by 6 to 8% a year, which is much higher than the CPI based growth from the traditional triple-net lease business that HCREITs have traditionally based their business models on. It definitely is the right time in the business cycle to use RIDEA to participate in this expected earnings upside at the operating level. However, the challenge for the HCREITs will be when fundamentals in seniors housing begin to soften. Seniors housing operator stocks, such as Emeritus and Brookdale, typically take a beating under such scenarios. It is likely that the stocks of HCREITs with meaningful RIDEA operating platforms would underperform under such a scenario as well.
NIC: HCREITs have performed well thus far in 2012 and have seen superior returns compared to all REITs over the past 5 years. Can you describe the institutional investor’s mindset towards HCREITs right now?
Okusanya: While the performance of HCREITs has been exceptional over the past five years, you do have to note that the past five years has seen very little economic growth. HCREITs perform very well under such scenarios given the stability and defensiveness of their long-term triple net portfolios. The group has performed in line with the broader RMZ REIT index this year as 1) reimbursement rates for skilled nursing and hospitals for the upcoming fiscal year turned out better than expected and 2) Obamacare was ratified by the Supreme Court. Sabra Healthcare REIT, in fact, is the best performing REIT stock in 2012. Over the next 12 months, we believe investors will remain in heightened state regarding changes to Medicare as the government tackles the impending fiscal cliff. The Democratic win in the presidential election is a positive given it means Obamacare would not be at risk of getting repealed. The best scenario for HCREITs stocks would be a world where fiscal cliff issues are resolved with just a slight decline in US GDP growth, and without a meaningful cut to Medicare. Despite the risk of heightened volatility that may occur with these stocks next year, REIT dedicated investors, however, do need to stay invested in the group given how large the sector has become as part of the broader REIT market. Kudos have to been given to the management teams at all the public healthcare REITs and industry organizations, such as NIC, in regards to educating investors about the sector over the past few years.
NIC: HCREITs have moved from owning under 10% of the seniors housing and care inventory/units a few years ago to roughly 13% as of year-end 2012. This growth has been fueled by a comparably lower cost of capital, a more efficient means of accessing capital compared to other capital sources and more flexible ownership structures (RIDEA/JVs). Are these cyclical or structural advantages for HCREITs? Do you see this providing opportunity for further growth over the next 3-5 years for HCREITs?
Okusanya: Growth via acquisitions has always been a theme for the HCREITs, but the rate of acquisition growth has been nothing short of astounding. It feels like a new billion dollar plus deal is announced every quarter. The driver has definitely been lower cost of capital, a more efficient means of accessing capital compared to other capital sources and more flexible ownership structures (RIDEA/JVs). We believe these drivers are around to stay for the next few years, especially as the Fed seems focused on keeping interest rates low until at least the year 2015. Once interest rates and cap rates start to move up again, I would expect deal activity to slow somewhat. Until then, the larger HCREITs have a huge advantage in the current environment, and we expect to see them continue to gain share in the acquisition market over the next 2-3 years.