Byline: Melanie Evans
Aging baby boomers and the nation's healthcare reform push may drive more demand for square footage to provide medical care, and efforts to curb health spending could mean providers increasingly tap into their real estate for cash.
These assumptions are a siren call to real estate investors, promoting dealmaking among publicly traded companies that buy and lease a growing number of U.S. nursing homes, medical office buildings and other healthcare property and luring new players to the sector.
A $7.4 billion deal unveiled last week between Ventas and Nationwide Health Properties underscores the rising interest in healthcare real estate, analysts and consultants said. The all-stock transaction, expected to close by the end of September, comes roughly four months after Ventas said it would buy Atria Senior Living for $3.1 billion.
Meanwhile, Health Care REIT--which will rank a distant third among its publicly traded rivals once Ventas swallows Nationwide--said last week it would spend $2.4 billion for the assets of Genesis HealthCare (See related story, p. 7).
And in February, a newly created real estate investment trust named American Realty Capital Healthcare Trust said in regulatory filings it would privately sell $1.5 billion in stock. 'There is a great demographic story for healthcare,' said Jeff Theiler, a healthcare analyst for Green Street Advisors, an REIT research and consulting firm.
That was the story Debra Cafaro, chairwoman and CEO of Ventas, told analysts in a conference call about the deal. Size is critical to compete as a wave of senior boomers and newly insured patients drive growth after a recent slowdown in healthcare capital investment, Cafaro said. 'This combination of growing demand and limited supply creates some of the best underlying fundamentals in the entire real estate industry.'
Should the deal close as planned, the newly created behemoth would operate across 47 states and the District of Columbia. For Ventas, it would reduce a heavy--and risky--dependence on only three customers and one sector of healthcare real estate. Credit analysts said the diversification could help improve the company's credit rating.
As recently as September, three tenants made up almost three-quarters of the company's operating income, which was highly concentrated (62%) in senior housing, according to Green Street Advisors. By comparison, Nationwide Health Properties earned slightly less than half (48%) from senior housing and about one-fifth of its income from medical office buildings as of last September.
Buying Nationwide would further bolster efforts by Ventas to diversify its assets following last year's deal for Lillibridge Healthcare Services, a medical office building owner and consulting company based in Chicago, Cafaro said in an interview. Last July, Ventas paid $381 million for Lillibridge, which owned some of or all of 95 medical office buildings and counted a few of the largest and most highly rated U.S. health systems as its tenants or customers, including Ascension Health.
But hospitals and health systems with demand for space or a desire to sell and lease back the space they own shouldn't worry that recent consolidation will reduce competition, analysts and consultants said, because healthcare real estate's popularity is drawing plenty of players and investors to the market.
Indeed, executives who oversee the sprawling square footage employed by health systems for outpatient diagnostic services, clinics or other ambulatory care say they have gained some leverage as capital-flush investors seek healthcare real estate deals. 'It absolutely has worked to our advantage,' said Patrick Hollister, administrative director of corporate ventures for Swedish Health Services.
The Seattle system recently leased two ambulatory centers with satellite emergency rooms and later this year will open a 175-bed hospital that is now under construction; it will also be leased from a developer. Hollister said Swedish development proposals elicit strong interest for the same reasons that are driving REIT consolidation: Healthcare performed well throughout the recession and will likely remain stable with demand for care projected to grow.
'We have a wealth and abundance of investors to select from,' Hollister said.
Philip Camp, a managing director in healthcare real estate for investment bank Shattuck Hammond Partners, said Ventas' bid for Nationwide reflects natural consolidation for the emerging healthcare REIT sector.
The maturing sector continues to attract new players, however, such as American Realty Capital Healthcare, he said. 'The landscape remains very competitive,' he said.
More insured patients and older boomers aren't the only reasons investors find healthcare real estate attractive, analysts said.
Healthcare fared better than other real estate sectors--such as retail or office space--during the economic downturn. And medical office building renters don't move as often as other tenants, said Green Street Advisors' Theiler.
Publicly traded healthcare REITS have also grown as other investment vehicles such as private equity struggled during the economic downturn, said Jan Svec, a senior director and REIT analyst for Fitch Ratings. Capital from private sources has become more scarce and selective in recent years, she said.
Douglas Pasquale, Nationwide's CEO, said during a conference call with analysts that the Newport Beach, Calif.-based company sought a deal that would create a formidable competitor and boost its place in the market. Nationwide officials were not available to be interviewed, a spokesman said.
Nationwide ranked as the fourth-largest publicly traded healthcare REIT at the end of February, with market capitalization of $5.4 billion, National Association of Real Estate Investment Trusts data show. With a market cap of $8.7 billion, Ventas trailed No. 1 HCP, with $14.1 billion. 'We felt scale, growth, diversification, balance sheet strength and cost of capital would become increasingly important in an industry we believe will become ever more competitive,' Pasquale said.
Cafaro, meanwhile, told analysts that healthcare REITs hold less than 10% of the $700 billion healthcare real estate market. 'As a result, we see continued opportunities for expansion and growth,' she said.
Analysts said Ventas' acquisition of Nationwide would improve the company's leverage and boost its size and scale, which could lower its cost of capital. Cafaro said that would allow the investment trust to offer more competitive deals to tenants and real estate sellers.
But if REITs are banking on providers cashing in their real estate chips, that's not happening yet, said Mike O'Keefe, director of the healthcare real estate group for Navigant Consulting. The capital flooding into healthcare real estate has met with a limited supply of sellers, 'That's what's driving some of this consolidation,' O'Keefe said.
Beverly Erickson, vice president of asset management for Trinity Health, said she cannot say how the Patient Protection and Affordable Care Act will affect providers' need for capital and space.
Trinity, based in Novi, Mich., owns and leases 6 million square feet of non-acute-care real estate. Trinity will use as much existing space as possible to meet demand and seek flexible design from development projects to prevent buildings from quickly growing obsolete, she said. Erickson said it's uncertain how quickly--or where--the newly insured will seek medical care. 'It's really premature' to speculate how fewer uninsured patients will affect demand for clinics and other ambulatory buildings, she said.
Mountain States Health Alliance will likely buy a leased cancer center adjacent to the replacement hospital now under construction for Johnston Memorial Hospital, in Abingdon, Va., said Marvin Eichorn, senior vice president and chief financial officer for Johnson City, Tenn.-based Mountain States. The system holds the controlling stake in Johnston, after Mountain States agreed to put $125 million toward construction of a new hospital.
Johnston Memorial leased the cancer center prior to the deal to preserve its capital. Eichorn said leased property usually costs more to finance for the tax-exempt system, so Mountain States typically owns property outright or swiftly exercises an option to buy leased buildings for that reason.
Overall activity involving medical office buildings grew sharply last year--to $3.9 billion, up 93% from the previous year--and publicly traded REITs claimed a larger share of the volume, according to the market research firm Real Capital Analytics. Publicly traded investment trusts accounted for 40% of the activity last year compared with 27% the prior year. The numbers in part reflect Ventas' acquisition of Lillibridge.
So far this year, the trend has continued, with publicly traded REITs accounting for 46% of activity through March 3, Real Capital Analytics figures show.
Cafaro said Ventas will be looking for capital-starved hospitals and health systems putting their real estate on the market. Medical office buildings, she said, are 'an untapped piggy bank' for those willing to sell.
Swedish recently partnered with developers to build on the system's property and lease two ambulatory-care centers in Redmond and Mill Creek, Wash. The system's five-floor hospital in Issaquah, which will open later this year, was built under the same arrangement. Hollister said Swedish turned to leasing so executives could invest capital elsewhere.
Payment from insurers has not kept pace with expenses, he said, which has left hospitals with fewer capital resources, a trend he said will accelerate as Medicaid expands under health reform.
'It's kind of a sad state of affairs,' he said. 'In the long term,' as landlords seek healthy returns for their investment, Hollister said, 'it all costs us more.'
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