When the Big Three healthcare REITs (Ventas, HCP and Welltower) largely divested their skilled nursing portfolios in the past few years, it prompted questions about the industry’s health. The exodus was kicked off in August 2015 by Ventas, which spun out most its skilled nursing/post-acute care portfolio into a separate REIT, Care Capital Properties (which just this month agreed to merge with Sabra Health Care REIT). Then, effective November 1, 2016, HCP followed suit, in a spin-off of its troubled HCR ManorCare assets (over 320 properties) into Quality Care Properties. Finally, after over a year of denying any such move, Welltower sold a 75% stake in 28 Genesis Healthcare-operated long-term/post-acute care facilities to a China-based joint venture, with more most likely to come.
But did the REITs choose the right time to divest? It appears so, as these large, high-profile exits came at a time of record-high values for skilled nursing facilities, which sold on average for $99,200 per bed in 2016 in arm’s length transactions, or 15% higher than the previous record set in 2015 of $85,900 per bed. The high values, driven by a record number of $100,000+ per bed transactions (previously a rarity), are not unfounded. Over the last few years, as seniors housing cap rates have fallen, many investors turned to skilled nursing (which has maintained a consistent cap rate around 12%) for a higher return, especially as interest rates start to rise. REITs like Omega Healthcare REIT and CareTrust REIT, the two most prolific buyers in 2016, were among those buyers, paying on average $106,300 per bed, or 7% higher than the market average.
But, healthcare REITs face several issues in the skilled nursing market, which may have prompted those exits. First is the aging of their investments. Despite their relative ability to provide capital for updates (for the most part), the majority of existing skilled nursing facilities are nonetheless over 30 years old, with many built over 40 years ago. Second is the financial impact of those 2.5% to 3.0% annual rent escalators. Although this problem has been somewhat assuaged by an increase in RIDEA acquisitions in the private pay seniors housing market, the issue came to a head with HCP’s spinoff of HCR ManorCare, which was struggling with lease coverage even after two rent reductions. Third, there is always reimbursement risk, which was made even more uncertain by the 2016 election. Lastly, the industry has seen acuity (and the associated costs of those more complex cases) increase but lengths of stay and reimbursement rates fall. For those facilities that attract higher paying Medicare patients in transitional care or short-term rehab, lower occupancy and fewer patient days have already begun to take their toll.