Strong Year Forecast for Health Care REITs in 2011

The nation's largest publicly traded health care real estate companies reported solid performance in their portfolios in 2010, with most forecasting accelerated internal and external growth in 2011 and beyond.

According to executives presenting fourth-quarter and year-end 2010 earnings reports, health care REITs predicted continued strong investment and merger and acquisition activity as the aging population base and growing numbers of insured patients drive demand for a limited supply of hospital, medical office and senior care facilities.

The big news last year was HCP Inc., the largest health care REIT, grew even bigger by agreeing to acquire HCR ManorCare for $6.1 billion. Since then, HCP has completed a $1.5 billion equity offering and a $2.4 billion bond offering, both records for REIT capital raising.

Ventas Inc.,another major health care REIT, announced plans to acquire 118 private-pay senior living communities from Atria Senior Living for $3.1 billion. The deal will make Ventas the largest owner of senior housing in the U.S. Both deals are expected to close in the first half of this year.

The health care and senior housing sectors are among the most dynamic in all of real estate, with growing demand, consolidation among asset owners and operators, integration of post-acute care, the onset of health care reform and the need for more capital sources by both health care systems and senior housing care providers, said Debra Cafaro, chairman and chief executive officer of Ventas Inc. (NYSE: VTR).

For investors in health care REITs, 2010 was a banner year with the publicly traded REITs enjoying liquidity advantages over private buyers. Many also saw positive investment spreads and private equity funds monetizing their health care assets to drive record amounts of capital into the space, Ventas President Raymond Lewis said.

"As we look forward into 2011, we see many of these trends continuing and perhaps even accelerating as private equity funds seek liquidity and operators continue to partner with REITs to access capital, drive consolidation and achieve scale," Lewis said.

Across all its health care property types, including seniors housing, skilled nursing, and to a lesser extent medical office buildings, Ventas predicts a number of unaffiliated regional operators will be looking to align with REIT capital or sell to strategic buyers.

In addition to the Atria acquisition, Ventas' largest transactions of 2010 included its $381 million acquisition of Lillibridge Healthcare Services and 96 medical office buildings which closed midyear; and the closing in December of the $186-million acquisition of Sunrise Senior Living's real estate interests, giving the Ventas full control of all 79 assisted-living facilities managed by Sunrise.

Healthcare REIT (NYSE: HCN) announced four major investments with Benchmark Senior Living, Brandywine Senior Living, Senior Star Living and Silverado Senior Living in conjunction with its latest financial results. The new investments include an expansion of HCN's relationships Senior Star and Silverado, key portfolio companies, plus new relationships with Brandywine and Benchmark, two highly regarded Northeast operators.

"All of these partnerships offer potential future external growth, with the right of first refusal on future investments," said George Chapman, chairman, CEO and president of Healthcare REIT. "It is also important to note that all of these partnerships [also] offer internal growth opportunity through occupancy, particularly the Silverado and Senior Star portfolios, with properties currently in lease up."

The aggregate occupancy of the four new investments is 86%, leaving significant room for upside in a portfolio of high-quality assets in high barrier to entry markets, Chapman said.

Health care REITs face cuts in government reimbursement rates in coming years, with cuts in Medicare proposed over the next five years by reducing or freezing payments to skilled nursing facilities, hospitals, and other providers. With a large portion of revenues being determined by government payout rates, forces beyond the company’s control could negatively affect revenue and operator coverage ratios.

The big shadow looming over this sector remains proposed spending cuts in government reimbursements for health care programs. Healthcare real estate executives acknowledged their exposure to potential Medicare and Medicaid cuts, and said they are doing their best to mitigate the risks.

"We continue to take a very, kind of strict underwriting view towards coverages and structure and everything like that on nursing homes, because as we know the changes in Medicare and Medicaid over time do create some significant ebbs and flows in operator cash flow," Ventas' Cafaro said. "We always want to know that our rents are money-good and very collectible, and that our tenants are very creditworthy."

"Medicaid has been a concern of ours, witness what we've done in terms of divesting portfolios of skilled nursing communities that have a lot of Medicaid exposure in them," said James Flaherty, chairman and CEO of HCP. HCP decided to move forward with the HCR ManorCare acquisition in the post-acute space, which is the platform that enjoys the highest quality mix and lowest Medicaid exposure. "We have increased our Medicaid exposure [with HCR ManorCare transaction], but we've done that with a very fine operator who's got a track record of performing exceptionally well through all sorts of different cycles and happens to have the lowest cost setting."