The SeniorCare Investor: Merrill Gardens Alignment--
Provider Links Up With Health Care REIT
Two years after terminating a large transaction for a group of Sunrise Senior Living (NYSE: SRZ) properties, which may go down as the best deal it never did, Health Care REIT (NYSE: HCN) broke the summer slumber in early August with the announcement that it had entered an agreement to form an $817 million joint venture with Merrill Gardens, an existing tenant. And if all goes according to plan, this time the marriage will be consummated and the relationship will grow over the years.
In order to obtain ever higher returns for their shareholders, REITs are increasingly using the structure authorized by the REIT Investment Diversification and Empowerment Act of 2007 (RIDEA) which allows them the opportunity to keep the economic benefits of real estate ownership (cash flow) above and beyond simply collecting rent. It also means they can suffer from a business downturn which could result in cash flow below what the standard rents would have provided. In other words, higher risk with a higher reward, but over time the REITs that are taking advantage of the 2007 change are viewing it as both an inflation hedge (if inflation ever returns, and it will), and a way to achieve a higher return that far outweighs the risk if they pick the right partner. Besides, if a provider is leasing most or all its assets from a REIT, isn’t the REIT really taking on the business risk anyway? This is how the REITs must be looking at it, and as the large REITs need size in their acquisitions these days, corporate deals such as this one will become more prevalent.
Before the joint venture was announced, Health Care REIT already owned 13 communities leased to and operated by Merrill Gardens. These were valued at approximately $307 million with debt associated with them of $132 million. The newly formed partnership will operate these 13 properties plus an additional 25 communities currently owned by Merrill Gardens that have been valued at $510 million. Health Care REIT’s consideration for its 80% interest in these 25 properties will consist of about $209 million of cash and its pro rata assumption of the $249 million of secured debt associated with the buildings, which comes to about $199 million. With a total of 4,388 units, of which about 65% are independent living and 35% are assisted living, the implied value for the entire partnership comes to just over $186,000 per unit.
Annual revenues for the portfolio are about $175 million, and the estimated EBITDA next year is between $60 million and $63 million. Using the mid-point, that results in an implied cap rate of 7.5% on 2011 cash flow after management fee. We say “implied” because this was not an outright acquisition, and we are sure there was some horse trading between the two sides. It had been well known that the Merrill family has wanted to get some liquidity from its sizable investment in Merrill Gardens. In fact, in 2007 Merrill Gardens sold a portfolio of 26 properties to Chartwell Seniors Housing REIT (TSX: CSH.UN) for $346.7 million, or $146,000 per unit. These were smaller buildings and considered to be “B” properties in B markets, but the price was relatively high because they sold at the market peak. The Merrill Gardens properties going into the partnership with Health Care REIT are considered to be higher quality and in better locations. So the Merrill family gets cashed out (mostly) but still gets to ride the seniors housing wave with its 20% interest. Want to read more? Click here for a free trial and download the current issue today