The SeniorCare Investor: Health Care REIT's Clobbered--

Even “Defensive” Investments Are Not Spared Today

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Health care REITs have long been considered to be "defen-
sive" stocks, a safe haven (or at least a safer haven) in troubling times. The triple net leases with cross-collateralized properties that were considered somewhat impervious to economic downturns were thought to mean a steady cash flow, and thus a dividend with steady annual increases resulting in stable stock prices. Because of the importance of the dividend yield, however, they have always been influenced by changes in interest rates, especially big swings. Unfortunately, the majority of health care REIT investors are investors in other REITs with all the different property types, so when they sell those REITs because of economic woes or problems in the commercial real estate market, health care REITs can get thrown in with the bunch from time to time.

Through September 30 of this year, however, the health care REIT sector performed as expected, with all the stocks in the sector up anywhere from 5% to 23% for the first nine months of the year, with the dividends boosting that return. That’s pretty impressive, especially given the overall market was down 18% in the same time period. Since then, however, it has been a completely different story. While the overall market has dropped by another 18% since September 30, health care REITs have plunged by an average of 35% in the past two months. Even though the overall performance for the year is still better than the rest of the market, it has not been a pretty picture, especially for Ventas (NYSE: VTR) and HCP Inc. (NYSE: HCP), which are down 49% and 41%, respectively, for the year mostly because of fears about their billion-dollar investments in properties managed by Sunrise Senior Living (NYSE: SRZ), which is teetering on bankruptcy (see story on page 1). The prices are so low that the dividend yields, ranging from 7.2% to 10.1%, are the highest they have been since the first half of 2003 which, not coincidentally, is when the assisted living and skilled nursing markets were coming out of their bankruptcy-ridden depression. Perhaps this is telling us something.

There have been some unintended casualties along the way. As health care REITs were acting true to form as a relatively safe investment haven for investors, two companies filed registration statements for IPOs of their REITs this year, which we mentioned at the time. In early August, CapitalSource (NYSE: CSE) announced that its newly formed subsidiary, CapitalSource Health Care REIT, had filed a registration for an IPO to raise approximately $300 million, all of which was to be upstreamed to the parent. The company planned to go to market in late September or October, and at the time who would have known that the overall stock market would collapse just as they were getting under way, with most everyone frozen watching their screens as stock values dropped faster than Bush’s approval ratings. The offering was pulled from the market before it got too far, which was the only thing to do during the market collapse. Two months earlier and it would have been completed.

The other REIT IPO, which was filed last June for Chicago-based Aviv REIT, was supposed to start its road show around the same time that CapitalSource Health Care REIT did, but they decided to postpone when the markets started their freefall. Aviv is quite different from CSE’s REIT in that it has been a private company for more than 25 years and has not strayed from its core investments in the skilled nursing sector. It owns more than 150 properties with over 15,000 licensed beds in 20 states. Most of the nursing facilities were purchased at prices below the national average price per bed, which can be good from a capital reimbursement perspective, but it also usually means that there is a relatively high Medicaid census. Aviv also had some financial issues with at least one of its tenants this summer, and while in the scheme of things that wasn’t necessarily a big deal, and it had nothing to do with the postponement of the IPO, we assume they would want to clean that up before going back to the market, whenever that may be.

There was no possible way for either REIT to proceed with their IPOs in the fourth quarter because as publicly traded health care REITs were getting clobbered, the entire IPO market virtually shut down. In the overall health care space, the last IPO was priced on March 18, and that was for a medical device company which, by the way, doubled in value and has since dropped back to its IPO price. Since that IPO, there have been nearly 20 health care-related IPOs that have been withdrawn or officially postponed, and many more that are just sitting in limbo. Until the capital markets stabilize, and health care REIT stocks in general start to rise, we don’t expect either of these REITs to go back to the market anytime soon, and they may have to wait at least another six to 12 months. We hope we are wrong about the market, but they also don’t want to go out at too cheap a price.
Meanwhile, the health care REITs that are already public are performing a lot better than their share prices would indicate. Ventas posted a third quarter 4.5% increase in funds from operations compared with the year-ago quarter and an adjusted net income increase of nearly 50%, and the company has $730 million of liquidity with just $219 million of debt due next year. Although full-year forecasts have been reduced, cash flow is certainly higher than the dividend payout. HCP, on the other hand, announced that its results for the full year will be at least a few pennies per share better than analysts’ estimates. Health Care REIT (NYSE: HCN) is locked and loaded after raising $300 million of equity in September for its deal for the 29 Sunrise properties, which was subsequently terminated, plus any other excess liquidity available for future investments. The point is that these "big three," with a combined market cap of more than $11 billion, even after their price drops, are still in strong financial positions and can take advantage, if they choose to, of what many expect to be a real buyer’s market in 2009, instead of the theoretical one in 2008. Until the lenders such as CIT Health Group (NYSE: CIT), CapitalSource and GE Healthcare (NYSE: GE) come back into the market, the REITs may be the only ones able to complete the $250 million and larger deals that may appear next year, and they will be in the driver’s seat from a pricing and structure perspective. In the meantime, those yields look very attractive today and we are not sure how long they will last.
 

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