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September
2007 issue
Seniors
Housing Occupancy--
Is development picking up and will credit markets slow it?
There has been some concern among investors
over declining occupancy rates at some of the largest seniors housing
companies, as well as over a potential new round of development. Should the
industry worry, or will the current credit market problems slow what may be
a quickening pace of new construction?
...
Investing In Health Care REITs--
Unfairly punished this year, health care REITs rebounding
Health care REIT stocks were pummeled for most of the year, even at a time
when their financial performance was strong. Did the market overreact?
...
Assisted Living Market
The acquisition market definitely appears to be slowing down beyond the
traditional summer lull. We still have six small deals to report on, plus a
large transaction that closed July 1.
...
Skilled Nursing Market
Behrman Capital is back in the skilled nursing business with a 35-property
acquisition, plus we have a few smaller deals to report on.
...
Market Updates
Advocat and Emeritus close their recent acquisitions, Morgan Stanley Real
Estate pays up in the UK and Manor Care sets the date for the shareholder
vote on its sale to The Carlyle Group.
...
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Articles Archive
Steve's BLOG on Senior Care
Companies Mentioned in this issue:
September 2007
A
Advocat p18
ASHA p2
Assisted Living Concepts p4
Atria Senior Living p5
Aviv Asset Management p16
B
Behrman Capital p14
Beverly Enterprises p19
Bristol Capital Advisors, LLC p18
Brookdale Senior Living p4, p8
C
Canyon Creek Development p14
Capital Senior Living p8
CapitalSource p8
Cathedral Rock p16
CB Richard Ellis p14
Covington Senior Living p19
E
Emeritus Assisted Living p4, p18
Encore Senior Living p12
F
Fillmore Capital Partners p19
Formation Capital p14
Fortress Investment Group p10
G
Genesis Health Care p19
H
Harrison Street Real Estate Capital LLC p19
Health Care Property Investors p8, p18
Herbert J. Sims & Co. p12
Holiday Retirement Corporation p3
Home Quality Management p19
HSH Nordbank AG p12
HUD p13
I
IDE Management Company p18
K
Kaplan Development Group p19
Kapson Senior Quarters p19
Kindred Healthcare p8
L
Litchfield Investment Company p19
Love Funding Corporation p13
M
Manor Care p18
Marcus & Millichap p13
Merrill Gardens p5
Merrill Lynch Capital p19
Merrill Lynch Capital Healthcare Finance p16
Morgan Keegan p10
Morgan Stanley Real Estate p18
N
NIC p2
O
Omega Healthcare Investors p19
P
Pramerica Real Estate Investors p18
R
Royal Senior Care p14
S
SEIU p19
Senior Living Investment Brokerage p13, p16
Senior Management Services of America p18
Slough Estates p10
Smith Healthcare LLC p13
Stifel Nicolaus p2
Summerville Senior Living p8, p18
Sunrise Senior Living p3, p8, p18
T
Tandem Health Care p14
The Carlyle Group p18
Touchstone Partners p16
Tutera Group p16
V
Ventas p8
W
Wilkinson Corporation p12
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Investing In Health Care REITs--
Unfairly punished this year, health care REITs rebounding
Email Editor
For any investor looking at the performance
of their health care REIT stocks this year, one would think that earnings
and cash flow had dropped, dividends had been cut or major tenants had
announced financial difficulties or even a bankruptcy or two. But no, none
of this has happened, and contrary to investor opinion, health care REITs
are in a good position to take advantage of the changed credit market
conditions.
So why did health care REITs take the plunge this year, and are they still
undervalued? The answer to the first question is a lot easier than the
second one. One common explanation at the time was that investors were
reacting to rising interest rates in the first six months of this year.
REIT stocks are interest-rate sensitive and usually move in an inverse
relationship with interest rates, but interest rates rose by just 50 basis
points in the first half of the year and then receded after June. That
hardly seemed to merit the punishment meted out by investors.
Second, health care REITs have had a tremendous run this decade, as have
most of the other REIT sectors. Real estate in general has been hot for
several years (just look at seniors housing), and then REITs got in the
cross-hairs of private equity firms, and takeover premiums started to push
share prices up even further. Meanwhile, real estate mutual funds that
invest in REITs received a record $11.2 billion of new funds to invest in
2006, and while we don’t know what portion of that went into health care
REITs, that amount of demand for real estate-oriented stocks had to have a
positive impact. So it would be easy to say that health care REITs, other
REITs and real estate in general basically peaked in early 2007 and, with
investor queasiness beginning with the residential real estate market, the
sentiment just changed.
But aren’t health care REITs different? With triple net leases, strong
lease coverage ratios and higher dividend yields, one would think that
investors might like health care REITs in general, and as a defensive
stock if the economy is beginning to wobble, because they are somewhat
recession-resistant. And within the health care REIT sector, there are
significant differences among the various companies. Investors, however,
don’t seem to see it that way, as five of the health care REITs reached a
52-week high on the same day (February 8, 2007), including the three
largest by market cap, and two others peaked the prior day. Six months
later, nine of the health care REITs hit 52-week lows within a two-week
period (July 26-August 9). So despite different dividend yields and payout
ratios, tenant concentrations and property types, they move remarkably in
tandem with each other. Unfortunately, they moved mostly lower this year.
So the plunge since February has to do with a combination of perceived
interest rate risk, a topping out of the real estate market in general,
cashing in after above-market returns in 2006 when the median health care
REIT total return was 36.9%, perhaps a belief that the seniors housing and
care industry itself was topping out (but we are really giving investors
too much credit on this one) and, perhaps, a little bit of ignorance.
Unfortunately, there are still a number of investors who look at the
sector as health care and not real estate, and penalize health care REITs
from a valuation perspective.
The final blow came in July with the subprime mortgage market mess, when
any lender/investor needing to tap the credit markets to grow and acquire
assets was hammered by investors seeking safety. Take the case of
CapitalSource (NYSE: CSE), which while not a health care REIT is a
significant player in the seniors housing market. CSE’s shares plunged 40%
in July based on concerns about the cost and availability of capital for
it to grow, resulting in a current dividend yield over 13%. If you are
looking for yield and believe the capital markets will settle down, that
is an incredible yield to lock in. We believe with health care REITs in
general that it has been a bit of a case of throwing the baby out with the
bath water.
As to the second question of whether health care REITs are undervalued,
the easy answer is that they were all significantly undervalued by the end
of July, if not before. The fact that they are all up by a range of 10% to
almost 40% from those lows in just one month certainly indicates that the
market overreacted to the credit crisis and its impact on health care
REITs. But that seems to be a pattern with investors and health care REITs
this year. Without being a wise guy, the time to invest would have been on
August 1 (don’t you love hindsight?), but no one really knew how many
other shoes were going to drop in the credit crisis.
The two largest health care REITs are Health Care Property Investors
(NYSE: HCP), which actually just changed its name to HCP, and
Ventas (NYSE: VTR). On a market cap basis, combined they represent
nearly 50% of the total health care REIT universe and tend to be quite
competitive with each other, to say the least. And although there are many
differences between the two companies, including style, the similarities
are extraordinary.
Although Ventas has been best known for being the primary landlord for
Kindred Healthcare (NYSE: KND), in terms of dollar value of
investments Kindred has dropped to third in VTR’s portfolio. The top two
are Sunrise Senior Living (NYSE: SRZ) and Brookdale Senior
Living (NYSE: BKD), with $1.96 billion and $1.39 billion in assets,
respectively. And wouldn’t you know it, the top two companies for HCP are
also Sunrise with $2.2 billion in investments and Brookdale with $662
million. Both REITs also have sizable investments in Capital Senior
Living (NYSE: CSU) and Summerville Senior Living. These four
companies represent about 65% of VTR’s investments and 41% of HCP’s.
One major difference, however, is that HCP receives rental income from its
103 Sunrise assets, while VTR receives all of the income (after paying a
management fee) from its 78 Sunrise properties, so it has the potential to
make a higher return if performance exceeds expectations (or lower returns
if the operations were to tank). In other words, unlike the traditional
REIT structure with a fixed rental stream, VTR owns the real estate and
the business with a variable income stream. This all becomes interesting
to watch because the outcome of the sale of Sunrise Senior Living,
currently in process, may be influenced by either HCP or VTR, since both
REITs have such a huge stake in seeing the company’s assets perform well.
While we have a pretty good sense that HCP’s senior management would like
to purchase Sunrise, possibly using its existing Sunrise assets as a
financing vehicle, the timing may not be right after just closing on the
$2.9 billion Slough Estates deal (primarily science and pharma lab
and office space in California). Whatever happens, any buyer, including
HCP, will be eying SRZ’s development pipeline as the goose that can lay a
lot of golden eggs. Why do you think Fortress Investment Group
(NYSE: FIG) paid such a high price for Holiday Retirement earlier this
year?
Despite the credit crunch, both VTR and HCP have ample credit facilities
for acquisitions without tapping the public markets, although according to
Morgan Keegan HCP has the largest untapped borrowing capacity in
place. Both companies will also benefit from what we believe to be a more
conservative acquisition market for the rest of this year and into 2008,
with higher cap rates and less competition from private equity firms. HCP
and VTR both hit their 52-week highs on February 8, while VTR hit its low
two weeks after HCP did this summer. Despite that lag, VTR has rebounded
by 44% from its low on August 9, while HCP is up just 21% from its low in
July. The reason why this is important is that HCP probably has more
near-term upside in its share price, although we believe both will perform
well once investors realize the baby, in fact, has been thrown out with
the bath water.
We like HCP’s 5.9% current dividend yield, compared with 5.0% with Ventas,
but we believe management at Ventas is more conservative than at HCP,
which is a plus in this market. We have never had the problem with the
Kindred portfolio that some (especially ratings agencies) have had, and
with the new rents and the high lease coverage ratios, we still believe it
gives balance to VTR. We also have some reservations about the Slough
Estates acquisition and how it will perform relative to HCP’s more
traditional assets. California real estate is usually looked upon
favorably, but we have heard very mixed opinions about the portfolio. Both
companies will have plenty of acquisition opportunities, and perhaps more
than the last few years if the credit markets don’t improve soon. So if
you looked at health care REIT values in the middle of the summer credit
market crisis and invested, you have made out quite well. It is not,
however, too late to take the plunge if you have a long-term horizon. |
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