REITs on hospi­tal hunt

Cap­i­tal-hun­gry op­er­a­tors given en­vi­able choice with real es­tate prices ris­ing

Modern Healthcare - - NEWS - By Beth Kutscher

In an era of non­tra­di­tional partnerships, the sale of for­profit hospi­tal chain Ar­dent Med­i­cal Ser­vices to Ven­tas this year stands out.

For Ven­tas, a real es­tate in­vest­ment trust, the deal marked its first en­try into the hospi­tal mar­ket af­ter lim­it­ing its hold­ings to se­nior hous­ing, med­i­cal of­fice build­ings and post-acute-care fa­cil­i­ties. The $1.75 bil­lion deal was one of the largest trans­ac­tions be­tween a hospi­tal op­er­a­tor and a REIT.

Three months later, hospi­tal op­er­a­tor Capella Health­care dis­closed that it would sell its real es­tate, too, mak­ing a $900 mil­lion deal with Med­i­cal Prop­er­ties Trust, a Birm­ing­ham, Ala.-based REIT.

In both trans­ac­tions, the REIT planned to sep­a­rate the real es­tate from the op­er­a­tions and re­tain a stake in the new op­er­at­ing com­pany.

“Our the­sis is that the acute-care hospi­tal will al­ways be at the top of the food chain,” said Ed­ward Aldag, Med­i­cal Prop­er­ties’ CEO. “When you look at the over­all rev­enue, clearly there’s been a shift from in­pa­tient to out­pa­tient. But it hasn’t been a move away from the hospi­tal. So we don’t view that as a bad thing.”

The Capella deal also is the largest buy for Med­i­cal Prop­er­ties, which has spe­cial­ized in acute-care as­sets since its found­ing. Hos­pi­tals cur­rently ac­count for 70% of its port­fo­lio, but it aims to in­crease that num­ber even fur­ther.

The health­care real es­tate mar­ket has been boom­ing, driven by the con­ver­gence of sev­eral trends. The shift of care from in­pa­tient to out­pa­tient has in­creased de­mand for on- and off-cam­pus med­i­cal space. Providers, who are hun­gry for cap­i­tal to in­vest in new care-de­liv­ery mod­els, can raise money by sell­ing off real es­tate. And low in­ter­est rates have driven up the price of those real es­tate as­sets across the coun­try.

Health sys­tems, with their bloated real es­tate port­fo­lios, have been more than will­ing to part­ner with REITs to gain ac­cess to some of the cap­i­tal locked up in the $1 tril­lion health­care real es­tate mar­ket. REITs see partnerships with not-for-profit health sys­tems as a pri­mary area for fu­ture growth.

REITs “have been pretty ef­fer­ves­cent in the M&A mar­ket,” said Mindy Berman, a health­care prac­tice lead in the cap­i­tal mar­kets group of JLL, an in­vest­ment man­age­ment firm spe­cial­iz­ing in real es­tate. “They’re go­ing to ben­e­fit from in­creases in rental rates and from in­vest­ing in op­er­a­tions.”

How­ever, the high price tags that health­care real es­tate as­sets are com­mand­ing in to­day’s mar­ket are rais­ing some con­cern a bub­ble may be form­ing, which could pop

with ris­ing in­ter­est rates or a gen­eral slow­down in the econ­omy. An in­ter­est rate hike, con­sid­ered im­mi­nent by most Fed­eral Re­serve Board watch­ers, would de­liver a dou­ble whammy. First, it would make debt more ex­pen­sive to take on, which would de­press REIT stocks and en­cour­age in­vestors to move their money into bonds (since bond prices fall as in­ter­est rates rise). And it would also cause real es­tate prices to either mod­er­ate or fall.

Se­nior hous­ing in par­tic­u­lar is sen­si­tive to the larger real es­tate mar­ket be­cause de­mand is de­pen­dent on se­niors’ abil­ity to sell their cur­rent res­i­dences. In ad­di­tion, acute- and post-acute-care providers are sus­cep­ti­ble to cuts in re­im­burse­ment, which af­fects the will­ing­ness of providers to pay higher rents for the build­ings they no longer own.

“We par­tic­i­pate com­pletely in the ups and downs of the econ­omy,” said Tom DeRosa, CEO of Well­tower, for­merly known as Health Care REIT. While the per­cep­tion is that health­care fa­cil­i­ties have long-term leases, the re­al­ity is that 35% are ac­tu­ally shorter-term op­er­at­ing leases. “In­ter­est rates go­ing up do af­fect our cost of cap­i­tal both on debt side and eq­uity,” he said.

But those threats aren’t dis­suad­ing deal-hun­gry REIT op­er­a­tors from scour­ing the states for new op­por­tuni- ties. Deal vol­ume for health­care REITs is on track to in­crease sig­nif­i­cantly in 2015 com­pared with the pre­vi­ous year. REITs in­vested in 41 pub­licly dis­closed trans­ac­tions, mostly for post-acute care and se­nior hous­ing as­sets, in the first three quar­ters of 2015, com­pared with 25 trans­ac­tions dur­ing the same pe­riod in 2014, ac­cord­ing to Mod­ern Health­care’s M&A data­base.

Well­tower has its as­sets con­cen­trated in ma­jor mar­kets such as New York, Wash­ing­ton and San Fran­cisco, where prop­erty val­ues have been in­creas­ing. Many of th­ese boom­ing ci­ties also need to build the in­fras­truc­ture to care for aging pop­u­la­tions. “The is­land of Man­hat­tan ba­si­cally has no mem­ory care” fa­cil­i­ties, DeRosa said. “We need to be pre­pared for a pop­u­la­tion that will have dif­fer­ent needs.”

Many health sys­tems lack the out­pa­tient cen­ters they will need as more care shifts out­side the hospi­tal walls. Part­ner­ing with a REIT al­lows them to in­crease their ser­vice of­fer­ings at a lower cost. “We see that as the fu­ture of the acute-care industry,” DeRosa said. “The hospi­tal of the fu­ture will be a much smaller hospi­tal with out­pa­tient fa­cil­i­ties.”

Well­tower’s strat­egy does not in­clude own­ing acute­care fa­cil­i­ties. “We stop at the front door of the hospi­tal,” DeRosa said.

But other play­ers such as Ven­tas are en­ticed by fac­tors such as an aging pop­u­la­tion, higher lev­els of in­sur­ance cov­er­age and pos­i­tive vol­ume trends to ac­quire hospi­tal fa­cil­i­ties. Ven­tas plans to use its ac­qui­si­tion of Ar­dent—its first foray into the acute-care space—as a plat­form to make more buys in the mar­ket, said CEO De­bra Ca­faro. Like Well­tower, it in­tends to find ways to use its scale to help op­er­at­ing com­pa­nies re­al­ize sav­ings, for ex­am­ple, through group pur­chas­ing.

Yet while the num­ber of hospi­tal real es­tate buy­outs is ex­pected to grow, there’s still skep­ti­cism about whether the prac­tice will be wide­spread. Among not­for-profit health sys­tems, such as aca­demic med­i­cal cen­ters, the idea of sell­ing their real es­tate isn’t be­ing widely dis­cussed, said Tor­rey McClary, a Los An­ge­les-

based health­care M&A at­tor­ney at law firm Ho­gan Lovells. “If you’re talk­ing about uni­ver­si­ties, they’re not go­ing to sell their dirt,” she said.

But she has seen in­ter­est in invit­ing out­side in­vestors to de­velop an­cil­lary as­sets such as mediplexes or med­i­cal malls—the one-stop-shop out­pa­tient cen­ters that com­bine di­ag­nos­tic and phar­macy space, physi­cian of­fices, and com­mu­nity health and ed­u­ca­tion fa­cil­i­ties. “I’m gen­er­ally see­ing more in­no­va­tion in terms of partnerships,” McClary said. “I’m start­ing to see more flex­i­bil­ity with whom providers are start­ing to part­ner.”

The loom­ing ques­tion for the en­tire real es­tate industry, of course, is what will hap­pen once the Fed­eral Re­serve raises in­ter­est rates, which is ex­pected to hap­pen by yearend. His­tor­i­cally low in­ter­est rates have made it cheaper to fi­nance real es­tate trans­ac­tions while also in­creas­ing de­mand for com­mer­cial real es­tate over­all.

“The low in­ter­est rate en­vi­ron­ment has cer­tainly helped drive up the value for all as­set classes,” said Robert Mil­li­gan, chief financial of­fi­cer of Health­care Trust of Amer­ica, a Scotts­dale, Ariz.-based REIT. “We’re see­ing a lot more deals get­ting done. We’re see­ing a lot more high-qual­ity deals.”

The po­ten­tial for a rate hike could slow down some of that ac­tiv­ity, REIT ex­ec­u­tives ac­knowl­edged. The stock mar­ket down­turn also has de­pressed the mar­ket cap­i­tal­iza­tions of many pub­licly traded REITs.

But industry play­ers in­sist that the long- term changes in health­care de­liv­ery and de­mo­graph­ics of­fer a com­pelling out­look that will su­per­sede the fi­nanc­ing en­vi­ron­ment.

“The ap­petite for (dif­fer­ent) prop­erty types will shift de­pend­ing on the reg­u­la­tions,” Berman said. “We may go through cy­cles with health­care. But the di­rec­tion is only up.”

Down­load the com­plete 2015 Q3 Health­care M&A Watch re­port at mod­ern­health­ /mawatch

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