Senior Housing is Defined by Assisted Living and Memory Care Facilities
Two of the “big three” healthcare REITs, Welltower (WELL) and Ventas (VTR) are strategically positioned with a majority of their portfolios skewed towards the senior housing sector. The senior housing “umbrella” is an expansive one, but for the purposes of these two blue chip REITs, the category is defined primarily by independent living, assisted living and memory care facilities.
Common Structures Include SHOP and NNN Lease
The investments themselves can be categorized as (SHOP) senior housing operating portfolios in which the REIT owns the assets outright and either manages the properties themselves or engages a third-party operator to manage the assets for a fee. In the case of SHOP structured investments, the REIT is fully exposed to the volatility in cash flow that arises from changes in revenue and expenses. The other potential structure is a NNN lease structure in which the REIT owns the underlying asset, but enters into a long-term lease arrangement with an operator and that operator is legally bound to make lease payments to the REIT for a defined period of time. These leases tend to be long term in nature, typically 10-15 years.
Senior Housing was One of the Worst Performing Property Types in 2020
The senior housing sector did not fare well during the Covid-19 pandemic and in fact was one of the worst performing property types in 2020 as Covid caused a precipitous drop in property occupancy levels and created a host of operating and labor challenges for the industry at large. The sector did stabilize and begin to rebound in 2021 as the country’s vaccination rates rose and death/hospitalization rates started to decline. At the close of 2021, occupancy levels, rents and margins were still materially below pre-pandemic levels, setting the stage for potential upside in subsequent years.
Welltower and Ventas are Dedicated to the Sector and Believe in the “Silver Tsunami”
Both WELL and VTR provided 1Q22 updates over the past week in anticipation of presenting at a large industry conference. In the case of VTR, senior housing represented over 50% of the portfolio at the end of 2021 and 70% of the company’s $3.7 billion of 2021 investments were dedicated to the senior housing sector.1 The company remains confident in the long-term demographic drivers of senior housing, often referred to as the “silver tsunami” and is making capital allocation decisions in line with their conviction.
VTR Believes SHOP drivers are Compelling and the Sector is at a “Cyclical Inflection Point”
The company’s highlights of 1Q22 performance included several positive pieces of information including a sizeable 420bp increase in SHOP occupancy thus far in the quarter along with an 8% increase to in-place rents. Net move-ins for January and February were modestly positive, but expected to ramp up as the year progresses. SHOP occupancy averaged 82.9% across the portfolio and while up from the lows reached in 2021 a substantial amount of potential upside remains. Operating expenses were higher in February than in January and labor costs have remained a challenge given the tight labor market being experienced across most of the country. In the senior housing NNN portfolio, 90% of all tenancy issues have been addressed and the balance of unresolved issues are coming into focus.1 The most encouraging commentary in the company’s investor presentation related to the senior housing industry being at a “cyclical inflection point” with new development starts near historic lows, the 80-year-old and up population at record highs and industry occupancy and margins substantially below pre-pandemic levels. The company references a $400 million NOI “recapture” opportunity as the portfolio reaches normalization.1
Aside from the operating update, we also learned that an activist REIT investor is initiating a proxy fight to nominate two “shareholder friendly” members to the Ventas board to focus on maximizing shareholder value.
WELL Looks to Renewal Rate Increases as a Key Indicator of Improvement
Welltower’s (WELL) senior housing exposure is close to 65% with much of the balance tilted towards medical office buildings, life science and health systems. The messaging from the WELL March 2022 business update was not dissimilar to what we heard from VTR. SHOP occupancy is “flat” thus far in the first quarter and renewal rate increases were categorized as robust. The company highlighted labor expenses as still being elevated but is anticipating these will moderate through the first half of the year, with additional improvements coming in the balance of the year.2 WELL continues on a course of substantial external growth with a reported investment volume of $1.2 billion thus far in 1Q22, the biggest volume to start the year in company history. Covid cases among residents and staff are down materially in 1Q22 and this improvement will drive operating results for the quarter. WELL’s commentary highlighted $550 million of imbedded NOI improvement as operations return to pre-pandemic levels.2
We Believe the Factors at Play will Provide a Material Tailwind to Funds in 2023 and Beyond
WELL and VTR, as the bellwether names in senior housing, are interesting complements to traditional rental housing in that they are still in the early stages of recovering from the ravages of the pandemic and thus will likely see operating cash flows accelerate and peak much later in the cycle than apartments or single-family rentals. Senior housing REITs have a window of opportunity to acquire at substantial discount to replacement cost values and to develop assets at highly attractive rates of return relative to their cost of capital. This external growth opportunity coupled with the sizeable imbedded net operating income (NOI) growth that should materialize as existing portfolios retrace pre-pandemic operating levels will provide a material tailwind to funds from operations (FFO) growth and net asset value (NAV) growth in 2023 and beyond.
Footnotes:
Ventas Investor Presentation – March 2022
Welltower Investor Presentation – March 2022
