Ventas Analysis: Growing Naturally
Board: Real Estate Investment Trusts
Investments that can capitalize on the aging population and demographic trends are by their very nature a growth industry. In 2012, 13.7% of the 314 million Americans (41 million) were over 65 and about 70% of them will need some sort of long term care at some time in their lives. That is expected to nearly double in the next sixteen years.
Ventas is one of the three biggest health care REITS and got there with high intensity focused asset acquisitions. Property has mushroomed from $1.1 billion 10 years ago to just of $20 billion at the end of Q3 2013. In 2011 alone they added $10 billion in properties.The company has returned 479% to investors over the high growth decade and paid an ever-increasing dividend (except for 2008) compounding at 9% with funds from operations (FFO) growing at an 11% CAGR over the same period.
Ventas is a healthcare REIT specializing in senior housing properties, skilled nursing facilities, medical office buildings and a handful of hospitals. As of September 2013, Ventas owned 1500 properties in the US and Canada. Their portfolio is concentrated in four types of properties:
1) Senior housing (456 triple net/237 operating)
2) Skilled nursing (365 triple net)
3) Medical office buildings consolidated, JVs &
unconsolidated (363 triple net)
4) Hospitals (47 triple net)
54% of net operating income (NOI) comes from the senior housing properties. Of these, about half are considered to be SHOP (owned by Ventas managed by a 3rd party) and the rest are triple net lease (NNN). REITs have only recently been allowed to increase the percentage of owned properties and directly collect rents and fees (REIT Diversification and Empowerment Act of 2007) and by owning operating assets they have the opportunity to raise fees and streamline costs and directly capitalize on operating improvements. Triple net leases allow for rent increases but little else. There is of course more risk if occupancy softens as opposed to the stability of a long-term lease. The Atria and Sunrise managed SHOP occupancy is 92% and the revenue per occupied room is $5,500.
VTR has 235 properties in the SHOP portfolio at 24,000 units returning NOI of roughly 6% year over year. Per room, they average $5500 per month –in excess of average rent for similar properties. In 2012, same store SHOP revenue increased 6% and NNN was up 2.3%. The company expects same store sales to continue to grow at 5%-6% in FY 2013.
These aren’t your grandma’s old folks homes. Most of the properties shown in company filings are elegant and inviting. Ventas focuses on acquisitions in more upscale communities with higher property values. The communities are studio, one bedroom and two bedroom apartments Residents are elderly and require varying levels of assistance from independent needing just meals and housekeeping to more extensive care. Charges for room, board and services are largely private pay. Because senior housing is 54% of net operating income and is private pay, Ventas is less affected by shifts in government spending patterns —- mainly Medicare and Medicaid.
[See Post for Tables]
Growth in the SHOP portfolio is much higher than the NNN lease portfolio. VTR can continue to grow the SHOP business up to the legal limits adding to the diversity of their revenue stream. Same store NNN revenue increased 2% in Q3 2013 while same store SHOP revenue was up 13.4%. This is the advantage of owning the properties —- organic growth will outperform leased property.
Owned properties incur operating expenses and lower margins than the expense-free operation of triple net property. Margin expansion theoretically could be way for VTR to create more value in their SHOP business. That seems unlikely given that over the past three quarters NOI margins have stayed around 32% and have been between 31%-32% for the last three years.
Triple Net Leases
The triple net lease for senior housing portfolio/skilled nursing/hospital facilities are leased to two big accounts—Brookdale (senior housing) and Kindred (skilled nursing and hospitals). The big accounts create some risk. In the third quarter 2013 and 2012, Brookdale was 5.5% and 6.1% of revenue respectively and Kindred was 7.6% and 10.1%.
Leasing provides a more stable revenue stream with a fairly predictable 2%-3% growth provided by built-in rent increases organically and of course a steady stream of acquisitions. The same store NOI increase for triple net properties was 1.8% for the first nine months of 2013 and 2.3% in 2012 -- much lower than the SHOP portfolio.
Analysts see the healthcare industry as being fragmented with only 10% of healthcare property tied up in REITs and a $1 trillion healthcare real estate market ripe for consolidation. Price depends on demand and as the real estate market improves the prices creep up. One year ago Ventas was getting properties at an average cap rate of 7%-7.5%. It dropped to 6.1%-6.4% in 2013 with some individual acquisitions coming in above 7.5%. That still compares favorably with other types of real estate coming in at 4%-5%.
Since the beginning of the third quarter, VTR invested $1.2 billion in Q3 buying mainly senior housing and medical office buildings. Senior housing is 63% of VTRs capital investments and 66% of revenue. The occupancy of the triple net senior housing properties is 86% lagging SHOP by 5%. Since the occupancy rate doesn’t affect lease agreements, this is less important to Ventas. However, if the lessees can’t keep the rooms fully occupied, paying the rent to VTR could become a problem. These numbers seem about on par with other health care REITs.
Lease negotiations with Kindred
Leasing comes with its own headaches when leases have to be renegotiated or tenants break/default on the lease. Part of the decline in Ventas’ share price may be attributable to its disappointing recent negotiations with Kindred.
Ventas offered Kindred a post-bankruptcy break on rent of around $50 million per annum. The reset on those properties was looming in 2015. Ventas floated a $111 million reset increase to Kindred last spring. The market obviously didn’t believe it since shares continued to drop. In October, they reached an agreement to a lease increase on 48 properties of $15 million and a $20 million one-time payment. That leaves 60 properties that are not covered and Vents has the right install new tenants in 2014. The rent increase kicks in in the 4th quarter of 2014. The other 60 are in limbo until leases are signed. This is probably weighing on the stock price along with the general disfavor REITs find themselves in after years of love.
Skilled nursing is for patients/residents who require more care than independent senior housing clients, but less than a hospital stay. It includes rehab and medical treatment with an emphasis on physical, occupational, speech, and respiratory therapies, including sub-acute clinical protocols as well as wound care and intravenous drug treatment. SNN is nearly 70% paid for by Medicare and Medicaid that leaves it vulnerable to budget cuts.
Luckily SNN is only around 12% of revenue allowing VTR to be less exposed to the whims of government reimbursement. SNN is triple net and VTR doesn’t manage any clients on its own behalf. The company's total payer sources were 72% private pay by 2Q'13 NOI and as a result, Fitch does not expect that changing Medicare and Medicaid changes for 2014 will have a negative impact on the company's portfolio. Prospective payment system payment growth rates for Medicare in skilled nursing facilities are 1.3% for FY 2014 following 1.8% in FY 2013 and for long-term acute care hospitals are 1.3% for FY 2014 following 1.7% in FY 2013. Sequestration that was effective April 1, 2013 lowered Medicare reimbursements by 2% per the Budget Control Act of 2011, but this should lower blended EBITDARM on Ventas' skilled nursing facility by less than 0.1x going forward
Substantially all of the VTR hospitals operate as long-term acute care hospitals with a Medicare average length of stay greater than 25 days and serve medically complex, chronically ill patients requiring a high level of monitoring and specialized care. Hospitals are triple net leased and average occupancy in the high 50%. This seems low but is similar to SNH. OHI didn’t report. Cash flow coverage is higher than SNN, MOBs and housing even with lower occupancy. Hospitals are only 4% of revenue, 7% of NOI and are 2% of Ventas total investments. All of the long-term acute care hospitals are freestanding facilities.
Medical Office Buildings
Last but not least are the medical office buildings. VTR owns 17 million square feet of multi-tenant properties. Tenants include physicians, dentists, psychologists, therapists and other healthcare providers, with space devoted to patient examination and treatment, diagnostic imaging, outpatient surgery and other outpatient services.
Medical offices are more costly to build than other commercial office space and they consume 18% of Ventas investment dollars and are 15% of revenue. Office occupancy is 91.4% and has been between 91.8%-91.4% over the last 5 quarters. The medical office building (MOB) platform includes the company's Lillibridge subsidiary and is 94% on-campus or affiliated across over 60 health systems, providing cash flow stability
Capital for future acquisitions
Since July 1, they raised about $900 million principally in the fixed income market at a blended rate of 3% and a weighted average maturity of 12.5 years. Ventas reduced the weighted average effective interest rate to 3.8%, and lengthened and staggered the debt maturity schedule to almost 7 years. The debt/enterprise value is 32%, debt to capital is 51% and debt/assets is 47%. The debt level is high moderate (just a skosh above moderate). The fixed charge coverage ratio was 4.3x.
VTR has had debt/assets as low as 37% in 2011 and as high as 71% in 2006. Current levels look manageable and the rates are low with staggered maturities. Near-term debt maturities were minimal as of June 30, 2013 with 2.5% of debt maturing in 2H'13, followed by 4.1% in 2014, and 13.1% in 2015 excluding unsecured credit facility borrowings.
In late 2013 they secured a new revolver through 2018 -- existing agreement expired in 2015. The unsecured credit is for $2 billion and can be increased to $3.5 billion There is an additional $1 billion available in unsecured term loan facilities. These come due in 2018-2019. With this capacity, Ventas has some funds for acquisitions in 2014.
Milton Cooper, often credited with starting the modern REIT era with Kimco Realty, said one-fourth of his company's assets should be financed with debt. David Simon of Simon Property Group thinks this is a little too conservative and was more likely to have debt levels at 50% to 55% of the properties' value.
Notes from Fitch’s investment grade rating
The 'BBB+' IDR reflects the balanced cash flow from the company's healthcare property portfolio that includes a diversified roster of operators and managers. Apparently the reliance on Brookdale and Kindred for 13% of revenue doesn’t trouble them.
Credit strengths include strong access to capital and liquidity, and a credit-focused but opportunistic management team that continues to seek growth in the fragmented healthcare real estate market. Fixed charge coverage has been and is expected to remain strong for the 'BBB+' rating. Fitch’s does comment leverage is at the high end for a health care REIT with a BBB+ rating. As of June 30, 2013, net debt to trailing 12 months recurring operating EBITDA was 5.4x (5.3x in 2Q'13), compared with 5.7x in FY2012 and 6.0x in FY2011. Leverage was high for the 'BBB+' rating at the end of both 2012 and 2011 due to the timing of the Cogdell Spencer, NHP and Atria acquisitions.
Moody’s raised its rating on the senior unsecured debt to Baa1 (stable) in August 2013.
FFO and dividends
Fitch calculates that the company's dividends and distributions represented 72.6% of normalized FFO adjusted for capital expenditures and straight-line rent in 2Q'13 compared with 72.3% in 2012, both of which indicate good retained liquidity generated from operating cash flow. In the fourth quarter the company will increase the dividend by to $0.725 per share. It’s currently 67¢. The 2013 dividend of $2.735 is a 10.3% increase over its 2012 dividend. For the past 10 years, the compound annual growth rate has been 10%. FFO is expected to increase around 11% with a range of $4.12 to $4.14 in 2013(diluted)
Normalized funds from operations (FFO) was $1.04 up -- 8.3% yoy. ?? Including non-recurring items, FFO was $1.03 --up 6.2% from 97¢ Q3 2012.
Growth was driven by acquisitions made this year and last with the largest contributions coming from an uptick in NOI from the private pay seniors housing communities and its SHOP portfolio. Earnings were also helped by declining weighted average interest rates and a lower share count.
Ventas invested $1.3 billion in the quarter in private pay seniors housing communities and MOBs. Highlights of the investments are:
(1) The expected first-year NOI yield is 7.3 percent.
(2) Of the $1.3 billion invested, approximately $360 million was invested
in seniors housing operating investments, transitioned to Atria at the
time of closing; just under $800 million was invested in independent
living triple-net leases with a new tenant; and approximately $120
million was invested in MOBs.
(3) The eight Atria-managed senior living communities contain 940
independent and assisted living units, are 91 percent occupied and are
located primarily in the top 31 Metropolitan Statistical Areas (MSAs).
(4) The triple-net independent living portfolio consists of 26 communities
with 3,138 apartment-like units and is 94 percent occupied.
(5) The eight MOBs contain 427,870 square feet, are located on the
campuses of A-rated hospital systems and are 90 percent occupied
Total revenue was $712.4 million – an 11.5% increase year over year. NOI was $124.8 million up from $89.6 million Q3 2013 for an increase of 39%. Total expenses increased by only 7%.
At the end of Q3 they had 140 seniors housing communities managed by Atria and 95 seniors housing communities managed by Sunrise for a total of 235 properties (7 acquired in Q3). NOI for these properties was $114.7 million. Atria and Sunrise managed units had occupancy rates at 91.7%. This is good news for VTR since these are the units they collect revenue directly from room occupants??. Same-store NOI increased 4.4% and revenue per occupied room was up 3.6%
??In Q3 Ventas spent $1.3 billion on acquisitions mainly in private pay seniors housing communities and medical office buildings. They are prudently diluting out SNN that relies on Medicare and Medicaid reimbursement.
VTR has $448.0 million borrowed under the unsecured revolver and $6.1 billion in senior notes and term loans. They have reset the revolver to 2018. The company’s current debt to total capitalization is 32% with a fixed charge coverage ratio of 4.3x and net debt to adjusted pro forma EBITDA of 5.6x.Guidance
For 2013 Ventas is estimating adjusted FFO per share will be in the range $4.12 – $4.14, up $4.06 – $4.10. ??NOI for 236 Atria- and Sunrise-managed properties (15 communities bought year to date) in the range of $447 million – $451 million for 2013($386.3 million in 2012). Same-store NOI growth should be in the range of 5% – 6%.??Value
Compared to other health care REITs if we use price/FFO, Ventas trades at a premium even though it is lower than its highs last May/June at 21x. Ventas currently trades around 14x with a forward price/FFO of 13.8x. It won’t be much cheaper next year at current prices. Since its spectacular fall from $82, it has found a bottom of sorts.Price/FFO
VTR forward 13.8x
VTR current 14.2x
SNH current 13.2x
OHI current 12.4x
HCP current 12.5xYields forward
The best measure of value per the experts is the NAV per share. That’s a value that we mere mortals don’t have much insight into. Specialty firms like Greenstreet have their own proprietary calculations based on extensive knowledge of the market value of particular types of assets. Ralph aka Reitnut was kind enough to share an NAV from Greenstreet for Ventas that was around $50/share. With the current price of $57 we can assume it’s selling for a premium. The price/FFO would confirm that.
Reverse engineering the $50/share NAV we can get to the cap rate and estimated market value of the properties through iterations. The cap rate comes in around 7% and that seems ballpark close. Recent acquisitions have been at cap rates in the 6.5% range and last year’s acquisitions were around 7.5%.
The acquired properties at cost are $20.3 billion and the appreciation implied is 6% or $21.4 billion. That also looks reasonable but is of course total supposition without detailed data on market values. VTR has senior properties that are appreciating at higher rates than the skilled nursing that is most likely selling lower due to reimbursement woes namely Medicare and Medicaid rates.
Conclusion is that Ventas is not a great a value but it might still be a great investment. The yield is high and the company has a long history of raises. They have the cash flow coverage and the balance sheet to keep the acquisition pipeline full. With acquisitions and a growing SHOP portfolio, NOI can keep moving up and the low payout ratio should allow relatively easy coverage of the dividend.
The liquidity looks good with the new revolver and the current debt load, while a bit on the higher side of moderate, is at a low average weighted interest rate and is reasonably comfortably staggered allowing pay off or roll forward as cash flow warrants. The investment grade ratings should allow them access to credit markets going forward.
Share price appreciation will probably lag some of the more interesting and perhaps speculative names like SNH. HCP also looks like it could be set for some appreciation after the market gets over hating REITs. Right now, many great names are priced well below the bubbling prices we were seeing in early-mid 2013. It’s time to look at a lot of REITs.