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Healthcare REIT sector: key developments in context of the US

Healthcare REITs are real estate investment trusts which own healthcare-related properties, majorly Senior Housing Communities (SHC), Skilled Nursing Facilities (SNF), Medical Office Buildings (MOB) and Hospitals, etc. They earn rental revenue from leasing these properties to health care and related organisations. The healthcare REIT like any other REIT earn a tax-free income, in return, they are required to distribute 90% of their earnings to their shareholders.

In order to provide better service to their customers (especially ageing population), healthcare sector in the U.S. has been evolving from a hospital-centric model to a low-cost and value-based care model through the senior housing, post-acute care, and outpatient settings. These provide medical services and care, but outside the typical hospital environment. This has spurred the growth of healthcare REIT industry in the U.S. that invest in these kinds of properties.

Globally, the healthcare REIT market is highly concentrated with the U.S. contributing over 90% of the revenues. While the top three U.S. players (Well tower Inc., Ventas Inc. and HCP Inc.) contribute over one-half of this revenue (source: Bloomberg).

Moreover, unlike real estate investments which are volatile and dependent on the general health of the economy, healthcare real estate investments are more resilient to the changes in the economy. This is due to the continuous demand for healthcare from the ailing population, as well as continuous growth in government expenditure on the health care sector as a percentage of GDP.

The healthcare REIT industry has undergone few changes over the past decade owning to certain external factors impacting the dynamics of the industry. Televisory has analysed these factors and their impact on the operational parameters of a few largest players in the industry.

At the outset, demographic changes in the U.S. population has spurred the demand for SHC and long-term care. According to the US census as of 2000, 12.5% of the population in the nation was aged 65 years or older, which is estimated to grow 16.1% by 2020. Further, as per the Pew Research (2010), around 10,000 baby boomers (the wealthiest generation) will turn 65 each day for the next 19 years. In order to cater to this expected increase in demand, the health REIT operators have continuously increased their investments in the sector over the past ten years.

There has been a drastic growth in investments by healthcare REITs commencing from the year 2010. This growth was due to an increase in the number of mergers and acquisitions held at that time because of a more reliable and lucrative investment nature as compared with other investment options available in the market.

* Ventas Inc. in August 2015 spun off 355 skilled nursing facilities and outpatient recovery centres into a new REIT. 

Secondly, over the past 4-5 years, the sector has seen a shift in its focus from SNF to SHC properties, to limit their exposure from the issue of government reimbursement. The U.S. government's Medicare and Medicaid programs constitute a major portion of the SNF revenue (these are state-licensed long-term care facilities), while SHC has a limited exposure to such government programs making them more tempting property sector within the healthcare REIT industry. In 2010, with the enactment of the Affordable Care Act (ACA), healthcare providers shifted their focus to the value of care delivered at lower rates rather than the earlier model of a volume of services and facilities provided. This has led to a negative impact on the SNF tenants’ ability to generate revenue and pay rent. Thus, the large healthcare REIT companies have started to pare their skilled-nursing holdings to more lucrative SHC, MOB and other healthcare properties, which have steadier income and more control over their billings and were seen as better bets.

     

* HCP acquired 300 rehabilitation and nursing facilities from ManorCare in 2011

The analysis on the players reveal that percentage SNF of total properties declined on a continuous basis from 2006 onwards. The SNF facilities require more stringent government licensing and there are other legal liabilities associated with the operations due to which they become an unattractive proposition. From 2010 onwards after the ACA implementation, the decline in SNF properties became more prominent.

Thirdly, unlike other REITs, healthcare REITs were not allowed to participate in operations of the healthcare properties, but with the enactment of RIDEA (REIT Investment Diversification and Empowerment Act) legislation in 2007, the healthcare REITs started participating in the actual net operating income of the properties through Taxable REIT Subsidiaries (TRS), rather than the earlier allowable triple net lease structure which allowed only rental income. The companies under the analysis saw an increase in the resident fee and service revenue (revenue from the TRS), while rental revenue experienced a decline, indicating that the companies started shifting their focus on the TRS structure to participate in the growth opportunities in the U.S. health care sector rather than just to earn fixed contracted rental revenues.

     

The above analysis depicts that healthcare REIT sector in the U.S. will perform favourably in the long-term due to the demographic changes in the U.S., the population requiring more long-term care and a rising trend among healthcare providers to embrace third party ownership and management of real estate. Thus, by going asset light healthcare providers can preserve their capital resources for more value-added uses as per the ACA. In turn, the healthcare REIT companies having a large pool of resources can own assets and earn a steady income.

On the downside, since the healthcare REITs are required to distribute 90% of the net profit as dividends to the shareholders, hence they have to raise debt or new equity to fund new capital requirements and property operations, which poses an interest rate risk for the companies. Furthermore, RIDEA structure also poses operational and legal risks with its adoption.

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