The coronavirus pandemic has changed a great many things in the world, but demographics still point to a robust future for senior housing properties. That's a big-picture story that got shoved aside in 2020 as COVID-19 hit the senior housing sector hard, given that the illness is particularly problematic for older people and spreads easily in group settings. Despite the still lingering fallout, Ventas (NYSE: VTR) has decided to leverage itself to a senior housing recovery via an acquisition. Here's what you need to know.
Bad and worse
As the coronavirus spread through senior housing properties, Wall Street dumped out of real estate investment trusts (REITs) that focus on the space. The move made complete sense, given the nature of the pandemic. In the end, move-outs (an industry term that includes deaths) increased, move-ins fell, and costs rose throughout the senior housing sector.
That said, there are actually two ways for a REIT to go about owning senior housing real estate. In the "normal" approach, a REIT owns the property and simply leases it out to another company. Generally speaking, a net lease approach is taken whereby the lessee is responsible for most of the ongoing costs of the properties they occupy (like taxes and building upkeep). In this situation, the REIT is just collecting rent, and it's due regardless of the performance of the underlying property. The businesses of senior housing-focused landlords using the net lease model held up relatively well in 2020.
However, there's another way to own senior housing: a senior housing operating portfolio, or SHOP in industry lingo. As the name suggests, the REIT both owns and operates these properties. In practice, the REIT hires a third party to handle the day-to-day management of the assets, but the big difference is that the performance of SHOP properties flow directly through to the REIT's financial statements. When times are good, that's a huge benefit; when times are bad, like in 2020, it's terrible.
About one-fourth of Ventas' net operating income came from SHOP assets in the first quarter. The exposure to this type of property led the REIT to cut its dividend nearly 45% last year.
Healthcare REITs took different approaches in 2020, with most simply hunkering down in an attempt to weather the hit. Healthpeak notably chose to get out of the senior housing space altogether. Ventas initially looked to muddle through with the rest, but in early 2021 it noted that property-level performance in its senior housing business was starting to turn higher. Move-outs were declining, leads were improving, and more people had begun to move in.
Now consider the demographic tailwinds that are still in place, with the target 80-plus population expected to increase from 13 million in 2020 to 20 million in 2030. Add in the fact that there has been a notable drop in industry-wide construction. That suggests increased demand and decreased supply, once the world learns to deal with the coronavirus. Ventas believed there was an opportunity.
It agreed to buy senior housing REIT New Senior Investment Group (NYSE: SNR) in an all-stock deal valued at around $2.3 billion. However, there's an important wrinkle here that investors need to understand. While New Senior owns senior housing assets, roughly 95% of its first-quarter net operating income came from its SHOP portfolio.
The New Senior purchase will increase Ventas' SHOP portfolio to the extent that it will be responsible for roughly 31% of its net operating income. So the REIT is not only increasing its exposure to senior housing, but it's doing so in a way that leverages its performance to an industry upturn.
It's worth noting that the trends Ventas is seeing in its portfolio are consistent with what's occurring at New Senior. So this is a big bet, but it appears that Ventas has a good handle on what's happening beneath the surface and is timing its acquisition extremely well. That, of course, assumes that the positive trends continue. If the recent uptick in coronavirus infections becomes a larger problem, Ventas will basically be doubling down on its worst-performing business.
As an investor, you need to consider the implications of this move for your portfolio. The 2020 dividend cut at Ventas was, obviously, not a particularly desirable outcome, even if it was the right move for the company. If you're still worried about the dividend here, given the ongoing nature of the pandemic, Ventas' decision to buy New Senior might demonstrate more risk tolerance than you feel comfortable with. In a worst-case scenario, the increased scope of the SHOP portfolio would be a big drag on the REIT's performance.
However, the long-term demographic trends are still favorable for the industry, and the improved property-level performance suggests that, eventually, Ventas' SHOP assets will get back on track. And when that happens, assuming the New Senior acquisition is consummated without any problems, the REIT will be leveraged to an industry upturn even more so than it would have been prior to the deal.
Given the 2020 headwinds, it might take a strong stomach to ride this out, but if you can handle some near-term uncertainty, it appears that Ventas is making a sound, well-timed decision. Just know it could be a year or more before the full benefits of the deal really start to show.