Healthcare Reits: Senior moment

Property and healthcare: two of the most timeless and popular asset classes. Yet the two combined - US healthcare real estate investment trusts, three of which are valued at upwards of $30bn - get little attention (it does not help that two of them go by the anodyne names HCP and Healthcare Reit). But on Monday the third of the big three, Ventas, announced a flurry of transactions worthy of notice.

There is an estimated $1tn worth of healthcare property in the US. Only a tenth of that is owned by healthcare reits (reits are landlords that collect rent and avoid corporate level income tax if they distribute the bulk of earnings to investors). Ventas, HCP and HCR own properties including hospitals, medical office buildings, senior housing and nursing homes.

Ventas announced that it would be spinning off most of its nursing homes for the elderly into a new listed entity to be worth $4bn. Separately, it said it would acquire $1.4bn worth of hospitals from a private equity firm.

After the deal, Ventas will derive more than half its profit from senior housing - essentially upscale residential developments for the elderly. It is typically paid for with private insurance or personal wealth; nursing homes are much more dependent on erratic government reimbursement policies.

Ventas says an emphasis on retirement accommodation would bump up its organic profit growth rate by 40 basis points, to just over 4 per cent. But risks abound. A regulatory change in 2008 allows Reits to go beyond simple rent collection to become operators. Ventas is the operator of more than half of its retirement accommodation assets. That model is working well at the moment because the US economy is growing. But the operators suffer when household income and wealth decline.

Reits, like all yield instruments, have also suffered of late as Fed tightening looms (Ventas shares were down as much as a tenth this year). Falling equity prices become problematic because Reits have used their cost of capital advantage (around a 20 times earnings multiple) for acquisitions to bolster their low-single digit organic growth (Ventas spent $3bn on acquisitions in 2014).

In the past decade, the total return of all three big healthcare Reits was at least double that of the S&P 500. Mean reversion though is timeless, too.

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