Ventas (VTR)

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Thomas Gaffney

Ventas (VTR) is a Real estate investment trust that owns and leases nursing homes and other health care properties. In the last five years, Ventas has acquired $5B in assets as it repositions its portfolio towards properties that require private payment.^[1] Since VTR's tenants earn a higher margin from patients that pay out of pocket and with private health insurance, it wants to minimize the number of facilities in its network that rely on government reimbursement programs (i.e. Medicare/Medicaid) for their revenues.

To that end, in 2007 the company made a $2.0B acquisition of Sunrise REIT, a collection of 79 private pay senior housing communities. VTR also acquired $150M in medical office buildings that year; the company manages these offices directly, unlike its other properties which have third party managers, and revenues from these buildings are not tied to the government's health care reimbursement levels.^[2] These acquisitions brought VTR's total assets to 519 properties in 43 states.^[3] Geographic diversity reduces the company's exposure to changes in the individual states' Medicaid reimbursement and medical licensing laws.

Business Financials

As of December 31, 2007, VTR owned 253 senior housing communities, 197 skilled nursing facilities, 42 hospitals and 27 medical office buildings for a total of 519 assets in 43 states.^[4] VTR earns its revenue by leasing these properties to operating tenants. VTR receives the vast majority of its revenues from three operators, Kindred Healthcare (KND), Brookdale Senior Living (BKD) and Sunrise Senior Living (SRZ). In 2007 Kindred , Brookdale and Sunrise accounted for 30.8%, 15.7% and 36.2% of revenues, respectively.

VTR breaks its operating properties into two segments, triple net leased operations and senior living operations.^[5] Prior to 2007, almost all of VTR's properties were leased on a triple net basis to Kindred and Brookdale.^[6] Triple net means the tenants pay VTR fixed rents and are responsible for all operating costs associated with a property. In 2007, however, VTR acquired 79 senior housing communities in the acquisition of Sunrise REIT.^[7] As part of the acquisition, VTR signed a 30 year management deal with Sunrise Senior Living (SRZ). Under this agreement SRZ manages the Sunrise properties in exchange for a percentage of tenants’ rents, called a management fee. This agreement differs from VTR’s triple net leases because all rents are paid directly to VTR and VTR is responsible for paying all costs associated with operating the properties.

The majority of VTR's properties cater towards the elderly. These include:

1. Senior housing centers: Assisted living communities for seniors which provide access to on premise health care, have support staff on call, and offer various levels of community activities for its senior residents. Residents typically live in apartments or condominium units and the level of service provided is lower than that of a nursing home. Many senior housing facilities are private pay assets, they do not accept or are not eligible for government reimbursement.
2. Skilled nursing facilities: Otherwise known as nursing homes, these are centers which provide nursing services focused on the elderly but also to patients who require rehabilitation or therapy but that does not require the technology or care of a hospital. Skilled nursing facilities usually accept government reimbursement in the form of Medicare/Medicaid.
3. Hospitals: Primarily for long-term, acute care, catering to chronically ill elderly patients. Most hospitals accept government Medicare/Medicaid reimbursement.
4. Medical office buildings: Providing office space for medical professionals and hospitals. The individual practitioners in the MOB have the option of whether or not to accept Medicare or Medicaid government reimbursement.

VTR's property mix, based on 4th quarter 2007 revenues, is listed below. VTR has been trying to weight its portfolio toward private pay sources, which it considers less volatile than health care centers that rely on government reimbursement. Senior housing centers and medical office buildings are primarily private pay facilities, while skilled nursing facilities and hospitals receive the majority of their revenue from Medicare and Medicaid.

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VTR's revenues continued to increase in 2007. The Sunrise acquisition accounted for approximately 80% of that increase.^[9] Other properties acquired in 2006 and 2007 accounted for the remainder of the increase.^[10] Though revenues increased in 2007, operating income fell due to the operating expenses at Sunrise REIT. Major expense increases included: interest expense, up 50% due to the debt used in the Sunrise acquisition; depreciation expense, doubling due to the depreciation of the Sunrise assets; and operating expenses, a category VTR was forced to recognize for the first time as a result of the acquisition.^[11] As VTR pays down the debt used in the Sunrises acquisition and depreciation on those assets begins to slow, VTR will see an increase in operating income.

^[12]

Trends and Forces

The Aging Baby Boomers Population Is Likely To Increase Demand For Health Care Services and Therefore VTR's Properties

• Many of VTR's properties cater to the elderly, including its senior housing, hospitals and skilled nursing facilities.
• Health Care is the single largest industry in the United States based on GDP.^[13] According to the National Health Expenditures report released in January 2007 by the Center for Medicare and Medicaid Services (CMS) the healthcare industry is projected to represent 16.5% of the U.S.’s GPD in 2008. ^[14] The CMS projects this will expand to 22% by 2015 as the U.S. population ages and requires more health care services.
• The number of Americans 65 and older is expected to grow 36% between 2010 and 2020, compared to a 9% growth rate for the general population.^[15] According to the Center for Medicare and Medicaid Services, persons 75 years of age and older spend 60% more on healthcare than those 65-74 and 200% more than the population average. ^[16] An increase in the number of older Americans is expected to fuel a large increase in demand for health care services and health care properties.

^[17]

Government Regulation Has The Potential To Negatively Impact VTR's Collections of Rents From Tenants

• The government has typically refrained from regulating the senior housing industry, and since this business accounted for 66% of VTR's revenues in 4th quarter 2007 the company benefits from freedom in this market.^[18] In contrast, operators of skilled nursing facilities and acute care hospitals, accounting for 31% of VTR's revenues in 4th quarter 2007, are heavily regulated by the Federal Government.^[19] VTR believes that the regulatory environment around the long term healthcare industry has intensified, especially for large, for profit, multi-facility providers like Kindred and Brookdale. These tenants’ leases accounted for 30.8% and 15.7%, respectively, of VTR's revenues in 2007. ^[20] If one of VTR's properties fails to meet federal regulations, the government can deny Medicare or Medicaid Reimbursements, or even require the facility's closure.^[21] Such a closure would result in a lease termination by the operating tenant, causing a reduction in rents paid to VTR.
• In 2007 74% of states where VTR operates had a licensing regulation called a Certificate of Need ("CON") law.^[22] This law requires a health care REIT to show a state licensing board the need for a facility before transferring operating control.^[23] Change in operating control occurs when VTR opens a new center or when an operating tenant vacates a property and VTR has to find a new tenant. Many states are tightening their CON laws, making it more difficult for a property owner like VTR to show the need for its facility.^[24] CON laws prohibit a property from operating until until they have passed CON inspection. If VTR has to show need for a property under state CON laws, it is unable to earn income from that property until the approval process is complete.^[25] If the CON process fails, VTR has to renovate the facility for another purpose before transferring it to another operator.

Some of VTR's Tenants Are Subject To Medicare and Medicaid Reimbursement Laws

• In 2007 private pay sources, including private insurance companies, accounted for 2/3 of VTR's tenants’ revenues.^[26] The rest of tenant revenues were from government reimbursement (i.e. Medicare/Medicaid) sources. Over the last five years, VTR has spent $5B in acquisitions as it tries to shift its portfolio towards private pay assets.^[27]
• As of December 31, 2007 Kindred Healthcare (KND) leased 203 of the company's 239 skilled nursing centers and acute care hospitals.^[28][29] In 2007 Kindred's lease payments accounted for 30.8% of VTR's revenues.^[30] Kindred Healthcare (KND) receives virtually all of its revenues from Medicare and Medicaid.^[31]
• In 2007 the government announced budget cuts in the amount of reimbursement to skilled nursing facilities under Medicaid. These cuts are expected to decrease revenues for skilled nursing facilities by $490M over the next five years.^[32]
• Many states have announced potential budget shortfalls under Medicaid. Because of this, some states have implemented or are considering “freezes” or cuts in Medicaid rates paid to providers.^[33] VTR tries to geographically disburse its properties in order to minimize the impact of these types of changes in state regulation or reimbursement.^[34] As of December 31, 2007 no state accounted for more than 13% of VTR's revenues.^[35]
• At the end of 2007 private pay sources made up 69% of VTR's tenants' revenues, which decreases the company's exposure to varying levels of government reimbursement.^[36] However, there is increasing political momentum for Universal Health Coverage in the United States. Democratic presidential candidates Hillary Clinton and Barack Obama have both laid out plans that would provide some sort of universal access to health care coverage.^[37] These plans, if implemented, will cause VTR’s tenants’ revenues to become more heavily weighted towards government reimbursements, which would impact revenues.

VTR is Highly Levered, Increasing Refinancing Risk During The Credit Crunch

• As VTR repositions its portfolio towards private-pay assets, it requires large amounts of capital. Because of the legislation requiring REITs to pay out 90% of their taxable income in dividends, VTR financed much of its expansion with debt. As of December 31, 2007 the company had about $3.4B in total debt outstanding of which approximately $467M was variable rate debt.^[38]
• Approximately $800M, or 25%, of VTR's debt matures within the next two years.^[39] If interest rates rise VTR will have to refinance this debt at higher rates. In the case of fixed rate debt, this will mean higher interest payments over the life of the loans.
• If VTR is unable to refinance maturing debt due to the credit crunch it will have to repay the debt in other ways. One option is to issue equity. However, if equity is issued at low prices it would dilute the ownership stake of existing shareholders. VTR could also sell some of its properties to raise cash. However, if VTR is forced to sell assets before they can reach their full potential, it will fail to meet its target return on those assets. Similarly, a lack of credit creates a lack of able buyers which creates difficulty when finding a buyer for distressed properties.
• VTR faces little risk that increasing interest rates will impact its debt service payments on current debt. As of December 31, 2007 a 1% increase in interest rates on VTR's variable rate debt would only increase interest expense by $2.7M, decreasing operating income by approximately 2%.^[40] However, as interest rates rise, as a dividend-paying stock VTR sees a decrease in its stock price as alternative investments provide greater Return on investment (ROI). This occurs because as rates rise, fixed income instruments such as bonds provide higher returns. Since investors are able to earn a higher risk-adjusted return on fixed income instruments, they shift their investment out of VTR's stock and into these fixed income products. When the number of people wishing to hold VTR's stock decreases, the stock price falls.

Competitors

VTR is distinguished by its large percentage of revenues from senior housing communities, 66% in 2007 compared to 32% for Health Care REIT (HCN) and 36% for Health Care Property Investors (HCP).^[41] This is due to the company's 2007 acquisition of Sunrise Senior living. Senior living communities receive a smaller portion of their revenues from government reimbursement programs, decreasing VTR's reliance on government reimbursements.^[42]

VTR and its competitors all operate on a national scale, and earn annual revenues between $300M and $1B. VTR and Nationwide Health Properties (NHP) operate in the most states, which reduces their risk to changes in state Medicaid reimbursement laws and state licensing laws. VTR is larger than Nationwide Health Properties (NHP) and Health Care REIT (HCN) in revenues and market cap but operates the fewest properties of any of its competitors. Its large revenue and market cap is due to its 2007 acquistion of Sunrise Senior Living. This acquisition only added 79 properties to VTR's portfolio, but because they are operating properties they increased VTR's revenues by almost $300M.

The table below provides competitive data comparing VTR with some of its close competitors.

Market Share

VTR is the second largest health care REIT in the U.S. by gross property value. It accounts for 22% of the gross value of health care properties owned by health care REITs, but less than 1% of the value of total U.S. health care real estate. As of February 1, 2008 there were ten REITs in the United States dedicated to owning health care related properties. The largest five represent approximately 90% the gross value of health care properties owned by health care REITs.^[59][60] The health care industry is highly fragmented; as a sector, health care REITs account for less than 4% of the gross value of U.S. health care real estate.^[61][62] In the chart below, properties measured include skilled nursing facilities, medical office buildings, senior housing and specialty/acute care hospitals.

^[63][64]

The following presents the value of U.S. Health Care assets by property type. As of December 31, 2007 no health care REIT accounted for more than 2% of the value any particular property type or 1% of all U.S. health care real estate.

^[65]

References

1. ↑ 2007 Annual Report, Chairman’s Letter To Investors, Page 2
2. ↑ Investor Presentation, April 2008, Pages 14, 17
3. ↑ Reuters
4. ↑ Reuters
5. ↑ 2007 Form 10-K, Page 77
6. ↑ 2007 Form 10-K, Page 77
7. ↑ 2007 Form 10-K, Page 81
8. ↑ Investor Presentation, April 2008, Page 13
9. ↑ 2007 Form 10-K, Page 51
10. ↑ 2007 Form 10-K, Page 51
11. ↑ 2007 Form 10-K, Page 51
12. ↑ Google Finance
13. ↑ HCN 2007 Form 10-K Page 1
14. ↑ HCN 2007 Form 10-K Page 1
15. ↑ Forbes.Com "Sector Snap-Health Care REITS", Associated Press
16. ↑ 2007 Form 10-K Page 2
17. ↑ Investor Presentation, September 17th, 2007 Page 3
18. ↑ 2007 Form 10-K, Page 10
19. ↑ 2007 Form 10-K, Page 11
20. ↑ 2007 Form 10-K, Page 29
21. ↑ 2007 Form 10-K, Page 11
22. ↑ 2007 Form 10-K, Page 4
23. ↑ 2007 Form 10-K, Page 11
24. ↑ 2007 Form 10-K, Page 11
25. ↑ 2007 Form 10-K, Page 11
26. ↑ Investor Presentation, April 2008, Page 13
27. ↑ 2007 Annual Report, Chairman’s Letter To Investors, Page 2
28. ↑ 2007 Form 10-K, Page 72
29. ↑ Google Finance
30. ↑ 2007 Form 10-K, Page 56
31. ↑ 2007 Form 10-K, Page 29
32. ↑ 2007 Form 10-K, Page 15
33. ↑ 2007 Form 10-K, Page 16
34. ↑ Investor Presentation, April 2008, Page 12
35. ↑ 2007 Form 10-K, Page 3
36. ↑ 2007 Annual Report, Chairman’s Letter To Investors, Page 3
37. ↑ Factcheck.Org
38. ↑ 2007 Form 10-K, Page 91 and 55
39. ↑ 2007 Form 10-K, Page 91
40. ↑ 2007 Form 10-K, Page 55
41. ↑ Company's 2007 annual reports. See Wikinvest Articles on Health Care Property Investors (HCP) and Health Care REIT (HCN)
42. ↑ 2007 Form 10-K, Page 10
43. ↑ Google Finance
44. ↑ Google Finance
45. ↑ [1]
46. ↑ [2]
47. ↑ Google Finance
48. ↑ Google Finance
49. ↑ Reuters
50. ↑ 2007 Company 10-K Page 36
51. ↑ Google Finance
52. ↑ Google Finance
53. ↑ Reuters
54. ↑ Reuters
55. ↑ Google Finance
56. ↑ Google Finance
57. ↑ Reuters
58. ↑ Reuters
59. ↑ NAREIT, February 1st 2008
60. ↑ Google Finance
61. ↑ Google Finance
62. ↑ 2007 Form 10-K Page 41
63. ↑ Google Finance
64. ↑ 2007 Form 10-K Page 41
65. ↑ 2007 Form 10-K Page 41