The merger of two of the largest senior housing operators in REIT portfolios will impact the healthcare REIT landscape and further consolidation in the tenant base of healthcare-focused REITs is likely, according to Fitch.
While Fitch expected operator consolidation, it believed it would be larger operators acquiring smaller, private, regional operators rather than a merger between larger peers.
Brookdale Senior Living and Emeritus Corp. announced a merger agreement late last week. For the rated REITs that are landlords to the combined company, Fitch expects the merger will enhance coverage modestly while also boosting concentration, which is a negative for credit quality. The transaction will also enable further dispositions of properties to tenants via exercised options.
The combined company expects revenue and expense synergies. A healthier tenant will be a credit positive as it reduces cash flow volatility stemming from a previous bankruptcy. The transaction may also allow the REITs to push rents over the longer term, although their ability to do so remains uncertain. While the headline of USD45m in expected cost synergies is notable, the savings at the corporate level (USD25m) versus the property level (USD20m) will dictate the amount by which REIT operator coverage improves (excluding master leases with operator guarantees).
A healthier tenant base reduces the probability of default but the larger and more concentrated profile increases a default's potential consequences. Fitch estimates the combined company will represent a significant percentage of revenues for HCP (21 per cent of revenues; IDR: BBB+/Stable), Ventas (seven per cent, IDR: BBB+/Stable) and Health Care REIT (seven per cent of investments not revenues, IDR: BBB/Stable). Larger, more concentrated tenants have significant leverage when negotiating lease renewals given the pooling of assets into master leases. The downside potential from material tenant concentration will continue to be a focal point for healthcare REIT ratings.
Of less importance initially is the combined company's focus on realising value by reacquiring USD2.3bn to USD2.8bn of properties, principally by exercising tenant purchase options. The lost revenues in any one year is less of a credit concern than the potential effects on healthcare REITs' share prices, which have been closely linked to growth expectations. A rise in the cost of equity due to lower growth expectations could hinder REITs' ability and willingness to raise equity capital to maintain or improve credit metrics.
Large scale M&A in the for-profit healthcare industry has traditionally been encouraged by the financial benefits of scale and geographic diversification. These elements are being reinforced by secular shifts in the landscape, including growth in the consumer share of healthcare spending, regulatory reforms including the Affordable Care Act, and a shift toward value-based payments. These factors are resulting in lower payments to providers and pressuring profit margins.