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Welltower Fixes the Broken Capital Structure -- Part 1

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By Steve Moran

I thought I could do this in a single article, but it turned out I can’t. Part 1 describes the problem as I see it.

Part 2 -- which will publish tomorrow -- talks about how Weltower is fixing the problem and it is actually quite a cool story . . . depending on how things play out.  

I have been frequently critical of REIT financing for senior living. This is because I think it aligns operators and capital providers away from what is best for residents, team members, the industry itself and even the long-term economic interests of investors and operators.

The traditional “triple net lease” deal is sort of like this:

REIT: “Have I got a deal for you!”

Operator/Developer: “Tell me more.”

REIT: “That new project you want to build . . . I will finance 100% and, even better, I will actually allow you to pull out significant development fees.”

Operator (thinking to themselves: This is cool, I can do a whole bunch more projects, make a whole bunch more money and serve a bunch more seniors. Development fees in the pocket are really cool. But . . . on the other hand . . . it sounds too good to be true.)

Operator to REIT: “This is really cool, but it seems too good to be true. What’s the catch?”

REIT: “You almost certainly have nothing to worry about. Look at how strong the market is, and all those people who are getting older. There is demand like crazy and always will be. If anything you won’t be able to build enough units to keep up with demand! And we will be your partner every step of the way, caring for seniors and making buckets of money.”

Operator: “That sounds good, and yet . . . I am nervous when something seems too good to be true. What else should I know?”

REIT:  “Well there are a few fine points, but nothing that should concern you at all. Here they are though:

      1. “You actually don’t own the real estate -- so if the value goes up, we get all the benefit of that.”

      2. “And that mortgage payment you make, well it is not really a mortgage payment . . . it is a lease payment, which means that any reduction in debt benefits us, the REIT not you. But it is not really that much money anyway.”
      3. “That payment you are making . . . yep, it is much higher than if you borrowed money. But remember 100% financing, so of course, it will take a bigger part of your free cash flow every month."
      4. “One other thing about that payment . . . every 5 years it will go up . . . even if your NOI does not. But again, no big deal, look at all those Boomers who are getting old!”

No One, Not a Single Person

If you were offered a mortgage for your home under those conditions, you would say "Thanks but no thanks!" Because you would be paying above market for what would -- in effect -- be a rental, except you would have all the responsibility. In fairness, unlike a home, the operator does have the potential upside of upside cash flow. Also, because these financing vehicles are leases -- and not traditional debt -- they make balance sheets look really good.

In effect, they are not much different than “rent-to-own” furniture and housing deals that are offered to people with very limited financial resources.

In Fairness

There are a few things I need to say in fairness:

  • My view is very cynical and perhaps too simplistic.

  • In a very real sense, operators have more responsibility for the REIT problems than do the REITs themselves -- because in all of this, REITs are just being REITs.  Operators saw an easy way to grow with little or no short-term pain and hoped -- or even believed -- the demand would continue unabated.

  • Some senior living operators have used REIT-style “financing” with great success and are going to think I am a jerk for writing this.  

    If it works for you, I am delighted.

  • If you are a REIT or an operator who believes I am blowing smoke and have it all wrong . . . I would be willing to publish your article calling me out. If you don’t think I mean it, check out the only time anyone has ever taken me up on the offer. It was brutal and I think unfair, but I published it anyway: Steve Moran Gets Taken to the Cleaners on Affordable Housing.

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