New York, NY

While health care real estate stocks are taking a beating, industry watchers say the long-term prognosis is sound, saved by a large aging population expected to nearly double by 2030.

That's buffered the sector as the overall economy struggles through a real-estate sparked recession: So far this year, health care REITs have slumped nearly 22%, pulled down by Ventas Inc. (VTR) falling nearly 40% and HCP Inc. (HCP) dropping nearly 32%. Health Care REIT (HCN) and Nationwide Health Properties Inc. (NHP) have each seen shares slip more than 16%.

Even with that double digit loss, the health care sector remains a recession-resilient star within the battered REITs: Retail has plunged by nearly half this year, and office saw a nearly 45% drop as of Wednesday. Health care is helped by a swelling potential customer count: People are living longer and the over-65 population, now above 37 million, should top 40 million by 2010, according to Deutsche Bank.

Plus, for senior housing acquisitions and refinancing, they can work around the frozen credit market with help from government-controlled Fannie Mae (FNM) and Freddie Mac (FRE). There's also diversity beyond senior housing: REITs also profit from medical office buildings, considered less cyclical because tenants include always-needed doctors. Industry giant Ventas' portfolio also includes dozens of hospitals. Finally, with fewer senior housing construction starts, oversupply shouldn't be a vexing issue as supply could fall short of demand in the long run, analysts say.

"It's a brighter spot in an overall gloomy horizon," said John S. Wadsworth, vice president of Colliers International's Healthcare Real Estate Group. "The fundamentals of the market are sound; I think REITs recognize that over the long term."

The biggest jitters right now come from senior living, which, according to Green Street Advisors, generates roughly 40% of the sector's net operating income. Rent growth and occupancy trends, likely to see stress from the weakened economy for some time, are getting increased scrutiny. The average national monthly cost across the 31 largest metro markets is $2,486 for independent living and $3,575 for assisted living, according to the National Investment Center for the Seniors Housing & Care Industry.

With the economic boom over, the senior housing segment is "arguably the most vulnerable health care real estate line of business during weak economic times," said Richard Anderson, BMO Capital Markets analyst. Unemployment has a big impact. In November alone, the nation shaved a stunning 533,000 jobs, the largest decline in more than 30 years. That trickles down to senior housing because children might chip in for parents' care, and the unemployed are more likely to take care of parents at home - particularly for basic care.

"People have more time and have less money, if they lost their jobs, so they have time to help mom or dad, their loved ones, taking care of them," NHP executive Abdo Khoury said in a recent earnings call.

The housing market, the worst this nation has seen in decades, poses yet another problem. Seniors have long counted on their home's equity to pay upfront or monthly living costs at some facilities, particularly entrance fee continuing care retirement communities mostly concentrated in urban areas. But with housing prices depressed, inventory bloated and credit standards tightened for buyers, selling houses typically requires luck or a steep discount. As a result, some seniors are delaying the decision until the market rebounds.

Occupancy for both independent and assisted living facilities have fallen along with the S&P/Case-Shiller U.S. National Home Price Index, which posted a record 16.6% year-over-year decline in the third quarter. "Sometimes seniors, or their children have no choice to make a change to their living arrangements, but other times it's a decision that can be reasonably put off for a year or two," Anderson said. As residents "pass away, there are fewer new residents coming in the front door." As vacancy rates rise, operators are more likely to cut rates - as opposed to increase them - and offer incentives to fill beds, weakening the bottom line. That makes operators more likely to boost their level of care or charge more for services.

Another area of concern is the sector's exposure to Sunrise Senior Living (SRZ) and Brookdale Senior Living (BKD), two giant senior housing operators. Both companies seen their stock battered amid mounting concerns about senior housing's weakened operating fundamentals and their own stretched balance sheets during the credit crunch, according to Green Street Advisors. So far this year, Sunrise's shares have plunged nearly 95%, fueling bankruptcy concerns, while Brookdale's loss has topped 86%.

That's left investors nervous because properties leased to or managed by the operating duo produce 21% of the sector's net operating income, according to Green Street. In the third quarter, BMO points out, Ventas, whose portfolio is 65% senior housing, was 38% exposed to the companies - 19% each. HCP comes in next, with 15% exposure to Sunrise and 6% to Brookdale. Nationwide and Health Care REIT both have no exposure to Sunrise, and some exposure to Brookdale, BMO said.

Should an operator fail, REITs risk having to find new operators in a highly fragmented business and the replacement could muscle a lower rent. There could also be employee disruption. On the bright side, the REITs do maintain cash flow coverage above their rent, buffering them from modest declines in tenant operations, said Karin Ford, an analyst with KeyBanc Capital Markets, adding she "not as concerned" because the REITs are insulated.

But a bankruptcy would come with headlines and investors should be showing more trepidation, Green Street said, because a failure would bring more bad than good news - particularly in the short run. In the short term, "a bankruptcy of Sunrise or Brookdale would likely have an immediate and deep negative impact on the operating performance of properties that bear their brand names due to concerns for potential residents (and their children) would have about the quality of care and the future prospects for the facility," said firm analyst Rosemary Pugh. "But in the long run, for the well-located and high quality properties, the damage should be manageable."

About Colliers International

Colliers International is a global partnership of independently owned and operated commercial real estate firms. The organization's 12,749 employees span the world in 294 offices in 61 countries. On a worldwide basis, Colliers manages 1.1 Billion square feet, and has revenue of US $1.6 Billion. For more information about Colliers International, visit our website at www.colliers.com.

Contact Information

John S. Wadsworth 
Vice President
Colliers International

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