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This week Brookdale Senior Living (NYSE: BKD) announced it will buy 41 of its leased communities for $610 million, increasing the company’s share of owned and managed units to about two-thirds of its total portfolio. Brookdale funded the transaction – more precisely, three separate deals with different landlords – through a handful of moves, including with new financing led by investor Deerfield Management and with help from Flat Footed, LLC. Brookdale CEO Cindy Baier noted the operator undertook the move in part to preserve flexibility to modify its portfolio based upon “the right decision for Brookdale and our shareholders,” Baier said. That’s something that “doesn’t exist when communities are locked within a leased structure.”
As I look across the industry, I think more operators with leased portfolios will weigh similar moves within the next 12 to 24 months as they seek to gain more control over their own destiny and reap the benefits of looming demand. It’s a strategy that operators including Bellevue, Washington-based Aegis Living have taken. Today, the company outright owns more than half of the 40 communities it manages. That’s by design, co-founder and CEO Dwayne Clark told me. “A company that controls its real estate and controls its operations is going to have unlimited value because you don’t have to pry one from the other to make a sale,” Clark told me. “It’s all synergetic.”
Companies like Brookdale and its capital partners have the scale and liquidity to buy chunks of their portfolios, and I don’t think it’s a strategy that every senior living company will be able to undertake. And Brookdale has its own share of challenges that more ownership won’t necessarily solve. In this week’s exclusive, subscribers-only SHN+ Update, I analyze the recent Brookdale news and offer the following takeaways, including:
- Inside Brookdale’s transaction and why the company undertook it
- What might come next for Brookdale
- The importance and value of a strong operating company
Brookdale on the offensive:
Following the news earlier this week of the Brookdale transaction, worth $610 million, Baier told SHN the deal allowed the industry’s largest operator to “replace a high and escalating cost of capital with a lower cost interest.” The move also reduced Brookdale’s long-term lease obligations and pushed the lion’s share of its debt maturities further down the road. Looking ahead Baier noted that the company’s “largest opportunity” remains capturing organic growth from communities Brookdale currently operates. Tao Qiu, senior healthcare equity research analyst at Macquarie US Equity Research, stated in a recent investor note that the transactions were a “first step for Brookdale to rebuild another leg of growth” given that organic growth could be normalizing from the post-Covid recovery period. Qui opines that the transactions “kill three birds with one stone” by increasing investment, reducing lease burdens, and refinancing near-term debt maturities. From this perspective, the deal was a good one, even if pricing was not “bargain basement,” as Qiu put it.
The $610 million price tag equates to a 7.4% in-place cap rate versus a 4.7% blended rate. Still, some of the assets are performing strongly and in appealing markets. Investors initially seemed to react favorably to the deal, with Brookdale shares up on the news, which marked a shift after a long period of relative inactivity from the senior living provider in terms of large acquisitions. Public market investors appeared to take this deal as Brookdale goes on the offensive, Qiu wrote. However, as of Thursday afternoon, Brookdale’s share price had dropped to its lowest point in a month. Clearly, for all the advantages the big acquisition brings, the company still has challenges ahead and further moves to make.
Looking ahead, Brookdale will have more large portfolio decisions to make, chief among them the upcoming renewal of its 2020 master lease with landlord Ventas (NYSE: VTR) covering 121 communities. Dispositions are almost surely ahead as well. The deal announced this week includes the purchase of 25 communities from Diversified Healthcare Trust (NYSE: DHC), with an average size of 49 units. At least a portion of these seem destined to be sold, given their location, size, and the fact that occupancy in this portfolio of communities is only 80%. In addition to these further portfolio moves, Brookdale still has ground to make up in terms of driving its overall portfolio occupancy, which sat at 80.4% at the end of August. For comparison, the occupancy rate across the 31 NIC MAP Vision primary markets reached 85.9% in the second quarter of this year.
The future of Brookdale has always been a matter of much industry speculation, driven in part by past activist investor activity and various rumors of a company sale in the offing. Activists have pushed for Brookdale to split into an operating company and REIT, to unlock the value of its owned real estate. And when rumors of a company sale have surfaced – as they did two years ago – analysts have typically been quick to point out that Brookdale’s ties to REITs would have to be negotiated and could complicate any transaction. These latest transactions certainly would help pave the way for such large-scale moves, with Brookdale now owning even more real estate and even less encumbered by leases. This is not to say that a transformational move is likely, but simply to say that the company now has greater flexibility to take bigger swings and make some more dramatic pivots – which may be needed, as my colleague Tim Mullaney argued in early 2023.
To be fair, the $610 million play announced this week might more accurately be seen as just another sign that leases and traditional management contracts are falling out of favor in the senior living sector, and is a Brookdale-sized example of a trend that has been ongoing and will continue to gain momentum. That is, a trend toward operators gaining backing from investors who are drawn to the space and believe in a management team, with more operators owning the communities they manage or engaging in capital structures that involve greater alignment than leases or 5% management contracts. No doubt, other operators are feeling the market forces driving Brookdale’s strategy. I think that is why senior living companies, especially those with lease-to-purchase structures baked into contracts, will be well-positioned to take greater control of their portfolios in the future dominated by demand and lack of new supply in key, primary markets.
Strong operating companies have “unlimited value” potential:
In the last four years, senior living operators have faced a wide range of challenges, both in seeking strong operating performance at pre-pandemic levels while juggling staffing and daily operations headwinds. By owning the communities they manage, senior living operators could make better decisions regarding operations and narrow the delta between recovery and stabilization. As Clark sees it, controlling a management company’s path ahead helps create stability and can keep branding and culture intact during periods of new growth. Historically operating companies in lease agreements with ownership groups are often granted a 5% management fee, something that he sees as unsustainable for a portfolio to grow organically, Clark said. This has driven outside groups to purchase an operating company, with or without the accompanying real estate as operators seek a bigger piece of the pie because in today’s senior living operating environment, holding third-party management agreements alone could be unsustainable in the years ahead. For example in 2022, with Singaporian firm Keppel Corp. Ltd. to purchase a 50% stake in Tucson, Arizona-based Watermark Retirement for just over $77 million. And Lee Equity Partners and Coastwood backed Discovery Senior Living when that company recapped in 2022.
I believe that the value of operating companies will only increase as new supply remains muted in the short-term and outside investors seek to gain further traction by investing in perceived strong operators. “Operating companies are going to be worth a fortune because it’s too hard to try to assemble a really good operating company,” Clark told me. “It takes decades to do that.” By owning “both sides of the equation,” Clark said a smaller operating company that owns a majority of its portfolio can create greater value more quickly compared to larger organizations in varying lease structures. That is indeed Brookdale’s strategy going forward. By deploying new unit types and techniques, operators can further align themselves with growth opportunities in key markets and maximize the value of their communities.
