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A Bellwether Deal in Seniors Housing

Health Care REIT, Merrill Gardens form $817 million joint venture to capitalize on new REIT structure.

The recent blockbuster deal between Merrill Gardens and Health Care REIT underscores the growth potential in seniors housing, say industry experts. The companies are forming an $817 million partnership that will own and operate 38 seniors housing communities with about 4,300 units.

The partnership is the first of its type in seniors housing structured under the REIT Investment Diversification and Empowerment Act of 2007, or RIDEA. It allows healthcare REITs to receive rents as a landlord and participate in operating profits as a tenant.

After management fees, Health Care REIT expects annual average net operating income growth of about 5% compared with 2.5% annual rent increases under triple-net lease structures.

The deal comes as the seniors housing industry appears poised to rebound. With the economy slowly recovering, occupancies at seniors housing properties are expected to improve over the next 24 months. Meanwhile, the elderly population continues to swell.

New projects now underway equal 1.1% of the existing inventory. New construction peaked in the first quarter of 2008 at 4.2% of existing inventory, says the National Investment Center for the Seniors Housing & Care Industry.

“There will be pricing power with high-end buildings in great locations,” says George Chapman, CEO at Toledo, Ohio-based Health Care REIT.

The partnership will consist of 25 buildings now owned by Merrill Gardens. Another 13 buildings owned by Health Care REIT, currently managed by Merrill Gardens, are included. Health Care REIT will own 80% of the partnership, and Merrill Gardens 20%.

Health Care REIT will pay $209 million cash for its share in the Merrill Gardens buildings and assume debt of $249 million at an average interest rate of 5%. The deal closes in September.

The properties are mostly located in affluent West Coast markets where it is difficult to develop because land is expensive and zoning approvals are hard to win. The communities feature independent, assisted and/or memory care units. About 99% of all building revenue is from private-pay residents.

The average occupancy rate at Merrill Gardens buildings is 92% compared with 88% industry-wide, says Bill Pettit, president and chief operating officer of privately held Merrill Gardens in Seattle.

Merrill Gardens plans to boost the occupancy rate across its portfolio to 97% over the next 18 months. “We expect good top-line revenue growth,” says Pettit. Rents at Merrill Gardens buildings average about $3,500 a month, and will rise this year about 3% to 5%.

For Merrill Gardens, the new partnership provides access to capital at a time when funding for new projects is scarce and expensive. “We wanted an institutional investor as a partner to grow the company,” says Pettit.

Over the next three years, Merrill Gardens expects to develop nine communities valued at $300 million. The joint venture has the option to purchase the buildings.

Expect more deals using the RIDEA structure to surface, but only for independent and assisted living properties, says Rob Mains, research analyst at Morgan Keegan in Saratoga Springs, N.Y. The profit potential is in private-pay housing, he adds, not nursing homes that depend on government reimbursements.


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