They say life begins at 40. That's good news for anyone approaching that age, but it's also an old adage that has taken on new meaning. That is to say, the globe's population is getting, on average, a lot older and quite rapidly at that. The OECD predicts that more than 20 percent of the world's population will be over the age of 60 by 2050.
There's no single reason for the boom in human longevity, but better pharmaceuticals, access to quality healthcare, diet, and exercise (mostly lifestyle choices, really) are credited with extending lifespans. The traditional retirement age of 65, which the Social Security Administration chose in the 1930s, was because, statistically, a person would live just a few more years after retiring. Today, we see pension plans of large companies and Social Security itself being strained their limits to support retirees that got on to live another quarter century. So where are all these older people going to reside and get the kind of help with physical therapy, medicine, and nutritious meals that senior citizens need?
New Senior Investment Group
That's where New Senior Investment Group (NYSE:SNR) comes in. This is a senior housing asset with 88 percent occupancy spread across a geographically diverse portfolio of 152 US facilities. Some 92 percent of its residents pay privately. Forty percent of the portfolio is triple-net-leased for between 15 and 17 years with an average of between one and two years in on the contract life. So there's lots of runway here. Debt? Sixty percent of the stack is fixed rate at low interest rates (3.65 percent to 8.00 percent depending on the nursing home site) and the remaining 40 percent of the debt pays floating rate interest based on a short-term measure of LIBOR plus 2.20 percent to 3.25 percent. The average debt maturity is around 6.8 years. Notably, 82 percent of the debt associated with the triple-net leased assets are set to fixed rate, so the company is positioned to gain as each year it takes pre-arranged rent increases of 2.5 percent to 3.5 percent, thereby outpacing any rise in interest expense directly related to these assets.
The business is streamlined and its many facilities take advantage of economies of scale: SNR boasts annualized net operating income of approximately $200 million and $90 million of distributable cash flow (26c/quarter dividend = $1.04/share). So where's the downside? Theoretically, a drop in occupancy. But all data point to the fact that senior citizens as a percentage of the general population are on the rise for the next 30 years and beyond. If occupancy at SNR were to drop, the business could be forced to cut the dividend to avoid defaulting on its debt. According to the company's 2014 annual report, the average occupancy rates for their managed properties were 83.6 percent and 82.5 percent in 2014 and 2013, respectively. The average 2013 and 2014 occupancy rates for their triple-net properties were 88.8 percent and 89.1 percent, respectively. So this year occupancy has actually improved on average relative to the past two years. No surprise then that SNR actually increased the annual dividend by 2c a share this past June.
Consider as well that so-called Baby Boomers (Americans born between 1945 and 1964) account for about half the American population. According to a report by Nielsen, Boomers, who are now entering into the ranks of retirees and are in search of senior housing, could by next year hold 70 percent of disposable income in America and buy half of all consumer-packaged goods. So again, a drop in occupancy would come more because of aggressive new construction around SNR's existing facilities rather than a reverse of a demographic trends.
Retirees are living longer and demanding more quality housing.
According to New Senior Investment Group's CEO, Susan Givens, there are 1.4 million senior housing units in the United States and 32 million people over the age of 70. Of those 32 million people, only 1.2 million of them live in senior housing units today, said Givens during 2015's third quarter earnings call. The penetration rate is at just under 4 percent and a small increase of just 50 basis points to 4.5 percent would absorb all of the existing supply in the industry, Givens said. "As senior housing continues to be an increasingly accepted option for these individuals, we think this penetration rate will only increase over time," she said during the call.
Givens also said that over the next five years, projections show that there will be another 6.5 million seniors over the age of 70. Assuming penetration rates stay constant, that's an additional demand for more than 250,000 senior housing units. Put another way, we're looking at a 10 percent increase in demand for inventory over the next five years alone. Competition? Nursing homes, retirement homes, and senior communities each cater to different clienteles. For example, an independent living facility would not compete with a high intensity nursing facility - even if the two were built next door to one another. Givens said that if one were to segment by category the construction taking place around SNR's 152 facilities, then only 11 percent of the company's total net operating income could be thought to be experiencing competitive pressure. It's also worth noting that SNR has the ability to shift the mix of its portfolio by buying and selling over time if it feels one location or another has gotten crowded.
Perhaps the most surprising aspect of New Senior Investment Group is that none other than Fortress Investment Group (NYSE:FIG) externally manages the REIT and takes in between $20 million and $25 million in fees each year. In addition, Fortress owns the two management companies (Blue Harbor and Holiday) that operate SNR's 94 managed properties. Blue Harbor and Holiday are paid 2 to 3 percent more than average for their services. Fortress also gets 25 percent of any growth in an adjusted calculation of book value that's beyond a 10 percent return on equity.
Fortress also receives options as a bonus whenever SNR sells new stock to the public. Under this externally managed arrangement, some investors might be justified in feeling their upside is capped and their rights are being abused. Indeed, externally managed REITs are typically seen to pose a conflict of interest and often trade at persistent discounts. But we would remind those who feel that way that SNR's share price has been cut in half since it was spun out of NCT in October of 2014, and that it currently trades at better than an 11 percent yield. So to those who feel abused, we say, why not get paid to wait? Also note that SNR did a secondary offering of shares for the purpose of acquisition of finance and in doing so scared investors in the spring of last year (see stock price chart below). It also didn't help that BAML put a sell rating on the stock at the time.
New Senior Investment Group
Share Price Trailing 12 months
Source: Google Finance
Let's suppose there were a change of control. A likely scenario could be that a strategic acquirer such as Ventas (NYSE:VTR) or perhaps HCP (NYSE:HCP) bought the REIT and was able to eliminate the 'Fortress tax.' That could free up, say, $25 million a year, and those savings alone capitalized at 6 percent to 12 percent would be worth between $200 million and $400 million, or $2.50 to $5.00 a share.
Fortress has a series of these so-called "permanent capital" vehicles that have all gotten smacked (NRZ, NCT, NEWM, ECT, FTAI)... like this stock, which has been cut in half. To be sure, these vehicles can be a double-edged sword. On the one hand, their presence is good because the management is smart. But on the other, it's bad because the P&L, balance sheet, and contracts are all rigged to feed Fortress instead of the shareholders. To that we say, so what? Those special vehicles and fees are the reason the stock is currently so cheap.
In other developments, New Senior Investment Group has attracted a 13D filing from John Levin & Co. In response to an open letter written by Levin, NSR recently conducted a $30 million Dutch tender offer at $9.00 a share and announced a $100 million buyback authorization. So despite Fortress's aggressive fees, and minimal stock ownership (1.8 percent), they are not entirely deaf to the cries of shareholders. After all, it can't be easy for a group of over-achievers like the folks at Fortress to watch the shares plummet of no fewer than six permanent capital vehicles (SNR among them). Maybe they'll cut their fees one day and maybe not. But for those new to the stock, Mr. Market has already mightily penalized the share price.
The low share price and related high dividend yield could be viewed in a different light. Perhaps, it's Mr. Market's revenge! The 11 percent yield is the public's fee to Fortress for the privilege of 'permanent capital.' This notion is reinforced by the observation that SNR is quite literally the highest yielding healthcare REIT in the market today and trades on the lowest ratio of 2016 price to FFO (similar to P/E). Please note SNR's stats highlighted in green in the table below.
Finally, there's a certain amount of patience an investor should have with SNR. The retirement home demographic is growing rapidly, but it's going to be growing over the course of decades. So buying SNR and settling back into a favorite rocking chair to collect 11 percent a year might be the best prescription for a long, healthy life ... for the stock, that is.
Disclosure: I am/we are long SNR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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