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New Kid on the Block

In a milestone for senior housing, Health Care Property Investors in May agreed to pay $5.2 billion for CNL Retirement Properties. The largest purchase of senior housing ever is expected to close in the third quarter.

Analysts say that the acquisition of CNL will provide Health Care Property with additional heft and reduce its cost of capital. As the nation's largest healthcare real estate investment trust, Health Care Property Investors, based in Long Beach, Calif., currently has a market capitalization of $3.5 billion with 534 properties in 42 states. The merger will boost its portfolio to 800 properties in 44 states.

Strategically, the deal is a diversification play by the REIT behemoth. Historically, Health Care Property dabbled in senior housing, but most of its assets were in hospitals, nursing homes, and medical office buildings — facilities that are heavily dependent on the whims of government policy concerning Medicare and Medicaid.

CNL, an Orlando-based REIT, is concentrated in retirement housing, including assisted-living units, where tenants can receive meals and help with daily tasks. Residents in assisted living tend to pay most of their own costs and aren't too dependent on government programs.

The cap rate on the mega-deal is 6%, according to Richard Anderson, an analyst with Harris Nesbitt. “A year ago, the price would have been lower, and the cap rate would have been about 75 basis points higher,” says Anderson.

In recent years retirement properties have gained a reputation in the institutional investment community as a mature field. “Top operators are reporting attractive operating margins and strong occupancy rates of more than 90%,” says Robert Mains, a Ryan Beck analyst.

What's more, sale prices of healthcare properties remain relatively low compared with the record levels of prime offices and retail properties.

Health Care Property'sacquisition could produce some unexpected earnings. Some of the CNL properties are new facilities that have not yet been fully leased. Once the buildings attract residents, profit margins will climb.

For CNL, the sale represents a big win. The private REIT, whose portfolio includes 262 properties in 33 states, accumulated many of its properties in 2002 and 2003. At the time, prices were soft because the sector was recovering from excess construction in the late 1990s.

With prices depressed, CNL acquired premier properties at cap rates of more than 8%, says Robert Kramer, president of the National Investment Center for the Seniors Housing and Care Industry (NIC), a nonprofit education group in Annapolis, Md.

Anderson of Harris Nesbitt says that the acquisition will help to lessen Health Care Property's dependence on Tenet Healthcare, a hospital chain that has been plagued by federal investigations and bad debts. Currently, 16% of Health Care Property's net operating income comes from Tenet Healthcare, says Anderson. That figure will be reduced to 6% after the CNL purchase closes.

Kramer of NIC expects to see more merger and acquisition activity this year. New buyers are coming into the industry, including private equity groups and owners who recently sold real estate and are looking to reinvest. Also, single-property investors who might be open to buyouts hold half of the facilities in the 30 largest metro areas in the U.S., says Kramer. “There has been some consolidation, but we will continue to see more.”

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