There’s been a lot of news lately about the RIDEA structure, but there seems to be some confusion on the make-up, utilization, and perceived benefits and risks of the structure. Within this article, I’ll examine the history of the RIDEA act, describe how it is typically utilized by REITs, and list some of the benefits and risks inherent within the design.
RIDEA (typically pronounced Rye-Dee-Uh, or Rye-Day-Uh) is an acronym that stands for the REIT Investment Diversification and Empowerment Act. This legislation was enacted in a REIT reform act of 2007 and allowed REITs to change the way they accounted for healthcare real estate income. Prior to this act, healthcare real estate investments had to be structured as leases (typically triple-net leases) with annual rent payments and escalations. The RIDEA act allowed REITs to participate in the actual net operating income, as long as there was an involved third party manager. The legal structuring includes creating Taxable REIT Subsidiaries (TRS), with an in-place lease between the landlord and tenant entities (both owned by the REIT).
How did this change the landscape of the industry? Instead of just underwriting a steady rent payment and annual escalation, REITs could analyze and underwrite larger shifts in operations and income. This is critical for value-add projects where there is material upside from enhanced operations and occupancy, and opened the door for REITs to expand their investment horizon (including joint venture structures). Additionally, the underwriting mentality shifted from tenant credit profile and lease coverage analysis (net operating income / rent payment), to sophisticated operating underwriting proforma models, in-depth market analysis, and operator knowledge and industry experience.
So, what are some of the benefits of this structure? The main benefit is the ability for the REIT to invest in non-stable assets, and the opportunity capture increased annual income growth from enhanced operations. Instead of the standard 2-3% rent escalations in a triple-net lease structure, the REITs can benefit from the market rent increases (or rent adjustments), occupancy increases, and overall operational improvement and efficiencies. This has led to normalized income growth well above the 2-3% range. For example, during the second quarter of 2014, Ventas (VTR) reported their U.S. RIDEA portfolio (called their seniors housing operating portfolio) experienced income growth of 6.6% on a year-over-year, same-store basis. This is almost double the range of any typical escalation within a NNN lease investment. Another benefit is a hedge against inflation, as increased inflation will lead to larger increases in rental rates, operating expenses, and overall NOI. The Tenant/Manager can also benefit, as they do not need to assume the long-term liability, but still maintain favorable management fees from operations, as well as potential incentive management fees linked to superior performance.
But, there are also some additional risks. Along with the ability to greatly increase the operations, there is also a risk of decreased operations and income (no credit guaranteed rent). However, this can be partially mitigated by creating credit enhancements within the Management Agreement (to be discussed in a later article). These credit enhancements can also create favorable alignment between the REIT and Manager, as both are focused on maximizing operational efficiency and operating income. Additionally, since the REIT is participating in the operations, there is additional risk of potential legal liability. There are also increased on-going operating costs, including a TRS income tax (from the difference in the TRS lease rent), as well as on-going capital expenditure investments to maintain a competitive advantage and appeal within the market. Last, it’s critical the REIT maintains a solid asset management platform, including constant monitoring of operating metrics, and a team experienced in seniors housing operations and market fundamentals.
Overall, the RIDEA structure has definitely changed the way REITs look at potential investments, and with effective underwriting, program implementation, and asset management, and coupled with traditional NNN investments, the RIDEA structure can positively enhance the income growth and overall returns of a seniors housing portfolio.
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Scott leverages 20 years of senior living real estate investment, development, and operations experience to increase performance and maximize value and investor returns. Learn more about Vita Senior Living and their investment strategy at vitaseniorliving.com, and be sure to visit the senior living educational and improvement platform, generationalmovement.com