In the midst of the Covid-19 pandemic last year, Welltower (NYSE: WELL) sold its stake in all 10 Merrill Gardens communities in its senior housing operating portfolio. The Seattle-based owner-operator, and its partner, AEW Capital Management, purchased the portfolio for $700 million.
The transaction was facilitated, in part, via a $460 million loan provided by PGIM Real Estate, and made headlines at the time for its volume and the size of the debt placement, especially during an extreme event which caused lenders to significantly restrict where they would place capital.
The deal also stands as an example of how strong preexisting relationships among owners, providers, lenders and even sellers are essential to closing transactions, as well as having shared alignment and end goals among all parties involved, leaders with R.D. Merrill Company, AEW Capital Management and PGIM Real Estate agreed Wednesday during a webinar hosted by the National Investment Center for Seniors Housing & Care (NIC).
Without a shared objective, a thorough understanding of the risks involved, and alignment of long-term objectives, this deal would not have been completed, AEW Vice President Brian Sunday said.
“This took a village,” he said.
Strength of existing relationships
The seeds of the transaction were planted in early 2019, R.D. Merrill Company President Bill Pettit said. R.D. Merrill is the parent company of Merrill Gardens, which operates a portfolio of 68 senior living communities.
Welltower, the Toledo, Ohio-based health care real estate investment trust (REIT), approached R.D. Merrill about selling its 80% stake in the portfolio. Merrill was receptive to the REIT’s wishes, but did not want to sell its stake. The communities are in markets in California, Oregon and Nevada with favorable barriers to entry, ensuring long-term, sustained performance and success.
So, R.D. Merrill commenced a search for a capital partner willing to step forward.
“This [is how we] wound up with AEW,” Pettit said.
The relationship between Merrill and AEW dates back to 2016. The Boston-based real estate investor has a sizable presence in the senior living sector, and employed a two-pronged strategy of ground-up development and core asset acquisitions. It raised $500 million with its third fund in 2017 and was in the process of raising its latest fund when the pandemic hit, Sunday said.
In June 2019, Merrill approached AEW with the opportunity to buy Welltower’s stake in the venture. After reviewing the pricing and Merrill’s analysis, Sunday decided to present it to AEW’s investment committee.
“We looked at the pricing and [determined] that it made sense,” he said.
He credits that to the relationship developed between the two firms over the years. Each has a sense of the other’s appetite for risk and the details related to modeling acquisition opportunities for projected returns on investment (ROI).
Merrill also modeled worst-case pandemic scenarios to determine what revenues and operations would look like during a theoretical second wave of Covid-19 cases — projections that did not come to pass once the actual second wave arrived and the operator’s Covid-19 response was in place and tweaked.
AEW also looked at the portfolio’s past performance as an indicator of how it would rebound in a post-pandemic environment. The firm agreed with Merrill’s assessment on the barriers to entry and determined that the communities are well-positioned to return to historic performance.
“If this [portfolio] doesn’t come back, then we’re in bigger trouble, as a sector,” Sunday said.
Underwriting during a pandemic
Welltower first announced it reached a definitive agreement to sell the portfolio in February 2020, but Covid-19 put a stop to further movement on the deal.
This was due, in part, to debt and equity providers halting capital placements during the outbreak’s early months. Instead, lenders focused on recapitalizations and servicing existing clients with proven track records of success.
PGIM Real Estate had existing relationships with Merrill and AEW. Moreover, the lender asked the same questions about when operations would rebound, starting with net operating income (NOI), Executive Director Trace Wilson said.
Like AEW, PGIM started by reviewing the portfolio’s historic performance in its markets, which gave the firm the confidence that Merrill would be able to spearhead a post-pandemic return to historic levels.
Ultimately, PGIM decided to underwrite the transaction, at 65% loan-to-value ratio. Wilson noted that this was done with confidence in Merrill’s track record as a provider, and that the underwriting would have been similar, pre-pandemic.
“You owe [yourself] a lot more sensitivity around potential options, and where do you land on [lending],” he said. “Where we landed was obviously a favorable spot.”
All parties involved agree that the deal would not have been consummated if there was a lack of trust. AEW was impressed that Merrill put its own skin in the game and is willing to assume a share of the risk in the deal. PGIM appreciated Merrill’s due diligence on top of its own, and that both the provider and AEW placed a sizable amount of their own money in the deal.
But more than the longstanding relationships, Pettit credits the alignment between the parties for closing the deal. In fact, he believes that alignment is the top priority of any working relationship.
“If we’re going to do a deal in the middle of a pandemic, you want an equity partner as well as a lender that not only believes in the asset, but believes in you as an operator,” he said.
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