What is the RIDEA Structure and how is it used in senior living investment?

By Scott McCorvie, CEO, Enhance Senior Living

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There’s been a lot of interest about the RIDEA structure, but there seems to be some confusion on the make-up, utilization, and perceived benefits and risks of the investment 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 structure for senior living investment.

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 allows REITs to change the way they account for healthcare (senior living) real estate income. Prior to this act, healthcare and senior living real estate investments had to be structured as leases (typically triple-net leases) with monthly rent payments and annual escalations over a specific term of the lease.

The RIDEA Act allowed REITs to participate in the actual net operating income produced from the community, as long as there was a third-party manager in control of the day-to-day operations. 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 senior living investment landscape? Instead of REITs just underwriting the stagnant rent income with annual rent escalations over the term of the lease, REITs could analyze and underwrite larger shifts in operations and income potential. This is critical for value-add investments where there is material upside from enhanced occupancy, operational efficiency, and opened the door for REITs to expand their acquisition and investment horizon (including joint venture investment structures). Additionally, the investment 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 selection — including the operator’s senior living leadership, culture, and prior senior living performance.

So, what are the benefits of this structure? The main benefit is the ability for the REIT to invest in non-stable assets (including new development and value-add opportunities), and the ability to capture increased annual income growth from enhanced senior living operations and operational efficiency. Instead of the standard 2-3% rent escalations in a triple-net lease structure, the REITs can benefit from the market rent increases (or rate adjustments), increased occupancy, and overall operational improvements and efficiencies. This has led to normalized income growth well above the 2-3% range found in a triple-net lease.

For example, during the second quarter of 2014, Ventas (VTR) reported their U.S. RIDEA portfolio (called their seniors housing operating portfolio or ‘SHOP’) 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 third-party manager can also benefit, as they do not need to assume the long-term liability of a lease, but still maintain favorable management fees from operations, as well as potential incentive management fees tied to superior performance.

But, there are also some additional risks. Along with the ability to greatly increase the operations and income, there is also a risk of decreased operations and income (no credit guaranteed rent payments). However, this can be partially mitigated by creating credit enhancements within the Management Agreement (to be discussed in a later article). These credit enhancements also create favorable alignment between the REIT and Manager — as both are focused on maximizing operational efficiency and net 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 the competitive advantage and appeal of the community within the market. Last, it’s critical the REIT maintains a solid asset management platform, including consistent monitoring of operating metrics, and a team experienced in senior living operations, market fundamentals, and new competition.

Overall, the RIDEA structure has definitely changed the way REITs look at potential senior living 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 senior living portfolio.

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To enhance your senior living knowledge subscribe to the Enhance Senior Living Podcast. The show is on all podcast platforms including Apple Podcasts | Spotify | Amazon Music

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What is the RIDEA Structure?

What is the RIDEA Structure and how is it used in senior living investment?