Jason Ren: I am Jason Ren, REIT analyst with Morningstar. Joining me today is, Philip Martin, REIT strategist with Morningstar and chairman and CEO of Ventas, Deb Cafaro. Ventas is a narrow-moat health-care REIT that we cover. Thank you for being here.
Debra Cafaro: It's my pleasure.
Ren: Ventas has built a quite tremendous total return during the last decade, and it's sometimes been held up as a poster child of building wealth through splitting property operations, PropCo/OpCo, and while others have tried, very few have succeeded. I was wondering, what do you view as the keys toward a successful PropCo/OpCo split?
Cafaro: Yes, Ventas started out 12 years ago or 13 years ago separating what was then the largest vertically integrated owner/operator of long-term care in the United States. We had a single tenant essentially in the early days. The key to PropCo/OpCo wealth creation is that we were able to adopt and execute a growth and diversification play-in over the years.
It was heralded it as a very smart strategy, but it's very common-sense, which is, we had a single tenant and no matter how good the tenant was, we knew that we had to have more tenant relationships. We knew that, it was important to diversify effectively. We knew that our single tenant was in the nursing home and hospital business. So, it was important to expand that to other kinds of asset types within health care. And now Ventas is really 70% private pay net operating income, so we've diversified in that way, as well.
We knew that we had to change our balance sheet at that point in time. We really had access to a single source of capital which was really the bank market, and so understood that as a REIT, we had really to rely on multiple capital markets. So, we really embarked on a strategy of growth and diversification at that time.
We built a great team, and that's really been a big part of it--the team's skill and the team's execution of our strategy. And this is what I think creates total return: We were able to consistently reduce risk in our business, through balance sheet management, through diversification, through good governance, et cetera, while we consistently built cash flows.
So, those two principles, I think, create shareholder wealth. As you know over the past 10 or 12 years, Ventas has led the pack of publicly traded financial firms and REITs in terms of creating wealth for shareholders, and that's what our team is focused on. Again the principles, I think, are managing risks while at the same time building cash flows.
Ren: As of late, a theme we've heard in health care is consolidation. And while some operators overlap across the major health-care REITs, you're also seeing Ventas Healthcare REIT and HCP really putting the dollars behind very specific horses and having sizeable tenant concentration. What is your outlook on consolidation, and how do you kind of mitigate the risk of "possibly backing the wrong horse" in terms of operators?
Cafaro: Yes. Well, we are the most diversified now of health-care REITs, which is a great accomplishment for us, coming as we did from essentially a single-tenant REIT. We do believe in diversification because that is one way to manage risk, as I said, which is very important. The way we look at things is we know there is going to be consolidation in health care.
I mean, I really believe that on the government reimbursed side, you're going to see consolidation as health care changes with health care reform and so on. And then on the senior housing side, I think you're going to see consolidation because that's really the next logical step in the evolution of these companies. They will be able to realize general and administrative savings, build brand, and build scale, and I think that is going to be valuable for them.
So, we want to be with the winners, obviously, and the winners really can either be companies that are the consolidators and remain, or they can also be good companies, who maybe don't have scale but who'll have something really valuable to offer in terms of their management contracts or their assets. And even if those companies become absorbed by other companies, that's still a way to win. If we own those assets and those consolidate into a great company, that's also a good outcome for Ventas.
So, the key thing for us and part of the thesis on the NHP acquisition is we do foresee consolidation among operators in the future. We, Ventas, want to be large and diverse enough to participate and actually add value to our shareholders as these consolidations come rather than trying to be back on our heels and not be able to participate in those consolidations. We want to be a participant. We maybe want to finance some of the consolidations, and we want to be able to add value for our shareholders through what we see is a coming trend.
Philip Martin: I'm sorry to interrupt, we hear often times how fragmented the industry is.
Cafaro: It is. Yes.
Martin: I think I am getting the answer, how fragmented is it really, and number two, this new diversified business model, I would have to think, would be attractive to the smaller, up-and-coming operators looking to gain access into systems, efficiencies, with the whole cost and care appropriateness being on everybody's radar screen in the next generation really. If you can just go and talk a bit how you are set up now to grow through the next wave here in the next few years?
Cafaro: That's a great question. So, health care is really a large pie. Health-care real estate is a trillion dollars of real estate. It's very fragmented, and most of it is still owned by owner-operators, as you know. All the health-care REITs combined only own about 8% of that real estate compared with say malls where the ownership of REITs say is 65% or more. So, what we have in health-care real estate is a great foundation for continued growth of Ventas because you have a large pie. It's a growing pie. We know that because of demographics, and yet it's still very fragmented. So, that's where we do see a lot of opportunities.
Now, I mentioned a recent NHP acquisition, and this really gets back to the question that you asked. One of the things we really liked about it is we expanded our existing tenant relationships by 6 times because they have a lot more of the smaller tenant relationships, and we view that first of all as a potential sort of proprietary pipeline as those operators want to continue to grow. These relationships can be very sticky, and we can add to that. But also as you mentioned there may be other small operators who are drawn to that business model and that we can bring into the fold and know that they can have programmatic growth capital.
We have other relationships. Those operators who are tenants of Ventas can share best practices. I mean, we see the whole range of operations really in the senior housing business, where we're the largest owner in the United States, and we can help share some of those best practices and help operators with common questions and problems whether it's insurance coverage or things like that.
We have good insight and can help them with their business. A little bit the way GE does. If you know they have a great program for their customers, to help them be more sophisticated, more profitable and better care providers.
Martin: I have to think about even gaining access to the relationships you have with these systems, the health-care systems, et cetera has to be a great…
Cafaro: Exactly. Well on the medical office building side now we have relationships with 50 leading hospitals across the United States pretty much coast-to-coast between the Lillibridge business that we own, and the PNB franchise that we have on the West Coast where we have a built-in exclusive relationship. So, again as you see post-acute convergence and lots of things in the future, we can see more overlap I think among our different clients and customers.
Ren: Thank you for your time, Philip and Debbie.
Cafaro: Well, thank you for having us. At Ventas, 12 years later we still live, breathe, and get up every day to create value for shareholders. So, thank you for having us here.