The competition for distressed deals is heating up among entrepreneurial capital in the quest for high returns, but while it could get much hotter before new developments come online, more operators may look to shore up existing portfolios in 2013.
“The number of properties with occupancy issues, or serious physical plant needs where capital needs to be invested, or management issues—we think those opportunities exist, but they’re not plentiful,” says Rick Shamberg, co-managing partner at Cerulean Partners, LLC, which targets turnaround properties.
His firm, in a joint venture with capital partners Real Estate Special Opportunity Portfolio and Real Estate Portfolio Management, recently acquired a struggling Las Vegas independent living community for $4.25 million after beating out a couple other entrepreneurs, he says.
When using capital from entrepreneurial investors, good returns are a must, says Shamberg. He and Kerry Haskins, Cerulean’s other managing partner, generally look for a more than 20% return on investment. The Vegas property, acquired for approximately $36,000 a unit at an 8.2% cap rate based on in-place net operating income, is about 85% occupied and offers significant upside.
“There are around 20 vacancies and we can add revenue which will generally all go to the bottom line through increasing occupancy, along with rents on new residents and better management,” Shamberg says. “You have to be willing to look outside the box and create a new paradigm.”
As the senior housing market stabilizes and fundamentals get stronger, that translates to less and less distress, says Ben Firestone, vice president of investments at real estate investment services firm Marcus & Millichap.
“There’s big demand for distressed properties for certain investors, because it provides more opportunity for return, but there’s less distress as a whole in the industry,” he says. High-profile distressed portfolios in particular has already been “cleaned up,” he says, referencing Sunrise Senior Living’s acquisition by Health Care REIT, which closed in January, or HCP Inc.’s 2012 purchase of the Blackstone/Emeritus joint venture of Sunwest assets.
However, just about every large investment book is going to have its bottom 5-10% of outlying properties whose performance is dragging down the entire portfolio’s metrics, says Shamberg.
“A lot of people might say they like the idea of buying [these kinds of properties], but the product’s not there. The product is there, you just have to turn over the rocks to find the opportunities,” he says.
On a microlevel, deals can be found—especially in independent living, including non-profit, entry fee-model continuing care retirement communities that opened around the time of the economic downturn, according to Firestone.
“When the housing market crashed, [newly-opening communities] couldn’t fill all the [IL] units,” he says. “Now, current resident turnover is starting to happen and they’re trying to get their equity back, but they’re competing with new units that never sold in the first place.”
When operators and investors see one or two outliers weighing down the larger impact of 10-12 successful projects, and new construction in the pipeline, it can prompt an effort to start shoring up operations.
“This year, I think we’re going to see a focus on maximizing the value of each property within a portfolio,” says Stephanie Harris, president and CEO of Turnaround Solutions. “A lot more people are entering into senior housing because of a lot of activity and stability in this marketplace, but if you have one underperforming asset, it can have a ‘rude awakening’ effect.”
With such high volume of properties changing hands in 2011 and 2012, says Shamberg, operators this year are likely to look to management partners to shore up existing portfolios.
“Everyone’s always looking for opportunities to add units,” he says. “But if I had acquired a bunch of properties, I’d want to make sure a vast majority of those properties are performing well before I add new ones.”
Written by Alyssa Gerace