The seniors housing market enjoyed a blockbuster year in 2011, with merger and acquisition activity reaching its highest level since the sector’s peak years of 2006 and 2007.
The $25 billion worth of transactions were conducted primarily by real estate investment trusts (REITs), which were responsible for almost $20 billion of those deals, according to the National Investment Center for the Seniors Housing & Care Industry (NIC).
If 2011 was the year of the mega-deals, smaller, regional communities will be the acquisition targets of the next 12 months, industry experts say.
Buyer vs. Seller
Buyers are seeking a few specific qualities in today’s senior housing market, says Rob Reis, San Francisco-based senior associate for senior living brokerage firm Marcus & Millichap.
The ideal assisted or independent living communities are 15 years old or newer and are located in large metropolitan areas such as Seattle, Portland, Chicago or Dallas, Reis says. Sellers look for in-place cash flow and strong occupancy performance that allows them to ask a premium at a cap rate around 8%, often getting multiple offers on the table.
Average cap rates have seen a moderate increase over the course of the last year after falling sharply from 9%-plus to below 8% in 2010, according to NIC. Today, the average cap rate hovers around 8%, the latest NIC data shows.
Buyers benefit from these scenarios in their upside potential, Reis says. An ideal situation may be where an 80- to 100-unit property is 85% or 90% occupied, but with a margin less than 30%.
“That is a great opportunity for those buyers waiting with cash ready to go, or who have a relationship with a REIT or access to FNMA financing. They can look at the property and see that occupancy is OK, but can be improved, and that margins can be increased to 35% or more,” says Reis.
Private pay is preferred, due to its lack of exposure to government Medicare and Medicaid policy and reimbursement changes. Buyers also look to cases where they can improve occupancy, says Ben Firestone, a senior associate with Marcus & Millichap at its Chicago office, considering the 88.2% national average occupancy rate for senior housing properties, according to NIC.
“Buyers really like upside. Is there occupancy upside? Can you increase the level of care and cut expenses?” Firestone asks.
Seller motivation is still driven by the same factors—a life changing event, partnership issues or other opportunities. For those who did not have to sell immediately, however, they are well positioned in today’s market.
“What may have changed is that three years ago someone in that situation might have been able to hold on,” Reis says. “Now, they can look out and say, ‘Occupancy has been good. We’re able to keep this place full without major discounts on rent. Let’s take it out to market.”
Leave Distress in the Past
The biggest change over the past few years, according to many working on transactions, is that the distressed properties today are not having too big an impact on the greater market. This opens opportunities for higher quality properties and sellers who are not as desperate to make the sale.
“Since 2008, I think people thought there would be a lot more distress. It’s not that there haven’t been distressed properties, but they tend to be concentrated in several large portfolios and not disbursed,” says Jeff Davis, president and CEO of Chicago-based Cambridge Realty Capital Companies. “Combined with banks being reluctant to sell some of their assets, it created an environment where people thought there would be more distressed properties than there actually were.”
These large portfolio deals can be seen in a joint venture between Emeritus and Blackstone Corp., when they agreed in 2010 to buy a $1.2 billion portfolio of more than 140 Sunwest properties out of bankruptcy.
“In the several years leading up to 2011 there were few high-quality assets coming to market,” Reis says. “That changed in 2011. Although there were some broken development projects, there were quite a few stabilized, well-maintained properties that traded hands. These communities had cap rates in the range of 7.5-8.5%.”
There has been some perception change, however, as a result of REITs buying other REITs or strings of large operating companies. While it may not have a direct impact on the small seller, it can still have some bearing.
“It does have an effect where the perception out there is better,” Reis says.
REITs have changed the landscape with their buying power in recent years, having accounted for more than three-quarters of sales activity in the senior housing sector last year according to NIC. But their strategy tends to differ from other buyers in the market.
“Our strategy has been very consistent,” says John Cobb, chief investment officer for Ventas REIT Inc. “We’re focused highly on private pay senior housing. Usually Class B, or Class A, that’s our main focus.”
A good deal might not have any particular specifications in terms of occupancy, location or financing, but rather, the operations are the essential component, Cobb says.
“There are some banks and others that might say we are only interested in ‘X’ percent occupancy,” he says. “We have over 100 operator relationships. We like better properties, better operations, we like to be full.”
Smaller deals have also garnered new interest after institutional investors like private equity firms and REITs recapitalized the majority of larger opportunities in the market.
“Now, given the institutions’ continued need to place capital in the marketplace, they are willing to seek out relatively smaller deals that would have been less attractive relative to an available mega-deal,” Firestone says.
Ventas, for example, acquired a single-property Arizona assisted living community from Milestone Retirement for $7 million in March 2011. That transaction represented a smaller deal for the large REIT.
“Smaller deals have become more attractive,” Firestone says. “The seller of a small company is now in a better position. Now there’s an opportunity for regional and smaller players to capitalize.”
An instance of this can be seen in the sale of Tiffany Court, a 15-year-old 57-unit building with consistent high occupancy and a great reputation in the community, which Reis brokered in December 2011. The San Francisco-area property was previously operated by a husband and wife team who sold it in order to move on to a new venture.
“The buyer, SHPT, saw the value in the location and the strong operational history,” Reis says. The property sold at 95% occupancy for $11.3 million, or $198,246 per unit.
Still, market hasn’t lent itself to easy transactions.
“Nothing is easy anymore given the last few years,” says Cobb. “We take our time and try to find good operators. They need to get to know you and you need to get to know them. Very rarely do we walk fresh into a client and do a deal overnight.”
The number of deals may not return to its previous level, but volume projections are steady for the coming year.
“The volume of sales is not going to be what it was,” Firestone says, “but probably the number of sales will be relatively consistent.”
Looking back at several years with little conventional financing and still next to no new construction financing, the sector appears well positioned as demand for senior living communities is stable.
“There are a lot of deals out there that are good for both the buyer and the seller,” Firestone says. “We can make a match where it’s not a zero sum game.”
Sellers are able to get a price they feel is sufficient and buyers see opportunity in reshaping communities to meet higher acuity level needs.
“It might be taking an independent living community and licensing some units for assisted living, then taking assisted living and converting a portion of those units to memory care. I see that in all markets,” Reis says.
“The sector has performed strong versus other businesses,” Davis says. “It’s not that different from how it was in the 2005-2007 period.”
The property quality is an important driver in today’s climate, as occupancy has risen steadily in both assisted living and independent living communities since 2010, with demand now outweighing supply.
“The variable being satisfied that wasn’t the case a few years ago is the quality of properties. We saw them coming to market last year, and this year and continue to see them,” Reis says. “That is what satisfies a good deal for the sellers and buyers out there.”
Written by Elizabeth Ecker
This article is sponsored by the Assisted Living Federation of America (ALFA) as part of its efforts to advance excellence and explore topics impacting the future of senior living. For more information about ALFA, visit www.alfa.org.