With more defaults expected in the continuing care retirement community (CCRC) space among those financed with tax-exempt bond financing that opened around the time of the economic downturn, private equity investors are being presented with opportunities that could yield substantial returns.
“There will be billions of dollars of defaults in that space in the next couple years—we’ve already seen some,” said Curt Schaller, principal, Focus Healthcare Partners LLC, during a session on private equity at NIC’s 2013 Regional Conference held March 5-7 in San Diego. “The people who can figure out how to take advantage of [upcoming defaults] are going to make a lot of money.”
The heavily-leveraged CCRCs sponsored by non-profit entities with large, entry-free model independent living sections that opened when the housing market crashed can aptly be described as “train wrecks,” according to Schaller.
“Dozens of deals are coming down the pike of high-quality CCRCs in markets that were way overbuilt,” he said.
The CCRC sector has rarely been overbuilt, says David Reis, CEO of Senior Care Development, LLC, because of the cost and time of doing upfront pre-marketing of at least 60% before breaking ground on a community.
“CCRCs that started construction around 2005 and 2006 and later will most likely find themselves in financial trouble due to higher working capital needs than originally forecasted,” he told SHN in an email. The communities that started opening in 2007 or later felt the brunt of consumers’ general malaise when the economy went south, according to Reis, as move-ins slowed to a pace most CCRC developers and sponsors had not modeled for.
While the housing market is showing signs of recovery—Standard and Poor’s recorded a 7% increase in home value in 2012 with slight gains expected for 2013—it probably won’t be enough to rescue over-leveraged CCRCs that have struggled to lease-up, says Schaller.
What will happen to those communities is unclear, he says, as bondholders try to adjust their investment recovery strategies.
In the case of the Clare, a luxury high-rise CCRC in Chicago previously sponsored by the Franciscan Sisters of Chicago Service Corp., Chicago Senior Care (a partnership between Senior Care Development, Fundamental Advisors LP, and Life Care Companies LLC) was able to buy the community out of bankruptcy for $53 million, returning just pennies on the dollar to bondholders.
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When Clare Oaks—another CCRC in nearby Bartlett, Ill.—defaulted on its bonds, bondholders ended up abandoning the bankruptcy auction route after bids came in for only about 25 cents on the dollar, Schaller recounted. They opted instead to restructure the debt—still losing more than $23 million.
Reis, who through Senior Care Development was the DIP lender in the Clare Oaks case, says the lenders in that situation would have made more money taking the bankruptcy court offer to sell outright, than they will with the restructured debt plus the millions they put into the deal to emerge from bankruptcy.
“That said, where there are CCRC deals where there is only a traditional bank group, I believe those deal could potentially be worked out with a debtor,” he says. “Where there are tax-free or taxable bonds in the mix, these are almost impossible to work out absent a bankruptcy.”
There are a lot of bond deals for Senior Care Development to look at, says Reis, and others have their eye on the situation as well.
“People went crazy overbuilding these beautiful communities, and we see some opportunity in that,” Imran Javaid, managing director of health care real estate at Capital One Bank. “The current problem is, [certain CCRCs] aren’t stabilized. But if you give them a long enough time, they will stabilize.”
Opportunity for private equity can occur in cases where there’s not time or ability to wait for lease-ups that don’t go according to the original model, he told SHN.
Javaid described a scenario where a CCRC is built for about $50 million, defaults on debt after failing to stabilize according to schedule because of the economy, and then is bought by a private equity group at a steep discount.
“If [a private equity group] starts off at a capital base of $22 million versus $50 million, they can do a ton with their equity in there,” he says. “If they’re looking to leverage up the property by 50-70%, being in private equity, their goal is not to go to Fannie, Freddie, or HUD. For us, that’s an ideal borrower.”
There’s not much new competition entering the market because it’s hard to build new, says Javaid. While some communities may fall under distress in the near-term, it won’t last forever as the market continues to improve.
“If you have the stomach to wait for it to fill up, it will fill up,” he says.
Written by Alyssa Gerace
Editor’s note: A previous version of this article implied Curt Schaller’s comments were directed at the overall CCRC market, when they were directed toward certain sub-markets, specifically tax-exempt bond financed CCRCs.