The SeniorCare Investor: Senior Care: Rounding The Corner In 2002?

In the skilled nursing market, it is fair to say that the corner was turned in 2001, or at least it is making it around the bend. Two of the major companies emerged from bankruptcy protection with decent balance sheets, and two others have filed reorganization plans and should emerge in the first half of 2002.

The enigma is Integrated Health Services (OTCBB: IHSVQ), which shows little sign of progress with staff finding the exit doors. Industry profits are increasing thanks to more realistic reimbursement rates, but troubles still remain. Liability insurance, staffing problems and occupancy levels all are issues that need to be dealt with, and that is no small task.
In the assisted living sector, however, 2002 will be a turning point for an industry that is still quite young and has gone through just one downturn (nursing home owners are veterans). The number one priority, at least for the publicly traded firms, will be dealing with 2002 debt maturities and their ongoing leverage and recapitalization issues. For some, such as Alterra Healthcare (AMEX: ALI) and American Retirement Corp. (NYSE: ACR), 2002 will be a make-or-break year. The second priority will be increasing occupancy rates.

Many analysts, as well as the media, have focused on the "overbuilding" in the assisted living market as if it were a national disease. Although the rush to capture market share, combined with the financial games employed to fund the growth, resulted in many of the sector’s problems, few people are focusing on the fact that minimal development is occurring today and, more importantly, what this means for the next several years. In addition, there does appear to be a trend of combining assisted living and independent living in one community, not creating a true CCRC, but expanding the services and programs enough to attract a wider market and lower the turnover rate.

Barring some sort of disaster, most assisted living facilities built in the last year or two should reach stabilized occupancy by the end of this year, with the exception of misconceived properties, which may never see profitable occupancy levels. The lack of new development, as well as increased concentration on operations (as opposed to financial restructuring), will contribute to a stabilized market by the end of the year. But at some point, operators and investors will wake up and realize that there is a looming shortage of assisted living units in the marketplace, as hard as that may be to swallow on January 1, 2002.

Most large operators disbanded their development teams within the past 18 months and started selling sites that were never going to see a shovel. To start over again, a company would have to hire a team, find and buy sites, get the necessary zoning approvals and begin construction (the availability of financing will be ignored). It would be three to five years before any of these newly conceived facilities would open their doors to residents, and an entire new opportunity would be lost.

Except, that is, for Sunrise Assisted Living (NYSE: SRZ), the only major publicly traded company that has maintained its development program. Even though we continue to be critical of how the company reports gains on asset sales and what is means for its stock price, credit must be given when it is due. SRZ still owns about 100 of its properties and is expected to open an average of five to six facilities per quarter for the next two years at a time when most of the industry will not even mutter the "D" word. Some criticism has been leveled at the company that, after exploiting many of the premium markets on the east coast (targeted zip codes), management has been forced to move into less desirable markets where fill-up will take longer and margins will be lower. While this is logical, our hypothesis is, Will it matter?

By the end of this year, and certainly into 2003 and 2004, Sunrise will have little competition in the markets where its new facilities are opening. And, if the rest of the industry reaches stabilization by the end of this year, demand will outpace supply and there will be little anyone can do about it in the near term, other than enjoy it after several abysmal years. Sunrise management is aware of this market development, but is not changing its absorption assumptions and turnover estimates. The unknown, of course, is the future monthly price elasticity when the "shortage" of units materializes. What is also unclear is the level of new capital that may be attracted to a somewhat maturing industry that has already been through one complete cycle. While money will not pour in like it did several years ago, someone is bound to smell opportunity in a sector that presumably has learned from the sins of its past.