The SeniorCare Investor: When Cash Is King: So What Else Is New?

Once again, the acquisition activity in the past month was dominated by the sale of assisted living facilities, with nine separate sales totaling 27 facilities, compared to three nursing home transactions. Although maybe not so extreme, a similar ratio is expected for the rest of the summer as many of the large assisted living companies continue to shed properties.

As all buyers know, one of the major reasons for the slowed pace of acquisitions in the senior care market is the lack of financing (although June was anything but slow). In many cases, this has contributed to the inability of both parties to come to a "meeting of the minds" in a transaction. Given the record level of defaults and bankruptcies over the past two years, lenders can hardly be faulted these days for requiring more equity in deals or using historical financial results, instead of projections, to determine the worthiness of a transaction and its price. When someone is a "cash" player, however, everyone pays a little more attention, uncertainty at the negotiating table begins to dissipate and riskier potential buyers drop out of contention.

Such was the case in a recent deal for three assisted living facilities. Needham, Massachusetts-based Newton Senior Living (NSL) recently closed on the purchase of three assisted living facilities that had been managed by CareMatrix (OTCBB: CMDCQ) but owned by Chancellor Housing and Abe Gosman. The three facilities are located in Massachusetts (68 units), Pennsylvania (122 units) and Maryland (92 units) and have a total of 282 units. Newton also assumed management of a 108-unit independent living community in Ossining, New York that was purchased at the end of the month (see below).

Newton paid approximately $22.5 million for the three ALFs, or $80,000 per unit. After closing costs, working capital and required capital improvements, the buyer figures the all-in cost to be over $90,000 per unit. On a combined basis, the three had an occupancy rate of 67% and were cash flow positive before debt service. But here is the catch. For at least six to nine months, Newton will not have any debt service because it paid 100% cash for the facilities.

During the negotiations, NSL brought its venture capital partner, Charlesbank Capital Partners, to the table, and told the selling group, which also included Credit Suisse First Boston, that they would do a cash deal with no debt financing. This removed a lot of uncertainty in the transaction and essentially left NSL alone at the table. Last fall, NSL had received a $20 million equity commitment from Charlesbank and used just $3.6 million of it for an acquisition, so we assume they increased the commitment to get this transaction done.

All three facilities opened approximately two years ago and have average rents of about $3,400 per month. The occupancies range from 60% to 74% and each facility has an Alzheimer’s wing. At two of the facilities, the Alzheimer’s wings are almost filled, while at the third facility the Alzheimer’s wing is slightly ahead of the remaining units in terms of fill-up.

Newton is assuming no change in occupancy during the first three to four months, and then a net increase of two units per month at each facility. Intentionally conservative, this will yield a 93% stabilized occupancy in 14 to 15 months. In each market, the average occupancy rate is apparently 95%, so this should be achievable. Current revenues are about $7.7 million, but when an additional 75 units are filled, revenues should be close to $11 million. Although we do not know the magnitude of the current cash flow, most of the increased revenues will flow to the bottom line, and the buyer has indicated that the cap rate will be about 14% on stabilized EBITDA. With an all-in cost below construction costs for newly built properties in markets with good occupancy rates, this should be an attractive investment for NSL.

At the end of June, Newton Senior Living also closed on the acquisition of three Connecticut ALFs that it had been managing for a local operator, The Bridges Communities, on behalf of Finova, which subsequently took possession of the three. The purchase price was approximately $29 million to $30 million, or just under $90,000 per unit. Simultaneously, NSL closed on the purchase of the Ossining, New York retirement community for just over $10.5 million, or approximately $100,000 per unit. Health Care REIT (NYSE: HCN) provided sale/leaseback financing for the four facilities.

Newton took over management of the three Connecticut ALFs late last year when occupancy was about 75%. The company has increased the overall level to 78%, but one of the facilities is in a very competitive market where four new ALFs opened in an 18-month period. The three purchased by NSL all opened during 1999 and 2000. Each of the facilities has 22 dementia units, and although the remaining units are technically assisted living, about 15% to 18% of these units are occupied by residents considered to be more independent.

In NSL’s other communities, 25% to 30% of the units are independent living, and the goal is to increase these Connecticut facilities to the company average. The dementia units are all studios, but each community has five two-bedroom and more than 50 one-bedroom units, so the design should be able to accommodate the desired mix. The Ossining community, which was 82% occupied when NSL assumed management on May 1, is just under 90% today.

Health Care REIT closed on the financing in record time, since the lawyers for both sides were first introduced to the deal, and each other, on June 13 (of this year) and were able to close it on June 28. The combined cash flow of the properties covers the lease payments, even though the three Connecticut ALFs are only at 78% occupancy.

This is partly because they were purchased at about a 40% discount to the original all-in cost to build of almost $150,000 per unit. Consequently, any increase in occupancy should be gravy for NSL and its investors (with a slice going to HCN as well).