The SeniorCare Investor: The Skilled Nursing Market: Coming Back To Life

During the mid-1990s many in the assisted living sector wanted to write off the skilled nursing market as an anachronism, a dinosaur that had served its purpose but was about to become extinct as a new climate, and philosophy, began to take shape in a much-criticized part of the health care market. The timing was nearly perfect, and investors, both public and private, poured money into the hyper-growth assisted market only to watch it stumble, albeit temporarily, in a wave of over-supply and leverage that left investors, and perhaps some consumers, wary of the promises once made.

In the scheme of the entire retirement housing market, assisted living has really just begun to scratch the surface, and as an "industry" it will evolve and adapt as market conditions, as well as consumer demands, change. But during all the euphoria of a few years ago, something seemed to have been forgotten as people were writing their eulogies for the nursing home sector.

Although this will change over time, assisted living is still more residential than health care oriented, provides little in terms of short-term care (i.e. rehab) and basically remains a 100% private pay business. True, assisted living provides a certain level of personal care, usually referred to in terms of the number of ADLs that residents require assistance with, but the health care staffing hours are still dwarfed by the nursing home sector in comparison. This leads to the logical conclusion that the nursing home industry as we know it is not going away.

There is no question that the last three years have been difficult for the nursing home industry. But the major bankruptcies are over, balance sheets have been cleaned up, leverage is perhaps the lowest it has been in more than a decade (at least for the publicly traded companies), the declining occupancy rates seem to have bottomed out, cuts in Medicaid rates have not yet materialized to the extent feared 12 months ago and Medicare has added back some of its recent cuts. Sure, liability insurance remains a significant obstacle, but at least labor issues have eased to some degree.

The acquisition market for nursing homes has been relatively weak and slow, at least until the past month, but there are still plenty of buyers out there. Because we are in the last of three years of the significant nursing home divestiture programs, with Beverly Enterprises’ (NYSE: BEV) downsizing continuing into 2004, by next year those companies unwilling to accept simple internal growth will be back on the acquisition prowl. With interest rates remaining at low levels, public equity values finally rising and private equity still lurking in the background, the stage is set for nursing home per-bed prices to start increasing next year.

For the last three years, average per-bed prices have been between $35,000 and $40,000, but our first half-year statistics are showing that for 2003 the average price may drop to below $35,000 per bed for the first time since 1994. The reason is more a lack of quality product on the market than a willingness to pay higher prices, which is a natural result of the final stages of the recent divestiture programs. But as the large companies re-enter the acquisition market, increased demand will result in higher prices, enticing the owners of higher quality nursing facilities back into the market as sellers.

Much of the same holds true for the assisted living market, but based on the first half of 2003, average prices this year should recover from the disaster in 2002, a year that saw a 24% plunge in the average price per unit sold because of the high volume of sales from distressed operators or their lenders. Once most of the inventory of turnaround properties has been sold or closed, which should be by early next year, the national operators will be looking at the regionals, and the regionals will be paying up for stabilized facilities in their market areas. One might say that the cycle, begun in the early to mid-1990s for both nursing homes and assisted living, has been completed and that a new era will be upon us shortly.