The SeniorCare Investor: SNF Prices Hit Six-Year Low, Assisted Living Rises Modestly
When we reported on the results of our annual survey of the acquisition market a year ago, we were as surprised as anyone that the average price paid for nursing homes remained above $40,000 per bed for the fourth year in a row, registering a negligible decline of 1.5 % in 1999 versus 1998. This changed dramatically in 2000 as the financial turmoil in the nursing home industry has finally impacted acquisition values. In 2000, the average price per bed declined by 10%, from $40,680 in 1999 to $36,580, while the median declined by 13% to $33,150 per bed. These are the lowest levels recorded since 1994 and represent a fundamental change in the market. The range in prices paid, from $7,000 per bed to $79,000 per bed, was almost identical to 1999. The real difference was in the percentage of nursing homes sold in the various price ranges. Last year, 46% of the nursing homes sold were at prices below $30,000 per bed, compared to 32% in 1999.
At the other end of the spectrum, only 18% of the sales were for $50,000 per bed or more in 2000, compared to 25% in 1999. These results are very similar to what happened in 1994, the last year before a significant run-up in nursing home prices. In addition, in 2000 nearly 70% of the nursing homes sold were more than 20 years old, and because of design limitations and lower capital cost reimbursement from Medicaid, these facilities usually sell for lower prices than newer properties. This is especially true with the newer assisted living facilities siphoning off the lighter care, and profitable, private pay nursing home resident.
During 1999 and part of 2000, there was a definite disconnect between buyers and sellers in the market, with buyers feeling the pressure from the tightened capital markets and the inability to accurately forecast cash flow, but sellers not willing to recognize that there was a downward shift in valuations, or at least not willing to act on it. While the brunt of the financial distress that hit the nursing home industry was felt by the largest chains, the resulting change in sentiment affected all players in the market.
When five of the largest publicly traded nursing home companies filed for bankruptcy protection in late 1999 and early 2000, the market was not flooded with nursing homes for sale, as had been expected, because most of these companies no longer owned their facilities. In most cases, the real estate was owned by various health care REITs, and most of them were reluctant to book actual losses on the value of these properties, which would happen only if they are sold. Instead, the REITs either found new tenants (sometimes at reduced rent levels), hired a management company or formed their own management companies to stabilize the properties until the markets improved.
Although The Balanced Budget Act of 1997, with the change in Medicare reimbursement to a prospective payment system, was blamed for the mounting losses in the nursing home sector, several other factors contributed to the financial instability which ultimately led to the 10% decline in prices paid last year. These included excessive leverage, declining census, sharply higher litigation and liability insurance costs, increased competition from assisted living and rising labor costs. An unworkable regulatory environment, compounded by governmental investigations, also did not help.
While the Medicare situation is much better today than 18 months ago, all of the other problems continue to exist with little chance for improvement in the near future. Because of this, we expect nursing home prices to remain under pressure for the next year or two, even though the market appears to have bottomed out, at least from a publicly traded stock perspective. Perhaps the worst is behind us.
In the assisted living market, prices continued to rise last year despite the financial problems caused by overbuilding in many markets, rising labor costs and excessive leverage. The average price per unit rose a modest 4% to just over $82,500, which was very similar to the increase in 1999. In many ways, the assisted living acquisition market is mirroring the nursing home market, but with a one-year lag. In 1999, nursing home prices remained relatively high because the acquisition market was dominated by higher quality facilities, a phenomenon which was short lived. In 2000, average assisted living per unit prices rose for the fourth year in a row because of the impact the high end properties have on the market. These facilities are new, stabilized and in high income markets and attract both buyers who are operators as well as institutional investors who are willing to pay a premium for the top properties.
Most investors do not believe the assisted living market has bottomed out yet, with the expectation that at least one or two more bankruptcies may occur before market sentiment will change. Even though there will continue to be sales of high-end properties at premium prices in 2001, the market will most likely be dominated by the sale of underperforming assets from companies such as Alterra Healthcare (AMEX: ALI) and Atria Senior Quarters as they try to stabilize their capital structures and increase operating margins.
Average prices paid in the independent living retirement housing market soared in 2000 by about 11% to $96,400 per unit, representing the fifth straight year of rising prices. This segment of the market has not been faced with the issues of overbuilding and increasing costs from higher acuity levels and increased regulations. In addition, lenders still view independent living more as real estate because of the limited, if any, health care services provided. One of the factors contributing to the increase in average price was that more than 30% of the units sold were at prices in excess of $120,000 per unit. With 75% of the communities selling at prices above $10 million, the market has less competition from the smaller developers and operators that helped to saturate the assisted living market.
While cap rates in the nursing home market increased by an expected 90 basis points last year, they decreased in the assisted living segment. Most investors expected that assisted living cap rates would increase because of more stringent equity requirements from lenders as well as a general nervousness about occupancy levels and margins. Instead, they decreased by about 60 basis points to 11.5% last year, while independent living cap rates declined by 40 basis points to 10.5%. What this demonstrates is that even in difficult markets, buyers will continue to pay premium prices for the better properties.