The SeniorCare Investor: Where’s The Beef? Acquisition Volume Stalls in 2004
This was the year we were supposed to see big chains re-entering the acquisition market, consolidation among regional chains, the growing fear of acquisition prices outpacing values (now that’s a concept) and a basic feeding frenzy in the acquisition market. The table was set, but the feeding frenzy has yet to take place. The problem is that while everyone waiting at the table is hungry, there is nothing being served up. So where’s the beef these days?
Last year we saw a significant jump in publicly announced senior care acquisitions compared with the previous three years, fueled by what we believed to be the end (or close to it) of the asset redeployment phenomenon that resulted from the record number of industry bankruptcies. Buyers were plentiful, and as capital crept back into the market, lenders with unwanted real estate and operators still suffering from low occupancies and skimpy cash flow finally made the big push to unload assets at significant discounts to replacement cost. Or so the story goes.
As can be seen in the chart on page 1, publicly announced long-term care transactions in the first quarter of this year were down more than 50% when compared with both the previous quarter and the year-ago quarter. Unfortunately, the trend has continued into April as well. Acquisition activity in the overall health care services market was down in the first quarter as well, but not to the extent it was in long-term care.
In the long-term care market, one theory is that buyers became burned out after the rash of deals in 2003 and needed to take a breather. But from a historical perspective, this really doesn’t hold water because the level of activity last year was significantly less than each of the years from 1996 through 1998. It just seemed busy during 2003 given the relative drought that followed the record level of M&A activity in last half of the 1990s.
But things just don’t add up in the current market environment. From a seller’s perspective, the market is the best it has been in four to five years, and there should be a pent up supply of potential sellers waiting for the turmoil to be over and values to rise. Interest rates are still at historic lows, cap rates are in decline, capital is available, especially for higher-end product, buyers are chomping at the bit and the public companies are mostly turning in good quarterly numbers, have excess borrowing capacity and can finally use their stock as acquisition currency.
In a survey completed by Senior Living Valuation Services, 40% of respondents believe cap rates will decline this year by up to 100 basis points, compared with 19% last year and just 5% in 2002. That should be indicative of an aggressive pricing market this year.
Operators, investors and lessors should all be testing the market to see if values have really solidified, at least for the quality facilities. But they are still in hiding, and it is doubtful that these accommodating conditions will last beyond next year, especially the low cost of capital these days.
In another survey recently completed by CLW Health Care Services Group, 45% of active buyers (yes, we realize this is a contradiction in terms) in the assisted and independent living market responded that they are seeing less product in the market compared with a year ago, while 60% said the quality of what is available for purchase is worse than a year ago. Since the quality of last year’s product was not exceptionally high, this says that the pickin’s are really slim. A strong majority of 70% believes that the supply of product will be the same or worse a year from now, and 60% think the quality will be the same. The real kicker is that 89% of the respondents said they think it is either a seller’s market today or that we are heading towards a seller’s market (there was an even split between the two). This should be a wake-up call to anyone with any inkling to sell.
Owners of high-end facilities can almost command their price (within reason, of course) simply because there is so little competition in today’s market. It is unclear whether, given the absence of quality facilities in the market, buyers will go after and bid up prices for properties that they normally would avoid just to show some extra growth. Or perhaps operators have finally heeded the call of lenders, investors, consultants, accountants, lawyers, consumer groups, regulators, politicians and even Simon Cowell to tone down their acquisition appetite, not pay ridiculous prices and concentrate on improving existing operations. Have we mentioned a certain bridge with great river views for sale?
The point is that in any market, when demand far exceeds supply, something happens to prices, and in the case of the senior care market they will only go up, as required rates of return decline or, and we have already seen this, the prices paid will be based not on today’s cash flow, but on forecasts that are up to two years out, with all the risks inherent in that strategy. At some point, however, the providers of capital will rebel if pricing gets too out of whack. We have yet to reach that point.