The SeniorCare Investor: The Canadians Are Coming, But Not For Medical Care

Over the past decade, there has been a lot of publicity about Canadians going south of the border to avoid long waits for certain medical procedures, while recently Americans have been going north to buy lower-cost prescription drugs, a pastime made famous on the evening news shows with traveling bus groups leaving senior centers as if they were going to Atlantic City for a little extracurricular gambling. Unlike the casinos, it is one gamble that pretty much pays off 100% of the time. And now, investment dollars are flowing south from Canada, jumping into the current feeding frenzy in the seniors housing market. The difference in this gamble, however, is that the odds are looking better for the house, which in this case is the seller.

In one of the largest transactions of the year, and one speculated about in past issues of this publication, the six-community portfolio owned by Colorado-based Meridian Retirement Communities is under contract for $232 million, or just above $222,000 per unit. In the past few months, the rumor mill had churned up Prudential Real Estate Investors, Fortress Investment Group and Health Care Property Investors (NYSE: HCP) as the most likely finalists, so we were a bit surprised to find out that Chartwell Seniors Housing Real Estate Investment Trust (TSX: CSH), Canada’s largest owner of senior care properties, was the winning bidder. Chartwell, through a U.S. subsidiary, has formed a joint venture with ING Real Estate Australia Pty Limited to complete the acquisition, which is expected to close in August. It wasn’t the only joint venture formed in connection with this deal, but more on that later.

This was an unusual transaction from the start, with the controlling investor in Meridian, Ralph Nagel, inviting out to Colorado a series of brokers to express their opinions about value, marketing tactics and likely buyers. Apparently, after collecting the information he needed, he decided to bring the marketing of the portfolio in-house, and was able to get a price slightly higher than the recently appraised value. The portfolio includes five communities in Colorado and one in Texas with a total of 1,043 units, of which more than 80% are independent living.

The Colorado portfolio has been over 95% occupied for five years, and 82% of these five communities are comprised of independent living units. There is the potential to increase the number of units by 270 through future development and expansion on some of the campuses. The Texas campus includes stand-alone townhouses, apartments and a separate care center, all located on 20 acres and with current occupancy of 97%. Zoning approvals are in place to add approximately 125 units on seven acres. This stabilized portfolio has grown its revenues by an average of 4.7% for each of the last five years.

The estimated unleveraged cap rate, which we assume is based on the first year’s cash flow, is about 7.7%, which means that EBITDA is expected to be close to $17.8 million. The buyer will be financing $160 million of the purchase price with non-recourse debt at a rate of 5.25%, which will result in a 12.5% initial cash return on the equity invested. Since those kinds of returns are not common these days in the real estate market, it is no wonder why there is significant cross-border interest and why quality portfolios are going for prices that were unthinkable two years ago. Chartwell and ING will each own a 50% interest in the portfolio.

In the second component of the transaction, Chartwell is forming a joint venture with Florida-based Horizon Bay Management (HBM) to manage the newly acquired portfolio. The new venture, to be called Horizon Bay Chartwell, will be 50% owned by HBM and 50% owned by Chartwell, with the latter paying $3.1 million for its share. Although HBM has not returned our calls, our guess is that their contribution is their management expertise and back-office services. This seems to be a win-win for HBM because not only does it earn 50% of the management fees from the Meridian portfolio, but the new joint venture also will be the manager for other U.S. seniors housing assets that Chartwell may buy in the future. The working capital for the joint venture appears to be coming entirely from Chartwell, and we expect the REIT to be increasingly active in the U.S. When this transaction is completed, Chartwell’s seniors housing portfolio will include 143 facilities with 16,166 units, the majority of which is comprised of independent living units.

Sunrise Senior Living REIT (TSX: SZR) recently announced two separate transactions. In the first one, completed in late June, the Canadian REIT purchased three assisted living facilities with 275 units for $75.4 million, or just over $274,000 per unit. CRP Seniors Housing, an affiliate of The Carlyle Group, had owned 80% of two properties in the portfolio, while Sunrise Senior Living (NYSE: SRZ), also the manager of the facilities, owned the remaining 20% of those two, with Carlyle owning 100% of the third facility. What is most interesting is that the selling joint venture had owned the properties for less than two years, but made what appears to be a tidy profit, to say the least.

The three facilities are in California (85 units), Illinois (60 units) and North Carolina (130 units). The first two facilities were developed by Sunrise Senior Living. The California property opened in late 2004 and, considered the gem of the three, is about 75% occupied. The Illinois facility opened in late 2003 and is located four miles from downtown Chicago. Sunrise does not develop many urban facilities, and this one has taken longer to stabilize than expected, with occupancy approaching 80%.

The North Carolina facility was not developed by Sunrise and opened in late 2000 in the competitive Raleigh market. Carlyle purchased it in June 2004 for $9.75 million, or $75,000 per unit, and Sunrise took over management four months later. According to our records, occupancy a year ago was close to 80% and may be near that today. Carlyle made what may have been considered a gutsy acquisition in an over-built market a year ago, and it worked out better than they could have imagined.

If we assume the newer properties were purchased by the Carlyle joint venture for $200,000 per unit (which may be high), it would mean that almost a $35 million profit was made on all three, in just a year, on the sale to Sunrise the REIT. The REIT, however, is not uncomfortable with its investment, because it is buying the portfolio based on an unleveraged cap rate of 8.3%. Because the portfolio is not yet stabilized, Sunrise the operator, which will continue to manage the facilities, will make up any cash shortfall to guarantee that 8.3% return through December 2006, if necessary. After that, the REIT is on its own. The implied stabilized EBITDA is close to $6.2 million, which is a relatively high $22,500 per unit, or $19,500 per resident capacity.

In the second Sunrise REIT acquisition, which is expected to close on August 3, the REIT is buying the 75% interest in 13 assisted living facilities owned by an institutional partner of Sunrise the operator, which we assume to be CalPERS through its pension fund advisor AEW Capital Management. Sunrise the operator will retain its 25% ownership. The 13 facilities are in suburban markets in eight states and have 1,008 units with a resident capacity of 1,211.

The purchase price, based on a 100% stake, comes to $290 million, or about $288,000 per unit. The portfolio is 94% occupied, and the price reflects a 7.7% cap rate on expected net operating income. The REIT will finance part of the acquisition price with $190 million of new mortgage debt. Because of these two acquisitions, Sunrise REIT is withdrawing the financial forecast it made when it went public in the Canadian market last December, and will be re-issuing an upwardly revised forecast for the remainder of 2005 when it releases results for the second quarter.

Canadian buyers are not just interested in the lower acuity senior care market. In one of the largest skilled nursing facility transactions of the year, newly formed United Rehab, LLC purchased the 21 skilled nursing facilities, four rehab hospitals and various ancillary health care businesses that comprised Louisville, Kentucky-based EPI Corporation. The buyer is a subsidiary of TBMM Healthcare Inc., an entity affiliated with the Paul Reichmann family of Toronto, which also owns Balanced Care. EPI was owned by about 20 shareholders, with the majority of it owned by just five or six. The purchase price was $180 million, or $75,000 per bed, but not all of the beds were owned.

All of the nursing facilities, three of which are leased, are located in Kentucky. Four of the SNFs are 100% private pay and Medicare, which is unusual in today’s environment, but overall the 21 SNFs are about 15% Medicare and 30% private pay. Two of the rehab hospitals are in Kentucky with 40 beds each, with the other two in Ohio (50 beds) and Texas (41 beds). Although cash flow figures were not available, revenues for the portfolio in 2005 are expected to be approximately $175 million.

Jeff Kelly of White Eagle National Corp. arranged the acquisition, while Merrill Lynch Capital Healthcare Finance arranged $122.5 million of five-year floating rate debt as well as a $25 million working capital line of credit. Three other lenders participated in the term loan in the amount of $75 million. For the most part, EPI management, with the exception of its former president, will remain as the management team of United Rehab. Kyle White, formerly the CFO and director of operations of EPI, has been named the president of United Rehab.

With more than $775 million of Canadian senior care investments in the U.S. market in six weeks, one would think that might be enough for a while. Think again. Although unconfirmed at this point in time, we hear that a Canadian pension fund may be the top bidder for the Senior Resource Group (SRG) portfolio, which includes nine communities with more than 1,400 units. The price may also be above $500 million, topping the $300,000 per unit mark, and our two picks as the potential buyers include the Ontario Municipal Employees Retirement System (OMERS) and CDP of Quebec, although this is speculation for now. SRG would continue to manage the properties under any deal negotiated.