The SeniorCare Investor: Retirement Housing M&A--

After Taking A Back Seat, CCRC And IL Sales Growing

 For much of the past two years, the seniors housing and care merger and acquisition market has been dominated by sales of and investments in assisted living and skilled nursing facilities.  In fact, over most of the past decade these have dominated the M&A market.  But with the housing market crisis and the sometimes overblown fear of its impact on independent living communities and CCRCs, the sale of these types of properties seemed to plummet.  While it is true that some communities suffered from a drop in occupancy, the ones that were hardest hit were the ones not yet established in their local markets. 

 It is a difficult decision for many seniors to move out of their homes and into a congregate living environment, with the anxiety level increasing when the financial stability of a recently opened community comes into question.  That is just one reason why the established communities have often performed better than the others in this economic downturn.  And based on the volume of transactions, all very different from one another, that we have to report on this month, it is possible that buyers and other investors are taking a harder look at this asset class and deciding that now may just be the time to jump in, or perhaps wade in.   

 As readers know, there have not been many large acquisitions in the past 18 to 24 months, with only four coming in at over $200 million.  If all goes according to plan for Legacy Healthcare Properties Trust, that number will go to five deals.  Who?  Don’t be upset if the name is not familiar, since the REIT was just founded a few months ago, but it plans on making a big splash.  And if the Legacy name is not familiar (but we are sure the name was picked for a reason), Tom Hutchison and Phil Anderson sure are from their days at CNL Retirement before they sold that REIT to HCP Inc. (NYSE: HCP) at the peak of the market (perhaps that’s their legacy).  In fact, most of the management team at Legacy has CNL in their backgrounds, so it appears we have a nice little reunion get together.  But there is nothing little about what they are trying to do.

 Leagcy has filed with the SEC for an initial public offering, raising as much as $250 million, with plans to list its shares on the New York Stock Exchange under the symbol “LRP.”  Of the total raised, about $88.0 million will be used to fund the cash portion of its first acquisition and an additional $4.6 million for closing costs.  The REIT also plans to sell shares through a private placement, but details on this are limited.  UBS Investment Bank will be the lead underwriter for the IPO, but there may be some co-managers as well.  

 The platform acquisition for Legacy will be the purchase of five assisted and independent living communities in Florida, Illinois, New Jersey, New York and Virginia and one stand-alone assisted living facility in New York, with a total of 1,041 units.  The breakdown includes 636 independent living units, 317 assisted living units and 88 Alzheimer’s or dementia units.  Five of the six were built between 2000 and 2002, while the sixth was built in 1989 and 1998.  The two nicest properties are in Illinois and Florida, and the overall portfolio may be rated as B+ or slightly better (from what we hear).  One of the properties in New York is a campus that includes nine separate buildings.  The overall occupancy was about 92% in 2009, down from just under 94% in 2008, so the portfolio has weathered the economic storm pretty well.

 The transaction has not closed, but the purchase price is expected to be $246 million, or a hefty $236,300 per unit, making it one of the more expensive deals of the recent past, at least on a per-unit basis.  The controlling seller is Walton Street Capital, with a minority interest held by the manager, Senior Lifestyle Corporation.  Legacy will be assuming $158 million of Fannie Mae debt with a maturity in three years and a spread of 2.15% over the 3-month DMBS rate.  The rest of the purchase price will be paid in cash.  In 2009, the revenues and EBITDA for the portfolio were $41.45 million and $16.3 million, respectively, resulting in an historical cap rate of 6.6%.  This is after $1.84 million in management fees and a line item called “management and contract services” ($2.8 million), which no one can talk about because of the SEC quiet period.  The cap rate on 2010 forecasted cash flow is closer to 7.2%. 

 The lease rate in 2010, on an annualized basis since the deal won’t close until later this year, is $16.3 million, jumping to $18.4 million in 2011 and $20.7 million in 2012.  Senior Lifestyle will stay in as manager and will enter into new leases with Legacy with a term that will expire on January 31, 2012.  Obviously, the current cash flow is not much higher than the lease rates, but that may have something to do with the purchase price of the assets and the short-term nature of the leases.  We assume that Legacy is paying a bit of a premium for these properties in order to have a large enough platform acquisition with which to go public.  The reality is that there just aren’t many deals of this size, if any, in the market, so you do what you have to do.  Unfortunately, no one will talk on or off the record because of the SEC filing, so it has been difficult to determine what else is going on behind the scenes.  Regardless, this is an attractive deal for Walton Street, which will split up the $88 million in cash with Senior Lifestyle, and Legacy will try to recreate the CNL acquisition magic from the last decade. 

 Although smaller in dollar value, Iowa-based Life Care Services (LCS) acquired the assets of CRSA Holdings in a transaction that closed April 30, although terms of the deal were not disclosed.  Based in Tennessee, CRSA was established about 20 years ago and manages 29 retirement communities with 9,000 units in 17 states.  This compares with more than 23,000 units in 28 states for Life Care Services.  The founder and CEO of CRSA, Earl Wade, will assume the role of COO of the new CRSA/LCS operation.  Even though this is a large deal from the sheer number of units, because there was not any ownership interest, the dollar value of the sale should have been relatively low.  Management fee revenues would probably be between $15 million and $25 million, and the margin on that fee income can vary company to company, so we will not try to estimate it.  There could be development fee income as well since we know that CRSA has developed communities for other owners.  In addition, the multiple on management fee revenue is lower than on outright acquisitions or lease acquisitions, unless the management contracts are unusually lucrative with long terms and tough cancellation clauses.    

 In another portfolio deal involving a REIT, Chartwell Seniors Housing REIT (TSX: CSH.UN) purchased the 50% interest of a portfolio of six independent living communities it didn’t own from ING Real Estate Investment Management Australia for $110.5 million, or $212,100 per unit/bed on a grossed up basis ($221.0 million) for its now full 100% ownership.  Known as the “Meridian Portfolio,” the five properties in Colorado and one in Texas have 853 independent living units and 189 skilled nursing beds and will continue to be managed by Horizon Bay Chartwell.  These properties were built in the mid-1980s, and overall occupancy is about 94%, which is at the high end for the sector right now.  According to our records, the Chartwell/ING joint venture purchased the properties in August 2005 for approximately $232 million, or $222,400 per unit/bed, with a stated cap rate of 7.7% on first year EBITDA at the time (closer to 6.6% on historical cash flow).  Dave Rothschild, Mary Christian and Matthew Whitlock of CB Richard Ellis represented ING in the sale of their 50% stake.

 Other than the price, not much financial detail has been disclosed this time around, so we will have to make some educated estimates based on unit rates, occupancy and margins.  The one difficult part of the exercise is the skilled nursing beds, since the margins on these can vary so widely when they are part of a retirement community.  The apartment rates range from about $2,700 per month to more than $4,200 per month, plus various community fees and other service fees, and we assume the skilled nursing prices are about $200 to $225 per day.  With that caveat, we have assumed an average monthly revenue per occupied unit/bed of about $3,800, which produces annual revenues of about $44.5 million. 

 Here’s the tricky part.  Depending upon which numbers you use for the purchase five years ago, the EBITDA margin was somewhere between 40% and 45%.  If we use the high end, that results in EBITDA of $20.0 million today and a 9.0% cap rate on in-place cash flow, if our estimates are close.  Another way to check that is to take the EBITDA in 2004/2005 ($15.4 million) and grow it by 6% to 7% per year (remember, occupancy has stayed high during the past two years, so we are assuming little to no rent discounts).  That produces an estimated EBITDA for 2010 of $20.6 million to $21.6 million, so we are in the ball park with the first calculation.  Consequently, it looks like this is another portfolio that, from a valuation perspective, succumbed to the rise in cap rates despite improving cash flow since 2005.  Selling a 50% interest didn’t help, since from a market value perspective, that would have a minority discount applied, even though it was a 50% interest.  Although widely marketed, there are more buyers interested in 100% ownership than 50%, and Chartwell was the logical buyer.                 

 The Franciscan Sisters of Chicago Service Corporation (FSCSC) is having a difficult year, to say the least.  Last month we reported on the troubles at its new high-rise CCRC in Chicago, and how they had a tentative agreement with the bondholders to restructure the outstanding debt for about 70 cents on the dollar.  Now, they are close to selling another retirement community, located in Texas, which defaulted on its $36 million of debt and filed for bankruptcy protection in late February of this year.  The community just never got off the ground after opening in 2006, and it didn’t help that a large number of the initial “depositors” who had committed to move in didn’t when there were some delays and they had to make some other choices.  After the bankruptcy filing, the community was set to be put up for auction with a stalking horse bid of $14.6 million, or just over $75,000 per unit, from Covenant Group.

 Unfortunately for Covenant, California-based Kisco Senior Living had quietly bought up a controlling interest in the outstanding bonds and showed up at the auction in a position to credit bid.  We assume Covenant was not too pleased to find this out, and they probably figured that they had little to lose by bidding up the price, so the auction actually ended at $17.25 million, or close to $89,400 per unit, but much less than the debt outstanding. 

 The community was built in 2006 on 13.1 acres and, as we stated, was never able to reach stabilized occupancy.  It has 114 independent living units, 24 cottage homes, some of which were entrance fee, and 55 assisted living units.  Late last year, the combined independent living occupancy was about 62% while the assisted living was 55%.  Annualized revenues are currently just over $4.5 million, and although it is cash flow positive before debt service with an 18% operating margin, the $36 million of debt was just too much with the low census.  It should take Kisco about 12 months to stabilize the community, and with average rents of about $3,000 per month, annual revenues should be up around $6.4 million with EBITDA of at least $2.2 million.  That assumes a 35% operating margin after management fee, but Kisco will do better than that the year after stabilization (no pressure).  At $2.2 million, the value would be at least $25 million, and probably higher as the cash flow increases.  Not a bad investment return in a year or two after buying some distressed bonds.  The sale is expected to close on June 11, and Tom Barry and Jason Horowitz of Cain Brothers represented the Franciscan Sisters in the transaction.

 Timing is everything, and 2006 must have been a bad year to open up a new retirement community.  In addition to the Texas property described above, a smaller community with 100 independent living units in North Carolina opened in 2006 and was never able to fill up.  The housing market obviously hurt the situation, but the town has only 3,000 residents and while there was not any real competition, the market was small.  In addition, it turned out that residents wanted an assisted living option, and North Carolina has a fairly strict certificate of need requirement. 

 While this property was being marketed, occupancy was just 40% and it was losing money on $850,000 in revenues.  The three-story building has 12 studios, 66 one-bedroom units and 22 two-bedroom units with a total of 95,500 square feet (63,000 net rentable square feet).  The developer could not pay off or refinance the construction debt, so the lender took it over and sold it to a small finance company in Florida for $4.15 million, or just $41,500 per unit.  The buyer has hired North Carolina-based Agemark to manage it, and if they can get it to 90% occupancy, the stabilized revenues and EBITDA could get to $2.2 million and $750,000, respectively, if not higher if they can push rates above the $1,500 to $2,000 range.  It is always easier said than done, especially in a small community, but it is always easier when your cost basis is 50% below the replacement cost for a new community.  Mike Pardoll of Marcus & Millichap represented the seller.

 An older CCRC in Missouri was recently sold by a local not-for-profit, Community of Christ Church.  The community has about 300 skilled nursing beds, which includes a 100-bed memory care center, a 78-bed residential care facility (lower acuity assisted living in Missouri) and independent living units.  We believe occupancy at the nursing center was about 85%, but closer to 50% at the RCF.  Although no financial details have been disclosed, we have heard that the price was in the neighborhood of $17 million.  The purchaser was Illinois-based SW Management, and the seller was represented by Lancaster Pollard.