The SeniorCare Investor: Regional Players Dominate Growing Acquisition Market

In the past several weeks, the acquisition market picked up steam, with activity spread evenly across the full continuum. Some of the increase was the result of September 11-related delays, but it is also because the pricing spread between buyer and seller has narrowed. Assuming this narrowing spread continues, and it is expected to, acquisition activity will be heavy for the next several months, as long as the lenders remain in the market.

The current strength of the senior care merger and acquisition market is its depth. The "little guys" are now at the bidding table, after years of not being able to compete with the publicly traded companies that paid prices that, ultimately, proved to be excessive relative to sustainable cash flows in what most will agree is a difficult industry. Reality may have set in for now, but the acquisition market is cyclical, and as the financial turmoil of the past few years becomes a distant memory, buyers will become bold again, and the neophytes will be talking about long-term demographics, once again.

A consistent theme has been that the market, at least on the buy-side, is dominated by regional players of various sizes that believe in the importance of having a local presence (health care is back to being local). The financing has been a mix of traditional lenders, seller financing and equity, both institutional and small investor groups, but the dominant player, at least recently, has been Heller Healthcare Finance.

In this issue, we have 16 deals covering 23 facilities to report on, and the number of transactions is a record for a month. It may also be the first time that practically an entire issue has been devoted to the acquisition market, an issue that has been expanded because of the high level of activity.

With much publicity about its divestiture program, designed to shore up the company’s financial position, it is heartening to see that Alterra Healthcare (AMEX: ALI) is closing deals and is getting reasonable prices. The largest transaction of the month involved the sale of six assisted living facilities by Alterra for approximately $22 million, or $79,700 per unit. Four of the properties are in Maryland and two are in Delaware with a combined 276 units, or 319 licensed beds. The six facilities are in three clusters, with each cluster containing one assisted living and one Alzheimer’s facility. Only one of the six is stabilized, while five are in lease-up, one of which opened just a few months ago.

Because of the current market environment and the high level of risk aversion to properties not yet stabilized, this was not an appetizing portfolio to most buyers. Consequently, while ALI may have been looking for a higher price, they should be happy with the outcome. Mel Gamzon of Ft. Lauderdale, Florida-based Senior Housing Investment Advisors, together with Kelly Cook Andres of Sage Properties LLC, represented the seller in the transaction and have been hired for another deal by ALI. Heller Healthcare Finance provided the funding for the four Maryland facilities, while the two Delaware properties were financed by a local lender, Farmers & Mechanics Bank.

Because most of the facilities were in fill-up, statistics such as a cap rate are not very relevant. The deal makes sense for the buyer, Gaithersburg, Maryland-based Somerford Corporation, however, because the properties are in its backyard and the company wants a balance of assisted living and Alzheimer’s services. It also probably paid 25% below replacement cost because of the market and the fill-up risk.

Established in late 1998 as Chesapeake Healthcare Corp. by several former Manor Care (NYSE: HCR) executives with Stewart Bainum, Jr. as the major shareholder, Somerford now has 12 facilities, with five in California, five in Maryland and two in Delaware. A 13th facility in Maryland is expected to open in early November. Just after Chesapeake was formed, it purchased California-based Somerford, which had two operating Alzheimer’s assisted living facilities and a few development sites, and kept that name.

The company’s focus is heavily on Alzheimer’s care, and although management has a background in the skilled nursing market, they plan to stick with Alzheimer’s assisted living. Growth will be a combination of opportunistic acquisitions and development. Somerford currently owns sites in northern Virginia, Maryland and New Jersey, and is also looking at the suburban Philadelphia market. Having a group of facilities in clusters is key for their efficiency of operations, something that will become more commonplace in the future. Other significant shareholders of the company include Baron Asset Fund, Fresno Surgery Center and senior management.

A second Alterra deal involved the sale of a recently built, but never opened, assisted living facility in Santa Rosa, California. Privately owned Vintage Senior Living paid approximately $9.2 million, or $115,000 per unit, for the facility, which opened its doors just after the deal was consummated. Even though it cost $12 to $13 million to build it, ALI should be very pleased that Andy Plant of Marcus & Millichap was able to get that kind of per unit price in this market for an empty building. The existing lender must have been ecstatic.

There is a different side to the story, however. We have heard that there may be deposits for 20 to 25 of the units, and the buyer expects it will take up to 14 months to fill the facility. If the approximately $1.0 million of operating deficits and interest expense during fill-up are added to the purchase price, the buyer will end up with a new facility purchased with an effective cap rate of 12.7%, which is quite reasonable. That is based on projected stabilized revenues of just over $3.4 million and EBITDA of $1.3 million (38% margin). A local lender, Imperial Capital Bank, provided the first mortgage financing at about 70% loan-to-value and at LIBOR plus 400 basis points. If the projections pan out, this looks like a fair deal for all involved despite the initial shock of the per-unit price for an empty building.

In an example of location impacting price, in the third Alterra deal, Roanoke, Virginia-based Smith/Packett Med-Com purchased a 40-unit assisted living facility, which was 100% occupied with a waiting list, for $3.0 million, or $75,000 per unit. This property, located in Lynchburg, Virginia, opened in 1999 and had revenues of $1.4 million and EBITDA of just over $400,000. This was obviously not a distressed Alterra facility; rather, its status as an orphan precipitated the sale because it had little strategic value for the future of the company. Yet, it sold for $35,000 per unit less than an empty building in California. The logical answer is that California real estate values are higher than those in Virginia and the rates charged are higher as well.

In this particular deal, the buyer will be adding 15 to 16 units at a cost of about $550,000, bringing the overall cost down to $65,000 per unit. Wachovia National Bank is providing acquisition and construction financing of $3.35 million for a property that should be worth more than $4.5 million based on projected revenues of $1.95 million (post addition) and an operating margin of at least 30%. Smith/Packett has leased the property to a local provider.

David Rothschild of CB Richard Ellis represented Alterra on the Virginia transaction, as well as on a 50-unit assisted living facility in Mesa, Arizona. This time, the price of $1.1 million reflected the zero occupancy. However, the layout was a major factor, since the "campus" had seven small residential buildings and one administrative building. The property, built in 1996, was sold to a local nonprofit that will not be using it for senior housing.