The year 2005 will go down in senior care market history if not as the most memorable, then certainly as the most bountiful. Across the board, many records were set in the 2005 seniors housing acquisition market, which includes both assisted and independent living facilities, as investors rushed into this market sector and owners capitalized on a unique set of circumstances to cash out at the highest prices ever paid. In 2004, the froth may have been bubbling up, but by last year it reached the top and, some might say, began to dribble down. Even though the acquisition market got off to a strong start in 2006, thanks mostly to Brookdale Senior Living (NYSE: BKD), there appears to be a certain amount of exhaustion that is settling in, both at the pace of the deals as well as the prices being paid.
When looking at the seniors housing market as a whole, which includes IL and AL facilities combined, the average price per unit paid in 2005 soared to $145,700, representing a nearly 70% increase from the previous year and a new record. This is based on a record $3.5 billion of asset sales involving more than 24,000 units sold. For acquisition market statistical purposes, we put CCRCs in another category, but these sales added another $600 million to the total volume last year. The combined IL/AL cap rate, fueled by unprecedented demand from a variety of buyers, plunged by more than 100 basis points to 9.1%, the first time it has been in single digits since we started tracking the market in the late 1980s.
The assisted living market has had an unusual track record the past few years. Even as the sector was improving, it was hard for the acquisition market to shake off the remnants of the overbuilding in the late 1990s and its depressing impact on values and the acquisition environment in general. Buyers were looking for deals, purchasing new facilities at sometimes significant discounts to replacement cost. There are still plenty of non-stabilized properties that become available for sale, but what changed was the heightened demand for quality properties with strong cash flow combined with the sudden flow of high-end properties and portfolios to the market that in prior years remained on the sidelines. It was as if each new sale, at yet a lower cap rate and higher per-unit valuation than the previous deal, brought two more quality portfolios to the market in an auction-style sales process that itself added fuel to the bidding fire.
The end result of this was a nearly 50% increase in the average price per unit sold last year to a record $140,300 per unit. The median jumped by more than 50%, but with plenty of less attractive and older facilities on the market, the new record median was “just” $115,600 per unit. By the middle of 2005 we already had a strong indication that records would be set, based on what had closed and what we knew would close by year-end, but the levels reached are simply remarkable and have raised the visibility of the sector among more traditional real estate investors, who were attracted to the quality of properties available, the increased depth of management teams and the higher yields despite the drop in cap rates.
Obviously it was the demand, and the prices paid, for the portfolio transactions that drove the pricing statistics in 2005. In our report, we will break out portfolio sales from the rest of the market, and we expect that differential to be huge. But as stated above, with the overall market cap rate declining to record lows, the average assisted living cap rate also plunged by more than 100 basis points from the previous year to 9.7%. Even though there were many sales in the 7% to 8% range, there were also properties that were not in as much demand, were not performing well or were in fair to poor markets and, because they were single facility sales, the big portfolio buyers were not interested. Many of these sales were in the 10% to 11% cap rate range, and it is unlikely they will drop to single digits in the near future.
In the independent living market, which had really suffered from a lack of high-end properties on the market, record per-unit prices were also reached in 2005. And what a difference a year makes, when in 2004, despite a vastly improved market with new investors plowing their capital into acquisitions, independent living average per-unit prices actually declined by 20% when every indicator pointed to a year for a big increase. The only missing ingredient in 2004 was the lack of quality properties to drive average acquisition pricing up. That all changed by 2005.
Last year, as a result of some of the highest quality communities and portfolios seen on the market, the average IL price more than doubled to $150,500 per unit. Even though some underperforming properties were also on the market, as in all years, the median also more than doubled to $129,800 per unit. Single-digit cap rates had been common for years in the independent living market, viewed as the closest to traditional multifamily housing with the least amount of operational risk, but in 2005 they also dropped by more than 100 basis points to just 8.3%. Despite the decline, average IL cap rates still remain 250 to 350 basis points above multifamily housing, and that is attracting investors who are growing weary of 5% to 6% cash yields. It is interesting to note that the spread between the average assisted living cap rate and the average independent living cap rate remained at 140 basis points for the second year in a row, showing some level of consistency.
While it is possible that the average prices paid this year will be close to the record levels set in 2005, it is unlikely simply because the volume of high quality portfolios available for sale will drop. To keep up last year’s pace, there would have to be a lot of long-term industry players willing to say good-bye in the next 10 months, and we just don’t see that happening, despite the current cap rate environment. What has already happened, and is expected to continue this year, is owners of lesser quality assets expecting to achieve premium pricing in the market, and perhaps holding out for the top dollar that may not be coming. Cap rates, on the other hand, should stay about where they were in 2005, unless the quality of assets sold deteriorates this year—then a modest increase could be expected, all other things being equal.
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