The SeniorCare Investor: SNF Beds Reach Record Price
AL And IL Prices Close To Records Set In 2005
For the second year in a row, we have experienced a senior care acquisition market characterized by depth, demand, desire and a lot of dollars (but no defaults). In 2005, when owners couldn’t believe the prices buyers were paying, and at what seemed to be such low cap rates at the time, they sighed and asked, "If not now, when?" So they put their properties on the market and watched the bidding frenzy push prices even higher. The market players saw quality, in abundance, like they had never seen before, and this helped drive the market to new heights because of the premium placed on the "best of the class" properties.
But the market remained as strong, if not stronger in 2006, and cap rates continued to decline across the board. It was the cap rate decline, more than anything else, that kept prices high, and this can be interpreted as either higher demand for limited product or a willingness to accept a lower return for this class of real estate than in prior years. We believe it to be both.
In 2005, it was the assisted and independent living markets that took center stage with their record per-unit prices dominating the news. In 2006, however, the skilled nursing facility market continued to strengthen and, after a slight dip in the average price per bed in 2005, skilled nursing beds hit a record high of an average price of $47,400 per bed, or 10% higher than the prior year. To highlight the importance of this, and how far the market has come, this level is 50% higher than the average price per bed in 2003, just three short years ago.
As most readers know, our statistics are based on arm’s- length transactions that are sales of properties and portfolios that include both the real estate and the business operations. Portfolio sales that include ancillary business subsidiaries, such as rehab, hospice or pharmacy, or leased and managed properties in the total purchase price are excluded because they include assets that are priced differently from the typical facility sale. For these reasons, transactions such as the sale of Laurel Health Care and Tandem Health Care, as well as the purchase by GE Healthcare Financial Services of six skilled nursing portfolios from Formation Capital are not included in our statistical analysis. The "implied" price per bed for all three of these transactions would be higher than the $47,400 average price per bed we calculated for 2006, which would take the market average even higher, but such sales take place every year. In a similar vein, the average price per skilled nursing bed in sale/leaseback transactions with REITs is higher than the market average, but most of these are considered to be financing transactions and not arm’s- length sales.
For most of the past 20 years, "real estate" investors have avoided the skilled nursing market because of the various regulation, reimbursement, litigation and labor issues. In other words, it is more business than real estate, even though the physical plant has a higher percentage of the total value. But attitudes are changing, helped by the double-digit cap rates for skilled nursing facilities, a level that is all but gone for assisted and independent living facilities of good quality and disappeared long ago for other types of real estate. So in a period of low interest rates, and relatively low yields on alternative investments, investors in search of "yield" have naturally begun to gravitate towards the skilled nursing sector.
And since it is not difficult to find operators to lease or manage the facilities, non-traditional real estate investors are feeling more secure in a health care environment that is totally alien to them. Consequently, barring a sudden change in Medicare reimbursement policies, or a major recession shifting state budget surpluses into deficits, SNF bed values should remain strong, and we may finally be seeing a large capital commitment to renovate some of the existing stock.
In the assisted living market, the average price per unit dropped by 5% in 2006 to $132,900 per unit. The significance of this decline is minimal, however, since demand last year was as strong, or stronger, than in 2005. The only difference was in the supply of higher-end properties and portfolios, which diminished somewhat in 2006. After the rush to sell in 2005 by providers who had been on the sidelines for several years, we were not sure what the inventory of properties for sale would be in 2006, so the results were in some ways better than we anticipated. The average price per unit was helped by the continued decline in cap rates in 2006, especially for the more high-profile portfolios. But there are still plenty of transactions that sell at cap rates in the 9% to 11% range; it is just that the more publicized ones tend to be in the 6% to 8% range, and that is what everyone focuses on and remembers.
As it gets more expensive to build assisted living facilities, and as they get larger, both in terms of number of units and total square footage per unit, the prices will most likely continue to escalate. In late 2006, a transaction was announced (but not closed yet) where the price was above $400,000 per unit, and it is likely that we will see more sales in the $250,000 per unit to $400,000 per unit range in the next five years as properties built in this decade come onto the market. It should be remembered, however, that these higher-end facilities will always be balanced by those in the $75,000 per unit to $125,000 per unit range, and some below that. And a low price does not mean a "bad" facility; rather, it could be in an area where real estate prices in general are low, income levels are low, or both. Regardless, demand will remain very strong for above-average assisted living facilities for many years.
The independent living market, which saw the average price per unit more than double in 2005, was just as strong in 2006 with an average price of $145,700 per unit, about unchanged from the prior year, but with the median price increasing by nearly 2%. The only problem in this market is the dearth of properties for sale, as the demand is almost unlimited, especially for those communities with excess land to add cottages, assisted living, skilled nursing, or all three. The sale of the Holiday Retirement Corporation portfolio for an estimated $185,000 per unit and a sub-6% cap rate, a transaction that was scheduled to close February 28, has any owner of retirement housing properties scratching his head and deciding whether they want to retire. As we have said for several years, the market has been strong for the IL communities, it has just been the supply of these properties for sale that has kept the market limited. The outlook for 2007 and beyond is just as strong as last year.