The SeniorCare Investor: Aussies Buying Seniors Housing--
Two Large Acquisitions Show The Trend of Foreign Buying
The seniors housing and care acquisition market continues to be soft, with everything from the subprime mortgage mess to the weak housing market to valuation jitters impacting participants on both sides of the table, but mostly the buyers. While beauty may be in the eye of the beholder, "value" is in the currency of the holder. When we have a market where Europeans can come to New York City and, because the U.S. dollar is at such a low point, they can look at the cost of buying things, such as clothes, as so cheap that they can get two sweaters for the "price of one," it is no wonder that certain export businesses are booming today.
Europeans are chartering planes for the weekend just to shop in New York, while we can hardly afford the cost of gas, even though it is still cheaper than across the pond. Or take the case of the carpenter from Ireland, featured in the local media, who was eyeing the New York City co-op market for a second home because the prices were "so cheap" when converted to his local currency. And New York City real estate is still about the most expensive in the country.
It is no wonder, therefore, that we are seeing an increase in foreign buying appetite for seniors housing assets. Twenty years ago Japanese investors appeared to be taking over the U.S. real estate market, and while many people think the Middle Eastern countries, with their surge in oil wealth, are big buyers, they are overshadowed by institutional investors from Australia, who over the past 18 months have been the largest net buyers of U.S. real estate by a factor of three. This is obviously out of whack with the relative size of the Australian economy, but one of the reasons why there is so much money available for investment is that the country instituted what we have called a "retirement tax," whereby all employers must contribute 9% of every employee’s salary into a retirement/pension fund, and this influx of cash must be invested somewhere.
While the Australian seniors housing market is quite sophisticated, it is just not large enough for these new pension fund assets to be invested, nor is the rest of its real estate market. Consequently, they must look elsewhere, and the U.S is a natural market choice. But what is key is that the value of the Australian dollar has risen dramatically against the U.S. dollar in the past five years, so like the sweater buyers from Europe, the Aussies are on a buying spree, and they like what they have seen so far. Five years ago, A$1.00 was worth about US$0.55; in early November it hit a high of almost US$0.93. That can have as big an impact on pricing as the credit market jitters and subprime mess had for domestic buyers, and perhaps bigger.
So it is no mere coincidence that the two largest deals we have seen in the past few months involve two separate Australian buyers, one doing its first deal in the U.S. seniors housing market, the other expanding its investment portfolio. In the first transaction, and the smaller of the two, FKP Property Group (ASX: FKP), in partnership with Macquarie Group Limited, announced the purchase of an eight-property portfolio owned and operated by Georgia-based Principal Senior Living Group. The purchase was transacted through FKP’s local representative, Orlando, Florida-based Heritage Green.
The total acquisition "cost" was approximately $113.0 million, or $216,500 per unit, included closing, due diligence and other transaction costs, which may have been higher than usual because this was FKP’s first acquisition in the U.S. seniors housing market. We have estimated that these costs were at least $5.0 million, which would put the per-unit price of the transaction, at least for the seller, somewhere between $200,000 and $207,000. FKP and Macquarie each put up $23.5 million of equity, and borrowed a total of $66.7 million. Although no one wants to talk about it, the actual purchase price took a small haircut subsequent to the letter of intent because it came right at the moment that the credit markets were collapsing last summer. The cut was most likely to compensate the buyer for the unforeseen increase in the cost of debt. Given the state of the acquisition market after August, the sellers are a very fortunate lot indeed, and we have to believe that if FKP had walked after the due diligence period, the small haircut off the price would have been an additional $10 million, if not more, because in addition to the higher cost of capital, buyers were just not paying the same multiples anymore.
The portfolio consists of eight properties with 522 units in four southeastern states, ranging in size from 32 units to 115 units. Four of the facilities are in Florida, with two in Tennessee and one each in Georgia and South Carolina. They were all built in the past decade or so, with three of the properties and one addition on a fourth built in the past two years. They are mostly located in what could be called secondary markets, and five of the facilities are at 90% or better occupancy. One of those five has 90 assisted living units with a nearly 100% occupancy rate, but a 25-unit independent living addition that opened in April of this year is still in lease-up, although it is apparently filling up steadily now. The three properties that are not stabilized have occupancy rates, we believe, ranging from 65% to 80% and are the new facilities, but are apparently doing better than they were during the marketing of the portfolio. The portfolio is about 59% assisted living, 25% dementia and 16% independent living.
Most of the independent living units have rates ranging from $2,500 per month to $3,200, and the assisted living units range from $3,000 to $3,600. While no financial details have been disclosed, other than the total cost, we have heard a wide range of numbers about the financial performance, mostly dealing with the future. Our best guess is that revenues in 2008 are expected to be between $19 million and $21 million, with EBITDA in the $7 million to $8 million range, which would result in a pro forma cap rate of 6.6% (using $7.5 million, which was the seller’s estimate) on the total cost figure but closer to 7% on the "price." The non-stabilized facilities should fill up by the end of 2008 (we are only talking about an extra 60 units or so), and apparently the units are renting out steadily. Principal Senior Living will continue to manage the portfolio for FKP, but we don’t know how long that will last. Principal’s senior management has a few developments in the works that are not included in the deal, but when these properties are built we assume that FKP will be given a first look to buy them.
As everyone is aware, the debt markets became very conservative after August, with some lenders just as happy to walk away from deals rather than fund them. But FKP financed 40% of the total transaction cost with equity, which made the debt financing a little easier to swallow. We are not sure if there was any requirement in terms of the amount of equity, but remember that these Australian companies have a lot of cash that needs to be put to work. Peg Larson of Greystone Financial Group arranged the debt financing for FKP, which included 10-year fixed rate mortgages on the five stabilized properties placed with Fannie Mae. Greystone also provided non-recourse bridge financing for the other three properties at an 85% loan-to-cost, with a two-year term and a one-year renewal option. The intent is to flip them to Fannie Mae once they are stabilized.
FKP is the largest owner of seniors housing properties in Australia, with an approximately 15% market share. About 10 to 15 years ago, FKP started developing seniors housing in Australia, then started buying as well. Today, it operates close to 12,500 units and has another 3,500 under development. About 90% of its independent living portfolio is entry fee, so the Principal portfolio will be a bit different from its model. A few years ago, FKP purchased the largest seniors housing operator in New Zealand, showing that when it goes after a market, it does not like to be a small fry.
Although the company does not seem to have any further U.S. acquisitions in the pipeline, it would not surprise us if they announced another large deal next year. Our assumption is that they want to get their feet wet in this new market before expanding, and the Principal acquisition is of a reasonable size to do this. Because FKP’s background is in real estate development (not just seniors housing), a longer-term fit in the U.S. market could be a company such as Sunrise Senior Living (NYSE: SRZ), which is one of the top U.S developers of seniors housing. It would be too large a deal for FKP at this point, but if SRZ’s share price sinks any lower, who knows? It is obviously premature for such a move, but think about being the largest operator and developer of seniors housing in three English-speaking countries (forgive us for starting rumors). That would certainly be a boost to someone’s ego!
Many people did not think that the acquisition of the Principal portfolio would go through after the summer meltdown in the credit markets. In many ways, it was a test case to see if a $100 million-plus transaction could withstand the turmoil, and it did. This does say something about the strength of the industry to get a relatively high-value deal (on a per-unit basis) done, especially when there was plenty of gossip that the price paid was too high and based too much on the forward-looking cash flow, a concept that has become taboo with many lenders and buyers. But in this case, the buyer may think they bought the eight properties at a cheap price, when translated into their currency, and if the U.S. dollar increases in value over the time they own these assets, which is a reasonable bet over time given the U.S. dollar’s huge drop, the return will be even higher. Kudos should go to Bruce Gibson at CB Richard Ellis, who represented the seller and held the deal together at a time when the odds were heavily against him. We just want to see what FKP does next.
The GPT Group
In the second transaction from Down Under, The GPT Group (ASX: GPT) has purchased a portfolio of properties that offer assisted and independent living services as well as Alzheimer’s care in New England. The total portfolio includes 15 facilities with 1,174 units, but four are leased and the remaining 11 are owned. The total purchase price was $268 million, or $228,300 per unit, but if the four leases are capitalized the per-unit price would be closer to $300,000. Benchmark Assisted Living (BAL) has been the manager and will continue as the manager, and will be a joint venture partner on the purchase as well.
The seller was The Kuwait Finance House, through its U.S. representative, Grosvenor Investment Management US Inc. They originally purchased a 90% interest in the 11 owned facilities in 2004 for $148 million, or $196,000 per unit, and at the time occupancy was about 95% with an estimated EBITDA of approximately $12 million. Two years later they purchased a 90% interest in the four leaseholds, and both of these prior transactions were as a result of recapitalizations of existing joint ventures between BAL and AEW Capital Management. BAL management, board members and "friends" owned the other 10% of both the owned and leased facilities. Readers will remember that GPT acquired a 95% interest in 19 Benchmark-managed assisted living facilities late in 2006 for about $428 million (from Connecticut-based Greenfield Partners), or about $227,000 per unit on a grossed up basis, as well as a 20% interest in the management company itself.
So in the current transaction, GPT bought a 95% interest with management, the board and friends buying the remaining 5%. Most of the equity for the purchase came from GPT, but HJ Sims Investments LLC plus management and the board put up the rest. Debt financing totaling $175 million was arranged by Green Park Financial, which was structured in two equal parts and placed with Fannie Mae. The first part has a 10-year term with five years of interest only and a 30-year amortization. The second part has a five-year term at a fixed rate (interest only) with the option for the borrower to extend to a sixth year at a floating rate. The total credit facility was underwritten with a 72% loan-to-value and a 1.30x debt service coverage ratio. GPT now owns a 95% interest in 30 of the 43 facilities managed by Benchmark, plus the four leaseholds, and we assume they want to grow the company with some external acquisitions.
With nearly $400 million of acquisitions last month, it is safe to say that the Aussies are here, and we guess they are here to stay. The only question remaining is how big do they want to get in the U.S. seniors housing market, and the answer may well have to do with what happens to the relative value of the currencies over time. There also may be other investors from Down Under beyond GPT, FKP and Macquarie, that could surface as buyers next year. And we hear that one of them may be buying a certain group of leased nursing facilities in a certain southeastern state. Catch the wave and stay tuned.