The SeniorCare Investor: Prices Down, Cap Rates Up--
Mid-Year Data Confirm Market Suspicions About Trends
For the past 12 months, ever since the subprime mortgage market blew up in the summer of 2007, the seniors housing and care acquisition market entered into a new phase, and one that not many people were happy about. Everyone knew, or assumed, that cap rates would rise and the buying frenzy would be over, at least for a year or two. But it was mostly speculation and no one really knew what was going on because, for the most part, nothing was going on.
In early August, we hosted our annual audio conference that takes a look at the state of the M&A market, including mid-year statistics on sales in 2008 (CDs are available if you missed it). Our panel included Paul Diaz, CEO of Kindred Healthcare (NYSE: KND), Granger Cobb, co-CEO of Emeritus Senior Living (AMEX: ESC), Curt Schaller, senior managing director of GE Healthcare Financial Services and Arnold Whitman, CEO of Formation Capital. Collectively, this was a group with an exceptional background and unparalleled knowledge of our industry, and they provided some great insights.
The panelists were not too surprised by the mid-year acquisition statistics. The average price per bed for skilled nursing facilities dropped by 18% to $45,200 in the first half of 2008 compared with the full year 2007, while the median fell by just 2% to $43,900 per bed. Remember that 2007 was a record year for the skilled nursing market, helped by some high-end sales in the second half of the year. For the first half of 2007, the average price per bed was only 4% higher than the first half of 2008, so a lot can happen in the remaining months. While it looks as if the market deteriorated significantly, the real reason for the decline in prices was the overall decline in quality of the nursing facilities sold so far this year. In addition, average skilled nursing cap rates for the first half of 2008 increased by only 20 basis points to 12.2% compared with 2007, while the median also increased slightly to 12.3%. These results were fairly close to the numbers for the first half of 2007 as well.
The assisted living market experienced some similar trends. After setting a record in 2007, average per-unit prices declined by 14% to $136,600 in the first half of 2008; the median declined by 16%. It should be noted that both of these numbers were higher than the results for the full year 2006, and the median for the first half of 2008 is higher than any year prior to 2007. The conclusion, of course, is that while there is some softness in the market relative to values, these values can’t be looked at simply from the perspective of one unusual year (2007), but must be looked at from a broader perspective of the past several years. When that is done, the first half of 2008 looks very similar to both 2005 and 2006, and those were pretty decent years for the acquisition market.
Assisted living cap rates had fallen the most of any property type over the four-year period ending in 2007, with an almost 400 basis point drop, so this is where many people thought there was the most vulnerability. The most common number constantly thrown out in discussions was that assisted living cap rates had increased by at least 50 basis points since the peak of the market. According to our mid-year numbers, they actually increased by an average of 40 basis points (to 8.7%), which is quite close to what became the "accepted" increase, even though some people were suggesting as high as a 150 basis-point increase. Once again, the average cap rate so far in 2008 is still lower than all prior years with the exception of 2007, so the current market is just not in any kind of despair, as thin as this market may be. And it is thin, because the transaction volume in 2006 topped $22 billion and in 2007 it topped $16 billion, but unless one or two of the big deals currently in the market closes, we may not even reach $1.5 billion this year, which was the low level in the dark days of 2000 to 2002.
The main reasons why the panelists were not surprised by the results so far this year was because the actual transaction volume has been so limited and the prior numbers in 2007 and 2006 were so skewed by the large portfolio sales. And did we mention that the lending environment tightened a bit and is more expensive? While the panelists admitted that there is debt available, on big deals most lenders want to participate with other lenders instead of taking down the whole transaction as in the recent past, and on smaller loans, many lenders want other parts of the borrower’s banking business and not just a mortgage. There was also common agreement that the continued presence of Fannie Mae and Freddie Mac in the seniors housing market was crucial for liquidity, and without them values would certainly drop further.
The panelists also believe that the disconnect between the buyer and seller in today’s market continues to be fairly wide, but that beyond price, there is just a certain level of apprehension on both sides of the table that didn’t exist a year ago, with this apprehension coming from fear, with fear leading to mistrust and suspicion…and you get the picture. And if that’s how the buyer and seller are acting, just imagine how the lender must feel. Speaking of lenders, the panelists on average believed that the debt markets will open up in about 18 months or, in the case of one panelist, two years or 12 months after the real estate market gets back on its feet. Finally, three of the four panelists believe the acquisition market will be more active in 2009 than in 2008, but in some cases not by choice…