The SeniorCare Investor: The Collapse Of Wall Street--
And What It Means For Seniors Housing And Care
We have all read the headlines: "Wall Street Undone," "Wall Street Has Changed Forever," "Bye-Bye Bonuses," "Credit Markets Seize Up." Bankers, borrowers, investors and consumers are all scared, and while our do-nothing Congressional leaders and their merry band of whiners insist on playing the blame game (by the way, how does a state elect both Mitt Romney and Barney Frank without noticing the irony?), everyone else continues to suffer. The media has contributed to the hysteria as well. On the night of September 29, every news show talked about how the collective "we" lost $1.2 trillion in savings that day, but the next night did they tell us how we made $750 billion in one day? Of course not.
Wall Street’s eulogy has been delivered several times in the past 40 years, including the 1970s when fixed-rate commissions were abolished, Black Monday in 1987 with the largest one-day percentage drop in history and the Long-Term Capital Management bailout in the 1990s. While these events jolted the markets with the proverbial wake-up call, what is happening today is much more pervasive and as such, the impact will be longer lasting. In addition, in each of the past crises, Wall Street bankers were not talking about the end of Wall Street as we know it (the commission change may be the exception). That is not the case today. Because of the immense size of the combined federal bailouts in this crisis, there will be a price to pay, and everyone will pay it.
But what does change on Wall Street really mean? Other than the obvious lower profits and smaller bonuses, risk-taking will decline, competition will decrease, innovation will be hampered by what will be a more intrusive government (protecting its investment) and, most importantly for the seniors housing and care industry, the cost of capital will rise regardless of what happens to interest rates, at least for a few years. While not something that we want, there is a positive side to this development, at least for those providers with buildings already open. There may be fewer new entrants to the industry and new construction will be scaled back, helping occupancy rates because the demand for the product will certainly not decline. Operating income should rise when all of these influences start to impact the market.
The name of the game right now is liquidity, and in this market it currently does not exist. The number of large national banks is now down to three, the large finance companies that have been major players in seniors housing are trying to figure out where they can raise capital and what their role will be in the new environment (and they all want a significant role) and the CMBS market is shut down for now. The tax-exempt bond market has seized up, not because there is a credit problem with the issuers, but because the bond funds are seeing withdrawals and letter-of-credit support is hard to find. The big question is what will happen to the role of Fannie Mae and Freddie Mac in seniors housing next year? They are open for business (see Financing News on page 12), but if the government decides their entire focus should be to support the residential housing market, and "affordable housing" - not realizing their importance to the multifamily and seniors housing markets - then we will soon learn what a real liquidity crisis is like in our sector.
So who wins in this environment? Obviously, anyone with money, and right now we would put health care REITs at the top of that short list. Many of these REITs that were instrumental in financing the growth of the industry in the 1980s and 1990s have been diversifying away from seniors housing and care, primarily away from the reimbursement-dependant skilled nursing sector. With a combined $3 billion to $5 billion of capital to invest, depending on how you want to measure it, health care REITs are in a perfect position to capitalize on their industry expertise and desire to invest. With the cost of everyone else’s capital going up, combined with the demand for more equity from traditional lenders, REITs will not be losing out on pricing at this time. In fact, because the demand for capital remains high, they are in a position to be quite selective regarding whom they will deal with, and our suggestion would be that they become more creative in how they structure their investments, including more short-term deals. Despite all the progress that has been made in educating the capital markets in the past 10 years, it is almost as if we are back in the late 1980s to early 1990s when health care REITs reigned supreme in the seniors housing finance market. This won’t last forever, so they should capitalize on it while the going is good.
Others that should benefit from the current environment are mezzanine funds (that are still open and have money) because the demand for their funds will only grow through next year. Any regional bank with a strong balance sheet (and they do exist) is in a great position to provide mortgage financing, and they are doing so on a regional basis with small loans of $5 million to $20 million. When the dust settles, with the number of large investment banking firms cut in half, we expect to see a surge in boutique firms, not trading for their own account, but providing capital raising and M&A advice, which is precisely what the big boys did 25 years ago. And in this market they will make their money the old fashioned way, they will earn it (thank you, Smith Barney).
It is always important to remember that capital is a commodity, it moves quickly and has no boundaries. As such it will always go where the returns are the highest for the relative amount of risk. Despite the gyrations in the seniors housing publicly traded equities over the last few months, with much of that volatility based on fear, uncertainty and a lack of knowledge of the facts, the seniors housing and care industry not only remains a relatively safe investment vehicle, the returns will be favorable for many years and should beat other "real estate" oriented investments as well as other health care investments. The impact on the industry from the crisis of confidence on Wall Street may be severe in the short term, but it will also result in a more inward-looking industry focusing on operations, staffing, quality of care innovations and, perhaps, cooperation, and that will benefit everyone in the long term. For now, however, the strongest credits will still have access to capital, albeit at a higher price, while the weaker credits will either be locked out of the market or the price will be too high. For everyone in the industry there will be a renewed lender focus on track record, and it better be a good one.