The SeniorCare Investor: Senior Care Bed and Unit Prices Plunge
Skilled Nursing, Assisted And Independent Living All Fall
The party was fun while it lasted, but let’s admit it, there were a few too many trips to the bar for a re-fill in the past few years. We were criticized on several occasions for being a party-pooper when we would comment on some aggressive prices and cap rates that just did not seem to incorporate an appropriate level of risk, and especially when we started talking about a market peak. At the time, the risk we were referring to was plain vanilla industry risk—labor, reimbursement, management, regulations and so on—and not macroeconomic risk like the severe contraction of the credit markets, a collapse of the residential housing market and a 6,800 Dow. Although many people believe that the seniors housing and care industry is not cyclical in and of itself, it does happen to run in cycles, whether forced on it from the outside, which is mostly what is happening now, or mostly self-inflicted, which occurred in the last downturn in the 2000 to 2002 period.
Whether you are inclined to think of seniors housing and care as a separate real estate asset class, or a health care business with a large real estate component, there is no doubt that the run-up in values from 2004 to 2007 had more to do with the bull market for general real estate than it did with a new-found love affair that investors suddenly discovered with seniors housing, not to mention the availability of too much cheap capital. As real estate asset values escalated and cap rates declined, seniors housing and care provided some much needed relief for those investors not satisfied with the lower cash-on-cash returns derived from traditional real estate investments. And what was the risk? Not much, or so it was thought, what with the demographic tsunami (don’t you love that phrase?), the overbuilding problem becoming a thing of the past and with reimbursement flowing and 6% rate increases easy to obtain. But our industry always has been, and always will be, capital intensive, and capital is cyclical because economies are cyclical, and investors just seemed to let this little piece of economic theory slide past them. As we said, this is understandable after returning for one too many of those re-fills.
After hitting record average per-unit and per-bed prices in 2007, all sectors of seniors housing and care suffered from price declines in 2008. That said, the acquisition market did shrink in size considerably in 2008. In 2006, the dollar value of publicly announced deals was about $22.6 billion, and then fell to $16.6 billion in 2007. Well over 60% of the dollar volume in those years, however, was the result of just five transactions in each year. That said, the reality is that the dollar volume of publicly announced transactions plunged by more than 80% in 2008 to about $1.8 billion. The reason? There was not one transaction above $300 million, and we can’t remember the last time that happened. Of the $1.8 billion total, however, one-third was represented by two deals done by Emeritus Corporation (AMEX: ESC), a lease transaction and the acquisition of already managed properties. These and the large "corporate" deals are not used in our annual acquisition statistical analysis because they include the purchase of ancillary businesses, leases or management contracts, which alter the valuation. The dollar value of transactions, both publicly announced and private, that were used for the statistics in our upcoming Senior Care Acquisition Report declined by a smaller 58% from 2007.
Starting with the skilled nursing market, the average price per bed fell by just over 17% in 2008 to $45,500 per bed. One has to keep in mind that the average price per bed jumped by almost 28% from 2005 to 2007, so the decline in 2008 was essentially a two-year retreat in price, which is certainly better than a few other investment alternatives that we know of. We also caution readers to understand that this does not mean that the average skilled nursing facility dropped by 17% in value last year. One of the problems in the 2008 market was that the overall quality of properties that became available for sale, or that sold, deteriorated from the previous two years.
In a bad market environment, most owners who have the higher quality assets would rather wait for a better time than sell when it appears that everything is spiraling downward. On average, the skilled nursing facilities sold in 2008 were less profitable than the ones sold in 2007, which would result in lower prices even if cap rates stayed the same. But they didn’t.
Average skilled nursing cap rates hit a record low of 12.0% in 2007, and given where cap rates dropped to for every other kind of real estate asset, this still seemed rather high for investors not aware of the true risks involved in this business. In 2008, however, the average cap rate jumped by 90 basis points to 12.9%, and while this represents a significant increase, it is still lower than any year prior to 2006. Are deals still getting done at a 10% cap rate? Sure, but they are usually the better quality nursing facilities, either by age or census mix. So, according to our analysis, about 40% of the decline in the average price per bed in 2007 was the result of the increase in the average cap rate, while the remaining 60% of the decline came from a lower quality of assets sold, which is another way of saying lower cash flow per bed.
In the seniors housing sector, the declines were a little more severe, but this was to be expected since this is where we saw the most gains in the last three years, so the sector was more susceptible to downward pressure than skilled nursing. In the assisted living market, after hitting a record average price of $159,100 per unit in 2007, the average price per unit tumbled by 21% in 2008 to $124,900. The median price, which has always been lower than the average, dropped by 30% to $98,400 per unit. Once again, the culprit was a lower quality of assets sold in a very thin market. This was confirmed by the larger decline in the median price per unit, which means that just a few high-priced transactions really kept the average from falling even lower. Still, despite the significant decline last year, the average price per unit was just 6% less than the average in 2006. So overall, prices remained somewhat healthy in a terrible market environment.
As was expected, the average assisted living cap rate rose to 9.0% in 2008 from the record lows the previous year. The increase, 80 basis points, was a little smaller than the increase for skilled nursing facilities, but the cap rate was still lower than any year prior to 2007. The reason for the increase was a combination of more expensive and limited capital, which made buyers more conservative in their bidding, as well as fewer "A" properties on the market. Prior to 2008, these would have sold for prices with cap rates between 6% and 7%, and while that continues to happen (sometimes), there are just a lot fewer of them that go on the market these days. The lower quality properties, in addition to generally being older and less profitable, are also in less demand in the acquisition market, and when demand is lower, or the buyers for these properties have a higher cost of capital, then the cap rate will usually be higher.
Similar to what happened in the skilled nursing sector, about 40% of the decline in the average price per unit for assisted living was a result of the higher average cap rates, with the remaining 60% attributable to lower quality and, specifically, lower average cash flow per unit of those properties sold. What is interesting in the assisted living market is that all those "newly" built properties in the mid- to late-1990s, which were in such high demand at the time, are now not so new and often don’t compete too well against communities built in the past five years. This is especially true for those properties that have not been well-maintained or the seller is in a distressed financial situation, which usually implies limited annual upgrades as well. Especially now with so many providers worried about capital preservation, we may be seeing shrinking annual maintenance budgets this year and next, which will only contribute to this trend.
The independent living market was so thin in 2008 that we were hesitant to even come up with acquisition statistics for the year. This was a sector of the market that really saw a downturn in the quality of communities sold, partly because they trade closer to true real estate than either assisted living and skilled nursing, and the general real estate market was getting battered. In addition, everyone was assuming that independent living would be the hardest hit of the seniors housing product types because of the deteriorating housing market, but this was not really the case, other than for entrance fee CCRCs, which were not part of our statistical study. Consequently, there were very few owners of the high-end communities who wanted to venture into the market, especially after missing the market peak when their properties could have sold for prices with cap rates between 5% and 7%. For all but the best properties, those days are gone, at least for now.
Average independent living per-unit prices plunged by 32% in 2008 to just $118,100 per unit. The median, however, dropped by just 6% to approximately $137,000 per unit. We do not see this sector returning to the glory days of 2007 for quite a while. Independent living cap rates increased by only 50 basis points in 2008 to 8.6%, which was the smallest increase of the three industry segments. This means that the cap rate increase contributed to just 20% of the overall decrease in average prices, while the lower cash flow of the properties sold contributed to the remaining 80% of the decline.
This has always been a thin market which can change dramatically by what actually comes to market for sale. For example, from 2004 to 2005, the average price per unit more than doubled. Why? Because the quality and cash flow of what was sold increased so much. Average cap rates decreased by 120 basis points in 2005, yet that only accounted for less than 20% of the increase in per-unit values that year. The rest came from the substantial increase in cash flow per unit.
Without a significant loosening of capital in 2009, a change which very few people believe will come anytime soon, the seniors housing and care acquisition market will continue to stagger through 2009 much like it did in 2008. Even though we have already had the largest transaction in 18 months close this year (the $364 million sale of a Sunwest Management portfolio), without another transaction of a similar size, it is difficult to see how we will top last year’s relatively low dollar volume. Given what is going on at Sunwest, however, we would not be surprised if another similar-size deal came to market this year.
Most of the deals that are closing continue to be sales with one or two properties, often at relatively low values and financed by local, sub-regional and regional banks. We hear that some of the major players of the past, like the national finance companies such as CIT Healthcare, CapitalSource and GE Healthcare Finance, are putting financing proposals on the table, but it is unclear whether the pricing is attractive enough for the borrowers to sign. Fannie Mae and Freddie Mac are still there, but for how long in the seniors housing arena is anyone’s guess, even though their seniors housing portfolios are performing exceptionally well. We suppose Barney Frank and Chris Dodd will have more to do with their future in seniors housing than their loan performance.
For those buyers with access to capital and solid lending relationships, 2009 will certainly be looked at as a buyer’s market. The problem may be, however, that they will not find much they want to buy. And the marginal properties, those that they would buy only if they really got a good price, will most likely cause average per-unit and per-bed prices to slide again in 2009. Depending on when the capital markets recover, however, there may be some forced sales of higher quality properties to counteract that, but we don’t believe it will be enough, or at high enough prices.
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