The SeniorCare Investor: The State Of Senior's Housing--
Is It Really As Bad As The Stock Prices Say It Is?
The sky is falling, the sky is falling, or so cautions Chicken Little as she hops around warning everyone of impending doom. Not wanting to be accused of taking the current economic crisis too lightly, and we certainly don’t, especially with regard to the freeze in the capital markets and its impact in general on the overall economy, and specifically on the seniors housing market, but seniors housing has remained remarkably resilient in these difficult times.
It used to be said that seniors housing and care was recession-proof. That may have been an overstatement. The new phrase is that it is recession-resilient, and we have not seen any other real estate asset class that can make that claim in this market.
One only has to look at what happened in the sale of one of the most prestigious office buildings in New England, and certainly the tallest (the John Hancock Tower in Boston), that recently re-traded at a 50% discount to its last sales price less than three years ago. This is just not happening in seniors housing, unless occupancy at a particular community has fallen off the cliff. There is the argument that because so little is happening in the acquisition market right now, no one really knows what the price of that 6% cap rate, $275,000 per unit community from two years ago would really sell for today (probably 20% lower, all other things equal). But there were not many properties that fit that pricing description two years ago, even though we had a record market. There were a lot of buyers who just didn’t like the risk at those cap rate levels, and many of the lowest cap rate transactions came from traditional real estate investors looking for higher yields than they could get on alternative properties, as well as financial buyers who, unlike Chicken Little, saw the sky as the limit. Well, 18 months later, look where some of them are today.
The panic that started to hit seniors housing investors a year ago was related to fears about declining occupancy rates, followed by concerns about the large providers’ access to capital. And then it was the affordability of the seniors housing product itself. There was certainly cause for concern, and as the residential housing market deteriorated last year, occupancy at many seniors housing communities dropped. But we are not talking about a 10% or 20% plunge in census, not even 5% in most cases. Did providers have to work harder to get the customer in the door and make the sale? Of course. Did providers have to make some rent concessions to close the sale? Yes, sometimes significant, sometimes not very meaningful and more gimmicky than anything that was going to hurt the bottom line. And, in a point we make as often as possible, not only was it always very market specific, it was always very provider specific, with some providers having a bigger problem, or offering more significant discounts, than others.
So, what has really happened in the market relative to census and rates over the past year? Using the six publicly traded companies as proxies for the market, the news is a little mixed but not nearly as bad as one would think given their share prices and the rhetoric. Comparing communities that they operated both in the fourth quarter of 2007 and 2008 (same community), the change in census ranged from a decline of 240 basis points at Capital Senior Living (NYSE: CSU) to no change at Sunrise Senior Living (NYSE: SRZ). Assisted Living Concepts (NYSE: ALC) actually had the worst result, but most of it was the result of intentionally decreasing its Medicaid census, something that has been an ongoing process for more than a year, so it is not as comparable.
Now, when the sky is falling, and we are in the worst economic environment since the Great Depression, things could have been a lot worse than an average census decline of just over one percentage point. The same community occupancy rates in the fourth quarter for the five companies (excluding ALC) ranged from 87.1% at Emeritus Corporation (NYSE: ESC) to 90.0% at Brookdale Living Communities (NYSE: BKD). That is just a 290 basis point spread, which also demonstrates a certain level of consistency in the market, at least for the larger companies.
A lot can happen over 12 months, and by the fourth quarter of 2008, which in many ways was one of the scariest quarters in recent memory, at least in terms of the appearance of everything crashing around us, census levels seemed to begin to stabilize, or at least the declines slowed. Only four of the six companies had a sequential decline in occupancy in the fourth quarter, and for all four, that decline was less than the average quarterly decline for the previous three quarters.
In more normal times, that might result in a drawn out yawn, but these are not normal times. Investors, and the providers themselves, are looking for any positive movement in their operations, and this was about as good as it was going to get. On a sequential basis, Sunrise posted no change in occupancy, which is encouraging, and Brookdale had a small increase compared with the third quarter. That’s right, an increase, but because there has been so much speculation on free rent, discounts and other giveaways, BKD didn’t seem to get as much credit for this fact as perhaps it should have.
If census is bottoming out, what is happening to rate increases? Here, the data is a little bit more difficult to decipher because the publicly traded companies have a little more flexibility in how they define it. It can be "average monthly rent" or "average revenue per occupied unit," and based on that it is unclear when ancillary services or move-in fees are included or not. That said, based on what has been reported, the percentage increase in same community average rates from the fourth quarter of 2007 to the fourth quarter of 2008 ranged from 4.0% to 6.0%, excluding Sunrise which was just 1.7%, with the average for all six at 4.3% (for Assisted Living Concepts we just looked at the change in their private pay rates). That is relatively good, especially in a market environment where several providers have been forced to compete based on rate or giveaways in many local markets. So, with occupancy declines perhaps behind us and rate increases still reasonable, the sector should be poised for a rebound. You would never know it, however, by their share prices, even though they have bottomed out as well.
Census and rate increases are an indication of how well operations are doing, but profitability is still what matters. Using adjusted EBITDAR as a proxy, four of the companies had a year-over-year improvement in the fourth quarter of 2008. Only Sunrise performed significantly worse, but their problems are so large that their financial performance is skewed. Emeritus posted the best improvement with an 11% increase in EBITDAR, but all of these companies, with the exception of Assisted Living Concepts, still reported a net loss for the fourth quarter. We have to admit it is a bit counterintuitive that ALC, the company with by far the lowest overall occupancy rate (67.2%), is the only one that can eke out a GAAP profit and consequently is the only one trading at a true GAAP earnings per share multiple of 13.5x.
The important thing to remember is that unlike much of corporate America, seniors housing companies are still doing remarkably well and in many cases are growing their cash flow. If occupancy has bottomed out, and if the economy shows any signs of beginning to strengthen by the end of the year, many companies will be well-positioned for several years of organic growth. The companies that survive this economic downturn in reasonable shape may even see explosive growth beginning in 2010.
The dual effects of little new competition as a result of the development freeze, plus the pent-up demand from seniors who deferred their decision to move because of economic uncertainty, may significantly jump-start occupancy and rate increases, with cash flow to follow. On a local level, those communities that survive, or even thrive, in this environment will be the clear winners and, when the acquisition market gets going again, will be quite valuable even with the up-tick in cap rates.
One wild card still out there is the ultimate fate of Sunrise Senior Living. Earlier this year, management informed the investment community that it had enough cash flow to last until March 31, 2009, and then it, and the company’s creditors, would be faced with decision time: file for bankruptcy protection or the creditor group gives in. Well, in six to eight weeks time, lo and behold, they managed to raise a few million dollars through some sales and were able to cut operating costs a little bit more and what do you know, the March 31 deadline came and went, and nothing happened. And just before that hypothetical deadline, Sunrise and its lenders agreed to an eleventh amendment to its Bank Credit Facility, further waiving compliance with certain financial covenants until April 30, 2009. The purpose of this eleventh amendment, wouldn’t you guess it, is to give the two sides enough time to negotiate a twelfth amendment prior to the close of business on April 30.
One question that we have not heard very often is, Can Sunrise really afford to file for bankruptcy protection? Every month seems to be the end of the road in terms of cash to sustain operations, but what happens when their legal costs soar in a bankruptcy filing? Will bankruptcy be an out for some unhappy landlords to cancel their management contracts with Sunrise? Can Sunrise get debtor-in-possession financing, who would do it and how exactly would they get paid off at the end of the bankruptcy period? If lenders aren’t doing a lot of lending anyway, would they really want to risk $50 to $100 million on a somewhat dysfunctional company that seems to have difficulty making money on the management side of the business and that recently emerged from the agony of a prolonged accounting restatement fiasco?
Presumably, management has been in touch with potential DIP lenders, but we would love to see the list and find out what the loan terms would be. At one time, Sunrise had the premier name in the industry, but with each passing month, the corporate image keeps getting a little bit more tarnished, and in some markets potential customers have to start asking whether it is worth the risk to move in and whether they would be better off in a competing facility.
To the innocent bystander, it has seemed as if both sides have been playing a game of chicken, and so far neither side has blinked. The current management appeared to be overconfident late last year when they announced that they intended to have everything ironed out with the creditors before a previous expiration date, which was January 31, 2009 at the time. There is an obvious issue of credibility with the investment community right now and, we assume, with the lending community as well. The state of seniors housing won’t change with a bankruptcy filing, but its reputation will drop a notch simply because of who Sunrise is and how important the company has been in the evolution of the assisted living industry. Whatever happens, the only thing that most people agree on is that the Sunrise of the future will be a lot smaller, perhaps up to 50% smaller and, we assume, a bit more humble.