The SeniorCare Investor: Cap Rate and Debt Uncertainty

The Pricing Disconnect May Continue To Widen This Year

We recently hosted an audio conference with the title, "Profiting From A Buyer’s Market." There was a very informative discussion about changes in the acquisition market in 2008, what happened to cap rates and why, what the opportunities are today, who is buying, where are they getting the financing to buy, and so on.

Unfortunately, there was not much agreement on how to "profit" from the buyer’s market, let alone whether we were even in a buyer’s market.

From 2005 through most of 2007, there is little argument that we were in a seller’s market, and an unprecedented one at that. Cap rates plunged, profits increased and capital was more abundant than even during the 1990s bull market. It was a seller’s paradise, but many buyers were not complaining either, except the ones who would not, or could not, pay the escalating prices. Now, with prices depressed, cap rates rising and many of the buyers who contributed to the run-up in prices (do we hear the name Sunwest?) now on the sidelines or worse, we should be in a market where buyers rule and can basically name their price. But this is not happening, as our panelists pointed out, and we have yet to enter a buyer’s market in the traditional sense.

Perhaps the most startling statistic we have seen from 2008 comes from the recently published list of the largest assisted living providers in 2009, published in the March/April 2009 issue of ALFA’s magazine, Assisted Living Executive. In the magazine’s defense, the information was all provided by the companies themselves, and as always, some companies do not participate in the survey. One of the questions was whether they had done a merger or acquisition in 2008. Of these 70 largest companies, which ranged in size from 448 properties down to seven, only one, Five Star Quality Care (NYSE: FVE), responded "yes." Since we know that at least a few of the companies did do at least one acquisition, there may be some discrepancy between announcement date and closing date, or in some cases a related party made the acquisition so technically the respondent did not. But the stark reality of 69 out of 70 of the largest assisted living providers in the country reporting that they did not do any acquisitions last year pretty much sums up the state of the acquisition market in early 2009.

So why aren’t any of these companies, or other investors, buying right now when cap rates are rising and prices, in theory, are declining? The obvious answer is that there is no capital, or at least not enough for a fluid acquisition market. But the panelists in our audio conference were pretty much in agreement that another impediment is that there is still a significant disconnect between what the seller thinks a property is worth and what the buyer is willing to pay (and finance). And this means, theoretically, that even if the capital markets opened up a bit, we would still not see many transactions getting done. To make matters worse, some of the panelists, and others we have talked with, believe cap rates will continue to rise this year, which could cause the disconnect to grow even wider unless sellers begin to seriously change their attitude, if they want, or need, to sell.

This "disconnect" that everyone has been talking about for at least 12 months is really in the assisted and independent living market and much less so in the skilled nursing acquisition market. Remember that while cap rates in skilled nursing transactions did decline through 2007, the drop was nothing compared with the IL/AL market. That may be one of the reasons why we are seeing more skilled nursing transactions closing this year than in the other sectors. Especially with concerns on the reimbursement front, sellers do not seem to be starry-eyed in terms of what their nursing facilities are worth in this market. In other words, they have returned home from the land of Oz, while many in the IL/AL arena haven’t landed on solid ground yet. The problem this year, and possibly into 2010, is that if the market is increasingly oriented towards distressed property sales, whether because the property has problems or the operator is under financial stress, there will be an outsized impact on cap rates and buyer demand. Unfortunately, this will perpetuate the prevailing attitude that no one really knows where "market" cap rates are because they won’t believe the current market is truly representative of value. Value, this year, will not be in the eye of the beholder, but in the eye of the buyer with capital.