Senior Living Business: Valuing Acquisitions In Today’s Economy--
What’s Changed? What’s The Outlook For Seniors Housing?
Many not-for-profit senior living organizations seem to be managing just fine despite the economy. Others are holding their breath, waiting for the (inevitable) economic recovery. But some are in distress or hanging on by a thread—making them ripe for acquisition or affiliation. The credit markets, which have floundered in the last weeks and months, may be at last approaching some state of normalcy with regard to seniors housing.
In the meantime, the economic turmoil and financial uncertainty of the past several months have caused significant changes in the expectations of buyers and sellers, the behavior of lenders, and the valuation of not-for-profit assets.
Mainly, the buyer’s ability to get financing for properties that aren’t cash flowing or covering debt service has changed, according to Ryan Saul, Managing Director of Senior Living Investment Brokerage in Glen Ellyn, Illinois. “Buyers used to be able to get financing just by showing the track record of their other operations and comparing it to some of the same principles for the non-performing not-for-profit properties,” he said. “Today, lenders are being more selective and won’t give credit to future value.”
For appraiser Charles Bissel, National Practice Leader at Integra Realty Resources in Dallas, Texas, the nature of his assignments has changed. “Prior to Q1:08, most of our seniors housing and health care valuations were being done for refinancing or new developments,” he says. “Now, almost all the work we’re doing relates to potential loan workout or to investors needing to mark the value to market. We’re also seeing more deals for assets that are in trouble and are headed toward possible litigation or foreclosure.” For example, CCRCs having difficulty are usually those that were grossly overbuilt and that carry too much debt. The construction loan was too large, and lease up was too slow. So now, the owners are trying to do workouts or forbearance agreements with the bondholders, asking them to take a write down or extend the term.
Yet even prior to the last year or so, when the not-for-profit CCRC sector was humming, the markets were hot, and capital was available, few CCRC trades occurred unless the community was in some distress, according to Bill Mulligan, Managing Director, Group Head Senior Living & Post-Acute, at Ziegler Capital Markets. “It’s very difficult to generalize about the CCRC sector, though, as they come in all different sizes, offer many different kinds of contracts, and have different percentages of assisted living and nursing care. They’re not commodities in any way, shape, or form. ‘Seen one, seen one’ is what we tell people.”
Another complication of valuing entrance-fee CCRCs is that residents either own their homes in fee simple or their entrance fees are carried on the books as a liability of the facility. That’s a big hurdle. Even if the community is performing well and the cash flow is healthy, a buyer would get title only to the community assets—common areas—as residents may have some stake in their residential units and/or entrance fees that are refundable and are booked as a liability on the balance sheet.
Who’s buying? Who’s selling?
When not-for-profits are involved in an ownership transition, the transaction may take the form of an asset sale (an acquisition) or a membership assumption (a merger or affiliation). The buyers (acquirers or affiliators) tend to be the stronger multi-facility providers, according to Dan Hermann, Managing Director and Head of Senior Living Finance at Ziegler, although occasionally a single site will acquire a smaller single site. The sellers (those being acquired or affiliated) are generally single sites that recognize the benefit of joining a system that has scale, older communities that have become dated and are unable to implement marketing refinements in this environment, or debt-distressed facilities that are typically in fill-up mode or were unable to reach full stabilization.
Right now, Bissel sees buyers waiting in the wings. “Investors with a significant amount of capital are just waiting for the right time to jump in,” he said. “They don’t want to invest on the way down, but we certainly see people out there kicking the tires.” Interested buyers include for-profit seniors housing providers and pension funds or equity funds that have raised, in some cases, billions of dollars to capitalize on opportunities. And some local or regional operators are looking for deals that fit within their geography or operating plan. But most are for-profit companies. The not-for-profit providers appear to be in standby mode, spending their resources on expanding or developing their existing properties, or divesting.
On the seller side, not-for-profit hospital-based organizations are selling their freestanding skilled nursing or assisted living facilities to for-profit buyers to shore up the balance sheet of their core business. “Even with a slight downward pressure on pricing,” Saul observed, “they see that as a better alternative than continuing to fund losses month after month, year after year. And often their basis is so low that they’re realizing significant proceeds from the sale that can go towards fulfilling their overall mission.”
Not-for-profit skilled nursing properties are particularly ripe for acquisition. Most were built to the highest construction standards and quality. And being needs-based, their census is generally good in many parts of the country. They’re just very inefficient on the expense side, so an experienced operator providing good nursing care can capitalize on a financially underperforming skilled nursing asset even in this economy.
Assisted living, on the other hand, is up in the air. The for-profit sector is flooded with smaller, non-performing assisted living facilities, according to Saul. And given the lack of debt available for lower quality assets, they are not trading in big numbers.
Entry-fee CCRCs are proving particuarly difficult to finance in this economy. Spreads have widened, increasing the cost of borrowing tax-exempt funds. Investment income is down, making it much tougher (at least theoretically) for organizations to part with cash. And tax-exempt funds may not be used to acquire independent living. The few CCRCs that do change hands are often sold to a for-profit entity that repositions the property as a straight rental community. But now is definitely not the time to try to do something “outside your wheelhouse,” Mulligan advised. A provider who is intrigued by but has no experience with the CCRC model won’t have much luck asking a lender to leverage 80% of a struggling CCRC in this economic environment.
Stabilized vs. non-stabilized assets
Valuing stabilized assets is still fairly straightforward. It’s a matter of forecasting reasonable cash flows over the near future and applying a cap or discount rate. As a general percentage, on average, Saul is currently achieving cap rates between 12% and 13% for skilled nursing and 9% and 10% for stabilized assisted living.
Non-stabilized assets are much more problematic. They consume cash rather than generate it. Investors require a higher rate of return compared to stabilized assets. And determining when the property will become stabilized is difficult given the current economy. “We value non-stabilized assisted living assets on a price per unit based on an analysis of the specific geographic location and market, which is usually below replacement cost for non-performing properties, and then make an adjustment based on the quality of the asset, financial performance, and how much of a turnaround is involved in the opportunity,” explained Saul. For non-stabilized skilled nursing facilities, he looks at a gross income multiple—typically ranging from 0.7 to 0.9 in today’s market—and multiplies that by gross revenues for a “back-of-the-envelope” valuation.
In the 2006-2007 heyday, when a lot of very inexpensive capital was available in terms of both equity and debt, a lot of non-traditional players were willing to take on non-stabilized assets, valuing them based upon a pro forma of what the community would be like once it was stabilized. That has basically stopped, according to Mike Pardoll, Senior Vice President-Investments at Marcus & Millichap in Charlotte, North Carolina. “Almost all acquisitions now are based on trailing numbers,” he said. “And even the stronger players are finding some difficulty getting financing in place when the facility is still in the fill-up phase.”
At this point, Mulligan believes that the only way a non-stabilized facility can get debt is if the borrower can draw on a credit facility secured by other assets, pledge additional collateral, and/or offer guarantees from credit-worthy individuals or entities.
Assumable debt may make the difference between a non-stabilized property selling at par in today’s lending environment or whether some type of restructure will occur, but there are obstacles that must be overcome anytime debt is assumed. What are the borrower requirements (e.g., balance sheet requirements, financial position, and whether only a similar not-for-profit can assume the bonds)? Who pays for the reserves that are already on hand? Will the debt have to be restructured?
If the debt must be restructured, it’s important to understand that not-for-profits can issue tax-exempt bonds to develop independent living but not to acquire any portion of the asset attributable to independent living (and often the assisted living portion) within six months of the change in control, according to IRS rules. Therefore, a buyer may have to part with some cash over and above the outstanding debt, which happens rarely, or come up with taxable financing.
For a stabilized asset financed with Fannie Mae, Freddie Mac, or even HUD, assumable debt is not much of a factor. Chances are today’s rate is better than when the debt was put in place, if you can get the financing.
Get out the crystal ball
No one ever knows what the future holds, and there’s no guarantee that things won’t get worse. The general feeling now, though, is that we’re indeed approaching a normal market—at least for seniors housing.
“Aside from the need and desire for more lending, I would say that we’re pretty close to normalcy right now as it pertains to valuation and pricing,” said Saul. “The run up to the peak in 2007 was not normal. The amount of liquidity and interest in the market caused a lot of properties to be highly leveraged.”
Today, Saul’s firm is seeing a pretty good balance of activity—at least for deals in the $1 million to $25 million range. Buyers that were unable to compete before now appear to be in a position to make sensible acquisitions. “Buyers with lending relationships and with equity raised are in the driver’s seat when it comes to making a quality investment,” he said.
“The key factor [in the return to normalcy] is the housing market,” added Bissel, “and that is starting to stabilize. Once consumer confidence returns and people feel that their homes will sell, the pent-up demand for CCRCs will flow into those properties. As it is, occupancies have slid only a couple of percentage points, on average, so the fundamentals for seniors housing have remained pretty good, comparatively speaking.”
The biggest fear is that we haven’t seen the other shoe drop in other asset classes. The apartment, office, retail, and industrial sectors haven’t seen a significant number of foreclosures, so we’ll likely see more stress in the commercial real estate market as a whole. And if return requirements increase for everything else, seniors housing may be impacted to some degree.
Nevertheless, real estate is a cyclical business. Eventually, the market will recover and trend back to a seller’s market. “The cap and yield rates for seniors housing may never get as low as they were in late 2007,” Bissel suggested, “ but as returns for other property classes go down, seniors housing returns will go down as well.”
The demand for seniors housing will certainly increase over the long term, while the amount of new supply delivered will be low over the next two to three years. Therefore, looking out three, four, or five years, the fundamentals for the seniors housing business ought to be very strong. “We’ll continue to see affiliations on the not-for-profit side,” added Hermann. “In fact, I expect they’ll double. We had 13 in 2007, 15 in 2008, and it will not surprise me to see 30 in 2009 as a result of the current challenges that typical acquirees are facing.”
The consensus is, though, that providers who will own the successful senior care and seniors housing businesses will understand the business. Investors who don’t understand the business will focus on something they do know—apartment buildings, shopping centers, or other commercial real estate.