The SeniorCare Investor: Acquisition Market Is Stirring--
Activity Is At Its Peak Of The Year, And Should Increase
We all know that it has been a slow year in the seniors housing and care acquisition market, and if these past few months have not been the summer of your discontent, we know who you can talk with to really get depressed. Everyone has been moaning about how inactive the market has been, the lack of financing and its cost and terms when available (with HUD the possible exception), the lack of high-quality product on the market (but few would want to, or be able to, pay the asking price anyway) and anything else they want to complain about. It is the worst market they have ever seen, or so goes the common opinion. Memories, however, seem to be short.
From the fourth quarter of 2000 through the third quarter of 2001, there was an average of just 10 deals announced each quarter in the entire long-term care industry. For the mathematically challenged among us, that is a little more than three deals per month. The dollar value was close to $600 million in that 12-month period. There was a spike just after this 12-month period, in the fourth quarter of 2001, with more than double the quarterly volume of the previous four quarters and more than $400 million in announced value, but fourth quarters tend to see a lot of action, especially if the first nine months of the year have been slow. The next quarter, the first quarter in 2002, saw the volume drop in half to just 12 deals worth $152 million.
So, how has the market fared in this current M&A recession? The short answer is, well, better. No one needs to be reminded that the market was slow in the first half of 2009, but just not as slow as the bottom of the market eight years ago. In the first six months of 2009, we have averaged about 14 announced transactions per quarter. While this is 50% below the last six months of 2008, it is still well ahead of the last market bottom. Dollar volume has also been higher (more than $600 million in the first half of 2009), but this has been helped by the large Sunwest Management portfolio sale to Lone Star in the first quarter this year. One similarity is that in both market periods the majority of inventory for sale consisted of underperforming properties or, if performing, lower-quality properties. Another similarity is that many lenders quit lending – eight years ago because they were licking their wounds from bad loans, while now it is because they either don’t have the money to lend, their own cost of capital is too high or they are worrying about their own capital structure (and usually all three). The main difference is that there are fewer properties today on the market that are new and just never filled up. There were too many of these in the last down cycle.
In looking at the most recent month, July, there were as many announced transactions in just one month (and we are talking about a summer month, no less) as there were in entire quarters eight years ago. We will get to these latest trans-actions in a moment, as well as those deals with bid dates at the end of July that will not close until the fourth quarter. The point is that despite the apparent weak market, acquisition demand is actually quite strong. Pricing may not be strong, and certainly nowhere near what it was two years ago, but the pricing disconnect between buyer and seller, which has been with us for nearly two years now, appears to be breaking down, at long last. Where it has not broken down, however, is where the seller really can’t sell at a "market" price because there will be no material advantage to do so or where the debt may be higher than the market value. Brandywine Senior Living and the 27-property Sunrise Senior Living (NYSE: SRZ) portfolio offered by Goldman, Sachs come to mind as ones where seller expectations have more to do with need than market forces.
The current buzz in the market is that the fourth quarter, but really the last four months of this year, will be the most active period of the past 18 months. We may be seeing upwards of 10 closings announced per month, if not more, compared with the miserly seven transactions in the entire fourth quarter of 2000. Part of the upward trend in deals will be the few dozen Sunwest Management properties that are just now beginning to come to the closing table, but there are plenty of other sellers as well. And, we are hearing that the volume of new listings or listing inquiries is picking up, which will have an impact on transaction volume in 2010. Combine that with the reality that most brokers don’t want to waste their time with unrealistic sellers anymore, you end up getting a market where the pricing disconnect begins to dissipate.
While there is still a market for "A" quality properties and portfolios (and why wouldn’t there be?), the purchase multiple has to be realistic today (8.0% to 9.5% cap rate, not 6.0% to 7.0%). So what is selling in today’s capital-constrained market? In one sentence, they are mostly underperforming properties with promise, performing properties in secondary and tertiary markets which are generally average and which often need some sprucing up, and usually they are sold at a substantial discount to replacement cost. Now, replacement cost value may not have much meaning in many of these markets, where they just aren’t going to be replaced or a competitor is not going to break ground anytime soon. But the discount to replacement cost is important to the buyer and lender because the capital cost "bogey" becomes that much lower, the deal becomes less risky and the loan amount is smaller on an absolute level as well as on a per-unit basis. In many of these cases, if the new operator only does half as well as he expects to do, it’s a good deal with decent coverage; if he makes plan, however, it becomes a triple if not a home run, the value will rise by 25% to 100% and the lender in this capital-constrained market will be asking the borrower when they are going to bring another deal to finance. You may think we are joking, but we aren’t.
This scenario will not last forever, and the buyer does need to understand the business, especially marketing in this occupancy-sensitive time period. But we are back to the buy low, sell high environment, as opposed to the buy high and hope it keeps going higher situation we had in 2006 through 2007 and a little into 2008. And there will be investors who will make a lot of money. Remember how many people thought Formation Capital was crazy to buy up everyone’s Florida skilled nursing facilities at the height of the liability disaster in that state? They bought when there were no buyers, often at 50% of replacement cost (or less), fought off the trial bar, tried to improve cash flow and rode out the storm and waited for a better market. The rest, as they say, is history. Just like March of 2009 may have represented one of the best buying opportunities ever in the public equity market, the 2009 to 2010 period may be one of the top three in seniors housing and care history.