The SeniorCare Investor: M&A Market Is Not Dead--
Sales Volume In 2009 Will be Better Than Expected
By the middle of 2009, most everyone had written off the seniors housing and care merger and acquisition market as dead, or at least in hibernation, until the credit markets showed some new strength. No one could remember a period as slow as the 2009 market, and all we could say was that memories seemed to be far too short.
Admittedly, 2009 was slow, especially in the first half of the year. But the worst year was 2000, and at least in number of publicly announced seniors housing and care transactions, we passed the total volume for that full year by September 30, 2009 and should top it by at least 40% (yes, that much), if not more, if December closings occur as expected.
The dollar volume of "announced" transactions will also be higher in 2009 than in each of the four years from 1999 through 2002, which was the real bear market in this sector. In that period, the annual dollar volume ranged from $1.5 billion (twice) to $1.9 billion. We have already surpassed the $2.2 billion mark so far in 2009, which includes the approximately $1.2 billion Blackstone deal for the Sunwest Management portfolio but excludes the stalking horse bid for Erickson Retirement Communities, which is somewhere near $500 million depending on what debt is assumed. Neither of these is expected to close this year, but we track the market volume based on announced deals. Obviously, if the Blackstone transaction is removed the dollar volume drops significantly, but no one thought we would see a billion-dollar transaction in 2009 anyway, so that says something about the underlying strength of the market.
There were two primary factors limiting the transaction volume in 2009: the so-called pricing disconnect between seller and buyer, and the difficulty in obtaining financing once an acquisition was found. Another obvious problem was the lack of supply of properties that buyers really wanted, but this was really a result of the first two issues. It has taken a while, but the pricing disconnect seems to be dissipating, both as buyers are beginning to get a bit more aggressive and comfortable with the market and, more importantly, as the sellers are realizing that we will not see the pricing of the 2006 to 2007 period ever again, or at least not for quite some time. Consequently, if they have any inclination to sell, they are not holding out for those 5.5% to 6.5% cap rates on next year’s cash flow. But with each quarter, at least for the better-run companies and properties, the cash flow should be increasing, even in this environment, so a 6% cap rate on the cash flow of 18 months ago may be equal, in value, to a 6.5% or 7.0% cap rate today. And if there is any incentive to sell in the near future, it will be the fact that the current capital gains tax rate will be the lowest we will see for many years, if certain congressman and a resident of the White House have their way later next year.
On the financing side, debt is available, it is just more expensive than what buyers became accustomed to a few years ago, with terms and equity requirements they don’t particularly like. As a result, HUD has seen more activity than it can handle at this point with its current staffing, and Fannie Mae and Freddie Mac have been consistent players outside the skilled nursing side of the business. But that is not enough to make for a liquid acquisition market, and if any one of these three lenders stopped participating, the consequences would not be fun. For maturing loans, lenders have been "kicking the can down the road" if the borrower is current and not forcing a refinancing if one does not exist. The same can seems to be getting kicked down the road for closing a sale, often because of the financing issue. This is why we are seeing more all-cash deals lately, including several described below. In this market, sellers have been taking lower prices to remove the financing risk from a buyer’s list of contingencies. There is a price for certainty, and that price is as high as it has ever been.
Everything is pointing to a more robust acquisition market next year, everything except the impact of a further meltdown of the commercial property and mortgage market. The good news is that seniors housing loan portfolios are looking pretty good right now, both on their own as well as relative to other real estate asset classes. And the largest problem debtor—Erickson Retirement and the various not-for-profits associated with it—consists mostly of tax-exempt bonds which are under water. Even Sunwest Management will presumably be a thing of the past by early next year. Demand in the acquisition market is only growing, and while there may be fewer cherries in the bowl right now, the bowl will start to fill up next year as the seller logjam finally begins to break.
In addition, many buyers are counting on an influx of distressed high-quality CCRCs coming on the market in 2010 and 2011 as they begin to default on their tax-exempt bonds because fill-up expectations were not met. That may or may not happen, but the buyer market for these types of communities is much smaller than for the rest of the market, even at 50 cents on the dollar, and the buyers tend to be more discriminating on the location and design. So we project that the dollar volume of announced transactions this year will be in the neighborhood of $2.5 billion, barring any unusual deal in the closing weeks. That dollar amount happens to be what the dollar volume was in 2003, which was the last time the acquisition market was struggling to get out of its recession. The difference, and it is not an insignificant one, is that the industry fundamentals are much better today than they were in the 2002 to 2003 period.