The SeniorCare Investor

October 2004 issue

Two Regional Companies Cash Out, But More Are Expected
Five Star Quality Care is the winning bidder for LifeTrust America, and Benchmark Assisted Living quietly negotiates a family-friendly acquisition of a large New England assisted living company. Both deals are valued over $100 million, and we expect to see more of the same over the next 12 months.
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Other Assisted Living Deals
From California to New York, several single facility transactions were completed, with Carlyle Senior Housing completing the largest of the month. See page 4
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Independent Living Market
Two CCRCs are sold, plus a retirement community in Oklahoma with room for expansion. See page 5
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Skilled Nursing Market
In a busy month for the SNF market, eight facilities in six states are sold. See page 6
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Financing Market
A senior care-related company files for an IPO, and two private firms structure financings in excess of $100 million each. See page 10

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Companies Mentioned in this issue:
October 2004

AEW Capital Management p.11
Atria Senior Living Group p6
Aurora Health Care p.6
Bank of America Ventures p.2
Benchmark Assisted Living p.3
CalPERs p.11
Carlyle Senior Housing p.4
CB Richard Ellis p.4,6,8
Centre Partners p.2
Citizens Bank p.6
Clayton Associates p.2
CLW Health Care Services Group p.8
Coleman Swenson p.2
Credit Suisse First Boston p.8
Deutsche Bank Securities p.11
Eagle National Bank p.8
ElderLife Financial p.11
Emeritus Assisted Living p.11
Fannie Mae p.2,10
Five Star Quality Care p.1
Fortress Investment Group p.10
G&L Realty p.4
GEM Investors, Inc. p.11
GMAC Commercial Mortgage p.2
Grannie Mae p.11
Greenfield Partners,LLC p.4
Guaranty Federal Bank p.2
Health Care Property Investors p.1
Healthcare Transactions Group p.7
HealthEssentials, Inc. p.11
Kindred Healthcare p.6
LifeTrust America p.1
Manorhouse Retirement Centers p.2
Marcus & Millichap p.5
Mariner Health Care p.8
Merrimack Health Group p.6
Morgan Stanley Capital Partners p.2
National Benevolent Association p.10
National Senior Care p.8
Newton Senior Living p.11
Piper Jaffray p.11
Prime Care Properties p.2
Principal Senior Living Group p.5
Red Mortgage Capital p.10
Retirement Investment Properties p.4
Richland Ventures p.2
Salem Equity p.5
Senior Housing Properties Trust p.2
Senior Living Investment Brokerage p.7
Senior Resource Group p.10
Skilled Health Care Group p.7
Sunrise Senior Living p.11
The Quality Management Group p.8
The Shelter Group p.6
The Village at Manor Park p.6
Vencor p,11
Vestin Mortgage p.7
Village Retirement p.3
William Blair & Company p.11

In a development that has been anticipated all year, the owners of two sizable assisted living companies decided the time was right to sell their companies to larger entities and let the new owners grow them further. At this time last year we said that there were many regional companies that were getting to the point where they would have to raise new equity to continue growing, and that if they were large enough the public equity market was friendlier than it had been in years for senior care companies.

The alternative, of course, was to sell, which makes a lot of sense if your facilities are stabilized (or close to it) given the relatively low cost of capital for buyers and an environment where cap rates appear to be declining. We expect more selling in the months ahead.

In the first, and largest transaction, Five Star Quality Care (AMEX: FVE) has agreed to acquire LifeTrust America (LTA) in a transaction valued at $208 million. Based in Nashville, Tennessee, LifeTrust was founded in 1996 and is selling its portfolio of 47 assisted living facilities, with an independent living and Alzheimer’s component, with 2,636 units in seven southeastern states. Four of the 47 properties with about 190 units are currently leased from Health Care Property Investors (NYSE: HCP), while the remaining 43 are owned. In addition, LTA manages 12 assisted living facilities for third- party owners, 11 of which are owned by Indianapolis-based Prime Care Properties. FVE would obviously like to retain these management contracts, and there is a good chance they will, but it is doubtful that the cash flow from the management contracts influenced the purchase price.

LifeTrust built the majority of its facilities, but in late 2002 it bought nine of the former Manorhouse Retirement Centers properties, four in North Carolina and five in Virginia. These communities, with 834 units, average more than twice the number of units in a typical LifeTrust facility, and at the time of the acquisition, the overall occupancy of these nine was 85%, with three of them in excess of 95%. As part of that acquisition, LifeTrust assumed five HUD loans and four loans by GMAC Commercial Mortgage and Guaranty Federal Bank, a portion of which will in turn be assumed by FVE in the current transaction. In addition, the investors in Manorhouse, Bank of America Ventures, Richland Ventures and Centre Partners, received a minority equity stake in LifeTrust as part of that deal, but only one or two may have stayed in. They joined Morgan Stanley Capital Partners (the controlling investor with nearly a two-thirds interest), Clayton Associates and Coleman Swenson, as well as management, as the investors in LifeTrust.

And now to some details of the transaction. After removing the four leased properties, it looks as if FVE paid approximately $85,000 per unit for the portfolio. We have estimated total revenues for the 47 facilities to be in the $75 million to $80 million range, with EBITDARM to be close to $25 million, for a 30% to 33% operating margin. That would put the price to revenue multiple at just over 3.0x, which is where it should be for a portfolio such as this. The cap rate is a little more difficult to determine, but after deducting a 6% management fee from revenues, and an apportioned amount of EBITDAR for the four leased facilities, we derive a cap rate that is close to 9%. This is aggressive, even in today’s market, but it is becoming more of a requirement for buyers that want to buy new, and mostly stabilized, portfolios of assisted living facilities. If the management contracts can be retained, that would add over $1 million of revenues, some portion of which would go to the bottom line.

As of June 30, 2004, the LifeTrust portfolio was 85% occupied, but that has moved up a bit to the 86% to 87% range now. The key, of course, will be for Five Star to get that number above 90%, which would provide an additional $2.0 million to $2.5 million of cash flow and take the pro forma cap rate closer to 10%. Five Star has stated that for the first six to 12 months the acquisition will be neutral to earnings and start to be accretive by the second half of 2005. This may be conservative to provide a little goose to future quarterly earnings, which is typical, but perhaps not too far from the truth after you break down the cost of financing the deal.

Senior Housing Properties Trust (NYSE: SNH) has committed to purchase, on behalf of FVE, 35 of the 47 facilities with 1,880 units for $165 million, or just under $88,000 per unit. These properties produce EBITDARM of about $17.9 million, and SNH will lease them back to FVE at an initial annual lease rate of $14.9 million, or a 9.03% initial yield and a 1.2x coverage. As part of the transaction, SNH will assume $49.5 million of LifeTrust’s debt, mostly GMAC and Fannie Mae, with an average interest rate of 6.75%, and pay off approximately $100 million of debt, using its own cash and an unsecured revolving credit facility.

After deducting the $165 million from SNH, there remains $43 million of the purchase price to be financed. We believe that between $30 million and $40 million of HUD debt will be assumed, which means that Five Star may be putting less than $10 million of cash into the deal. That is one of the reasons why this transaction makes sense for FVE, and the amount of leverage is the primary reason why the deal will be at just breakeven during the first year.

As far as the LifeTrust investors are concerned, comparing the price with the amount of debt that is being assumed or paid off, they are certainly not going to brag about this one. We hear that they are telling people that they got their money out of it, but that may be optimistic. The transaction was competitively bid, however, and they got the best deal possible. The key for Five Star will be controlling costs, integrating the management of these facilities and getting over the 90% occupancy hump. Not an easy task, but it can be done.

In the second significant corporate transaction, Benchmark Assisted Living announced that it reached an agreement to purchase nine communities owned and operated by Rhode Island-based Village Retirement. Founded 15 years ago, Village Retirement operates two communities in Rhode Island, six in Connecticut and one in Massachusetts with a total of 1,160 units. The units are mostly traditional assisted living and Alzheimer’s, but with some independent living units as well. The prototype community is very different from the LifeTrust facilities because each property has over 100 units, and the last two that were built have 150 units each.

Although no financial terms of the transaction have been released, we believe the purchase price to be between $150 million and $160 million, or above $130,000 per unit. The portfolio has an occupancy rate of 91%, which includes the two 150-unit facilities built in the past two years that are at 80% occupancy and still filling up. The other seven are at 95% occupancy. Revenues in 2004 will be close to $40 million, but should reach $45 million next year.

Depending on which revenue figure is used, the price to revenue multiple is between 3.5x and 4.0x, which is on the high end for assisted living, but the units also include independent living, which usually has higher revenue multiples. We do not know the level of cash flow, but given some industry standards on margins for stabilized properties, our estimate is that the cap rate is somewhere in the 8.5% to 9.5% range on 2005 estimated cash flow, a year that will not be fully stabilized. The cap rate should be higher based on stabilized cash flow beginning in mid-2005.

To finance the acquisition, Benchmark is assuming the existing loans in the amount of $57.5 million on five of the properties and has received a financing commitment from a lender for the other four. The equity is being provided by two investors, including an investment fund managed by Greenfield Partners, LLC, and Benchmark has formed a joint venture with these investors to complete the transaction.

This deal will get criticized for being too expensive, both on a per-unit and a cap rate basis, but it also says something about how hungry the market is for quality assets. And that has been the problem these past few years—there have been so few higher-end, and stabilized, assisted or independent living facilities available for sale that buyers are willing to pay top dollar for the good ones, especially if they make so much strategic sense. This acquisition works well for Benchmark because it increases the number of units under management by 60%, and they are all in the company’s backyard, making it the largest assisted living provider in New England. The company’s revenue run rate for 2005 is close to $150 million, but we wouldn’t be surprised to see that jump with another acquisition.

The company has a relatively unique structure as most of the properties it buys or builds are actually owned by a few different joint ventures with different equity backers, but with Benchmark also participating in the real estate ownership. The deal for the Village Retirement properties is no different, with the two new investors providing the equity capital, and Benchmark providing management services. We hope to check in this time next year and see what the cap rate comes out to on 2005 cash flow.

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