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November 2004 issue
For Sale: The Market Revs Up, With More
Buyers Willing To Pay Top Dollar
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For Sale: The Market Revs Up, With More Buyers Willing To Pay Top DollarWe ended the third quarter with two aggressively priced assisted living deals involving multi-facility portfolios, with the pricing based on very specific reasons for the buyers involved. Eyebrows were raised, heads were shaking and phone lines were abuzz with excitement as details spilled out. After a slow first half of the year, it really seemed as if the acquisition market was heating up at last, but little did we know. And then, on the eve of the 14 th annual NIC Conference in Chicago, AEW Capital Management made its long-awaited announcement regarding a major portion of its Benchmark Assisted Living portfolio. Speeches were altered, year-to-date statistics were asterisked and conference participants began to think they had walked into a twilight zone of raised expectations in the acquisition market, especially with regard to cap rates and valuations.We had heard during the summer that AEW had turned down an offer for several Benchmark properties in its AEW Partners II opportunity fund at a sub-9% cap rate, a deal that sounded too good to be true at the time, and one that most of us thought should be taken before it disappeared. But it appears that AEW’s team knew exactly what they were doing, and held out for a better deal. Legg Mason Real Estate Services found Kuwait Finance House (KFH), Kuwait’s first Islamic bank, which was incorporated in 1977 and now has more than $11 billion in assets, to buy the 11 assisted living facilities in the Northeast for $148 million, or just under $196,000 per unit. GMAC Commercial Mortgage provided $105 million in financing for the acquisition. KFH, which is publicly traded but with a 49% stake held by the government, is fully compliant with Islamic laws and consequently looks at investment opportunities a bit differently than most real estate investors. The 11 facilities are located in all six New England states, with three of them being acquired and eight developed, although there have been some renovations on a few of the existing buildings. AEW’s original investment was in late 1997, with the last one in 2001. The portfolio, with 756 units, had an overall occupancy of over 95% with, apparently, plenty of room for decent rate increases above inflation. Although one facility had independent living units, most had a significant amount of Alzheimer’s units in addition to the traditional assisted living. Even though financial data was not disclosed, we believe that EBITDA was in the neighborhood of $12 million. The best we can determine is that the cap rate based on trailing 12-month cash flow was close to 8%, with the pro forma cap rate between 8% and 8.5%. Although we became accustomed to these levels last year when CNL Retirement Properties was snapping up $1 billion in assets, CNL’s portfolio acquisitions were not stabilized so there was the expectation of significant increases in cash flow as the facilities filled. Because these 11 properties are already above 95% occupancy, however, the Benchmark deal was viewed differently by the market and has perhaps set a new pricing standard. One argument claims that the low Benchmark cap rate is a giant step forward in lowering the spread between seniors housing cap rates and cap rates for other real estate classes. The other side of the argument, however, especially with the buyers who operate as opposed to the financial buyers, is that the risk premium for seniors housing is warranted because it is a much more difficult business than operating hotels, apartment buildings or shopping centers. If that premium shrinks too much, the argument goes, the risk of financial disruptions down the road goes up. It may take a while to find that new, lower level of risk premium that is realistic for all parties. But that’s the problem. As we wrote in February, the acquisition market is becoming increasingly divided by the required rate of return of the financial buyers compared with that of the operators seeking to grow by acquisition. One of the unintended results of attracting new capital to the market is the bifurcation of the acquisition market, something that no one really thought about. The Benchmark deal is of importance to the industry because the AEW fund was maturing and it was time to start selling assets and returning the capital to the investors. But the investors certainly got more than just their original capital back. AEW’s targeted net annual return to investors was 20%, but with this sale of 11 properties they exceeded that by at least a few hundred basis points. That does not include, however, AEW’s more than 20% ownership interest in the Benchmark management company, which will be gravy whenever that is cashed out. This level of return is certainly going to get the attention of other institutional investors, many of whom have been struggling to achieve annual returns in excess of 10%. We assume AEW will use this as an example to convince other fence-sitting investors to get into this sector sooner rather than later, and they should be commended for doing so well, especially since AEW jumped in just before the market took a fall as a result of overbuilding and careless financing. AEW is not done, however. In its AEW Partners IV fund there are the last four remaining Benchmark facilities. We believe that at least three of the four properties, all of which are in Massachusetts, were developed by Benchmark CEO Tom Grape’s previous company in the mid-1990s. They were last purchased for approximately $64 million in late 1998, or more than $160,000 per unit, and Benchmark took over management in late 2003. We understand that Kuwait Finance House may be buying these assets as well, but there has been no rumored price. AEW also has a few other non-Benchmark seniors housing properties that are about to go on the market. Timing is everything, and in the past five years there has been no better time to sell than now.
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