The Federal Reserve is apparently
getting concerned about "the real estate bubble," although Mr. Greenspan
has not yet brought out from the dust-bin of financial history his
infamous phrase, "irrational exuberance." The public concern over rising
real estate values, of course, deals with the residential housing market,
especially those markets where the ratio of market value to annual rental
rate is closing in on 30x. But there is also a growing industry concern
over what is happening in the senior care market, except it probably will
not make the evening news anytime soon.
There is no question that the
acquisition market is hot right now, and the only other time is was this
hot was in the 1996 to 1998 period, perhaps climaxing in 1997 with four
senior care deals announced that were in excess of $1.0 billion each, and
all were in the skilled nursing sector. We all know what happened a few
years later, and while one was not completely responsible for the other,
periods of disruption often follow frothy markets when pricing gets a bit
exuberant, and the market now is both frothy and getting a bit carried
away with itself.
What is interesting is that there is
nothing close to unanimity in opinion regarding the current market
environment (is there ever?). On the one hand, there are those who believe
the senior care industry, in particular assisted and independent living,
is finally getting the respect that has been lacking in the investment
markets. The spread between traditional real estate investment cap rates
(office buildings, apartments, etc.) and seniors housing was always too
wide, or so the argument goes, and the narrowing of that gap is something
that has been welcomed, and totally expected.
On the other side of the argument are
those who question the reasonableness of the recent decline in cap rates,
believing the market has gone too far too quickly, and that the current
pricing has everything to do with external factors (such as investors
seeking yield, wherever they can find it), and little to do with the
unique risk level of and trends in the senior care business. Another way
to put it is to ask if the market is going through a structural change
(the first argument) or a cyclical change (the second argument). The
answer is, a little bit of both.
In the second half of last year, the
talk of the town was when cap rates for assisted living portfolios headed
to the 8% to 9% range, something unthinkable just a few years before. Less
than a year later, we are hearing of large transactions that may get done
in the 6% to 8% cap rate range. Some of these portfolios may have unique
features that make them particularly attractive, and valuable, such as
high-end locations (ocean views with little possibility of new competition
comes to mind), but when you get down to these levels, one has to wonder
where the upside is, especially if the reverse cyclical factors come into
play several years from now and values decline while cap rates and
interest rates rise. The depth of the so-called structural changes in the
market may last only as long as investors are making money. A repeat of
the 2000 to 2002 period would be enough to send even the most optimistic
investor packing.
What the aggressive pricing has done
is bring out the most portfolios of properties we have seen at one time in
more than a decade. In the assisted/independent living market, five
portfolios worth more than $1.1 billion have closed this year or are under
contract. In addition, four other portfolios worth more than $1.0 billion
are in the middle to late stages of being marketed. Two of these, we hear,
may be going for more than $300,000 per unit, and will be competing for a
new pricing record.
In addition to the two skilled
nursing companies that are under contract (see below), there are at least
nine other nursing facility portfolios on the market, ranging from five
properties to almost 40. These have a combined market value of close to
$800 million, to which one must add the $2.0 billion Beverly
Enterprises (NYSE: BEV) auction that has entered its second round.
Estimated cap rates for the higher quality nursing home portfolios are in
the 10% to 12% range, compared with 13% to 15% as a national average every
year for the past 15 years for the nursing home market as a whole.
There are both similarities and
differences between the current market and the last great bull market in
senior care during the mid-1990s. What is the same, besides declining cap
rates, is the competitive nature of the bidding and the abundance of
capital. Ten years ago, it is fair to say, the lending market was a bit
loose, and the public equity market was either stupid or naïve, and in
some cases both.
What is different in today’s market
is the amount of equity going into many of the portfolio transactions, and
the higher quality of the real estate in those deals. The increased equity
started a few years ago when lenders, still recovering from the previous
financing debacle, required it, but soon the higher equity levels were the
result of more financial buyers coming into the market, particularly real
estate investors attracted to the higher yields offered in seniors
housing. Like many things, this could be a double-edged sword, because
unlike buyers who are operators, many of these investors usually have a
certain time horizon in which they expect to realize their gains with the
sale of the properties. The double whammy, of course, and what the worried
market participants are fearful of, is the disruption that could occur if
these investors end up selling just when the cycle is in a downward
period, worsening an already troubled market (in theory).
Six months ago, when talking about
the recent buying spree at higher than usual prices, we quoted an
anonymous source as sarcastically asking, "So what’s the exit strategy,
$200,000 per unit?" Given where cap rates and prices are going this year,
the proposed exit strategy may have to be $300,000 per unit, or even
higher in at least two cases. Let’s hope the froth does not turn into
blood.
