While some may argue that size matters, others claim it is occupancy. No one will dispute the benefits of size, especially if it is filling in a region that needs some attention, but limping along with no idea how best to deploy your assets, financial or otherwise, does not make much sense.
In today’s market, size certainly does matter, as buyers are aggressively bidding up prices for portfolios, often exceeding the already high expectations set by the sellers and their advisors. But most of the portfolios, at least in the assisted living side of the business, that have come onto the market in the past 12 to 18 months have been of much higher quality than the market as a whole. And in most cases, they have been stabilized and they have been very profitable.
With the influence of “financial buyers” on the market increasing in the past two years, sentiment has changed with regard to risk. Few of these buyers are really interested in buying a portfolio of properties that are underperforming, with weak occupancies and cash flow, even if the potential long-term returns are greater than for other transactions, and with a smaller amount of capital required.
Quite simply, they are just not interested. But give them a portfolio of newer, 94% occupied facilities with a solid cash flow that is 8% better than the previous stabilized year, and you will see cap rates decline below 9%, and perhaps below 8%.
As can be seen in the graph on page 1, reproduced from our 10th edition of The Senior Care Acquisition Report, the average prices paid for stabilized versus non-stabilized assisted living facilities have been significantly higher in the past two years, which is logical. Both data groups include single property sales and portfolios, as well as newer and older facilities. But the more than $40,000 per-unit difference in price paid helps explain what is happening in the current market.
The decline in cap rates that everyone is agitated about is really just a decline in the high-end, stabilized properties, especially the portfolios. The “risk averse” buyers are more willing to buy something at a cap rate of 7.5% to 8.5% if it is stabilized with strong cash flow than buy at a 12% cap rate (or higher) if it has occupancy and cash flow risk. Basically, many don’t even want to consider the latter buying opportunity. The turning point in this market froth will be when the buyers are willing to pay the same top dollar, and low cap rates, for lesser quality properties as they are for the high-end facilities.
The sellers, with dollar signs in their dreams, are already beginning to demand it, but we assume there will be some resistance. We know of one case where a broker walked away from a potential portfolio assignment because the seller’s price expectation was almost twice as high as the broker’s own estimate. That’s just too large of a discrepancy, and a sign that things are getting out of hand.
In the skilled nursing facility market last year we witnessed a similar phenomenon, as stabilized facilities sold on average for more than $56,000 per bed, compared with just $32,000 per bed for non-stabilized ones. We would be remiss if we did not mention that many of the stabilized facilities were also in high-cost real estate markets, especially in the Northeast.
But full facilities, with strong and stable cash flows, are a valuable commodity in a market that has been dominated in the past several years by struggling nursing facilities, usually built 30 years ago, with an over-reliance on Medi-caid reimbursement. The difference between the two markets, however, is that cap rates for skilled nursing facilities have not experienced the same downward shift as assisted living facilities, even for the high-end properties. Even in this market, buyers are mindful of the risk being undertaken when the majority of their revenues are derived from the government.