Going, Going, Gone… Sold To The Lucky Bidder?
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.
Companies Mentioned in this issue:
June 2005
Aegis Assisted Living p10
Alterra Healthcare p9
Asset Real Estate & Investment p8
Atria Senior Living p8
Behrman Capital p9
Beverly Enterprises p2
Brookdale Living Communities p9
Cambridge Realty Capital p12
Canyon Creek Development p8
CB Richard Ellis p9
Columbia-HCA p9
DeMuth, Folger & Wetherhill p4
Diakon Lutheran Social Ministries p9
Extendicare Health Services p6
Fannie Mae p11
Fortress Investment Group p10
GE Commercial Finance Healthcare Financial Service p12
GMAC Commercial Mortgage p11
Granite Investment Group p12
Greystone Communities p6
Greystone Servicing Corporation p12
Guaranty Bank p11
Harborside Healthcare Corporation p5
Health Care Property Investors p10
Health Care REIT p12
Hobart Retirement, LLC p11
HUD p11
Investcorp International p6
JCH Inc. p8
JER Partners p12
LaSalle National Bank p9
Lifestyles, LLC p11
Manor Care p5
Marcus & Millichap p6
Marriott Senior Living Services p7
Mercantile Bank p6
Meridian Retirement Communities p11
Merrill Lynch Capital Healthcare Finance p8
Nationwide Health Properties p12
Oakdale Heights Management p8
Oakmont Senior Living p10
Peak Medical Corporation p4
Proformance Senior Living p8
Red Mortgage Capital p11
RFE Investment Partners p4
Senior Living Investment Brokerage p10
Senior Resource Group p11
SeniorCare, LLC p5
Smith/Packett Med-Com p8
Starwood Capital p11
Sun Healthcare Group p3
Sunrise Senior Living p6
Sunwest Management p8
Tandem Health Care p9
The Forum Group p7
The Fountains Continuum of Care p7
Trisun Healthcare p12
Universal Health Realty Income Trust p12
Ventas p12