Although it takes a few days to catch up on the lack of sleep, at least for those of us who like to wander the hallways and hang out in the lobby until the wee hours, trying to get a whiff of the latest rumored deal or transaction detail, the annual NIC Conference is always a good source of information as well as a barometer for how the senior care industry is doing. Judging by the record number of attendees (more than 1,600), and the nearly exuberant atmosphere, it is safe to say that all is well, at least for now.
The hot topics, of course, were plunging cap rates, record per-unit prices paid in the market, the sheer volume of deals on the market, the unprecedented supply of capital and, finally, the fate of Beverly Enterprises (NYSE: BEV). In “the good old days,” which some people may think was just last year, cap rates for senior care properties were believed to be fairly standard by property type, such as 9-10% for independent living, 11-12% for assisted living and 13-14% for skilled nursing. Not only have the ranges dropped, but they have widened considerably and nothing is “fairly standard” any more. As Tony Mullen joked in the “Build vs. Buy” session at the conference, when someone states what a cap rate is, there are up to 12 follow-up questions to find out what they really mean. In our analysis of one sale this month, the theoretical cap rate ranges from 6.2% to 8.0% depending on which period is being used as well as what assumptions are applied. But at least you know some of the background so you can pick what you think is the most appropriate one for your own purposes.
Historically, when deriving cap rates, the EBITDA number we like to use is the most recent annualized period that best reflects the financial condition of the property and what the buyer thinks he is purchasing. Appraisers tend to deduct a “replacement reserve” from EBITDA, either a fixed percentage of revenues (1%) or a per unit amount ($300 per unit). Years ago, we decided not to include this deduction because it made little sense to have a similar reserve for a two-year old property as for a 15- or 20-year old facility. Also, we assume ordinary, ongoing repairs and maintenance to be in the operating expense numbers, while major capital projects would not be. As an example, a roof repair can be expensed, but a roof replacement is capitalized.
The more difficult analysis, especially for non-stabilized or underperforming (for whatever reason) properties, is what 12-month period of cash flow should be used to derive an acquisition’s cap rate. While most of the sellers in some of these recent high-end deals today would say the deal was done at a 6% or 7% cap rate, the buyers would probably say it was a 7% or 8% cap rate, if not higher. The reason is quite simple, other than market appearances, of course. The seller has a short time horizon and will never see the higher cash flows, so he is more apt to look at how the property is performing today, or will be performing next quarter. The buyer, on the other hand, will be owning the property for five, 10 or 15 years, and is purchasing it based on that time horizon, not what it will do next quarter. And in an upbeat market, such as today, it is easier to buy based on a positive forecast, and pay the seller for your future work. In a down market, buyers rarely will pay for the upside, despite the moaning and groaning from the seller.
But what is happening is that almost any price can be “justified” today because an appraiser or other consultant can use a variety of transactions to “get there.” In one recent appraisal report we came across, the sale-derived cap rates ranged from 7.8% to 11.3%, and for properties ranging from IL/AL, to stand-alone AL to assisted living with dementia units and skilled nursing beds. Applying an average cap rate from this group of sales is rather meaningless, but is happening every day. The cap rate controversy will not end, but as Tony said, remember to ask a lot of questions. Unfortunately, they may not all be answered.
So, what did we hear along the corridors and at the receptions at NIC? Regarding the “AEW Portfolio” of 15 assisted living facilities, being handled by CB Richard Ellis, Health Care Property Investors (NYSE: HCP) is looking to be the winning bidder (no price yet) and will most likely tap Brookdale Senior Living as the operator, according to the gossip, and it may take a while to close. The consensus view on the sale of Brandywine Senior Care, being handled by Houlihan Lokey, is that Dan Strauss and his Care One Realty will be buying the nine skilled nursing facilities for about $125 million, and that Warburg Pincus will be buying the nine assisted living facilities for about $150 million, and retaining Brandywine management to operate them.
Everyone was talking about the Hearthstone Assisted Living portfolio, also being handled by CB Richard Ellis. The best and final bids are in, but we had some old information in our last issue. The overall occupancy now stands at 92%, not the 83% we mentioned, and most people have heard that the price will be above $500 million. Market participants have commented on the high (70%) proportion of semi-private units in the Hearthstone portfolio. Coincidentally, last month the NIC came out with a study from its MAP Monitor program that showed semi-private units, on average, achieved 52% more revenue per unit than private units, or $1,473 per month more. That may be the driving factor in the pricing for Hearthstone.
First round bids were scheduled to be due the first week of October for the Cypress Senior Living portfolio as well as for a five-facility assisted living portfolio in the Midwest, both being handled by CB Richard Ellis. In the new portfolio side of the transaction business, Senior Living Investment Group is about to hit the market with a portfolio of assisted living facilities in the Southwest, and CLW Health Care Services Group will begin marketing a portfolio of retirement communities. And like the Energizer Bunny, CB Richard Ellis is coming to market with a nine-facility portfolio, consisting of more than 770 assisted, independent and Alzheimer’s units in several western states, eight of which are managed by Vancouver, Washington-based LifeStyles, Senior Housing Managers, LLC.
And finally, to Beverly Enterprises. Although we were not surprised not to see any Beverly senior management at the conference, it is quite possible they could feel the vibes coming from Washington. It was a little disappointing, because no one really had any concrete information on the proposed sale to Leonard Grunstein. A month ago, we assumed it was a done deal. But not so fast, as everyone now knows that Beverly was forced to grant the buyer a 60-day extension to come up with its equity. The sentiment at the conference was that the deal is derailing, with potential equity backers becoming more scarce. As far as we know, Formation Capital has not made “the call” to Fort Smith, and Bill Floyd’s ego would probably prevent him from calling Formation, or any of the other bidders, if they exist.
In a recent message to Beverly employees, Mr. Floyd stated, as FACT ONE, that North American Senior Care “has stated its intention to retain BEI’s various businesses, including BEI’s eldercare service businesses, and to keep BEI’s headquarters and company-support functions in and around Fort Smith.” First of all, if it’s not in the merger agreement—and we haven’t found it—the statement is somewhat meaningless. Second, equity investors are going to be hard pressed to put $350 million into the deal without knowing how costs are going to be cut and capital raised to pay off the new debt, which would be hard to do without making some fundamental structural changes to the company. A sale of Beverly will occur, but the odds now favor a slightly lower price, and a new buyer.
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