It Was A Year That Could Have Had A Different Ending
Almost everyone is in agreement about one thing—we are all glad 2009 is behind us. After that, most of us are happy that we survived the year. As we were approaching the end of the first quarter of 2009— when the stock market continued its plunge from the previous quarter, when life as we thought we knew it seemed like it was in for a big change, when it looked like we were going to have a new spate of major bankruptcies just like we did at the beginning of the decade—something happened.
People started to look up from their monitors, check their own businesses, review their internal spread sheets, call their friends in the business and then pinched themselves. While they may not have been in Kansas (other than Tim Buchanan), they had survived the surreal previous six months, and many did better than survive. We remember at the height of the economic downturn calling several private companies to check in on how they were dealing with the crisis. What struck us the most, and what was the turning point in our view of what the future would hold, was that many of these private companies had not seen much of a downturn in their businesses. Sure, occupancy may have dipped by 50 to 200 basis points for some of them, but there were just as many whose occupancy levels had held steady and even a few that had small increases. After all, the flu season can impact occupancy by more than 200 basis points, especially at those communities with fewer than 50 units. There was some common agreement that they had to work harder to fill their units, and often (but not always) had to use a variety of incentives to drive census, but there was no sense of panic.
Occupancy was one concern; the other big shoe that was supposed to drop was refinancing risk. Because of the banking crisis, and the virtual closing of the debt markets for a while, fear spread that as mortgage debt matured, there would be nowhere to go, and defaults would begin to balloon as values plunged, much like the residential housing market. The difference was that in our sector, these mortgage loans were still performing (with some obvious exceptions such as Sunwest Management), and lenders had the option to “kick the can” down the road, and when necessary, that’s exactly what they did. And why not? One commercial bank lender told us his credit committee loves the seniors housing group. Why? Because it was the only real estate-oriented part of the bank that was still performing, and with no losses. This is just one of the reasons why we believe that the seniors housing and care sector will emerge from this economic and credit crisis not only with its reputation intact, but with a stronger footing than perhaps all the other real estate sectors, and probably with a brighter long-term future as well. One caveat, of course, is that as other real estate areas take longer to recover, we will see an onslaught of “outsiders” enter the senior living market, riding the demographic wave, even though we all know that the wave does not start to really gather strength for another five to 10 years and does not start to peak until about 2030.
During the first half of 2009, the investment focus was on the negative, looking for any reason to sell a stock, not to buy a property, not to finance an acquisition and so on. By the second half of the year, everyone seemed to be looking for that positive bit of news, that occupancy declines had leveled off, that rate incentives were dissipating, that changes in Medicare reimbursement really were not going to be as bad as they could be, that states were not going to slash Medicaid rates, that yes, the HUD LEAN program was really going to work. By September, most of the news was turning positive, with the exception of the Erickson Retirement Communities bankruptcy filing, but industry insiders had known for a year that trouble was brewing with that company, so it was not a big surprise, despite the black-eye for the CCRC sector. And investors also started to focus on what didn’t happen: Sunrise Senior Living (NYSE: SRZ) did not file for bankruptcy protection, no publicly traded company defaulted on its debt, the GAO seemed to have more important things to do than investigate the merits of private equity ownership of skilled nursing facilities. They also focused on what was beginning to happen: large transactions were occurring again, private equity was knocking on the industry’s door again, lenders were becoming a bit more visible, occupancy levels started to rise (at least for some companies) and public equity values were on the upswing, and in a major way.
One of the problems we, as an industry, have is that a very small percentage of seniors housing and care assets is controlled by publicly traded companies. This means that these companies are scrutinized every quarter to decipher what the trends may be, but they represent such a small proportion that their results may be somewhat misleading as a guide for what is happening in the rest of the industry, especially in a time of economic turmoil. Take what happened to their stock values. Brookdale Senior Living (NYSE: BKD) plunged by 80% in 2008 and then dropped by another 57% in the first quarter of 2009 to hit a low of $2.50 per share. Was that realistic? Was business really so bad to warrant that? Were its lenders really going to force it into bankruptcy or some other recapitalization despite being current on its obligations? It all seems like a distant memory now, especially when BKD’s share price is now more than seven times higher than it was in March of 2009, just nine months ago. Is the business environment seven times better? Occupancy? Cash flow? No. There was simply an exaggerated fear that business could get really bad, even though it hadn’t deteriorated all that much. And Brookdale was not alone, just the biggest.
The only stock that should have been punished to the extent that it was, and where the low price reflected the reality of the situation, was Sunrise Senior Living, because there was a real threat of bankruptcy and practically every part of its business was having problems, big and small, but mostly big. But Sunrise’s problems were particular to that company and really had little to do with the rest of the industry, and we have been through their problems too many times in the past so we won’t bring them all up now.
One only has to look at the table on page 2 to see some of the absurdity of last year. Despite its gyrations (or because of them), Brookdale’s shares were the best performing among the seniors housing stocks with a 226% return in 2009. Number two was Five Star Quality Care (NYSE: FVE) with a 127% return, followed by Sunrise with a 92% return. These latter two stocks started the year below $2.00 per share, which exaggerated their percentage returns for 2009. Perhaps it is simplistic, but values basically returned to “normal” by the end of the year.
In the skilled nursing sector, there was much more of a mixed bag, but their values never swirled up and down like the IL/AL stocks did in 2009, and the negative ramifications of the real estate market were never felt, and they shouldn’t have been. Advocat (NASDAQ: AVCA) led the group with a 161% return, but it was the only company in the sector that started the year at such a low price that any upward movement resulted in outsized gains. There were also rumors that someone was making a play for the company, which would not be hard to do since its market capitalization is so small relative to its peer group. Of the larger companies, Kindred Healthcare (NYSE: KND) had the best year with a 42% return, and kudos should go to Paul Diaz and his team for weathering the political and economic storm. The skilled nursing sector continues to be under-appreciated in the investment market, but the stability has been somewhat remarkable after the blowup at the beginning of the last decade. With rumors about a possible IPO from HCR Manor Care, seeing that company’s recent financial statements might just be the incentive investors need.
We could not conclude without a mention of health care “reform.” The seniors housing industry may not be impacted too much, other than how these changes (whatever they may end up being and assuming they are ultimately passed) impact the economy, the debt markets, the financial condition of seniors, inflation and anything else. Our fear is that the impact will be negative across the board, at least by what we have seen so far, primarily because deficits will be high and taxes will go up. The skilled nursing sector has the most to gain or lose with future change because of its reliance on government funding which will only come under increasing pressure in this next decade. But if Medicare and Medicaid funding (and their respective returns) can finally be looked at together (something addressed in one Senate amendment), then it will be a win for the industry and MedPAC can stop its ubiquitous recommendations to Congress to either reduce or not increase Medicare rates for skilled nursing. Watching the embarrassing spectacle of our political leadership (from both parties) debate and vote on things they neither read nor really understood was truly the most disheartening part of 2009, and one which makes us concerned about the future. It left us with one thought: politicians are like diapers, they are full of the same thing and should be changed just as frequently.
It Was A Year That Could Have Had A Different Ending