Impact On Seniors Housing M&A, Values and Providers
The 2011 seniors housing and care acquisition market turned in its best year since the market peak in 2006 to 2007, and one of its best years ever. There were many reasons for that, one of which was the low interest rate environment. Last year, the Federal Reserve stated that it would keep short-term interest rates at their historic lows near zero through the end of 2012. Some thought it was a little politics mingled in with policy during an election year, as low rates would continue to help the struggling housing market as well as helping businesses with low-cost debt to spur growth.
In a recent development, the Fed has determined that the underpinnings of the economy are still not strong enough to move growth back to any level above 3% annually on a consistent basis, with the potential for extremely modest growth in the 1% to 2% range. As a result, the duration of the “near zero percent” monetary policy has been expanded through the end of 2014, which is quite a statement regarding the economic need for historically low interest rates. While it does not provide anyone with much confidence about the near-term direction of the economy, it does provide a more stable environment for seniors housing and care providers and investors to make some of their own decisions about the future, especially with regard to growth, acquisitions, development and operations.
Let’s first take a look at the acquisition market in general. From a buyer’s perspective, the willingness to “pay up” in price to secure a deal increases not only when the cost of debt is low, but also when that buyer knows that the cost to refinance that bridge acquisition financing in a year or two or three will also be relatively low, barring some unforeseen event. The level of risk diminishes when stability is in the air, and while economic stability may still take some time, combining low and stable interest rates with decent near-term demographics are two components for a healthy seniors housing acquisition market.
Since the cost of debt is a major component of a cap rate, a period of low rates by definition means that cap rates will stay where they are or perhaps continue to drop. In 2011, given the high volume of acquisitions, the higher quality of properties sold (at least on the seniors housing side of the business) and the aggressive bidding for the more institutional quality properties and portfolios, it would have been natural to assume that cap rates would decline, if not significantly, more than the 40 basis point drop from 2009 to 2010 for assisted and independent living combined. While our final 2011 statistics will not be available until mid-February, preliminary data point to a larger than 40 basis point drop in 2011. For data buffs, the largest one-year drop for average seniors housing cap rates (IL and AL combined) was 140 basis points from 2004 to 2005, which also happened to be the beginning of the strongest bull market for the sector on record. What has been occurring in the market during the past 12 months bodes well for a repeat performance, but one that may have more legs than the last bull market.
Why the confidence? First, one has to look at what might derail the current market and how it is different from the 2006 to 2007 period as well as other periods of increased value and market activity. Are we going to experience a glut of overbuilding that will bring down industry occupancy levels, send lenders and investors running for shelter and result in a spate of new bankruptcies? Unlikely, and even though as a whole the sector has had trouble learning from the past and not repeating the same mistakes (over a 20-plus year period), there are enough people around, both on the lending and operating side, who have been through at least two cycles and are not apt to act like wild frontiersmen (or women) in the future…Want to read more? Click here for a free trial to The SeniorCare Investor and download the current issue today