For the past nine months we’ve watched the cap rates trend up, occupancy trend down and the transaction market remain stagnant. The credit crisis of one year ago definitely chilled the “buyer” side and as a result, shoved values downward. The deals we did see done were few and far between, lots of one off deals in regional markets and clearly, value plays. Where we did see some larger deals in the works, these deals were slow in closing and in some cases, did not close at all due to appraisals that did not support the purchase price or sellers that were unrealistic about values once the appraiser confirmed the “lower” market value.
Despite the fact that the credit markets haven’t really expanded dramatically and lenders are still a bit gun-shy and conservative on terms, we are seeing the makings of more deals and predict that the third and fourth quarter will see more closings. The two biggest factors contributing to this “modest” rebound in market dynamics and deal dynamics are sellers coming to terms with where the values are today and occupancy rates that have moved upward (in general) across the industry. This is not to say that these occupancy increases have come without a price as many providers have been forced to get creative in terms of discounting and packaging to fill incremental units. Incidentally, as the residential real estate market is still lagging in most geographies, we don’t see the discounting trend to fill units abating any time soon. Many markets are border-line overbuilt and/or close to saturation and as a result, demand is still lagging compared to the supply of units available at traditional, pre-recession price per unit levels. In short, providers will still be challenged to stay creative if they wish to keep their occupancy numbers trending upward or stable. Interesting to note is that in comparison to a year or so ago, the incremental additional unit sales for most providers are not contributing to profitability at the same rate as a result of the discounting that was required to fill these units. We believe that it may take as long as an additional year to wash this effect through the market, essentially returning to post-recession per unit pricing levels in mid 2010 or the third quarter of 2010 (of course, some regional markets may take longer and some may recover a bit quicker).
On a product level, Assisted Living facilities that offer a higher-level of care within a more bundled pricing structure have tended to weather the down times better. For example, we have seen better performance and stronger occupancy levels from facilities that “specialize” in areas such as memory care and/or are specialized to a targeted population such as extremely frail elderly. Additionally, facilities that are connected with an SNF, CCRC or hospital have performed better than those that are free-standing. This trend may remain for quite some time as the maturity of the market implies that the next step toward success for the Assisted Living industry is less real-estate focused and more program and product specific. Without question, values in the industry will rebound but likely not soon to the to the pre-recession levels witnessed in 2007 and early 2008. For free-standing facilities, especially those that are non-distinct in terms of their product via a specific program or other twist (connected to a CCRC or SNF), their value expressed in a CAP rate may not return anytime soon to 2007 early 2008 levels, especially if they continue to struggle for occupancy or have to discount fees to attain higher occupancy levels.
In specifics, this remains a Buyer’s market for Assisted Living facilities. Sellers should continue to be prepared to be creative and reasonable if they wish to sell their property. What is reasonable? As few sellers are attempting to rid themselves of Grade A properties, the majority of the market is full of product that quite honestly, has some “hair” on it. By “hair” I mean either a dated building or a building in need of some improvement, one that has some occupancy problems or both. Sellers also need to be conscious of the market area in which they are attempting to sell their properties. Regardless of what anyone quotes as deals done with a particular cap rate of “X”, the reality is that cap rates are regionalized and definitely market specific. In other words, a deal done at an 8 cap in suburban Illinois does not translate to the same cap rate for a deal looking for a buyer in suburban Green Bay, Wisconsin. Similarly, rural markets and even over-bedded suburban and urban markets can dramatically influence pricing and valuations. Even facility size and of course, age of plant can have a dramatic impact on what a Buyer is willing to reasonably pay for a particular property. In some cases, Seller creativity can also play a role in what level of deal is attainable. Sellers, for example, that have some wherewithal to assist with financing either via a land contract or a similar lease to own or installment sale clauses can add value to the transaction without taking a “price haircut” to get the deal done.
On the Senior Housing side (non- ALF), the market remains rather tepid. Similar to the ALF side, financing is difficult to obtain and values are down, though not as dramatic as in the ALF market. Perhaps the strongest product remains the CCRC and as such, precious little volume in terms of transactions is occurring. Occupancy rates in this product are wide-ranging with nearly all markets seeing a continued softness in demand, though some far less so than others. Free standing, older congregate style (apartments) remain the most common type of property on the market and cap rates seem to have stabilized for the most part, north of 9. Again, markets and regions play a major factor as does the actual property, in terms of what cap rates are tied to what deals. For example, I have seen listings with occupancy problems seeking a 7 cap that have been on the market for a substantial amount of time – wholly unrealistic. I’ve also seen decent properties, solid A minus or B plus facilities that as little as a year or so ago that would have sold in the 8.5 cap range sit, even though the pricing is negotiable above a 9.5 cap. And still, I see properties close at 10 caps and higher; deals that literlly make sense. Projects that remain fairly attractive in the market are modest to lower income sites with stabilized occupancy, a clean building and are tax-credit financed or HUD financed. As the initial owners/operators explore the “out” windows in these deals, buyers still seem willing to step in and pay solid prices for these properties (no wonder).
Where the ALF market will take perhaps another year or more to recover, the Senior Housing market appears to be less far away from recovery. New development is still occurring, though not at the pace it was a couple of years ago. Lenders also seem to be a little more willing to work on straight senior housing projects, perhaps because the real estate component is the majority of the finance. Older projects with deferred maintenance or occupancy issues will still encounter wary buyers and depressed prices. A seller needs to be particularly cautious and understanding of the economics of the market and his/her property. If for example, the project is older and needs some upgrades, a buyer will be looking to acquire the property based on the “up-side”, necessitating a pretty solid discount to replacement cost. If the market area has a depressed economy and modest to declining wealth demographics, the buyer will be cautious and may have to seriously consider a re-development or re-packaging stategy to turn the project to profitability post-deal, again necessitating a more sizable discount than perhaps, the seller had considered. In summary, the projects most likely to find buyers are those that are priced at 50% to 60% of replacement cost, in decent economic markets with solid demographics, and can be viewed as having “up-side” potential, either in terms of additional occupancy, additional room for expansion, or capital upgrades that can position the project for new, higher rent paying occupants. A final word of caution for sellers is to be extremely cautious about current pricing for current tenants and the occupancy demographics thereto. Depressed rents, while presenting an up-side to a buyer in theory, may also foretell a problem that a buyer does not wish to inherit; having to play market “catch-up” with a tenant base that cannot afford it or within a market area that will view rapidly rising rents as “negative”.
On a final note, for non-profit owners of ALFs and Senior Housing projects, the most fertile ground for transactions today remains sales to or mergers with, other non-profits. The economics make far more sense for a non-profit to seek another non-profit as a partner and value can be extracted out of the deal for the “seller” in ways that a true asset sale to a for-profit buyer would never allow. This is not to say that a non-profit owner should seek exclusively a non-profit buyer, especially if the product for sale has solid occupancy and is well positioned in the market. It does mean however, that non-profits can leverage value and take advantage of a presently, more flexible and fluid market for transactions, by exploring a transaction (merger, other) with another non-profit – food for thought for non-profit buyers and sellers.