Acquisition Volume Returns to Normal

After years of boom-or-bust transaction levels in seniors housing, trading has settled into a rhythm.

By Jeff Shaw

Although it’s easy to look at year-over-year transaction volume in seniors housing and say “acquisitions are down,” 2018 was more a return to the average rather than a lull. 

When the feverish trade volume in 2011 to 2015 (peaking at over $25 billion in 2011) and the recession slowdown of 2008 to 2010 (bottoming out below $5 billion) are taken together, the last 11 years average approximately $14 billion per year in transaction volume. Although acquisitions in 2018 were down slightly over 2017, the total for the year was still $14.1 billion.

“When you include that spike in 2011 from big entity-level deals, and also the 2008 to 2009 period when people were worried the world was going to end, you get some highs and lows and we’re right in the middle,” says Jim Costello, senior vice president with Real Capital Analytics (RCA).

RCA, a New York City-based data firm focused on commercial real estate investment, bases its information on publicly announced property and portfolio sales $2.5 million and above across the United States.

Not only was 2018 an average year for transaction volume, but it also was a more active in certain ways. While massive portfolios and whole-company acquisitions were rare, individual transactions were up year-over-year.

“It’s a shift in who’s buying and who’s active,” says Costello. “You had an increase in purchases by private capital sources — smaller, local, regional-type operators — versus the portfolio and entity sales fueled by large capital sources buying to gain scale.” 

Charles Bissell, managing director of JLL Capital Markets – Seniors Housing, notes that not only are small transactions up, but they also tend to be the prime real estate assets in the sector.

“There were fewer blockbuster deals, but a steady flow of single-asset and smaller portfolio transactions,” says Bissell. “Also, we are seeing more high-quality, Class A assets selling, and those assets are commanding premium pricing, driving up the transaction volume. There is an abundance of equity available chasing deals, and this will continue to lead to strong transaction volume.”

REITs sell, but who’s buying?

The REITs generally are the engine of trading in seniors housing, and they were more active in 2018 (30 percent of total transaction volume) than 2017 (25 percent of total transaction volume), according to RCA. However, they were net sellers rather than net buyers, and 30 percent pales in comparison to the boom years when REITs accounted for over half of total deal volume.

In recent years, low stock prices were credited for increasing the cost of capital for publicly traded REITs. Now, with stock prices rebounding, many experts expect REITs to expand their role in seniors housing acquisitions.

“You’ll see the REITs come back this year, certainly more so than the past couple years,” says Austin Sacco, first vice president and co-
production lead for seniors housing with CBRE. “It’s still to be seen if they’ll be net buyers. But given that occupancy is the lowest it has been in a very long time, expect the REITs to be a little more selective.”

Bissell agrees that REITs will continue to increase their presence in 2019, but adds that private equity firms — which picked up significant slack from the REITs’ slowdown — will maintain their strong presence in the industry.

“REITs pay their investors dividends, and in order to do so generally invest in stabilized, cash-flowing assets,” says Bissell. “Private equity, on the other hand, has the flexibility to invest in assets that are still in lease-up, or assets that need renovations and/or management changes.”

While REIT spending is down overall, there was one huge, entity-level acquisition that grabbed headlines in 2018.

In July, a joint venture between REIT giant Welltower (NYSE: WELL) and nonprofit healthcare operator ProMedica Health System completed the acquisition of Quality Care Properties (NYSE: QCP). For the price of $4.4 billion, the venture acquired both QCP and its main tenant, HCR ManorCare. 

HCR ManorCare filed for Chapter 11 bankruptcy in March 2018 after struggling to pay rent to QCP, which owns nearly all of the facilities that HCR ManorCare operates. QCP itself is a spin-off of healthcare REIT HCP (NYSE: HCP), which created the company in 2016 specifically to remove HCR ManorCare’s 320 properties from its portfolio.

In a December interview with Seniors Housing Business, Shankh Mitra, Welltower chief investment officer, said Welltower’s strategy was based on an extremely low price per bed ($57,000 for the skilled nursing portion, $93,700 for skilled nursing and assisted living combined) and the partnership with a strong operator in
ProMedica. Average price per unit generally fluctuates around $120,000, according to RCA.

Additionally, Mitra praised the various companies for successfully executing an extremely complicated transaction.

“There were five parties involved — Welltower, QCP,
ProMedica, HCR ManorCare and a private equity sponsor. No one in the history of this business has done this, a for-profit and nonprofit partnering to buy a public company. It was very special circumstances that created that transaction.”

Bissell goes even a step further, suggesting that the QCP acquisition could pave the way for future transactions of this type.

“In the past, hospital systems have not been the most efficient owners or operators of skilled nursing,” says Bissell. “But with the changing nature of healthcare delivery, we may look back at this transaction as a pioneering deal that others will seek to emulate.”

“Obviously the seniors housing industry continues to break down new barriers in the way it’s evolving,” adds Sacco. “It’s a great transaction and a great thing for the space. As seniors housing is still maturing even today, I’d expect more people to explore these types of opportunities.”

Institutional investors dive in

For most types of investors, 2018 looked quite similar to 2017. Private equity firms were net buyers and spent about the same amount. Foreign investors did increase their trade volume, but at a total of $370 million they still only account for a small percentage of overall volume, according to RCA’s numbers.

The one exception to this rule was institutional investors, which not only spent more, but were heavily net buyers, spending $1.8 billion more than they sold.

As seniors housing has become more normalized and a standard part of many portfolios, institutional investors have been drawn to the high yield of senior living compared with more standard property types, says Costello. For example, overall multifamily capitalization rates were around mid-5 percent according to mid-2018 calculations by CBRE. Seniors housing, even at historically low cap rates, have held between an average of 7 and 8 percent across the continuum of care.

“What motivates them to buy? Institutional buyers love yield so they’ve been expanding their presence in the sector,” says Costello.

Sacco believes that is a sign that seniors housing is growing more sophisticated as it continues to succeed as a commercial real estate type, and investors “are getting more comfortable with the assets.” He cautions, however, that institutional investors should always partner with a strong operator that knows the business, rather than jumping in blindly because of a strong return on investment.

“It comes down to having a great operator and good staff,” says Sacco. “I expect the trend of institutional investors as strong buyers to continue, but it will be interesting to see how it all plays out when the REITs jump back in.”

Bissell adds that the “recession-resistant” nature of seniors housing is also a draw as investors plan for the U.S. economy to reach the end of its current boom cycle. And, of course, the looming presence of aging baby boomers also leads many to believe seniors housing is the hot asset class of the future.

“Many institutional investors also want to gain a foothold in the seniors housing market ahead of the huge increase in demand that will occur over the next few decades,” says Bissell.

The downside to all this investor interest, from a buyer’s perspective, is that it has kept cap rates for seniors housing near historic lows. Even as interest rates have trended upward over the last two years, cap rates for the most part haven’t budged much

“It’s an issue for all commercial property,” says Costello. “The expectation going into the fourth quarter was that interest rates are going up, therefore cap rates are going to go up as well. Instead, cap rates for most property types are flat or even down in some cases.”

“Sellers set their price expectations on a backward-looking basis,” adds Costello. “‘What was the last sale? Well my building should be worth that.’ If they’re not forced to sell, they’re not going to make any concessions.”

Despite these trends, Sacco suggests that “most folks acknowledge that cap rates and interest rates are still very attractive.”

Changes for 2019

As we approach the end of the first quarter, many experts expect acquisitions to pick up, leading to a strong year for transaction volume. Several factors have been artificially deflating sales activity:

• The industry has hit record-low occupancy rates, as new deliveries have outpaced absorption. This has led some to approach seniors housing more cautiously. However, the new construction inventory is set to slow down in 2019, and absorption and new construction are currently at equilibrium, according to NIC’s fourth-quarter 2018 report. Overbuilding could also lead to increased transactions, notes Sacco, as investors look to grow by purchasing rather than developing. “Value-add opportunities are very attractive for someone who can get a great community that, at this day and time, is dated and needs a cosmetic refresh.”

• Political uncertainty caused many investors to hit the “pause” button as the issues shake out, according to Costello. “There are so many own-goals from trade disputes and the government shutdown, it’s taking a lot of wind out of the growth of the economy. That’s pushing the 10-year Treasury yield down, but it hasn’t equated to changes in cap rates because investors know we’ll get through this temporary uncertainty at some point.” 

Overall, Sacco expects 2019 to feature a lot of similarities to 2018 in the seniors housing acquisitions market. Private equity firms will continue to dominate until REITs come back into full power, and Class A properties still in lease-up will continue to be a hot ticket.

Bissell agrees that there should not be any major, earth-shaking changes in seniors housing transactions in 2019. A trend he expects to see grow through the year is a continued focus on the quality of operators. Investors will continue to partner with strong operators, and in some cases purchase them outright as Bridge Investment Group did with Somerby Senior Living in January of this year.

“Some operators will deal with the operating headwinds more effectively than others, driving value to the communities they operate,” says Bissell. “I expect to see more transactions where investors buy or invest in operating companies.”