Depressed stock prices, plus uncertainty over interest rates and the economy, could dampen deal volume
By Jeff Shaw
Although volatility on Wall Street sharply curbed the buying activity of publicly traded healthcare REITs in the latter half of 2015, mergers and acquisitions activity in the U.S. seniors housing space for the entire year was $1.4 billion higher than in 2014.
The market turbulence has spilled into 2016, adding a layer of uncertainty to the overall transactions forecast.
According to New York-based Real Capital Analytics, U.S. property and portfolio sales totaled $19.4 billion in 2015, up from $18 billion in 2014, an increase of nearly 8 percent. What’s more, total volume rose for the third consecutive year. (The data is based on transactions $2.5 million and above.)
A $2.4 billion spike in portfolio sales helped buoy the overall total in 2015, but entity-level sales (acquisitions of entire companies) and individual property sales fell approximately $500 million each.
While M&A activity by total dollar volume was up in 2015 compared with the prior year, the number of transactions decreased — falling from 554 in 2014 to 514 in 2015, according to the National Investment Center for Seniors Housing & Care (NIC). Based in Annapolis, Md., NIC is a nonprofit organization that tracks data and analytics in the seniors housing industry.
The price per unit increased in many segments of seniors housing in 2015 year over over, but skilled nursing dipped. For independent living, assisted living and memory care, the price per unit averaged $174,000 in 2015, an 8 percent increase from the prior year.
In skilled nursing, the price per unit in 2015 dropped from $81,000 to $72,000, an 11 percent decrease. Industry experts attribute the drop in 2015 to increased uncertainty regarding government reimbursement due to the Affordable Care Act.
REITs hit speed bump
One of the reasons M&A activity didn’t see a bigger bump in 2015 is that, after bolting out of the gate at the start of the year, the public REITs slowed down as the year wore on, according to Beth Burnham Mace, chief economist for NIC.
“Slow activity in the second half was due to a combination of things,” points out Mace. “Acquisition prices were quite high, REITs were absorbing the large deals they closed over the last few years, and their cost of capital changed due to a drop in their stock values.”
“They were considered a bullish [investor] class when their stock prices were so high,” adds Mace. “That shifted in 2015.”
Stocks were hit even harder at the start of 2016. Management of several publicly traded seniors housing companies lowered their expectations in year-end earnings calls with analysts and in financial reports based on a lackluster performance in the fourth quarter of 2015.
Heading into the earnings call, analysts had expected Brookdale Senior Living to experience a dip in cash flow from operations (CFFO). But the report was even worse than expected. Consequently, the stock price plunged 25 percent in two hours as a result.
HCP also lowered its CFFO forecasts dramatically, largely due to falling revenue in its ManorCare skilled nursing subsidiary as the company struggles to adjust to changes in reimbursement models.
Meanwhile, Welltower’s stock hit a 24-month low in February.
But smaller buyers, to a certain extent, picked up the slack during the second half of 2015, says Mace. Most deals were in the $10 million to $50 million range — mid-size portfolio deals that big REITs may largely ignore.
Private buyers accounted for 42 percent of acquisitions in the second half of 2015, up from 21 percent during the first half of the year. Institutional buyers stayed consistent throughout the year, buying between 5 percent and 15 percent of the volume in any given quarter.
“It was a good year, but it was not a blowout kind of year,” says Jim Seymour, senior managing director of Capital One Healthcare, a highly active lender in the seniors housing space. “The first half was stronger than the second half.”
Seymour was, himself, involved in a massive acquisition in 2015 when Capital One bought his then-employer, GE Healthcare Financial Services, for $9 billion. The combined company, Capital One Healthcare, is a division of Capital One.
The $9 billion acquisition is not included in the RCA or NIC data since the vast majority of the purchase ($8.5 billion) was for the loans rather than the company or its properties.
Seymour suggests that the drop in the price per unit for skilled nursing properties is due to uncertainty about the future of the sector, as reimbursement models adjust to the Affordable Care Act.
“In the skilled nursing space, everyone is trying to process the changes to the reimbursement process and determine which business models are going to win,” says Seymour. “With alternative payment models and the industry going more toward a system based on outcomes than fee-for-service, what is the role of skilled nursing? Which types of facilities are primed to thrive in that kind of environment?”
Although Seymour was careful not to make predictions, he suggested that there will be room in the industry for both traditional skilled nursing and the “more short-stay, rehab-focused business.”
“There are thousands of traditional nursing homes. They’re going to remain part of the model,” says Seymour. “You really have two businesses within the skilled nursing space right now, both of which can be successful with the right models.”
Capital flows across borders
Mace expects more capital to flow both to and from foreign countries over the next year. Foreign investors recognize that the U.S. seniors housing industry provides higher yields than other property types.
For example, cap rates for assisted living and independent living properties are 200 to 300 basis points higher than traditional multifamily assets, and skilled nursing cap rates average another 300 basis points above that, says Mace.
U.S. REITs, meanwhile, are looking to foreign countries as a way to diversify. Welltower, for example, now has portfolios and offices in both Canada and the United Kingdom.
“Seniors housing is becoming more visible and understandable. It’s moving away from being a niche sector, but it’s still emerging and getting its legs underneath it,” says Mace. “Already in the U.S. there’s a lot more interest in seniors housing. That trend is just emerging with overseas investors.”
Investors’ understanding of the industry should deepen further with NIC expanding its data sets. The number of markets NIC covers will grow from 99 to 140 this year, and the organization is introducing new metrics such as actual rents, says Mace.
“I’ve been involved in the sector for 15 years, and a lot of this data just didn’t exist before,” says Mace. “Data makes the sector an easier sell. You have to have data to prove your story.”
Another factor that could fuel activity this year is the opportunity for consolidation in what
is still a highly fragmented industry. Many small operators and owners of only one or two properties are attractive targets for active buyers within the industry, says Mace.
Despite these positive trends, there are indications that the market will stay flat this year.
A recent poll of seniors housing executives, conducted by New York City-based commercial real estate appraisal firm Integra Realty Resources, shows that many think that the industry may have already peaked in this cycle. The survey gathered responses from seniors housing brokers, owners and acquisitions personnel.
With regard to assisted living and independent living, more than 80 percent of respondents thought valuations were either at or past peak. In skilled nursing, respondents were slightly more optimistic, with 61 percent believing that valuations had peaked.
For 2016, nearly 89 percent of respondents thought that the valuations of independent living and assisted living would either stay flat or go down. More than 62 percent thought the same for skilled nursing.
“I think 2016 is shaping up to be a flattish kind of year. We’re hearing more operators talk about short-term concerns over their growth rate,” says Seymour. “That’s driven by concerns of oversupply and general insecurity about the economy, at least in the short term.”
The IRR survey echoed those concerns of oversupply. More than 95 percent of respondents said that oversupply was either a high risk (33.3 percent) or a moderate disk (61.1 percent) for the independent living and assisted living segments in 2016.
These concerns did not extend to skilled nursing for the most part, however. Some 83.3 percent of respondents considered overbuilding to be a low risk in skilled nursing.
The next highest concern among survey participants was interest rates, with 75 percent of respondents labeling it as a moderate risk, though only 5.6 percent considered it a high risk.
No interest rate scares so far
While the future direction of interest rates is always a topic of discussion in a capital-intensive business like commercial real estate, industry professionals are not overreacting to the Federal Reserve’s decision in December to increase the federal funds rate — the central bank’s benchmark short-term interest rate — a quarter percentage point.
“The industry expects interest rates to rise at some level,” says Seymour. “The only way interest rates will drive a market dislocation is if they are sudden and outside the realm of what people expect.”
Interest rates are unlikely to rise in the immediate future while stock prices are low and the economy is generally perceived as soft, says Seymour. That economic uncertainty is reflected in the 10-year Treasury yield, a benchmark for long-term financing in commercial real estate, which stood at approximately 1.75 percent as of the middle of February. A year earlier, the 10-year yield was about 2.1 percent.
“Interest rates will rise at some point, but we can’t say if it will be this year,” says Seymour. “It won’t be a major factor in the seniors housing market because people are already expecting a modest rise in interest rates over the next 12 to 24 months.”
In his recent “2016 Seniors Housing Market Outlook,” Bradley Clousing of Senior Living Investment Brokerage suggested that the continued low interest rates present an opportunity for owners.
Long-term owners should lock in historically low interest rates and short-term owners should sell now while acquisition prices are still high, advises Clousing, a managing director with the Illinois-based brokerage firm. Owners hoping to renovate or reposition a property should build wiggle room into their budgets, leaving space for a potential increase on floating-rate financing, he adds.
“For the first time in a few years, you’re starting to see some of the buyers either fully allocated in their fund or even allocated in an entire asset class,” says Clousing. “Before, you might’ve had everybody tripping over each other for a single asset, with 10 or 12 buyers. You might be down to three now.”
It’s still a very good time to complete a transaction, continues Clousing. “Prices are still very aggressive, but we’re starting to see a few signs of a changing environment.”
There’s also a time lag. Deals made in late 2015 won’t close until later this year, notes Clousing. The impact of increased interest rates and other economic factors won’t truly be known until later in the year.