Veteran dealmakers discuss REIT consolidation, the bidding frenzy for top-quality assets and the year’s surprises so far.
Participants:
Ken J. Carriero National Director, Senior Vice President, Colliers National Seniors Housing Group
Ben Firestone, Managing Partner, Blueprint Healthcare Real Estate Advisors
Bruce Gibson, Principal, Senior Capital Advisors
James Hazzard, Senior Vice President, JCH Consulting Group
Allen McMurtry, Executive Managing Director, Principal, Cassidy Turley
Mike Pardoll, Senior Vice President, Senior Director – Senior Housing Division, Marcus & Millichap
Ryan Saul, Managing Director, Senior Living Investment Brokerage
Nick Stahler, Vice President, JCH Consulting Group
Matthew Whitlock, Senior Vice President, CBRE Capital Markets
It’s been an active 2014 on the acquisitions front in seniors housing. In February, Brentwood, Tenn.-based Brookdale Senior Living announced its merger with Seattle-based Emeritus Corp. in a $2.8 billion megadeal that closed in July. As a result, Brookdale now operates approximately 1,150 communities in 46 states with a capacity to serve more than 110,000 residents.
U.S. property and portfolio sales in seniors housing year-to-date through early August totaled $9.3 billion, up from $6.6 billion a year ago, according to Real Capital Analytics, based on transactions $2.5 million and above.
Seniors Housing Business asked several veteran brokers to share their insights on deal velocity, cap rates and the product types investors find most appealing today. An edited transcript follows:
Seniors Housing Business: What has been the most compelling trend, or biggest surprise, so far this year with regard to seniors housing property and portfolio sales?
James Hazzard/Nick Stahler: One of the biggest surprises is the continued demand for skilled nursing assets. We continue to see single-asset, small and large portfolios trade at very high valuations with multiple bidders.
This is surprising due to the constant uncertainty with reimbursement. Delays, reductions and new billing rules consistently plague reimbursement, yet it seems to have little effect on acquisition appetite in most states.
Bruce Gibson: The most interesting trend has been that of REIT consolidation and new REIT formation. The low cost of capital has allowed the REITs, both public and private, to grow substantially. The goal of bulking up in size on the part of newer or smaller REITs continues to fuel investment sales.
As some of these REITs grow, they then become interesting acquisitions for the larger REITs. This has been evidenced in several recent REIT-to-REIT transactions.
Ben Firestone: I’d say it has been very interesting to watch two of the non-traded REITs execute their respective exit strategies. Both ARC (American Realty Capital) and AHI (American Healthcare Investors) have put on incredible displays of capital aggregation and in turn have become very aggressive bidders with respect to Blueprint’s one-off and small portfolio offerings.
To see both groups package their portfolios and effectively sell to larger REITs lends a lot of credit to their investment strategies.
Allen McMurtry: The biggest surprise so far this year is the comeback of independent living. After the housing downturn, independent living suffered the greatest occupancy losses among seniors housing property types.
This year, occupancy numbers have fully recovered the losses, and consumers are continuing to find this an attractive living option. As further evidence of these trends, we are hearing a lot more about senior apartments.
Ken Carriero: It appears that investors in other asset types are seeing the benefit of the Baby Boomer generation aging into the seniors housing marketplace. Therefore, these investors are making the decision to include seniors housing in their real estate portfolios.
Furthermore, investor types other than the typical REIT and institutional investors are making offers on available portfolios. I have also been contacted by several foreign investment companies seeking opportunities to purchase seniors housing assets here in the U.S.
Mike Pardoll: We are still working with the non-traded REITs’ continued roll-up of small portfolios of skilled nursing, retirement, and even continuing care retirement communities (CCRCs), and now the mass exit sale to the publicly traded REITs. The non-traded REIT acquisitions are more in line with sale-manageback transactions rather than the traditional sale-leaseback.
This follows the movement of the publicly traded REITs with the same process associated with the RIDEA (REIT Investment Diversification and Empowerment Act) structures. We think the biggest surprise is the amount of operational risk all the REITs have now taken. The multi-billion dollar question is whether they can motivate the various operating partners they now have to continue to execute.
Ryan Saul: The biggest surprise has been the number of potential buyers for each offering. We are used to multiple buyers for each offering, but having a dozen or more write offers shows there is a shortage of quality opportunities on the market.
It is even more competitive for portfolio offerings, with every REIT and institutional buyer at the table. This has led to a trend of record prices being paid with faster closing timelines.
Buyers need to be aggressive in both pricing and terms to set themselves apart from other bidders. To do this, buyers have been increasing earnest money deposits, negotiating contracts quickly and shortening due diligence.
Matthew Whitlock: Among both trends and surprises is the continued increase in valuations and transaction volume. Consolidation among the REITs has been dramatic with over $8 billion in announced consolidations.
SHB: Has the volume of property sales in seniors housing so far this year met, exceeded or fallen short of your expectations? What is your outlook for the remainder of the year?
Firestone: The volume has exceeded Blueprint’s expectations year-to-date. It’s been amazing to see just how many deals have gone down. New entrants on the buy side have created more options for industry players in search of recapitalization.
Blueprint’s pipeline is incredibly robust for the remainder of the year, and I trust that we are not the only ones in the market who project a strong end to the year.
Hazzard/Stahler: We expected this to be a very high volume year, and it has met or exceeded our expectations. JCH has closed more transactions involving skilled nursing facilities in 2014 than any year in our history.
We have also seen continued demand for assisted living assets that are performing well.
The volume of assisted living assets has fallen short of our expectations, however. This is due to the lack of quality product coming available.
We have seen older performing assets become available and close, but the fully occupied Class A property under 10 years of age with a waiting list has become somewhat of the proverbial unicorn, and is the exception not the norm.
Gibson: Deal volume is about where I expected it to be for 2014. Given the large volume of transactions during 2013, there have been a few pauses as groups digest large portfolios or enterprises. For the most part, there has been a steady stream of opportunities for buyers.
SHB: Would you characterize today’s selling climate as a buyer’s market or a seller’s market?
McMurtry: For institutional-quality assets, it is very much a seller’s market. Why? The answer is basic supply and demand principles — limited supply and high demand. For Class B or lower properties, or properties in secondary/tertiary markets, the markets are in equilibrium.
Pardoll: I’d say that it’s both. Good-quality, well-occupied communities create a seller’s market, while distressed assets still selling below replacement cost create a buyer’s market.
Carriero: I would definitely classify today’s seniors housing market as a seller’s market. There are more buyers seeking to purchase, but with a limited amount of competitively priced stabilized properties available for acquisition. However, I have also seen “nouveau” buyers seeking to enter the seniors housing space, purchasing non-stabilized facilities at prices based on future value.
SHB: Compare and contrast how much cap rates have moved during the past 12 months for well-stabilized properties in primary markets versus secondary markets. How much do you expect cap rates to move over the next 12 months?
Carriero: I have not experienced a significant movement in cap rates over the trailing 12 months. Cap rates in primary markets have been hovering in the 7 percent to 7.5 percent range, while cap rates in the secondary markets were in the high 7’s or low 8’s.
However, the asset class — “A,” “B” or “C” — combined with buyers’ investment strategies will determine their individual cap rates.
Saul: Capitalization rates have not moved much during the past 12 months. Stabilized seniors housing communities in primary markets warrant capitalization rates in the 7 percent to 8 percent range. Those same assets in secondary markets achieve capitalization rates in the 8 percent to 9.5 percent range.
On the long-term care side of the business, stabilized communities in primary markets achieve capitalization rates in the 11 percent to 12.5 percent range. Assets in secondary markets are closer to 12.5 percent to 14.5 percent.
I don’t expect capitalization rates to move much over the next 12 months. The cost of capital should remain relatively constant. However, one factor that could contribute to upward movement in capitalization rates is if we see a number of older, distressed communities sold. Owners of undesirable assets may see this as a great time to divest tougher communities.
Firestone: Investors are increasingly demanding higher-quality projects and more sustainable properties. Consequently, the cap rates have compressed more substantially for well-stabilized deals in primary markets. We are seeing offerings with the highest demand trade at cap rates in the 6 percent to 6.5 percent range.
However, Blueprint is seeing plenty of investors being crowded out of these offerings by other investors in search of yield. While the spreads haven’t tightened quite as much on the “Class B” offerings in more tertiary markets, the investor demand is still significant. Blueprint sees no reason for the cap rates to move significantly toward 2015.
Whitlock: Cap rates are only slightly more aggressive in most primary markets than in most secondary markets. We see primary price drivers being occupancy, year-over-year net operating income growth and the age and condition of the assets.
However, the largest difference between cap rates in primary and secondary markets is in major West Coast and Northeast metro areas such as San Francisco, Los Angeles, New York, Boston and Washington, D.C. This observation is supported by recent sales comparables.
SHB: Which types of investors are the most active buyers of seniors housing today?
Whitlock: In terms of sales volume, the REITs, both publicly traded and non-traded, are by far the most active. In terms of deal volume, private equity and the non-traded REITs are the most active groups.
McMurtry: It depends on what caliber property you are describing. For institutional-caliber properties, REITs and pension funds are the dominant buyers. For smaller, older or more rural properties, regional operators are the most prevalent buyers.
Hazzard and Stahler: The type of investor varies depending on the asset we are discussing. We have seen the REITs, public and private, and private equity firms be very aggressive in the assisted living market. In the skilled nursing facilities market, the high-net-worth individual seems to dominate the larger portfolio purchases.
The majority of REITs are trying to diversify their portfolios with private pay assisted living facilities to help buffer their exposure to reimbursement risk in their skilled nursing holdings.
SHB: What product category of seniors housing is in greatest demand among investors? Why?
Saul: Majority assisted living communities are in the greatest demand right now, especially those assets that are over 50 units, under 10 years old and those that have the opportunity to expand services. Investors are attracted to high-quality real estate with need-based services paid for with private pay.
Whitlock: The private pay, need-based product, such as assisted living and memory care, appears to be in greatest demand among the investment community based on its relative resiliency to downturns in the economy and current consumer demand (occupancy).
SHB: Will the new product expected to come on line over the next 12 to 18 months create more equilibrium between supply and demand?
Whitlock: In theory, “yes.” In reality, demand for deals will outpace any increase in supply of product for the next 18 to 24 months.
McMurtry: Most of the properties coming on line in the next year or so will not likely come up for sale for several more years. The impact of this new construction will be felt in market occupancies and pressure on rate growth.
Gibson: New product will not have a significant impact on the buyer/seller equilibrium equation over the next 12 to 18 months, except in some markets typically prone to overbuilding.
Despite the fact that there appears to be a great deal of capital in the seniors housing sector, substantially all of the capital directed toward development is aligned with REITs and their lessee or joint venture operator, or private equity and their operators that are looking for longer-term hold periods.
There are only a handful of private groups that have successfully sourced development capital that will turn around and sell upon stabilization. That said, as long as interest rates and cap rates stay relatively low, there will continue to be sales of existing product.
SHB: What impact are interest rates having on deal velocity in the seniors housing investment sales market and the strategies of buyers and sellers? (The 10-year Treasury yield was hovering near 2.4 percent as of late August.)
Whitlock: While the 10-year Treasury note does impact valuations, based on the evolution of financing within the seniors housing space toward variable-rate financing priced off LIBOR, the 10-year Treasury has less impact on the sales market than in previous years.
Pardoll: The ability of REITs and institutional buyers to borrow at such low rates is what has fueled the amount of transactions over the past few years.
We have clients now refinancing properties with HUD at interest rates below 4 percent. This is great for the long-term holders, but potentially problematic for a seller due to HUD’s red tape and prepayment penalties.
McMurtry: Today’s interest rates are spurring some sellers to take advantage of this low interest rate environment before interest rates rise.
Hazzard/Stahler: The interest rate debate has been kicked around for years now. There is no doubt the friendly interest-rate environment has made it easy for buyers to buy, and for sellers to sell at high valuations.
Until we see a sharp increase in rates that holds for a long period of time, we will continue to see the free flow of debt into our market.
When you can lock in your facility at a sub-4 percent interest rate with non-recourse, 40-year HUD debt, it makes it very easy to price your acquisitions aggressively.
SHB: What question are you most often asked by buyers or sellers with regard to seniors housing, and what is your response?
Pardoll: The most common question is, “What is the appropriate cap rate?” Sellers always want to compare their asset to the best in the marketplace. Buyers always want to use actual trailing income to establish value. However, more times than not, sellers do not sell when everything is going well, but rather after some issue has caused a distressed sale situation.
Our response is to guide the seller on how simple operational improvements can increase the value. Sometimes the changes can be made quickly, but in some instances guidance over several quarters may be needed.
Whitlock: By far the most often asked question by would-be sellers within the marketplace is whether valuation for their product is similar or superior to publicly announced platform transactions. Our response is that platform transactions, based upon their structure and payment characteristics (cash, stock, warrants), include myriad more value components than simple pricing based off net operating income and financing.
— Compiled by Matt Valley