Waiting on an M&A Rebound

by Jeff Shaw

COVID-19 pandemic froze property sales in 2020, and experts say the big thaw likely won’t occur until occupancy improves.

By Jeff Shaw

U.S. seniors housing property and portfolio sales ground to a halt in 2020, with a total transaction volume of $9.9 billion, down 48 percent from $17.9 billion the prior year, according to Real Capital Analytics (RCA). 

The last time annual property sales for the sector were below $10 billion was in 2010, when the economy was still recovering from the Great Recession and total volume registered $6.2 billion.

To put that 48 percent annual decline in 2020 into perspective, consider that across all the major classes of commercial real estate property and portfolio sales fell 32 percent during the same period.

The blame falls squarely on the COVID-19 pandemic, according to Jim Costello, senior vice president of RCA, a New York City-based firm that tracks independent reports of property and portfolio sales $2.5 million and above.

“There are two aspects to COVID shutting things down,” says Costello. “First, you’re locked at home, you can’t look at a property, so you can’t file documents. The second element is that we’re in the middle of a recession. People aren’t sure what happens next, so deal activity suffers.” 

The first quarter of the year looked to be very active until the pandemic struck with full force in March. Everything came to a halt in the second quarter, followed by a slow recovery in the second half of the year. Transaction volume was $3.6 billion in the first quarter, $1.3 billion in the second quarter, $2.1 billion in the third quarter and $3.1 billion in the fourth quarter.

“For a while in the second quarter, even if you had a deal done, there were some counties where you couldn’t file papers for a deed,” says Costello. “You couldn’t get to the courthouse and there was no electronic option available. Things were chaotic.”

“It’s funny thinking back to the beginning of the year, just how naïve we were,” continues Costello. “We had this huge public health crisis right around the corner and folks were downplaying it. Our people overseas were seeing deal activity drop dramatically, but in the United States we were doing okay.”

For some, 2020 felt even worse than the 48 percent drop in transaction volume represents. “Frankly, I’m surprised that percentage is so low,” says Steve Blazejewski, managing director and senior portfolio manager with PGIM Real Estate. “Most of the transactions we were looking at in early 2020 were more or less on hold through the year.”

Also slowing transaction volume was more stringent underwriting requirements by lenders, with lower leverage available and non-recourse loans almost non-existent, adds Blazejewski.

PGIM Real Estate only closed a single seniors housing transaction the whole year, though Blazejewski says many potential sales that were put on hold are now beginning to re-emerge.

REITs seek greener pastures

The transaction volume that did occur was largely from large-scale dispositions by publicly traded REITs. The top two sellers of seniors housing in 2020 were Welltower and Healthpeak, which sought to both increase liquid assets to survive a period of depressed stock prices and move funds into the more lucrative commercial real estate sectors.

In 2020, Healthpeak either sold or received letters of intent for 28 separate transactions totaling $4.5 billion, according to an investor presentation the company released in November.

Healthpeak’s notable seniors housing dispositions included selling 10 communities in the West to a joint venture between Aegis Living and Blue Moon Capital Partners for $350 million. To kick off 2021, the company sold 24
Brookdale-operated properties to Omega Healthcare Investors for $510 million.

At the same time, the REIT invested heavily in life sciences and medical office real estate, representing nearly $1 billion in acquisitions in the second half of the year alone.

Welltower, meanwhile, sold off more than $2 billion in seniors housing last year. The most notable sale was a six-property portfolio of Boston-area communities, which a joint venture led by Taurus Investment Holdings and Northbridge Cos. purchased for $200 million. The company also backed out of its $3.1 billion bid to buy U.K.-based nursing home giant Barchester Healthcare as the pandemic gripped the world last April.

“If your share price is going down, new acquisitions are not accretive,” explains Costello. “It’s just natural to sell off some assets to raise cash.”

However, unlike Healthpeak, Welltower has made it clear that the company intends to remain in the seniors housing sector for the long term. The company made some acquisitions, but was only the 36th largest buyer, according to RCA.

The third of the “Big Three” REITs, Ventas, largely remained on the sidelines in 2020 when it came to seniors housing acquisitions and dispositions based on a review of public announcements. The company did credit its recent history of pushing billions into the life sciences sector for bolstering its financial results in 2020.

“Our decision to add life sciences to our enterprise has provided an uplift to our results, our investment activity and our value,” said CEO Debra Cafaro on the company’s fourth-quarter earnings call in February.

Who’s buying?

The buyers of seniors housing properties in 2020 were largely owner-operators and private equity funds, according to RCA. The top five buyers based on total dollar value, in order, were owner-operator Merrill Gardens, investment firm AEW, family-run investment team The Portopiccolo Group, private equity firm Kayne Anderson and owner-operator Aegis Living.

While the REITs sought to protect themselves from low stock prices, these particular investors sought to build their portfolios at a discount. Bill Pettit, president of Merrill Gardens’ parent company R.D. Merrill Co., explained the strategy in a January webinar panel. As the biggest buyer in 2020, Pettit suggested that the company intends to continue riding that momentum in 2021.

“We’re starting to see valuations that are well below what we can develop for,” he said. “If it’s the right business model and the right locations, we’ll be much more active on the acquisition side.”

Pettit added that 2021 might be a year to keep an eye out for owners and operators folding, offering up acquisition opportunities from lenders repossessing assets.

“If occupancy doesn’t pick up this summer, the pressure will really mount on operators. The best valuations for buyers [occur] when those properties are under the control of the financial institutions.”

Occupancy rates hit record lows at the end of the year, averaging 80.7 percent in private-pay seniors housing, according to the National Investment Center for Seniors Housing & Care (NIC).

Blazejewski agrees, and suggests “the sellers in the next 12 to 18 months will present a great opportunity for buyers.”

Blue Moon Capital Partners, the buyer in that $350 million transaction with Healthpeak, believes that seniors housing still has a bright future. What’s more, the company notes that oversupply concerns have been mitigated as “COVID impacted new supply by turning off that development spigot,” says Kathryn Sweeney, co-founder and managing partner.

This slowdown in development is partially driven by the lenders tightening their underwriting as well, adds Blazejewski. “If fewer buyers and developers are able to get debt financing, there will be less supply growth, which will have a positive effect on the overall sector. Less supply is ultimately a good thing for performance metrics.”

“Seniors housing is all we do, and the supply/demand fundamentals are compelling,” concludes Sweeney. “No matter what is going on in the economy, people are still aging. The first baby boomers turn 80 years old in 2025.”

Buyers, sellers at ‘impasse’

However, if sellers are truly eager to divest as some suggest, the capitalization rates certainly aren’t showing it.

Seniors housing cap rates hit a record low average of 6.8 percent at the end of 2020, meaning pricing on closed transactions has never been higher. During the Great Recession cap rates were 8.1 percent and during 2015’s seniors housing buying spree they hit 7 percent. RCA’s cap rate data for seniors housing dates back to 2001.

The combination of high pricing and low occupancy is a major contributing factor to the freezing of property sales, according to Costello.

“Owners are backward looking — if they see what something sold for six months ago, they want it to sell at that rate. Meanwhile, a buyer is looking forward at the worst-case scenarios of the current downturn. With those forces at opposite sides of the table, we’re at an impasse for now.”

“If somebody has to sell today they may not get the pricing they want,” continues Costello. “But they’re just not going to sell if they don’t have to.”

Blazejewski agrees, explaining that the main cause of the slow transaction activity is clearly the bid-ask spread. “There is a significant difference in expectations between buyers and sellers.”

In fact, PGIM Real Estate is one of those potential sellers that’s holding onto its properties. The closed-end-fund investor had just finished investing the capital raised in its fifth fund when the pandemic hit, meaning the company should have been entering selling mode. However, with buyers not offering the pricing PGIM Real Estate wanted and no financial rush to exit the investments, the company has elected to sit and wait.

“We were just getting to where our portfolio was stabilized and we were starting to think about some exits as COVID hit” says Blazejewski. 

“We’re not confident we can exit those investments at the pricing we should be getting. We’ve made the decision to ultimately hold onto those assets for later years. We’ll wait until the recovery happens.”

“If we can afford not to sell, then we won’t sell until we can get the price we want,” he adds. “The funds aren’t going to be shortsighted unless there’s pressure.”

Costello notes that the Great Recession of 2007-2009 was a “credit-driven recession,” meaning that lenders were foreclosing on many properties and then selling them off at discounted pricing. This recession is driven by low occupancy rates, and owners believe that is a temporary situation.

“With owners knowing there will be a turnaround, they’re not willing to throw the keys at the lender,” says Costello. “Folks are looking at the sector, thinking they can buy at rock-bottom prices, but that’s not as realistic in this recession as it was in the last one. 

“There will be some distress, but there will be more efforts to keep the current owner afloat rather than going to a bank and then an auction.”

Sweeney agrees, saying that “given the low-interest-rate environment combined with the favorable supply and demand factors, knowledgeable and discerning buyers are not discounting quality product in defensible markets with experienced and committed operators.” 

All that said, she predicts a thawing of the cold relations between sellers and buyers in the near future.

“Investors are looking at 2021 as a potential ripe year to market assets they delayed last year. Expect volume to pick up in the second half of 2021.”

Blazejewski says the timing of the eventual recovery in seniors housing is “the holy grail question.”

“The key aspect of a recovery is notable performance improvement. The industry continues to bleed occupancy. It’s going to take a flattening, then continued or sustained recovery, before you see transactions resume.”

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