Is the market pricing for the sale of long-term facilities in a bubble? That is an important question given the purchase and sale dynamics that exist today. First, by the measure of per bed and per unit prices, 2013 senior healthcare and housing sale prices set record highs:
· $73,300 per bed for Skilled Nursing Facilities, a 27% Increase over 2012 ($57,909/bed)
· $150,600 per unit for Assisted Living Facilities
· $191,950 per unit for Independent Living Communities
Depending on which data source you use (Irvin Levin Associates or National Center for Senior Housing and Health (NIC)) Cap Rates hit record lows, but not as striking as the per bed and per unit prices. The Irvin Levin Cap Rate for the sale of skilled nursing home facilities was 13.0%, the NIC Cap Rate for the sale of skilled nursing home facilities was 12.2%. At least as it pertains to the sale of skilled nursing facilities, piercing the historic Cap Rate floor of 13% is a historic first.
Second, more than 2,000 people attended the NIC Conference in Chicago last week, showing an exuberant interest and confidence in the senior housing and healthcare industry. Wall-to-wall lenders and equity sources populated the receptions and networking lounges. There were many more skilled nursing facility and assisted living and independent living facility buyers than sellers. The industry is awash is low-cost capital looking for more than a few good long-term care facility sale deals.
Third, one other unprecedented sign is the sale of nursing home and assisted living operating companies sans ownership of the real estate. I am hearing often about asset-less operating companies on the market whose physical plants are leased from third-parties, often public or private REITs. To put this into perspective, I am hearing about deals of skilled nursing facility companies that sold their real estate to REITs, for say $125,000/bed or more, and are now asking $50,000/bed for the purchase of the operating company. Keep in the mind that the operating company has lease obligations with annual rent escalators and there is no purchase option for the real estate. Owners recapitalized their assets once by selling to a REIT, to employ capital on operations and acquisitions instead of real estate and to take money off the table. Now, they are going back to the well and trying to sell their operations too. The deals I am hearing about when you calculate the lease plus the operating company price on a per bed basis approach an aggregate of $200,000 per skilled nursing facility bed. As the Gershwin song goes: Nice work if you can get it. And you can get it if you try
We need to dig deeper into this to decide if the long-term care facility industry is in a bubble. In the 1990s, when I was working for Integrated Health Services, I was developing a five-year pro forma model of assisting living facilities. Our model projected nosebleed valuations of $125,000 to $150,000 per assisted living unit. When I showed the results to Dr. Robert Elkins, cofounder and CEO of Integrated Health Services, his poignant words to me were: “You’re crazy. Those are hospital prices.” That was the end of that analysis. Now the valuations that he considered crazy are average mundane deal prices for assisted living units, meaning that there are plenty of assisted living sales above $150,000 per unit. Who would have thought that the Cap Rate for the sale of assisted living facilities would be around 8.5%?
The Wall Street Journal of October 11, 2014 had an article about Nobel-prize meaning Yale University finance professor and economist, Robert Schiller, known for his novel work regarding the valuation of stocks and real estate. Professor Schiller, who incidentally spoke at the NIC Conference a couple of years back, prophetically predicated the tech stock and real estate bubbles in 2000 and in 2008, respectively. Professor Schiller’s work on asset valuation essentially contests the efficient-market hypothesis, which predicates that because of efficient and widespread distribution of information about an asset to all potential buyers, market investors rationally determine stock prices on the expected receipt of future dividends, discounted to a present value. However, Professor Schiller states in WSJ article that: “The market is supposed to estimate the value of earnings, but the value of earnings depends on people’s perception of what they can sell it again for” to other investors. Please reread the words of his statement in bold. This is a stunning admission. Applying this theory to the sale of long-term care facilities, buyers are paying high prices on the expectation that in the long-run they can sell it for more. This is the norm. Some of this rationale as it applies to the sale of nursing homes and assisted living facilities is based on the premise that there is added value in better management and in potential synergies realized, thus justifying the incrementally higher price. Nonetheless, Professor Schiller is correct, no matter the purchaser’s added value justification, there is also a prevailing expectation that they can probably sell it for an even higher price in the future. As Professor Schiller says, the long-term average is “highly psychological” and that today’s prices “might be high relative to history, but how do we know that history has not changed.” From my own experience, there were plenty of skilled nursing facility sale deals I closed a mere ten years ago, priced at between $45,000 to $50,000, that at the time seemed astronomically high, that would easily fetch more than $100,000 a skilled nursing facility bed today.
Some would argue cynically that the Professor Schiller’s insight is a sophisticated reconstruction of the “greater fool theory,” upon which bubbles ultimately derive their source. Restated, the greater fool theory is that although an asset or market is fully valued, the price is justified because there are enough buyers to push prices further upward and resold to at a later date. Of course, this is synonymous with the standard definition of a bubble. This phenomenon is not new. In 1890, The Chicago Tribune, writing about the then mania in real-estate prices, described "men who bought property at prices they knew perfectly well were fictitious, but who were prepared to pay such prices simply because they knew that some still greater fool could be depended on to take the property off their hands and leave them with a profit".
There are genuine value-added opportunities buyers in the skilled nursing and senior housing space who will pay a incremental premium based on the upside potential and improvements that they expect to carry out. They are not willing to pay for one hundred percentage of what the value they can create; that would be irrational. On the other hand, there are young and hungry first-time buyers who are willing to pay high prices today on the premise conditions continue to remain favorable, which is not an unreasonable assumption in the nursing home and senior housing industry, they will turn a profit in five years upon resale. The only concern is that the speculators may be crowding out the value-added owner/operators who are in it for the long-haul, and that REITs are correspondingly lowering their coverage ratios too, signals that the industry has reached the irrational exuberance phase
I do not know the answer. But it appears the music continues to play in the skilled nursing and senior housing industry and the fundamentals look excellent and promising from any vantage point. When the music stops nobody knows. “Nice work if you can get it. And if you get it won't you tell me how?”