Friday, January 9, 2015

Intermediary Fee Structures for Skilled Nursing Facility Sale Transactions

The common commission or fee structure for brokers or intermediaries for nursing home sales is 2% of the selling price, applied to the purchase price and paid at closing. If the transaction involves a single facility, then the fee can vary from 2% to 4%, although 2% is most customary commission percentage used in the nursing home industry. If the transaction involves multiple facilities, that is a portfolio deal, a sliding scale fee model is typically used, consistent with the Lehman Formula concept. Thus, in the nursing home sales industry when a multiple facility transaction is involved, for sellers’ to pay a 2% or higher commission, without resorting to use of using a sliding commission schedule or a maximum commission fee paid, is rare. Sometimes in multiple facility nursing home sales deals up to $25,000,000, a flat 1% fee is used. Beyond that the Lehman formula and variations thereof is customarily used.

The Lehman Scale is an industry accepted formula used by investment banks, M&A advisory firms, and business brokers to calculate the commissions or transaction fees on sell-side engagements. The Lehman Scale is calculated based on a percentage of Purchase Price as follows:

·       5% of the first $1,000,000, plus
·       4% of the second $1,000,000, plus,
·       3% of the third $1,000,000, plus,
·       2% of the fourth $1,000,000, plus,
·       1% of the remaining total.

As a practical matter, the exact percentages set forth in the Lehman model are not generally used for nursing home transactions, as indicated above.  However, the principle of a sliding scale formula in multiple facility transactions unquestionably prevails in the nursing home industry.   Thus the basic concept underlying the Lehman formula that the broker charges a smaller percentage for each certain dollar amount that the transaction is worth is prevalent and used in the nursing home sale transactions in the U.S.  Accordingly, the size of the deal dictates how negotiable the percentages used in a sliding scale formula.  Usually the seller will have more negotiating room on fees the bigger the transaction value potentially gets, and as a function of the attractiveness of the business for sale and underlying industry and credit market conditions.

From our experience, reasonable brokerage or finder commissions or fees used in the nursing home industry, as percentages applied to the purchase price, would be in the following ranges below, although we recognize that the transaction value and corresponding fee breaks can vary.  However, we would argue that this variation is usually found under the $25,000,000 value threshold.  In transactions in excess of $25,000,000, the declining fee percentages kick in.

In my opinion, because of current low interest rate conditions and high demand for ownership of nursing home facilities, combined with the constrained and diminishing supply of nursing facilities, it is currently a highly robust “sellers’ market” for nursing home facilities. According to Irvin Levin Associates data, nursing home selling prices are at their highest level. Therefore, given these very seller favorable market conditions, it is perplexing why sellers should agree to a fee structure that includes an incentive fee for the intermediary? Moreover, given these highly favorable market conditions, the seller has the leverage to probably lower the commission because of the size of the transaction, as indicated in the foregoing, and the lower market resistance and difficulty in selling skilled nursing facilties. Lastly, under these propitious market conditions, it is also not totally uncommon for sellers to set a “not-to-exceed” cap on the brokerage or transaction fee earned.

Friday, January 2, 2015

Factors that Increase or Decrease Nursing Home Sale Values

As is well-known in the healthcare transactions world, the baseline metric for the valuation of skilled nursing facilities is the amount of Net Operating Income generated by operations, or more specifically, EBITDAR, measured by the sum of Earnings before Interest, Taxes, Depreciation, Amortization and Rent, divided by rates of return specific to the nursing home industry (known as the “Capitalization Rates” or “Cap Rates”). Cap Rates are derived from historical nursing home sales data. This formula is known as the Income Capitalization Model. It is the standard tool used to determine baseline and back of the envelope pricing in the sale of nursing homes. It is based on the premise that asset value is predicated on the amount of free and clear cash flow a business generates per year. The nursing home industry’s historical capitalization rates range from 12.0% to 14.0%.  In the current market, the Cap Rate for the sale of skilled nursing facilities is probably around 12.5%, maybe even lower.

However, a back of the envelope singular calculation is insufficient:  In arriving at a composite valuation, it is necessary to adjust the baseline EBITDAR valuation calculation (determined by the Income Capitalization Model) up and down by estimating the effect of certain internal and external variables on pricing, independent of the financial and operational antecedents.  While it is hard to separate cause from effect here, but that is necessary for analytic purposes because nursing home sale valuations are multifactorial. Accordingly, these primary internal and external variables can increase or detract from value as shown below:

Increasers to Value:

1. Newly constructed building.
2. Spacious facility.
3. Ability to Expand physical plant
4. Visibility from Road
5. Private and Semiprivate Rooms
6. Presence of State Certificate of Need Process or Medicaid Moratorium
7. Located in Deep Demographic market
8. Favorable Medicaid Reimbursement for Capital
9. Close to Acute Care Hospitals

Reducers of Value:

1. Old building, particularly physical plants before 1970.
2. Postage stamp property with no ability to expand
3. Lack of space for rehab and storage
4. Limited or no road visibility
5. Three-bed and Four-bed rooms
6. No Certificate of Need process or Medicaid Moratorium controlling new construction
7. Previous attempts to sell failed
8. History of poor surveys. Watch List
9. Unfavorable Workers’ Compensation History
10. Located in Sparsely Populated Rural Market