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