Should I Buy, Sell or Hold?

North Shore Place in suburban Chicago recently sold for $700,000 per unit. The new owner, Blue Moon Capital, plans to add another 32 units to the assisted living building. North Shore Place in suburban Chicago recently sold for $700,000 per unit. The new owner, Blue Moon Capital, plans to add another 32 units to the assisted living building.

With supply pressures growing, the stakes are higher for investors seeking to maximize returns.

By Jane Adler

Investors and owners alike agree that the long-term forecast for seniors housing is nothing but sunny. The raw demographics of an aging population are sending a strong buy signal. But dig a little deeper into current market conditions, and the decision of whether to buy, hold or sell becomes somewhat cloudy. 

Much of today’s transaction activity is being driven by a wave of new construction, coupled with the fact that the huge cohort of Baby Boomers won’t be ready to start moving into seniors housing for several more years. Complicated by other factors, such as uncertainty about healthcare legislation, investment strategies are being recalculated. 

The publicly traded REITs, already rich in seniors housing properties, are mostly making only selective purchases or development deals as they shed skilled nursing portfolios due to occupancy pressures. Institutional buyers, typically through private equity funds, have been picking up the transaction slack, buying a wide range of property types, betting the long-run approach will pay off. 

Some buyers are sitting on the sidelines waiting for new, but distressed properties to come on the market at a discounted price. Other buyers are seeking opportunities where they can add value to a property, ride out a bumpy lease-up period and hold it for resale later. 

Mom-and-pop owners are looking to exit the business while prices are still solid. Merchant builders are selling too, often just as the facility garners its certificate of occupancy — a strategy that offers the buyer some upside potential as the building leases up. 

Meanwhile, the buyer pool is expanding, drawing new kinds of investors such as sovereign wealth funds and more high-net-worth individuals — all eager to enjoy the healthy returns not seen in other commercial real estate asset types. 

According to the National Council of Real Estate Investment Fiduciaries (NCREIF), the total seniors housing return in the first quarter of 2017 was 12.05 percent, based on the returns of 86 seniors housing stabilized properties. By comparison, returns for the NCREIF Property Index (NPI), which tracks commercial real estate (apartment, hotel, industrial, office and retail), were 7.27 percent. On a 10-year basis, total returns for seniors housing surpassed the NPI by more than 400 basis points.

“Despite the supply pressures causing concerns today, there is still a ton of capital in the market,” says Russell Dey, a vice president with Walker & Dunlop, a mortgage servicer based in Bethesda, Maryland. “And no one can deny that going forward there will be a ton of demand, and seniors housing is a strong play.”

From a dollar standpoint, transaction volume rebounded in the third quarter of 2017 to $4.6 billion from the second quarter total of $1.4 billion, according to the National Investment Center for Seniors Housing & Care (NIC) headquartered in Annapolis, Maryland. A large part of the third quarter total was the result of the Sabra Health Care REIT acquisition of Care Capital Properties (see sidebar), which closed for $2.1 billion. 

The number of deals closed in the third quarter slowed, according to NIC. There were 84 deals that closed, though that is a preliminary count and the total may change as more deals are tallied. This compares to 125 deals closed in the second quarter of 2017. 

Of the closed second-quarter deals, most were single-property transactions and 95 percent were closed for $50 million or less, the largest share of deals closed in that price range since the fourth quarter of 2010. 

“There’s still a lot of activity,” confirms Bill Kauffman, senior principal at NIC. 

A change in buyers 

REITs have curbed their appetite for acquisitions, while institutional/private equity funds account for the majority of purchases today. These hungry investors need to put the money they’ve raised to work. There is some discrepancy between the expectations of buyers and sellers, especially among private owners who’ve held their properties for a long time and expect big payouts, according to brokers.

The relatively large number of small deals, however, has helped to keep pricing stable. The average price per unit for seniors housing ranged between $165,000 and $175,000 over the last four quarters, ending June 30, while skilled nursing averaged about $97,000 in the second quarter.

Highly prized properties are fetching eye-popping prices. North Shore Place in suburban Chicago recently sold for $700,000 per unit. Blue Moon Capital Partners, a private equity firm backed by public pension plans and a sovereign wealth investor, bought investor AEW’s ownership position in the 156-unit assisted living and memory care building. The joint venture partner and operator is Chicago-based Senior Lifestyle Corp.

Kathryn Sweeney, co-founder and managing partner at Boston-based Blue Moon Capital Partners, says that the site is entitled for 32 additional units, effectively lowering the purchase price to $650,000 per unit, including the cost to develop the new apartments. 

She believes that the acquisition is a smart investment because the property is a trophy, Class A-plus asset in an affluent market with high barriers to entry. “Those don’t come around very much,” she emphasizes.

Rising prices in the marketplace have led to opportunistic sales. CNL Healthcare Properties, a non-traded REIT, recently sold Dogwood Forest of Acworth, a 92-unit assisted living and memory care building near Atlanta, for about $34 million. CNL developed the property, which opened in 2014, for about $19 million.

CNL President and CEO Steve Mauldin says that the company had every intention of owning the community for an extended period of time, but elected to sell because the exit value was so high. 

The company liquidated its Lifestyle Properties REIT with more than $1.6 billion in seniors housing assets in 2015. Its new fund currently includes 71 seniors housing communities, plus ground-up development worth nearly $120 million.

“CNL remains very convicted and optimistic about the seniors housing space,” says Mauldin. “Capital is available and a fairly broad set of investors remain active.”

Pathway to Living owns and operates 25 properties, and has another five projects in partnership with other investors. The company has two new ground-up developments in the Chicago area: Azpira Place of Lake Zurich and Aspired Living of Westmont. Both buildings offer assisted living and memory care. 

The company is avoiding certain markets, such as Florida and Texas, because of overbuilding concerns. But Pathway figures to be a long-term owner and sees the senior living market as a good opportunity, according to Patrick Dimaano, director of acquisitions and strategic partnerships at the Chicago-based company. “Healthy markets can withstand a dip in occupancy,” he says.

While some investors sit on the sidelines waiting for distressed properties to come on the market at better prices, others are tweaking their strategies as they hunt for special opportunities. These could be new buildings struggling to lease up in markets with a lot of new competition, or poorly managed properties. 

For example, National Health Investors Inc. (NYSE: NHI) has set its sights mostly on single-asset investments. Asked to characterize whether the REIT is in more of a “hold” mode, Chief Investment Officer Kevin Pascoe describes the company’s approach as “cautious.” He says the Murfreesboro, Tennessee-based REIT is looking to acquire properties while adhering to its rigorous criteria, including a thorough underwriting of the operator to assess the credit they bring to the deal to help bolster the investment.  “It has to be a compelling opportunity,” says Pascoe.

In a recent opportunity, NHI provided a $10 million acquisition loan to the purchaser of a 40-unit memory care building in New Hampshire. The building, renamed Evolve at Rye, was purchased out of bankruptcy. “It was a good asset in a great market, but the operator did not have its arms around the property,” says Pascoe. 

An experienced seniors housing team, Evolve Senior Living, with new management systems, is now operating the property. NHI has a purchase option on the building. 

Value-add opportunities

Other investors are seeking underperforming projects. In June, Focus Healthcare Partners LLC closed its $312 million fund, Focus Senior Housing Fund I. Investors include institutions and university endowments, says Curt Schaller, co-founder and principal of Chicago-based Focus. “The dynamics in many markets are better suited now for acquisitions that can be significantly improved rather than new construction,” he says. 

Focus doesn’t invest in skilled nursing or continuing care retirement communities (CCRCs). The company prefers senior apartments, rental CCRCs, independent and assisted living, and memory care facilities. 

Though stabilized buildings are preferred, Focus will consider properties that can be improved, says Schaller. An example is a property that has not been designed appropriately for the market, such as an assisted living building that needs memory care units. 

Prior to the formation of this most recent fund, other Focus entities had already made investments in these value-add types of seniors housing properties. 

The new fund has its first building under contract, a Class B facility in a growing Southeast market that is 100 percent occupied. The plan is to bring in a new management company and invest capital to improve the property to a Class B-plus level, says Schaller, who declined to provide the property’s name. 

With premier properties trading at high prices, those seeking some upside are now willing to take on the lease-up risk. Investors can buy a new property still in lease-up mode for less than it would cost at 95 percent leased, sources say. 

Property broker Marcus & Millichap recently sold a new independent living building near Philadelphia for $220,000 a unit. (Marcus & Millichap declined to provide the names of the parties involved.) At the time of purchase, the developer owned the building, which was 75 percent leased. The investor was a private equity fund new to the seniors housing sector. 

When occupancy stabilizes at the market average of 90 to 92 percent, the property will be valued at 25 percent more than the purchase price, predicts Joshua Jandris, senior managing director of the seniors housing group at Chicago-based Institutional Property Advisors, a division of Marcus & Millichap.

CA Senior Living is taking a similar approach. “We see opportunity in buying new product with lease-ups going slower than expected,” says Ben Burke, president of CA Senior Living, Chicago. 

The firm, which owns 14 buildings with its limited partner, the investment firm Goldman Sachs, recently purchased a three-building portfolio in the Dallas area. The properties are about two years old on average and 50 percent leased. Integral Senior Living of Carlsbad, Calif., manages the properties. 

CA Senior Living is bullish on the Dallas market, in part, because its parent, CA Ventures, a $7 billion real estate fund, owns office properties there providing insights into the market. “Jobs are growing there,” says Burke, noting that a quickly expanding area will attract more senior living customers. The deal gives CA a foothold in a strong market without having to develop a new building.

Burke declined to provide the portfolio’s purchase price, but says it was no more than what it would have cost to develop the properties. He adds that other investors bid on the portfolio. 

New development is always an attractive draw to consumers, and CA believes in the long-term strategy of developing Class A projects in high barrier-to-entry markets. 

But Burke cites several trends making new development less attractive to investors. Construction prices are rising due to material cost increases, he says, and it’s taking longer to build new projects and lease them up. “Those factors are a meaningful hit to returns.”