Lately, I have spoken with several Skilled Nursing facility owners about why capitalization rates are so much higher for Skilled Nursing facilities than Assisted Living and Independent Living facilities, not to mention other commercial real estate classes.
First off, a primer on how cap rates work. A cap rate is defined as the NOI divided by the purchase price of the facility. Using a very simple example, if a facility has $1 million in NOI and it has a 10% cap rate, the facility will be worth $10 million ($1 million / .1).
Average cap rates vary based on industry trends and interest rates, but currently average cap rate ranges are as follows:
- Independent Living – 7.0%-8.0%
- Assisted Living – 8.0%-9.5%
- Skilled Nursing – 12.5%-13.5%
There are three reasons that Skilled Nursing facilities have much higher cap rates than Assisted Living or Independent Living facilities:
1. Reliance on Government Reimbursement: There is no question that the majority of Skilled Nursing facilities rely on Medicaid and Medicare reimbursement for the majority of their revenue sources. Assisted Living typically has very little Medicaid reimbursement and Independent Living has no government reimbursement (unless it’s low income housing).
This can have an enormous impact on value because if the state cuts its Medicaid rate by 10%, every SNF in the state will lose 10% of its Medicaid revenue with little that the facility can do to recoup it. If the federal government cuts its Medicare rate by 5%, every SNF in the country will lose 5% of its Medicare revenue. This decline in revenue dramatically impacts the bottom line.
While other real estate classes are affected by economic trends, both nationally and locally, government reimbursement is an added risk for the Skilled Nursing class that needs to be factored into expected returns and hence, values / cap rates.
2. Additional Liability: As the acuity level of the residents increases, the risk of liability increases. A resident that needs more assistance is going to be more likely to have an accident or unexpected downturn in his/her health, which can lead to greater risk of a lawsuit. In states that do not have tort reform, this can be a large risk that is not easily insured against, even with liability insurance policies.
3. Increased Specialization in Care: Additionally, as the acuity level of the residents increases, the specialization and expertise needed to care for those residents increases. An operator of Skilled Nursing facilities needs to hire more competent staff with a greater level of skill in caring for residents than Assisted Living or Independent Living operators.
While an operator needs to consider the increased risk of running Skilled Nursing facilities, higher cap rates lead to greater investment returns than most other commercial real estate classes.
Jeff Binder and Brad Clousing sold a 62 unit seniors housing community consisting of 15 independent living cottages, 35 assisted living units and 12 memory care/SCALF units. The community benefits from being the largest facility in Walker County and the only facility in the area offering memory care services. This is the only facility the Seller operates in Alabama and was divesting of the asset in order to deploy capital to other projects and consolidate operations. The property was built in stages in 1998/2004/2006 and census averaged 94%. Senior Living Investment Brokerage, Inc. was able to generate national interest in the community. Multiple offers were procured and a national REIT was selected as the Buyer. The property will be run by a regional operator based in Florida- this is their second building in Alabama. The community sold for $7,000,000 at an 8.50% capitalization rate. For additional information, please contact Brad at firstname.lastname@example.org or Jeff at email@example.com
Retrades have become a relatively common occurrence in seniors housing M&A. For those readers who are fortunate enough to have not experienced this, a retrade is renegotiating the agreed upon purchase price – oftentimes at the point after the buyer has completed due diligence and earnest money is about to become non-refundable. Retrades are often linked to some unexpected decline in census or performance, or findings in the physical plant which will require major expense. These retrades are much easier to negotiate than the times a buyer asks for a reduced price and it appears that they didn’t do their homework on the front end, or never planned on following through on their offer price which secured the deal.
There are two hurdles that retrades create:
1. Seller’s Sales Expectations: If we are under contract on a facility for $12 million and before closing the buyer asks for a retrade down to $10.5 million and the deal falls apart, the Seller will never forget that at one time their facility was “worth” $12 million, even if all the other market feedback was $10-10.5 million. The original buyer set an unrealistic sales expectation that can be very difficult to duplicate.
2. Wasted Time: When a buyer retrades to a lower price, oftentimes our firm already had multiple offers in that lower range, only now we may be closing in on year-end or other deadlines and/or both sides have a significant investment into the deal.
What does this mean for Sellers? One benefit of working with Senior Living Investment Brokerage is to utilize our knowledge of who closes deals at or near the original terms and who “ties” deals up. However, too many times the reason we have to deal with a retrade is because the seller “took their hands off the wheel” once the deal was under contract. A Seller needs to run the community as if they weren’t selling- right up until the day of closing.
What does this mean for Buyers? We have already experienced clients who request that potential buyers put up non-refundable earnest money at the time of signing the LOI. That doesn’t fly in today’s market, but we can see things moving that direction, even if only a “token” amount is non-refundable. As more and more buyers enter the market, sellers are looking for ways to differentiate between Lookers and Closers.
Matt Alley spoke at the Texas Health Care Association Annual Convention this week. Matt spoke on Tactical Debt Financing and Achieving Your Bottom Line. He co-hosted with Lancaster Pollard and Oxford Finance. The topic specifically related to buying and selling long term care and senior housing properties. For more information you can contact Matt at 630/858-2501 or firstname.lastname@example.org Matt is Managing Director at Senior Living Investment Brokerage, Inc.
Ryan Saul and Brad Clousing recently sold 2 Skilled Nursing Facilities in Northern Florida. Both facilities have solid reputations and have achieved at least a 40% Medicare mix since 2007. One facility is 60 beds and was developed by the Seller in 1999. The other property is 90 beds originally built as 60 beds in 1993 with a 30 bed Medicare addition in 2007. The dedicated Medicare wings at both locations contribute to the strong financial performance and high Medicare census. The Seller is a Florida based owner/operator. The Buyer is an investment group that leased the operations to a national provider. Senior Living Investment Brokerage sold the two properties for $139,000/bed. To find out how we can assist you in the sale of your seniors housing community, contact Ryan or Brad at 630/858-2501 or email@example.com or Brad at firstname.lastname@example.org