Editor's Note: The following conversation occurred prior to the mortgage lending crisis and subsequent interest rate changes and should be read in that context.
How has seniors housing and care performed during the first half of 2007, and how does the industry look going forward? Five of the country's most active lenders and investors gave their review on a recent call with Executive Circle members of the National Investment Center for the Seniors Housing & Care Industry (NIC). The following are highlights, as moderated by Bradley Razook, president of Cohen & Steers Capital Advisors LLC. Guest panelists were Kathryn A. Sweeney, managing director at The GPT Group; Kevin J. McMeen, managing director at Merrill Lynch Capital; Deborah Laycock, managing director for healthcare finance at Guaranty Bank; and Raymond W. Braun, president of Health Care REIT, Inc.
What do you like about market conditions so far this year?
Deborah Laycock: The operating fundamentals still look good, and we're seeing that in our portfolio, as well. The amount of activity is strong. The projects that are going in are well thought out, with a lot of them in urban areas. The amenity packages are much more tailored to consumers, focusing on their personal preferences, wellness, preventive healthcare, personal enrichment, and so forth. We're seeing a lot of expansion opportunities that we like. We like the continuum of care on the same campus. Also, with the NIC Market Area Profiles (MAP) and other data available to us, information is much better, and I think our operators have become stronger over the years.
Bradley Razook: In other good news, there remains a worldwide glut of investment capital looking for financial assets. There is unprecedented liquidity in the capital markets. One example is our experience at Cohen & Steers. Since 2006, we have served as financial adviser in connection with approximately $18 billion of merger and acquisition (M&A) transactions, or about $1 billion a month, which was as much as we would previously do in a typical year.
Also, more investors continue to show an interest in seniors housing and care, and this trend should continue absent any kind of major hiccup. The traditional private equity people who were burned by the reimbursement and overbuilding disaster in the late 1990s are back or starting to come back. Real estate–oriented investors have gone increasingly up the acuity scale, starting with independent living, moving on with assisted living, and then to skilled nursing. In some cases, we've seen them take their profits through real estate and maintain an ongoing investment in an operating company, which is something that you never would have seen four or five years ago.
What has caused these investors to look more at healthcare-related assets?
Razook: It's clear that capitalization rate compression and declining internal rate of return (IRR) expectations in other asset classes have forced investors who historically were fearful of the intensive operating component of healthcare to actually roll up their sleeves and jump in. As a consequence, private companies now have many more options than they did five years ago when mortgage or sale-leaseback financing was about all that was available. Today, private and public equity is available, along with joint venture financing, management buyout financing, leverage recaps, and M&A solutions, whether you are a seller, a buyer, or pursuing a strategic transaction.
What do you not like about the market? Any areas of concern?
Laycock: We dislike seeing the aggressive loan structures—for example, the nonrecourse loans. We're also bothered by the lack of price differential between national and local operators. In other words, local operators are getting a fairly attractive loan structure either from local banks or from larger finance companies that probably doesn't reflect the associated credit risk. Lastly, interest rates have continued to move up slightly, and we see that as a risk going forward, as well.
Razook: There are other worrisome developments. It seems clear that the Federal Reserve Board is not going to ease any time soon, and there is much worry about inflation. The subprime residential mortgage disaster seems to have affected rates, spreads over treasuries for commercial mortgage financing, and loan-to-values, with a further potential for affecting cap rates. This is a very fluid situation and bears close monitoring.
The REIT market is more competitive than ever. What are typical terms today for an average deal, such as a $15 million to $25 million transaction for a regional operator?
Raymond W. Braun: A number of REITs are actively doing transactions. As far as terms for a deal—and these would not be part of a portfolio or deemed strategic for the REIT involved—we're typically seeing leases of 10 to 15 years and going-in rates of 7.5% to 9.5%, depending on the type of asset and its condition, with annual increases of roughly 25 basis points. I would say that's reflective of the general market for those types of deals. Compared with three or four years ago, it's 100 to 300 basis points tighter on the rates. Otherwise, the terms are similar.