Senior housing properties, which include assisted living, memory care facilities and skilled nursing centers, are frequently owned by one company and operated by another. But over the years, many operators recognize the value of the real estate where they work and decide to acquire it themselves.
“Owner-operators are definitely a piece of the business that’s baked in,” says Patrick Shearer, a director and loan originator with Greystone. “It’s relatively frequent, especially on the front end, for a new operator to come in and negotiate an option to purchase.”
Historically, operators typically look at the lease cost relative to the debt costs to determine whether buying the property makes sense.
“Over the past three to five years, it’s been more favorable to buy than in the past,” says Christopher Clare, a managing director with Greystone.
Many senior housing property owners want to bring in experienced third-party operators rather than run the facilities themselves and will include a purchase option as part of the deal, says Scott Thurman, head of production for FHA Healthcare for Greystone.
“We’re also seeing some operators who have been in this space long enough to see a lot of escalators on their operating leases,” says Thurman. “Buying the real estate offers them a way to control that.”
Making the Numbers Work
Typically, a senior housing operator will enter into a five-year or longer lease with an investor, according to Clare.
“Skilled Nursing Cap rates are generally around 12.5% and the typical lease rate could be 10%,” Clare says. “The investor could finance it over the last 10 years or so for around 6%. So, the investor would keep the spread between 6% and 10% and the operator would keep the spread between 10% and 12.5% in addition to their 5% management fee. There’s enough juice in there for everyone to make money.”
The value of skilled nursing facilities on a per bed basis has risen dramatically in recent years, Clare says.
“When the investor and operator strike a deal, it’s based on the valuation dynamics at the time,” says Clare. “For example, if a building was worth $10 million in 2015, the operator can purchase it for $13 million in seven years. But today, that building could be worth $20 million. So now it’s become very advantageous for the operators to exercise their purchase option. In certain cases, it may be worth paying a penalty to the landlord so that the operator can exercise their purchase option early.”
Advantages for Operators to Become Owners
While the ability to buy a building valued at $20 million for $13 million is a clear advantage, there are other reasons for operators to become owners.
“If you’re operating in a metro area with 15 good nursing homes and you own three, it can be smart to buy three more for the market advantage,” says Shearer. “You add to your real estate portfolio, and you can leverage efficiencies.”
In an inflationary environment, the ability to avoid lease escalations and transition to fixed-rate long-term debt is beneficial, says Thurman.
“A lot of operators are in fairly old nursing home properties and are coming to the end of their lease,” says Thurman. “They’ve had lots of profitability and upside on their old lease. They know a new landlord may not want to sign a lease with them, so that’s another reason to consider buying the facility themselves.”
“Also, in an inflationary period, it’s ‘economics 101’ that it’s beneficial to own a hard asset like real estate as opposed to cash”, Clare points out.
Financing a Senior Housing Acquisition
According to Shearer, purchasing a senior housing facility can be a complex transaction. Buyers need equity to make the purchase and the liquidity and net worth to qualify for a bridge loan and there are factors to consider for the HUD loan as well.
“We have specific products and experience on our team at Greystone to help operators if they want to exercise their option to buy,” says Clare.
For example, Clare recently worked with an operator to purchase the previously mentioned building valued at $20 million for $13 million.
“Greystone provided a 70% LTV loan, so the operator will own the building with 100% loan-to-cost financing,” says Clare.
In that case, the operators had a history with the building and had shown their ability to deliver good performance. In addition, the valuation of the building provided significant equity to protect the lender.
“If you’re a good operator, you can leverage that experience to get into a building with a private equity partner and then acquire the building at the end of their fund life or when they decide to exit,” says Shearer. “Nothing gives a lender more heartburn than a new operator. There’s always disruption even with good operators when they’re new and this structure maintains that continuity of operator, which makes operations more stable.”
Purchase options are particularly attractive for smaller operators, Clare says.
“When they first step into the building, they’re often a former administrator and this is their first chance to own a business,” says Clare. “If they do well and hit their performance goals, there’s a scenario where they can own the building for very little equity.”
Some smaller operators turn into a sophisticated group after many years of experience and become sought after by building owners willing to offer an exit opportunity, says Shearer. Operators with a good track record are attractive to a wider spectrum of lenders, too.
There are also opportunities for operators to buy properties from smaller operators who made it through COVID but may not want to deal with new regulations and are therefore ready to exit, says Shearer.
REITs and Senior Housing Transactions
Historically, REITs that own senior housing have been less likely to offer operators a purchase option, says Shearer. However, that may be changing.
“Obviously, the long run REIT business model is to keep the assets and throw off the cash flow as dividends for their investors,” says Shearer. “It’s not common for them to have an operator come in, optimize the building and then buy it out from underneath them. But at least one group of senior housing operators I’m working with is getting opportunities to take over the operations of several REIT-owned buildings with a purchase option.”
Shearer believes this may be happening because of a concern about finding quality operators. Senior housing is still recovering from COVID and there are uncertainties about whether a Medicare reduction is coming or if Medicare will stay level despite rising costs, says Shearer. A strong operator who can manage this volatile environment may be worth giving an option to purchase compared to sticking with an operator who is not succeeding, he says.
The rising interest rate environment doesn’t appear to be slowing senior housing acquisitions, particularly with HUD financing.
“The larger, more sophisticated groups have the luxury of looking at interest rates and doing some financial engineering,” states Clare. “But for that single site operator where this is his or her first and only building, it’s their shot to own real estate so they’ll accept the 9% rate because the building is worth a 12.5% cap. When the rates go down, they’ll refinance.”