Product type, acuity, building size, NOI margins and occupancy upside – these are the top components of senior living operations affecting community valuation.
Cory Wake, founding partner of Silver Wave Capital, recently analyzed revenue multiples, which the firm uses to measure the valuation of a property to find where it can generate additional net operating income based on existing revenues. He and the firm used three years of data sourced from over 500 deals in an effort to find new ways to identify transactions that would carry the highest revenue potential in lieu of studying cap rates, which analyze the yield of a property over one year based on its income and value.
Silver Wave Capital’s analysis found four aspects that tie into a building’s ability to generate revenue: care type and acuity levels, building size, net operating income margins and having room to increase occupancy. Senior living communities with 30% or higher margins and between 70 and 80% occupancy carried some of the highest revenue multiples in the data set.
“We repeatedly hear from operators, and what we’ve seen in our existing portfolio, is that buying buildings and right-sizing expenses is a much quicker path to profitability than building revenues, if the existing revenues are in place and the expenses have room,” Wake told Senior Housing News.
Wake and Silver Wave looks at deals from the lens of finding a quicker path to profitability over cutting expenses.
Meanwhile, operators like Sonida Senior Living (NYSE: SNDA) also approach deals and acquisitions more through the lens of net operating income on a per unit basis due the variances that can be found from market to market.
One of the key findings from Silver Wake Capital’s tool is the potential in community types and the services they offer. Independent living only communities in the company’s data set had a median revenue multiple rating of 4.39 times across 33 deals, meaning the median deal might be worth more than four times the in-place revenues.
Operators judge the NOI potential of a building using similar benchmarks, particularly when examining service types based on general assessments. Patrick Mathews, chief investment officer and chief financial officer at Charter Senior Living, said independent living units carry higher margins on average, and as such the company goes into acquisitions of them expecting a 40% margin rate. Once assisted living services and expenses are added into that formula, expected margins decline to the 25% to 30% range. Adding memory care services drops margins even further, to the 20% to 30% range.
“It certainly changes the way you’re thinking through the valuation,” Matthews said.
Higher-acuity services pose lower revenue multiples when it comes to the valuation of a building. According to Silver Wave’s data, memory care only buildings see a potential valuation of 2.31 times the in-place revenue and assisted living only communities had 2.64 times across 21 and 73 deals respectively.
Assisted living and memory care are not guaranteed to fall into these patterns, and resident rate potential factors into revenue multiples. For example, memory care only communities might have a higher revenue potential than independent living, depending on the location, due to the higher base rates, according to Levy. This becomes even more evident when there is an initial lower occupancy rate and it can be filled quickly.
“We did selectively buy a couple memory care only, which historically has a tougher reputation, for good reason,” Levy said. “These have actually found similar occupancy uplift opportunity and the ability to stabilize. In strong markets, there is an ability to drive outsized occupancy gains in a relatively short period of time.”
Deals with the highest potential reached a mean of 4.06 times, were communities with less than 60% occupancy. On the other side of the coin were buildings exceeding 90% occupancy, which had a mean of 3.73 times, according to Silver Wave Capital.
Harbert Management Corporation, a real estate investment firm that has a dedicated senior living team, bases its investments on occupancy levels, according to Brian Landrum, co-head of the company’s senior housing team. In instances where a targeted acquisition’s occupancy is less than 80% but in a strong submarket, sometimes changing the operator can lead to quick occupancy gains and rate increases that generate a significant return on the company’s investment.
“You’ve got to understand your asset and where it sits in terms of the competitive landscape,” Landrum said. “Are you the Haagen-Dazs in the submarket, and you can increase rates a little more than maybe the average community? Or are you the average community, and you need to be in line with historical inflationary rent increases in our business?”
Ideal buys
There are a number of factors leading into ideal portfolio additions for operators and firms. It also depends on who the capital partner is, according to Matthews.
Large real estate investment trusts typically look for stabilized assets that fit in their portfolio investment parameters of “core” or “core plus” that won’t be a cash drag on their portfolios, Matthews said. Smaller private equity investors, on the other hand, look for “significant returns” of 20% or more over the span of three to five years.
“In those cases, we’re typically looking for something that has some meat on the bone,” Matthews said. “You’re looking for an opportunity that either needs an operational turnaround … Or it needs significant capital investment, and then it’s going to be a turnaround from there, because we’re actually able to compete in the market.”
Silver Wake Capital found newer buildings built after 2020 and between 125 and 200 units tend to carry the most valuation potential. Operators like Sonida also believe “bigger is better” for community size. Communities with 80 or more units help the operator create efficiencies to get a higher margin, according to Levy. That is much more difficult to achieve when a community has 60 units or less.
Harbert Management Corporation has found its success in traditionally acquiring single site assets, focusing on reinvesting and upgrading the communities to stabilize them, then selling to larger groups who can “move the needle” for their portfolios.
“That’s how we’ve built our deal sourcing networks across the country, and so that’s firmly our strategy, is single asset investing, and then ultimately aggregating high quality, high performing senior housing portfolios on the exit to groups that are looking to write larger equity checks at the closing table than potentially our funds have historically,” Landrum said.
And operators are going to continue seeking out under managed or improperly managed deals, along with developing in markets where they can pair with the right investor, according to Matthews.
“We’ve had the fortunate opportunity, as happened at the end of the year last year, to continue to grow with some of the bigger players in the industry,” he said. “We just try to balance out how we grow, when we grow, and which markets we grow in. At the end of the day, I need to balance out the pressure that’s on our team to be able to continue to perform and provide those returns.”