Value Add vs. Stabilized Properties – How are they valued?

Value Add vs. Stabilized Properties – How are they valued?

For a property to be considered “stabilized”, it’s census and monthly (daily) rates must be similar to other properties in the market.  For example, if market occupancy is 92% and the average private pay rate for assisted living is $3,500/month, and if the property that is being analyzed has an occupancy of 93% and average rate of $3,400/month, the property would be considered stabilized.   In this case, the best way to determine its value is by using the Capitalization Rate method.  This involves using the Net Operating Income of the property (NOI) and dividing it by Cap Rate.  If a property has an NOI of $1,000,000 a year and the typical Cap Rate for this type of property is a 7.5%, then the property’s value would be $13,333,000.  This is a very straight forward method of analyzing the value of a property.

Where valuing a property becomes more challenging is when the property is not stabilized at the current market occupancy and rates.   For example, if a property is 100% occupied with an average monthly rate of $3,500, one might assume that it will be hard to maintain a 100% occupancy on a going forward basis, and therefore will reduce the revenue in their analysis to an amount closer to market occupancy, thus reducing its NOI and price from its current state. 

Likewise, if a property has an occupancy rate below market, for example 75%, the NOI of the property is probably very low or may even be negative.  However, the property still has value.  Depending on the quality and location of the property, it may have the potential to achieve a market occupancy rate, and therefore be worth significantly more than simply using the Cap Rate method to determine its value.  A new owner must identify what changes need to take place (capital expenditures, a new marketing plan, a new administrator, etc), the time, cost and likeliness of success to determine the potential future net operating income.   Typically, we see properties that are operating significantly below the market getting sold at a price somewhere between its current state (current NOI/Cap Rate) and its future value (potential NOI/Cap Rate).  The new buyer must be rewarded for solving problems and taking the risks involved in turning around a property.  However, the current owner will not sell unless they think they are getting a fair price for giving up the future upside.

Senior Living Investment Brokerage, INC works with many buyers for both stabilized and non-stabilized facilities and has a long track record of selling both types of facilities.  For a more complete analysis of the value of a property, please contact me at punzel@slibinc.com or Jason Punzel – 630-858-2501.

Washington Healthcare Association Conference

On Monday, February 24^th, I had the honor to present at the Washington Health Care Association’s Spring Conference.  The topic was on Valuing and Analyzing Senior Living and Skilled Nursing Facilities.  During the hour long session, we discussed the current market and valuations, and then analyzed facilities using an ROI/IRR spreadsheet.   This allows investors to calculate how small changes in assumptions (rent growth, expense growth, exit cap rates, etc) can have huge impacts on the IRR over the hold period.

For those of you who were not able to attend, feel free to contact me at punzel@slibinc.com or 630/858-2501 to get a copy of the presentation, including the most recent market valuations.  

How Closely are Cap Rates and Interest Rates Correlated?

A cap rate is calculated by dividing the net operating income of a property by the purchase price.   The cap rate would equal the rate of return on equity if a property was bought with all cash and the net operating income stayed the same for the next twelve months.    As cap rates increase, the purchase price decreases, and vice versa.  

The interest rate on a US Treasury Bond is considered the “risk free” rate of return, since US Government has never defaulted in the past, it is the World’s trade currency, and it has the ability through the Federal Reserve to print money to meet its obligations.   Therefore, many investments are analyzed by their spread over the US Treasury rate.   The riskier the asset, the larger the spread is over the US Treasury.  Over the past 10 years, skilled nursing cap rates have averaged about 1,000 basis points above the US 10 year treasury rate and assisted living cap rates have averaged about 600 basis points above the US 10 year treasury rate.   This is because skilled nursing is considered a riskier asset than assisted living.

This raises the question, is the risk “spread” over the US Treasury a constant or not?  Or, when interest rates change, do cap rates always change in exact correlation?   Although interest rates and cap rates are closely connected, there is not a 100% correlation. 

However, inherently, the risk premium over the “risk free” rate of a US Treasury Bond of any asset is going to vary based upon the demand of investors.   Additionally, the risk premium varies based upon future expectations of a given asset.  Seniors Housing assets still have a greater risk premium than traditional market rate apartments since the investment community considers it a more risky asset.  However, given the future demand for seniors housing, this risk premium may decrease, resulting in a lower cap rate, even if interest rates increase.  Thus, while interest rates do have a strong correlation with cap rates, there are many other factors that go into determining a cap rate, mostly importantly, the future risk that investors perceive in a given asset.

For more information about Senior Living asset values, please contact Jason Punzel, Senior Associate, at Senior Living Investment Brokerage, INC.  punzel@slibinc.com.

Cap Rates

How Cap Rates Are Determined

A cap rate is calculated by dividing the net operating income of a property by the purchase price.   The cap rate would equal the rate of return on equity if a property was bought with all cash and the net operating income stayed the same for the next twelve months.    As cap rates increase, the purchase price decreases, and vice versa.  

The cap rate is a measure of risk.  Typically, the higher the cap rate, the riskier the asset is.  Cap rates for skilled nursing facilities typically range between 11-15%, where-as assisted living facilities typically range from 7-10%.  However, why does one assisted living facility sell for a 7% cap rate and another one sells for a 10% cap rate?

Typically, newer, larger facilities located in larger, growing,  metropolitan  areas sell at lower cap rates than older, rural facilities.   Other determinates are the income/occupancy history of a property.  Those properties that have a history of high occupancy and consistent earnings sell for lower cap rates than properties that have struggled in the past.   

Outside factors also determine cap rates such as interest rates, availability of debt and equity capital and general economic conditions. 

The first step in determining value is to engage an experienced professional to assist in the valuation and analysis of your property/properties.  Please contact us if you would like a no-obligation market analysis.   

Jason Punzel, Senior Associate.  punzel@slibinc.com

What's up with Capitalization Rates?

There are a number of variables that impact capitalization rates. Sellers always ask, "What capitalization rates are you seeing out there?" There is no easy answer.

Some of the blockbuster, portfolio deals that have been announced for 6% - 8% capitalization rates don't tell the whole story. Was occupancy at 85% - 88% with a real, stabilized capitalization rate closer to 9%? Did the operator use a REIT and put some equity into the deal above and beyond the reported price the REIT paid, resulting in an overall higher capitalization rate?

It is dangerous to apply publicly announced capitalization rates to your operation as a means to determine value. To determine value, you need to consider age, location, condition, occupancy, payor type/rates, demographics, future upside, etc.

Allow me to put together a confidential analysis of your facility or portfolio. Senior Living Investment Brokerage, Inc. represented more transactions than any other firm over the last three years. We are able to draw from national data, as well as the large number of transactions we represented. Let us determine an accurate capitalization rate for your skilled nursing or assisted living facility in this ever-changing market.

Please contact Ryan Saul at the following link for a confidential analysis. Email Ryan Saul.