News: GE HFS/ Formation Capital (July 2006)

Massive deal shows skilled nursing’s rise

GE LOOKS TO COMPLETE $1.4 BILLION ACQUISITION FROM FORMATION CAPITAL IN Q3

 

By Sonja Pedersen-Green

 

The $1.4 billion acquisition deal that GE Healthcare Financial Services (GE HFS) recently signed with Alpharetta, Ga.-based Formation Capital LLC is more than just a huge transaction. It’s proof that the economics have changed for the skilled nursing market.

It wasn’t too long ago that most investors wouldn’t dare dip their toes in the skilled nursing market. But now, according to John Cobb, senior managing director for GE HFS’ real estate team, the market is going strong and GE HFS is eager to be involved.

“We’re very excited about it,” Mr. Cobb says. “It’s a big step for us. It’s our largest equity transaction to date.”

The agreed upon transaction, which is expected to close in the third quarter of this year, composes 186 Formation Capital skilled nursing facilities with more that 21,000 beds. The acquisition would almost double GE’s equity portfolio, bringing its total investments in healthcare real estate assets to more than $4 billion. About $2.6 billion of that is in the senior living market.

GE HFS officers describe the pending deal as a sale/ leaseback, as the buyer will contract with Formation Capital for asset management services. Therefore, according to Mr. Cobb, the operation of the properties will be status quo, with building names and property managers remaining the same.

“The residents and the owners will now be paying rent to GE as opposed to Formation Capital,” Mr. Cobb says. “It’s a very seamless transition for the owners and the tenants of the buildings.”

As a result of the transaction, GE HFS will now have ownership interests in skilled nursing facilities operated by Laurel Healthcare, Centennial Healthcare, Opis Health Services, Harrington Healthcare, Sovereign Health Services and Epsilon Healthcare.

Fifty percent of the properties in the Formation Capital portfolio are located in Florida while the remaining facilities are in 20 other states, including Michigan, North Carolina, Ohio, Indiana, Massachusetts and Mississippi.

Involved in equity

Although GE HFS is certainly more known for providing debt products, it got involved in equity ownership about a year and a half ago at the urging of its customers. The firm initially became involved through two joint ventures, including one with Formation Capital. Its first deal was with Dallas-based Capital Senior Living

According to Mr. Cobb, GE HFS’s leading customers in recent years began “demanding” that the company create an equity line.

“It’s helping our customers grow,” Mr. Cobb says, “and (we are) creating products to help them do that.”

As GE HFS looks to grow its equity line, it is concentrating on three different sectors, Mr. Cobb says.

“We’re looking at doing equity investments in skilled nursing, senior housing and medical properties,” Mr. Cobb says, “It just happened to be this is the first large deal and it’s in skilled nursing.”

Mr. Cobb notes that the deal with Formation Capital was especially attractive because of the improving economic indicators in the skilled nursing sector.

“We liked the market fundamentals,” Mr. Cobb says, adding that the firm did a a classic supply-and-demand analysis before striking the agreement with Formation. “We think that there is very limited new supply and demand is growing every year… If you look at the industry statistics for the last three years, occupancy is up.”

Demand in the skilled nursing sector is actually better than in other real estate classes, Mr. Cobb adds.

 “Occupancy has gone up every year for the past three or four years one percent a year,” he says. “And there’s really not a lot of that happening in fundamental real estate, so we really liked the numbers.”

Strong fundamentals

Even with economic indicators showing positive signs across the board in skilled nursing, GE HFS wasn’t hasty about entering the agreement with Formation Capital, Mr. Cobb says.

“Obviously, this is a 1.4 billion dollar deal so we have a lot of due diligence,” Mr. Cobb says, “We believe that when you buy good quality real estate that serves good market operators, that’s probably a very good investment.”

Mr. Cobb says the Formation Capital portfolio fundamentals are even stronger than market averages, which have picked up recently. For example, the average age of the facilities is 22 years, compared to the industry average of 30 years. In addition, he says, overall occupancy is 90 percent, while the industry average is 86 percent.

GE HFS’s history with Formation Capital and a number of the tenants also played a large role in the purchase.

The two developed a relationship about six years ago, and since then, Mr. Cobb says, GE HFS has provided Formation Capital with financing totaling almost $400 million. As noted earlier, the two had also engaged in a previous joint venture.

“We have a great relationship with Formation, and we really liked the tenants,” Mr. Cobb says. GE HFS already has financing deals with four of the six operators in the Formation Capital portfolio.

“We know the tenants, we’ve worked with the tenants, we know how they operate,” Mr. Cobb says. “Obviously the tenants are the ones who have filled the buildings to 90 percent occupancy, and that doesn’t happen by dumb luck. So there are great operators that have great performance that we really like.” q