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Sale-Leaseback: The Next Frontier

Sale-leasebacks have been a standard — if underutilized — tool in commercial real estate for years. Routinely, operators of hotels, office buildings, factories and stores weigh the pros and cons of owning their facilities and wind up calling in the sale-leaseback brokers to make a deal.

In the past, relatively few players in the seniors-housing industry have opted for the sale-leaseback. Experts now say the industry has become increasingly aware of the benefits. “It's definitely a major trend in seniors housing now,” says Jim Moore, president of Moore Diversified Services, a Fort Worth-based seniors- housing consultancy. “But it didn't burst onto the scene suddenly. It's a business strategy that's evolved over time.”

The sale-leaseback model is reaching critical mass as publicly held companies become more prominent in the seniors-housing business, especially through consolidation. Though still a fragmented business, with the top five publicly held companies operating only about 5% of all seniors-housing units, according to the American Seniors Housing Association, it's likely that their share will grow through further consolidation, says Moore.

It is public companies such as Sunrise Senior Living, a $1.7 billion operator of some 420 facilities, that can benefit most from sale-managebacks, a structure similar to sale-leasebacks (see sidebar p. 70). The transactions can improve earnings by removing real estate from balance sheets, generating cash for expansion, and eliminating depreciation on the property. Extracting property from the balance sheet is a benefit when it comes to income taxes, but creates a charge against net earnings.

“It's basically a financing strategy that follows the company's business strategy,” says Thomas Grape, CEO of Benchmark Assisted Living based in Wellesley, Mass. “A company that's trying to access the public markets would find this appealing, since most public companies find owning real estate a drag on earnings. As a private company, that would be less of a concern, though in some cases private owners might want to sell as well.”

For smaller private owners, a sale-leaseback might form part of an owner's exit strategy. “In the case of an owner of only a handful of facilities, a sale-leaseback might be a part of an individual's retirement or estate planning,” Grape says.

There are no comprehensive figures on the trend, but the anecdotal evidence is building that seniors housing may be the next great opportunity for the sale-leaseback business. In the closing months of 2005, for example, Senior Residential Care and Wingate Healthcare sold 13 skilled nursing facilities in the Northeast to Nationwide Health Properties for $171 million, and then leased them back. Meanwhile, Capital Senior Living sold six retirement communities to Ventas for $85 million and also leased them back.

Joys of ownership

Jerry Doctrow, a Baltimore-based research analyst with Stifel Nicholas who tracks the seniors-housing industry, points out that ownership for seniors-housing operators still has its advantages, many of which are common to other property types. “If you're the owner, the benefits of higher occupancy and higher rents and appreciation accrue to you,” he says. “You don't have to share with anyone.”

But ownership has its problems as well, says Doctrow. Depreciation is charged against earnings, and an owner assumes the full risks of not being able to control such expenses as utility and labor costs. “In a sale-leaseback, the goal for an owner is to capture the increase in value in the property since its purchase, minimize the downside of ownership, yet retain use of the facility,” he says.

The potential for separation of ownership and management in seniors housing is often compared to that of the hospitality industry, where separation is the norm in many cases. “Both the hotel business and the seniors housing business have heavy operational components,” says Thilo Best, president of Tampa-based Horizon Bay Senior Communities.

Seniors housing is even more of a specialized service business than hospitality, requiring more specialized skill sets to deal with the layers of regulation. “Without the real estate to worry about, seniors housing operators can focus on providing services, just as hotel owners do,” says Best.

A property owner can achieve some of the same benefits of a leaseback through refinancing — but not all. “If you merely refinanced, you probably couldn't get the remaining 25% or so in cash, because lenders won't exceed their loan-to-value [ratios],” says Moore. “In a sale-leaseback or sale-manageback, you receive full value of the property.”

Not all seniors-housing owners are interested in sale-leasebacks. “If we wanted to cash out, we could,” says Bruce Kaplan, president of Chicago-based, privately owned Senior Life Corp., which owns 45 properties. “We've considered all the options. But if you take the approach of owning your own properties, then you can control your destiny. Nowhere down the road do we have to renegotiate leases, or face the possibility of losing control of them altogether.”

Still, Kaplan acknowledges that more of his competitors are looking at property disposition. “Is it right for other companies?” he asks. “It probably is, especially among some of the larger public companies. Certainly it's becoming more of an accepted strategy.”

If seniors-housing operators see pros and cons in owning their facilities, investors show no such ambivalence, says Doctrow. There is no trouble finding backers for deals. “While unleveraged returns on seniors-housing properties can be modest — 7% to 8% annually — with low-cost debt,” returns can be goosed into the 12% to 15% range, Doctrow adds.

Investors are also betting on improving fundamentals of the seniors-housing market. The National Investment Center for the Seniors Housing & Care Industry (NIC) reports that in the second quarter of 2005, the median occupancy rate for independent living properties rose to 92%, a modest uptick from the 91.5% average rate for the past five years. For assisted living, median occupancy increased to 89%, compared to a five-year average of 88.5%. NIC attributes the jump to dwindling construction, as the market responded to the overbuilding of the late 1990s.

Approaching disposition

Capital Senior Living Corp., a publicly traded company based in Dallas, operates more than 50 seniors-housing properties. The company recently embarked on a plan to enter into sale-leasebacks on the 30 properties it owns. “The model we're pursuing has a primary term of 10 years, with two 10-year options to renew,” says James Stroud, chairman of Capital Senior Living. The deals are structured so that capital gains can be recognized over 10 years, instead of in one year, as a simple sale would, he says. “It evens things out.”

Horizon Bay, a private owner, found it advantageous to pursue a sale-leaseback. In 2004, the company sold a portfolio of facilities to CNL Retirement Corp. for $562 million. “That deal was driven by two considerations,” explains Best. “We were taking advantage of attractive valuation for the properties. But we also needed to return liquidity to some investor groups, and this was the best way to do it.”

Sunrise Senior Living, based in McLean, Va., has developed an approach to the sale-manageback structure that CEO Paul Klaassen says gives it the best of both worlds. When the company negotiates a sale-manageback — as it has done on most of its portfolio — it typically retains a 20% equity ownership, an interest that will rise in value along with the value of the underlying property.

“It allows us to participate in the upside, but doesn't require us to participate in the debt,” he says. “If we owned more than 50%, we'd have all the debt on the balance sheet.”

For Klaassen, the major benefit is redeploying capital for expansion. “We're developing 39 properties and we can do that without having to issue more shares,” he points out. “If we wanted to own all of our properties, and grow fast, we might have to issue more shares every year. That would dilute our shareholder value — and it would be hard to get out from under.”

Dees Stribling is a Chicago-based writer.


Third-party ownership of seniors housing is on the rise, as shown by data from ASHA in 2004 and 2005. One contributing factor to this shift may be that as operators sell their underlying real estate, they become third-party managers of the properties they previously owned.

Type 2004 2005
Self-managed 50.4% 31.8%
Third-party managed 21.8% 45.1%
Affiliate of owner 27.2% 23.1%
Sources: American Seniors Housing Association, “The State of Seniors Housing 2005”

How a sale-leaseback differs from a sale-manageback

In a sale-leaseback, the property is typically sold to a REIT or institutional investor. The seller signs a triple-net lease and assumes responsibility for all property expenses, and pays the new owner a monthly lease fee. In 2005, the prevailing rate for leases was 7% to 8% of the sale price, with annual escalators of 2% to 3%.

Typical leases are for 10- or 20-year terms, with multiple options for an extension. After paying the lease fee to the lessor and fulfilling its triple-net obligations, the lessee then makes money via net operating income from the facilities.

Right now the market is rewarding sellers in sale-leaseback deals. According to the National Investment Center for the Seniors Housing & Care Industry, during the second quarter of 2005, cap rates for assisted living ranged from 7.25% to 10.5%, with a mean of 9.25%. Cap rates for independent living ranged from 7% to 10.5%, with a mean of 8.2%.

A sale manageback structure is similar to a sale-leaseback, but differs in how the owner compensates the operator. Instead of taking its financial compensation from the difference between the lease fee/triple-net expenses and the operating income, the operator is paid a specific compensation package for well-defined services involved in running the properties.

The manageback can provide more upside for operators. Contracts begin with flat monthly fees during the initial fill-up of a new community. Next, the operator is paid a percentage of revenues — usually about 5%. Then there are special financial incentives, if the operator achieves high occupancies or meets specified income and cash-flow targets, or penalties for not meeting specified targets.
— Dees Stribling

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