October 2015.

The triple bottom line return in Seniors Living – a SPIRE report from the recent US Seniors Housing conference and review of 10 ROC Seniors assets in California.

Having spent the past week in the US (with ROC Seniors COO Rick Steinberger and their primary community operator partner Meridian Seniors Living) SPIRE:

1. walked away feeling incredibly proud to be associated with our partners who manage and operate these communities that we invest in.

2. was convinced that the quality of the partnership, and the underlying dynamics in the sub markets ROC Seniors are investing in, will enable the team to exceed the objective of a achieving a minimum net 16% IRR per asset.

This is what we learnt from the week …..

• Well run Seniors communities provide a great quality of life for their residents so we should all feel good about enhancing the assets and amenities that improve the lifestyle of Seniors.

• The management and care givers in these communities have a special DNA and are central to the enterprise value created – the quality of care and financial performance of a community are a virtuous circle.

• Successful Seniors communities are primarily built on the quality of the people and programs delivering the resident experience; the physical assets and amenities (real estate) support this experience. Meridian’s Montessori “moment in time” experience and “validation” techniques are consistently executed across each of their communities …. this sensitive and supportive approach to care builds extraordinary goodwill with residents and their families; Goodwill manifests in Good Business!

• Cultural and Financial alignment between the owner /asset manager and the operator is essential to ensure the plan is executed. For example, Meridian, largest third party manager by number of ROC Senior’s assets,  holds an equity position (typically 5%) in each of these assets alongside ROC and is incentivised to drive Net Operating Income above hurdle rates. Alignment is strong!

• Intimate local sub market knowledge of the resident segment, competitor universe and new development initiatives is critical for successful transition of assets and improvement in operating margins. The investment thesis, plan and associated DCF modelling includes a review of the comparator set pricing along with sub market supply/demand analysis in each of the relevant segments.

• There is extraordinary pricing power for owners (and investors) particularly in high barrier to entry sub markets where previous management have failed to price to market. The Meridian Californian assets are forecast to increase NOI by 50 – 200% over next 3 years as the asset rehab program creates new look and energy.

• The community Executive Director (ED = CEO) and Marketing Director are the key personnel driving operating performance however there are a range of critical roles performed as part of the team including nursing, asset mgt and programs director. A cohesive team is essential. In the 10 assets I reviewed some of which are transitioning to Meridian only one ED is being moved on.

• The asset level arbitrage is available by transitioning existing assets from operating margins of 20% up to 35-40% through driving rents, occupancy, care services and managing expenses through scale, systems and processes to ensure the ratio of residents to care givers is managed effectively and efficiently.

• The market level arbitrage for stabilised scaleable portfolios will persist as demand will continue to outstrip supply and as the industry becomes increasingly “institutionalised” ie. large REITs buying large portfolios of stabilised assets from the private operators. The current modelling across the 43 assets in the portfolio assumes an exit cap rate of 7.25% visa current equivalent trades of 5% in the listed REIT market. The 200-250 basis points spread provides “buffer” against cap rate expansion in the event of interest rate rises.  Or “blue sky” beyond the pro-forma financial models net 16% IRR return target.