Cap Rates and Interest Rates’ Effects on IHC

Wally Smith:
Mike, let’s talk about cap rates. Can you describe in layman’s terms what is it cap rate?

Mike Jones:
It took me a couple years to figure it out, I think. Essentially, a cap rate is the rate of return a buyer is willing to accept or expects from the cash flows provided by a property. And so when we look at property appraisals, the most heavily weighted valuation method is an income capitalization approach, which takes the income and projected income of a property and applies a market cap rate to it to reach a purchase price. So the valuation of our properties are function of the operating business of taking care of these, of our seniors residents.

Mike Jones:
And so with the exception of 2020 when there was very limited inventory available for purchase, purchase cap rates have really been at historically low levels the past few years, which means they traded at relatively higher prices. And that’s been a function of low interest rates and the amount of cash in our economic system. And you can see what’s been the result of that with all the inflationary pressures. But seniors housing, in addition to being recession-resilient, also has a very low volatility within the cap rates. So in my time of doing seniors housing transactions on a typical assisted living memory care property that we offer, you’ll see cap rates anywhere between five and a half and 7% high end, depending on market and class. So it’s a pretty low spread between cap rates, and we’ve been operating at the lower end of those cap rates. With interest rates rising, we’re starting to see those cap rates come up a little bit into the middle of that range. And we’ve been able to get some more attractive
purchase prices here.

Wally Smith:
So you feel that rising interest rates, that’s actually potentially an advantage for you?

Mike Jones:
I think so, especially in the case of the deals that work all-cash. When we talk about leverage, actually the banks are really struggling to price things, but interest rates are coming up on the bank side of things. And so yeah, we’re able to negotiate better purchase prices of late, I would say, just within the last month or so, just based on the fact that a lot of the buyers in our industry are unsure about the leverage that they’re going to be able to get. So our ability to go all cash coupled with the relationships that we have with banks and my understanding of what I know that the bank is willing to do for me has been really a benefit for us of here of late.