Investing in Healthcare Real Estate Part 2 | The 1031 Show™ | Episode 23 | Inspired Healthcare Capital

00:00 – 00:36: Teaser

00:36 – 01:13: Introduction

01:13 – 01:26: Bumper

01:26 – 03:27: Spotlight: Patrick Lam and Mike Jones

03:27 – 04:53: Why Healthcare?

04:53 – 06:27: Managing IHC’s Facilities with Volante

06:27 – 08:09: Covid’s Effect on IHC

08:09 – 11:12: Structure of IHC’s DST Investments

11:12 – 12:35: Other Types of Properties in the Healthcare Sector

12:35 – 15:22: IHC’s Location Preferences and a Supply and Demand Problem

15:22 – 18.53: IHC’s Due Diligence Process

18:53 – 19:45: What Makes IHC Different?

19:45 – 23:11: Cap Rates and Interest Rates’ Effects on IHC

23:11 – 24:50: IHC’s Location Preferences and a Supply and Demand Problem Continued

24:50 – 25:55: Private Pay vs. Medicare

25:55 – 27:45: What Maes IHC Different Continued

27:45: End and Disclosures

Show Transcript:

Wally Smith:
It’s been a few months since we’ve had you guys on. Why don’t we start from scratch? And Patrick, Mike, why don’t you introduce yourselves and what you do for Inspired Healthcare?

Patrick Lam:
Sure. Thank you so much, Wally. My name is Patrick Lam. I’m the president of Capital Markets and the national sales manager here at Inspired Healthcare Capital. With the team here at Inspired Healthcare Capital, we have about 10 operations people and about seven wholesalers throughout the country.

Wally Smith:
Okay. So a smaller company. You pack a punch though. You guys, what do you specialize in and what do you do for the firm? You’re the president so you keep everybody in line?

Patrick Lam:
Yeah, absolutely. Our goal this year was to raise $500 million following an amazing 2022 when we raised just a little bit over 200 million. And so this year, our goal is to have 14 DSTs fully subscribed. We’re on track to get there, and I think we’re on track to hit 600 million this year.

Wally Smith:
Wow, that is growth. I know the market has been just on a tear, so that’s great. Mike, introduce yourself, and what do you do?

Mike Jones:
My name is Mike Jones. I’m the director of investments at Inspired Healthcare Capital. My primary responsibilities are to oversee the underwriting of our seniors housing real estate offers and structuring the investments to meet the needs of our investors. I also oversee the assets for the life cycle of their whole period through disposition. My backgrounds in commercial banking during my career, I’ve underwritten all types of operating businesses and different types of real estate assets, and I decided to devote all of my attention to seniors housing real estate a little over 10 years ago. I’ve been with IHC for nearly three years. Prior to that, I oversaw the bridge lending program for a national finance company seniors housing platform, which is one of the largest in the nation.

Wally Smith:
Very good. Well, this sounds like a lot of depth definitely in this sector and obviously in the industry as a whole. You guys, you’ve chosen healthcare. Obviously the demographic, the baby boomer wave and all of that is supportive of that. What do you like about it? What do you like about healthcare? I know it seems to be one of the strongest DST sectors that we work in.

Patrick Lam:
Absolutely. One of the things that excite us the most about the healthcare sector is as you mostly know, not all real estate is created equal. And we like the healthcare or senior housing asset class because it’s more recession resilient than most other asset classes.

Patrick Lam:
Let me tell you what I mean by that. You don’t ever choose as a baby boomer or senior when you get sick or when you need long-term care or when you start losing your memory or have Alzheimer’s. And because of that, it’s not sensitive to the economic cycle. And so when you’re a baby boomer that you need a certain type of care every single day, we’re the provider for you. And that’s why we really like healthcare or senior housing. But more importantly, we only focus on something called assisted living and memory care, and that’s really the most predictable, the most conservative, and more importantly, the most consistent type of asset class inside healthcare and real estate.

Wally Smith:
So with the DSTs for a lot of our viewers, they don’t know how that works. You have a master lease arrangement, and the master lease ends up being the manager of the property. And you guys have a lot of strength in that, in that management of this sector. So do you keep the management when you buy new property generally or is it accretive? You bring it in and fold it into your master group?

Patrick Lam:
Sure. And there’s exceptions to, I think, every rule. But most of the time when we look at a senior housing facility or community, the first thing we look at is number one, how their occupancy is and how are they performing? And if things are going well and they are 95 to 100% occupied, they’re performing well with the rents, the last thing we want to do as a new owner is to come in and disrupt things that are going very well, which is why we created Volante. What Volante does as our operator is they will come in, be the new operator, but they will hire every single staff member from that community. And so what that does is builds consistency for the baby boomers that are living there, but more importantly, it helps us become more efficient in terms of oversight and just cost and efficiencies throughout the communities.

Wally Smith:
When did you create Volante?

Patrick Lam:
We started that about a year ago, and now it’s fully running on full speed. It’s occupying about 15 communities at seven different states.

Wally Smith:
Wow. That’s excellent. COVID. COVID shocked everybody’s system. How did it affect you guys?

Patrick Lam:
I think the biggest misconception about COVID was the fact that it had on senior housing and healthcare. You heard almost every day in 2021 that COVID hit a lot of nursing homes throughout the United States of America. But really, it really just hurt nursing homes. It didn’t really hurt assisted living facilities or memory care facilities. And that’s what we’re really proud of. Most of our communities went through COVID without much issues. Maybe there was one or two deaths, but definitely not an outbreak or anybody leaving any facilities because of COVID.

Wally Smith:
I know with the nursing homes, a lot of people felt like, “Okay, we’re going to bring mom home now. We’re not going to leave or we’ll just figure it out. We’ll take care of the nursing ourselves or whatever.” It was so messy for so many. So you didn’t have to uproot people for the most part out of their homes in their assisted living? That’s great.

Patrick Lam:
I think one thing you point out is compare assisted living and memory care facilities to nursing homes is it’s a completely different staff. We have 25 usually full-time employees that only work in our community or facility. When you’re in a nursing home-

Wally Smith:
The ratio that you have-

Patrick Lam:
I’m sorry?

Wally Smith:
What ratio do you have, staff to residents?

Patrick Lam:
I think it’s about one to three, one to two and a half.

Wally Smith:
Really? That’s excellent.

Patrick Lam:
But one thing I wanted to say was with nursing homes, you have a lot of part-time employees. And that’s really why there were outbreaks, because you have a nurse that came from a hospital in the morning shift to go to their afternoon shift to hit the nursing home. And that’s where you saw a lot of spreads throughout the country.

Wally Smith:
Very good. Getting into the structure of some of the deals, you offer both all-cash and leverage deals. I know in the past, it has flip flopped. You have one, have the next. What’s your plan there going forward. Do you continue to still have both?

Patrick Lam:
Oh, absolutely. I think we always go into the deal, not picking already what that deal is going to be, whether it’s all-cash or leverage. I think when we look at a community or an offering, we want to make sure it works and it pencils real well through underwriting and Mike Jones and his department. Once we like the facility and realize the stabilized facility with a lot of potential, then that’s when we figure out if we want to do an all-cash or a leverage deal. And so if we look forward to the next six months, we’re going to have about six leverage deals and about three all cash deals coming out.

Wally Smith:
Excellent. Good deal. Is there a size that’s a sweet spot for you? 100 beds or what size facilities do you like?

Patrick Lam:
Mike?

Mike Jones:
Yeah. I think that what you said is about right. That’s about the sweet spot, anywhere from 80 to 120 units. Our purchase price on something like that is depending on location and class and vantage of the assets, anywhere from 25 to $50 million.

Wally Smith:
Okay. And then as far as you’re structuring these things, do you take on outside debt to be able to do them? Do you have your own war chest, if you will? How do you approach the deals?

Mike Jones:
Yeah, both. From the leverage standpoint, we work with several different banks that are comfortable with the DST structure that we’ve been able to provide leverage. So they provide loans on first mortgage debt on the properties, somewhere around 50% loan to value on the offers. The leverage we offer is typically 45 to 53, 54% leverage on our deals. From the standpoint of closing, we do have our own fund that we use to make sure we have the ability to close when in the chance that there’s a gap between the capital raise and the closing of the property.

Wally Smith:
It really puts you in a strong position then when you’re bidding for a property, I guess.

Mike Jones:
Yeah, absolutely. Yeah.

Patrick Lam:
And I think that’s really the biggest difference between us and other sponsors in the DST space. We not only have banks and lenders that we’re preferred that we work with, but you’re right, we have that war chest. So if you do business with us at IHC or Inspired Healthcare Capital, you are going to know 100% that we’re going to close on time.

Wally Smith:
That’s nice. That’s excellent. Mike, you mentioned you’ve been in the healthcare industry for 10 years or so. We’re talking here mostly about senior living and memory care, but what are the other sectors? What are the other kinds of assets or properties that are in the healthcare sector?

Mike Jones:
Sure. So when we talk about seniors housing, we talk about levels of acuity. That’s based on the amount of needs a senior would have. And so within that spectrum, you go from 55 plus apartments, which essentially just an age-restricted market rate multi-family deal, all the way through your sub-acute post-rehab skilled nursing facility. And so like Patrick said, we like to focus on assisted living and memory care. We do have some component of independent living, which is seniors who don’t yet have needs but want to be provided meals at the residences. And so they’ll have an apartment, but they act as feeders into our assisted living and/or memory care from there. So there, our independent living component of any of our communities is a relatively small percentage.

Wally Smith:
And so Mike, where do you find properties? Where do you scarf? How do you source them?

Mike Jones:
Yeah. We look nationwide and we source primarily through brokerage houses that focus on seniors housing. It’s a pretty niche industry, and we have built relationships with the larger brokerage houses and then some smaller ones throughout in different regions where we’ve purchased properties. And then the amount of experience here that we have in industry, we’ve also have built relationships with various operators. And so we’ll get deals off market from those operators that are operating communities. In fact, I’m traveling to Utah tomorrow to two communities that we’ve bid on that have not gone to market. They just brought them to us.

Wally Smith:
That is excellent. How many senior living and memory care facilities are there in the country?

Mike Jones:
That’s a good question. I don’t know. That’s a good question. I’ve never been asked how many there are. I’m sure there’s a standard-

Wally Smith:
A trade magazine somewhere for it, right?

Mike Jones:
I know. I know I have the data. I just would have to look it up.

Sly Pusiri:
The more important thing to know is that they need more. We need more.

Mike Jones:
Yeah, that’s correct. There’s not enough. That’s the right answer.

Patrick Lam:
Yeah. Something we talk about is… We don’t hear this in the last presidential election. Maybe we won’t hear it in 2024. But definitely by 2028, I think you’re going to hear that being the fact that there’s not enough supply for the demand of the baby boomer generation, that’s going to be a huge problem for America coming up.

Wally Smith:
Do you see a lot of these small residential? We see homes and communities that have four or five bedrooms in a ranch house right down the block that is a independent living or senior living facility. Is that a big trend right now, trying to fill that demand?

Mike Jones:
That has been part of the industry for some time. They typically don’t provide the level of care that you see in the communities that we purchase. It is more personal. I think it’s just a matter of preference. They are typically less expensive. But the level of care and the access to nursing in those communities is not as great as you would find in the communities that we offer.

Wally Smith:
Mike, can you talk through your due diligence process just a little bit? So when my clients ask me, how do we know this is a good deal? How do we know who’s looked at it? I try to describe to them how many sets of eyeballs have generally been on a deal from initially you guys to the banks, the financing inspection. What does that process look like?

Mike Jones:
Yeah. So when the communities come to our attention, we talked to the current operator. We talked to the broker and we get a relatively simple set of… We get financial statements. We can look up state surveys, et cetera, to see how the building’s operated. But then from a due diligence standpoint, yeah. We get a number of third-party reports just like you would in other a real estate asset classes. We get appraisals. We get environmental reports. We get property condition reports. We get real estate tax report from another third-party to make sure we’re underwriting real estate taxes correctly. And then we have data sources for the state regulations. So we’re looking at licensing issues and compliance issues from the licensing standpoint. Our banks order their own set of third-party reports that we have access to before we waive due diligence. So yeah, there’s quite a bit of eyeballs on that purchasing.

Patrick Lam:
Yeah. Just with Inspired Healthcare alone, I think there’s about six people that sign off on a deal before we actually go to market with it. And then if you’re looking at a lended or leverage deal, there’s another probably four or five sets of eyeballs from the bank that will look at and underwrite that deal. And that’s just with Inspired and the lender. And then we focus in on getting it approved at Emerson Equity, our managing broker dealer. There’s another three sets of eyeballs there. So at least a dozen just on the fact that it needs to get approved through the due diligence process.

Wally Smith:
Well, without naming properties specifically, I think it’s good to know that you guys don’t take every single deal that comes along. On the contrary, you’re very picky and choosy. And I know recently, you got all the way up to the altar with a project and decided, “Nope, it wasn’t right.” So that due diligence process is continual.

Patrick Lam:
Absolutely. One thing about that, I’m glad that you brought that up, Wally. Lakewood Ranch was a deal that we walked away from near the final hour, and we could have came out to market with it quite honestly. A lot of people were excited about it. And at the end of the day, when we finally just looked at the due diligence with some of the things that we were concerned with, it didn’t quite check all the boxes we wanted. It didn’t really quite fit all the requirements we wanted.

Patrick Lam:
And I’ll tell you that we made a really tough decision and decided to walk away from it. It was over 25… Actually excuse me, $32 million in capital raised in terms of just alone. I think that hurted everybody. We understand that would hurt everybody, including your clients. But we did the right thing. And it might hurt the short-term for everybody, but the long-term was we didn’t want to come out with a market or with an offering just to come out with the offering because we knew the market wanted it. We wanted to do the right thing for investors. And that’s what we wanted.

Wally Smith:
That’s what you said. How many deals have you guys done total?

Patrick Lam:
Total since inception, we’re probably at our 21st deal altogether now.

Wally Smith:
How many have gone full-cycle?

Patrick Lam:
We have two full-cycle events right during the middle of COVID. And we didn’t have to full-cycle it, but quite honestly, we full-cycled those offerings early. And we wanted to show that number one, assisted living and memory care were virtually unaffected by COVID and we had financial strength to go full-cycle during COVID for those offerings.

Wally Smith:
That’s excellent. Have you guys ever missed a distribution payment?

Patrick Lam:
Absolutely not. And that’s one of the things really pride ourselves on. We haven’t stopped distributions. We haven’t-

Wally Smith:
You haven’t lowered distribution?

Patrick Lam:
We haven’t stopped distributions. We haven’t suspended distributions. We haven’t lowered distributions. We are doing everything we say we’re going to do.

Wally Smith:
That’s excellent. 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.

Wally Smith:
As far as the area in the country, I know when we first started working with you guys, I think we were focused around the Atlanta area. You had two, three properties in that area. You just mentioned Utah a little bit ago. Is there an area? Are you trying to keep away from the coastal areas? Are you trying to keep in the warm areas? How do you determine that?

Mike Jones:
Yeah. We look at a number of different things. But from a demographic standpoint, you see a definite migration out of colder climates into warmer climates. We actually are looking at a number of properties right now in Florida.

Wally Smith:
I believe.

Mike Jones:
Yes. So to that point, we do listen. And so we are looking at tax-free states. We do have a couple deals in Nevada that we’ve done. We have several coming out in Florida. We’re looking at several in Texas right now.

Wally Smith:
Oh, great.

Mike Jones:
All of which have been, they are their own little niche areas. And it took us a minute to get some headwinds in those and create relationships in those areas. But our pipeline is actually predominantly Florida and Texas right now. But we have a number in the Midwest. We’ll continue to grow there. As you know, our operating companies is operating a number of properties in the Midwest. So to create some economies of scale for our investors, we’ll continue to look there.

Wally Smith:
Good deal. I know you focus. It’s all a big selling points, private pay, not Medicare reimbursement. Is that a key box that you guys have to check on a property?

Patrick Lam:
I think it’s not always. Oh, sorry.

Wally Smith:
Yeah.

Patrick Lam:
Go ahead. Sorry.

Mike Jones:
Sorry, Patrick.

Patrick Lam:
Go ahead, Mike.

Mike Jones:
Get about this stuff.

Patrick Lam:
No, no, please.

Mike Jones:
Yeah. So Medicare, we don’t deal with Medicare reimbursement at all. That’s solely a function in skilled nursing, and Medicare is constantly changing. I underwrote quite a few skilled nursing transactions in my time in the finance world, and I’m glad not to do that anymore. They changed. They completely change the system, it seems, about once every five years.

Wally Smith:
Does Medicare come to play with memory care?

Mike Jones:
We deal with Medicaid. On the state level, we deal with Medicaid reimbursement in some of our properties. And so we’re very selective when it comes to properties that accept Medicaid. It’s a state by state basis where the state budgets are sound and they have a previous Medicaid reimbursement program.

Wally Smith:
Okay. One last question, Patrick. This will be a total softball for you. But you’re one of the top selling DST sponsors in the industry within your offerings. What are some of the key differences? How come you’re so successful? And how can you offer the generally higher yields that we’re seeing from your firm?

Patrick Lam:
Absolutely. I think one of the things that sets us apart from other sponsors in the marketplaces, we listen. And we not only listen to our advisors, but we listen and take action. And so I remember having this conversation with, I believe, you and your team at Ridgegate Financial when we talked about our disposition fee. And it was simple. Our first DST that we ever came out with didn’t subordinate the disposition fee to the return of capital to our investors. And what we did after our conversation with you and Rich and the entire team at Ridgegate Financial was very simple. We said it would make a lot of sense and make our story a lot more powerful if we don’t take a disposition fee unless we do our job.

Patrick Lam:
And our job is very simple. We continue to pay out the high income that we have with senior housing. We return all your client’s money and their entire capital. And at that point, that’s when we deserve a disposition fee. And we understand that. And the good thing about that is now, that makes our structure aligned with every single investor in the market.

Wally Smith:
Yeah. Well, and as you know, that’s the way we approach our business. We try to line up with the client, and when they win, we win and vice versa. So really enjoy working with your firm. The responsiveness has been fantastic. Work mostly with you was fine, and it’s been a great relationship. We look forward to what the rest of this year holds and appreciate your time. Thanks for coming on.

Patrick Lam:
Thank you so much. We appreciate your partnership as well. Thank you.

Wally Smith:
All right. Take care.

Disclosures:

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Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. Investment advisory services offered through AE Wealth Management (AEWM).

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