Meet Arnold Whitman, founder and chairman of Atlanta-based Formation Capital. Whitman founded the company in 1999 after a “tsunami” of negative events, including the credit crisis of 1998, a change in the prospective payment system and a host of liability issues. Having spent 15 years in the senior housing business at that time, Whitman decided to shift his approach from debt to equity. With more than $6 billion in transactions to date, he hasn’t looked back.
Today, Formation Capital is an active senior housing investor and “Arnie” has personally made a name for himself in the industry as Chairman Emeritus of the National Investment Center for Seniors Housing and Care (NIC), as co-chairman of Genesis Healthcare, as a partner to Aging2.0 and more. We sat down with Arnie to hear his definition of leadership, how a big risk can pay off and why senior housing provides a unique upside not found in other industries.
Take me back to the early days of Formation. What did your first investment look like?
We had a nice business plan and were very fortunate in that we secured our first transaction in Florida by acquiring (or trying to acquire) 53 facilities from Beverly Enterprises. It was 49 skilled nursing and four assisted living buildings for $165 million in July 2001. My partner and I put down all of the money that we had, literally.
We did that because we had debt and equity lined up alongside us, and said ‘OK, we’re ready to go, we’re going to make our first big investment.’
Florida was under huge pressure from all of the trial lawyers that were suing for anything they could as far as liability went at the time. In Florida, under the patient rights bill, if you served cold food, you could be sued. It was a very negative environment and all of the public companies were trying to get out of the state at that time. We had gone to Beverly, made this deal, we had the deal under contract, and we were thinking, ‘OK, we’re going to be on the map.’
Then 9/11 comes.
Two weeks later we went to New York to see UBS and Black Acre (which was our equity partner), and both of them bailed.
Now, we had had firm contracts with them to finance us. They used what’s called an MAC clause, [which address the possibility of a] material adverse change, to say ‘We are no longer going to do this deal.’ Everybody was, as you know, stunned.
The Trade Centers had come down, capital markets had crashed, everything was negative. So we were sitting there, everything we had on the table, and wondering, ‘Are we going to survive? Are we going to get through this? And what’s going to happen?’ My partner Steve Fishman and I literally pounded the pavement in New York looking for a way to finance that deal. It was pure desperation.
It took us about three months. There were a lot of threats thrown at us from Beverly Enterprises. If you’d been there you would have just been stunned.
What kind of threats?
We ultimately did the deal with Citibank and they saved us. Beverly Enterprises, who had us under contract, had a right to take our deposit.
We hadn’t performed because we had lost our lenders. We were sitting four blocks from the World Trade Center in Citibank. You could still see the soot from the World Trade Center that had come down. One particular guy from Beverly Enterprises was banging on the table and saying, ‘We’re going to take your money, you have 30 days!’ We knew we were stuck. It’s one of those moments when you think, ‘Has this guy got any empathy at all?’
Were they just trying to get a good deal because they knew they had you?
A good deal would have been one thing, but it was also very innovative. Needless to say, we were able to finance the transaction at the time with Citibank. The impetus for that was that we separated the real estate and operations when we bought these assets. All of the old liabilities went with the company and we assumed responsibility of those assets going forward. This what the bankers of Citi did, which was brilliant. They said, ‘Worst case scenario we’re not going to see realization of any of these claims take place [on] Day One for two years.’ Without that cost of litigation and without the cost of insurance, the cash flow was huge. We were buying these assets at a relatively low price based on normal business and took a larger piece of equity to finance the deal. Ultimately it worked out to be fantastic. We sold those assets three-and-a-half years later for over $400 million to GE.
But at that point in time when it was better to be lucky than good, we really created what became Formation Capital.
From there, we gained credibility and it gave us the ability to raise more capital. The nice thing about being private is we don’t have to stay inside any box.
I saw firsthand that you can really make a difference in people’s lives, and you can make money. There are very few opportunities in business where you can actually do that. – Arnold Whitman
Was the deal that you did in 2001 the hardest deal you’ve ever had to get done?
Yes, for a lot of reasons. When you say hardest deal, between the elements of the circumstances, complexity, the emotion, and being the first deal, it would definitely be. We’ve done a lot of deals and almost all deals are challenging, but because of the dynamics and what happened with 9/11, it could’ve gone either way.
When you said that all deals are hard, there was a big smile on your face. Is it fair to say that you like doing deals?
I love doing deals. I love doing good deals. The truth of the matter is, from a philosophical standpoint, the basic premise when I look at opportunities to invest, especially in the senior care field, there are a couple of things that really attract me to it. There is creation of value. Unlike, let’s say a REIT, that might [be] yield driven or return driven, our [focus] is more opportunity driven. Where do we extract value in a transaction?
It’s both economic and it might be [about finding] synergies. It might be an overhead play, it might be a merger play, it might be a recapitalization play. We look at it as, ‘Let’s identify what the transaction is and what we’re buying, and then really ascertain how we are going to create value in this.’ That varies with time. If you’re in a distressed market it’s sometimes easier to say, ‘Wow there’s a lot of opportunity here,’ but it’s also hard to raise money in those situations. Up until about three months ago, the market got to a place that made you wonder, ‘How are we going to extract value here? Where’s the real value here, because we’re paying higher prices, we’re competing with more people?’ But the answer to the question is different. It doesn’t necessarily mean that there aren’t good opportunities; I think the opportunities get narrower.
The other piece that really attracts me to this industry and investing in this business has to do with creation of value. You’re changing people’s lives. You have a chance to create value socially and economically. It’s one of the reasons I’m so attracted to what Katy Fike is doing with Aging2.0. I saw firsthand that you can really make a difference in people’s lives, and you can make money. There are very few opportunities in business where you can actually do that. That’s one of the reasons I’m attracted to investing. You get a chance, whether it’s turning an older building into something that’s newer, or changing culture or in the case of Aging2.0, developing new, innovative ways to improve people’s lives.
Do you like the operational side of the business? I read an interview from back in 2012 and you said something along the lines that you really like the operational business because you can see that you can add value there, too.
Do I like the operating side of the business? I do not like being an operator—it’s hard! I have unbelievable respect for people that do that work. It really is challenging. Caregiving is a sacrifice. There are other complexities, and not just from the caring side but the complexities around regulatory, reimbursement, insurance, liability….
These are all things you guys go after, too.
Yes, but I can strategically deal with those. I don’t have to hands-on deal with those. The senior housing and care business is a hybrid between real estate and operations. We used to have a running joke: Is it a real estate business or an operating business? The answer would be: Depends who you’re talking to.
We have a theory of alignment of interests that we like to utilize. It involves an approach of partnering with our providers that shares in the overall creation of value in an investment. The theory is that because real estate rent valuations and cash flow income valuations trade at different multiples. If you can structure a deal where if you can expand cash flow and then transfer that additional expanded cash into rent you effectively create additional value for the overall enterprise. If structured in a partnership properly this approach is a win/win. This dynamic does not really exist in any other real estate class.
