In a blockbuster deal announced in January that marks a strategic shift for Genesis HealthCare Corp., two private equity firms have agreed to acquire the nursing home operator for a cash payment of $1.25 billion. Affiliates of Formation Capital LLC and JER Partners will pay $63 per share in cash for Genesis (NasdaqGS: GHCI). The buyers will also assume $450 million in debt.

The deal gives Genesis, which emerged from bankruptcy in 2001, the financial flexibility it needs going forward amid a $250 million facilities' modernization program. Genesis operates 220 buildings in 13 states. It does not develop new properties.

"We were looking for a partner that believed in the demographics of the market and long-term value creation," says Jim McKeon, CFO of Genesis based in Kennett Square, Pa. Several other investment groups bid on the company, he notes. A spokesman at JER, an institutional investor based in McLean, Va., declined to comment for this story.

Georgia-based Formation Capital is known as a savvy investor in the seniors housing sector. Formation astutely picked up nursing home portfolios in the late 1990s when a number of operators were in bankruptcy largely because of changes in Medicare reimbursement rules.

Last year, Formation sold six portfolios with 186 skilled nursing facilities for $1.4 billion to GE Healthcare Financial Services, its first foray into ownership. Soon after, Formation and JER teamed up to buy Florida-based nursing home operator Tandem Health Care Inc. for $620 million.

"Formation Capital has shown real insight into where there are opportunities," says Bob Kramer, president of the National Investment Center for the Seniors Housing & Care Industry.

But unlike past deals, the Genesis acquisition isn't a turnaround scenario, according to Formation CEO Arnold Whitman. Instead, he says, today's nursing home industry has strong fundamentals. By modernizing the Genesis buildings, which have highly desirable locations in big cities, Formation believes that it can enhance operations even further.

Whitman's strategy is to align with quality operators, but to have investors own only the real estate portion and not the operation. He says investors don't understand the operating side of the nursing home business, a tough one that faces regulatory and reimbursement issues.

"Investors don't want to be in the line of fire," Whitman notes. The deals are structured as a twist on a sale-leaseback, he explains. Investors get additional rent when the operation generates profits. To make that happen, operators are given incentives. "The better they do, the more they make, and the more the investors make," says Whitman.

Genesis embarked on its building modernization program in 2003 after it was spun off from long-term care pharmacy services provider NeighborCare Inc., says McKeon at Genesis. Specialty units for the treatment of dialysis patients and dementia care will be added to buildings as needed. "It takes time to see the return," notes McKeon. "Our new partners are not focused on quarterly results."

Genesis' buildings are about 27 years old on average, fairly typical of existing nursing homes. About $750,000 to $1 million per building is spent by Genesis on upgrades, McKeon says. Much of the money goes toward basics such as paint, roofs, and updated dining areas —improvements deferred when the company was cash- strapped. He adds that 8,000 hand-cranked beds have been replaced in the last 18 months with electric models.

Industry observers see upside potential for Genesis. The new services to be added for short-term residents should generate additional revenue. And modernized nursing homes will fare well.

Another plus: The number of nursing homes is declining. Old buildings are being shuttered, while new properties are difficult to develop because of government regulations. That bodes well for existing operators like Genesis going forward, observers say.

No announcement has been made about Genesis management, though industry sources think the new owners will probably leave the current team in place. Formation's Whitman expects the deal to close in June or July.

Some observers caution that nursing homes remain a risky and cyclical business. "We have short memories," says Matthew F. Whitlock, vice president of senior housing at MMA Realty Capital LLC in Salem, Mass. "It wasn't that long ago our industry was suffering from significant occupancy issues and overbuilding."

Patrick Leardo, global real estate advisory leader at PricewaterhouseCoopers in New York, sounds a cautionary note: "Nursing homes are hot because capital is available, not because this is a vehicle that offers super returns."