Investor sees a bright future in seniors housing.
By Jeff Shaw
Harrison Street, a Chicago-based investment management firm, has made its name by specializing in alternative assets — focusing on seniors housing, student housing, medical office, life sciences, data centers and self-storage.
Through privately managed funds, the investor built an impressive portfolio. Harrison Street owns more than 200 communities totaling approximately 28,000 units, of which 35 percent are independent living, 45 percent are assisted living and 20 percent are memory care.
The American Seniors Housing Association (ASHA) ranked Harrison Street as the eighth largest owner of seniors housing in the U.S. as of June 1, 2020. (The updated rankings have not yet been released.)
The firm has targeted $2 billion for its eighth and most recent opportunity fund. Through the second quarter of 2021, its core fund has had one of its most active capital-raising periods, with a substantial allocation toward seniors housing.
Michael Gordon was one of the founders of the firm in 2005, just four years after graduating from college. He now serves as partner and global chief investment officer.
Seniors Housing Business spoke with Gordon about his company’s investment strategy and what drew him to seniors housing.
Seniors Housing Business: Walk me through your professional history leading up to founding Harrison Street in 2005.
Michael Gordon: It was quite brief. I graduated from Emory University in 2001. Immediately prior to Harrison Street, I worked at PGIM. While my primary focus was on traditional sectors, I was always eager to review and better understand PGIM’s investments in alternative sectors, such as seniors housing and self-storage. Having said that, I’ve grown up around real estate, and I’ve been hooked for nearly my entire life.
SHB: What do you love about it?
Gordon: From acquisition to development to debt financing to equity structuring to leasing and dispositions, I love the strategy and the nuances of it all.
At Harrison Street, we’re contrarians in a lot of what we do. We’ve always focused on the alternative sectors that were largely overlooked by other institutional investors.
I feel really fortunate to have landed on our strategy more than 15 years ago, especially in this current environment wherein there is a massive rotation occurring out of the traditional asset classes and into the alternative asset classes such as seniors housing. What we have built during the past 15 years (25 operating partners, a tremendous Rolodex, the ability to mine data across one of the largest portfolios in the industry), is impossible to replicate and uniquely positions us for continued success.
SHB: You handle the investment strategy for the firm. So what is your strategy when it comes to seniors housing?
Gordon: At the end of the day, our high-level seniors housing thesis is largely tied to supply and demand. On a more tactical level, its predicated on ensuring alignment with the best operators and developers in our target markets, as well as investing in the right supply for the biggest pool of unmet demand in a micro market.
First is market selection. We focus on micro markets with the right competitive landscape, adequate barriers to entry and strong demographics and seniors housing fundamentals. We’re very research-driven, and we have spent considerable time developing a “hit list” of zip codes that serve to be our primary targets as we expand our seniors housing portfolios.
Once we identify a new micro market, we spend a tremendous amount of time understanding the opportunity set relative to operators, competitive profile and whether new supply needs to exist. We generally source about two-thirds of our transactions on an off-market basis.
Next is operating partner selection and alignment. Since 2005, we have meticulously identified around 25 operators throughout the U.S., with whom we’ve formed joint ventures. It’s critical that you align yourself with an operating partner that really understands the importance of catering to its employees and residents.
Last, but as important, is ensuring that the community that we are acquiring or developing is the absolute best fit with our target resident, and that our service, care and real estate offering is in line with the demographic and psychographic profile of our micro market.
SHB: How do you think that strategy separates you from, say, the REITs in the industry?
Gordon: We are hyper-focused on aligning with regional operating partners and growing our portfolio one asset at a time. While we have become a substantive player within the industry, it’s the byproduct of more than 15 years of evaluating operating partner platforms and the merits of individual asset acquisitions and development.
At our peak, we’ve owned more than 200 senior communities. However, we have only been involved in about a dozen large portfolio acquisitions. We focus on the one- or two-asset deals, which are very difficult for the REITs. Interestingly, across the entire Harrison Street platform, roughly 80 percent of our transactions consist of a single asset.
We don’t think in quarters. We have a long-term approach. We have great relationships with all the REITs. We’ve found creative ways to transact with them.
SHB: What is the typical hold period for your seniors housing properties?
Gordon: We underwrite a variety of hold periods to align with our defined strategy for an investment or joint venture. While our opportunistic investments are typically underwritten on a five- to seven-year basis, our core investments are typically underwritten to a 10-year hold, even though these latter mandates are open-ended. As it relates to exits, they typically take the form of a portfolio recapitalization or a portfolio sale. We understand the importance of brand trust and continuity, and if we can maximize proceeds via recapitalizing out of an asset, thus allowing our partner to continue operating a community, that is generally the preferred path.
Pick your partner
SHB: As one of the 10 largest owners in the industry, what’s your strategy for choosing operators to manage that large portfolio?
Gordon: Our primary objective within the sector is to identify and align ourselves with the best operators in our target submarkets. I am extremely proud of our regional network, and it is absolutely unrivaled in the industry.
I pinch myself when I think about the names that have entrusted us for years — groups like Engel Burman, Belmont Village, Brightview, REDICO, Bridgewood, Springs Living and Oakmont, to name a few. And, they all have one big thing in common. They’re all “people first” businesses.
Our typical partner has a tremendous focus on targeting the right talent, providing training, fostering their growth, empowering them, showing recognition and appreciation, and retaining that talent.
At the end of the day, the senior living workforce is not nearly large enough to service the needs of the broader sector, let alone one that should grow exponentially over the next couple of decades. Our partners really tend to focus on those employees that are just good people, with strong core values and a desire to serve the senior population. While you can train your staff in areas of concrete skills, you can’t train values. On top of that, we have an exhaustive list of criteria that must be met when evaluating new partners
The obvious question is whether this investment philosophy works, and my response is to simply look at performance. When assessing our partners’ trends and performance against their competitive sets, submarkets and industry metrics, we’re very pleased at the results.
SHB: As of 2014, Harrison Street’s portfolio was built about 70 percent through acquisition and 30 percent through development. Has that shifted over the years?
Gordon: It really varies year to year. We’re laser-focused on ensuring that we’re pursuing the best opportunities within the sector. While our opportunity funds provide capital for both development and acquisitions, our core mandates are more focused on stable acquisitions. In 2020, we invested in 38 seniors housing communities. By asset count, 74 percent of these communities were acquisitions, but by gross transaction cost, acquisitions represented 60 percent of this volume.
Even though these acquisitions entailed communities in largely coastal markets with strong seniors housing and demographic fundamentals, they were essentially basis plays.
Our development activity entailed highly amenitized, Class A communities in fortress markets. These communities are a bit larger than our acquired properties.
All of this activity was done with a group of 14 operating partners.
In 2021, we have closed or are closing on 65 seniors housing communities. By asset count, 70 percent of these communities are acquisitions, which represents about 60 percent of gross transaction costs. Our 2021 activity is alongside 17 operating partners. I expect that our development activity will continue to be more moderate than our acquisition activity, as our typical development projects have a lead time, in some cases, upwards of seven to eight years. Over the past couple of years, we have broken ground on a number of developments that I’ve been working on since before my daughter was born. She’s turning six in September.
SHB: What made you choose seniors housing as one of your asset classes?
Gordon: When we launched the firm in 2005, we spent nearly a year whiteboarding a strategy predicated on investing in sectors with demographic-based demand drivers and alignment with entrepreneurial, family-run operating platforms. We conceived a thematic approach to investing in real estate, primarily in the areas of healthcare, education and storage.
We were intrigued by the compelling risk-adjusted returns when analyzed against the common denominators present among each of our asset classes.
First, each sector is defensive in that it is tied to unique, demographic-based demand drivers, and less predicated on the strength of the overall economy, offering a level of consistency and low volatility that is difficult to find in the traditional asset classes. Even when benefitting from these attributes, our asset classes lended themselves to outsized yields and discount rates versus the traditional sectors. Further making our sectors compelling was that supply growth remained significantly behind demand growth.
Next, these asset classes have leases with very short terms, which provides significant upside in an inflationary environment to reset rent.
Lastly, each of these sectors were and still are highly fragmented, and based on Harrison Street’s relationship base and visibility, we are positioned to take advantage of this network.
SHB: Has COVID-19 had any impact on your investor returns or your investment strategy? Did you buy, sell or hold during the pandemic?
Gordon: We’ve bought and we’ve built. We’re a tremendous believer in the long-term thesis that we developed years ago, and COVID is a short-term phenomenon that led to a short-term interruption in a sector that is bolstered by long-term demographic trends.
Why waste an opportunity to swim against the current? There was tremendous fear for a few quarters, and we quickly mobilized to gauge the investment landscape and offer capital solutions to those counterparties in need of options. These transactions were heavily structured and provided for outstanding risk return.
A couple of notable transactions that we completed during the pandemic include: the acquisition of a 12-property, off-market portfolio, which we closed with five different operators, as well as an off-market, five-property Mid-Atlantic portfolio, which we assembled nine years ago, sold five years ago, and are now buying back with our former operating partner.
In the case of the latter transaction, our former basis was roughly $128 million. We sold the portfolio for $185 million, and we bought it back for $112 million. While this sort of pricing dislocation was more the exception than the rule, we are excited to have been able to consummate so many compelling opportunities in an environment wherein the majority of the capital was sitting on the sidelines waiting for the dust to settle.
I couldn’t be more appreciative to be in the foxhole with like-minded operating partners and investors.