Five factors starting with location and product type guide decisions of investors and lenders alike
By Jane Adler
With 250,000 units nationwide, assisted living makes up about 78 percent of the seniors housing inventory. This vast market may be getting overbuilt, however, as another 25,000 units are now being readied to open. Although prices of existing properties appear to be cooling a bit, the highest-quality assisted living buildings are still trading at a premium.
Further complicating the assisted living landscape is its changing business model. As residents arrive older and frailer, operators are providing more medical care and adding more risk to the ownership equation (see sidebar, page 36).
Despite the challenges, funding is still readily available, sources say, and new investors continue to enter the market. Investors like the fact that assisted living is a product needed by consumers and that it weathered the downturn better than other real estate asset classes.
But investors and lenders are becoming more selective about where and how to deploy capital. “The assisted living business needs to be evaluated depending on where you are building or buying,” says Kathryn Sweeney, managing partner at Blue Moon Capital Partners, a Boston-based seniors housing investment management firm.
With this context in mind, what follows is a closer look at five factors driving assisted living investment and lending decisions.
1 Location
Because of the wave of new construction, investors prefer markets with high barriers to entry. These markets are typically found on the coasts and in urban infill areas where municipal approvals for new development are difficult to secure and competition is sparse.
“We monitor geographic pockets that are oversupplied and avoid those areas,” says Ross Sanders, vice president at Healthcare Trust Inc., a non-traded REIT based in New York City. Formerly known as American Realty Capital Healthcare Trust II, the company changed its name last fall.
Healthcare Trust owns 60 seniors housing communities, which account for 60 percent of the company’s portfolio. The other 40 percent of the portfolio includes medical office buildings, surgery centers and hospitals.
Assisted living continues to exhibit strong fundamentals, says Sanders, citing favorable demographics. What’s more, the population of elderly persons age 85 and older is expected to increase by about 3 million people by 2030, according to U.S. Census data.
Despite the long-term prospects for seniors housing, Sanders currently bypasses certain submarkets of Dallas and Houston, plus Naples, Fla., because they are overbuilt. Other sources report that assisted living is oversaturated in Southern California, Northern Virginia, San Antonio and Austin, Texas, and in the Chicago area.
Properties in high barrier-to-entry markets can fetch premium prices. An example is Healthcare Trust’s recent purchase of the Renaissance on Peachtree for $78.6 million. Located in the heart of Atlanta’s upscale Buckhead neighborhood, the Renaissance includes 229 assisted living and independent living units.
“There are many challenges in developing seniors housing in this market, which provides for significant barriers to entry, including the limited availability of development sites, expensive land costs and significant zoning and municipal regulations,” says Sanders, referring to Atlanta. He adds that the bidding process for the property was highly competitive.
Another example is Queen Anne Manor in Seattle, a 93-unit assisted living and memory care property located in the historic Queen Anne neighborhood where many of the city’s founding fathers lived.
Originally built in 1908 as a children’s hospital, the building was acquired by Queen Anne Manor LLC in 2007 for $17.2 million and underwent a $6 million renovation and repositioning in 2011, including the conversion of two floors to memory care units. The property traded hands again in January 2016 for $36.3 million, or about $400,000 a unit. The buyer was Capital Seniors Housing, a private equity firm based in Washington, D.C.
2 Product type
While stand-alone assisted living properties can generate attractive returns, the category is falling somewhat out of favor with investors. Instead, they like the idea that aging residents can receive a higher level of care in a single setting and thereby extend their length of stay while boosting the property’s bottom line.
“I will not buy stand-alone assisted living,” says John Rijos, chairman and CEO of CPF Living Communities and co-founder and operating partner of investment fund Chicago Pacific Founders. The Chicago-based company owns eight communities outright, and another 18 communities in partnership with Welltower, a large healthcare REIT.
During his tenure as co-president and chief operating officer of Brookdale Senior Living from 2000 to 2013, Rijos observed that 40 percent of the operator’s assisted living residents moved out within six months.
So, he prefers communities that combine levels of care to keep residents longer. He seeks properties with a mix of some assisted living, independent living and memory care units. Rijos also considers assisted living properties where the unit mix can be changed, or ones with adjacent land where another product line can be built.
Noting the runup in assisted living supply, Sweeney of Blue Moon Capital Partners also prefers projects with several levels of housing and care. That model provides peace of mind for those residents who might eventually need services, she says. And it appeals to couples who are aging at different rates. For example, one spouse may need assisted living, while the other does not and can live independently in an apartment on the same campus.
Blue Moon has several new projects underway featuring some independent living units that act as feeders to the assisted living and memory care units. The Village at Belmar in Lakewood, Colo., broke ground last September and is slated to open in February 2017.
The seven-and-a-half acre campus features a main building with 72 units of assisted living, 24 memory care units and amenity space. The 64 independent living units are designed for younger seniors and are located in 16 separate buildings with four units per building.
3 Pricing and cap rates
Lenders are becoming more cautious, and some are pulling back on construction lending as more new developments open, say sources.
Acquisition pricing appears to have peaked in the third quarter of last year, according to Jason Schreiber, senior vice president of seniors housing finance at Pittsburgh-based PNC Real Estate.
Cap rates have risen about 25 to 50 basis points since then. Although a lot of capital, primarily from private equity funds, is seeking assisted living investments, the big healthcare REITs are not as active in acquisitions as they were last year.
“There just aren’t as many buyers,” says Schreiber who operates out of PNC’s office in Chapel Hill, N.C.
Cap rates for highly desirable properties are currently about 6 percent, according to Chad Lavender, senior managing director at HFF. A pricing gap is developing between buyers and sellers of properties in secondary and tertiary markets, and for older properties, he says. But he is quick to add that “deals are still getting done.”
At the recent Spring Investment Forum hosted by the National Investment Center for Seniors Housing & Care (NIC) in Dallas, an informal survey of attendees showed that no one expected cap rates to decline. Most indicated cap rates would rise.
Welltower, a large healthcare REIT based in Toledo, Ohio continues to be bullish on assisted living. But the company isn’t chasing transactions at unwarranted prices, according to Mercedes Kerr, head of business development.
“The market is a little frothy,” says Kerr, whose office is located in Newport Beach, Calif.
She points to a telltale sign of an overheated market: Class A assisted living properties have been trading at only a small premium to Class B properties. “We’re being disciplined,” she says, noting that most of the company’s seniors housing portfolio consists of assisted living units.
Like other investors, Welltower prefers projects with some combination of independent living, assisted living and memory care units. The company is less likely to purchase stand-alone independent living than stand-alone assisted or memory care because of the need-based nature of the projects.
Some of Welltower’s operators are converting a portion of assisted living units to memory care, a national trend among operators. “There’s growing demand for specialty care,” says Kerr.
Buying opportunities could increase over the next 24 months, according to Humair Sabir, vice president of acquisitions for Granite Investment Group, a private equity firm based in Irvine, Calif. The company owns 33 skilled nursing and assisted living properties and has three other properties under contract.
“We see a lot of development,” says Sabir. Some of the projects are ill conceived, he says, explaining that developers new to the space lack operating experience in assisted living. That means poorly performing properties could be available for purchase in 24 months at a discount of 75 cents on the dollar. “We’re cautiously optimistic about assisted living,” he adds.
4 Expenses
Investors are watching expenses closely, especially labor costs at care-intensive assisted living properties. It’s estimated that labor accounts for 75 percent of operational expenses at assisted living properties.
Over the last year or so, the availability of reliable workers at a reasonable price has taken on new urgency for assisted living owners and operators.
“Employee retention is an issue,” says Welltower’s Kerr. New competition may not lure residents away from stabilized properties, she notes, but employees may jump to a new building for a pay increase.
Sanders at Healthcare Trust expects more pressure on wages, which could impact returns. “Operators will have to manage costs,” he says. Fourteen states implemented higher minimum wage requirements at the start of 2016. Several states and cities are considering proposals to gradually lift pay to $15 an hour — a change already underway in San Francisco and Seattle.
The labor issue isn’t confined to front-line caregivers. One developer discontinued its assisted living construction program because of the lack of high-quality executive directors.
Separately, Charter Senior Living, a new owner and operator based in Naperville, Ill., plans to differentiate itself from competitors through its focus on creating a culture to support its executive directors and department heads.
Investors expect technology to pick up some of the labor slack. “More staff is not the answer,” says Rijos of CPF Living Communities, explaining that increased staffing does not boost the bottom line.
He envisions a role for sensors to monitor the chronic conditions of residents, along with software programs to measure outcomes. “Technology will play a huge role,” predicts Rijos.
5 Operators
In a competitive and evolving assisted living environment, experienced operating partners are key to investors and lenders. They need to understand whether an operator embraces a social model of assisted living, a medical model, or something in between. “The risks of each approach are different,” says Sweeney of Blue Moon Capital.
PNC prefers borrowers with a track record. “We’re very judicious on operational capabilities,” says PNC’s Schreiber. The bank doesn’t finance groups new to the assisted living space. Borrowers also need meaningful amounts of capital and liquity in order to ride out any bumps in the market.
Like many other investors, Granite Investment Group prefers regional operators. For example, Granite bought a 48-unit assisted living facility last year in Shawnee, Kan., a suburb of Kansas City. The four-acre property features vacant land that can be used to add memory care units. The local family-owned operator, Advantage Health Group, manages several other area properties.
“We know their focus is on that property,” says Sabir of Granite. The operator has some economies of scale because of its other local properties, and as a result has been able to boost rental rates. “The property is driving really good value.”
As the operating model of assisted living becomes more complex, investors expect more regulation from the states.
“There’s concern,” says Sabir. He doesn’t predict sweeping changes anytime soon, but he does think assisted living will become more highly regulated in the next five to 10 years.
Granite, which owns skilled nursing facilities and is familiar with navigating the rules, keeps an updated analysis of state regulations in all of its targeted markets.
According to Sabir, the shifting regulatory landscape in skilled nursing “impacts our view.”