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A Golden Age for Senior Housing

“Fundamentals Have Just Never Been Better”

Perhaps the only force in real estate that trumps location is demographics. That's why investors around the world are paying attention to the aging of populations in the United States, Europe and Asia. In the U.S., the percent of the population over the age of 65 will soon hit 13%. For developed countries, the average is about 15%, and in Japan, it's already 28%.

In the U.S., investors have been pouring money into seniors housing at record rates.   Loan volume for the industry reached a record $1.64 billion in the third quarter last year, up 135% from a year earlier, according to the National Investment Center for the Seniors Housing & Care Industry (NIC).

Deals like GE Healthcare Financial Services’ $1.4 billion acquisition of six seniors housing portfolios from Alpharetta, Ga.-based Formation Capital helped drive overall transaction volume beyond $22 billion in 2006 – three times the previous year’s volume.

“There is a lot of money going after seniors housing,” says Beth Burnham Mace, a principal in research at AEW Capital Management LP in Boston. “As a result, cap rates for assisted living have been falling and are in the high 6% to mid 7% range. Caps for independent living are probably 25 to 50 basis points lower than that.” (Those cap rates--the nominal annual rate of return at the time of acquisition--are the for the best quality and most stable assets in senior housing; cap rates on lower-quality assets can range to twice those levels.)

The senior housing market is benefiting from rising demand and little new construction—a welcome turnaround from the overbuilding that occurred in the late 1990s. Then, developers launched too many projects and profitability in the sector plunged. Now, demand has caught up with supply and daily room rates—and profitability—are up. Occupancy rates averaged 93% in the third quarter for independent living, and 89.5% for assisted living, according to the NIC Key Financial Indicators report, published Jan. 30.

Seniors housing includes a range of products, from assisted living complexes to acute care facilities. The most desirable properties are private-pay facilities, which can include independent living, assisted living and Alzheimer’s care properties. Skilled nursing homes, by contrast, depend heavily on government health care programs (Medicare), which dictates rates, limiting profitability.

As the global search for yield has forced real estate investors to branch into new property types, many have turned to seniors housing. “The industry has attracted high-quality institutional investment for a number of years, and that has gotten the attention of international investors,” says Kathryn Sweeney, a principal at AEW Capital Management.

Many overseas investors who are putting money into U.S. seniors housing assets learned about the property type in their own markets first, Sweeney says. Independent living and assisted living assets operate much the same from country to country. The same can be said for skilled nursing homes, although the terminology is more likely to vary between markets, depending on healthcare funding practices.

And while the Baby Boomer generation is an international phenomenon, the sheer size of the U.S. Boomer cohort—77 million—makes the U.S. the most popular place to invest in seniors housing. For example, Canada’s Chartwell Seniors Housing Real Estate Investment Trust and ING Real Estate Australia Pty. Ltd. have teamed up to buy U.S. assets. “Chartwell is very aggressive in coming into the U.S. market,” Kramer says. “They’ve put in over $800 million and plan to go farther.”

Chartwell and ING have worked with Tampa.-based Horizon Bay Senior Communities to identify and acquire 22 U.S. properties since August 2005, according to Mike Roderer, director of budgeting and finance at Horizon Bay. That amounts to a little more than 4,000 living units, a number that could easily double in a year and a half, Roderer says.

“Global capital is part of what’s driving valuations up and cap rates down,” says Bob Kramer, NIC president. “And we’re seeing more and more long-term investors coming in.”  Capitalization rates for independent living fell to 7.7% in the third quarter from 8.3% at midyear 2006, according to NIC. But it's a mixed picture: Assisted living caps averaged 9.2%, up from 8.7% in the second quarter, while skilled nursing facilities averaged 12.7%, unchanged from the previous quarter.

 As with other forms of commercial real estate, properties with more risky revenue sources garner lower prices, hence the higher cap rates on most nursing facilities. The excellent recent performance of independent living facilities has garnered escalating acquisition bids and squeezed cap rates.

Like many foreign investors, Roderer says, ING and Chartwell are pursuing a diversification strategy by buying outside their home markets, in addition to reaping the high yields available from strong U.S. properties. While both companies are learning the intricacies of seniors housing in the USA, they rely on Horizon to assess markets and individual properties for acquisition. A partner experienced in the local market, and in the operation of seniors housing, is essential to avoid overpaying or encountering snags later on, Roderer says.

“Like it or not, we’re a very litigious culture,” Roderer says. “And in the U.S., we have some pretty tough tax laws. It’s certainly something that potential investors should be aware of.”

Investors can avoid some pitfalls by taking advantage of new tools that were unavailable a decade ago. Those include detailed occupancy, rental rate and construction information on the 30 largest U.S. markets, available from Market Area Profiles published quarterly by NIC. The organization also publishes nationwide statistics free of charge on its Web site, at http://www.nic.org/kfi/.

There is also better data available on what projects are actually under construction in particular markets. “Now, not only do we have good data, but we also have performance over time,” says Kramer, the NIC president.

“This is an historic time for the industry, in terms of having arrived, of being discovered by institutional capital and global investors,” Kramer says. “The size of the deals, the pricing of the deals, and the industry fundamentals have just never been better.”