>From Wall St. to Main St., all eyes are on seniors in '98 The marketplace will have a vast potential for success in spite of assisted living consolidation this year.
The seniors housing industry has moved closer toward the center of the real estate investment radar screen. For those who are looking to capitalize on the demographic tsunami in the coming decades, the evolving seniors housing business offers the astute investor a variety of options. The growing belief in the industry's market and economic fundamentals have created awareness from Wall Street to Main Street, the result of which is a business that should expand dramatically in the coming years. There is no question that the industry has taken off like a rocket.
Unlike the last generation of this burgeoning industry, which faltered in the early part of the decade, underwriting standards, consumer and investor awareness, and documented operating statistics provide a framework to consider investment alternatives. The track record of successes has been demonstrated through a variety of research efforts all geared to providing benchmarks for future acquisition and development activities.
In its fifth year, The State of Seniors Housing 1997 is believed to be the most comprehensive report of the industry's financial and operational performance. This national survey of seniors housing communities, encompassing 55,000 independent/congregate, assisted living and continuing care retirement community (CCRC) units, was recently released by the Washington, D.C.-based American Seniors Housing Association (ASHA) in collaboration with Coopers & Lybrand L.L.P. The results are impressive and confirm a growing trend toward operational stability at a time of rapid new development.
Nationwide, this research report verifies that for all seniors housing property types surveyed, the median occupancy rate is in excess of 95%. All sample segments experienced relative increases from 1996 occupancy levels, further suggesting that operators are refining their marketing acumen while consumers become more receptive to seniors housing alternatives. The good news is the financial performance of the industry, as reported by The State of Seniors Housing 1997. The survey reveals that the median debt service coverage ratios are in excess of 1.4 for all business sectors. The trend toward industry financial stability is also demonstrated by the survey's findings that the median return on investment (unleveraged) was 15.9% for assisted living residences, while only 11.3% for rental congregate facilities. Given the overall age of the congregate sample relative to the more recently constructed assisted living survey inventory, this finding is not surprising as many older congregate facilities were over financed. However, median gross operating margins (EBITDA/Total Revenue) were highest for congregate residences surveyed (38.7%) followed by CCRCs (35.9%) and assisted living residences (30.3%). The start-up nature of many assisted living facilities likely is reflected in these operating performance statistics, although most industry professionals feel that as the assisted living concept matures the figures will improve.
Although all industry sectors are prime for investment, Wall Street and investment sources from around the nation have gravitated toward the assisted living marketplace. There is both good and bad news for assisted living. The good news is that Wall Street is, at least for the near future, falling deeper in love with assisted living. However, as is the case with any hot new development concept, there will be a shake-out of under capitalized and inexperienced assisted living owner/operators, as well as the smaller mom and pop facility owners who find it difficult to compete with multifacility operators. Consolidation will intensify in the year ahead and benefit those with available capital and sophisticated operating and management systems in place. The largest 25 assisted living owners control a mere 7% of the units nationwide. The market cycle is prime for acquisitions as the surge of new development activity will likely create occupancy softness in select regions.
The 1997 publicly traded assisted living financial figures are in, and the overall results are encouraging. For companies with a market cap over $100 million, eight assisted living entities posted total returns of more than 40%, while in the year before only half that number showed similar performance levels. According to Steve Monroe, editor of New Canaan, Conn.-based The Senior Care Investor, "It will be difficult to repeat this kind of performance, and if any of the companies do not meet their 1998 earnings estimates, investors will show no mercy.
"Companies such as Portland, Ore.-based Assisted Living Concepts (ALC), which went public in late-1994 with basically no operating history and only five communities, has grown to more than 110 facilities. Stringent controls on development and operating costs and an orientation to the affordable marketplace have helped ALC show a 1997 return to investors of a whopping 159%. Yet with all the favorable news about assisted living, the level of new development in process and anticipated in the year ahead, the blood-letting and industry consolidation have begun and will unquestionably intensify over the next 24 months. Given the increased level of competition and pressures to control operating costs, it's "pay up or shut up" time for a number of the publicly traded companies. The ability to deliver on earnings expectations will help determine how investors value these companies and, ultimately, if they are take-over candidates. Just within the past year, Wall Street heavyweights such a Lazard Freres and Goldman Sachs, both based in New York, through affiliated investment entities have entered the seniors housing business in a big way. The concept of strategic institutional investors in conjunction with sophisticated industry operatives has resulted in several major completed or pending transactions.
Likewise, the merger of pure-play, publicly traded assisted living companies such as the Brookfield, Wis.-based Alternative Living Services merger with Sterling Housing, which qualified as a tax-free reorganization, represents a trend that will continue unabated in the coming year. Without question, "merger mania" is in full gear; only time will tell as to who will be left standing in the rush to gain critical mass and increase market share. In all likelihood, at least a third of today's public assisted living companies will be consolidated within two years.
Whether public or private entity, large or small, the assisted living industry segment has survived the tentative stages of infancy and has moved into the awkward stages of adolescence. However, by nature adolescence is a period of trial and error, experimenting with new ideas while offering limited remorse to those who have made significant investments.
According to the Los Angeles-based investment banking firm Jefferies & Company Inc., throughout the United States there are currently an estimated 740,000 assisted living units. This number is projected to grow to 1,150,000 during the next four years. This growth spawned by capital from the equity markets, REITs, conventional lenders, pension funds and internally generated cash flow, may be impacted by the regulatory environment.
Since assisted living has primarily been a private pay business, government regulators on both the federal and state levels have to date not given these residences the same level of scrutiny as the nursing home industry has seen. While state regulators have been inconsistent in their approach to the assisted living sector, we can count on more attention given to this business by government officials. As the number and acuity level of the residents served in these facilities increases and the public sector recognizes the cost savings of providing Medicaid recipients with assisted living accommodations, regulators will surely intensify their efforts to impose more stringent laws.
While only six states have Certificate of Needs (CON) as a mechanism to regulate assisted living, there is no assurance in the near future that this restrictive approach will be limited to these states. As nursing home and the small rest home interests attempt to limit assisted living competition, we can anticipate the CON debate to intensify in the year ahead.
"The dynamics of the assisted living industry with regard to key licensure and regulatory issues bears watching in 1998. It appears that there are brewing tensions in a number of states between small owner/operators and more sophisticated professional companies with purpose-built residences on a host of issues, ranging from certificate of need to fire safety to quality assurance," says David Schless, executive director of ASHA. "It is incorrect to assume that the interest of professional assisted living owners and managers are congruent with the interests of the board and care industry. The reality is that some nursing home operators, as well as some small board and care operators, feel very threatened by the growing presence of professionally owned and managed assisted living. As was demonstrated six months ago in North Carolina, these dynamics can lead to conflicts.
"In the highly publicized North Carolina assisted living building moratorium battle, the nursing home and rest home interests were successful in halting new assisted living development for now. While the outcome of the North Carolina debate remains uncertain, industry watchers have their sights focused on the ultimate result of these efforts to stymie new assisted living construction.
On the federal level, the Government Accounting Office (GAO), at the request of Congress, initiated a field study of the assisted living industry and is focusing on quality of care and consumer protection issues. Although the outcome of this investigation has yet to be determined, there is no question that the industry will need to intensify its efforts to impose standards and operating guidelines in an effort to self-regulate. As recently expressed by William Lasky, chairman of the Assisted Living Federation of American (ALFA), "Our customers have to be able to vote with their feet when they are not satisfied with the care." Industry lobbyists are counting on the fact that federal regulators recognize the benefits associated with assisted living and will not impose regulations that will hinder new development.
The obvious conclusion is that traditional real estate skills are not sufficient to be successful in the assisted living or other service-oriented seniors housing businesses. The investment value is added through the integration of marketing and management talent to deliver high quality, affordable services for the discerning elderly consumer.
Beyond "pure" assisted living, the investment and real estate community has a variety of alternatives to consider in the congregate as well as continuing care sectors. Currently, there is an abundance of capital for congregate acquisitions, refinancings and new construction. With interest rates at record low levels and the recognition that assisted living can represent a complex operating situation for many real estate professionals, congregate housing is back in vogue with both debt and equity sources. Recent acquisitions of congregate facilities demonstrate that high caliber facilities with stable earnings are commanding premium prices. According to statistics compiled by Capital Research Group, a consulting and research firm based in Newark, Del., the average sale price per congregate unit increased by 60% in just two years to a figure of $84,784 by late-1997, while the average net operating income increased from 30.4% in 1995 to 37.8% in 1997. Likewise, capitalization rates for prime congregate and assisted living assets are trading at figures between 9.5% and 10.5%. Given the lower operating costs associated with congregate ventures as compared to assisted living facilities, the lack of government regulations of this industry segment and solid occupancy rates, the congregate business is poised for dramatic growth in the year ahead.
To facilitate the "aging in place" that occurs naturally in both congregate and assisted living communities, the new generation of products may include home healthcare agencies (HHAs) as part of their service plans - effectively creating a continuum of care environment without crossing the line into the healthcare arena. Resident turnover rates can be reduced while staffing costs and burnout problems caused by residents requiring additional care are minimized. The HHAs, which are available on a contract basis, provide quality, dependable and appropriate supplemental services to residents who need additional care. Further, these licensed organizations provide the congregate developer/investor with community healthcare credibility and essentially help create a de facto assisted living residence.
Further, within the next few years, the concept of congregate and CCRC condominiums and cooperatives will become more commonplace as a result of home ownership tax law changes. The benefits that accrue to prospective residents in many situations can far outweigh the costs associated with rental communities. Whether small-scale or larger CCRC environments, this is a development product for the 21st century, as the baby-boomer generation approaches retirement age. Innovative prototypes that integrate an active adult lifestyle with congregate type services on an a la carte basis is a trend which will likely become a dominant industry force.
Success in the operations-oriented seniors housing business will be determined by several critical issues, namely:
MANAGED CARE IS A REALITY According to the Health Care Finance Administration (HCFA), the frail elderly consume more than 60% of public healthcare dollars. In light of this alarming fact, senior healthcare is a critical issue for managed care planners, who are looking to control the delivery of care while maintaining outcomes and quality. Fitting into the vertically integrated managed care system is a win-win situation for facility owners and residents. The seniors housing industry has the opportunity to offer managed care provider contracts within a region to help create a controlled cost containment environment. In turn, hospitals and managed care providers represent a significant source for resident referrals. Fitting into the seamless structure of managed care can have long-term benefits to seniors housing investors if the industry can adapt to the ground rules established by managed care organizations.
"There's no question that assisted living will become an integral part of the managed care realities in our nation," says Karen Wayne, president of ALFA. "By monitoring residents' health conditions and controlling costs in a residential environment, assisted living should be increasingly attractive to lenders and investors.
COST CONTAINMENT IS ESSENTIAL >From project initiation through full operations, the ability to control costs can mean the difference between success or failure when providing an array of facilities and services to the seniors market. For example, a $5,000 per unit savings in development costs will lower a resident's monthly fees by roughly $45, a consideration that will affect the project's marketability.
The use of value engineering techniques as a method to reduce the development budget and optimize the layout and functionality of common spaces will go a long way to create cost effective residential environments. Further, projects should be sized to enhance operating efficiencies and programmed to accommodate potential changes in the regulatory environment and ultimately saving costs to retrofit a structure.
In terms of on-going operating performance, the balance between maintaining a quality, innovative and flexible management structure while focusing on cost containment is an important consideration. The need for sophisticated systems and caring personnel is accentuated by the reality that staffing at all levels represents a major concern for owners and investors. The hiring, training and retention of key personnel is essential for industry growth with labor costs typically accounting for roughly 30% to 35% of total revenues. Cross-training staff in key areas of assisted living services, house keeping and food service will help keep operating budgets in check and impact the ultimate value of the asset.
AVAILABILITY OF CAPITAL Both debt and equity have become increasingly available to all sectors of the seniors housing industry as performance and underwriting standards have become more sophisticated. New forms of financing such as synthetic lease arrangements and sale/management back structures will become more commonplace in the coming year. Likewise, the pension fund industry is on the brink of committing substantial funding to the industry. Pension advisers such as The RREEF Funds and AEW Capital Management have already stuck their toe into the seniors housing waters. Expect other pension fund entities to follow suit in 1998. "We are extremely excited about our recent commitment to the seniors housing industry," says Gary Kachadurian, principal at The RREEF Funds. "We anticipate dedicating substantial funding to our partnership with Parkside Senior Services L.L.C."
A further financing innovation that has widespread applicability to this industry is the use of the "black box" or off-balance sheet models. In an effort to mitigate the negative cost consequences of the construction and fill-up phases of a seniors housing venture, publicly traded entities are establishing relationships with private investors and developers who carry the development phase losses while providing the much needed comprehensive real estate expertise. Expect more of these tax planning arrangements as the public companies attempt to maximize their earning per share objectives.
PRICING POLICIES In planning new ventures, developers will oftentimes underestimate resident turnover rates and resident acuity levels with the result that prices are set artificially low and profitability is jeopardized. Starting with the project pro forma, pricing sensitivity must be realistic to ensure adequate investor returns while being affordable to the budget conscious elderly consumer. In response to the "cost creep" phenomenon, which can inadvertently occur in a service-oriented seniors community, project sponsors are adopting tiered, multi-level pricing strategies that balance a resident's need for predictable and affordable services with the investors' concern for financial stability and entrepreneurial profit. No simple task when considering the dynamics of this industry.
Heading toward the millennium, the overall industry outlook is favorable. However, just like the stock market, the assisted living sector is prime for a correction. As the seniors housing industry has previously witnessed, a correction in this business does not necessarily suggest an oversupply of product. Rather, it is more likely a reflection of the development community's misunderstandings of the seniors housing marketplace. Anticipating change and adjusting business strategies to capitalize on market dynamics for at least the next five years will be critical for success in this growth industry.
Mel Gamzon is president of Senior Housing Investment Advisors Inc., a Newton Mass.-based investment consulting and real estate brokerage firm that nationally specializes in the seniors housing and assisted living business. He is the co-author of Urban Land Institute's book Housing for Seniors: Developing Successful Projects.
Connecticut, Illinois, Kentucky, Missouri, New York, New Jersey
* Volume of assisted living IPO's diminishes as consolidation with merger consolidation with merger and acquisition activity intensifies. * Growing interest in congregate rental/ownership CCRC sectors. * Assisted living will be offered with more diverse pricing and service package programs. * Managed care initiatives take hold. * Assisted living regulatory initiatives intensify.
The following statistics recently presented in a survey research report by ALFA and Coopers & Lybrand L.L.P. revealed the level of frailty within 286 assisted living communities in 35 states and Canada including:
* more than 30% of residents were transferred from an acute care hospital to an assisted living facility;
* 48% of residents complain of cognitive impairment;
* 38% of residents use wheel chairs or walkers;
* 30% of residents are incontinent; and
* more than 50% of residents require assistance with medicines.