During the past several years, as the seniors housing industry has slowly evolved and matured, many industry practitioners voiced the optimistic theme "stay alive 'til '95." Through the acquisition binge that has sustained industry growth during the past several years, the belief was that by mid-decade we would establish a more consistent track record of financial successes as a foundation to entice investment capital into this growth sector of the multifamily housing business. The goodis that the industry is well on its way to being financially competitive with other real estate investment alternatives. The bad news is that seniors housing is inextricably tied to the vagaries of national economic and political issues, which affect the cost and availability of capital as well as the attitudes of conservative-minded seniors who may be considering a complex maze of lifestyle, health care and housing decisions.
According to the National Association of Home Builders, the economy is likely to weaken in 1995 and 1996 as the Fed administers a stronger dose of monetary restraint in an effort to minimize inflationary fears. This will not be favorable for the capital-intensive seniors housing industry that must pass along the cost of acquisitions, development and operations to its generally fixed-income clientele.
Although the Washington political landscape is uncertain, Republicans in the House of Representatives appear committed to sponsoring legislation that would drastically restrict the federal government's ability to regulate a range of businesses, including seniors housing. House Republicans will likely propose legislation that would make it easier for groups affected by regulations to challenge them before they become effective or are even formally proposed. New procedures would be implemented, including a review of the costs and benefits of proposed regulation by outside experts in the initial drafting period. These expert analyses could be challenged in court.
House Republicans are also expected to propose a regulatory budget or "ceiling" that would specifically limit the costs associated with complying with all federal regulations. Taken as a whole, the proposals (which are included in a draft bill called the Job Creation and Wage Enhancement Act of 1995) could reduce long-standing concerns many investors and operators have had about the possibility of increased federal regulation over seniors housing.
Federal regulation can be damaging
As David Schless, executive director of the Washington, D.C.-based American Seniors Housing Association, notes: "Those interested in the long-term health of the seniors housing industry need only look at the nursing home industry to see just how damaging federal regulation can be. The ability of seniors housing to offer older adults and their families affordable residential housing and services is, in my opinion, a reflection of the strong market influences that have shaped this industry and the lack of extensive federal regulation."
Structural changes at HUD may also prove beneficial to the investor-oriented seniors housing industry. In the aftermath of the recent election, the White House and HUD are proposing a fundamental overhaul of the agency's mission. The re-invention of HUD has three components: (1) consolidation of HUD's 60 programs into three flexible performance-based funds for FY98 -- Housing Certificates for Families and Individuals, the Affordable Housing Fund and the Community Opportunity Fund; (2) deregulation of nontroubled housing authorities and the conversions of operating subsidies for public housing agencies to rental assistance for residents who would be given the choice to stay where they are or move to apartments in the private rental market; and (3) transformation of the Federal Housing Administration into an entrepreneurial, government-owned corporation using public/private partnerships and other market mechanisms to address its mission.
In terms of the potential reorganization of the FHA, significant investment opportunities may evolve over the next several years. The potential acquisition of more than $1 billion worth of foreclosed Retirement Service Center (rental congregate) assets and mortgages represents the remnants of the 1980s' ill-conceived or over-leveraged FHA-financed seniors projects. Given the mounting pressures of HUD to clear its books of these troubled ventures, RTC-like disposition procedures will hopefully be forthcoming to efficiently reduce this inventory.
A restructured FHA will also enhance the ability of this organization to process seniors housing financing initiatives through the recently expanded Section 232 mortgage insurance program for assisted-living projects. New FHA regulations also permit refinancing of conventional (non-FHA insured) nursing homes, intermediate-care facilities and assisted-living residences.
Although the budget-cutting ax may fall hardest on non-profit seniors housing sponsors who will attempt to procure tax-exempt financing and local real estate tax concessions for their projects, the private investor sector with alternative sources of capital will expand incrementally. Opportunities to establish strategic alliances with non-profits who have market credibility and operation expertise will continue to make sense on a selective basis.
The track record of successes is being articulated through industry research reports and at national forums such as the National Investment Conference on Senior Living and Long-Term Care, which attracted more than 800 lenders, investors and owner/operators to its recent Washington symposium. Further, for the second year, the American Seniors Housing Association (ASHA) in collaboration with Coopers & Lybrand has completed a comprehensive statistical review of industry performance, including investment and operational data on rental congregate facilities, assisted-living residences and continuing care retirement communities (CCRC). This research report, entitled The State of Seniors Housing 1994, includes comprehensive 1993 data collected from 326 facilities comprising over 60,000 residential units.
The seniors housing inventory sampled for the report enjoys a healthy occupancy of 93% across all properties, an indication that the occupancy problems of the late 1980s and early 1990s have been overcome. All sectors of the industry report strong occupancy rates with CCRCs experiencing slightly higher median occupancy rates (94%) than congregate residences (93%) and assisted-living residences (91%). The survey found that the overall sample's occupancy increased a solid 6% between the end of 1992 and the end of 1993. This reduction in vacancy is likely a reflection of an improved economy and a strengthened supply and demand equilibrium.
Other positive indicators were also evident as rents increased for all property types between year-end 1992 and year-end 1993. Assisted-living residences report the highest median increase in rents (5%), followed by congregate residences (4%) and CCRCs (3.8%).
Despite these very positive developments, the ASHA/Coopers & Lybrand research also indicates that there continues to be a certain number of properties, particularly within the rental congregate sector, that are experiencing financial difficulties. Less than 50% of congregate residences surveyed report that they are covering debt service requirements vs. nearly 75% of both the assisted-living and CCRC sectors.
While it is possible that the severity of the problem may be overstated due to some respondents incorrectly including non-cash items such as depreciation and amortization in operating costs, the research indicates that, despite high occupancies and increasing rents, financial problems persist with the rental congregate sector of the industry. The congregate sector's financial problems appear to be caused in large part by over-leveraging.
It is important to note, however, that only 11% of all seniors housing properties constructed since 1991 are experiencing operating losses. This indicates that, with better underwriting and increased developer/operator understanding, the industry seems poised for a period of financial stability and the likelihood of incremental growth during the next several years.
During the past year, an increasing number of lenders and investors have made significant commitments to this industry. Witness Health and Retirement Properties Trust, a REIT that recently concluded a complex $320 million sale/leaseback transaction of a 14-property Marriott International seniors housing, or GE Capital's $95 million refinancing of an assisted-living portfolio owned by Sunrise Retirement Homes & Communities.
Debt and equity available
While the cost of capital will likely rise during the year, both debt and equity are readily available for financially solid industry practitioners with a track record of success in the business. In particular, pension funds and their investment intermediaries, real estate investment trusts, financial services/credit companies, Wall Street securitization entities and evenare testing the waters for viable seniors housing investments with defined exit strategies.
Pension funds represent an enormous untapped supply of capital for the seniors housing industry. These institutions, who have recently begun a more aggressive diversification process into real estate investments, are seeking equity and debt positions in viable ventures. Possibly in conjunction with REIT partners or individually, pension funds are slowly changing from a defensive investment strategy to a more forward-looking posture. As the supply of multifamily housing investments diminishes, pension funds and their advisers will be seeking alternative investments, which could include seniors housing products that generate competitive yields.
Further, the industry increasingly will witness joint ventures between investment banking institutions and commercial banks. In such arrangements, the commercial lender will supply the construction funds while investment banks will provide forward commitments for take-out financing or securitization. This financial fromat represents a breakthrough from a few years ago when construction lenders were not able to find comfort in the limited permanent takeout marketplace.
Affordability remains one of the critical challenges facing the seniors housing industry. As long as the cost of capital is on the upswing, a significant portion of the seniors housing marketplace will be shut out. Current initiatives to expand the scope of the Low-Income Housing Tax Credit program offers hope that the affordability factor can be enhanced. As more corporate tax credit investors who can utilize the passive losses associated with this financing vehicle explore the possibilities associated with serviceoriented seniors ventures, the pool of affordable capital for the industry could increase over the years. However, the uncertainty of the near-term interest rate environment and the complexities associated with seniors housing projects will need to be monitored during the coming year.
As we set our sights toward the upcoming millennium, the business of producing a variety of housing types and services for our aging population is coming into focus. The fact is that, in 1990, approximately 9 million Americans aged 65 and older lived alone. By 2010, that number will likely approach 13 million. Also in 1990, fewer than one in 10 elderly persons was aged 85 or older. By 2045, the oldest sector of the aged will be one in five. Increasing longevity and the number of baby boomers moving into this age group will drive this population trend.
A further reality is that, although health care reform has temporarily been put on the political back burner, the issues of non-institutional, managedcare alternatives will not disappear. Currently, more than one-third of total national health care expenditures are for the 12% of the population aged 65 and older. If unchecked, the United States could spend an estimated 20% of its Gross Domestic Product on health care by the year 2000.
While in recent years the assisted-living sector of the industry has taken center stage, a variety of seniors housing types represent viable investment alternatives for the savvy owner or financing source. Supportive services contracted for by non-developer providers can be integrated into most forms of seniors housing thus improving the affordability of the end product while reducing the developers' operational risks.
With a volatile political and economic climate and the increasing costs of capital, there is no margin for error in this evolving business.
Turning HUD Around
Components of "Re-invention"
1 Consolidation of HUD's 60 programs into three flexible performance-based funds for FY98
2 Deregulation of non-troubled housing authorities and the conversions of operating subsidies for public housing agencies to rental assistance for residents who would be given the choice to stay where they are or move to apartments in the private rental market
3 Transformation of the Federal Housing Administration into an entrepreneurial, government-owned corporation using public/privated and other market mechanisms
New Program Uses Novel Approach
Seeing the potential for growth in the seniors housing industry, Vienna, Va.-based Washington Mortgage Financial Group has begun employing a newly designed model of risk-based pricing to determine financing. Discussing Washington Mortgage's outlook on senior housing is Renee DuBois, vice president and manager of long-term care financing for the company, which, along with its subsidiaries and affiliates, originates and services conventional and FHA-insured multifamily loans nationwide.
Q. How would you describe the investment opportunity offered by seniors housing?
A. Tremendous. And the potential seems unlimited. A recent JP Morgan industry analysis report projects that expenditures for nursing home care will double by the year 2000, reaching $125 billion. Thanks to advances in health care and an increasing desire to stay fit, people are living much longer, healthier lives. The old notion of going directly into a nursing home when you needed even minor assistance has changed dramatically. Assisted living has become an important bridge that connects skilled nursing care with independent senior living.
Q. How does WMF's approach to financing senior housing differ from other programs?
A. Most lenders have traditionally looked at past history and performance to determine loan amounts. Our analysis also focuses on current performance and potential for future success. Each facility is a unique business enterprise, and we don't believe in cookie-cutter applications to underwriting. Our program offers conventional, fixed-rate seven-year, 10-year and 20-year loans. Loan amortization is 20 to 25 years, depending on the age and condition of the property.
Q. What types of qualities do you look for in owners?
A. Experience, reputation and savvy. We like to see owners with a minimum of five to seven years' experience in running their facility or facilities. Also, good reputations for patient care and marketing savvy in attracting residents are important.
Q. How do you evaluate the way an owner solicits clients/patients?
A. A good owner is very proficient at screening clients and maintains low delinquency rates. Don't bring in folks that will cost you more money to care for than you can charge them. Also, look for patients with higher acuity levels, because more serious illnesses require more attention and nursing or doctor care. This correlates with higher reimbursement rates.
Q. What do you look for in terms of staffing requirements?
A. We look for an appropriate ratio of caregiver to resident -- the staff must be well-trained and able to take care of the type of residents the facility attracts. Also, if a facility has substantial turnover among its staff, this can be unsettling, especially in nursing homes, where consistency and relationships are critical.
Q. Is there anything unique to WMF's pricing of these loans that borrowers should know about?
A. We use a newly designed model of risk-based pricing to determine financing. This is another example of how crucial it is to have a deep understanding of the health care industry. We have identified a set of variables that helps us understand the perceived risk in the transaction and therefore determines what spreads the interest rates will be based upon. Some examples of these variables are marketing skills and management capabilities of the owner. We have three tiers of risk-based pricing, with the best rates of 300 to 325 basis points over the corresponding Treasury security.
Q. Do you view competition in the market as a benefit or disadvantage?
A. It depends. We evaluate general occupancy rates in the market, as well as within the facility that's considering renovation. We do not look favorably at markets that are overbuilt or overbedded.
Q. What does the industry's future look like?
A. Demand may level off, but people are continuing to live well beyond what anyone expected 10 years ago. It is becoming more fashionable to live in assisted care or congregate living facilities, because they offer socializing and independent living with assistance as needed. As this trend continues, there will be a natural progression from assisted-living scenarios to nursing homes with more complete care needs.