The seniors housing industry lost some ground to the assisted living boom, but the markets are beginning to even out.
NREI recently interviewed Mel Gamzon, president of Senior Housing Investment Advisors Inc., a Ft. Lauderdale, Fla.-based investment real estateand advisory firm. Gamzon is a founder and executive board member of the American Seniors Housing Association and a 20-year veteran in this emerging business. During the past year alone, he has successfully hand-led more than $100 million worth of investment real estate transactions. Gamzon shared his perspective with NREI on the potential for industry growth.
NREI: As an industry expert, where are we in the evolution of this business?
Gamzon: Thank you for the compliment, but the only real expert in this industry is the senior consumer. We have learned many lessons in the past several years, the most important of which is that the end-user for senior housing and supportive services is in the driver's seat, and all the sophisticated pro formas and unique financing vehicles that have been used must still translate “up” to the consumer.
In many respects, we are at a crossroads in the evolution of the industry. The past five years have primarily been dominated by the emergence of assisted living. The overall seniors housing industry lost much of its identity to this upstart sector. Fast money was chasing this new product, which was still in a formative stage.
The bottom line is that assisted living went from infancy to adolescence with lightning speed. Take a look at the publicly traded assisted living companies. Wall Street investors jumped into the fray and fueled the explosive growth of the assisted living market. Overly zealous earnings forecasts based on extensive acquisitions and fast-track new development ventures were never realized. The business went from Main Street to Wall Street, when in fact assisted living has always been a Main Street business.
The goodis that we have essentially recaptured the major components of this emerging industry, and assisted living is becoming an integral part of the continuum rather than being the dominant product. This is a healthy sign for investors who are looking for a diversification play, real estate entrepreneurs who are interested in expanding their market base, and of course the consumers who are constantly seeking an independent lifestyle.
NREI: What is the status of these publicly traded companies and their impact on the seniors housingbusiness?
Gamzon: No question, there's a mess on “the Street.” We went from a market capitalization of more than $2 billion a few years ago to a current valuation of the remaining 11 public companies of more than $600 million today. The hype and hoopla was analogous in some respects to what happened to the technology sector. Was Wall Street ever in love with assisted living? I think that lust more accurately reflects what really happened. The concept is great, but the timing for the public capital markets was way off, and investors are now feeling the pain.
Assisted living consolidation is in full swing and the values of these assets have come down to realistic levels for acquisition. Our firm has been representing two of the largest assisted living providers in selectively selling these facilities, most of which have been starved for investment oxygen during the fill-up cycle. When Wall Street and other sources of capital effectively cut off the financial tap, liquidity became the mantra of the operators. Even with strong management teams in place, timing to sustain ongoing operations has become an issue.
Who will survive and what will happen to the rest of these public companies? My best prediction is that by the end of this year, at least 40% to 50% of these companies will go private or be consolidated with other publicly traded entities. This is a positive outcome, given that, in my opinion, early staged assisted living companies were no place for Wall Street investors. In some respects, greed replaced need and the rest is history.
“If we look at the overall performance of the [assisted living] industry beyond the handful of publicly traded companies, we see a very positive picture of industry performance and tremendous growth potential.”
— Mel Gamzon
Senior Housing Investment Advisors
The impact of the Wall Street debacle in our industry has certainly had a ripple effect. However, if we look at the overall performance of the industry beyond the handful of publicly traded companies, we see a very positive picture of industry performance andtremendous growth potential.
NREI: So where are we in the consolidation process?
Gamzon: We will likely be through this painful but opportunistic consolidation process within the next 12 to 18 months. Cap rates have risen and owners and their lenders/investors are becoming more realistic in their valuations. Since we are dealing with operating businesses with staff, residents and in many cases licensure involved, reality is setting in and more rationalare being structured. The astute and well-capitalized investor will have vast opportunities for value-added transactions during this period.
The ability to enhance operating efficiencies, lower debt-service payments and expand the market potential through more diverse service programs will give new owners a leg up in the business. In addition, the tightening of the capital markets during the past year has constrained the production of new facilities. All of these factors add up to opportunities as long as reasonable projections of likely financial performance are used. This is certainly an ideal time for contrarian investors who are seeking a real estate market niche in a multifamily sector, which hastremendous long-term potential.
NREI: You mentioned that the seniors housing industry overall is financially solid. Can you please explore this subject further?
Gamzon: Without question, the assisted living sector has had difficulties, which are being addressed through this period of consolidation. The Washington, D.C.-based American Seniors Housing Association recently produced the best statistical measure of overall industry performance. It is interesting to note that even assisted living, except for the publicly traded companies, is doing reasonably well.
The State of Seniors Housing 2000 incorporatesfrom 195 senior communities with more than 45,000 congregate, assisted living and continuing care units. The sample reveals that overall occupancy levels are at 93.7%, with assisted living residences showing a strong performance at 90%.
In terms of profitability, congregate facilities that can include a broad array of services, typically not encompassing assisted living services, show the highest current rate of return on investments. This is not surprising to those of us who have been tracking the industry for many years. On an unleveraged basis, the median return on investment for this congregate sample was 11.5% as compared with assisted living at 9.4%. The higher operating costs and the shorter length of stay associated with assisted living are key contributing factors to the situation. This national survey reveals that the median annual resident turnover rates in congregate facilities is 33% compared with 60.3% in assisted living residences. Clearly, the more independent the resident population, the better the financial returns. In fact, if we look at continuing care communities (excluding skilled nursing beds), their annual resident turnover rate is even lower at 23.4%.
NREI: What can be concluded from the above statistics?
Gamzon: The above summary facts are a snapshot of an industry that is on solid financial footing. Okay, assisted living got off to a rocky start and investors generally were not rewarded for their pioneering efforts. However, we are moving into a new phase of industry growth, albeit more measured growth.
NREI: What are the critical areas of concern in the seniors housingindustry?
Gamzon: In no necessary order, the key issues that should be considered by investors are staffing, the availability of capital, regulatory issues, affordability and market segmentation. On the subject of staffing, the ability to recruit, train and retain competent and caring staff can mean the difference between financial success and failure in this industry. When the value of the real estate is in large part dependent on the quality of the operations, staffing and the ability to deliver cost-effective services to residents is of paramount importance.
Further, the capital markets have pulled back considerably due to the debacle in the assisted living sector. While we still have a disconnect between sources of capital and the industry, in recent months there appears to be signs of a turnaround as the perceived oversupply of assisted living units in select markets improves. For example, pension funds and their advisors are taking a more pronounced role in the acquisition of existing facilities while financially strong operators are teaming up with capital sources to get a jump on the next wave of industry growth. Underwriting standards and equity requirements have tightened, which in the long run will be good for the industry.
On a regulatory front, we are in a cautious period as state and federal agencies monitor the consolidation in the assisted living sector. Hopefully, the ownership transition in most instances will be smooth and resident services will not be impacted by the need for owner/operator cost containment. In states such as Florida, draconian legislation intended to protect residents and encourage plaintiff litigation against industry operators is being tracked closely by the industry associations.
My advice to new investors in our industry is to understand the regulatory landscape and develop business strategies that minimize the risks of regulations. For example, the ability to form partnerships or strategic alliances with providers of health-related services (e.g. hospitals, home health agencies and other health organizations) can reduce operating costs and minimize the risks of regulations while enhancing market credibility.
Affordability represents an ongoing challenge for cost-sensitive senior consumers and their families. Reducing costs throughout the development process and attempting to use cost-efficient financing methods such as tax-exempt bonds, the HUD232 program and the like, can make a dent in this critical issue. To date, creative solutions have been limited, yet innovative approaches to ownership models and the use of system-built housing may provide some answers. Market segmentation is an important issue that is being addressed in a variety of ways. Senior consumers for the most part demand an independent lifestyle with affordable access to services. The initial planning should not be limited to traditional quantitative market research.
Consumer focus groups and other qualitative techniques are essential for proper facility programming, in addition to thoughtful business plans that emphasize market segmentation. We have found that the “plain vanilla” approaches will typically not work in this industry where product differentiation is critical to success.
NREI: Where is the industry headed in the year ahead, and what products are on the cutting edge for investorconsideration?
Gamzon: Even though we have had ups and downs in this emerging business, there is one constant — the aging of our population. The numbers are staggering in many markets. Our industry needs to provide innovative housing and service solutions for our seniors. Furthermore, most industry practitioners have, to date, focused on the relatively narrow market between 80 and 85 years of age. Products that tend to expand this market will become increasingly important.
We are beginning to see a blurring of the lines between congregate and assisted living environments. Providing independent living arrangements with available health and wellness services will replace the stand-alone assisted living “box.” It's just too bad that Wall Street jumped onto the bandwagon so early in the game. These developments are being initiated on both a rental and ownership format.
It is my firm belief that senior condominiums and cooperatives will also become an important part of our industry going forward. There are numerous advantages of these models, including the financial benefits associated with home ownership, the opportunity to attract more couples at earlier ages to these developments, the developers ability to pay more for land, and the recognition that the consumer is effectively the take-out lender. Not a bad exit strategy, especially when ongoing management controls can be integrated into these ventures. When we consider that seniors control more than 60% of equity in U.S. households, the market opportunity is enormous. Several of the largest industry players have successfully initiated ownership models. This is a product to seriously consider, especially for those entities that already have experience with multifamily ownership ventures.
The concept of integrating seniors developments within mixed-use environments will also become more visible, both in urban and suburban locations. Seniors are seeking dynamic lifestyles and the opportunity to participate in work-related, entertainment and cultural activities. For the developer, the ability to offer a perceived “community beneficial” use in conjunction with larger-scale commercial uses may pay off with bonus densities. Effectively, seniors housing becomes a win-win scenario for all.
And finally, we will be seeing more active adult communities being planned. The ability to include single-family, zero lot line and other low-density formats with congregate and even assisted living components is a trend that is taking hold. These ventures can be initiated as part of golf course communities and other recreation-oriented developments.
NREI: To summarize, it seems that you are bullish on real estate investments in this industry?
Gamzon: Cautiously optimistic may be more accurate. From my vantage point in the trenches of these deals, it appears that the worst is behind us and the coming market up-cycle is in sight. Given that there is a limited margin for error in this business, transactions must be structured with a conservative perspective, including all contingencies. Reducing the risks in operations through joint ventures with competent management entities is something that new investors and real estate professionals should seriously consider.