Remember that tired cliche about how seniors housing is dull and boring? No excitement, right?
Wrong!
The recent National Investment Conference for the Senior Living and Long Term Care Industries (thankfully also known as "NIC") reminded me of recent hotel conferences I've attended. The "buzz" of excitement about the senior living industry was all over the Marriott Crystal Gateway Hotel in Arlington, Va. Deals were being done in the halls. Anybody who was anybody in the business was there. And by the way, that's one big business these days, and growing bigger by the minute (more than 1,000 attended NIC '96).
All of this simply mirrors senior living's place now at the commercial property table along with hotels, industrial, multifamily, office and retail. Investors as diverse as regional and multinational banks, life companies, pension funds and Wall Street have not been able to ignore the fact that the demand for seniors housing facilities will continue to grow exponentially as far into the future as the eye can see.
According to the latest research available on the seniors industry - using conservative estimates mind you - investors are pumping some $4 billion or more a year into the growing $86 billion seniors housing segment.
That heavy capital flow is already setting off alarm bells about the possibility of overbuilding among many industry-watchers.
Which is an important reason why the conference theme of "Separating Hype from Performance" was definitely on the mark. Seniors housing is unlike the other commercial property types since it relies so heavily on demographics and the actual operations and management of each property (in that sense it is most akin to hotels and multifamily communities, but is still more highly specialized) In other words, new investors in this industry must bone up on the ground rules before proceeding.
Many of the newest facility owners and operators have created sophistication within the industry. Seniors housing is very much a growing industry, and one that is beginning to define itself in terms that relate to the objectives of institutional investors.
But many questions remain about the viability of the segment moving forward. For example, where is all of the money to support the industry coming from? Who's lending/investing, and who's sitting on the sidelines?
Since 1991, NIC has been answering those questions. This non-profit educational forum uses the conference proceeds to fund research and other efforts to provide a process of efficient capital formation in the senior living and long term care industries.
Lender/investor survey
This year's sixth annual NIC conference provided investors with more substantive evidence of the industry's dynamics. In particular, an eye-opening study of the senior living investment universe - conducted by NIC and Princeton, N.J.-based Valuation Counselors - provided attendees with more powerful reasons to be involved in a big way.
The objective of the just-published 1996 Lender and Investor Survey, with its distinctive metallic gold cover, was to measure lender and investor preferences in financing long-term care and senior living projects. Last summer, surveys were sent to 600 leading lenders and investors around the country who were believed to be active in seniors housing financing. This resulted in 91 completed questionnaires. The research updated an earlier study done in 1994. NIC Research Director Harvey Singer and Valuation Counselors Vice President Wade Collins were instrumental in organizing the survey and verifying its results.
The NIC research confirmed an important industry trend - assisted living is one hot property type. But while assisted living has received the lion's share of seniors housing money in recent years, Anthony J. Mullen, the committee chairman for NIC research projects and himself actively involved in the industry as the managing partner of Traditions of America G.P., believes that trend could change. "We are going to see return on investment equity come down for assisted living because of competition and influx of capital. Although assisted living has a higher acuity resident and this trend has been rising over the last seven or eight years, it may not continue. As with any industry, if you put too much money into one segment of the market, you get tremendous competition that drives down returns."
It's just this type of analysis that Robert Kramer, NIC's executive director, believes forms a real cornerstone for industry growth and prosperity and why NIC chose to announce the results of the survey at its opening address at this year's conference. "We are in an information- and data-hungry environment right now," observes Kramer. "If there is one recurring theme from our board of directors and owner/operator advisory group meetings, it's this: an efficient flow of capital by lenders and investors will only become available if good benchmark data becomes available. We hope that the response to such data - as presented in the Lender and Investor Survey - will be a catalyst to attract significant interest from the institutional investment community. And that seeing the impact such data can make will underscore the wisdom of continuing to provide it for the industry."
It is also the reason behind NIC's mission. "Our mission," continues Kramer, "is to generate valid and useful data so that lenders and investors can make informed decisions by having guidelines and performance benchmarks to follow," says Kramer. "Although we want to see capital made available to the industry, we feel it is equally important that good decisions are made by educated lenders and investors."
To illustrate the importance of having educated lenders and investors in the marketplace, Mullen points to a period in the early to mid 1980s when over-investing in congregate care facilities was associated with a performance downturn that hurt the entire industry. "In the past, this industry didn't have a lot of information available to the investment community," explains Mullen. "And what happens when you don't have enough information? You have fear because you don't understand the product well. And when you have fear, you tend to make unwise decisions. We don't want to see that happen again."
But in fact, while current demand for seniors housing on a national basis may be strong, a few suburban areas are already showing signs of becoming overbuilt, says Mullen. "We advise lenders and investors to do their homework, by getting a competitive analysis on every investment they are interested in. This includes not only identifying existing competitive properties, but also calling all zoning officials in the primary market to find out what projects are currently in planning and zoning application or land development. To me, this advice is the single major criterion that will prevent overbuilding. And if the lender/investor doesn't require this analysis, it may not get done."
But generally, opportunities for lenders and investors still exist today. "It's true that all of the underwriting criteria are becoming less stringent. Part of the reason for this is that there is competition in the investment community. But at the same time, there is still a lot of real demand for capital. Current lenders and investors in the industry have proven that you can make money," says Mullen.
"Five years ago there were really only about 10 long term care companies that were publicly traded and very few lenders focused on this segment," says Mullen. "Today, there are 39 or more public companies. Looking at the number of attendees at the NIC conference and its speakers/attendees list, I'm reminded of how incredibly large the industry has grown in such a short time."
Major findings
There is no question, based on the survey responses, that the senior living and long term care industries are viewed as viable options for today's lenders and investors. In fact, a majority of the respondents view the industry as superior to investing in conventional real estate. Still, lenders are tending to the conservative side of the fence, preferring proven properties over start-ups and often imposing relatively stringent underwriting requirements.
But there's no denying that the last two years have seen enormous capital flows into the industries. And the flow has become more intensive as the industry has matured. Consider that.
* More firms and more varied types of firms are making loans and investments; a the average investment per firm has increased;
* more service-intensive investments are being made;
* financing terms are becoming less restrictive. "As lenders and investors become more sophisticated about the nuances of the industry," observes Harvey Singer, NIC research director, "we see them providing better terms. For example, loan size, loan-to-value ratios, and amortization periods are increasing. Other lending terms are coming down, such as spreads, points, and debt service coverage ratios. And personal recourse, cross-collateralization, and syndications to reduce risk are no longer necessarily, required. The result is that we're seeing a more competitive marketplace and a more efficient flow of capital."
* the total volume of financing already in place makes the industry one that cannot be ignored by capital providers when making lending and investment portfolio decisions.
Here are more specific findings from the survey:
* Of the respondents, commercial banks, mortgage bankers, investment bankers and insurance companies were the most represented and the most active in providing loans to this industry. They comprised 77% of the survey response and 74% of those found to be making loans to long term care and senior living properties.
* The level of lending activity is high and the trend has increased substantially, as evidenced by. the share of respondents actively placing loans in the industry, which rose from 69% in 1993 (when 1994's survey asked about the pervious year) to 83% in 1994 to 96% for 1995 to 98% expected in 1996 and 1997. And it is likely to continue. Respondents are projecting a 60% increase - from $50 million in 1996 to $80 million in 1997 - in median volume of financing that each lender/investor intends to place within the industry each year. This would create annual total financing volume of over $6 billion from survey respondents alone. Also, 26 of those firms each reported outstanding debt and equity investments to the industry exceeding $100 million, representing a total of over $12 billion placed to date.
* Lower-risk loans are preferred, such as refinancing existing permanent debt, providing permanent financing for new projects that have achieved fill-up, and providing permanent debt for acquisitions of existing stabilized projects.
Many firms also provide higher-risk financing, such as construction and mini-permanent financing for start-up properties, construction financing for projects with permanent commitments in place, or permanent debt for acquisition of existing distressed properties. Not surprisingly, almost 90% of the commercial banks provided construction/mini-permanent financing for start-ups.
* The median yield lenders are targeting on permanent mortgages in the interest-rate environment at the time of the survey (late summer 1996) was just under 9.5%.
* Underwriting is stringent, often requiring debt service coverage ratios of 1.25 or better, personal recourse loans and loan-to-value ratios of 75% or less. However, underwriting standards have loosened in the last two years, as a result of tenders, increased familiarity with the industry.
* Compared to the 1994 survey, more lenders expressed a willingness to provide financing for facilities with more service and personal care components - nursing homes, free-standing assisted living projects and specialty facilities such as free-standing sub-acute, acute care, Alzheimer's care, etc.
Almost two-thirds have financed congregate projects with assisted living units. Fewer respondents than in 1994 were providing financing for seniors apartments with no services, and for rental congregate projects with no health care.
* Considerable differences exist regarding terms and conditions on such things as loan terms, points, interest rates, debt service coverage ratios and similar items. This indicates that loans are being crafted to meet specific borrowers, situations and needs.
* Investors are most frequently appraising property values at income capitalization rates of 11% to 12%, or corresponding multiples of about 8 to 9 times earnings. Lower capitalization rates are often given to senior living projects, while higher capitalization rates are given to long term care projects.
* Underwriting standards view the financing of long term care and seniors housing as both a real estate and business venture. Only 8% of the lenders still treat long term care properties as "pure real estate" or as "primarily real estate with a smaller business component." For both types of properties - senior living and long term care - business considerations influence the underwriting more heavily than was the case two years ago.
* Lenders are impressed with the industry today. Eighty-nine percent of all respondents rated long term care as having better lending potential or at least equal lending potential from a reward-versus-risk standpoint, compared to conventional real estate projects, such as commercial, industrial, retail and other residential real estate. For senior living investments the figure was even higher at 95%. This represents a sharp increase from 1994. The survey shows that the more lenders and in@ vestors understand and participate in this market, the more bullish they become.
The participants
Now that the results have wowed you, maybe you're wondering just exactly who the respondents to NIC's survey were.
In both the 1994 and the updated 1996 research, survey forms were sent to lenders and investors believed to be active in providing financing to the industry - past attendees of the NIC conference who had indicated their primary business activities as lender/investors or financial intermediaries; firms listed in several national directories with listings, indicating lending or investing activity in senior living projects, long term care or related health care; and, in 1996, firms believed by Valuation Counselors to be active.
Of the 91 responses to the survey, commercial banks, investment bankers and mortgage bankers (both those who employ their own funds and also mortgage funding conduits) were the major institutions found to be involved in the industry, representing 70% of total responses. Other types of institutions providing financing include REITs, pension funds and other institutional investors, savings institutions, insurance companies and credit finance companies.
Future projects
In the future, the lenders and investors indicated that free-standing assisted living facilities, nursing homes and rental congregate projects with assisted living units will be the types of facilities for which most will provide financing. And 60% or more of the respondents are planning to finance specialty facilities (free-standing sub-acute, acute care, rehabilitation, Alzheimer's care, etc.).
Most favored among lenders was freestanding assisted living, with nursing homes following closely behind. "It appears," says Collins of Valuations Counselors, "that facilities providing more long term care services on a rental rather than ownership basis are more favored, since investors can more readily identify them with having similar investment characteristics to familiar nursing home products."
Investment potential
What a difference two years makes. This contrast really defines the investment potential going forward, along with the long term growth prospects for the industry.
In this survey question, long term care properties include sub-acute, Alzheimer's units, nursing homes and free-standing assisted living projects. Senior living properties are defined to include active adult communities, seniors apartments, congregate projects with/without assisted living units and CCRCs.
The good news is that lenders view these properties as equal or superior to conventional real estate projects and that the assessments of lending potential for senior living and long term care properties have improved in the last two years compared to traditional real estate investments.
If you compare the 1996 numbers to 1994's, 75% of respondents rated long term care projects superior to traditional real estate, compared to 50% who favored the industry in the 1994 survey. For senior living projects, the rating increased from 40% in 1994 to 56% in 1996 (and 95% of respondents said that senior living project investment potential was at least as attractive as traditional real estate).
Investment drivers
As with any property type, there are positive and negative influences driving investment potential for the senior living and long term care industries.
The three most important positive factors driving growth and attracting capital include demographics (90% of respondents cited this factor), the limited supply of new nursing beds and accompanying higher utilization rates and the investment community's increased understanding of the industry, as more investors discover the risk/reward advantages.
Of course, there also are negative factors to consider. About 75% of respondents are worried about overbuilding, there is uncertainty over regulatory and reimbursement issues, and there is the potential for defaults from poorly conceived and poorly managed facilities.
Another important factor that is discouraging capital infusion is a lack of understanding of the different product segments within the industry. A study commissioned by NIC in conjunction with Price Waterhouse, to be released next month, addresses the often confusing nomenclature, as well as ways of categorizing properties associated with senior living and long term care.
For now, borrowers in this industry must address some of the same basic criteria that lenders look for in other industries and product types. Respondents were asked "What specifically should borrowers do to make it more attractive for your lending/investment firm to lend on a project?" Here's what they said..
* Qualified, professional management should be in place in order to increase the attractiveness of lending on
* Comprehensive business plans should be developed that include budgets and contingency plans.
* Management should have a strategy to differentiate its products/services and develop a market niche.
* Strong knowledge is required about the market and competition.
* High-quality operating and financial data should be obtained and incorporated into loan package submissions.
Many survey respondents also mentioned the need to maintain the physical property, quality of patient care and positive community relations. On a financial basis, several lenders expressed a desire for properties to be less highly leveraged and for liquidity to be maintained through more retained earnings, with less paid out to management.
Copies of the full 44-page 1996 Lender and Investor Survey, including a copy of the survey questionnaire, are available for $75 from NIC at 705 Melvin Avenue, Suite 201, Annapolis, Md. 21401, telephone (410) 267-0504 or fax (410) 268-4620.