Columbia Roundtable (April 2006)

CCRCs are hot, nursing homes are not

COLUMBIA UNIVERSITY WEIGHS IN ON MAJOR TRENDS IN SENIOR LIVING REAL ESTATE

Editor’s Note: This is the second installment of our two-part series covering “Trends in Health Care Real Estate,” a  Feb. 7 Real Estate Roundtable discussion presented by  the Columbia University Master of Science in Real Estate Development (MSRED). The event, which was held on the Columbia campus in New York and was sponsored in part by a grant from Ernst & Young LLP, featured a lively discussion by nine industry experts. Healthcare Real Estate Insights™ was on hand. This month’s article presents highlights from the panel’s discussion of senior living.

A wide range of healthcare real estate facilities are lumped under the category of “senior living.” But developers, lenders and investors need to understand that there are distinct differences among the various types of senior living properties, and they need to structure their real estate strategies accordingly.

That was one of the major points made by a group of industry experts who gathered Feb. 7 in New York to take part in “Trends in Health Care Real Estate,” part of the Real Estate Roundtable Series presented by the Columbia University Master of Science in Real Estate Development (MSRED).

The roundtable participants included:

▪ Flint Besecker, president, CIT Healthcare

▪ Jerry Doctrow, managing director, Stifel Nicolaus & Co. Inc.

▪ Brian Dowd, managing director, Rockwood Realty Associates Inc.

▪ Sandy Graves, senior vice president, capital management, Sunrise Senior Living         

▪ John Malloy, principal, John Molloy Architects

▪ Gordon Soderlund, senior vice president, DASCO Cos.

▪ Alison Wilson, vice president, Anchor Health Properties

▪ John Winer, partner, Ernst & Young LLP

▪ Murray Wolf, publisher, HREI™

The moderator was Michael Buckley, director, Columbia University MSRED Program.

CCRCs are in vogue

One property type that has come into vogue in recent years, according to Mr. Dowd of Rockwood Realty, is the continuing care retirement community (CCRC). His firm is the co-sponsor of a private equity fund formed expressly to invest in entrance fee CCRCs.

(According to a Rockwood Realty brochure, its Westport Senior Living Investment Fund is a private equity fund that was capitalized in 1999 with $165 million in equity from several institutional investors. It has acquired or developed CCRCs in Florida, Texas, Nevada and California, and has invested in CCRCs in Hawaii and New York. )

CCRCs tend to be very large senior housing campuses with up to 750 units, Mr. Dowd said. They include a range of senior living options, including independent living, assisted living, skilled nursing and memory care units. Residents can begin with a lower level of care, usually independent living, then shift to the other units as they age and their healthcare needs grow. This model allows people to spend “literally the rest of their life” in the same community, he said.

Mr. Dowd said that CCRCs use “a fairly complex financial model” called an endowment model. Under that model, the CCRC owns the residential units and the common areas. Residents pay an up-front entrance fee – an endowment – as well as monthly fees. A portion of the entrance fee is refunded when residents leave the facility.

Many seniors have embraced the model because it provides some assurance that their progressively more intensive healthcare needs can be satisfied at a single location. It also provides some certainty regarding costs. Whereas skilled nursing facilities can cost $6,000 per month, he said CCRC fees are often capped at $2,500 or $3,000 per month.

Although CCRCs are growing in popularity, Mr. Dowd said that they are still “kind of under the radar within the senior housing industry.” He estimated that there are less than 2,500 CCRCs in the United States.

An evolving market

“I think it’s still very much an evolving field,” Mr. Doctrow of Stifel Nicolaus & Co. Inc. said of the senior living segment. He noted that the assisted living concept dates back only to about 1981, when Sunrise Senior Living was formed, and most development has taken place since the mid-‘90s.

“It’s still very much, I think, a work progress and very much evolving, and consumer preferences are still changing,” he said.

“We’re very bullish on senior living,” said Ms. Graves of Sunrise. She noted that capitalization rates for senior living facilities have “risen dramatically” since she joined Sunrise from Marriott Senior Living, which Sunrise acquired in 2003.

Sunrise has employed a “sale/long-term manage-back” strategy. Under that strategy, Sunrise has sold most of the facilities it developed and has allowed third parties to develop most of its new facilities. In both cases, Sunrise leases and operates the facilities, but without the capital investment required to cover the real estate costs.

“Sunrise’s pipeline is 85 percent owned by third parties,” Ms. Graves said. Her role is to work with clients, such as institutional investors, pension funds and private real estate investment trusts (REITs).

Rockwood Realty’s Mr. Dowd added that CCRCs tend to appeal to “independent seniors,” but he said the definition of that term has changed.

“Five, 10 years ago, that used to be somebody in their upper 60s, lower 70s. Now that person is literally in their lower to mid 80s,” he said. Most seniors prefer to remain in their homes as long as possible, he said, and their first move into a healthcare-related facility is often to an independent living setting. Many people put off planning for their later years, he added.

“Nobody wants to be mortal,” he said. “The continuum of care is really about somebody planning ahead.”

Mr. Dowd noted that the length of stay in a CCRC is up to 12 years, with most of that time spent in the independent living units. The goal, he said, is to stay mentally and physically active as long as possible, with only a short stay in assisted living or skilled nursing. Some refer to that as “compressed morbidity” or an effort to “live long, die short,” he said.

Private pay is attractive

“The part of this whole business we’re most excited about from an investment standpoint as a stock picker is private pay senior housing…” Mr. Doctrow said. “You don’t have to worry about government reimbursement, there’s less regulation and there’s a lot of opportunities, I think, for developing new products.”

There is plenty of demand for senior living facilities, he added, but there is “constant tension” between demand and payers. Medicare and Medicaid reimbursement rates are of particular concern, Mr. Doctrow noted.

Mr. Buckley of Columbia University asked if that means that government policy has a major impact on senior living.

Different types of senior living are affected differently by government reimbursement rates, Mr. Doctrow replied. Mr. Winer of Ernst & Young agreed.

“Healthcare real estate covers a wide swath,” he said. “Some is immediately impacted by changes in government policy, some of it is more insulated.”

Mr. Besecker of CIT agreed, noting that the differences between property types affect underwriting criteria.

“The assessment of the real estate in skilled nursing is substantially different than the assessment of outpatient, which is substantially different than medical office building, and substantially different than acute care,” he said. “The point really is that the drivers behind these different asset classes are very unique and so you need to understand those unique drivers behind the different classes.”

“Most of my clients are either operators like Sunrise … or are healthcare REITs… This is all they do,” Mr. Besecker said. “They have that expertise. They’re very comfortable investing.”

“I think most of my healthcare REITs would be happier if there were somewhat more controversy because their biggest problem is that too much capital is flowing in, particularly in medical office, particularly in private pay senior housing, which are the least complex, the most like conventional real estate,” he added.

“Assisted living may be complicated,” Mr. Besecker said, “but you can get (cap rates of) six and a half or seven on assisted living. Compared to four, that looks great – and this looks a lot like an apartment building.”

Mr. Buckley said it sounds like healthcare real estate is a business with positive demographic trends and a growing awareness on the part of institutional investors. He noted that pension funds and other institutions own most of the stock in Sunrise (NYSE: SRZ).

Ms. Graves said that, yes, institutions do own the majority of Sunrise as an operating company. But, she noted that they’ve also invested in the asset side: the real estate.

Mr. Winer pointed out that Sunrise offers two ways to invest in senior living. One is to buy stock in Sunrise; the other is to invest in real estate where Sunrise has operations.

No love for nursing homes

During the question-and-answer period following the roundtable discussion, it was noted that municipalities sometimes restrict and resist the development of senior living facilities. That’s why some operators move to the outskirts of metro areas, Ms. Graves said.

But, Mr. Winer said that senior living is usually viewed as a favorable use because it doesn’t put much pressure on the municipal budget for things like schools and roads.

In answer to another question, Mr. Dowd said that some of his fund’s CCRCs are located near universities, which seems to be a growing trend.

“There is a movement to locate near universities to allow seniors to integrate into universities and take advantage of the education programs there,” he said. “There are some universities that have sponsored senior living communities, either on their campuses (or near) their campuses. So, you’re seeing … a bit of that.

“The difficulty of trying to build these communities in urban areas where the amenities already exist is, today, you’re competing with just this huge housing market. It’s really the highest and best use out there is residential real estate, and it’s generally for-sale real estate.”

That means senior living facilities must compete with condo projects with 20 percent to 30 percent margins, he said. Land and construction costs make it difficult to do an urban in-fill senior living project.

Most of innovations in senior living facilities appear to be in the assisted-living segment, Mr. Dowd added.

“Nobody wants to go into skilled nursing. It’s the horror show,” he said. “Most of the facilities around the country are pretty old and very institutional looking. They probably all use the same shade of green and they have, you know, office equipment from the ‘60s. But, that’s a very medical model that hasn’t really evolved.”

Boomers not a factor — yet

In response to another question, Mr. Doctrow noted that, despite all we hear about Baby Boomers, the group has not yet significantly affected the senior living market. The oldest Boomers are still in their early 60s, he pointed out, which means most are not yet moving into retirement housing.

“Maybe they’re starting to think about a second home, or maybe they have a second home. Maybe they’re thinking about active adult (communities),” he said.

Even so, there is plenty of demand from folks in their 70s, 80s and beyond. Despite this growing demand, however, some homebuilders shy away from including senior living units in their developments, Mr. Doctrow said. They fear that people don’t perceive themselves as seniors and might be turned off by anything positioned as senior housing.

Another audience member asked about liability risk. In the past, Ms. Graves said, some senior living developers exited or avoided markets like Florida and Texas due to the high cost of medical malpractice insurance. More recently, however, that situation has improved thanks to tort reforms.

“There is a real movement …of separating the real estate from the operations,” Mr. Dowd said, “and you’re seeing institutional money come in and buy the real estate and then net lease it to an operator to try to insulate themselves from that liability risk.” But, he noted that there are other risks.

“At the end of the day, though, if the operator has no money left to pay your rent, you’re going to suffer,” he said. “But, they are trying to, sort of, take apart the asset from the operation so that you can get lower cost of capital for the real estate because it’s a secure, secured investment versus the operating company, which anyone would underwrite much more stringently, and generally it’s more of an unsecured bet.”

In response to another question, Mr. Doctrow said: “There’s a huge, huge opportunity for low-income senior housing with some services.” But, he said that it’s extremely difficult for those deals to work. It’s possible to finance the real estate, but an operating company couldn’t make it because many seniors couldn’t afford the services.

“That’s both a huge opportunity but extremely difficult to put together because there’s no funding for the service piece,” he said. ‘