Product Focus: Senior Living (Febuary 2007

Great demos are obvious

BUT SENIOR LIVING SUCCESS ISN’T QUITE SO SIMPLE

By Brian Busek

 

For an investor interested in senior housing and healthcare real estate, a glance at population demographic data suggests that gold – and lots of it – will soon be found in ‘them thar’ properties.

However, as the winners and losers in any gold rush can report, some miners find rich veins that yield astonishing results while others never quite find their way to the fortune. The mere presence of gold and a general idea of where it might be found aren’t enough to ensure success. The winners sort through and understand a wider set of factors in order to zero in on the treasure that lies within a favorable environment.

The same is true when it comes to developing and investing in real estate for senior living, industry sources say. There is a need to develop a sophisticated understanding of the emerging senior population beyond a simple appreciation of its impressive bulk.

We’ve all heard ad nauseum about the Baby Boom Generation. And it seems painfully obvious that the “pig in the python” – the massive population bubble presented by Boomers – will spur demand for products and services catering to that desirable demographic cohort. With Boomers now ranging from 43 to 61 years of age, you can’t go wrong in the coming years by focusing on real estate for seniors, right?

Not necessarily.

Industry experts say that successful senior living investors are those who look beyond demographic generalizations to capitalize on the nuances of the marketplace.

Understanding and weighing the importance of key demand drivers is crucial to developing strategies for addressing the opportunities presented by an aging population, according to the research team that is part of the Baltimore-based capital markets group of Stifel Nicolaus & Co. The firm, based in St. Louis, is one of the largest middle-market investment banks.

Well-known securities analyst Jerry Doctrow – recognized as a Wall Street Journal “Best on the Street” analyst for three years running – leads Stifel Nicolaus’s respected healthcare provider and healthcare real estate research team. So an invitation-only group of industry executives was all ears as Mr. Doctrow and his colleagues shared their take on the market during the Stifel Nicolaus Capital Markets Senior Housing and Health Care Real Estate Conference held in Key Biscayne, Fla., on Jan. 8 and 9.

Seduced by Boomers

“In assessing demand for senior housing and healthcare real estate, we are increasingly convinced that too much emphasis has been placed on demographics, with insufficient attention paid to other key demand drivers, such as disability rates, ability to pay and consumer preferences,” the Stifel Nicolaus team stated in a research report shared with conference attendees.

In addition, the report notes that demographic data suggests that investors and developers should pay as much attention to impact of the Roaring Twenties as the Baby Boom. That’s because the 85-plus group – not the Baby Boomers – currently drives demand for senior housing, skilled nursing and hospice services, according to the report.

The average entrance age for residents of most private-pay senior housing and skilled nursing facilities is 80 years old. Five percent of the U.S. population or about 15 million people – described as Roaring Twenties Babies by Stifel Nicolaus – was born from 1918 to 1929, with the 85 and older group growing at three times the rate of the general population. The high rate growth rate in the 85-plus group is projected to continue until 2010, when it is expected to slow until about 2030, when Baby Boomers enter that age group.

But while the most significant impact of Baby Boomers on senior living might still be decades away, that age cohort is already having an effect in other areas of healthcare. The Baby Boomers include 84 million people born from 1946 to 1964, representing 26 percent of the population. The 50 to 64 age group, which includes the leading edge of the Baby Boom Generation, is growing four times faster than the general population.

Consequently, Baby Boomers are already important drivers in the demand for medical office buildings, as well as hospitals and other outpatient facilities. And while they are not yet ready to move into senior living facilities themselves, they are often important influencers and decision-makers regarding senior living facilities for their parents.

“Typically, we find that the adult daughter is going to be involved with the decision,” Laurie A. Bebo, president and CEO of Assisted Living Concepts Inc. (NYSE: ALC), said during a panel discussion at the Stifel Nicolaus conference.

Key demand drivers

What dynamics drive senior living and healthcare demands among these key populations? Here are some key factors identified by Stifel Nicolaus:

■ Consumer health. Disability rates for Roaring Twenties Babies have been significantly lower than with previous generations and that factor has steered many Roaring Twenties Babies to private pay senior housing alternatives while reducing interest in skilled nursing facilities (SNFs), more commonly known as nursing homes.

■ Consumer affluence. Roaring Twenties Babies, who are now living in private-pay senior housing or skilled nursing facilities, are more affluent than previous generations. Baby Boomers in the long term are projected to have more wealth and more income than earlier generations; however, greater disparities in resources might be found among them.

 

■ Consumer preferences. A trend already apparent is that with lower disability rates and greater affluence the Roaring Twenties Babies have shown a preference for less-institutional settings. The nursing home market has responded by focusing on higher acuity, short and long-stay patients and on lower income patients for whom the decision is driven by Medicaid.

“As we look at the demographics, they’re only for us right now… I think there are many opportunities still available to us,” Evrett W. Benton, president and CEO of Five Star Quality Care Inc. (AMEX: FVE) said during a panel discussion at the conference.

And while the demographics clearly support the development of senior living facilities now and in the future, a major concern for healthcare operators and real estate firms – and society as a whole – is how seniors will pay for their care.

“We look at statistics and demographics and we’re very concerned in the out years on how people are going to be served,” said Randall J. (Randy) Bufford, president and CEO of Trilogy Health Services LLC, who spoke on a panel at the conference.

“If you look at some of the people who are spending every dime, they’re not saving,” Mr. Bufford said. “And so when they have to pay for their long-term care, is the insurance going to be there? Is the estate going to be enough to pay for what is a very, very expensive – depending upon your markets – type care? And so there’s going to need to be that safety net.”

‘Under control’

In addition to profiling the populations that will affect the senior housing market in the near term and long term, the Stifel Nicolaus report also explores current construction trends. The report looks at monitoring data collected by the National Investment Center for the Seniors Housing and Care Industries (NIC) and the American Seniors Housing Association (ASHA) in 75 major metro areas.

The report concludes that the level of new senior living facilities construction is “under control.” The total supply in 2006 was estimated to be growing by 1.4 percent, according to the report.

The report notes that growth was accelerating in the independent living (IL) area while it was flat in assisted living (AL) and SNFs.

In terms of construction costs, some of the executives who spoke at the Stifel Nicolaus conference said that the rapid inflation of the past two years has started to ease.

“Land pricing is clearly more available and at better pricing because we’re competing a little bit less with homebuilders and multifamily developers,” said Paul J. Klaassen, founder, chairman and CEO of Sunrise Senior Living Inc. (NYSE: SRZ). “So I’m cautiously optimistic. It hasn’t really shown up in per square foot costs yet.”

“We’re seeing construction flattening a little bit,” said John C. Erickson, chairman and CEO of Erickson Retirement Communities. “But … even with construction going up, it didn’t go up as fast as housing values did. So it stayed in proportion. That was the most important thing for us – to make sure that housing values were rising faster than construction costs.”

In terms of acquisitions, some of the executives at the conference were of the opinion that just about all of the major deals have been done or are already in the works.

“This is a very fragmented industry,” noted Lawrence A. Cohen, vice chairman and CEO of Capital Senior Living Corp. (NYSE: CSU). He said that his firm made numerous acquisitions in 2006, but the largest deal involved five assets – the rest of the transactions involved one or two properties.

Mr. Benton said that Five Star is seeing the same thing.

“Even the very largest amongst us … we’re a very, very small fraction of what’s available in this business,” he said. “There are a million units out there.”

Mr. Benton continued: “We’re looking at onesies and twosies. Why? Because we can make those deals work.”

Mr. Cohen added that one pocket of acquisition opportunities might be found in not-for-profit senior living facilities. Although most of those organizations would probably prefer to retain ownership of their real estate, selling those assets would enable them to retire the debt on the property. As a result, the new owners could make needed capital improvements.

Solid prospects

Overall, Stifel Nicolaus sees solid profitability and growth prospects throughout the senior housing market in 2007.

Healthcare real estate investment trusts (REITs) might not reach the stellar returns of 2006, but prospects remain attractive, according to the report. The REITs have benefited from improving operating fundamentals and the low cost of capital.

Private senior housing carries higher risk than REITs, but it also has the potential for greater returns, according to the report. The sector is positioned to capitalize on improving fundamental trends.

SNFs should benefit from a pullback in share prices in late 2006 as well as the positive impact of the Medicare cost of living increase during the fourth quarter of 2006.

During the Stifel Nicolaus conference, various panel discussions of industry executives touched on the question of which product types present the best opportunities in senior living: IL facilities such as apartments; AL facilities; SNFs; Alzheimer’s and memory care units; continuing care retirement communities (CCRCs); or others.

“I think the lines between AL, IL, CCRCs – all that – skilled nursing, have all been blurring for many, many years, said Mr. Klaassen of Sunrise.

“It’s our view that seniors want to have a real say over how and when and where they receive services,” he emphasized. “And since care is totally portable … it means less and less to say a resident’s receiving AL or IL … Clearly, the concept that care is portable has had a big impact on our field.”

Mr. Klaassen continued: “Our view is that resident-centered senior living is really what consumers want today. They want to have a big say about how, where and when they receive their services and, frankly, they’re getting that.”

So which senior living real estate product types present the greatest opportunities for investors?

“We really believe that the best senior living has yet to be invented,” Mr. Klaassen said. He said the senior living sector could benefit from studying other industries. For example, he notes that there are dozens of makes and model of cars, but only a handful of types of senior living facilities. Just as 50 consumers might choose 50 different cars, they should have more options for “new models” of senior living, he said.

For example, most CCRCs currently require a large entrance fee, plus monthly charges. A large percentage of the entrance fee is returned when the resident leaves, but there is no actual real estate ownership.

“The next generation CCRC, I think, is going to include more real ownership,” Mr. Klaassen said. “We’re about the only countries in the world that ask people to put up a ton of money and only get 90 percent of it back five years later and think that’s a good deal.” He said Sunrise is also working a range of other concepts, including IL and AL rentals and for-sale properties, condo structures, different price points, ala cart options, and bundled options.

“We have to have lots of different models.”

Mr. Erickson said he also sees growing opportunities within existing models.

“I think the biggest changes you’re going to see are in the wellness side,” he said. “Our model is we believe that the single biggest killer of the elderly today is social isolation.” He said seniors benefit from a “community based” environment.

“There’s going to be a huge push toward community based wellness,” Mr. Erickson predicted. He said senior living facilities will need better amenities, including larger swimming pools and fitness centers, and more dining options.

“Residents like larger units,” added Mr. Cohen of Capital Senior Living Corp.

What’s ahead?

Despite the overall positive assessment, some SNF operators who spoke during the Stifel Nicolaus conference expressed concerns about the future of the industry.

Even with more generous Medicaid reimbursement rates, one executive said, nursing homes still have the lowest average operating margins of any type of healthcare facility – something confirmed by the Stifel Nicolaus report. The report notes that SNF operators have lower EBITDA margins, lower growth prospects, and lower EV/EBITDAR compared to the statistics of senior housing and health care real estate.

With an estimated replacement cost of $140,000 per bed, thin margins make it difficult for SNF operators to make the capital investments required to keep aging facilities competitive, according to the executive, who declined to identified. Shifting the payer mix – reducing the percentage of Medicaid patients and increasing the amount of patients who have private insurance – is the best opportunity for operators to increase profitability, he said.

And, above all, operators and real estate firms says they want to avoid the boom and bust cycles that plagued much of the senior living industry in the 1980s and ‘90s. Too much “easy” capital led to significant overbuilding.

“Leverage is not a good thing” due to the cyclical nature of the business, Trilogy’s Mr. Bufford cautioned. “I think fiscal restraint is a huge thing” in terms of debt and leases, he said. q

Brian Busek specializes in writing about commercial real estate and architecture.