COVER STORY, APRIL 2012

LOOSENING THE PURSE STRINGS FOR SENIORS
Seniors housing’s strong performance is giving lenders confidence to make deals again.
John Nelson

The atmosphere for lending in the seniors housing space can be accurately described as active, which hasn’t always been the case. Douglas O’Toole, vice president of investments at Marcus & Millichap in Houston, says that lenders years ago didn’t have seniors facilities on their radar as much as they do now.

“Lenders, in years past, never considered seniors housing to be a Class A asset as compared to apartments, retail or office,” he says. “That’s no longer true. Seniors housing is now considered a prime asset class simply because it’s so need and choice-driven. Lenders now see seniors housing as a long-term viable product type.”

In today’s seniors housing market, lenders such as Oak Grove Capital and Beech Street Capital, and even agency lenders like Fannie Mae and Freddie Mac, are financing acquisitions, handling properties’ refinancing and providing construction financing. Jeff Ringwald, senior vice president of Oak Grove’s Seniors Housing group, believes that financial institutions and lenders are in a better position now to finance seniors housing properties than in recent years.

“The financial system is getting its feet back under it. You have some stability in clearing out the bad loans,” says Ringwald. “The healthcare space, seniors housing in particular, has held up very well and is actually quite strong.”

Seniors housing posted an annual return of 12.8 percent for 2011, according to the National Council of Real Estate Investment Fiduciaries (NCREIF) Research Database. The return is based on 77 properties that are a mix of independent living, assisted living and skilled nursing facilities. The return is the highest it’s been since the second quarter 2008.

The fundamentals for Texas’ seniors housing facilities are on a slight decline, according to the National Investment Center for the Seniors Housing & Care Industry (NIC) MAP Data & Analysis Service. The occupancy for the fourth quarter of 2011 was 84.7 percent, compared to 85.1 percent occupancy in the fourth quarter of 2010. Additionally, the annual absorption rate is at 3.6 percent, down from 4.2 percent in 2010, and the construction versus inventory rate is at 2.1 percent, down from 4.3 percent in the fourth quarter of 2010. However, lenders and seniors housing operators in Texas point out that those figures are a lagging indicator and haven’t yet captured the uptick in activity in the new year.

Some property sectors within seniors housing, namely independent living, aren’t out of the woods quite yet. The need-driven property types, such as assisted living, dementia/memory care and skilled nursing, are outperforming the choice-driven property types, such as senior apartments or independent living.

“Independent living is still struggling; it’s getting slightly better but may take a little longer,” says Eric Mendelsohn, senior vice president of corporate development at Emeritus Senior Living, a national seniors housing owner/operator. “The market for assisted living and memory care buildings is very strong. The financing is available and it’s not overbuilt.”

OWNER/OPERATORS

Before providing financing, lenders closely examine the track record of the owner/operators applying for loans. Owner/operators provide care, determine rents, maintain the property and keep up with state and federal regulations. A strong owner/operator is a safe investment for lenders who want to finance a seniors housing facility.

“The No. 1 thing is always the cash flow, but you also need strong ownership of the facility and strong management whether it’s a management agent or operator of a facility,” says Ed Foulon, vice president of FHA Credit at Beech Street Capital. “(Seniors housing facilities) are very management-intensive because it’s not just shelter, you have a business component.”

Ringwald goes so far as to say that seniors housing is an operating business that happens to be housed in real estate.

“I always say this is a real estate business, but it is 10 percent real estate and 90 percent operations. It’s very much an operating business,” says Ringwald.

Ringwald is in the camp of lenders who would rather lend on a less-than-desirable seniors housing facility run by an owner/operator with a proven track record than finance a new Class A product run by a multifamily owner with no seniors housing operating experience.

Foulon questions the resale value of seniors housing properties, which are largely purpose-built for seniors. The lack of residual value from a vacated property is another reason to value a strong owner/operator.

“The owner/operator is key because if you don’t have a strong operator or a good business in there, what’s that building worth? What are you going to do, turn it into a microbrewery or hotel or single-room occupancy apartment?” ponders Foulon.

Like lenders, investors also closely scrutinize the owner/operator when determining whether to invest in a seniors property. John Cobb, chief investment officer of Ventas REIT, the most active seniors housing and healthcare REIT in the U.S., says that choosing the owner/operators is a primary focus for the company.

“We obviously look at the fundamentals of the real estate like where it’s located, how much money it makes, what’s the right cap rate, etc. We can do that and we can do that like everyone else. What we try to focus on is picking our companies correctly,” says Cobb. “It doesn’t matter if they operate 200 buildings or 3 buildings.”

NEW CONSTRUCTION

There hasn’t been a lot of new construction on the healthcare side in the last few years just because the economics didn’t support it, according to Foulon.

“Now there’s pent up demand,” says Foulon. “What we’re starting to see is more and more demand on the assisted living and independent living side.”

“In terms of more senior housing properties coming on line this year, not a lot is happening yet — the ‘rumors’ still outweigh the reality of new development getting delivered, although we are starting to see some movement,” continues John Moore, CEO of Atria Senior Living, a national seniors housing operator.

Although it’s not at a rapid pace, there is some new construction in the seniors housing space, especially among need-driven properties. Stroud Properties, a Dallas-based developer, is building a $12 million assisted living and Alzheimer’s community in Carrollton. Caddis Partners and the McFarlin Group are developing the 78-unit Orchard Park at Murphy, an assisted living facility. Also, Dallas-based US Memory Care has plans to develop, manage and own a 58,000-square-foot memory care facility in Colleyville. The firm is planning to develop 20 memory care properties during the next 4 years. Other properties in the pipeline include Cadence McShane Construction Co.’s Legacy at Bear Creek in Keller and Orchard Park of Odessa in Odessa.

Lenders are still wary of providing construction financing for seniors housing facilities because of the risk involved. Developers are having a tough time selling the lenders on this point.

“Assisted living and memory care are still a challenge to convince a lender that you have a good location, you know what you’re doing in construction, and that you can lease it up and then run it,” says Mendelsohn. “That’s a lot of challenges before the lender gets paid back.”

One reason developers are more aggressively seeking construction financing for assisted living than independent living is that the assisted living sector hasn’t been overbuilt.

The choice-driven market was built up too much in the past because it doesn’t take a lot of overhead to operate and it’s not licensed, according to Mendelsohn. Also, Texas is one of 14 states that don’t require a certificate of need, therefore it has less barriers to entry than most other states when it comes to seniors housing development. Those factors led to overbuilding in the independent living market.

Lenders are wary about new construction in the skilled nursing sector because of the uncertainty in cash flow due to Medicaid reimbursement cuts. On the other hand, the demographic trends for senior citizens is attractive for lenders. The Department of Health and Senior Services Administration on Aging predicts the 65 and older population in the U.S. to increase from 40 million people in 2010 to 55 million in 2020. Also, the 85 and older population is anticipated to increase from 5.5 million people in 2010 to 6.6 million in 2020.

“The demand is there for seniors and healthcare facilities to meet the demand of an aging populace. The baby boomers will demand quality retirement housing and this demand will go up exponentially as the boomers age,” explains O’Toole. “Both choice and need driven housing will be in high demand in the next 20 years.

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