FEATURE ARTICLE, DECEMBER 2008

COMING OUT ON TOP
Texas’ senior housing market continues to attract retirees from other states, making it a good bet for 2009.
Robert M. Stone, CCIM

The second half of 2008 has produced a barrage of economic challenges for owners, managers and developers of commercial real estate nationwide. While Texas may be sheltered from these impacts, it is not immune to them. Should senior housing be viewed as an investment safe haven during these uncertain economic times? Is financing available on better terms for senior housing than for other commercial real estate sectors? Did Hurricane Ike significantly change the complexion or value for senior housing projects along the Texas Gulf Coast? Only time will tell, but here are some factors specific to senior housing that may help owners, managers and developers evaluate the near-term opportunities.

Availability of Debt

Numerous articles have been written about the implosion of the commercial mortgage backed securities (conduit) market, the volatility of the taxable and tax-exempt bond markets, and the availability of conventional bank financing on acceptable terms. The majority of the financing alternatives available in 2007 are not likely to be fully resurrected for senior housing or any other commercial property type, and they probably will look quite different when they do reappear. Conventional bank lenders still offer excellent interest rates for their clients with deep pockets who will accept full or partial recourse loans, but over the past few months, most senior housing bankers have become extremely selective in establishing new lending relationships.

We have all read enough negative news recently, so let’s take a look at a recent major change that makes it worthwhile to revisit the Federal Housing Administration (FHA) Section 232/223(f) programs for senior housing. This year, a new LEAN processing system was launched by the Department of Housing and Urban Development (HUD) that promises to shorten the loan approval time dramatically. (HUD oversees all FHA programs, so HUD and FHA are used interchangeably when referring to the 232/223(f) loan program.) FHA coined its LEAN moniker based upon two books on “LEAN production” and “LEAN thinking” written by James P. Womack and Daniel T. Jones in 1990 and 1996, respectively. Of particular note is that the 232/223(f) program was moved from the underwriting group that processes apartment loans to the Office of Insured Health Care Facilities (OIHCF), which has a history of efficiently processing hospital and healthcare facility loans under the Section 242 program. The OIHCF underwriting group is more familiar with the business of long-term resident healthcare services than their predecessors. The FHA loan program retained its favorable features, which include high leverage, long amortization schedules; low interest rates; non-recourse provisions; and some flexibility to negotiate prepayment provisions. Getting loan approval still requires significant up-front work by the borrower, as the LEAN program requires a complete application to begin processing. The application checklist is extensive since there are few contingencies for HUD to back out once they issue a loan commitment. Currently, the LEAN program is available for the acquisition and refinancing of existing properties, and the new construction/major rehabilitation loan program should reopen soon under the new underwriting team.

Lifestyle Choice or Need-Based Senior Housing

Over the last few years, the property-type lines have blurred between senior apartments, independent living/assisted living/memory care fa-cilities, nursing homes, and retirement communities offering multiple levels of healthcare services. However, an elderly resident’s initial move-in decision still boils down to one or the other: is it a lifestyle choice or a healthcare need? Newly constructed lifestyle senior housing alternatives (senior apartments, cottages or independent living units, for example) are likely to experience a slowdown in new leasing and sales activity during these tumultuous economic times because the resident’s decision can be postponed easily. For this reason, new ground-up developments may be shelved, unless they are located in upper-income, densely populated infill areas. Existing phased developments may consider this a great time for expansions and general facelifts to capture market share before the next building boom occurs.

Statistics indicate that the majority of healthy residents moving into senior housing communities are in their late 70s or early 80s, while 85.3 is the median age for those moving into an assisted living or skilled nursing facility due to a healthcare need. The more than 80 age cohort is rising rapidly statewide, particularly in metropolitan areas, as the average lifespan continues to increase. The majority of Texas nursing home buildings were built prior to 1975, and the bulk of the freestanding assisted living facilities were built in the mid-1990s. New buildings offer more amenities and ancillary services than those designed 15 or more years ago. Developers and operators of need-based buildings that are comfortable with the risks of the state and federal regulatory environments are anxious to meet the rising demand, and they expect to benefit from the overall development slowdown. Many anticipate land price reductions that may allow them to afford sites in 2009 that were out of reach 1 year ago.

Unfortunately, the largest segment of the need-based elderly population in Texas is comprised of senior citizens eligible for government entitlements to pay for their health care. According to the Texas Health Care Association, approximately 80 percent of nursing home patients relied on either Medicare or Medicaid to pay their bills as of February 2008. Currently, Medicaid expenditures account for approximately 26 percent of the Texas state budget. Most Texas assisted living facilities and nursing homes lose money, or break even at best, in caring for Medicaid-funded residents under the state’s current system. Therefore, many of these impoverished residents end up going into older buildings while new buildings compete for the more profitable, private-pay residents or residents needing healthcare services that are covered by Medicare. Watch for changes in 2009 to both the Medicaid and Medicare programs, which may point to additional opportunities for well-managed businesses.

Hurricane Ike Impacts

The devastation to Galveston Island and other portions of the Texas coastline still has yet to be completely quantified several months after Ike’s September 13th landfall. It may be a decade or more before portions of the ecosystem recover from the damage caused by saltwater and other chemicals deposited inland from the storm surge, so formerly scenic views may no longer be an amenity to be marketed by lifestyle choice properties. Most coastal senior housing facilities were evacuated efficiently, due to lessons learned from Hurricane Rita in 2005. However, the majority of buildings that suffered heavy damage from Hurricane Ike are still completely vacant.

Numerous insurance claims are slowly being resolved because insurance adjustors were not allowed into many ravaged areas until late September. Several owners have discovered gaps in their property and casualty insurance coverage and may elect not to rebuild. The three storms that hit Texas this year (Dolly, Eduard and Ike) have exhausted the Catastrophic Reserve Trust Fund, which stands behind the Texas Windstorm Insurance Association (TWIA). So, a $100 million assessment in 2009 should be anticipated by program participants, in addition to an increase in future windstorm premiums, if changes are not made to the program. The state’s General Fund is obligated to fund the balance of the TWIA losses, so look for the legislature to consider an overhaul of the TWIA program when it convenes next year. Also, owners of Gulf Coast senior housing properties should be prepared to fight 2009 assessed valuations vigorously, as the property tax rates could rise dramatically throughout the impacted counties.

The obvious beneficiaries are the greater Houston area senior housing facilities that escaped serious damage and accepted private pay evacuees, which may not return to their former residences. However, the rise in occupancy is spread statewide for nursing homes, as owners of multiple Medicaid-certified buildings moved many residents to their other Texas buildings with vacancies, some of which were as far as 200 miles inland.

Looking forward, 2009 should be an above-average year for those associated with long-term care, transitional care, and dedicated Alzheimer’s- or dementia-care facilities. Owners and managers of existing senior apartments, independent living and other lifestyle-choice senior housing properties also are likely to benefit, as their occupancy rates should rise with fewer new buildings in the development pipeline. Texas continues to attract retirees from other states that have higher costs of living, state income taxes and harsher winters.

Robert M. Stone leads the Senior Housing Division of Henry S. Miller Brokerage, LLC, in Dallas.

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