‘Wait and See’

With a successful annual conference behind him, NIC’s Founder and President Robert Kramer discussed with Long-Term Living Editor Maureen Hrehocik the short- and long-term outlook for financing in the seniors housing and care (SHC) sector. With signs that the frozen credit markets are beginning to thaw, people are wondering how soon the thaw will have beneficial effects on the SHC market. How soon will capital begin to flow and from whom to whom? People want to see deals being made to get a sense of pricing and valuation, according to Kramer. No one wants to be first for fear of paying too much. Even with the unprecedented financial events of 2008, Kramer says it’s quite remarkable how the SHC industry has performed during this recession compared to other types of investment properties.

Hrehocik: Any signs of the lending logjam breaking up?

Kramer: There are some early indications of good things happening that normally would lead to that logjam breaking up, but in terms of actual lender activity, there’s still very little. We are seeing local banks doing relationship lending, which is resulting in a limited amount of construction in some smaller metro areas. Oftentimes, these banks have not had a lot of real estate exposure, so they may be more inclined to lend. On the private equity side, I think there are a lot of investors who see opportunity in our sector and are poised to get involved. REITs [Real Estate Investment Trusts] have also been strengthening their own balance sheets lately by raising capital, so one expects they’ll be rather aggressive players when they see opportunities.

But the missing piece is still debt financing. There just isn’t much available yet and that’s the challenge. Even when banks participate in deals, their limits are much lower and that means more banks have to be involved. GE is starting to get active again and MidCap Financial has been successful in raising more than $500 million in equity, so there definitely are going to be eager and significant players out there. On the private-pay side, Freddie Mac and Fannie Mae have been the only significant lenders in terms of permanent financing. On the skilled nursing side, obviously, there is the HUD program. There the issue is the volume of requests in the pipeline versus what HUD is actually able to get done.

Hrehocik: What are some other financial instruments that are particularly popular right now?

Kramer: As I mentioned, the GSEs [government-supported exercises] are not just popular but, for the most part, are the only source of permanent financing available. While Freddie Mac and Fannie Mae are only available to stabilized independent living and assisted living properties, HUD offers financing for rehab and renovation of existing skilled nursing and assisted living properties, as well as new construction and takeout financing. Of course, for operators with debt maturities coming due, the focus is on being able to refinance. In that case, many will find that the amount of equity has to be increased because overall valuations have gone down.

Many in the financial community are trying to put together new deal approaches, but nothing has yet taken hold. That’s partly due to the hesitancy in being the first in, because people are still unclear on how things should be priced and valued in today’s market. No one wants to overpay for a portfolio. Clearly, there’s been some action, such as Sunrise selling back to the original management team at Greystone and the sale of parts of the Sunwest portfolio. But other than a few small skilled nursing and assisted living deals, we just haven’t yet seen a major volume of activity. My sense is that when a couple of significant deals do get done, they will set some pricing levels and open the doors for others.

Hrehocik: How is the illiquidity of potential customers affecting independent living?

Kramer: It’s certainly had an impact, but I’d say it’s as much of a perception issue as a real one. The average senior owns their home outright and has been in it for more than 20 years. Even though it has lost value compared to what it would have sold for two years ago, it has still appreciated enormously since they bought it. Some seniors forget that, so it creates the hesitancy. Of course, seeing the sustained significant losses in their investment portfolios also affects the psyche of the senior.

Are there challenges in selling to seniors today? Yes. Seniors housing operators have had to be very creative in working with potential residents to help them sell their homes, including how to price and present them, and also help them find creative types of bridge financing. Elderlife Financial Services, for instance, provides loans to seniors or their families that are really bridge loans. They have more customers than they did two years ago, because so many seniors housing operators desperately want to work with them. That’s obviously the result of the economic crisis. The reality is that moving into independent living is a choice that one can postpone, but only for so long because the home just becomes too much to take care of. So there is a need-driven aspect. The average age of people moving into independent living and assisted living is rising, well into the 80s. And since people are moving in when they’re older, they’re more likely to have increasing frailty.

All of this puts more of a burden, in a good sense, on seniors housing and care providers to demonstrate the value of what they offer. You’re not so much selling luxury; you’re selling value. You can provide seniors with a setting that will maximize their quality of life, not just their quality of care, because of the socialization offered through onsite health and wellness programs, planned activities, exercise options, available transportation, etc. Doing a cost comparison of paying for all these services when you’re living at home and maintaining your house versus living in a seniors community, plus the added incentive of socialization provided by the latter, is very compelling.

As an industry, we know people who are lonely suffer quicker physical and mental health deterioration. Research continues to show the value of socialization in terms of increased and improved brain function. That’s important because one of the greatest fears of an 80-plus senior is some form of dementia. Communicating that type of research can lead to a more compelling story of what seniors housing and care has to offer.

Hrehocik: Is there a particular seniors housing and care sector that you feel is doing relatively well during this time of financial turbulence?

Kramer: The implementation of the Prospective Payment System sent a lot of larger skilled nursing operators into bankruptcy. But since that time, the sector has enjoyed an impressive run of stability in terms of reimbursement. Now, however, there are a number of questions looming over skilled nursing-concerns about future Medicare cuts to pay for healthcare reform and Medicaid cuts as states struggle with massive deficits-you see this reflected in skilled nursing stocks. But overall, the last five years have been a very positive time for the sector. And with that, we’ve seen an increasing shift by operators to focus more on attracting the post-acute, short-term stay resident. Many providers have not shifted totally, but they’re seeking to increase their Medicare and managed care quality mix.

When it comes to assisted living, I think the first part of the recession did not hit the sector nearly as hard as independent living, partly because of its more need-driven nature. Now, though, the number of adult children out of jobs has had some effect on assisted living. In some instances, the adult children keep mom at home because they need her income to help them pay their mortgage. In independent living, areas with large housing bubbles and huge pricing gaps between the market’s peak and trough have made for some real challenges. California, Arizona, Florida, and Las Vegas have been particularly hard hit. Some operators, though, have been able to maintain very high occupancies, demonstrating that challenges can be overcome if you’re delivering a good product and have a great word-of-mouth referral system in place. In all, seniors housing and care has maintained positive rent growth even though the pace of rent growth has slowed considerably. It’s the only commercial real estate area that has accomplished this over the course of this recession.

We also have to remember that with the exception of skilled nursing, we have seen occupancy levels retreat from historic highs for assisted living, memory care, and independent living. In 2001 or 2002, if people had said the national average for assisted living occupancy was 89% that would’ve looked pretty good, because then the industry was struggling to get to 85%. Well now, 89% doesn’t look so good when we’ve seen 93% occupancy rates as recently as the first quarter of 2007. So it’s a matter of perspective. Probably the area that’s seen the greatest growth in new product, but from a very small base, has been memory or dementia care. Obviously, it’s very need-driven and very expensive because of the amount of staffing involved, but it’s definitely a phenomenon that has seen significant growth over the last couple of years, even in the midst of this recession.

Hrehocik: What can providers do to better their chances of raising capital?

Kramer: Providers need to demonstrate a laser-like focus on operations, and the ability to control expenses and drive ancillary revenues in a tough operating environment. It is also essential to really understand your numbers and not spring surprises on your lender. Be candid if you’re facing some problems in terms of debt service or not hitting the numbers you should be hitting. Don’t keep things a secret. Plus, you should be able to demonstrate how you’re performing compared to the competition. There’s data available through NIC’s MAP service to do that kind of benchmarking. More than ever, lenders are looking to operators who have a focus on operations, a track record as good operators, and a level of transparency. And building that relationship is absolutely essential. Operators who will end up benefitting are those who have demonstrated their skill to operate during this difficult, challenging period. They will get rewarded by lenders bringing them other properties and saying, “Would you take over management?” They’re going to be in a position to grow if they want to over the next two to three years.

Hrehocik: Have you ever seen a financial situation that compares to what long-term care is currently experiencing?

Kramer: No. Many times before, the challenges to the industry were self-imposed. What we had happen in 2008 were external factors. Having the residential housing market, credit markets, public equities market, and consumer confidence collapse all at the same time has never happened before. That’s quite a coalescing of external negative factors over which the industry had no control. As I said, I think it’s quite remarkable how the industry has held up. Once we’re out of the recession and things are turning around, I think it will be a compelling story of how the SHC industry performed compared to other investment property types.

Hrehocik: What is the outlook for the future?

Kramer: I’m very bullish on our sector for several different reasons. First, we currently have constrained supply. There’s very little new construction now left in the pipeline. So we’ll have a period with very little new supply from 2010 for the next several years. I think we’ll see upward pressure on occupancy rates as seniors who have waited to move can’t wait any longer.

Second, demographics are in our favor. The off-the-chart demographics are still 20 years away, but they’re still positive now. Baby boomers are affecting us more now as they look for housing and care for their parents, not for themselves. Third, we are getting more sophisticated operators who know how to manage expenses well, who know how to deliver quality of life, not just quality of care. Operators who are investing in their staffs and residents are realizing that if those two populations are pleased, then business success will follow. Fourth, new product types are being developed. What we see 10 years from now will make today’s properties look like boring uniformity. Last, lenders and investors are becoming more knowledgeable about our space. This has been helped, I believe, by organizations such as ours who provide good data. It used to be you were taking a shot in the dark on seniors housing and care market fundamentals. You really didn’t know how much construction was going on or what the track record was on occupancy or rates or overall rents plus care fees. Now we have that data. Investors can benchmark their portfolios and see how a particular provider is doing compared to others. And with more transparency, we create a greater comfort level among investors and, hopefully, more informed investment decisions.