It seems every market study and appraisal produced in the healthcare industry today contains the language, ‘due to the aging of the Baby-Boom generation…’ – implying that all is well with the world and all healthcare markets are strong because of the aging of the Baby-Boomer generation. This assumption is emphatically not true.
The reality is, with the first Baby Boomers just starting to collect Social Security, it will be a while before they are direct contributors to the market.
This generation is still years away from becoming residents of the senior-service centers and assisted-living facilities that accumulated in the late 1980s and throughout the 1990s – when buyers, developers, owners and operators all began to believe that the Boomers would create huge senior-housing and healthcare demands.
That said, the excess capacity in these facilities is finally starting to be absorbed by the parents of these Baby Boomers, and the Boomers themselves are responsible for much of their parents' placements, which means their tastes and financial strengths are beginning to be felt in the industry in a noticeable way.
Affordable versus private pay
First, we must recognize that there are two distinct segments in seniors housing and healthcare housing: affordable and market/private pay. Private-pay price levels for independent senior-living facilities generally start around $900 to $1,200 a month, not including meals, and can cost 50% to 100% more for meal and minimal service packages.
Assisted-living and memory-care facilities' entry-level monthly fees range from $2,200 to $2,400 and $3,400 to $4,500, respectively. The private-pay levels in both of these markets include no affordability component.
To support affordability in any of these facilities, government programs or private endowments must provide subsidies. Charitable, religious, ethnic, fraternal or housing/healthcare alliances have been the sponsors of most of the affordable segment.
At the same time, some private owners have focused on Social Security, Veterans Benefits options and – in some states – Medicaid waiver vouchers separately or in combination with Section 8 rental assistance.
Although most states and several governmental and private agencies recognize the current and growing need for this segment, they have few resources to significantly support new development. Consequently, the ownership or purchase of successful affordable projects and the rare ability to amass the resources to develop a new project present quite an opportunity.
Opportunities in the private-pay market are more plentiful, but they are limited by higher-income market demand. More decision-making by adult children for parent placement is creating some new demand in newer upscale neighborhoods, though many seniors are reluctant to have their children dictate where they will live and insist on remaining in or near their longtime home neighborhoods.
In either market location, the cost of producing new units is very high today. Taxes, personnel and insurance costs in a given market can drive expenses higher and place greater demand on revenue production.
Common-area amenities and design are also critical for residents and their visiting families, as are electronics amenities. Per unit, development costs for independent and assisted units can easily exceed the $150,000-to-$200,000 range. Best locations, best amenities, best designs and proper unit sizing, therefore, are vital for participants to obtain the maximum occupancy and revenue.
Nevertheless, there are certain markets, segments and properties that hold considerable value and still more potential for savvy buyers, owners, developers and operators. Identifying and financing these is the key to success.
Financing options
There are numerous entrepreneurial opportunities today in the market:
- First, there are existing operations that can use a modest repositioning that often results in the addition of more memory-care units. This opportunity gives facilities with a larger number of units and a sustaining vacancy the opportunity to reposition and become more attractive to the market.
- The repositioning can be accomplished by combining smaller existing units into much larger spaces that can be used for entry-level assisted living. The smaller remaining units can then be separated and converted to memory care.
- Where adjacent land is available, additions can be made to create new, larger assisted-living units and smaller memory-care space, a setup that will match the new market demand. This sort of reposition adds considerably more revenue with proportionately smaller increases in expenses – resulting in nice gains to the bottom line.
- Many existing assisted-living projects will also have more land available, and their operators are taking advantage of that to build independent units to add to the campus.
- Finally, we do see opportunities for entirely new projects in certain markets across the country that have the right fundamental characteristics to attract different niche developments.
Though many avenues have existed for the development and short-term financing of independent, assisted, memory-care and skilled-nursing projects, the recent credit crisis has eliminated many lenders and frightened many more.
Before, during and after this event, however, the Federal Housing Administration (FHA) has been a source for development, acquisition, redevelopment and long-term permanent financing. In the long-term permanent market, there simply is no loan product that can compete on term and loan-to-value (LTV).
Securing 80%-90% LTV – and in some limited development instances, up to 100% of the asset cost – with 35-40 year fixed-rate financing allows tremendous operating latitude to generate real profits.
Unlike conventional financing, which requires a construction loan with or without mini-perm and then a longer-term (up to 10-year) permanent loan, FHA financing can insure the construction and permanent all in one step, one loan, at one rate from the opening of the first construction draw through the next 40 years.
Though the process is somewhat cumbersome compared to conventional lending, it produces significant beneficial results. Many owner/operators have diversified their holdings' financings with FHA as a mix for development and a major component of permanent debt.
FHA financing can also be deployed in tandem with an initial bridge loan to buy and position a property and then do a take-out with the FHA permanent loan.
FHA improvements
In the past, lenders did have problems with FHA financing, but those issues began to fade in 2000 with the implementation of lender-based Mortgagee Accelerated Processing (MAP), in which the lender prepares and approves the entire loan package and submits it to FHA for its review only.
As a result, mortgagors no longer have to rely on the vagaries and schedules in a particular FHA office. Standardized processing and review procedures have eliminated most of the processing uncertainty, and when the borrower works with a strong and experienced FHA lender, certainty of execution is very high today.
Though the conventional lenders and capital markets conduit lending will return, healthcare will be low on the product list to return, just as it was slow to develop in the past. FHA and conventional sources ought to be considered side-by-side and in combination when possible.
Those who enter or increase their position in the seniors housing and healthcare market today will be the ones who benefit from the ultimate arrival of the Baby Boomers in the next two decades.
Bruce Gerhart is first vice president and Midwest regional manager at Love Funding, a national full-service commercial mortgage banking firm that offers loan placement services for borrowers, as well as origination, consulting and servicing of loans for investors. Gerhart is based in Cleveland and can be contacted at (216) 583-0812.
