Social Infrastructure 5/15/2019

Senior Living - Investing in a growing population

Senior living
Investing in a growing population

Senior living is a critical element of our society and increasingly so. Throughout America, our aging population is a vexing challenge, with the number of households with seniors in their 80s and older projected to more than double by 2037.1 At Tortoise, we believe we’re on the cusp of a significant surge in demand for senior living facilities, and we are investing in essential projects that cater to the baby boomer “silver tsunami."

How U.S. senior care has evolved

Before the 19th century, senior living solutions in the U.S. did not exist, with many elderly cared for by family or placed in shelters for the poor. Often, the elderly were placed in “almshouses” or “poorhouses,” a concept brought to the U.S. by English settlers.2 These homes fell well short of providing quality care for aging workers who were no longer able to earn a wage. As the issue became more prevalent, the U.S. Social Security program was established in 1935, designed to pay retired workers age 65 and older a continuing pension income after retirement.

National health care

The 1965 passage of Medicare and Medicaid was kicked off when former President Truman, an early proponent of national health insurance, was issued the first Medicare card by President Lyndon Johnson. This was a milestone for seniors, propelling senior care forward.

July 30, 1965: With former President Truman at his side, President Lyndon Johnson signs the Medicare bill into law.
Source: LBJ Library

Choice, dignity and independence

As the industry grew, retirement housing for seniors matured and often included meals, housekeeping and transportation. The term “assisted living” came into vogue in the mid-1980s with a vision to bring together a physical environment that offered care, service and a more appealing living situation for “residents.” Decisions about accepting or rejecting medical care and “aging in place” allowed residents to stay in one facility or move locations voluntarily. In the late 1980s, assisted living prototypes in rural communities began to emerge where land was affordable and older adults had few options.3

By the 1990s, consumer groups and public policy leaders became increasingly aware of senior living challenges. Multiple approaches of assisted living existed with four distinct scenarios emerging (hybrid, hospitality, housing and health care). Small-scale replication of care facilities grew and capital for real estate development projects proved difficult to access as financial institutions grasped to understand funding needs.

The late 1990s into the 2000s was a period of expansion for the sector as capital markets funding became more accessible and quality of care continued to be fine-tuned with new standards of care. Curb appeal, along with location, became increasingly important as growing numbers of seniors began to retire in their own communities, often near family, rather than moving to traditional, warmer retirement areas such as Arizona and Florida.

Shunning the early days of the poorhouse scenario, today’s modern day senior housing looks nothing like your grandparents’ old folks home. Today’s seniors are empowered, active and selective consumers of facilities that best suit their lifestyles.

The growing housing needs of seniors

With advances in medicine, more active lifestyles and better eating habits, today’s seniors are living much longer. In 1940, individuals surviving to age 65 had an average remaining life expectancy of 12.7 years.4 Today, individuals turning 65 are expected to live another 18.7 years on average.5 About one out of every four 65-year-olds will live to be 90 years old, with one out of every 10 expected to live past 95 years.6

Growth of aging population

Source: U.S. Census Bureau, Population Division

By 2035, 78 million people in the U.S. will be 65 years or older, with those 85 years or older growing at an even steeper rate. The number of housing units needed will increase to keep up with demand. Making a decision about senior living facilities generally comes into play by seniors in their early to mid-80s. That decision is often hard for those hesitant to leave their homes or those concerned about the cost of care.

Senior living models

Today’s senior living facilities offer an array of care services typically divided into four categories: independent living, assisted living, memory care and nursing care. As independent living properties continue to experience a rising entry age for residents, there is less distinction between the services provided in assisted living and independent living. Some independent living operators increasingly provide more of the services available in an assisted living property, either through third-party ancillary service providers or on their own.

Continuing care retirement communities (CCRCs), also known as life plan communities, are gaining popularity as they offer a continuum of care with at least two care segments in a combined campus setting. CCRCs focus on ensuring residents can age in place by using a flexible building design.

According to the Centers for Disease Control, in 2014, there were over 15,000 nursing homes and 30,000 assisted living facilities in America, providing options to support seniors' changing needs. Determining the type of care needed is typically measured by activities of daily living (ADLs), such as eating, walking and personal hygiene. The number of assisted ADLs needed determines the level of care and costs. Assisted living facilities usually include a small number of ADLs services in the base monthly cost. Care services can include assistance with bathing, grooming, dressing, eating, medication management and other daily activities. Medical services can include skilled nursing, rehab therapy and long-term care. Besides housing, senior living facilities offer a variety of services including meals, transportation, housekeeping, entertainment and concierge services.

Senior living facilities overview

Independent living (IL) communities Assisted living (AL) communities Skilled nursing facilities (SNFs) CCRCs
Key features Three daily meals, central dining, housekeeping, transportation, and social and recreational activities. All IL features plus management of medication, bathing, dressing, toileting and eating. Includes units dedicated to memory care. Licensed daily rate or rental properties. All AL features plus 24-hour nursing and/or medical care. Combination of all IL, AL and SNF features available to residents on one campus.
Average facility size* 136 units 95 units 99 units 106 units
Average age of current residents** 80.6 years 86.9 years 85.8 years 89.8 years
Average rent $3,215 monthly $4,818 monthly $9,600 monthly $3,320 monthly
Occupancy rate 90.7% 86.3% 86.2% 90.8%
Inventory units 328,200 268,624 579,933 228,314
Source: NIC MAP data via Bloomberg Intelligence
*Based on properties under construction in 2017. **A collaborative research project of AAHSA, ALFA, ASHA, NCAL and NIC.

Other data influencing the sector

  • Average lease up period: 22 months, up 14% year-over-year
  • Average unit count: 128, up 5% year-over-year (gross building area up 4%)
  • Average cost: $35,750,000
  • Average cost/unit: $270,200
  • Average cost/square foot: $298

Source: CBRE – U.S. Seniors Housing Development Costs Report (December 2018)

Challenges and trends in senior living and care

Soft occupancy rates

While national senior housing occupancy rates remain soft, particularly in localized areas, there was a modest improvement to 88.0% in the fourth quarter of 2018 compared to the seven-year low of 87.9% in the third quarter of 2018.7 It's important to note that not all markets have seen the same occupancy softening, and some markets have maintained very robust occupancy rates pointing to the idiosyncratic characteristics of each project. Interestingly, while net absorption of inventory in the fourth quarter of 2018 of 5,149 units was the highest ever reported by NIC, the contributing factor to the softness is the larger number of units being brought online that have not been leased, with poorer performing properties additionally pulling down the average occupancy rate.7

Quality care

Preparing for the silver tsunami comes with a host of challenges, and one of the greatest is hiring and retention of a well-trained workforce to provide quality care. In today’s low unemployment environment, the cost of quality labor continues to rise along with new state minimum wage standards. And while many providers have a passion to serve seniors, a quality wage for the provision of quality care is critical.

With expectations that 1 million to 2.5 million additional caregivers will be needed between now and the end of the next decade to counter this lack of supply, many providers are offering key employee retention plans with attractive benefits packages including health insurance, paid time off, transportation, 401(k) plans and more.8

Affordability and the path to Medicare

As baby boomers age, there will be an increasing need for low cost senior housing and more subsidies needed for health care costs for those who have not adequately saved for retirement. While many developer projects focus on private pay or market rate projects, some are developing projects to serve the affordable segment of the aging population.

Medicare continues to be a major provider of health care for seniors. In 2017, there were 58.5 million people receiving health care coverage through Medicare, with spending reaching $672.1 billion in 2016, approximately 20% of total national health care spending.9 While Medicare typically covers nursing home stays, there is no requirement that Medicare must pay for assisted living. As a result, the level and type of support varies widely for Medicare-assisted care from state to state. States have started contracting with health plans to operate as Medicaid-managed care organizations, replacing the traditional state-operated, fee-for-service Medicaid system. Managed care helps fill the gaps in Medicare coverage.

Medicare Advantage, which offers private, Medicare-approved insurance, has experienced headwinds resulting in seniors receiving lower daily reimbursement rates, shorter lengths of stay for care and more referrals to home care instead of inpatient rehabilitation facilities. There is some relief expected in 2019 with Medicare’s introduction of the Patient Driven Payment Model taking effect October 1st that should provide an improved reimbursement model for care and potentially reduce project operating margins.10

Uneven regulation

While the skilled nursing industry is highly regulated at the federal and state levels, regulation of assisted living and memory care facilities differs by state and is not uniform. Examples include building design standards, licensures and staffing requirements. This makes underwriting for investors a challenge which is only mitigated by experience and knowledge of regulatory idiosyncrasies.

CONs – another layer of regulation

In addition to a state licensure, a certificate of need, or CON, is an endorsement that numerous states require before approving the construction of a new health care facility. From an underwriting perspective, CONs can create investment opportunities because they can create barriers to entry.

Assessing senior facilities – investment opportunity

As more investors take notice of senior living projects, asset valuations are rising which is spurring more lending. Today there are approximately 23,500 investment grade senior housing and care properties containing 3 million units/beds.10 Investment grade properties are those defined as age-restricted, with at least 25 units/beds.10 They charge market rates for housing and services. The investment grade seniors housing and care market is estimated at $409 billion.10

Seniors housing construction

Source: NIC MAP data via Bloomberg Intelligence

As the aging population has grown, so has the number of units under construction. In addition, even though occupancy rates have slightly declined over the past few years, rents have increased. Historically, seniors housing and care properties delivered relatively steady leasing revenue when compared to other real estate property types.
Asking rent growth since 2011 averaged 2.5% for seniors housing properties and has been historically less volatile than other commercial real estate sectors.10

Commercial real estate asking rent growth trends

Source: NIC Investment Guide – Investing in Seniors Housing & Care Properties, Fifth Edition

Overzealous development in 2018 created supply/demand imbalance

2018 was a year of overzealous development with capital eager to invest, rents on the rise and developers from other sectors jumping into the space. Developers and sponsors of certain projects brought online a significant amount of new supply. Meanwhile, the sector faced headwinds from rising construction costs due to trade tariffs and a skilled labor shortage. In 2018, occupancy rates suffered as the market focused on absorbing supply. We saw historically high, 6% of total inventory on an annual run rate, being brought online. That continues to have an impact on a supply/demand imbalance. In the later part of 2018, we began to see supply and demand reaching equilibrium, setting the stage for the digestion of existing supply in senior living housing and a rise in occupancy rates, though there certainly are geographically localized areas where the imbalance is more pronounced including Atlanta, Cleveland, Houston, Las Vegas and San Antonio.11

Occupancy rates stable while rent increases

Source: NIC MAP data via Bloomberg Intelligence

Interest rate environment – a possible headwind

In the ever-changing geopolitical environment, interest rates can change. In these instances, increased borrowing costs could negatively impact project cash flows. An offset to rising rates could be stronger net operating income from improving market fundamentals, rising occupancy rates and new inflows of capital into the sector.

Shift in investor composition

In recent years, the senior housing investment market has shifted from a largely REIT investor base to growing interest by institutional and private equity investors. Foreign capital or “cross-border” buyers from Europe, Asia and the Middle East are actively investing in U.S. senior housing. The growing demand for senior living facilities is driving the need for public funding.

Senior housing and care transaction activity ($B) by buyer type

Source: CBRE – Senior Housing Marketing Insights 2018 Q2 Review

Tortoise’s take on senior living investment opportunities

Tortoise provides capital to the dislocated senior facilities market, including those that offer the entire continuum from independent living to assisted living, to palliative care and hospice, and to an extent, skilled nursing for targeted opportunities. Tortoise’s approach is to source investment opportunities and deploy capital by investing in directly originated securities. Tortoise focuses on the estimated 5,400 facilities in the not-for-profit residential care and with for-profit developers with a goal to provide capital to provide bridge financing to entities until they are better positioned to obtain traditional financing.

Tortoise’s process focuses on risk mitigation

When underwriting directly-originated securities, Tortoise’s social infrastructure team considers how best to mitigate risk in order to balance the interests of investors and borrowers. When originating an investment, Tortoise assesses how a senior living facility opportunity fits into its specific market area and regulatory environment. In addition to personally vetting the principals and visiting the site, Tortoise deploys and utilizes third party market studies and financial feasibility studies to reaffirm the project’s viability. Ultimately, the goal is to find and invest in well-managed assets that are highly-essential to their markets and make a strong impact in their communities, which means a higher likelihood of success.

Once a deal passes an initial screen, it is structured to balance the needs of our borrowers while still accomplishing the goals of our investors. As part of the deal structuring, documents are drawn up to outline the borrower’s accountability to Tortoise and its investors. There is not a one-size-fits-all approach to the document structure. Documents are tailored based on projected performance and reasonable targets for a facility. For instance, while it might be ideal to require a senior living facility to reach 90% occupancy within six months of its grand opening, putting that as a covenant in the contract could be setting a facility up for failure – which benefits neither the facility nor our investors. Regular communications on financial performance, progress towards stabilization and any other changes that could impact the success of the project are routinely reviewed.

While upfront due diligence mitigates risks, contractual covenant violations can periodically occur. Typically, these can be resolved by ensuring that a solid property management team is in place.

CASE STUDY

Tortoise recently closed a senior living facility financing located in Arizona that will consist of independent living, assisted living and memory care units, totaling 142 units or 149 beds. This facility qualifies as affordable housing, with 20% of the units expected to be leased to tenants at or below 50% of the area’s median income.

Tax-exempt transaction summary

Type: combination of senior and subordinate bonds
Amount of first draw: $10,000,000
Maturity: seven years with a tender option at year five

Source: Mountain Plains Equity Group, Inc.

Conclusion

Senior living care has advanced and evolved to become a consumer-centered industry focused on the needs and preferences of older adults. Keeping pace with constructing quality senior facilities for America’s aging population will be a challenge for years to come. A healthy rebalancing of supply/demand is underway, following a surge in construction projects and flat occupancy rates in 2018. This market dislocation allows Tortoise to be a strategic provider of capital for demand growth. As investors, Tortoise recognizes that senior living projects are indispensable to our economy and society. Providing quality care for our society’s parents and grandparents speaks to the heart of Tortoise’s essential assets focus.


  1. JCHS of Harvard University – Housing America's Older Adults 2018
  2. Foundation Aiding the Elderly – The History of Nursing Homes
  3. The Gerontologist – Historical Evolution of Assisted Living in the United States, 1979 to the Present
  4. Social Security Administration – Life Expectancy for Social Security
  5. Kenan Institute of Private Enterprise – The Business of Healthcare: Adapting to an Aging Economy
  6. Social Security Administration – Retirement & Survivors Benefits: Life Expectancy Calculator, 2018
  7. NIC Press Release – Five Key Takeaways from NIC’s Fourth Quarter 2018 Senior Housing Data Release, Jan. 23, 2019
  8. The Senior Care Investor – Dec. 2018 - Volume 30, Issue 12
  9. MedicareResources.Org – A Brief History of Medicare in America
    NIC Investment Guide – Investing in Seniors Housing & Care Properties, Fifth Edition
  10. NIC – Quarterly Map Data (as of 4Q 2018)

Nothing contained in this communication constitutes tax, legal or investment advice. Investors must consult their tax adviser or legal counsel for advice and information concerning their particular situation. This piece contains certain statements that may include “forward-looking statements.” All statements, other than statements of historical fact, included herein are “forward-looking statements.” Although Tortoise believes that the expectations reflected in these forward-looking statements are reasonable, they do involve assumptions, risks and uncertainties, and these expectations may prove to be incorrect. Actual events could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors. You should not place undue reliance on these forward-looking statements. This piece reflects our views and opinions as of the date herein, which are subject to change at any time based on market and other conditions. We disclaim any responsibility to update these views. These views should not be relied on as investment advice or an indication of trading intent.

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