After the ups and downs of the early 1990's, the seniors housing market has settled on a winning concept to meet the diverse needs of the growing seniors population.  After experimenting with independent living, continuing care, and congregate care retirement community models, many developers have found assisted living facilities (ALFs) to be the most marketable and profitable type of seniors housing.  Many investors consider ALFs to be an attractive investment vehicle in light of an aging population that's spurring continued demand for these services.

What is Assisted Living ?

Assisted living combines "housing, supportive services, personalized assistance, and health care designed to respond to the individual requirements of residents needing help with activities of daily living (ADL)," according to the Assisted Living Federation of America (ALFA).  In addition to providing room and board, ALF's offer residents a wide array of care and services, which may include:

  • Three daily meals served in a common dining area;

  • Assistance with ADL such as bathing, dressing, grooming, eating, and walking;

  • Emergency call systems and 24-hour security;

  • Management and administration of medication;

  • Personal laundry and housekeeping Social and recreational activities; and 

  • Transportation to medical services and stores.

Why Invest in Assisted Living?

The nation's aging population's continued demand for services has made assisted living development an attractive investment vehicle.  The fastest growing age group in the United States, the over 85 population segment, is expected to increase by 39 percent by 2000 and 33 percent between 2000 and 2010, according to the U.S. Census Bureau.  ALFA predicts that assisted living - today a $12 billion to $15 billion industry - will double by 2000.

The increasing net worth of seniors also contributes to the growth of this industry.  By the year 2000, more than 53 percent of people over 80 years old will have incomes of $15,000, and almost 53 percent will have incomes of at least $25,000, according to Claritas, Inc., a demographics research company.  This is an important factor because most assisted living is funded through private income such as resident's financial resources.

Another factor contributing to demand is the lack of available nursing home beds.  Due to limitations on Medicaid funding, the primary source of nursing home revenue, many states have issued moratoriums on authorizing the new development of nursing home beds, attempting to control their Medicaid budgets by limiting the number of beds on the market.  This, in combination with high occupancy rates for nursing homes and increased concentration on higher-acuity patients, has resulted in a lack of available beds for low-acuity residents.

Impact of Hotel/Multifamily Developers

As the multifamily and hospitality markets move towards saturation, developers from these arenas are entering the assisted living market.  Marriott and Hyatt are two hospitality-related companies that have made a strong entry into ALFs.  On an operations basis, hotels are most similar to assisted living development due to their service package (offering food service, concierge, and other amenities).  Hotels do, however, lack the health care component that is essential to ALF operation.  Multifamily developments, while similar in construction features, lack both the service package and the health care component.  With demand still exceeding supply in many markets, assisted living development is an investment on par with hospitality and multifamily projects.  Further, lenders have not reached their saturation point; money is still readily available for experienced operators.

Development Trends

The assisted living market is one of rapid change.  Several of the following trends currently are shaping the industry's development landscape.

Alzheimer's Care

An increasing number of ALFs offer specialized Alzheimer's or dementia-care programs designed to meet these individuals' more demanding needs.  Specialized Alzheimer's programs typically are housed within a separate wing or in a dedicated freestanding facility.

Larger Developments

Today, 24 to 28 units is the minimum facility size at which operators can realize economies of scale and maximize profit margins.  Currently, most developers and operators are constructing facilities ranging in size from 40 to 90 units.  These larger facilities can maintain their own staffing and provide the level of care required to carry residents as they age.  Depending on location and revenue generated, well maintained facilities of this size typically realize profit margins ranging from 30 percent to 40 percent.  Effective and efficient management is, of course, a necessity for maintaining high profit margins.

Increasing Levels of Care

ALFs now are catering to a higher level of care and many are beginning to meet the needs of traditional long-term care residents.  There is also a trend towards multiple levels of care through which facilities can provide more extensive care and realize increased revenues.

A la Carte Services

Operators have found that bundling or packaging services often is financially inefficient and fails to adequately address residents' individual needs.  Providing services a la carte corrects these shortcomings and also allows for increased revenues since bundling the services normally results in discounting.

Less Institutional Design and Feel

In contrast to early ALFs that were modeled after nursing homes, developments today are moving away from long corridors and small semiprivate units.  Especially in more affluent markets, residents are demanding more privacy and luxury.  Private apartment units of 400 to 600 or more square feet increasingly are more common.

Increased Concentration in Secondary Markets

As large metropolitan areas such as Atlanta begin to reach potential saturation points, developers are turning towards secondary markets.  For example, Alternate Living Services, one of the largest national ALF providers, recently built ALFs in Gainesville and Palm Coast, Florida.

ALF Market Analysis

Real estate professionals who are considering entering the ALF market need to study the market carefully because many experienced players have extensive expansion plans for this segment.  A market analysis based on qualitative and quantitative is often the first step to determine the need for a facility.  For the analysis of any senior housing project, income and demographics are typically confined to the over-75 population base.

The overall process for evaluating a potential ALF market should include the following key components:

Site Evaluation

Determining the feasibility of an ALF development must incorporate the micro and macro aspect of a community.  For instance, site determination may be limited to restrictive zoning, rock formation, and/or state planning lists.  Initial research into local and state planning parameters, as well as a site survey, may save time and prior to developing a full analysis of the market.

Neighborhood Economic Factors

Local economic factors may have a large impact in the decision making process.  For instance, smaller communities that are dependent on one or two employment bases may be subject to either downsizing or expansions that change the size and economic viability of the population of adult children.  This could be critical because adult children are often the primary decision-makers in the fill-up process.  Larger cities boast a more diverse employment base, although they too can be affected by the actions of large employers.  The age of community residents also is important - ALFs are more successful in areas with an older adult children population base (aged 35 to 44 years).

A community's economic development office is a good source for defining area economics and is a good starting point for determining movement and traffic patterns within the community, which influence the exposure and accessibility of a project.

Competitive Factors

As the industry continues to evolve, many competitive factors have emerged.  Through the early '90s, independent living facilities concentrated on the active adult.  During the last five years, many operators have added either home health care and/or assisted living wings to their centers.  This has retained residents for a longer period of time, preventing the movement of residents from a retirement facility to a full service ALF.  In addition, local home health agencies have become much more active, servicing the frail elderly in their homes.  While sometimes an expensive and not completely adequate alternative, home health services and to a lesser degree, community-based services do maintain frail seniors in their own homes, which prevents them from having to move into full-service ALFs.

Nursing homes are a competitive factor for the low-acuity assisted living resident.  Many national nursing home companies, such as Life Care Centers of America, Beverly Enterprises, and Integrated Health Services, as well as local operators, have either developed stand-alone licensed Alzheimer's facilities, added assisted living units to existing nursing homes, or have developed stand-alone assisted living centers on the campus of their nursing home.  This allows smooth transition from an assisted living setting to a nursing home setting without disrupting the resident.  Furthermore, such settings give the appearance of continuum-of-care to the adult child.

Survey of Market Trends

Survey all competitive facilities within the primary market area (PMA) to determine occupancy levels, level of care, movement within the community, adult children's influence, area economic factors, and the percentage of residents from outside the PMA.  Frequently, senior housing marketing directors track residents' prior living situations.  This information can be very insightful in determining the percentage of residents the subject property can expect to draw from inside and outside the PMA.  Further, marketing directors are a good source of information on absorption and occupancy rates as well as any impending economic factors that may affect the area.  Area managers also have good insight into traffic patterns and movement by adult children from areas of residence to places of work.

Determining the PMA

Combining these factors should provide a reasonably clear picture of movement within the community.  At this point, the PMA, from which the subject should expect to draw the majority of its residents, should be determined.

Analysis of the Secondary Market Area

The secondary market area is all areas outside the PMA.  The impact of the secondary market area is determined the impact of adult children and through discussions with area administrators.  A larger adult population is usually indicative of a market in which more residents will be pulled into the area and relocate into the facility from outside the PMA.

Analysis of Income and Demographics

After determining the PMA, compile demographics from reporting services.  Analyze income and demographics on the basis of age, ethnic makeup, care of residents with physical or mental disabilities, female population base, and household income.

Determining of the Utilization Rate

Analyzing the various alternate services within a community will determine the PMA's utilization rate, which is the likelihood that a resident will choose the assisted living setting over other available alternatives.  In general, those communities with few services should have a higher utilization rate (i.e., residents with fewer alternatives from which to choose will be more likely to relocate to a new ALF).

Frailty/Care Modality

Care modality represents the number of residents that have either physical or mental limitations.  Claritas, for example, reports the percentage of residents within the PMA that have a care need.  This percentage represents the age-qualified residents that would benefit from assisted living services.

Determination of PMA Draw

The PMA draw represents the percentage of residents that a facility can expect to draw from within the PMA.  This figure, which adjusts for in-migration from areas outside the market, typically is derived from analysis of historical fill-up of existing facilities as well as conversations with area operators and local officials.

Supply Analysis

It is essential to survey all competitive supply, including independent living, nursing, and assisted living facilities as well as the impact of home health services.  All surveys should include the determination of the physical plant, mix of units, unit rates, service pricing format (tiered or a-la-carte), occupancy, and services offered,  In addition, consider and survey all planned facilities.

A survey of competitive facilities close to the PMA is critical to determine their impact.  In addition, account for turnover of beds and vacancy factors within the market.

Determining Net Demand

Detailing the target population base and adjusting for such factors as utilization, care modality, supply (planned and existing), and income qualification determine the PMA's net bed demand.  (This figure is a measure of overall unmet demand and is not a forecast of penetration or facility fill-up.

Determining Penetration

As a second check on the strength of a market, determine the penetration of qualified residents within the market area that the new facility needs to capture to reach stabilization and sheds light on the viability of the market.

Financing

Several different sources offer financing for the development and purchase of ALFs.  These include the U.S. Department of  Housing and Urban Development (HUD) Section 232 program, tax-exempt bonds, conventional banking, real-estate investment trusts (REITs) specializing in health care, Small Business Administration loans, and Fannie Mae loans.  The HUD 232 program and tax-exempt bonds are both non-recourse-lending services.  The majority of other available sources are recourse loans.

One of the newer developments in assisted living financing is the synthetic lease.  A synthetic lease essentially is a loan that allows projects to keep mortgage interest and depreciation deductions off the balance sheet to improve earnings.

Though historically most assisted living lending has been for the purchase of existing projects, the past few years have brought a steady increase in new construction.  Though financing parameters for new development remain stringent, developers are finding a limited amount of good existing product available to purchase.  With profit margins remaining strong, assisted living should continue to be a popular venture for both new and established player, and the recent spur of development is likely to continue over the short term.

The Future of Assisted Living

Given the growth projections of the market it serves, assisted living development is anticipated to remain strong in the coming years.  Several companies have established themselves as specialists in this industry, both developing and running these management-intensive facilities.  This, along with the potential of hospitality REITs to acquire ALFs as a hedge against a downturn in the hotel market, provides a continuing source of product and financing to keep the market growing to meet demand.

Assisted Living vs. Hotel and Multifamily Investments

Assisted Living vs. Hotel and Multifamily Investments
   Assumptions
  Loan-to-value ratio: 75% Growth rate: 4% per year
  Amortization: 20 years Cost of sales: 8%
 
Return Rates
ALF
Hotel
Multifamily
Internal rate of return
12.13%
14.72%
11.08%
Modified rate of return
11.67%
13.59%
11.41%
Gross income multiplier
3.46%
1.87%
6.63%
Cap rate
10.11%
11.01%
10.00%
Cash on cash
1.55%
5.12%
1.09%
After-tax cash on cash
2.75%
6.18
2.26%
Equity return rate
23.17%
26.59%
22.68%
Similar lending criteria and a straight line mothod of depreciation are used. All operations are based on actual operations with implied capitalization rates utilized (rates range from approximately 10 percent to 11 percent)