CREJ - Journal

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March 18-March 31, 2015 — COLORADO REAL ESTATE JOURNAL — Page 5B
T he senior care industry
recently has seen
increased interest from
outside investors, developers,
and debt and equity providers.
The specific reasons may vary
by participant but, broadly
speaking, this increased interest
is driven by an asset class
risk profile that has gained
acceptance by the capital
markets, more so today than in
previous years.
The senior care asset class
is piquing interest, fueled
by a lack of opportunities in
other commercial real estate
areas, such as office and retail,
combined with the favorable
demand demographics of
senior care. The result is a
real estate-based asset class
that has outperformed other
property types over the past
decade. As diversified investors
reach for the efficient frontier,
senior care is an asset class that
remains largely uncorrelated
to the broader market and
with relatively low volatility.
These attributes are appealing
for investors and are driving
demand for senior care assets.
Asset Class Risk Profile
It is important to first define
how the capital markets view
the senior care asset class. For
the purposes of this discussion,
we will focus on risks at the
individual site level. Through
this lens, two main categories of
risk emerge – operational risk
and financial risk. Given the
range of business complexity
and resident profiles, it would
be imprudent to develop a one-
size-fits-all risk profile for the
asset class.
Spanning the financial
risk spectrum, the various
stages of a senior care asset’s
business lifecycle include new
construction, stabilization,
turnaround and acquisition.
Further, subdividing the asset
classes into continuing care
retirement community, skilled
nursing facility, assisted living
or Alzheimer’s care, and
independent living allows
us to categorize operational
risk across the revenue types,
acuity levels and business
complexity. In total, this gives
us 16 characterizations across
the asset class around which we
can develop and subsequently
assign quartile ratings and
benchmark metrics.
Each site is assessed relative
to its characterization
benchmark metrics and
assigned a risk profile. The
site-specific risk profile dictates
the capital mix and the cost of
capital available to owners and
operators to meet their own
strategic objectives.
Lower Cost of Capital
Driving Valuations
The appetite for portfolio
holders and outside investors
(diversified participants) to
own senior care assets resulted
in higher valuations and, in
some markets, record-breaking
valuations. This begs the
question – are these valuations
excessive and the result of a
lack of investment discipline, or
are these valuations justified?
In order to make a proper
assessment, we can compare
cap rates to the cost of capital
of the diversified participants.
For the most part, all
participants have access
to the same senior debt
financing vehicles, such as
agency financing via the
U.S. Department of Urban
Housing and Federal Housing
Administration, or Fannie Mae.
The true advantage comes from
access to a lower cost of equity.
As valuations stretch and cap
rates decline, equity financing
is needed to fill capital gaps
required in transactions.
Outside participants and
large portfolio holders have a
distinct advantage on this front
because they have a lower cost
of equity. This lower cost of
equity is achieved because they
are more diversified, either by
geography or asset class.
The cost of equity, using
the capital asset pricing
model, ranges from 3.1 to
4.8 percent for diversified
participants. Comparatively
speaking, owners and operators
of smaller portfolios and
single assets have a higher
cost of equity from 10 to 15
percent. This is typical for
entrepreneurs who may have a
significant portion of their net
worth invested in senior care
assets and are not as diversified.
When the capital asset
pricing model is applied to
a transaction where loan to
value is 80 percent and cost of
debt is 4 percent, it translates
to a weighted cost of capital
of approximately 4 percent
for the diversified participant
and 5.2 percent for the less
diversified participant. The
lower cost of capital allows
the diversified participant to
lower its hurdle rate while
maintaining a similar risk
premium. The effect is higher
asset values due to the lower
cost of capital.
Does this mean risk
premiums will remain stable
indefinitely? The answer to
this question remains to be
seen. Historically, the data
leads us to believe that as more
diversified investors enter the
market, the stability of the risk
premium may come under
pressure. The chart shows a
tightening of spreads between
the 10-year Treasury and cap
rates of skilled nursing facilities
and senior housing. As one can
see in the table above, spreads
are tightening while cap rates
remain even. It is unclear
as to whether shrinking risk
premiums are causing spreads
to tighten or if the asset class is
becoming even less correlated
to the overall market.
Generally, the acceptance
of senior care as an asset
class is a positive trend for
an industry that relies on a
variety of financing structures
to achieve strategic objectives.
This is good news for the
less diversified participants
as they have the option of
either continuing to realize
the rewards of owning and
operating a senior care asset or
divesting their asset in a more
robust and liquid market with
growing valuations.
Matt Lindsay
Senior vice president, Lancaster
Pollard, Columbus, Ohio
Authority. Developers include
a mix of for-profit developers,
nonprofit developers and local
housing authorities. Some for-
profit developers with new or
under-construction affordable
properties include Hendricks
Communities, The Burgwyn
Co., Koelbel and Co., Atlantic
Development, McDermott
Properties, Legacy Senior
Residences, Wazee Partners
and MEJansen Development.
Housing authorities with new
senior apartments include
Aurora Housing Authority,
Metro West Housing Solutions,
Boulder Housing Partners,
Longmont Housing Authority,
Jefferson County Housing
Authority and the Denver
Housing Authority. Two
nonprofit organizations,
InnovAge and Accessible Space
Inc., opened new buildings in
Thornton and Greeley.
So, given all that is already
in the development pipeline,
is there remaining opportunity
and, if so, where is it? The
answer is a selective yes, if it is
the right product type in the
right location.
It is clear that current
development is concentrated
in certain housing and care
facility types, and is unevenly
dispersed geographically.
Regarding housing and care
facility types, most of the
units under development or
recently opened are either
assisted living or memory care.
Development of independent
living apartments has been
slower to return since the
end of the recession, with
only a modest resurgence
of development underway.
The newest independent
living facilities to open have
done very well, and there is
additional demand in many
geographic areas. Finally, a
number of skilled nursing
facilities, primarily focused
on short-term rehabilitation
patients, recently opened
or are underway in metro
Denver, Colorado Springs and
Grand Junction – and there
is probably more demand in
other markets within the Front
Range.
Looking at specific
geographic markets, some
areas with the highest
volume of new development
are the southeast Denver
metro area and southeast
Aurora, the Broomfield and
Westminster area and the
northern portion of Colorado
Springs. Yet, even in those
areas, the communities under
development are limited to
certain types and there may be
additional demand for other
products. For example, most
of the current development in
Broomfield and Westminster
is limited to assisted living and
memory care.
Opportunities are there if
you do your homework to
find a strong and underserved
market, and then plan the
right project with a high-
quality team. But, be sure to
understand what is already in
the pipeline, as many projects
are underway or about to open.
further delay the licensing
process.
Medicaid Certification
The Colorado Department
of Health Care Policy and
Financing administers the
Colorado Medicaid program
for assisted living residences.
A Medicaid-certified assisted
living residence is known as
an alternative care facility. The
current operator must provide
notice to HCPF at least 30 days
prior to the anticipated change
of ownership date and the
new operator must submit a
separate Medicaid application
with HCPF. There is no option
for an alternative care facility
to assign an existing Medicaid
provider agreement, and the
new operator cannot bill under
the prior operator’s Medicaid
provider agreement if an
assisted living residence license
is issued, but the Medicaid
change of ownership process is
not complete. A new operator
cannot bill for Medicaid
services until the Medicaid
application has been approved
and a new Medicaid provider
agreement has been entered
into. The effective date of
the Medicaid approval can be
retroactive to the effective date
of the assisted living residence
license. So, there can be a
delay in receiving Medicaid
payments if a Medicaid change
of ownership is not processed
in a timely manner.
Both the licensing and
the Medicaid certification
processes can take a significant
amount of time to complete.
DPHE will make every effort
to process the health facility
application as quickly as
possible, but with limited
resources DPHE cannot always
expedite the processing of
a license application. There
are a number of factors that
could substantially increase
the time needed to process
the assisted living residence
license application, including
issues that arise from the
fitness review, obtaining local
jurisdiction or DFPC sign-offs.
If a new operator is
considering applying for a new
Medicaid provider agreement,
the operator must plan
ahead and file the Medicaid
application and supporting
documentation sufficiently
in advance to minimize the
period of time that it will not
be able to bill the Medicaid
program.