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An aging boom

Institutional investors are piling into the senior housing sector, and the demographics look appealing. But bargains are becoming tougher to find.

Metropolitan Life Insurance Co., with $35 billion in real estate, owns stakes in skyscrapers, factories and apartments. But until recently, the New York­based insurer had no presence in a U.S. property sector that is growing as surely as baby boomers are going gray: senior housing. The category, which covers everything from age-restricted, no-children-permitted condos to skilled-nursing facilities, reported $140.2 billion in revenues in 2004, compared with $86.8 billion for the U.S. lodging industry.

In late September, MetLife agreed to invest an unspecified sum to develop as many as ten senior living communities in partnership with Sunrise Senior Living, a developer and operator in McLean, Virginia. The venture, 80 percent owned by MetLife and 20 percent by Sunrise, has five properties under contract -- two in Kansas, two in Texas and one in Arizona.

Basic demographics -- all those aging baby boomers and their aged parents -- appealed to MetLife. The insurer was not interested, though, in the burden of managing the real estate, so it struck an alliance with Sunrise to do that. MetLife plans to build the properties, fill them with residents and dispose of the real estate at a profit in the not-too-distant future.

"The plan is to build and sell," explains Robert Merck, the insurer's head of real estate investment. "There's a lot of investment demand right now for these high-quality properties in strong locations managed by someone like Sunrise that has a great reputation."

MetLife is one of a growing contingent of institutional investors crossing the age barrier. Along with appealing demographics -- the U.S. Census Bureau projects that by 2030 one in five U.S. citizens will be at least 65 -- senior housing offers attractive value right now when compared with other kinds of real estate. The flood of capital into every property sector, from office and apartment buildings to hotels and warehouses, is still strong. That's driving prices higher and making capitalization rates -- the ratio of net operating income to purchase price and the key industry measure of profitability -- lower across sectors.

By that yardstick, senior housing still looks like a relative bargain. Cap rates are 10.5 percent for assisted living and 12 percent for skilled-nursing homes. And although those figures are 30 to 80 basis points lower than they were a year ago, they are still attractive compared with cap rates of 6.6 percent for central business district office buildings and 7.6 percent for industrial properties.

"As more capital enters the real estate space, and as the yields on core investment strategies keep getting driven lower and lower, people naturally say, 'I've got to expand my strategy,'" observes Stephen Blank, a senior resident fellow at the Urban Land Institute in Washington. "They start looking at the nontraditional niches, such as senior housing. Student housing and medical offices are benefiting as well."

Senior housing covers a range of property types. Most age-restricted developments require residents to be at least 55 or 60. Independent-living communities, also known as congregate-care facilities, serve couples or individual retirees who live on their own but share meals and use services like housekeeping and transportation. Assisted living takes the level of services up a notch, providing staff to help residents with bathing, dressing and taking medicines. Continuing-care retirement communities (CCRCs) offer a range of living situations, so that residents, who are healthy when they move in, can avail themselves of greater assistance -- up to around-the-clock nursing home care -- as they come to need it. Then there are nursing homes and skilled-nursing facilities.

Occupancy rates for senior housing of all sorts are on the rise. According to Marcus & Millichap Real Estate Investment Brokerage Co. of Encino, California, CCRCs averaged 93.7 percent occupancy in late 2005, compared with 88.5 percent in 2002; independent-living facilities averaged 90.5 percent, up from 87.5 percent in 2002; assisted-living facilities averaged 90.3 percent, compared with 85.5 percent in 2001; skilled-nursing facilities averaged 89.7 percent, versus 83.5 percent in 2001.

Such numbers are enticing to investors. "There's definitely an increased investor pool," notes Kathy Sweeney, a principal and senior housing specialist at Boston-based real estate investment adviser AEW Capital Management. "For every investment opportunity that I'm looking at, I'm usually one of many, where previously, I was one of few."

Inevitably, increased demand is driving up prices. According to Marcus & Millichap, assisted-living properties sold for an average of $101,000 per unit in late December, compared with $95,100 in 2004; independent-living facilities, which cost $90,000 per unit in 2004, rose to $98,400 in 2005; and skilled-nursing facilities were $50,200, compared with $44,600 a year ago.

"The market is hot," confirms Gary Lucas, who heads Marcus & Millichap's national senior housing group, which has 20 brokers. "In terms of sales brokered, last year was about 36 percent better than 2004, which had been our strongest year."

For AEW's Sweeney, the market may be getting a little too hot. In 2001 the company launched a joint venture with the California Public Employees' Retirement System to invest in senior housing. Since then it has acquired $700 million of property in the sector. Recently, though, the venture has been selling as well. It made its most recent purchase in December 2004, when it bought assisted living facilities in four markets. Well leased at 95 percent occupancy, the properties had an average cap rate of almost 9 percent. In August 2005, AEW-CalPERS sold a similar but larger portfolio of assisted-living facilities: Encompassing 13 markets, these had 90 percent occupancy and a cap rate of just 7.14 percent.

"That bookends for you where the market went and how quickly it moved," Sweeney observes. AEW focuses on independent- and assisted-living properties.

But plenty of high-profile deals continue to close. In late September, Louisville, Kentucky­based Ventas, a health care real estate investment trust with mostly senior housing assets in its portfolio, paid $85 million for six senior communities totaling 950 units in markets from Buffalo, New York, to Santa Barbara, California. Capital Senior Living Corp. of Dallas and Blackstone Real Estate Advisors of New York sold the properties, which were primarily independent-living accommodations; Ventas then leased them back to Capital Senior to operate.

"Demographics favor senior housing assets and will continue to do so," says Ventas CEO Debra Cafaro. "Investors see this as an attractuve sector. We see demand increasing, and that says, 'Buy.'"

American Retirement Corp., a Brentwood, Tennessee, REIT, in early November formed a joint venture with Parsippany, New Jersey­based Prudential Real Estate Investors to buy an eight-property, 831-unit portfolio from Waltham, Massachusetts­based Epoch Senior Living for $138 million. ARC will manage the properties -- mostly assisted-living facilities, including some Alzheimer's units -- and own 20 percent of the venture. The remaining 80 percent will be owned by the third senior housing fund that Prudential has put together since 1998.

Another REIT, Omega Healthcare Investors of Timonium, Maryland, paid $115.5 million in December for ten skilled-nursing properties and one assisted-living facility, all of which will continue to be run by affiliates of CommuniCare Health Services, an operator in Cincinnati, Ohio.

K. Hovnanian Homes, one of the country's biggest homebuilders, is going after the (comparative) youth market. In December the Red Bank, New Jersey­based company announced plans for what it calls an "active adult community" consisting of 300 single-story homes in Maple Grove, Minnesota, that will be restricted to families with at least one member who is 55 or older.

Hovnanian is not alone in recognizing that retiring baby boomers are still young, healthy and active and want more in their golden years than the image of a "retirement home" conjures. Some developers are investing in homes and condos to sell specifically to that age group. Another example: Sunrise and Germany's HSH Nordbank are developing what they term a "luxury senior condominium community" in Bethesda, Maryland, restricted to those 60 and older. The 240-unit project will include the kinds of amenities one might expect at a resort or high-profile condo development, including a spa, performing arts center, fitness center and an indoor swimming pool. It will also offer on-site facilities and resources to serve residents' needs for assisted living, Alzheimer's care and outpatient rehabilitation.

The senior housing market today is a far cry from what it was in 2000­'02. During that difficult stretch -- which coincided with the bear market for stocks -- the sector had a glut of space. The mid- to late 1990s had seen a surge in construction of senior housing, fueled by low interest rates and readily available financing. To some observers, the optimism about senior housing then also reflected a misunderstanding of demographics, based on the misguided notion that millions of baby boomers were about to become senior citizens, when in fact the oldest of the generation (born in 1946) turn 60 this year.

"When the baby boomers hit 70 -- that's when demand starts to surge off the chart," says Noah Levy, who manages senior housing funds for Prudential. "But many baby boomers are ten, 15 years away from that point. Investors got into trouble in the 1990s when they overestimated the demand for senior housing from aging baby boomers."

Development peaked in 1999, when 65,000 units were built, the bulk in assisted-living facilities. According to Washington-based industry group American Seniors Housing Association, new starts dropped dramatically in 2000, when approximately 35,305 units were built. The numbers continued to decline for several years, totaling 28,964 in 2001 and 21,495 in 2002. They then began to slowly rise, to 28,696 in 2003 and 32,184 in 2004. "It was a very challenging time for all segments of senior housing, particularly assisted living," says David Schless, president of the ASHA, a trade association that lobbies Congress and provides industry research and education.

During this period some real estate ventures fell apart because first-time owners in the sector did not appreciate the importance of operational expertise. Owning and managing senior housing is not like owning and managing other types of properties. Says Prudential's Levy: "Back in the late 1990s, people didn't know what they were getting into, and a lot of equity was destroyed. You can have the perfect building in the perfect market, and if the operator doesn't do a good job, it's a lousy investment."

AEW's Sweeney agrees: "We place heavy credence on the quality and the experience of the operator. A lot of our due diligence focuses on how operators provide services to residents."

Some observers say the spate of new construction may now pose the greatest threat to the market. Marcus & Millichap estimates that 30,000 new senior housing units will be completed by the end of this year in the 30 largest metro areas. That's up from 2004 but still well below the 1999 peak of 65,000.

Although the 2006 edition of Emerging Trends in Real Estate, prepared by PricewaterhouseCoopers and the Urban Land Institute, touts senior housing as one of the five best bets in real estate development this year, the ULI's Blank advises would-be developers to be careful.

"We're finally just getting over a period when we clearly had an excess of development, particularly in the assisted-living area," notes Blank. "Let's not create another one. I'm sending a yellow-light signal: Caution ahead." Still, others see only green.