Are Wall Street and the seniors housing industry getting an annulment?

The answer tends to depend on which side of the church you sat on - the bride's or the groom's. Unquestionably, there has been a disconnect between sources of capital and the fledgling assisted living sector, made worse by misperceptions, aggressive financing techniques (e.g., black/gray box financing vehicles), and overzealous earnings expectations by a number of the publicly traded assisted living entities.

Clearly, entrepreneurs did not bother to consider that Wall Street investors and their bankers would shift their attention when projected EPS and growth figures were not realized.

In retrospect, the public equities market never was in love with the assisted living concept. Rather, lust may be a more appropriate term to characterize the preoccupation that investment bankers had with the nubile young companies.

Fueled by aggressive capital chasing the next great real estate investment sector, funding was provided in the mid-1990s to the upstart assisted living sector. But it was mere bucketfuls compared with the huge demographic wave of frail seniors seeking an alternative to living alone without supportive services or residing in a nursing facility. Need was replaced with greed, and the rest is history.

Several publicly traded assisted living companies that were projected to sustain near-term growth earnings rates exceeding 50% per year saw their financing evaporate and their operating performance decrease. The ultimate result has been a dramatic sell-off of institutional investor positions in most of these public companies.

The bottom-line result for the 13 companies currently left standing is an overall decline of nearly 60% in stock price over the past 12 months - not a rosy picture for those initial pioneers. While solid performers such as Sunrise Assisted Living (SNZR), American Retirement Corp. (ACR), Brookdale Living Communities Inc. (BLCI) and Alterra Healthcare Corp. (ALT) continue to provide a beacon of hope for the public assisted living companies, the Wall Street mantra of "Show us the money!" is ever present.

The burden of proof has fallen squarely on the remaining companies. With stock prices in these companies depressed relative to the intrinsic value of their underlying real estate, investors such as Walton Street Capital, the Reichmann interests and other substantial institutional and real estate investors have begun to make strategic investments in several of these fundamentally sound operating entities.

With a total market cap of approximately $1 billion, the assisted living sector is a mere blip on Wall Street's radar screen. As the industry has begun the transition from Wall Street back to Main Street, key industry operatives are rejoicing in the notion that the overall seniors housing industry is no longer defined by the short-lived focus on a handful of publicly traded companies and their opportunistic investment bankers. It's back to basics, and the future is promising.

With a red-hot national economy and national consumer confidence levels at a 31-year high, the seniors housing industry with its array of housing and service options stands poised to capture a growing share of the lucrative seniors market. While the availability and likely increase in the cost of capital resulting from advancing interest rates may influence short-term business decisions, the horizon is generally clear for all product types.

Solid industry fundamentals Overall, the past year has proven to be a financially productive period for the seniors housing industry. In many respects, the tightening of the capital markets has dramatically reduced the torrid pace of new construction in many markets. This much-needed pause, especially in the assisted living sector, should be viewed as an opportunity to focus attention on the key issues that will influence the industry in the years ahead. The ability to refine innovative approaches to new development in this burgeoning industry will likely have long-term benefits to investors.

In all sectors, the basis for measured industry growth is rooted in the recognition that, in most instances, performance standards have been achieved by the well-capitalized owner/operators with sophisticated management systems in place. One of the industry's best barometers for financial and operational performance is the recently released annual survey conducted by the American Seniors Housing Association (ASHA), the National Investment Center for the Seniors Housing & Care Industries and PricewaterhouseCoopers.

Assessing the survey results, ASHA Executive Director David Schless, notes, "The seniors housing industry, in general, continues to perform well across all three major property types. While there have been isolated and seemingly temporary problems in certain markets, most of the industry looks quite solid."

The State of Seniors Housing 1999 survey has been conducted since 1993, with the latest sample encompassing approximately 51,000 living units in 248 seniors communities scattered throughout 27 states. This comprehensive survey reveals that occupancy rates for the entire sector remain strong as illustrated by median occupancy rates in excess of 92% for all property types.

Median occupancy rates were highest for congregate residences (95%), followed by assisted living (93.7%) and continuing care retirement communities/CCRCs (92.7%). Median annual change in occupancy is higher for assisted living relative to other property types (2% vs. .7% for congregate residences and .3% for CCRCs) because a higher proportion of assisted living residences opened in the year preceding the survey. Many of these properties have yet to reach stabilization.

In terms of resident turnover and length of stay, this national survey confirms that assisted living residents have the highest median turnover rates (50%), followed by congregate facilities (31.8%) and continuing care communities at (21.9%).

Resident turnover rates in assisted living decreased slightly in the survey due to the larger supply of assisted living residences with a correspondingly greater ability to care for residents with higher acuity needs. The average length of stay was longest for independent units in CCRCs (45.4 months), followed by independent units in congregate residences (42.8 months) and skilled nursing beds in CCRCs (23.2%). Assisted living beds in all property types have an average length of stay of approximately 18.5 months.

These statistics show that while assisted living has been the hot sector for the past several years, resident turnover rates and average length of stay figures indicate the vulnerable nature of the stand-alone, assisted living product and the intensive management and marketing systems typically required for these facilities to maintain a consistently strong revenue stream.

In assessing specific financial results, it is evident that there is life beyond assisted living as congregate and CCRCs continue to maintain solid economic performance. The State of Seniors Housing 1999 survey indicates that median operating margins (EBITDAR/Total Revenue) was highest for congregate residences (39.3%) followed by CCRCs (27.2%) and assisted living residences (26.4%). Overall, the current return on investment (unleveraged) was highest for congregate residences (11.7%), followed by CCRCs (11.4%) and assisted living facilities (9.7%).

It's like retailing - maybe better In many respects, the service-oriented seniors housing industry is more akin to retailing than a health-care business. Consider the similarities. Senior housing is primarily a cash business where residents pay rent in advance. A primarily private pay industry, it has neither the governmental pricing guidelines nor the vast accounts receivables typically associated with health-care facilities.

In many respects, there is a captive heterogeneous market for the seniors housing industry. Unlike most retailing businesses, seniors housing is targeted to consumers who have an existing or potential need for quality services as compared to discretionary or impulse purchasing. This captive consumer typically exhibits a strong resistance to move to another "store" as long as pricing remains reasonable and the quality of services provided is maintained.

Similar to the retail sector, there is a need to produce an appropriate box from which an assortment of services is provided, recognizing, however, that the value for the real estate is created through quality and cost efficiency of operations. Aging-in-place for residents remains a fundamental industry concept necessitating flexible housing and supportive service options that can accommodate the residents' changing requirements over time.

Strong future demand The one constant is the reality that our nation's population is aging, and that every day more than 6,500 people celebrate their 65th birthday - a total of some 2.5 million annually. The number of people requiring seniors housing services will reach a projected 2.9 million to 4.6 million by 2030.

The industry is also responding to fundamental shifts in our society. Social and economic issues that will provide the underlying current for future seniors housing demand include, but are not limited to:

* the rising incidence of mobility patterns and divorce;

* increased dependency on two-wage-earner families;

* the erosion of multigenerational family structures; and

* extended life expectancy.

The result? Adult children are less inclined to care for aging loved ones. In essence, the seniors housing industry will continue to grow, much in the same way the overall economy has focused on the commercialization of services formerly provided in the home. The non-institutional approach emphasized in the seniors housing industry will be refined through innovative, but realistically planned, approaches to development.

Innovation: a key to success The evolution of this young industry has been well-documented by others and provides a foundation for new ventures that will stand the test of time. A combination of definitive yet adaptable business strategies, management and marketing systems, available and predictable capital, and realistic expectations will be the industry success hallmark in the 21st century.

In addition, the regulatory environment, especially as it relates to the assisted living sector, appears to be in check for the future. On the federal legislative and regulatory front, while 1999 was a year with a lot of concern nationally about a much-anticipated General Accounting Office (GAO) report on assisted living quality (released in April last year), 2000 appears to be a year that will be far quieter.

According to ASHA's Schless, "The assisted living industry has been working very hard in the past 12 months on issues related to consumer disclosure and informed decision-making. With a strong commitment to consumers across the country, the industry seems poised to take responsibility for some of the weaknesses identified in the GAO study and subsequent hearings held by the U.S. Senate Special Committee on Aging."

With the industry commitment to quality, development of two national assisted living accreditation programs under way and significant state activity in recent years related to assisted living oversight, the threat of federal regulation of assisted living does not appear likely.

Considering these issues, innovative approaches to new development are coming out of the ground and represent prototypes for others to follow. While their individual financial feasibility should be tested rigorously, the following two examples are noteworthy for urban as well as suburban locations.

While consolidation is in full swing in the assisted living sector, investors and developers have both the opportunity for quality acquisitions at values below replacement costs as well as the ability to initiate new ventures. Condominium and cooperative formats will also begin to take hold in major markets, as consumers in effect become the take-out lenders for those ventures.

Prior to initiating new investments in the seniors housing business, the prudent entrepreneur will need to consider a comprehensive business strategy, evaluate the realistic value of the existing real estate and management expertise, consider capital market variables and have a well-defined exit strategy. The year ahead should be an opportune time for contrarian real estate investors and financially strong industry operatives who can creatively package niche seniors housing ventures.

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