The SeniorCare Investor: Occupancy And Debt Problems:
Is The Seniors Housing Industry Stronger Than It Appears?
The troubled residential housing market is in the news every day, often many times every day. It’s all we talk about, but it hasn’t been what the providers have been talking about, at least, not until now. The first seniors housing company to publicly acknowledge that a weak housing market may be impacting occupancy levels was Brookdale Senior Living (NYSE: BKD), when it revealed that entrance fee deposits were lower than expected in the second quarter last year. This also came at a time when some studies were showing an up-tick in new construction nationally, especially with independent living units. Putting aside the methodology disagreement between "new construction starts" and "total units under construction," there are few people today worried about a rush to development and the consequent overbuilding in this capital-starved environment.
Through the last half of 2007, and even into 2008, many large providers were still not experiencing a housing-market related occupancy dip. A naysayer or two would say they were in denial, but numbers don’t lie. Or can they? Assisted Living Concepts (NYSE: ALC), featured last month, has had a strategically planned, consistent drop in occupancy for about a year as it gets out of the Medicaid waiver program in most states (step 1) and tries to fill those units with private-paying residents (step 2). Step 2 has been the problem, as the private paying census has not grown much at all. So, is the strategy, and the ability to fill those units with wealthier, perhaps home-owning elderly, being impacted by the weak housing market? Or is it the location of those facilities in secondary and even tertiary markets, the reputation in the local market or just the facilities themselves? Or is it simply taking longer than originally estimated? The reality is that we really don’t know, and because the company is spread across the country, there is probably no simple answer, and most likely there is a facility-by-facility reason, with the housing market the culprit with just some of them. So, ALC’s statistics get thrown into the industry pot, and we can blame the housing market.
Now, take the case of a medium-size private company with more than 1,000 mostly independent living units across a few regions. This company has all stabilized assets with average occupancy usually in the 94% to 96% range. Has occupancy slipped compared with the first quarter of 2007? Yes, but by only 100 to 150 basis points and it is still quite healthy. Has the housing market had an impact? Not at all. In fact, the number of new leases signed in the first 17 weeks of 2008 is exactly the same as the number signed in the first 17 weeks of 2007. The culprit in this case is an unusually higher level of move-outs, either as a result of needing a higher level of care or death. This happens, but they are not seeing any hesitancy in signing up new residents. And did we mention that rates are still increasing by 5% annually, and rent concessions are virtually nonexistent? They are focusing more on marketing now so they can fill those empty units, which is a good thing regardless of the business environment. But when resident turnover returns to its historical range, higher occupancy rates will follow. In other words, they are not waiting for the housing market to improve, because that’s not the problem. In fact, in one of their locations with the weakest housing market, they are at 100% occupancy, and this is not for a "need-driven" community. Or is it?
Just like there is something called "assisted living lite," there is also something we can call "independent living heavy" (seen for the first time here, but not very catchy). How many independent living communities have no residents who need help with activities of daily living, or who don’t have home health care aides come for their daily visits? Most new IL communities also offer assisted living services or separate wings, and there are many residents in assisted living facilities that could just as easily live in an "independent" living facility. Often, where they live is the facility of convenience, just like those residents who moved into nursing facilities in the past who really didn’t need nursing care, but had no other options locally. The point we are trying to make is that when people say that the "need-driven" sectors of seniors housing will not be impacted by the housing crisis, or will have a limited impact, they are being much too simplistic because there are so many other factors which determine when and where someone moves. We will know a lot more about census trends by the middle of May, however, when all the public companies report their earnings and occupancy rates for the first quarter.
The one sector that is the most vulnerable to the housing market, however, is the entrance fee CCRC market, because most of the elderly need their home equity to fund the initial entrance fee, but CCRC operators are getting creative to deal with this problem. On the other hand, according to an ongoing and informal survey of its borrowing customers by Ziegler Capital Markets, 52% said the local real estate market is not having an impact on their CCRCs (65% for stabilized properties), and for pre-sale/fill stage communities, 46% said the housing market had no impact. The consensus opinion would have it that all CCRCs are feeling the pain. For the rest of the industry who thinks the housing market is hurting occupancy, or just wants to boost occupancy in general, help is on the way. Unfortunately, and quite illogically, some operators are ignoring a lifeline being thrown their way.
We are talking about the consumer financing option offered by Elderlife Financial Services, which we wrote about in detail in the November 2007 issue. And, to set the record straight, we have no financial interest in the company, and never have, despite some readers’ assumptions to the contrary. Quite simply, what the Elderlife financing option does is provide financing for those who don’t have the available funds right now for a move into a seniors housing facility, or who don’t have the sufficient monthly income. The financing can be used as a bridge until a home sells, for entry fees, as a bridge to stock sales (especially when someone’s portfolio may be a little under water in today’s market), or to fund the gap between what someone can afford and where they want to be, with the adult children signing on to the loan. The point is, when you walk into a car dealership or a furniture store, you automatically expect to be offered some sort of financing option, so why not with seniors housing?
While we realize that this concept is still relatively new for the seniors housing industry, there are some incredible anecdotal stories about providers losing potential residents, and thus income, by either not responding to the needs of the market, or not understanding what it is all about. In one case, a Midwestern a local resident wanted to move into a religious oriented not-for-profit retirement community and had a $14,000 loan from Elderlife approved, signed and ready to be wired. The community, however, would not accept the funds, and essentially turned away someone who may have been a member of their own faith, who then had to find another community that would accept the funds. Was this organization afraid to take on a resident who had to "borrow" funds to make the move, with the possibility of that resident not being able to afford it down the road, and the community either subsidizing her and forcing her out if she could not pay the rent? Or did they just not understand the concept? We will never know, but the fact that they did not even want to engage in a discussion says more than enough. Ignorance is bliss? And Elderlife’s customers are not deadbeats, with some coming in with very high credit scores.
In another situation, a potential resident wanted to move into a facility managed by a large, national provider and had the loan approved with the funds ready to be wired. At the facility and regional level, everyone was ready to go, but higher up the ranks the response was silence. So what did this person end up doing? She is close to moving into an Emeritus Assisted Living (AMEX: ESC) facility up the road, which was more than happy to accept the financed funds. And the other facility is experiencing occupancy problems, so go figure. Now, in defense of that competing company, Emeritus was much further along in understanding the Elderlife program than the competitor was, and as a company had already taken in residents who used the Elderlife funding option. But at a time when occupancy seems to be the number one priority in the industry, one would think that everyone would bend over backwards to fill their units. New things always take a while to catch on, but consumer financing is not new, and once people begin to understand it in that way, the bell will go off.
Now, we all know that many providers will often offer one month’s free rent to entice a new resident to make a move, especially in a competitive market. As an alternative, what about offering to pay the financing cost (the interest expense) for one year, including the cost of financing an initial move-in fee? Why does this make sense? Because the 12 months of interest expense (your offer) will total less than that one month free rent you are so willing to offer as an inducement, especially in this market. It’s not too different from a retailer saying, "Buy now and make no payments for three months, or six months." Everyone understands that, accepts that and does that. So why not seniors housing?
Elderlife has already signed up several large national providers, including Emeritus and Brookdale Senior Living (NYSE: BKD), as well as large regional providers such as Merrill Gardens and Horizon Bay Senior Communities, but this is just the tip of the iceberg. They have taken applications from providers from Florida to Washington State, and they have already seen a significant increase in the per-family loan amount requested, especially when the reason for the financing revolves around how long it will take to sell the house. They are making it as easy as possible for the providers, but the provider has to make it as easy as possible for the consumer, and for the marketing director. The train is leaving the station.
So what does all of this have to do with the capital markets, and specifically the debt market? As everyone knows, most lenders have not been too willing to part with their money these days. Some because their cost of funds is too high to even attract borrowers in today’s still low interest rate environment. Others because they have been told to curtail their real estate lending because of problem "real estate" investments in other parts of the institution. Add to this the concern, which we believe is still overstated, that occupancy levels will drop because of the residential housing crisis, causing margins and cash flow to decline industry-wide. We know there are ways to boost occupancy if the resident doesn’t have the necessary funds to make the move (see above), so this doesn’t really cut the mustard.
What everyone seems to be forgetting, or ignoring, is that the last time the lending sources dried up for the seniors housing industry, which was at the beginning of this decade, it was because the seniors housing industry performed miserably, defaulting on hundreds of millions of dollars of debt, leaving lenders licking their wounds in a dismal market. While some blamed the capital providers for going overboard with capital and funding unrealistic growth plans in the 1990s, the providers eagerly went along for the ride. How long did it take lenders to forget this rather large hiccup in the market? Two years. So now we have a situation where lenders may be suffering, but it has nothing to do with the seniors housing industry, which is still in good shape. Default rates? Minimal. Occupancy problems? Varied, and any problems today will straighten themselves out in time, as demand will be building up if the elderly delay their planned moves, and demand in general will be growing, although at a slightly slower pace in the next few years. The bottom line is that when lenders are given the green light again, there will be no bad memories and bad loans to forget, contrary to the last time, and we suspect they will be jumping back to the market with size. The point is that this industry is too good of a business opportunity for lenders to ignore, and the smart ones know it. So, the industry needs to be patient, and this illiquid capital market may return to normal sooner than expected.