The senior housing sector is stabilizing from the rough seas of recent years and attracting capital from a wide range of investors. "Senior housing had been viewed as overbuilt and people lost a lot of money in the late 1990s," says Ray Lewis, chief investment officer for Ventas Inc. in Chicago. Ventas (NYSE: VTR) is a healthcare real estate investment trust (REIT) based in Louisville, Ky. "The industry was ignored for the better part of four years and now people are taking a second look."

Last year was a turning point, says Greg Scrine, vice president of long-term care strategy at GE Healthcare Financial Services in Chicago.

"The industry came off a difficult time in terms of excess capacity and underperforming projects," Mr. Scrine says. "We've had a great deal of restructuring and we've seen the entrance of new investors."

He quotes figures from Irving Levin Associates that indicate the price of assisted living and independent living units reached bottom in 2002. Assisted living units sold for an average of $85,500 in 2001, $65,200 in 2002 and $72,500 in 2003. Independent living units followed a similar pattern: $97,400 in 2001, $81,000 in 2002 and $89,500 in 2003.

Capitalization rates have decreased for assisted living and independent living properties, particularly for the high-quality buildings, and that is placing upward pressure on prices, Mr. Scrine adds.

Attracting capital

Capital is entering the market from multiple sources, Mr. Lewis says. Private equity, opportunity funds, credit companies and REITs all are interested in senior housing, but the level of caution has increased.

"Investors have to understand the industry and how the business works," he says. "You can't just find a good site; you have to market, lease and run it profitably."

Developers drove the senior housing market in the 1990s, but now successful operators and managers lead the market, Mr. Scrine says.

The one category that is not attracting investment is skilled nursing, says Bill Pomeranz, senior vice president of senior living at the San Francisco office of Cain Bros., a healthcare investment banking firm. Skilled nursing facilities are increasingly dependent on Medicaid and thus less profitable. Although capital is available, the market is not offering much to buy, says Talya Nevo, treasurer and senior vice president of strategic development at Health Care Property Investors Inc. (NYSE: HCP), a healthcare REIT in Long Beach, Calif. Operators are more successful and therefore do not have an incentive to sell their properties.

One of the larger deals in recent months was CNL Retirement Properties Inc.'s $562 million purchase of 20 senior housing complexes from the Horizon Bay Senior Communities portfolio.

"There is not an enormous amount of senior housing out there," Ms. Nevo says.

"Last year, we saw a very active market with many distressed sales and some large portfolios," Mr. Scrine says. "Many of the bargain opportunities are gone. Properties will continue to change hands but likely at more stable values. This year may not be quite as busy as last year but it remains to be seen."

Developers like CCRCs

Most development dollars are directed toward continuing care retirement communities, or CCRCs. These campuses allow residents to "age in place" by offering a range of independent and assisted living options; many also have memory care facilities. CCRCs generally sell units but some offer rental housing. Rental projects are difficult to finance without a strong balance sheet, Mr.Pomeranz says.

Most CCRCs are owned by not-for-profit organizations and are not part of a REIT or private investment portfolios, Mr. Lewis says.

The developments also require a venture-capital style of investment because units must be presold to finance the construction, Mr. Pomeranz says. "It is very risky, and the costs are forcing projects from a middle-class base to an upper-class constituency," he adds.

"We're not developing for low or moderate incomes," says Michael Lanahan, chairman and CEO of Greystone Communities Inc., a senior housing developer and operator in Irving, Texas.

All of Greystone's communities are owned by not-for-profit entities. That model works for two reasons, Mr. Lanahan says. Seniors feel comfortable moving into a community-based asset and the developer can rely on municipal bonds to finance each project individually.

Afew for-profit developers are entering the CCRC market. One such company is Classic Residence by Hyatt, a Chicago-based sister company to hotel giant Hyatt Hotels Corp. Classic Residence by Hyatt entered the CCRC market in the early 1990s when it purchased Bentley Village in Naples, Fla., says Matt Phillips, senior vice president of new business.

The company now has 19 senior communities in 11 states, including new developments and troubled properties that it purchased and expanded.

The newest Classic Residence is under construction in Palo Alto, Calif., and will be built on land leased from Stanford University, part of a trend of senior developments on college and university campuses.

Classic Residence by Hyatt communities meet the luxury standard. The average cost to build a project is $150 million and the company seeks residents who are age 75 and older with household incomes of $75,000 or more.

The cost of the units hovers around the median home value in the local community, usually $300,000 or higher, Mr. Phillips says. The barriers to entry are steep because CCRCs often require state licensure and millions of dollars in marketing costs.

"CCRCs require a large capital commitment," Mr. Phillips says." They are not going to crop up on every corner."

Mr. Pomeranz notes that CCRC projects get more risky as the cost of the units rises above the median home value. Cain Bros. is witnessing the first wave of technical defaults on developer-driven CCRCs that got too expensive and did not sell as expected. Since 1997, the price to produce a CCRC unit has increased more than 50 percent, due to larger units and the price of development and construction.

The higher cost makes it more difficult to sell units, as fewer seniors can afford them. Plus, even wealthy seniors want value for their housing dollars.

Classic Residence by Hyatt presells 70 percent of its independent units before construction begins, and sells 85 percent to 90 percent of those units during the two-year construction process, Mr. Phillips says. All but one of the Classic Residences are 100 percent occupied.

A little AL development

Sunrise Senior Living Inc. (NYSE:SRZ) of McLean, Va., continues to build assisted living projects, says spokeswoman Sarah Evers. The company avoids the perils of the market by concentrating on major metropolitan areas where the barriers to entry, including zoning regulations and land availability, keep competition at bay.

Three years ago, Sunrise began divesting itself of properties with sale/manage-back contracts and now operates as a developer and manager of senior living properties. The company acquired the management contracts from Marriott Senior Living Services in a well-publicized deal last spring. (Please see "Sale/manage-back tactic spurs Sunrise" in the April 2003 edition of HREI™.)

Purchases such as this one likely will become more common, Mr. Lewis says. The senior housing market is fragmented and he expects to see market consolidation during the next six to 18 months. Ventas has invested $375 million in senior housing in the first few months of 2004.

"Owners are waiting for the right opportunity to sell and buyers are looking for stabilized assets to establish portfolios," he says. "We like the underlying fundamentals of the market."

Jessica Griffith is a business writer specializing in commercial real estate.