Insider Newsletter

July-August 2013

A Discussion with Michael Gordon, Principal at Harrison Street Real Estate Capital, LLC

Image of Michael GordonIn the latest in a series of dialogues with key players regarding the current capital environment in the seniors housing and care industry, Chuck Harry, NIC’s Managing Director, recently interviewed Michael Gordon, Principal at Harrison Street Real Estate Capital, LLC.

NIC: Harrison Street, with approximately $5 billion in assets under management (AUM) began investing in the seniors housing space about 5 years ago. During that time you have become a very active investor. Can you talk about the reasons you entered the space and provide us an overview of your seniors housing portfolio?

Michael Gordon: HSRE invests in needs-based real estate sectors that are supported by long-term demographic trends. Our focus is on healthcare, education and storage real estate. We began deploying capital in these asset classes on behalf of our fund investors in 2005. Our current investment spectrum includes development, value-add and stabilized properties, and we have raised capital specific for these opportunities and the risk/reward spectrum that they cover.

HSRE’s senior housing investment thesis has always been tied to favorable demographic statistics and trends and their impact on segment demand. In our underwriting, we consider these demographics, as well as the study of micro supply and demand to create a meaningful and predictable view on potential demand within submarkets and down to our properties. As we all appreciate, the aging US population has largely driven demand in senior housing and the largest cohort of the aging population is at least a decade from requiring broad senior housing (and perhaps longer for assisted living). We have always focused on higher-acuity residents (AL/ALZ) as we believed, and still do believe, that this strategy would largely insulate our performance from a potential economic downturn. Our strategy was validated during the recession. As important, we’ve elected to maintain environments for staff and residents, as well as providing quality care to seniors. This sector creates the unique ability to benefit from the relationships between care givers and residents on a long-term basis, and this leads to an element of “stickiness” wherein a property can capitalize from annual rent increases that outpace other asset classes. However, operations need to be executed flawlessly and reputation needs to remain stellar in order to benefit from this dynamic. This is why operator selection is so critical.

HSRE currently owns 76 senior housing communities (approximately 8,500 units) in 21 states. These assets cover the acuity spectrum, and the majority of our residents fall under the assisted living and memory care levels of-care. We remain very dedicated to the senior housing space, and we are actively exploring numerous opportunities to acquire and develop senior housing with both existing and new joint venture partners nationwide. Additionally, we are in discussions to expand our brand oversees.

NIC: Harrison Street teamed up with Engel Burman Group as the buyer in one of the highest price per unit transactions thus far in 2013, buying back 7 properties (under the Bristal brand) in the New York MSA in a transaction valued at $370 million. Can you talk about some of the factors that drove your interest in buying at that price?

Michael Gordon: When we assess “core” investment opportunities, I frequently ask the question, what’s our insurance policy that will ensure that an asset or portfolio will provide predictable cash flows during a rather long hold period? As Harrison Street Core Property Fund is an open-end commingled fund, we are acquiring assets that will most likely be held for a 10+ year timeframe. As such, this fund is targeting properties that are positioned to stand the test of time. As it relates to senior housing, we believe “core” is Class-A, purpose-built communities that are oriented towards a more affluent and higher acuity resident. We concentrate on assets that are situated in markets with a palpable and favorable supply/demand imbalance, wherein the immediate locations benefit from high barriers to entry (jurisdictional, physical and economic).

We have known the Engel Burman team for years, and we recognize them as the preeminent operator and developer of senior housing in Long Island, NY. We have been circling the greater New York metro area for senior housing opportunities, and we have always coveted the Bristal Portfolio. When Engel Burman approached us with the prospect of forming a venture to reacquire their portfolio, we jumped at the opportunity. HSRE has been involved in the senior housing industry for nearly a decade, and we have canvassed the entire landscape – both operators and assets. In my opinion, there is not another portfolio in this sector that is a better fit for our Core Fund strategy than Bristal. The properties are Class-A, fully amenitized assets that are superior to the alternatives in each of the respective properties’ competitive sets. The communities are located in New York, which is an extremely challenging state as it relates to licensing and Department of Health approvals. The portfolio is situated within affluent submarkets throughout Long Island, which is one of the most prohibitive development markets in the United States, due to a scarcity of land, challenging entitlement/permit processes and expensive land prices. The strength of the Bristal brand is the by-product of providing best-in-class care to high acuity residents for more than a decade, and the operator benefits from tremendous word-of-mouth marketing, catering to primarily the high-end, which so happens to be the majority of the demand pool in the communities’ respective markets. All of these factors have manifested into a portfolio that is currently 99% occupied.

While the $370M purchase price, which consists of $318M for the former Chartwell REIT / ING properties and $52M for East Northport (a property that was owned by Engel Burman and recapitalized by the venture), represents $351K per unit, the YTD (June) 2013 cap rate on this transaction is currently 7.0%. As it is practically impossible to replace and/or duplicate this portfolio in these submarkets, we were more focused on yield than on price per pound. In any case, unit price simply reflects the lofty rents in this market, the near 100% occupancy and the impressive margins generated by this portfolio. HSRE is a very active participant in the acquisition market for institutional senior housing assets and portfolios, and we believe that the Bristal transaction was purchased at a cap rate that is roughly 75-100bps higher than its closest comparable sales transactions that have taken place during the past year, and none of these transactions benefit from the quality of asset, market and operator.

NIC: There are signs across the industry that construction, particularly on the assisted living and memory care side is picking up. Construction levels have risen to 4.9 as a percent of existing inventory in the 31 largest metro markets for assisted living properties and represents a new high since 2005. How is this affecting your investment and underwriting strategy?

Michael Gordon: Our development strategy has always been predicated on forming relationships with best-in-class developers and identifying sites in markets where new Class-A supply NEEDS to exist. Our value-add funds’ approach to development has always followed a process of market selection, submarket selection and site selection. We will only break ground on the development of communities that will serve an under-supplied market and match perfectly with the majority of the demand pool. Our emphasis is on venturing with established developers that have a regional focus, and investing in projects that cater to affluent submarkets and high acuity residents. This has translated into the successful delivery of assets and an expeditious lease-up. We try not to let industry statistics or national averages impact our strategy, as we believe this business is very local. We have elected to pass on certain opportunities in markets which have a glut of new supply either under construction or in-planning stages; our typical development deals are situated in submarkets with extremely high barriers-to-entry, where our local operating partner has spent years in site selection, politicking and predevelopment. We find that most developers don’t have the patience to focus on projects that require that amount of lead-time and up-front capital.

Development represents approximately 10% of our senior housing portfolio. We have been more active in acquiring existing communities with a business strategy of redeveloping/repositioning (roughly 15% of HSRE’s senior housing portfolio) in order to address a specific market’s needs.

NIC: Harrison Street invests across multiple asset classes, including core real estate. Several industry participants have recently argued that seniors housing cap rates should trade more in line with multifamily cap rates. What is your opinion on this?

Michael Gordon: The senior housing vs. multifamily cap rate discussion has become more prominent as the senior housing sector has become more widely accepted by institutional investors. These two sectors both cater to “residents” and are both impacted by demographics and the overall dynamic within local markets. Having said that, the similarities begin to diverge when one focuses on the operationally intensive nature of senior housing vs. multifamily. We would suggest that the market discounts senior housing because of the mistakes that investors can and have made in it. Drivers of cap rate spread include: (1) the risk inherent in the potential for mismanagement and the multiple issues that arise from it (e.g. costs/time of replacing poor management) versus similar situations in multifamily, (2) the operational/leasing attributes of senior housing, (3) the limited universe of institutional buyers of senior housing vs. the larger pool of buyers for multifamily and (4) the lower cost of capital, both debt and equity, available to the multifamily market.

While we all have seen a compression in both senior housing and multifamily cap rates, a spread between these two sectors continues to exist. I can tell you that it’s a fun time to be a seller of senior housing at the moment, and it will be interesting to see what types of capital trends we encounter going forward.

An Interview with Tony Mullen

Image of Tony MullenNIC President Robert G. Kramer recently interviewed Anthony Mullen. Tony was one of NIC’s four cofounders, including Bob Kramer. Since then Tony has served the organization in a number of different roles including, most recently, NIC Senior Fellow, the position from which he is now stepping down in order to devote his full energies to other industry projects.

NIC: As one who has been engaged with NIC since its founding in 1991, what is your perspective on the mission of NIC – both then and now?

Tony Mullen: When NIC was launched in 1991, there was a very simple goal: to dramatically increase the equity and debt capital and then lower that cost of capital. The early years saw the growth of the conference and then key research publications such as the NIC National Supply Estimate of Seniors Housing & Care Properties and The Investment Case for Senior Living & Long Term Care Properties in an Institutional Real Estate Portfolio. But it became clear that the sector had to have the supply, demand and return data that other commercial real estate sectors had; and I was committed, along with you, to make sure NIC fulfilled this part of its mission and NIC MAP was conceived and named. Many key industry leaders worked together to make it happen, and I believe it is one of the main reasons that NIC has made so much progress on its initial mission. The mission today flows from the same essence but is now more focused on facilitating INFORMED investments in debt and equity. I strongly emphasize that word because of how critical it is to the future success of the industry in lowering the cost of capital. Measuring investment returns and the risk of those returns with a large and representative sample on an ongoing basis is now paramount, and NIC, with help from institutional real estate groups, is moving closer to achieving that reality. More detailed financial and operating data from actual audited and reviewed financial statements will be a key component of that objective.

NIC: What do you see as NIC’s most significant contributions to the seniors housing and care industry?

Tony Mullen: I believe that NIC is truly unique among non-profit industry organizations in that from the outset it was conceived to be a true partnership between capital executives and operator/developer executives. NIC deliberately has a healthy tension that balances the needs and wants of each group in its organizational structure and ensures that, while clearly serving the industry’s need for capital, the organization remains impartial. NIC objectively reports the data and seeks to help both groups be transparent with each other and with outside constituents. The organization also wanted to help provide the means to professionalize the field, and I was fortunate to help conceive and build the educational arms of both Johns Hopkins and the Erickson School of Aging Studies at UMBC and what became the only peer reviewed academic journal focused on the practice community for the industry, the Seniors Housing and Care Journal. The ongoing effort of NIC to build academic partnerships is proving very fruitful, and the internship program for future leaders will reap large benefits in increasing the talent pool for the industry. A great achievement of the seniors housing sector for which NIC’s efforts have been crucial is that capital is plentiful and the cost of that capital is coming down, though perhaps not at the rate we would like compared to other real estate asset classes. All involved in NIC should be very proud of the exceptional contributions that the organization has made to the industry.

NIC: What do you believe are the greatest opportunities and challenges facing the seniors housing and care industry going forward?

Tony Mullen: One important opportunity for the industry is the further professionalization of operations, care delivery and sales. I have made the case in many forums that all properties can and should operate at 100% occupancy. We fail to connect with four out of five prospects who visit us and have a need/want. The lost ROI and the lost improved lifestyle for these prospects is a travesty. The key challenges for the industry are that: we must come together to go beyond state-mandated minimum levels of care; we must seek to instill true servant leadership/employee-centered approaches for all professionally managed companies; and we must invest in ongoing, personalized development/learning for our people. The largest immediate challenge for the industry will be handling event risk which may be triggered by the unraveling of the largest financial gamble ever made: the unprecedented deficit spending and debt accumulation by the USA and other major countries. There is a domino element set in place that could cause interest rates to go up quickly and confidence to be completely lost. The downside could be enormous.

NIC: What’s next for you? Tell us about your new venture.

Tony Mullen: I will be stepping down from my role of NIC Senior Fellow in order to devote my energies to specific projects in the industry. I have started a new venture called Journey to Mastery focused on helping companies to dramatically change the way they relate and sell to prospects and to achieve 100% occupancy. This is a passion for me. I will also continue to run the Advanced Sales Summit each year and to do selective development projects. I could have a new project which would open in 2016-2017, but that will depend upon a whole host of factors. I feel truly blessed to have been one of the founders of NIC and to have served the organization in multiple roles over the years. I will be forever grateful to all who supported what NIC has accomplished and what NIC will accomplish going forward.

Assisted Living Construction Continues to Rise

Assisted living construction across the largest 31 metropolitan markets has been rising steadily during the three (3) years since the second quarter of 2010. As of the second quarter of 2013, construction as a percent of existing inventory in majority assisted living properties was 4.9%. —100 basis points above its previous cyclical peak. Within majority assisted living, combined assisted living properties (i.e., properties with assisted living care in addition to at least one other care segment) represented the largest share of construction at 70% of the total units under construction, followed by freestanding memory care properties and freestanding assisted living properties, which represented 17% and 13%, respectively, of the total units under construction. In addition, construction is becoming more widespread, albeit still relatively concentrated, across the various metropolitan markets. As of the second quarter of 2013, 27 of the 31 largest metropolitan markets had construction activity in assisted living properties, and 15 of those markets saw their respective construction pipeline activity increase from the first quarter.

Majority Assisted Living Construction vs Inventory 1Q06 to 2Q13

Certain metropolitan markets are seeing elevated pipeline activity, as construction as of the second quarter of 2013 in Houston, Denver, Dallas, San Antonio, and Phoenix represented more than 10% of their respective inventory. Houston had the most construction in assisted living properties at 1,141 units, which represented 21% of its existing inventory. – See more at: http://www.nic.org/insider/stories/Assisted_Living_Construction_Continues_to_Rise#sthash.8GUJlJLD.dpuf

NIC MAP® Data & Analysis Service New Product Development

NIC’s web-based NIC MAP® Data and Analysis Service subscription product provides quarterly updated information on more than 12,700 seniors housing properties in the 100 largest metropolitan US markets divided into eight (8) regions outlined below:

Properties are classified into three categories: majority independent living, majority assisted living (includes majority memory care), and majority nursing care. Within each property, NIC MAP® tracks the number of units by care segment, which includes: independent living, assisted living, memory care, and nursing care. Properties can also be classified into campus types, which are based on the mix of care segment units. The campus type categories are: CCRCs (offers independent living and nursing care at a minimum), freestanding properties (contains only one care segment, e.g. offers only independent living), and combined properties (contains multiple care segments, but is not a CCRC).
Majority Assisted Living Construction vs Inventory 1Q06 to 2Q13

A new version of the NIC MAP® Data & Analysis Service currently scheduled for release during the first quarter of 2014 will allow subscribers to analyze data at the property, care segment, and campus type level. We look forward to providing users with this enhanced analytical ability.

For example, a topic of significant interest currently is the number of assisted living and memory care units, regardless of the property type the units are in, that are currently under construction. This would be an example of analyzing data grouped at the care segment level. A regional analysis based on these care segments provides the following information:

Majority Assisted Living Construction vs Inventory 1Q06 to 2Q13

– See more at: http://www.nic.org/insider/stories/NIC_MAP_Data_Analysis_Service_New_Product_Development#sthash.hP3eFnwP.dpufNIC’s web-based NIC MAP® Data and Analysis Service subscription product provides quarterly updated information on more than 12,700 seniors housing properties in the 100 largest metropolitan US markets divided into eight (8) regions outlined below:

Properties are classified into three categories: majority independent living, majority assisted living (includes majority memory care), and majority nursing care. Within each property, NIC MAP® tracks the number of units by care segment, which includes: independent living, assisted living, memory care, and nursing care. Properties can also be classified into campus types, which are based on the mix of care segment units. The campus type categories are: CCRCs (offers independent living and nursing care at a minimum), freestanding properties (contains only one care segment, e.g. offers only independent living), and combined properties (contains multiple care segments, but is not a CCRC).
Majority Assisted Living Construction vs Inventory 1Q06 to 2Q13

A new version of the NIC MAP® Data & Analysis Service currently scheduled for release during the first quarter of 2014 will allow subscribers to analyze data at the property, care segment, and campus type level. We look forward to providing users with this enhanced analytical ability.

For example, a topic of significant interest currently is the number of assisted living and memory care units, regardless of the property type the units are in, that are currently under construction. This would be an example of analyzing data grouped at the care segment level. A regional analysis based on these care segments provides the following information:

Majority Assisted Living Construction vs Inventory 1Q06 to 2Q13

Tell us Your Views of Transaction Pricing and Deal Flows

Part of NIC’s program line-up at this year’s national conference is a session titled “Seniors Housing Acquisitions and Valuations: You Can’t Always Get What You Want.” The session panel will discuss some of the market-defining transactions of 2013 and in what ways they may impact the deal-making marketplace in the coming year. To gather insight into current and future deal flows in the industry, cost of capital, and transaction pricing both now and in the future, a brief, confidential and anonymous survey is being conducted and your feedback is needed. The results of this survey will be aggregated, shared and responded to by the panel, including:

  • Charles Bissell, National Practice Leader, Integra Realty Resources
  • Steve Blazejewski, Principal, Senior Housing, Prudential Real Estate Investors
  • John D. Cobb, Executive Vice President and Chief Investment Officer, Ventas, Inc.
  • Gray Hampton, Managing Director, Bank of America Merrill Lynch
  • William D. Pettit, Jr., President and COO, R.D. Merrill Co, Merrill Gardens

Please take a few minutes to complete this brief survey.

Click here for detailed session descriptions and speaker bios.

REMINDER: Early Bird Rates End TODAY, Wednesday August 28th!

Image of Tony Mullen

Don’t wait, register now for NIC’s National Conference and take advantage of the early bird savings. If you register before 11:59 p.m. EST on Wednesday, August 28, you’ll save $250+ off the regular rates.

To register and learn more about the conference, please visit our conference website.

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