SACRAMENTO, Calif. -- There's a new buzz surrounding the assisted living industry now that the $175 billion California Public Employees' Retirement System has announced plans to commit $200 million to the sector.
The system expects to recommend several managers to the board at its June 19 meeting, said Mark Albertson, who oversees a $3 billion non-core real estate portfolio for Sacramento-based CalPERS.
Despite problems with operators and oversupply in some markets, the system is making its first commitment to senior living. Mr. Albertson said he believes the oversupply is creating a strong opportunity for institutional investment.
"Most of the problems have been identified, which means those with capital will find pricing very attractive now. There is little institutional capital in the field, so investors who get into it now will be able to earn a premium until it's more widely established," he said.
He is projecting returns of between 12% and 16% on investments in these facilities, depending on the risk level.
Focus on real estate
In CalPERS' senior living investments, Mr. Albertson said, "we're most interested in independent living and congregate care facilities, which provide a full continuum of care and allow a person to age in the same place, getting more levels of help, as needed. CalPERS prefers to make investments that focus on real estate and that are private pay rather than government sponsored."
What also makes the assisted living industry attractive to CalPERS is that its economic performance is driven by demographics, not by the business cycle, which will allow the system to diversify its real estate risk.
Many other pension funds have investments in the industry through a variety of real estate advisers, including: Lazard Freres & Co., New York; AEW Capital Management, Boston; Prudential Real Estate Investors, Parsippany, N.J.; and Cordia Senior Living, a subsidiary of Lend Lease Real Estate Investments Inc., Atlanta.
"Senior housing can be a sound investment if done right," said Jack Barthell, a partner at PricewaterhouseCoopers, New York, which analyzed the industry for CalPERS. According to the analysis, the gross capital size of the senior housing market is expected to grow from $86 billion in 1996 to $126 billion in 2005 and $490 billion in 2030.
"It's a great time to get into it because of the compelling demographics," said Robert Kramer, executive director of the National Investment Center for the Seniors Housing & Care Industries, Annapolis, Md., an independent research and networking organization linking senior housing developers and providers with investors.
"Pension funds are interested because the industry is not subject to the same market cycles as other real estate investments. It also makes good sense as a social investment," Mr. Kramer said.
Jim Lee, a principal at Kensington Realty Advisors, Chicago, who recently established a joint venture with Formation Capital, Atlanta, known as KMF Senior Housing Investors, also sees a strong interest because of the demographics. "We're just starting to market to state pension funds, and they are very interested," he said.
KMF plans to buy properties and hire operators to run them. Eventually, it might take partial positions in properties.
Mr. Barthell and other industry experts emphasized that the key to success is pooling the right combination of real estate management and operating skills. "Plan sponsors are a good market for these investments because their constituency is the target market," Mr. Barthell said. But, he cautioned, "several of these investments were made four or five years ago and haven't run full cycle, so it's too soon to know how they will perform. Also, there have been problems on the operating side as well as overbuilding, which has left the industry in somewhat of a slump. Some are doing a lot better than others."
Many investors are expecting opportunistic returns of 20%, Mr. Barthell added, but they would do better to seek returns in the mid-teens.
Prudential Real Estate Investors' Senior Housing Partners I, which closed at $183.3 million in 1998, is the only fund to focus solely on senior living, said Noah Levy, a principal at Prudential Real Estate, which contributed $36.6 million, or 20% of the fund. "We're a niche fund that buys properties either with an operator or from an operator. We're not buying into the companies themselves, but we always know who the operators are," Mr. Levy said. "Instead, we focus on the property level or on mezzanine financing. There has been a lot of interest in the fund, which could lead to a second one."
"These are really operating businesses, and it's important to understand that side of the business or have someone along who does have this knowledge," said Robin Du Brin, president and chief executive officer of Columbia Du Brin Realty Advisors LLC, Seattle, which advises institutions on senior living investments. "Normally, investors pay 50 basis points for asset management, but it should be 125 basis points for senior living, because it takes more work and more due diligence to do it right."
Lazard, one of the biggest players in the sector, with an estimated $550 million invested through its $1.5 billion LF Strategic Realty Investors II, currently has large positions in ARV Assisted Living Inc., Costa Mesa, Calif.; Kapson Senior Quarters, New York; and Atria Inc., Louisville, Ky., which merged with Kapson in 1998.
Now there is a supply-demand imbalance, because the debt and equity markets contracted, leaving excess supply in some markets. But Michael Medzigian, president of Lazard, forecast that since the capital spigot has been shut off, demand will grow and supply will slow.
"At our companies, we're focusing on improving the operational business and creating maximum shareholder value," he said. While there had been reports that Lazard might sell some of its senior living holdings, Mr. Medzigian said there are no plans to do so at this time.
One limited partner of the fund, who asked to remain anonymous, said he believes Mr. Medzigian, who joined Lazard in the fall, is on the right track as he tries to turn around the businesses. "The fund got into these properties at the top of the market and overpaid, compared to current prices in a sector that has been beaten up. But the new management at Lazard seems to have stopped the bleeding," he said.
Several Taft-Hartley funds have been moving into this sector, participating mainly on the debt side. The $1.3 billion AFL-CIO Building Investment Trust, Baltimore, two years ago provided a $37 million construction and permanent loan for a 287-unit facility in Vernon Hills, Ill., said Robert Law, managing director for institutional real estate at Mercantile Safe Deposit & Trust Co., Baltimore, which administers the trust. "We are still finding our role, but expect to be a debt player," Mr. Law said.
And Washington Capital Management Inc., Seattle, has invested successfully in four senior housing projects through a $193 million commingled fund it runs for 18 Northwestern Taft-Harley pension plans, said El Jahcke, principal. They all have been set up as conventional debt financing arrangements for either a combination of construction and permanent mortgages or just construction loans.
They included a congregate care facility in Wilsonville, Ore., and an assisted living facility with 100 units in Poulsbo, Wash.
"No one ever missed a payment and returns averaged 9% to 10%. We might do more of these, but are being cautious right now because there has been so much overbuilding," Mr. Jahcke said.
AEW Capital, Boston, also has grown cautious because of the glut in some areas. It has decided to stay on the sidelines until it determines where it can be opportunistic. "We wouldn't do more development at this stage, but might look for acquisitions," said Kathryn Sweeney, vice president.
The firm has been investing in senior housing since 1997 through its opportunity funds AEW Partners II and AEW Partners III, with $120 million committed to the sector to date, Ms. Sweeney said. Investments include Benchmark Assisted Living, which focuses on investments in New England; Castle Sr. Living LLC, which focuses on metropolitan New York; and Carege LLC, Seattle, which focuses on the West Coast.
AEW gave Benchmark $25 million in start-up capital while Castle, an early-stage investment, got $38 million and Carege got $25 million to expand.