Today, senior housing is an expanding real estate product type that provides a mix of real estate, hospitality and care services. Given the spectrum of senior housing options, commercial real estate investors are often perplexed by this otherwise niche asset class. In this article, we provide a primer on the economics of senior housing.
The Spectrum of Senior Housing Options
Before we get into the economics, it’s important for commercial real estate investors to understand the breadth of senior housing options. The industry now offers much more than the traditional “nursing home” model. Today, there are options for younger, healthier and more active seniors. There are also more options for older, more infirm seniors who need around-the-clock care.
The spectrum of senior housing options looks something like the image below, with acuity of required care increasing from left to right:
Age-restricted multifamily properties are usually for those aged 55 and older. Units can range from single family rentals to apartments and townhouses. Most revenues are generated by rental fees, with a slight premium added for special activities and amenities, such as a shuttle bus for those who prefer not to drive.
Independent living facilities are the next category on the spectrum. They are similar to age-restricted housing except independent living facilities tend to cover more programming and amenities, such as restaurant-style dining. Assisted-living facilities are one step up, providing additional service with activities of daily living, such as eating and bathing. Assisted living facilities are regulated and must be licensed to provide medical care.
Memory care communities are designed for those with memory-loss issues. Memory care facilities are often integrated with independent living and assisted living communities, but can also be provided on a standalone basis. The most intensive senior housing are skilled nursing facilities, which are similar to traditional nursing homes and also licensed.
Although there are several different types of senior housing, the general economic principles described below apply to all.
When evaluating senior housing opportunities, it is important to first understand that senior housing is an operating intensive business that is heavily regulated, making the operator’s experience of utmost importance. We take a look at this in more detail below, as well as some of the additional underlying economics that can influence the profitability of an investment:
While senior housing is a real estate asset class, it is also a local operating business. The experience of an operator is critically important to the successful operation of a facility (and thereby, the success of an investment) and sets the tone for prospective investors looking to place capital in a deal.
An operator has many tasks. For one, senior housing is a heavily regulated industry, and as a result, demands a high-quality operator who understands the nuances of these regulations in order to remain in compliance.
Another role of the operator is in attracting, training and retaining the staff who run the facility, as labor is one of the biggest operating expenses in senior housing. Operators must also have strong systems, policies and procedures to ensure resident safety and compliance with laws, while simultaneously creating a warm and caring environment that is appealing to customers (and thereby, minimizes vacancy).
While good operations for any property is important to the investment’s success, operator risk to senior housing is magnified compared to other commercial real estate asset classes. For a senior housing project to achieve its full potential, it must have an operator lined up who has a detailed understanding of local regulations, and how to operate and manage a senior housing business.
Gut instinct is to evaluate local demographics to understand aging trends. One might initially believe that an area that has a high concentration of aging adults would be a logical place to invest in senior housing. Demand is more nuanced than that, though. Demand for senior housing is actually most often driven by the location of seniors’ adult children, who often become the critical decision maker as it pertains to whether their parent(s) will move into a senior living facility. Investors should consider both age cohorts (those aged 45 to 64, and those aged 65 and above) when evaluating potential demand for senior housing.
Most senior housing investors will want to look at the demographic profile of those living within a five- to ten-mile radius of the subject property. Some of the most critical demographic information to collect within that trade area includes:
- Number and growth of seniors
- Median household income of seniors living independently
- Median household income of adult children
- Local housing values, as this tends to be a good proxy for wealth
Typically, you’ll want to know how many households earn above a particular income threshold (such as $100,000 or $150,000) and whether this demographic is increasing or declining within the local trade area.
Sources of Rental Payments
It is also critical to understand the likely source of rental payments for senior housing occupants. Depending on the nature of the senior housing complex, the monthly rental payments can exceed well over $10,000 – this is particularly true as you move up the spectrum to memory care and skilled nursing facilities. That said, the national median household income for those aged 75 and above is under $30,000. For many, income alone is not enough to cover the costs of rent and services for the average senior housing unit.
Assuming most seniors will be collecting Social Security benefits, and assuming this will be insufficient to cover the full costs of senior housing – where does the additional income come from? This is a critical piece of the due diligence investors must do before investing in senior housing. Aside from income, what other household assets may be contributed? This may include money from savings accounts, stocks, bonds, retirement accounts, the sale of real estate assets, vehicles, and more. Seniors may also have long-term care insurance policies. Others, still, may receive financial support from their adult children.
In short, you want to know what portion of the rent payments will be provided through Medicaid versus private-pay residents. Among the private-pay residents, it’s important to understand whether the demographic you’re targeting in the market you’re analyzing can support the rental payments through any combination of the income and assets described above.
Most seniors want to either age in place, or age in a community close to their families. They don’t want to move hundreds of miles away. As such, it’s important to look at competition within your specific submarket. What type of care/facilities are offered? Are there gaps in what exists today? What are the comparable market rents at other local facilities? What are competitors’ occupancy ranges? How many units or beds does each location have? Answering these questions will help you better understand your submarket competition.
The senior housing sector was once considered a specialty asset class but in recent years it has become a more mainstream product type that is attracting attention from individual and institutional investors alike. With Americans living longer than ever before, there’s no reason to believe that interest in senior housing will slow down. Understanding the economics of senior housing is a critical first step for anyone looking to add senior housing to their investment portfolios.