Assisted living facilities create new REIT niche.

The aging U.S. population and a strong demand for Assisted Living Facilities - a concept receiving new emphasis in retirement living - are converging to create a significant opportunity for real estate investors, according to KPMG Peat Marwick's Real Estate Consulting Group.

KPMG Peat Marwick also believes that Assisted Living Facilities represent a potential niche category for new real a potential niche category for new real estate investment trusts (REITs) or a diversification opportunity for an existing REIT already involved with health care properties.

Assisted Living Facilities, designed for seniors who don't require a high level of nursing care, provide a variety and range of health care and home services.

The firm predicts that demand for these facilities is so high that a REIT offering substantially devoted to retirement and Assisted Living assets could be brought to market by the end of the year, assuming the capital markets are receptive to new issues.

"A typical Assisted Living Facility can produce returns of 12 to 14 percent," says Donald R. Cavan, a senior manager with the firm's consulting group who believes acquiring bargain properties and operating them as Assisted Living Facilities has home-run potential written all over it.

"This is shaping up to be a cutting-edge business in its infancy, and there is little doubt that new sources of investment including real estate interests will be introduced to take advantage of the potential returns."

Approximately 10 percent of all REITs already consist of full-care nursing homes, yet the Assisted Living segment remains untapped. Cavan said REITs already invested in nursing homes or retirement communities should have a relatively easy time diversifying into Assisted Living Facilities.

The typical healthcare REIT arrangement of sale/leaseback could be applied to Assisted Living providing capital for expansion and an acceptable return for investors.

Cavan noted, however, that Assisted Living Facilities require marketing linkage to other retirement or health care properties. The challenge is to create a distinctive investment property without having "stand alone" facilities which are difficult to market.

A Niche Market 

"During the construction boom of the last decade, many of the retirement facilities being built were either golf course-type communities or nursing homes," Cavan said. "These facilities are at the extremes of the market. The true demand is somewhere in the middle and Assisted Living can fill this demand."

According to Cavan, Continuing Care Retirement Communities (CCRCs) are currently meeting some of this consumer demand. Standard & Poor's has recently announced that they will begin rating tax-exempt CCRCs, which should improve investor perception of their potential as tenants or users of capital.

Jill M. Krueger, a health care specialist and partner in KPMG Peat Marwick's Chicago office, adds that many CCRCs are likely to give Assisted Living a look as a result of pending health care reform.

"Today, many continuing care retirement organizations are considering adding assisted living units to their existing campuses or constructing new assisted living facilities," Krueger said. "In addition to being less costly to both the residents and the facility, they offer more flexible care in a more desirable environment."

Increased interest in Assisted Living also is likely to come from hospitals and other health care providers seeking a less costly place for low-maintenance patient recovery, Cavan said. Further demand is expected from nursing home residents who need some form of assistance but not full-time nursing care.

He believes demand will be particularly high in middle- to upper-class neighborhoods of major cities.

Converting Existing Facilities

"The diminishing inventory of distressed apartment and retirement buildings could possibly fill some of the demand through conversion to Assisted Living," Cavan said.

Conversion would require renovating interiors for easier elderly access, supplying an on-call nursing and concierge staff, and providing a management and marketing staff. Distressed apartment, hotels and other appropriate conversion properties, lingering from the overbuilding era, are still available. However, Cavan warns that owning Assisted Living Facilities is not for the typical investor or developer. Instead, he equates it to owning a group of hotels - but with a twist.

"Developers should be experienced in retirement or health care, or hire a management team with such experience," he said.

According to Cavan, the model real estate company to take such a group of properties public would be well-capitalized with newly acquired, distressed apartment or hotel buildings in affluent neighborhoods of cities over 200,000 with Assisted Living conversion plans in place. The company should also be skilled in acquisition, retirement property management, leasing and tenant relations.

"Forming a REIT or utilizing other innovative capital market methods of financing for these owners is about the only option for financing an Assisted Living venture because traditional lenders are still holding back cash for this type of commercial property," Cavan said. Also, since a REIT for tax purposes is limited in the type of income it can recognize, care must be taken to properly plan the asset ownership and type of income realized by a REIT.

Ideal Market Conditions

"The REIT market exploded in the past two years because of low interest rates and favorable capital market conditions," Cavan said. "Investors gladly invested in almost any REIT, eagerly awaiting returns that not only outperformed other investments, but the stock market in general. Now, however, rising interest rates has investors more closely examining the underlying securities in REIT public offerings, picking those that hold properties with high-growth potential," he added. "Competition is high among REITs with more focused property types, such as those consisting of only multi-family housing, hotels or retail properties. The inclusion of Assisted Living Facilities into REITs is suited to current market expectations of earnings growth."

A provision in 1993 tax legislation, which modifies the five/fifty rule to allow freer use of REITs in pension funds, also has brought more corporate investors into the REIT market.

"It's likely that once this opportunity is identified, institutional investors will bring a wave of capital to REITs for Assisted Living Facilities," Cavan predicts. "These investors, now actively investing in REITs, are taking a long-term, asset-driven approach, managing portfolios in terms of property type and geographic mix."