Providing compassionate care to the elderly is a core tenet of our society. Unfortunately, there is currently a growing gap in the continuum of care spectrum for lower- to middle-income seniors. As the well-documented demographic wave of boomers gets closer, more attention is being paid to how to fill that gap and provide affordable, quality care to all.
On the front end of care, affordable age-restricted housing for the elderly who do not yet require assistance with activities of daily living (ADLs) exists for many of our seniors. Conversely, for those that demand more acute care such as the kind offered in a skilled nursing facility (SNF), these services are frequently subsidized by the government. However, a gap exists for the growing class of lower- to middle-income seniors who can no longer live on their own but are not so frail that they need to be in a SNF. Assisted living (AL) facilities are a great solution for those that can afford them. AL facilities that are affordable, however, are the exception, not the norm. Although several states are working on a variety of solutions to better serve this group of seniors, there remains plenty of work to be done.
In a past article, we discussed Illinois’ supportive living facilities (SLFs) and Indiana's Medicaid waivers and how these programs are important components of solving the problem. In this article, we provide an overview of three major areas of consideration in financing and developing affordable AL facilities: development costs, operating costs and design considerations.
Financing the development of an affordable assisted living (AAL) facility often requires a patchwork of funding sources in order to create a financially feasible project. A viable capital stack will typically include not just traditional equity and debt, but may also necessitate additional gap financing. Point of fact, equity and debt used in developing AAL facilities is usually anything but “traditional.”
As with low-income multifamily housing projects, certain AAL facilities can use low-income housing tax credits (LIHTCs) as a source of equity. Using LIHTCs requires a substantial outlay of time and additional costs, but the source of equity can ultimately be worth the extra resources. Partnering with an experienced tax credit developer is crucial for success when employing LIHTCs as an equity source.
Debt can come from a variety of traditional and non-traditional sources including banks, specialty finance companies, real estate investment trusts (REITs), the U.S. Department of Housing and Urban Development (HUD)/Federal Housing Administration (FHA) and government sponsored entities (GSEs) such as state housing authorities. Not only do new developments require debt, but so do existing projects looking to recapitalize.
Some seniors housing and care operators have had success refinancing AAL facilities using the FHA Sec. 232/223(f) program. For example, Braemar Living at Medford, a 200-bed AAL facility in New York, recently obtained a $26.3 million loan pursuant to the 232/223(f) program to refinance its existing debt. The facility was developed using LIHTC equity and private activity bonds, which were refunded as part of the transaction. In addition to generating over $450,000 in annual cash flow savings, the new loan offers a safer and more permanent debt structure.
One potential benefit of coupling FHA financing with LIHTCs or tax-exempt bonds is the fact that the FHA program allows for a market valuation in this scenario. This means value for debt sizing can be based on market-rate rents and expenses as if unencumbered by use restrictions. Use of this higher unrestricted value allows for loan-to-value (LTV) to be based on a true market valuation. In this scenario, debt may be limited by debt service coverage as opposed to a low restricted valuation.
Because of equity and debt limitations and potential higher costs due to the use of LIHTCs, these sources are not always sufficient to fully cover the development costs of AAL projects. As a result, owners and developers often must employ additional financing sources. These funds will likely come in the form of grants or other state and local grant programs. Clearly, the more grant funding that can be acquired the better, as it will allow the project to minimize debt service and alleviate strain on operating cash flow.
Not only is the capital structure different for an AAL facility versus a traditional AL facility, but operating budgets are also quite different. The typical resident simply cannot afford the true cost of residing in an AL facility. Funding for resident rent payments must come from other sources and must cover two separate expense areas—the traditional rent of the dwelling unit and the services/levels of care. Services include food costs as well as care costs. Depending on regional location, these combined costs can be quite considerable. Existing state and federal funding programs would not sufficiently cover the room, board, and care costs of a traditional AL facility. Therefore, in order to function successfully, the operator has two options—either lower the cost of operations or combine more than one revenue source to provide the necessary lift to operating revenue.
In another recent example, an AAL facility combined three distinct revenue streams in order to provide sufficient cash flow to operate. In many AAL facilities, the critical revenue driver is Medicaid waiver income. Unfortunately, resident income provided by the Medicaid waiver program is often inadequate on its own. This property coupled Medicaid waiver revenue with a project-based Section (Sec.) 8 contract along with a resident paid portion, as detailed in the Sec. 8 contract. In this case the Sec. 8 and private pay portion covered the housing portion of the unit rent. Costs for board and care were covered by the Medicaid waiver income. This was a creative and effective way to cover the property operating expenses, while simultaneously filling an unmet need in the market place. Of course, Sec. 8 funding is not always available to senior living operators, but when used it can be an effective way to fund operations.
In other cases, grant funding or charitable organizations may provide funding or service to cover the care portion of the costs. This is clearly a critical component in some transactions and would need to be ironed out in the early planning phases of a deal.
Even in states with well-developed Medicaid waiver programs, Medicaid funding does not provide the same level of revenue that a traditional private pay AL facility would expect to generate. Because of this disparity in top line revenue, it is necessary to design an AAL facility with economies of operation in mind. The most common private pay AL units are either one bedroom or studio style. Cost is typically the driver for a resident when choosing which type of unit to reside in on the private pay side, and those who can afford it often choose a private unit.
In the affordable scenario, because the private units are more expensive to both build and operate, a more cost effective structure can be a semi-private configuration of units. Semi-private units can actually take on several different layout options, ranging from a single shared room to separate suite rooms. A relatively popular option is one in which the semi-private unit has two bedrooms with a shared bath and shared efficiency living room. In this configuration the unit size is still minimized to save costs, but provides privacy for each resident.
Building and operating costs can be effectively managed by developing and maintaining semi-private units, but that alone may not provide sufficient operating margins. In many cases, certain economies of scale can also provide a workable solution. Larger facilities are able to spread fixed costs over a greater number of units. Although not necessarily feasible for traditional private pay facilities due to market demand constraints, scaled AAL facilities (between 100 to 200 beds) achieve greater economies than smaller facilities. Because of the sheer lack of facilities in existence, filling AAL properties is often less challenging than filling private pay facilities. Therefore a larger facility may very well make sense, provided the operating revenue sources exist in sufficient volume.
Given the demographics of the aging population, there is no question that the already tremendous demand for AAL will only increase in the coming decades. Despite the challenges in financing and funding the operations of such facilities, those in the seniors housing and care industry are working hard to alleviate the problem. As such, the asset class is expected to grow significantly within the overall marketplace. Working with experienced developers, financiers, and government partners such as HUD will be crucial in effectively closing this gap in the continuum of care.
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