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Fixed-Income Insights

Baby boomers are expected to enter Continuing Care Retirement Communities in force in about 15 years. 

[Note: This article is from the July 2017 edition of The Muni Quarterly.]

Continuing Care Retirement Communities (CCRCs) were introduced in the United States in the 1970s in response to a growing desire among Americans to “age in place.” These communities, which serve persons age 65 and older, typically provide a range of capabilities, including independent living, assisted living, memory care, and skilled nursing.

We believe that CCRCs present an attractive investment opportunity in the high-yield, tax-exempt municipal market. To mitigate the risk associated with investing in this below-investment-grade sector, we perform in-depth analysis to identify the optimal investment candidates. What follows is a look at key financial and operational features of CCRCs, and the factors that inform our analysis of the sector.

A Quick Guide to Evaluating CCRCs
The two most common payment models for these facilities are rental and entrance fee.  In a rental model, residents pay a monthly fee for access to the services they receive. Rental models usually serve residents in the final years of life. In contrast, entrance-fee CCRCs typically serve a client base that makes an early decision on a retirement lifestyle. Residents move in when they can still live independently, and then move through the continuum of care available in the community as they get older. Entrance-fee models require a large refundable entrance fee and monthly fee, reflective of health care provided.

The CCRC industry benefits from strong management and a flexible business model. However, the industry is sensitive to housing market and stock market performance. We can divide the market into two primary categories, greenfield (i.e., startup) and expansion projects, to provide a framework for discussing credit factors. 

Greenfield CCRCs: Bonds issued to finance these projects offer attractive investment yields to compensate for the increased risks of new construction costs and attracting a sufficient number of residents. The most favorable borrower is one with existing senior living assets that provides an equity contribution to the new CCRC project. The development team should include a developer, marketing staff, architect, contractor, and project manager with extensive senior living experience.  Contract provisions should have price guarantees, payment and performance bonds, and liquidated damages.  

To evaluate the competitive landscape, we consider the types of senior living facilities (entry fee versus rental), occupancy, the quality of competitive offerings within the primary market area, and potential for new entrants. We review legal covenants of bond issues to determine if they provide adequate legal protection.  Financials typically are evaluated to determine if projections are achievable and what minimum level of performance is required to meet debt service.

Expansion CCRCs: Expansion projects offer less risk. Often, expansion projects reflect a need to increase the number of independent living units, upgrade the amenities, or replace/modernize the on-site healthcare facility. For projects that increase the number of independent living units, we evaluate the appropriateness of the units for the area (apartment, cottage, or villa), size and quality of units (larger units with upgraded kitchens are in higher demand), and price of the units (significant price increases may be difficult to market). For non-revenue-generating projects such as upgrades or modernization efforts, we examine the impact to financial metrics. While initially these projects may weaken an operator’s financials, failure to invest in upgrades or modernization will, ultimately, erode occupancy—and pricing power.  

In expansion projects, management is likely to serve as the developer, project manager, and marketing team. Contractors should be experienced in senior living, and contract provisions should be similar to the terms required in a startup project. The construction timeline is evaluated to determine if expectations for completion and occupancy targets are achievable. Depending on the size of the project, the risk of delay is somewhat mitigated by existing operations.

The focus of the financial analysis for expansion projects is on the overall debt and liquidity profile and the operator’s ability to meet debt-service requirements without growth. In addition, we will evaluate the operational changes that are expected to be driven by the expansion, such as improved occupancy, reduced reliance on entrance fees, and improved payor mix (that is, a higher percentage of revenues from private insurers or direct payments from occupants).

Tracking Industry Trends
The senior living industry has operated in a stable environment thanks to recent developments, including good housing values, a stronger stock market, and an aging population. These factors are contributing to good financial performance and modest growth. According to real estate firm Marcus & Millichap, the national stabilized occupancy rate at CCRC centers is expected to rise 0.2% in 2017, to 91.1%. The average monthly rent also is forecast to climb 2.7%, year over year, to $3,189 per month.

The industry’s future challenges include an evolving retiree population with a different financial profile—and changing lifestyle preferences. Baby boomers are expected to enter CCRCs in force in approximately 15 years. Boomers’ financial profile will reflect the transition to 401(k)s as the main retirement savings vehicle. Boomers also prefer a high-service environment, want to maintain connections with the world outside their retirement communities, are tech savvy, and are focused on wellness.

Operators of CCRCs already have begun to change their product offerings to meet these new demands, with extended learning options, wellness facilities, state-of-the-art fitness facilities, concierge services, and fine dining. Other ways that CCRCs may adapt include co-housing, distributed housing, and multigenerational developments.

Not all CCRCs that we evaluate will meet our strict criteria. However, we will continue to evaluate broader market trends and individual offerings, carefully scrutinizing CCRC firms’ operations, finances, and credit quality in order to select the best investment opportunities with the most attractive risk/reward profiles.

 

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THE MUNI QUARTERLY

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The July 2017 edition offers insights from our analysts on key topics for municipal bond investors, along with essential market information.

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