Why Urban Development Is in High Demand

The Watermark at Brooklyn Heights is an old hotel that is being converted into a luxury seniors housing property in New York City. The Watermark at Brooklyn Heights is an old hotel that is being converted into a luxury seniors housing property in New York City.

Developers, investors increasingly seek high-barrier-to-entry markets to inoculate themselves against overbuilding.

By Jane Adler

Markets with high barriers to entry are hitting the industry’s sweet spot. Investors and developers are increasingly turning to dense infill markets amid concerns that the seniors housing sector is overbuilt. 

The calculation is that places where the development process is long and difficult will have less existing competition. Obstacle-laden locations will also act as a hedge against future competition. The result: a fast lease-up, and robust long-term returns.

Developers and investors are seeking new spots in urban settings such as Manhattan, the Washington, D.C. area and Los Angeles, where little or no new seniors housing has been built in the past few years. Older suburbs with a large number of seniors are prime targets too. 

The strategy has kept new development alive, diverting developers from places that already have too much seniors housing — a move that could help ease the supply overhang.

“We love high-barrier-to-entry markets,” says Max Newland, managing director of healthcare real estate at Kayne Anderson Real Estate, a private equity investment firm.

Last October, Kayne Anderson purchased a former hotel building for $200 million in the trendy New York neighborhood of Brooklyn Heights. The firm plans to spend another $100 million to convert the property into a senior living community. 

“This is a poster child for a high-barrier-to-entry market,” says Newland, whose office is in Boca Raton, Fla.  

In general business terms, “barriers to entry” is defined by the website Investopedia as the existence of high start-up costs and other obstacles that prevent new competitors from easily entering an industry. In real estate, the high-barrier-to-entry locations are typically situated in densely populated neighborhoods. Open land is unavailable.

Assembling parcels is expensive and time consuming. Construction timelines are measured in multiple years, not months. The phrase “patient money” doesn’t begin to describe the fortitude needed by investors to withstand the lengthy wait for healthy returns. 

Also, the parcels tend to be small. The lack of acreage usually necessitates a vertical building design, which is expensive to build. A vertical layout with elevators can make it more problematic for senior living operators to deliver services to residents. 

High costs demand high rents. That shrinks the pool of seniors who can afford the product, making a quick lease-up a potentially dicey proposition.

Another hurdle: winning municipal approval to rezone land for a new use. 

Senior Lifestyle’s proposed $79 million, six-story senior living building was recently rebuffed by the Village Board in Oak Brook, Ill., a suburb of Chicago with little seniors housing. The Village Board said it preferred to have retailers that generate tax revenue in the mostly commercial area, despite the lack of demand for space among shopkeepers and restaurants alike. 

High risk, high return

Barriers aside, the prospect of healthy returns is tantalizing. It’s worth the effort, developers say, even though only about one in five high-barrier-to-entry locations may pan out.

A successful strategy depends on the simple arithmetic of supply and demand, according to Ben Burke, president of Chicago-based CA Senior Living. The company is a developer and owner with 16 properties. Low barrier-to-entry markets with healthy population growth and high incomes have already been picked over, he says. 

Instead, CA Senior Living is concentrating on densely populated, high-barrier-to-entry suburban areas. The best places haven’t had any new seniors housing built in the last five years, which makes a new building more attractive to potential residents. Other developers are less likely to follow because of the difficulty of building in the area, says Burke.

Several months ago, CA Senior Living broke ground on a seven-story project in Englewood, Colo., an older suburb just south of Denver. The facility will feature 130 high-end units of assisted living and memory care. Atria Senior Living will operate the building.

“We liked this location because it’s an affluent infill location with a dense population,” says Burke. Whereas many suburban locations may have 10,000 potential senior residents within a five-mile radius, the Englewood site has about 30,000 seniors in the market area. 

The site is small, only three-quarters of an acre. It had been occupied by a medical office building that was torn down. The site was expensive. (Burke declined to share the cost of the project, or of the land.) The entitlement process with the municipality took 18 months. By comparison, the entitlement process in a low-barrier-to-entry market takes about six to nine months, Burke estimates. 

With its vertical design, says Burke, CA’s mid-rise project in Englewood will serve as a prototype for other infill projects in dense suburban locations. 

There’s little margin for any kind of error in a high-barrier-to-entry market, sources say. This is especially true as labor and construction costs continue to rise. 

“You have to be more selective in a high-barrier-to-entry market,” says Clint Malin, executive vice president and chief investment officer at LTC Properties (NYSE: LTC), a publicly traded healthcare real estate investment trust based in Westlake Village, Calif. 

LTC has two new projects in the Chicago area in suburban infill locations. A memory care project in Oak Lawn is slated to open this spring. Another memory care project in Glenview is already open. The developer and operator of both buildings in metro Chicago is Anthem Memory Care based in Lake Oswego, Ore. 

“Every market from a development standpoint is unique,” says Malin. 

Big city wish list

Developers are bullish on New York City. Kayne Anderson and its partner, the Freshwater Group, had been looking for years for a suitable location in the market. The Freshwater Group is the acquisition, finance, design and development arm of Watermark Retirement Communities, which will operate the building in Brooklyn Heights. Watermark and Freshwater are based in Tucson, Ariz. 

New York City is attractive because it has had little development of new seniors housing, says Newland at Kayne Anderson. And it has lots of seniors. 

By 2040, New York City’s population of residents age 60 and older is projected to reach 1.86 million, a 48.5 percent increase from 2000. This group will comprise 20.6 percent of the city’s total population, compared with 15.6 percent in 2000, according to the New York City Department for the Aging. 

Other developers have recently announced new projects in New York City. Harrison Street Real Estate Capital partnered with The Northwind Group and The Engel Burman Group to purchase a 16-story art deco building on Manhattan’s West Side with plans to upgrade the building into luxury senior housing. 

Welltower (NYSE: HCN), a publicly traded real estate investment trust, has a project under construction in Midtown Manhattan. Maplewood Senior Living and its partner Omega Healthcare Investors (NYSE: OHI), a publicly traded REIT, have a project on the Upper East Side (see sidebar)

The Kayne Anderson project in Brooklyn Heights was originally built as a hotel. The Jehovah’s Witnesses church group, which most recently owned the building, was using it as a dorm to house volunteers. 

The building didn’t have to be rezoned for senior living — a huge advantage. Assisted living was permitted under the existing zoning provision. “We don’t like to take entitlement risk,” says Newland at Kayne Anderson, pointing out that the municipal approval process can easily scuttle a deal. 

One reason Kayne Anderson won the deal over the multifamily developers also bidding on the project was that assisted living requires little parking. This can work to the advantage of seniors housing developers competing for prime infill locations, sources say.

Renovations on the Brooklyn project will start this spring. The community will be named the Watermark at Brooklyn Heights and is expected to open in November 2019. Upon completion, the project will include about 275 units. Two floors will offer memory care units. The remainder will be a mix of independent and assisted living apartments. 

The project’s big differentiator from its competitors, according to Newland, is the 70,000 square feet of common area space. It will feature a high-end wellness center, swimming pool, activity rooms and multiple dining venues. The 10,000-square-foot rooftop terrace has unobstructed views of lower Manhattan. 

The renovations will cost about $1.1 million per unit. Rents will start at about $8,000 to $9,000 a month for a studio apartment, with additional care charges as needed. Larger apartments will rent for about $15,000 a month, plus care charges. 

Those prices are in line with other seniors housing projects in New York City, says Newland, who is confident that the project will produce healthy investment returns. 

Newland adds that his company is seeking other high-barrier-to-entry locations in New York City and the San Francisco Bay area. 

Infill sites, outsized returns

Finding a good site in dense markets is tough. 

“It’s hard to assemble sites,’’ says Bill Pettit, vice chairman of Merrill Gardens. The Seattle-based company owns and operates 30 properties. It has another 10 projects under development. 

It took several years to assemble the two sites needed for Merrill Gardens at Ballard, a 105-unit senior living building that opened a year ago in an urban infill neighborhood just north of downtown Seattle. “Once you target sites, the word gets out quickly,” says Pettit. “Everybody feels they have the key site for assemblage.”

The assembled land for the Ballard project was only a half-acre in size, presenting design challenges. Much of the outdoor space, for example, consists of a rooftop garden. 

Infill construction is more complex. City streets and sidewalks must remain passable. Municipalities may require a fee for a license to accommodate construction on a city street. 

Construction costs are higher for infill locations by about 10 percent, says Pettit. But the trouble is worth it. The Ballard project leased up in less than a year, compared with a typical 18- to 24-month lease-up for most senior living projects. 

Infill projects can generate attractive returns, sources say. Merrill Gardens has a project in the Seattle suburb of Burien, located in a redeveloped town center. The project hit 94 percent occupancy in six months. Annual revenue totals about $2.2 million, generating a cash-on-cash return of 12.82 percent (see table).

“Seniors prefer to be integrated into a community,” says Pettit. The Ballard project, for example, is located in a trendy neighborhood with lots of restaurants, shops and young families. 

The easy thing to do is to find a site on the outskirts of town where you can build, notes Pettit. “But that’s not always the right answer if you are looking to deliver an environment that seniors will value with the ability to walk outside into a vibrant neighborhood.”

Macro trends are impacting site selection. Artis Senior Living found a retail center in Wilmette, Ill., a dense suburb of Chicago. The center was not fully occupied, but was not for sale. The tenants, however, were not shops but service providers, such as a nail salon and driving school. 

The retail center in Wilmette will be taken down, and Artis will begin a new three-story project on the site in late 2019. The facility will include 64 memory care units.

“Retail in this country is going through a huge change,” says Jay Hicks, senior vice president of Artis, headquartered in McLean, Va. “We are playing into that dynamic of senior living as a service provider.” 

Artis owns and operates 10 properties and has another 25 projects in various stages of pre-development. The company was launched in 2012 by the Bainum family, which started the nursing home company that would eventually become HCR Manor Care. The Bainum family does not own any interest in HCR Manor Care. 

Artis also has a project under construction in Chicago’s Lakeview neighborhood on a one-acre infill site. The five-story project will include 140 units offering assisted living and memory care. It will open sometime in 2019.

Hicks previously headed up the international real estate portfolio for the U.S. State Department, tasked with finding locations for embassies around the world. He found the site for the new U.S. embassy in London that opened in January as well as the spot for the American embassy in Bagdad. 

Asked to compare the site search for an embassy versus a senior living property, Hicks is quick to respond: “Good, close-in assisted living sites are harder to find.”