As more baby boomers retire, the opportunity arises for investors to benefit from growth in the senior housing market. Although some in the industry compare senior housing to hotels and multi-family developments, senior housing has several unique characteristics that set it apart from other forms of specialty real estate. Investors in this space and their attorneys and advisors must remain cognizant of the various state regulations and, where possible, use risk management techniques to reduce the investor’s exposure to the tort liability that can arise from operating a senior housing facility. This article identifies several important considerations that investors should keep in mind to be successful in the senior housing industry.
Overview of the Types of Senior Housing
The variations in senior housing are best understood by looking at the types of services each facility provides to its residents. The most common types of senior housing in order of increasing services offered to residents of the facility are independent living (IL); assisted living (AL), including specialized forms of AL, such as memory care (MC); and skilled nursing facilities (SNF). Another type of senior housing that can encompass IL, AL, MC, and SNF is the continuing care retirement community (CCRC). CCRCs require residents to pay an initial fee in addition to monthly rent that guarantees the resident a bed at the facility for the rest of his life, regardless of whether that resident lives in the IL, AL, MC, or SNF sectors of the facility. Most senior housing facilities offer daily meals, housekeeping, and social programs; but daily interaction between residents and staff is more common in AL, MC, and SNF as it relates to medication management, hygiene, and mobility. An overview of the individual characteristics of IL, AL, MC, and SNF senior housing facilities follows.
IL facilities cater to seniors in relatively good health. These communities are typically advertised as retirement or age-restricted communities and can range in form from gated, single-family home communities to townhouses, apartments, or condominiums. IL communities may offer certain recreational or activity-based amenities to their residents, but the provision of any living (transport, laundry, meals) or care services is up to the individual resident to elect.
AL facilities, also known as adult group homes, residential care, or board and care, are targeted at seniors who do not need full-time care but who may need daily assistance with daily tasks such as dressing, eating, and walking. Transportation and meal services are standard, and assistance with activities of daily living (ADLs), including bathing, grooming, and administration of medication, is readily available to all residents.
MC facilities are essentially AL facilities specially equipped to assist seniors suffering from Alzheimer’s or dementia who may be otherwise relatively healthy individuals but who require specialized care because of memory loss. MC facilities, though a form of AL, are typically separate facilities or ancillary to non-MC AL facilities.
SNF facilities, also known as long-term care facilities, cater to seniors who require the highest level of full-time medical care, often in a more institutionalized setting. In both MC and SNF, a higher ratio of staff to residents is often necessary, and staff must be licensed by the state or federal government to treat the specific conditions they are managing. SNF facilities often provide rehabilitation therapy and chronic care services.
Investing in the Senior Housing Industry
In order to invest and succeed in the senior housing industry, the investor, its counsel, and its other advisors must consider (1) how best to structure the ownership of the facility to minimize risk; (2) what licenses are required to operate the facility in compliance with the law; and (3) whether to build a new facility or acquire an existing one. If an investor chooses to acquire an existing facility, due consideration must be given to the proper form of acquisition based on the investor’s particular operational and risk management goals.
Structuring the Ownership of the Senior Housing Facility
Investors in the senior housing industry come in many shapes and forms and can include real estate investment trusts (REITs), private funds, pension funds, family offices, high net worth investors, and retail investors. Though the operational risks inherent in operating a senior housing facility may be inappropriate for some investors, many of those risks can be mitigated by isolating the facility’s real estate assets from its operations. Most investors achieve this isolation by dividing the ownership and operations of the facility among two entities, the property owner (PropCo) and the operator (OpCo). Under this ownership structure, the only assets of the PropCo are the real property assets of the facility, which the PropCo then leases to the OpCo who handles the operations of the facility. By separating the operations of the facility from the ownership of the assets, the investor is better able to shield the PropCo’s assets from claims against the OpCo arising from the operations of the facility.
Investors are further able to mitigate the operational risks associated with running a senior housing facility by having the OpCo enter into a management agreement with a third-party management company (a Manager) who, as part of the agreement, assumes responsibility for the day-to-day operations and performance of the facility. Managers often have localized expertise in the operation of senior housing facilities and, as such, can help shoulder some of the operational risk inherent in running a senior housing facility while contributing insight that an investor new to the industry would not yet have.
Licensing and Other Regulatory Considerations
Each type of senior housing facility has its own set of licensure requirements, but there are some requirements common to all. In addition to Medicare or Medicaid licenses, AL, MC, and SNF facilities typically require separate licenses. Licenses are typically valid only for a specified period and must be periodically renewed. Licenses are usually non-transferable, and in most cases, a new license must be obtained by the purchaser of a senior housing facility before operating the facility, regardless of whether the purchaser acquired the facility through a stock purchase or an asset purchase. Ari Markenson, Jeannie Adams, Caroline Berdzik, American Health Lawyers Association, Post-Acute Care Handbook: Regulatory, Risk and Compliance Issues, Overview of Certificate of Need and Licensure for Nursing Home, Continuing Care and Assisted Living, § 4 (2014).
In conjunction with applying for the requisite licenses, other regulatory filings may be required, including (1) submission of a change of ownership application for review and approval by the state before closing of the purchase transaction if the investor is purchasing stock or assets of an existing facility; (2) submission of a certificate of need to the state describing the need for a senior housing facility in the particular location where the facility will be situated if the investor is constructing a new facility (according to the NIC Investment Guide, Section H.3.2., certificates of need are required in two-thirds of the states); and (3) submission of an application for a CLIA certificate under the federal Clinical Laboratory Improvement Amendments (CLIA), 42 U.S.C. § 263a, if the facility will perform tests that fall under the CLIA, such as glucose or dip stick urine tests. When submitting an application to the state for a license, it is important to remember that certain states require significant notice periods before issuing a license. The purchase agreement should, therefore, reflect realistic closing deadlines based on the applicable licensing requirements.
Deciding which entity in the ownership structure to license is a state-by-state determination and can often depend on how the parties choose to allocate the risk of holding the license among themselves. Typically, as long as the OpCo holds a license, the PropCo and Manager need not hold a license themselves. Licensing the OpCo can also provide for more flexibility in continuing the operations of the facility if the PropCo decides to sell the facility down the road and can give the OpCo the ability to terminate the Manager without losing its license to operate. Some investors prefer a shield from the potential first-hand liability for day-to-day operations that can come with holding the license and may choose, if state law permits, to have the Manager hold the license instead.
In addition to the licensing requirements mentioned above, each state has regulations governing the standard of care required at senior housing facilities including resident rights, admission agreements, resident funds, abuse prevention, mandatory resident services, and staff qualifications, including training and continued education. State government regulation of senior housing facilities can even extend to a wide variety of design features of the facility including, but not limited to, fire suppression systems, ventilation and lighting, sanitation, handicap access, hallway and doorway widths, backup electric generation capability, and hazardous waste handling. These regulations can evolve with changes in state and federal government, so operators would be wise to keep up to date on these changes to avoid incurring any regulatory liability.
Deciding Among the Various Forms of Acquisition
Investors who decide to purchase an established senior housing facility instead of building one have several options when deciding how to structure the transaction. The investor can (1) purchase all of the stock of the seller through a stock purchase; (2) purchase certain assets of the seller through an asset purchase; or (3) merge or join in a strategic partnership with an existing business in the senior housing industry. Of these, stock purchases and asset purchases are the most common.
Stock purchases are a form of transaction generally available only to for-profit sellers. The benefit of a stock purchase is that the seller can keep the provider numbers it is using to operate the facility because the seller entity will remain in existence after the transaction is completed. The seller entity’s retention of provider numbers ensures that cash flow from the government and private payor programs to the facility will remain uninterrupted, reducing the amount of working capital needed to close the transaction. On the other hand, a stock purchase transaction results in the purchaser assuming both the assets and the liabilities of the senior housing facility. Because of the nature of the business, a stock purchase transaction can present the opportunity for state regulatory and tort liability for actions that took place under the seller’s ownership before the closing of the transaction.
The majority of transactions are structured as asset purchases because asset purchases allow the investor both to acquire the assets of the seller and to specially determine which liabilities, if any, it will assume. Examples of types of liabilities commonly excluded are third-party contracts with unfavorable terms and pre-closing litigation and other liability claims. The primary concern in an asset purchase transaction is that the investor must acquire not only a new license from the state but also new provider numbers from Medicare and Medicaid, which can lead to the loss of certain grandfathered exceptions the seller enjoyed and can delay or even prevent the closing of the transaction if the purchaser fails to get approved. The need to procure new provider numbers can also result in a gap in payments while the new provider numbers are being acquired.
Mergers and Strategic Partnerships
Mergers can be beneficial because they allow an investor to seamlessly acquire an existing business in the senior housing industry along with the expertise and potentially the licenses that come along with it, as is the case in a stock purchase. But mergers also result in the assumption of all assets and liabilities of the merged entity and therefore tend to lack the appeal of an asset purchase. Strategic partnerships can be beneficial for similar reasons, particularly when an investor chooses to partner with an established business in the senior housing industry and in doing so benefits from the expertise of that business. As is the case in strategic partnerships in any other industry, however, a partnership presents the risk of joint and several liability of the partners for the acts of the others and, as such, can be a riskier means of investing in the senior housing industry.
What to Consider When Drafting Asset Purchase and Other Ancillary Agreements
Drafting the Asset Purchase Agreement
As stated previously, asset purchases are the preferred form of acquisition because they allow an investor to avoid assuming certain liabilities of the seller. For the most part, asset purchases of senior living facilities are the same as purchases of other asset classes, but there are a few considerations unique to the senior housing industry that investors and their attorneys should keep in mind. For example, when defining the assets to be purchased, it is important to determine how the active and historical residents’ files and records housed at the facility will be transferred in compliance with state and HIPPA law and which of the governmental licenses, permits, authorizations, and certifications required to operate the facility can and will be transferred. Investors and their attorneys should also ensure that the seller makes representations and warranties affirming the facility’s compliance with all applicable legal requirements, including the various health care laws and programs such as Medicare and Medicaid, and that the facility is adequately insured and will continue to be so through the closing of the purchase transaction.
During the due diligence period, investors should obtain (1) copies of any information relating to pending claims on the insurance policies of the facility; (2) descriptions of any current or threatened litigation disputes; and (3) any third party billing audits of medical records. Along with the traditional termination provisions often found in asset purchase agreements, an asset purchase agreement for a senior housing facility should also include language stating that the parties can mutually agree to terminate the agreement if the purchaser is unable to acquire the necessary licenses or approvals required from state or federal regulatory agencies in a given time. An asset purchase agreement also can include per-facility termination rights that permit a purchaser that is purchasing multiple facilities to remove one of the facilities from the overall sale and reduce the purchase price accordingly, if certain closing conditions are not met with respect to that property.
Drafting Lease and Management Agreements
In addition to the purchase agreement, investors in the senior housing industry who choose the PropCo/OpCo ownership structure should require a lease agreement between the PropCo and the OpCo, and, if applicable, a management agreement between the OpCo and the Manager. When drafting lease agreements and management agreements, the primary considerations are risk allocation among the parties, quality assurance, and the economics of the transaction. Management agreements often go one step further to include provisions regarding (1) the Manager’s exclusivity in a territory; (2) duties and responsibilities of the Manager; (3) reasons and methods for terminating the management agreement; and (4) whether any termination fees will apply. Because Managers typically generate income through management fees on a percentage of gross revenues basis (ranging anywhere from three to six percent), management agreements can also often include subordination and even termination for below-market performance and incentive fees for above-market performance.
Management of the facility can include anything from instituting operating systems, policies, and procedures to developing sales and marketing initiatives and managing the facility’s finances and capital expenditures. If an investor has limited industry experience in the senior housing industry, lenders or underwriters may require the investor to retain a nationally recognized third-party management company to manage the facility. If a lender or underwriter does not require the investor to retain a third-party management company, the investor and its attorney and advisors should still conduct a cost-benefit analysis to determine whether it is cost-effective for the investor to develop the capability to manage the facility or whether a third-party management company should be hired instead. Jim Moore, Moore Diversified Services, Inc., American Seniors Housing Association Special Issue Brief: Management Companies and Fees – The Changing Dynamics Between Ownership and Management (Fall 2018).
Most management companies aim to shift the cost-benefit analysis in their favor by expanding the services they provide with the ultimate goal of spreading the overhead costs associated with operating a facility among various properties. In exchange for providing superior performance, Managers are negotiating larger management fees and longer contracts, with the management agreement commonly having a duration of five years with renewal options.
Drafting Resident Agreements
Though resident agreements are similar in many respects to residential leases, there are several important differences that investors should keep in mind. For example, when an investor purchases an existing senior housing facility, the investor often assumes the resident agreements already in place between the seller and the residents, and these agreements may have terms that are not favorable to the investor. Depending on the type of senior housing facility, evictions of existing residents can also be cumbersome. Most states require a review of both statutes and the accompanying regulations to ensure compliance with the requisite levels of care for each type of senior housing facility and the various rules regarding moving residents between levels of care.
The senior housing market presents an exciting opportunity for both new and seasoned investors to partake in a growing retirement industry. In addition to consulting with attorneys and financial advisors experienced in the industry, investors can raise their chances of success in the senior housing market by keeping several key considerations in mind. To begin with, investors can mitigate a portion of the risks associated with their investment by separating the ownership of the senior housing facility from the liabilities associated with the operations of the facility by vesting ownership and operations responsibilities in two separate entities, the PropCo and the OpCo. Where necessary or economical, investors should also consider hiring a management company with experience in operating a senior housing facility to compensate for any shortcomings the investor may have in expertise or resources.
Taking care to comply with the necessary licensing and regulatory requirements of the state in which the facility is located is also important, and investors should determine whether their entity or the Manager is the most appropriate entity to hold the facility’s operating license. When deciding the form of acquisition, investors should weigh the various pros and cons associated with each form and, in particular, consider both their specific needs for risk management and the requisite levels of expertise and synergies of resources most likely to lead to their success. Finally, it is important to remember the differences between drafting asset purchase, lease, management, and resident agreements for a senior housing facility and drafting agreements for other forms of specialty real estate, including the need to plan for specific types of operational risks and to ensure compliance with applicable state regulations.