Such improvements, coupled with the tremendous future need for the services these facilities provide and regulatory limits on supply, are transforming the senior care housing segment into a real estate asset class that will offer unprecedented and lasting investment opportunities. For those who doubt this prediction, I have two words: baby boomers. Members in this demographic bubble want to place their parents in high-quality facilities, the same types they will occupy in droves themselves in a few years.

As an added bonus, many states restrict the ability to build certain kinds of senior facilities: New bed licenses are not issued unless demand can be clearly demonstrated. What’s more, demand generally remains constant—seniors rely on fixed retirement incomes, not jobs and salaries. No other real estate sector enjoys these types of barriers to entry or insulation from the economic cycle.

Senior housing offering skilled nursing care (high acuity) or assisted and independent living (low acuity) exist in a variety of settings, with myriad hospitality and care services. Each of these care options offers numerous investment opportunities.

REITS, such as Healthcare Property Investors, Ventas, Health Care REIT and others, vary in size and strategy, but they all own properties—from senior housing to hospitals—and triple-net lease those to operators. This is generally the safest play, as operators cannot operate without facilities. REIT returns have been strong, averaging well over 15 percent per year for the past five years and between 5 and 9 percent (with dividends) over a 10-year period.

Individuals can invest directly in the senior care segment via IRS 1031 exchanges. There are operators that specialize in raising equity capital in this fashion. Though returns can vary substantially, they generally range from 8 to 11 percent. Alternatively, investors can make direct cash investments in property development or acquisitions with an operator. This option combines direct investment in both the real estate and the senior care operation, which carries both high risk and returns and is certainly not intended for unsophisticated investors. Stable acquisitions of this type can generate five-year levered cash yields of 13 to 15 percent, ignoring asset appreciation.

Finally, there are stock market plays in such companies as HCR Manor Care, Genesis HealthCare and Kindred Healthcare in skilled nursing, and Sunrise Senior Living, Emeritus Assisted Living and Brookdale Senior Living in the senior housing segment. HCR Manor Care is arguably the benchmark for the skilled nursing industry, with steady returns and strong management. Sunrise has long been viewed as the public benchmark for senior housing, with high-end facilities and generally strong, consistent growth.

Enough Is Enough
Though baby boomer demographics and controlled supply will ultimately make senior housing and care an attractive investment, this sector is not without risk. Of the publicly traded skilled nursing companies, only HCR Manor Care has avoided bankruptcy. It has generated five-year average annual returns of about 19 percent. Genesis HealthCare’s stock grew over 40 percent per year on average since it emerged from bankruptcy in 2004.

In the low acuity segment, few barriers to entry exist, so overbuilding can be a problem. In this nongovernment reimbursed sector, margins range from the mid-20 to mid-40 percent levels, but can quickly erode when overbuilt supply outstrips demand.

As might be expected, a predominantly government-paid business, like skilled nursing, carries low margins (generally single digits to upper teens). Ironically, what should be a low margin, low volatility business has not been the case. Changes in reimbursement, labor markets and liability issues surrounding care have wreaked havoc on the profitability of skilled nursing facilities.

Senior housing and long-term care is still a niche market, and the ebb and flow of capital can have a tremendous impact on it. Yet, it is a market that is moving from niche to the mainstream, therefore opening up tremendous long-term investment possibilities.

Kevin McMeen is managing director of Merrill Lynch Capital Healthcare Finance in Chicago.