Assisted Living Owners; Are Your Property Taxes Too High?

By John Garippa, as published in Multifamily Executive, August 2000

Assisted living facilities contain significant amounts of value that are not real estate driven, but rather business related, such as medical and recreational services.  Taxing jurisdictions relying on traditional income approaches are significantly overstating value for tax purposes because of this.  It's incumbent on owners of assisted living facilities (ALF) to present a valuation model that removes these intangible business income values that are unrelated to the real estate.

The Assisted Living Federation of America has defined ALFs as: "a special combination of housing, supportive services, personalized assistance and health care that responds to the individual needs of those who need help with the activities of daily living, but do not need 24-hour skilled medical care."

Distorted View

Income is generated from these facilities by providing a number of individualized services.  There is a base rent plus any number of services requested by the resident.  As the residents age, more services are provided and the associated fees grow.  However, there is a danger in looking at the income data from these facilities and ascribing its value to the real estate.  What you generally see with income data are gross numbers, which substantially distort the view of the property.

Most of these facilities operate differently based on management styles.  Identical buildings often create different levels of income, based on the level of services and management style.  In other words, the income approach values the real estate as if it were a going concern - the inclusion of all elements of value, real property and business intangible assets.  This grossly overstates the underlying value of the real estate for tax assessment purposes.

If a company relied on the cost approach to value, other infirmities become obvious.  The costs to erect these facilities are not related to real estate value.  It typically takes two to three years for these facilities to lease up.  In the last several years, substantial premiums were paid to build facilities in particular areas to capture marketshare.  These premiums often are not related to market value.  While it may seem appropriate to discuss the cost approach in valuing these facilities, in times of dynamic change, cost rarely equals value.

There is strong evidence to indicate that ALFs have become overbuilt.  As a result of this overbuilt condition, not only would developers find no profit in the construction of these facilities, they could easily be faced with losses.  No one would value a hotel based on the cost approach.  Given this very salient fact, why would anyone value an ALF on that same basis?

Further insights into the recognition of business value issues in ALFs can be gleaned from a review of the U.S. Department of Housing and Urban Development (HUD) Notice H97-01 relating to mortgage underwriting standards for these types of properties.  This notice, which was issued Feb. 5, 1997, states that capitalization rates and expense ratios used by mortgage underwriters were too low.  "For example, the cap rates used (most less than 10 percent) didn't reflect the proper returns expected for the level of risk involved with this type of facility."

The general reason for default of these types of facilities was the inexperience of the developer.  With the focus on hospitality coupled with health care, assisted living units require much more intensive management than rental apartments.

HUD clearly identified this issue in its underwriting notice.  the notice said that this product is much more a health care business enterprise than a housing facility that merely provides additional services and amenities.  An ALF must be profitable for the project to remain viable.  The real estate is not what makes the project financially successful.

While there are very few court decisions discussing assisted living, the 19th Judicial Circuit of Virginia heard Marriott Senior Living Services Inc. vs. Board of Supervisors of Fairfax.  The court concluded that capitalization rates for these facilities must be higher than typical apartments and townhomes because of the need for more intensive management and greater risks due to amenities.

The "Real" Expense

The key issue is that real estate is perhaps the smallest part of this pie.  The operating expenses are the big piece.  these non-realty operating expenses include, but are not limited to nursing services, assisted living services, recreation therapy, transportation, social services, day care, medical needs, food services, housekeeping, laundry and beauty shops.  While there are separate fees for some of these services, often they are merged into the monthly rental.  Additional non-realty payroll expenses can include an executive director, activities director, administrative secretary, receptionist, marketing director, wellness director and recreation specialist.  Add to this a kitchen staff, which can include a food services manager, chef, food servers and dishwashers, in addition to extensive security specialists, and the evidence becomes overwhelming.

When we see that the combined fee for all these non-realty services may be as much as $2,000 to $3,000 per month, or higher, for a small one-bedroom assisted living unit, it becomes easier to understand why the rental rates are so high.

Perhaps the only way to remove all of the intangible business value from the operating real estate is to try to compare the facilities to appropriate comparable rental units for similar quality apartment complexes that do not offer non-realty service.  Adjustments can be made for differences in comparable rental rates due to variations in common areas and amenities.

While this adjustment process may appear to be less than perfect, the methodology comes much closer to the mark to value the real property at its proper level.  It will not be unusual in this methodology to show high-end senior apartments without any ancillary amenities at a ratio of one-third of the assisted living facilities rental units.  This approach allows for a fairer treatment of assisted living rental properties.

The assessing community must be educated to the fact that the real estate component of assisted living may be the least important factor in the overall income.  Hopefully, in the coming years, the appraisal community will accept these assessments.

John E. Garippa is senior partner with the law firm of Garippa, Lotz & Giannuario, with offices in New Jersey, New York and Pennsylvania.