Senior Housing’s 2011 Construction Pipeline Clogged in Anticipation

The seniors housing and care industry was in recovery mode in 2011 as the construction pipeline leveled off and occupancy rates rose, and while this creates development opportunity going forward, industry analysts don’t expect to see substantial amounts of new construction in 2012.

The sector saw slight improvement in some fundamentals such as occupancy, revenue, and rent growth, says Nick Gesue, senior vice president at Lancaster Pollard, with the exception of skilled nursing, which has been hit by Medicare cuts.

“What we’re focused on in 2012 is the new development world,” says Gesue. “We’re now in a period where there have been significantly depressed new starts on projects, for three years now. We’re hitting a point where the lack of supply, coupled with the continued aging and frailty of the population, is going to create pockets where there’s going to be huge opportunity for new development.”

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However, he adds that that new development isn’t going to be “wild” thanks to the continued difficulty banks have had in lending to this new construction space.

New projects are subject to underwriting requirements and the availability of capital, agrees Michael Hargrave, vice president of the National Investment Center for the Seniors Housing & Care Industry’s market area profiles data and analysis service (NIC MAP).

“In order to drive the pipeline up further, it’s going to require a more significant loosening of underwriting criteria and/or some larger sources of capital such as Wall Street or the REITs getting interested in development,” says Hargrave. “Once those sources are interested in development again, that’s the next period when you’ll see the construction to inventory pipeline rise above the 2% range again.”

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Construction pipeline dwindles

In 2011, the overall construction pipeline fell 63% since the fourth quarter of 2007, when more than 21,000 units were under construction in NIC’s top 31 Metropolitan Statistical Areas (MSAs), according to NIC data. Now, there are about 7,000 units under construction, with about 1.5% of existing inventory in the largest metro areas.

“We saw the pipeline contract from 2008 to 2010, and it’s still slowly declining, but settling into a lower range,” says Hargrave, pointing toward a 1% inventory growth in the most recent quarter of 2011 compared to the middle of 2008, when the rate was growing annually at about 2.8%.

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“What this means going forward is that this is setting the stage for some attractive supply-demand fundamentals that are emerging in the sector right now,” he says.

Demand for senior housing has been steadily building and is expected to continue to do so, resulting in a “year of anticipation” in 2011, according to Phil Downey, co-principal of Senior Housing Analytics.

“We still don’t see a lot of groundbreaking of new construction activity, but there’s been more mobilization and more interest in building pipelines for development over the next 3-5 years,” he says. “You can’t really point to hard numbers in terms of construction starts, but you can anticipate that will come to fruition over the next 24 months.”

Occupancy rising steadily

Dwindling inventory will increase demand, but growth will remain steady on a smaller scale, says Hargrave.

“In 2012, we are going to see this steady sort of [about] 1% of inventory growth; we’ll probably see the number of units under construction bounce between say 6,000 and 10,000 in 31 largest MSAs,” he said. “Given what we know now about the economy, consumer confidence, supply, etc., there will be continued upward pressure on occupancy rates throughout 2012. “

He pointed out that while occupancy rates have risen to 88% across the largest 31 MSAs, they are still significantly down from levels of nearly 92% that were reached at the end of 2006 through the beginning of 2007.

“It’s going to be some time before we get back to ninety-plus percent industry wide,” Hargrave says. “We need to see higher levels of absorption. My guess is, there will be continued modest increases throughout the year.”

Construction activity across various types of senior housing & care

Helped by its “needs-based” services, assisted living hasn’t seen as much of a slow down, says Hargrave.

“It’s no where near to the extent on the independent living side,” he says, adding that inventory is growing at 1.3%, compared to its high rate of 1.7% in the middle part of 2009.

Plus, there’s room for further development in this sector.

“There seems to be sustained interest in memory care-specialized facilities as a development model,” says Downey. “It’s a niche that hasn’t been fully exploited.”

Independent living, on the other hand, saw more of a contraction in its pipeline than assisted living. There was a more than 65% decrease in the number of units under construction between now and at the end of 2007, Hargrave says.

“The inventory right now is growing annually at a rate of 1%, and it’s going to slow further into 2012 because the pipeline isn’t sufficient to support inventory growth in excess of 1%,” he says. “It’s very attractive supply fundamentals.”

There’s not much supply left, Downey agreed, but independent living has seen more positive absorption year over year compared to the previous year.

As for continuing care retirement communities, Downey says there “seems to be a cloud over the entry fee model” especially with recent publicized defaults and bankruptcies.

“There’s uncertainty around the future viability of entry fee models, and concern over how they’ll bounce back,” he says.

Supply and demand factors in 2012

New or more construction will depend on the availability of financing, and some of that might come in the form of REITs (real estate investment trusts) since the Department of Housing and Urban Development isn’t always the best option.

“HUD as a construction lender is not a very efficient source of capital, given the timing delays and their very open concern over funding new development,” says Lancaster Pollard’s Gesue.

REITs will have more capital for next year, however, according to Downey. “They’ll be doing RIDEA structures, and they appear willing to channel more capital into growth—it’s a significant trend,” he says.

The past 12 months have been a year of anticipation with REIT consolidation and players lining up, he adds. This sentiment was echoed by Gesue, who says it’s possible that REITs could take a broader role in financing new development; heading into the new year, this could feature into building balance sheets.

“REITs can finance development. They can fund with cash the construction of new properties for their operator partners,” Gesue says, although this never been a dominant financing vehicle.

Although the senior housing and care industry is gearing up for what some have termed a “silver tsunami,” it’s not hitting yet, Downey and Hargrave agree. This means that absorption levels are likely to rise, pushing occupancy rates higher, before there’s a surge in new construction.

“We’ll know two years in advance of any sort of higher levels of construction activity” through seeing units getting started, construction starts picking up, and the pipeline filling and translating into inventory growth, Hargrave said. “Absorption (the pace at which people are moving into units) is growing around 1.9% right now, while the pace of inventory is growing at 1%. Barring more significant economic stress or things that hit consumer confidence, I don’t see factors that are going to lead toward demand or absorption being lower than supply right now.”

Written by Alyssa Gerace

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