Despite concerns that a senior housing bubble is forming, the market shows no signs of instability. In fact, cap rate spreads suggest there’s much more room to grow.
And while investors have taken note of some regional hot spots for development, new construction is well under where it should be in order to meet the rising tidal wave of demand, according to findings from CBRE’s 2014 Cap Rate Survey.
The survey analyzes senior housing cap rates as compared to the 10-year Treasury to determine if the market is getting more bullish with a lower risk threshold, or if investors are pulling back and applying more risk in how they deploy capital.
And CBRE’s findings only point to more growth opportunities — in the short and long term.
“If you look at where cap rates are today compared to the 10-year Treasury, we’re pretty much right in the sweet spot,” says Zach Bowyer, Managing Director at CBRE. “There’s nothing to suggest current pricing levels are too aggressive.”
Cap Rates Show Room to Grow
Senior housing cap rates have averaged a roughly 516 basis point (bps) spread to the 10-year Treasury, with the most recent spread nearly equal to the historical average, at 517 basis points.
This alone, the report notes, indicates room for further compression in the case of rising interest rates, with a bottom — or bubble — expected to fall when spreads are realized in the 350- to 400-bps range. In the past, spreads dropped to this range in late 1999-early 2000 and in 2006-2007, prior to the market downturns.
A compressed, or smaller, spread shows investors’ strong appetite in the sector, marked by a positive outlook and lower cap rates. A wider spread, on the other hand, indicates investor concern, a slow-down in market activity and higher cap rates — which were seen following the market downturns.
“Looking at the current spread, there’s nothing to suggest that we’re currently at bubble levels in terms of pricing, where you would be concerned that people are paying too much,” Bowyer says.
The report also compares senior housing cap rate trends to those in the multifamily housing sector, noting that cap rate spreads for senior housing are “clearly compressing to apartment levels.”
“From a risk outlook standpoint, it is getting closer to your standard multifamily risk outlook,” Bowyer says.
Construction Increasing, But Not Fast Enough
Despite senior housing construction activity moving toward a high-growth period, with inventories expanding at their fastest pace in recent years, this supply still isn’t nearly enough to meet the coming demand.
In fact, supply will have to increase nearly 150% in order to meet peak demand in 2044, with a significant supply shortage beginning in 2024.
CBRE reports that approximately 40,325 units must be added per year in order to meet this demand, compared to the current construction rate of about 16,440 units per year.
The key, however, will be maintaining a balance over the next several years, with supply growth expected to slightly outpace demand growth in the near term.
“What you would expect over the next 10 to 15 years is that some markets will experience short-term downward pressure on occupancy and rent growth due to increased supply, coupled with an influx of inexperienced market participants entering the market,” Bowyer says. “But once the baby boomer demographic truly enters the space, it’s literally going to be a tidal wave of demand. The truth is, there’s going to be demand for every different [type] of product, whether it’s home care, affordable or high end.”
Download the CBRE Cap Rate Survey here.
Written by Emily Study