The senior housing golden age occurring since the end of the recession has been marked by record-high transaction volume, new capital in the sector and blockbuster deals. But the economic cycle that has proven so fruitful is nearing its peak, meaning it’s time that investors and operators take a hard look at what’s ahead for the industry, according to Beth Mace, chief economist and director of capital markets at the National Investment Center for Seniors Housing & Care (NIC).
Mace outlined the current economic climate for the senior housing sector Friday at the NIC National Conference in the Washington, D.C. area. She covered the effect that impending target interest rate hikes and fluctuating cap rates could have, saying that net operating income (NOI) will have to increase to compensate for challenges posed by these factors.
“Roll up your sleeves, know your markets and know your properties,” Mace told Senior Housing News about the approach that senior housing stakeholders should have at the moment. “We’re heading into an environment of potentially rising interest rates, which will have a major impact on capital markets—cost of capital, valuations—at a time when construction is coming. Have some dry powder put aside to be able to withstand any kind of a future challenge going on.”
Little financing was available for new construction starts during the recession, but development has since been on the rise, prompting fears of oversupply, particularly in certain markets. Despite such concerns, commercial real estate professionals have indicated their faith in the sector, according to research findings released by NIC in August. And Mace said over the next four quarters, she expects supply to mirror demand.
As for the interest rate environment, the Federal Reserve recently decided to stay the course on its federal funds rate target, maintaining its 0% target that’s been in place since December 2008. When that target ticks upward, though, Mace said to expect some shakeup in the industry, especially when it comes to cap rates, valuations, development and transactions, which will require NOI growth.
Currently, senior housing cap rates are steady at about 7.7%, and Mace said it’s unclear whether they would follow rising interest rates or spread wider. The average price per unit is $173,000 for senior housing and $72,500 for skilled nursing as of the second quarter of 2015.
It’s inevitable for that to change moving forward, though, Mace said, given the cyclical nature of real estate and the economy in general.
“The market has changed, and there’s a cycle going on,” Mace tells SHN. “We’re in a part of the cycle that has more growth, so it just means you need to pay more attention to the contributors to revenue.”
A shift in market conditions doubtless will have its implications on how cash flow is managed, Mace said. Making sure that some cash it put aside is key, then, she said, in order to avoid being caught short like some were in the last downturn.
“Make sure that you have strong properties and locations to try to be able to grow NOI, because there will be pressure,” Mace said.
Still, Mace said she doesn’t believe the sky would fall in an interest rate hike and doesn’t foresee major challenges down the line.
“We had 0% interest rates when we were in a crisis mode in the U.S. economy, when everything was falling apart,” she said. “Generally, the economy is pretty strong. I think we can weather higher interest rates.”
Written by Kourtney Liepelt