Senior housing owners and operators saw their share prices slide on Monday as the markets plunged, with the Dow Jones industrial index posting its largest-ever intraday decline of nearly 1,600 points.
Toldeo, Ohio-based Welltower Inc. (NYSE: HCN) finished the regular trading day down 3.28%, Chicago-based Ventas Inc. (NYSE: VTR) posted a decline of 2.67%, and Irvine, California-based HCP Inc. (NYSE: HCP) dropped 2.56%. The companies are known as the “Big Three” health care REITs and are among the largest owners of senior housing properties in the country.
Other senior housing-focused REITs also felt the pain: Sabra Health Care REIT declined 2.78%; LTC Properties (NYSE: LTC) was down 3.99%; National Health Investors (NYSE: NHI) decreased 3.15%; New Senior Investment Group (NYSE: SNR) fell 3.87%; and Senior Housing Properties Trust (NYSE: SNH) took a hit of 4.00%.
After a prolonged boom, with the Dow reaching record levels, some market analysts say a correction has been in the cards. As for the timing, concerns over rising interest rates might be one factor for Monday’s precipitous market drop overall and the REIT impacts specifically. Because they are steady dividend producers that can be treated much like bonds, REITs and similar types of companies, such as utilities, are vulnerable when bond yields increase and investors shift away from the equity markets.
“The broader equity market is suddenly seeing huge downside and volatility as investors grapple with higher long-term U.S. Treasury yields and the potential for higher inflation,” Green Street analyst Michael Knott told Senior Housing News. “The health care REIT share price reaction is a reflection of these broad equity and debt market forces.”
The U.S Federal Reserve has made no secret of its intention to raise short-term interest rates, but there is added uncertainty at the moment, given that Janet Yellen has just stepped down as Fed chairman, being replaced by Jerome Powell.
“I think the shift at the Fed this past week, with Janet Yellen having led her last FOMC [Fed Open Market Committee] meeting and Jerome Powell taking the helm of the Federal Reserve, has also added some uncertainty since the markets generally understood Janet Yellen’s intentions and words,” Beth Burnham Mace, chief economist of the National Investment Center for Seniors Housing & Care (NIC), told Senior Housing News.
The installation of Powell might be stoking fears of even more aggressive interest rate increases than under Yellen, the Washington Post reported Monday.
Wage inflation, and how the Fed might respond to inflation, is also on investors’ minds, in Mace’s view. For four straight months, the unemployment rate has been at a 17-year-low of 4.1%, according to Bureau of Labor Statistics data released last Friday. Given that this is below what the Fed consider the “natural rate of unemployment,” it could signal that wages will increase. And, in fact, a separate BLS report last week showed that private sector wages and salaries rose 2.8% year-over-year in the final quarter of 2017; this was the fastest growth rate since the Great Recession.
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“It is also notable that for seniors housing, average hourly earnings were up by 5.3% in the third quarter from year-earlier levels, significantly faster than the national average for all industry sectors,” Mace stated.
Nirvana on the way?
Monday’s stock sell-off was a scenario anticipated by investment bank and market research firm Mizuho. A 10% to 15% sell-off in equities might occur early in 2018, tied to changes in the yield curve for bonds as well as inflation fears, the firm predicted in a report last month.
REITs might be hopeful that Mizuho will keep proving prescient: The firm has also predicted an equity rally in the second half of 2018. The argument is that, given that the U.S. economy has strong fundamentals and corporate balance sheets are healthy, interest rates might hit a ceiling and the Fed would move toward easing monetary policy in the back half of the year.
“…Upon realization that the increase in rates has formed a so-called ceiling (timing that event will be the trick), we would expect REITs to perform relatively well in the aftermath,” the report states. “The second leg of the economic expansion, sans a further increase in the 10-year Treasury rate, could be near nirvana from a REIT performance perspective.”
That said, health care REITs have some special considerations, including that Medicare and Medicaid rates could take a hit as the federal government seeks to keep deficits in check in the aftermath of the recently enacted tax reform. Furthermore, senior housing may continue to grapple with oversupply issues into 2019. But as REITs sell off assets and strategize in response to shifting health care policies, investors might see attractive opportunities not too far down the road, the report suggests.
Providers down too
Senior living provider companies were not immune to the damage inflicted on market valuations on Monday. Brentwood, Tennessee-based Brookdale Senior Living (NYSE: BKD), the nation’s largest provider, was down 2.18%. Dallas-based Capital Senior Living (NYSE: CSU), saw its shares drop 3.19%, and Newton, Massachusetts-based Five Star Senior Living (NYSE: FVE) was down 6.45%.
In addition to wage inflation putting pressure on labor expenses, a rising interest rate environment could constrain the ability to expand and renovate buildings, Mace noted.
“As rates rise, the economics of development will be affected and go-forward decisions on development activity may be paused or aborted,” she said. “This will have many repercussions for businesses directly involved in development, as well as for those with indirect ties to development activity.”
On the transaction side, senior housing valuations generally go down as interest rates—and capitalization rates with them—go up. This is not a foregone conclusion, however.
“Values could remain stable if … cap rates do not rise in lock step with interest rates, thereby allowing the risk premium, or the gap between the risk-free 10-year Treasury yield and the cap rates for seniors housing, to narrow,” Mace explained. “The risk premium could narrow if the perceived risk of investing in seniors housing declines. And this outcome is entirely possible since institutional investor interest in the sector is quite strong, keeping downward pressure on cap rates.”
Written by Tim Mullaney