Rising Interest Rates, Valuations Could Shorten Senior Housing Investment Runway

With active adult gaining popularity among investors as a property type, no slowdown in M&A activity and a more educated investor pool, senior housing capital markets maintained a robust performance in 2018. These factors are pushing asset valuations higher and spurring more lending.

But industry experts at last week’s National Investment Center for Seniors Housing & Care (NIC) fall conference in Chicago questioned how much runway remains before investor interest wanes and valuations see a course correction.

One eye on interest rates

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The Federal Reserve raised interest rates three times this year — most recently last month — and at least three more hikes are likely. The previous rate hikes have not curbed lenders from underwriting deals, but future rates may have that impact, KeyBank Real Estate Capital Vice President John Randolph told Senior Housing News.

The interest rate environment has not slowed KeyBank down. The firm ended the 2018 fiscal year as the top Federal Housing Administration (FHA) health care lender with $812.7 million in deal volume, the largest single-year number for the 232 Lean program. KeyBank recognizes that the brick-and-mortar component of senior housing is just a fraction of a property’s value, and has been underwriting properties with strong operators attached.

“Assets with good operators attached to them can absorb a jump in interest rates,” Randolph said.

KeyBank has been aggressive with bridge-to-HUD loans. Typically, these are underwritten with five-year terms and floating interest rates, so that borrowers have flexibility throughout the loan term. But the firm is also capital agnostic, doing a lot of agency business and looking to source alternative capital sources that don’t fit with the agency or FHA models, KeyBank SVP Ed Foulon told SHN.

M&A activity driving foreign investment, scale 

Equity investors remain hot on senior housing, with foreign capital playing a larger role in the sector and seeking to build scale. The Canada Pension Plan Investment Board (CPPIB), for example, is looking to deploy $1 billion in equity in the senior housing space.

The firm likes senior housing as an investment because senior housing is less correlated to GDP and, until recently, there was a lack of competition for assets, CPPIB Director of Real Estate Investments Lora Gotcheva said at NIC. CPPIB partnered with Toledo, Ohio-based real estate investment trust (REIT) Welltower (NYSE: WELL) to acquire a six-building portfolio in Florida in 2016.

As CPPIB is looking to deploy its additional $1 billion, it prefers larger metropolitan and urban infill areas. Memory care is as high as the firm is willing to invest, on the acuity spectrum.

“We’re not a core investor. We’re looking for dislocation in our target markets and high rates of return,” Gotcheva said.

Foreign investors from other nations also have a healthy appetite for senior living. For instance, Hong Kong-based Chevalier International Holdings Limited recently purchased a five-property portfolio from a publicly traded REIT. Beijing-based Cindat Capital Management announced last year it would deploy $2 billion toward senior housing acquisitions. Cindat now owns 145 senior housing properties in the U.S., Canada and the UK, Senior Partner Allan He said at NIC. Cindat has also identified operations as the primary driver in ROI, and will invest in operators in its markets moving forward.

“We are a strong believer in senior housing as a value creator,” He said.

However, Chinese investment in senior housing has stalled a bit — a result of the Chinese government’s efforts to restrict the flow of outbound capital.

Courtesy of NIC
Industry experts believe seniors-only apartment values will increase in the upcoming years.

Cap rates expected to compress

Capitalization rates in senior housing are also driving investor interest. But with valuations rising and an uncertain interest rate environment, a majority of experts polled by NIC expect cap rates to compress over the next decade. The supply currently on the market is not enough to satisfy investor demand, JLL Valuation & Advisory Services Managing Director Charles Bissell said at NIC.

Courtesy of NIC
A majority of respondents to a recent NIC survey believe cap rates will compress in the future.

“If a deal goes to auction, a market clearing price is set and bids rise to a level that ignore a property’s issues,” Bissell said. “As a result, the equity return is being dragged down.”

Investor interest is driving valuations upward, even as more data is released contradicting investor appetite, Locust Point Capital Managing Director Chris Claps said. This data includes declining occupancy rates, which have hit historically low levels as new supply has flooded certain markets, and growing disconnect between buyers and sellers. Capps believes investors are buying assets with long-term holds in mind.

“On the equity side, it’s a hard time to be direct,” Claps said. “Certain assets have intrinsic value because of their size; others are purely cash flow driven. Investors need to look at factoring out cap rates three to five years from now, as well as future sensibilities, to determine how aggressive they want to be.”

A wild card in future cap rate compression is REIT activity. The trusts have stayed on the sidelines in recent years but may become more aggressive as pricing drops.

“What happens if private equity converges with REITs re-entering the market?” Claps asked.

Written by Chuck Sudo

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