Well before 2019 was on the horizon, experts were speculating on the health of the senior housing industry.
As 2018 came to a close, investor confidence in the market continued to drive interest, and flooded the capital markets with money. Deals like Apollo Global Management’s $428 million deal for HCP’s Brookdale Senior Living portfolio and Greystone’s $300 million collateralized loan obligation (CLO) epitomized that confidence. While the industry struggled with low occupancy rates for much of the year, a decreasing number of new construction starts indicated a reversal us around the corner.
In order to determine what trends to keep an eye on in the new year and get a sense of how the markets will respond, Senior Housing News caught up with Calvin Schnure, senior vice president of research and economic analytics for the National Association of Real Estate Investment Trusts (NAREIT), and Don Husi, managing director of Chicago-based speciality investment bank Ziegler, to paint a picture of the year to come.
Overall, their view for senior housing is mixed, with a debt-equity mismatch growing starker, active adult gaining traction, a need to address affordable housing and lending getting even tighter.
A pullback on lending
Even before the Federal Reserve started raising interest rates, banks were tightening their real estate lending, particularly on construction loans. The past six months have seen banks do significant pullback on lending terms, so that they are not overleveraged. The new year may see a contraction of the total pool of debt available to borrowers. This will put significant pressure for buyers to finance properties lacking existing cash flow. Sponsorship strength will become more critical to secure financing.
“On construction loans, banks are moving their loan-to-cost ratio to the 55%-60% range,” Husi said.
The Fed’s rate hikes have also impacted the yields on three- and five-year bonds, which Schnure predicts will have an impact on mezzanine loan volume. Every 50 basis point increase in interest rates will affect mezzanine lending.
“The majority of deals will still be attractive,” he said. “But interest rate hikes will make some deals that were touch and go, less attractive.”
That said, lending still favors the borrowers, Schnure said. The rate on the 10-year Treasury note remains low and attractive for borrowers. While Federal Reserve Chairman Jerome Powell said he would slow the pace of interest rate hikes moving forward, seeing rates increase another 25 to 50 basis points would not place the market in hibernation.
“If we look at risks, if they don’t raise rates enough, we risk an overheating economy,” Schnure said. “The risk of too little tightening is remote.”
And expect equity to remain plentiful.
“There is still plenty of equity looking at deals,” Husi said. “It’s already placed in funds and being more cautious about where to deploy capital. There is a fair amount of new money out there that is very active. Some of that seems to be moving to distressed properties, and some into new development.”
Active adult will grow in popularity
Active adult, as proven by the popularity of new concepts like Margaritaville and tried-and-true models like Sun City, is a contributing factor in the low occupancy rates for independent and assisted living the past year. Schnure and Husi expressed caution for the growing active adult market, moving forward.
Husi said the active adult trend is the latest he has seen in his 30 years in the industry.
“The first cycle fizzled out because of overbuilding,” he said. “There are a few companies that are betting big on active adult. But in terms of what owners and operators are doing, I see it having little impact on assisted living and memory care, because there are so few opportunities out there.”
Schnure sees this active adult trend sticking, driven by the desires of the silent and boomer generations moving into active adult and age-restricted communities. Schnure believes the earnings potential of Gen X and millennials hold the key to any explosion of growth in active adult.
“For a generation, one big factor in moving into senior housing is the employment status of the child living closest to a parent,” Schnure said. “If we see higher wages among workers in their 30s, 40s and 50s, it will make it easier for seniors to make the transition to active adult.”
Home sales will be another contributing factor, as the revenue from those sales paves the way for seniors to transition to active adult. Husi said there is no indication housing values are declining, but the rate of increase appears to be slowing, depending on the market.
Affordable housing pressures
The pressure to provide quality affordable housing for seniors mirrors the pressures being felt in multifamily real estate. Those pressures will only grow as developers expand their marketplace. For-profit operators could explore Section 142(d) retirement housing bonds to fill the void, Husi suggested. These tax-exempt bonds can be an attractive non-recourse financing source. To qualify, 20% of the residents must have taxable incomes at 50% of the area median or below.
“We hope to expand and accelerate this usage, as the need for affordable housing grows,” Husi said.
A lack of quality operators
The mergers and acquisitions in the senior housing market have widened the gap between operators with scalable national platforms and regional operators struggling to maintain quality of care as their portfolios grow.
“What is clear is there are fewer high-quality operators with scale that can be effective working with multiple owners and geographies,” Husi said.
Husi added that it is hard to find regional operators that can operate a portfolio exceeding 50 properties efficiently. As these operators expand, it is harder to maintain focus and manage company culture, even with advancements in technology.
REITs remain a wild card
After a heavy period of trading a few years ago, real estate investment trusts (REITs) have stayed on the sidelines the past couple years, when the cost of capital increased, Schnure said. Instead, the trusts have focused on restructuring portfolios and developing strategies for when the cost of capital becomes more favorable.
When that time is, is anyone’s guess.
“Any uptick in acquisitions will depend on stock returns,” Schnure said. “There were some promising numbers in Q3 2018. If prices continue to rise and trading increases, we could see them return to the market.”