Covid-19 Driving Cap Rate Expansion, Could Lead to Pricing Disconnect for Senior Living

While the Covid-19 pandemic will surely cause major disruptions in the short-term, the senior housing industry is still a good long-term bet if the economy rebounds relatively quickly.

The conditions which have girded the senior housing market in recent years — changing demographics chief among them — are not expected to leave with Covid-19. At the same time, the pandemic could give the industry a chance to prove its worth amid a challenging and scary time for older adults and their families.

But that doesn’t mean the landscape for U.S. senior housing won’t change as the pandemic drags on. Specifically, the industry may see some repricing in the months ahead, according to Mary Ludgin, senior managing director of global investment research for real estate investment management firm Heitman.

“I anticipate that there will be an expansion of cap rates in this sector on a relative basis in the near-term,” Ludgin said on a National Investment Center for Seniors Housing & Care (NIC) webinar Thursday. “Long-term … the demand is strong, and this pandemic is not going to change that meaningfully.”

On the operations side, senior living providers are already grappling with declining occupancy and a slowing rate of move-ins.

A recent NIC survey of 105 senior housing and long-term care owners and executives found that 51% of all respondents that offer independent living reported at least some declines in occupancy in the past month. Among assisted living providers, 65% said they had seen some occupancy declines in that time period; and among providers that offer memory care, 58% reported occupancy declines in the past month. For nursing care providers, the picture is even more dire. A whopping 84% of nursing care respondents reported at least some declines in occupancy in the past month.

Move-ins have also decelerated in the wake of the pandemic, with 71% of independent living providers, 74% of assisted living providers and 64% of memory care providers reporting a deceleration in the pace of move-ins in the past 30 days. The same was true for 87% of nursing care providers who responded to the survey.

NIC

Health care and senior housing REITs saw stock prices plummet at the outset of the pandemic, partly because investors didn’t know how to price the risk of Covid-19. The private markets will likely also take a hit in pricing, but where prices might end up isn’t clear right now, according to Calvin Schnure, senior vice president of research and economic analysis for National Association of Real Estate Investment Trusts (NAREIT).

“The private prices are going to be down,” Schnure said. “Whether they settle at where we were several weeks ago, where we are right now or where we end up in the public market in a couple of weeks, we’re just going to have to wait and see.”

But periods of sharp decline in pricing, whether it’s in the private market or in the public market, may also create an entry point for investors, according to Michael Acton, managing director and head of research at AEW Capital Management.

“There are going to be opportunities, there are opportunities already,” Acton said on Thursday’s webinar. “Periods of very large price decline are typically followed by periods of very outsized performance.”

New transactions will be trickier, at least in the short-term, as many of the metrics used in valuations are still not clear right now.

“We’re going to have buyers that have one view of value and sellers that have another view,” Ludgin said. “And you’re going to see a lot of structured transactions come out of this where those would-be sellers need capital, but they don’t want to sell at the prices we’re willing to buy.”

In the long-run, investors still see the demographics behind senior housing as favorable, Acton said. But in the short-run, challenges caused by the pandemic will lengthen lease-up periods for new developments, slow move-ins and put a damper on occupancy.

Other pressures caused by the pandemic’s economic fallout may squeeze the industry, too. Specifically, some of the trends that played out during the Great Recession may return.

“Things we saw back in the financial crisis may come into play,” Acton said. “More difficulty for seniors to sell their home [to] use those funds to pay for their residency, or possibly adult children being under financial pressure.”

To Schnure, the biggest risk to the sector right now is the possibility that an economic downturn would delay the baby boomers moving into senior housing communities en masse. If the downturn continues even longer than expected, and induces permanent job losses and more bankruptcies in the process, the economic effects could well outlast the pandemic itself.

“This is in the middle of a demographic transition, and the high level of supply was really counting on a rising wave of older Americans moving into senior housing,” Schnure said. “And the biggest risk right now is that that will be delayed or maybe won’t even happen.”

Additionally, another unexpected disaster on top of the pandemic could tip things from bad to worse.

The biggest downside risk right now is that something else happens while all of this is going on,” Acton said. “It doesn’t seem like the policymakers have much bandwidth right now to deal with much of anything else.”

But there is a silver lining. The senior housing industry can use the pandemic to illustrate how it is well-equipped to care for the nation’s older adults, and potentially emerge on the other side with a stronger reputation.

“There are a lot of headlines out there that are making people anxious and nervous,” Acton said. “But I think this industry … is demonstrating that this is actually a remarkably safe place for your elderly relatives to be.”