Senior Living Providers, Investors Must Heed Early Warning on Oversupply

I did not expect potential senior housing oversupply to be a hot topic at the National Investment Center for Seniors Housing & Care (NIC) conference last week, but I also was not surprised by the concerns.

I did not anticipate this would be a hot-button issue because high material costs, construction industry labor pressures and tangled supply chains are still presenting obstacles for new development.

On the other hand, I was not shocked to learn that construction is surging, with some markets seeing more starts in Q42021 than they did in Q42019, according to NIC MAP Vision data. That finding lines up with statistics from other sources, including architecture, engineering, and construction data firm PSMJ Resources. And it aligns with messages from senior living operators and developers, who have signaled an intention to pursue new construction despite obstacles.

In this week’s exclusive, members-only SHN+ Update, I analyze senior living construction trends and offer key takeaways, including:

• Significant hurdles are not deterring new construction
• Nuanced market analysis must consider factors such as “hidden supply,” labor dynamics
• Building for a consumer niche is more critical than ever, especially in hot markets
• Owners and operators must strategize now about plans for older communities

Hurdles do not deter construction

I was at a dinner at NIC last Wednesday night when the CEO of a regional provider first raised concerns about possible overbuilding. The CEO told me that NIC Chief Economist Beth Mace has been seeing early signs of a construction boom, and he urged me to spread the word via Senior Housing News.

Sure enough, Mace raised the issue in a presentation the next morning. Her comments were measured but her message was clear: The data show independent living and assisted living starts rose “pretty sharply” in the last six months, and developers must be wary.

“There is a lot of interest in developing senior housing, and there are absolutely a lot of opportunities to develop it,” she said. “Just keep in mind that there are a lot of competitors, and a lot of other operators and businesses that want to do it.”

To a casual listener, her words most likely seemed mild. But to those in the industry — like that CEO who shared his concerns over dinner — her message was more dramatic. That’s because a slowdown in new construction has been routinely cited as a silver lining of the Covid-19 pandemic, helping to resolve persistent oversupply issues and promising a period of less intense competition for established owners and operators as they seek to rebuild occupancy and NOI.

For example, Welltower’s investor presentation cites “meaningful deterrents for new SH construction” as helping to support sustained revenue acceleration this year and beyond.

Ventas’ presentation highlights a slowdown in construction starts as part of “compelling supply and demand trends.”

And Brookdale’s presentation likewise includes data on reduced starts and community openings, describing a “favorable, lower new supply trend.”

To be sure, such slides are still valid — Mace noted that construction levels remain below pre-pandemic levels in most primary markets.

But Q42021 starts eclipsed Q42019 levels in Washington, D.C.; Portland, Oregon; Dallas; Miami; and Orlando.

And NIC is not the only organization to highlight a construction comeback in senior living. PSMJ surveys architecture, engineering and construction (AEC) professionals each quarter, asking whether they have seen an improvement or decline in proposal activity across a range of sectors. In Q42021, 51% of respondents in senior/assisted living saw an improvement and only 5% observed a decline, with the remaining respondents saying the market held steady.

Out of all the sectors tracked, senior/assisted living displayed the 10th-fastest improvement between Q3 and Q4 of last year.

“As it stood at the end of the year, the outlook for 2022 … looked very strong,” Jerry Guerra, principal at AEC thought leadership, marketing and business intelligence firm JAGG Group, told me. “It will be very interesting to see the first quarter of 2022. None of the factors we saw back [in Q4], including inflation, were slowing the market down.”

This quarter, prices for oil, steel and other construction-related products have spiked as a result of the war in Ukraine. Possibly, these costs could be deterring new construction; on the other hand, looming interest rate increases could keep projects moving.

“This plays into that decision, do you go ahead with construction, not knowing what materials will cost and when the project will be finished, or do you wait until things calm down? And I’d say the signal here is go ahead now, before projects stop penciling out because of higher rates,” Kenneth Simonson, chief economist at the Associated General Contractors of America, said at NIC.

Nuanced analysis a must

Investment in senior living is on the upswing despite all of the current costs and complications for two primary reasons, NIC Board Chair Kurt Read, managing director of RSF Partners, proposed at the conference.

“We have a simple, easy to understand story around the drivers of growth in our space, and we have demonstrated good returns over the long run,” he said.

While the demographics might be simple, the considerations about whether and where to develop new senior living projects are becoming increasingly complex, demanding nuanced analysis.

For instance, with more people able to work from home than in the past, smaller cities with lower costs and high quality of life have attracted people from larger metros. Last year, Idaho was No. 1 in the nation for population growth at 2.9%, Simonson noted.

“I do think that Boise and Coeur D’Alene will have staying power; they’ll continue to draw people from the West Coast,” he said.

Developers understandably are eyeing these growing markets for senior living opportunities, but they should beware — at NIC, I spoke with an industry veteran who was involved in building memory care in Coeur D’Alene, and he noted unexpected challenges from the large number of small care homes in the area. Small homes are a growing segment of the industry and might not appear on traditional market analyses gauging competition.

Labor availability is another element of market analysis that has gained in importance as the senior living workforce has shrunk amid the so-called “Great Resignation” and other pandemic-related disruptions.

“Now, when people are penciling out feasibility studies, they don’t just look at the adult children as well as the density of seniors; they are also looking at, where’s that labor going to be coming from?” Mace said at NIC. “ … A lot of operators are putting the same amount of effort that they put into marketing for residents into marketing plans for new staff.”

The severe labor crunch appears to be driving a trend of creating new workforce housing or subsidizing housing in conjunction with senior living development projects. For example, skilled nursing operator Majestic Care offers a 20% housing discount to workers in certain markets through a partnership with a company called Panda ECS.

Developer Navigator Homes is working with a hospital partner to create workforce housing in conjunction with a Green House project on Martha’s Vineyard. Creating such housing is especially important in resort areas without an existing housing stock at an affordable price point, and Navigator Homes President and CEO Renee Lohman believes this practice will become “the norm throughout southeastern Massachusetts, up through Boston.”

Twin Cities-based Presbyterian Homes & Services (PHS) has been pursuing a workforce housing strategy since before the Covid-19 pandemic, which has aided the provider in recruiting staff internationally and in addressing turnover.

“With workforce housing already hard to secure, this creates challenges for employees to maintain active employment, and also creates significant household pressure to ‘job hop’ based on fairly nominal increases (10-25 cents per hour) in wages offered elsewhere,” Jon Fletcher, vice president of PHS’ development arm Senior Housing Partners, told SHN in 2019.

More differentiated products

While the demographics suggest an incipient boom in demand for senior housing, older adults have an increasing array of options for where they live and how they access services, Mace pointed out at NIC.

So, developers must be “careful” to “build the housing that the consumer really wants,” she said.

I am optimistic that investors and operators have learned some hard lessons from past cycles of oversupply and are creating more differentiated products that will appeal to specific consumer niches, rather than flooding markets with cookie-cutter buildings.

Washington, D.C. could be a case in point. This is one of the markets where construction starts exceeded 2019 levels at the end of last year. However, I’m optimistic that the nation’s capital might illustrate how differentiated products can co-exist and thrive as new communities open in the coming years.

On the high end, Mather is building a life plan community in Tysons; Galerie is bringing its ultra-luxe Corso brand to the market; Maplewood is undertaking its second Inspir project; and Silverstone is pursuing a pipeline with Watermark Retirement. These are distinct projects, from Mather’s high-rise entrance-fee option to Maplewood’s historic redevelopment to Watermark’s wellness-forward offering to Galerie’s continuum-of-care rental model with highly customizable living units.

And there’s also innovative activity at the other end of the price spectrum, with operators Northbridge Companies and its partners developing a middle-market assisted living community through a Medicaid waiver pilot.

The ultimate hope is that these sorts of communities will appeal to distinct market segments but also expand the proportion of older adults who move into senior living, driving up the penetration rate that has been stuck at around 11% industry-wide.

“If we’re able to increase the penetration rate by just a little bit, we can take all the new supply that’s coming in pretty quickly,” Mace noted.

The future of aging buildings

While development activity is ramping up now, new buildings that are just under construction will not open for about two years or more, particularly given the delays caused by supply chain disruption.

So, now is the time for senior living owners and operators to assess their existing portfolios and devise strategies for older buildings.

In primary markets, 60% of senior housing stock is more than 17 years old, Mace noted.

Many of these communities are already past their years of peak performance, which typically occurs when a property is between 10 and 17 years old, according to data that NIC shared with SHN in 2019.

As new buildings come online in the coming years, these older communities will face an increasingly difficult challenge in maintaining occupancy. At NIC, I spoke with the CEO of a highly regarded operator who said that — no matter a community’s strong programming, warm atmosphere and stellar brand — an outdated building simply deters move-ins.

I think this is real talk, and I suspect that investing CapEx into a 20-year-old building to refresh carpets, fixtures and paint will not be enough to compete with shiny new communities. Forward-thinking organizations should get creative about the future of their older stock.

Perhaps these communities can be converted into a middle-market model, in the vein of what Merrill Gardens is doing with its Truewood portfolio. Maybe they can serve as workforce housing, particularly if a company is pursuing new development nearby — or if competitors are doing so, creating demand for affordable housing for their employees. A conversion to behavioral health might be on the table.

In any case, owners and operators cannot afford to drag their feet as they consider the future of aging stock — and investors eyeing the sector should not only consider ground-up development opportunities but think creatively about the potential for significantly repositioning older buildings or portfolios.