Senior living operators face short-term turbulence when it comes to property values across all care types, but that turbulence could be an opportunity for well-positioned buyers looking to expand their portfolios.
Higher interest rates have made inking new deals prohibitive in the short-term, with operators and lenders needing to get even more creative than before in order to get deals to pencil out.
“You just can’t do deals like the way you did 12 months ago,” said VIUM Capital Managing Director Grant Blosser. “It’s not an opportune time to sell right now.”
Senior living property values have risen in recent years, a trend that was halted and reversed by the Covid-19 pandemic. In 2023, dealmaking has yet to return to pre-pandemic levels as market conditions today complicate new deals.
While property values aren’t at their lowest-ever totals, they have yet to return to pre-pandemic levels, according to Blosser. Ultimately current trends could lead to a reset in senior living property values, which could act as a green light for more transactions down the road. But for now, creativity is the name of the game.
“I think what’s driving [values] right now is there’s just more creativity in the market,” Blosser told Senior Housing News. “There’s probably some upside for everyone in the next 12 to 18 months once rates pause and start coming back down.”
The National Investment Center for Seniors Housing and Care (NIC), reported $800 million in transaction activity in the first quarter of 2023, representing a dealmaking slowdown versus previous years that could continue for the remainder of the year, NIC Chief Economist Beth Mace told SHN. She likened the current landscape for new transactions as “a little like a game of chicken.”
“If you’re a seller, you want to make sure that you can get the best price,” Mace said. “And if you’re a buyer you don’t want to buy something that you think could go down in value tomorrow, so a lot of folks are on the sidelines.”
Deal creativity, market complications
Creativity in dealmaking often takes the form of buyers offering up how much they can finance.If an agreed price is reached, sellers need the buyers to take out a loan note while delaying part of the payoff. Despite that creativity in new deals, Blosser said many senior living real estate sellers are holding back for now, at least until conditions improve.
Often, sellers in 2023 have had to reduce their desired price, offer flexible financing, or both. Types of deals happening this year most often include higher-acuity properties, or a range of IL, AL and memory care, rather than one specific type. With needs-based demand driving AL and memory care transactions, other assets like active adult and IL could see a trickle-down of deals, Blosser estimated.
With buyers running into debt service constraints, the delicate balance of getting a transaction done has been thrown off by high interest rates. That’s left sellers “basically keeping some skin in the game,” Blosser said.
“I think that piece has helped mitigate some of the draw-down in pricing,” Blosser added. “We’re not at the peak, but [values] haven’t totally collapsed because sellers are giving some skin in the game with a seller note.”
In some instances, operators have taken over a community’s operations, leased the property back to stable and then executed on financing 12 months down the road on a real estate transfer.
“That’s one angle we’ve seen and it’s worked well for folks, especially if they have a warm relationship with that seller if they’re known in the market because there’s trust there,” Blosser said.
Property values will “muddle through for the time being” until the interest rate tightening schedule from the U.S. Federal Reserve ends, Blosser said, ultimately leaving prices “where they are at today.”
But the glimmer of strong demographics and demand for senior living could be all that new investors need to jump in on senior living properties, leaving investment demand ultimately high.
“I think the demographics will light the fire that gets more people looking at senior housing as part of their investment portfolio,” Blosser said.
The tough climate for dealmaking has also resulted in changes to the types of properties listed on the market, as financial experts told Senior Housing News that Class-A type assets are not being listed for sale at the same pace as they previously were.
Values for Class-A assets in senior living have also fallen, said Walker Dunlap Managing Director Mark Myers. He noted that values for Class-A properties have fallen between 15% and 25% this year. This could also be the first time in the last five years that capitalization rates are driving valuations, as sellers report a 7.5% cap rate on trailing net operating income (NOI), which loan proceeds are based off of, Myers added.
“But right now, it’s really going in cap rate is how we’re finding everything is being priced and that going in cap rate for lower acuity stuff has to be at least close to at parity with the debt constant just to avoid a negative leverage situation,” Myers said.
With tough short-term lending conditions, Myers added that well-positioned buyers want to buy assets and “want to buy more of it” because buyers can raise rates, lower expenses.They likely have the benefit of the property’s “debt is almost free” through structuring 30 to 35-year fixed, fully amortizing, fully non-recourse loans through federal lending programs via the U.S. Department of Housing and Urban Development (HUD).
“Your buyer pool is more limited now you have bigger players putting more money down and you just have fewer bites,” Myers said.
SLIB Senior Vice President Dave Balow said that SLIB adjusts valuations over time in light of the market’s short-term challenges, in an attempt at getting buyers and sellers on the same page. That resulted in some tough decisions being made.
By getting mutual understanding between buyers and sellers, firms like SLIB can narrow the bid-ask spread between 5% and 10% of a seller’s asking price even with all the swirling headwinds, Balow said.
“We’re typically putting numbers in front of people and they plug their nose and decide if they want to move forward,” Balow said.
Valuations vary by market
While senior living investment and transaction activity are slowed compared to previous levels, geography could play a big factor in a deal working out, according to Balow.
Primary markets are receiving “respectable pricing” trading at “good numbers, but not where they were,” Balow told SHN. Where distress comes most into play regarding valuations is in secondary and tertiary markets.
“That’s the case pretty much throughout the country,” Balow said. “We’re really struggling with it and have been since these rate hikes have come through.”
That’s led to buyers sitting on the sidelines until the short-term pain wanes. In normal market conditions, a deal could see six to eight bids, Balow said, but that’s fallen to one or two bids on a transaction.
“Right now we’re getting absolutely crushed trying to get respectable pricing for our sellers and the secondary markets,” he added.”We just don’t have a lot of buyers in the game right now.”
Even if a deal receives competitive bids, Balow said some buyers can “smell blood in the water” and go for extremely low pricing on an asset.
“Buyers are well aware that if they’re actively buying, there’s probably not much competition for deals now,” Balow said. “They kind of factor that in when they’re talking to us about deals. We just can’t push pricing too hard.”
Strong market fundamentals in primary markets will hold values higher while secondary markets face more trouble with holding property values.
Across care types, Balow said standalone memory care deals were tough to complete due to property size, while IL demand remains strong and a mix of all care types remains the strongest properties selling in today’s beleaguered market.
“It’s hard for me to see [values] go much lower,” Balow said. “The volatility won’t be as much as it was, but it’s hard for me to see values much lower than they are right now.”
SLIB data shared with senior housing news shows the differences in cap rates in primary markets compared with secondary markets.
For example, cap rates in Eugene, Oregon, a secondary market; are about 50 basis points higher than those in Portland, Oregon. A similar trend is playing out between Seattle and Spokane, Washington, where cap rates would be about 75 basis points higher in Spokane compared to Seattle. In both examples, Balow said price per unit in secondary markets are approximately 10% to 20% lower in value than in primary markets.
Cap rates are about 100 basis points higher in the secondary market of Pittsburgh compared to the primary market of Philadelphia. Similarly, cap rates were about 150 basis points higher in Buffalo, New York, compared to New York City, according to another example provided by SLIB.
‘We’ll see more buyers come back’
Once the market volatility slows down and interest rates level out, those who spoke with SHN said there is optimism for what’s ahead for senior living transaction activity. Balow said he sees more buyers coming back to the fold with dry powder to fire away and expand portfolios.
“By the end of the year, we’ll see more buyers come back into the game which will help drive values close to where they were before all these [rate] hikes came through,” Balow said.
In the second half of the year and into 2024, Myers said Walker and Dunlap anticipate “a wave” of distressed properties to hit the market. That means sellers should be prepared to act fast.
“We’re encouraging groups to get ahead of the curve and hit the market now prior to that wave of distress that’s coming,” Myers said. “Once there is a flood of opportunities for buyers. It’s clearly more of a buyers market right now than a seller’s market in most cases.”
That means distressed assets will be selling at very attractive prices per unit for operators with the capital to step up, and properties that are in a desirable market will be able to sell quickly. With many factors at play, Mace said the tough environment for senior living transactions will hang around for the remainder of the year.
“There’s a bifurcation in the market between the stronger operators and those in less favorable positions,” Mace said.
For the next 12 to 18 months, Blosser said he anticipates that valuations will hold depending on where interest rates are at.
“Until we see our first rate cut or we get clear signaling from the Fed that inflation is tamped, that’s when valuations start bubbling up again,” Blosser said. “Until then, I think we’re in a holding pattern.”
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