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The senior living sector could be in for a long slog ahead in 2024 and even beyond.
This was one gloomy takeaway from this week’s National Investment Center for Seniors Housing & Care Fall Conference in Chicago.
To be sure, there were plenty of reasons for optimism., Occupancy is still on the upswing, and demand is growing as the baby boomers loom over the industry. New construction starts have remained relatively low. Senior living operators are inking — or at least discussing — new next-gen management contracts that position them to better work with capital and ownership groups down the road.
On the other hand, average margins have largely still not risen to pre-pandemic levels thanks to higher and stubborn expenses in areas such as staffing and insurance. What the boomers want is still somewhat of a tough nut to crack. And while lower construction starts should help buoy occupancy in the years ahead for operators with open communities, the runway could be very long and bumpy before development can resume at a healthy pace. And speaking of long and bumpy runways, investors and operators also were not sounding hopeful about interest rate relief.
In this week’s exclusive, members-only SHN+ Update, I offer my analysis of key ideas from the NIC conference and offer takeaways, including:
- The uncertain state of senior living M&A and capital markets
- How alignment with ownership is a new and growing differentiator in operations
Capital markets, M&A in ‘wait-and-see’ mode
Perhaps the biggest specter looming over the industry at the cusp of 2024 is financing and the cost of capital.
Higher interest rates and general uncertainty in the senior living market have led lenders to become much more choosy about the deals they are choosing to fund, and how they are funding them. A year ago, interest rates had just exceeded 3%, according to federal economic data. In just a year’s time, that number had ticked up to 5.5%.
While “there is capital out there” at the tail-end of 2023, “the box for that is much narrower,” according to Brian Heagler, who is an SVP and senior banker at KeyBank.
“Banks are going through liquidity and capital issues … and that certainly had a tremendous effect on bank capital,” he said during a panel discussion.
Bridge Investment Group CEO Robb Chapin added that the industry is in the midst of a “daunting time” with regard to investments and the ability to source new capital.
“Investor sentiment is [that they are] not keen to jump right back in,” he said. “I think there’s still this wait-and-see attitude, broadly speaking.”
Despite the gloomier outlook for new investments and sourcing financing, Chapin added that he is hopeful about the future given the long-term prospects in demand.
“If you’ve been through market cycles like me — it will shift again,” Chapin said. “The guessing game right now is, when is that going to happen?”
Chapin added that “the only form of liquidity today … is selling assets,” and stressed the importance of financial acumen in the year ahead.
“Being able to execute in a very inefficient market on selling assets, raise liquidity to continue to preserve the balance sheet and to protect those assets … is really the risk that we have today,” he said.
The current challenges have also led to more frank discussions among buyers and sellers of senior living communities: While sellers have had to get more realistic about senior living community pricing, buyers also have had to grasp that many sellers still have a hard line in the sand, despite the relative end of “extend and pretend.”
That said, Blueprint CEO Ben Firestone said he is seeing “plenty of distress” related to floating-rate debt deals and debt maturities coming due. That will force some sellers to concede and take a loss.
“It will be interesting to see when those sellers that don’t have to sell today decide to say … ‘I’m not going to hit my target value, not going to hit my target return, I just want to move on from this,” he said.
Once the real estate cycle turns, Chapin sees the current challenges giving way to an “unprecedented buying opportunity” in the next three years.
“If you’ve got the right capital formation, the right lending partners, the right operating partners in your business, you’re going to be really successful in this next phase,” he said.
Operator/owner alignment keeps coming into focus
Given the difficult landscape for senior living operators and the fast-evolving consumer demographic, one popular strategy for growth opportunities and more support is to link up with a larger industry player, such as a REIT like Ventas (NYSE: VTR) or Welltower (NYSE: WELL) or a capital source like Lee Equity and Coastwood.
Operators including Merrill Gardens, Discovery Senior Living and Benchmark have grown using that strategy over the years.
Through its various management companies, Discovery’s umbrella now includes more than 300 communities in 40 states, including many third-party management contracts.
The company’s more recent growth, including bringing Integral Senior Living (ISL) into the fold, has been facilitated through a model first hammered out by Lee Equity and hotel company Aimbridge Hospitality.
Discovery Senior Living CEO Richard Hutchinson said he had an “epiphany” about operator and owner alignment in 2018, as he was pondering the industry’s next evolution. He realized that creating the senior living communities that boomers will desire will require high levels of coordination and investment.
“For us to be able to take this to the next level effectively — the vision that I had for Discovery — we needed an actual investor into the operating platform and debt that was focused on the operating plan,” he said.
Although “alignment” is often a word used to describe joint-venture management agreements, Hutchinson added that, with the right setup, even companies focused more on third-party management can walk in lockstep with owners.
“If you have good alignment, and you have the same goal that is stated up front and along the way, I think you can work your way into a really good situation,” he said.
On the other side of the coin, alignment is also what large REITs like Welltower and Ventas are seeking.
Welltower CEO Shankh Mitra did not mince his words when he said it will take a true bottom-up rethinking of the industry and operations in order to get to the industry’s next evolution. His view is that senior living operators need well-capitalized partners with scale if they want to grow in the most effective way.
“It’s an aligned structure: If our owners make more money, you make more money — both should be happy about that,” Mitra told me.
A 3- to 5-year window
While operators, including Discovery, have been able to expand through acquisition even through this period of uncertain and capital markets upheaval, new development has been all but snuffed out.
The lack of new supply should help occupancy, but in the longer term, the inability to build will hamper the industry from being able to serve the huge demand wave that is growing nearer each year.
Mitra, for one, said that development is not even close to viable at the moment, and will not be for years.
“If you’re a lender today, and you want to lend to senior housing construction, I think you’ll have better luck going to Vegas,” he said. “Equity, I personally think the probability of success is higher if you buy lottery tickets.”
Ventas CEO Debra Cafaro forecast a three- to five-year time period, with regard to when the current development lull might end.
“At occupancy levels where they are today, with construction costs where they are today, with [resident] rates where they are today … and with interest, and capital rates where they are today, it is nearly impossible to justify any kind of senior housing development,” she told SHN.
She cited a return to occupancy in the low- to mid-90s, and improved construction and capital costs, as necessary conditions for development to kick back into gear.
“We’ve got a three-to-five year window here, at a minimum, where I think you’re really not going to see any meaningful development,” she said.
At NIC, Marquis Companies CEO Phil Fogg estimated that the sector is about three years away from feeling the full force of the boomer demand wave, assuming an average move-in age of around 82 or 83. So, depending on how long it takes for development to pick up pace again, there could be a period of several years when boomer demand is cresting but new supply is lagging.
Predicting the future with any amount of confidence is especially foolhardy given how recently Covid-19 upended even the shrewdest forecasts. But the population most certainly will age, and senior living investors, developers, lenders and operators are all anxiously hoping for conditions to improve, so that they can seize on the opportunities rapidly approaching.