Senior Housing Takes Steps to a Recovery

This October Taurus Investment Holdings and Northbridge Cos. formed a partnership acquiring six class-A senior housing properties for $200 million from the senior housing REIT Welltower. The 507-unit portfolio marked Taurus Investment Holdings’ first investment within this sector of the commercial real estate universe.

For various—and obvious—reasons, a plunge into the senior housing market right now may seem to be a contrarian play. But Taurus is undaunted.

“We believe that the demand for high quality senior housing will remain strong in the coming years with the upcoming demographic shift as the 75-plus population continues to accelerate,” CEO Peter A. Merrigan said at the time of the deal.

Merrigan has good reasons to enter the space right now. What better time, after all, to buy when pricing is low.

Also, future supply and demand fundamentals are aligning favorably.

Before COVID-19, construction starts had started to slow due to oversupply, increasing land costs, increasing operating and construction costs, and some widening in credit spreads, according to Kevin Maddron, CFO of  Foundry Commercial, all of which is changing as the pandemic rages on. “A slowdown in new construction costs coupled with an improving labor market and an increasing older population will create significant investment opportunities in the future,” he says.

At the same time there are subtle signs that the pandemic’s negative effects are starting to wear off.

Still, there is a reason the Taurus-Northbridge deal is a rarity: the current situation on the ground is a sobering one. As Taurus entered what was a solid asset class pre-pandemic, dealmaking had dropped significantly and fundamentals were soft.  In general, Maddron says, “it is challenging to gaze into a crystal ball and know with any degree of certainty what the near-term holds.”

WHERE DID THE DEALS GO?

Indeed, the number of publicly announced seniors housing and care acquisitions in the third quarter fell to a new low of 58 deals, according to Irving Levin Associates. That dip only represents a 3% decline from the 60 transactions in the previous quarter, but it’s a steep 44% drop from the 104 deals made public in the third quarter of 2019. On the bright side, the $1.48 billion spent on third-quarter transactions shows an increase from the previous quarter’s total of $1.36 billion by 9%, based on publicly disclosed prices. However, compared with the third quarter of 2019, when $5.74 billion was spent, dollar volume nosedived by 74%.

“The pandemic continues to stymie dealmaking in the seniors housing and care sector,” says Ben Swett, editor of The SeniorCare Investor, a publication associated with Irving Levin. “Difficulty in obtaining acquisition financing, third-party approvals and property inspections, along with serious questions about the time it will take for occupancy and operations to recover, has caused many buyers to either delay or hit the pause button on dealmaking.”

A PROBLEM WITH PRICING

Another problem—and one not limited to senior housing—has been less-than-transparent pricing, in some part because deals have been so few and far between.

In some cases, for example, cap rates are diverging from valuations, according to participants on a recent CBRE podcast.

“Across the board, cap rates haven’t moved that much for a stabilized product,” said Spencer Levy, chairman of Americas Research and senior economic advisor.

But cap rates aren’t the only things that affect value. Changes in NOI and operating costs also impact what a property is worth and in the senior housing space people are removing the temporary operating costs associated with COVID from the cap rate equation.

“For the stabilized assets, the cap rates really haven’t changed all that much,” Lisa Widmier, EVP of CBRE’s senior housing capital markets practice told podcast listeners. “But returns have gone down to investors because of the fact that you can only get 50% leverage versus 65% leverage. In a logical world, debt is less expensive than equity. So the average cost of capital is impacting our pricing.”

MISSING BUYERS

Perhaps the greatest issue, though, is the simple fact that many traditional buyers are missing in action.

In the seniors housing market, private senior care providers usually comprise the majority of buyers but in this year’s third quarter, they accounted for only 63% of the deals, according to Irving Levin data. Not-for-profit buyers were the next busiest group, with 11% of deals, followed by private equity (9%), real estate investors (9%) and REITs (4%).

The private company O&M Investments was the only acquirer in multiple transactions during the third quarter, completing two deals. The largest trade in the period, and likely the entire year, was Welltower’s $702-million sale of a seniors housing portfolio in the western US. A joint venture between AEW Capital Management and Merrill Gardens Senior Living bought the asset, which featured 11 properties across California, Nevada and Washington.

Skilled nursing deals represented a minority of third-quarter merger and acquisition activity—as they have during previous quarters—in terms of both transactions (41%) and properties (44%).

“Skilled nursing facilities bore the brunt of the pandemic, especially in the early months, and many owners are waiting for operations to stabilize and to see what happens with federal funding relief before considering a sale,” explained Swett.

Seniors housing deals made up the balance of the quarter’s transaction volume in the segment, with assisted living accounting for 34% of deals, followed by age-restricted communities (12%), independent living (7%) and CCRCs (5%).

A NEW LOW IN OCCUPANCY

At the same time, the sector is experiencing a significant softening of fundamentals fueled by the pandemic.

Senior housing occupancy fell 2.6 percentage points in the third quarter, from 84.7% to 82.1%, according to data from NIC MAP Data Service provided by the National Investment Center for Seniors Housing & Care.

This is the second quarter in a row where occupancy fell more than 2.5 percentage points. With two consecutive quarters of deteriorating occupancies, the senior housing sector is now experiencing its largest drop in occupancy on record, according to NIC.

None of this comes as a surprise to experts in the field. “When you drop 800 basis points of occupancy by restraining move-ins, it takes a while to get it back,” Patricia Will, co-founder and CEO of Belmont Village Senior Living. “In March, when COVID-19 hit major cities across America, most senior housing providers shut the front door and worked tirelessly to test, acquire personal protection equipment, and adjust to real rigor for mitigating contagion.”

Assisted living and independent living facilities experienced their largest occupancy drop to date, according to NIC, falling 2.9 percentage points to 79.1% and 2.4 percentage points to 84.9%, respectively.

“COVID has pushed revenues down in seniors’ housing,” Greg Limoncelli, a partner with Akerman, says. “It has pushed expenses up and made people afraid to go into facilities. As a general rule, COVID has really hit the industry hard.”

As occupancy fell, independent living facilities saw their largest increase in inventory since early 2009. “This reflects the relatively robust lending and development environment of 18 to 24 months ago that supported construction starts back then and which now are completed properties entering the market,” noted Chuck Harry, NIC’s chief operating officer in a prepared statement. “Construction starts activity in the third quarter continued to be relatively weak, reflecting today’s more constrained capital markets.”

But Limoncelli thinks the sector’s current struggles don’t paint an accurate picture of its full potential in the future. While revenues may be challenged because fewer people want to go into seniors’ facilities because they’re afraid of the virus, he thinks that operators can do things to ease these fears.

“What I think a lot of operators have seen is that if they increase their transparency, including their communication with the families, residents and physicians, people start feeling safer,” Limoncelli says.

A SHIFT UNDERWAY?

This is perhaps one among a handful of subtle shifts underway that suggest that senior housing may be on the cusp of a turning point from its pandemic lows. For starters, now that the shock of Covid has worn off, investors are beginning to refocus again on the strong demographics that favor senior living. These will continue to strengthen, Maddron says. ”With new supply coming to market at a manageable pace in relation to the changing demographics, we think investing in seniors housing will continue to favor investors.”

Will of Belmont Village Senior Living reports that there is a lot of pent-up demand on the part of consumers. ”Seniors and their families realize that it is better to be in a quality community than to be home alone,” she says. “In the end, 2020 and 2021 will not be our best, but during these difficult times we are seeing real demand for our product and terrific brand loyalty.”

Additionally, she continues, many of the changes that have been made at senior living facilitates will improve seniors’ social engagement activity and will outlive the pandemic, such as a major bandwidth for technology. “Telemedicine is also important, and has improved the ability for seniors to obtain medical advice from healthcare providers from the comfort of their home.”

Another silver lining: The pandemic has caused the regulators and the industry to evaluate how to better approach such occurrences going forward. “This is a good result,” says Mark Hamister, CEO of the Hamister Group.

“Further it is our opinion that the assisted living and independent living models today represent the best opportunities for providing a quality service and earning a respectable return for investors,” he adds.

Perhaps for these reasons, there are distinct signs that capital is beginning to return and investor interest is perking up, Joel Nelson, CEO of LCS, a Des Moines, Iowa-based senior living company, told the CBRE podcast. “We’re seeing some deals that were tabled initially with COVID coming back onto the market,” he said. In addition, new institutions and other investors are showing interest in the senior housing sector as they move away from sectors that have been harder hit by the COVID-19 pandemic.

“There’s a lot of new capital that’s reallocating from theaters and retail centers, [and] convention hotels into the space,” according to Lisa Widmier, EVP of CBRE’s Senior Housing Capital Markets practice, who also participated in the podcast. “And that’s not only just for domestic capital, but we’re seeing an uptick in global interest in the US senior housing market. So we’re pretty optimistic about 2021.”