Senior Living’s New Lease On Life

The senior living sector continues to make a steady recovery from the catastrophe inflicted on it by the pandemic. Occupancy rates steadily increased throughout 2022, with rents notching their most rapid increase in more than a decade.

As more and more senior living properties stabilize, with occupancy levels approaching 90% and net absorption rapidly filling the number of units relinquished in the pandemic, investors are bidding up the prices for these well-positioned, recession-resistant assets.

A rising tide of capital in 2022 zeroed in on senior living and all of its subsets—including senior housing, assisted living, independent living, skilled nursing facilities, memory care, and a booming new growth sector they’re calling “active adult.”

Volatility has fueled a frenzy of trading activity in senior living assets that shows no signs of slowing down anytime soon. In September, Walker & Dunlop reported that it sold $1.3 billion of senior housing and long-term care facilities in the first seven months of 2022, the firm’s highest recorded sales for such a period.

With long-term demographics, excuse the pun, to die for—70 million baby boomers, now aged 58 to 76, are approaching the average age of entry (early 80s) for senior living—industry players are expecting the tide of capital to keep fueling transactions in senior living assets despite the rising cost of debt.

“Newmark is seeing significant interest for stabilized cash-flowing assets. We expect that to remain unchanged and to see new capital continue to enter the market,” Newmark Vice Chairman Chad Lavender, who heads the company’s Health & Alternatives Assets unit, says.

“Continued positive net operating incomes and occupancy trends are driving increased transaction volume in the sector, along with demographic tailwinds and historically-low anticipated supply,” Lavender said.

But the flip side of tailwinds are headwinds, which have created significant challenges for operators and developers of senior living facilities.

OPERATORS COPE WITH SHRINKING NOI AS COSTS RISE

Despite steadily rising senior living occupancy rates, margins in 2022 began shrinking for operators—even in stabilized facilities with occu-pancy approaching 90%.

Inflation and a shortage of skilled labor, especially nurses—a shortage which predated the pandemic but has grown much worse during it as nurses became part of the Great Resignation—have caused a surge in operating costs that is squeezing NOI margins at senior living facilities.

Managing costs has become priority number one for senior living operators. For those relying on agencies to fill staffing shortages, that’s a tough row to hoe.

“Operators’ bottom lines are being squeezed tremendously due to higher agency costs,” Edward Pan, a Colliers first vice president who specializes in senior housing, says. “Operators are relying heavily on agencies to fill staffing shortages, adding as much as 20% to the cost of labor compared to [an in-house paid staff].”

Some operators have seen their margins cut in half by rising labor costs, a few have seen them shrink to a near-break-even point.

In its Q2 earnings report, senior housing REIT Welltower reported 15.4% same-store NOI growth, driven by 5% occupan-cy growth and a 4.5% RevPOR increase—but the bottom line was clouded by new facilities that were under water.

“We have about 120 senior housing properties that are generating negative cash flow today. If we just shut down these buildings, our earnings would be significantly higher, [but] they were recently developed or are going through a value and repositioning program,” Shankh Mitra, Welltower’s CEO, said in the Q2 earnings call.

Rent increases and rising care fees remain the remedies of choice for dealing with rising operating costs. “Some operators use universal workers and technology to help manage costs. Most owners are having to raise rental and care rates to regain their 2019 margins,” Lavender said.

“Owners’ costs to operate have increased, so we can expect to see premier assets and operators continue to raise rates higher than his-torical levels to regain margins,” he told us.

Rents surged by 4.7% YOY in the senior living sector in Q2 2022, the quickest pace in more than a decade. But by Q4, some were warning that affordability could impact occupancy levels.

“Margins in this sector are such that increased costs must be passed along, which can impact affordability,” Pan said. “Rising rents nega-tively impact occupancy recovery, especially in independent living.”

OPERATORS MUST ‘THINK OUTSIDE THE BOX’

“Operators are exploring several ways to manage increases, including the use of volunteers, partnering with non-profits and technology en-hancements. But this sector is by nature a high-touch, very personal business and best practices will take time to react to and address the labor shortages,” Pan said.

Pan encourages senior living operators to “think outside the box” to reduce expenses.

“Operators need to spend the time and truly understand how each facility is running from the bottom up,” Pan said. “They need to ask themselves, are we scheduling for staff based on occupancy or evaluating each resident individually to see who truly needs the care ser-vice?”

Lavender thinks labor costs have plateaued. He predicts that “further stabilization” of NOIs and higher replacement costs will continue to drive up the value of well-positioned assets.

“Margins are starting to stabilize and expand in most parts of the country, though this varies greatly based on acuity type. We have likely hit a plateau on labor costs, which would help the margins moving forward,” he said.

The jury is still out on whether constricted NOI margins at some facilities will induce owner-operators to put more senior living assets on the market.

“The ownership and capital structure of a company [may determine] whether they’re able to manage through a decrease in operating mar-gin,” Julie Ferguson, executive vice president, senior living at Ryan Companies, told GlobeSt.

“There will be owners who are unable to provide additional working capital to projects if their lease-up is not on track or their expenses are higher than budgeted. It’s hard to say whether there will be more or less of these in [2023] because there are a lot of variables that factor into these decisions,” she said.

“I anticipate more properties becoming available on the market. With government funding drying up and increasing labor costs, operators are trying to get their occupancies up so they can sell the assets at a reasonable price,” Pan said.

Pan thinks senior living REITs who have been keeping their powder dry while buttressing bottom lines may also jump into the market.

“We’re seeing REITs being cautious on non-performing assets due to the interest rate hikes,” he said. “However, a stabilized and well-performing senior housing asset is still attractive to REITs from a HUD-financing perspective. In today’s market, you can obtain HUD financing for 35 years fixed at 4.95%, typically 175 bps lower than traditional bank financing.”

HISTORICALLY LOW NEW SUPPLY

This should be a boom time for developers building new senior living units. An estimated 25,000 new units will be needed every year be-tween now and 2030 to keep up with burgeoning demand as Boomers age. NIC has estimated that more than 800K units of new supply will be needed between now and 2030.

However—as is the case in all other asset classes—new construction is lagging in the senior living sector due to the rising cost of debt, inflation and labor shortages. Some developers are pausing projects in senior housing, others are delaying construction starts.

“New construction will be more challenging to accomplish with the rising cost of debt. There was a decrease in the number of construction starts in the second quarter, and I expect further reductions in the number of starts,” Ferguson told us.

Ryan, the fifth largest owner and operator of senior housing, is keeping one of the busiest pipelines moving forward, but also is carefully evaluating the impact of inflation and the rising cost of debt.

“We’re moving forward with the projects that meet our investment criteria,” Ferguson said. “We have seven projects in our pipeline for 2023 as well as five that we’re evaluating for 2024 construction starts. We’ll continue to evaluate these projects as construction costs change and capital markets move.”

With a growing national portfolio, Ryan has been tailoring its growth strategy to markets where it can build at a lower cost.

“Since construction costs have been on a continuous rise for the past two years, we’ve really focused our efforts in the near-term in mar-kets that we can build communities and product types out of lower-cost construction materials like wood frame,” Ferguson said.

The company also is keeping a close eye on rental rate increases nationwide, factoring the potential for rent growth into its decisions on project starts.

“We expect rent growth to continue into 2023. It’s important for our evaluation of new projects to track the increases happening in a market for rental rates as well as care charges,” Ferguson said.

ACTIVE ADULTS: A HOT NEW GROWTH SECTOR

Senior living owners, operators and developers eagerly are awaiting the “silver tsunami” of baby boomers who will begin entering the aver-age age range for assisted living in four years.

But the 70 million boomers born between 1946 and 1964 already are doing the wave: they’re flocking to an emerging rental property type that rapidly is becoming the hottest growth sector in senior housing.

Active adult rental properties are aiming for boomers in their early 70s (68-74 is the average range), a demographic that skews younger than independent living and attracts people who are more active and have much lower acuity needs than the current residents of independ-ent living facilities.

According to a new report from NIC, active adult communities generally have higher rents than multifamily, lower expenses than inde-pendent living—requiring fewer employees and no nurses or medical certification—and long lengths of stay (the average turnover is 20%, compared to 50% for multifamily) that yield healthy margins in a stabilized asset.

From a valuation standpoint, active adult rental properties are being pegged between traditional independent living and conventional multifamily, with cap rates trending toward multifamily—below 5%, with some below 4% in recent trades.

Rent rates at active adult properties typically are 10% to 30% higher than comparable multifamily, and 20% to 50% lower than independ-ent living properties in the same area, according to NIC.

Underwriters are noting that active adult communities have less risk than traditional senior housing. By design, active adult assets can avoid the labor shortages that have been shrinking the margins of senior living facilities serving residents that have high acuity needs.

“The demographics and economics make active adult a fast-growing market segment that has been compared to the growth of the assist-ed living market of the mid- to late 1990s,” NIC’s report said.

“We’re seeing the active adult sector getting much of the attention today,” Doug Prickett, a senior managing director at Transwestern, told GlobeSt.

“There is a significant population among the baby boomer generation who are seeking an active lifestyle and who don’t require the ser-vices for daily needs and care. This cohort is driving considerable demand for active adult properties,” he said.

Ryan is pursuing several active adult development projects, Ferguson told us. “Active adult is a good fit for our company with our experi-ence in senior living as well as multifamily,” she said.

NIC’s initial survey of active adult rental properties in the US revealed about 230 “first-generation” assets, most built between 2010 and 2018. NIC believes this is a huge undercount because an industry consensus is still forming around a precise definition for the active adult sector.

NIC defines active adult rental properties as age-eligible (meaning age restricted), market-rate, multifamily properties that are lifestyle fo-cused, but do not offer meals, transportation, laundry, activities of daily life (ADL) or medical services.

Unlike assisted living, memory care or skilled nursing facilities, active adult communities don’t provide ADL services including medication management or assistance with bathing, dressing and mobility. They also don’t offer specialized memory care or the short-term post-acute care available at skilled nursing facilities.