Is Seniors Housing at the Cyclical Peak?

Seniors housing hit its sweet spot in mid-2007. High occupancies, rising rents, solid yields and the prospect of a quickly aging population lured investors to the sector with more than $30 billion in deals over the last year and a half. Cap rates reached historic lows as property prices hit all-time highs.

But nerves have been rattled by the meltdown in the broader credit markets, raising fears that the big deals announced recently might not close and acquisition activity will slow. A deepening housing slump could also hurt operators and owners. At most risk: buildings for independent seniors who may not be able to sell their homes and move.

“The turmoil will have an impact on seniors housing,” confirms Angela G. Mago, senior vice president and national manager at KeyBank Real Estate Capital in Cleveland. Deals may be difficult to price because of market volatility, and the capital markets may be hard to access. “There's a lot of uncertainty,” Mago adds.

Housing slump's ripple effect

While lenders eye construction levels, the really big worry is the housing market. The move to an independent-style apartment is a choice that often involves the sale of a long-time primary residence. Seniors who want to move into a continuing care project typically must sell their homes to pay the expensive entrance fees. Seniors who can't sell their homes can't make the move to a new building.

“We're paying close attention to the housing market,” says Mago. She monitors indicators such as how many days a home sits on the market, along with wider demographic trends. Areas with influxes of new residents are favorable because the housing market can recover quickly.

Building occupancies could sag as home sales slow, says Keven J. McMeen, managing director at Merrill Lynch Capital Healthcare Finance in Chicago. When potential residents delay move-in decisions, occupancies may drop resulting in little pricing power for building operators and lower returns for investors.

A sluggish housing market could be a very big problem in small markets, says Kathryn Sweeney, managing director of U.S. seniors housing at the GPT Group in Boston. “In markets with low barriers to entry, the housing market could have a meaningful impact on absorption.” Softening is most likely in the Midwest and South where seniors cannot sell their homes. “We don't see an event that would lead me to believe there will be further erosion in housing in the big cities,” she says. “But outside the top 30 metro areas, it could be an issue.”

For now, observers are hopeful that the credit markets will settle down over the next few months. Consolidation will continue at a moderate pace, but pricing may soften because fewer buyers with less capital will be competing for properties.

Seniors housing experts also are tracking the upcoming election, which could impact reimbursements from the Medicaid and Medicare programs that nursing homes rely on for income. But barring some unforeseen event, Mark Myers, senior director at national brokerage Marcus & Millichap in Chicago, remains optimistic. “For the next few quarters, we should be OK.”

Inside the numbers

For the moment, the real estate fundamentals of seniors housing are strong. “The last 18 months have never been better for seniors housing,” says Robert Kramer, president of the National Investment Center for the Seniors Housing & Care Industry (NIC). Indeed, the average occupancy at independent living buildings in the top 31 metro markets rose to 93.8% in the first quarter of 2007, a year-over-year gain of 0.9%, according to NIC statistics. Assisted living showed a gain of 0.3%, reaching an overall occupancy of 91.5%. Nursing homes declined 0.1% to 90.7%.

High occupancies and low levels of new construction have given owners and operators pricing power. Year-over-year revenue per occupied unit in the first quarter of 2007 grew 6.6% in independent living buildings, with average monthly rents currently at $2,376. Assisted living rents rose 5.8% to $3,358, and nursing home rents were up 5.2% to $6,360.

Dissatisfied with current yields offered by traditional real estate products, investors are attracted to seniors housing, says NIC's Kramer. Seniors housing assets currently yield about 14% annually, sources say, compared with about 8% for other commercial property sectors.

Foreign investors are active in the U.S. seniors housing market as well. Money is flowing into the sector from Europe and Australia. The Canadian REIT Chartwell Seniors Housing, the third largest owner and operator of seniors housing in North America, has made a big push into the U.S. Some 12,900 units, or one-third of Chartwell's holdings, are located here.

The flood of capital has generated bidding wars and blockbuster deals, with billion-dollar transactions grabbing the headlines. Holiday Retirement was purchased in the first quarter of 2007 for $6.8 billion by Fortress Investment. Genesis Healthcare went private last July in a $2 billion acquisition by Formation Capital and JER Partners.

In the second quarter of this year, Ventas Healthcare Properties purchased Canadian Sunrise Senior Living REIT for $2.1 billion. Carlyle Group agreed to purchase Manor Care for $6 billion, a deal set to close in the first quarter of 2008.

Prices peak

“Valuations have increased rapidly,” notes John Cobb, senior managing director at Chicago-based GE Healthcare Financial Services. Four years ago, an assisted living unit traded for about $200,000, and it now costs about $300,000, a 50% increase.

Prices may have recently plateaued, however. Experts expect consolidation in the fragmented seniors housing market to continue, but perhaps not at such a frantic pace. The sector may be too frothy, they say, as the subprime mortgage mess spills into the broader credit markets.

Last June, KeyBank closed a $123 million refinancing for nursing home operator Athena Health Care Systems. Several banks purchased the primary debt tranche of $101 million, while a hedge fund bought the secondary tranche of $22 million. If the deal were trying to close today, Mago says the banks would execute their portion, but the hedge fund might not be able to participate because of wider rate spreads and pricing volatility.

No big transactions have blown up yet. But industry watchers don't expect blockbuster deals in the year ahead. Many of the big players have already been sold. And creative deals that rely on multiple sources of capital, especially from Wall Street, may not be easily funded.

A lot of portfolios have traded hands and investors with cash are hunting for new opportunities. Health Care REIT, an owner of seniors housing and healthcare real estate, currently has $1.15 billion ready to spend, says Ray Braun, president at the Toledo-based company. “The credit market blowup will help us,” he says.

Braun figures there will be less competition to finance properties. Deals that previously would have been done with CMBS debt will seek other forms of financing. “[Buyers] will look to us to do sale leasebacks,” says Braun.

Even so, cap rates could be poised to rise. “I think we are in a transition period,” says Myers of Marcus & Millichap. “The market has the potential to soften.”

Curiously, the gap on cap rates between assisted and independent living buildings has virtually closed, Myers notes. Cap rates are currently at about 8% for both property segments. In 2002, assisted living properties traded at cap rates 100 points higher than independent living complexes, reflecting the risks associated with operating an assisted building. But assisted living has gained a lot of consumer acceptance and the properties are in demand, which has compressed cap rates.

Wary of overbuilding

Developers often tout aging demographics as justification for new projects, but baby boomers won't reach age 75 until 15 years from now. That makes today's market more sensitive to overbuilding.

Lenders are warily watching construction trends. Because building costs are high, new construction is constrained. In the late 1990s, an assisted living facility might have been built for about $10 million, says Michael Hargrave, vice president at NIC. Today, that same facility would cost $20 million.

Another pressure: well-located sites are difficult to find. Seniors-only apartments compete for vacant land with other types of commercial developments, and zoning approvals are sometimes hard to win.

On the nursing home side, new buildings are tricky because of state and federal licensing regulations, and government reimbursement policies. “There's no ramp up in construction,” notes Hargrave. That's a plus for investors, though regulatory changes are always a worry.

Magnet markets for construction

That's not to say development has taken a hiatus. In some markets, construction of certain product segments is fairly robust. Continuing care retirement communities and apartments focusing on independent living are seeing the most growth.

About 30 big new continuing care campuses are in the pipeline, worth about $80 million apiece. Construction of apartments for independent seniors is also on the upswing. Four markets with growing populations have more than 10% of the existing inventory under way: Houston, Seattle, Denver and Atlanta. NIC's Hargrave isn't alarmed about the uptick because absorption rates are high.

Take Seattle, for example. In the first quarter of 2007, the construction rate of apartments for independent seniors was 14.8% of the existing inventory. But the penetration rate — the number of units compared with the number of targeted households age 75-plus — is 10.17%. That's almost double the penetration rate of other major metro markets.

Seattle occupancies are solid at 93.8%. “Seattle looks like it has high construction levels,” says Hargrave. But, he notes, “Seattle residents accept the product, and there's a high demand for it.”

Even so, Hargrave admits a lot of the apartment construction centered on independent living is just ramping up now. “Time will tell what will happen.”

Jane Adler is a Chicago-based writer.

Aging Europeans, new markets

Buoyed by the strength of the U.S. seniors housing industry, investors are carefully dipping into the European market. Interest is being driven by the same trend at work here in America: an aging population.

Investors better do their homework, though, experts emphasize. Government programs and regulations vary widely overseas, greatly affecting the prospects for new development. Strong local customs often favor family and home care over a congregate-care facility.

“We are starting to see a lot of investment activity overseas on the private-pay side of seniors housing,” says Raymond J. Lewis, vice president and chief investment officer in the Chicago office of Ventas Healthcare Properties.

Investors especially like Western Europe with a population even older than that of the United States. About 12% of the U.S. population is over the age of 65, but 17% of Germans are 65 or older. And seniors in the U.K. make up 16% of the population there.

Sunrise Senior Living, a big senior housing company in the U.S., operates 12 properties in the United Kingdom, with another 18 under way there. Nine Sunrise buildings are open in Germany. Another one opens there in January. Each building has a mix of assisted living and memory support suites.

Cap rates in Germany currently range from about 6.5% to 8%, sources say. “Germany is a promising market for private-pay seniors housing,” according to Roberto Marconi, managing director of Sunrise in Germany. The demographics are positive, and the government foots part of the bill. Daily rates at Sunrise start at about $115 (USD).

The German market historically hasn't provided the kind of upscale housing alternative that Sunrise now offers, Marconi says. Much of Western Europe relies on home care for seniors or state-supported programs. But Marconi admits it may take time for Germans to get used to the idea of moving elderly relatives to a seniors housing facility rather than taking care of them at home. “We are educating the market,” he says.

The GPT Group, a property trust based in Australia, is evaluating the U.K. market. “It's about five years behind the U.S.,” says Kathryn Sweeney, managing director in Boston for GPT. Government licensing of buildings is just taking shape.

“A strong solid operator can work collaboratively with the local licensing authority,” explains Sweeney. But, she adds, consumer acceptance in the U.K. of assisted living is also about five years behind where it is in the United States.
Jane Adler

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