A growing development pipeline is not dampening the outlook for the seniors housing sector. Exclusive research conducted jointly by NREI and the National Investment Center for Seniors Housing & Care (NIC) shows that industry participants remain optimistic about improving fundamentals and investment opportunities in the sector.
The big story of late in the seniors housing sector has been the uptick in construction. In fact, the greatest number of units came online in the second quarter of this year compared to any other quarter in the past six years. As of the second quarter, construction versus inventory over the previous 12 months grew by 4.2 percent for seniors housing and 0.7 percent for nursing care, according to NIC data.
The majority of survey respondents (69 percent) anticipate more construction starts ahead in the coming 12 months, with 55 percent who predict that construction starts will increase somewhat and 14 percent who believe that construction starts will increase significantly [Figure 1 in Slideshow].
Yet the majority of respondents also believe that the new supply remains in check with demand. Nearly two-thirds of respondents do not think that the construction will result in overbuilding compared to the one-third who are concerned that overbuilding will occur. The upside of the story is that demand has been matching that new supply. “So the outlook is fairly bullish in that even though there is new product coming into the market, demand will be there to fully absorb that product,” says NIC Chief Economist Beth Mace.
Also, it is important to note that the new supply is not widespread, but rather limited to certain markets. NIC tracks seniors housing market data in 99 metropolitan areas. According to NIC, there are about 35 markets that represent about 80 percent of all the construction activity in the U.S. “So, in general, construction remains relatively concentrated,” says Mace.
About 20 percent of those metropolitan areas had no seniors housing construction during second quarter. However, at the other end of the spectrum, some markets saw a spike in activity at a rate of more than 15 percent in expansion relative to existing inventory, including San Antonio, Salt Lake City, Austin, Houston and Sacramento.
Investors want to increase holdings
The positive side of that development activity is that it is providing fresh inventory for investors who remain eager to expand portfolios amid stiff buyer competition. “It has always been a very competitive market, but I believe it has gotten more competitive,” says Noah Levy, head of the Senior Housing business for Prudential Real Estate Investors (PREI). There has been more capital coming into the seniors housing sector for the past two to three years. “It is not just the health-care REITs that have gotten bigger and more acquisitive, but there also is an increase in private equity in the space,” says Levy.
Among respondents who already own seniors housing properties, nearly half (47 percent) said they plan to hold assets over the next 12 months, while 36 percent plan to buy more and 17 percent said they will sell assets.
PREI is among those actively acquiring property. The company has been investing in seniors housing properties since the late 1990s. In May, PREI closed its fifth Senior Housing Partners fund with $629 million in equity commitments to be spent exclusively on seniors housing, including independent living, assisted living and memory care. The fund will target direct acquisitions, forward commitments, developments and mezzanine loans among other opportunities.
The key investment criterion that PREI looks for is assurance that the operator, the real estate and the market are all a good fit, notes Levy. For example, PREI completed its first acquisition for Fund V in late May with the $110 million acquisition of three assisted living and memory care communities in Tennessee and Connecticut. The properties included two newly developed properties in Franklin, Tenn., and Glastonbury, Conn., and a third facility in Nashville that opened in 2012.
More buyers enter the market
The field of buyers chasing seniors housing properties is expanding as the sector continues to gain attention from a wide spectrum of investors. Although the survey pool may be biased in their preference for this sector, respondents rate seniors housing as the most attractive real estate property type. On a scale of 1 to 10 with 10 being extremely attractive, respondents rated seniors housing a mean of 7.7 percent followed by apartments at 6.8, industrial at 6.0, hotels at 5.5, office at 5.3 and retail at 5.2.
There is no question that seniors housing is increasingly viewed by investors as a true investment grade asset class. “There has been a significant amount of new interest in seniors housing coming out of the recession,” says Ryan Maconachy, a managing director at HFF. There are a number of new funds that have launched just in the last 18 to 24 months that are devoted solely to seniors housing properties, he adds.
REITs, private equity and pension fund advisors such as Prudential, AEW Capital Management, Harrison Street Real Estate Capital and the Carlyle Group have been active in the seniors housing sector for more than a decade. Other groups, such as Kayne Anderson Real Estate Advisors and Bridge Investment Group, that have traditionally bought property across the spectrum of commercial real estate are now focusing more attention on seniors housing, says Maconachy. For example, Harrison Street announced in January that it had raised about $1 billion for its latest fund that would focus on seniors housing, health care, education and storage real estate.
The interest in seniors housing is evident in the spike in investment sales transactions over the past year for both seniors housing properties and nursing care facilities. At the end of second quarter, sales activity for seniors housing properties for the previous 12 months totaled $17.2 billion—up 42 percent compared to the same period a year ago. Nursing care facilities saw an even bigger rise of 118 over that same period to total $7.3 billion in sales, according to Real Capital Analytics.
Many respondents expect that robust sales activity to continue into 2016. Slightly more than half of respondents (53 percent) believe that property sales transactions will increase over the next 12 months compared to 40 percent who think sales activity will remain the same. Only 7 percent expect sales to dip in the coming year.
Cap rates remain aggressive
The liquidity that has come into the commercial real estate sector over the last two decades has driven down cap rates across the industry, and the seniors housing space is no exception. Cap rates have stabilized at a “fairly aggressive” level, but properties still trade at a spread that is higher than other forms of commercial real estate, notes Levy. The premium is due to the degree of operational risk related to the higher expense ratios that exist for seniors housing.
Pricing has been fairly stable over the last six months, notes Maconachy. For example, all of the seniors housing properties HFF has sold in the past 24 months have been at cap rates in the 5s and 6s—if not lower, says Maconachy. In addition, the pricing differential between core and secondary markets for seniors housing properties is much smaller compared to other property types. The differential between core and secondary/tertiary markets is between 100 to 150 basis points for seniors housing versus 200 to 400 basis points in other product types, he says. One reason for that is because the demand from seniors is very localized and investors place a high value on the strength of the operator regardless of location.
Nearly half of respondents (47 percent) expect cap rates to increase over the next 12 months, compared to 27 percent who believe there will be no change and 25 percent who anticipate a decline. However, any increase that does occur is expected to be modest. Among those who predict an increase, most (43 percent) anticipate that cap rates will rise by less than 100 basis points and the mean increase is 15 basis points [Figure 5 in Slideshow].
The aggressive cap rates are a reflection of the high buyer demand and “seller’s market” that exists. “There is a dearth of high quality product on the market,” says Chad Lavender, a managing director at HFF. Although there is a good amount of product available for sale, many of the buyers are focused on class-A, newly built, purpose built assets in the best-of-the-best markets across the country. There is a very aggressive bidder pool chasing both portfolio deals and single assets that fit that criteria as those properties are in short supply, he adds.
“From the buy side, the market is incredibly competitive,” agrees Maconachy. HFF is seeing bidder pools in the double digits on most assets, including both portfolio deals and single assets. “It is a very deep field of buyers with very diversified buckets of capital,” he says.
In particular, there is high demand for all of the private pay product—independent living, assisted living and memory care. However, there are an equal number of buyers on the public pay side chasing deals, it is just a different group of buyers, says Maconachy. Buyers and developers have also begun to focus on age restricted apartments, which can offer investors a way to get a foot in the door in the seniors sector at perhaps a lower cost or without the added issues of working with an operating company, he adds.
Buyers find ample capital sources
Respondents are optimistic about their access to capital over the next 12 months. Nine out of 10 investors believe that their access to equity capital will be the same or better, while eight out of 10 investors think their access to debt capital will be the same if not better. Borrowers have very good access to capital for acquisitions, refinancing and new construction, says Joshua Rosen, senior vice president and team leader at Capital One in Chicago and a specialist in agency financing, including Fannie Mae, Freddie Mac and FHA. “We haven’t seen this much activity in the market for a long time,” he says.
More lenders that pulled back from the market due to the recession have returned and are willing to lend. On top of that, the group of active lenders is expanding. Seniors housing used to be a more specialized financing niche. Some lenders didn’t understand it and had no interest in understanding the property type, says Rosen. “Now what you’re seeing is a lot of these local banks and finance companies not only want to do the business, but they actively compete for the business,” he says. A big part of that motivation is that the top margins on health-care properties can be much greater than other types of commercial real estate, he adds.
Survey results show that borrowers continue to tap a variety of different capital sources. On a scale of 1 to 10 with 1 representing borrowers that had obtained no capital from that source and 10 representing a significant source of capital, respondents scored REITs the highest with a mean score of 7.1. Fannie Mae and Freddie Mac, institutional lenders and national banks also scored high at 6.5. HUD scored a 6.3 followed by local and regional banks and pension funds each at 6.2 and life insurance companies at 6.0.
“People want the business. So, competition is fierce,” says Rosen. He believes lenders are being aggressive because they value the product and they are operating in a context where they see a relatively healthy future for the sector.
Most respondents (60 percent) expect no change to underwriting standards in the coming 12 months, although 24 percent do believe that underwriting could tighten and another 16 percent anticipate looser underwriting standards. More specifically, 75 percent expect no change in debt service coverage ratios, while 59 percent believe there will be no change to the risk premium (i.e., the spread between the risk-free 10-year treasury and seniors housing cap rates). In addition, 69 percent believe that loan-to-value ratios will remain the same [Figure 9 in Slideshow]. Borrowers are finding good leverage at 75 to 85 percent, with the ability to push higher with the addition of mezzanine financing or another alternative financing vehicle to layer on top, notes Rosen.
The consensus is that interest rates will move higher in the next 12 months. The big question is how much higher. Regarding interest rates, a majority of 71 percent expect rates to rise in the coming months, while 28 percent believe rates will remain the same and a nominal 1 percent predict a decline in rates.
Positive outlook for occupancy
Respondents believe that both the state of the U.S. economy and the addition of new, competing facilities have had the most significant impact on occupancy rates in the past six months. On a scale of 1 to 5, with 1 being not at all and 5 representing a significant impact, both factors scored a mean 3.6 percent. This survey supports some of the anecdotal feedback that competition is heating up for some operators as new product comes online, notes Mace. State of the U.S. housing market also scored a 3.4, while rental discounts and incentives rated as 3.1.
Despite the new supply coming online in terms of new construction, respondents are confident that the underlying fundamentals remain strong. Seventy two percent believe that occupancies will rise, while 16 percent predict a decline and 14 percent believe occupancies will remain the same. However, most (66 percent) expect a modest rise of less than 100 basis points [Figure 2 in Slideshow].
Respondents’ expectations for how much occupancies will rise is slightly lower than last year’s survey results at a mean of 25.7 basis points compared to 37.5 basis points in the 2014 survey. “That would make sense, because we are coming off the years following the recession where there were some pretty significant gains in occupancy as the market re-stabilized,” says Mace.
According to NIC data, in the second quarter, occupancies dropped slightly compared to year-end levels, and remained relatively flat on a year-over-year comparison. Seniors housing properties combined, including independent and assisted living, averaged occupancies of 89.9 percent as of second quarter—10 basis points higher than a year ago, according to NIC. Separately, the occupancy rate for independent living properties and assisted living properties averaged 91.0 percent and 88.4 percent respectively during the second quarter of 2015. Occupancy for independent living was still 0.5 percentage points above year-ago levels, compared to assisted living which was down 0.3 percentage points from the second quarter of 2014.
During the second quarter of 2015, annual asking rent growth for seniors housing properties was at 2.3 percent, 20 basis points higher than its pace one year earlier. On the nursing care side, occupancies declined from 88.3 percent a year ago to 87.9 percent in second quarter 2015, while year-over-year rents rose 2.5 percent, according to NIC.
Respondents also are optimistic that rents will continue to rise over the next 12 months. An overwhelming majority (85 percent) believe rents will rise, compared to 12 percent who anticipate no change and only 5 percent who predict a decline. The average mean increase expected is that rents will rise by 1.5 percent [Figure 12 in Slideshow]. That optimism is consistent with the NIC forecast. NIC expects seniors housing vacancies to remain relatively flat with a nominal 10 basis point drop to 89.8 by second quarter 2016, while nursing care occupancies are forecast to rise slightly from 87.9 percent to 88.3 percent.
Outlook remains rosy
Ultimately, the strong fundamentals are among several factors fueling investor interest in the seniors housing sector. Seniors housing also has emerged as a sector that is better understood due to greater transparency on data related to performance and sales activity, says Mace. “It has become more of a mainstay asset type similar to the other traditional asset types such as office, industrial, retail or multifamily,” she says. “As the transaction volumes go up, it is also creating greater liquidity in the market.”
Institutional investors have been increasing allocations to real estate in general in the last two decades, and seniors housing has benefited from that increase. “I also think that more and more people have realized that seniors housing is out there,” says Levy. There is more data available through organizations such as NIC, and that data shows that seniors housing held up relatively well even during the downturn, he adds.
The aging population is providing an added incentive to investors to gain a greater foothold in the sector. The baby-boomer population is sizable at nearly 76.4 million and has the potential to drive big change across the industry in terms of the demand and the types of facilities needed. However, baby boomers are defined as those individuals born between 1946 and 1964. So, even the oldest boomers are just shy of 70 years old. The average age for residents in most buildings is around 84 or 85, and the average age for those first entering a seniors housing property is early 80s.
What that means is that today’s facilities are primarily serving the parents of baby boomers, and there is still a good decade to go before boomers themselves will consider seniors housing properties. “There is a growing demographic tailwind for this business, and we are only in the beginning portion of that,” says Levy.
Methodology: Between June 11 and July 31, NREI and NIC emailed members of their respective databases of commercial real estate professionals requesting participation in an online survey about seniors housing. One hundred and eighty-two responses to the survey were collected and tabulated.