After several years of consistent, pragmatic investment in senior living care properties, new market variables have some financiers concerned about volatility and its impact on current development, industry specialists say. A return to the meltdowns of 1999 and 2008 are unlikely, they say, but some factors warrant closer inspection.
Jeff Sands, managing principal at HJ Sims, characterizes the investor outlook as “cautiously optimistic” and says whatever rifts that appear now won’t serve as a discouragement to continued funding. However, “a reason for caution is a reaction to some of the news that has trickled out lately, such as Brookdale Senior Living’s problems and some of the concerns expressed by the REITs regarding the impact of the increase in new construction,” he says.
Other influencers, such as rising interest rates, potentially could have a cooling effect on investment, though Sands says he is not tremendously concerned.
“Even with some increase, rates are still at historic lows,” he says. “Many existing providers have already locked into their debt costs. Also, senior housing rents have historically tended to rise with rising interest rates, so it could actually be a positive for some providers.” The investment climate in seniors housing “has definitely shifted in the past 18 months,” notes Michael Hass, founding partner of Drive Development Partners. Lenders and investors, he says, are looking more closely at units mix, competition, demand, operators and the overall market.
“Whereas there was a bias to invest and build in 2015, now there is a slight bias against it,” Hass says. “More capital is taking a pass on projects that would have been viable in 2015 or 2016.”
Dague Retzlaff, senior vice president of Capital One Healthcare, sees a capital flow that continues to be strong “as investors on both the debt and equity sides seek higher returns that can be found in the more traditional commercial real estate asset classes.” And although market dynamics remain stable, Retzlaff concedes that “a rise in new construction in some submarkets has forced us as lenders to be a little more diligent in underwriting in those markets.”
The HUD machine
In the wake of the 2008 meltdown, the Department of Housing and Urban Development picked up the underwriting slack for seniors housing operators and has continued to be a stalwart in financing over the past nine years. Industry observers say they see no reason for HUD to cease its prolific output.
“One of the selling points of HUD mortgage insurance is that it provides a stable, affordable source of capital when other sources exit the market,” says Anthony Luzzi, president of Sims Mortgage Funding. “We saw that during the credit crunch in 2008 and the recession that followed. However, despite the re-emergence of other capital sources, HUD continues to play an important role in the market. Their loan insurance programs provide long-term, fixed rate financing with full amortization and non-recourse provisions. Moreover, HUD is now able to accommodate more complicated financing and operating structures, giving it enhanced relevancy as a capital source.”
Variables such as higher interest rates are still low by historical standards and should not pose any obstacles to HUD-insured funding, Luzzi says.
“Many of the HUD-insured loans for healthcare projects feature debt service coverage ratios considerably above HUD’s 1.45 minimum, because the capitalization rates used to determine value and loans have been higher than the interest rates used to calculate loans based on debt service coverage,” he says. “An increase in interest rates will result in a lower coverage ratio, but not necessarily lead to a reduction in loan sizing.”
To be sure, “HUD continues to play a major role in refinancing senior living, and ‘bridge to HUD’ programs have become very popular,” Sands says.
Michael Gehl, chief investment officer for HUD lender HHC Finance, expects the Federal Reserve to raise interest rates this year but doesn’t expect it have a huge impact. “I don’t see it as a big mover of activity in the market,” he says. “HUD borrowers typically want to lock in. Some might want to look at a floating rate, but I don’t see people racing into it, and it should not be a big concern.”
New money wants in
If the long-term care market is nearing the boiling point, it most likely could be from what Hass sees as “lots of ‘country club’ money from private investors wanting to get into the space.” There is “a dislocation between expectations on timing and the reality of a new senior housing project,” but new money simply seeks to enter the space without thought to consequence, he says.
New investors wanting to put money in long-term care doesn’t surprise David Friend, M.D., chief transformation officer and managing director in the BDO Center for Healthcare Excellence & Innovation.
“The demographics are overwhelming — especially for memory care,” he says. “Half of the people age 85 have some sort of dementia and with the aging of the population, that number will only continue to grow. Over the next 10 years, we will double the number of people with dementia who need an institutional bed. That is a powerful incentive to continue to build and renovate buildings for seniors.”
Friend believes that demand currently outstrips supply, so the market can absorb the projects in progress now and into the near future. If there is one exception, he says it is for upscale senior living communities. “If the market is frothy, it is in the high end, where there aren’t enough wealthy people to support it,” he points out.
One notable new player in the market from China, Cindat Capital Management, a Chinese investment firm focused on overseas properties, is reportedly seeking to spend $2 billion in seniors housing.
“China and other Asian companies see the U.S. market as an investment opportunity,” Gehl says. “It will be interesting to see what they do.”
If there is a pronounced change in finance, it is that lender preferences for sector, project type and care mixes are evolving, Sands says. On the seniors housing side, the fastest-growing segment has been the construction of new independent living communities. On the skilled nursing side, he says there has been “tremendous consolidation occurring” and that banks have been “actively engaged” in lending in the sector.
Conversely, Sands maintains that healthcare REITs have “backed off of nursing homes over a concern about the impact of budgetary and regulatory matters” and that the void is being filled by private lenders.
“Private equity continues to raise capital and so they will continue in the game with an emphasis on development of new portfolios of multilevel senior housing,” he says. “The nonprofit companies that specialize in continuing care communities are active, and the municipal bond market has continued its appetite for this product.”
Likewise, Hass thinks private equity “still has cash to deploy, but they are, and have always been, discerning in their partnerships and project selection.” Even so, I feel like they still have a slight bias to invest,” he says.
The Trump factor
A new administration sometimes can have an impact on the industry, so how could President Trump influence the long-term care market? Views are fuzzy because it is so early in the Trump presidency, but overall the outlook appears positive.
“We are happy that a Trump administration is continuing to be as supportive of HUD’s mortgage insurance programs as previous administrations,” Luzzi says.
On the positive side for providers, Sands sees lower taxes, regulation reduction and un-cuffing of financial institutions. On the negative side, he says, restricting the flow of immigrants, Medicaid block grants and uncertainty over the repeal of ACA could hurt.”
Friend predicts that “mandates, regulations and subsidies will be replaced by choice, competition and actuarial soundness.”
Ultimately, Hass believes Trump will focus on the tax policy equation.
“If they adjust carried interest or reduce the corporate rate, it could lead to more capital investment,” he says. “What they do with healthcare, if anything, won’t deplete demand for senior care in 2022 and beyond. People will continue to age.”
The caregiver shortage could be exacerbated by deportations and the immigration ban, Hass says, but he adds, “Washington is a place where what happens is what’s most politically expedient, not what follows the loudest rhetoric.”