When it comes to attracting capital, it is possible to have too much of a good thing in seniors housing. And the investment levels that are building up in the sector already have some observers worried about overheating.
It has taken nearly seven years to reach this feverish pace after an extended dormant period following the Wall Street implosion in 2008. Seniors housing was not as damaged by the financial turmoil as were commercial real estate and other parts of the economy, and it has proven advantageous in its recovery.
After years of sitting on the sidelines, lenders are once again actively engaged in the market, says Russ Dey, assistant vice president of Healthcare and Multifamily Finance for Walker & Dunlop.
“Competition is the word,” he says. “The seniors housing asset class has become more and more attractive to institutional capital as it continues to provide investors with competitive, risk-adjusted returns, at a higher going-in yield than other mainstream asset classes. This has translated into more capital chasing every deal from both an equity and debt standpoint, including lenders and developers that are new to the space.”
Similarly, F. Donald Kelly III, senior director of healthcare finance for CapitalSource, calls the current state of the capital market “aggressive,” and that competition for property acquisition has been “fierce,” citing a drop in acquisition cap rates based upon “in place” net operating income.
“Buyers are paying for upside a couple years into the future, which is concerning from a macro perspective,” Kelly says.
With memories of the 1999-2000 overdevelopment fallout still fresh 15 years later, investment pros have solid context on how vulnerable senior housing can be to irresponsible financing. And with the marketplace showing signs of a budding frenzy, their concerns are legitimate.
Not all financiers are worried about the sector reaching a boiling point yet, however. Michael Gehl, chief investment officer at Home & Health Care Finance, sees the investment rate as “stable” and that capital is “abundant” for facility operators who need it.
“If you look at the best data we have from NIC MAP, industry occupancy at assisted living facilities has been increasing from cyclical lows, and while there has been a pickup in new inventory, projections show absorption keeping pace with new inventory, creating a stable occupancy environment,” he says. “There are clearly markets where this is not the case, but generally speaking, the supply-demand relationship is a stable one.”
With commercial banks, real estate investment trusts, private equity finance companies and commercial mortgage-backed securities firms along with public financing stalwarts HUD, Fannie Mae and Freddie Mac lining up to underwrite loans at low interest rates, “it could not be a better time to be a borrower” in the senior housing space, Gehl says.
Even with a growing amount of capital entering the space, the critical indicators in the market show no reason for alarm about overheating, Gehl says, pointing to the following:
• Occupancy levels — Citing NIC MAP data, the occupancy rate for assisted living facilities averaged 89.3%, which is 2.8% above its cyclical low. Those numbers show a strong demand for a needs-based product, but also a “recession-resistant” nature of the property, he says.
• Operational stability — Based on the Earnings Before Interest, Taxes, Depreciation, Amortization and Rent, assisted living margins have been “pretty consistent” in the 25% to 30% range, which is well within the confines of acceptability, Gehl says.
• Property development — Construction starts as a percentage of inventory in the assisted living space are in line with unit absorption, which indicates stability in the marketplace.
Overall, the seniors housing industry continues to experience incremental gains in average occupancy and rent growth, which Dey agrees indicates rational, positive performance for the market.
“There are a couple pockets around the country where new inventory is outpacing current absorption, but this shouldn’t impact the fundamentals too much in the long term,” he says. “It’s important to remember that the first baby boomers are only turning 69 this year, so the big wave of demand that everyone is anticipating is still a long way out when you consider the average age of a seniors housing resident is 82.”
Different lenders have specific preferences in the types of projects they underwrite, but in general they are looking for a balance between need-driven services and private income sources, financial specialists say.
“Many lenders would prefer to finance properties where the predominant payer source is private pay for need-driven services due to the perceived stability this model provides,” Dey says. “Other lenders take the opposite view and would prefer a heavy Medicaid concentration in assisted living, provided the state is on solid financial footing.”
There are also some lenders who still prefer choice-based independent living due to the lack of operational risk associated with this care type, Dey explains.
“Over time, lenders for properties that offer higher acuity care will have to adapt to changing payer sources as ACOs become more prominent and the national healthcare delivery model continues to evolve.”