Looming Seniors Housing Shortage:
Few projects under development

Like other commercial real estate sectors, seniors housing has seen a slowdown in construction during this downturn. But unlike other sectors, demand for seniors housing is forecast to outpace supply in the future.

“Almost all seniors housing development has stopped,” says Danny Prosky, president & COO of Grubb & Ellis Healthcare REIT, a public non-traded REIT that invests in healthcare facilities, including seniors housing. “If we don’t start seeing some development soon, we’re going to see a real shortage in 15 years.”

Graying population

Today, some 39 million Americans, or 13% of the U.S. population, are 65 and older – up from 4% in 1900, according to Pew Research Center. A century-long expansion in the share of world population that is 65 and older is the product of dramatic advances in medical science and public health as well as steep declines in fertility rates.

In this country, the increase has leveled off since 1990 but it will start rising again when the first wave of the nation’s 76 million baby boomers turn 65 in 2011. By 2050, according to Pew Research projections, about one in five Americans will be over age 65, and about 5% will be age 85 and older, up from 2% now. These ratios will put the United States at mid-century roughly where Japan, Italy and Germany—the three “oldest” large countries in the world—are today.

“The overall demographics continue to favor seniors housing and the economic downturn didn’t change the demographics,” points out Brian Heagler, a senior relationship manager with KeyBank Real Estate Capital, who specializes in seniors housing. “If anything, seniors housing, especially memory care, is becoming more important as Baby Boomers get older.”

Strong performance

In fact, the seniors housing sector performed well during the recession, with demand dropping off very little for assisted living and increasing for skilled nursing. Independent living facilities were more impacted.

“This asset class performed very well, probably better than even people in the industry expected,” Heagler says. “Assisted living and memory care are need-driven issues. During a recession, you can try to put it off, but at some point, need takes over. There was an expectation that asset class would fare better but I don’t think industry experts thought it would fare as well as it did.”

For example, the average occupancy rate for seniors housing properties during third quarter 2010 was 87.7%, which was unchanged from second quarter and suggests that occupancy has stabilized. Since second quarter 2009, seniors housing occupancy rates have been trending within a tight range between 87.5% in first quarter 2010 and 88.1% in third quarter 2009, according to Annapolis, Md.-based National Investment Center for the Seniors Housing & Care Industry (NIC).

“There’s been some drop in occupancy (to be expected) but it has not been extreme; the fact that rents have continued to increase during the recession is particularly notable,” says Brent Holman-Gomez, senior vice president with Cambridge Realty Capital Cos., a Chicago-based company that owns and operates seniors housing properties, in addition to serving as a lender to other owners and operators.

For seniors housing properties, annual absorption was 1.2% in third quarter 2010. This is lower than 1.7% in second quarter of the year but does reflect higher levels than in 2008 and 2009. From first quarter 2008 to fourth quarter 2009, the annual pace of seniors housing absorption was below 1%. Third quarter 2010 marked the third consecutive quarter where annual absorption was above 1%.

Independent living properties have taken more of a hit than assisted living. “Need-based facilities have performed better than those that are a lifestyle choice,” Holman-Gomez says. “In early 2008, there was a quick drop off in demand for assisted living. People were worried about economic news and they delayed that move but they could only delay it for so long.”

NIC MAP data also reveals divergent trends in occupancy rates between independent living and assisted living properties. The independent living occupancy rate was 87.1% in third quarter 2010, down 30 basis points from the previous quarter. In contrast, assisted living occupancy was 88.7% in this quarter—up 40 basis points from second quarter 2010.

“While independent living occupancy rates continue to establish new cyclical lows, assisted living occupancy rates are recovering from recent lows,” says Chuck Harry, NIC’s research director.

One of the industry’s largest owners, Chicago-based Ventas Inc., says its properties are exhibiting strong occupancy gains. For example: occupancy for its operating portfolio, which is comprised of 79 high-end mansion-style, assisted living communities managed by Sunrise Senior Living, was 89.5% at the end of third quarter, up 110 basis points from second quarter.

“This positive trend and stabilized occupancy has continued into the fourth quarter as the portfolio is currently over 90%,” says Ray Lewis, Ventas’ chief operating officer. “As the economy has stabilized, these need-driven assets are benefiting from strong industry fundamentals because there is limited new supply and a fast growing 85-plus population fueling demand.”

Annual rent growth for seniors housing in third quarter 2010 was 0.7%, little changed in comparison to the previous quarter when it was 0.8%. One year ago, in third quarter 2009, annual rent growth was 2%. “Rent growth, while still positive, has slowed and reflects the challenging leasing environment that many operators are in today,” Harry notes.

Conservative construction

Owners, operators and lenders have been hesitant about starting new projects, despite the strong performance of the seniors housing sector.

“Our findings mirror the general lack of available construction financing still prevalent in the marketplace,” says Robert Kramer, NIC president. “Many regional banks, traditionally the source of construction financing for our sector, simply aren’t lending to the level they were prior to the recession/credit crisis.”

Construction activity for seniors housing declined slightly in third quarter 2010 to 2%, and it appears to be leveling, according to NIC. Roughly 9,860 assisted living and independent living units were under construction in the nation’s top 31 markets during third quarter, which represents 2% of inventory. That pales in comparison to third quarter 2007, when 19,443 units were under construction, or 4.2% of inventory.

The data shows that select projects are moving forward, but new construction starts are largely replacing the units opening on a quarterly basis. “To the extent that financiers are lending on construction or willing to entertain construction, underwriting guidelines remain tight,” Harry adds. “Today, you need a lot of experience, a great location, a strong sponsor and more equity in the project than was required two to three years ago. In fact, given the increased equity requirements combined with the tighter underwriting, some projects simply are not feasible.”   

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