The development boom underway in the seniors housing space has not put a damper on confidence. Exclusive survey results from the fourth annual NREI / NIC Seniors Housing Market Study indicate a more positive outlook across the board on questions related to improving fundamentals, access to capital and transaction pipeline.
The steady stream of new supply being added to the market has been a hot topic of conversation across the industry, and a majority of respondents (59 percent) expect to see a further increase in construction starts over the next 12 months. That is a notable increase over the 45 percent who held that view a year ago. Overall, 26 percent of respondents believe that construction starts will remain the same, while 15 percent predict a decline.
Current construction as a share of existing inventory for seniors housing preliminary maintained a robust pace of 5.8 percent in the second quarter, which is 0.8 percent below its recent high of 6.6 percent in the third quarter of 2016. Despite the new supply already added, and more on the way, 80 percent of respondents said they do not think that new construction will lead to overbuilding.
Demographics continue to be a big driver for development. “As active as the market is with the product that we have today, we are looking at the tip of the iceberg in terms of boomers hitting retirement age,” says Scott Stewart, a managing partner at Capitol Seniors Housing, a private equity-backed real estate acquisition, development and investment management firm based in Washington, D.C. “The fast-paced growth of that population in that sector is going to make today’s discussion of overbuilding obsolete, because there just aren’t enough places for everybody today,” he says.
Another factor driving development is that the available product is outdated compared to what today’s seniors want in terms of the properties, services and amenities.
“The seniors housing industry is rapidly changing and a lot of the product out there is just archaic. It is not filling all the needs of seniors, and we want to change that,” says Stewart. Capital Seniors Housing moved into development about three years ago. Currently, the firm has 15 seniors housing projects in various stages of development, including two new projects in New Jersey that broke ground this summer.
The fact that activity has been concentrated in relatively few markets is also helping to keep fears of overbuilding in check, notes Beth Burnham Mace, NIC’s chief economist and director of outreach. Over the past year through June there has been nearly 35,000 units added to the stock of seniors housing inventory among the nation’s largest 99 metropolitan areas.
Roughly 30 percent of this growth occurred in seven metro areas: Dallas, Chicago, Minneapolis, Atlanta, Houston, Miami and Boston. Dallas and Minneapolis alone accounted for 12 percent of all new seniors housing inventory in the past 12 months, according to NIC.
Data on the high number of units being built nationally is making headlines, notes Stewart. “But if you peel back the layers, a lot of the new properties are going into markets that don’t have barriers to entry and are being flooded with product,” he adds. “We run for the hills when we see that. We try to go where no one else is going.”
Demand mops up new supply
Despite the new supply coming online, respondents remain confident in improving fundamentals. A majority of respondents (78 percent) anticipate that rents will rise over the next 12 months, which ticked slightly higher compared to the 73 percent who predicted that rents would rise in last year’s survey. An average increase of 84.2 basis points is expected.
NIC reported that average asking rents for seniors housing grew at a rate of 3.4 percent as of second quarter, which represents a 20 basis point increase from the prior year.
Respondents also are more bullish that occupancies will rise over the next year. Overall, 65 percent said they felt that way this year vs. 56 percent who held that view in 2016. Among those who do anticipate an increase, the average rise expected is just 10.9 basis points.
At a glance, that confidence appears to run contrary to NIC data that shows a slight decline in occupancy during the second quarter. The overall occupancy rate for seniors housing properties dropped 90 basis points year-over-year to 88.8 percent, a drop that is likely due to new supply and properties still in lease-up phases.
The increase in the percentage of respondents who believe occupancy rates may improve in the coming months may be due to the fact that respondents are considering their local market conditions, notes Mace. “There are certainly some regions of the country that have not experienced the same level of development as others,” she says.
When asked to rate the strength of market fundamentals by region, the South/Southeast/Southwest rated the highest. On a scale of one to 10 with 10 being the highest, 46 percent rated that region as an eight or higher; followed by the West/Mountain/Pacific at 42 percent; East at 20 percent; and Midwest /East & West North Central at 19 percent. “In general and broad terms, the West has experienced less development activity than has the Southeast, South and Northeast, in large part due to higher barriers to entry,” says Mace.
For example, the occupancy rate for seniors housing in San Jose, Calif., ranked as the highest in the nation, at 95 percent in the second quarter. Sacramento, Calif., and Los Angeles also both had occupancy rates above 90 percent. At the other end of the spectrum were San Antonio, Houston and Dallas, which ranked near the lower end of occupancy rates among the nation’s largest metropolitan areas with occupancy rates between 81 percent and 84 percent, according to NIC.
When comparing with other property types, respondents continue to rate seniors housing as a highly attractive property type. Its scores topped that of the five major property types on a scale of one to 10.
Buyers continue to pursue assets
The big three REITs have been more subdued in their acquisition activity this year, which analysts attribute in part to political uncertainty surrounding healthcare reform and caution regarding new supply. However, nearly half of survey respondents (47 percent) said that they plan to buy seniors housing property over the next 12 months compared to 38 percent who said the same in the 2016 survey. Overall, 42 percent plan to hold property and 11 percent intend to sell assets.
Most respondents (48 percent) anticipate that sales volume will maintain a steady pace over the next year. However, a bigger percentage of respondents expect sales transactions to increase over the next year as compared to a year ago. In fact, 39 percent said believe sales will rise as compared to 26 percent who held that view in the 2016 survey. Those who predict a decline in sales are in the minority at 13 percent.
Investment sales transaction volume for seniors housing and care facilities held steady during the first half of the year as sales across the broader commercial real estate investment sales market slowed by 8 percent. An estimated $6.5 billion in sales closed during the first half of the year, according to Real Capital Analytics.
A growing number of respondents said they think deal speeds might be slower in the next 12 months. In this year’s survey, the percentage of respondents expecting deals to take longer was u to 23.2 percent—an increase from 16.7 percent in 2016.
However, sales volume is likely getting a boost from a few large portfolio deals that closed in the first quarter. Three sales accounted for about 40 percent of first quarter volume at roughly $1.6 billion, notes Joshua Jandris, senior managing director of investments for the Institutional Property Advisors’ (IPA) Seniors Housing Group and Marcus & Millichap’s National Seniors Housing Group. “2015 was a banner year for our industry. Cap rates were very, very low relative to the preceding years, and what we are experiencing in 2016 and 2017 is kind of a plateau from a volume standpoint,” says Jandris.
“The market is pretty similar to last year,” adds Danny Prosky, a principal at American Healthcare Investors and president and COO at Griffin-American Healthcare REIT III and IV. Specific to seniors housing properties, Griffin-American Healthcare REIT focuses on acquiring small portfolios that include three to eight assisted living properties. “It is certainly not a buyer’s market, but there is inventory available and we are able to get similar pricing this year as we did last year,” says Prosky. The REIT, which also buys medical office buildings and skilled nursing facilities, recently acquired an eight-property portfolio of assisted living facilities in Northern California.
Like many buyers these days, Griffin-American Healthcare REIT is keeping close tabs on the new supply coming into markets today.
“We focus a lot more on what’s coming online in any particular market we’re looking at more so than we did in the past,” says Prosky. Specifically, the firm is looking for acquisition opportunities in markets where there is not an above average percentage of new supply coming on board, he adds.
Higher cap rates ahead?
One of the key factors that has continued to attract new capital to the space is the higher yields seniors housing properties have been generating. Seniors housing is still trading at a higher cap rate relative to other traditional asset classes, such as multifamily and student housing. Good assisted living assets are trading at cap rates that range between 6.5 percent and 8 percent whereas a multifamily or student housing opportunity is trading considerably lower, notes Jandris.
The influx of new inventory is also creating more pricing disparity between class-A- and B+ or class-B and -C assets, notes Jandris. That is producing a disconnect in pricing expectations between buyers and sellers, which is weighing on transaction volume. There also is a bigger pricing disparity emerging depending on the market, such as a top 20 market or a top 50 market or suburban versus tertiary, he adds.
In total, 52 percent of respondents believe that cap rates will increase over the next 12 months, while 28 percent predict no change and 20 percent anticipate a decrease.
There are a significant number of respondents that anticipate higher cap rates, which is likely a reflection of views that interest rates will move higher in the coming year, says Mace. “As rates rise, it would not be surprising to see cap rates rise, although perhaps not to the same degree as the risk premium for seniors housing remains relatively large,” she says.
Capital remains widely available
Respondents continue to believe that there is ample to moderate capital available from lenders across the board. On a scale of one to 10 with 10 being the highest, REITs rated the highest with 33 percent rating availability at an eight or greater; followed by HUD (29 percent) and institutional lenders (27 percent).
“It is still a very active market out there with well capitalized, experienced sponsors and strong competition across segments,” says Kevin Murray, national market manager of the healthcare group at KeyBank. “KeyBank focuses primarily on providing financing for the acquisition and refinancing on seniors housing properties with a secondary focus on construction…. There continues to be a good amount of both debt and equity in the space and continued interest from new sources, be it foreign capital, institutional capital or private capital.”
Survey results show mixed expectations for the availability of debt capital and equity capital. Respondents are more pessimistic that debt will be less available over the next 12 months as compared to equity.
In all, 42 percent of respondents predict that debt financing will be tighter, while 37 percent anticipate no change and 21 percent think access to debt will improve. On the equity side, most (45 percent) expect no change, while 31 percent think access to equity will be greater and 24 percent said equity would be less available.
Lenders are also accounting for the bigger increases in new supply being delivered in some markets and submarkets.
“I think there has been pretty good discipline on the construction financing side in general as far as the terms,” says Murray. In addition, because the seniors housing space has very distinctive permanent market exits, there are strong guidelines in place on how construction loans are structured, he adds.
When it comes to credit factors, a bulk of respondents expect interest rates to continue to rise. Respondents expect less movement on loan-to-value ratios, debt service coverage and the risk premium in the next 12 months.
Disparity between markets
Looking ahead, new supply will continue to be an issue to watch. On a scale of one to five with five being the most significant impact, 59 percent of respondents rated the impact of new and competing facilities as either a four or a five. Respondents also rated the state of the U.S. economy as a very or somewhat significant factor at 40 percent; and state of the U.S. housing market at 39 percent. Rental discounts and concessions were viewed as having the lowest impact on occupancies at 34 percent.
However, there may be some disparity in how the impact from new supply is being felt across the industry, notes Mace. “In general, inventory growth has been ramping up for a much longer period for assisted living than for independent living,” she says.
As of the second quarter, annual inventory growth for assisted living reached its highest level since NIC began reporting the data in 2006—5.9 percent. Although absorption has accelerated, the new supply is putting downward pressure on occupancy. The occupancy rate for assisted living properties fell to 86.5 percent in the second quarter, which is the lowest level since 2006. In comparison, the occupancy rate for independent living was significantly higher at 90.6 percent in the second quarter, according to NIC.
Nearly half of respondents (48 percent) view the seniors housing market as being in the recovery/expansion phase of the cycle. However, the disparity between markets also explains differing opinions that include 22 percent who think the market is at the peak, 12 percent who said the market is in a trough or recession and another 18 percent who were not sure of the phase. There are metros such as Houston and Atlanta that are past their peak with occupancy rates declining and supply exceeding demand, notes Mace. “At the same time, many markets in the U.S. are in expansion phases with new supply entering the market, and in many instances, supply and demand are matching each other allowing occupancy rates to stay relatively stable,” she says. n
Methodology: In July, NREI emailed members of its database of commercial real estate professionals requesting participation in an online survey about seniors housing. The survey yielded 153 responses.