By Mel Gamzon
It has taken nearly three decades, but seniors housing has surfaced as a vibrant star in the U.S. real estate universe. Through innovation and perseverance on the part of industry operatives and their investors, a track record of successes has been established—even during the challenging past few years. The foundation has been set for a new generation of seniors housing products, which will begin to emerge in the year ahead. Yet the political and economic uncertainty in this country has been a consistent burden for the deployment of capital as well as the impact on the financial resources and psyches of senior consumers. There are numerous proposals at the federal level that will impact the cost and availability of capital, taxes and regulatory oversight. When will stability finally take hold? Hopefully, soon. However, what the government needs to do versus what it will do remains unclear.
Healthcare reform, in whatever format it eventually takes, will likely become reality after this election year. Certain provisions of the Affordable Care Act, even if dramatically modified, will provide the stimulus to alter the massive healthcare cost structure in the nation. Herein lies a vast opportunity for perceptive investors seeking to enter this sector: The healthcare continuum for seniors is evolving, with increased pressure to service our aging population within non-institutional settings that offer housing and supportive care options. This downward pressure for more affordable healthcare options in residential settings has only begun, as the impact of the Baby Boom generation will not be fully realized for at least 15 years.
For the skilled nursing business, the line in the sand has already been drawn at the federal level. The Centers for Medicare & Medicaid Services (CMS) lowered the boom on this segment last July with a draconian Medicare rate cut that impacted property values. This action, one year ahead of schedule, along with likely Medicaid rate cuts by many states that are suffering from severe budget deficits, will provide further impetus for investments in private-pay seniors housing. The handwriting is on the wall for cost containment, and seniors housing in all formats is the logical beneficiary.
Many investors are already focusing on such opportunities, as evidenced by M&A velocity in 2011. Despite all the uncertainty in the capital markets, seniors housing witnessed its second-best year ever, with a more than $16 billion transaction volume, catalyzed by the ultra-aggressive healthcare REITs. From the second half of 2010 into 2011, the REITs closed more than $20 billion worth of portfolio transactions in this space using the REIT Investment Diversification and Empowerment Act (RIDEA) and triple-net-lease structures. The REITs and their institutional capital partners have put the seniors housing sector front and center with prospective industry investment sources that are seeking returns greater than other real estate asset classes can offer.
Buoyed by historically low interest rates, private equity, pension funds, insurance companies and traditional investors have cautiously entered the business. Slowly and with careful consideration for potential operational complexities, the M&A market begins 2012 with a craving for both value-add and stabilized assets and portfolios. Because interest rates are likely to remain at historically low levels through 2014, we anticipate continued stability for asset valuations. Likewise, cap rates for high-caliber independent- and assisted-living assets—which dropped by at least 50 basis points last year—should remain stable if not tick down even lower in 2012 as the prospects for new construction are limited by the lack of available financing.
And U.S. investors are not the only ones monitoring this sector. The volatility of global economies and a need to generate predictable yields are attracting an increasing number of foreign investors. A growing number are studying industry dynamics and metrics with the objective of generating longer-term returns and the ability to “export” seniors housing technologies to their own countries. Like their counterparts in the United States, they are after the yield, safety and stability offered by this generally need-based real estate platform.
While the equity players have jumped off the sidelines for action, we are still waiting for debt to catch up. Therein lies the dilemma, as the GSEs have been the dominant debt providers in this space for the past several years. While it is reasonable to suggest that these entities are somewhat insulated from structural change during this election season, all bets are off the table after November’s election. Budgets are already tightening, and the delays in loan processing are creating frustrations with many borrowers.
Clearly, we are at a point where there is a huge opportunity for new sources of debt to enter the market—sources we likely will see as the year progresses.
Slowly picking up the slack in the debt markets are highly selective national and regional banks, insurance companies and non-traditional lenders. While bridge financing and balancesheet lending are becoming more prevalent, will we also see an emergence of the CMBS markets? Likely not, as some of the most aggressive commercial loans made in 2007 hit their maturity dates this year. There is roughly $55 billion worth of non-seniors CMBS loans out of a total of $580 billion in maturing commercial loans coming due. Those are tough numbers to tackle at a time when refinancing options are limited for non-stabilized assets. The good news is that, industry-wide, seniors housing loan defaults have been negligible relative to those of other sectors.
It helps that seniors housing is not an overheated sector. In fact, were it not for lenders’ continued hesitation to finance any but the triple-A ventures with experienced seniors housing practitioners, ground-up development would absolutely be possible and appropriate in many markets. Industry occupancy rates are at roughly 89 percent, with profit margins continuing to gradually improve. In many respects, there is a window of opportunity for industry owners and operators as well as investors to secure capital at highly competitive rates and terms.
The year ahead will mark the beginning of a dynamic new era for this industry. M&A activity will gradually accelerate as the year progresses, with owners seeking to monetize their current positions. Furthermore, as residents age in place, transitional housing and service options will evolve. In many instances, independent living will begin looking more like assisted living “light,” while traditional assisted living will assume a broader range of revenue-enhancing services.
Expanding into ancillary businesses such as home care and rehabilitation services represents an opportunity to improve revenue and strengthen market position as healthcare reform intensifies. Prospective new investors should recognize that strategic alliances with health and wellness providers can redirect the regulatory and legal issues to these service providers. Industry professionals are refining new approaches to these relationships.
All in all, then, prospects are good for the seniors housing sector. In fact, in many respects, despite the daunting challenges our nation faces, the next few years will be prime time for the sector as it begins to share center stage with the apartment industry.
Mel Gamzon is president of Senior Housing Investment Advisors Inc., a real estate advisory firm, and a member of the CPE editorial advisory board and the executive board of The American Seniors Housing Association. He produces a biannual seniors housing investment report for CPE TV and MHN TV. He can be reached at firstname.lastname@example.org.