Market View: Seniors Housing
While the seniors housing industry certainly has not been recession proof, it has survived the depths of the economic downturn with resilience and a reasonably sound track record of accomplishments by maintaining a healthy level of occupancy, a very low loan default rate and controlled development. As 2011 begins, the industry is being transformed from a 25-year upstart to a full-fledged member of the real estate community.
Investors, both in the United States and abroad, have discovered that this generally need-based product type has measurably outperformed other real estate options. National Council for Real Estate Fiduciaries statistics for 2004-2009 reveal that it has outperformed, on an operating performance and asset valuation basis, all other real estate categories. This is impressive justification that there is logic and not just rhetoric behind industry fundamentals. Overall, industry occupancy levels are approaching 90 percent at a time when office, industrial, retail and hotel assets are all struggling to achieve something comparable.
Investment returns are compelling, and with the development pipeline at a near standstill, the industry is poised for fresh capital to emerge. There are less than 1.5 million investment-grade seniors housing units in the United States today, and by 2015 there will be 22.4 million people over 75. That sets the stage for growth that will only be constrained by the cost and availability of financing. With new construction volume down 66 percent from the industry high of 45,000 units in 1999, there is ample opportunity for the astute investor in both acquisitions and selective new construction.
In light of the federal government’s control over monetary policy, the direction of the economy and most definitely the debate over the government-sponsored enterprises, there is concern for making prudent business decisions across the capital markets. As the year unfolds, it is safe to say that the uncertainty over the future of the GSEs will be a critical factor influencing industry investment growth. Underwriting standards at the GSEs have become more stringent, while the timeline to successfully complete financing transactions with them has lengthened.
Considering that these entities account for nearly 95 percent of the permanent debt in this industry, we are vulnerable to the whims of the political landscape. Will Fannie Mae and Freddie Mac be privatized? Their evolution will likely occur over the next three to five years.
2011 will emerge as a time of transition in the capital markets. We will witness a continued rise of alternative and non-traditional sources of both debt and equity. Recognizing intrinsic industry fundamentals and the likely restructuring of the seniors housing capital stack, national and regional banks have begun to re-enter the bridge loan business, although construction financing remains available only on a limited basis, with full recourse and loan proceeds reaching a maximum of 65 to 75 percent of cost. There will continue to be a need for bridge lending, as many properties purchased between 2005 and 2007 with three- to seven-year term loans will not qualify for GSE takeouts, and that should provide opportunity for insurance firms and banks to lock in above-market rates.
That paves the way for investment by REITs, private equity players and foreign investors that have strategically accelerated their involvement with the industry. When the economy started to deteriorate in late 2007, the REITs began to shore up their balance sheets and liquidity while reducing leverage in anticipation of better days to come for investments in this space. They amassed a war chest of capital to fuel the acquisition market and replace traditional lenders.
Healthcare and seniors housing REITs have recently begun utilizing the taxable REIT subsidiary structure to supplement their traditional sale-leaseback models by providing non-customary services, such as management, to tenants. The TRS allows REITs to be more flexible in structuring deals and better compete for the full value of a property. Instead of recognizing only the capitalized value of the lease income, REITs can now see the value of the operating income after the lease payment to the extent they serve as managers.
For the seniors housing owner/operator, the acquisition market has improved dramatically from pre-2010 levels. Opportunities to monetize their investment positions through financial leveraging with new partnership structures and REIT deals will intensify as the year progresses. Likewise, the emergence of foreign capital into the U.S. seniors housing business is taking hold, with several portfolio transactions scheduled to close within the next few months. Offshore investors with longer-term investment horizons appear to be considering more defensive U.S. real estate platforms such as seniors housing, with investment returns consistent with more conservative underwriting criteria. As the global population ages, acquiring the knowledge base of U.S. companies will potentially represent a huge advantage for these foreign investors in their own countries.
The fact that in the second half of 2010 more than $6 billion worth of non-skilled nursing facility portfolio transactions were either announced or actually closed at reasonably aggressive pricing bodes well for a good start to 2011. Now may be the time for newcomers to enter the seniors housing market or for current participants to deploy new capital—while the investment environment is fertile, with reasonable cap rates and historically low interest rates. The demographics will continue to drive growth. This will create opportunities in seniors housing during 2011 and for years to come.
—Mel Gamzon is a principal & senior managing director of Senior Housing Investment Advisors and a member of the CPE editorial advisory board and the executive board of The American Seniors Housing Association. He produces a quarterly seniors housing report on CPE TV and MHN TV and can be reached at email@example.com.