Unlocking Opportunities: Deleveraging as the Path to Seniors Housing Investment

For most real estate sectors, the party ended last year, with the New Year bringing continued pain–or at least a severe hangover–that will likely linger throughout 2009 and beyond. But amidst the wreckage of the economic system, there are fundamental signs that all is not lost in the up-and-coming seniors housing space. In fact, with supply and demand in check in most markets, there are compelling reasons why this real estate sector may still have some reason to celebrate.While the avalanche of bad economic news has certainly impacted seniors housing, this sector has performed relatively well in the recent real estate environment, where financial dysfunction is the norm. With relatively few loan defaults thus far, need is the driving force, as the consumer is motivated by a desire for a broad range of supportive services and adaptable housing options.The near-term housing market turmoil and the meltdown of individual net worth have caused industry management and marketing professionals to fine-tune their approaches to stringent cost-control measures, customer retention and aggressive marketing efforts. The pressures on occupancy and rates will continue unabated for the foreseeable future. But the industry continues to maintain overall occupancy rates in the low 90 percent range–down more than 200 basis points from a few years ago, but unless we experience a devastating recession lasting several years, most knowledgeable industry operatives feel cautiously optimistic about the industry’s success for weathering the storm. For example, David Schless, president of the American Seniors Housing Association, believes that, overall, most operators have remained profitable.That may not remain the case, however. As deleveraging becomes the cornerstone of investment structuring, the capital markets will challenge an increasing number of seniors housing practitioners. Therein lies an emerging opportunity for those with a war chest of available capital, the ability to access debt and the motivation to close without delay. Liquidity will continue to be a problem, at least through the end of this year. In 2009, an increasing number of operators will be pressured by overleveraged financing, the lack of refinancing options and CMBS obligations coming due. We will see forced distressed sales and bankruptcies for both individual assets and companies. In many instances, cap rates have ticked up more than 200 basis points from 2007. When this upward momentum will subside remains a question, but individual assets and portfolios are becoming more favorably priced, with the spread between buyers and sellers narrowing in favor of acquiring entities. We are likely to witness cap rates approaching levels not seen since the early part of this decade.There is still the problem of a lack of institutions able to provide ample debt. Effectively today, there are just three national lenders in this business: the government-sponsored enterprises and the Department of Housing and Urban Development. Select regional banks, private equity shops and institutional sources will be emerging as new sources of capital. With the subprime mortgage debacle devastating massive financial institutions, though, debt is severely limited to relationship borrowers or well-capitalized entrepreneurs, and only prime opportunities will be considered. And with the unsecured debt markets frozen and the convertible debt market dismantled, in the near term, secured debt is the only game in town. As for development, it will likely remain limited through at least 2009—and Bob Kramer, president of the National Investment Center for the Seniors Housing & Care Industry, expects that by 2010 there will be an extended period with virtually no new supply. Select new development ventures may come online in the 2011-12 time frame, but with a recovering economy, supply-demand imbalance should keep occupancy rates strong for several years to come.There is, then, opportunity for the savvy investor that recognizes that industry fundamentals are reasonably solid. Enter the international real estate conglomerates such as Australian Macquarie Group, which manages in excess of $180 billion in global assets and has determined that now is the time to strike in this sector, while valuations have moderated and financial engineering skills can prove beneficial to property owners in need of capital while at the same time producing favorable returns for its own investors. In addition, well-capitalized healthcare REITs, existing owner/operators and private equity players are getting ready for action.We have yet to see the demographic sweet spot for this industry. But it is coming, and for those who can see beyond the next few years, the logic becomes infinitely more profound.Reach Mel Gamzon, president of Senior Housing Investment Advisors Inc., at mgamzon@snrhousing.com or www.snrhousing.com.