Better with Age

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By Bruce Gibson and Lisa Silvers, Senior Housing Group ‘ CB Richard Ellis

There have been numerous headlines about the recent credit crunch and the real estate downturn. However, it should be noted that the impacts are reflected in different ways depending on the fundamentals, relative pricing/return levels, and supply and demand of each real estate sector. Senior housing is one sector of the real estate market that may behave a little differently than the others.

The recent slide in the residential market along with the credit crunch has impacted certain segments of the senior housing industry, but to varying degrees. New resident move-in rates for Independent Living have declined as seniors recognize the equity in their homes has been eroded. Some seniors, considering the move to an Independent Living Facility or a Continuing Care Retirement Community, are holding off the move to see what happens in the residential market with the hope that they will regain the equity they recently lost. However, Assisted Living and Skilled Nursing Facilities have not seen a decrease in move-in rates as this type of move is a health driven decision, as opposed to a lifestyle decision as with Independent Living.

Within the senior housing sector, capitalization rates for Class A assets have increased 75 to 100 basis points since the credit squeeze last August. Currently, Independent Living capitalization rates of Class A-quality communities average about 7.0 percent to 7.25 percent, while Assisted Living rates average about 7.75 percent to 8.0 percent. Capitalization rates for Class B and lower quality properties have increased by more than 100 basis points. During the same time, buyers’ and sellers’ underwriting has also shifted from a 12-month forward looking pro forma, which we saw during the last three years, to a 6-month lookback. Only in situations of new or expanding communities or in some markets with particularly compelling dynamics are pro forma income statements currently used.

2006 and the first half of 2007 will be remembered as the cowboy days for loose underwriting and record loan volumes, but not for senior housing. Certainly, the senior housing asset class continued its rise in favor among those committed to the industry and also by those new to the scene. However, underwriting fundamentals were maintained, with recourse on new construction, limited use of interest–only loans and reasonable leverage overall. Government Sponsored Enterprises or GSE’s (including FNMA, FHLMC and FHA) were able to provide superior terms for senior housing as well as multifamily and were the favored execution where possible.

Compared to Commercial Mortgage Backed Securities (CMBS) default rates of 0.27 percent, senior housing saw 0.3 percent of loans restructured and no foreclosures for the first three quarters of 2007 as tracked by The National Investment Center for the Seniors Housing and Care Industry (“NIC”). While the CMBS default rate is expected to triple in the next year, according to Fitch Ratings, it is not anticipated that the senior housing default rate will increase significantly as high leverage and interest-only have never been part of the senior housing lender’s vocabulary. Also provide by the NIC, loan volume for skilled nursing, assisted living, independent living and continuing care retirement centers combined was $57.9 billion through the third quarter of 2007.

If 2007 was characterized by stable underwriting parameters for the senior housing industry, what will 2008 look like? Will the current credit turmoil impact this industry? The answers are two-fold. First, due to the impact of the CMBS market, many investment banks have either closed or sold off their senior housing divisions. As a result, there are fewer options for borrowers. Of those that remain, they are approaching transactions cautiously, often focusing on existing relationships and tier one clients only. This should make for a bumpy 2008.

Whether portfolio or GSE, leverage has decreased, with expectations around 75 percent on average. While spreads are wider across the board, overall rates are still at historical lows and should still be attractive to borrowers. However, with fewer options for permanent loans, obtaining construction financing has become challenging. Specifically, construction lenders have tightened their underwriting and are choosing transactions carefully to ensure the likelihood of a permanent takeout.

The result of lower leverage has created an opportunity for equity investors who are able to deploy greater dollars to an asset class that is strong and expanding. The challenge for owners in 2008 will continue to be new construction, as most equity investors prefer existing assets.

Despite these substantive market changes, the fundamentals of senior housing remain strong. Average occupancies, in most major MSA’s, for Independent Living Facilities are in the low 90’s and Assisted Living slightly lower, but still above 90 percent. Operators have been able to obtain regular rental rate increases at or above CPI since there has not been the dramatic overbuilding that was experienced in senior housing in the late 1990’s.

Looking forward, we expect to see continued sound fundamentals for senior housing, with increasing demand into the foreseeable future as more and more baby boomers reach retirement age. Over the next 10 to 20 years, demand will far outstrip current supply as baby boomers reach their 70s and 80s. This translates to a tremendous outlook for senior housing owners and investors.


Bruce Gibson is a Senior Vice President with CB Richard Ellis and heads the Miami-based Senior Housing Group.

Lisa Silvers is vice president of CBRE | Melody Senior Housing Group.

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