Dr. Peter Linneman
With the economic downturn battering investors, positive real estate news has been relatively sparse. Yet, seniors housing is emerging as potential bright spot for firms with available capital. A push by industry leadership for greater financial transparency over the last several years has given institutional investors greater confidence to evaluate seniors housing for their portfolios.
As with other types of real estate, seniors housing demand tends to track the economic recovery, both nationally and regionally. While recovery of the sector has been modest, the number of seniors housing transactions is rising with property and portfolio sales totaling $27.4 billion trading in 2011, according to NIC MAP Data & Analysis Service. This figure is a substantial increase from $6.3 billion in 2010.
Recent M&A activity includes Genesis Healthcare’s acquisition of Sun Healthcare in June for more than $273 million. With an ever-aging American population, long-term investors should not overlook seniors housing.
Historical perspective
Seniors housing was far from immune to the economic downturn that began in 2008. At the low point of the recession, independent living and assisted living posted year-over-year occupancy rate declines in excess of 250 and 150 basis points, respectively. Construction came to a grinding halt as developers lacked the capital to continue projects.
Although the industry has made gains during the last two years, the occupancy rate for independent living in the second quarter of this year stood at 88.5 percent, approximately 400 basis points below its 2006 peak. Similarly, assisted living stood at 88.7 percent in the second quarter, down 200 basis points from its peak.
From a consumer demand perspective, retirement funds, home values, and interest income have taken significant hits as a result of the prolonged recession and all-time low interest rates. With the stagnant housing market, seniors who wish to move struggle to sell their existing homes. However, given that the sector is closely tied to the national economy, seniors housing will continue to strengthen during the recovery.
Institutional investors step up
Prior to the downturn, healthcare REITS were beneficiaries of legislation that allowed them the same profits as entities that owned other property types. Under the REIT Investment Diversification and Empowerment Act (RIDEA), healthcare REITs are no longer subjected to the triple-net-lease structure or to a single-ownership organization, allowing them to reap greater benefits from their properties.
The increase in available capital has allowed healthcare REITs looking for new ventures to turn to seniors housing, which subsequently has attracted new interest from larger private equity firms.
1) More data transparency. The new interest in the seniors housing market coincides with changes in the way the industry provides data. In 2008, Linneman Associates addressed this point with a report commissioned by the National Investment Center for the Seniors Housing and Care Industry (NIC), writing that “simplicity, clarity, and consistency will serve to decrease the transparency risk premium currently assigned to the (seniors housing) industry.”
Four years later, the changes made by NIC have met with success. Investors now have a much greater level of clarity of the market than ever before, and investors can seriously evaluate seniors housing options when looking for new ventures.
Specifically, the top 31 metropolitan statistical areas covered by NIC now have compiled nearly seven years of quarterly data including occupancy, inventory and construction, which enables investors to better benchmark performance.
2) Economic recovery. The increase in capital to the industry has shown that REITs and private equity firms alike feel increased comfort with the industry, and anticipate growth for the sector.
A slow economy is just one of the challenges that face the seniors housing industry. The industry must also be wary of the overexcitement, which spurred the previous housing bubble. With more seniors housing construction in the pipeline and renewed interest, investors should take care not to overheat the market.
For developers, more affordable construction is also a concern as costs have the potential to skyrocket. An inability to control these costs adversely affects realized returns. An influx of new seniors housing residents will also increase the need for better operating procedures to keep costs under control while meeting the needs of its residents.
3) Boost penetration rates. Seniors housing has great potential to blossom for investors. Fundamentally the industry is strong, catering to a growing demographic. However, the key to growth for the industry will be to increase penetration rates among seniors within each market on both a unit and an occupied basis.
That is, on a unit basis, there is great potential to increase the number of seniors housing units as a percentage of the number of households in each market headed by persons 75 years of age or older.
Similarly, on an occupied basis, the number of households in seniors housing as a percentage of the total number of households in each market headed by persons 75 years of age or older also has significant growth potential.
To date, efforts to boost the penetration rate have been hampered by the weak economic environment and poor public understanding of the product.
Thus, we expect that the combination of increased data transparency, a focus on penetration rates and the economic recovery — including housing — will propel the sector into a long-term growth cycle.
— Dr. Peter Linneman is a principal of Linneman Associates, KL Realty and American Land Funds, and is the Albert Sussman Emeritus Professor of Real Estate, Finance, and Business Public Policy at the Wharton School of Business at the University of Pennsylvania.