Strong absorption isn’t enough to outrun the feverish pace of new seniors housing development, particularly in assisted living.
By Jeff Shaw
The numbers don’t lie: despite healthy consumer demand, seniors housing is overbuilt.
Absorption in the sector has been consistently positive and strong, according to the National Investment Center for Seniors Housing and Care (NIC). The Annapolis, Md.-based, nonprofit data and analytics organization tracks data using the top 31 primary metropolitan U.S. markets.
NIC numbers show that absorption has been particularly strong in assisted living, where it has held at over 3 percent of existing inventory every quarter for several years. However, new construction has outpaced that number, hovering around a 5 percent increase each quarter. Independent living features a similar trend, though slightly more muted for both absorption (1.2 percent) and inventory growth (1.9 percent).
The result has been a noticeable sag in occupancy rates. In the second quarter of 2018, the combined occupancy rate for independent living, assisted living and memory care hit an eight-year low of 87.9 percent. Broken out by segment, the data shows the occupancy rate for assisted living dipped to 85.2 percent in the second quarter, the lowest point since NIC started tracking the numbers in 2005. NIC predicts further occupancy declines for the immediate future.
In short, consumer demand is healthy and seniors housing is attracting new residents, but the addition of new supply is occurring at an even faster rate. Consequently, occupancy rates are struggling.
“The second quarter of 2018 was the 10th consecutive quarter in which supply outpaced absorption,” says Chuck Harry, chief of research and analytics for NIC.
Investors flocked to seniors housing in the wake of the Great Recession because the sector proved to be more recession-resistant than other real estate asset classes due to the need-based component of providing care, according to Harry.
“Seniors housing proved to be more resilient during that downturn in terms of both operational and investment performance. That definitely drew attention, especially from institutional investors,” says Harry. “Seniors housing has proven to be less cyclical. This construction cycle has been driven by the assisted living space.”
Unfortunately, NIC predicts several more quarters of sliding occupancy rates before demand and supply find a balance.
Many developers seem to be building for the fabled Silver Tsunami of aging baby boomers. However, that demographic wave isn’t due for another 10 years or so.
The youngest baby boomers are just now retiring, with the largest spike in the 83-and-over population not coming until 2030, according to U.S. Census Bureau projections. The average age of an assisted living resident is approximately 87, according to the American Seniors Housing Association.
“This year and next year we see moderate rates of growth in the 83 to 87 age cohort, but it does pick up thereafter,” says Harry. “But in terms of when the baby boomer generation is apt to start seriously considering seniors housing for its needs, that’s likely a decade off.”
What do we do now?
Developers often wave off the NIC numbers by pointing out that seniors housing is a local business. The prevailing wisdom is that many markets are still underserved, and it’s simply a matter of finding those markets.
But when supply and demand fundamentals are having such a clear impact on the industry as a whole, how can developers be sure they’ve found that underserved market?
“There are a lot of people who have made mistakes. They have built on the wrong property, in the wrong market, with the wrong product, with the wrong unit mix, with the wrong architect,” says Joe McElwee, development principal with Washington, D.C.-based private equity firm Capitol Seniors Housing.
Capitol’s pipeline currently includes 15 developments either opened, under construction or awaiting building permits totaling about 1,350 units. McElwee says Capitol is constantly reviewing its market selection criteria, making sure that nothing is missed.
“I’m always looking in the rear-view mirror and questioning myself and whether I have the best site, and whether a competitor could trump me and get a better site. We have a very disciplined approach to site selection, not only where the competitors are, how old they are and who they’re being managed by, but also their relation to what we think is the right market.”
Market reports must be deep and multifaceted for developers to be sure they’re not contributing to overdevelopment, according to David Laffey, head of LCS Real Estate, the equity investment subsidiary of Des Moines, Iowa-based owner-operator LCS.
LCS uses an in-house market research group to vet potential development opportunities. Key metrics are tracked, including local penetration rates, job market, population growth, household income and average home price. “There’s a swath of things to consider in determining the appropriate market score,” says Laffey.
It’s also extremely important to physically visit the market, he adds. Putting “boots on the ground” allows LCS to gain a different perspective of the area.
“We’re being more disciplined about where we’re building,” says Laffey. “But it’s market specific, right? You can’t just say the market is generally overbuilt. There are niche markets, and more infill and urban areas.”
Solera Senior Living searches for “hyper-local” pockets of opportunity, according to Adam Kaplan, founder and CEO of the Denver-based developer and operator. Kaplan launched the company in 2016. Solera currently owns and operates one community with three more in various stages of development.
Kaplan describes himself as “geographically agnostic,” evidenced by the fact that his four communities are located in Colorado, Maryland, Florida and Pennsylvania. Solera prefers markets with high barriers to entry, where there is little opportunity to buy land and the zoning and entitlement process is complicated. These barriers help prevent overbuilding.
“At this point in the cycle I try to remain hyper-disciplined,” says Kaplan. “We look for areas where it’s going to be more difficult for another competitor to come in.”
Waiting for the boomers
While development may have outpaced the incoming seniors population, it is true that the Silver Tsunami will eventually arrive. The current spike in development is simply a little early.
“If you have to wait five to 10 years to have a home run, you’re going to be broke before that ever happens,” says McElwee. “You can’t build for the future. You have to build for the moment.”
However, as the baby boomers age, properties positioned earlier on the continuum of care such as active-adult communities or independent living may be well positioned to capitalize. The oldest boomers are now 72 years old, a prime target age for active adult operators.
Some developers have bet heavily on targeting that group. The Wolff Company has announced plans to build $300 million to $400 million worth of active adult and independent living communities annually. Holiday Retirement, which focuses exclusively on independent living, currently ranks as the third largest operator of seniors housing in the United States, according to the American Seniors Housing Association (ASHA). As of June 1, 2018, Holiday operated 263 properties and 31,862 units nationwide.
“I grew up out of the hospitality industry,” says Kaplan. “After a few years in finance, I worked at Senior Lifestyle Corp., my family’s business that started over 30 years ago as a primarily independent living company. I always look at every opportunity and think of how I can introduce independent living.”
“If you offer a continuum of care it’s more marketable for a consumer,” continues Kaplan. “Residents know they can move in when they’re more active and independent. Then, if they decline, they don’t have to relocate. They can stay in an environment where they’re comfortable.”
Kaplan says Solera intentionally seeks sites “closer to the action,” such as the core of downtowns, which appeal to a younger, active, independent senior.
“It doesn’t have to necessarily be walkable to retail, but it has to be an area that’s vibrant and suitable for multifamily,” says Kaplan. “It can’t be 10 miles away from the city center where people are put out to pasture. That’s not what people want in an independent living environment.”
LCS specializes in large-
campus continuing care retirement communities (CCRCs) that span the continuum of care with a minimum of 100 total units. For the company’s new developments, independent living will be the “anchor” and represent the lion’s share of units in new developments.
“We believe that the Silver Tsunami is much more interested in independent living and focused on health and wellness [than previous generations],” says Laffey.
Charter Senior Living, an Illinois-based owner and operator of 13 communities, approaches all development opportunities with independent living foremost in mind, according to Keven Bennema, the company’s president and CEO. All properties currently in Charter’s development pipeline are committing to a significant number of independent living units.
“Most market studies we do are showing stronger demand for independent living, but most of the overdevelopment is in assisted living and memory care,” says Bennema. “The development is coming too soon. It’s premature.”
Capital: The Great Equalizer
In theory, smart underwriting by the lenders and investors should prevent overdevelopment from happening. If the sector is developing too much, the numbers should raise a red flag among those with the money that seniors housing is a bad investment.
“Capital is the great equalizer. Lenders and capital partners need to focus on who the developer is and its experience,” says McElwee. “Perhaps the new developers without experience won’t have access to capital, and their buildings won’t be built. In that scenario, overdevelopment may not become as significant an issue.”
What concerns Bennema, however, is that the traditional relationship between lenders and borrowers has been turned upside down. Capital sources want to be involved in seniors housing and will deploy funds into the sector whether the timing is right or not. Lenders and investors should not “do a deal just to do a deal.”
“One of my greatest fears is we have so much capital out there right now that needs to be deployed,” says Bennema. “It’s like the capital is driving the development, without a lot of consideration to the seniors not coming for another 10 years.”
Although capital continues to still flow into seniors housing development, most lenders say their underwriting has gotten more strict in the past year or two due to both increasing interest rates and decreasing occupancy rates.
“Construction financing is more difficult to get,” says Jeff Sands, managing principal and general counsel with Connecticut-based lender HJ Sims. “I see the leverage going down and the demands for recourse financing going up. The bigger banks in particular are being very cautious about construction financing these days.”
Laffey agrees that capital sources must act as a backstop against overbuilding. It’s his observation that debt and equity sources are showing signs of increased discipline. Whereas new construction starts for assisted living and memory care were cropping up “like mushrooms after a spring rain” just a few years ago, that trend is starting to calm now.
“We have a responsibility to our stockholders, investors, employees and residents that we’re going to be a good steward of those homes and add value for the investors and residents,” says Laffey.
“All seniors housing developments are not created equal. Owners and managers are not created equal. The marketplace is putting a premium on established, credible sources,” continues Laffey. “We’re seeing the lenders being a bit more discerning as to who they’re doing business with.”
Even the municipalities should implement more stringent approval processes, and developers must be more careful about what they choose to build, says Bennema.
“A lot of people own land. They say, ‘I can’t do much with it so why not make it a senior living facility?’ That’s not a good enough reason to build. Some of these local municipalities need to make sure they have more discretion on approving developments.”
Solera’s Kaplan notes that the responsibility for preventing overbuilding shouldn’t rest entirely on the shoulders of the capital sources.
The developers themselves need to only look at the best possible locations, and only build when all the factors align to create a successful property.
“I don’t expect my capital partners to do my analysis for me. As a developer and an operator, I have to make sound investment decisions,” says Kaplan. “I’m going to study the market, do proper diligence. By the time that I go out and raise the capital, I must have a compelling case.”
Additionally, everyone in the industry should be cautious of “develop-and-dump” companies — merchant developers that only build seniors housing communities to sell them — says Kaplan. Although there’s nothing inherently wrong with this strategy, it does attract developers that aren’t invested in the long-term success of a property.
“Right now we have too many fee developers and third-party operators just looking to grow scale and generate fees,” says Kaplan. “I’m not saying I have an issue with that model, but it does bring into question whether all your stakeholders are truly well aligned. What are their motivations? If the project doesn’t succeed, they’re not the ones covering the cost overruns. The best-case scenario is to have good alignment of all the stakeholders.”