Alex Florea, Managing Director, Blueprint Healthcare Real Estate Advisors
Ross Sanders, Managing Director, Investment Sales, Berkadia Senior Housing & Healthcare
Ryan Saul, Managing Director, Senior Living Investment Brokerage
John Sweeny Jr., Co-Head National Senior Housing, CBRE
Jay Jordan & David Kliewer, Grandbridge Real Estate Capital
Cindy Hazzard, PresidentJCH Senior Housing Investment Brokerage
Ken Carriero, Senior Vice President, Colliers
Bill & Madison Meiser, CEO, COO, WMRG Real Estate
Andrew Wittenauer, Senior Associate, Helios Healthcare Advisors
By Jeff Shaw
We all know the factors by now that are slowing transaction volume across commercial real estate sectors — escalating interest rates, inflation, labor costs, construction costs and unpredictability.
But the ones with the front-row seat to this uncertainty are the brokers tasked with continuing to get deals done.
Seniors Housing Business spoke with 11 of the top brokers within the senior living sector about the present and future of acquisition activity within this space.
Seniors Housing Business: How has transaction volume changed over the last 12 months?
Sanders: There has been a steady decrease in transaction volume over the last 12 months with significant slowdowns of closings and new listings over the summer months. The sudden spike in interest rates and the volatility of the debt markets have been the primary drivers of the dip, in addition to the typical reduced activity in the summer months.
Many property owners who do not have an urgent need to sell — those without pending debt maturities, liquidity needs or operating obstacles — are in a holding pattern. There are still numerous active buyers seeking to deploy capital, and with fewer opportunities in the market today, each deal is getting more attention.
I expect transaction volume will pick up some in the second half of the year as summer winds down and some sellers experience pressure with debt maturities and floating rates.
Florea: There are two components to that: Inbound volume and closing volume. Inbound volume has been a series of tidal waves with interim quiet periods interspersed. That speaks to the combination of deferred monetizations through COVID and the interest rate run-up, loans on their final-final extension, and simmering distress and/or fatigue in the space. That has led to a meaningful number of closings, but at a slower pace as the transaction timeline expands with debt and equity moving more cautiously than ever.
Saul: Transaction volume has been consistent over the last 12 months at SLIB when compared to the previous 12 months. While deals are taking longer and buyers and sellers need to be more creative, deals are getting done.
Sweeny: The first half of 2022 was very active from an M&A perspective as industry fundamentals continue to move in an upward trajectory (nine quarters of positive momentum since the advent of the COVID vaccine as occupancy, rent growth and agency labor usage normalize).
In the second half of 2022, transaction activity decreased significantly with the rise in interest rates and the liquidity challenges in the banking sector.
2023 started with positive momentum, but since the SVB banking failure in March, transactions have remained slower as owners contemplate refinancings, sales or keeping their heads down and focused on improving NOI.
Jordan: For our team, sales of distressed assets have been consistent with strong volume. We expect this trend to continue through the balance of this year and beginning of next year.
Where we have seen a change and recent uptick is in higher-quality, cash-
flowing deals. We’re engaged on roughly $450 million in sales activity that is either being actively marketed or we’ll be launching in the next couple of months.
Hazzard: Acquisition volume during the last half of 2022 was stagnant. We believe this was caused by the volatility of interest rates, and increased expenses with rental rates not adjusting at a fast enough pace to overcome these obstacles.
Deal volume has been increasing slightly over the last six months. While interest rates are still high, everyone, while unhappy with the current lending environment, is beginning to adjust to this new reality.
We are also seeing an increase in broker opinions of value (BOV) requests, which is indicative of a transaction volume increase.
Carriero: I have noticed interest has increased both in purchasing existing facilities and also in development of new facilities. Transaction volume has increased.
Meiser: The transaction volume has picked up in the last quarter. At the beginning of 2023 we slowed initially due to increase in interest rates, but now we are seeing that buyers are making acquisitions again.
Wittenauer: Investment sales volume is down comparatively to 2022 given the substantial rate increases and stagnation of market occupancy levels across the country. We’re seeing a shift in the profile of our assignments.
The lending environment of 2021 and early 2022 gave REITs, developers and mom-and-pops the ability to “ring the register” and close transactions at high and often overvalued prices. Conversely, this year has been focused on sellers who are pressure-motivated rather than proceeds-motivated.
SHB: What are some of the hidden factors affecting deals right now?
Florea: I wouldn’t call it hidden, but as some of the big-name debt and equity players move to the sidelines, there’s a greater concentration of activity around the more known commodities still putting money to work. This can create a bottleneck, but also the opportunity to create value by finding the under-the-radar or re-emerging players.
Sanders: The obvious and most significant factor is the volatility in the debt markets. But some of the smaller factors that impact buyers’ underwriting are the rise in property insurance premiums and real estate taxes. These are fixed costs that can be challenging to offset and can significantly impact a property’s bottom line.
Depending on the purchase price in relation to the asset’s basis, a buyer could see considerable increases in real estate taxes upon a post-closing tax reassessment. The reassessment risk and impact can often be estimated by tax professionals, but can sometimes miss the mark.
The impact of labor shortages, labor rates and high inflation from supplies to raw food also puts pressure on margins. Some of these additional expenses are being offset through significant rental rate growth, but it is often not enough to cover the higher expense load.
Sweeny: The biggest issue is debt availability. If your asset or portfolio is not fully stabilized, you’re looking at relationship banks or debt funds.
The cost of financing has increased significantly in the past 16 months. Some owners are facing near-term debt or fund maturities that can be challenging in the current fluid capital markets environment.
Saul: Staffing and shrinking margins remain a hidden factor affecting deals. Sellers will often take attention away from managing expenses and building a solid staff. This leads to less cash flow and increased expenses, which are affecting deals getting done.
Kliewer: Some of the other less discussed factors include rising cost-of-capital expenditures in buyer pro formas and the notion of a portfolio penalty.
By grouping underperforming or non-cash-flowing deals together as a package, there can be a penalty (as opposed to a portfolio premium) as buyers see this as too many turnarounds to take on at once. We’ve found it better to allow for flexibility and proper pairing of assets to allow for multiple buyers.
Hazzard: The biggest factors we see affecting deals right now are high interest rates and equity requirements.
Many facilities have not increased rents at the same velocity that their expenses were increasing. As a result, most of them had their bottom line evaporate, or at a minimum, they were much less profitable.
Buyers and sellers may agree upon a price, but the lenders will determine at what price they’re willing to lend, determining the actual sales price.
Carriero: Some sellers’ expectations are at times higher than actual market values.
Financing can still be a hurdle to overcome.
Meiser: Profitability, the lack of staffing and higher payrolls have put added pressure on facility operators to maintain bottom-line numbers.
Wittenauer: Beyond the challenges the capital markets present, the stagnation of margins and lease-up at the ground floor of these communities are having a big impact on valuations and loan sizing.
Communities in strong markets that had occupancy over 90 percent pre-COVID are hovering around 85 percent census now. The biggest question is whether this will become the new normal as families continue to find alternative solutions to moving their loved ones into these settings. More tertiary communities are still below historical occupancy percentages and may never recover.
Many of these tertiary deals experienced all-private-pay census when acquired pre-2020 and now have to take in Medicaid-waiver residents to keep their beds full.
Seller carryback financing is a lever that buyers have utilized to bridge the gap when sellers have higher pricing expectations. Roughly 30 percent of the transactions we’ve closed this year have contemplated some form of seller carryback.
Many of the developers that completed projects after March 2020 saw total project costs 20 to 30 percent higher than budgeted, which has impacted their ability to capitalize those projects with permanent financing or a sale. These projects are starting to reach the maturity of their construction debt and the ones hitting the market are having a hard time meeting budgeted exit cap rates and values. We’ve noticed a clear difference in valuation expectations for these projects versus ones that were constructed pre-COVID.
SHB: What changes are we seeing as related to valuations and capitalization rates during this time?
Florea: Cap rates are being pressured upward by elevated debt costs as sponsors don’t want to risk open-ended negative leverage. Valuations more broadly, particularly for value-add deals, are increasingly focused on an inclusive and de-risked estimate of total uses of funds, particularly with debt sizing (and lender flexibility) limited right now.
The new-vintage, cash-flowing deal is modestly impacted by higher debt costs. The breakeven renovation play requires a lot more sensitivity analysis and a stronger stomach in this environment.
Sweeny: As debt costs increase, cap rates increase so owners are faced with tougher choices on whether they pursue an outright sale or refinancing. Valuations have changed somewhere between 15 and 30 percent today depending on the facts and circumstances (class, vintage, location, performance, stabilized versus lease-up, acuity mix and operator).
Saul: We haven’t seen a lot of cash-flowing deals close in the current interest rate environment to draw conclusions on how valuations or capitalization rates have been affected. I think the next 12 months will reveal a lot as more deals close.
Jordan: Compared to the first half of 2022, we are seeing cap rates that are 100 or more basis points higher — mostly due to interest rates, but also more conservative underwriting assumptions from buyers with a greater emphasis placed on in-place trends.
Hazzard: We are seeing upward pressure on cap rates, but not as high as anticipated. Cap rates for stabilized, Class A buildings in high-barrier markets really haven’t changed much, whereas stabilized, Class B or older facilities, depending on the location, have gone up between 50 and 150 basis points.
The major factor in this is a decrease in NOI due to increased expenses outpacing increased rental rates.
Carriero: I have seen a slight increase in valuations, which in turn shows that cap rates have slightly decreased.
Wittenauer: We’ve seen a moderate cap rate expansion for core/stabilized assets and a more minor expansion for turnaround and distressed communities. Although the cost of debt has skyrocketed, the active buyers (and deals being effectuated) see upside in deals through rate increases and operational efficiencies that keep acquisition cap rates lower than expected.
Transactions that offer assumable debt (typically HUD) with rates between 2.9 and 4 percent and at an appropriate leverage basis (at least 65 percent of their sales price) are receiving a 10 to 12 percent pricing premium above what their value would be in a lower-interest-rate environment.
For turnaround opportunities, buyers are projecting a 50 to 75 percent longer time period to stabilize communities than on a pre-COVID basis. A typical projected turnaround time may have been six to nine months, but now it is pushing toward 12 to 18 months. In turn, this is pushing valuations lower as buyers need more cash reserved to cover operational losses during the early years of their investment.
SHB: Who are the biggest buyers and sellers right now, and why? How has that changed over the last year?
Florea: There are a few categories of sellers. The now familiar standby of private equity with fund maturities or debt pressure is still there, but there’s also a growing wave of fatigue, or triage, to go with the distress.
We see more sponsors of all profiles start to take a harder look at their problem children and asking if extending another year really makes sense.
REITs are a consistent seller block just due to the size of their portfolios. On the buyer side, folks willing to live with low leverage or who have been stockpiling cash to be unlevered buyers are having their day in the sun. If you don’t need debt, there are some amazing bargains to be had.
Sanders: Despite the current market conditions, astute buyers with access to equity and debt are in the most optimal position to capitalize on the limited number of opportunities in the market. Owner-operators and capital providers with strong operators are in the pole position to take on value-add opportunities at a basis well below replacement cost. Given the REITs’ lower cost of capital, we are hopeful to see them become very active as well.
The trend of mom-and-pops selling out to larger operators will likely continue due to fatigue, complications with existing debt, and the challenging operating environment. Institutional investors are also assessing their portfolios for potential sale opportunities due to subpar performance or the desire to remove non-core assets. In addition, we expect to see several lender- and receiver-directed transactions as some owners struggle to cover their rising interest rate costs and run into a liquidity crunch.
I expect most transactions throughout the remainder of the year will stem from “need to sell” scenarios instead of “want to sell” scenarios. A year ago, many sellers took advantage of a more robust buyer pool that benefited from historically inexpensive debt terms.
Saul: The biggest buyers are the private, regional companies looking to expand their portfolios. The institutional, larger companies and nonprofits continue to lead the way selling as they rightsize and divest non-core assets. A year ago, institutional capital was looking to grow more than it was looking to sell.
Hazzard: All categories of buyers are writing offers, provided the asset makes sense for their portfolio. Regional operators are actively looking for new facilities in the middle markets.
The largest group of sellers are those that are having significant performance issues. REITs are also pruning their portfolios to remove the deadwood before it becomes a toxic asset.
Carriero: The biggest sellers I have seen are the individual owner-operators and LLCs. The biggest buyers are the national and regional corporations.
Meiser: The biggest buyers are the ones looking for value-add opportunities. The biggest sellers are the people coming out of COVID that are still struggling due to staffing and loss of tenants.
Wittenauer: The biggest change over the past 12 months has been regional and institutional investors with strong balance sheets — often boosted by recently obtained Employee Retention Credit (ERC) funds — considering cross-deploying capital outside of their core business plan. A breakeven regional operator now has millions of dollars they’re sitting on as these ERC checks come through and are feeling pressure to put this capital to work. There is still another 20 percent of applied funds to be distributed for ERC, so I’m sure we will continue to see this prop up demand for acquisitions.
Through NIC MAP Vision’s portal, we’ve seen a number of skilled nursing providers consider jumping across the acuity spectrum into assisted living/memory care opportunities and vice versa. Additionally, the service has broadened our outreach to out-of-market providers that are considering entering a new state/region.
SHB: Which segments of seniors housing are you most bullish and bearish on right now and why? Has your opinion changed at all in recent years?
Sanders: I believe that we will continue to see the most appetite from investors for newer-vintage properties with lower acuity levels such as independent living and active adult, as well as campuses that include multiple acuity levels. Due to lower staffing needs, these assets are less impacted by the challenging labor markets.
Standalone memory care, properties of older vintage and communities with fewer than 50 units will continue to be the less attractive asset profiles.
Investor sentiment and appetite for these types of communities has not changed considerably. What has changed is the ability to obtain attractive financing for certain asset profiles. The financabiity of specific transactions is what will ultimately drive investors to be bearish or bullish on certain acquisitions.
Sweeny: We’re most bullish on active adult properties. That asset class has been a top performer since COVID and has several favorable investment statistics — strong sector fundamentals, average length of stay, creditworthiness of residents, compound annual growth rate, low employee labor requirement, and crossover investors from both seniors housing and multifamily.
We’re most bearish on standalone memory care because of performance, complexity in managing high-acuity product, labor and resident turnover.
Saul: There is significant opportunity for buyers with access to capital and relationship lenders to purchase real value-add opportunities in the current market. I am bullish on any assets that are breakeven or losing a little money that can be purchased well below replacement cost.
Kliewer: We remain very bullish on anything with barriers to entry and/or unique scale that is not otherwise easily replaced. New construction — if it can be capitalized — will do well in the coming years, though with current costs, this type of development is almost exclusively limited to the luxury/high-end segment of seniors.
We continue to see price-per-unit metrics separate out between high-end, Class A assets and those that are not. Some of this is reflective of the capital expenditure investment needs of these older buildings and some is reflective of the lower operating metrics these older communities can achieve. Many are filling the void needed in the middle market and we believe will find success through these types of reinvestment and revitalization.
SHB: Looking into your crystal ball, what do the next 12 months hold for seniors housing?
Florea: I see a potential rollercoaster of uncertainty. I think we’re at risk of whipsawing wildly based on every unemployment print, monthly CPI and Fed meeting. I have no idea where we are 12 months from now, but I think we’ll have a lot of noise getting there.
You almost have to assume the status quo, but prepare yourself to hit the market lightning fast when there is a window. That’s the upside to the volatility; there will definitely be some “risk on” windows.
Sanders: From an operational standpoint, we are seeing occupancy gains, strong rental rate growth and recovering margins. With limited new development, this will allow existing properties to grow occupancy, especially as demand continues to ramp up. The overall operating environment will continue to recover throughout the next year.
From a transaction perspective, market growth will be slower as investors determine what their appetite is, as well as what debt is available and at what cost. Many groups able to acquire or develop in this choppy environment will be rewarded when the capital markets environment stabilizes.
Sweeny: We’ll see continued fundamental improvements and interest from new- and old-money investors coming back on account of positive tailwinds. There will be new pricing guidelines on account of the capital markets and a lower supply picture.
Saul: Deals are going to get more challenging. Lending will likely be tougher to come by, which will lead to sellers needing to provide some sort of seller financing and/or flexibility in pricing to get deals done.
Jordan: There will be more of the same. We expect to see another strong push in top-line rate increases in 2024 and a continued steady flow of distressed assets as they work their way through the system.
Fundamental operating margins will continue to improve and make headway. Improved NOI margins are actually happening, which is a great positive to see.
Hazzard: Given that most sectors of seniors housing are needs-driven, we believe that census will continue to increase with more facilities achieving stability. Operating margins will continue to improve through growth in the rental rate revenue, and expenses will also begin to stabilize.
Carriero: I see the market improving even more than it already has.
Meiser: New construction has slowed due to the increase in construction costs and cost of capital. Existing facilities will be closer to capacity, putting further increased pressure on demand for newer beds.
Wittenauer: Employment and ‘stickier’ inflation keeping interest rates higher for longer than originally expected will delay a return to heightened investment and financing activity. The majority of transactions in the next 12 months will be from owners who have to transact versus more exploratory processes (big valuations/proceeds or cash-out refinance requests).
However, the influx of ERC funds this year has in theory given providers a six- to nine-month working capital fund to play defense and hold off on transacting. Most of these providers would rather roll the dice and see if their market occupancy improves as opposed to selling at a discount.