Roundtable participants
Aron Will, Co-Head of Seniors Housing, CBRE
Jana Harris, Senior Associate, Evans Senior Investments
Ryan Saul, Managing Director, Senior Living Investment Brokerage
Cindy Hazzard, President, JCH Senior Housing Investment Brokerage
Cody Tremper, Managing Director, Berkadia Seniors Housing & Healthcare Investment Sales
Philip Kayden, Executive Managing Director, Blueprint Healthcare Real Estate Advisors
Mark Myers, Managing Director, Walker & Dunlop
By Jeff Shaw
Although seniors housing acquisitions activity has been muted recently, driven largely by the sudden spike in interest rates over the last two years, transaction brokers in the space see plenty of reasons to be optimistic.
Despite no rate cut by the Fed as of press time, transactions are up so far in 2024, and dealmakers believe this development will only strengthen in coming months. It’s more than distressed sellers having their own capital markets struggles, overall transaction volume is returning as both buyers and sellers settle into the new standard of interest rates and cap rates.
Seniors Housing Business spoke with seven of the industry’s top brokers about the current state of the transaction market and where we’re trending into the future.
Seniors Housing Business: How has transaction volume changed over the last 12 months?
Tremper: Transaction volume, in terms of the number of deals being completed, has increased over the last 12 months. The industry is projected to see roughly 550 deals completed this year, which would be an increase of nearly 25 percent from 2023.
When we look at the dollar value of these deals, we see a lot of smaller, all-cash deals getting completed, including larger portfolios being spun off into smaller one-off transactions. During the second quarter of this year, we started to see more activity in the newer vintage/Class A space, especially for those properties with strong net operating income (NOI).
Harris: In recent months, seniors housing transactions have surged nearly tenfold, reflecting shifting market dynamics. Owners are adjusting to high interest rates and rising costs, leading to a new pricing floor for assets.
Will: Investment sales have picked up substantially in the last 12 months. Our team’s transaction volume in the first half of 2024 nearly matched our volume in all of 2023.
The deals in the first half of this year came from across the risk spectrum: opportunistic, value add and core plus/core. This is largely being driven by some of the sector’s first trophy, stabilized trades since the pandemic, whereas the majority of what traded from 2020 to 2023 were distressed assets or had some undesired catalyst driving the sale.
Our debt team has also been very busy, and we are expecting 2024 to be one of our better years in the last decade.
Hazzard: Over the past 12 months, transaction volume, specifically closing transactions, has remained relatively stable. However, we’ve seen a significant increase in valuation requests.
We attribute this uptick to several factors:
1. Maturing loan debt and difficulties in refinancing.
2. Retirement of owners with one to five assets.
3. Challenges faced by small owner-operators in recovering from the pandemic, leading to an inability to sustain their operations.
Saul: We’ve seen overall transaction volume increase over the last 12 months. This is due, in part, to a number of turnaround and distressed assets hitting the market. The new offerings are being met with more active lenders and stabilized interest rates.
Kayden: While total dollar volume may be down on the year, driven by fewer stable Class A assets and fewer large portfolio trades, we anticipate a very strong second half of 2024.
On the flip side, transaction count is up meaningfully, and that can be attributed to buyers finding more value in the sum of the parts than as a portfolio. Financing has been available for that market segment as well, which is driving activity.
Myers: Mergers and acquisitions (M&A) activity in the seniors housing and care sector set a new quarterly record with 183 publicly announced transactions in the second quarter of 2024, as reported by LevinPro LTC. This represents a 21 percent increase over the 151 transactions from the first quarter of 2024, and a 49 percent rise compared to the 123 deals in the second quarter of the previous year.
SHB: Obviously interest rates are a major factor this year so far. What is the current effect and when can we expect a change?
Harris: The seniors housing market is approaching a potential turning point due to current interest rate trends. High rates have increased borrowing costs, raised capitalization rates and led to higher operational expenses. Future rate changes will hinge on broader economic indicators like inflation, employment and overall economic growth.
As of June 2024, inflation dropped to 3 percent from 3.3 percent in May, indicating stabilization. This trend could lead to a rate cut and lower borrowing costs if the central bank decides to act in September.
Will: Many in our industry were expecting a rate cut by summer, but it has yet to come. Even if we see one or two rate cuts this year, the underlying economics of floating-rate loans will not change appreciably.
The more important factor is that investors need to feel that valuations have bottomed out and are on the uptick. This will prompt a subset of wary investors to re-emerge from the sidelines. Once that happens, it could have an immediate impact given liquidity will be amplified, which will drive better pricing and cap rates.
Hazzard: Interest rates have been a significant factor this year. While they remain high, they have stabilized, and both sellers and buyers have adapted to this new reality, allowing deals to proceed. “Creative financing” has become common, with lease-purchase scenarios often used to bridge the gap between seller expectations and buyer offers. Seller financing is also popular, provided the seller has sufficient equity.
Kayden: Higher rates make the debt math a lot more restrictive. Not only do you pay more for the same loan, but higher rates mean lower sizing. There is also a lack of participants in the debt market. The winds may be rapidly shifting on this front, all around.
SHB: While interest rates are the big, major factor on everyone’s mind, what are some of the more hidden factors affecting deals right now?
Harris: A major factor contributing to the current pressures on the seniors housing industry is the looming wave of debt maturities. Approximately $2.7 billion in senior living municipal debt is set to come due in the final months of 2024, with an additional $3.5 billion maturing next year.
Moreover, nearly 8 percent of the $43.2 billion in senior living municipal debt is already in default, according to recent Bloomberg data. While rising interest rates can lead to increased loan defaults, the sheer volume of maturing debt presents its own challenges.
Another major factor affecting the industry is the current inflationary environment. Over the past few years, inflation has led to a rise in expenses that has outpaced revenue growth, causing operating margins in the seniors housing sector to shrink.
However, operators have managed to increase rental rates by 7 percent to 10 percent annually with minimal resistance from residents. With occupancy rates at an all-time high post-pandemic, we are optimistic that margins will improve in the final months of 2024 and into the new year.
Will: One key factor is the more conservative underwriting on the part of lenders, specifically commercial banks, Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are requiring substantially higher debt-service coverages and lower leverage in the post-pandemic era. Factoring in a 55 to 65 percent maximum loan-to-value ratio, depending on the deal, is prudent in today’s market.
Hazzard: One key factor is having enough NOI to cover the debt-service coverage ratio (DCR). Additionally, maintaining a positive trend in operations is crucial. Sellers must stay proactive and drive their operations forward rather than putting them into neutral.
Kayden: Equity is still limited and equity fundraising is still slow. There are a lot of sponsors still sidelined or at partial capacity as they raise the next fund(s). It’s not enough to freeze the market, but enough to create a meaningful headwind beyond the debt piece.
Saul: Other factors affecting deals right now are staffing, insurance increases and overall cost increases due to inflation. While staffing has improved, it comes at a higher cost, eroding margins.
Increased litigation, tougher regulation and natural disasters are not only making insurance more expensive, but it’s also challenging to get coverage at all.
Investors and operators are feeling the effects of inflation across all expense categories.
Myers: It is difficult to obtain financing for value-add opportunities today. Most of our deals are being done with all-cash buyers such as REITs, which are not as dependent on interest rates as buyers seeking leverage. All-cash buyers require a discount from historical pricing in order to justify spending their cash, but they increase closing probability. Also, active investors who are selling their properties at a 10 to 15 percent discount are buying properties at the same discount, so in some ways the costs and benefits of this market balance out for mid- to long-term holders.
Another considerable factor is the lack of new supply coming over the next 12 to 24 months. Construction as a percentage of current supply is at its lowest level in nearly a decade, which gives both buyers and sellers confidence that the performance of assets will continue to improve. This, along with reduced financing costs, will help compress going-in yields.
SHB: Who are the biggest buyers and sellers right now, and why? How has that changed over the last year?
Tremper: Private equity funds are not as active due to slower fundraising. REITs have managed to be more aggressive with cap rate trends and are making their way back into the space. REIT deal volume has increased 3 percent compared to last year, while institutional buyers have increased their acquisition volume by 5 percent. Equity funds and investment managers have been the top sellers as their funds reach the end of life.
Harris: In 2024, the seniors housing market has primarily been driven by private equity investors with substantial capital, regional operators looking for consolidation opportunities, and both public and private REITs. Private investors — including private equity firms, unlisted REITs and high-net-worth individuals — continue to be the dominant players, accounting for 78.2 percent of acquisitions and 60 percent of total sales in 2023.
Transaction activity this year is likely to match record levels, and certainly expected to exceed that of 2023. Sellers today are primarily made up of independent owner-operators that lack the sophistication to adapt to the post-COVID operating environment.
Hazzard: Currently, the biggest buyers are regional players aiming to expand their portfolios. On the selling side, there are a few key groups:
• Those with maturing loan debt facing refinancing difficulties;
• Owner-operators with one to five assets looking to retire;
• Small mom-and-pop owner-operators that are unable to recover from the pandemic and are forced to sell.
Saul: The biggest buyers right now are the middle-market, regional groups that are well capitalized. They have strong relationship lenders that are excited to have good operators grow their portfolios.
The biggest sellers are the standalone, individual owners and large institutional groups looking to prune their portfolios. A year ago, the regional groups couldn’t compete with the larger, institutional groups to buy properties. Now we are seeing those buyers act while larger groups right-size their portfolios.
Kayden: We see two groups of buyers very active right now. The REITs are a leading player on stable, lower-cap-rate assets. DST (Delaware Statutory Trust) buyers and private equity are still active on stable Class A deals, but it’s a REIT-led segment because they have more flexibility on how they look at cost of capital in a shifting market.
For value-add and lease-up deals, there’s a dedicated subset of private equity buyers looking to pick off high-quality-but-underperforming assets on an unlevered basis.
From a seller standpoint, it’s still a little bit of everything. The seller pool has continued to be diverse and has only expanded as fundamentals have continued to improve.
SHB: Looking into your crystal ball, what do the next 12 months hold for seniors housing?
Tremper: Asset values should continue to climb as occupancy increases, thanks to the growing demand for seniors housing and the declining construction pipeline. We also expect deal volume, both in terms of the number of deals and pricing, to rise as buyers have more power with the cost of capital expected to drop.
Harris: While the market is undoubtedly experiencing a period of distress, we believe that the turbulence is likely to drive positive change in M&A activity within the industry in the next 12 months. Given the reduction of new inventory for senior living, we expect occupancy to continue to strengthen, and we expect rental rates to increase 5 to 7 percent annually.
As the labor market continues to cool, we expect less overtime and agency staffing, which will improve operating margins. The improvement in margins and potential for interest-rate reductions will drive higher valuations.
Will: I expect to see continued improvement in operating fundamentals with capital markets conditions that are likely to improve, while acknowledging that there is a lot of uncertainty with an upcoming election. Interest rates are unlikely to go up substantially over the next year, and the industry will continue to grow census and cash flow, which will likely not be the case for many other asset classes.
Saul: Transaction volume will continue to increase. Once we see relief with interest rates coming down, buyers will move quickly to acquire and absorb opportunities on the market.
Construction costs remain high. Buyers will be able to purchase communities at well below replacement cost in anticipation of the increasing demographic that will need seniors housing.
Kayden: We will see a wave of transactions as rates come down, valuations start to improve and financeability improves. There are a lot of high-quality assets that have been on the sidelines waiting for this day.
Myers: I expect to see increased velocity of transactions as pent-up demand from buyers is released, given the lack of construction of new product juxtaposed against the coming silver tsunami. Velocity will be further fueled by any reduction in interest rates by the Federal Reserve.
This is, of course, all subject to the direction of policies instituted by the new president and Congress that take control in 2025.
SHB: What issues in our industry keep you up at night?
Tremper: The proposed Health Over Wealth bill, which would reclassify rent payments to assisted living facilities as non-qualifying REIT income, is something I keep my eye on. This could deter REIT investment in the assisted living industry.
Also, I continue to be concerned by rising operating costs, particularly in the insurance and labor areas, which are two of the biggest line-item expenses for operators.
Harris: A growing concern is the senior living product’s failure to adapt to changing preferences. Data shows that over 77 percent of adults age 50 to 80 prefer to stay in their current homes or downsize, with only 6 percent interested in active adult communities and 3 percent in independent or assisted living. Despite having the financial means, the baby boomer generation avoids seniors housing.
With the aging population increasingly living in smart homes equipped with on-demand delivery and care services, there is a growing demand for personalized living experiences with diverse options. Traditional senior living models offering group activities, scheduled meals and standardized living spaces are at odds with this trend.
According to NIC MAP Vision, approximately two-thirds of seniors housing communities are outdated and require significant upgrades or repurposing. Developers and owners need to elevate their operational standards and invest in systems that meet and exceed these evolving expectations.
The future of the seniors housing industry will depend on their ability to create autonomous, high-quality living environments that are more appealing than traditional homeownership.
Will: Minimum wages in certain states continue to climb, which can be absorbed at the high end of the market but not necessarily with the middle- and upper-middle market consumer. Also, SOFR staying higher for longer continues to put undue pressure on bridge and construction loans. A reprieve would help immensely over the next 12 months.
Hazzard: What keeps me up at night are concerns about how we can structure deals that meet both seller expectations and buyer need.
Additionally, the constant influx of new regulations often feels excessive, as if they are being introduced merely for the sake of regulation. While I understand the importance of advocating for the well-being of our sensitive population, overly burdensome regulations can sometimes detract from patient care and ultimately harm the industry.
Staffing issues also weigh heavily on my mind, as finding and retaining qualified staff remains a persistent challenge.
Myers: We need to build at 3.5 times the rate we are building to meet the 2030 demand for seniors housing units. The cost of construction and inability for many Americans to afford the monthly rates for newly built properties poses a challenge that calls for the federal government to provide incentives for the development of affordable seniors housing.