Investment sales professionals express optimism for the future of seniors housing despite the pain caused by the COVID-19 pandemic.
Brooks Minford, Associate Director, Berkadia
Daniel Geraghty, Senior Vice President, Senior Living Investment Brokerage
Jordyn Berger, Senior Director, Walker & Dunlop
Bruce Gibson, Principal, Senior Capital Advisors
Cindy Hazzard, Broker, JCH Senior Housing Brokerage
Ted Flagg, Senior Managing Director, JLL Capital Markets
Aron Will, Vice Chairman, CBRE Capital Markets
Kris Lowes, Director, Evans Senior Investments
Richard Swartz, Vice Chairman, Cushman & Wakefield
Jeffrey Hyman, Senior Vice President, Colliers National Seniors Housing Group
Steve Thomes and Ryan Chase, Senior Managing Directors, Blueprint Healthcare Real Estate Advisors
Todd Lindblom, National Director, Marcus & Millichap
Adam Heavenrich, Managing Director, Heavenrich & Company
By Jeff Shaw
The pandemic that took on the world and threw the U.S. economy into disarray hit seniors housing hard. Housing an age group that’s particularly susceptible to the virus has proven to be an extreme challenge.
However, those within the industry still believe in the long-term health of seniors housing as an asset class. During the Great Recession of 2007 and 2008, seniors housing fared better than many other types of real estate. While this recession is distinctly different, many expect seniors housing to fare well again.
Seniors Housing Business spoke with over a dozen brokers that work in senior living real estate and asked them about the past, present and future of this sector in light of the COVID-19 pandemic.
Seniors Housing Business: How was acquisition volume trending in the six months before the pandemic?
Geraghty: Over the past five to six years, the M&A volume has been strong and 2020 was not looking much different — we were trending toward another record year as an industry.
Berger: Acquisition volume was on a terrific trajectory pre-pandemic and slowed significantly mid-year. While we are seeing velocity starting to return, buyers are keeping their feet on the ground by implementing more conservative underwriting and making sure that any projected cash flows can actually be achieved. Additionally, they are incorporating some post-COVID-19 expenses that are here to stay, such as additional costs for infection control including personal protective equipment (PPE).
While first mortgage rates are currently lower than pre-pandemic rates, leverage has decreased causing the blended cost of capital to be very similar to pre-COVID levels.
Flagg: Heading into COVID-19, acquisition volume was consistent with recent years with the exception that larger seniors housing portfolios began to represent a historically high percentage of the total. Several large trades were put on hold as COVID-19 hit.
Hazzard: We were in line to have one of our best years ever. The good news is that we still have most of them in process. Most of our deals are moving forward, albeit at a much slower pace.
Hyman: Acquisition volume held steady through 2019, with a flurry of activity in the fourth quarter. Deals were taking longer to get to closings, as buyers and their equity were looking for longer sustained operations histories.
SHB: What have been the effects of the pandemic on acquisitions?
Heavenrich: Uncertainty. COVID has created a new paradigm for the assisted living income statement, which is only slowly emerging. On the revenue side, buyers must get comfortable with underwriting projected occupancy rates with uncertain demand. On the expense side, virtually every line item has to be reexamined, including staffing, insurance, equipment and training.
The counter force has been the flood of capital from private equity. In addition, the continued downward pressure on interest rates has translated to cheap debt for transactions.
These uncertainties are causing a slowdown in transaction volume, lower leverage transactions and higher cap rates in the short term.
Minford: As with many industries, COVID–19 forced owners and operators of seniors housing to stop and think about the way they conduct their day-to-day business within the sector. Everything — building layouts, staffing, policies and procedures, geographic locations, care levels and payor sources — is being discussed amongst the owners we are speaking with.
Ultimately, it seems seniors housing operators have largely proven they are capable of safely handling and managing through these tough times and the general public is acknowledging that.
Geraghty: Generally, the transactions SLIB has closed or been working on fall into four buckets:
1) Closed at the original terms.
2) Closed with a price reduction (typically 3 to 5 percent) and some extended timeframe given the inability to conduct tours or finish on-site work.
3) Timeframes of the transaction were extended or put on hold given the more conservative lending environment or underwriting uncertainty.
4) The transaction was terminated due to losing the lender, declining performance or dealing with issues related to their existing portfolio.
Additionally, it could be a combination of all four challenges.
Gibson: Most owners that were contemplating selling pre-pandemic are holding off until they see more stability in perceived pricing and buy-side demand. The same is true for buyers in that many are sitting on the sidelines. Other investors have shifted focus to troubled or turnaround properties.
Flagg: There are multiple factors that complicate transactions in the current environment, including a less robust finance market, difficulties in conducting property tours and third-party inspections, and issues relating to license transfers.
But even with all of these potential roadblocks, transactions are occurring, and we are seeing a gradual thawing of the market. JLL is working on a growing number of transactions that are likely to close this year or early in 2021. We are also seeing a significant uptick in broker’s opinion of value (BOV) requests, which is often a leading indicator of transaction volume.
Will: Until enough time passed to gather some empirical data about how the sector performed during the crisis, many equity investors were hesitant to commit to deals. This was due to an inability to reasonably underwrite them, let alone perform the perfunctory due diligence required with onsite visits. Now that time has elapsed, there is enough data for investors to dip their toes back in the water. The issue is now the disconnect vis a vis buyers and sellers regarding valuations.
Swartz: There has been a significant slowdown in transactions during the pandemic due to transaction mechanics and uncertainty.
Starting in late May, we began to arrange virtual tours for third-party reports, which has given way to limited in-person touring and the ability to move deals along. We were also able to bring a few new properties to market.
Most deals that launched in late first quarter were subsequently pulled or otherwise put on hold. Since the early days of the pandemic there have been few opportunities to come to market, and those that have are being marketed in a more limited fashion. That said, we are increasingly seeing investors’ willingness to underwrite new opportunities, which is driving some institutional owners to test the market. We have a number of Class A opportunities that we are just launching now.
Thomes: Acquisitions have slowed somewhat, particularly in March and April as everyone was scrambling to figure out what was happening at the community level as well as with capital markets. What we’re seeing as the most significant impediments to closing:
1) Lack of debt capital/uncertainty of lenders
2) Ability to safely transfer operations amid COVID
3) Slowing acquisitions to ensure safe and effective operations within the current portfolio
SHB: What changes are we seeing related to valuations and capitalization rates during this time?
Minford: Generally speaking, we have seen pricing adjustments of roughly 10 to 20 percent depending on the deal. We typically are seeing these adjustments on communities where occupancy has been hit hard over the last few months and the buyers’ previous underwriting no longer aligns with current performance. For deals that have managed to remain in a strong occupancy and revenue position, the adjustment has been minimal — this is largely attributed to interest rates remaining at such low levels.
Berger: Valuations are now based on post-COVID operating expenses, which incorporate some items that were not present pre-COVID, including infection control expenses and heightened dietary expenses. We are seeing less aggressive forecasting year one, with operations remaining close to post-COVID status quo.
Gibson: Theoretically, values for stabilized properties in the upper tier have not been as impacted by cap rate changes as they have by occupancy dips due to the pandemic. There was already a bifurcation in the market separating Class A versus Class B and C properties in terms of cap rate margin. I believe this gap will widen in the short term, hurting B and C property values.
Flagg: In the current environment, cap rates are not the best tool to use in valuing senior housing assets. The vast majority of assets are suffering from a decline in occupancy due to COVID-19, as well as increased expenses due to the purchase of PPE and higher payroll costs. These factors result in an impairment to NOI that will be short term and non-recurring in nature.
Applying a cap rate to actual or near-term forecasted NOI effectively assumes that the short-term impairment to NOI is permanent, and this is punitive to valuations. Therefore, prudent investors in the current environment are more focused on longer-term cash flow projections where assumptions relating to post-COVID-19 occupancy improvement and expense reductions can be factored in. We find that most core and core-plus capital has not altered their long-term return expectations, but many value-add and distress buyers are seeking higher returns in the current market.
Hazzard: We have heard from several appraisers that some lenders are putting pressure to add a half percentage point to cap rates as a COVID penalty or a “just in case.” As a possible balance to this, many lenders and underwriters are looking more closely at the previous two to three years for the stability of the cash flow and to verify that any dip in census and revenue will rebound after COVID-19.
Chase: I have a little soapbox campaign on cap rates in general. Cap rates are supposed to describe the risk of holding stabilized assets. The majority of transactions each year, pandemic or not, aren’t stabilized. So, I would encourage the investment community to use cap rates as a secondary reference point for valuation when thinking about assigning risk.
Speaking to the overall transaction market, there are fewer institutional, large seniors housing transactions happening right now. Valuations on value-add deals are holding near pre-pandemic levels. From a macro standpoint, there are a lot of buyers who want to pursue deals now, yet there are fewer deals available on the market. So while the financial textbooks say we may expect to see higher returns demanded during a period of increased uncertainty, the practical application of having many buyers with too few goods to purchase is having an offsetting effect.
Lindblom: Regions and facilities have been affected differently. Marcus & Millichap has recently marketed several assets with essentially no COVID-19 expenses being underwritten. The facilities offer a solid census and the assets have generated significant interest in the market with numerous offers tendered. However, communities that have been impacted more significantly by the virus, with elevated PPE costs and staffing wages, are being underwritten with these costs in place, impacting asset values. We are advising clients to carefully track COVID-19-related expenses to help ensure the assets are being valued fairly.
Who’s still buying?
SHB: Who are the biggest buyers and sellers right now, and why? How has that changed over the last year?
Geraghty: In the current environment, we have seen local and regional operators become the most aggressive in terms of acquiring existing assets. They often partner up with a REIT or a private equity group. If they elect to purchase on their own, they typically use a conventional bank loan and/or raise equity through high-net-worth individuals or through friends and family. Many of the national or institutional capital partners have been sidelined for the time being.
Over the past year, the largest sellers have either been REITs or private owner-operators with one to five facilities in their portfolio. The REITs are mostly looking to sell some of their older, non-core, struggling assets to clean up their balance sheet and reposition their portfolio with newer assets. The private owner-operators are selling due to newer, tougher regulations within state and federal law. Many smaller owners with institutional-quality assets were also receiving strong pricing pre-COVID, which has driven transactions.
Swartz: Most buyers continue to be private equity in nature. The previous 24 months has seen a steady flow of new institutional commitments to the seniors housing space, which has resulted in strong fundraising among many private equity funds that target seniors housing. While fundraising has been impacted in 2020, we still expect in excess of $5 billion to be committed this year. With the limited amount of product to come to market in 2020, there is a significant amount of dry powder on the sidelines that is increasingly eager to be deployed.
Most of the sellers that have come to market have been publicly traded groups that seek to realign their portfolios and operator relationships, or private sellers with a limited number of distressed deals where ownership has capitulated.
Will: Private equity is still the dominant buyer category, although several of the major REITs have re-emerged and are looking at deals again. The REITs have largely been net sellers over the past few years, and this will continue for at least a few who are shifting strategies.
Flagg: Sellers currently active in the market are groups that have some compelling reason to sell. That could be the need to adjust allocations or a looming debt maturity. Another situation we are seeing is that some newer assets have not performed as anticipated, and the equity has decided to sell even if that means taking a loss. The REITs are active sellers currently, as they seek to redeploy capital into the medical office or life sciences spaces, or simply to exit certain seniors housing assets and replace them with assets that are more in keeping with their current business plans.
Active buyers today include private equity groups, public and private REITs, and large family offices. Foreign capital is also kicking the tires on a lot of deals but has been slow to actually transact.
Hazzard: The biggest buyers are those that have strong balance sheets and previously established banking and lending relationships. Most of the lenders we are working with are far more cautious, but still pressing forward. We are finding in general that lenders are reticent about making new loans to unproven operators and organizations.
The biggest sellers really have not changed that much. We find sellers active in pretty much every category from institutional and small portfolio, down to the individual mom-and-pop.
Lowes: There are a few REITs and private equity funds that are still active, but most have pulled out of the acquisition market as they are managing their troubled assets and dealing with the volatile capital markets issues. Any investors that do not have sector expertise (family offices, pension funds, etc.) were scared off by the potential impacts of COVID on the sector. The most active groups currently are owner-operators working to build their portfolios and value-add buyers looking to find distressed deals.
From a seller standpoint, independent and institutional groups have both been looking to sell their communities. This pandemic appears to be a tipping point for many independent owners who have been thinking about getting out of the business for a long time. On the institutional side, we are seeing a lot of owners deciding to divest distressed projects that have a long time horizon for a turnaround. It has certainly accelerated many groups’ plans to take distressed deals to market.
Thomes: We’re seeing private equity making the most significant moves, which isn’t really a significant change from 2019. We’re also seeing REITs opportunistically get back into the market. However, there remains significant price competition and structure flexibility offered by the private equity corner of the market, resulting in a majority of transactions being won by private groups.
Lindblom: Transaction activity currently remains constrained. That being said, owners that entered the market over the past five to 10 years as more of a real estate play are now seeing the operational complexity involved with seniors housing, and many will likely consider exiting this property type. Large owners are evaluating their portfolios and will also likely make some moves.
War chests of cash are being built for deployment into U.S. seniors housing properties. Several opportunistic buyers are closely monitoring the market and searching for assets that wouldn’t normally become available to the marketplace.
SHB: What has surprised you the most about the marketplace for transactions since the pandemic struck in mid-March?
Berger: We were surprised by how buyers were so quick to bail on transactions, even Class A real estate. However, it was understandable, since no one knew where the bottom would be found. Now that things seem to have bounced off the bottom, we see buyers coming back to the market.
It has also been surprising and deeply encouraging to see how well onsite and corporate staff have handled the care of residents. They have been rock stars in this regard, despite so many more requirements and restrictions placed on them, along with additional pressures relating to family and friends not being able to visit residents. Staff did a terrific job of providing activities, dining and connection points without exposing residents to COVID-19.
Minford: Overall, the market seems to be responding well to acknowledging that seniors housing is a need-based business. As more operators accelerate the pace of resident move-ins, we will continue to see renewed confidence from buyers and lenders to get deals done. We have already seen buyers get creative on how they will conduct due diligence on communities they have under contract and I expect that to continue for some time, as they remain sensitive to limiting the number of visits to the buildings up until closing.
Gibson: Having seen several cycles, very little surprises me.
Hazzard: For the most part, other than deals taking longer, we are as busy if not busier than prior to the pandemic. Yes, when the pandemic first hit a significant number of deals came to a screeching halt. However, by the end of May most were coming back online. I am a bit surprised that lenders are taking their time jumping back in.
Flagg: I’ve seen several market cycles in my career, but this one is quite different than the ones before. The seniors housing market is influenced by the opinions and sentiment of the many individuals that influence transaction decisions.
One notable surprise is that some of the groups with capital raised and ready to deploy have not been more aggressive in seeking out deals in the current environment. I view this time as a short-term window during which investors can snap up assets at attractive prices, and I wonder why more investors are not actively seeking to do so.
Will: There was an almost visceral reaction and pullback on the part of the commercial banks in March and April. Although it wasn’t long lasting, that swift initial pullback was even more severe than we witnessed in 2008. Thankfully, at least half of the lenders in our sector are back in the market.
Hyman: After the initial pause to assess how the industry would be affected, the marketplace is still robust. Both top-tier properties as well as mid-priced properties are highly desirable. It should be noted that the increases in construction costs have, pre-pandemic, focused activity on acquiring property operations. We have seen a little easing of construction costs, but expect continued strong asset acquisition activity.
Type of care matters
SHB: Which segments of seniors housing are you most bullish and bearish on right now and why? Has your opinion changed at all since the start of the pandemic?
Berger: We believe that the majority of the market segments within seniors housing remain strong in the long term. While there have been some difficult public relations challenges for our industry, we know that, ultimately, we operate within a needs-based environment and that our providers and their staff want what is best for their residents and their families. Additionally, the changes that have hit our workforce will reduce some of the staffing pressures of the past.
Gibson: There have been many negative articles on assisted living and skilled nursing over the last few years. I’m most concerned about knee-jerk legislation that may have unintended harmful consequences on investors and operators in these segments. I’m slightly more bullish on the independent living market in the near and mid-term.
Flagg: Many thought that the active adult and independent living sectors would be the hardest hit. But surprisingly, we are seeing that active adult projects are faring relatively well during COVID-19, as are many independent living properties. As these sectors will also be the first to benefit from the coming baby boomer wave hitting age 75, we are bullish on these sectors. Assisted living and memory have been hit harder in many cases, and we are hearing about more issues with COVID-19 outbreaks in memory care. But I believe these are short-term issues and expect occupancy levels to recover over time.
A silver lining of the COVID-19 pandemic is that seniors housing construction starts have fallen precipitously and are expected to remain low for some time. This will allow assets in previously saturated markets to improve occupancy over the coming years.
Chase: I’m more bullish on the higher acuity, needs-based segment of the market right now. My opinion has changed a bit since the start of the pandemic on this. We’re going to see the effects of consumer preferences translate to overall lower industry performance for the independent living segment, essentially consumers holding off on the decision to move into a communal setting because they don’t have to. I see the psychological impact of the pandemic playing out over the longer term in the lower acuity settings. Conversely, consumer needs should support the assisted living, memory care and skilled nursing segments.
SHB: What impact, if any, are lenders having on deal velocity?
Geraghty: Over the past four to six months, our industry has seen the lending market drastically change in terms of how it analyzes a transaction. The most significant disconnect between the borrower and lender appears to be loan-to-value (LTV) ratios as lenders have different perceptions of risk mostly due to the uncertainty surrounding COVID-19. Lenders require more equity from the borrower. Most lenders also want significant recourse for higher LTV loans. Rates have remained attractive, which is the one positive.
Gibson: There is a definite gap between supply and demand for construction lending. Although there has obviously been overbuilding in certain markets, there are still many projects in stable markets that should move forward but are slowed or killed due to inability of the sponsors to obtain debt. Even if you can obtain construction or acquisition debt, the entire process is extremely cumbersome and slows down the transaction process. This is an area that needs an industry disruptor.
Hazzard: Instead of waiting to see what the actual impact was, a surprising number of lenders totally bailed out of the seniors housing market when the pandemic first hit. I certainly agree with using caution and additional due diligence, but to walk away from an entire industry I find troubling.
Until the lenders get off the bleachers and back onto the playing floor, our industry will simply muddle along.
Lowes: At this point in the cycle, they are not slowing deals down in any capacity. There seems to be a large number of lenders still active for acquisition financing for cash-flow-positive deals.
Chase: The ‘super nationals’ (BMO, Grandbridge, KeyBank, Wells Fargo) are sidelined or limited at the moment. This has a direct impact on velocity of institutional, large-scale transactions — especially on the seniors housing side. Everything is deal specific, but these have the collective impact of lowering equity returns in the short run. I would expect to see a lot of loan refinancings in 2022 or 2023 that were written in 2020.
The road ahead
SHB: Looking into your crystal ball, what do the next 12 months hold for seniors housing?
Minford: Activity on our current pipeline is telling us that the next two to three months leading into the holiday season will be active as buyers and sellers want to close out the transactions currently in process. How well the industry handles any resurgence of COVID in the winter months will have a direct impact on 2021 activity. That said, confidence does seem to be coming back and our hope is by late first-quarter 2021, the seniors housing industry would have demonstrated its capabilities to handle whatever comes its way.
Gibson: I don’t see much change in the seniors housing market until there is a vaccine that has been widely distributed. While there could be decreasing occupancy due to lower move-in rates, I believe most operators have done a phenomenal job of dealing with the situation by taking appropriate precautions and implementing better training and strong safety standards. Let’s all hope for a quick solution.
Hazzard: We are turning the corner. Once the general election is over, regardless of who wins, there will be huge strides toward normalcy. All the parts of the economy that were driving the seniors housing industry engine are still there. With the slowdown in new construction, we could see average census creep back up.
Lowes: There is a strong pent-up demand for new resident move-ins due to the ban on admissions most communities imposed earlier in the pandemic. Most families have a current hesitancy to move in their family members due to the lack of visitation possibilities at present. New development projects that opened before COVID will struggle the most as lease-up velocity will likely slow down. Projects currently under construction certainly face an ominous future until a vaccine arrives.
Swartz: After almost no activity in May, we have valued over $2 billion of sales opportunities in the last 60 days. Given the pent-up demand of buyers, we expect to see a significant increase in transaction levels as market participants become clearer in their understanding of valuations.
Hyman: As the country continues to respond to the effects of the pandemic, there will be significant opportunities in asset acquisitions, as sellers work through their portfolios determining the best business models going forward.
SHB: What issues in our industry keep you up at night?
Berger: Providing more attractive affordable seniors housing options is critical to enhance the percentage of the target population who benefit from our products and services. We hope we continue to see new and more innovative product alternatives along the continuum, such as well-conceived active adult concepts, technology solutions and developers willing to take a risk on affordable options.
Lowes: The pandemic has caused a lot of the industry to forget the tremendous staffing issue that we faced before the pandemic. The widespread job loss certainly will help our industry attract more potential employees to the sector, but our biggest fear continues to be widespread pay structure increases.
Target has increased its minimum wage to $15 per hour, following Amazon and other companies. How long does this take to migrate over to seniors housing?
Swartz: We are concerned about the lack of distinction between skilled nursing and seniors housing in many press pieces, which seems to have inspired recent Congressional fact-finding activity targeting the seniors housing space. We are watching federal regulations and policies carefully and will calibrate expectations accordingly.
Lindblom: In many cases the media has driven a perception gap as it attributes health risks to all parts of the seniors housing spectrum.
One concern will be how the traditional onset of flu season could erroneously be attributed to COVID, creating headlines that mischaracterize the operational reality of most senior care facilities. Facilities are in a better position to manage the flu season than ever before, although some media may tell a different story.