A panel of top brokers discusses the state of M&A activity.
Roundtable participants
Jay M. Wagner, Vice Chairman, Senior Housing Capital Markets, Cushman & Wakefield
Brooks Minford, Director, Berkadia Senior Housing & Healthcare
Adam Heavenrich, Managing Director, Heavenrich & Company
Brooks Blackmon, Senior Director, Blueprint Healthcare Real Estate Advisors
Bradley Clousing, Managing Director, Senior Living Investment Brokerage
Charles Bissell, Managing Director, JLL Capital Markets
John L. Sweeny Jr., Principal, Partner, Co-Head National Senior Housing, CBRE
Ari Adlerstein, Senior Managing Director, Meridian Capital Group
Cindy Hazzard, President, JCH Senior Housing Investment Brokerage
Mark Myers, Managing Director, Investment Sales, Walker & Dunlop
By Jeff Shaw
While COVID is still an issue for seniors housing, and occupancy for the industry at large remains well below pre-pandemic level, when it comes to property sales the consensus is in: We’re back.
Seniors Housing Business spoke with 10 brokers who specialize in the seniors housing industry about where we are and where we’re going as an asset class.
Seniors Housing Business: How has transaction volume changed over the last 12 months?
Wagner: Coming out of COVID, starting in the second quarter of 2021, there was a significant increase in transaction volume, which has continued into the second quarter. That said, market volatility has increased in line with the Fed’s surprise 75-basis-point rate hike in July, with some investors re-evaluating their deal pipeline, driven in part by rising borrowing costs. Despite this volatility, we still expect elevated transaction volume for the balance of 2022.
Minford: Transaction volume has increased substantially. This is largely driven by fatigued owners, operators and investors. But some of this is also driven by owners looking to divest of non-core assets as the challenges of running a senior living community in today’s environment continue. That said, for those in the value-add acquisition space, we see a lot of opportunities for buyers with a strong operating partner to purchase distressed assets and turn them around.
Blackmon: We have continued to see a surge in transaction volume that started around mid-year 2021. We are as busy as we’ve ever been and expect the trend to continue. This is largely a result of disposition mandates that were put on hold during and immediately following the COVID-19 pandemic. Sellers are now getting to a more stable place operationally and are eager to exit certain assets originally slated for disposition in 2020 and 2021.
Sweeny: With the advent of the vaccine, mergers and acquisition (M&A) activity has increased considerably. During the pandemic, volume was off by around 80 percent. We are now turning the corner to a better market climate, especially considering fundamentals in the space continue to improve.
Banks and sponsors were well capitalized going into the pandemic but will look to monetize investments at some point.
Clousing: Transaction volume has remained steady for us throughout the past 12 months. Our firm closed 25 transactions in the second quarter of 2022, which is the best quarter we have had.
Bissell: Our volume of closed transactions (sales, debt and equity) for the first seven months of 2022 stands at $1.66 billion, which is 70 percent of our 2021 full-year deal volume. So we are definitely trending ahead of 2021. The initial 75-basis-point federal reserve rate hike did cause some buyers to pull back a bit, but we are starting to see many return to the market.
Adlerstein: The year of 2021 was our team’s biggest to date. We closed more than $5.5 billion in transaction volume across 126 deals in 35 states. While I think the industry as a whole might see a bit of a slowdown in volume, our team continues to see an extremely active and aggressive market. Our clients are pushing forward on deals with an emphasis on strategic growth in spite of the recent rising interest rates and economic uncertainty.
Myers: Volume has increased exponentially. We have closed $1 billion through July and have another $1 billion in the pipeline for this year or early 2023.
SHB: What are some of the hidden factors affecting deals right now?
Wagner: What might not be apparent to less active players in the space is the changing nature of the investor ranks that play for seniors housing transactions. Since 2021, there has been a more diversified array of capital sources. While not all of these groups show up on every opportunity, the overall impact is a broader pool of buyers looking for seniors housing exposure.
Minford: Interest rates and higher wages are the most obvious challenges everyone is talking about, but year-over-year rent growth is also a big item up for debate. Currently we are hearing buyers accept pro-forma underwriting of between 5 and 8 percent, depending on the market and acuity. The question is how long buyers can count on those rents to continue increasing before rent growth outpaces the residents’ ability (or desire) to pay at those increased levels. Other factors include insurance, capital expenditure projects, food and other expenses that are increasing, and ultimately bringing margins lower.
Clousing: In many markets, insurance has been very difficult to find, and quotes have been coming in much higher during renewals. Lender underwriting has also been tightening, which has created more scrutiny of budgets, underwriting and potentially less aggressive lending terms. The cost of goods, utilities, supplies, food and all items have been increasing rapidly. Most buildings can raise rates fairly significantly right now, but it will be interesting to see if rates increase can keep pace with the rising costs of operations.
Adlerstein: Our team continuously monitors federal and state-level changes and shifting trends in the market — whether it be the rising rate environment, regulatory nuances and updates that vary by state, or staffing and general market trends both regionally and nationwide. These challenges should be laid out and discussed at length at the outset of any transaction as important variables that need to be considered.
Hazzard: Many sellers are exhausted, rightfully so, from navigating the pandemic and staffing shortages. However, they want to bring their assets to market before restoring their census and NOI to pre-pandemic levels, yet expect offers more indicative of a performing asset.
Lenders are seeing a lot more deal flow. If buyers want to spend too much time shopping term sheets, they will find themselves back at the bottom of the lender’s pile, or being asked for more money down, at a higher cost of capital.
Myers: Interest rates are on the rise, the staffing crisis seems endemic and potential residents are staying home longer.
SHB: What changes are we seeing in valuations and capitalization rates during this time?
Wagner: During the past 12 months, cap rates compressed, driven by increased competition among buyers and improved confidence in rising occupancies. In some instances involving stabilized properties, this compression was up to 50 basis points, driving cap rates for these opportunities into the sub-6 percent realm on year-one rates.
In the first quarter of this year, a gradually tightening debt market began to put some pressure on values, particularly on pre-stabilized offerings. Since the initial hike of 75 basis points, this trend has accelerated with particular focus on achieving higher in-place or trailing cap rates than over the previous six months.
Minford: Generally, pricing has shifted very little from the valuation metrics used. Rather, the drag seems to be associated with the margins and overall lower revenues.
Blackmon: Valuations are sliding down as interest rates continue to rise. In-place cap rates are inching up, though we’re seeing terminal cap rates move 50 basis points in a lot of cases. While the bid-ask spread for lease-up deals and/or deals not yet recovered from COVID has grown wider, pricing for fully stable deals hasn’t changed much and those deals remain favorable for sellers.
Heavenrich: The seniors housing sector saw an immediate impact on transaction cap rates when the Fed, in its effort to cool rapid inflation, completed two aggressive rate hikes totaling 150 basis points and signaled more to come. You can expect to see further cap rate creep upwards over the next two years as the full impact of increased lending costs filters into further cap rate movement.
The cap rate movement will likely be more pronounced and immediately evident on transactions that involve stabilized cash flow, with post-leverage cash flow being a key part of the valuation and return equation.
The long-term outlook in seniors housing remains positive with many tailwinds, such as favorable demographics, undersupply and anticipation, the Fed will move rates down in a few years, pushing cap rates down to previous levels.
Sweeny: Debt is more expensive and is being sized more conservatively. Investor sentiment is currently uncertain as buyers need better empirical data to support prudent underwriting.
Clousing: The turnaround opportunities and riskier offerings have seen the largest pullback. There still seems to be aggressive capital and strong lending for well-located, quality assets. Underwriting might be a bit tighter, but in many offerings we have not observed a significant pullback in activity or pricing.
Bissell: Buyers are relying more on discounted cash-flow analyses than cap rates. Historically, cap rate changes have trailed long-term interest rate changes. This suggests that cap rates may rise over time as rates continue to increase over the coming year.
However, seniors housing is one of the few sectors where buyers can still buy stabilized deals using positive leverage, and this means that the spread between long-term interest rates and cap rates could compress as buyers seeking yield are attracted to seniors housing.
Adlerstein: At this point, as it relates to valuation, there is no question that buyers are generally more conservative in their approach on deals.
While buyers remain aggressive in the space, they are also keenly aware of the multiple issues at play, namely staffing struggles and interest rates, and are weighing those factors heavily in the decision-making process when considering new acquisitions. Lenders have also become more conservative in their underwriting of new opportunities and willingness to pursue and work on certain deals, so we throw a wind of caution when asked for a broker opinion of value.
Hazzard: Buyers are beginning to ask if cap rates will rise to match the increase in the cost of capital.
Cost per unit in 2020 decreased because only those distressed assets were taken to market at the onset of the pandemic. In 2021, more assets came to market as lenders began to get comfortable with the uncertainty of our industry and some groups decided to leave altogether. The first half of 2022 saw more of the same distressed properties coming to market, with the second half bringing those new assets that were licensed during COVID to market.
Myers: For skilled nursing, there was no change in the 12.5 percent historical cap rate. For active adult, we saw a 50-basis-point increase in cap rates. For independent living, it was a 50- to 100-basis-point increase, and 100 to 150 basis points in assisted living, depending on age, quality of property and location.
SHB: Who are the biggest buyers and sellers right now, and why? How has that changed over the last year?
Wagner: The most active sellers are private equity investors that deferred their disposition efforts during the pandemic and are now looking to take advantage of the stronger buyer market. The most active buyers in recent months have been public REITs and some of the more recent entrants to the seniors housing investment market, including private REITs and Delaware Statutory Trust funds.
Minford: With the swings in interest rates today, the REITs are obviously looking to be very active and take advantage of their position in the market. That said, due to the lack of capital deployment that has largely occurred over the last two years (relatively speaking), we are still seeing the larger private equity shops remain competitive for a lot of our deals. Time will tell whether that will remain the case or if one of these groups solidifies their upper hand, but we are undoubtedly still getting active feedback from a variety of different buyer groups.
Blackmon: We’re currently seeing institutional private equity and REITs most active on the sell side. Not far behind are the local/regional owner-operators. Most of these groups waited for as close to a full recovery as possible before pruning non-core assets or exiting the business, and it has taken most of them until recently to be in a position to command pricing they are comfortable with.
Sweeny: Institutional investors represent the most active buyers and sellers. REITs were the most active a year ago, but have been more cautious lately on account of the capital market volatility.
Clousing: We are continuing to see many institutional owners shed non-core assets. Additionally, many of the owner-operators with fully stabilized assets are looking to move while we are still in a historically strong pricing environment. We are likely off the peak, but if an asset is stabilized or close to stabilized we are still observing strong bidding.
Bissell: In 2020 and 2021, the majority of sellers had some compelling reason to sell, such as a looming debt maturity, an equity source needing to sell, or a need to pare portfolios of non-core assets. Since late 2021, the seller pool began to shift to include groups without a specific trigger pushing them to sell. Many more of these groups have decided to test the market this year, and are sellers if reasonable pricing expectations can be met.
In the current environment of increasing interest rates, projects that qualify for permanent fixed-rate financing are very attractive in the market, as buyers will be able to lock in long-term financing at current interest rates.
Currently, we are seeking activity across the buyer pool, including public and private REITs, pension funds, private equity and operators.
Adlerstein: We have seen regional operators and family offices as some of the most aggressive buyers, while a lot of the private equity shops and REITs seem to have slowed (granted, with some notable exceptions). We saw a slew of divestments last year from some of the larger players, but we believe that there is a renewed sense of optimism that if we hold on a bit, things will stabilize.
As such, we are working closely with some of the larger institutions in helping them think more creatively about their existing portfolios and ways they can grow strategically in this changing landscape. We have also seen smaller operators continue to build out their portfolios in an effort to further develop regional strongholds in the markets where they already have a presence.
Hazzard: The biggest buyers right now seem to be regional operators with funding from private equity groups and REITs. There is significant capital waiting to be deployed, but underwriting is difficult. While most facilities are recovering from COVID-related census issues, inflation has created significant increases in operating expenses, decreasing NOI.
All of the traditional buyers are active, plus there are many first-time buyers entering the seniors housing space. The business dynamics that have made senior healthcare thrive have only gotten better. Every boomer will have turned 65 by 2030. Boomers control more than two-thirds of the disposable income in the U.S., making it a very attractive market.
While it appears that the mix of buyers and sellers has not changed much, the reason for selling is changing. We are seeing a lot of smaller operators that are disappointed how the industry has changed. Many have said that the business has quit being fun and no longer enjoy going to work. Some of the struggle may be the labor shortage. Some have commented that they are paying a much higher hourly rate, but the quality of the employee is often marginal. This may change during the recession.
Myers: At present, the biggest buyers are private companies, family offices and private equity and crossover buyers from multi-family. Prior to the rise in interest rates, REITs dominated the landscape for seniors housing acquisitions and private companies for skilled nursing.
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?
Wagner: We remain bullish on larger, full-continuum product as we have seen this product consistently resonate with both residents and investors. We further see continued active adult development as a very attractive way to gain early exposure to low/no acuity residents that are just entering the demographic “sweet spot.”
We have concerns on older, potentially obsolescent assets, even in markets with favorable supply/
demand dynamics. We would share this approach for standalone memory care given the operational volatility that seems inherent with the property type.
Minford: The 55-plus sector has really taken off, and for good reason. Investors in this space have seen strong returns and will continue to do so. That said, the debate goes on as to how and when 55-plus blends into independent living. That said, the licensed care of assisted living and memory care continues to be in strong demand in certain parts of the nation, particularly those with a good product and middle-market pricing.
Blackmon: Any time we’re in a down market, we tend to see the most resiliency in assisted living and memory care communities given how need-based each care type is. Independent living and active adult should see continued growth but at a slower pace than assisted living and memory care.
Sweeny: Investors are most bullish on active adult. Performance has been strong during the pandemic because it didn’t have any imposed restrictions on admissions. Also, it exhibits a longer length of stay, lower labor needs and a larger buyer pool.
Investors are most bearish on standalone memory care because smaller units, higher acuity, shorter length of stay and higher labor needs make it more volatile.
Clousing: Much of the institutional capital has focused on larger campus offerings, and specifically newer assets with higher percentage of independent living or age-restricted units. This provides insulation from many of the labor and inflationary pressures. Additionally, many of the lower-acuity units lease very quickly.
While this is very positive, the pricing has been very aggressive, which in turn has driven down yields. For strong operators of standalone assisted living and memory care assets, there are good values to be had as many institutions continue to focus on larger and lower-acuity opportunities. There is a strong place in the market for standalone assisted living and memory care as development slows. Occupancy and rates are quickly improving across almost all assets we have been working on.
Bissell: Active adult is a segment that is proving to have an important role in the seniors housing continuum. Residents are attracted to active adult because it provides a housing solution that is tailored to their needs, but is affordable for middle-market seniors. For owners, active adult is desirable due to the low staffing requirement and the strong investor demand for this product.
Continuum-of-care facilities also remain desirable, as they provide the ability to retain a resident for a longer period of time and provide services as the resident’s care needs change.
Freestanding memory care is a sector that has been out of favor for several years, but with the rapidly growing number of seniors with dementia, a strong contrarian play could prove fruitful in this segment.
Hazzard: With such low inventory, the outlook for the skilled nursing sector will probably remain bullish. Meanwhile, the more abundant inventory from distressed to newly constructed and stabilized properties in the seniors housing sector will allow buyers to negotiate more aggressively. Need-driven products, such as memory care and high-acuity assisted living, will remain strong performers.
The independent living sector will do fine, but the high cost of new construction will likely slow the expansion of this market.
SHB: Looking into your crystal ball, what do the next 12 months hold for seniors housing?
Minford: There are still some challenges related to operations, wages and perhaps the year-over-year rate growth due to economic conditions. That said, I think the industry has again proven to be largely a resilient one and a safe place for families to place loved ones who are in need of care.
Blackmon: We are bullish on the next 12 months and believe the M&A market for seniors housing will continue to be strong. A lot of assets are in funds near or past the end of their life cycle, and some will need to be sold even if not at prices sellers are excited about. Further, there will continue to be some distressed asset sales and the public investors will continue to prune non-core assets.
Clousing: I believe a lot will depend on interest rates, the labor markets and inflation. We are in a great industry within commercial real estate and we will fare well overall. While pricing will not be at peak, I don’t think we will see large corrections. Additionally, there likely will be consistent volume as there are specific motivations for both buyers and sellers right now.
Bissell: Seniors housing occupancy levels will continue to improve at a steady pace, and we expect to see construction starts tail off due to the difficulty in getting new construction deals to pencil out given escalating construction costs and interest rates.
Many market participants pulled back after the initial Fed rate increase. But many buyers have significant capital to deploy, and we anticipate buyers to be more active in the later half of 2022 and on into 2023. We also expect to see more capital flowing into seniors housing as investors seek sectors with higher returns and property sectors that have performed better during recessions.
Adlerstein: In the short term, from both a macro and transaction-focused perspective, we will see a drop in volume when compared to 2020 and 2021, but I don’t foresee that being a trend that lasts. There is significant interest in the space with new institutional players that have been raising funds and are eager to deploy capital. The growing attention on the space and an aging population will likely keep us all very busy in the coming months and years.
Hazzard: Active adult seems to be the new “it” sector. As boomers continue to influence the design of facilities and the use of amenities, you can expect the need for more active/social spaces in independent living to draw more of those active adults into their product type, permitting them to age in place longer. Whereas if you look through the medical model of care, skilled nursing is receiving more medically complex residents.
In time, this will force higher acuity residents into the assisted living population. Assisted living operators that embrace offering medical services such as physical therapy and glucose management on-site will find themselves better positioned to address the medical needs of incoming residents. Those operators that can successfully blend the medical/hospitality model will be ahead of the shift.
Myers: Cap rates will climb a bit through the end of this year and then start to decline as the Fed pulls back and interest rates decline.
SHB: What issues in our industry keep you up at night?
Wagner: A potential weakening in the housing market could limit seniors’ ability to sell their homes to enter active adult or independent living facilities.
Minford: As a financial intermediary, any sudden talk of interest rates moving or a shift in the financial markets can cause concern among investors. That said, I think we can overcome most of that by way of the continued increase in performance across the seniors housing space. Legislation would be the other major piece, particularly any legislation that impacts laws surrounding insurance or how care is provided.
Sweeny: We are cautiously optimistic about labor and supply as we head in/toward/near a recession. Supply continues to come down from its pre-pandemic heights as it is difficult to find feasible sites that can be financed.
Labor is tougher in the short run, but once the industry “marks to market” (meaning that it pays folks a market wage), we are cautiously optimistic growth rates will moderate going forward.
Clousing: The labor shortage is the largest headwind facing our industry and most other industries. Runaway inflation or significant global conflict that further exacerbates the current supply chain issues could also prove very difficult for our industry.
Adlerstein: The primary concern for us and our clients is the staffing difficulties we are seeing nationally, as well as the recent movements in pricing in the capital markets and the broader financing implications that come with that.
Hazzard: Our nurses and caregivers are taking care of more medically complex residents, yet the burden of rising operating costs inhibits the operator’s ability to provide the living wage they deserve. I worry about the mass exodus of caregivers from our industry.
I also wonder how to attract young people entering the job market to our jobs.
How do we compete in a world that demands flexibility, celebrates the success of a remote workforce and expects the recognition of the individual, yet in many areas our workforce has to work two jobs to survive?