By Matt Valley
March is notoriously volatile weather-wise, but March 2023 will long be remembered as a particularly stormy month for the financial markets.
The collapse of two banks over a 48-hour period early in the month hit like a bolt of lightning. Santa Clara, California-based Silicon Valley Bank, a lender to technology startups, failed following a bank run during which depositors and investors withdrew $42 billion on March 9 alone. On March 10, the bank was placed under the receivership of the Federal Deposit Insurance Corp. (FDIC).
Two days later, regulators closed New York City-based Signature Bank — known for frequently doing business with cryptocurrency firms — after its depositors withdrew billions of dollars in a bank run.
The demise of Silicon Valley Bank ($209 billion in assets) and Signature Bank ($110 billion in assets) — the second- and third-largest bank failures in U.S. history, respectively — was followed by the acquisition of embattled Credit Suisse by Swiss investment bank UBS in a shotgun merger on March 19.
Amid the crisis, Moody’s Investors Service on March 14 downgraded the U.S. banking sector to “negative” from “stable.”
According to Bloomberg, U.S. bank lending contracted by the most on record in the last two weeks of March, indicating a tightening of credit conditions in the wake of several high-profile bank collapses.
War on inflation drives up interest rates
Despite the banking turmoil, the Federal Reserve continued its attack on inflation, which was running at a 6 percent annual rate in February. On March 22, the central bank raised the federal funds rate 25 basis points to a target range of 4.75 percent to 5 percent. It was the ninth consecutive increase by the Fed over a 12-month period. A year earlier, the fed funds rate was less than 1 percent.
The dramatic rise in interest rates over the past year has had a negative impact on investment sales. Nationally, seniors housing investment sales in 2022 totaled $12.4 billion, down 38 percent from $20.2 billion in 2021 based on property and portfolio sales $2.5 million and above, according to MSCI Real Assets.
“The next 12 to 18 months are going to be really rocky in our sector,” predicts Aron Will, vice chairman and co-head of seniors housing for CBRE Capital Markets. The real estate fundamentals — namely occupancies and rents — are rebounding, but stubbornly high operating expenses and the sharp rise in interest rates are weighing heavily on many owners and operators, says Will.
Case in point: Dallas-based Sonida Senior Living (NYSE: SNDA), an owner-operator with a portfolio of 72 independent living, assisted living and memory care communities in 18 states, warned March 30 in its fourth-quarter 2022 earnings release that the company’s ability to continue as a going concern is in doubt.
“Due to the current inflationary environment, elevated interest rates and continued impact of COVID-19 on our financial position, as well as our upcoming debt maturities, our management concluded as of Dec. 31, 2022, there is substantial doubt about our ability to continue as a going concern,” the company stated.
Sonida reported a net loss of $16.6 million for the quarter and $54.4 million for the year, after a positive net income of $125.6 million in 2021.
Management noted that the company has undertaken strategic and cash-preservation initiatives designed to provide the company with adequate liquidity to meet its obligations for at least the next year.
But the remediation plan “is dependent on conditions and matters that may be outside of the company’s control, and no assurance can be given that certain options will be available on terms acceptable to the company, or at all.”
The company’s stock price on Thursday, April 6, closed at $7.03 per share, down from the 52-week high of $35.48 per share.
Who’s vulnerable?
The rent increases in seniors housing during the past few years haven’t caught up to the spike in wages, particularly temporary labor, says Will. Relatively low occupancies stemming from the COVID-19 pandemic have only compounded the problem.
The U.S. seniors housing occupancy rate rose from 82.9 percent in the fourth quarter of 2022 to 83.2 percent in the first quarter of 2023, according to NIC, but it remains well below the pre-pandemic occupancy high of 87.2 percent in the first quarter of 2020.
Many older and middle-market seniors housing communities are vulnerable today because operators don’t have the luxury of being able to aggressively increase rental rates to offset the high operating costs. “You can’t just push 10 percent rent increases through on middle-market properties like you can in some newer properties with higher-end demographics. Those are the properties that are really struggling the most, the ones that haven’t come back as much,” says Will.
On the agency side, many mortgage loans on middle-market product in tertiary or secondary markets — loans typically originated at 70 to 75 percent loan-to-value — are now reaching maturity, according to Will. “We’re in a situation where it’s very difficult to refinance those assets.”
Many fully stabilized properties that received bridge loans from banks at 60 to 70 percent loan-to-value prior to the sharp uptick in interest rates also are struggling financially, says Will. The payments on these bridge loans are eating up borrowers’ cash flow because they are paying 8 percent-plus in interest. Oftentimes, these loans that were originated roughly between 2019 and 2021 were interest-only for the first two or three years before converting to fully amortizing loans.
“So, there are properties with stabilized debt yields of 10 percent-plus that have minimal cash flow after debt service,” says Will. (The debt yield is the annual net operating income divided by the loan amount. The higher the percentage, the safer the loan is in the eyes of the lender. Most lenders today would like to see at least a 10 percent debt yield.)
Investors offer clear-eyed assessment
A combination of expected capitalization rate expansion and rising operating expenses could lead to a decrease in seniors housing pricing this year unless it’s offset by record-setting rental rate growth. That’s one of the big takeaways from a survey of “the most significant” U.S. investors, developers, lenders and brokers in seniors housing conducted in January by Dallas-based commercial real estate services firm BBG.
Capitalization rates for all seniors housing care levels are expected to remain flat or expand in 2023. Survey respondents say active adult and independent living communities are expected to have the lowest cap rates.
Meanwhile, rental rate growth for all care levels is expected to continue increasing significantly this year. Nearly 90 percent of survey respondents anticipate higher rental rates. More specifically, assisted living and memory care are expected to experience the highest increase in rents, ranging from 5 to 10 percent.
Slightly more than three-quarters of respondents (77.5 percent) project seniors housing operating expenses to increase by 3 to 5 percent in 2023 compared with the prior year. Also, 77 percent of respondents expect margins to remain flat or decline this year.
The anticipated pressure on margins is attributed to higher staffing costs, inflation and increasing property insurance expenses.
R.J. DeBee III, managing director and national seniors housing practice leader at BBG, doesn’t sugarcoat the challenges facing the industry, but he sees brighter days ahead. “Despite the headwinds swirling around seniors housing this year, the longer-term trend of providing adequate housing to meet the demands of an aging population makes this asset class a highly attractive investment option.”