By Matt Valley
Make no mistake about it, transaction volume in the seniors housing investment sales market has been significantly hampered by COVID-19, the respiratory disease linked to 197,000 deaths nationally as of Sept. 17.
Year-to-date through July, property and portfolio sales in the seniors housing and care sector totaled just under $5.3 billion, down 52 percent from nearly $10.8 billion during the same period a year ago, according to Real Capital Analytics (RCA). The number of properties that traded over that same period fell from 703 in 2019 to 366 in 2020, says RCA. The data is based on transactions $2.5 million and above.
Michael Gehl, chief investment officer for North Bethesda, Md.-based Housing & Healthcare Finance, attributes the slowdown in the pace of activity to heightened uncertainty.
Investors are accustomed to making decisions based on the strength of an operator, the supply-demand dynamics of a given geographical market or capital market dynamics, says Gehl.
“But a pandemic that has not happened since 1918 — and which raises questions of how long it will last and how it will play out with the flu season — creates such a level of uncertainty with regard to the cash flow that some capital has been pushed to the sidelines,” explains Gehl.
Alan Plush, CEO of appraisal firm HealthTrust based in Sarasota, Florida, says the RCA figures are in line with his observations from the trenches. HealthTrust’s volume of business dropped 25 percent in the latter half of March following the initial outbreak of COVID-19 in the U.S. before dipping more than 50 percent in April as the pandemic worsened. Since then, the economy has gradually improved but the rebound for the industry has been decidedly choppy, observes Plush.
The appraiser describes the second quarter as an “inflection point” — the moment the reality set in that the economic recovery was going to be a slog. Occupancies at senior living communities had slipped by several percentage points by that stage, leading to a decline in revenues while expenses related to COVID-19 continued to mount. The end result was that operators began to see significant margin compression.
“During the period April through June, there was a huge disconnect between buyers and sellers and lenders. The market was in a kerfuffle, an uproar,” says Plush.
Investor outlook on cap rates shifts
At the end of 2019, the average cap rate for majority independent living communities stood at 5.6 percent compared with 6.1 percent for majority assisted living facilities and 10.2 percent for majority nursing care facilities, according to RCA. (The data research firm did not provide a second-quarter update on cap rates due to the low level of transaction activity.)
Cap rates have widened slightly for assisted living properties this year, observes Gehl. “But a lot of that has to do with Class B and C, mom-and-pop type product that has been trading and usually trades at a wider cap rate. Also, there have been occupancy declines and expense bumps that justify a wider cap rate.”
Meanwhile, cap rates for skilled nursing facilities haven’t moved much, says Gehl. “The facilities that have been hit hard by COVID are just not trading, and the facilities that have seen a decline in cash flow due to occupancy declines and labor/supply increases have seen mitigation through billions of dollars of stimulus money,” he explains.
Investor sentiment with respect to the future direction of cap rates shifted dramatically during the first half of 2020, according to a report compiled by JLL’s Valuation Advisory Seniors Housing team. In a Jan. 31 survey of more than 100 transactional professionals specializing in the seniors housing and care space, 72 percent of respondents expected no change in cap rates in the near term.
However, that survey was taken before COVID-19 swept across the U.S., leading to a heavy loss of life and a virtual shutdown of whole parts of the economy. When JLL posed that cap rate question again on May 22 to the same pool of respondents, 83 percent indicated that they expect to see an increase in cap rates as a result of COVID-19.
“Although survey respondents expect short-term capitalization rates to increase, we expect this to be a blip on the radar as more data becomes available to the market,” says Bryan Lockard, managing director of JLL’s Valuation Advisory Seniors Housing division.
“Medium- and long-range investor sentiment is still strong as experts prepare for the ‘silver tsunami,’ with the leading-edge Baby Boomers now within a 10-year investment cycle of occupancy,” adds Lockard.
JLL concludes that the conventional wisdom among investors is that cap rates will “mostly” return to pre-COVID-19 levels once the crisis passes.
Plush estimates that cap rates have risen between 25 and 50 basis points this year, but that the increase has not been uniform across the industry. Markets that have been hit by a combination of oversupply and a significant COVID-19 outbreak — Phoenix, Atlanta, and many parts of Texas and Florida fit that description — are experiencing the biggest uptick in cap rates, says Plush.
The veteran appraiser can relate to the financial strain that operators and owners of senior living communities are under as a result of COVID-19. In addition to serving as an appraiser for the past 35 years, he is the owner of Harbor Chase of Sarasota, a 108-unit assisted living and memory care facility in Florida.
At the end of February, the community’s occupancy rate was 90 percent. It’s now down well below that level. “We’ve been struggling to bounce back because property tours are limited and competition is intense,” says Plush.
Sarasota was an overbuilt market heading into the pandemic, explains Plush. “We even had three buildings open during this COVID-19
pandemic. It’s the dumbest thing I’ve ever seen in my life. So, it’s just going to be a scrappy market for a long time.”
Key to underwriting a deal
Deals are getting done, points out Lockard, but getting those deals across the finish line has required additional due diligence to better understand the short-term impact of COVID-19.
Each property needs to be analyzed individually, says Lockard. “Some properties have experienced little to no increase in expenses, and this should be reflected in the underwriting. On the skilled nursing side, expenses are increasing for most properties. However, government assistance has helped to mitigate these costs, and both stimulus and increased expenses should be considered in underwriting the deal.”