COVID-19 Impacts Property Valuations

by Jeff Shaw

Seniors housing pricing takes a hit amid pandemic.

By James Tellatin

The COVID-19 pandemic has clearly impacted seniors housing valuations. 

The market for seniors housing assets is only beginning to thaw from the pandemic’s spring and summer freeze. In the absence of actual sales data priced in the pandemic, using enterprise valuations from publicly traded REITs and operating companies with large concentrations of seniors housing is a proxy to individual asset values. 

Operationally, most properties are experiencing lower occupancies and higher per-resident-day operating expenses and these conditions are likely to persist for some time.

Lower mortgage rates may offset some of the negative valuation drivers from the first months of the pandemic. Government stimulus, to date, has helped operators. But, since value is based on anticipated earnings and those stimulus payments are now water under the bridge, those past payments do not transfer into present value. 

Anticipated future stimulus money will factor into value. However, as of this writing, there is no certainty that private-pay seniors housing will receive further assistance. Healthcare providers, such as skilled nursing facilities, hospitals and other medical providers, have received and can expect to continue receiving stimulus.

The painful numbers

Salient factors stemming from the coronavirus pandemic globally impacting seniors housing operating results and valuations include:

• Lower occupancies as controllable move outs exceed move ins. This is a result of self-imposed reasons at the facility level and hesitation from a market that leans toward greater social distancing, which will remain a significant factor until the virus is brought under control. Data from the National Investment Center for Seniors Housing & Care (NIC) shows occupancy rates for surveyed properties with mostly independent living falling by more than 150 basis points from March to May of 2020; assisted living occupancy declined by more than 250 basis points in the same period.

• Operating expenses are difficult to rachet down in tandem with lower census levels, as some expenses are fixed and some variable expenses are increasing, like food and protective equipment.

• Existing residents are minimizing use of common area amenities for social distancing purposes, which are important factors in residents choosing seniors housing options; thus residents feel they are not receiving full value or benefits for their rent.

• Elevated risks are being built into capitalization and discount rates.

There is no question that COVID-19 has negatively impacted valuations for the healthcare and seniors housing property markets. 

Cash flows are disrupted by reduced occupancy, higher operating expenses, possible lowering of rent caused by changes in demand and additional risk premiums applied to the capitalization processes.

The lifeblood of an appraiser is comparable sales data, which provides guidance for capitalization rates and per-unit pricing, the paramount value markers. Given the absence of contemporary sales data in the early months of this pandemic, an appraiser will likely apply pre-COVID data and adjust the pricing to reflect current market conditions.

The equities market is liquid and provides a valuation consensus among a large and diverse group of investors. Historically, there is a correlation between valuations in the equities market and the real estate market.

Healthcare REIT enterprise valuation (equity plus current assets and liabilities) fell over 20 percent during the first half of 2020.

Looking to the past

The deterioration of equity values during the Great Recession paralleled a decline in the average per-unit price for seniors housing and nursing facility transactions during that period. 

Between 2007 and 2009, the average price for independent living and assisted living properties declined 28.5 percent, according to Senior Care Acquisition Reports. Capitalization rates for both property types increased by more than 100 basis points from 2007 to 2009 (spanning the depths of the recession), even though interest rates were significantly lower in 2009 than 2007. 

Equity values for the “Big Three” healthcare REITs fell roughly 20 percent from Sept. 1, 2008, through Aug. 31, 2009. Roughly midway through this timespan, the average equity valuations from the Big Three were off 50 percent.

This rough comparison between the average seniors housing price trends around the time of the Great Recession displays a parallel relationship between the two markets — publicly traded REITs and individual asset values. The question today is whether or not such a relationship exists in today’s market, even though the circumstances driving valuations are hugely different — global financial crisis versus global health pandemic. 

Seniors housing properties are largely valued off cash flow, with most properties priced off normalized net operating income (NOI) or EBITDAR (earnings before interest, taxes, depreciation, amortization and rent). 

The NOI is capitalized into value by dividing NOI by the rate to equal value. As shown in the REIT valuations, a 20 percent value decline may be caused by several scenarios: 

1) NOI would drop by 20 percent, and the capitalization rate would remain unchanged.

2) NOI remains unchanged, and the capitalization rate increases by roughly 180 basis points (from 7 percent to 8.8 percent, for example).

3) More likely, NOI declines some, and the capitalization rate increases by some amount to equate to a 20 percent decline in value. 

We see some REITs reducing their dividends, and also seeing their dividend yields increase, resulting in lower valuations. It is likely that going forward for some time, NOI levels will be lower and capitalization rates will be higher than before the pandemic. Quantifying these two parts of the valuation equation is difficult. For example, a 20 percent decline in value might be caused by an increase in the capitalization rate from 6.5 percent to 7 percent, and a 12 percent drop in NOI. 

Many real estate investors look to Moody’s Analytics’ commercial property price index (CPPI) as a guide to future property values. Moody’s tracks apartments, retail, office and industrial property sectors. 

Moody’s anticipates CPPI indices to reach low points in early 2021, with “total” real estate dropping from 100 percent in January 2020 to 85 percent in September 2020, before reaching a low of 79 percent in March 2021 or ahead of the expected arrival of an effective vaccine.

In conclusion, if the equities market is near the valley today, then over the next six to 12 months we would expect individual property values to decline approximately 10 percent to 15 percent given the experiences from the financial crisis in 2008 to 2009. The CPPI lines up with REIT valuations. So, while individual asset transaction data is nearly non-existent currently, these other references point to the uncomfortable conclusion that seniors housing property values, on average, have deteriorated. 

This may be more so in the markets that were already experiencing oversaturation prior to the pandemic, and less so in markets where unmet need existed. In those markets where there is unmet need, it will be interesting to see if developers pursue or delay planned projects.

A silver lining is that taking on a development start today will likely be completed after the pandemic is resolved — let’s all hope. 

James Tellatin is senior managing director of Integra Realty Resources’ Healthcare & Senior Housing Practice Group. He is also author of The Appraisal Institute’s textbook “The Appraisal of Nursing Facilities.”

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