For more than a year, seniors housing operators have battled rising vacancy, pressure on net operating income and uncertainty about the future as potential residents steered clear from property tours and lease commitments.
Those difficulties have created a tough financing environment for the segment. But a growing number of seniors housing discussions today are centered on how operators and the industry are recovering, according to Christopher Callaghan, head of healthcare banking at M&T Bank. To what degree a recovery is occurring, however, depends on several variables.
“There is still a lot of noise in the market, and the recovery is submarket by submarket and facility by facility,” says Callaghan. “While we’re hearing positive news about increasing leasing activity, in some places there are still challenges related to how much supply was being added to a market just before the pandemic hit as well as staff shortages, vaccinations of staff and vaccinations of incoming residents.”
For the last few quarters, independent living and assisted living properties have set consecutive record-low occupancy rates, according to the National Investment Center for the Seniors Housing & Care Industry (NIC). In the first quarter of 2021, independent living recorded an average occupancy of 81.8 percent, down from the previous record-low of 83.5 percent in the fourth quarter of 2020. Likewise, over the same period, assisted living average occupancy fell to 75.5 percent from 77.7 percent. Since March 2020, average independent living and assisted living occupancy has dropped 7.9 and 9.5 percentage points, respectively, NIC reports.
The low-occupancy environment is putting pressure on rental rate growth, and in turn some operators are offering incentives and concessions, says Matthew Pipitone, seniors housing platform manager with M&T Realty Capital Corporation. Historically, seniors housing properties have experienced average rental rate growth of 2 percent to 4 percent a year, according to NIC. But NIC notes that, on average, rental rate growth at assisted and independent living assets fell to 0.9 percent in the first quarter this year from 1.6 percent in the fourth quarter of 2020.
Given that backdrop, seniors housing debt providers are still taking a cautious approach despite becoming more active. The U.S. Department of Housing and Urban Development (HUD), Fannie Mae and Freddie Mac, for example, have largely dropped a debt service reserve requirement added last year, Pipitone says, and borrowers can receive a HUD loan for 80 percent of value and debt coverage ratio of 1.45 for stabilized properties. However, HUD never formally implemented reserves for every transaction, but can require on a case-by-case basis if a deal warrants.
The problem is that there are fewer stabilized properties today than before the onset of the coronavirus, he adds. Consequently, as an alternative to considering a sponsor’s trailing 12-month NOI and occupancy performance, HUD may look at trailing performances of six months or three months to predict future operations.
“HUD and the agencies are trying to get their arms around the volatility in the market,” Pipitone explains. “We’re heading to pre-COVID underwriting, but we’re not quite there yet. Transactions with maximum leverage are still hard to underwrite.”
Meanwhile, balance sheet lenders tend to prefer working with sponsors with whom they have already established a relationship, says Callaghan. They also have intensified scrutiny on facilities, submarkets, competition, facility staffing and demand trends. M&T Bank provides construction loans as well as bridge financing that facilitate the stabilization of assets before they are taken out by pre-arranged, permanent HUD and agency loans.
“We’re looking at whether a property’s occupancy has eroded,” Callaghan explains. “If it has, when did it start coming back? And if it hasn’t, what is the sponsor’s ability to carry a lower level of occupancy until the units are re-leased?”
Combined with the struggling fundamentals, a plunge in investment sales is adversely affecting seniors housing values, Pipitone and Callaghan point out. Seniors housing investment sales in 2020 fell 46 percent to $6.5 billion from the prior year, according to JLL’s Spring 2021 Seniors Housing & Care Investors Survey and Trends Outlook. The report also indicates that capitalization rates crept up to 6.7 percent in the first quarter of 2021 from 5.9 percent in late 2019.
Plus, Callaghan states, appraisals for some properties have declined 5 percent to 10 percent from where they were prior to the pandemic due to lower occupancies, discounted rental rates and higher operating costs.
Still, 37 percent of respondents to JLL’s survey identified assisted living as the most sought-after investment opportunity in 2021. Meanwhile, in June, private real estate funds targeting North America had some $225.6 billion available for deployment, according to PwC’s Real estate deals insights: 2021 midyear outlook.
“With all of the capital that’s on the sidelines, competition is going to drive prices up over the next several months,” Pipitone predicts, “and values will start climbing again.”
Additionally, developers who delayed projects during the pandemic are now revisiting them, fueling an increase in construction lending requests, Callaghan says. But developers, too, remain disciplined and selective when it comes to submarket demographics, locations and budgets.
“Seniors housing has been a great asset for a long time, and we’re beginning to sense optimism among lenders, developers and even seniors who are once again looking for a place that meets their needs,” Callaghan notes. “It’s still a mixed story, but it’s improving.”
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