It could be argued that the last 30 months have presented the seniors housing and skilled nursing industries with their most adverse operating environment ever. Heading into 2023, at least some difficulties appear to be abating.
Seniors housing occupancy rates continue to improve, reaching 81.4 percent in June this year, which was an improvement of 90 basis points over the March figure, according to the National Investment Center for Seniors Housing and Care (NIC). That was also 340 basis points higher than the time series low of 78 percent recorded in June 2021.
“We’ve had some starts and stops, whether it be with Omicron or other COVID variants, but we’re moving in the right direction and demographics are clearly in our favor,” says Michael Gehl, chief investment officer for FHA Lending at NewPoint Real Estate Capital. “As we get into 2023, I think we’ll see occupancy get closer to pre-pandemic levels.”
In another spot of good news, seniors housing operators have recorded healthy annual rent increases in 2022 – 3.4 percent in the first quarter and 3.7 percent in the second, according to NIC. In the second quarter alone, annual rents in the assisted living sector grew 4.6 percent, the largest increase since NIC began tracking the metric in 2005, while annual rents in independent living climbed 3 percent.
With the 75+ population growing at an increasing rate and the amount of new construction down significantly, it is expected that occupancy rates and rent growth will continue to improve into 2023, adds Kathy Stewart, a managing director with NewPoint and leader of its Seniors Housing Agency Platform.
“We’re hearing from many of our clients that rental rate increases are being passed through with very little resistance from residents and families,” she says. “But inflation could potentially slow a recovery in occupancy, particularly for non-needs driven lifestyle options.”
Additionally, nursing homes saw an increase of 2.6 percent in annual care costs in the second quarter, NIC reports. Not only have multiple states increased Medicaid funding to account for inflation, but the Medicare reimbursement rate for skilled nursing operators will increase 2.7 percent in fiscal year 2023, Gehl points out.
That’s a better outlook than the 0.7 percent cut that the skilled nursing industry anticipated due to an adjustment to Medicare’s Patient Driven Payment Model (PDPM) coming October 1, he explains. To lessen the impact, the Centers for Medicare & Medicaid Services (CMS) is phasing the change in over two years.
“The decision to space that adjustment out has been a big positive for the skilled nursing industry,” Gehl states. “The growth in the reimbursement rate is helpful as operators attempt to get back to where they were pre-pandemic.”
Margins Under Pressure
In many cases, seniors housing operators have had little choice but to raise rents due to rising utilities, insurance premiums and labor costs, which have compressed operating margins. Prior to the pandemic, assisted living and memory care facilities typically had operating margins of around 30 percent, but they have dropped to 20 percent or below today, Stewart says.
Of those expenses, staffing shortages are arguably the most pressing and costly problem operators face, especially on the skilled nursing side of the business. Omega Healthcare Investors, a real estate investment trust (REIT), reported in its second quarter earnings call that nursing home providers were experiencing a sixfold increase in temporary staffing agency expenses compared to 2019.
“There is an acute shortage of labor – some 230,000 employees have left the nursing home space,” Gehl says. “So, operators must use agency staff to fill the gaps; otherwise, they can’t take care of residents. And that’s expensive labor.”
Nursing homes have begun to pay higher wages to permanent staff and provide some flexibility in work schedules, which has helped improve the labor picture to a degree, Gehl says. Still, some operators have stopped taking new patients after souring on staffing agencies, he reports.
While higher cost is one hindrance, another is that agency workers lack familiarity with a facility’s residents and its policies and procedures, which can degrade the quality of care. One silver lining that speaks to an improving labor picture is the August jobs report, which showed an approximate 11,600 increase in skilled nursing workers month over month — that is off an increase of 8,700 the prior month.
Looking ahead, the Biden administration is considering whether to require a minimum standard of staffing at nursing homes, which is fueling additional concerns about added expenses, Gehl adds.
Labor shortages continue to challenge seniors housing operators, as well, Stewart says. “The use of agency labor has been mitigated to a certain degree, but in order to fill open positions, operators are having to pay higher wages,” she reports. “It’s still a major issue that is putting pressure on operating margins.”
Many seniors housing and skilled nursing owners of properties that opened or were under development during the pandemic have yet to achieve stabilization, which remains an obstacle to finding permanent financing. Until early this year, soft occupancy rates and rising operating costs prevented lenders from making long-term loans. Rising interest rates since then have only created more vigilance among lenders.
Fannie Mae and Freddie Mac, for example, are focused on stable markets that have strong fundamentals and minimal disruptive supply risk, Stewart says. What’s more, funding decisions are based upon in-place cash flow — there is no benefit for current valuations or pro-forma projections.
“The agencies are being very cautious when underwriting assets, and they are evaluating transactions on a deal-by-deal basis,” she states. “Sponsor experience and background are more important today than ever, and they’re showing favor to operators of multiple communities that have scale and a successful track record.”
Skilled nursing property owners are experiencing similar challenges, as the Department of Housing and Urban Development (HUD), a major lender to the industry, has become more conservative. If a deal has seen a dip in financial performance during the HUD process (agency labor costs, etc.), several months of improved cash flow will be required to proceed with the application, says Gehl.
Consequently, asset owners in both camps continue to seek bridge loans to buy more time. But short-term debt has become much more expensive over the past several months, which in some instances requires borrowers to bring more equity to deals or agree to earnout structures. The benchmark Secured Overnight Financing Rate (SOFR) has rocketed to nearly 2.65 percent from virtually zero at the beginning of the year — and it has roughly doubled since early July alone.
Higher interest rates and the volatile financial markets are expected to negatively affect seniors housing valuations, and while plentiful, equity has moved to the sidelines to a degree to wait for capitalization rates to adjust, Stewart says. Transactions are occurring in both the value-add and stabilized markets, Gehl adds.
“Some markets and operators haven’t been able to turn around, but there are others that are back to performing at pre-pandemic levels, if not better,” he points out. “We’re definitely seeing deals for good, stabilized properties getting done as investors continue to seek out attractive cash-on-cash returns.”
The Senior Care Investor just cited four deals with above 85 percent occupancy and an average price per unit of $262,600 in assisted living, which represents a substantial bump from 2021, when the price per unit was $235,000 for above-85-percent-occupied facilities.
Despite current challenges and possible recessionary scenarios, improving fundamentals and valuations, waning COVID stigmas and powerful demographic tailwinds support not only a road to recovery, but a view that some of the strongest years of demand for the seniors housing and healthcare sectors are just around the corner.
— By Joe Gose. This article was written in conjunction with NewPoint Real Estate Capital, a content partner of Seniors Housing Business.
NewPoint Real Estate Capital is a prominent real estate finance company delivering lending solutions to investors of multifamily, affordable housing, seniors housing, healthcare and manufactured housing properties nationwide. Learn more at NewPoint.com.
Kathy Stewart, Managing Director – Seniors Housing Agency Platform Lead ([email protected])
Michael Gehl, Chief Investment Officer, FHA Lending