Softening real estate fundamentals combined with facility lockdowns stymie deals.
By Matt Valley
The longer the COVID-19 pandemic goes, the bigger the toll will be on investment sales activity, say commercial real estate finance professionals. PGIM Real Estate early this year completed its capital raise for Senior Housing Partners VI, a closed-end fund with a total of $996 million in commitments. But Steve Blazejewski, managing director at PGIM Real Estate, says the investment firm’s acquisition pipeline is currently “on ice.”
“It’s really difficult to pursue an acquisition of some size when you can’t even walk a building or tour it. You can’t get anybody to come into the building to inspect it. You can’t get your license because a lot of the government offices are shut down,” according to Blazejewski, referring to the lockdown of senior living communities and much of the economy in an effort to contain the spread of the highly contagious coronavirus.
His comments came May 7 during a webinar hosted by the National Investment Center for Seniors Housing & Care (NIC). The webinar was titled “Confronting The New ‘Normal’: A Conversation Between Operators, Lenders and Private Equity Providers During a Pandemic.”
PGIM Real Estate has been investing in the seniors housing sector since 1998. The Senior Housing Partners VI fund exceeded its $750 million target and included $570 million from existing institutional clients, in addition to $426 million from new institutional and high-net-worth investors.
The fund — which invests in the independent living, assisted living and memory care segments of seniors housing — employs a flexible investment strategy that targets direct acquisitions, developments, pre-sales and other opportunities.
“I am very contrarian by nature,” said Blazejewski. “I actually do believe this is the time to be investing. We’re fortunate that we just raised an almost $1 billion fund, and we still have 90 percent of that capital remaining. As we look at this type of environment, it’s a very favorable environment for us to be in.”
Chris Taylor, managing director of seniors housing and care at Capital One and a participant in the NIC webinar, said his top priorities currently are to address any portfolio challenges that arise and field questions from customers. “We are still open for business. Candidly, we’re just not seeing a huge amount of deal activity right now. As the weeks and months go by and people conclude what the new normal is and when it’s time to look at opportunities, I think we’ll see more of that.”
Transaction activity ebbs
U.S. property and portfolio sales in the seniors housing and care sector totaled $18.1 billion in 2019, up 18 percent from the prior year, according to Real Capital Analytics (RCA). However, the $3.46 billion in deal volume during the first quarter of 2020 was down 14 percent from the $4.01 billion in transaction activity notched during the same period a year ago, reports RCA, which tracks deals $2.5 million and above.
Data from the New York City-based real estate research firm shows 110 transactions were completed in the seniors housing and care space during the first quarter of this year, down from 175 in the first quarter of 2019, a 37 percent drop. The second-quarter figures will be more telling since the pandemic didn’t hit the U.S. until mid-March.
In one of the biggest deals to close in the first quarter of this year, New Senior Investment Group (NYSE: SNR) sold its entire assisted living and memory care portfolio for $385 million to ReNew REIT, a company founded by George Chapman, the former CEO of Health Care REIT, now known as Welltower. The portfolio included 28 properties across 14 states totaling 2,840 units.
The sale left New Senior with 102 independent living properties and one continuing care retirement community. The sale enabled the company to reduce its debt by about $350 million and focus on the stronger performing segment of New Senior’s portfolio — independent living.
Shape of recovery uncertain
Internal discussions at PGIM Real Estate these days often center on how deep the U.S. recession will be and how quickly the economy will rebound, explained Blazejewski. Since the coronavirus struck in mid-March, nearly 43 million Americans have filed for unemployment benefits. The national unemployment rate spiked to 14.7 percent in April from 4.4 percent in March.
The possible economic scenarios include a V-shaped recovery (a sudden and sharp downturn followed by a strong rebound), a W-shaped recovery (also known as a double-dip recession), or a U-shaped recovery (a recession in which the economy tumbles along the bottom for a few quarters before improving).
“We’re working on an investment committee memo right now where we have to show three different scenarios. I still think we’re in a huge period of uncertainty,” said Blazejewski. “Do we end up in a prolonged recession as we did during the GFC (global financial crisis of 2007-2009)? Is it deeper, but shorter?”
As senior portfolio manager for PGIM Real Estate’s Senior Housing Partners fund series, Blazejewski and his team spend a lot of time poring over rent growth and operating growth assumptions at each community. The underwriting process factors in the pace of lease-ups, which has slowed amid the economic turbulence.
“We just expect that we’re not going to have really any positive move-ins for 2020. Maybe in the third to fourth quarter we might start to see some, but we are forecasting net erosion of occupancy with flattish to negative rent growth, then a more positive outlook in 2021,” explained Blazejewski.
Data compiled by NIC show a decline in the occupancy rate for April, the first full month of the COVID-19 pandemic in the U.S. More specifically, seniors housing facilities tracked by NIC experienced a 1.1 percentage point decrease in occupancy to 88.7 percent, while occupancy at nursing care facilities was down 2.2 percentage points to 84.7 percent.
Future of cap rates
One question on the minds of many seniors housing investors is where valuations are headed in the near term in light of weakening real estate fundamentals. Beth Mace, chief economist for NIC, posed that question to Blazejewski during the webinar she moderated.
“I’m a believer in the self-fulfilling prophecy that if we keep talking about cap rates going up and we talk about the erosion of the capital markets, then it’s going to happen eventually because people start believing what they hear,” he stated. (Cap rates are a measure of asset value. When cap rates rise, valuations fall.)
“Obviously, the fundamentals are changing. We are seeing pressure on margins and operating expenditures,” observed Blazejewski. “In time, I think we’ll see improvement in the labor market, which has really been pressuring the industry for many years. But to answer your question more directly, I do think there will be probably six to 12 months of pain in terms of cap rates.” n