Funds see opportunity to turn around seniors housing properties
By Bendix Anderson
Private equity funds have become leading buyers of seniors housing. They accounted for 14 percent of seniors housing acquisitions in the second quarter — tripling their market share from the year before by dollar volume, according to the National Investment Center for Seniors Housing & Care (NIC).
Although their stock prices took a beating late last year and early this year, real estate investment trusts (REITs) still account for more than one-third of seniors housing acquisitions, often buying large portfolios of properties. That figure is down from nearly two-thirds earlier in the economic recovery, giving private equity buyers more opportunities to buy at attractive prices.
“They have become the dominant buyer, more so than the REITs over the past year,” says Richard Swartz, executive managing director at Cushman & Wakefield, who heads up the brokerage firm’s national seniors housing capital markets team that operates out of its Boston and Irvine, Calif., offices.
Because private equity often buys properties one at a time, this investor class has become quite influential in the universe of single-property sales.
Private equity funds also have a growing amount of capital to spend from investors. They have a “value-added” business model well-suited to the current moment in the real estate cycle. With industry experts concerned that too much new construction will lead to higher vacancies, private equity funds are well positioned to turn around troubled properties and add value.
“We’ve closed five or six large transactions this year with private equity firms,” says Mark Myers, executive director in the Chicago office of Institutional Property Advisors, a division of Marcus & Millichap.
Inside the numbers
Investment partnerships led by private equity funds acquired $819 million in seniors housing properties during the four quarters that ended June 30, or 9 percent of all closed seniors housing transactions. That’s up from 6 percent the year before, including independent living, assisted living and memory care, according to NIC.
During the same period, public buyers, including the large REITs, lost market share as their percentage of all seniors housing acquisitions fell from 66 percent to 43 percent.
The trend increased in the second quarter of 2016, when private equity bought $210 million in seniors housing properties, according to NIC. This represented 14 percent of all closed seniors housing transactions, compared with 4 percent in the second quarter of 2015.
Public buyers, including the large REITs, posted a market share of 32 percent in the second quarter of 2016, down from 62 percent the year before.
“There are hundreds of funds now that are looking at the space,” says Lisa Widmier, executive vice president for CBRE National Senior Housing. The number of funds investing in seniors housing has steadily grown over the years, but until recently, REIT purchases of portfolios pushed up prices throughout the market, making it difficult for funds to deploy their capital.
REITs have been less active this year, after several years as the top buyers of seniors housing portfolios.
“REITs have been left on the sidelines because of their high cost of capital and the potential for overbuilding in this sector,” says Mel Gamzon, principal with Seniors Housing Global Advisors, based in Miami.
For much of the past year, REIT stock prices took a beating due to stock market volatility. For example, Welltower, a top REIT, saw its stock price fall to less than $55 per share near the start of 2016, from a peak of over $80 a share at the start of 2015, giving up most of the gains of 2014. More recently, at the end of August 2016, the stock price was back up to more than $75 per share.
REITs are also sensitive to interest rates, which seemed likely to rise earlier this year. Interest rates have remained persistently low, however. A few large REIT transactions occurred as REIT stock prices recovered some of their lost value. In August, Welltower announced it agreed to buy a $1.15 billion portfolio of 19 independent living, assisted living and memory care properties from Vintage Senior Living.
However, REITs are not expected to return to their dominant position as top buyers.
One reason is that REITs often buy properties in large portfolios, rather than one at a time. “There are not that many large transactions in the marketplace today,” says Gamzon. REITs may also take some time to absorb and integrate the properties they have acquired over the last few years.
“This is going to be a continuing opportunity for private equity funds,” says Kevin Tyler, a healthcare real estate analyst in the Newport Beach office of research firm Green Street Advisors. “REITs are going to be more cautious than they have been. They are sensitive to overbuilding.”
Investors accept seniors housing
Private equity funds have a lot of money to spend on seniors housing properties, thanks to investors who are increasingly interested in the sector.
Last year, six closed-end private equity funds with exposure to seniors housing closed their fundraising, having raised an aggregate of $2.7 billion, according to research firm Preqin, which tracks private equity funds. That’s much more than the aggregate $900 million raised by funds that closed the year before.
So far in 2016, just one fund has closed with about $300 million, though that number is likely to grow.
The big total only includes funds that explicitly target seniors housing in their fundraising. Many more private equity funds buy seniors housing properties to diversify their investments.
“We’ve certainly seen private equity consider acquiring seniors housing assets for different kinds of funds, including core, value-added and opportunistic,” says Matthew Whitlock, executive vice president and partner with CBRE National Senior Housing based in San Diego.
Private equity funds also benefit as investors become more familiar with seniors housing. “There is just a huge surge in cross-border investment looking to place money in the seniors housing sector,” says CBRE’s Widmier. CBRE Capital Advisors, the investment banking business of CBRE in the Americas, is working with cross-border clients who are focused on investing in seniors housing in the U.S.
Many investors now consider stabilized seniors housing properties in strong locations to be a core real estate type, similar to stabilized apartments. Until recently, investors considered such properties to be a riskier, niche property type.
“The reclassification of seniors housing as core real estate has attracted more investors,” says Whitlock. “Though I would still categorize seniors housing as ‘core plus’ — there is still a discount value or a premium yield for even stabilized seniors housing compared to multifamily.”
As more investors plow capital into seniors housing, private equity funds that explicitly have exposure to seniors housing are getting larger.
Harrison Street Real Estate Partners V began 2016 with $850 million to invest opportunistically in medical and healthcare, self-storage, seniors housing and student housing. That makes it the largest seniors housing fund of its kind in the last 10 years, according Preqin.
Fund V is the latest commitment to seniors housing from Chicago-based Harrison Street. The fund manager also closed funds that targeted seniors housing in 2008, 2011 and 2013. It is a leader in the private equity world overall — it ranked No. 31 on the list of the top 50 largest private equity real estate firms in the world in 2016, based on how much equity they raised over the past five years, according to PERE.
ROC Seniors Housing Fund Manager, a division of Bridge Investment Group Partners, based in Orlando, Fla., is preparing to raise capital for a new $750 million fund.
ROC closed its first seniors housing fund, ROC Seniors Housing and Medical Properties Fund I, in July 2015 with $737 million.
“We have been very encouraged with early interest and demand,” says Robb Chapin, CEO of ROC. “We look forward to continuing our deep commitment to the seniors housing industry.”
Stars aligned for private equity players
Most private equity players are looking for some kind of value-added strategy, observes IPA’s Myers. That often means buying older seniors housing properties and upgrading their operations. With cap rates so low for well-located, well-stabilized properties, the value-added strategy is a smart play today.
“We are primarily a value-added investor. We look for the potential to increase operating income,” says Phil Anderson, ROC’s chief investment officer.
Even when ROC appears to be buying a portfolio of stabilized properties, the fund finds ways to increase the income at the properties.
For example, ROC plans to control expenses and enhance the revenue at the six seniors housing properties it bought at the end of 2015 — even though the properties already had a healthy average occupancy rate of 89.1 percent.
ROC bought the portfolio from a partnership between two other private equity funds: developer CSH and the Carlyle Group, both based in Washington, D.C. The six communities include 596 independent living, assisted living and memory care apartments located in Southern California, Michigan, Philadelphia and Washington, D.C.
“It’s a light value-added investment,” says Anderson. “We’re taking a story that had already been started — the prior owners had done a fantastic job — and we are finishing it up.”
ROC’s first, $737 million fund is roughly two-thirds of the way to completing its goal to invest in approximately 60 seniors housing properties, with an aggregate value of about $2 billion, by the end of this year.
“We are well on the way to investing our first fund and we are preparing to launch our fundraising for our second fund,” says Anderson.
PGIM Real Estate, another leading fund manager and the real estate investment business of Prudential Financial, finds opportunities to add value to seniors housing in markets across the country, including secondary markets.
“We aren’t just in the biggest of the big markets. The concentration of new supply is heaviest in the 20 big markets,” says Noah Levy, managing director in the Madison, N.J., office of PGIM Real Estate.
Private equity buyers also add value to properties where some problem has kept occupancies low.
“Private equity is acquiring assets that aren’t fully stabilized,” says Gamzon.
In a typical deal, a fund might buy a property that is 78 percent to 80 percent occupied. Normally, a partially occupied property would sell at a steep discount. Private equity can agree to pay a higher price, closer to that of a fully occupied community, but withhold 5 to 10 percent of the purchase price until the property has stabilized eight to 16 months later, according to Gamzon, who has structured several such transactions.
The properties that private equity funds refurbish or recapitalize frequently rent for less than brand new properties, even after they are refurbished. As a result of these lower rents, the updated properties are likely to be competitive even in overbuilt markets where brand new properties are much more expensive.
Overbuilding opportunity knocks
The conventional wisdom is that seniors housing developers are building too many new ground-up projects in select markets, creating an opportunity for private equity funds to buy these facilities and add value.
“Repositioning new construction properties — that is a perfect role for private equity,” says ROC’s Anderson. “It’s what private equity is really good at.”
The amount of new seniors housing currently under construction, including independent living, assisted living and memory care, represents 5.68 percent of existing inventory. That’s up from an average of 3.5 percent during the period 2008 to today, according to NIC.
Some of these properties are likely to face challenges reaching full occupancy. Much of this new construction is concentrated in a handful of metro areas, according to NIC. These new communities will compete to attract a limited number of seniors who are ready to move.
“In the last couple cycles when you had supply added, when a community crashed, it was because the community ran out of its debt reserves,” says Anderson. “Someone else had to come in a recapitalize the project.”
ROC is now looking for opportunities to buy properties in strong locations that may face temporary challenges as the facilities reach stabilization. “I don’t think it’s going to happen as deeply or as badly as 2000,” says Anderson. “Developments are better capitalized with lower leverage.”
However, a significant number of new developments are likely to need an infusion of new capital. “No less than 10 to 15 percent of the new-built inventory will need to be recapitalized,” predicts Gamzon.
The properties that private equity funds buy today are also likely to benefit from stronger demand for seniors housing when the funds sell the assets in five to 10 years, which is typical hold period for private equity funds.
The number of people who are age 80 and above has grown at an annual rate of between 1.5 and 2 percent over the last few years. That rate of growth is expected to rise to 4 percent in 2023 and 6 percent in 2027, according to Green Street.
“Growth will accelerate in the early 2020s and even more in the mid-2020s, when the demographics come on in a big way and as the Baby Boomers age,” says Tyler of Green Street. “By 2021, five years from now, the trend should favor investors and it’s reasonable to think it will be reflected, or is already reflected, in their underwriting.”