Private Equity Watches and Waits

by Jeff Shaw

Although these funds collectively have raised billions of dollars, they are in no hurry to spend the capital amid dicey market conditions. 

By Bendix Anderson

Talk about patient capital. Many private equity funds, flush with hundreds of millions of dollars, are willing to wait and wait for the right deal at the right price before acquiring a seniors housing property or portfolio.

At the same time, private equity investors are spending more than ever before to buy or build conventional apartments. They’re even snapping up alternative niche properties — from student housing to cell phone towers — at high prices. 

Because seniors housing took a direct hit from the pandemic that resulted in rising vacancies and escalating operating costs, private equity has clearly taken a more cautious approach toward seniors housing than pre-COVID-19. Fund managers today have a long list of requirements for the seniors housing properties they consider buying. They seek great locations, operators with a track record of strong performance and, most of all, favorable pricing.

“The sellers that are out there are not willing to sell at the prices the buyers are willing to pay,” says Steve Blazejewski, senior portfolio manager for PGIM Real Estate’s Senior Housing Partners, a leading investor in seniors housing since 1998. “The spread is really in terms of assumptions buyers are making with respect to occupancy gains and risk related to post-COVID lease-up.  Sellers want full price; buyers haven’t been pricing that in.”

Willing investors

The irony is that private equity funds focused on seniors housing continue to raise capital from eager institutional investors looking for relatively higher yields. Stabilized seniors housing properties tend to offer annual yields roughly a percentage point higher than comparable, conventional multifamily properties.

“There has been a lot of money raised,” confirms John Sweeny, senior vice president of CBRE Senior Housing Capital Markets. 

Private equity fund managers raised $22.2 billion in 2021 for 30 real estate funds planning investments in alternative types of real estate including seniors housing, according to Preqin, an investment data company based in London. 

That’s the most money ever raised by such funds except for 2018, when managers raised $23.7 billion for 49 different funds. It’s also more than twice the $11 billion fund managers raised in 2020, the first year of the pandemic.

In November 2021, Kayne Anderson Capital Advisors closed fundraising for its largest fund ever, Kayne Anderson Real Estate Partners VI. The closed-end fund was oversubscribed, raising $2.75 billion, significantly more than its original $2 billion target. The opportunistic fund will invest primarily in seniors housing, office and student housing. 

“Alternative real estate investments are getting a lot of interest right now,” says Max Newland, co-head and senior managing director of seniors housing for Kayne Anderson Real Estate (KA Real Estate), based in Boca Raton, Florida. Alternatives often provide higher yields and risk-adjusted returns than traditional core real estate sectors. The difference often works out to dozens of basis points in annual yield.

The fund manager has invested in 17,400 seniors housing units. “Seniors housing has been 30 to 40 percent of our investment activity in funds IV and V. I wouldn’t be surprised if Fund VI continued that, although we have no strict targets.”

Harrison Street, based in Chicago, also had a busy 2021. Harrison Street Real Estate Partners VIII, the fund manager’s eighth opportunistic real estate fund, exceeded its initial $1.5 billion target, finally closing its fundraising at its hard cap of $2 billion. Harrison Street also created an additional $510 million in co-investment vehicles alongside Fund VIII for a total of $2.5 billion of equity raised. The fund has already invested in several property segments including seniors housing, student housing and medical office. 

“Institutional buyers have dry powder to put to work,” say Beth Burnham Mace, chief economist and director of research and analytics at the National Investment Center for Seniors Housing & Care (NIC), based in Annapolis, Maryland. 

Fewer deals getting done

Institutional buyers — a category that includes most private equity funds — spent $2 billion on seniors housing properties in 2021, according to New York City-based Real Capital Analytics (RCA). That’s a 60 percent decrease from the $5 billion they spent in 2019, their biggest showing in the last decade. It’s also 9 percent below the $2.2 billion they spent in 2020, the first year of the pandemic.

“Regarding institutional buyers, aside from some activity from Harrison Street and Lone Star in the second quarter of 2021, there was not much activity in that period,” says Mace, referring to Lone Star Funds, a private equity firm based in Dallas. 

In June 2021, Harrison Street agreed to pay $1.2 billion for a portfolio of 24 Class A, stabilized seniors housing properties, mostly assisted living and memory care, totaling 2,195 units in California and Nevada. Those properties were fully stabilized and available to buy — a rare occurrence in the current market. 

“The assets acquired are managed by a leading operator in Oakmont Senior Living and located in attractive markets backed by solid demographics, high barriers to entry and historically high occupancy rates,” says Michael Gordon, global chief investment officer at Harrison Street.

In past years, private equity funds often completed several large deals similar to Harrison Street’s acquisition. But in 2021, Harrison Street’s deal was by far the largest purchase of seniors housing by a private equity fund. No other transaction even came close.

In contrast, annual investment volume in the apartment sector totaled $335.3 billion nationally in 2021, according to RCA, more than double the amount recorded in 2020, the first year of the pandemic. 

“On our investment committee, I see the activity going on in multifamily, and even potentially more in the industrial sector. You see very aggressive transactions happening [in those sectors],” says PGIM’s Blazejewski. “You would think that with all the money earmarked, that seniors housing would be as active, and it is clearly not.” 

Meanwhile, publicly traded companies spent $5.2 billion on seniors housing in 2021, up from $1.5 billion in 2020, according to RCA. Leading REITs such as Ventas, Welltower and Omega Healthcare Investors all went on buying sprees. That’s the most REITs have spent on seniors housing since 2015. 

These REITs seem willing to pay the high prices sellers want for seniors housing properties. However, many private equity buyers are only willing to pay those high prices for properties that demonstrate the strongest performance.

“Cap rates have gotten back to where they were pre-COVID for those assets that can support them,” says Richard Swartz, a vice chairman in the Boston office of Cushman & Wakefield who leads a team of capital markets specialists dedicated to seniors housing. New properties with strong occupancies and rent growth often earn cap rates in the 5 to 5.5 percent range, he says. 

Headwinds persist for operators

Many seniors housing properties suffered a financial setback due to the pandemic. More are now struggling with the rising cost of doing business, especially the high cost of labor. Investors are keenly aware of the financial challenges affecting operators. 

“There are a number of metrics that we look for when we approach a new investment,” says Kayne’s Newland. Among the key questions that Newland asks: Does the property have a strong operating history? Is there a proven operator in place? Is the property in a favorable location with proven demand for seniors housing?

Although KA Real Estate’s last purchase was in the fall of 2021, it has remained active. “There has been very little that checked all the boxes. There are very few bullet-proof operators or assets out there.”

A double whammy

The overbuilding that occurred immediately prior to the deadly COVID-19 outbreak that struck in early 2020 softened real estate fundamentals. The ensuing pandemic only served to exacerbate the problem. The percentage of seniors housing units occupied in the fourth quarter of 2019 in the 31 primary markets tracked by NIC MAP Data Service slipped to 87.6 percent, down from 88.5 percent in the fourth quarter of 2017, the strongest year for seniors housing in the current real estate cycle, according to NIC MAP Vision. (The NIC data covers independent living, assisted living and memory care communities.)

Doctors diagnosed the first cases of coronavirus in the U.S. in the first quarter of 2020. As the virus spread, many seniors housing properties did not rent units to new residents due to safety considerations. As a result, the occupancy rate dropped to a low of 78 percent in the first and second quarters of 2021, according to NIC MAP. 

The vital signs of the industry are improving, however. As of the first quarter of 2022, the occupancy rate was 80.6 percent, up 20 basis points from the prior quarter. On average, seniors housing properties are gradually recovering from the pandemic, explains Mace, but some are faring much better than others. “There is a wide disparity in occupancy performance.”

More than one-third of seniors housing properties (40.6 percent) tracked in the NIC MAP Primary Markets had an occupancy rate of less than 80 percent or less in the first quarter of 2022. Some of these properties may eventually be bought at a discount by private equity investors eager to renovate. 

So far, however, relatively few owners have been forced to sell. “Lenders have been patient through a period of low interest rates, even for properties that have been distressed,” says PGIM’s Blazejewski. 

Other seniors housing properties are performing well, despite wave after wave of coronavirus infections. At nearly one in seven (14.1 percent) of the properties tracked by NIC MAP Primary Markets, the percentage of occupied units was at or over 95 percent.

But even well-performing seniors housing properties face problems, including rapidly rising operational costs  — especially the cost of labor. For example, the wages earned by assisted living employees grew at an average annual rate of 9 percent in the fourth quarter of 2021. That’s many times the rate wages grew in recent years. 

The cost of virtually everything continues to rise, including the food served to residents, fuel and the construction materials used to build or renovate seniors housing properties. The Consumer Price Index for all items rose 8.5 percent over the 12 months that ended in March 2022, according to the U.S. Bureau of Labor Statistics. That’s the biggest 12-month increase since December 1981. 

The rents earned at seniors housing properties are also growing, but not nearly as fast. “Rents are a bit high, but expenses are even higher,” says Blazejewski.

Asking rents increased an average of 2.7 percent over the year that ended in the first quarter of 2022 at majority independent living properties in NIC’s primary markets and rose 4.1 percent at assisted living facilities. The increase in rates for assisted living was the highest since NIC began collecting data in 2005.

However, even that large rent increase for assisted living is just a fraction of the rate that rents grew at apartment properties overall over the same period, according to CBRE.

The financial stresses on seniors housing operators have had a negative impact on investors’ returns. The total one-year return for investments in seniors housing was 3.54 percent on average in the fourth quarter of 2021, according to the National Council of Real Estate Investment Fiduciaries (NCREIF), which focuses on investors who own best-in-class properties in best-in-class locations. 

By comparison, the average one-year return for real estate investments overall in 2021 was 17.7 percent, according to NCREIF. 

Rising interest rates are making deals even more difficult. The 10-year Treasury yield, the benchmark for permanent, fixed-rate financing in commercial real estate, was 2.7 percent at the close of business on April 13, up about 120 basis points from 1.5 percent at the end of 2021. 

Most lenders won’t make a loan if the monthly income generated by the property isn’t significantly more than the monthly mortgage payments. As interest rates rise, the amount of debt a property can support becomes smaller and smaller.               

Development is difficult

Private equity funds also continue to face challenges on the development and construction front. “Persistent labor shortages and general inflation are putting tremendous pressure on underwriting,” says KA Real Estate’s Newland.

Upward wage pressure and the rising cost of construction materials — in addition to an uptick in interest rates — create an even bigger challenge. 

Despite these hazards, developers started construction on thousands of new units of seniors housing in 2021 — 7,700 new independent living units and more than 11,600 assisted living units, according to NIC MAP. While the number of units that developers broke ground on in 2021 was higher than 2020 (when developers started 6,200 units for majority independent living and 8,300 for majority assisted living), this is still far less than the peak years from 2016 to 2019.

KA Real Estate currently has seniors housing developments under construction in New Orleans; Wilmington, North Carolina; St. Louis, Missouri; and Ft. Collins, Colorado. 

“Challenges aside, we believe it’s a great time to be building as we believe demand will outpace supply for the foreseeable future,” says Newland.

Other private equity fund managers are more restrained about new construction.

“We are very cautious on development,” says Kathy Sweeney, chief investment officer, managing partner and co-founder of Boston-based Blue Moon Capital Partners. “In our normal pipeline, at this point in our fund life we would have half the fund equity invested in development. But it is hard to underwrite getting paid for the risk with rising costs. Any new development at this stage would be a unicorn.” 

Active adult bucks trend

Private equity investors are having an easier time buying and building one segment of seniors housing: active adult properties. 

“Active adult is probably the most favored,” says John Sweeny, senior vice president of CBRE Senior Housing Capital Markets. “It looks the most like multifamily.”

National data on the volume of sales and property performance is not yet available for this relatively new type of seniors housing that targets persons age 55 and above. Most data sources differentiate active adult properties from conventional multifamily in two ways: The communities don’t provide the kind of health services available at assisted living communities, or the meal services provided at independent living. 

As a result, active adult properties have been hurt less by the rising cost of hiring staff. “It’s less labor intensive,” says Sweeny.

Active adult properties were also less impacted by the coronavirus pandemic. Younger, active residents were much less vulnerable to the virus. In most jurisdictions, active adult properties did not have to close their doors to visitors during the pandemic and were still able to lease apartments.

“Active adult properties really trade like multifamily,” says Michael Hartman, principal for Capitol Seniors Housing (CSH) and leader of the private equity fund manager’s active living platform. “We are now at the point where you have a pretty liquid market in active adult.”

Investors are willing to pay high prices relative to the income produced at active adult properties, says Hartman. Cap rates for active adult properties are comparable to those for apartment properties — often ranging from 3.5 to 4.5 percent.

In late 2021, CSH bought NorthStar Georgetown, a newly constructed active adult community in the greater Austin, Texas area. CSH, based in Washington, D.C., partnered with Bain Capital Real Estate to buy the community. CSH and Bain have teamed up to buy a total of four active adult properties in Texas in the last year. CSH also started construction on two new active adult properties.

“That’s a really good year,” says Hartman. n

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