The silver lining of development in your market

by Jeff Shaw

New product raises industry awareness, penetration rate, rents

By Kevin Carden

Attend any seniors housing conference, read any newsletter or speak to any industry professional and it will be difficult to avoid the topic of overdevelopment in independent living, assisted living and memory care. 

These fears are not unfounded. Overdevelopment and the opening of buildings in rapid succession can be highly disruptive to markets and the industry as a whole. New buildings may offer amenities that are out of your reach. These amenities may also prove irresistible for prospects, current residents and even loyal employees. 

Considering that seniors housing construction has recently approached levels not seen since the late 1990s, it’s easy to believe this sector is heading headlong into the late 1990s-style building boom. Improved data from the National Investment Center for Seniors Housing & Care (NIC), better product awareness and claims that “we’re smarter now” offer little comfort. 

However, once the panic subsides, it is also important to consider the benefits of new development to the industry, as well as the submarkets that experience new development. Further, if you’re panicking, you’re likely one of these potential beneficiaries. There are quite a few “silver linings” to this trend. 


It’s good for the industry

While short-term risk and disruption are likely, new inventory is positive for a real estate sector. New development allows innovation, sparks new investor interest, is reflective of current investor interest and increases product awareness. Consider the hospitality and student housing industries — few institutional investors or consumers would rush to invest in, or stay in, a 1950s vintage motel or my college dorm (the latter for good reason). 

New development has played a pivotal role in the growing institutional and consumer acceptance of real estate sectors such as student housing, storage and seniors housing. Valuations for these buildings have increased along with this growing acceptance. If you are currently an owner of seniors housing, this is a good thing. 


Increased market awareness

The Philadelphia market is often noted for its exceptional penetration rate. It’s a market with a long-term presence of seniors housing, and the resultant product awareness is usually cited as the cause for the high penetration. 

It is staggering to think of the possibilities if all seniors housing markets were as educated as Philadelphia. New development is critical in creating this awareness. 

Compare market awareness 25 years ago versus today. This increased acceptance and performance of the industry would not have occurred without new inventory, including that inventory that was started in previous development booms.


Your basis is better

In most cases, new seniors housing communities are delivered at a materially higher cost basis than existing inventory. Therefore, as long as the existing communities are competitive, the owners of existing inventory have more financial and strategic flexibility. 

This flexibility can allow a current owner to work with monthly fees and operating expenses, refinance or recapitalize, or do their own new development. Development often comes in the form of a new addition or substantial renovation. 

It should also be great comfort to existing owners that someone values seniors housing cash flow much more than what the existing owners paid for it.


Rents rise across the board

Because of the relatively higher cost basis of new developments, many new communities are forced to charge higher monthly fees than their competitors. The higher rates at these new communities can theoretically raise rates across the market, including older buildings. 

For example, NIC MAP reported in its second-quarter 2016 data that annual rent growth rose to its highest level since 2008, which obviously comes during a period of high development. There is also anecdotal evidence of this phenomenon by examining NIC MAP data. 

For instance, Bakersfield, Calif., enjoyed annual rent growth of 9.9 percent in second-quarter 2014 with construction representing 12.7 percent of existing inventory. Melbourne, Fla., enjoyed annual rent growth of 9.4 percent in first-quarter 2016 with construction versus inventory of 13.6 percent. The next quarter, Melbourne experienced rent growth of 7.6 percent, again with construction versus inventory of 13.6 percent. 

If new development were as disruptive as advertised, one would expect rents to decline (along with occupancy) in markets with a material amount of new development. Therefore, this lack of negative correlation could provide further evidence of the positive rent pressure that new developments create. 


New acquisition opportunities

Historically, even the most overbuilt seniors housing markets have stabilized, given enough time. Considering rising product awareness and staggeringly favorable demographics, most industry pundits seem to believe this track record will continue. 

Many seniors housing companies were created by acquiring failed developments at a deep discount, turning them around, and selling them at considerable premiums. Poorly capitalized or conceived developments that cause headaches today may become high-performing communities in a few years, making them exciting acquisition opportunities. The developer may run out of working capital and time, but a patient and successful operator can leverage its market knowledge and better capital structure and acquire these failed developments. 

New development has disrupted some submarkets, and clearly was a principal cause of the industry slowdown in the early 2000s. For those communities that are performing poorly or that have obsolete physical plants and are at the bottom of the local totem pole, this is bad news. But the need to adjust operations is inevitable anyway. 

No matter how pretty or ugly an existing community may be, it’s still about providing quality care and services, reinvesting as appropriate, and remaining competitive (hopefully even pushing the competition). 

While new development may be another addition to the long list of challenges, existing owners should know that they are in an industry that knowledgeable investors value highly, and that the new development has improved many value metrics of seniors housing in their market. They should also know that someone values senior housing cash flow more than they do. These successful operators can develop themselves, enjoy the rising tide of higher rates, or sell to someone who values their building higher than they do.


Kevin Carden is senior vice president of acquisitions for REDICO. He focuses on the strategic expansion of the company’s senior living business, including the growth of the American House Senior Living brand of communities.

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