Is the Market at its Peak in Seniors Housing?

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For the first time in many years, we have started to hear buyers, lenders and operators start to question whether the market peaked.   Commercial real estate in general, and Seniors Housing specifically, both have seen increases in value since the trough of the market in 2009-2010.

Cap rate trends are a good way to follow the market.  Cap rates vary widely, but according to the latest report from Irving Levin & Associates, the average cap rate for the 12 months proceeding Oct 1, 2015 for Independent Living was 7.2%, Assisted Living was 7.8% and Skilled Nursing was 11.8%.   Overall, the cap rates were steady, or had dropped slightly from the end of 2014.

Cap rates, and thus real estate values, tend to correlate closely to interest rates.   This is not only because most buyers use some type of leverage on the properties, but even more so, interest rates are a base rate of return that all investors use to evaluate all types of investments.  We have seen many new investors start to invest in the Seniors Housing market over the past several years because the cap rates were higher than in other types of income producing real estate.  Many saw it as an opportunity to achieve better returns.

Couple this with short term interest rates near zero percent and the 10 year US Treasury around 2-2.3%,  and there is little room for rates to go lower.   Thus, there is little room for cap rates to go lower as far as being correlated with general interest rates.  Currently, it does not appear that the Federal Reserve will be dramatically increasing interest rates anytime soon, there is certainly a lot more room for interest rates to go up than down.

However, cap rates remain higher in Seniors Housing than many other types of real estate and income producing assets.   To the extent that investors continue to divert money from other investments into Seniors Housing.  Cap rates could still go lower, pushing prices higher.  Nonetheless, with the amount of new investors that have entered the industry in the past several years, it is doubtful that a significant amount more new investors will continue to enter this industry causing a further compression in cap rates.

If the net operating income of an asset goes up, or down, prices will likely also go up, or down, with cap rates staying the same.   Given relatively low inflation and a surge in new construction, it is doubtful that net operating income will increase dramatically in Seniors Housing over the next several years.

Overall, we believe the main driver for increased values going forward will be an increase in net operating income, not a further compression in cap rates.  While net operating income in Seniors Housing could continue to grow, it will probably be at a slower pace.  Cap rates have more room to go up than down.  Though given relatively low inflation and a slowdown in the global economy, it is doubtful that an increase in rates will happen at a fast pace anytime soon.  The combination of these factors will mostly likely lead to Seniors Housing prices staying relatively stable, but with a risk of a decrease if interest rates increase faster than expected.

If you believe now might be a good time to sell your Seniors Housing Community, please contact Jason Punzel at [email protected] or 630-858-2501 for an in depth analysis of what your community might be worth.

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Matthew Alley Speaks at InterFace Seniors Housing Texas Conference

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On November 19th, I participated in a panel entitled “Investment Market Update: Who’s Buying, Who’s Selling & Will Velocity Keep Going Up and Cap Rates Keep Going Down”. We had a lively discussion on the current market, and I wanted to share a few takeaways.

1. Who are the active buyers and sellers in today’s market? There is more variety in buyers now than in the past decade. REITs, private equity, owner-operators and even some “mom and pops” have been interested in purchasing properties and growing their portfolio.  The sellers have been more diverse than normal as well.  “Mom and pops” are still very active sellers, but we have seen more regional and national owners look to take advantage of the strong market and either sell their entire portfolio or divest of a couple of properties that don’t match their strategic vision.

2. Are there different buyers for different seniors housing asset classes? Yes, absolutely.  Institutional groups typically chase larger, higher quality assets with consistent cash flow.  Their low cost of funds has driven owner-operators down the acquisition spectrum to the smaller assets that may be underperforming.

3. What are the most important metrics that buyers are using in today’s market? Cap rates are the most important metric when valuing a cash flowing property.  The difficulty comes in valuing a property that is underperforming.  In those cases, a potential new operator will put together a pro forma and land on a rate of return that they’re comfortable with.  Those deals typically see a wide range in offer prices.

4. What is the optimal size for acquisitions? Typically, the larger the offering, the better.  Institutional groups have a lot of equity to deploy and if they can deploy it in 10 $30 million transactions as opposed to 25 $10 million transactions, groups will typically prefer fewer transactions.  One-off or small portfolio transactions have a different pool of buyers, which tends to be less institutional and requires a broker to have a greater knowledge of the individual market and its individual buyers.

5. With pricing so strong in today’s market, why are some owners making a decision to hold? The current market conditions have hastened the timeframe for owners that had a planned exit strategy in the next 12-24 months.  That being said, some owners are trying to increase their portfolio’s profitability and increase value in that way.  Even if cap rates see a modest increase, a major increase in profitability will still see the owner come out ahead by waiting to sell.

6. Should we be concerned about overdevelopment in the seniors housing space? I think it is the biggest risk to the acquisition market moving forward.  This is obviously a market-to-market (and sometimes, submarket-to-submarket) risk.  If the area that an owner has a seniors housing facility becomes overdeveloped in the future, census levels will obviously suffer and valuations will go down.

7. What does the increase in development do to cap rates moving forward?  It adds a level of risk moving forward.  Anything that adds risk – whether it be development, reimbursement or labor risk among others – will naturally push cap rates up.

8. Where do you see the market headed over the next 12-24 months? In the near-term, it should be strong – cap rates are still higher than most other asset classes, interest rates are low and institutional equity needs to be placed.  Further into the future, overdevelopment, government reimbursement changes, interest rate increases, increased regulation, increased tax rates and the housing market could cause a bit of a pullback in pricing.  That being said, I still think the seniors housing space is better equipped to handle this uncertainty than other asset classes.

If you have any questions on the topic of this post or would like a confidential valuation of part or all of your seniors housing portfolio, please contact Matthew Alley at 630-858-2501 ext. 225 or [email protected].

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Should I sell or lease my Senior Living Facility?

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When considering to exit the senior living industry, there are two main alternatives to consider, selling the facility fee simple, or leasing it to an operator.  There are advantages and disadvantages of each option.

The biggest advantage of selling an assisted living facility (or independent living facility) is an owner receives all of their cash up front and has no future financial liabilities or risk.  The owner no longer has the risk of the market going down in the future, new government regulations, overbuilding, etc.   The biggest disadvantage of selling is paying the capital gains tax, which can be substantial for those owners who have owned their facilities for a number of years.

Leasing, on the other hand, has the advantage of not having to pay a large sum of capital gains tax and the advantage of receiving monthly rent.  For those owners who do not need a large amount of cash upfront, leasing can provide a great residual income for years.    However, the disadvantages of leasing are many.  To begin with, an owner must find a quality tenant that has the operational and financial ability to run the facility for the length of the lease.   If the operator defaults on the lease, the owner could be in the position to have to take over the operations of the facility, which could be in poor condition.  Additionally, at the end of the lease, the owner still has to make a decision on what to do with the facility.  If the market is worse, and/or if there are new competitors in the area, the facility could be worth substantially less than at the beginning of the lease.

When the market to sell a senior living facility is good, like it is today, it typically makes more sense to sell and eliminate the risk of an operator defaulting and/or the facility being worth a lot less at the end of the lease.    However, when the market to sell is not as good (like it was in 2009-2010) it might make more sense to lease the facility to a quality operator.

For more information on different exit strategies, contact Jason Punzel at [email protected] or (630) 858-2501 x 233.

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When is the best time to list a seniors housing or nursing home community?

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I’m often asked when is the best time of year to list a seniors housing or nursing home asset?  We are all used to residential real estate agents telling us to list in the Spring while the weather is starting to change (at least for us Northerners).

Does it matter for seniors housing communities?

Yes and no.  While there is not the seasonality in the seniors housing market as there is in the residential market, there are good and less optimal times for getting buyers’ (even institutional buyers’) attention.

I would argue that we are entering into one of those sweet spots as we get into the middle of September.  Typically, Senior Living Investment Brokerage, Inc. has its highest volume of listings in September and early October.

Why is that?

During the Labor Day / beginning of October time frame, Buyers have made it through the Summer and are looking to deploy capital before the end of the year.  They are hoping to make one last push to meet their aggressive beginning of the year expansion goals.

With a typical 3-4 month closing period, now is as good of a time as any to consider listing your property with Senior Living Investment Brokerage, Inc.  We can help you procure the right Buyer, who can close the transaction prior to year-end.  Many Buyers are looking to “get money out the door” by December 31st and this may give you an advantage in coercing those groups into making a more aggressive bid than they would in the middle of the year.

If you have any questions on the topic of this post or would like a confidential valuation of part or all of your seniors housing portfolio, please contact Matthew Alley at 630-858-2501 ext. 225 or [email protected].

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