JCH National Real Estate Investor Magazine Article
Nick Stahler, Senior Vice President, JCH Consulting Group
The State of the California and National Senior Housing Market: Analysis and in-depth look into its future.
Senior Housing has been a stable asset class so far in 2017, but several factors could affect market performance in 2018 and 2019. The industry is divided into three major market segments: Independent Living (IL), Skilled Nursing Facilities (SNF), and Assisted Living Facilities (ALF). For the scope of this article our focus will be on licensed healthcare facilities, SNF and ALF. ALF deals have been relatively calm in 2017, with only a handful of large transactions this year and only one large operator divesting on a national basis. Conversely, Skilled Nursing Facilities (SNF) have seen some changes, the trends of Real Estate Investment Trusts (REITS) divesting of SNF assets continues, as large portfolios have entered the market from large industry operators and REITs.
One major transaction that was recently announced is the $7.4 billion merger of two REITs: SABRA and Capital Providers (CCP), a spinoff of Ventas. In 2016, Ventas took all SNF assets out of their portfolio and created Care Capital Providers. A well-managed SABRA will then emerge as the dominant REIT, assuming SABRA’s corporate culture, with its CEO running the entire new entity. The merger of the two REITs is a good fit, and allows them to compete against larger REITs.
After pushing upwards in 2016, Cap Rates have remained stable in 2017 for both SNF and ALF. The class “A” ALF Cap Rate will be in the high 6% range, and then go up, depending on the facility’s quality, performance, and location. SNF Cap Rates have remained consistent between 12% and 13%. However, large portfolio sales may skew these numbers somewhat once they close. Two of the industry’s largest SNF operators are currently marketing assets, with one of them announcing that they have a large portfolio of SNF assets available in California.
New construction continues to be popular in ALF and Memory Care Facilities, so much so that depending upon which expert you speak to, between six and seven markets in the country have become oversaturated with new construction. This potentially creates a situation where we will have to wait for demand to catch up to new construction starts in those markets. Fortunately, most industry veterans feel there is enough demand in the pipeline that it all will be absorbed at some point. However, the question is how fast, and will we see any major issues arising from that? Equity partners may become concerned about debt, which is usually predicated on a tight model for a stabilized asset (a facility that is full, stabilized, and operating). If demand does not keep up with construction, there could be some turbulence in the market, and equity investors possibly looking to sell if they are dissatisfied with returns. But keep in mind that there is a large population of seniors and aging baby boomers who will soon need senior housing services.
Senior Housing operations have been stable in 2017. SNF operators face larger issues due to Medicare reimbursement increasing only 1% over the next year, and President Trump’s budget for 2018 calls for $610 million in Medicaid cuts over the next decade. Expenses continue to rise for both ALF and SNF. The minimum wage has increased as have insurance costs – two of the industry’s highest expense line items. Fortunately, ALF’s with a private pay model have been able to pass on these increases to residents.
It is more difficult for a SNF to recapture these increases in expenses due to the reimbursement-based model with government set rates. Again, ALF appears promising, but there might be some new construction issues down the road with oversupply and lack of demand in certain markets. The SNF operational side could see some turbulence with increased expenses and flat revenues, but there is still plenty of profitability in the market for well-run facilities. Looking forward, expect ALF Cap Rates to remain steady. On the low side, Class A assets will be in the high 6% range. Most of the assisted living deals will trade in the 7% range, and Cap Rates could go up to 8% or 9%, depending on the asset’s quality. For a secondary or tertiary market, the Cap Rate most likely will be 8% or 9%. This is unlikely to occur in 2017, but rather in 2018 or 2019. If construction starts are open and operating but not filling, we could see some turbulence in Cap Rates and their effect on ALF pricing. SNF Cap Rates rose in 2016 and have maintained in 2017. Also, where these large portfolios will close remains to be seen. Obviously, it will be a driving force in the market and set pricing. When that many facilities and beds are trading hands, it will set a precedent for future pricing. We’ll have to wait and see. Today the overall attitude of investors and industry people is one of calculation and caution in Skilled Nursing. While it is unlikely that current valuations are going to break any records, some favorable pricing going forward is not only attainable but sustainable. Overall, the outlook is stable and therefor positive.
It is expected that interest rates on the debt piece will continue to rise, although how much and how fast has yet to be seen. Many operators and investors that we deal with have made contingency plans for an increase in interest rates on debt. If rates go up significantly, pricing will be affected. Still, at this point it looks stable, and everyone has prudently planned ahead.
The big topics looking forward will be the absorption rate on new construction, specifically on ALF and Memory Care, as well as how some of these large portfolios play out, and what Cap Rates and Price Per Bed they close at in the Skilled Nursing world. That will dictate what pricing looks like for the remainder of 2017 as well as 2018. Nevertheless, all other fundamentals in Senior Housing are still very strong, and the number of seniors and baby boomers who need Senior Housing services will continue to grow at a substantial rate.