Are We In A Pricing Bubble
About To Burst?
JCH Consulting Group was once again asked to participate in the Senior Housing Business magazine’s Broker Q & A, “Are we in a pricing bubble about to burst?” Here is the full interview with Nick Stahler.
- What has been the most compelling trend or biggest surprise so far this year in seniors housing property and portfolio sales?
The most surprising trend we have seen is who some of the Sellers are. We have seen pricing increase to the point that owners/operators that were traditionally never going to sell have become sellers. This trend developed as owners/operators were continually outbid on deals they felt they had submitted a competitive offer on. At some point if you have become priced out of the market as a buyer, maybe it’s time to take advantage of the pricing and become a seller.
- The data shows that acquisition prices and volume have reached record highs during the last year or two. How does this change your approach to the market? What advice do you give buyers and sellers in today’s frothy market?
Our valuation approach is more aggressive in today’s market. The Seller’s market we are experiencing allows us to price aggressively, constantly testing the inelasticity of pricing. The new buyer pool we are exposed to has also allowed us to change and incorporate new methods in which we solicit offers.
Our advice to sellers is to capitalize on current pricing and take some chips off of the table. It is an excellent time to pull equity out of your portfolio or sell it outright. There are plenty of options available to owner operators that allow them to maintain the operations or management of the facility while extracting the equity out of the real estate. The end goal is to either exit the industry entirely or return to the equity investment side at later date.
Our advice to buyers in this frothy market is to stay consistent when hunting for deals, you may not win them all, but being at the negotiating table is half the battle, one will go your way eventually. We are also advising buyers to differentiate themselves wherever possible. Whether this is through the speed at which you can close or the premium pricing you can offer, standing out in the crowd of buyers is essential. In addition to this, we are advising to consider development as well. If existing asset pricing no longer makes sense for you, perhaps it’s time to consider the pros and cons of development. We have seen a huge increase in development deal volume and appetite for these deals.
- How long do you think the market can sustain the feverish activity? Is there any concern that the market is creating a bubble that could burst?
We believe the market will sustain this level of activity as long as all of the current market conditions remain intact. The fundamentals of senior housing are continually improving, we believe the low interest rate environment and flood of equity investing into the sector is what we will have to watch closely. The equity infusion into senior housing will probably hold strong as long as the interest rates remain low and the returns are higher than those of other real estate asset classes. With that being said, we are absolutely in a pricing bubble that could sustain a pricing correction if the raising of interest rates or other economic issues coming into play.
- In which segments of seniors housing are you seeing the most transactions — independent living, assisted living/memory care, skilled nursing, or CCRC? What geographic areas are most active?
The majority of the transactions we have recently completed are in AL/ALZ and skilled nursing. The major metro and coastal markets will always be the most attractive, that’s real estate 101. With that being said, recently we have seen a lot of attention turn to secondary and tertiary markets for several reasons. For one, typically there is less competition in the bidding process, two; there is much less competition once operating the asset. We work with buyers that specially seek out the rural markets with only one or two facilities in town, while the barriers to entry remain low and definitely a risk factor, it is much easier to beat out one or two competitors than 10 plus competitors.
- In addition to the high acquisition volume, a lot of new development is also underway. Will all the new deliveries over the next year or two balance out supply and demand?
We don’t believe we are building fast enough to balance supply and demand long term. While we are starting to see some over development in certain markets, we think this will only be an issue over the next 3-5 years. The IRR driven investor that is looking for a quick turn on their capital will likely cause the greatest problems for development. Calculated, tempered, long term investment into development will pay the highest dividends to the industry as a whole. The age wave we are beginning to see in our facilities will undoubtedly demand a newer product, but oversaturation of new units, especially not well thought out units, is our greatest concern for the industry short term.
- Seniors housing performed well during the Great Recession relative to other property types in terms of total returns, according to the National Council of Real Estate Investment Fiduciaries, which has led to more capital flowing into the sector. From a historical perspective, is there more capital coming into the sector now than in previous up cycles for seniors housing? Please explain.
Absolutely, we are seeing more outside investment in this up cycle than previous cycles. While we have experienced robust up cycles in the past, the abundant amount of attention from outsider and foreign equity is relatively new. Not only are our long term, industry veteran, clients bringing new capital sources to the table, we have a large increase in first time buyers entering the market place. We believe the attraction occurs for several reasons, one of the largest being the historically higher cap rates in senior housing than other real estate asset classes. Although, this is now debatable as increased outsider investment has compressed our cap rates to the ranges of other asset classes. Secondly, the “need” driven consumer of the product is what really drives our fundamentals and allows us to essentially be recession proof in the eyes of investors.
- Which classes of investors (REITs, life companies, pension funds, private entities, etc.) are the most active in seniors housing right now?
REIT’s have been and continue to be the largest driving force in the market place. Foreign investment, China in particular, has become a player in the market place as well. In addition to these investors we are still seeing a lot of activity from private equity groups, new and existing alike. We have also seen investment directly from operators who have cash on the books to get deals done in house.
- Do “wildcard” factors like the economic problems in Greece have any impact on the sector, or is this part of the industry somehow insulated from those outside influences?
This is an excellent question that comes up often. While these “wildcard” factors generally do not directly impact the fundamentals of senior housing, they can have a ripple affect into our industry. They can affect financial markets which will hurt transaction volume and operators access to capital. Wildcard factors can also affect our consumer’s personal net worth, which may impede their ability to pay the rental rates we want to achieve in our facilities. To answer the question, senior housing is fairly well insulated from “wildcard” factors compared to other real estate asset classes, but we will always be subject to the ripple effect of external markets since we need to access these markets on a daily basis.