Diverse Senior Housing Investment Opportunities Across the Risk Spectrum

Keen senior housing investors have a growing pool of opportunities that span the risk spectrum, at dislocated pricing, set against the backdrop of one of the most compelling fundamental stories in the real estate sector. This dynamic may accelerate in the coming months as several compounding forces coalesce to motivate sellers to strategically evaluate options, including to transact.

What is Currently on Market

The majority of deals on market can be widely categorized into two major groups: operating performance-driven and capital stack-driven.

Operating performance-driven sales encompass: 1) newer vintage assets, delivered just before or during the pandemic, experiencing a protracted or stalled lease-up, 2) older vintage assets that have lost market positioning, or 3) assets in currently saturated markets where supply has outstripped demand. Addressing the underperformance can involve resetting loan-to-values, requiring additional capital infusion, sales by tired equity capital, or sales by lenders who have lost confidence, in some cases accepting discounted payoffs.

Capital stack-driven sales, on the other hand, stem from challenges in capital composition. On the equity side, end-of-fund life issues, showcasing wins for the next fund raise, or addressing redemption backlogs is leading to sales. On the debt side, near-term maturities, expiring interest rate hedges, and a sudden increase in the cost of debt, are driving sales despite otherwise performing operations.

What to Expect for 2024

The capital markets have remained tight to start off the year. Sellers anticipating a downward trend in the UST 10Yr have witnessed a reversal in fortunes so far. As a recent Wall Street Journal article aptly titled “Investors Are Almost Always Wrong About the Fed,” sellers waiting on favorable capital markets may have to contend with a different reality. Coupled with mounting capital challenges on both the debt and equity fronts, this may accelerate the opportunities outlined earlier.

In addition to the prevailing factors, several other forces are set to intensify and converge in the coming months that may drive deal volume. First, according to NIC, there are $18 billion of senior housing loans maturing in 2024 and 2025. Second, expiring interest rate hedges in a still-elevated rate environment are straining levered free cash flows. Third, senior housing continues to garner interest from institutional equity, attracting both new entrants that have already signaled allocations and a reinforced commitment from existing groups. According to JLL Research, there is $402 billion of dry powder waiting to be deployed in commercial real estate. Given the attractive risk-adjusted-return profile for senior housing, there may be an escalating number of newcomers to the space which could fuel an even larger appetite for deals.

Investors who do transact stand to benefit not only from dislocated pricing, but also from participating in the positive fundamental growth story unfolding in the senior housing sector. Operational metrics continue an upward trajectory, with occupancy in the NIC MAP Primary Markets reaching 85.1%, marking the tenth consecutive quarter of gains. Occupied units in primary markets sit at ~599K – ~30K units higher than pre-pandemic.

In terms of supply, the backlog of delivering product continues to shrink while new starts continue to dwindle due to debt availability and still elevated construction costs. Construction starts were 2,221 units for the Primary and Secondary Markets in the fourth quarter 2023 – the lowest number since the second quarter 2009. Contractor bids remain elevated in a still tight labor market for skilled workers. The costs for raw and finished goods have seen some relief recently, but it may be short lived as geopolitical pressures have caused notable disruptions in the global supply-chains. Trans-Pacific shipping rates surged 24% sequentially in the week ended January 31st, according to the Drewry Hong Kong-Los Angeles benchmark. This index is up 338% from last year. Combined with lowered loan-to-costs, the substantial decrease in starts is likely to persist for the near future. On the demand side of the equation, in recent research by NIC MAP Vision, it was reported that to maintain the current market penetration rates, the sector will need 806,000 additional units by 2030.

The dynamics in play are set to create an active transaction environment in 2024 for investors spanning the cost of capital spectrum amidst increasingly favorable fundamentals with tailwinds for the foreseeable future.

Sources:

1. 4Q23 NIC MAP® Market Fundamentals Data

2. “Investors Are Almost Always Wrong About the Fed”, The Wall Street Journal, https://www.wsj.com/finance/investing/investors-fed-interest-rates-a842073c?tpl=cb&mod=hp_lead_pos2

3. “Containerliner Rates Climb as Red Sea Hostilities Intensify”, Bloomberg, https://blinks.bloomberg.com/news/stories/S84R91DWRGG0