Exclusive Research: COVID-19 Weighs on Near-Term Outlook for Seniors HousingExclusive Research: COVID-19 Weighs on Near-Term Outlook for Seniors Housing

Every aspect of the seniors housing sector has been affected by the COVID-19 pandemic.

The coronavirus has made its mark on sentiments among seniors housing investors. Exclusive results from the annual NREI / NIC seniors housing investor sentiment survey highlight near-term concerns about pressures on occupancies, expenses and rent growth, while long-term views are optimistic about future performance.

Overall, survey respondents have a less favorable view of seniors housing as an investment property than in past years. When asked to rate the attractiveness of different property types for investment on a scale of 1 to 10, industrial and apartments rated the highest at 7.4 and 7.1 respectively, which is close to past years and meshes with general market sentiment that those two sectors have been the least affected by the pandemic. All other property types showed a decline compared to past years with seniors housing dropping to 6.3, office to 4.1, hotels to 3.6 and retail to 3.4.

The 6.3 rating for seniors housing is the lowest level that it has been in the seven-year history of the survey. In fact, for the five-year period from 2015 to 2019, respondents in this survey had ranked seniors housing as the most attractive property type.

Seniors have been at the frontlines in the battle with the coronavirus. Although people age 65 and older represent a modest 15.7 percent of total cases of those infected by the virus, they account for 79.3 percent of domestic fatalities, according to data from the U.S. Centers for Disease Control and Prevention.

“I think some of the negative headlines associated with skilled nursing facilities have bled over to seniors housing,” says Beth Burnham Mace, chief economist and director of outreach at the National Investment Center for Seniors Housing & Care (NIC). Negative investment performance in the second quarter is another factor that likely contributed to the decline in sentiment. The NCREIF Property Index showed a total return for seniors housing at -1.0 percent in the second quarter, which was the first negative quarter for the sector since 2012.

A majority of survey respondents also point to the COVID-19 virus as the biggest factor impacting occupancy rates at seniors housing facilities over the past six months. In all 81 percent of respondents said the pandemic has had at least some impact (65 percent said significant impact), while 55 percent also reported that the state of the economy is having an impact.

“Part of the story for seniors housing is that there is a two-part hit here,” says Mace. One is the negative impacts from the virus on move-in rates and occupancies. The second impact is the sharp drop in the overall economy, which also weighs on seniors housing demand. The economic impact is a little bit more indirect, because it feeds through overall levels of confidence, as well as the impact from lost wealth and wages, she says.

Survey methodology: The NREI/NIC research report on the seniors housing sector was conducted via an online survey distributed to NREI readers in August. The 2020 survey results are based on responses from 167 participants. The majority of respondents hold top positions at their firms with 48 percent who said they were either an owner or C-suite executive. Respondents also represent a cross-section of different roles in the seniors housing sector, including investors, lenders, developers, brokers and owner/operators.

Elevating precautions at properties to keep residents safe brings with it more expenses.

The coronavirus is taking a toll on net operating incomes for seniors housing investors. The vast majority of respondents (90 percent) said there has been at least some increase in expenses due to the virus from March 1 until August 1 with an estimated mean increase of 9.2 percent. In particular, operators have seen costs rise for “hero pay” or bonuses paid to staff, testing for staff and residents, increases related to personal protective equipment and additional cleaning.

More than half of respondents (57 percent) expect a permanent increase in expenses due to the COVID-19 virus, while 22 percent think expenses will remain the same, 18 percent were unsure, and a minority (3 percent) believe expenses will decline.

Across its portfolio, National Health Investors (NHI) saw coronavirus-related expenses that ranged between $10,000 to $20,000 per building at the beginning of the pandemic.

“We have started to see that number drift down over the last few months as operators have started to figure out how they can create the most efficiency and better operate buildings,” says Kevin Pascoe, NHI’s chief investment officer. COVID-19 also has given seniors housing operators somewhat of a break in their battle with labor costs. “With the current unemployment levels, our operators have been on a hiring spree where they have been able to get people and keep some of that turnover and wage pressure at bay,” says Pascoe.

As the employment market improves, it could once again create a pain point for seniors housing operators, but with the national unemployment rate still north of 8 percent, there remain a lot of Americans looking for jobs.

Operators also could see greater cost pressures in the form of higher property taxes and higher insurance costs that could impact future net operating income (NOI). “These are all subsets to operating expenses that could be meaningful going forward, and I do think they could have long-term impacts on our space,” says Steve Blazejewski, managing director and senior portfolio manager for PGIM Real Estate’s seniors housing strategies.

Eroding fundamentals have left operators unsure whether the vacancy rate at properties will rise or fall in the next 12 months.

Although expenses are a concern, the bigger issue for operators is a decline in occupancies and slowing rent growth that could weigh on NOI and put downward pressure on sale prices. According to NIC MAP data, seniors housing occupancies fell 2.8 percent in the second quarter to average 84.9 percent—the largest quarterly decline since reporting began in 2005. Occupancies at skilled nursing facilities were more severely impacted, dropping 6.5 percent to 80.2 percent compared to a 3.2 percent decline for assisted living to 82.1 percent and a 2.4 percent dip for independent living facilities to 87.4 percent.

Respondents have mixed views on whether occupancies will rise or fall further over the next 12 months. Nearly half of respondents (45 percent) predict an improvement in occupancies, while 42 percent said that occupancies are likely to decline and 13 percent anticipate no change.

Although respondents appear surprisingly optimistic that occupancies will rise, the overall average expectation is for a slight increase of 25.5 basis points. In addition, the results show a clear deterioration in confidence when compared to past surveys. Notably, 72 percent of respondents had predicted an increase in occupancies in the 2019 survey.

Realistically, the outlook for occupancies over the next 12 months is going to depend heavily on the path of the coronavirus and what happens in term of levels of infection during peak flu season in the fall and winter months. However, the positive views may be attributed to the fact that seniors housing properties have made it through the first wave of COVID-19, and many operators are now seeing some signs of occupancy stabilization and a return of leasing activity. For example, most of NHI’s operators are budgeting a flat year for the balance of 2020.

“We’re watching that very closely to see if that stays on track,” says Pascoe. “Initial indications are that traffic is up, but we need to see those convert to sales, and the only way that is going to happen is with continued confidence in the product type and the world at large.”

Within NHI’s portfolio, needs-driven housing has been more resilient as compared to discretionary properties where people moving into independent living properties are usually making lifestyle choices.

“We have seen traffic drop off dramatically in discretionary properties, because people are just deferring the decision until they can have a little more clarity on what the virus is doing,” says Pascoe. Occupancies at the REIT’s continuing care retirement communities (CCRCs ) also have held up a bit better because there is a built-in needs-based component.

According to NIC MAP Data, annual rent growth is slowing, but still positive, declining from a growth rate of 2.6 percent in the first quarter to 2.1 percent in the second quarter.

More than half of respondents (54 percent) expect continued rent growth over the next 12 months compared with 30 percent who think rents will decline and 16 percent who said rents are likely to remain the same. That is stark drop in sentiment compared to previous surveys in which a strong majority—upwards of 70 percent—have said that rates were more likely to rise.

Deal velocity has slowed as part of a broader drop in commercial real estate investment sales activity.

Although uncertainty related to the path of the coronavirus is likely weighing on near-term investment decisions, investors are more bullish on their long-term plans in the sector. Nearly half of respondents said there will be no change in their near-term (47 percent) or long-term (52 percent) strategies for investing in the sector.

However, views are split on whether their investment activity will increase or decrease in the near term and long term. In all, 36 percent of investors said they plan to invest less in the near term compared to 18 percent who plan to invest more. Those percentages flip when asked about long-term strategies with 34 percent who expect to invest more in the long-term and 15 percent who think they will invest less.

“Most savvy investors understand the business model for seniors housing is still valid. We still have the need for the business due to the demand and demographics,” says Lisa Widmier, executive vice president, Senior Housing Capital Markets at CBRE Capital Advisors.

In particular, there is no lack of liquidity from private equity firms, while the REITs seem to be on the sidelines, she says. “There is a shortage of supply for sale. Owners, smartly so, are holding off offering properties—unless totally desperate—until this pandemic is better controlled in terms of detection and control,” she adds.

PGIM Real Estate has been investing in the U.S. seniors housing sector through its Senior Housing Partners (SHP) fund series since 1998. Earlier this year, the firm completed its largest capital raise to date with a February close on its $996 million SHP VI. “Going into COVID, we had a fairly ambitious pipeline,” says Blazejewski. The management team expected to have about 45 percent of the funds committed by the end of 2020, but as of the end of August only about 20 percent of funds had been committed.

COVID-19 has changed that timetable due to a broader slowdown in the transaction market. “Because of COVID, there is a lot of pricing discovery going on and a lot of transactions were pulled off the market with a significant bid-ask spread,” says Blazejewski. That being said, every deal that PGIM Real Estate had in its pipeline pre-COVID-19 is still in the works. The firm expects those deals will close, albeit with some pricing modifications related to changes in property-level performance and fluctuations in capital markets, he adds.

“We’re still bullish long-term on the sector. So, while some of the acquisitions may have paused, we are still thinking very much about development,” adds Blazejewski. The firm remains confident in its development strategy due to the favorable long-term demographic trends. According to the Department of Housing and Urban Development, there are an estimated 75 million baby boomers in the U.S. and 3 million Americans turn 65 every year. Projects that start construction now are not going to open until 2022 or 2023. “We’re also looking at a general situation where the environment may be more favorable, because we may see improved development costs,” he says.

Market participants are already observing some pent up demand among buyers and sellers.

Mirroring the broader commercial real estate market, sales volume of seniors housing and care facilities dropped sharply in the second quarter, falling 66 percent year-over-year to $1.3 billion, according to Real Capital Analytics.

Overall, 41 one percent of survey respondents believe that transaction volume will decline over the next year, while 29 percent think it could increase and 30 percent said it will likely remain the same. A majority of respondents (58 percent) also expect it will take more time to close transactions over the next 12 months.

However, some market participants are already observing some pent-up demand among buyers and sellers. The question is when activity will resume. “Obviously, people’s programs for 2020 sales got pushed way back. So, our queue in terms of properties we’re analyzing for potential sale has never been bigger,” says Rick Swartz, a vice chairman and co-head of the Senior Housing Capital Markets Group at Cushman & Wakefield. Swartz expects some of those sales to start coming to market in late September with the fourth quarter of 2020 and the first quarter of 2021 likely to be busy investment periods.

On the buy side, there has been a lot of capital raised among some of the major seniors housing investors, including specialty funds and mixed-asset funds. “There is a significant interest in putting money to work and they want to see deals, but because of COVID they are being a little more cautious,” says Swartz. Although investors believe operators have a pretty good grasp of the impact of the virus on operating expenses, the biggest caution is around leasing, he says. Investors are looking for stabilized core properties, as well as those properties in strong submarkets with a history of good leasing prior to the pandemic, he adds.

About half of respondents (53 percent) expect cap rates to rise over the next 12 months, while 24 percent anticipate no change and 23 percent think cap rates could decline. That does show a change in sentiment compared to the 2019 survey in which 43 percent had predicted an increase in cap rates over the proceeding 12 months.

“What we have heard is that there hasn’t been a broad correction from a cap rate perspective or levered IRR target for investments. But we are seeing a more conservative approach to underwriting, particularly as it relates to the leasing velocity, says Jay Wagner, executive managing director and co-head of the Senior Housing Capital Markets Group at Cushman & Wakefield. The more conservative underwriting is impacting year-one numbers for projected NOI, which as a result is driving pricing down slightly, he adds.

Stabilized, core properties in strong markets are likely to see minimal or no impact on pricing. Meanwhile, situations with a value-add component requiring more leasing to raise occupancies could see discounts of 5 to 10 percent, he adds.

Pascoe also expects to see some distressed buying opportunities emerging over the next 12 months. At the same time, there is a lot of capital that has been raised that is looking for those opportunities. “Just how far we go into distressed pricing is still to be seen,” he says. Government programs, such as PPP loans have helped operators weather the challenges. However, if the virus continues to weigh on occupancies, those funds will run out at some point. “I do believe there will be opportunity, but I couldn’t tell you when,” he says.

Two out of every three seniors housing properties were built before 2000.

Most respondents (63 percent) think seniors housing construction starts will decrease over the next 12 months, while 19 percent believe they will remain the same and 18 percent predict an increase. That is a notable shift compared to survey results over the past five years where nearly half, if not more, of respondents consistently anticipated an increase in starts.

NIC reported construction as a percentage of inventory at 6.2 percent in the second quarter, which reflects a 40-basis-point decline compared to the prior quarter. NIC MAP’s Primary Markets report also shows 15,471 new construction starts in the last four quarters, the fewest 12-month new-start total since 2014.

“There is still a fair amount of construction underway, but I would imagine that some of these projects are going to get delayed. Some will get canceled and lenders will look more carefully at the market conditions. Until there is more certainty related to COVID-19 and the impact of the coronavirus on seniors and on the economy, there will continue to be a lot of uncertainty and people are going to be cautious about putting in new developments,” says Mace. Although there have been some pockets of oversupply that have emerged, such as in Atlanta, few survey respondents (13 percent) think construction will result in overbuilding.

Another point to note related to development is that the inventory of seniors housing is relatively old. Two out of every three properties were built before 2000. That means a good chunk of the supply in the market is becoming out of date and as that level of obsolescence increases, it will create demand for new, more modern supply, adds Mace.

In addition, the coronavirus outbreak may have accelerated obsolescence as health and safety standards for HVAC systems and having portions of properties where operators can safely isolate infected residents have become front and center concerns for building design, notes Mace.

Capital markets have not frozen up completely, but lenders have become more stringent.

A bigger number of respondents believe both equity and debt will be tighter over the next 12 months. Debt is expected to be more constrained with 57 percent who think financing will tighten compared to 29 percent who said it will remain the same and 14 percent who anticipate better access to debt. On the equity side, 45 percent said it will be tighter, 38 percent think it will remain the same and 17 percent believe it could be greater.

That is a notable shift compared to prior surveys. Over each of the past five years, the vast majority of survey respondents have generally predicted greater or the same access to debt and equity. In 2019, about half of respondents had predicted that access to debt (54 percent) and equity (50 percent) would remain the same and those who thought it would be tighter were in the minority at 23 percent for debt and 17 percent for equity.

“There has been a pause or pullback by lenders who want to see how the virus and the impact on performance is going to play out,” says John K. Powell Jr., executive vice president, national director Agency Production at Bellwether Enterprise, a national mortgage banking company. Even Fannie Mae and Freddie Mac have cut back on their overall production to seniors housing compared to prior years, he says.

Out of all the capital providers, FHA has probably been the least impacted, adds Powell. Their pipeline has definitely increased on Section 232 loans, those fixed-rate, non-recourse loans used to finance the acquisition, development or major rehab of seniors housing and skilled nursing facilities.

Survey respondents believe that local/regional banks are considered the most significant sources of debt capital for the seniors housing sector, followed closely by Fannie/Freddie and HUD. Yet Powell also notes that lenders across the board have lowered leverage and increased debt service coverage ratios (DSCRs). For example, Fannie Mae is not going above 60 percent LTV, while Freddie Mac has increased its minimum DSCR by about 5 basis points. DSCRs depend somewhat on the acuity level, with a typical range of 1.35-1.4 for independent living properties and 1.45-1.5x for assisted living and memory care.

“The other thing that we have seen is that lenders are more focused on creating a stressed NOI where they are being asked to increase vacancy a few percentage points above where it is currently, as well as increasing expenses to account for the higher costs associated with operating properties going forward due to new COVID protocols,” he says.

Half of respondents expect increased risk premiums (53 percent) and debt service coverage ratios (50 percent) over the next 12 months, and stable interest rates (52 percent) over the next 12 months. The vast majority (80 percent) also anticipate a tightening of underwriting standards over that same time period.

The wild card that remains for lenders, investors and operators in the coming year is whether or not there will be a bigger resurgence of the coronavirus in the fall or winter months in line with the traditional timing of peak flu season.

“I think the investment thesis for seniors housing remains compelling, but there are challenges in the near term that need to get resolved, and they won’t get fully resolved until we get past this COVID-19 challenge,” says Mace.