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By Duane Craig
February 4, 2019
Senior housing projects spawned more than $13 billion in deals during the second quarter in 2018 alone. The money is not just local or regional either—in fact, almost half of foreign investments is coming from China. Beyond the demand of the growing senior population, returns on senior housing have outpaced other commercial real estate for the past decade.
Here's what's behind the market and the strategies builders can use to get into the projects.
First, you have to rethink the senior demographics. Senior housing residents are usually 83 years old or older. The influx of baby boomers to the senior housing ranks is a way off—the oldest boomer today is 72. Therefore, it'll be another decade before boomers hit the ages where they'll traditionally enter senior housing.
The main categories of senior housing are independent living and assisted living. Independent living properties had a 90 percent occupancy rate in 2018 while assisted living properties—85 percent. The independent living projects usually have all the characteristics of multifamily projects and include amenities like pools, exercise rooms, laundry, and restaurant-style dining. Assisted living projects, on the other hand, tend to look more like healthcare. They include nursing centers, laundry, dining facilities, and physical therapy facilities.
During 2018, senior housing occupancy slipped to 88 percent, its lowest levels since 2011. However, the number may be misleading because while new inventory went up 3.4 percent, the annual absorption rate went down to 2.4 percent. The numbers suggest the market is at an inflection point, waiting for the demand to catch up to the inventory. There's little doubt the demand won't come as the population of seniors is projected to increase from 50 million in 2016 to 71.5 million in 2030.
Location Location Location
Senior housing growth is not the same everywhere. The problems exist in the marginal markets where investors funded deals expecting a sustained 90 or 95 percent occupancy rate. Dropping occupancy rates in weak markets, coupled with rising wages, are putting pressure on both new and old deals in such places. Meanwhile, where investors partnered with strong operators in strong markets, the returns remain strong.
The silver lining in the challenged markets is the availability of distressed deals and operations needing capital or new partners to make improvements so they can weather the market cycle.
The Tax Cuts and Jobs Act of 2017 was very good to banks. In the first quarter of 2017, banks reported record net operating income bolstered by a $7 billion windfall from the legislation. Bank equity was also up by almost 15 percent, beating its five-year annualized return by four percent.
This means commercial banks should be good sources of project funding in 2019. But, another factor is the competition from other lender types. Banks are showing a greater affinity for risk, and bigger banks are looking to make larger loans for well-thought-out projects. What’s more, banks are not the only ones looking to invest in real estate in 2019.
Nonbank institutions, such as savings & loans, credit unions, hedge funds, insurers, and investment banks, expect to increase their real estate lending in 2019. Fannie Mae and Freddie Mac will also be a large source of real estate funding this year, along with other government-sponsored enterprises.
Project Entry Points
If you've built multi-family before, you're in a good position to secure a place on a senior living project. Nevertheless, firms specializing in senior living development exist, and they can make a good starting point in markets with the best growth. For example, South Bay Partners have 2,000 units under construction, while Spectrum Retirement Communities is adding 1,000 units through 2021. You'll find senior living developers mainly opening projects in the larger metro areas where the costs of building and running senior housing match up with seniors who can afford it.
For the rest of the country, senior housing must rely heavily on subsidies from the government, most notably on the low-income housing tax credit programs managed by states. Also, $678 million was approved for the section 202 program last March, a 35 percent increase over its previous funding level, restarting the program after several years of not being funded. With the change in leadership of the House of Representatives, it's expected that more emphasis will flow to senior housing in areas where seniors need subsidies so they can afford to move out of their paid-for homes.
States and local municipalities can also use federal block grant programs designed for affordable communities to fund senior living projects. So, this is another entry point for contractors who want to pick up projects in this market.
If you've gotten the bug to become a developer yourself, there's always the option of building your own. The projects can range from refurbishments of existing properties to new construction. For both renovations and new construction, if you partner with operators experienced in running senior living facilities, you’ll be able to create an attractive investment opportunity for banks and other types of lenders.
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