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Dueling Perspectives: What is the State of the Seniors Housing M&A Market?

After a six-year bull market where capitalization rates declined and median values increased, momentum in seniors housing prices leveled off during the first quarter of 2016. What does this mean for the sector moving forward? Will the recent headwinds in the market be able to overpower the tailwinds? 

We have asked two members of our mergers and acquisitions (M&A) team to present dueling perspectives—one will be the optimist and the other will be the pessimist. Kevin Laidlaw will be arguing that the recent decline is only a minor speedbump and that a robust market and higher values pave the road ahead. Dan Klodor has been tasked with being the pessimist and he will argue that the recent decline is more concerning and a sign of things to come.

Laidlaw:

A major tailwind for the seniors housing space is the large influx of capital the sector has seen in recent years. Recognizing the positive attributes of seniors housing, several different types of capital providers have either become new participants in the sector or have significantly increased their investment in the space. The main positive attribute attracting the new participants is the performance of the sector over the past 10 years, during which it has outperformed and delivered higher yields than all other real estate asset classes on a risk adjusted basis (Figure 1). It’s simple supply and demand. These new participants are driving up valuations as more buyers are seeking acquisitions. 

 

 

Klodor:

Yes, there has been a new infusion of capital, but many of the experienced capital participants are slowing their investment in the space so far this year, if not stopping it all together. For example, many of the large public real estate investment trusts (REITs) have announced they are ceasing acquisition activity and are instead pursuing divestitures. During its most recent earnings call, Ventas, a health care REIT, disclosed its expectation of $150 million in investments this year compared to $500 million of divestitures. Compared to its 2015 activity that included $5 billion of acquisitions and $700 million of disposed assets, this is a clear reversion for one of the leaders in the seniors housing space. 

Laidlaw:

True, however, unique market factors are impacting the actions of public REITs. The REITs are ultra-sensitive to changes in their stocks prices and have to react to changes in their cost of capital. Most of industry capital providers are not subject to this phenomenon. In addition, public REITs only account for 15% of the market. Any recent void in the market left by public REITs moving towards the sideline has been filled by other new entrants to the market such as pension funds, private equity and foreign capital, to name a few.   

Klodor:

A lot of the new capital infusion into the sector has resulted in new construction activity. That is why both independent living and assisted living occupancies have flattened during the past year after five years of consistent increases. As of the first quarter 2016, the rolling four-quarter seniors housing inventory growth across the secondary markets reached a new peak of 8,900 units, well above its previous peak of 7,400 units six years earlier. The increased supply in the market has exceeded the new demand. The market recognizes that many markets are becoming overbuilt, which is why there has been a drop in new construction activity. This has been and will continue to be a drag on the sector. 

In addition, a lot of the new capital providers to the sector need to rely on a third party operator to manage their acquisitions. Considering these participants have high credit standards when selecting an operating partner, this handcuffs the market as there are a limited number of such operators currently in the space. 

Laidlaw:

The new construction activity has been needed due to the outstanding long-term demographics for the seniors housing sector. The population for the seniors housing population is projected to explode as the baby boomer generation enters retirement age. The 85 years or older population in the U.S. is expected to double within the next 25 years as this population segment increases from 2.1% of the population to 3.9% (Figure 2). The seniors housing sector’s demographics are incredibly encouraging.

 

Klodor:

Yes, the demographics of the senior housing and skilled nursing industry are tough to beat. However, sector bulls often forget about one major competitor that is gaining strength—seniors living at home.  Survey after survey highlights the fact that most seniors prefer to stay in their own homes as long as possible. New technology is accelerating the shift towards this trend and allowing seniors to delay moving out of their homes. Services such as Uber, Instacart, and TaskRabbit are now making assistance with everyday tasks more affordable and more accessible for all. 

Laidlaw:

Yes, the seniors housing market will lose some demand to seniors staying in their homes longer, but the sector will also see an increase in demand resulting from this same market dynamic. Although seniors housing can be more expensive than living at home with the assistance of home health or similar services, it is much more inexpensive than skilled nursing and other higher acuity care. The increasing popularity of the Medicaid Waiver programs administered by several states are great examples of states moving low acuity skilled nursing residents into Medicaid waiver assisted living facilities. States would much rather pay $3,000 a month for these types of residents to receive the oversight and assistance with activities of daily living that assisted living facilities provide, rather than pay $200 a day for skilled nursing care. In addition, residents would prefer an assisted living environment to a skilled nursing environment, so it’s a win-win.       

Klodor:

Moving towards external factors that expect to provide headwinds for the sector, systemic risks such as inflation, global recession and interest rates, could all be drags on seniors housing. These concerns combined with the current prolonged business cycle point towards the need for a correction. The average length of the last 10 business cycles was 58 months. We are now in month 80 of the most recent cycle, which should be a cause for concern.  

Laidlaw:

The greater transparency currently available in the market allows for a more balanced market, and therefore longer business cycles. These are unique times in regards to the world economy and fiscal policy across the globe, so one would expect abnormal deal cycles.

Now that the various points have been spelled out, let’s take a look at the debate  from an objective viewpoint. Which case was more persuasive?   

Laidlaw: 

I think the deck was stacked in my favor as simple demographics dictate that the seniors housing sector will remain strong. I expect the near-term market to remain stable as all the new capital that has entered the market will need to be invested. There may be some bumps in the road, but I am confident the strength of the long-term tailwinds will ensure the seniors housing sector remains robust. 

Klodor:

Being the pessimist is a tough job, but I was happy to do it. I think Kevin’s assessment is accurate. Although there may be some choppiness in the near-term, the positive long-term metrics of the seniors housing sector are undeniable.

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