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Discriminating Investors Seek Opportunity As Seniors Housing Matures
The outlook for the seniors housing market is increasingly positive. Facilitated by a slowdown in construction, occupancy in existing communities continues to climb from the lows recorded in 2002 and has surpassed 90 percent in many metros. Operating models have become more homogeneous and well defined, which has helped lift margins to enticing levels. As a result, investor appetites are high, but finding good, well‑priced product has become a challenge. Fueling increased competition are institutional investors, who have' raised their stake in the market over the past several months. Owners have witnessed healthy asset appreciation due to the impact of both improved operations and falling cap rates.
Stringent Buyer Requirements Make Finding Property a Challenge
Investment activity today mirrors the heated pace of the mid‑to‑late 1990s. Cap rates have returned to similar levels, occupancy rates are up, and capital is more plentiful than ever. What is different today is the sophistication of the buyer. Today's seniors housing investors, and the industry in general, have a clearer sense of what works and what does not. Operating models are more defined as a result. Larger unit sizes, quality locations, state‑of‑the‑art amenities and a clearer sense of service levels and the average associated costs drive today's growing pool of investors. As a result, time on the market for quality properties has shortened tremendously and portfolio sales have risen. Conversely, time on the market for older properties with smaller unit sizes and antiquated service levels has lengthened. Today's discriminating investors are finding it difficult to accept the risk associated with turnarounds or redevelopment plays at current prices.
Skilled Operators Lifting Margins
The seniors housing industry has emerged successfully from a period when developers and investors, with several different business models, flooded the market. Gone are participants that viewed the industry as a development play or a hospitality business model. Skilled operators are beginning to dominate the landscape, which is resulting in improved operations. As a result, average margins for quality properties are up across all sectors. The independent‑living (IL) sector is reporting margins in excess of 40 percent, while assisted‑living (AL) margins have risen to over 30 percent for larger communities. Skilled nursing (SN) has also reported gains, with margins for quality facilities in the 11 percent to 13 percent range.
Independent‑Living Facilities
The IL sector continues to outperform its seniors housing counterparts. The nationwide occupancy rate has remained relatively flat over the past few quarters at 91 percent; however, when analyzing the 30 largest MSAs, occupancy rises to 95.1 percent. Boston, Baltimore and Washington, D.C., all boast occupancy rates above 98 percent, which has lured many developers to the northeast. As a result, the majority of the 8,400 IL units expected to be completed this year are located in the northeast, which could dampen revenue growth over the near term. Comparatively, the revenue outlook for Orlando and Miami is stronger. These markets are relatively undersupplied and have limited construction activity. Similar dynamics are found in Sacramento, Los Angeles and the Bay Area. Despite rising occupancy, concessions remain prevalent in many markets.
In the past, cap rates for lL, facilities have been more than 300 basis points above traditional apartments, but the gap is narrowing. While IL cap rates average 9.5 percent, quality facilities have sold at 8 percent, 150 to 200 basis points above the apartment average. Investors have been tempted by heftier yields and higher operating margins in the IL sector. While the average price fell slightly in 2004 to $71,600 per unit, this was not indicative of market fundamentals. Only 35 percent of the sales involved stabilized properties with occupancy at 90 percent or better. Stabilized properties traded for an average price per unit in excess of $100,000, compared to $55,000 per unit for unstabilized properties. This year, a few quality portfolios have sold. One example is the announced sale of a six‑community portfolio from Meridian Retirement to Canadian interest Chartwell Seniors Housing REIT for approximately $222,000 per unit. The combination of large sales and cap rate compression are expected to push the average price to over $90,000 per unit this year, with another 5 percent to 10 percent gain forecast in 2006.
Assisted‑Living ‑Facilities
The AL sector continues to improve, with overall occupancy up 70 basis points so far this year to 88.7 percent, following a 250 basis point gain in 2004. Of the 30 largest MSAs, several are now reporting occupancies above 93 percent, and the number of fully occupied facilities has grown to nearly 25 percent of the inventory. While positive, this suggests that there are several facilities still underperforming, offering a pool of assets for opportunistic investors. Consistent with the IL sector, occupancy remains highest in the northeast, led by New York, Boston and Washington, D.C., and followed by San Jose and San Francisco. When assessing supply/demand indicators, the strongest markets are San Jose, Sacramento and San Diego.
Improved operations are drawing investors back to this once supply plagued sector. As a result, values are climbing, with the average price per unit currently up 2 percent from 2004 to $97,000. Cap rates have fallen to an average of 10 percent, with some assets trading in the low‑ to mid‑8 percent range. Furthermore, there have been some large portfolio sales announced in recent months at sub‑8 percent cap rates. In the m id‑1990s, capital flowed into the AL sector, putting upward pressure on prices. This ultimately contributed to financial stress in the industry. This time around, however, AL prices are rising in response to improved operations. As long as construction remains restrained, we expect continued improvement in operations. Investors and developers should note, however, that demand in the AL sector is growing at 3 percent per year, and a spike in demand is still years away. |