SAN DIEGO — The one-two punch of the COVID-19 pandemic followed by a period of high inflation and soaring interest rates has had a negative impact on the performance of seniors housing, but affects the different sub-sectors in different ways.
The need to boost revenues is the primary issue in private-pay senior living, while a labor shortage remains the biggest drag on skilled nursing, say industry experts. Due to uncertainty over how these issues will be resolved, cap rates are rising to reflect the risk to investors.
Operating margins for stable seniors housing properties pre-pandemic ranged from 35 to 45 percent, according to Colleen Blumenthal, COO and partner at appraisal firm HealthTrust. But operating margins today at those same properties struggle to get out of the mid to high-20s. The reasons for the underperformance can vary greatly, including too much product in the market or too much turnover at the management level. It takes time to figure it out.
“Unfortunately, as it does take time, people are getting desperate,” said Blumenthal. “Their lenders are getting desperate. Private equity is getting impatient, and concessions are really starting to eat some of that revenue at a time when we really need to be increasing it. Because we don’t really know what’s going to happen with cashflows, cap rates are going up to recognize that risk.”
The comments from Blumenthal came during a panel discussion as part of the 2023 NIC Spring Conference that took place in early March at the Marriott Marquis San Diego Marina. The three-day conference attracted nearly 2,000 attendees.
Moderated by Bill Kauffman, senior principal of NIC, the panel was titled “Valuations — Avoiding the Rough and Deploying Capital Prudently.”
In addition to Blumenthal, other panelists included Dague Retzlaff, senior vice president, Capital One; Clint Malin, co-president and chief investment officer, LTC REIT; Josh Simpson, managing director, Meridian Capital Group; and Dana Scheppmann, vice president, PGIM Real Estate.
Poring over the numbers
Scheppmann of PGIM, a private equity company that oversees a series of funds dedicated to seniors housing, said one of her biggest challenges as an investor is trying to get a handle on expenses.
“The last 18 months have been really difficult to predict where expenses are going on pretty much every line item on the P&L (profit and loss) statement.”
The good news is that the labor market is starting to stabilize as evidenced by the growing number of fully staffed properties in PGIM’s portfolio, according to Scheppmann. That’s significant because now she can more accurately predict the year-over-year increase in wages among PGIM’s operators. Staffing costs comprise most of the P&L at a senior living property.
“Once you get a handle on expenses, you then can appropriately charge rates in certain markets that are doing better from an occupancy standpoint, or even ones that aren’t,” explained Scheppmann.
“You can articulate to residents’ families, ‘This is why we’re going to raise rates. This is what you’re getting out of it.’ We’ve done that. We’ve raised rates on our properties where they are 60 percent occupied because we felt very strongly that in order to keep the good talent on the ground at the community, we needed to be able to drive more revenue so we could pay those people,” she added.
Skilled nursing’s nagging pain
The primary concern in the skilled nursing segment is the labor shortage, Blumenthal reiterated. Almost 1.1 million nurses are expected to retire between 2019 and 2024, creating a shortage of workers. “The nursing schools can’t keep up.”
From a transaction standpoint, Simpson of Meridan Capital Group said much of the company’s activity of late has been on the skilled nursing side. “That’s where the deal flow is right now, and that’s where banks are going to lend right now for the most part. You can do value-add there much more easily than on the [private-pay] seniors housing side,” he said.
Cashflow in the skilled nursing segment in general is solid and getting better, according to Simpson. The State of Pennsylvania, for example, approved a 17.5 percent increase in Medicaid reimbursement that went into effect in January.
Malin of LTC, a publicly traded real estate investment trust, described the skilled nursing segment as a bifurcated market. “You have the older, more traditional skilled nursing. Then you have the newer, short-term-stay, transitional care model. I think the buyer is very different for those two asset types,” he said.
Last year, LTC acquired $125 million worth of transitional, short-term-stay properties. Primarily new assets, the properties all have private rooms and private bathrooms. It’s a very different market than the traditional skilled nursing, said Malin.
On the flip side, LTC announced this week that it had sold two skilled nursing facilities in New Mexico for $21.3 million. The two facilities had a combined 235 units and were built in 1975 and 1985, respectively.
LTC saw the deal as a way to reduce the age of its portfolio and either redeploy that capital to new investments or deleverage its balance sheet.
The Fed factor
Simpson voiced concern that the seniors housing industry is not listening to the Federal Reserve, which has vowed to continue raising interest rates to combat inflation.
“[Borrowers] have not been buying interest rate caps for a reason. They’re saying, ‘We’re at the top.’ But if you look at the last three weeks, this is changing daily,” Simpson said.
“Three weeks ago, people thought that the one-month term SOFR was going to cap out at 4.86 percent. Now, the SOFR forward curves have gone up to 5.50 percent at the high. People need to be prepared to have these higher interest rates for longer and really prepare themselves from a cashflow and cash reserve perspective.”
The spike in interest rates over the past year is causing property values to rise, but less so among skilled nursing facilities in Class A markets, according to Simpson. The biggest impact of higher rates has been on tertiary markets, where several skilled nursing facilities have closed, he added.
Think outside the box
Many in the industry are seeking to “rightsize” their expenses, said Malin. One operator that LTC was talking to at the conference was weighing the idea of implementing a base level of food costs. If a resident wants to upgrade from meatloaf to filet, for example, there is a cost associated with that.
“People are getting creative and really peeling the onion back on all the expense line items to see where they can come up with savings,” said Malin.
Brighter days ahead
Blumenthal offered these reassuring words for industry professionals who are disheartened by the current state of affairs.
“For everyone who can hold on for the next two years, you should go down to Home Depot and buy a fleet of wheelbarrows because there is going to be a ton of money you are going to need to take to the bank. All new construction is compressed and not happening. Once we get through this really ugly period, and I think it will be ugly still for a couple years, there is not going to be a lot of competition. You are going to start seeing, both on the skilled and senior side, a lot of interest and demand to move into these buildings.”
Retzlaff of Capital One echoed those comments. “This is a really resilient business. We had the shock to the system that was COVID. Now we have the labor costs, we have the rising interest rates. As lenders, there is not a lot of losses for us. Again, it’s short-term pain, but internally we can say we had these two significant bumps in the road, and we’ve come out with barely any losses at all.”
— Matt Valley
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