LOS ANGELES — The advice offered by the Development Outlook panel at InterFace Conference Group’s Seniors Housing West, held Feb. 2 at the Omni Los Angeles, mirrors the advice many would give to their senior residents. Namely, “stay active and stay creative.”
But these verbs take on a slightly different meaning when you’re talking about the smartest plays for seniors housing developers in a time when everything is changing.
“The smarter operators and developers have been developing a pipeline,” said panelist Paul Mullin, principal at Flatiron Development Group. “The key is momentum. Keep momentum going. Keep the pipeline going. Don’t stop because bankers aren’t lending. We’ll all get out of this. I see it as a short-term issue we have to overcome.”
The issue of the current market conditions may be short-term, but it’s also multi-faceted, as David Waite, partner at Cox, Castle & Nicholson. pointed out.
“The challenges are real,” he said. “You’ve got the spread between bid and ask and a rising-cap-rate environment. To go in and buy an asset today in this market is super challenging because you know it’s going in the wrong direction in terms of the valuation.”
The solution, according to Waite, is to employ a little imagination.
“Come up with different, more creative strategies in terms of acquisitions, joint venture and optioning property, and do things that aren’t just the all-cash buyer coming in with 30-day due diligence contingency,” he said. “Those days are over. It’s now a new world. The buyer and seller have to get very creative about how they can come together. My view is to stay in the market. Don’t sideline yourself. If you do, you’ll miss a lot of great opportunities.”
Panelists shared a variety of suggestions for remaining active and in the market at a time when financing and traditional acquisitions are hard to come by.
Mullin suggested building memory care in markets that don’t already have it.
Bill Pettit, managing partner at Black Dog Capital Advisors, noted there’s a good chance investors have current properties that could use some love.
“There is plenty of work that can be deployed into existing properties,” he said. “You can upgrade and refurbish. Inflation and the pressure on margins make it really hard to justify new development projects.”
Frank Haffner, founder and chairman of Monarch Senior Living, suggested looking for markets where there’s a supply and demand imbalance. This may include higher-income areas or underserved areas where there’s pent-up demand. The key here, he noted, was not simply finding a lag in supply, but a way to market how your product would fulfill a need in that community.
“Make sure you can articulate that demand to other people, who can then articulate it to other lenders and equity partners,” he said.
Frankie Pane, president of GSI/Transforming Age, added that developers and investors didn’t necessarily have to force creativity to remain active in this market. Sometimes, he said, there’s nothing wrong with staying the course.
“Focus on operations,” he advised. “New development right now is just tough. If you look at what costs an existing product was built at, what its interest rates were compared to what interest rates and construction prices will be in 24 months, why would you come out of the ground right now? You’re setting yourself up for failure.”
The better strategy, according to Pane, is to be patient as loans come due.
“There’s a huge tranche of existing assets, especially on the assisted living and memory care side, that have 2018 or 2019 financing and they’re barely making a profit,” he said. “There will be a lot of existing assets that come available for good acquisition plays. [These include] distressed assets that you can take on at a lower price. There’s going to be a re-pricing that takes place.”
The current environment is so hostile for new development, Pane said, that he even sees opportunities down the road for mistakes made today.
“From an opportunity perspective, I think it’s going to be a great 24 months ahead,” he said. “But it will be painful for some. For anyone who wants to come out of the ground right now, I look forward to owning some of your assets in five years.”
Acting on active adult
Development may be challenging right now, but those hurdles aren’t felt equally across the board, Pettit asserted.
“There’s a window I remain intrigued with,” he said. “I see opportunity in moving forward with development of active adult housing.”
Pettit noted this product was “much easier” with higher margins and lower development costs than licensed seniors housing.
“The numbers pencil with strong demand remaining in that area and without the labor pressure on margins that exist in full-service seniors,” he continued.
Waite added that developing active adult product can come with many incentives, especially in California and with an affordability component.
“In California, you get a density bonus of 20 percent for seniors housing,” he said. “If you pile on affordable housing, you get additional development incentives. You get relief on things like height, setbacks and the big one, which is parking requirements.”
Not everyone is on board the active adult train, however. Pane noted that active adult communities are soaring right now, but that may be short-lived.
“Active adult is the first to pull back its purse strings [in a downturn],” he said. “I wouldn’t do it if it’s not affiliated with a healthcare group. It’s the last to come out of a recession. For me, in the short-term, I’m bearish on active adult, but bullish in the long run.”
But Pettit views active adult in a different light. He sees a product that can offer the majority of what’s included in the full-service seniors housing experience for a fraction of the price. To him, that’s a winning combination.
“You have 85 percent of seniors who can’t afford full-service seniors housing but can afford access to active adult communities,” he explained. “Active adult has more absorption opportunities to move seniors out of their homes at a higher pace because it’s more affordable than full-service. But it also offers 70 percent to 90 percent of the benefits of moving into full-service seniors housing.”
With this in mind, Pettit sees now as the time to act. That’s because land sites are less expensive, while the pressure of inflation, labor costs and construction costs should lessen in the two to three years it takes to build the product, he said.
“Full-service seniors housing still has a good future,” he added. “I’m just intrigued right now to get into a segment that has a huge market and little competition today for well-run active adult properties. If you want to develop, I see this as an area of opportunity.”
Adapt to adaptive reuse
Converting the use of an outdated property is always a creative strategy, especially in tough markets like this one. But sometimes creativity isn’t enough to make an out-of-the-box idea successful. Mullin noted that the money saved buying an adaptive reuse property can quickly be spent fixing up that asset.
“It’s really hard to operate some of these older buildings,” he said. “You have to be careful and watch what you’re looking for. I see lots of hotels and motels [considered for seniors housing], and weird things that shouldn’t be adapted or reused.
“You can buy a 70-year-old building for $150,000 a door, but you can also spend unlimited capital to keep that thing running. Be very, very careful about those economics. They’re not as great as they look on paper with replacement cost theory.”
Haffner prefers to avoid the repositioning game altogether by seeking out distressed properties instead.
“Look for troubled assets that didn’t have enough ammunition, enough capital, enough liquidity,” he advised. “You’re better served by finding these things. Whether you put money in as rescue capital or whether you get the right opportunity at the right price, it’s probably a better bet than buying something that’s 25 years old.”
Remaining active and creative may be what keeps you afloat in this market, but panelists cautioned that other factors must be considered as well. After all, a looming recession always leads to a discussion of discipline, and talks of discipline tend to espouse the virtue of patience.
“I’ve set expectations with property owners that I’m not closing until the third or fourth quarter of 2024 at the absolute earliest,” said Pane. “Set realistic expectations with buyers and your equity partners.
“Right now, my equity partners and lenders are pushing things on me non-stop to deploy capital, but if I’m going to be the most responsible steward of their investment then I need to think through what is going to get them the best return at the least risk. That’s being prudent and talking with all the partners about a much-elongated timeline.”
Most of all, never lose focus on what you’re actually providing to seniors and their families. For Mullin, that doesn’t come down to active adult versus full-service seniors housing.
“For all product types, create community,” he said. “That’s what people want. They want a lifestyle.”
— Nellie Day
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