CHICAGO — Welltower CEO Shankh Mitra believes it could be a few years before seniors housing development will once again be feasible for the giant healthcare REIT to undertake because of strong headwinds facing the industry, including the “out-of-control” cost of construction.
Construction costs have increased 50 percent or more over the past five years, according to Mitra. “I don’t see how that [cost] comes down meaningfully unless we solve the labor situation.”
There were 363,000 job openings in the construction industry at the end of July, up 10,000 from the same period a year ago, or about 3 percent, according to the U.S. Bureau of Labor Statistics. The labor shortage is contributing to higher labor costs and longer completion times.
Factoring in the dramatic spike in the cost of capital over the past 18 months, plus the increases in property insurance and operating costs, the numbers don’t pencil out 95 percent of the time for developers today, said Mitra.
The benchmark federal funds rate has climbed from near zero percent in early 2022 to a target range of 5.25 percent to 5.5 percent currently, the highest level in 22 years. Meanwhile, the secured overnight financing rate used to help price construction loans has risen from 0.05 percent to 5.3 percent.
“If you’re a lender today and you want to lend on seniors housing construction, I think you will have better luck if you go to [Las] Vegas — and have more fun,” said Mitra.
The REIT executive’s comments came Monday afternoon during a panel discussion at the 2023 NIC Fall Conference. Titled “Unlocking Creative Capital Relationships,” the panel also featured Debra Cafaro, CEO of Ventas, who joined Mitra on the main stage at the Sheraton Grand Chicago Riverwalk. Randy Richardson, former president of Vi, a developer, owner and operator of luxury senior living communities, served as panel moderator.
The annual conference, a networking and educational event attracted 2,800 industry professionals, on par with last year’s conference attendance, according to NIC.
Nearly three-fourths of attendees (74 percent) are executive decision-makers in the C-suite. A breakdown of attendees by job discipline reveals 72 percent of attendees are either operators, developers or capital providers, while the remaining 28 percent represent a variety of other industry-related disciplines.
A day of financial reckoning coming?
There is nearly $1.5 trillion of U.S. commercial real estate debt set to mature before the end of 2025, according to Cafaro. That could prove to be problematic for some borrowers who will need to refinance that maturing debt.
For example, suppose a borrower has a floating-rate mortgage loan and the property’s net operating income hasn’t risen to pre-COVID levels. And let’s say that unlike during the global financial crisis — where interest rates were near zero percent — now the borrower has a base rate of 5 percent or higher on a short-term loan, and then a spread on top of that.
“You’re not going to have the ability do the old ‘pretend and extend,’ where we’ll kick the can down the road and after a while it’ll all work out — and it mostly did,” said Cafaro.
“What’s different now is the cash flow projections and the amount necessary to carry the loan for that period of time. And so, that’s going to require either significant equity paydowns, and/or there are going to be other actions taken,” she added.
History shows that it helps to have staying power in commercial real estate, stated Cafaro. “We’ve focused on building a big, strong company that has staying power that can be committed to an industry through cycles of all types. That’s where we find ourselves today.”
Cafaro credited Justin Hutchens — who holds the dual role of executive vice president of seniors housing and chief investment officer at Ventas — for marrying his vast operational expertise with data analytics to help operators provide better care and services to seniors.
“Clearly, if you can bring the best of what both the capital side and the operating side have and do it in collaboration, you can really win together for the benefit of the community,” said Cafaro.
One advantage that Welltower has is that it is a low-leverage company that has very little floating-rate debt and has very staggered loan maturities, said Mitra. “There are many private companies that are well run, that very much have a conservative capital structure. It’s not just public companies.’
Ultimately, Welltower’s top priority is to help its existing operating partners grow their business.
Future looks bright
Cafaro said that the dearth of construction starts combined with the projected 25 percent increase in seniors housing population over the next several years bodes well for occupancy rates for the foreseeable future.
She recalled that after the financial crisis of 2007-2009, the senior population that Ventas serves grew about 7 percent. By 2014, occupancy rates in the REIT’s portfolio reached into the low 90s.
“If occupancies went to the lower 90s after the financial crisis, certainly you would imagine with 25 percent growth [in the senior population] you could see overshooting these pre-pandemic occupancies over a period of time,” said Cafaro.
In short, the strong demand for Ventas’ services combined with favorable demographics “gives us optimism about the future,” she emphasized.
Mitra is optimistic that the next 10 years will not be a repeat of the past decade, during which the industry dealt with three crises in succession: an oversupply situation in several markets stemming from a big ramp-up in development from 2015 to 2019; a pandemic that led to plummeting occupancies and a high level of burnout and turnover among frontline staff; and a series of interest rate hikes by the Federal Reserve to combat inflation.
But Mitra cautions that the performance of the seniors housing industry needs to improve if it expects to continue attracting capital.
“On average, in the last 10 years we haven’t made any money for capital [providers],” said Mitra, taking into account both the public and private side of the business.” That’s led some capital providers to exit the business over the past three years, he emphasized.
“We have to do better. If capital can’t find a risk-adjusted return, capital will leave that business. My hope is that we will turn the corner and that the next 10 years will be better than the last 10 years, hopefully because demand is better. Hopefully, some of the reckless insane development with other people’s money will not happen.”
Giants in their space
Toledo, Ohio-based Welltower (NYSE: WELL) the nation’s biggest healthcare REIT, is the largest owner of U.S. seniors housing with 943 properties and 95,281 units in its portfolio as of July 1, according to the American Seniors Housing Association (ASHA), which annually ranks the top 50 owners.
Welltower’s stock price closed at $84.29 per share on Tuesday, slightly below its 52-week high of $86.97, but well above its 52-week low of $57.10. Welltower’s market cap is $43.7 billion.
Chicago-based Ventas (NYSE: VTR) is the second largest owner of U.S. seniors housing with 737 properties and 67,679 units in its portfolio as of July 1, according to ASHA.
Ventas’ stock price closed Tuesday at $42.38 per share, considerably below its 52-week high of $53.15 and well above its 52-week low of $35.89. Ventas’ market cap is $17.05 billion.
— Matt Valley
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