A lower cost of capital and a shallow pool of acquisition opportunities have made conditions more favorable for sellers of senior living properties in recent years — but there are recent signs that the market is tilting back toward the buyers.
For one, senior living operators are still grappling with a higher cost of doing business for many important line items, from food to labor. Although many senior living companies have done well treading water over the last two and a half years, owners of these assets — particularly underperforming or distressed communities — are increasingly looking to sell. At the same time, interest in senior living development is rising, meaning more companies are opting for new builds rather than seeking an acquisition target.
All of that is helping to make conditions more favorable for buyers of properties by driving down pricing for existing assets. In recent weeks, several operators have shared with SHN that they are seeing more good deals on the market today than only months prior.
While the vast majority of deals coming to market now were pre-baked months ago, a more recent combination of higher interest rates, inflation and pressure on operators to bring more capital to the table have caused deal activity to sputter, according to National Investment Center for Seniors Housing and Care (NIC) Chief Economist Beth Mace.
“The markets have changed largely because of what’s going on in the economy, and largely because of the threat of rising inflation,” Mace told Senior Housing News.
Landscape ‘still evolving’
Mace cautioned that the financial landscape for senior living buyers and sellers is “still evolving,” and that there is “a little bit of discovery left to be done” with regard to finding where industry pricing and valuations will ultimately land.
While it’s clear the market fundamentals are changing, some in the industry see this as a continuation of an older trend. For instance, JLL Capital Markets Managing Director Cody Tremper said he believes the industry has been in a pricing discovery phase since the start of the pandemic, and that interest rate hikes are not the cause of recent market shifts.
“It’s been a challenging time for the industry throughout Covid,” he told SHN. “I don’t think the interest rates moving has necessarily swung [the market] in favor of buyers all of a sudden.”
He added that JLL is still seeing robust deal volume and a range of opportunities to access capital.
But what has perhaps changed is the widening gap between companies that are well-capitalized, and those that are not. Specifically, buyers lacking a strong capital position face far more risk exposure and potentially require negotiations from a seller to complete a transaction, whether it’s a seller note or a concession on price, said White Oak Healthcare Partners Managing Director Jason Dopoulos.
Buyers and sellers are also working more closely together to find solutions and close deals e, said Senior Living Investment Brokerage Managing Director Ryan Saul.
While the senior living asset class remains a strong performing asset class, a buyer will likely need to come up with more capital to get deals done in today’s climate, he added. Inversely, sellers might not be able to pull out as much equity on a sale or a refinancing to get over the finish line.
Although Saul said he believed the industry was still in a sellers’ market for quality, high-performing assets he sees more downward pressure on valuations and pricing for distressed assets.
“It’s starting to normalize,” he said. It’s heavily been a seller’s market but we are starting to see more balance.”
A recent CBRE survey showed average cap rates in senior housing have compressed since last year. The average senior housing capitalization rate fell by 2 basis points from pre-pandemic levels in 2020, which CBRE noted indicates slightly higher asset values.
That is a trend that VIUM Capital Executive Managing Director Kassem Matt has also noted.
But while the goal posts for getting a deal done could be moving closer together, Tremper highlighted the fact that cap rates within senior living never got as low as some other real estate asset classes, particularly those that saw a massive run-up in value due to lower borrowing costs prior to the Fed’s actions.
“We still see a broad range of different product types available out there, from stabilized products to devalued products and all the way down,” he said.
Even with capital circulating still in the market, prices could be trending down, Matt added.
Buyers willing to take on more risk in the form of distressed assets “have a little more power than they had pre-Covid,” Dopoulos said.
“But when you flip sides, the owners aren’t going to make concessions for what’s going on right now in terms of the difficulty others may be having in their local market,” he added ”
In the meantime, interest rates are potentially set to rise again, with Fed officials signaling a rate hike would be “reasonable” for later this month. The looming hikes could put pressure on sellers to rid underperforming properties — also to the advantage of buyers.
At the end of the day, those who are well-capitalized can work out deal financing and snap up turnaround properties as value-adds to their portfolio. That’s seen in excitement from White Oak’s clients, Dopoulos said, as they are able to get turnaround properties at a good price.
With the Fed laser-focused on tamping down rising inflation, transactions might pick up in the short-term as stakeholders scramble to lock in deals. But in the long-term, Mace predicted that higher interest rates could eventually dampen M&A activity.
“That would probably be through this year and into next year,” Mace said.
Tremper said those well-positioned within senior living will continue to make deals regardless of market conditions. Operator demand for value-add projects for operators is also running high.
“Over the next five years, [senior living] is a great place to be and I think macro-wise, a lot of smart capital understands that,” Tremper said.
Although the massive wave of distressed assets predicted at the start of the pandemic has yet to materialize, , Saul said he felt owners were still “trying to hold on,” before selling and ride out bad conditions — but they can only kick the can so far down the road.
“There are going to be more opportunities in tertiary markets, and consolidation is making the game tougher for individual private owners to make a go of it without economics of scale and buying power,” he said.
For White Oak, Dopoulos said he expected federal and agency lending to be “a little slower than normal” for the remainder of the year, while there could be the potential for increased bridge loan lending due to an increased demand for all acquisition types.
“I don’t see anything big happening,” he added. “No one wants crazy surprises from the Fed and absent inflation running wild we could see some stabilization going through the fall and into winter.”
Both Kass and Kennedy said they hope lenders and investors are “realistic” about pro forma financials and headwinds from inflation, interest rates and inflation. For buyers the challenge is buying properties at an appropriate basis to not incur vast risk.
“If you look at the shape of the yield curve, continued flattening of the curve says you want to get into the permanent markets as fast as you possibly can,” Kass said. “The shape of the curve is going to be critically important as those decisions are made and how we get there.”
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