Editorial Note: The following has been republished with permission from the author, Reg’s blog.
Now that the real estate dynamics have shifted from on balance to par or better (the majority of markets can liquidate inventory at stable or rising prices with constant or modestly increasing demand), the outlook for senior housing—independent living (IL), assisted living (AL), and continuing care retirement communities (CCRC)—is less murky. The recession of the last seven to eight years has lifted. What is visible, while still fairly complex market to market, is a picture that is illustrative of the next 10 or so years: ample to adequate supply and average to slightly soft overall demand. Perhaps this is the Brookdale lesson?
What we know statistically is that demand has globally peaked and now has flattened. Recall that senior housing is very much locally and regionally biased, so some markets may be experiencing more demand than others. By example, in 2010 (full recession impact), occupancy in the sector was 86.7%. By the end of 2014 and since, occupancy recovered, but only to an average of 90% (per the National Investment Center). During this same later period, new unit production has increased to an average of 3,200 per quarter (trailing seven quarters since the end of 2016). This is a 50% increase over the prior eight quarters.
What has caused this increase? It’s less about occupancy reality and more about better real estate dynamics. Also contributing are growing economic optimism and more accessible capital, particularly as nontraditional sources have entered the sector (such as private equity).
As a quick translation of these trends, we can expect an increase of approximately 5,000 additional units in the top 31 metropolitan statistical areas—possibly as much as 6,000 depending on where the units are in the development cycle. This additional inventory is entering a market that is showing signs of oversupply.
In multiple articles, I have written about phantom or, perhaps more accurately, misunderstood economic and demographic trends. Global demand for senior housing is very elastic, particularly for IL and CCRC projects that are at or above market (as the bulk of the industry is). Demand elasticity exists where and when price directly impacts the number of consumers looking for a good or service, as well as their willingness to consume that service. As price rises, the number decreases; as it falls, the number increases.
For senior housing, demand trends toward inelasticity when the price mirrors rent-controlled or modest-income housing. In this case, demand is constant and actually proportionately inverse (more demand than supply). Better economic real estate conditions and improved investment market conditions (stock market, investment returns, etc.) influence to a lesser extent the demand outlook, as stronger or stable wealth profiles for consumers reduce purchase anxiety—especially where entry fee models are concerned.
From a demographic perspective, the issue at hand is the actual number of seniors in the target age range with an economic wherewithal to consume. Only about 10% of seniors 75 and older reside in senior housing specifically (IL or CCRC), and a slightly larger (aggregate) number reside in quasi-senior housing projects (age-limited housing developments a la Del Webb). Between 2010 and 2016, the 75-plus population grew at an anemic rate of 1.8%. The expected rate of growth for this cohort over the next five years increases to 3.8%. More telling, for this same period, the subset of 75–79 will grow at a rate of 5.7%. These numbers present a bit of optimism, but in real terms, the demand change within the demographic doesn’t create sufficient opportunities for absorption of inventory growth if the latter maintains its present pace. The demographic fortune doesn’t really begin to change dramatically until 2021 and beyond. At 2021, the group turning 75 represents the start of the baby boomers. Prior to this point, seniors 75 and above still reflect the World War II trend of birth suppression.
The operative lesson is that Brookdale has far too much supply for the real organic demand that exists for plus-market-rate, congregate senior housing. In my outlook comments below, readers will note how the demand around senior housing and the congregate model is actually shifting slightly, which has negatively impacted Brookdale. The acquisition of Emeritus has since offered proof of some age-old adages regarding senior housing, including:
- Not conforming to retail outlet strategies
- Very elastic demand
- Tough to inflate prices for earnings and margin
- Asset-intense and thus sensitive to capital reinvestment
- Full of me-too projects that are difficult to differentiate by brand
In the Emeritus acquisition, economies of scale and cultural assimilation proved difficult, but frankly, such is always the case. The real crux is that the retail outlets (the Emeritus properties) were not accretive—senior housing doesn’t quite work that way. While the asset value of Brookdale skyrocketed, the earnings on those assets retrenched. With soft demand, a lot of highly similar congregate projects, and no room at the ceiling for price elevation, the outcome was a fait accompli.
The lesson? Certain types of senior housing are about played-out vanilla, above-market projects, and a heavy concentration of this in a portfolio will present challenges regarding occupancy and rental income return, rather than price inflation. Demand is also soft for reasons mentioned above, primarily demographic but also economic in some instances. Similarly, as I mentioned above, senior housing is very local. A retail brand strategy simply won’t work. Residents identify brand to local or at best regional—national means nothing. If the market isn’t supportive regardless of who or what it is, the project will be challenged. Emeritus brought too many of these projects into the Brookdale portfolio.
Below are my key outlook points for 2017 and the next five or so years for IL and CCRCs (non-affordable housing):
- Demand across most property types will remain soft to stagnant. This means 90% occupation is a good target. Of course, rent-controlled projects will continue to experience high demand, particularly if the projects are well located and well managed. Regional and local demand will vary significantly. The projects that will experience the softest demand are above-market, congregate, non–full continuum (non-CCRC). Projects with the best demand profile contain mixed-use, mixed-style accommodations with freestanding and villa-style properties. While projects with more amenities will attract traffic, demand isn’t necessarily better due to price elasticity in the segment.
- Improving economic conditions/outlook will undergird and help bolster demand, though the demographics are still the primary factor. Some notes to consider:
- The real estate economy can benefit, even with a slightly higher interest rate trend, if employment and wages continue to strengthen and deregulation of some current lending constraints occurs. I think the latter two points will offset any interest rate increases in the near to moderate term.
- Rising interest rates help seniors more than stock market returns, though this trend is changing as seniors have been forced to equities to bolster return. Still, most seniors are highly exposed to fixed-income investments, and a somewhat improving interest rate market will improve income outlooks. Improved income does have a positive psychological impact on the consumption equation.
- Capital access will remain favorable, and banking deregulation may help push banks back to the sector. (They have been shy on senior housing for the last five to eight years.)
- Even with improved economic conditions, the mismatch between demand and supply (discussed earlier) will restrain rent increases in the near term. This could present some modest operating challenges for the sector as price inflation on wages, etc. will occur before any opportunity to raise fees or rent. The net effect is a modest erosion in margin. I don’t see much opportunity to fight this with increased occupancy.
- Increasing occupancy—or, in some cases, staying at current occupancy levels—will continue to require incentives. Incentives negatively impact revenue in the short run.
- The average age for residency on admission and across the product profile will continue to move up. In addition, the resident profile will continue to slide toward infirmity and debility. Providers will continue to work to find ways to keep projects occupied by offering aging-in-place services. While this is a good strategy to a certain extent, it does harm the ability to market and sales-convert units to a more independent resident profile. I liken this to a “rob Peter to pay Paul” approach—it works, but not without potentially harmful consequences down the road.
- The additional inventory that is coming into the sector won’t slow down for another two or so years. This is in spite of weak to stagnant demand. Some investors and developers are willing to be somewhat ahead of the baby boomer curve, even though I believe this is unwise (see next point).
- The reason I believe the baby boomer impact for the sector will be modest (and actually disheartening) is that the demographic shift doesn’t directly translate to product demand. Boomers have a different view of the world and a different set of housing and lifestyle expectations, in addition to their economic capacity.
- The first group of boomers was hurt the hardest by the most recent recession; many were the first displaced as jobs eroded (being the oldest and highest-paid employees). They also have less employment time to recoup any income/savings losses.
- Generationally, boomers’ savings rate is significantly less than their parents. These folks, while still more modest in comparison to boomers born five to 10 years later, didn’t delay gratification or extravagance the way their recession-influenced parents did. Less overall wealth negatively impacts their ability to afford higher-end senior housing.
- Congregate living (apartments) is less their style. Boomers are the first age group used to a more expansive living arrangement. While they’ll move eventually, they will not see 1,200 square feet at $4,000 a month as attractive (not even at $3,000). They will have unfortunately mismatched expectations in terms of size versus cost. They’ll want larger, but for less rent than is realistic.
- Boomers are generally healthier than their parents, with a different view of retirement and retirement residency. Don’t look for 75-year-old boomers to be greatly interested in a CCRC or senior housing development, particularly if their health is good. They’ll wait until 80 or older to trigger a move.
- Boomers are more mobile and more detached than their parents. This means in-market moves and the traditional radius math will be less applicable year-over-year with boomers. They will be willing to shop broader for value and price—looking to get more for less or at least, a perception of the same. They are nowhere near as homogeneous by social construct as their parents.
- Greater pricing flexibility will continue to evolve. This means different entry fee options, monthly service options with/without amenities, more a la carte, etc. Service infrastructure for certain communities may suffer as residents will continue to want more choice but less bundle (they won’t pay inflated fees for things they don’t use or want).
- Because the sector is highly influenced and trended local, some markets will continue to thrive while others will continue to struggle, regardless of national trends.