Senior housing in the form of CCRCs, Independent Living and Assisted Living (including memory care) is a large user of debt financing. While equity has become more prevalent via increasing private equity interests in senior living, operators, especially non-profits, continue to rely heavily on bank and bond financing. Private equity and venture capital investment trends tend to curve toward newer projects, acquisitions, healthcare offerings on the post-acute side (home health for example) and other ancillary businesses (SNFists/intensivist physician practices, pharmacy, therapy). Given the current economic conditions and banking environment, now is a good time to take a look at where the senior housing/senior living industry is from a financing perspective.
Perhaps the largest current concern focuses on existing debt that comes due in 2023 and 2024. The industry will see billions of bank and bond debt that matures or has variable rate features that will reprice across the next twelve to eighteen months. Two challenges thus exist. First, the cost of capital, expressed as interest rates, is higher now than it has been for the last fifteen years. While the rate environment (expressed as climbing or falling) seems to tack to a stable point, inflation has yet to fall to Fed target levels. As long as inflation remains high, the risk of the Fed continuing to raise rates remains. Effectively, expiring debt that requires refinancing will cost more going forward. Debt that is variable and repricing will cost more. Depending on the rate increase level, providers may face significant margin erosion and/or operational drag as debt service costs increase. A chart of the last twenty years is below. More analysis is also available here: <a href=’https://www.macrotrends.net/2015/fed-funds-rate-historical-chart’>Federal Funds Rate – 62 Year Historical Chart</a>
The second challenge is capital access. While rate is a concern, accessing capital is also a concern as lending conditions have tightened due to bank capital structural changes and generalized commercial credit concerns – real estate in particular. Valuation challenges also come into play such that operators/owners may find the overall value of their projects has changed, negatively so. Credit access is not only a function of real property collateral (value) but also, the strength of operations to meet debt service requirements. With occupancy challenges remaining, though improvement is occurring, and costs rising faster than revenues in many organizations (labor, energy, supply), credit profiles for providers (owners) have changed – negatively. In short, the spigot of available capital is less open now than it was, pre-pandemic.
The pandemic slowed the pace of property improvement and to a certain extent, the deferred maintenance “bill” for needed improvement is now coming due. Per NIC (National Investment Conference), across 31 markets that they track for senior housing data, two-thirds of the communities in these markets are old and in need of improvement – redevelopment or major upgrade. This of course, begets a need for capital and today, the capital availability is not as prevalent as five years ago and the cost of the capital, three to five times more expensive.
When improvement is required, capital access and cost are relevant but so is the cost of the improvement. The industry is seeing a bit of a perfect storm (currently) as capital is more expensive and construction costs are as well. In this scenario. project feasibility and payback conditions become stressed. Infrastructure improvements or community updates and refreshment may be required just to retain occupancy or to manage market share BUT the same may beget no new revenue or minimal revenue increase opportunities, not proportional to the investment. For many of these older communities, market location and property composition are such that significant increased revenue opportunity is unlikely. Given this prospect, the alternative to improvement via financing may be for some, merger or affiliation. See my post on this topic here: https://wp.me/ptUlY-tH
Bank debt/lending continues to be the primary source for capital but recent banking failures have tightened lending activity. We saw a bit of improvement via mini-perm lending at FYE 2022 but even there, overall loan volumes remained down compared to pre-pandemic levels. Balances did stay near all-time highs for housing but nursing care balances reduced. Construction lending remained soft and I suspect, it will continue this trend for the balance of 2023 and into 2024. Nursing care construction lending remained suppressed and senior housing construction lending sat at a quarter of 2016 levels. A good overview from NIC is here: NIC_Lender_Survey_Report_4Q_2022_FINAL
What I’ll be watching are default levels and loan volume (new levels). If we see a condition of softening rates later this year, volumes will lag but loans in-queue will tick-up. There is definitely some pent-up demand for capital and any condition or combination, of softer rates and lower construction costs due to a recession or slower overall commercial activity will ignite senior housing capital access demand. I’ll also pay close attention going forward, to default or pre-default conditions that motivate additional acquisition and affiliation deals. Softer valuation levels are good for buyers that have existing capital capacity or in some cases, equity raised capital, ready for investment. The key is patience and market conditions that produce deals that have inherent, accretive value prospects.