On Monday, Fitch (investment rating agency) dropped a non-rating commentary as an alert that should the economy hit a recession (I would argue not “should” but “when”), that Life Plan communities will encounter additional financial pressure. Recall that in December 2022, Fitch issued its outlook on the Life Plan/CCRC market, qualifying it as “deteriorating.”
Per Fitch: “Slower economic growth and persistent inflation, especially from higher wages for hospitality and nursing staffing, as well as higher costs for food and other supplies, are leading Fitch economists to call for a possible recession in either late-2023 or early-2024. This scenario, if it plays out, could exacerbate the already ‘deteriorating’ sector outlook Fitch has in place for LPCs. Should these inflationary pressures persist beyond the next two years, LPCs may encounter resistance from residents to the substantial rate increases that may be required to offset the added cost pressure, according to Fitch Senior Director and sector head Margaret Johnson.”
The full press release is available here: https://www.fitchratings.com/research/us-public-finance/struggles-to-continue-for-us-life-plan-communities-as-possible-recession-looms-18-09-2023#:~:text=Fitch%20revised%20its%20Outlook%20for,up%20to%20the%20double%20digits.
Over the years, I have written extensively about the connection between entry fee Life Plan outlooks and the housing market (residential real estate). A good synopsis is found in a post I did dating back to 2010 – the last time the real estate market tanked “bigly”. You can access the post here: https://rhislop3.com/2010/03/23/the-housing-market-and-ccrc-prospects-what-each-means-to-the-other/
Suffice to say that a declining resale market for residential real estate combined with increasing mortgage rates creates a certain amount of illiquidity in the market. While we have yet to see price deterioration on homes, sellers will likely need to soften asking prices in the future to assist buyers with attaining a reasonable level of debt (mortgage). The average decline in existing home sales has been -24.65% over the last 4 quarters (dating back to 2022). In the second quarter, new home sales ticked up 8.4% but the three previous quarters were down, average of 18.3%. Overall, housing starts have been down with a slight moderation found in multi-family housing, though it too was down in the most recent quarter. The National Association of Realtors economic forecast (data source on housing, etc.) is available here: forecast-q3-2023-us-economic-outlook-07-27-2023
As Fitch notes, so far Life Plan communities have weathered inflation pressure and wage pressure via larger than typical, price increases. In some cases, I have seen double digit increases, generally in the form of two increases in a twelve-month period. Fitch notes that this rate of increases (frequency and amount) is not likely sustainable, and I agree.
There exists an opportunity for a double whammy to occur whereby real estate sales remain very slow to almost non-existent such that new prospects can not effectively liquidate their home for the entry fee proceeds. This will hurt occupancy prospects on a sector that has just recently moved to pre-pandemic occupancy levels. At the same time, inflationary pressure continues via higher wage demands from staff (new and existing) and supply and energy costs. If occupancy falls and cost pressure remains elevated, the community will have fewer occupied units to contribute rent/monthly fees to the revenue side of the equation. Likewise, many Life Plan communities rely on entry fees as a source of revenue or capital and definitely, as a contributory element (positive) toward debt service covenants (if the community maintains debt with covenants which many do).
The balance for many is rather delicate. Most need a turnover, including resales (new entry fees), to balance their revenue model and to assist with covenant compliance. Fee increases are sustainable in the short term but may become problematic if occupancy dips and the pressure on revenue is such that even HIGHER rate levels become necessary. Residents will only accommodate larger than normal increases for so long.
Listening to Fed Chair Powell yesterday afternoon, I got a feel that a recession was likely coming by year-end or early 2023. Rising interest rates and restrictive monetary policy (balance sheet run-off) have a lagging effect on the economy. GDP growth is nominal, yet inflation remains sticky at or near, 4%. This is classically known as stagflation if it persists. I also got a feel that another rate increase remains on the table, though none occurred yesterday. Recovery, to a lower 2ish% inflation level and a stable price environment, seems a bit down the road, especially as energy (all forms petroleum) is rising again. Gas and fuel prices impact production costs and final delivered goods costs, keeping inflation sticky.