With occupancy rebounding to pre-pandemic levels and demand remaining strong, CCRCs/Life Plan Communities continue to face economic headwinds from capitalizing on improving market conditions.
Capital costs continue to rise making borrowing money a challenge or alternatively, perhaps adding additional debt service costs if existing debt is variable.
Accessing capital is nearly imperative for most CCRCs/Life Plan organizations as property maintenance is key to achieving ongoing unit sales targets. The lion-share of organizations with entry fees use the fees to collateralize refunds due (payable) to prior unit holders upon transition. Some are fortunate enough to have pricing structures that provide a portion of the fee (entry) for refurbishment of the unit (the one that is turning over) or for reserve. When needed, especially for capital investment and improvements, accessing capital (borrowing) is a function most communities rely on. As costs for borrowing rise, ROIs on projects quickly turn negative.
A number of years ago, I did a presentation at a conference on pricing, real estate relationships, etc. for a conference. The presentation is here: https://rhislop3.com/wp-content/uploads/2023/03/intersection-of-pricing-and-marketing-v.2.ppt It is also available on the Presentations page on this site.
I have written time and time again, and given presentations at numerous conferences, about the relationship between the residential real estate market (strength, weakness) and the sales function of units at Life Plan/CCRCs, especially entry-fee CCRCs, regardless of contract type (fully refundable, partially refundable, etc.).
Simply stated: When residential real estate markets approach near illiquidity, seniors have a challenge in terms of selling their residence, the principal source for the CCRC/Life Plan entry fee. The presentation I referenced (earlier) provides a good explanation of the economic pricing dynamics of entry-fee communities and the relationship with residential real estate.
To the title of this post. Continued restrictive Federal Reserve (Fed) monetary policy, deployed to curb inflation, has been two-fold (in terms of residential real estate). First, the Fed has raised the interbank rates known as the Fed Funds rate. This is the amount of interest that banks can charge each other for overnight loans. The higher this rate goes, the less capital demand exists as borrowing becomes more expensive (cost of money from a bank), slowing economic activity and reducing the supply of money in the economy.
Second, the Fed has gradually shrunk its balance sheet, reducing the investments (market govt. securities) it has. One such reduction has been mortgage-backed securities (basically, investments that pool or combine, mortgages issued by banks and lenders). As the Fed stops purchasing those securities, the private market (private investors) will step-in and buy but at a higher rate, requiring a greater return than the Federal Reserve. This demand function thus, raises the cost (expressed by interest) of mortgages. Today, a 30-year fixed-rate mortgage is at or above in most markets, 8%. Below is a chart from Iowa, generally, a lower cost/rate state compared to say, New York or California.
As borrowing costs rise, fewer buyers can afford to purchase a home. Typically, this would mean that home prices would need to decline to attract buyers, even if on average, incomes had risen over a similar period of time, such as recent. While incomes have risen, so has inflation, the largest components being food, energy, and shelter (housing). Unless incomes have risen faster than the overall cost increase of shelter (housing), affordability is negatively impacted. See below. Additional inflationary impacts don’t help.
As the demand for entry fee units is highly price elastic (the higher the price, the greater the number of alternatives at lower price, become favorable), residential real estate market dynamics can affect demand. Simply, the senior that cannot liquidate his/her residence at a price equal or greater to the entry fee will likely not, unless forced by external pressure (family, health, etc.), sell. This level of illiquidity slows the CCRC sales cycle as new vacancies cannot be filled, efficiently. The full affordability report is here: hai-q2-2023-quarterly-housing-affordability-2023-08-10
What has transpired this year, and now fully into the third quarter, is declining sales to the point where every region in the country across every price point, has experienced declining sales. Demand has been significantly, negatively, impacted by two factors.
- Rising rates (mortgage, borrowing) have reduced the number of buyers in the market. As the affordability charts and date illustrate, it takes more resources to afford a home purchase as the cost of borrowing rises.
- Supply has remained fairly steady, but price has continued to move-up. This is a function of two phenomena. First, the housing supply was relatively low, pre-pandemic. Via new housing starts, it hasn’t really grown to keep pace with increases in population. Starting new residential housing, especially single family, is expensive due to higher cost materials (inflation, supply chain) and higher cost capital. These elements drive price for new homes, up. Second, extended periods of time with historically low mortgage costs (sub 4%), have trapped people in-place or in other words, made the “buy-up” move or the move for “location” almost impossible. Selling a residence, even at premium, only makes sense if the premium achieved is sufficiently larger to apply to the next home, keeping the cost with the new mortgage at a much higher rate, parallel. This today is simply, not occurring, even with higher housing prices.
The full September existing home sales report is available here: ehs-09-2023-summary-2023-10-19
Taking the current data from NAR (National Association of Realtors) into account, the outlook for CCRCs/Life Plan communities continues to be more down than up. This fits with the Fitch Ratings outlook for 2023 of “deteriorating”. I personally believe that the current economic fragility, higher core operating costs, costs of capital, and illiquid real estate market will suppress the sector even more and potentially, for longer – deep into 2024.
There are also some new headwinds such as middle east conflicts which could negatively impact global oil supply and thus, cost. Higher energy costs are more certain than not.
Federal Reserve interest rate policy appears to be higher longer versus forecasting cuts. This means that mortgage rates will stay sticky high, longer, keeping real estate sales suppressed and capital costs for the CCRC, higher with restricted access.
The NAR Confidence Index survey is here, paralleling in many ways, my guarded pessimism. 2023-09-realtors-confidence-index-monthly-report-10-19-2023