TGIF! On a calendar year basis, we are into the home stretch for 2023. It’s generally about now that I start looking at how 2024 is shaping up. What trends are there to watch? What do markets look like now, socially and economically? What does policy and politics tell us about the year to come? Today’s feature is about senior living investment, real estate and M&A focused, for 2024.
As I’ve written earlier this year, M&A activity has been slow, and real estate investment even a tad slower. The reasons are basically, all economic. The one reason that dwarfs all others? Capital cost combined with restricted capital access. Federal Reserve monetary policy that jumped interest rates (inter-bank) rapidly escalated the cost of capital (borrowing). Simultaneously, the rise in rates began to crush bank portfolios filled with long bonds that were purchased by banks to create returns (higher yields). Once rates began to move past the security yields, the valuations of the bonds held became quickly, underwater. The result was some regional and slightly larger, bank failures (liquidity challenged).
Depositors, fearing a bank collapse and/or chasing higher safe yields (short term Treasuries and money market rates elevating quickly), pulled deposits from banks (from low interest-bearing accounts). Bank lending is predicated on deposit bases and as the same shrunk, so did bank lending capacity.
As we ease out of 2023 and look ahead, the framework we have for Senior Living investment is weak at best, except for those investors with significant cash or equity access. A great report on the real estate outlook for 2024 was recently released by Price Waterhouse Coopers. It covers all real estate sectors in the U.S. and Canada, from an investment perspective. The report is available here: pwc-2024-etre-us-final
The trends that are current, high capital cost, more restricted capital access via banks, and economic uncertainties are the drivers of a tepid investment outlook. This is fundamentally true for senior living, save perhaps lifestyle housing and low/moderate income housing. While demand is strong and strengthening for senior housing, new development of product/units is mired in capital cost and access issues along with continued commodity price inflation (labor, construction materials, energy costs, etc.).
The first graph above is illustrative. It reflects the feedback of the survey participants from the Price Waterhouse report/outlook. The top two items of great importance are capital related – cost and access.
Not too be ignored, the second graph is also illustrative in so much that it reflects the generalized societal mood of today, projected forward. Notice that housing costs are of great importance followed by immigration policy. Frankly, I’m surprised that the sentiment regarding the federal budget deficit isn’t of greater importance as the budgetary issues, namely deficits caused by excess spending, are driving the inflation in the economy and thus, restrictive Federal Reserve monetary policy (higher rates).
Given the current economy, the jobs report today which substantiated employment slowing (new openings/creation plus a pretty healthy revision of prior period numbers), the Federal Reserve GDP forecast of just a bit over 2% for the 4th quarter, the ISM reports, the Consumer Confidence Index, my outlook for senior housing/senior living investment for 2024 follows. I have provided links to all of the referenced data sources at the end of the post.
- New building/new development starts will remain slow throughout 2024 with a possible uptick in the 4th quarter of 2024.
- Capital costs will remain at their current elevated level to mid-2024. We may see some downward trend at the end of the second quarter, early third quarter.
- Labor costs and availability will remain a challenge, of greater importance, to sectors that require specialized labor such as nurses, CNAs, etc. (SNFs, ALFs, Memory Care, Home Health, Hospice).
- The residential housing market will continue to be tight. Home prices won’t erode quickly but mortgage rates, following Federal Reserve policy and tighter lending access will suppress buyers in the market. Cash sales will remain high as a percentage of all sales.
- Senior living deals will see valuation challenges as prices will need to come down and cap rates, due to higher interest costs, will rise.
- Term debt repricing will be a challenge to refinance as rates will be higher for longer and the total amount of debt to value a bank may wish to lend, will be lower (70% LTV vs. 80%).
- Given regional banking conditions being less strong, larger deals are likely to require syndication (multiple banks for one borrower). Syndication is more complex and slower to create a credit facility.
- The good news is that for senior living segments that don’t heavily rely on government reimbursement as primary revenue sources, revenues look solid on both occupancy increases as well as price increases (market still bearing higher than customary rate increases.
- Jobs Report: https://www.bls.gov/news.release/empsit.nr0.htm
- Federal Reserve GDP Forecast: https://www.atlantafed.org/cqer/research/gdpnow#:~:text=Latest%20estimate%3A%201.2%20percent%20%2D%2D,2.3%20percent%20on%20October%2027.
- ISM Reports: https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/
- Consumer Confidence: https://www.conference-board.org/topics/consumer-confidence