Despite constrained capital markets and a challenging operating environment, the senior housing sector could be looking at a window of opportunity far more attractive than it has been for some time.
Occupancy is recovering. The supply of new properties has slowed in part because of a pullback by lenders. And the long-awaited big demographic wave of baby boomers is finally beginning to break. They’re reaching the age where some type of senior housing makes sense.
“The stars are starting to align for opportunities looking forward,” said Rick Brace, director at AEW Capital Management. 
Brace made the observation during a recent NIC Leadership Huddle, the third in a series of webinars led by NIC Chief Economist Beth Mace. They were joined by Mary Ludgin, senior managing director and head of global research at Heitman.
“We are pleased to be able to talk with two highly regarded research directors,” said Mace, noting that they’ve experienced the ups and downs of the commercial real estate market. “They’re cycle-tested.”
Before tackling the specifics of the senior housing segment, the researchers provided context on the macroeconomic climate, the broader commercial real estate sector, capital markets, and valuation trends.
Expect the Economy to Slow
An economic downturn seems likely, though when and how deep is hard to predict, the researchers said.
The most recent consumer price index decelerated to 4%, the smallest 12-month increase since March 2021. Though the pace of inflation is headed in the right direction, Brace expects an economic downturn in part because of volatility in the capital markets.
After 15 months of consecutive interest rate hikes, the Federal Reserve skipped in June on raising rates. But Ludgin thinks the Federal Reserve may have raised interest rates too fast. “The risk is a recession,” she said.
If the economy is headed toward a recession, Ludgin noted that the commercial property markets are broadly in good shape. The big exception is the office market, beset with vacancy problems as many employees continue to work from home and companies shrink their office space footprints.
Meanwhile, industrial markets are holding up fairly well and retail properties are beginning to stabilize. Apartments could be somewhat overbuilt, however.
In 2022, valuations among the public REITs fell about 25%. Private market valuations have not declined that far but could be down 15% over the course of this correction period, according to the researchers.
Context Counts
How does this cycle compare to the 2007-2008 Global Financial Crisis (GFC), asked Mace.
“There’s not a lot to compare,” said Ludgin. The GFC started as a housing downturn with wide geographic scope, followed by a banking meltdown. “We are not seeing something like that,” she said.
Unlike the zero-interest rate policy (ZIRP) in the wake of the GFC, however, Brace pointed out that this time the cost of capital has been rising quickly. That gives borrowers less wiggle room with lenders. “It’s something to keep an eye on,” he said.
Putting the latest economic chapter in perspective, Mace compared the pandemic to an earthquake, resulting in secondary aftershocks such as supply chain disruptions and demand spikes. That led to inflation, which the Federal Reserve stepped in to slow with a rapid series of rate hikes. “Now we’re living through the impact,” she said.
Expectations for investment returns are lower in the near term. But looking ahead there will likely be opportunities for higher returns with potentially lower risks.
AEW is rolling out its fifth senior housing investment fund. The fund will initially be less focused on new development. “It’s a little too early,” said Brace. For now, opportunities will be explored in debt platforms, preferred equity, and rescue capital.
Because of spikes in new construction during the last decade, Heitman had stepped away from equity investments in U.S. senior housing, preferring debt positions instead. But the firm recently made an equity investment in a portfolio that includes existing senior housing and some new development.
Explaining the shift in strategy, Ludgin noted that a large portion of the existing stock of senior housing is 30-40 years old and becoming obsolete. “That creates an opportunity,” she said.
Operators are Key
Underwriting standards haven’t changed much, according to the researchers. Few deals are getting done, so guidelines are a little more conservative.
“We’re looking for growth in net operating income,” said Brace. Also, concerns are mounting about the huge amount of debt coming due in the next few years. Mace estimated the total at $10-$12 billion. “Refinancing is a challenge,” she said.
Turning to new investments, both researchers emphasized the importance of the operator in any decision.
Heitman won’t enter deals with a questionable operator even if the deal looks good on paper. The operator needs a good track record and a clear idea of how to best manage the needs of seniors.
AEW has had success working with smaller, mid-size operators, though the firm is open to talking to operators of all sizes.
The webinar ended on an optimistic note. Despite some pricing resets and other challenges, the researchers expect the senior housing market to perform well in the coming years. “We’re well along in this recovery,” said Brace.
To view the recording of this and other past NIC Leadership Huddle webinars, visit our website.
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