Supply and demand more balanced; occupancy sustained above 90%

In the first quarter of 2018, among the 31 primary markets tracked by NIC MAP, independent living had an occupancy rate of 90.3%, which was about 70 basis points less than stabilized occupancy. Comparatively, assisted living had a differential of 230 basis points, more than three times as large since there are many more units that have opened but are still in lease up for assisted living than for independent living.

The most recent cycle of independent living inventory growth began in the middle of 2015. Despite a 5% increase in stock, occupancy rates have been sustained above 90% since early 2014 as demand has held up reasonably well. Metropolitan markets such as Atlanta, Houston, Kansas City, and San Antonio, have increased their independent living stock, but other markets such as Washington, D.C., Denver, Detroit, Los Angeles, New York, and Philadelphia, among others, have maintained relatively low-to-moderate supply growth.

Of additional note, the data show a 30-basis point quarterly decline in the independent living occupancy rate to 90.3%, which stemmed from a marked slowdown in first quarter absorption and somewhat weaker inventory growth. Reasons for the slower pace of activity could be related to seasonality patterns typically seen in the seniors housing data including influenza and influenza-like illnesses and winter weather, which tend to subdue both inventory growth and demand. Anecdotally, many properties lost marketing days in January and February due to the weather and flu-related property-level quarantines. Given that these factors were especially harsh during 4Q2017 and 1Q2018, there may potentially be a corresponding bounce back in in the second quarter as delayed move-ins from the winter months take place.

Inventory growth largely concentrated in a few markets

The map below shows the parts of the country that have seen the most change in independent living inventory in the past year. During the past year, there have been more than 11,000 independent living units added to inventory among the primary and secondary markets.

About one third of this growth in inventory occurred in seven metro areas: Dallas, Philadelphia, Columbus, Fort Myers, Houston, Detroit and Austin. While Minneapolis and Miami also saw strong independent living inventory growth over the past year, Baton Rouge, Charleston and Syracuse were geographies that experienced the greatest percentage gains in inventory.

Are construction starts plateauing or rising?

After peaking in mid-2016, construction starts in the secondary markets have been falling on a four-quarter moving-sum basis. In the primary markets, however, the peak was earlier (mid-2015) and the trend for the primary markets appears to be flat or rising.

Of note, anecdotal reports of delays in starts due to the weather and interruptions in starts due to delays in financing and funding may have caused some groundbreaking dates to be pushed back. And while construction starts data are subject to revision for these reasons, the numbers provide insight into what is in the pipeline. Interestingly, while the data shows a potential increase in independent living starts in the 99 primary and secondary metropolitan areas tracked by NIC MAP, it also shows a slowdown in starts for assisted living, which may signal increasing interest in independent living from investors and developers.

Seniors housing and care updated transactions figures show a total of $2.6 billion closed deals in the first quarter of 2018. That includes $1.7 billion of seniors housing, and $900 million in nursing care transactions. The total volume was down 5% from the previous quarter’s $2.7 billion, and down 45% from the first quarter of 2017 when volume totaled $4.7 billion.

The central theme of the first quarter of 2018 is that activity by private buyers—which include any company that is not publicly traded, e.g. a private REIT or single owner or partnership, family offices, etc.—continues to be very consistent. The first quarter of 2018 represented the 19^th consecutive quarter of more than $1 billion in closed transaction volume by private buyers, totaling $1.3 billion.  With only $2.6 billion closing in the first quarter overall, private buyers represented half of all closed volume. Private buyer volume was up 9% from the fourth quarter of 2017. However, it was down 8% from a year ago in the first quarter of 2017 when volume registered $1.4 billion.

As far as the other buyer types, both public and institutional buyers each closed on about $600 million worth of transactions in the first quarter. Public buyers registered $547 million in transactions and institutional buyers totaled $606 million. The public buyer represented 21% of total volume in the first quarter, an increase from a year ago in the first quarter of 2017 when it represented only 9% of volume. The institutional buyer represented 23% of the total volume in the first quarter of 2018, which was down from 55% a year ago.

Institutional buyer volume was down 41% from the last quarter when volume registered $1.0 billion. Volume was down 76% from a year ago in the first quarter of 2017 when institutional buyers registered an unusually high amount of volume for a first quarter at $2.6 billion. The first quarter of 2017 was the highest closed volume for the institutional buyer going back to 2008, primarily because of several large Blackstone transactions.

Public buyer volume was up 36% from last quarter, although from a relatively small base of only $403 million, and up 26% from a year ago, again from a relatively small base of only $433 million. The public buyers have had a harder time competing for deals as their cost of capital has significantly increased over the past year. Below is a graphic which is a good measure of the cost of capital within the sector for the public markets. The orange line represents skilled nursing and includes the cost of capital of Sabra Health Care REIT and Omega Healthcare Investors. The blue line represents seniors housing and includes the “Big 3” healthcare REITs: HCP, Ventas and Welltower.

This graphic shows the premium at which the stocks are trading relative to their gross asset value. That means when the REITs trade at a premium to asset value (asset value is based on the private market capitalization rates and the REIT’s portfolio holdings) then the REITs can go out and buy properties by raising equity and realize an instant increase in value because the private market value is lower than their publicly traded equity value. In other words, their cost of capital is low when the premium is high. This can basically be an arbitrage play when these stocks are trading at high premiums. As seen here starting in 2013, the premium began to trend down, which in turn effectively raised their cost of capital making it harder to pay higher prices for properties. This premium took another leg down in 2015, which is reflected in closed transaction volume as public REIT activity decreased dramatically after the second quarter of 2015 and continued to decline through 2017. Now, well into 2018, we see a significant decrease in the premium and, in fact, it turned negative for seniors housing at nearly -10% in the first quarter 2018.

As private equity is still relatively active in the markets and pricing still remains strong, many public REITs are finding it harder to compete for properties, especially larger portfolios. Anecdotally, many deals closed by public REITs include existing operator relationships.

The Labor Department reported that there were 164,000 jobs created in the U.S. economy in April, below the consensus expectation of 193,000.  This followed a downwardly revised gain of 324,000 jobs in February (originally reported as 326,000) and an upwardly revised gain of 135,000 in March (originally reported as 103,000).  The two-month revision was a positive 30,000 new jobs.

The April increase in employment marked the 91^st consecutive month of positive job gains for the U.S. economy, the longest period of steady job growth on record by the BLS. Through the first three months of the year, job gains have averaged 208,000, stronger than the monthly pace of 182,000 in 2017.

The unemployment rate fell to 3.9% in April from 4.1% in March, its lowest level in 18 years. This is well below the rate of what is generally believed to be the “natural rate of unemployment” of 4.5% and continues to suggest that there will be growing upward pressure on wage rates.  The jobless rate is calculated from a different survey than the survey used to calculate the number of new jobs (the household versus the establishment survey, respectively).

Average hourly earnings for all employees on private nonfarm payrolls rose in April by four cents to $26.84. Over the past 12 months, average hourly earnings have increased by 67 cents, or 2.6%.

The number of long-term unemployed (those jobless for 27 weeks or more) was little changed at 1.3 million and accounted for 20.0% of the unemployed.  A broader measure of unemployment, which includes those who are working part time but would prefer full-time jobs and those that they have given up searching—the U-6 unemployment rate—fell to 7.8% in April from 8.0% in March and was down from 9.2% as recently as December 2016.  April’s rate was the lowest level in 17 years.

The labor force participation rate, which is a measure of the share of working age people who are employed or looking for work fell by 0.1 percentage point to 62.8% but was up from 62.4% in 2015.  Nevertheless, this remains quite low by historic standards, at least partially reflecting the effects of retiring baby boomers.

Health care added 24,000 jobs in April and 305,000 over the past year.

The April jobs report will provide further support for increases in interest rates through 2018 by the Federal Reserve. Already, the Fed increased the fed funds rate 25 basis points at its March 20/21^st FOMC meeting.  The Fed has raised rates by a quarter percentage point six times since late 2015, and most recently to a range between 1.50% and 1.75%, after keeping them near zero for seven years.  Hence, it is likely that there will be another 25-basis point increase announced by the Fed at its June FOMC meeting.

The Labor Department reported that there were 223,000 jobs created in the U.S. economy in May, well above the consensus expectation of 190,000.  This followed a downwardly revised gain of 159,000 jobs in April (originally reported as 164,000) and an upwardly revised gain of 155,000 in March (originally reported as 135,000).  The two-month revision was a positive 15,000 new jobs.  After revisions and thus far five months into the year, payrolls gains have averaged 207,000 per month, up from 182,000 per month last year.

The unemployment rate fell to 3.8% in May from 3.9% in April, its lowest level since April 2000. This is well below the rate of what is generally believed to be the “natural rate of unemployment” of 4.5% and continues to suggest that there will be growing upward pressure on wage rates.  The jobless rate is calculated from a different survey than the survey used to calculate the number of new jobs (the household versus the establishment survey, respectively).

A broader measure of unemployment, which includes those who are working part time but would prefer full-time jobs and those that they have given up searching—the U-6 unemployment rate—fell to 7.6% in May from 7.8% in April and was down from 9.2% as recently as December 2016.  May’s rate was the lowest level in 17 years.

In May, the number of unemployed persons declined by 772,000.  The number of long-term unemployed (those jobless for 27 weeks or more) was little changed at 1.2 million and accounted for 19.4% of the unemployed. Over the past 12 months, the number of long-term unemployed has declined by 476,000.

Average hourly earnings for all employees on private nonfarm payrolls rose in May by eight cents to $26.92. Over the past 12 months, average hourly earnings have increased by 71 cents, or 2.7%.  This is up from 2.6% in April and 2.5% on average in 2017.

The labor force participation rate, which is a measure of the share of working age people who are employed or looking for work fell by 0.1 percentage point to 62.7% but was up from 62.4% in 2015.  Nevertheless, this remains quite low by historic standards, at least partially reflecting the effects of retiring baby boomers.

Health care added 29,000 jobs in May, in line with monthly gains in the past year.

The May jobs report will provide further support for increases in interest rates through 2018 by the Federal Reserve. Already, the Fed increased the fed funds rate 25 basis points at its March 20/21^st FOMC meeting.  The Fed has raised rates by a quarter percentage point six times since late 2015, and most recently to a range between 1.50% and 1.75%, after keeping them near zero for seven years.  Hence, it is likely that there will be another 25-basis point increase announced by the Fed at its June 12th – 13th FOMC meeting.

NIC MAP^® Data Service clients attended a webinar in mid-April on the key seniors housing data trends during the first quarter of 2018. Key takeaways included the following.

Takeaway #1:  Seniors housing occupancy fell to 88.3%

The all occupancy rate for seniors housing, which includes properties still in lease up was 88.3% in the first quarter, down 90 basis points from 89.2% in the first quarter of 2016 and down 50 basis points from the fourth quarter.  This was the lowest occupancy rate in six years.   Notably, assisted living occupancy fell to a record low rate of 85.7% in the first quarter.

The quarterly decline in the overall occupancy rate stemmed from a marked slowdown in first quarter absorption as well as less inventory growth.  Winter weather typically causes a slowdown in both inventory growth and demand in the first quarter. This year, a particularly harsh flu season may have also slowed leasing activity as many properties lost marketing days due to flu-related property-level quarantines.

Takeaway #2:  Annual inventory growth outpaced annual absorption for both assisted living and independent living

Assisted living inventory growth has been ramping up for a longer period than independent living in the Primary Markets.   In mid-2012, the occupancy rate of independent living was the same as for assisted living at 88.8%.  Since that time, there has been a clear divergence in occupancy performance reflecting the differences in supply growth and demand for the two property types. For majority independent living properties, inventory growth exceeded absorption by 70 basis points in the first quarter—1.9% versus 1.2%.  The occupancy rate for majority independent living properties was 90.3% in the fourth quarter.  Annual inventory growth for majority assisted living properties was 4.7%, up a bit from the fourth quarter.  Annual absorption slipped back to a pace of 3.2%.

Key Takeaway #3:  Seniors Housing Occupancy: Twenty-two markets down, seven up year over year

The following slide shows a comparison of occupancy rates among the Primary Markets. The blue dot shows the current occupancy rate, and the orange dot shows the year-ago occupancy rate. The top of the blue bar shows the all-time highest occupancy rate by market, and the bottom of the blue line shows the all-time low.

Fifteen markets had occupancy rates higher than the Primary Market average. Starting on the left is the market with the highest first-quarter occupancy rate: San Jose, at 95.1%.  After San Jose, the highest occupancy levels are in Baltimore, Portland, Sacramento, Pittsburgh and Seattle, all markets with occupancy rates above 91%.  At the other end of the spectrum are San Antonio, with an occupancy of 78.3%, followed by Houston, Atlanta Dallas, Las Vegas and Kansas City, all with occupancy rates below 85.0%.

Twenty-two of the thirty-one markets had occupancy rates lower than year-earlier levels, while seven markets had higher occupancy rates than one year ago and two were unchanged (Sacramento and Philadelphia).   The most significant deterioration occurred in Detroit (down 360 basis points to 87.3%), St. Louis (down 3 full percentage points from 91.1% to 88.1%), Phoenix, Houston and Washington DC.  The most improvement occurred in Portland Oregon where occupancy increased by 1.7 percentage points to 93.0%, while Riverside was up 1.0 percentage points to 86.3%.

Key Takeaway #4:  Same-store rent growth decelerated

Same-store asking rent growth for seniors housing decelerated in the first quarter, with year-over-year growth of 2.3%.  This was down from 3.7% in the fourth quarter of 2016 when it reached a cyclical peak and the smallest increase since early 2014.  Asking rent growth for assisted living was 2.9% for the first quarter, up 20 basis points from the fourth quarter. For independent living, rent growth slipped back to 2.0%, half the 4.1% pace it achieved in the third quarter of 2016 when rent growth reached its highest pace since NIC began collecting this data.

According to the U.S. Bureau of Labor Statistics, average hourly earnings were up 5.0% for assisted living employees as of Q4 2017.  Together, these lines show the pressure operators may be having as expense growth has been pressured higher, while rent growth has been easing.  For many operators, labor expenses amount to 60% of their expenses.

Key Takeaway #5:  Closed Seniors Housing & Care Dollar Volume: $2.3Bn for 1Q18

Seniors housing and care transactions volume totaled $2.3 billion in the first quarter based on preliminary estimates. That includes $1.5 billion for seniors housing and $800 million in nursing care transactions. The total volume was down 17% from the previous quarter’s $2.8 billion and down 50% from the first quarter of 2017 when volume came in at $4.7 billion.

The first quarter of the year is usually one of the weakest quarters in volume, due to the usual rush to close deals at the end of the year, leaving the pipeline a bit empty flowing into the first quarter.  There were some other dynamics at play as well toward the end of last year with tax reform but the first quarter of 2018 was relatively quiet overall, even with these preliminary figures.

A few relatively notable transactions in the first quarter were:

• Invesque (Toronto-based group) bought 40 properties from Care Investment Trust including mostly seniors housing units but some skilled nursing beds to total over 3,300 units /beds for over $400 million, and
• Cascade/KKR JV bought 18 seniors housing properties from Welltower for a little over $300 million including over 1,400 units.