Green Street Advisors



Senior Housing: A Tale of Two Valuations

Lukas Hartwich, Green Street’s lead analyst for health care, lodging, and data centers, provides insight into senior housing demographic trends (e.g., the “silver tsunami”) and examines the sector’s outlook through the lens of supply and demand. He further opines on rising capital expenditures, as well as key pricing differences between public and private markets.

What Makes Senior Housing Distinct from Other Health Care Segments?

Senior housing is one of health care real estate’s largest segments, representing approximately $300 billion dollars of asset value within the U.S. The property type can be viewed as a cross between apartments and hotels. Like apartments, senior housing is a place of residence. However, it also offers more in terms of amenities and services, like a hotel. In contrast to other segments of health care real estate, senior housing is primarily paid for with "out-of-pocket" consumer spending. This insulates it from "stroke-of-the-pen" risk associated with government-funded payments while also reducing exposure to the inefficient U.S. health care system (e.g., ~20% of GDP vs. ~10% for many developed economies). For example, there is little risk related to government reimbursement policy changes with programs such as Medicare and Medicaid.

Demographic Shifts and an Evolving Demand Tailwind

Senior housing demand growth has been under pressure in recent years due largely to demographics.  On average, residents move into senior housing properties in their early-to-mid 80s, which means that the industry is currently catering to people born during the Great Depression. As you might expect, the tough economic circumstances during that era led to fewer births, which has acted as a drag on senior housing demand. However, Green Street anticipates demographics will switch to a demand tailwind starting in the early-to-mid 2020s as the industry starts to accommodate aging Baby Boomers.

Supply Pressures Continue

Unfortunately for the senior housing sector, weak demand trends have been met by oversupply, which has created a difficult operating environment. This supply pressure is partly a result of developers building in anticipation of the coming wave of aging Baby Boomers, which has yet to manifest. Green Street expects occupancy declines to persist through at least 2019, before occupancy growth turns positive in the early 2020s. However, investors should be mindful that supply can easily ramp back up, and is likely to do so as demand growth accelerates.

Cloudy Cap-Ex Data for a Young Sector

As is the case in many other property sectors, cap-ex requirements tend to be underestimated in the senior housing industry. Cap-ex captures the cost of keeping a property competitive over time, and Green Street has thoughtfully assessed cap-ex reserves in many sectors over the past couple years. When estimating the cap-ex requirements of senior housing, it's important to note that the industry is relatively young, with most properties having been built in the last 20 years. As a result, historical data is limited and likely understates cap-ex needs since spending ramps up significantly as properties age. Health care REITs have owned large senior housing portfolios for several years, which provides insight into real world cap-ex spending. Spending has picked up since 2013, likely due to at least two factors. First, many properties are nearing 20 years of age, which is when cap-ex spending tends to increase significantly. Second, elevated supply growth has forced owners to invest in properties in order to compete with newly built product. NCREIF data corroborates what the REITs have reported, showing increases in cap-ex over the past few years. Consequently, Green Street recently raised the cap-ex reserve for senior housing.

How is Senior Housing Priced Today?

Green Street assesses valuation from both a private, and public-market perspective. In the private market, senior housing is priced to deliver unleveraged, risk-adjusted returns in the 6% to 7% range, which compares to the sector average of around 6%. Therefore, Green Street believes senior housing is attractively priced in the private market. Unfortunately for public-market investors, REITs that own senior housing tend to trade at NAV premiums, which lowers prospective returns. As a result, senior housing is closer to fairly valued in the public market.

Within the health care sector, Green Street covers five unique property types. In addition to senior housing, these include hospital, life science, medical office buildings (MOBs), and skilled nursing facilities (SNFs). The health care team not only produces numerous reports to opine on the sector more broadly, but also dives deeply into each particular property type. For example, “Senior Housing Cap-Ex – Up It Goes” and “What’s the ‘Right’ Rent Coverage for SNFs?” were two key reports published this year to shed light on developing trends and challenge investors to reevaluate underwriting and management of health care properties.

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