The fundamentals of the senior living industry remain favorable. Operating from the poor economic environment of the last few years, the industry has proven remarkably resilient – focusing simultaneously on improved customer service, lower operating expenses and more effective marketing. The industry continues to benefit from its excellent reputation for resident satisfaction. Development of new communities is increasingly driven by lower land costs, attractive financing, stable building prices, more efficient building and operating designs and aging competition. Many new communities with the latest amenities are opening at price points equal to older competitors.
The capital markets for senior living communities are favorable. The tax-free bond market has recovered from Meredith Whitney’s very public but inaccurate prediction of widespread defaults. The REITs continue to be active both as financiers and partners. Insurance companies and private equity are moving back into financing senior living, and HUD is becoming more efficient at processing, even with the high demand for its insurance. More regional and local banks have recognized the favorable characteristics of the industry and have entered the market.
Most lenders today are demanding more liquidity to survive poor economic conditions including slower fill-ups, higher marketing expenses, more move-in incentives and construction delays and overruns. If a provider cannot afford to provide this liquidity, Sims is helping the providers either through the sale of subordinate debt or equity to its clients or through the introduction of providers to institutional partners.
The strongest sectors of the industry have been assisted living and memory care. Rental independent communities have also been successful. Many believe that nursing homes and entrance fee CCRCs will fade away. We strongly disagree, as we have seen all segments of the senior living industry be in and out of favor since we began financing the industry in the mid-1960s.
For example, in the late 1970s and early 1980s, entrance fee CCRCs burst upon the market. Residents and investors were enthusiastic. However, some developments were poorly structured with inexperienced participants. Some defaults and bankruptcies occurred, and many entrance fee CCRC projects were suspect in the early 1990s. From the mid 1990s through the mid-2000s, entrance fee CCRCs had a spectacular run with high occupancies and ever more elegant facilities.
Of course, the worst residential housing market in 75 years began in 2006 and continues today. Considering the entire universe of entrance fee CCRCs and the poor housing market, entrance fee CCRCs have been remarkably successful. Nevertheless, consumers today are incredibly price sensitive, and it is imperative that communities in fill-up respond to that sensitivity. New communities will be more efficient in space and operations and more affordable.
The track record of value oriented, start-up entrance fee CCRCs remains strong. The rewards for remaining home-bound continue to dwindle: little house price appreciation and higher living expenses. Of course, all senior living communities are subject to the economic environment. A strong economy increases employment which increases the number of households looking for housing which helps seniors sell their homes. It seems as though the country is holding its breath for our politicians to have the courage to wisely manage our governments’ budgets. We all know what has to be done, and the quicker the better.
So far, the low cost of borrowing has enabled politicians to avoid the inevitable. The U.S. looks solid compared to some European countries, and our country has attracted investment money that would have gone to Europe. However, these countries will eventually solve their fiscal problems (as Canada and Australia did in the 1990s). Then, it could be the U.S.’s turn to face negative psychology and higher interest rates.
In 2005, the interest rate curve was relatively flat between short and long-term rates, and the credit spreads were extraordinarily narrow between lower and non-rated bonds versus A rated and higher bonds. As we begin 2012, the yield curve is very steep, and the credit spreads are wide. Over time, we expect short-term rates to rise more than long-term rates, and the credit spreads to remain relatively stable until our economy resumes substantial growth.
The senior living industry has performed remarkably well over the past five years. New developments can compete in price and offer enhanced facilities thanks to low interest rates, stable construction costs and efficient building and operations designs.
The U.S. economy is poised for growth. Politicians could accelerate growth by building up the courage to manage our governments’ budgets. If the politicians will not act on their own, the bond market will force the issue with higher rates. Eventually, a bipartisan plan (several have already been created) will pass, and the country can resume a higher growth rate. We expect short-term U.S. rates to rise after the European debt crisis is resolved. We also expect credit spreads to remain stable. The senior living industry will prosper in our current environment as long as resident satisfaction remains high and price points remain affordable, but industry success will increase enormously in a stronger economy.