Page 12 — Health Care & Life Sciences Quarterly — October 2022 SENIOR HOUSING - UPDATE Let us Guide Your Senior Living Community to Success Consulting and Managed Services Call today to learn more. 720-400-3616 • Operational expertise • Regulatory compliance • Resident wellness programs • Clinical expertise • Sales and marketing • Resident satisfaction • Human resources and talent recruitment • Financial oversight • Innovative technologies • Centralized procurement • Project feasibility and development Independent Living | Assisted Living | Memory Care | Wel | 12136 W. Bayaud Ave. Suite 200, Lakewood, CO 80228 T he actions of the Federal Reserve are the most sig- nificant impact on senior housing real estate at this time. But, there are other new developments in this sector. The National Investment Center reported second-quarter figures for the Denver metro and Colo- rado Front Range areas in August, and they show the average over- all Denver metro seniors housing occupancy at just under 82%, or up nicely from about 78% in second- quarter 2021, with year-over-year rent growth of 3.6%, both of which lag national indicators slightly. The second-quarter Denver metro construction supply pipeline as a percent of inventory is slightly above the national average, with the metro penetration rate far above the national penetration rate, both of which indicate plentiful supply relative to demand, especially with just over 1,000 new units of senior housing under construction as of the second quarter in the Denver metro area. NIC also released in Septem- ber the first-ever definition of the “active adult” sector. What are active adult rental properties? NIC defines the active adult segment as follows: Active adult rental proper- ties are age-eligible, market rate, multifamily properties that are life- style focused; general operations do not provide meals. These properties aim to provide independence coupled with oppor- tunities for social engagement that reflect the active lifestyle of their tenants. Clearly defining the seg- ment will enable better data collec- tion on the growth and performance of the sector, which supports the transparency investors need and ultimately provides greater access and choice for older adults. With its new report, NIC has defined a new senior living prod- uct type for the first time since the 1990s. The Federal Reserve on Sept. 21 raised the benchmark fed funds overnight rate another 75 basis points, or 0.75%, which now puts it at the mid-3% range, affecting bor- rowing costs for all commercial real estate, including senior housing. Although the strongest life insur- ance companies are quoting rates in the mid-5% range on five-year terms, the Department of Housing and Urban Development, Fannie Mae and local banks generally are quoting north of 6% interest rates even with 60% loan to value and more than 1.25 debt-service cover- age. I have seen some deals priced at 7% interest being terminated by borrowers due to rate shock. While I am not a lender or mortgage broker, and strong borrowers are encour- aged to shop aggressively, especially asking for lenders’ best three- to five-year interest-only terms, it is clear the financing environment has changed dramatically since the beginning of 2022. Capitalization rate expectations are beginning to increase. Repric- ing is occurring in offerings. Many senior housing deals being closed in August and September were based on rates locked in 60 to 90 days prior, so recently closed deals are not good indicators of changing cap rates. Capitalization rates are not just a historical fact derived from comparable sales but a dynamic indicator increasing in real time as marketplace participants measure debt and equity yields and adjust their “going-in” cap rate require- ments, expectations and pricing accordingly. Appraisers label it the mortgage-equity method, lenders call it a DSC requirement, but it is the same thought process to re- price expectations. Equity investors now look at rising yields in “safe” Treasurys and other bonds with renewed interest in a way they did not a year ago, so equity investors are also pulling back slightly. There has been a lag effect for rising inter- est rates to impact cap rates, but I am seeing more and more discon- nect between buyers and sellers. On the positive side, if the Fed is successful in battling inflation (including rent increases), this eases the burden and uncertainty on senior housing workers, the major- ity of whom are not homeowners and who are quite stressed by rising housing costs. This could lead to a slowdown in the increase in wage increases and improve profit ratios for communities over time. Demo- graphically, what is also very posi- tive is that the relatively flat growth of key seniors housing demand seg- ments we have experienced in the last 10 years (in the range of 1.5% to 2% annually) is about to be overtak- en by the accelerating growth of the 80-plus cohort as the Great Depres- sion “baby bust” of 1928-1940 is left behind. Most of the major operators and real estate investment trusts have reported 400 to 500 basis point increases in occupancy year over year 2021 to mid-2022, so perhaps this is already happening? I am not sure, but it makes sense. Also, the industry is riding a wave of increas- ing senior housing affordability, which is up 205% since 2008 despite rent growth of 140%, according to NIC and Bloomberg – tough to see given the major supply increases in the 2017 to 2021 period, which are just now being absorbed. If the Fed is successful fighting inflation, then there could also be a modera- tion in the growth of most expense categories, which could result in very strong income statement profit ratios in the coming two to three years and which would set us up for another nice round of deals and help valuations. But, all of this is predicated on the Fed engineer- ing a soft landing for an economy that has been in overdrive for two years. s Senior housing: Can the Fed deliver a soft landing? Michael J. Martin, CFA, MAI Founder and president, Martin Property Research Inc.