With solid demand, increasing occupancy and reduced supply, the underlying fundamentals driving top-line revenue growth in senior living are good, making it difficult not to get excited about the sector this year, according to one financial expert.
Capital market dynamics and shifting valuations are affecting senior living, but AEW Capital Management Research Group Director Rick Brace told McKnight’s Senior Living that the sector is well into its recovery phase of the market cycle. That strong outlook is driven by demographic trends and an increasing demand for third-party care.
In a new fourth-quarter 2023 AEW Research Seniors Housing Research Perspective report, Brace laid out the argument for senior living’s market resilience — sustained demand and positive recovery indicators — along with how the sector has proven its value post-COVID in serving and caring for vulnerable older adults. That value, he said, creates attractive investment opportunities for new capital investment in a recovering market where transactions are increasing.
The sector remains in recovery mode with margins remaining under pressure, but improvements are evident with each passing quarter, Brace said.
“While capital market dynamics continue to weigh on assets and portfolios that were constructed at peak valuations with variable rate debt when borrowing costs reflected a different rate environment, the strength of the underlying fundamentals driving top-line revenue growth are difficult to ignore,” Brace wrote in the report.
Occupancy, demand drive improvement
Using occupancy as a benchmark, Brace said the sector fell off by 900 basis points from the end of the fourth quarter of 2019, but it now is within 140 basis points of where it was at that point — returning 80% of the way back from pandemic lows. Brace said that stabilized occupancy levels should be returning to pre-COVID levels by the end of 2025 or early 2026 and reaching 90% by the second half of 2026.
Supply-side dynamics also continued to improve, he said. The pace of supply growth is slowing dramatically, Brace said, with the amount of new construction starts down to 1.5% of inventory, down from 4.5% pre-pandemic. And the sector hasn’t seen the bottom yet, as the amount of space under construction is trending downward fairly quickly amid scarce new construction financing and tight lending standards.
Demand-related growth and absorption each were running, on average, 2.3% in the 10 years leading up to the COVID-19 pandemic before falling off. That pace in 2022 and 2023 was up to 5%, Brace said, adding that those figures continue to run ahead of pre-pandemic figures, signaling that it is not “knee-jerk pent-up demand.”
“We’re getting solid demand here,” he said. “It parallels the dynamics we’re seeing on the demographics side.”
As occupancy and demand climbed, Brace said, operators were able to implement rental increases of 8% to 10% in 2023, with anticipated increases falling between 6% and 8% for this year due to significant cost-of-living increase for residents.
Expense challenges ease
One of the bigger challenges for senior living is on the expense side, he said, noting that the sector took a big hit on expenses due to pandemic-related costs, including labor costs.
But Brace noted that labor availability and costs have continued to improve, with operators reporting fewer needs for contract labor. Wage inflation and wage growth also are coming down, giving operators a better sense of budgets, he said.
Transactions gaining momentum
Looking at the capital markets, Brace noted that investors have been strained for a long time, leading to limited transactions because of limited liquidity and difficulties selling and refinancing.
Much transient capital came into the market before the pandemic, he said, but those investors are realizing that senior living is different from multi-family and more of an operating business. Those investors, he said, are looking to get out of the senior living market and are willing to accept a much lower value for their assets.
That willingness creates opportunities as more high-quality assets are being marketed, Brace said. Although transactions were down 22% for 2023, the fourth quarter saw a notable uptick in momentum, both in dollars and the number of deals, he said.
