Are REITs taking the senior housing industry down an unsustainable path?

Last December I wrote an article with some predictions. One of those predictions was that we will begin to see some overbuilt marketplaces and corresponding senior housing community failures.   A few weeks ago Senior Housing News published two articles that would seem to suggest my prediction will come true.  

Are REIT’s Suckers

The first article published June 19,  “REIT-Backed Buyers are Senior Housing Sellers’ Best Bet”  makes the point that regional operators who are backed with REIT money are “. . . paying ‘crazy’ prices because the REIT cost of capital is so low . . .”  When I read this article my first cynical, irreverent thought was to wonder if this article could be titled “Are REITs being suckers?”   In many ways, the low cost of capital is a great thing for senior housing, but it also creates more pressure on capital providers to seek out higher return investments and no matter how you slice it, higher returns equals higher risk.  I am very concerned that some of these REITs are heading down the same path as the one so recently traveled by home mortgage lenders who deluded themselves into thinking there was no end to the ever rising prices..

  Inventory Growth

The very next day, June 20, they published this article: “NIC: Senior Living Inventory Growth to Rise 63% in Next Year”.  This is a great headline (something I might have written myself) but not necessarily all that helpful because what is perhaps more important, is to understand the percentage increase in total beds. The bottom line is that NIC is projecting 10,000 new assisted living beds will come on-line in the coming 4 quarters which is 63% more new beds than the previous 4 quarters.   According to a rough estimate I did, based on some less than perfect data I extracted from the NIC website, there are around 540,000 what they classify as “investment grade” assisted living beds in the U.S. so a 10,000 bed increase is less than 2% which sounds a lot better.  And yet . . .

• While not at all statistical (which is even more dangerous than trusting statistics), it is hard for me to believe that the annual increase in beds is anything close to being as low as 10,000 beds, which is just 133 total new properties figuring an average size of 75 residents.  My guess would be a doubling of that number would be safer.
• NIC reports a pretty persistent occupancy rate of just under 90% and so even a 2% increase in inventory will cause pain.
• Those bed increases are unevenly distributed which means there are likely to be some marketplaces that will be really pounded and others that will be unaffected.   Interestingly, it is that likely that some of the best markets (today) that will end up being the hardest hit.
• As I talk to assisted living operators, their number one concern seems to be filling and keeping full their units. This further suggests rough waters ahead.
• Ultimately, because there is so much sameness in the assisted living marketplace, those companies and more importantly those local executive directors and marketing directors who are clever and smart will consistently beat the market.

It is my hope that the REITs will act with great prudence, because the risk is that a clump of imprudent investments will result in a short-term or medium-term poisoning of what really is and will continue to be a great investment opportunities.   What do you think?   Are we heading into troubled waters or something else?   Steve Moran