Senior housing market valuations peaked at the end of 2015, but since descending from that high investors have struggled to agree on the sector’s future. While Millennials overtook Baby Boomers as America’s largest generation last year, Baby Boomers remain an enormous generation and number some 76 million individuals. Many of those people are approaching ages where they are more likely to use senior housing services, and that demographic shift promises to accelerate demand in the senior housing industry.
But the story isn’t that simple. The sector is experiencing headwinds as critical markets become overbuilt, yet experts don’t agree on the severity or scope of the problem. While short-term and long-term prospects in the sector differ, investors who understand the evolving dynamics at play are well positioned to take advantage of market opportunities.
Overbuilding and market saturation
Overbuilding is the biggest problem facing the senior housing industry. JLL’s most recent Senior Housing Market Report said overbuilding pushed average occupancy levels for senior housing assets, including independent living, assisted living and memory care, below 90% on the national level. That’s down 190 basis points from the cyclical high.
Assisted living and memory care assets have been especially impacted by this supply increase, and occupancy levels in key markets like Dallas and Las Vegas hover around 85% or below. In the most saturated markets many developers are offering rent concessions to attract tenants, but despite those efforts, JLL said absorption rates are sluggish in overbuilt areas.
While it’s clear that overbuilding has damaged several senior housing markets, recent research from National Real Estate Investor suggests some overbuilding concerns may be overblown. NREI’s research said much of the sector’s construction activity has been concentrated in just a handful of markets. Although the 99 largest U.S. metro areas experienced an influx of 35,000 new units over the last year through June, 30% of those additions happened in just seven markets: Dallas, Minneapolis, Houston, Atlanta, Miami, Chicago and Boston. That suggests there could still be room for expansion in unsaturated markets.
Aging Baby Boomers position the sector strongly
Despite the headwinds, the senior housing sector is in position to benefit from a massive demographics shift. Baby Boomers began turning 65 in 2011, and today more than 10,000 Baby Boomers turn 65 everyday. Those people will fuel demand for senior housing, and if penetration rates hold steady, JLL said demand will double by 2035. That’s a serious upside to the industry, and it’s the main reason investors are throwing so much money into senior housing. Much of that capital has gone to construction, and as of Q4 2016 construction in the sector grew 5.7% as a share of total inventory.
While the demographics clearly favor senior housing, most people only need such services once they are over 80 years old. So despite the excitement, Baby Boomers should not have a serious impact on demand until 2026, although there may be some market impact as the oldest Boomers turn 75 in 2021.
To capitalize on this shift developers are increasingly betting on large urban facilities that, instead of focusing on one segment of care, offer multiple services under the same roof. This model could prove attractive to aging Baby Boomers and their families because residents know they will be able to stay in place as they age and their needs change. These types of communities also make it easy for couples with different needs to continue living together. While developers building these large urban facilities are betting that urban dwellers will not want to move to the suburbs as they age, JLL said these assets are a smart move and will likely attract premium pricing from institutional capital in the long-run.
The bottom line
Several senior housing markets are experiencing headwinds from overbuilding. Those headwinds are likely to continue until Baby Boomers actually start to need senior housing services. Saturated markets can expect downward pressure on rents and falling occupancy levels, but assisted living and memory care assets are the most at risk. Independent living facilities are expected to perform better, since those are the first services seniors tend to use and should be the first to benefit as Baby Boomers age.
“In markets with relatively low occupancy levels, slow lease-ups, and pricing concessions, it is just a matter of time before financial distress begins to become evident for some assets,” said JLL’s report.
Despite saturation concerns, JLL said strong investor demand should keep prices stable. While most Baby Boomers are years away from needing senior housing, investors understand that demographics strongly position the sector and are expected to keep betting on it. Although several markets are plagued by saturation problems, there are certainly opportunities for developers to build the right properties in the right markets. While these dynamics make senior housing a tricky asset, investors who lay strong groundwork now will benefit massively as Baby Boomers age. They just need to wait a few years.