Dr. Victor Calanog, VP of Research & Economics, Reis Inc
Ryan Severino, CFA, Senior Economist, Reis Inc
Brad Doremus, Associate, Reis Inc
Within the last 15 years, senior housing went from being a small niche property sector to one of the key secondary property types in commercial real estate. The primary driver of this change is the major demographic shift that is taking place in the United States; over the next couple of decades, there will be a marked increase in the number of elderly residents over the age of 65, and market observers are betting that this will generate significant demand for senior housing. In this paper, we will discuss this demographic shift and how the senior housing sector is evolving as a response. Additionally, we will take a look at the current state of the market using data from Reis.
An Aging Population
The sizeable increase in the nation’s elderly population is due to the aging of the “Baby Boom” generation, defined by the Census Bureau as anyone born between the years 1946 and 1964. The beginning of that interval coincides with the end of World War II and the return home of U.S. servicemen while the end of that interval coincides, roughly, with the growing use and (eventually) legalization of the birth control pill. In the generations before and after these two events, birth rates in the US and the absolute number of births per year were significantly lower. There were 76 million children born between 1945 and 1964, the largest generation up to that point. This can be observed in Exhibit 1, which depicts the population pyramid of the U.S.
Figure 1: U.S. Population Pyramid
Source: U.S. Census Bureau
This pyramid depicts the population, divided into men and women by 5-year cohorts. The graph clearly shows the bulge of persons that are roughly 50 to 68 years of age.
But Why Focus on Senior Housing Now?
Why should this sector be attractive today? Only the front end of the baby boomers are even of retirement age. It would appear that society is years away from the bulk of these people requiring the type assistance in living their daily lives that senior housing facilities provide. Moreover, this is an industry that has been prone to overbuilding in the past.
Typically, there is a significant uptick in the need for assistance in daily living around the age of 70. For empirical evidence of this, if we look at Chart 2, we see the percentage of people in the US that live in a multi-unit property by age of householder for 2013, the most recent year for which data was available.
Figure 2: Percent of Households Living in Multi-Unit Buildings, by Age of Householder, 2013
Source: U.S. Census Bureau, Trulia
The chart depicts the likelihood that someone, specifically the head of the household, lives in a multi-unit property. As the chart clearly shows, this probability generally declines as one gets older. The percentage falls steeply at first when people are in their 20s and 30s, from around 63% to about 23% by the time people are in their 40s. Not surprisingly, this has a strong negative correlation with home ownership rate by age in the United States, which increases significantly as people enter their late 20s and 30s. When people reach their 40s and 50s, the percentage of households living in multi-unit buildings continues to decline, though modestly. However, around 70 years of age, the trend actually reverses. The percentage of people living in multi-unit properties begins to rise again, fairly significantly – from around 19% in their early 70s to approximately 33% for those at the age of 85 or greater.
Although some of this increase is due to people moving from detached single-family houses into condos and apartments, much of this increase is attributed to people moving into some kind of senior housing facility. Continually, the age at which this transition occurs is getting pushed back over time – as people are healthier with longer life expectancies they prefer to stay in their house as long as they can. However, declining health will usually force households to make decisions about care for the elderly. Although 20% to 33% of households still represents a minority within those age brackets, demand for senior housing units is going to increase because the size of the baby boom generation is significantly larger than the generation that preceded it.
The upswing in the percentage of households living in multi-unit properties beyond the age of 70 is of paramount importance at this juncture because the oldest baby boomers are only two years away from reaching that age milestone. Beyond that point it is increasingly likely that they will require assistance with their daily lives and greater numbers than in the past will turn to senior housing facilities to meet their needs as their children will be unable (and often unwilling) to take care of them. Moreover, the sophistication and quality of the senior housing facilities today are far superior to those of the past that were frequently thought of as poor, often used as last resort. By comparison, many of today’s properties are high end – clean, safe, and with an abundance of amenities. They are attractive properties. It is estimated that baby boomers control over 80% of personal financial assets and more than half of all consumer spending in the United States. That provides millions of baby boomers with the ability to afford the high rents commanded by premium senior housing facilities.
The Case for Senior Housing
Favorable demographics is, however, just one of several reasons that investors are finding the senior housing market to be an attractive proposition. One of the less publicized analyses of the senior housing market involves the current supply situation. Despite the aging of the large baby boom generation, the supply of housing units is relatively restrained. The sector was overbuilt in the late 1990s, forcing many developers to go bankrupt or merge as vacancies climbed and demand waned. As a result, inventory growth came to a halt and never truly ramped up again. Moreover, the Great Recession of the late 2000s constrained lending, which further hobbled any development of senior housing. As such, the market today faces a potential shortage of senior housing for the eventual influx of baby boomers.
Investors also view the senior housing market as a very stable source of income that is less subject to business cycles, versus other property types. Much of this is due to the fact that the decision to move into senior housing is a life decision not usually reliant on the business cycle. For instance, health reasons often spur a move into a facility with some level of assistance. Exceptions certainly exist; a major downturn that cuts into a person’s savings may cause a delay in a move to an independent living facility. In fact, this consideration may have come into play for many in the midst of the recent Great Recession, potentially restraining demand for units, as retirement savings declined and home prices plummeted. It should also be noted that the relative lack of correlation with the business cycle provides a diversification element to investing in senior housing, potentially lowering an investor’s real estate portfolio risk.
Higher yields are another attractive characteristic of the senior housing market. But why does this property type offer relatively higher yields than the more prominent commercial real estate sectors? Less liquidity and coverage are two of the main reasons. Fewer players in the senior housing space than in other CRE property markets results in fewer transactions and thus a demand for higher yield. Likewise, investors also require higher yields as less market data and coverage leads to less market transparency.
Current State of the Market
Reis introduced its coverage of the Senior Housing sector in 2014 for 57 US markets and 184 submarkets. We separate our coverage into four primary care levels: independent living, assisted living, memory care and skilled nursing. In aggregate, the national senior housing vacancy rate is 8.7% as of the second quarter of 2014, down from 10.1% at the end of 2012. Vacancy is falling due to demand outpacing supply additions. Since 2012, occupied stock has expanded 2.4% versus inventory growth of 0.8%.
Rent levels associated with each subtype are correlated with the amount of care provided. As such, independent living rents are the lowest among the group. The average asking rent for one independent living unit in the U.S. during the second quarter of 2014 was $2,803 per month. At the other end of the spectrum are units in skilled nursing facilities, where the average rent reached $7,944 in the second quarter due to intensive care from both staff and specialized medical machinery. Assisted living and memory care facilities had average rents of $3,990 and $6,558, respectively.
Rent growth slowed across all four categories during the second quarter of 2014. Most notably, rent growth for assisted living fell from a robust 1.1% in the first quarter to 0.3% in the second. Rent increases for all four subtypes were between 0.2% and 0.3%. Rent growth over the past year and a half, however, has been slowest among the units providing the most care. Asking rents for memory care and skilled nursing units are up 1.8% and 2.0%, respectively, since 2012. Growth is relatively more robust for the assisted living and independent living categories, with asking rents up 3.6% and 2.7%, respectively, since 2012. This difference in growth rates is not really surprising. For one, rents at facilities providing more intensive care are much higher, so significant rent increases would be unlikely. These intensive care facilities also rely on steady payments from Medicare for many of their tenants: regulation constrains the amount by which operators can raise fees. Lastly, only the oldest of the baby boomer generation are approaching age 70, when the need for more intensive care is most prevalent. So at present, the population bulge represented by this generation is mostly pushing up demand for the units with less intensive care.
Current vacancy levels among the subtypes all fall in a fairly narrow range in the high single digits. The skilled nursing segment currently exhibits the tightest vacancy among the group at 8.1%. With a vacancy of 9.7%, the assisted living category has the highest vacancy level. This was not the case just a year and a half ago. At the end of 2012, independent living facilities had the highest vacancy level of the group at 11.0%. But in the time period since, the subtype had the largest vacancy compression of the group, with vacancy dropping 220 basis points to 8.8%. Meanwhile, memory care facilities, the subtype with the lowest vacancy at the end of 2012, actually saw vacancy rise by 10 basis points to 9.3% as of the second quarter of 2014.
Figure 3: Senior Housing Vacancy Rates
Why did occupancy decline for memory care facilities in the past year and a half while occupancy increased across all three other subtypes? Supply growth certainly played a role here. Since the end of 2012, the inventory of memory care units has increased 3.1%, far outstripping the supply growth rates of the other three categories. Independent living inventory expanded at the second highest rate, which was just 1.1%, a full 200 basis points below the rate of memory care supply additions. Much of that 3.1% growth came in the second quarter of 2013, which temporarily pushed vacancy in memory care facilities up to 9.9%. In contrast, skilled nursing inventory has barely budged over the past year and a half, growing just 0.3%.
Despite the large supply growth in memory care units, demand has remained strong since 2012, which limited the vacancy increase to just 10 basis points. Memory care occupied stock climbed 3.1% over the past year and a half. This was the second highest rate among the senior housing subtypes, eclipsed only by the 3.6% jump in occupied stock displayed by independent living units, explaining why independent living has had the largest compression in vacancy since 2012. Occupied stock in the assisted living and skilled nursing categories increased at roughly the same rates, 1.9% and 1.8%, respectively.
A More Granular Look
As you can see in the table below, the list of metros with the lowest aggregate vacancies in the country are dominated by markets on both the east and west coasts. From the east coast, Long Island is ranked as the tightest market with an overall vacancy rate of 4.3%. From Connecticut, both Hartford and New Haven rank in the top ten, and not surprisingly, two Florida markets also appear, Jacksonville and Miami. Among west coast markets, San Jose had the lowest vacancy, with just 4.5% of inventory lacking tenants. Oakland and Portland, OR ranked just below that as the third and fourth tightest markets in the nation. San Francisco rounded out the top ten with a vacancy rate of 7.0%. The bottom of the list, a.k.a. the metros with the highest vacancy, are mostly found in the spacious markets of Texas and in the Midwest. Dallas, San Antonio and Houston can all be found in the bottom five with vacancy rates of 12.4%, 11.5% and 11.4%. Two Ohio markets, Akron and Dayton, were among the highest vacancy metros, with three more (Toledo, Columbus and Cleveland) not far outside the bottom ten.
Table 1: Top and Bottom Metro Aggregate Vacancy Rates, Second Quarter 2014
To take a deeper look at metro performance, we examined recent trends in gross revenue (taking into account vacancy and rent changes) across all of our markets in each of the four senior housing subtypes. Interestingly, a look at the top and bottom performers across subtypes reveals very few similarities. The list of metros is quite varied, with some markets even among the top performers for one subtype while being a bottom performer in another subtype. However, there are a few consistencies. Most notably, San Francisco and Richmond have both been standout performers over the past year in each of the four property subtypes. Over the past year, gross revenue growth in San Francisco ranges from a low of 6.4% for independent living to a high of 8.1% for assisted living. Meanwhile, in Richmond gross revenue growth ranged from 7.2% for independent living to 9.2% for assisted living. On the downside, Hartford, CT was a serial offender, ranking among the ten worst performers in the independent living (+1.9%), assisted living (+0.1%) and skilled nursing (+2.5%) categories.
What Does the Future Hold for Senior Housing?
Risks and uncertainty remain: Supply remains restrained, but will developers eventually respond with a deluge of new product? Will there be any major technological or medicinal advances in the coming years that will further delay the influx of baby boomers? Will future changes to the nation’s healthcare system and Medicare program cause major disruptions in the senior housing business? Still, favorable demographics, restrained supply, steady income, potential diversification benefits and relatively high yields all contribute to the current growing interest in senior housing.