Flush with cash, private equity funds struggle to find high-yielding seniors housing investments.
By Bendix Anderson
In July, a new seniors housing community opened in Paoli, Pa., about 25 miles northwest of Philadelphia. Just a month later, more than half of the 78 assisted living and memory care apartments at Daylesford Crossing were leased or committed to be leased.
“The lease-up has been very strong,” says Chris Kazantis, director for AEW Capital Management, a private equity fund manager based in Boston. AEW developed Daylesford in partnership with Springfield, Pa.-based seniors housing operator Sage Senior Living.
Private equity firms like AEW continue to commit new capital to seniors housing — partly motivated by the strong performance of communities like Daylesford.
However, high prices for seniors housing properties are steering private equity funds away from new, fully leased properties. Instead, private equity funds are pouring their billions of dollars into ground-up seniors housing developments or into existing properties that can be improved to add value.
Favorable fundraising environment
Private equity funds have a lot of money to spend on seniors housing. Often the money comes from institutional investors such as pension funds, foundations and endowments, which contribute hundreds of millions to these private equity funds.
For example, in July 2014, AEW closed the fundraising for its second seniors housing fund, AEW Seniors Housing Investors II, with commitments from 11 investors and $371 million. That’s a lot more than the fund’s original $300 million target.
As of late July 2014, AEW had already invested $302 million of the fund’s capital, including several new developments such as Daylesford Crossing.
AEW is far from the only seniors housing private equity fund manager to raise more capital than its original target. In May, Prudential Real Estate Investors (PREI) closed its $629 million Seniors Housing Partners V. The private equity fund raised much more than its original target of $500 million and could have grown even larger.
“We cut it off,” says Noah Levy, head of PREI’s senior housing business. “We didn’t want it to get too big.”
The 15 investors in Seniors Housing Partners V are institutional investors including U.S. public and corporate pension plans.
In the first seven months of 2015, closed-end real estate funds targeting niche property types, including seniors housing, have raised $4.4 billion from investors.
That’s much more than the $1.9 billion niche funds raised in 2014, or the $2.6 billion raised in 2013, according to Preqin, a data firm with offices in New York City and London.
The largest fund closings so far this year include Harrison Street Real Estate Capital, which closed its $850 million Harrison Street Real Estate Partners V fund in January. The fund is making opportunistic investments in real estate, including seniors housing and student housing properties.
In April, Kayne Anderson Real Estate Advisors (KAREA) closed its fundraising for its $1 billion Real Estate Partners IV private equity fund for value-added investments.
Pension funds have had more money to invest because many institutional investors have gradually increased their allocation to real estate, from around 5 percent in the late 1990s to closer to 10 percent today.
A growing number of new investors are also warming up to real estate — particularly seniors housing. “We are seeing more investors making a particular play on seniors housing… who may not be large or consistent real estate investors,” says Prudential’s Levy. “We have not seen that in the past.”
The pool of investors also has broadened. In addition to institutions like pension funds and endowments, some private equity funds now raise capital through retail channels, such as investment managers who raise investment from financial institutions and wealthy individuals.
Niche sector becomes core
Private equity funds that focus on core real estate are increasingly willing to consider seniors housing. Harrison Street, for example, includes seniors housing in its core real estate funds.
These private equity funds consider seniors housing “core” real estate partly because new data on the seniors housing market now helps investors assess trends like vacancy rates and new construction underway in the seniors housing market.
“Investing in seniors housing is becoming more mainstream,” says Beth Mace, chief economist for National Investment Center for Seniors Housing & Care (NIC). “There is more familiarity and understanding by the investment community in the sector due to greater transparency in the data.”
This data shows the resilience of the seniors housing business in good times and bad. Total returns on seniors housing investments averaged 14 percent a year over the 10-year period that ended in the first quarter, according to the National Council of Real Estate Investment Fiduciaries (NCREIF).
On a 10-year basis, total returns for seniors housing exceeded both the National Property Index and apartments by roughly 600 basis points, according to NCREIF.
“The returns are quite strong,” says Mace. “Best-in-class properties have been producing good income returns as well as appreciation returns.”
Seniors housing fundamentals are also strong despite a large number of new seniors housing properties that opened in 2014. The sector also endured a tough flu season in the winter of 2014-15 that created some new vacancies at seniors housing communities as some seniors passed away.
The occupancy rate at independent living communities fell 20 basis points to 91.2 percent in the second quarter of 2015 from the first quarter, according to NIC data on the top 31 metro markets for seniors housing. At assisted living communities, the occupancy rate fell to 88.4 percent from 88.6 percent.
“Over the next 12 months, we expect demand to largely match supply and occupancy rates to improve modestly,” says Mace. “Demand, as measured by net absorption of units, picked up in the second quarter. In the third quarter, I expect demand to pick up further.”
High valuations pose dilemma
Strong real estate fundamentals continue to attract investors. Fund managers now face the challenge of how to deploy the capital they have raised. Prices for fully leased seniors housing properties are now too high to achieve the yield that many private equity funds need to provide to their investors.
“It’s pretty frothy from a valuation perspective,” says Aron Will, executive vice president of national senior housing for CBRE Capital Markets.
In the fourth quarter of 2014, the average sales price of a seniors housing unit was $147,000 on a 12-month moving average, up 64 percent from its low point in 2010. Meanwhile, the average cap rate for seniors housing continues to hover between 7.5 percent and 7.9 percent, according to NIC.
With prices so high, private equity funds are less interested in the bidding wars to buy new, fully leased seniors housing properties located in prime, metropolitan markets.
“They are not typically going to go for properties that are going to price at the top of the market per unit,” says Richard Swartz, executive managing director and national head of senior housing equity, debt and structured finance for Cushman & Wakefield.
Private equity buyers accounted for just 2.8 percent, or $339 million, of the seniors housing and skilled nursing properties acquired in the first half of 2015, according to data from NIC. That’s down from 9.5 percent, or $579 million, in the first half of 2014.
“Private equity’s share went down,” says Mace. “For many public real estate investment trusts (REITs), their numbers went up.”
REITs have a lower cost of capital than private equity fund buyers. REITs also tend to hold the properties they purchase for longer periods of time, which may make REITs more willing to bid high for portfolios of properties they believe will grow their rents.
“The REITs are favored buyers at this point in the business cycle,” says Mace. “They are winning deals.”
Prudential solves the challenge of finding deals by forging strong relationships with operating partners that often provide opportunities for future deals.
In May, PREI invested $110 million from its SHP V fund to buy three seniors housing properties totaling 391 units of assisted living and memory care housing. Hearth Management, which previously owned the properties through a joint venture partnership, will continue to manage the properties.
“It is a new operator for us,” says Levy. “We look forward to partnering with Hearth Management, a proven seniors housing operator, to deliver attractive risk-adjusted returns for SHP V investors.”
The communities are relatively new. All three have opened since 2012. The properties are also located in markets far away from the largest coastal cities. The three properties are located in Hendersonville and Franklin, Tenn., near Nashville, and in Glastonbury, Conn., Southeast of Hartford.
“A lot of the private equity funds that had a bias to big markets are now going into secondary and tertiary markets and not blinking,” says CBRE’s Will.
High risk, high reward
Private equity funds eager to make high-yielding investments are also putting capital into properties that have some potential upside to their valuation.
“In a perfect world, we would only invest in high-yield projects with no development risk, but the riskier the project, the higher return expectation,” says Max Newland, KAREA’s managing director of healthcare real estate.
KAREA’s new $1 billion Real Estate Partners IV fund targets value-added investments, including independent living, assisted living and memory care communities.
“We’ve got a very deep pipeline of investment opportunities — all cash-flowing assets with varying degrees of stabilization,” says Newland. “We are targeting Class A properties in markets with strong demographic trends.”
Investors are interested enough in value-added seniors housing properties to commit dollars to relatively new private equity funds.
In January, ROC Seniors Housing Fund Manager announced that it had raised an additional $137 million in equity, raising its total commitment to $450 million. The money is specifically targeting seniors housing and medical properties in the U.S.
ROC is quickly putting this money to work. It acquired about $390 million in seniors housing properties in 2014 and early 2015, and has a strong pipeline of properties to acquire.
“Our objectives are to provide high current income and capital appreciation by acquiring and optimizing properties through capital investment and resident service,” says Robert Morse, chairman of Bridge Investment Group Partners, ROC’s parent company.
Bridge has a long history in the apartment business, owning and managing a portfolio of about 32,000 apartments, including seniors housing units.
New development beckons
Private equity funds focused on seniors housing are also investing more of their capital in ground-up development than in the recent past. “The returns are pretty enticing,” says Mace.
PREI, for example, is able to allocate up to 20 percent of the capital in SHP V to new development. That’s up from 10 percent in SHP IV.
“Because of the competitive landscape, private equity funds are making much heavier allocations to development,” says CBRE’s Will.
Other private equity funds that once invested 20 to 25 percent of their capital in new development now invest 30 to 40 percent. “They can’t get their returns anywhere else,” says Will.