Uptick in seniors housing construction bears watching

Al Rabil is the managing partner and CEO of Kayne Anderson Capital Advisors' real estate private equity activities. He oversees the origination, execution and management of private investments in specialized niche real estate sectors, principally off-campus student housing, seniors housing and medical office. Al Rabil is the managing partner and CEO of Kayne Anderson Capital Advisors' real estate private equity activities. He oversees the origination, execution and management of private investments in specialized niche real estate sectors, principally off-campus student housing, seniors housing and medical office.

The growing number of developers new to the sector is cause for concern

One of my favorite questions from investors is, “What keeps you up at night?” As a fund manager within a $26 billion alternative investment management company, my response to that question may take many different shapes. (Kayne Anderson is currently managing KAREP REIT III, a $750 million investment fund targeting equity investments in the seniors housing, student housing and medical office sectors.)

For the seniors housing sector, the answer centers on new construction activity as we are experiencing a noticeable uptick in development after several slow years. Most readers are familiar with the perils of overbuilding that took years to work through after the late 1990s boom. 

Do recent trends suggest another boom is approaching? Although supply data does not currently support this claim, the industry must expand meaningfully to support demand trends. 

New supply is on its way…

As illustrated in the chart below, independent living and assisted living deliveries have been on the rise since bottoming out in 2011. In the top 100 markets, as defined by the National Investment Center for the Seniors Housing & Care Industry (NIC) and American Seniors Housing Association (ASHA), construction deliveries are nearing pre-recession levels. We expect further increases in 2014 and beyond, as capital inflows to the sector continue and the availability of construction financing increases. 

For more than 30 years, Kayne Anderson has been able to spot trends identifying niche sectors that are opportunistic due to marketplace dislocation, and Kayne Anderson Real Estate Advisors’ interest in seniors housing is a classic example of that model. 

During the last several quarters, my investment team has observed a noticeable increase in developers seeking equity capital. More than half of our current, incoming investment inquiries are for development projects. Although this trend alone is not particularly troubling given where we are in the cycle, the number of groups migrating to the sector with no demonstrable track record is unsettling. Although many of these projects will ultimately fail to attract capital necessary for successful completions, the trend of new entrants to the sector has given us pause. 

So is demand …

Unlike many other asset classes, the seniors housing sector is benefiting from a wealth of positive demand drivers: surging population of seniors, wealthier seniors (and their children), growth of life expectancy, and growth in home healthcare, all of which have been well documented in this publication.

Every day from now until 2030, 10,000 Americans will turn age 65. That means the 65-plus population will grow from approximately 40 million in 2010 to 71 million by 2030. That’s a 113 percent increase or, stated differently, a 3.9 percent compounded annual growth rate during the period.

Seniors housing market share will capture market share as asset class becomes more accepted

On a standalone basis, the aforementioned growth suggests the need for more seniors housing product. In addition, growth in the acceptance of the property type — and related penetration rates among seniors — further strengthen the story. 

We analyzed historical penetration rates, or the numbers of seniors who are utilizing the seniors housing stock, by age group. Between 1998 and 2010, penetration rates increased approximately 300 basis points for ages 60–64, 200 basis points for ages 65–74, and 800 basis points for ages 75 and above. Further advances in product quality, amenities, and operational expertise should allow this trend to continue in the foreseeable future.

Our analysis of future seniors housing supply needs is based on varying levels of penetration among seniors. Just to keep up with population growth, the industry will need to add 2.7 million units during the period ending in 2030. This analysis holds penetration rates flat. Assuming penetration rates continue to trend upward as more seniors are introduced to the asset class, it’s easy to envision a scenario where the existing supply would need to double by 2030. 

Specifically, penetration rate increases of 2 percent, 3 percent or 4 percent would require an additional 4.2 million units (117 percent growth), 4.9 million units (137 percent growth), and 5.5 million units (158 percent growth), respectively. 

Natural barriers to entry should temper over-exuberance

The seniors housing sector differs from the traditional real estate asset classes in several important ways, which should prevent the industry from overheating. Those distinctions include high resident turnover rates, state regulations (certificate of need, licensing), and expanding amenities required to attract residents. Layer in uncertainty surrounding government reimbursement rates, and you have an asset class full of idiosyncrasies that new industry entrants should understand. 

Transition of industry is afoot

The type of supply/demand dynamic we are experiencing in seniors housing is incredibly rare and will be a catalyst for the industry to transition from a “niche,” highly specialized subsector of real estate to something more mainstream. We are witnessing that trend through the expansion of the healthcare REITs and inflow of new institutional capital to the sector. 

Despite the uptick in new construction, Kayne Anderson is unequivocally bullish on the sector, having been one of the more active private buyers of seniors housing assets — and other healthcare-related assets — during the last year. We are able to deploy a “boots-on-the-ground” strategy with respect to investments in this operationally intensive sector, a capability that many in the industry do not have. 

The Baby Boomer generation is responsible for 80 percent of the aggregated wealth in America and, for the most part, can afford to live in active seniors housing communities. Seniors are more active, wealthier and living longer. As a result, they are contributing more to the communities in which they live than ever before. 

Although we’ve been careful picking our spots within the sector, we have amassed a compelling platform and have an incredible pipeline of future investment opportunities.

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