Reports from high-profile agencies project robust numbers for future supply needs in senior housing.
The data indicates that the issue is complicated.
Always the contrarian, I remain wary on the sector.
I recently read a report from the National Investment Center for Seniors Housing and Care ("NIC") entitled "Looking into the Future: How Much Seniors Housing Will Be Needed?" The report intends on projecting through 2040 how many senior housing units will be needed to meet the needs of the growing baby boomer cohort. The import and accuracy of such an undertaking has tremendous implications for senior housing REITs such as Welltower (WELL) and Ventas (VTR). My intent today is to discuss the conclusions made by the authors of the report and challenge some of their assumptions.
The authors of the report, Beth Burnham Mace, Chief Economist, and Anne Standish, Research Statistician, both work at the NIC. They use data from the U.S. Census Bureau to project out how many baby boomers there will be in the future and use that number to project how much new senior housing should be constructed to meet demand given various penetration rates. The penetration rate is simply a ratio that shows much senior housing supply exists as a percentage of the target population. They use individual housing units in the numerator and a population to household conversion ratio in the denominator. In other words, instead of counting each person, they assume that married couples will, of course, be living together and occupy the same unit. After factoring in a supposed number of singles, the population to household conversion number comes out to 1.43 for those 80 years old and up. So, for 2019 numbers, the penetration rate is 18% (1.592 million units / 8.860 million households= 0.18).
To maintain that penetration rate, more units will need to be built for the target cohort as it gets larger - those persons older than 80 years of age. On to their conclusion:
For the 80 plus household cohort using an 18% penetration rate, there are approximately 881,000 additional units of inventory that will be needed to serve seniors between 2019 and 2030. Due to demographic patterns, the rate of change in demand accelerates further out, with a need for roughly 54,000 units per year required between 2020 and 2025; 95,000 between 2025 and 2030 and 105,000 between 2030 and 2040. In the immediate term, however, 31,000 units are needed in 2019; 36,000 in 2020; and 41,000 in 2021-fewer estimated units than were added to national inventory in 2018.
The number of units added in 2018 was ~48,000.
The primary issue with all the foregoing is that the penetration rates used in the study represent all supply, not occupied supply. It's not that the researchers were being deceiving or dumb. They explained the disparity in the article:
"... other analysts use occupied stock as opposed to total inventory. Probably there is no one perfect metric, but consistency for comparison purposes is important."
So, they were conscious and upfront about their choice. That doesn't mean that their choice was a good one. Total supply means nothing if rooms aren't occupied. Flooding a market with inventory is disastrous if people aren't soaking it up. Just ask Crocs. So, basing the needed inventory growth on a calculation that excludes the effects of demand ignores fundamental economic basics.
The decision to use supply penetration as opposed to occupied penetration is a folly that author Beth Mace was well aware of and should have avoided, according to observations she made as reported by an article on Senior Housing News that was published a year before the report on future senior housing needs. That article reads:
... it stands to reason that a city’s occupancy trends would be in line with its penetration rate trends, but often they are not correlated, Mace said. This was another surprise to her, and another facet of penetration rates that requires further analysis.
Against her better judgement, she used numbers and projections throughout her report that are absolutely inaccurate. Presumably, due to the high profile of the NIC, investors, land developers, and real estate buyers are going to base their decisions off this report. So, the exaggerated numbers are going to drive decisions, potentially further unbalancing supply and demand. NIC has huge names, including Welltower and Ventas, as clients. Are they simply telling them what they want to hear? Perhaps that is another topic for another day.
The truth is that forecasting needed inventory in this arena at all is a fool's game. With consumable goods, any build-up in supply created from a misjudgement of demand can be whittled down through aggressive promotions and discounts. If that still doesn't work, the business can write it off and move on. Sure, it's going to hit the bottom line in a bad way, but it usually isn't disastrous (even Crocs survived). But with something like a senior living complex, none of that flexibility exists. It takes tremendous amounts of money to build and maintain, and is not easily repurposed for some other use (hotel maybe?) and/or sold. And using aggressive pricing to attract tenants typically attracts the wrong kind of tenants, if any. If the forecast for demand is wrong, that investment becomes a capital-sucking black hole.
So, not only did the authors base their research on a faulty premise (penetration rates as total supply), even the attempt to forecast was errant.
When organizations build or buy senior housing facilities based on the premise of "there are going to be more old people," they do so at great peril. Nicole Moberg, chief sales officer at Atlanta-based Thrive Senior Living, summarized the situation well:
“My belief is that current senior living sales teams as a whole are not well-equipped to sell, as they’ve had the ‘build it and they will come’ mentality,” she said. “The typical sales role 10 years ago, or even five or six years ago, was, ‘People walked in, sales people signed residents up.’ That doesn’t exist anymore. There are more options than ever for families to consider, and it’s confusing to the person trying to make the decision.”
The report linked above from Senior Housing News, published late in 2018, underscores how complicated the situation is. You would expect that if the widely accepted "logic" of more old people = more need for senior housing were true, occupied senior housing penetration would be steadily rising in the majority of markets over time. However, this is not occurring. There are nearly as many markets with declining occupied penetration rates as there are with rising rates. The following tables for both independent living and assisted living bear out the point:
This data surprised even the professionals. Chuck Harry, head of research and analytics at NIC, said:
It’s a little perplexing right now that there’s no discernible trend as to what is driving penetration rates in markets.
NIC Chief Economist Beth Mace - who co-authored the main article under observation - agreed:
I was a bit surprised. I had anticipated we would see more markets with a rising rate, and it’s kind of evenly split.
This entire data set challenges the basic premise of investing in senior housing because there are going to be more old people. Demand nationwide is clearly not increasing across the board. The factors that are influencing these dynamics are many, and I don't pretend to know even half of them. I therefore choose to not make considerable investment outlays into arenas that evade my understanding.
It's all about location, location, location, right? Perhaps not, or at least finding the right location is hard to do. The same article from above explains the unique situation in Washington, D.C. The capital district launched participation in the World Health Organization's age-friendly initiative in 2012, the two main thrusts of which are addressing the trends towards urbanization and the aging population. Among many other things, this initiative has many components that aim to make life more fulfilling for seniors, like more wellness centers, training law enforcement in elder abuse prevention, age in place programs, access to transportation infrastructure, age-friendly business and hiring practices (Back To Work 50+), helping older adults with technology (SpotOn Grownups), and many others. Additionally, DC is home to several Continuing Care Retirement Communities (CCRC) that are well-known, well-respected, and have been in business for over 100 years. Product acceptance is high. You would think that all these features would have seniors flocking to DC, and many of them ending up in senior housing arrangements. However, notice from the graph above that DC has led the decline in occupied penetration rates in both assisted living and independent living from the time period under consideration. What gives?
Recall from earlier that 48,000 units were added in 2018, and the projected need for 2019 was 31,000. According to Senior Housing News, we have already added that many in 2019 and more - 17,000 more, to be exact. So, not only is the projected need exaggerated based on a too-high penetration rate, we also have more supply added than needed even with that high penetration rate. This on top of the fact that occupancy levels for senior housing just bounced off an all-time low of 87.7% in Q2, recovering to 88% in Q3. And 2019 isn't over yet. More supply is yet to come. This in spite of the fact that 2020 hasn't started yet and the projected need of 31,000 more units for that year is already almost half met.
This is what happens when you try and take a broad fact - more old people - and assume that will represent an investment gold mine. This is the definition of a bubble: everyone piling into an idea without real due diligence so as to not miss out. It happened with tech in 2000. It happened with real estate in 2008. But we aren't learning from the past. Wide-eyed investors commit capital to fund new senior housing project development, contractors and land developers are happy to oblige, costs rise, prices rise, and it can't go on forever.
While new senior housing construction starts have moderated a lot from their 2016 peak, plenty of data still points to oversupply. Many sources say that the wave is yet to hit and all that supply will start to be absorbed. That may, in fact, happen. However, until that absorption starts to materialize in the data, investors are gambling. I liken this to the saying that has been attributed to many military leaders across history but is most well-known in America from the Battle of Bunker Hill, where Colonel Prescott encourages his troops to not fire on the British until they could "see the whites of their eyes." Doing so increased deadly accuracy, saved time and ammunition, and proved tactically important for the overall war effort (even though technically the American's lost that battle). It might be a stretch, but this is good investment advice. Capital is limited. Wait until you can see the data materialize before initiating a large position. I understanding wanting to get in before the fact for fear of missing out, but if everyone is doing the same, it's simply a bubble.
I appreciate that the authors of the report included some disclaimers that underscored how their report should not be considered conclusive or exact. The most important are:
... the age of senior housing residents may be increasing as individuals delay the move into assisted living until a specific activity of daily living is failing. If the age continues to rise for entry into seniors housing as has been the case in the past decade, the projections of new demand could be overstated in the near term.
... this analysis looks solely at potential demand in terms of penetration rates and demographics-pure demand, so to speak. It does not make any assumptions about absorption rates, lease up rates, consumer preferences, move-ins, move-outs nor occupancy
The main takeaway is something I have said and will keep saying: "More old people" is simply not a good investment thesis.
It's coming - the "silver tsunami." The indisputable demographic wave. Call it whatever you want, it is most assuredly coming. I am not meaning to deny that. My aim is to caution people against assuming that this wave will make them rich. It is so remarkably complex that foregoing or short-changing the due diligence process and swallowing whole the incessant sound bites could be catastrophic. Trusting other people's research and projections is dangerous.
It is not enough to have more people to sell a product to. Understanding consumer preference and whether or not those people will accept the product is vital. For me, I am skeptical that swathes of baby boomers are going to opt into senior housing. They simply have so many other more attractive options. Perhaps personalizing it is key: ask yourself honestly what you would want when you reach retirement. Personally (and literally everyone I talk to that is of baby boomer age or older), I would want to stay in my home. Comfortable, familiar and paid off seems miles better than smaller, foreign and expensive.
I concede that I may be dead wrong. I am not omniscient, but I do try to be data driven, and the data I have found is not convincing enough for me to bet on this "wave."
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.