An update on the current supply and demand of the market from Aron Will, Vice Chairman and Co-Head of National Senior Housing at CBRE Capital Markets. Hear his take on what to expect in 2024 as occupancy increases across the board.
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This episode was recorded at the NIC Fall Conference.
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Lucas 00:51

Welcome to Bridge The Gap podcast, the senior living podcast with Josh and Lucas in a special kind of a solo episode. Josh had a conflict. We're here at the NIC Conference in Chicago, fall NIC. I can't remember the last time we were in Chicago, but I want to welcome back to the show. Aron will, Vice Chairman and Co-Head National Seniors Housing at CBRE Capital Markets. Welcome to the show.
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Aron 1:15

Delighted to do it again.
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Lucas 1:16

Gosh, when were we here in Chicago last? Had to be...
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Aron 1:19

Four or five years ago at least.
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Lucas 1:21

Yeah, I think so. You know, it's kinda of like riding a bike though. I knew where to pick up my badge. I knew how to get down to the river level. We're good to go.
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Aron 1:29

Yeah, exactly.
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Lucas 1:30

Well, I really, really enjoyed the last time that you were on the show, I think it was Spring NIC. We hadn't really spent a lot of time together and I was just really fascinated by the way that you see the marketplace and your insights. And so very grateful to have you back on the show. Off mic, we started to talk about your thoughts on what does 2024 look like. Could you bring some of our listeners maybe up to speed before you hit 2024 and maybe hit a couple of the highlights from 2023?
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Aron 1:59

2023 was kind of a fascinating time in the marketplace in that for the better part of a year, 18 months, right? We saw operational gains, right? It's a juxtaposition between accretion in census, significant rent growth, labor normalizing to a large degree. I mean, insurance is still a massive variable in commercial real estate, generally speaking, particularly in certain geographies like Florida. But by and large, things started to normalize on the operating side, right? And that's a very good thing for senior housing. All the while a lot of construction came to a screeching halt, right? Which plays into the supply demand imbalance in particular leading into 2025, 2026, when finally the last of the real baby boomer demographic is I've heard is coming up age.
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Lucas 2:47

I've heard about that for a number of years.
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Aron 2:49

We've been talking about it for 20 years. All the while summer 22, the capital markets turned on their head, right? For senior housing. So it's kind of another gut punch, right? It's very, very interesting. When we look at senior living today and the operating fundamentals in the context of the broader commercial real estate landscape, it's very positive. We're finally a bright light shining star amongst various asset classes. We're starting to see multi-family rents go negative in a lot of markets, right? You compare and contrast that to senior housing, and we're paying attention to a lot of the 24 operator budgets that come across on various financings and sales of recap mandates. And there's very few that are projecting less than 5, 5.5%, some still 7, 8, 9% for 2024.
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Lucas 3:41

Rate increases?
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Aron 3:42

Rate increases, which is terrific, right? And will offset some of that margin erosion, right? You can get back to 25, 30, 35, pick a number depending on the fit and finish and quality of the asset in the market and the acuity mix margin levels, right? So that's all very, very positive. Whereas the fundamentals and many other real estate asset classes are heading in the wrong direction. And in particular, some of the ones that were the shining stars during Covid. Those are good things that we see right now as we head into 24 though on the capital market side, transitioning over to that. It's challenged. It's a really, really challenged market. And the reason is it's kind of the tail wagging the dog in that the financing markets are very, very challenged. The bridge market for institutional sponsors wanting to buy value assets on the acquisition side, you get 55 or 60% non-recourse debt, for the longest time doesn't exist.
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Aron 4:40

Banks are trying to shed non-conforming loans like they're going out of style, not book 'em. You have to target 75 a hundred, 125 lenders to generate one to two term sheets. It's that kind of market and only terrific sponsors are getting any sort of financing. So if you think about our industry, again, uniquely we were the only asset class that didn't have cap rate compression within the resi segments during Covid. How could you, when your operating fundamentals are suppressed, right? So now you have tremendous amount of product that is built up, right? It's sitting there and people were largely in price discovery mode in my opinion, in 2021, 22 and 23 for sure. And now they have out of necessity really needs to monetize assets. The valuations aren't great in particular because a lot of the buyers for senior housing assets today are looking at it through a very different prisms in many instances, unlevered.
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Aron 5:47

So if you're looking at a mid-teens return unlevered, what does that translate to value? The answer is it's significant degradation and value relative to a lot of the valuations that people kind of expected. The other thing I would tell you is it's a bifurcated market, okay, right? In that there's everything value add, and the question is how do you finance it and so on and so forth. And that's really one of the tricky parts today and just generally liquidity in the market. I would tell you at the end of last year, there was a lull in activity and liquidity, right? In order to run a successful auction for anything, for debt, for equity, doesn't matter what it is, you kind of have to have at least 50%, 40, 50% market participation. It was a point in time at the end of 22, when we were December, we were like 20, 25%.
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Aron 6:41

It's very difficult. Today we're probably in that 40, 50% range. So the combination of illiquidity, and a lot of the tried and true investors historically that have played a meaningful role in senior housing are now largely in kind of asset management and portfolio management. They're raising next funds and so forth. So it's on the value add side for those that aren't encumbered with legacy issues. For those that have dry powder for those that can buy on lever or at least look at it through that lens to be competitive. Very interesting time in the value add segment of our space.
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Lucas 7:17

I noticed this year, I'm a renovator, I'm a value add renovator and 22 is a struggle. I had a huge pipeline and nothing happened. It was really rough. And this year it picked back up and I noticed I started to get newer clients that were primarily developers that repositioned and pivoted into value add because they said we can't build, right? So we're going to buy value add. And that bridged the gap for my business a lot this year in 23.
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Aron 7:44

The bifurcation is then you flip over to the stabilized side, right? There's needs, monetization needs in which is going to fuel precipitate capital markets activity on both sides. If we didn't have cap recompression, our operating fundamentals were suppressed. There's a lot of folks that have been sitting on product that now have debt maturities, now have fund maturities, debt pay downs that are significant. I'm not talking about 5% of loan amount. In some instances they're asking for 25% of loan amount. And then you have this other category of like performing stuff, right? Assets that were a subset of the marketplace that performed well, maybe an asset that was 96% that dropped to 88% and is now back to 94 or 95% with comparable margins close, if not at par, better than where they were, you know, pre-COVID. And the thing you need to look at there is, it's pretty basic to me, which you can pay for something in life is what your underlying debt costs are.
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Aron 8:43

Doesn't matter if it's a house, a boat. If you look at underlying treasuries now, right? Where they are, the 10 years surpassed 5%, 7 years, like 5 ,10, 5, 15, most kind of core plus, buyers of stabilized stuff, targeting low teens, mid-teen, depending on like how much meat on the bone is there for acquisitions, is using seven year debt instruments. So if you're seven year interpolated, it's a five 10 and it's just assume it's an agency spread of 200, underlying debt cost is seven plus percent. There are some very special unique assets out there that would price closer to parity to debt costs that have embedded tremendous compounded cash flow growth potential, right? Where people would look at that and say, it's a seven year entitlement deal, nothing's come in the market, it's a fabulous owner operator attached, but that's a pretty small swath of the market.
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Aron 9:37

And then there's everything else performing b plus A minus asset, 10, 15 years old, right? And for those assets, what does a buyer need so far as differential, the delta between underlying debt costs and going in yields, right? Because inherently there's operating risk in our business, it's an operating business attached to real estate. Trades like real estate. I mean, that's a farce. It's really an operating business. The answer is a lot of times minimum 50, but 75, a hundred, 125 basis point differential in underlying fixed rate debt costs, let's say agency debt life insurance company, whatever it is. And what I'm willing to pay for something that's kind of, at least at this moment in time, somewhat of a new normal, we do a lot of work in traffic heavily in the active adult segment within that rhymes from, at least from a cap rate standpoint, given the compression in that segment of the market trading at parody to multi and looking at the rent growth there relative to multi, again, a lot of markets where we value active adult assets, multi-family rents are going negative.
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Aron 10:43

I don't think they will in that segment of the market because it's a very, if you program it right, it's a very sticky resident base that drives a real sense of purpose from living in the community. And they're not going to move if you pop 'em four or 5%. They're just not, again, multifamily rents have gone flat to negative amount of markets. So how do you rationalize negative leverage? Negative leverage has been a phenomenon in real estate, industrial and multifamily and a lot of spaces for the last several years. We don't see it happening very much. It's got to be a very special asset, special market, perception of rent growth in a tough macro climate in the next 12 months, 18 months, 24 months, whatever it ends up being. For senior housing. I mean, negative leverage is really tough to swallow given the operational risk despite much better promise.
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Aron 11:40

So far as rent growth, as far as cashflow growth. Cap rates have moved 200 basis points, two 50 basis points significant. And so those are kind of the two segments of the market as I see it. And you're visiting with people. For anybody who really understands our space and is entrenched and understands kind of where the puck is going, so to speak, is excited, right? This is a unique moment in time where there's going to be buying opportunities in many instances at a fraction of replacement cost, 2000 10, 11, 12, where you look up after purchasing something in 15 and say, "Gosh, it was a heck of a buy. It was this really unique moment in time." I view the marketplace as in senior housing today as that when NCREIF and NIC started tracking the data and demonstrating to people that it performs in recessionary environments better than other real estate asset classes. Given the needs driven component that really caused, in my opinion, a tremendous amount of institutional investment to flood into the space. History has a tendency to repeat itself and I have a very strong suspicion that our asset class is going to outperform the rest of real estate, but we got to get through some really choppy times in the interim. Really choppy.
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Lucas 12:59

What do developers do in 2024?
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Aron 13:03

Pray. You look at it, the three or four variables that go into develop, what's my yield on cost? If your underlying debt cost is 7% and you were building a senior housing deal to eight or eight and a half previously, that's tough, right? Because that deal may trade somewhere relative close to where you're building it for, right? And how much spread does somebody need to get comfortable funding a development deal? The other thing is a lot of people are like, "Why develop when we can buy cheaper than developing right now?" We were hopeful that construction costs would come down. They haven't, appreciably. Really the subs of GCs and land sellers are like in these kind of cycles, the last ones to really get the memo, but their workloads are going down. People are pricing more competitively depending on where commodities prices go.
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Aron 13:56

I mean, they could go down somewhat and that would be helpful to develop. Those things translate into levered returns. If you can get construction debt maybe 50%, 55%, 60 if you hit an absolute home run type leverage levels. And so it's hard to make the numbers work. Now, what we are seeing and working on within our own pipeline of stuff on the finance side of the business for ground up developments are very unique.
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Lucas 14:25

Gotcha.
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Aron 14:26

The commodity ALMC in a secondary market with a hundred units is those deals. I don't know. I mean, I don't really see them getting done, you know, and I think we're a fairly good bellwether the market with what crumbs across our desk. And so if somebody has a very unique piece of property in a coastal market or super high barrier to entry market, nothing's coming in and out, got assets within that PMA that are performing really well at $14,000 rents, maybe that project makes sense, right?
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Aron 14:55

Those are the kind of deals that are making sense in some instances we're seeing active adult deals make sense, right? Because if you can build in the sevens with real numbers, given multi debt prices, 40 basis points, call it in an agency context, less than senior housing. I mean, if you can get a hundred basis points now and spread or a hundred fifteen, a hundred twenty five, pick a number, that feels pretty good. There are some deals within the act of adult segment. That's about it. Really high quality deals with good rent structures in the 55 plus active adult and really precious senior housing deals that you can't time the capital markets in any cycle perfectly. That will stand the test of time. Everything else is really tough. But again, that weighs into the whole supply demand. We're at 84, probably realistically at 84.5% at this point. Occupancy, I think we'll be back.
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Aron 15:50

You asked about projections in 24. 87 and a half by this time next year, I think it's going to be significant pickup in occupancy. In part you were speaking to, you posed a question, how does you know, the single family story play into our sector. Even though values are down on the single family side? Right? If you think about it compared to the GFC, like moving into a product like active adults or independent living, if single family home values then in certain markets were down 50%, you couldn't necessarily rationalize monetizing your home and putting those dollars to work congregate care, right? From social elements and otherwise. And now because of the runup in resi the last few years, even if you are down 10 or 15 or 20% or pick a number relative to where you were, you had a hell of a buildup. So there's a lot of built up equity in this particular baby boomer generation and home values, right?
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Aron 16:49

That's very positive. They're not trading out into extremely high interest rates, right? Stuff's still trading in single family. The velocity is not there, but stuff's still trading. People can sell their homes today at better values, much better values than like 2010, 11 in a timeframe, again, because of the buildup. And so what asset type within the acuity spectrum are you most concerned about? You know, if you look at it as we did during the GFC, you couldn't give away two bedroom IL units, couldn't give 'em away during that timeframe. Now, I mean, every, if you talk to every operator, every developer you know, they wish they built more two bedrooms and IL and AL and everything, right? There's been a significant consumer preference shift to larger units. That again plays into independent living right now. And I think active adult and then assisted living and memory cure is needs-based and then significant post-acute, same thing.
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Aron 17:53

That's not going away with nothing being built. So it's a really interesting time rate fundamentals in our sector, really choppy capital markets, people are going to, unfortunately, have to live with the consequences of where we are in the cycle of monetizing assets. It kind of is what it is. And I don't think in particular as it relates to the commercial banking system, people say, "Oh, liquidity's going to be back in 24." And the underlying term SOFR, this is an easy example. I mean, it's not going to go down to 2% overnight, right? Right. We're going to be in a high interest rate environment, but fixed rate underlying treasuries as well as like Term SOFR for a while, and that puts a lot of stress on commercial real estate books generally speaking, when debt was free for the better part of 15 years among other issues that commercial banks had.
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Aron 18:50

I think I spoke on some of these issues on our last podcast, so I don't want to be repetitive, but it's definitely not a snap your fingers exercise. I think the commercial banking system will definitively be challenged in 2024. So it's going to be a rocky road, but we'll come through it as an industry. We're going to have a run here where we have, I think I used in the other interview that I gave the word "gangbusters activity" just for pen up transactional activity that just needs to clear today on both the stabilized as well as the kind of the value on the other end of the risk spectrum. All the while in the next five years or so. It's going to be an amazing run.
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Lucas 19:31

I love getting your insights just because like you said, the stuff that comes across your desk. I had the fortunate opportunity just a few weeks ago to discuss with over 70 Executive Directors where they're at right now. And across the board the answer was, "Occupancy is finally going up." And we're being able to control or better control our labor issues. It's not solved, we're not there, but I'm hearing that across the board. Obviously that's one company, but these were communities from California to Maine, and it was really good to hear. It's really interesting to hear, and obviously very interesting to hear this juxtaposition. We know you have a busy schedule and I super appreciate despite that I'm a Texas Rangers fan that you'd agreed to come back on the program.
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Aron 20:18

Yeah, well, exactly. Well, I am wearing my Astros socks here just for you.
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Lucas 20:22

That's right. There we go. We got a big game tonight. When this airs, we'll know what the outcome is, but it's fun to talk about it anyway.
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Aron 20:29

You want to wager bet?
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Lucas 20:30

Okay, let's do it.
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Aron 20:32

All right. Free dinner anywhere in the country. You pick or I pick.
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Lucas 20:38

Wow. Okay. Alright, we'll do it.
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Aron 20:42

Alright.
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Lucas 20:43

Alright. It's documented.
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Aron 20:44

Yeah, exactly. Good to spend some time, in any case.
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Lucas 20:46

I love it. I love it. Aron, thank you so much for spending time with us.
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Aron 20:50

Delighted to do it.
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Lucas 20:51

And for our listeners that listened in and want know more about the NIC Conference or about Aron Will's organization, CBRE, we'll connect with that in the show notes. Go to bgtvoice.com, listen to this episode of many more, and thanks for listening to another great episode of Bridge The Gap.
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21:08

Thanks for listening to Bridge The Gap podcast with Josh and Lucas. Connect with the BTG network team and use your voice to influence the industry by connecting with us at btgvoice.com.