Managing partner argues that supply constraints should drive upside as more baby boomers age
When an investment trend is backed by demographics an investor might worry that a forward-looking market has already priced in all the upside. It’s no secret that the largest and wealthiest generation in North American history is getting older and that more of those baby boomers are going to need some kind of senior housing. Operators across the three tiers of senior housing, independent living, assisted living, and long-term care, have seen share prices appreciate in recent years as the overhangs of the pandemic faded away and the demographic story took hold again. The question, though, is whether there is room to run any further in this real estate subsector.
Samuel Sahn believes there is. The Managing Partner and Portfolio Manager at Hazelview Investments explains that in addition to the demographic trends driving demand for senior housing, there is a serious issue of undersupply that allows the current owners and operators of senior housing even greater upside opportunity.
“There are no new senior housing facilities being built today. A lot of that has to do with rising construction costs, higher financing costs, longer entitlement time, longer permitting time, higher labour costs, and higher land values, all of which make development more challenging,” Sahn says. “When Covid happened, senior housing as a concept, as a property type, really got hurt… fast forward six years and that’s changed a lot. The industry has changed in terms of its safety, its amenities, and the mechanisms by which communities are operated. You take all that together, in addition to what’s going on with rent, occupancies, and margins, and the sector has a very strong runway for growth potential over the next decade.”
In determining just how much further there is to run for investors here, Sahn and his team look at where rents look to be going in the next decade and the trend for occupancy rates in that same period. He sees net operating income margins growing between 5 and 10 per cent in that period, which could drive double-digit annual returns for companies operating in this sector.
While many of the largest senior housing operators in North America are publicly traded, there are private enterprises in the space that might hold some appeal. Sahn, however, argues that the opportunity for ordinary investors will be realized through the public acquisition of private operators. He notes that the levels of transparency required for public operators make them more attractive for investors given some of the policy risks that can still overhang the space.
While each tier of senior housing has its own market dynamics, Sahn argues that the upside potential is similar for independent living, assisted living, and long-term care in North America. Demographics underpin that outlook, as he sees an aging baby boomer starting in independent living before steadily progressing towards long-term care.
While some have remarked on baby boomers’ preference for aging in place as a potential impediment to this sector, Sahn argues that the sheer number of people in North America who will age past 80 between 2025 and 2030, as well as the lack of supply of senior housing, as too powerful of a demographic tide for investors to ignore. He argues, too, that the improvement on margin will allow many of these operators to invest in their facilities, creating more appealing environments for older people to move into.
There are still risks in the sector, despite what Sahn characterizes as solid fundamental building blocks. Those risks, he says, are largely exogenous. They could be regulatory or government-driven risk that is unforeseen at this point, or another black-swan event like the COVID-19 pandemic which further challenges the logistics of communal living. Given the unpredictable nature of those risks, though, he believes this is a segment of the real estate market that advisors should consider.
Sahn argues that the greatest upside for advisors may come through the largest publicly traded senior housing REITs. These are assets that represent a large degree of style and geographic diversification and that come with management expertise necessary to navigate in a relatively regulated space. They have scale, too, to improve margins as demographics drive demand and supply stays constrained.
“What typically kills traditional real estate cycles is not demand. It's not a recession. It's not a financial market crash. It's supply. Supply is the number one underappreciated factor that hurts the performance of real estate,” Sahn says. “There is effectively no supply happening right now in the market, and it's too costly to build. The underwriting math doesn't make sense to break ground and new starts as a percent of existing inventory being at a multi-decade low. That characteristic is the single best variable that provides the longest possible runway for the strong demand to continue to generate really strong returns.”
