Senior living

Demographic trends win over regulatory scrutiny in the valuation of Healthcare REITs

July 25, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

If you are looking for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.

“By 2017, growth in the 82-86 age cohort will start to accelerate and will generally continue to do so until 2025,” notes Beth Brunham Mace, chief economist of NIC, a data provider for the senior living industry. “Investor interest in the sector continues to grow, as evidenced by the sheer volume of deals and dollars. Additionally, balance sheet lenders such as life companies, debt providers such as CMBS lenders and growing numbers of pension funds are investing in the sector today.”

Three trends support her view. Client demand is increasing, as individuals age 75 will be the fastest growing age cohort in the next 20 years. Seniors are living longer due to medical breakthroughs in the past 50 years. In the 1970s, life expectancy was 71 years; it is now 81 years. Seniors also possess greater financial resources than in the past. GDP per capita increased by six fold in the past forty years.    

But there are challenges. There is increased state and local regulation of assisted living and skilled nursing sectors, which translates to a higher cost of doing business. Like any other company, these sectors’ financial results may be negatively impacted by increasing employment costs, including salaries and health care benefits. And Medicare has been reducing reimbursement rates since 2011 with further benefits scheduled to expire at the end of 2017. All are detrimental to earnings.

Two invariable risks are unpredictable government actions and the economy. The Affordable Care Act resulted in expanded health care coverage to millions previously uninsured. To help fund this expansion, reductions were made in Medicare reimbursement. It has negatively impacted the earnings of healthcare REITs. And because the cost associated with senior living is not reimbursable under government programs, only seniors with income and assets higher than normal can afford to pay monthly resident fees. And an economic downturn, a change in the housing market, or stock market volatility can alter the ability of some seniors to live in a senior living environment.  

Key performance indicators for assessing a healthcare REIT include operating performance, credit strength and concentration risk. Operating performance includes earnings measures, such as net income available to stockholders, funds from operations, and net operating income. Credit strength includes leverage ratios such as debt to book value and coverage ratios such as adjusted fixed charge coverage ratio. Concentration risk is the exposure to property type and geographic type.