Real Estate

Three Reasons Why We Like the Senior-Housing Sector

Article

Oct 19, 2020

The COVID-19 pandemic has hit the listed senior-housing sector hard.

Share prices of real estate investment trusts (REITs) with portfolio exposure to senior housing declined sharply at the onset of the pandemic, as public markets anticipated declines in occupancy and profitability. New policies and procedures related to protecting residents, care-workers and other employees from the virus led to significant operational challenges and rising expenses. Occupancy levels fell due to low move-in activity, as facilities stopped accepting new residents. Net operating income (NOI) for the sector fell approximately 40% in the second quarter from earlier this year before the pandemic, according to our analysis.

The sector has yet to recover to pre-pandemic price levels, and we believe this dislocation represents a great opportunity for investors going forward. In our view, the sector is severely undervalued and poised for a rebound. Here are three reasons why.

1. The pandemic is likely to be a temporary, rather than a permanent, industry dislocation. In the coming months, there are likely to be significant breakthroughs in therapeutics and vaccines, and eventually there will be an end to this pandemic. In the meantime, the sector already appears to be emerging from its temporary dislocation, and this could provide a boost to share prices once markets catch on.

Many facilities were caught off guard when the pandemic hit earlier this year, and most saw a related spike in cases. Senior-housing operators quickly figured out ways to source personal protective equipment (PPE) and implement new cleaning and resident-protection protocols, including temperature checks, symptom screening, resident cohorts and social distancing. These efforts—at least some of which will likely be around for the foreseeable future—have allowed resident facilities to open back up to new residents while also reducing case counts. The number of cases in senior homes is now trending down while cases rise in the U.S. at large.

For instance, one REIT owning senior-housing communities across the U.S., Canada and the UK estimates that over 90% of its senior-housing portfolio is now effectively clean of COVID-19 cases. The average daily number of new COVID-19 cases at its senior-housing facilities was 4.1 in September, drastically down from 26.6 in April (see the orange line in the chart below). This is in contrast to the increasing number of confirmed cases in the broader U.S. (See the blue line below).

Covid-19 case counts at senior housing facilities are improving

2. A better-than-expected flu season could benefit the sector. Flu season in the southern hemisphere was better than people expected for a number of reasons. If we see the same in the northern hemisphere during the 2020-2021 season, listed senior housing could be poised to experience an incremental boost in both investor sentiment and operating performance, in our view.

Flu seasons typically provide a seasonal headwind to the U.S. senior-housing market, reducing occupancy levels by 50-200 basis points depending on flu severity. This headwind could be gone this year, if the U.S. sees similar influenza transmission to what Australia experienced. The chart below shows how cases of the flu in Australia were almost nonexistent this season.

Efforts to curtail the spread of COVID-19—from stay-at-home measures and social distancing to mask wearing and flight suspensions—likely played a role in reducing flu transmission, as did a high percentage of the population receiving the flu vaccine. Looking forward, similar measures could keep flu case counts down in the northern hemisphere. In addition, we expect transmission of influenza this year from the southern hemisphere to the north will be materially lower than in past years, given the south’s better-than-expected flu season so far and low levels of international travel.

The flu was almost nonexistent in Australia this year

3. Demographic trends support the sector. Longer term, there are several demographic tailwinds supporting this sector. These include an aging population (see the chart below), increased life expectancy and the related growing need for specialized care, such as memory care for people with dementia. These trends should help sector occupancy and profitability—and we are already seeing them translate into strong private-market demand for senior-housing properties. In recent months, for instance, there have been a slew of transactions where private equity firms have purchased senior-housing assets, citing the demographic trends supporting the sector over the long term.

The 80+ US population is on the rise

The investing implications
We believe senior-housing sector fundamentals are poised for a recovery, with this area of the real estate market offering long-term value. We see current discounted valuations as an attractive entry point and investment opportunity for our clients. We particularly like diversified health care REITs with exposure to the senior-housing space.

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