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Fixed-Income Insights

Key strengths drive a positive outlook for muni-bond credits in the continuing-care retirement community industry, although cost pressures may present challenges.

[Note: This article is from the forthcoming issue of The Muni Quarterly.]

Lord Abbett’s 2018 outlook for not-for-profit continuing-care retirement communities (CCRCs) remains positive.  Several key factors inform our position, including healthy independent living (IL) occupancy levels that are expected to continue; a strong U.S. stock market and housing market, potentially giving seniors the financial wherewithal to move into the communities; savvy CCRC management teams that are reacting quickly to evolving demands; and the continuation of merger and consolidation in the industry, resulting in stronger credits. 

Independent living occupancy is expected to remain healthy as the U.S. population ages.  According to year-end 2017 data from the National Investment Center (NIC), overall occupancy for senior living in the United States was stable between 2016 and 2017, at 91.4%.  Annual inventory growth for 2017 was modest at 2.1%, while new IL construction made up only 4.7% of inventory.  In addition, rent growth was stable at 2.4%, indicating steady demand and operators’ ability to raise monthly fees.  Occupancy is expected to improve further as the population ages, in particular as baby boomers reach their mid-70s over the next three years.

The strong U.S. stock market (despite recent volatility) and housing market continue to positively affect retirees’ perceived wealth and influence their willingness to move into CCRCs.  As home sale prices have rebounded, they have become better aligned with the communities’ entrance fees. This, along with the wealth effect from healthy stock market returns, is making it easier for seniors to rationalize a move, resulting, eventually, in improved liquidity and debt-service coverage for the sector. 

Skillful Adaptation
Management of senior living firms continues to exhibit an impressive ability to adapt to an environment of constantly changing insurance reimbursement policies and consumer demand.  More and more construction projects are focused on tailoring residences or shared spaces, such as combining studio apartments to create more desirable one- or two-bedrooms units, or renovating common rooms or dining areas to modernize them and enhance their appeal.  In addition, we increasingly see projects that feature flexibility for future alterations, such as assisted living (AL) units that could be customized in the future to allow for a higher level of care.

Finally, the pace of mergers and consolidation among existing senior living providers continues to accelerate.  Drivers of consolidation include an increasingly complex operating and regulatory environment for the industry, technology demands, heightened competition, and the need for access to capital.  Combining entities generally leads to stronger credits, such as the 2016 merger of California-based nonprofit operators be.group and American Baptist Homes of the West.  

While we expect 2018 to be a year of healthy operations for the senior living industry, there are some pockets of stress.  These include:

  • Modest declines in occupancy in assisted living;
  • Ongoing reimbursement challenges in skilled nursing;
  • Labor shortages pressuring operations and increasing the cost of new projects; and
  • Higher leverage resulting from increased reinvestment in communities.

According to the NIC, AL occupancy for 2017 was down 0.3% year over year, to 88%, for the top 31 U.S. metropolitan statistical areas (MSAs).   Declines in occupancy are likely linked to increases in inventory, which grew 4.6% year over year, the third highest rate since 2006.  Based on construction as a percent of inventory (9.1% in fourth quarter 2017 for AL, versus 4.7% for IL, according to NIC), we expect the trend of modestly weakening occupancy to continue in the medium term.  

Current Challenges
Skilled nursing facilities (SNFs) have had to respond to changing payer environments over the past several years. The newest changes to payments include bundled payments and Medicare readmissions penalties, which are proving challenging.  Under bundled payment models, hospitals are incentivized to discharge patients to settings with the lowest cost of care—for example, home health care—rather than a high-priced SNF.   In addition, due to a heightened focus on readmission rates, hospitals are seeking partnerships with SNFs that can demonstrate superior outcomes, thereby raising the bar for these facilities and intensifying competition.

Labor shortages also are pressuring CCRCs, affecting both operations and new projects. Reduced availability of qualified nursing and administrative staff is increasing operating costs, while shortages for construction labor are resulting in projects coming in above budget and past deadlines.    

As noted above, CCRCs are actively investing in their facilities to modernize and meet the demands of the next generation of residents.  Communities are being pressured to offer various high-quality dining venues, wellness centers, aquatics, and spas, among other amenities, to attract and retain the new generation of retirees.  Further, CCRCs have had to invest in technology to meet the needs of tech-savvy boomers. 

While CCRC management continues to demonstrate its flexibility in the face of these changing demands, the financial cost of doing so results in increased leverage.  According to medians published by Fitch Ratings, debt-to-capitalization ratios increased during the 2012–16 period, from 57% to 62.4%, for ‘BBB’ rated communities, and from 76.7% to 85.8% for below investment-grade rated communities. 

While these facilities will continue to be pressured to evolve in order to meet a shifting consumer landscape and regulatory environment, we expect continuing care retirement communities to continue to profit from key strengths seen in the last few years, especially the strong U.S. equity and housing markets, and robust occupancy trends in independent living. 

 

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