High insolvency rates in the senior housing sector

The recent bankruptcy of a Connecticut-based company highlights the challenge of investing in the senior housing sector, known throughout the municipal market as one of the riskier areas, especially in a post-Covid world. However, some market participants remain optimistic, driven by widening spreads, macro dynamics and demand-led expansion.

The senior living sector has always faced challenges, with a default rate of 10.8% in 2023 compared to an overall municipal default rate of 0.41%, excluding Puerto Rico debt, said Lisa Washburn, chief lending officer and managing director at Municipal Market Analytics, Inc.

But it has come under more pressure post-pandemic as “the post-COVID world has changed the landscape and investment thesis for many project finance deals,” said Jeff Lipton, a research analyst and market strategist, driving up default rates.

Washburn said the sector’s default rate rose to 10.8% last year, up 4.9% in 2018.

Falling occupancy rates, staff shortages and rising labor costs have increased risk in the sector, with Greenwich Investment Management’s bankruptcy announcement last month providing another example of the sector in question.

Its bankruptcy was caused by the Sawgrass Grand Senior Living Project led by Greenwich Investment Management, which involved the transformation of an almost 300-room hotel into a center for seniors.

The project, financed by the sale of $35.8 million in senior revenue bonds issued by Capital Trust Agency, resulted in a “significant loss of capital in client portfolios,” according to SEC filings.

Greenwich Investment Management filed lawsuits against the developer and the underwriter, maintaining that the defendants’ actions led to the collapse of the project, default on the bonds and harm to bondholders.

“Adverse events…have damaged GIM’s reputation and resulted in the loss of customers,” and the company’s revenue decline “reduces GIM’s ability to correct contested projects,” the filing said.

Greenwich Investment Management did not respond to calls for comment on the bankruptcy.

In the senior housing sector, Washburn said Greenwich Investment Management selects the “riskiest” securities.

She noted that the money manager has focused on unrated pensions, which have a higher risk of default than the rated part of the sector.

“If you invest in the riskiest sector in the market and you invest in the unrated part of it, you are taking on a disproportionate share of the risk,” Washburn said, citing concentration risk in that area, which likely contributed to Greenwich’s bankruptcy filing.

In its bankruptcy filing, the company mentioned other pending projects serving the seniors market, listing at least 38 bonds that the company continued to work on in 2023.

“The number and total size of the challenged projects exceeded GIM’s recovery resources, both human and liquidity,” the money manager said in its bankruptcy filing.

The bankruptcy confirms there is “significant” risk to seniors’ lives, and investors need to conduct a full credit analysis and be mindful of “the quality of the design behind the bonds they purchase,” Washburn said.

However, she noted that Greenwich’s bankruptcy filing does not mean the sector is riskier than before, but challenges remain in the wake of Covid-19.

“Many of these funded projects were vintage viruses that struggled to come to fruition and then struggled with inflation, excessive costs and poor management,” James Pruskowski, chief investment officer at 16Rock Asset Management.

Every year, some senior living residents die or move into more involved care, and former spaces are filled with new residents, said Margaret Johnson, senior director and senior living sector leader at Fitch.

However, she noted that the pandemic disrupted this model because new residents did not want to move to planned life communities.

Operating margins are also “deteriorating” as continuing care retirement communities (CCRCs) are “extremely vulnerable to rising wages,” putting downward pressure on margins, sad Vikram Rai, head of municipal markets strategy at Wells Fargo, in a February report .

There are also “unforeseen” construction costs, and inflation is contributing to budgets exceeding estimates, even after accounting for “contingent expenses,” he said.

“Not only have they seen costs increase, but some prospective residents have even canceled contracts, citing construction delays and financial constraints due to the poor housing market,” Rai said.

Older people have trouble attracting residents, said Pat Luby, manager of urban research at CreditSights.

“The potential population that could end up in these senior centers is a small fraction of the population,” while “the hospital serves everyone by offering a combination of private pay, Medicare and charity care,” he said.

“Senior centers have a single business purpose, which limits the population of people who are not only interested and willing, but also able to afford the costs of entering these centers and incurring these costs, which are significant,” Luby said.

According to Johnson, these challenges, along with higher expenses, staffing shortages and reliance on government reimbursements, particularly Medicaid, have contributed to three recent downgrades of Fitch life plan communities.

She noted that Midwest-based Christian Horizons is experiencing weak operations, while Presbyterian Villages of Michigan is under operational pressure and will be unable to meet its debt service obligations.

Meanwhile, Texas-based The Legacy at Willow Bend became embroiled in competitive pressures, market pressures and additional debt that resulted in a downgrade despite its excellent reputation, Johnson said.

“The sector has experienced the highest number of insolvencies post-pandemic, and while we expect insolvencies to remain high, the recent reduction in spreads has improved the risk-reward dynamic for investors,” Rai said in a February commentary.

Senior housing, while a risky sector, is “one of the sectors we like and invest in,” said Brad Libby, fixed-income portfolio manager and credit analyst at Hartford Funds.

Senior living offers a “nice spread increase” compared to other similarly rated sectors, although he admitted the last 18 months have been more volatile, even on a rating-by-rating comparison.

“Some of the top risks are favorable from a buyability standpoint and create some opportunities and additional spread or profit for the ‘quality’ operators in the sector,” said Jon Mondillo, head of North American fixed income at abrdn.

Broad macro dynamics are supporting the sector, such as aging demographics, which will create demand for senior living communities as it “continues to accelerate rapidly in the coming decades,” according to an article by Craig Mauermann, associate portfolio manager at Thornburg Investment Management.

That demand will lead to expansions and additional capital projects, which is one reason Fitch gives the life plan community a positive outlook or raises its issuer rating, Johnson said.

“Typically, this is a self-contained dwelling unit development project that has been successfully completed, is generating revenue and is on track in terms of expected benefits to the community,” she said.

And without expectations of undertaking another major capital project in the foreseeable future, “that revenues and cash flow will increase on (life planning communities’) balance sheets and that they will begin to pay down their debt, we believe that credit quality will improve.” “

In addition, overall operations and occupancy have increased to near pre-pandemic levels, Mondillo said.

Overall, high-yield investments can perform well and produce successful results, but “the level of due diligence, on-site reviews, management interaction, understanding of competitive forces and, very importantly, overall portfolio diversification of these types of investments becomes much greater today extremely important,” Lipton said.

But compared to other high-performing sectors, senior centers can “raise rates and control their own revenue streams to maintain sustainable operations for their residents,” Johnson said.

She noted that hospitals cannot raise interest rates in a similar way, and other high-yield issuers, such as charter schools, have other risks to their businesses, such as the risk of losing their charter.

“Advantageously, unlike some other high-profit sectors, they have the ability to control their own destiny,” she said.