A Connecticut firm's recent bankruptcy highlights the challenge of investing in the senior living sector, known throughout the muni market as one of the riskier areas, particularly in a post-COVID world. However, some market participants are still bullish, fueled by spread pickup, macro dynamics and demand-driven expansion.
The senior living sector has always been challenged, with a default rate of 10.8% in 2023, compared to the overall muni market's 0.41% default rate, excluding Puerto Rico debt, said Lisa Washburn, chief credit officer and managing director at Municipal Market Analytics, Inc.
However, it faced more pressure after the pandemic, as "a post-COVID world has changed the landscape and investment thesis for many project finance deals," said Jeff Lipton, a research analyst and market strategist, pushing default rates higher.
The sector rose to a default rate of 10.8% last year, up 4.9% in 2018, Washburn said.
Falling occupancy figures, staffing shortages, and rising labor costs have increased the sector's risk, with Greenwich Investment Management's Chapter 11 bankruptcy filing last month yet another example of the challenged sector.
Greenwich Investment Management's Sawgrass Grand Senior Living Project, a conversion of a nearly 300-room hotel in Sunrise, Florida, into a senior living facility, contributed to its bankruptcy.
The project, financed by selling $35.8 million of senior living revenue bonds issued from Capital Trust Agency, was completed with a "substantial loss of principal in client portfolios," according to an SEC filing.
Greenwich Investment Management filed lawsuits against the developer and underwriter, alleging the defendants' actions led to the project's breakdown, defaulted bonds and damage to the bondholders.
"The negative developments … damaged the reputation of GIM and led to client attrition," and the firm's decline in revenue "diminishes GIM's ability to remediate challenged projects," the filing said.
Greenwich Investment Management did not respond to calls for comment on the bankruptcy.
Within the senior living sector, Greenwich Investment Management seemed to pick the "riskiest" securities, Washburn said.
The money manager focused on unrated retirement, which has a higher incidence of default than the sector's rated portion, she noted.
"If you're investing in the riskiest sector in the marketplace and investing in the unrated portion of it, you are taking on a disproportionate amount of the risk," Washburn said, citing concentration risk in this area is likely contributed to Greenwich's bankruptcy filing.
In its bankruptcy filing, the firm mentioned other defaulted projects that serve the "senior citizen" market, listing at least 38 defaulted bonds the firm continued to work on in 2023.
"The number and collective size of the challenged projects has surpassed GIM's remedial resources, both personnel and liquidity," the money manager said in its bankruptcy filing.
The bankruptcy confirms there are "significant" risks to senior living, and investors need to perform full credit analysis and be mindful of the "quality of the projects that are backing the bonds that they're purchasing," Washburn said.
However, she noted that Greenwich's bankruptcy filing does not mean the sector is riskier than it was before, but challenges still persist following COVID-19.
"A lot of these projects financed were vintage COVID, which struggled to fill up and then got hit with inflation, excess costs and mismanagement," James Pruskowski, chief investment officer of 16Rock Asset Management.
Every year, some of the senior living centers' residents die or move into more involved care, and the previous spots are filled with new residents, said Margaret Johnson, senior director and sector lead for senior living at Fitch.
However, she noted that the pandemic disrupted this model because new residents did not want to move into life-plan communities.
There are also "deteriorating" operating margins, as continuing care retirement communities, or CCRCs, have been "extremely susceptible 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 "unanticipated" construction costs, with inflation contributing to budgets exceeding estimates even after considering "contingent spending," he said.
"Not only have they seen their costs escalate, but some potential residents have even canceled their contracts, citing construction delays and financial constraints given the lackluster housing market," Rai said.
Senior living struggles to attract residents, said Pat Luby, head of municipal research at CreditSights.
"The potential population that can go into these senior living centers, it's a small slice of the population," whereas a "hospital serves everybody with a mix of private pay and Medicare and charity care," he said.
"A senior living center has a single business objective, and that limits the population of people not only interested and willing but also able to pay the cost of getting into these facilities and paying the costs, which are significant," Luby said.
These challenges, along with higher expenses, staffing shortages, and reliance on governmental reimbursement, specifically Medicaid, have contributed to three recent downgrades of life plan communities from Fitch, according to Johnson.
Midwest-based Christian Horizons has weak operations, while Presbyterian Villages of Michigan faces some operating pressures and will be unable to meet its debt service covenants, she noted.
Meanwhile, the Texas-based The Legacy at Willow Bend got "caught up" in competitive pressures, along with market pressures and additional debt driving the downgrade, despite its high-end reputation, Johnson said.
"This sector has witnessed the highest number of defaults post-pandemic and while we expect the number of defaults to remain high, the recent cheapening in spreads has improved the risk-reward dynamic for investors," Rai said in a commentary from February.
Senior living, despite being a risky sector, is "one of the sectors we like and invest in," said Brad Libby, a fixed-income portfolio manager and credit analyst at Hartford Funds.
Senior living provides a "nice spread pickup" compared to other similarly rated sectors, though he conceded the past 18 months have been more volatile, even on a ratings-by-ratings comparison.
"Some of the headline risks are beneficial for buying opportunities and create a bit of opportunity and a bit of additional spread or yield for 'quality' operators in the sector," said Jon Mondillo, head of North American fixed income at abrdn.
The broad macro dynamics support the sector, such as aging demographics, which will create demand for senior living communities as they "continue accelerating rapidly over the coming decades," according to an article from Craig Mauermann, an associate portfolio manager at Thornburg Investment Management.
This demand will lead to expansions and additional capital projects, one reason Fitch gives a life plan community on a positive outlook or upgrades the issuer, Johnson said.
"Usually, it's an independent living unit expansion project that has successfully filled, is generating revenue, and is on target in terms of what it's expecting to generate for the community," she said.
And without expectations of undertaking another major capital project in the foreseeable future, "that revenue and cash flow accretes to the [life plan communities'] balance sheet, and they start to pay off their debt, we think that the credit quality will improve."
Additionally, overall operations and occupancy rates have rebounded to near pre-COVID levels, Mondillo said.
Overall, high-yield investing can perform well with successful outcomes, but "the level of due diligence, on-site reviews, management interaction, understanding of competitive forces, and very importantly, portfolio diversification of these types of investments at all become far more critically important today," Lipton said.
Compared to other high-yield sectors, though, senior living centers can "raise rates and control their own revenue streams so they can maintain stable operations for their residents," Johnson said.
Hospitals can't raise rates similarly, and other high-yield issuers, like charter schools, have other threats to their operations, like the risk of losing their charter, she noted.
"Favorably, they have the ability to control their own destiny, in contrast to some of the other high-yield sectors," she said.
