The not-for-profit senior living sector has outperformed other revenue bond indexes for the past three years. There are three main factors driving this performance. Two of the factors are related to demographic shifts and the maturation of the providers, with the third factor being a broader municipal-market force. This is a trend we expect to continue in 2016.
Taking a closer look at 2015, this return becomes even more impressive. Despite a major uptick in new issue supply in 2015, the senior living sector outperformed the broader market. Senior living public debt issuance increased by 35% year-over-year, resulting in volume of $4.5B, the largest new issue volume since 2007. Equally relevant to the supply increase was the amount of transactions. There were approximately 185 separate transactions resulting in an average transaction size of $25 million. The municipal bond market is historically driven by supply and demand dynamics. The supply of new investable cash into tax-exempt mutual funds and the supply of new issues brought to the market have a tangible effect on bond prices. As such, major increases in volume can hurt specific municipal sector performance. That said, the senior living sector outperformed other revenue bond sectors in a year when volume was significantly up and the supply was spread over multiple different issuers.
The first demand component for the senior living sector investment performance is due to the need of communities for retirees. With nearly 8,000 seniors retiring every day, there are seismic demographic changes happening in the United States. Roughly 44 million people are now age 65 and older and the U.S. Census Bureau expects that to double in year 2050. Approximately 63% of people ages 65 and older need some form of long-term care.
Not-for-profit senior living projects are a key component in meeting this demand, and the municipal market has created an environment and credit requirements to finance this growing sector. In the process of tax-exempt capital allocations to this sector, investors are being provided with a relative value opportunity to invest in these fixed income securities.
The second component of senior living sector outperformance is a lag in the broader identification of key credit metrics. As not-for-profit senior living campuses continue to re-invest capital in their facilities, build cash on their balance sheets, and implement operational best practices, more of them are accessing capital in the municipal market to meet the growing demand for care. According to LeadingAge, the recognized data aggregator in the not-for profit senior living sector, the net default rate for the sector is 3% (including recovered dollars). From 1970 to 2014, Moody’s Investor Services estimates the non-general obligation municipal market’s default rate is on average 0.034% (a number that doesn’t include Puerto Rico’s ongoing situation). Roughly 25% of senior living projects are non-rated. Of the 25% that are rated, all are “A” rated and below (lower investment grade). This results in higher yielding securities for investors. The maturation of the senior living sector, localized nature of the projects, lack of credit ratings in general, and their alignment with actual default risk, presents a unique opportunity.
It is our opinion that the amount of ratings and rating levels will continue to lag the actual performance of the projects. This is evidenced by the sector’s outperformance of the broader revenue bond market. Over the past three years, senior living sector investors are getting yields, which are in excess of credit risk. The third outperformance driver is the lack of yield in the municipal market. As in all fixed income products, yields are historically low. The tax-exempt institutional buyers of the municipal market have combated these low yields and benefited from overweighting in the senior living sector.
In closing, with current futures interest rate markets predicting a small chance of rate increases in the United States and globally, we believe municipals are positioned to remain at low interest rates, with the senior living sector out-performing other revenue bond sectors in 2016.
Adam Buchanan is senior vice president of Institutional Sales and Trading at Ziegler.
