Investing In Senior Housing Muni Bonds Amid Demographic Change

By Catherine Stienstra, Head of Municipal Investments; Douglas Rangel, CFA, Vice President, Fixed Income Client Portfolio Manager

This credit sector can offer attractive opportunities, but investors shouldn’t be drawn in by high yield alone.

Continuing care retirement communities (CCRC) and senior housing facilities have historically been a sought-after category by institutional investors, who are often attracted to this credit sector because of its higher yield. Yield aside, investing in the senior living sector is supported by positive demographic fundamentals that should expand opportunities in this sector.

CCRCs fall within a broader category of municipal bonds called private activity bonds (PABs). Local and state governments issue PABs on behalf of private users – in this case, mainly developers and operators of CCRCs – to meet the housing needs of their older residents. In a similar fashion, a municipality might issue school bonds, which also support a certain segment of the overall population.

The overall size of the CCRC market is still relatively small ($5 billion of issuance in 2018), but it’s doubled in size over the past decade.1 As a percentage of total new issuance, the CCRC and senior living sectors accounted for 1.4% of tax-exempt issuance in 2018, compared with 0.7% a decade ago2. We anticipate that CCRC issuance will continue to increase, which may present attractive opportunities for investors who understand the intricacies and nuances of this corner of the market.

Data from the U.S. Census Bureau and the Joint Center for Housing Studies at Harvard University examined the senior population trend and its impact on housing and care service in the next 20 years.

Investing In Senior Housing Muni Bonds Amid Demographic Change

CCRCs offer residents a range of options from independent living to assisted living to full-service healthcare-based options with skilled nursing. Many of the negative connotations once associated with traditional nursing homes have dissipated because these communities offer a range of amenities for residents like swimming pools, fitness centers, libraries and art studios. Moving into these communities is a lifestyle choice that allows for a seamless transition through the various stages of care necessary as residents age.

The financial success of these communities depends on a number of factors, but in general, there are two types of retirement living communities consumers can choose from (and that bond investors can invest in). The first is an entrance fee-based community, which requires a new resident to pay the entrance fee up-front, usually in hundreds of thousands of dollars, and is often financed by the proceeds from the resident selling their house. The second is a monthly rental-based community; there is no entrance fee requirement, so residents could move in first and sell their houses later. Typically, residents pay a monthly service fee to reside in the community, but it varies by property and is usually much lower than monthly fees in rental-based communities. Other services, such as housekeeping, medication assistance or bathing assistance, are usually considered additional charges. The financial resource requirements for eligible seniors considering the two living options differ significantly, and these two types of senior living facilities behave differently from a credit risk standpoint.

According to Columbia Threadneedle Senior Credit Analyst Ben Woo, who has been following the sector for 26 years, entrance fee-based CCRCs experienced a significantly higher level of financial stress during the 2008 recession and housing downturn, mostly due to eligible seniors’ reluctance to list their houses and move to a CCRC when home valuation was down. CCRC borrowers had much-lower-than-expected turnover entrance fees to pay debt services and operating expenses, leading to deteriorated debt service coverage, elevated cases of liquidity stress and even loan indenture covenant violations. In contrast, rental-based communities reported less marketing and occupancy challenges during the same period. Their financial performance declined noticeably less relative to entrance fee-based communities.

Be aware of the risks

Despite favorable demographic trends, investing in senior living poses multiple risk elements to investors, making fundamental credit analysis, security selection and ongoing credit surveillance paramount. Risks such as construction cost overruns, local market competition, low occupancy or simply poor management execution can lead to adverse outcomes for investors.

Bottom line

With a potential yield advantage over AAA munis, CCRC issues can offer attractive tax-exempt income in a well-diversified portfolio. The incremental yield and uncorrelated performance (relative to larger portions of the municipal market such as state GOs or transportation bonds) can make CCRCs an attractive option for many investors. However, it’s important for investors to refrain from being drawn in by high yield alone. Understanding the differences between opportunities requires comprehensive analysis and experience.

Disclosures

1 Columbia Threadneedle Investments.

2 Columbia Threadneedle Investments.

Investing involves risk including the risk of loss of principal. There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities. Income from tax-exempt municipal bonds or municipal bond funds may be subject to state and local taxes, and a portion of income may be subject to the federal and/or state alternative minimum tax for certain investors. Federal income tax rules will apply to any capital gains.

Columbia Threadneedle Investments does not offer tax or legal advice. Consult with a tax advisor or attorney.

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The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that any forecasts are accurate.

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