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Final month, I heard one thing uncommon on Welltower’s (NYSE: WELL) This autumn 2024 earnings name: CEO Shankh Mitra referring to “underpants gnomes.”
The reference got here up as he was describing the “elementary misunderstanding” that senior residing builders appear to have when speaking about alternatives forward. He in contrast their plans to these of the underpants gnomes – small fantasy creatures featured in a 1998 episode of South Park.
Within the episode, the gnomes secretly steal underwear and stack them in an enormous pile. When South Park’s protagonists ask the gnomes why they steal underpants, the gnomes reply they’ve a easy, three-phase marketing strategy:
- Section 1: Acquire underpants
- Section 2: ?
- Section 3: Revenue
In the same manner, Mitra stated, senior residing builders see the demand for senior residing within the years forward and imagine they stand to revenue from it, however don’t have a great plan for creating new communities within the short-term.
In his thoughts, part 1 is demand from the incoming child boomer era, and part 3 is revenue. However he believes part 2 continues to be an enormous query mark.
“The economics don’t work. That’s the issue,” Mitra informed me in a current interview.
I feel Mitra’s humorous comparability is backed by some compelling monetary math. And growth – or the dearth thereof – has been on my thoughts since I hosted a panel on the Spring NIC Convention just a few weeks in the past. On stage, I requested the panelists how they felt concerning the “underpants gnome fallacy.”
Matt Derrick, managing director at developer Confluent Senior Dwelling, joked that he has “a greater professional forma than the gnomes.” However on a extra critical word, he’s involved about how that disconnect between demand and growth might damage senior residing within the long-term.
“I’m involved that this trade is about to hit a disaster level. We aren’t placing shovels within the floor,” he stated. “It is a needs-based trade, and if we don’t meet the demand, our trade goes to undergo.”
He does suppose the monetary math required for brand new growth will work in some unspecified time in the future sooner or later.
“I firmly imagine in it, and I’m betting my profession on it,” he stated.
On this members-only SHN+ Replace, I mirror on my current interview with Mitra, my panel at NIC and different trade developments to supply the next takeaways:
- Extra on the rationale behind Mitra’s underpants gnomes comparability
- What senior residing builders are doing now to speed up their plans to develop
- Why Mitra believes a senior residing Manhattan Challenge is required
Contained in the ‘underpants gnomes fallacy’ of senior residing growth
Underpinning Mitra’s argument is the truth that senior residing growth is simply too tough and expensive to pencil out in 2025.
There have been fewer than 22,000 models underneath development within the fourth quarter of 2024, representing the bottom stage of latest development because the first quarter of 2014, in line with the most recent NIC MAP occupancy report.
Rates of interest for development loans – if one can discover such a mortgage proper now – are as a lot as twice as excessive in 2025 as they have been in 2019, he stated. And even when one might begin a brand new challenge at this time, the time from begin to stabilization has risen to as a lot as seven to 9 years.
On the identical time, development and labor prices have risen whereas trade rents stay nicely under ranges to make new tasks possible. Assuming a growth price of $450,000 per unit and a stabilized yield on price of between 8% and 9.5%, senior residing firms must obtain a income per occupied unit (RevPOR) of between $11,000 and $13,000 to make the challenge pencil out.
For instance, Mitra stated {that a} hypothetical challenge within the Chicago suburb of Winnetka, Illinois, with an assumed price foundation of $1 million possible would balloon to growth prices of $1.3 million to $1.4 million. He estimated the neighborhood must cost far larger than common trade rents – as a lot as two occasions – to make the maths work. “Good luck” attaining that, particularly given the relative monetary constraints of the boomers, he stated.
As Mitra has famous earlier than, a developer would possibly construct one thing at this time on a value foundation of a greenback and promote it for 70 cents down the highway – definitely not a great enterprise end result for firms that make cash promoting belongings at a better value level than it took to construct them.
I do suppose senior residing builders have the same mindset. Throughout the panel I hosted at NIC, Derrick informed me Confluent is being “very cautious and conservative” in its underwriting with any new offers.
“The previous few years have been a number of the most tough that we’ve ever encountered on this area,” he stated.
That stated, the corporate has constructed up a growth pipeline of about $400 million during the last couple of years and is transferring ahead with formidable plans to increase.
“Most of these offers are about two years outdated, which implies I spent a variety of my time renegotiating land contracts,” Derrick stated. “We’re undoubtedly seeing extra curiosity in growth during the last six months than we now have during the last two years. We at the moment are full-steam forward on design and pre-development, actually gearing our portfolio up for floor breaks later in ‘25 and ‘26.”
Besides, I don’t see any of those circumstances altering within the fast future. So long as communities commerce under substitute price, fairness will goal acquisitions. If builders can get a challenge within the floor now, they is perhaps doing so with dangerous capital stacks.
The place growth offers are getting accomplished, Mitra famous they’re typically funded by what he calls OPM – different folks’s cash. A typical growth capital stack is perhaps structured with 80% coming from borrowed funds, with the remainder coming from different traders. Solely a small share of funds comes from builders themselves – that’s the place the issue lies, he stated.
“[The developer] additionally costs not less than as a lot of their very own fairness as charges. If you consider the economics, by the point they go into the bottom, [the developer] is nice. They don’t have any cash in play,” Mitra stated.
That disconnect between financing and execution can result in dangerous capital constructions that arrange tasks to fail on the finish of the day. For firms like Welltower, this isn’t a nasty factor. Mitra shared an instance of a senior residing developer that had priced a portfolio of communities at as a lot as $600,000 per unit in 2019 – a value he didn’t agree on on the time.
“I ended up shopping for 20 of the perfect belongings at 50 cents on the greenback from the lender within the final 15 months,” he informed me.
Societal implications
Whereas Derrick warned of a coming trade disaster, Mitra described a disaster within the making for the nation as a complete. Unhealthy senior residing offers imply communities find yourself within the palms of the banks that funded them, which may’t simply foreclose on them.
“Someday, the FDIC will come and take these belongings and finally, the taxpayers pays,” he stated. “I’m saying that we shouldn’t be engaged in an financial exercise the place the profit goes to the non-public sector and the losses go to American taxpayers.”
One other societal downside is the resident charges required to make senior residing pencil out. Whereas the incoming group of older adults is massive, the boomers don’t have as many pensions, financial savings or grownup youngsters because the era earlier than them. Affordability may very well be an enormous barrier for them, and in flip damage operators’ skill to develop their providers for a wider group of consumers.
“There may very well be demand for the product, however not the power to pay for the product,” Mitra stated.
Mitra’s evaluation paints a dire image of the trade’s skill to adequately meet the rising demand for its providers. As NIC MAP CEO Arick Morton identified on the NIC Spring Convention, the trade “must develop about twice as many models as we’ve ever developed, each single yr in mixture for the following 20 years” to maintain up with demand.
On the finish of the day, Mitra stated he has no good answer in thoughts that might rapidly repair senior residing growth. However he careworn that the answer won’t come from the general public or non-public sector alone, however from either side working collectively. What the trade wants now’s a type of “Manhattan Challenge” for senior residing, he stated.
“Convey a bunch of sensible folks in a room and say, ‘What’s required and the way will we afford it?’” he stated.
