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The Case for Seniors Housing and Healthcare Real Estate

The Case for Seniors Housing and Healthcare Real Estate

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According to an April 2017 Gallup poll, Americans ranked real estate as the No.1 long-term investment asset class the four previous years.1 And it is not hard to see why. Historically, hard assets such as commodities and real estate have been good hedges against inflation. In addition, while interest rates are slowly rising, income-seeking and growth-oriented investors are still looking for portfolio diversification through assets like real estate.

Two real estate sectors, seniors housing and healthcare, have continued to attract investments by developers and landlords alike, as well as provide income and growth opportunities to investors. While many real estate sectors are impacted by macroeconomic events that cascade to a particular market, seniors housing and healthcare real estate are largely nondiscretionary or needs based, mostly insulating them from economic drivers.

This article discusses the factors that are driving interest in seniors housing and healthcare real estate investments.

NEEDS-BASED REAL ESTATE

Seniors housing and healthcare facilities are needs based. The primary drivers leading to demand for these assets center around a rapidly aging population and rising healthcare costs. In addition, healthcare employment has steadily grown, unlike the overall employment population, which has been impacted by the same economic triggers affecting other real estate sectors. It is important to note that investing in seniors housing and healthcare real estate can take place through different investment vehicles with varying risk levels, fee structures and time horizons. In addition, trends for in-home care or care outside traditional healthcare facilities may impact the ability of the real estate investment to accomplish its objectives.

Demographic Shifts — The "Silver Tsunami"
Today's population is aging at a fast rate with more than 12,000 Americans turning 65 every day (refer to Figure 1).2 According to the U.S. Census Bureau, the senior population will more than double between 2015 and 2060, with 24 percent of the population projected to be 65 or older by 2060.2 This aging of America is impacting the supply and demand of seniors housing real estate, as retirees seek living options to meet their growing needs.

Healthcare Employment Trends
In addition, healthcare employment is one of the fastest growing employment sectors (refer to the navy line in Figure 1). Healthcare employment has also proven to be less tied to the economy. Jobs in this sector continued to increase during and after the Great Recession of 2008–2009. Combined, today's aging population and upward trajectory in healthcare employment have augmented the durability of seniors housing and healthcare real estate.

Rising Healthcare-Related Costs
Lastly, healthcare spending is projected to continue rising as a result of today's aging population and chronic illnesses. National healthcare spending is projected to increase to approximately 20 percent of the gross domestic product by 2025, representing an expense of almost $1 for every $5 spent during retirement.3 A report by HealthView Services states that retirement healthcare costs will rise at an average annual rate of more than 5 percent for the foreseeable future.4

Trends in Healthcare Employment and the Seniors Population

INCOME AND GROWTH OPPORTUNITIES

Today's low interest rates have created a favorable environment for investing in real estate. When combined with the existing supply and demand imbalance in seniors housing and healthcare facilities and the price swings experienced in the equity markets, it is easy to understand why investors are paying closer attention to real estate investments in these two sectors.

The Potential For Income
As mentioned earlier, seniors housing and healthcare real estate have continued to provide income opportunities to investors. As Figure 2 illustrates, the spread between the projected annual return on the real estate portfolio (or cap rate) on a seniors housing investment to a conventional mortgage is still favorable. As a result, many developers and landlords are taking advantage of today's low borrowing costs, before interest rates begin to increase and costs and investment risks start to rise.

Even after interest rates increase, real estate investments should continue to provide income in geographic areas where demand is strong and occupancy rates are high. First, real estate assets with shorter leases will be able to adjust to interest rate changes quicker. Second, narrower spreads between cap rates and borrowing costs may be mitigated by income generated from higher rental rates. As interest rates rise, so do inflation levels, thus leading to rental rate increases as evidenced by the average annual asking rent for seniors housing units, which has outpaced inflation.5,6,7

Seniors Housing Cap Rate Spreads on Conventional Mortgages

The Potential For Growth
Finally, there is a supply and demand imbalance in seniors housing and healthcare facilities. A 284 percent increase in seniors housing units is needed per year from 2030–2035 to meet demand projections.8 It is important to note that while these trends are favorable, there is no guarantee a real estate investment will be profitable due to different variables, including significant sector competition.

Furthermore, as the need for medical services outside of hospitals continues to grow, the existing supply of healthcare facilities will likely be insufficient to meet future demand. In recent years, there's been a shift toward a more consumer-centric, outpatient delivery model.9 According to data from a 2016 report from the American Hospital Association, outpatient surgeries have increased by 32 percent since 1994, and more than 65 percent of surgeries do not require an overnight hospital stay.10 Together, these findings point to an expanding need to develop medical office buildings and post-acute care facilities.

IN BRIEF

Unlike other real estate asset classes, seniors housing and healthcare are primarily impacted by a growing aging population and rising healthcare costs. Healthcare employment also continues to grow steadily, unlike the overall employment population. And while other real estate sectors have not been immune to economic events trickling down to a particular market, seniors housing and healthcare real estate are durable asset classes that continue to provide income and growth opportunities to investors.

A final note about investing in seniors housing and healthcare real estate: There are significant risks associated with these two sectors, including market risks impacting demand, litigation risks and the cost of being responsive to changing government regulations. The ability to evaluate local conditions, identify appropriate opportunities and find qualified tenants will impact an investment's success in these sectors. If properties are acquired through a taxable real estate investment trust (REIT) subsidiary, engaging and retaining qualified independent managers can create additional risks. Individuals should refer to an investment's prospectus. There might be room for traded and non-traded real estate investments in a portfolio depending on an investor's liquidity and diversification needs.

CNL Healthcare Properties II is a non-traded REIT11 that provides an opportunity for investors seeking income and growth for their portfolios. For more information about CNL Healthcare Properties II, please visit cnlhealthcarepropertiesii.com, or contact the managing dealer, CNL Securities, member FINRA/SIPC, at 866-650-0650. For additional educational materials about real estate or non-traded REITs, visit Advisor Resources.

References and Endnotes

1 Lydia Saad, "Americans Still Favor Real Estate for Long-Term Investment," Gallup, April 21, 2017.
2 "U.S. Population Projections: 2014–2060," U.S. Census Bureau, Dec. 10, 2014.
3 National Healthcare Expenditures 2016 to 2025, Centers for Medicare and Medicaid Services, July 25, 2016.
4 2017 Retirement Health Care Costs Data Report, HealthView Services, 2017.
5 Consumer Price Index, U.S. Bureau of Labor Statistics, accessed on March 31, 2017.
6 NIC MAP® Data Service, National Investment Center for Seniors Housing & Care, 4Q 2016.
7 This is not indicative of how an investment in CNL Healthcare Properties II will perform in relationship to inflation. There is no assurance the asking rental growth rate will continue to increase or will not reverse itself in the future. Seniors housing rental rates have not outpaced the consumer price index growth rates for every calendar year. Trends for seniors housing rent growth rates differ based upon the supply and demand experienced in varying geographical regions.
8 A Projection of U.S. Seniors Housing Demand 2015–2040, American Seniors Housing Association, Summer 2016.
9 U.S. Office Investment Forecast, Marcus & Millichap, 2016.
10 Trendwatch Chartbook 2016, American Hospital Association, 2016.
11 CNL Healthcare Properties II intends to qualify and elect REIT tax status beginning with the first year in which it commences material operations, the taxable year ending Dec. 31, 2017, although there is no assurance the REIT tax status will occur within the stated time frame. If the company fails to meet the REIT qualification standards now or in the future, the company will be subject to increased taxes, which will decrease investors' returns.
 

Risk Factors
Investing in a non-traded REIT is a higher risk, longer term investment than many listed securities and is not suitable for all investors. Shares may lose value, or investors could lose their entire investment.

The REIT was recently organized and has a limited operating history on which investors may evaluate operations and prospects for the future. The REIT is a blind pool offering that is in the initial stages of property acquisitions and has made limited investments.

This is a best-efforts offering, and if the REIT raises substantially less than the maximum offering amount, it may not be able to invest in a large variety of portfolio assets, which will subject investors to greater risk.

Non-traded REITs are illiquid. There is no public trading market for the shares. The REIT does not expect to offer a liquidity event in the near future, and investors should be prepared to hold shares for an indefinite period of time. If investors are able to sell their shares, the sale would likely be at a substantial discount.

There are significant limitations on the redemption of investors' shares under the REIT's redemption plan. The REIT can determine not to redeem any shares or to redeem only a portion of the shares for which redemption is requested. In no event will more than 5 percent of the weighted average of all share classes of the outstanding shares be redeemed in any 12-month period. The REIT may modify, suspend or terminate the redemption plan at any time. Holding periods may be waived for qualifying events.

The REIT is obligated to pay substantial fees to its advisor, managing dealer, property manager and their respective affiliates for their services in managing the day-to-day operations of the REIT based upon agreements that have not been negotiated at arm's length, and some of which are payable based upon factors other than the quality of services. These fees could influence their advice and judgment in performing services. In addition, certain officers and directors of the advisor also serve as the REIT's officers and directors, as well as officers and directors of competing programs, resulting in conflicts of interest.

There is no guarantee of future cash distributions or if distributions will be paid at all. Due to the high levels of investment costs and fees incurred during the REIT's initial phase, distributions will not be fully covered by cash flows from operating activities and will be paid from expense waivers, borrowings and offering proceeds. For the three months ended March 31, 2017, 100 percent of total distributions were funded by offering proceeds. Distributions paid from sources other than operating cash flow, now and in the future, are not sustainable and can reduce investors' overall return.

The per-share amount of distributions on Class A, Class T and Class I shares will differ because of the timing of certain class-specific expenses. Specifically, distributions on Class T shares and Class I shares will be lower than distributions on Class A shares because the REIT is required to pay ongoing distribution and servicing fees with respect to the Class T shares and Class I shares. These fees are not applicable to Class A shares.

If the REIT fails to maintain its qualification as a REIT for any taxable year, it will be subject to federal income tax and net earnings available for investment or distributions would be reduced.

The use of leverage to acquire assets may hinder the REIT's ability to pay distributions and/or decrease the value of shareholders' investments.

There are significant risks associated with the seniors housing and healthcare sectors, including market risks impacting demand, litigation risks and the cost of being responsive to changing government regulations. The REIT's success in these sectors is dependent, in part, on the ability to evaluate local conditions, identify appropriate opportunities and find qualified tenants or, where properties are acquired through a taxable REIT subsidiary, engage and retain qualified independent managers.

GENERAL NOTICES
No offering is made to residents of New York, Maryland or any other state, except by a prospectus filed with the Department of Law of the state of New York, the Maryland Division of Securities or the respective state securities administrator. Neither the U.S. Securities and Exchange Commission, the attorney general of the state of New York, the Maryland Division of Securities nor any other state securities administrator has passed on or endorsed the merits of the REIT's offering or the adequacy or accuracy of this piece or the REIT's prospectus. Any representation to the contrary is unlawful.

This is not an offer to sell nor a solicitation of an offer to buy shares of the REIT. Only the prospectus makes such an offer. This piece must be read in conjunction with the prospectus in order to understand fully all the objectives, risks, charges and expenses associated with an investment and must not be relied upon to make a decision. The information herein does not supplement or revise any information in the REIT's public filings. To the extent information herein conflicts with the prospectus, the information in the prospectus shall govern.

Forward-looking statements are based on current expectations and may be identified by words such as believes, expects, may, could and terms of similar substance and speak only as of the date made. Actual results could differ materially due to risks and uncertainties that are beyond the REIT's ability to control or accurately predict. Investors should not place undue reliance on forward-looking statements.

Managing dealer of CNL Healthcare Properties II is CNL Securities, member FINRA/SIPC. Shares are offered to the public through selling firms. Selling firms are reminded that the REIT's communications must be accompanied or preceded by a prospectus.

An investment in the REIT is subject to significant risks, some of which are summarized in the Risk Factors section of this piece and are fully detailed in the Risk Factors section in the REIT's prospectus. Investors should read and understand all of the risks and the entire prospectus before making a decision to invest. The prospectus is available on sec.gov and cnlhealthcarepropertiesii.com.

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