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By Qaiser Mian, Senior Director - Research, Valuation & Advisory | Paul Chmeleski, Senior Consultant - Commercial Property Tax | May 29, 2020

With retirement and long-term care residences at the epicentre of COVID-19 outbreaks in Canada, owners, investors and operators are struggling to address daily operating challenges, while also trying to gain clarity about the potential impact on values going forward.

Since March 13, when jurisdictions across the country began imposing containment measures, and with no clear timeline yet for ending restrictions, the impacts of the novel coronavirus pandemic are only gradually revealing themselves.

While we don’t yet know what next year or even next month will look like, following is a snapshot of Canada’s seniors housing industry in these early days of the “time of COVID” – what’s currently happening in capital and transaction markets as well as pressures the sector is experiencing related to operations, supply and demand. This information may be helpful for owners, investors and operators as you plan strategies for your seniors housing assets.

Also included is an update on provincial and municipal tax abatements, appeals and deferrals available for seniors housing, which may help to alleviate some of the financial pressures the industry is currently experiencing.

Capital Markets

While the Bank of Canada reduced its benchmark interest rate to 0.25% in late March, this has yet to translate into lower rates for most borrowers. Instead, lenders are increasing spreads to maintain interest rates, in effect treating the higher spread as a ‘risk premium’ for access to liquidity in the current environment.

On a positive note, lenders are showing a strong willingness to work with existing borrowers through the crisis. Existing borrowers have yet to report significant cash flow issues despite higher operating costs associated with containment measures. The current situation is viewed as a relatively short-term crisis while the long-term fundamentals of the industry remain strong.

A prolonged crisis may challenge this cooperation as lenders look to reduce risk within loan portfolios. This would likely flow through to capitalization rates as investors adjust return expectations to match capital market changes.

Operational Issues

Seniors housing operators are on the front line of managing the health impacts of the novel coronavirus pandemic. Efforts to prevent and contain COVID-19 cases come at a high cost. Everything from labour to equipment is significantly higher.

Staffing will continue to be an issue in the short- to medium-term. This will result in higher recruitment and retention costs industry wide. Some workers may prefer to access the Canada Emergency Response Benefit (CERB) rather than working in facilities that are high risk for contracting coronavirus. A lasting impact of the crisis will be a need to revise staffing ratios throughout the care spectrum.

Enhanced infection control measures for residents and safety for workers are resulting in higher operating costs. Extra staffing, personal protective equipment and supplies, cleaning and maintenance staff/equipment expenses have all been impacted. Going forward, these costs are expected to remain elevated above historic levels.

Liability insurance premiums are expected to rise. Acts or omissions related to policies, procedures or legislative requirements can give rise to liability. With so many COVID-19 illnesses and deaths associated with long-term care homes, it is expected that patients, family members and workers who became infected with COVID-19 in these residences could seek legal remedies.

Marketing and sales efforts have been adjusted or curtailed. Most operators have placed a moratorium on checking in new residents for 60 days. Accordingly, sales and marketing activities have been scaled back and marketing efforts are focusing on providing information valued by target audiences.

 The need for retrofitting, particularly in the regulated long-term care sector, is anticipated. In January this year, the Canadian Association for Long Term Care requested government funding by 2023 for the construction, renovation and retrofit of 400 long-term care homes to meet current design standards and the needs of today’s seniors.

Homes with shared bedrooms, washrooms and dining rooms are a particular challenge from an infection control perspective. To provide safer facilities, the industry and the government will have to review physical infrastructure and practices.

With nearly 80% of Canada’s COVID-19 deaths having occurred in nursing homes as of May 2020, momentum is building to bring privately-owned long-term care homes under the Canada Health Act to improve care for the elderly. This could potentially redesign the entire industry.

In the nearer term there is potential for greater regulatory scrutiny and higher costs associated with compliance.

Transaction Markets

The true impact of COVID-19 on the seniors housing industry is expected to become clearer over the next few quarters. Preliminary data, however, suggests transaction volume is down significantly with potential for price corrections to come. For prospective vendors, price discovery will be the first challenge coming out of the crisis.

While most large operators have healthy balance sheets and continue to grow organically, smaller, less well capitalized operators are more vulnerable during this crisis. Over time, it’s expected there will be higher transaction volumes in the mid-to-lower end of the industry.

Vendors with the ability to delay transactions may do so in order to avoid re-negotiating pricing. Buyers, on the other hand, will view this as an opportunity to acquire at a relative discount to 2019 prices. Marketing and due diligence periods are likely to be extended through the remainder of 2020 and into 2021.

More valuations will be based on discounted cash flow. Rather than the more common direct capitalization approach, the discounted cash flow approach will be used more frequently to capture cash flow fluctuations and the impact of the crisis on asset values. Alternatively, to account for near-term income loss, below-the-line adjustments to the value derived via the direct capitalization approach may be warranted.

Underwriting challenges. Given the uncertainty regarding the duration of constricted cash flows and capitalization rates, confidently underwriting acquisitions and discretionary capital expenditures is expected to be challenging. Underwriting assumptions should be assessed with particular consideration for the following:

  • market vs. in-place rents;
  • revenue growth assumptions;
  • vacancy and lease-up assumptions; and
  • expense growth assumptions related to staffing, property taxes, cost of supplies, insurance and marketing.

More frequent reviews of value warranted. While stakeholders are not experiencing significant financial distress, the current situation is more of a valuation challenge than a value challenge. As the coronavirus situation evolves, consider more frequent reviews of value, particularly for the non-regulated segments of the sector. Timely updates of property value enable owners and investors to support strategic decisions.

Pressures on Demand

Finances of potential residents may be strained coming out of COVID-19. A significant number of potential residents of retirement homes rely on the sale of their primary residence as well as savings to fund retirement living. Canada Mortgage and Housing Corporation expects housing prices to decline between 9% and 18% through 2021. This could have direct implications on the ability of retirees to fund their move to retirement living in the short to medium term and may result in longer lease-up periods coming out of the crisis as well as a need for higher vacancy allowances in the interim.

Rising unemployment is expected to further compound demand dynamics as children of retirees see their ability to supplement their parents move to retirement homes eroded. Inducements may be needed to assist with affordability, which will result in suppressed revenues in the medium term, potentially impacting value.

Reputational risk will soon affect demand. The impact of reputational risk to the industry generally and individual facilities specifically due to infection management challenges is more complex to gauge and will require more time to assess. The stigma associated with publicity related to COVID-19 outbreaks and fatalities make it more difficult to attract and retain residents. Indirectly, reputational risk may result in higher yield requirements from investors.

 

Opportunities for tax abatements, deferrals and appeals

During this stressful time for the seniors housing industry, any opportunity to reduce costs is welcome. Fortunately, to mitigate the burden of higher costs and vacancies until operations stabilize, municipalities across Canada have been rolling out tax rebate and deferral programs, and some provinces are providing extensions to property tax appeal deadlines. Here are some of the key offers to be aware of.

The effect of COVID-19 on assessments will soon begin to be seen. When provinces across the country started announcing states of emergency in response to COVID-19 outbreaks, property assessment and taxation were integrated into relief efforts.

Most municipalities offer property tax relief. Most municipalities across Canada are offering some form of deferral of property tax obligations and forgiveness of late fees and interest for arrears. For the current status of programs and financial relief across the country, refer to: Property Tax ­ – Municipal and provincial Response to COVID-19.

More time to appeal assessments in Ontario. To appeal an assessment for a retirement home in Ontario it is necessary to begin with the informal appeal process – a Request for Reconsideration (RFR). The Ontario government has extended the RFR deadline to 16 days after the province lifts the state of emergency. At this time the state of emergency is scheduled to end on June 9, which would indicate an RFR appeal deadline date of June 25. If a resolution cannot be reached through the RFR process, a formal appeal may be launched with the Assessment Review Board within 90 days after the decision date.

In Ontario, long-term care homes are taxed as commercial properties. While the RFR process is not a precondition of appealing to the Assessment Review Board (ARB) for these properties, it is available to those who wish to start with an informal appeal process. The deadline to file appeals with the ARB is typically March 31 but has been extended to May 29.

Ontario has delayed, by at least one year, its planned reassessment for the 2021-2024 assessment cycle, which is to be based on 2019 values. Assessments for 2021 will continue to be based on current value at January 1, 2016  – updated to reflect any additions or improvements to properties.

Varying appeal deadlines across Canada. The provinces have different deadlines for assessment appeals. Although most deadlines for the 2020 taxation year have passed across the country, a number of provinces update their assessment valuations annually. For the current status, refer to: 2020 Canadian Property Assessment Appeal Deadlines.

In Alberta and British Columbia, which have yearly assessments, property values for the 2021 tax year will be based on a valuation date of July 1, 2020. These will be the first provinces whose valuation date falls within the COVID-19 period. It will be interesting to see the difference in values on the assessment rolls of these provinces between the July 2019 and July 2020 valuation dates.

There will be opportunities to pre-negotiate values, which will be helpful in gaining an understanding of assessors’ perspectives. There is generally a window to discuss and make changes before the assessment roll is finalized.

Municipal Act applications.  In Ontario, there may also be opportunities to apply for tax reductions under the Municipal Act, 2001,  which provides municipalities with the authority to cancel, reduce or refund taxes based on specific criteria.  The deadline to file a Municipal Act application is February 28, 2021.

Documentation of losses due to COVID-19.  For those who intend to seek property tax relief, be sure to carefully document all financial losses – this will be essential for quantifying COVID-19 impacts.

Supply Slowdown Expected

So far, the development side of the seniors housing industry remains robust. Equipped with strong balance sheets and lender support, developers continue to pursue projects during this low interest rate environment. Demographic trends remain favourable with some estimates suggesting that by 2026, more than 2.4 million Canadians aged 65 and older will need continuing care.

With indoor construction having been curtailed due to social distancing requirements, construction delays are expected. This slowdown of new supply entering the market is expected to help with post-COVID lease up of existing retirement homes, although this may vary on a market-by-market basis.

Industry Fundamentals Continue to be Strong

Overall, industry fundamentals remain strong. While the seniors housing industry will certainly look very different post-COVID, stakeholders have the resources, ingenuity and expertise to come out of the crisis stronger and better positioned for long-term success. By staying informed about what the marketplace continues to reveal, and carefully weighing likely impacts, you can make timely decisions to protect, and build, the value of your assets.

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