GSEs Continue to Innovate

Fannie Mae, Freddie Mac roll out new programs that reward green initiatives and provide financing for properties still in lease-up.

By Jane Adler

As new investors embrace seniors housing, Fannie Mae and Freddie Mac are racking up record loan volumes in the sector. The government-sponsored enterprises (GSEs), or agency lenders as they’re known, have always been a big and reliable source of permanent financing for seniors housing properties. 

But the most recent boost in demand for debt financing has come largely from private investors. Acquisition activity that had been dominated by large, public real estate investment trusts (REITs) has been replaced over the last two years by institutional investors and private equity funds. Unlike REITs, private buyers tend to rely on mortgage debt to finance properties, a need which has led to higher lending volume at the agencies. 

“The demand for seniors housing financing has exploded,” says Steve Schmidt, national director of seniors housing at Freddie Mac, whose office is in Chicago. 

While the GSEs enjoy the recent lending boom, they also face tough competition from a push by life insurance companies into the seniors housing mortgage market. 

In response, Fannie Mae and Freddie Mac are offering more aggressive financing packages. The agencies are also tweaking their product offerings, although the basic parameters of their programs haven’t changed. 

Fast closings and interest rate locks are available. Freddie Mac, in some instances, will provide early-stage takeout financing for new properties still in lease-up. 

Both GSEs also now offer “green” initiatives, financing solutions that provide capital for the upfront costs of building improvements to save energy and water. 

Meanwhile, Fannie Mae and Freddie Mac are managing their portfolios to avoid the situation that arose last year when it appeared they might hit their lending cap and retreat from the market. The Federal Housing Finance Agency (FHFA) established lending caps in order to maintain the presence of the agencies in the mortgage market while not crowding out private capital.

Affordable and “green” projects are excluded from the cap, which gives the agencies more room to maneuver. The bottom line is that capital will be available throughout the remainder of 2017. 

It’s important to note that there are ongoing discussions in the U.S. Congress about GSE reform, but industry insiders don’t expect new legislation anytime soon that would disrupt the lenders’ programs.

“Freddie Mac and Fannie Mae have provided the lion’s share of permanent mortgage financing for seniors housing since the late 1990s,” says Aron Will, vice chairman of the national seniors housing group at CBRE Capital Markets in Houston. “They’ve been very creative to come up with solutions to meet the borrower’s needs.”

Loan volume hits record levels

Seniors housing represents a small, though growing part of the multifamily portfolio at both Fannie Mae and Freddie Mac. In 2016, Fannie Mae provided $55.3 billion in financing for multifamily housing, while Freddie Mac’s volume was slightly higher at $56.8 billion. Seniors housing represents about six percent of Freddie Mac’s multifamily business, and three percent at Fannie Mae.  

In 2016, Freddie Mac posted a record $3.2 billion in deal volume in the seniors housing mortgage market, up from the previous record of $2.5 billion established in 2015. Freddie Mac’s mortgage volume in 2014 paled by comparison, totaling $1.2 billion. 

The outlook for Freddie Mac is for mortgage volume to total approximately $3 billion in 2017, according to Schmidt. “This year is very strong,” he says.

Freddie Mac has never had a loan default on a seniors housing property. 

At Fannie Mae, seniors housing loan volume totaled $1.6 billion in 2016. Seniors housing loan volume at Fannie Mae tends to fluctuate from year to year, says Phyllis Klein, vice president of borrower relationships for seniors housing at Fannie Mae. But volume in the first quarter of 2017 has already exceeded the total loan volume for all of 2016.

“We’re on track to have a very good year,” says Klein, who is based in Fannie Mae’s Los Angeles office. She adds that Fannie Mae has had one or two defaults on seniors housing properties in its 20-year history with the sector. 

Several large transactions helped to boost volume in the first quarter at Fannie Mae, says Klein, who declined to cite specific deals. She also credits the continued availability of low interest rates as a reason that owners are refinancing their loans now. 

The 10-year U.S. Treasury yield stood at 2.18 percent on June 7, up from 1.71 percent a year earlier, but still well below the long-term average of about 6 percent. 

Putting the lending boom into context, interest in seniors housing by private investors has grown since the recession. The asset class has become more accepted and is now seen as somewhat recession resistant because of the need for products such as assisted living. 

The mortgage market, in particular, has been bolstered by the growing confidence of institutional investors in the seniors housing asset class, which has helped to facilitate securitizations, say sources. The GSEs package mortgages and sell them as securities to investors. 

Freddie Mac securitizes seniors housing mortgages with other multifamily product loans and as standalone offerings. “We are growing the investor base that only wants seniors housing securitizations,” says Freddie Mac’s Schmidt. “That’s a good trend for our program.”

Competition among lenders has been a plus for borrowers. A handful of life insurance companies are now providing permanent mortgages for seniors housing projects. These lenders typically offer a less flexible financing package than the GSEs, say industry sources. 

The life companies prefer high-quality properties in major markets. 

These tend to be bigger assets, with loan sizes of more than $20 million. The insurers usually offer a 60 to 65 percent loan-to-value ratio. By comparison, the GSEs provide maximum leverage of 75 percent. “The insurers have taken a chunk of the market in the lower leverage space,” notes Will at CBRE. 

Supply concerns

In general, the GSEs finance independent living, assisted living, memory care and continuing care retirement communities. The agencies avoid properties that strictly provide skilled nursing, but increasingly they will consider lending on facilities with a skilled nursing component, say sources. 

Fannie Mae and Freddie Mac do not avoid certain markets. “We have never redlined a market and never would,” says Freddie Mac’s Schmidt. He explains that every market has a deal structure that makes sense. 

Overbuilding is not a big concern of the agencies despite a widespread industry belief that the seniors housing market is getting overbuilt in some markets. Schmidt believes that a quality project with a proven operator can withstand the next several years of relatively slow demographic growth among the senior population. 

By 2020, the country will need 50,000 new units of seniors housing a year to meet the demand of aging baby boomers who will start to turn 75 that year, says Schmidt. About 25,000 new units are currently being added annually. 

On a local level, however, supply is something the agencies and lenders watch carefully, according to Trace Wilson, director at PGIM Real Estate Finance. They want to be assured that a solid business plan is in place that takes competition from new construction into consideration. “This is a case where operations experience helps,” says Wilson, who is based in PGIM’s Atlanta office.

The quality of the building operator is highly important to both Fannie Mae and Freddie Mac. They seek experienced operators with a track record of success in the seniors housing sector. 

“We look closely at the operator and our experience level with the operator,” says Fannie Mae’s Klein. “That’s always a key consideration for us.”

Lease-up loans emerge

Both agencies are closing deals earlier in the property life cycle, according to sources. Freddie Mac, for example, now finances new projects still in the lease-up stage. Loan proceeds are available as much as three to six months earlier, enabling borrowers to exit their construction loans. 

The program was first piloted last year, resulting in several so-called lease-up transactions. Freddie Mac expects to close six to eight lease-up transactions in 2017. 

One lease-up deal, for example, involved a newly opened seniors housing property in the Midwest with 85 percent occupancy. (The details of the transaction, including the property name and buyer, were not made available.) At the time the deal closed, the projection was that it would be another four to six months before the property’s occupancy rate stabilized in the low-to-mid 90 percent range. 

Freddie Mac was able to provide a loan with a lower than standard minimum debt-service coverage. The difference in loan proceeds between the lower debt-service coverage and the standard debt-service coverage was held in escrow for several months until the property achieved stabilization. 

Besides these so-called holdbacks, Freddie Mac offers other creative solutions such as letters of credit and loan guarantees. 

Fannie Mae does not have a similar product, but provides some flexibility on the timing of closings on newly built properties. 

Walker & Dunlop, a commercial real estate financing firm based in Bethesda, Md., was recently able to close a Fannie Mae loan shortly after stabilization. “We got Fannie Mae comfortable with the borrower without having to let the occupancy ‘season’ for very long,” says Russell Dey, vice president at Walker & Dunlop. 

“Seasoning” refers to the time period a property needs to have been stabilized prior to being eligible for agency financing. In this case, Dey was able to demonstrate that the market did not have a lot of new supply under construction and that the property would be able to sustain a high occupancy level after the initial lease-up period. In other words, residents would not be lost to a newer property opening up down the road. 

The key for a faster closing on a new property is to correctly gauge the operating expenses, says Dey. Lenders need to be comfortable that the projected operating expenses are appropriate even though there’s no operating history. “That allows us to move forward quicker than we normally would,” says Dey. 

He explains that large owner-operators have an advantage since they have comparable properties in their portfolios. Operating expenses from existing properties can be used as a guide to underwrite new properties. 

Faster approvals

Deal turnaround time has improved at both agencies over the last 15 to 18 months, says Carolyn Nazdin, senior vice president with KeyBank Real Estate Capital, who is based in the company’s Washington, D.C. office. 

Fannie Mae has increased the amount of work delegated to the lender, which underwrites and closes the deal, expediting the process. For example, KeyBank closed an additional credit facility with a repeat borrower on 11 properties for $70 million in 45 days. 

Freddie Mac delegates less work to the lender and re-underwrites transactions, which can slow the approval process, according to sources. 

With interest rates expected to edge higher, both agencies provide some rate increase protections. Freddie Mac offers a 75-day rate lock from the time of application. Floating-rate loans also feature a rate lock option. 

“Borrowers can manage rate volatility,” says Schmidt at Freddie Mac. He adds that rate locks are becoming more important to borrowers who expect interest rates to rise. “This has allowed us to capture an even larger share of the growing seniors housing mortgage market,” says Schmidt. 

Building a sustainable future

Both GSEs offer new “green” initiative programs for seniors housing. The programs focus on the reduction of expenses through property improvements, specifically related to energy and water efficiency. The programs, available to all multifamily properties including seniors housing, provides upfront costs at the time a property is refinanced or acquired. 

Freddie Mac’s “green” program gives borrowers a choice of options to qualify for more proceeds and better pricing to finance improvements. Borrowers must demonstrate that they can save at least 15 percent or more on energy or water bills. Modern windows and low-flow water appliances are examples of two improvements that can be made under the program. 

Several seniors housing loans have been approved under the agency’s green program, says Schmidt. 

But he notes that the program isn’t as popular in the seniors housing sector as it is in the broader multifamily market because much of the seniors housing stock has been built since the late 1990s. Many of these newer properties already have the energy- and water-saving systems in place that the program seeks to encourage. 

But Schmidt notes that new lending programs such as the green and early lease-up initiatives capitalize on the changing dynamics of the seniors housing market. “Freddie Mac has continued to innovate.”