As interest rates rise, seniors housing lenders look for new business.
By Rachel Goff
With interest rates ticking up, the seniors housing lenders who provide agency loans to licensed assisted living and skilled nursing facilities through the Department of Housing and Urban Development’s LEAN 232 program say they expect to complete fewer HUD transactions in 2014 than in 2013.
To offset the projected drop in the refinancing of existing HUD loans — known in the industry as HUD 232 (a) (7) loans — seniors housing agency lenders are looking to target more new HUD borrowers and focus heavily on bridge and construction financing deals.
In the immediate aftermath of the Great Recession, interest rates fell to near all-time lows, leading a majority of borrowers with existing HUD loans to refinance. But that window is closing. The yield on the 10-year U.S. Treasury bond registered 2.89 percent as of Dec. 18, 2013, up from 1.78 percent a year earlier.
“The rise in rates certainly affects our strategy. We are not going to be looking as much for (a) (7) loan deals,” says Josh Rosen, executive vice president at Bethesda, Md.-based Beech Street Capital. “The acquisition market is very hot right now, and a lot of deals are getting done. I think we will see more new borrowers and new players coming into the market.”
Rosen helped Infinity Healthcare Management secure more than $83 million in HUD LEAN 232 (a) (7) loans this year for 10 skilled nursing facilities throughout Indiana and Illinois. “By taking advantage of the current interest rate climate, Infinity was able to lock in long-term financing at very attractive rates and save millions of dollars.”
Beech Street Capital completed close to $300 million in seniors housing financing in 2013, with more than half of its volume dedicated to (a)(7) loans. More specifically, Beech Street closed $167.3 million in LEAN loans during HUD’s 2013 fiscal year, which ran from Oct. 1, 2012 to Sept. 30, 2013.
HUD achieved a record level of lending volume through its LEAN mortgage insurance program in the fiscal year that ended Sept. 30, 2013, according to data released by the agency. HUD insured $5.82 billion in loan volume, outpacing the previous year’s total of $5.5 billion by more than 6 percent.
A bridge to more business
The vast majority of HUD-backed loans refinance existing stabilized nursing homes and assisted living properties, according to Michael Vaughn, senior vice president at commercial lender Walker & Dunlop, based in Bethesda, Md. He says HUD lends to a variety of borrowers, ranging from single-property owners to some of the largest REITs in the industry.
“I think the development of our proprietary bridge program makes HUD financing more attractive for the best operators who are acquiring and repositioning properties,” says Vaughn, who previously directed HUD’s office of residential care facilities. “Major REITs are also using HUD financing because of its low long-term rates.”
Vaughn says proprietary bridge financing is interim financing provided by Walker & Dunlop under a program using its own funds or in combination with another interim funding provider.
Through Walker & Dunlop’s bridge program, the company can originate loans for borrowers on a tight deadline or for properties that do not currently qualify for permanent financing through HUD or other agency lenders.
In 2013, Washington, D.C.-based Love Funding provided bridge financing to Cara Graceland LLC for the acquisition of Graceland at Garden Ridge, a 46-bed assisted living and memory care facility in Garden Ridge, Texas.
During the application process for the $4.9 million loan, HUD exhausted its commitment authority for the 2013 fiscal year, which prevented the agency from issuing a final commitment.
“Had the purchase and sale agreement expired, the borrower would have lost his deposit and all costs associated with the transaction,” says Leonard Lucas, senior director at Love Funding. The lender offered the borrower bridge financing against its own balance sheet to keep the acquisition on track.
HUD restores reputation
Due to complaints about the backlog of loan applications, HUD in 2008 introduced its LEAN program, which changed the way loans are processed. While the vast majority of loans are refinancings, the average loan processing time in 2012 was 50 days, compared with 220 days before the LEAN program was implemented, according to HUD.
“HUD has streamlined its application process and has made the results more predictable,” says Adrian Hartman, a director in Love Funding’s St. Louis office. “The LEAN program also increased HUD’s productivity by building a team with a specialized knowledge base and streamlining the process.” The lender closed nearly $380 million in seniors housing financing in 2013, almost doubling its 2012 volume of $190 million.
Although borrowers complain about the paperwork associated with HUD-insured loans, the benefits are worth it, says Jeff Davis, CEO and chairman of Chicago-based Cambridge Realty Capital Cos., which closed $429 million in LEAN loans during HUD’s 2013 fiscal year. “I would not think about the amount of paperwork, but instead what my interest savings will be,” he says. “You pay the price to get what you want.”
Clearly, securing a loan at a low interest rate for a term of 30 years is worth the trouble for borrowers in many cases. Building owners can lock in a fixed interest rate of approximately 4.25 percent for a refinancing and between 5.25 and 5.5 percent for construction financing, says Robyn Cunningham, a senior director in Love Funding’s St. Louis office.
In early 2012, borrowers looking to refinance an assisted living or skilled nursing property through HUD could lock in rates between 2.25 and 2.5 percent, says Davis of Cambridge Realty Capital. Today, borrowers are receiving HUD loans in the 4.25 to 4.5 percent range, he says.
Erik Howard, managing director of real estate finance at Capital Funding LLC, says borrowers began taking advantage of low rates in 2011, but he has seen a significant increase in HUD refinancing transactions this year. “Interest rates have risen significantly during the last six months, and borrowers who needed to do an (a) (7) have already done so,” he says.
“I really doubt HUD will reach that number in 2014, and it has not really changed our strategy,” says Howard, referring to the $5.82 billion in loans HUD insured during its 2013 fiscal year.
“Yes, for the last few years we have focused more on (a) (7)s, but historically our strategy has been refinancings and new construction — that was just an anomaly in the market because of how quickly rates had fallen,” emphasizes Howard.
HUD still has its problems. Loan processing of multifamily and healthcare deals slowed in March 2013, when HUD ran low on funds authorized by Congress for the first half of the year. However, HUD was finally authorized to insure $12.8 billion in multifamily and healthcare loans spending for the period from March 28 through Sept. 30.
Then came the government shutdown on Oct. 1, and HUD’s backlog suffered slightly as a result. But commitment authority was restored as a result of the budget deal, which lenders began to see soon after, says Brian Pollard, senior managing director of Lancaster Pollard.
HUD requested $30 billion in commitment authority for fiscal year 2014 and currently is operating with a pro-rated portion of the $25 billion level granted in 2013.
Approximately one-third of the loans closed during HUD’s 2013 fiscal year were backed by assisted living properties, while the remainder involved skilled nursing facilities, according to Vaughn of Walker & Dunlop. The average loan size was $7.6 million for a 120-unit facility. Refinance loans averaged $83,000 per unit for assisted living and $57,000 per bed for skilled nursing.
A record-breaking year
HUD reached its highest level of senior housing lending through its LEAN mortgage insurance program in the 2013 fiscal year. The loan activity comprised 766 loans closed by 49 lenders, with Columbus, Ohio-based Lancaster Pollard, a financial adviser and mortgage banker, closing the greatest percentage of loan volume at $811.7 million or 13.9 percent of the total.
“Refinancing of existing HUD loans represented a large majority of program activity as property owners took advantage of historically low rates,” says Pollard of Lancaster Pollard, which was on pace to complete $1.3 billion in senior living financing in calendar year 2013 as of press time. Pollard says he estimates HUD’s total volume to drop by one-third in 2014.
Lancaster Pollard recently helped Samaritan Village refinance $23.3 million to convert a portion of their independent living units into assisted living units to meet resident demand. Samaritan Village is a long-term care community located in Hughson, Calif., and operated by Hughson Samaritan Village.
The firm negotiated a discounted payoff with existing bond holders and obtained a letter of credit with a local bank that covered the debt service reserve cash requirement. The loan is insured by the FHA Sec. 232/223(f) program, and the owners of the community will benefit from approximately $560,000 in annual debt service savings. In addition, the refinance will fund $580,000 in repairs, the majority of which facilitated the unit conversion.
Also in 2013, Lancaster Pollard refinanced an existing HUD-insured loan for the owner of Normandy Manor of Rocky River, a 150-bed skilled nursing facility in Rocky River, Ohio.
The refinancing was used to fund an expansion of the therapy and memory care space and a renovation of the facility’s common areas while generating annual debt service savings of nearly $125,000.
Capital Funding, a full-service healthcare finance company based in Baltimore, closed nearly $660 million in LEAN loans during HUD’s 2013 fiscal year, making it the second largest HUD loan lender this year in terms of total volume.
HUD approved 16 new construction loans in 2013, 12 of which were for assisted living facilities averaging a building cost of $122,000 per unit. The other four loans were for skilled nursing and averaged approximately $84,000 per bed, according to Vaughn.
HUD’s improved infrastructure combined with fewer expected refinancing transactions during the agency’s 2014 fiscal year could mean other types of lending on the horizon, says Pollard, such as new construction loans.
“Overall construction activity picked up dramatically in 2013, and it would represent a larger share of our volume if timing of the application process in HUD programs would improve, which we are hopeful will occur in 2014,” says Pollard.
Howard of Capital Funding also says he is seeing a “ramp up” in construction financing opportunities, especially among long-term care/skilled nursing facilities. “We feel like part of that is a byproduct of the lack of supply available in the acquisition arena,” he says. “You have owners and operators that are looking to grow their business, and they are looking at construction as opposed to acquiring more properties.”
Approximately 10 percent of Capital Funding’s lending volume in 2013 was allocated to construction financing. Howard has observed an increase in construction during the past year.
During the third quarter of 2013, the number of assisted living units under construction rose 2 percent compared with the previous quarter, according to the National Investment Center for the Seniors Housing & Care Industry. On a year-over-year basis, construction activity in the assisted living segment was 39 percent higher than the same period in 2012.
Historically, construction loans comprised just a small percentage of HUD lending.
Borrowers looking to build an affordable need-based community, such as an assisted living facility, are most likely to win HUD’s approval for a new construction loan, says Hartman of Love Funding. An equity contribution amounting to as much as 30 percent of the construction cost is also a plus, he says.
However, construction financing through HUD isn’t for everyone. Howard says HUD’s regulations and extra costs that go along with HUD construction financing may not be worth it. “You may have to pay your contractors more than you would with a conventional loan.”