As the U.S. population ages, the future is bright for seniors housing, despite today’s challenges

In the short term, higher interest rates and tightening credit markets have made it significantly more costly and difficult to finance seniors housing facilities. Looking ahead, however, strengthening occupancy levels indicate that the sector’s long-term outlook is bright as the U.S. population ages.

At the National Investment Conference for Seniors Housing and Care (NIC), October in Chicago, KeyBank Real Estate Capital’s Brian Heagler, Senior Vice President and Senior Banker, joined a panel on financing trends in the seniors housing sector. His fellow panelists were moderator Aaron Becker, Senior Managing Director, Head of Seniors Housing and Healthcare Production, Lument; Robb Chapin, CEO and Chief Investment Officer, Bridge Investment Group; Lori Coombs, Managing Director and Group Head of Seniors and Student Housing, Wells Fargo; and David Young, Managing Director of Structuring Locust Point Capital.
 

Rapidly rising interest rates create “shock wave”

No one in the seniors housing sector anticipated the shock wave of the rapid interest rate increases. During 2022, the federal funds rate was in the range of 2.25% to 2.50%, but by the time of the NIC event, it was hovering between 5.25% and 5.50% — with further potential increases on the horizon. Similarly, the one-month secured overnight financing rate (SOFR) rose from 3.02% in 2022 to 5.33%, while the 10-year U.S. Treasury bond rate rose from 3.44% to approximately 4.9%.   

In addition, the rising cost of capital has created a dramatic decline in transactions. Institutional investors have lacked exit strategies that would free up cash for new seniors housing investment. In fact, Delaware Statutory Trust and 1031 activity is down approximately 50% year over year because acquirers lack access to financing.
 

Where financing activity is occurring

The transactions that are still occurring are driven by maturity risk, a cap rate or covenant issue, or an investor seeking an exit, panelists said. Government-sponsored entities (GSEs), including Fannie Mae, Freddie Mac, and FHA, are still active in seniors housing debt purchases, but agencies are looking closely at their portfolios and how sponsors are performing. Even if a sponsor has achieved pre-pandemic occupancy levels, their net operating income may not be enough to cover today’s higher debt service.   

Despite the challenging environment, KeyBank continues to support its clients involved in seniors housing. “We’ve been an active lender in seniors housing for 25 years and will continue to be so,” said Brian Heagler. “Our clear priority right now is to help our clients weather this storm. That means working with clients to reset their loan covenants and right-size their loans for the next 12 to 36 months.”
 

Shifts in debt underwriting

Many loans today require recourse, noted the panelists, with loan-to-value ratios below pre-pandemic levels, stricter loan covenants, and higher all-in rates. The single biggest change in recent years is the emphasis on in-place cash flow to cover debt service, noted Heagler. If current cash flow from operations is not currently sufficient to cover debt service, as in a turn-around or lease-up business plan, a project sponsor will find it difficult to obtain a traditional bank loan.

“The strength of the project sponsor, the quality of the operator, and the quality of the real estate have always been important, and even more so in today’s environment,” said Heagler. “The ability of the sponsor to bring in additional capital to address an issue is getting much more attention than in the past.”
 

Valuation challenges

Given the slowdown in transactions, asset valuations have also become a challenge. Higher interest rates affect cap rates and, therefore, asset valuation, Heagler observed. “We’re seeing appraisers take borrower projections and give them significant ‘haircuts’ on both the revenue and expense side,” said Heagler. “If you combine that lower net operating income and higher cap rates, you will have a significant decline in value.”

Lacking a transactions baseline, a panelist remarked that their asset management firm is valuing projects on the basis of multiple factors — including its own perceptions of value. The firm looks for strong NOI, for example, and cap rates in the 7% to 7.5% range for a stabilized asset.

Reason for optimism in the long run

Today’s capital market is very challenging for banks that finance seniors housing projects, said Heagler. However, the good news is that many bank balance sheets are healthy and real estate fundamentals are strong from a long-term perspective. Banks like KeyBank that are well-positioned to weather the current environment are understandably cautious but will be able to quickly deploy capital when conditions improve.

Just as lenders are cautious, investors are taking a “wait-and-see” approach. The tailwind of demand for seniors housing is undeniable and investors will be back looking for opportunities over the next 18 to 24 months. Already, the asset management firm on the panel was seeing more meetings and inquiries from investors as performance improves in the firm’s seniors housing portfolio. Investors with the right capital formation, the right lending partners, and the right operating partners will be successful when the seniors housing industry goes back on the upswing.

To dive deeper into this topic or discuss what financing options are best for your next project, reach out to Brian Heagler. For more information, key.com/nic.
 

Survey says ...

Take a look at our recent survey of seniors housing professionals and their current perspectives on the industry and outlook for the next 12 months.
 

About KeyBank Real Estate Capital

KeyBank Real Estate Capital is a leading provider of commercial real estate finance. Its professionals, located across the country, provide a broad range of financing solutions on both a corporate and project basis. The group provides interim and construction financing, permanent mortgages, commercial real estate loan servicing, investment banking, and cash management services for virtually all types of income-producing commercial real estate. As a Fannie Mae Delegated Underwriter and Servicer, Freddie Mac Program Plus Seller/Servicer, and FHA-approved mortgagee, KeyBank Real Estate Capital offers a variety of agency financing solutions for multifamily properties, including affordable housing, seniors housing, and student housing. KeyBank Real Estate Capital is also one of the nation’s largest and highest-rated commercial mortgage servicers.