The need for senior housing will only swell as the earliest born in the Baby Boom generation begin to hit 80 in 2025. For many, market rate housing will be out of their reach and will fuel further demand for affordable options.
But higher interest rates and construction costs, building material shortages, and depressed prices for low-income housing tax credits are making affordable senior housing development and renovation more difficult at a time when much more supply is needed.
In 2019, 10.2 million households headed by a person aged 65 or older, or roughly a third of that population cohort, paid a disproportionate share of their incomes for housing, according to the State of The Nation’s Housing 2022 report issued by Harvard University’s Joint Center for Housing Studies.
The report also pointed out that even if the cost-burdened share of seniors remained steady the next several years, the affordable need would escalate sharply simply because of the large cohort of aging Baby Boomers. The number of 65-and-over households will surge to more than 50 million in 1938, a 51 percent increase over the number in 2018.
“A lot of seniors are in a place where they can’t increase their incomes to keep up with inflation, and they’re facing tough choices,” said Jeffrey Jaeger, a principal and co-founder of Standard Communities, a San Francisco-based developer focused on affordable and workforce housing. “There are a lot of luxury communities that have been built for the aging population, but there continues to be high demand and need for a quality affordable senior product.”
While labor shortages and rising operating expenses have prolonged a difficult senior housing environment that was initially created by the pandemic, occupancy continues to improve. The average senior housing occupancy rate increased nearly a percentage point to 81.4 percent in the second quarter from the first quarter this year, according to the National Center for Seniors Housing & Care. That marked the fourth consecutive quarter of occupancy growth and 340 basis points higher than the pandemic low of 78 percent, the group reported.
Occupancy rates in many affordable senior housing projects are much higher – typically at 95 percent or higher, said Andrew Anania, a managing director in Berkadia’s tax credit syndication practice.
But a volatile construction environment is challenging developers. NHP Foundation, a New York-based non-profit developer of affordable housing for families and seniors, experienced an 18 percent construction cost increase when the closing of a deal to develop 74-units in Houston was delayed, said Stephen Green, executive vice president and chief investment officer of the organization. Part of these price increases stem from premiums that subcontractors are having to pay for cabinets, flooring, drywall and other materials, he added.
“The demand for affordable senior housing is always there – occupancy isn’t the issue,” Green explained. “But the price increases and supply chain issues have been difficult to manage. And now we’re in a rising interest rate environment.”
Cost of Capital Rising
Indeed, the Federal Reserve’s focus on raising interest rates to fight inflation has had a significant impact on the ability of developers to build affordable seniors housing projects, said Jaeger. After falling to below 3 percent in late July, the 10-Year Treasury yield topped 3 percent in late August. That’s roughly double where the yield started 2022.
Meanwhile short-term interest rates have ballooned even more than that. The benchmark securitized overnight funding rate (SOFR) spiked 75 basis points to 2.28 percent in late July and remains there. At the beginning of 2022, SOFR was virtually zero.
“There has been a lot of volatility in the debt markets for senior housing, particularly over the last six weeks,” said Aaron Will, vice chairman and co-head of national senior housing with CBRE in Houston.
At the same time, lower LIHTC prices have made it more difficult to raise equity. The average three-month LIHTC price dropped roughly 3 cents to around 90 cents per tax credit in early 2020 and has hovered around that level as of April this year, according to Novogradac, an accounting, valuation and consulting firm. Buyers of the tax credits that went to the sidelines as the virus took hold fueled some of the decline, said Anania.
But a late 2020 law that converted the 4 percent tax credit to a fixed rate from a floating rate, which had been a little more than 3 percent, has also influenced the lower price levels. As a result of the fix, developers can raise more equity through the sale of fewer tax credits, which has benefitted the market, observers say. But the 4 percent fix also has effectively created a greater supply of tax credits.
“When you have a fixed demand for the credits and then you put a lot more credits in the market, what happens?” Green asked. “Prices go down.”
Additionally, a higher federal funds rate has increased the cost of capital for banks, which purchase the lion’s share of tax credits as part of their Community Reinvestment Act (CRA) obligations, added Anania. That, along with recessionary trends, could also negatively impact pricing going forward.
Given the complexity of financing projects with rental rates that meet low-income thresholds, developers typically need additional money even in more normal times. But all of these variables together – construction cost increases and delays, higher interest rates and lower LIHTC prices – have only exacerbated that situation.
“The combination of economic conditions as well as the lingering COVID-19 impacts have generated a budget gap for the developer,” Anania said. “And it can happen as construction costs and interest rates move higher on them during the development period. As you’re waiting to get a solution for one particular situation, another problem pops up.”
How are developers filling that gap? In some cases they’re tapping federal funds available through sources such as the $1.9 trillion American Rescue Plan Act of 2021 and disaster recovery funds, as well as state and local subsidies, grants or low-interest loans geared toward affordable housing. The state of Connecticut provided NHP with an additional subsidy of $3 million – for a total of $7 million – after costs for a project rose 17 percent, Green said.
“It’s is the rare transaction where funding is just LIHTC equity and debt – although there are some and we’ve done a couple,” he said. “But when you’re doing new construction or a major renovation, you’re going to have a gap, and it has definitely gotten bigger.”