Financing Senior Housing When Liquidity Is Low
Hudson Realty Capital's Alex Loo on shifts in financing dynamics triggered by limited lending.
One of the biggest challenges facing senior housing developers and investors today is how to secure favorable financing amid limited lending activity. But there are solutions, Hudson Realty Capital‘s Alex Loo suggests. Multi-Housing News spoke to Loo, director of originations for the middle-market lender, about how how lower leverage and increased equity requirements are impacting senior housing development and about the potential effects of rising distress within the sector.
How has economic uncertainty impacted senior housing financing overall?
Loo: Macroeconomic volatility has not had as much of a direct impact on senior housing financing but rather has created a whiplash effect stemming from the broader commercial real estate industry that is significantly influencing how senior housing developers seek financial support. Limited lending activity has led to a shift in financing dynamics, with developers struggling to secure sufficient funding with favorable terms. As a result, deals are now being finalized at low leverage with increased equity. The trend of lower leverage and increased equity has ignited a rise in mezzanine lending when it comes to senior debt. While this is an alternative route to receive funding, it also comes with higher interest rates, ultimately affecting the overall cost and feasibility of new senior housing developments.
Moreover, the slow lending activity has redirected owners and operators to focus on achieving operational efficiency at their properties. While we’re seeing a rebound in property performance and operations, owners are still grappling with the challenge of covering existing debt service or securing refinancing without the addition of further equity.
READ ALSO: What to Expect for Senior Housing in 2024
What are the main trends you’re noticing in terms of senior housing loans?
Loo: In the past year, discernible trends in the senior housing loan landscape have emerged, particularly a continued flight to quality by lending institutions. Loans backed by top-tier sponsors and located in highly lucrative markets have attracted more attention and competitive bidding. The appeal of these loans comes from the perceived stability and potential safety of reputable sponsors and promising market conditions.
With middle-market loans, specifically those backed by less institutional sponsors in less robust markets, there’s been a chasm of drop-off in financial interest, barring substantial deposit potential or existing relationships. The gap in attractiveness for these loans has been significant, pointing to a hesitancy among lenders for loans that aren’t exactly in their strike zones.
So what financing options are there today for borrowers?
Loo: The current lending landscape is undeniably tight across the board. Most banks focus on existing exposures, aren’t prioritizing new business, or onboarding new relationships within the senior housing market. As mentioned, those who are capable of lending are favoring top sponsors with assets in thriving markets and with robust cash flow.
How can developers bring new supply to the market in this lending landscape?
Loo: There’s no immediate solution for developers seeking to bring new inventory to the market. Right now, it’s not a matter of having the best land or the best development team, but more so about how much equity developers can put behind deals they truly believe in. Consequently, we are seeing an increased focus on the middle market. Developers are opting to purchase older buildings and renovate them rather than starting from the ground up. This approach has proven to be more cost-effective and time-efficient while navigating the current challenges of receiving financing and meeting the demand for affordable senior housing versus greenfield development.
How has demand for HUD loans on senior housing evolved in the past three years?
Loo: Historically, HUD has been perceived as the lender of last resort within the real estate landscape. However, that has not always been the case for the senior housing sector, specifically for skilled nursing homes and assisted living facilities. Unlike Fannie Mae and Freddie Mac, HUD offers higher leverage options in terms of financing and a self-amortizing 35-year term, catering to the needs of senior housing owners, operators and occasionally also developers. That said, there is a notable disadvantage associated with HUD—the underwriting and closing process is substantially longer than that of alternatives. This elongated timeline poses a challenge, especially for developers with generally stabilized properties, as they might opt for an alternative financing solution in times of rising interest rates. In times of stable or potentially even declining interest rates, a lot of that risk is mitigated.
READ ALSO: How Will the Affordable Senior Housing Gap Be Filled?
How concerned are you about distress and defaults in senior housing? What kinds of opportunities do you see emerging from the distress?
Loo: Increased distress and defaults within the senior housing sector will likely continue. As banks reach their limits in assisting distressed sponsors, we can expect to see an increase in mark-to-market on the lending side and more distressed sales or alternative solutions. There is a heightened worry among lenders surrounding existing borrowers’ ability to sustain properties where financial recovery lags behind operational improvements.
The continued number of distressed assets is likely to prompt tough conversations among stakeholders, particularly as they choose which assets to keep or let go. In response, lenders may consider exploring other options such as collaborating with alternative lenders for note-on-note financing to address underperforming assets or moving deals to work out.
How does Hudson Realty Capital adapt its financing strategy to meet the unique needs of different senior housing developers?
Loo: We assess the opportunities available in the market and tailor our financial products to accommodate those needs. For example, at present there isn’t much senior debt available for non-stabilizing properties due to underwriting standards, so borrowing senior debt as a primary source of financing for projects is increasingly unlikely. Therefore, preferred equity and mezzanine debt are taking more prominent roles in the capital stack.
What are your expectations for senior housing financing this year in light of expected easing on interest rates?
Loo: Regardless of where interest rates are headed, the fact remains that operational performance within senior housing facilities is only going to improve, ideally allowing operators more room and control in securing additional funding on deals with clear visibility towards stability. Deals backed by strong narratives and improved operational performance should remain attractive to the lending market regardless of interest rate volatility. Our primary concern lies more in the realm of broader global or macroeconomic conditions, elements that fall beyond our control or capacity to predict, that will prevent the return of the stable and liquid borrowing environment.
Predicting the future trajectory for senior housing financing remains a challenge, but we’re certainly keeping a pulse on the market as we enter the new year.
