Property upgrades, loan modifications ramp up in fiscal 2015.
By Matt Valley
The big takeaway in the first half of fiscal 2015 in the HUD/FHA mortgage insurance program is that loan modifications are up dramatically, but overall deal volume is down from the same period a year ago. Meanwhile, borrowers are increasingly using loan proceeds to upgrade their properties.
Recently released data by HUD/FHA shows the Section 232 mortgage insurance program used to finance seniors housing facilities closed $1.36 billion in loans during the first half of fiscal 2015, down from $1.62 billion during the same period a year ago. (HUD’s fiscal year runs from Oct. 1 through Sept. 30.)
The total number of loans closed decreased from 191 in the first half of fiscal 2014 to 148 in the first half of fiscal 2015.
In particular, the volume of 223(a)(7) loans — the refinancing of existing HUD loans — fell sharply from $515 million to $66 million on a year-over-year basis. That’s largely because loan modifications — which are not included in the data — eliminated the need for many borrowers to refinance, say lenders.
HUD introduced the loan modification program about a year ago as a streamlined way for its borrowers in good standing to reduce their interest rates without extending their loan terms or getting additional loan proceeds.
Capital One, Housing & Health-care Finance and RED Capital Group all have completed several loan modifications for existing HUD borrowers. Unlike a refinancing, where a full underwriting takes place, a loan modification simply means that the interest rate is modified on the borrower’s current note to take advantage of a lower interest rate.
For example, Housing & Health-care Finance closed over $210 million in loan modifications for its clients over a two-month period (March and April). The 26 loan modifications resulted in significant interest rate reductions on their HUD loans, according to Erik Lindenauer, founder and director of Chevy Chase, Md.-based Housing & Healthcare Finance.
“We keep the balance the same, we keep the terms the same and we recast the debt service at a lower interest rate. The old loan is paid off,” says Lindenauer.
Only the mortgagee of record can make the loan modification, which requires HUD approval, adds Lindenauer. The borrower still has to pay any applicable prepayment penalties, but the penalty can be built into the interest rate.
“The interest rate might be slightly higher than the market rate due to the prepayment penalty, but it’s going to be less than the borrower’s current rate,” says Lindenauer. “There is no application fee, there is no cost to it, so it’s sound money to the borrower based on the current interest rate environment.”
Joshua Rosen, senior vice president and team leader for seniors housing and healthcare at Capital One based in the company’s Chicago office, points out that while Capital One has been doing a lot of loan modifications, “those deals don’t count as part of your numbers for new closings because it’s not actually a new closing.”
Excluding the 232/223(a)(7) loans, deal volume in the first half of fiscal 2015 year is up approximately 18 percent from the same period a year ago, says Jason Smeck, managing director for seniors housing and healthcare at Columbus, Ohio-based RED Capital Group. “So, the program continues to be very effective and popular among borrowers.”
In fiscal 2014, RED provided $228.3 million in financing to the seniors housing industry, ranking it as the seventh largest HUD Section 232 lender. RED’s volume this fiscal year is on par with last year, says Smeck. “The FHA mortgage insurance program continues to have great interest for our clients due to the program’s extremely attractive interest rates and long-term, non-recourse structure.”
For example, a borrower seeking to refinance a skilled nursing facility that has a strong financial track record and is well occupied could potentially secure a 35-year, non-recourse loan at an interest rate of less than 4 percent.
Reinvestment in assets
A growing number of HUD borrowers are using loan proceeds to upgrade their communities through renovations or the repurposing of existing community space into areas that provide more value to residents, or that appeal to a wider variety of care levels, says Smeck.
Section 232/241(a) insures mortgage loans to finance repairs, additions and improvements to multifamily rental housing and healthcare facilities with FHA-insured first mortgages or HUD-held mortgages.
“The low cost of capital provided within the program makes such strategies tremendously attractive,” says Smeck. “Owners should view this as a key opportunity to revitalize and reshape their senior housing communities and position them for success, not just today but in the years to come.”
Last July, Red Mortgage Capital, the mortgage banking arm of RED Capital Group, provided a $31 million FHA-insured 232/241(a) supplemental loan to develop Parker Senior Living by MorningStar, a seniors housing community located in Parker, Colo., part of the growing southeast suburbs of Denver. The deal was a joint venture between two Denver-area firms, Faestel Properties and JHL Constructors.
A 64-unit assisted living and memory care community, Parker Assisted Living by MorningStar, already occupied the site. The supplemental loan provided construction and permanent financing to fund two new senior resident buildings, adding 49 units of independent living, 54 units of assisted living, and 24 units of dementia/memory care to create the Parker Senior Living by MorningStar campus. MorningStar Senior Living will manage all the buildings.
The complementary buildings will help fulfill the enormous demand in Parker and nearby communities for assisted living and memory care, according to RED, while providing more independent seniors the opportunity to live on a campus with active living options and the ability to transition to different care levels without moving to a new community.
Another trend that Smeck observes is the growing number of owners looking to expand their portfolio through single-property acquisitions.
“Through RED Capital Group’s balance sheet lending program, we can work with buyers to provide that short-term financing needed so that they can get into properties faster, make the changes necessary to transition and integrate that community into their portfolio. Then when the time is right we can provide that final permanent debt structure.”
Capital One has a strong bridge platform, according to Rosen. “When we sign on to provide a bridge deal, we’re looking at not only how the property operates today, but we also look out six to 24 months after a bridge loan gets placed. We’ll look at the strength of the market and operator, and we’ll underwrite the deal on a takeout basis upfront.”
In December 2014, Capital One Bank provided a $60 million secured term loan for the acquisition of a portfolio of 19 skilled nursing facilities in Indiana and Iowa. The bank also provided a $6 million revolving line of credit to fund ongoing working capital at the facilities.
The diverse portfolio of properties built between 1920 and 2006 included 1,163 licensed beds at the time of the transaction. This loan was structured as a bridge-to-HUD transaction and will be refinanced once the required debt seasoning has been reached.
Motivating factors
Nursing homes account for much of the recent uptick in 232/241(a) loan volume, says Lindenauer of Housing & Healthcare Finance.
“Nursing homes have run into a lot of headwinds lately. There have been a lot of cuts to Medicaid on the state level and expenses are going up on everything from wages to nursing care to pharmacy, so margins are being squeezed,” explains Lindenauer.
In response to those cost pressures, many owners of nursing homes are modifying their properties by adding a short-term, post-acute rehabilitation services wing to attract Medicare patients, he says.
“If patients gets released from a hospital for a hip replacement or after having had a stroke, they don’t need long-term care, which would be Medicaid. They need short-term rehab, intensive therapy, which is Medicare,” explains Lindenauer.
“Whereas Medicaid may pay $150 a day, Medicare pays $500 a day because of the type of therapy it is. People are looking to improve their nursing home and attract short-term Medicare residents to increase their profit margins,” adds the veteran lender.
The vast majority of HUD’s deal volume in the first half of 2015 can be attributed to new loans coming into the HUD program, specifically 232/223(f) loans used for the refinancing of existing debt or acquisition financing. These loans totaled $1.24 billion during the first half of fiscal 2015, up from $952 million from the same period in fiscal 2014.
“We’re seeing a lot of those 232/223(f) loans,” says Rosen of Capital One. “We’re actually seeing a few acquisition loans get done with HUD. Typically, borrowers have shied away from using HUD for an acquisition, but given the speed that HUD has been working at lately and some of the certainties that you are seeing now in the market, as long as the seller is willing to be a little patient, it’s a very viable option.”
Housing & Healthcare Finance, which finished fiscal 2014 as the number one HUD lender in the country with $748.4 million in loan volume, recently closed $76.4 million in HUD 232/223(f) loans to refinance the conventional debt on three skilled nursing facilities located in California.
The non-recourse, fixed rate HUD loans included $27.5 million for a 139-bed facility and $28.8 million for a 180-bed facility both of which are located Northern California. The third HUD loan was $20.1 million for a 163-bed facility in Southern California.
The experienced owner, which operates several skilled nursing facilities throughout the state of California, locked in low interest rates for 30 years on each of the facilities.
Housing & Healthcare Finance closed the three loans simultaneously. “This was a complex transaction with many moving parts because the loans we refinanced were cross-collateralized with other loans in a large credit facility,” says Lindenauer. “We were pleased to meet our customer’s expectations and lock in low rates for them for the next 30 years.”
Rosen describes Capital One’s deal pipeline in the HUD Section 232 Program as strong for fiscal 2015, with $130 million in loans closed year-to-date through April and another $100 million in the pipeline that is expected to close before the end of the fiscal year.
“Our numbers to this point match last year. We don’t expect to beat last year,” says Rosen. As a HUD lender, approximately 70 percent of Capital One’s deal volume is refinancing, 20 percent acquisitions and 10 percent new construction.
Lender track record matters
Steve Kennedy, managing director and member of the executive committee at Columbus, Ohio-based Lancaster Pollard, says the pre-screening of a project is critical in the HUD lending business. At Lancaster Pollard, the loan committee approves every deal, big and small.
“Our loan committee includes the head of our asset management group, every one of our HUD-approved underwriters, and our primary principals that sit in and actively vote on the loan. The banker and the associates working on the project formally present the project to loan committee,” explains Kennedy. Last year, Lancaster Pollard closed $718.6 million in HUD financing.
“How is an organization like Lancaster Pollard compensated? We’re not paid until the deal closes, so it’s important that when we decide to invest our resources into a project, it will close, and close in a manner consistent with the client’s expectations. Our loan committee process maximizes the probability of that occurring and aligns all parties’ incentives.”
Kennedy says the tremendous investment that Lancaster Pollard has made in pre-screening projects, as well as its significant investment in its loan servicing and asset management groups, has paid off.
“We service billions of dollars of FHA/HUD, FNMA and USDA debt that we originated ourselves. We have zero loans that are in default and zero loans that are delinquent. That track record matters to the agencies because they know we underwrite sound projects and make quality loans.”
While the HUD loan application process can be onerous for some borrowers, the attractive features — low rates, non-recourse and assumability — are hard to beat.
While timing to close a HUD-insured loan is traditionally longer than closing a bank loan, timing has improved dramatically over the last year. “Right now there is no queue. An application that is submitted should be assigned to a HUD underwriter within a week or so, and then HUD’s goal is to get the project to its loan committee for a commitment within about 45 days.
“All-in-all, when accounting for the completion of the third-party reports and HUD application, HUD’s processing of the application, and then the closing process, the quickest you are going to get a refinancing done from start to finish is about five or six months,” says Kennedy.
Capital One’s Rosen says that while total deal volume for all of fiscal 2015 will likely fall short of the $4.21 billion reached last year and well below the high-water mark of $5.82 billion set in fiscal 2013, the totals need to be put into perspective. “It’s going to be another great year historically, but when you compare it to the last two years it’s not going to be quite as rambunctious.”