A Rebound in Seniors Housing Is Underway, But We’re Not Out of the Woods Just Yet

by Jeff Shaw

Interest rates have more than doubled and capital market activity is down all while operations seem to be improving.

By Alex Loo, director of originations, Hudson Realty Capital

It’s now been four years since the COVID-19 pandemic first swept the globe. 

The seniors housing and healthcare industry has since experienced many substantial transformations after having endured the government-imposed move-in bans, difficulties in hiring permanent staff, and the reluctance of older adults to transition to assisted living facilities.

Recent data from NIC MAP Vision shows that in October, the occupancy rate for primary markets stood at a mere 200 basis points below its pre-pandemic March 2020 level, while secondary-market occupancy lingers just 10 basis points below the pre-pandemic level. All of this points to a pronounced recovery within the industry.

One noteworthy change contributing to the rebound is the industry’s shift from heavy reliance on staffing agencies during the pandemic’s peak. Although staffing costs have changed, other associated expenses have exhibited a more stagnant growth trajectory coinciding with inflationary pressures. Furthermore, Cushman & Wakefield’s November 2023 Trends Report found annual rent growth at a robust 7 to 9 percent in key U.S. Markets. 

However, despite the positive indicators, many industry participants may find it perplexing that while they have achieved operational efficiency at their properties, they still struggle in fully covering existing debt service or securing refinancing without the addition of further equity. 

There are two warring factors at play here

The first is the prioritization of operational recovery and delivering high-quality services to residents, and the second is the banking sector’s limited lending activity in commercial real estate especially following the collapse of Signature Bank, Silicon Valley Bank, Silvergate and First Republic Bank.

Fannie Mae’s 2023 Q3 report reveals the concerning statistic that 40 percent of its seniors housing portfolio has a debt service coverage ratio (DSCR) of less than 1.0x, indicating potential financial vulnerability within the sector. Furthermore, Freddie Mac says that the rise in multifamily delinquency rates is driven by issues in seniors housing with small-balance loan portfolios underscoring the financial challenges faced by these segments. 

These findings have ignited a heightened worry among lenders on whether or not their loans can be paid off via refinances or whether potential property buyers can procure acquisition financing themselves. Most notably, lenders are concerned about the ability of their existing borrowers to sustain properties where financial recovery lags behind operational improvements. 

Many banks are ramping up their real estate workout and portfolio management groups in anticipation of the substantial distress and discounted valuations in the office sector — an area much larger within commercial real estate than seniors housing. Consequently, originating new business and onboarding new relationships in seniors housing is currently not a priority for most banks with existing exposure. Those capable of lending are prioritizing top sponsors with assets in thriving markets, boasting strong cash flows, or showcasing other positive factors, excluding a majority of assets in the market. 

Where does this leave non-Class A, top-tier market participants? 

While it’s no doubt a great time for new banks and alternative lenders lacking existing portfolio exposure to enter the market and finance top-tier assets with premier sponsors, it raises concern about the standing of other market participants. 

The coming months will initiate tough conversations — both internally within lending institutions and externally between these institutions and their clients, not to mention between regulators and the regulated lending institutions. 

The properties that have either met or are nearing their business plan objectives will have clear-cut credit decisions, as will the properties facing ongoing operational challenges. However, the properties making slower progress or situated in weaker markets will be the ones lending institutions anticipate spending a considerable amount of time parsing through, determining which lever to push and pull in their toolbox. Will they relax covenants? Push back technical default rates? Extend loan maturities?

Within the changing landscape, the above tools don’t work as well anymore. For banks, forcing these sub-performing deals off their balance sheets would only make things worse — it’s well known what the capital markets environment is like for not-yet-stabilized seniors housing communities, with rising capitalization rates and declining per-unit prices. Combine that with limited certainty that the properties could be sold at an acceptable price, and it’s a convoluted mess for lenders. Commercial real estate has been in this place before, albeit the last time (following the Great Financial Crisis) the seniors housing industry wasn’t as developed as it is now. 

Strategies that were once effective are now deemed unsuitable due to several factors from greater regulatory scrutiny, higher interest rates and improved operational performance in the industry. It’s harder for lenders to justify a deal’s delay when interest rates have more than doubled and capital markets activity is down all while operations seem to be improving.

A viable option for lenders is collaborating with alternative lenders for note-on-note financing to address underperforming assets. Though most borrowers won’t like having to refinance their loans at a higher spread (generally SOFR plus 450 to 550 basis points), it’s preferable to defaulting or facing foreclosure. This way, existing lenders are able to reduce their loan exposure and focus on other pressing portfolio matters while collaborating with strong partners.

Alex Loo is a director of originations at Hudson Realty Capital, where he focuses on originations and helping to expand the company’s debt platform.

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