Borrowers Face Stiffening Headwinds as Interest Rates Spike While Some Lenders Hit Pause Button

By Matt Valley

The seniors housing industry can’t seem to catch a break in the wake of the COVID-19 pandemic, says Aron Will of CBRE Capital Markets. While operational performance has improved the past several months due to a gradual rise in occupancy and less reliance on temporary workers, the capital markets have become increasingly difficult to navigate due to a spike in interest rates. This juxtaposition isn’t lost on Will.

“The debt markets are about as choppy as we’ve seen since 2008 and 2009. The bank market has really tightened, if not frozen up entirely, for the larger banks,” says Will, who serves as vice chairman and co-head of seniors housing for CBRE Capital Markets.

Will expects the choppiness in the lending market to persist for the next 12 to 18 months. He says that borrowers should be prepared for more volatility in interest rates, lower loan-to-value ratios, more loan covenants and a generally more challenging environment to get deals done.

Chris Blanda, senior managing director with Columbus, Ohio-based VIUM Capital, a seniors housing and healthcare lender that has closed over $3 billion in loans since its inception in April 2020, says borrowers are going to have to weather the storm in the near term.

 “Everybody’s borrowing costs are going up. The banks’ borrowing costs are going up, the borrowers’ borrowing costs are going up. We hope that it’s a soft landing with respect to inflation, and that the economy won’t get hit too hard. Then the Fed can begin to at least stop tightening rates and maybe start to loosen things next year at some point.”

The Consumer Price Index rose 8.2 percent in September on a year-over-year basis, according to the Bureau of Labor Statistics, following an 8.3 percent increase in August. 

To cover the inflated expenses, Blanda says it’s more important than ever for owner-operators to focus on achieving high occupancies.

The good news is that the seniors housing occupancy rate increased one percentage point to 82.2 percent in the third quarter across the 31 primary markets tracked by NIC MAP. It was the fifth consecutive quarterly increase. The additional top-line revenues will help offset expenses.

“The biggest expense line item in an income statement for a seniors housing and care community is labor. So, we’ve got labor supply shortages for frontline care staff, which is causing significant wage inflation, and putting pressure on NOI (net operating income). Then you have all the materials cost inflation, food being the primary one, as well as medical supplies,” says Blanda.

Some lending institutions call timeout

The national banks that have played a meaningful role in the seniors housing space are currently sitting on the sidelines for various reasons, including changing liquidity provisions, treasury management issues and a shift in overall market sentiment, says Will.

Meanwhile, the regional banks are completing deals on a select basis. CBRE National Senior Housing recently arranged construction financing for The Crestmoor at Green Hills in Nashville on behalf of a joint venture between Bridgewood Property Co. and Harrison Street. CBRE originated a five-year construction loan through a regional bank. The project will consist of 117 independent living units, 45 assisting living units and 29 memory care units for a total of 191 units. 

“The regional banks that are active are probably in regions where the metrics are good for seniors housing and long-term care. The reimbursement rates are solid, the buildings are performing well and they understand the business,” says Blanda. 

In contrast, the national banks tend to make decisions based on headlines about labor costs, lackluster occupancy and declining NOI, explains Blanda. “If you look at the sector on a national level, you say to yourself, ‘This industry is in trouble.’ But if you pick the right regions and the right operators, there are some bright spots. The regional banks are more entrenched in regional relationships and regional businesses.”

Interest rates are volatile

Interest rates have risen sharply and quickly this year, catching many borrowers by surprise. The 10-year U.S. Treasury yield, a benchmark for long-term, fixed-rate mortgages, rose from 1.63 percent at the start of the year to 4.2 percent at the close of business on Oct. 24. 

Meanwhile, the 30-day Secured Overnight Financing Rate (SOFR), the benchmark for variable-rate construction and bridge loans, climbed from 0.05 percent to 3.01 percent during the same period.

“The net effect of the rising interest rates has been the stifling of deal volume a little bit, mainly on the seniors housing private-pay part of the acuity spectrum,” says Blanda. “That’s because the cap rates for those lower-acuity assets are much lower than for skilled nursing facilities. So, as interest rates rise, those interest rates start to bump up against the cap rates of those lower-acuity assets.”

The cap rate represents a property’s yield over a one-year time horizon and is based on the NOI and the purchase price of the asset. The convergence of cap rates and interest rates provides a much narrower spread between the borrowing costs and the amount of cash generated by a property, which in turn puts added financial pressure on the borrower, explains Blanda.

To illustrate the point, let’s say the cap rate of an assisted living facility is 7.5 percent, and that the borrowing costs on that asset two years ago ranged from 2 to 5 percent, depending on length of the loan and whether it was a floating- or fixed-rate loan. In that scenario, the spread between the cap rate and the borrowing costs is fairly wide. Now suppose the borrowing costs increase to 6 to 7 percent. The spread narrows considerably.

In a worst-case scenario, the borrower’s debt costs become more expensive than the going-in cap rate. This is known as negative leverage.

“Are people willing to accept negative leverage for really high-quality deals right now?” asks Will of CBRE. “That’s certainly a big question, and I don’t know the answer. We’ll see.”

Medicaid gets a boost

In addition to monitoring interest rates, operating costs and occupancy levels, VIUM Capital is also tracking Medicaid reimbursement rates. 

“On the nursing home side, what we’re most excited about over the coming six to 12 months is higher Medicaid reimbursement rates in a lot of states that are compensating owner-operators for the costs that they incurred in 2021 and 2022, explains Blanda. 

“There are a lot of states we’re working in right now where rates are set to reset at significantly higher levels, which will be a meaningful increase in revenue to more appropriately compensate providers for costs of care. It will return certain nursing homes in certain states to a level of profitability that they probably haven’t seen since 2017 and 2018.”