Capital Corner: Why Bond Financing Volume Remains Healthy

Life plan communities make a comeback, while for-profit companies find inventive ways to achieve tax-free financing.

By Jeff Shaw

Although the use of bond financing for seniors housing has changed over the years, issuance has continued its steady increase since the Great Recession. Total issuance across all segments rose from $3 billion in 2011 to $8.1 billion in 2016.

Pre-recession, bond issuance reached a peak for new construction, particularly for continuing care retirement communities (CCRCs). As volume recovered following the housing market crash, bond borrowers in seniors housing were seeking to refinance or reposition properties.

In recent years, bond refinancing activity has maintained a steady pace as borrowers take advantage of low interest rates, with most development bonds earmarked for the expansion of existing CCRC campuses. But nearly 10 years after the recession, ground-up construction activity in the CCRC segment is perking up.

“I’m seeing a significant number of new projects — not where we were pre-recession, but growing,” says Jeff Sands, managing principal at HJ Sims. “There was a lot of discussion over whether the CCRC is dead. If you look at bond issues, it’s actually making a comeback.”

Additionally, volume is being bolstered by an inventive new source.

For-profits enter the tax-free fray

Some seniors housing developers are taking advantage of a government program — IRS Section 142(d) — that allows for-profit entities to receive tax-free bond financing. Intended to support market-rate housing, the program requires that at least 20 percent of the units in an assisted living facility be reserved for residents making 50 percent or less of the area median income.

“For years, nobody used the 142(d) provision. Then some people did it successfully and others started paying attention,” says Dan Hermann, head of investment banking for Ziegler. “There are about 50 of those projects completed now. It’s become another financing tool in the for-profit market for new construction.”

Thanks to the 142(d) program, developers can build in high-income areas and allocate a portion of each project to affordable housing. The rents for the affordable units are still high enough for the project to work economically, and the market-rate rents in the rest of the property make up the difference.

“In Stamford, Conn., the median income is $80,000. It’s not very hard to find a lot of elderly people with taxable income less than $40,000,” explains Sands. “It’s another thing when you’re in rural Georgia. The median income will be $40,000, so you have to have 20 residents that have taxable income less than $20,000. That’s a whole different ballgame.”

Although 142(d) financing is still a small fraction of overall bond issuance, across all real estate sectors the program accounted for a record-high $713.7 million in 2016, according to Ziegler.

Seniors housing is a particularly ripe target for this type of program. By definition, retirees don’t have employment income. Many seniors might have the money and assets on hand to afford a seniors housing apartment, but they meet the requirements of 142(d) because they have little continuing income.

“A lot of seniors don’t have a lot of taxable income — often just Social Security and pensions,” says Sands. “When you compare it to the total median income for a market, the theory is it shouldn’t be very hard for you to have 20 percent of residents below that 50 percent annual median income threshold.”

Residents paying via Medicaid reimbursement can count toward the 20 percent as well, notes Sands, meaning a resident might have his or her rent fully reimbursed despite having no real income.

However, despite the uptick, many bond lenders are in “wait-and-see” mode regarding 142(d) financing, says Sands. Some of the developers that jumped on this program early are struggling to become profitable, and some lenders are skeptical that developers can make the math work based on the income requirements. Underwriters are even hedging their revenue projections for these projects by 15 to 20 percent to guard against potential losses, says Sands.  

Keeping an eye on legislative changes

On the operations side there is plenty of attention being paid to possible legislative changes at the federal level. Important issues such as healthcare and immigration reform have the potential to cause major changes in the industry.

On the bond financing side, though, more attention is being paid to state-by-state regulations that could change how seniors housing projects are financed in certain markets.

In Florida, for example, legislation is being considered that would prioritize entrance-fee refunds over paying back lenders in the case of a CCRC defaulting. While this could be good news for the residents, it “affects the financeability of CCRCs,” says Sands.

“Bondholders like to be the ultimate solver of a problem. If you put up $100 million, you want to be at the table and have power to bring in a consultant, require a change of management or dictate rental fees,” says Sands. “If the state can come in and do whatever it wants, including not pay you, that’s not good.“

Similarly, in California, entrance fee refunds must be paid to the family within 90 days of a resident’s passing or the money will accrue interest.

“Those highly regulated states are part of why new campus construction is down,” says Hermann. “It’s very difficult for a nonprofit to navigate in Florida, Maryland and New York in particular.”

Both Ziegler and HJ Sims are taking a conservative approach regarding potential changes to the federal tax code under President Donald Trump’s administration.

Both companies are quick to note that bond financing volume is strong and that the low interest rate environment is expected to persist in the near term. The 10-Year Treasury Yield was at approximately 2.2 percent as of Aug. 22.

“Interest rates have stayed extraordinarily low,” says Hermann. “The cost of capital is literally as attractive as ever for both bonds and bank financing.”