Falling Rates Are Sweet Music to Borrowers’ Ears

Expect lenders to turn up the volume on loan closings.

By Matt Valley

The sharp drop in interest rates over the past several months has not only lowered the cost of capital for borrowers, but it has also helped offset higher operating costs at a critically important time, say seniors housing lenders.

At the close of business on Aug. 20, the 10-year Treasury yield — a benchmark for long-term, fixed-rate permanent financing in commercial real estate — stood at 1.60 percent, down about 100 basis points from the start of 2019.

Meanwhile, the 30-day London Interbank Offered Rate (LIBOR), which is used to help set interest rates on construction loans, registered 220 basis points as of mid-August, a drop of about 30 basis points since the beginning of the year.

Adding an element of drama and complexity to the overall picture is the inverted yield curve scenario, the point at which the 10-year Treasury bond falls below the level on the two-year bond. That’s precisely what occurred on Aug. 14, resulting in high volatility on Wall Street.

Historically, an inverted yield curve is a strong indicator that the risk of recession is increasing. It means that investors are concerned about the economic outlook in the short term, but it provides no guarantee that a recession is imminent.

“From a permanent finance lending perspective, the flattening yield curve and the decline in interest rates is a leading story in the senior living industry. It’s driving significant financings,” says Doug Harper, managing director of agency finance at Columbus, Ohio-based Lancaster Pollard, a national investment banking and financial services firm. 

Simply put, today’s extremely low interest rate environment is highly attractive for borrowers and spurring new activity, observes Harper. 

A representative deal

In July, Lancaster Pollard provided a $25.3 million permanent loan through Fannie Mae for The Ridge Foothill, a 138-unit assisted living and memory care facility in Salt Lake City, Utah. Constructed in 2016, the fully stabilized property had completed a successful lease-up period, according to Harper. 

The 10-year, fixed-rate loan included an interest rate under 4 percent. The deal was structured as cash-out refinancing for the borrower.

“We’re seeing a lot of new-construction projects leasing up. We’re able to take out the construction loan with a non-recourse Fannie Mae loan and provide cash to ownership for its business and strategic plans,” says Harper.

Meanwhile, borrowers in the U.S. Department of Housing and Urban Development’s Lean mortgage insurance program are showing renewed interest in loan modifications and 232/223 (a)(7) loan products that allow existing HUD borrowers to access lower interest rates in this environment, according to Harper.

Donald Clark, senior vice president of commercial banking with Old Second National Bank, says that many borrowers who were intent on refinancing their properties at some future point through Fannie Mae or Freddie Mac are having to act earlier than they originally anticipated. 

“Maybe they thought they missed a window earlier, and now they see rates dropping again and they’re trying to get back into agency debt,” says Clark.

Old Second National Bank, which is headquartered in Aurora, Ill., was established in 1871. The bank’s sweet spot in the private pay seniors housing space is loans ranging from $5 million to $20 million.

Construction financing accounts for about 20 to 25 percent of the bank’s overall portfolio in the seniors housing and healthcare space, bridge financing accounts for another 40 percent, and the remainder is split between acquisitions and refinancing, according to Clark.

While the lower interest rates haven’t materially impacted the bank’s deal volume up to this point, he notes their positive impact. 

“Certainly it makes it a little bit easier for some underwriting parameters, particularly if you can lock in those rates,” says Clark, who operates out of the bank’s Chicago-Loop location. 

Clark, who has over 30 years of commercial banking and financial services experience and most recently worked in the national healthcare banking group at MB Financial, joined Old Second National Bank in July. His job is to grow the bank’s healthcare lending platform on a national basis.

Obtaining a construction loan is tougher today than it was a few years ago because banks in general are more cautious, and in some cases they have bowed out of the construction lending business altogether, says Clark.

“There are certainly plenty of markets in which developers maybe jumped the gun a little early. And now you are seeing some distress and some lag in lease-up, even for good operators who have been successful. They’re still struggling a little bit, and lease-up times are extending,” emphasizes Clark.

It may take a minimum of 30 months for a newly constructed property to reach stabilization today versus 18 months just three years ago, says Clark.

Occupancy issues persist

The falling interest rates may be just what the doctor ordered. The average occupancy rate nationally at seniors housing properties (independent living and assisted living) fell 10 basis points in the second quarter to 87.8 percent, according to the National Investment Center for Seniors Housing & Care (NIC). That’s the lowest occupancy level since the second quarter of 2011.

More specifically, the average occupancy rate at assisted living facilities fell to a record low of 85.1 percent in the second quarter. The occupancy rate at independent living dipped to 90.2 percent from 90.5 percent the prior quarter. 

The good news is that the current disequilibrium between supply and demand is not a permanent condition.  

“We are seeing a clear downward trend occurring in construction starts nationwide for new seniors housing units, especially for assisted living. Industry leaders should keep an eye on this data going forward to make informed decisions on new developments and other potential investments,” says Beth Burnham Mace, NIC’s chief economist.

Adding to the challenges, operating margins are getting squeezed due to rising labor costs as competition for caregivers intensifies and employee turnover remains high. With the growth of the senior population expected to outpace the increase in the number of caregivers, this problem isn’t likely going to abate anytime soon.

“Senior living has some near-term headwinds, but just due to sheer demographics it has a good, long runway and it will be a strong, viable industry for a good 20 years,” says Casey Moore, managing director of agency finance at Lancaster Pollard.

From Moore’s perspective, the lower borrowing costs can only help operators “get through any sort of recessionary-type period with minimal damage.” n