Lending volume lags last year’s pace despite a healthy amount of refinancing and acquisition financing activity
By Matt Valley
Editor
Loan production generated through the U.S. Department of Housing and Urban Development’s Section 232 Lean mortgage insurance program, which plays a vital role in the long-term financing of nursing homes and assisted living facilities, fell 17 percent during the first half of fiscal 2016 on a year-over-year basis.
HUD lenders closed nearly $1.13 billion in loans for the six-month period ending March 31 compared with $1.37 billion recorded during the same period a year ago. (HUD’s fiscal year runs from Oct. 1 through Sept. 30.)
The number of transactions also is down from a year ago. HUD lenders closed 110 loans in the mortgage insurance program during the first half of fiscal 2016 compared with 149 loans closed during the same period a year ago.
At the current pace, deal volume for all of fiscal 2016 is on track to finish below the $2.7 billion figure reached in fiscal 2015 and well below the record $4.2 billion tallied in fiscal 2014 when a flood of borrowers refinanced existing HUD loans.
Review and fast forward
“What we’re seeing is a continuation of the trend over the last 36 to 48 months,” says Jeffrey Davis, founder and CEO of Chicago-based Cambridge Realty Capital Cos., which closed $205 million in loans through the HUD mortgage insurance program in fiscal 2015, making the company the fourth highest producer for the year. Cambridge has ranked among the top five HUD healthcare lenders for the past 15 years.
“Just to give you some historical perspective, up until the 2007-2008 recession, HUD only did $800 million of financing a year on average in the nursing home business,” explains Davis. “HUD’s numbers got accelerated tremendously — and for the right reasons I might add — during the recession because so many other lenders were not in business.”
Davis expects total annual lending volume to flatten out a bit below the $2.7 billion notched in fiscal 2015.
There are relatively few nursing homes being built today, which limits HUD lending opportunities to a degree, points out Davis. “Skilled nursing facilities still account for the clear majority of the HUD program at the end of the day. The HUD lending program really works best for owners and operators of skilled nursing facilities who own both the real estate and the operations.”
Richard Lerner, a director at Chevy Chase, Md.-based Housing & Healthcare Finance, agrees that there hasn’t been any significant uptick in construction activity in the skilled nursing segment during the past 15 to 20 years. However, he says that skilled nursing properties trade hands quite often. “Every time they change hands, you usually need a new loan.”
Furthermore, Lerner anticipates more assisted living product will be financed through HUD in the years ahead. There are limits to the amount of business that the government-sponsored agencies Fannie Mae and Freddie Mac can generate, he says. If the agencies were to run out of capacity, the banks could step in to capture some of that borrower demand, but banks generally don’t have the same long-term outlook as agencies.
The Medicaid waiver program, which is catching on in certain states, presents another area of growth opportunity for HUD lenders, Lerner believes. A growing number of states are moving long-term care patients with less health complications out of skilled nursing into assisted living because it’s cheaper to do so.
“The agencies don’t like those assisted living buildings because they tend to be older facilities with less population and they’re not as shiny. You are starting to see the owners of those facilities come to HUD for financing,” says Lerner.
Housing & Healthcare Finance closed $264 million in HUD deal volume in fiscal 2015, second only to Lancaster Pollard.
Jonathan Camps, senior vice president with Love Funding based in Washington, D.C., says the mindset in his shop is that the seniors housing healthcare lending business is in a growth phase. A convergence of factors is helping the HUD Section 232 mortgage insurance program to evolve and capture new opportunities.
Banks are tightening their credit standards, which means in some cases they can’t be as competitive as other financial sources. Meanwhile, HUD continues to refine and improve its processes, including the certainty of execution. Add to the mix a low interest rate environment and HUD’s attractive loan terms.
“We’re definitely starting to see more activity on the assisted living and memory care side of the business,” says Camps.
Peeling away layers of the onion
A closer look at the first-half stats shows that 98 of the 110 transactions closed were 223(f) loans, which are new loans coming into the HUD program used for the refinancing of existing debt or acquisition financing. In stark contrast, there were only five 223(a)(7) loans — the refinancing of existing HUD loans — that closed during the first half of fiscal 2016.
Among other first-half highlights, HUD lenders in the Section 232 program closed four 241(a) loans, also known as supplemental loans, used to finance repairs, additions and improvements of healthcare facilities that have a HUD-held mortgage in place. Additionally, three 232 loans used for new construction or substantial rehabilitation closed during the same period.
“Clearly, the bulk of activity is still being driven by acquisitions and refinancing,” says Kass Matt, president of Columbus, Ohio-based Lancaster Pollard, the top lender in the HUD Lean mortgage insurance program in fiscal 2015 with 65 loans closed totaling $531 million.
“However, the other programs remain active. Lancaster Pollard closed three transactions through the 232 and 232/241(a) programs that provided funds for new construction, expansion and substantial renovations,” adds Matt.
Although the overall pace of activity has slowed since 2015 due to a reduction in refinance opportunities, Matt expects HUD to continue to play an important role in the world of seniors housing finance, especially while interest rates remain at historic lows.
Jason Smeck, managing director for seniors housing and healthcare at Columbus, Ohio-based RED Capital Group, believes the 241(a) supplemental loan program is underutilized and underappreciated by borrowers.
“In many cases, owners and operators have the space to expand their existing property,” says Smeck. “It makes a ton of sense because you can add units, add revenue, and in a lot of cases you’re not adding a substantial amount of expense because you’ve got the people in place to provide the care to those additional residents.”
Last summer, RED closed a $3.5 million 241(a) supplemental loan for Woodlands at Hampton Woods, a skilled nursing and assisted living facility located in Poland, Ohio. The supplemental loan funded the addition of a new skilled nursing building to the existing 121-bed campus.
The project, called The Rehabilitation Center at Hampton Woods, included 26 private beds designed for short-term rehabilitation care and a 5,000-square-foot therapy gym.
In 2014, RED completed the refinancing of the existing facility utilizing the 223(f) program as planning was underway for the expansion.
In the end, the 241(a) transaction provided the borrower with an attractive non-recourse construction and permanent financing, a fixed interest rate, and a long, fully amortizing loan term. RED also obtained an early start approval for the owner that allowed construction to begin prior to the loan closing.
Why are owners of seniors housing properties not taking full advantage of the 241(a) program?
“People get concerned about the timing and perceptions of red tape involved in a HUD-financed construction project, but the HUD program can work very well when executed proficiently by a lender with expertise and experience in contruction lending,” says Smeck.
In fiscal 2015, RED Capital’s loan production in the HUD Lean mortgage insurance program totaled $107 million. Smeck expects the company to reach or exceed that figure this fiscal year.
A project for the record books
In December 2015, Housing & Healthcare Finance LLC closed the largest HUD refinancing ever of a single-asset skilled nursing facility for $80.7 million through the 223(f) program. The 520-bed Riverside Premier Rehabilitation & Healing Center is located on Manhattan’s Upper West Side.
“It’s probably the only skilled healthcare facility in the country, at least in HUD’s portfolio, where the dirt without the building on it is worth more than the loan,” says Lerner of Housing & Healthcare Finance. “It’s a great facility. It’s almost a portfolio in and of itself.”
The loan replaced existing conventional bank debt used to finance the skilled nursing facility, which was acquired by a member of the CareRite Centers network three years ago. The property was then renovated significantly.
“The asset is in a great neighborhood on Riverside Drive. A lot of the rooms have river views,” says Erik Lindenauer, a director at Housing & Healthcare Finance.
Because of the large loan size, the lender needed to gain approval from multiple levels at HUD including the Office of Risk Management and the deputy secretary. “I’ve never gone through a process like this before in terms of levels of approval,” says Lindenauer.
The fixed-rate, non-recourse loan is for a term of 30 years and provides flexible prepayment conditions. “There is no lockout on it. The borrower could immediate prepay,” according to Lindenauer.
The borrower received an interest rate in the mid-three percent range.
Unconventional project in Windy City
In February, Love Funding closed a $12.3 million loan for the construction of Montclare Senior Residences of Lawndale, a supportive living facility currently under construction in Chicago. The project is slated for completion in April 2017.
Montclare Senior Residences will be 100 percent backed by the Supportive Living Program, which Illinois developed as an alternative to nursing home care for low-income older persons and those with disabilities under Medicaid. The program combines apartment-style housing with personal care and other services, so residents can live independently and take part in decision-making.
The new facility is being built on a 2.5-acre lot in an urban neighborhood less than six miles from downtown Chicago, and will feature one two-story building with a mix of 120 studio and one-bedroom residential units. It will serve an area where residents do not have the means to afford market-rate rents in properties of this type.
Love Funding Midwest Regional Director Bruce Gerhart secured the financing through the HUD’s Section 232 loan insurance program. The HUD program provided the development team with low-rate, non-recourse financing for the duration of construction and for a subsequent 40-year term.
Funding was also provided by 9 percent low-income housing tax credits through the Illinois Housing Development Authority, a Chicago Department of Housing loan, a tax-increment financing grant and an Illinois Department of Commerce & Economic Opportunity grant.
Philip I. Mappa, managing member and founder of MR Properties LLC and an experienced borrower with HUD experience, is leading the development. Mappa has been active in real estate development in the Chicago area for over 40 years.
Cinnaire, a nonprofit real estate investment firm formerly known as Great Lakes Capital Fund, is purchasing the housing tax credits. The firm has partnered with Gerhart and Love Funding on tax credit developments for the past 15 years.
“The originators that are the most successful are the ones who really are invested in certain communities they market to,” says Camps, “and they understand what a project like this can do for the community.”