By Matt Valley
Loan production in the HUD Section 232 mortgage insurance program is running slightly behind last year’s pace through the first half of fiscal year (FY) 2024 due to two main factors: elevated interest rates and margin compression experienced by operators of skilled nursing and seniors housing facilities. But a growing deal pipeline will likely result in loan closings in FY 2024 surpassing last year’s total of $2.87 billion, says one seasoned lender.
Michael Gehl, chief investment officer on the FHA lending team at NewPoint Real Estate Capital, notes that loan commitments through the first half of FY 2024 totaled $1.73 billion, up from $1.1 billion in the first half of FY 2023. Loan applications through the first half of FY 2024 totaled $3.9 billion versus $2.3 billion during the same period a year ago.
“While the endorsements [loan closings] might have been slow in the first half of the year, there is an avalanche of activity in the program that should well exceed last year’s production and set us up for strong production next year as well,” explains Gehl.
Through the first 26 weeks of FY 2024, loan closings in the HUD Section 232 program totaled just over $1.1 billion compared with $1.3 billion during the same period a year ago. HUD’s fiscal year runs Oct. 1 to Sept. 30.
Tony Ruberg, senior managing director with VIUM Capital, says that improvements in operational performance and Medicaid rate increases in multiple states nationally have helped boost the HUD loan pipeline.
“However, that has lengthened the HUD queue and HUD’s processing times. Interest rates on HUD loans have also remained at elevated levels relative to recent history, causing some borrowers to delay closings in the hope that the Fed will cut rates and we’ll see long-term rates follow. Those two factors have increased timing overall from HUD application submission to closing,” says Ruberg.
The length of time between when VIUM Capital signs an engagement letter with a client to the loan closing currently ranges from eight to nine months for a “straightforward” deal, says Ruberg. Abnormally large loans or transactions involving facilities with more complexities may require additional levels of review by HUD, lengthening the time frame.
Interest rates ‘higher for longer’
The federal funds rate currently ranges from 5.25 to 5.5 percent — a level unchanged since July 2023 — up from near zero percent in March 2022. Heading into 2024, the Federal Reserve telegraphed as many as three cuts in the federal funds rate this year, but hotter-than-expected inflation data has caused the Fed to tamp down those expectations.
The Consumer Price Index (CPI) increased 3.4 percent in April on an annualized basis, down sharply from 9.1 percent in June 2022. The Fed has indicated that it would like to see the inflation rate closer to 2 percent before it begins cutting interest rates.
“You would read predictions for four to five rate cuts from various banks and economists. But as the inflation and economic data came in stronger [than expected], Federal Reserve Chairman Jerome Powell removed the punch bowl,” says Gehl.
“The conventional market wisdom is that we can expect two rate cuts this year as economic data has cooled a little. While that seems reasonable, pretty much every rate prediction has been wrong. The last thing Powell wants to do is cut too soon and have to raise rates after a mistake. I expect one rate cut at the end of the year, but any hot inflation or strong jobs number will push that back further,” adds Gehl.
Ruberg expects a maximum of one rate cut this year. While the Fed’s actions have more of a direct impact on short-term rates, he says the central bank’s decisions also have some impact on long-term rates. “I’d expect that when we do see short-term rates come down, we’d see a flattening of the yield curve rather than a parallel shift downward (i.e. short-term rates fall faster than long-term rates).”
Jason Smeck, a director at Lument who specializes in seniors housing and healthcare production, says he thought the market was getting ahead of itself last fall by anticipating multiple rate cuts this year.
“I am not surprised that the fed funds range currently stands the same as it was in July 2023. The Fed absolutely wants to be sure inflation is in check before it starts to loosen the reins on the economy through decreases in short-term rates. Current sentiment seems to be banking on the ‘higher for longer’ mantra,” says Smeck.
Interest rates on HUD refinancing or acquisition loans today generally range from 5.75 to 6.25 percent compared with 3.5 to 4.5 percent in the years following the Great Financial Crisis and through the COVID-19 pandemic, says Ruberg.
The combination of the unfavorable interest rate environment and compressed operating margins is prompting borrowers to consider their financing options, says Smeck.
“For example, should a borrower move forward with closing its loan if loan proceeds alone are not sufficient to cover the payoff of its existing indebtedness? Should a borrower wait until financial performance improves before moving forward with seeking long-term financing? What are other short-term and long-term financing options in today’s rate environment? These are real questions that borrowers face in the current market,” explains Smeck.
Market fundamentals rising
The occupancy rate for nursing care properties in the top 31 primary metropolitan markets was 83.9 percent in the first quarter, up 80 basis points from the prior quarter, according to NIC MAP Vision. The occupancy rate for the private-pay seniors housing segment was 85.6 percent in the first quarter, up 50 basis points from the previous quarter. Construction as a percentage of total inventory was 4.2 percent in the senior living segment during the first quarter and 0.1 percent in nursing care.
“In terms of supply and demand, we’re largely in a good place,” says Smeck. “Occupancy rates are slightly below pre-pandemic levels but continue to improve month by month. Over the past four years there has been very minimal construction and new development. As boomers age, will we have enough seniors housing resident capacity to meet the demand for services from a much larger target population?”
The biggest concern centers on net operating income (NOI), which for the most part has not rebounded to pre-pandemic levels, Smeck notes.
“While operators have been able to increase rents in recent years, those rent increases just have not kept up with higher operating costs. This year, operators in many states have seen much-needed increases in Medicaid reimbursement rates for skilled nursing and assisted living communities, but for those communities solely oriented to private-pay residents, it has been difficult to keep pace with pre-pandemic NOI levels,” says Smeck.
Gehl says that on the expense side of the ledger, labor costs remain a challenge. “However, it is getting better with less agency utilization and declining wage growth (still above pre-pandemic levels), leading to revenue growth that exceeds expense growth, creating NOI margin expansion. Are we fully back to pre-pandemic levels? No, but we are seeing the necessary improvements.”
Ruberg notes that the performance of the skilled nursing sector varies greatly by state. “In states that have pushed through Medicaid rate increases, we are seeing relatively healthy markets. We have also seen occupancy gains across the board and some level of stabilization on the staffing side of things. This has helped that asset class improve performance on a macro scale and is leading to increased HUD lending activity on skilled nursing facilities.”
The minimum staffing rule for skilled nursing facilities, which the Biden Administration recently enacted and will be phased in over the next few years, threatens to cause significant harm to the nursing home industry, Ruberg believes.
The staffing rule mandates that a registered nurse be in every skilled nursing facility 24 hours a day, seven days a week. Additionally, there must be enough staff to provide every resident with at least 3.48 hours of nursing care each day.
“Fortunately, there is significant bipartisan and industry pushback against the unrealistic policy,” says Ruberg.
The velocity of investment sales in the seniors housing segment of the industry appears as if buyers and sellers are finding some footing on cap rate levels, says Ruberg.
“The bid-ask spread has narrowed between buyer and seller pricing expectations. We’ve also seen an uptick in Medicaid-waiver projects as several states have provided increases in funding for those projects. We continue to be bullish on that asset class in certain states.”
Notable deals, trends
Through the first 26 weeks of FY 2024, lenders in the HUD Section 232 loan program closed 85 loans, 84 of which were classified as 232/223(f) loans, which allow for the purchase, rehabilitation or refinancing of nursing homes, assisted living facilities as well as board and care properties. Under terms of the program, borrowers receive non-recourse, fixed-rate financing up to 40 years for new and rehabilitated properties and up to 35 years for existing properties without rehabilitation.
NewPoint recently refinanced The Paramount at Somers Rehabilitation & Nursing Center, a 300-bed skilled nursing facility in located in Somers, New York, roughly a 30-minute drive from New York City. The facility was originally constructed in 1974 and was completely remodeled and modernized by the current owner through a multi-million-dollar renovation plan. The deal was underwritten at a 70 percent loan-to-value.
“With a four-star CMS (Centers for Medicare and Medicaid Services) rating, this renovated facility sets the bar for skilled nursing care,” says Gehl.
This spring, Lument closed on a $16.5 million loan for Assured Senior Living to refinance a portfolio of assisted living and memory care communities in metro Denver.
The portfolio consists of 10 ranch-style homes located within a larger neighborhood. The homes feature a maximum of 12 residents each and use shared services. Nine of the 10 homes offer memory care, and one specializes in care for traumatic brain injuries.
“Initially, HUD was reluctant of this deal because of the scattered site concept,” says Smeck. “HUD visited the site with Lument and was so impressed by the operations that it became an enthusiastic proponent of the deal. We were able to close on this complicated transaction largely due to our strong working relationship with HUD.”
VIUM Capital closed a HUD loan in the first quarter of this year that enabled a Northeast-based buyer to refinance a portfolio of skilled nursing facilities in Indiana operated by an Indiana-based company.
VIUM provided the acquisition financing via its bridge lending program in late 2022. “The refinancing enabled the borrower to realize a significantly lower cost structure with non-recourse financing from HUD,” says Ruberg.