As if seniors housing developers and operators did not have enough difficulties rebounding from the pandemic, what with constrained occupancy, elevated expenses and staffing shortages plaguing the sector, they are now navigating an environment where the rising cost of capital is limiting their financial flexibility.
While the 10-Year Treasury yield has retraded about 50 basis points from its recent peak of nearly 3.5 percent in mid-June, it is still twice as high as it was at the beginning of the year. Likewise, the secured overnight financing rate (SOFR) has shot up to around 1.5 percent from effectively zero percent in early March.
The rate shock has impacted both in-process loans and slowed investment sales activity as sellers want more for their assets than what buyers are willing to pay, says Morgin Morris, a senior vice president with KeyBank Real Estate Capital in Seattle. Year to date through May, seniors housing and care sales have totaled $4.1 billion, representing a year-over-year decline of 39 percent, according to MSCI Real Assets, which tracks investment sales of $2.5 million and above.
At the same time, a slowing home sales market, the recent stock market slump and signs of recession are weighing on seniors housing move-ins, which have moderated over the last few months, according to monthly surveys conducted by the NIC (National Investment Center for Seniors Housing & Care).
“This asset class was hit early in the pandemic and there are headwinds that still face the seniors housing and skilled nursing space,” Morris states. “During 2020 and 2021, many owners that were unable reach their performance metrics were given a pass by their lenders. We are hearing from our clients that some financial institutions are running out of patience and bandwidth.”
KeyBank’s healthcare financing arm remains bullish on the sector, however. “Key has been in the aging seniors housing business for more than 35 years, and we’re doubling down on the space,” she adds. “We see this time as an opportunity to take back market share.”
Adjusting to the Market
Assets are taking longer to season and recover from the pandemic and Key is finding ways to be opportunistic. Currently, that includes a healthy number of bridge-to-bridge opportunities, where clients may need additional term coming out of their construction loan. Additionally, repositioning opportunities have started to emerge where a struggling asset is sold to a more experienced operator to reposition. We look to take these assets to the permanent market once the assets have seasoned and stabilized. Agencies have been very competitive, relative to other permanent or fixed rate options available, but the number of stabilized assets that need permanent financing loans are limited. In many cases borrowers have had to temper expectations regarding the amount of proceeds they can receive due to debt service coverage constraints that have accompanied higher interest rates, she says.
On the bridge side of the business, KeyBank is providing borrowers with more time to meet their performance targets. On the permanent side, it is offering longer interest-only payment periods to help borrowers build up equity through cash flow and more flexible term structures that could present an opportunity to refinance sooner rather than later.
Among other programs, KeyBank and real estate investment trust Welltower have created a $750 million unitranche fund to provide seniors housing owners with financing, which blends senior and junior debt pricing in a single first mortgage loan.
“We’re trying to capture both ends of the market,” Morris declares, “whether it’s classic lower-leverage seniors housing deals or riskier, higher-leverage opportunities that involve more credit-intensive underwriting.”
Reset on Tap
Eventually, higher interest rates will lead to a rise in capitalization rates but compared to other real estate classes seniors and skilled assets have more cushion, Morris predicts. Already, cap rate appraisals have grown more conservative, and the U.S. Department of Housing and Urban Development has started to push back on underwriting deals in which it thinks cap rates are too low.
Still, plenty of debt and equity capital sources remain keen on seniors housing. Currently, borrowers can secure a fixed interest rate generally ranging from 160 to 200 basis points above the 10-Year bond yield, she says, and for the right deal, Fannie Mae and Freddie Mac are offering as attractive pricing terms and loan structures as any lender. When it comes to equity, private equity firms and other traditional seniors housing investors continue to recognize the sector’s long-term value.
“I think the recent dramatic shift in the price of debt is causing some ripple effects on investment – we’ve been on a debt roller coaster the last six months. Some of our clients have headed to the sidelines,” she explains. “I expect this to be a short-term reaction as expectations reset. The undeniable demographic wave that is coming will continue to drive capital to our space.”
The rise of capital costs have added another layer of challenges onto the shoulders of seniors housing owners and operators. In NIC’s most recent monthly survey conducted from May 31 to June 26, 84 percent of seniors housing executives reported that operating expenses had continued to increase throughout 2022.
As a result, former optimism that operating margins would improve in the next six months has begun to wane. What’s more, about half of the respondents indicated that staffing would still be a problem in 2024 and 2025. That was roughly double the number of executives that thought such problems would last that long in NIC’s prior month survey.
In addition to seizing the opportunity to expand its client roster, KeyBank is also focusing on helping seniors housing owners and operators lessen the impact that these adverse conditions have on business performance. Efforts to date include more strategic discussions on staggering debt, collaborating on new opportunities early to support growth endeavors and keeping our clients up to date on market conditions. I am spending time talking to clients about ways to offset expenses, outsource some on-site expenses to the corporate office and bring in ancillary preventative medical services through Medicaid Advantage that even private-pay facilities can access, Morris reports.
“The lending environment has changed a lot since the beginning of the year, and our role has changed, too,” she says. “We’re not just lenders – we’re economists and market forecasters, and we’re sharing success stories and ideas so that we can be more meaningful to the seniors housing industry.”