CHICAGO — For veteran lender Aaron Becker, it feels as if the seniors housing industry is working through the five stages of grief in response to the “incredible change” in interest rates since March 2022. “We haven’t seen this in 40 years,” says Becker, senior managing director and head of seniors housing and healthcare production at Lument.
He’s referring, of course, to a string of 11 increases in the federal funds rate beginning in March 2022. To combat inflation, the Federal Reserve has aggressively raised the fed funds rate from near zero percent to a target range of 5.25 to 5.5 percent over the last year and a half, leading to higher borrowing costs across the board in the seniors housing industry.
For example, the 30-day Secured Overnight Financing Rate (SOFR), used to price variable-rate bridge loans, was 0.05 percent in March 2022 and today stands at 5.3 percent. The U.S. 10-year Treasury yield — a benchmark rate used by lenders for the pricing of fixed-rate permanent loans in commercial real estate, soared from 1.6 percent in March of last year to 5 percent in late October of this year before receding to 4.5 percent as of mid-November.
“We’ve been in this business long enough to know that there was a time not so long ago where federal funds rates plus or minus 5 percent was normal, a 10-year Treasury [yield] at 5 to 5.5 percent was normal. It feels very abnormal and painful to us now considering we came from [near zero interest rates] and absolute historically low rates. But we’re starting to see the industry adjust to this new reality, and we’ll continue to do so,” says Becker.
His comments came during a panel discussion titled “Deep Dive on the Debt Market” at the annual NIC Fall Conference in Chicago. The event, held Oct. 23-25 at the Sheraton Grand Chicago Riverwalk, attracted 2,800 attendees, nearly 74 percent of whom were executive decision makers, or C-suite executives.
Becker served as moderator of the debt market panel discussion. Joining him on stage were Robb Chapin, senior managing director at Bridge Investment Group and CEO and Co-Chief Investment Officer of Bridge Seniors Housing Fund Manager LLC; Lori Coombs, managing director, Wells Fargo; Brian Heagler, senior vice president and senior banker, KeyBank; and David Young, managing director, Locust Point Capital.
Navigating a series of crises
Chapin, who is based in Florida and is no stranger to hurricanes, reflected on what operators in particular have had to endure over the past three-plus years. “Certainly, our industry has been hit by several hurricanes. It started out with Hurricane COVID, and [then] Hurricane Inflation and Hurricane Labor Challenge. And now we’ve got the Hurricane Debt Market Turbulence,” said Chapin.
Despite the pressure on operators and owners to boost occupancy and net operating income (NOI), Chapin is still excited to be actively engaged in the seniors housing industry after nearly 30 years in the business. “We’re going to get through this, and we are getting through this. And not only are we going to get through this, the future for our industry is very bright, as we all know.”
To Chapin’s point, the real estate fundamentals of the business are trending upward. The seniors housing occupancy rate for the 31 NIC MAP Primary Markets increased 0.8 percentage points between the second and third quarters of this year to reach 84.4 percent. The occupancy rate has increased 6.6 percentage points overall from a pandemic low of 77.8 percent in the second quarter of 2021. Still, the occupancy rate remains 2.7 percentage points below the pre-pandemic level of 87.1 percent in the first quarter of 2020.
At another point of the panel discussion, Chapin pointed out the wall of debt maturities coming due in the next few years will lead to more situational distress across the seniors housing industry.
“We are telling investors today that we think that there is an unprecedented investment opportunity in this sector over the next three years. We really have high conviction around that. If you’ve got the right capital formation, the right lending partners, the right operating partners in your business, you’re going to be really successful in this next phase.”
Deal volume plummets
The rising interest rate environment and the bid-ask gap between buyers and sellers has taken its toll on the investment sales market, acknowledged Young of Locust Point Capital. For example, Real Capital Analytics reports that the dollar volume of U.S. property sales across commercial real estate is down about 60 percent year to date through September compared with the same period a year ago, according to Young. In the skilled nursing sector, Irving Levin Associates reports a 75 percent decrease in M&A deal volume year to date through September on a year-over-year basis, added Young.
The dearth of deal volume in the investment sales market makes it challenging to determine which way capitalization rates are trending, Young pointed out. A cap rate is the ratio of NOI to the current market value of the property. The ratio, expressed as a percentage, is an estimation of an investor’s potential return on the investment.
“I think, honestly, the jury’s out as to how seniors housing cap rates have moved. A cap rate is really informative when it’s done on a stabilized deal. I don’t think we’re yet at that point where you’re seeing enough sample size of stabilized deals,” said Young.
Emphasis on in-place cash flow
From the perspective of a regulated financial institution, Heagler of KeyBank said it’s a difficult market in which to operate. “There is capital out there, but the box for that is much narrower, certainly, than it was a year or so ago. It’s a challenging time. Banks are going through liquidity and capital issues.”
Becker asked Heagler what’s driving credit decisions today at banks and what it’s going to take to loosen their purse strings.
The sponsor, the operator, along with the real estate, continue to be very important to the lender in any deal that is being vetted, said Heagler. “But one thing that definitely has changed more recently is a real focus on underwriting in-place cash flow. So, if in-place cash flow does not cover debt service, it’s very challenging to get something done today. Turnaround assets, lease-up assets, are more difficult to finance.”
Coombs of Wells Fargo said Fannie Mae and Freddie Mac are open for business and lending, but that these two government-sponsored enterprises (GSEs) are proceeding with caution. “If I was going to put one word on lending and on people’s perspective, there is just so much uncertainty out there. “There’s a lot of political risk, there’s geopolitical risk, there’s valuation risk.”
In short, the GSEs are evaluating everything closely and making no assumptions.
— Matt Valley