Low Interest Rates Lift Fortunes of HUD Lenders

Deal volume in FY 2020 reached $4.3 billion, up 17 percent from the previous year.

By Matt Valley

Despite the COVID-19 pandemic, lenders in the U.S. Department of Housing and Urban Development’s Section 232 healthcare mortgage insurance program closed $4.38 billion in loans during fiscal year (FY) 2020, a 17 percent increase from $3.73 billion the prior year. 

The number of transactions completed climbed from 288 to 323, a 12 percent increase, and the average mortgage amount ticked up from $12.9 million to $13.5 million. HUD’s fiscal year runs from Oct. 1 to Sept. 30. 

“The two primary drivers I see today are the low interest rates and the lack of competition. A lot of lenders have left the market,” says Scott Thurman, chief credit officer for FHA lending at Greystone. The New York City-based lender closed nearly 75 loans totaling $1.2 billion in FY 2020 through the HUD Section 232 program, doubling its production from the prior year when it closed 36 loans for $606.5 million.

“We’ve taken advantage of some of the turmoil in the finance market amid the mergers and acquisitions of different lending companies. We’ve helped fill that void,” says Thurman.

Administered by HUD’s Office of Residential Care Facilities, Section 232 offers HUD/FHA loan products that provide mortgage insurance for nursing homes, assisted living facilities and board and care properties. Section 232 is also commonly referred to as the HUD Lean program because of the highly efficient manner in which loan applications are processed.

Refinancing Wave

One major contributing factor to the double-digit increase in annual loan closings across the program during FY 2020 was a big uptick in the refinancing of existing HUD/FHA-insured loans, more officially known as 223(a)(7) loans. Lenders active in the HUD Lean Section 232 Program closed only two such loans for all of FY 2019, but that figure jumped to 54 in FY 2020. 

The 223(a)(7) loan provides a borrower with an opportunity to lower its monthly debt service by refinancing at a lower interest rate and potentially extending the remaining loan term, says Michael Gehl, chief investment officer at Housing & Healthcare Finance (HHC) based in North Bethesda, Md.

“The combination of a drop in interest rates and a number of Federal Reserve bond-buying programs have allowed borrowers to realize substantial savings through refinancing existing HUD loans,” explains Gehl. (As of Nov. 9, the 10-year Treasury yield stood at 0.95 percent, about 100 basis points lower than a year ago.)

HHC closed slightly over $450 million in transactions through the HUD Lean program in FY 2020, up from $336 million the prior year. Gehl says that a number of large transactions helped boost deal volume. One particularly noteworthy transaction was a $61.4 million refinancing of a 360-bed skilled nursing facility in Queens, New York. 

The five-star property, which is family-owned and operated, reported three consecutive years of 97-plus occupancy at the time of the transaction. What’s more, the short- and long-term rehab portions of the nursing home had recently been renovated. Because this particular facility had been stabilized for over three years and the loan-to-value was below 60 percent, HUD waived the standard two-year debt seasoning requirement.

HHC also completed 41 loan modifications totaling over $410 million in FY 2020 thanks to a precipitous drop in interest rates and the relative ease with which loan modifications can be completed. (HUD does not include loan modifications in its summary statistics.)

In a loan modification, the interest rate is reduced based on market factors, but the underlying loan remains the same, explains Orin Parvin, director and deputy chief underwriter at New York City-based Lument, formerly Orix Real Estate Capital LLC. “So, there is no extension of the terms, no addition of principal. It’s simply re-amortizing the remaining balance at a lower interest rate.” 

In fact, loan modifications were the big story for Lument in FY 2020. Of the 129 transactions the lender closed through the HUD Section 232 program, 74 were note modifications totaling $744.8 million. Lument also closed an additional 55 transactions, totaling $735 million, through a combination of construction financing, 241(a) loans; the refinancing of existing HUD loans, 223(a)(7) loans and 223(f) loans.

On a combined basis, Lument closed just under $1.5 billion in FY 2020. The note modifications served Lument’s clients quite well during the pandemic, especially early on, says Aaron Becker, head of production for seniors housing and healthcare at Lument.

“We could get these loans submitted to HUD in a week, rate lock a little more than two weeks later, and close shortly thereafter,” Becker points out.

While overall lending volume in the Section 232 program increased in FY 2020, the number of 223(f) loans used to acquire or refinance residential care facilities declined from 266 to 253 on a year-over-year basis. Gehl attributes that drop-off to the pandemic. 

“Early on, the focus was on the frontlines, understanding the spread, keeping both residents and staff safe, acquiring personal protective equipment (PPE), maintaining staffing levels,” explains Gehl “The focus on financing was rightly put on the back burner.”

The National Investment Center for Seniors Housing & Care (NIC) reports that private-pay seniors housing occupancy fell 2.6 percentage points in the third quarter of 2020, from 84.7 percent to 82.1 percent, indicating a steady decline since the pandemic began. It’s the second quarter in a row where occupancy fell more than 2.5 percentage points.

Outlook for FY 2021

With occupancies across the seniors housing sector down about 10 percent on average from pre-pandemic levels, the corresponding decline in financial performance will impact the ability of a number of property owners to refinance, says Gehl, who adds that acquisition volumes are down substantially as well. “As a result, I see a 10 to 15 percent drop in production for fiscal year 2021.”

According to Real Capital Analytics, U.S. sales in the seniors housing sector year-to-date through September totaled $6.65 billion, down from nearly $13 billion during the same period a year ago. The RCA data is based on deals $2.5 million and above.

Due to COVID-19, a number of senior living facilities have experienced a drop in financial performance stemming from both occupancy declines and increased expenses for PPE and staffing, says Gehl. Against that backdrop, the No. 1 question borrowers have of lenders is, “How do we underwrite the cash flow?”

The answer is a gray area, explains Gehl. “For facilities where the impact has not been dramatic, with an experienced operator, we feel comfortable that the cash flows will return to normalcy at the end of pandemic, and we will move forward with a transaction. When we see deals with more than a 25 percent decline in occupancy, we will most likely need to put that deal on hold.”

Erik Howard, managing director of real estate finance at Baltimore-based Capital Funding LLC, says that with interest rates so low and many banks exiting the long-term care and seniors housing space, resulting in a shrinking lending pool, he anticipates tremendous borrower demand for HUD-insured loans over the next 12 to 24 months.

“We recently submitted a loan to HUD, and there were already 40 or so loans in the queue. That’s as long as we’ve seen it in a couple of months,” observes Howard.

Capital Funding’s bridge-to-HUD program helps keep its deal pipeline full. Borrowers in need of financing in short order to acquire or refinance seniors housing properties, or to renovate or repair their facilities, can receive variable-rate loans starting at $3 million for a period of 18 to 60 months, according to the company’s website. The interim loan is eventually replaced by the HUD loan, which provides fixed-rate, non-recourse financing for up to 35 years.

“Our bridge portfolio has grown significantly to over $1.5 billion,” says Howard. “We’ll get to $2 billion by the end of this year in terms of bridge loans we have on and off balance sheet, which eventually translate into HUD loans. On Nov. 2, we closed a $311 million bridge-to-HUD loan, which we believe is the largest in the long-term care sector this year. It is the first financing for CFG Credit Partners, our recently launched debt fund.”

The incredibly low interest rates are the silver lining of this pandemic, according to Becker at Lument. “Interest rates started dropping in March when the Fed got involved. We would have gladly traded a more normal interest rate environment for no pandemic, but it’s the only positive thing that’s come out of this crisis in the industry.”

Greystone’s Thurman anticipates an uptick in the volume of 241(a) loans — used to finance repairs, additions and improvements to seniors housing communities — in FY 2021 and beyond. More specifically, he expects to see the construction of quarantine wings at seniors housing facilities that will provide operators the ability to isolate residents as necessary.

Thurman, who has been immersed in the healthcare real estate industry for 25 years, says he has never encountered interest rates this low. A year ago, the conventional wisdom was that debt capital couldn’t be priced much lower. At that time, a seasoned owner of a well-stabilized skilled nursing facility could expect to receive a non-recourse loan for a period of 35 years at a fixed interest rate of 3 percent. Today, that fixed rate is down to 2.25 percent.

The business community is learning to adapt to COVID-19, says Thurman. Lender inspections of buildings are still being conducted remotely to avoid the spread of the virus. Appraisers conduct virtual walk-throughs and rely on pictures of the physical inspection.

“The unfortunate part of where we’re at today, and where things are not back to normal, is the conferences,” says Thurman. For example, NIC’s fall conference this year was transformed into a virtual event. The inability to meet people in person presents a hurdle that’s not always easy to clear, he notes.

“A year ago, we would have just set up a meeting in D.C. with the people from HUD that needed to be in the room, the people from our shop and the borrower. We’d sit down and negotiate a solution,” says Thurman. “It’s a challenge to do that — not having the face-to-face conversation. I’ll be excited when that returns to normal.” n