Borrowers have plenty of choices for permanent financing, but Freddie Mac and Fannie Mae lead the way with new ideas and flexibility.
By Bendix Anderson
More and more borrowers are turning to Freddie Mac and Fannie Mae for permanent loans on seniors housing properties.
Freddie Mac provided a total of $4.1 billion in financing to seniors housing properties in 2018, its biggest year ever. And Fannie Mae provided $2.8 billion, its third biggest year. Both of the government sponsored entities (GSEs) plan to keep expanding their lending programs in the seniors housing space in 2019.
“Fannie and Freddie are implementing new loan programs, opening up more options for seniors housing borrowers,” says Chris
Kronenberger, managing director of Boston-based Blue Moon Capital Partners, a private equity fund focused on seniors housing and a seasoned borrower.
Lenders of all types compete to make permanent loans to seniors housing properties — even amid concerns over slowing U.S. economic growth and the large number of empty beds at many seniors housing communities. Despite these worries and the growing competition to lend, Freddie Mac and Fannie Mae continue to grow their business, offering competitive interest rates and increasing flexibility.
“The availability of permanent financing is the strongest I have seen in my career,” says Richard Thomas, senior vice president and seniors housing product manager for Grandbridge Real Estate Capital, a subsidiary of BB&T Corp. Grandbridge is a Fannie Mae delegated underwriting and servicing lender and a Freddie Mac Multifamily Approved Seller/Servicer. Thomas is based in the firm’s Atlanta office.
Kingpins of market share
Agency lending programs — including Freddie Mac, Fannie Mae and the Federal Housing Administration — accounted for nearly 41 percent of all primary loans to existing seniors housing properties in 2018, according to Real Capital Analytics (see chart, page 33).
“They continue to grow and grow… over time becoming almost dominant,” says David G. Shillington, president of Marcus & Millichap Capital Corp., who operates out of the company’s Atlanta office.
Both GSEs had record-setting years for lending to seniors housing properties in 2018. “We had a massive year,” confirms Phyllis Klein, vice president of marketing strategies and communications for Fannie Mae. “It was our third-best year ever. We are getting more competitive.”
Even so, Fannie Mae’s $2.8 billion in loans to seniors housing properties in 2018 was just half the $5.5 billion in seniors housing financing completed by Fannie Mae in 2017. A few giant deals to finance whole portfolios of seniors housing properties distorted the numbers in 2017.
Freddie Mac and Fannie Mae are rapidly expanding their lending to seniors housing despite heavy competition from other lenders, including many newcomers to seniors housing.
“As investors and lenders become increasingly comfortable with the operational complexity and demographic story of seniors housing, we have observed several banks, debt funds, and life insurance companies enter the space,” says Alden Campbell, director of bridge structured finance at Bridge Investment Group in Orlando, Florida.
Interest rate surprise
Typically, the GSEs are offering interest rates in the mid-4 percent range for fully leveraged, 10-year loans to seniors housing properties, according to experts like Aron Will, vice chairman of CBRE Capital Markets, who is based in Houston. That’s slightly less than 2018, when borrowers received interest rates in the high 4 percent to low 5 percent range.
Those rates are often more than 20 basis points lower than the rates offered by other seniors housing lenders, especially for loans that cover more than 70 percent of the value of the property. However, every deal is different, which can make comparisons difficult. “Fannie Mae and Freddie Mac’s loans to seniors housing properties are hand-priced. It’s not formulaic,” says Will.
Long-term interest rates have fallen throughout the U.S. economy, confounding the expectations of experts who predicted that interest rates would continue their long, slow climb in 2019. Worries about the global economy, ranging from the planned exit of Britain from the European Union to trade disputes between the U.S. and China, have helped keep interest rates low. A change of plans at the Federal Reserve has pushed interest rates even lower.
The benchmark yield on 10-year Treasury bonds was just 2.5 percent on March 20, 2019. That’s the lowest the yield has been since January 2018. The yield hovered around 3 percent for most of 2018, as investors enjoyed mostly strong economic news and economists predicted the Federal Reserve would continue to gradually hike its own benchmark interest rate targets. In March 2019, the Federal Reserve officials switched course and signaled that they are likely going to increase the Fed Funds rate again this year.
Lenders don’t immediately pass along higher or lower interest rates to borrowers. When benchmark rates rise, they often reduce the “spread” that they add to the all-in interest rate, but over time. When rates fall substantially, they typically raise spreads over time. “There is some correlation between interest rates and spreads, which tend to gap out if Treasury yields drop, but they are not directly correlated as many other factors come into play,” says Will.
Last year, the spread that Freddie Mac and Fannie Mae lenders added to the interest rate they charge borrowers shrank below 200 basis points as the yield on Treasury bonds rose toward 3 percent. Now that the yield has dropped toward 2.5 percent, the typical spread has risen in some cases, but not proportionately to the dramatic drop in Treasuries.
“The all-in cost of capital is now as low as it has been for fixed-rate loans in some time,” says Will.
Going off ‘the grid’
To win deals they are especially interested in, the GSEs have given themselves the freedom to diverge from their standard pricing models for interest rates, which experts call “the grid.”
“The grid pricing doesn’t bear any resemblance to what they are doing today,” says
Carolyn Nazdin, national production manager for healthcare mortgage banking at KeyBank Real Estate Capital. “Every seniors deal is
custom-priced based on its unique attributes. The GSEs are quoting to win.”
The GSEs fight hardest to make loans on properties that do not count toward their lending cap set by the federal government. Many loans to seniors housing properties don’t fully count toward these lending caps.
The federal government assumed control of Fannie Mae and Freddie Mac during the financial crisis in 2008. In 2019, the Federal Housing Finance Agency (FHFA) will allow them to each make $35 billion in permanent loans to apartment properties.
However, FHFA does not count loans to certain types of apartment properties toward the caps, including communities that provide housing that is affordable to low- and
moderate-income people. Many private-pay seniors housing apartments count as affordable housing, even if the monthly cost of living in these seniors housing units is high. Much of that cost is for medical services.
Fannie Mae and Freddie Mac offer lower interest rates to properties that include these affordable seniors housing units. “It can be 10 or 15 basis points,” says Will. “It’s meaningful.”
The GSEs are eager to make multifamily loans that don’t count toward the caps set by FHFA. Both GSEs were so eager, in fact, that they each completed a total of more than $70 billion in multifamily financing in 2018. That’s twice the $35 billion that each is allowed in the lending caps.
“We work hard to get the business that fits,” says Fannie Mae’s Klein.
Hundred-Million-Dollar Deals
In December 2019, Berkadia, a New York-based investment sales and mortgage banking firm, closed $327 million in Freddie Mac financing for Brookdale Senior Living, the largest owner and operator of seniors housing in the United States. The deal refinanced 2,200 units of seniors housing at 28 properties across the country.
Freddie Mac and Fannie Mae are increasingly interested in making very large loans similar to the Brookdale transaction to finance whole portfolios of seniors housing properties.
“There has been a lot of interest in what is called our credit facility, a portfolio management tool,” says Klein.
Large deals like this, often totaling well over $100 million, are a big part of the reason that Fannie Mae was able to lend more than $5 billion to seniors housing properties in 2017, according to Klein. Big years like that may become more common as the number of large borrowers grows. “The market is much more sophisticated and more fluid in terms of owners and sponsors. There are much larger owners (today) and fewer smaller operators,” says Klein.
Fannie Mae and Freddie Mac are aggressively courting this business by offering an interest rate discount. “They will give a pricing waiver — they will come off the grid,” says Marcus & Millichap’s Shillington.
Freddie Mac and Fannie Mae can provide a mix of fixed- and floating-rate interest rates to the individual properties in the pool. “It enables more flexibility when choosing to renovate assets. Floating-rate loans are cheaper to prepay,” says Freddie Mac’s Schmidt.
Tougher standards for green lending
Fannie Mae and Freddie Mac also offer lower interest rates to borrowers who commit to renovating their properties in order to conserve energy and water.
So far, relatively few seniors housing borrowers have taken advantage of the green financing programs rolled out by the GSEs. “It’s early,” says Klein.
Owners of conventional apartment properties have eagerly applied for loans through the GSEs’ green lending programs. More than one-quarter of their apartment loans in 2018 qualified and received interest rates as much as 30 basis points lower than the GSEs’ loans to conventional apartments that are not in the green program, depending on the particulars of the deal and the level of competition. The interest rate discount can make a big difference in the size of the loan the property can support. Borrowers can get up to a 5 percent increase in the loan amount, experts say.
The GSEs are eager to make green loans on conventional apartment properties. Just like loans on affordable housing properties, these green program loans do not count toward the limits set by FHFA. However, the GSEs might not offer discounts quite that large to seniors housing properties that go green. That’s because many seniors housing apartments already do not count toward FHFA’s limits, and have already received lower interest rates. The GSEs are unlikely to double their discounts for these properties.
“For seniors housing the pricing has gotten so aggressive. Borrowers are already getting these huge discounts,” says Marcus & Millichap’s Shillington.
However, owners of properties that cut their energy usage still benefit. “That energy efficiency equates to savings, and ultimately higher net operating income,” says Blue Moon’s Kronenberger. “It is still in the early stages, but you will continue to see increased utilization of these programs.”
Borrowers will also have to do more in 2019 to qualify for green financing than they did in 2018. They will have to commit to cutting water and energy usage at their buildings by 30 percent, up from 25 percent previously. More importantly, half of that reduction will have to come from energy. In the past, borrowers have focused the vast majority of their efforts on renovations that save water, like low-flow faucets, which are often relatively cheap and easy to install.
“FHFA has made changes. Borrowers will need to spend more per unit to meet the new standard,” says Freddie Mac’s Schmidt.
Faster money in lease-up
Freddie Mac lenders also continue to offer permanent financing to some seniors housing properties that have not yet reached stabilization. The GSE’s flexibility — along with its credit facilities — has enabled Freddie Mac’s seniors housing lending business to keep growing. “These programs were a large part of our record year in 2018,” says Schmidt.
If a borrower has a strong relationship with Freddie and owns a newly opened property that is leasing up well and seems likely to be fully leased, Freddie Mac may offer the borrower permanent financing. “Freddie will fund a permanent lease-up loan at 75 percent occupancy,” says Chris Fenton, principal with PGIM Real Estate Finance in Newark, N.J.
Freddie Mac is expanding its Lease-Up program despite widespread worries that many seniors housing market are overbuilt.
Occupancy rates are now the lowest they have been in seven years. At assisted living and independent living properties, the average occupancy rate in the fourth quarter of 2018 was 88 percent across the top 31 markets for seniors housing, according to the National Investment Center for Seniors Housing & Care (NIC), based in Annapolis, Md.
“We have the confidence to provide good financing in markets that others might consider risky,” says Schmidt. To identify good deals in troubled markets, Freddie Mac relies on its relationships with borrowers in addition to strong knowledge of local markets. “We rely on NIC data supplemented by calls to local zoning boards,” says Schmidt.
The GSEs are also giving borrowers more flexibility to prepay their loans. Both Freddie Mac and Fannie Mae sell their seniors housing loans to investors as bonds. If borrowers prepay these loans, the bond investors still need to receive the yield that they were promised. Both GSEs allow borrowers to use complicated techniques to accomplish this. Both Freddie Mac and Fannie Mae borrowers can use yield maintenance. Freddie Mac borrowers can also use defeasance. However, the processes are involved and can be expensive.
The GSEs can now offer simpler alternatives. Bond investors have become more comfortable with buying bonds backed by seniors housing loans with a variety of structures. As a result, borrowers can obtain seven- or 10-year loans that they can prepay in one to three years, provided they agree when the loan is negotiated to pay a little more in interest. Conversely, borrowers who agree not to prepay may get a reduced spread, according to Schmidt.
“Because [bond buyers] are much more comfortable with the asset class, you can build more flexibility into the underwriting and structuring of seniors housing loans,” says Will. “The agencies are finding ways to be innovative.”