Just like any other commercial real estate asset class, however, the heightened inflationary and interest rate environments are impacting the senior housing sector and its financing prospects. For mortgage brokers working with clients in this space, there is much to be aware of when structuring and closing deals.

Positives and negatives

According to Green Street’s recent U.S. Senior Housing Outlook report, senior housing occupancy levels at the national level have recouped slightly more than half of the decline experienced early in the pandemic. At the end of last year, national occupancy was in the high-80% range, about four percentage points below the pre-pandemic level.

The near-term risk of oversupply in certain markets is low as it will reportedly take several years for supply growth to catch up with demand. Rent and occupancy growth is anticipated to average 6.5% per year through 2027. There’s a strong likelihood that the national occupancy rate will reach a new record high, with a forecast average of 92% in 2027. Additionally, net operating income (NOI) forecasts call for sectorwide growth of 20% in both 2023 and 2024.

While occupancy and NOI expectations showcase the post-pandemic resilience and ability of the senior housing sector to rebound, owners and operators are still experiencing significant challenges. Interest rates are an obvious pressure. According to a March 2023 survey of industry executives conducted by the National Investment Center (NIC), 51% of respondents indicated that rising rates are impacting their ability to recapitalize assets. And 36% of respondents cited elevated interest rates as a challenge when purchasing new properties.

As the NIC survey showed, however, interest rates aren’t the foremost challenge faced today by senior housing owners and operators. Rising operational expenses topped this list, cited by a whopping 92% of respondents. Notably, the proportion of organizations that reported rising operator expenses as a significant challenge increased by 15 percentage points from the month prior.

Staff turnover was the second-largest concern, mentioned by 88% of executives. Being able to recruit and hire community and caregiver staff was the third-greatest challenge, with 82% of respondents currently impacted.

Financing outlook

Senior housing certainly isn’t immune from the impacts of the Federal Reserve’s efforts to quell record-level inflation. Although the most recent quarter-point increase this past May (the Fed’s 10th consecutive hike since March 2022) might be one of the last, it took the fed funds rate to a target range of 5% to 5.25%, its highest level since August 2007.

Unsurprisingly, the cost of mortgage debt for senior living facilities has grown in line with interest rate increases over the past year, heavily impacting owners and their assets. In some cases, the cost of debt coupled with the rising cost of construction has delayed timelines for new projects, while in other cases, it has rendered them completely unfeasible.

Additionally, while debt remains available, it is more limited. This has led to a decrease in sales transaction volume, with the exception of distressed assets.

Amid these capital-market dynamics, lenders are now likely to place greater emphasis on the quality of sponsors. Because senior housing is an incredibly specialized field within commercial real estate, ensuring the success of assets typically requires deep market expertise.

Thus, lenders that remain active in financing these projects today are looking to work with owners and operators with experience in the field. They are likely to prioritize opportunities to finance well-maintained and well-managed properties over alternatives, and mortgage brokers can expect more rigid loan qualification parameters, including in facility acuity levels.

Possible path

While many lenders have slowed their activities in this sector, there are financing options available today for numerous types of senior living centers. These include nursing homes, board and care homes, intermediate care facilities and assisted living facilities.

Given an environment in which lenders have either expanded their underwriting guidelines or pulled back on dealmaking, the U.S. Department of Housing and Urban Development (HUD) can be an ideal alternative for owners and operators. While other capital sources adjust and tighten their underwriting metrics in times of economic decline or volatility, HUD financing is countercyclical and its underwriting guidelines do not change.

HUD’s 232 loan program is government-insured financing that offers a fixed rate and full amortization, with the rate determined by market conditions at the time of the rate lock. These loans are nonrecourse and long term in nature — up to 40 years for new or substantially rehabilitated properties, or 35 years for non-rehab acquisitions that can be funded by Ginnie Mae mortgage-backed securities.

The loan review period typically spans 60 days, once the application has been picked up by the HUD underwriter, and the queue is markedly shorter than in prior years. Current interest rates range from 5% to 6%. A mortgage insurance premium is required, equating to 1% of the loan amount at closing and between 0.45% to 0.65% annually.

HUD-approved lending partners will continue to be active at this time, even as others slow or curtail their activities. These capital sources will be an important lifeline for the senior housing industry during this period of economic uncertainty. ●

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The COVID-19 pandemic hit this sector disproportionately hard due to the initial lack of preventive health measures, the severity of infections and persistent staffing shortages. The sectorwide vacancy rate jumped from 10% in 2019 to 17% in early 2021 before vaccines became widely available among residents and staff. But as COVID concerns gradually faded, other emerging macroeconomic factors (geopolitical conflicts, persistent labor shortages, and higher costs for labor and building materials) continued to shake up the sector’s fundamentals.

Moody’s data shows that senior housing construction deliveries in 2021 were down to less than 60% of their pre-pandemic average while starts fell to a five-year low. Last year, as the cost of capital shot up and credit availability tightened, deliveries were only 10% of their 2021 level. While senior housing construction activity slowed, demand rose steadily as confidence in the safety of these facilities gradually returned amid robust need from the U.S. senior population.

Census data shows that the number of Americans who are 65 or older reached 55.8 million — or 16.8% of the nation’s population — in 2020. The rapid growth of this demographic since 2010 is being driven by aging baby boomers, who began turning 65 in 2011. This combination of persistent demand and reduced supply growth caused the senior housing vacancy rate to decline for eight straight quarters, by a total of 390 basis points (bps), to reach 13.2% in Q1 2023.

Across the four senior housing types, memory care facilities were under the most pressure during the pandemic due to their need for specialized living designs and trained staff members. Memory care lagged the other three subsectors with the highest level and steepest increase of vacancy rate during the pandemic era. At the other end of the spectrum, independent living facilities — which are the most affordable of the senior housing types — have been the most resilient.

Need-based demand and weak construction activity have continued to cause excessive supply to be absorbed. Across the board, vacancy rates dropped during the year ending this past March, led by memory care (-240 bps) and assisted living facilities (-200 bps). Independent living (-190 bps) and skilled nursing facilities (-150 bps) weren’t far behind.

The senior housing sector usually registers its largest rent increases in the first quarter, when repricing occurs as regulatory and budgetary considerations take effect. In Q1 2023, rents for the four subsectors jumped by 3.5% to 3.7%, the highest annualized growth in Moody’s 10-year tracking history. Strong demand tightened market conditions and justified rapid rent growth.

Moreover, rising inflation and elevated interest rates have forced the adjustment of rent to account for higher operational and capital expenses. Over the past four years, rents for assisted living and independent living units have grown the most due to their relatively lower rent levels. Cumulative rent growth has reached 10.5% for assisted living, 9.6% for independent living, and 9% for both memory care and skilled nursing facilities.

How long will the boom last? Although the answer may depend on the interplay of factors such as the cost of goods and services, the availability of mortgage credit and the supply of skilled labor, the need for senior community support services will continue to rise as baby boomers retire and age. The passage of the Inflation Reduction Act (which will lower medical expenses for senior citizens) is likely to produce some long-term benefit for the sector’s recovery.

Across various regions, Midwest and Northeast senior housing markets were hit hardest during the pandemic but have been leading the recovery up to present day. A full understanding of the senior population, especially at the local level, will be critical for investors to turn a profit during an approaching economic downturn. ●

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Growing demand

Recent recovery

Investor sentiment

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MHCs have undergone a significant transformation over the past two decades and have been established as a niche in commercial real estate financing. This asset class, however, still faces long-ingrained negative perceptions that are simply untrue today.

The new MHC owner and financing model have completely changed. Potential investors looking to break into this niche, and the mortgage brokers representing them, should adjust their mindset and learn more about what lenders are looking for in MHC owners.

Rethinking MHCs

MHCs continue to face negative perceptions from the lender side that they are simply old “trailer parks.” The contemporary MHC could not be further from this outdated stereotype. More commonly referred to as mobile-home parks, the properties in MHCs are not actually mobile. The only mobile element of any of the properties is that the homes are constructed in a factory and transported to their final location. Some 95 percent of mobile homes are never moved once installed.

The mobile-home park of yesteryear had owners who considered the parks net-leased properties that didn’t require much from an operational standpoint. But these days, an MHC owner serves as property manager and as the governing body of property operations. They are responsible for the delivery of basic utilities, like water and sewage, as well as other services that enhance the quality of life and improve the safety and well-being of the residents. These services can include communitywide amenities, enforcement of rules and regulations, and maintenance and implementation of capital- improvement projects.

Many new MHCs include communitywide amenities like clubhouses, swimming pools, and tennis and basketball courts. The majority of homes are move-in ready, three-bedroom units with full kitchens, bathrooms and laundry facilities. The subdivision setup of MHCs allows for private parking, individual gardens, lawns and patios on small, easy-to-maintain lots.

Affordability comes into play considering that the quality of new MHC units are equal to site-built homes, but the costs are a fraction of that of site-built homes. This allows residents to possibly save hundreds of dollars per month on their monthly rent or mortgage payments, as well as utilities, when compared with living in an apartment or site-built home.

Buying an MHC

The affordability factor also makes owning an MHC an attractive opportunity. If you’re considering buying an MHC, be sure you have thoughtful answers to the following questions:

Can you get three months of bank statements that prove all of the rents are being collected and deposited?

Do you have any experience owning and managing MHCs, or any other type of commercial real estate?

Do you have good credit, a personal financial statement, proof of liquidity, a driver’s license, a resume and two years of federal tax returns?

Do you have the 25 percent cash equity in the bank required for the acquisition of this property?

Although some of these points seem like no-brainers, ensuring your client is prepared to provide all of this information will help you, the broker, in the pursuit to secure financing. Additionally, the lender’s first impression of the site is a make-or-break factor, because many lenders won’t make a loan on a property that does not seem safe or secure, or one that lacks the potential to be well-maintained. If the site’s first impression is positive and you can answer the lender’s key questions, your project may be viable.

Getting creative

Many commercial lending institutions still frown on the MHC market segment, but that narrow thinking opens the doors for numerous other lenders and financing options. Commercial banks may shy away from MHC lending for various reasons, including unfamiliarity with MHCs or because they want to focus on local properties and borrowers.

For out-of-state buyers, this challenge opens up the opportunity for national lenders, such as debt funds, that will make loans and are agnostic as to where borrowers are based, or where the properties are located — so long as there is good cash flow and demand generators for the long-term viability of the asset.

As a commercial mortgage broker, it pays to get creative and source loans from any type of lender that understands the emerging significance of the MHC asset class. Vast possibilities exist in MHC financing, which can be secured for park improvements and new-home inventory, or cash-out refinancing so owners can achieve liquidity without having to sell the property.

Many MHC financing deals can include a value-add component, like new streets, landscaping, sites, amenities, utility upgrades, rebranding or the installation of new homes. There have been very few new MHCs developed in the U.S. over the past 15 years, so the trend is toward upgrading existing communities with modern amenities and improvements. MHC owners need to make strategic decisions about how they fill vacant sites. The options include: acquiring homes and renting them out, acquiring homes and renting them with a lease-to-own option, or selling homes to residents with financing.

• • •

New lenders are flocking to fund loans on MHCs because they realize that many lenders are avoiding this asset class. This dynamic allows these forward-thinking lenders to make loans that are more profitable than those in the highly competitive multifamily-lending business.

To get a loan financed, borrowers and the brokers working with them need to be fully prepared with a business plan; a park-improvement budget; management expertise; local contractors for projects; a creditworthy borrowing history; liquidity for unforeseen circumstances; and the ability to develop new inventory, sell and/or finance homes and to market the properties to quality, creditworthy borrowers.

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Niche products are a conversation starter. They set you apart from the competition. They allow mortgage brokers and lenders to say “yes” to deals more often. And they enhance your revenue stream.

Commercial real estate agents are often deluged by originators who peddle flyers offering loan programs and services that usually have no discernible difference from each other. In addition, many Realtors have long-standing relationships with mortgage brokers who they feel comfortable with, so over-coming their reluctance to establishing a new relationship can be hard to accomplish.

This is where an introduction to your niche products can come in handy. The same Realtors, as a result of their hesitancy, may be oblivious to the opportunities afforded by niche products.

Realtors may find it difficult to resist an originator who asks about their deals that could not get done, to see if there was a loan program available that could accommodate the transaction and earn the Realtor a commission. It is better (and easier) to set up a meeting with a new referral source by asking them to discuss the deals they lost rather than walking in with doughnuts and a rate sheet.

Niche-loan examples

Regardless of the space in which you originate commercial mortgages, there is probably a niche product (or products) that can enhance your matrix and help you close more loans. Some mortgage brokers are fearful of establishing new relationships with lenders that offer niche products, given they have no prior experience with them. Certainly, that can be a cause for concern as you do not want to jeopardize a referral source or client. There are no rewards, however, for those who do not take risks.

The majority of lenders that offer niche programs are well-established in the marketplace. In addition, niche products afford you options for deals that may not qualify for conventional loans because of a multitude of factors. This is not to say that niche programs are offered only by nonbank lenders. If you primarily originate multifamily loans, for example, there are conventional lenders that do not require a borrower’s tax returns or historical income and expenses.

Some transactions through the government-sponsored enterprises Fannie Mae and Freddie Mac also do not require tax returns from the guarantor. Some conventional lenders will allow you to close on a vacant property using market rents to qualify. Other lenders will work with borrowers who have, for example, an outstanding violation from a city’s environmental control board or department of buildings, or those with FICO scores as low as 620.

Depending on how aggressive you want to be in offering niche programs, you can find loans with low minimum debt-service-coverage ratio requirements; “low FICO” products for borrowers with credit scores below 500; stated-income and no-ratio loans that reduce or eliminate income-verification requirements; and even owner-occupied commercial real estate transactions that rely mainly on a business’ profit and loss statements.

All of the above are examples of niche loans, and the ability to accommodate transactions that happen to meet any or all of these factors equates to more closed loans. Although a lender or mortgage broker may receive many referrals from conventional sources, they often close more loans when there are obstacles to conventional financing, and they are able to provide viable solutions. That is the main benefit of niche lending.

For the most part, the commercial real estate lending landscape has taken on a similar shape as the low-documentation Alt-A market of a decade ago within the residential mortgage space. Whether that is a good thing or a bad thing can be debated.

It is irrefutable, however, that these additional options afforded to commercial mortgage originators provide more avenues to get deals done and, as a result, open up the possibility for relationships with more referral sources and clients. It also should be noted that many of these niche products come with conventional interest rates, and those offered by nonbank lenders normally come with “soft-money” terms that are a viable and less-costly alternative to traditional hard money loans.

Unique property types

Niche lending is not limited to products, however. It also includes numerous property types that conventional lenders may not finance for any number of reasons. Properties such as gas stations, car washes and auto-repair shops, for example, may pose environmental issues that can deter conventional lenders from financing them.

The U.S. Small Business Administration will only finance certain niche property types if they are owner-occupied transactions, so there is a void to be filled by lenders willing to finance these property types as investor deals. The niche-property space has become a larger share of the commercial mortgage market, and brokers can benefit from this evolution — if they are able to line up financing terms for a sports-complex acquisition, church construction or purchase of a vacant mixed-use building, just to name a few examples.

Another potentially beneficial niche property type is medical-office financing, where you can provide for the business-purpose purchase of a condominium, co-op or single-family home while simultaneously financing the build-out or equipment acquisitions. A mortgage broker may develop a contact list filled with doctors, dentists, surgeons and veterinarians who become repeat clients or refer new clients.

Geographic location may be a determining factor for the types of niche products or properties you offer to clients. In areas where co-ops are prominent, for example, offering underlying co-op financing or bulk-share loans (in which a loan is secured by multiple co-op units owned by the same borrower or entity) can be construed as a niche product that is not offered by some conventional lenders.

For areas of the country in which condos are prevalent, you may be able to provide financing to a homeowners association (HOA) for a property purchase, or deal with “fractured condo” transactions in which multiple housing units have gone unsold and are available for a bulk purchase. Maybe you work in the Bible Belt and want to offer acquisition or construction financing of churches to enhance your share of the market with lenders that specialize in these properties.

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Any or all of these niche programs and property types may prove to be lucrative offerings that enhance your position in the marketplace. As a commercial mortgage broker, the more property types you can finance — and the more options you have to finance them with — the better your odds are for success.

As we quickly approach the tail end of a nearly decade-long run of growth in the commercial real estate market, one could argue the low-hanging fruit has been picked. Conventional lenders are becoming more conservative and are limiting the property types they will finance. As interest rates and cap rates rise, fewer deals will qualify through these sources, so the need for niche-lending connections has never been more critical to your future success.

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