The rapid increase in interest rates has created multiple challenges across all real estate sectors, and senior housing is no exception.
“Any transaction conceived in the period prior to the summer of 2023 can no longer generate the loan proceeds and value necessary to close that transaction,” Greystone Managing Director for Senior Housing Lending Mike Patterson told Multi-Housing News.
Despite senior housing occupancy reaching 84.4 percent in Q3 2023, marking the ninth consecutive quarter of improvement, according to a recent National Investment Center for Senior Housing & Care report—many properties have not completed their occupancy or held it above the 90-to-95 percent level necessary to acquire mortgages with the best terms and rates, noted Patterson.
Here’s what else Patterson shared about the industry’s outlook.
What were the most challenging aspects of acquisition financing for senior housing properties during the past year?
Patterson: In the past 12 months, acquisition financing challenges have been either generating sufficient loan amounts in the face of higher interest rates or lending on properties with low but recovering occupancy levels. The senior housing industry has been gaining monthly in occupancy through 2023, but a significant number of properties remain below their stabilized occupancy goals.
The rapid increase in interest rates during last year created a number of challenges for acquisitions. Interest rates almost tripled from their 2021-2022 lows. Also, floating-rate transactions closed prior to summer 2023 have likely reset their rates significantly higher than at closing and the escrows needed to keep pace for future interest rate caps are also significantly higher. These properties likely can’t refinance to a fixed-rate mortgage sufficient to repay in whole the floating-rate loan.
Tell us more about the impact of increased interest rates/cost of debt and inflation on the senior housing sector. What will be the long-term effects of the current economic volatility?
Patterson: Interest rates and inflation increased so fast and so much over a short period that the industry was not able to rely on its inherent mechanisms to continue profitable levels of operating margin. Rents couldn’t be increased fast enough. Expenses couldn’t be reduced through productivity increases quickly or sufficiently. All property capital stacks that were conceived of in the 2016-2021 period will need to be rethought and recast with more equity. Otherwise, they will not meet their maturity refinancing or return demands.
As distressed properties are sold at lower prices, they will be able to reset rents lower, creating pressure on higher-cost properties. Higher-cost properties will include those built and delivered within the last couple of years. Many people continue to look to the pending large growth in older adults as a savior of the current situation, but there is still a significant amount of time before they arrive and the ‘silver tsunami’ truly happens.
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Given the current economic environment, what challenges will senior housing developers, investors, owners be facing in the near future?
Patterson: Near-term challenges include the need for occupancies to continue to grow and reach their 90-to-95 percent stabilized level, the continued shortages of staff—and/or the higher increases in wages required for staff—and continued higher interest rates which will cause large double digit rent and care increases in 2024. Developers and owners will need additional equity capital to fill gaps caused by the higher rates. The need for additional capital is a difficult challenge for the industry as values and operating margins are down across the industry. There seems to be few answers to return values and operating margins to previous levels.
What does the senior housing lending market need to have a relatively strong year?
Patterson: One large need for the lending market is knowing where senior housing property values are and for the values to construct a transparent, solid level. In 2023, there were few sales and a number of properties became distressed or troubled. The bid/ask range for properties grew and was difficult to document. As soon as a number of transactions occur, a value per unit floor will develop and the lending industry can again restart its origination practices.
What investment and development opportunities are emerging within the sector?
Patterson: A developing investment opportunity within the senior housing sector is the purchase of distressed senior housing properties from existing borrowers or lenders. The new owners are in need of mortgage sources with available capital to lend at new likely lower levels. Many properties became distressed due to borrowing too much at lower interest rates with floating rate terms. Now that the interest rates have increased so much the properties have become over financed and borrowers are having to provide more equity to meet the payment amount.
Another investment opportunity due to higher interest rates is a consolidation of owners within the industry. Those with weaker management teams, old unrenovated or poorly located properties likely being unable to survive larger interest payments and will need to consolidate with stronger more experienced teams with access to capital.
Construction/development opportunities are few and far between today. Interest rates are very high, higher volumes of potential tenants are still to come, and resident demands are shifting greatly. Developers need to concentrate on the existing older properties and execute renovation plans for them, such as change-of-use to a non-senior housing use or enlarging the common and unit spaces to match the coming boomer demands.
READ ALSO: What to Expect for Senior Housing in 2024
Are there any notable regulatory or policy changes on the horizon that could impact the senior housing sector over the next few years?
Patterson: Over time, in the next five to 10 years, regulation and policies in the senior housing industry should grow. One cause of the growth will be Baby Boomer residents and their adult children who will force changes in our industry as they become a higher percentage of its residents. This situation has occurred in other industries as Baby Boomers have grown to be their largest customers, witness the auto and banking industries to name a couple.
Environmental concerns will also be an ever-growing factor in increased regulatory and policy impacts. Senior housing properties consume a large amount of energy, are very reliant on energy always being available, and typically all senior housing properties’ utilities are master metered. This is a recipe for expense risks to senior housing investors, not the residents—as opposed to multifamily properties who have dispersed their utility risks to the tenants through individual metering and bill-paying responsibility. Additionally, senior housing properties use a considerable amount of single-use plastic materials—changing public opinions of the need to reduce, recycle or reuse these materials will cause policy changes and burdens on the industry.
What will define the senior housing lending landscape this year?
Patterson: I suspect 2024 to be a continued year of healing for the senior housing industry, despite the continued higher interest rates. A better year than 2023.
Some high-level predictions include: Mortgage rates will likely be in the 5.5 percent to seven percent range for fixed rate deals; The number of loans that were troubled and distressed in 2023 will decline by either having been worked out or their occupancies will improve to stabilize them. These events will produce a new per unit value level for existing properties. A per unit value level was missing most of 2023 and without it, fewer loans closed; Freddie Mac and Fannie Mae will desire to have more loans made than this past year; New housing supply being delivered to the market will be significantly lower in 2024; The increase in the population of people over 75 or 80 will continue to increase.
What advice would you offer to individuals or organizations considering investing in senior housing next year?
Patterson: Senior housing is unique among multifamily properties in that it has an operating business within the property and is not just a passive real estate investment. Currently, and over the coming years, running the operating business will be even more paramount than monitoring the real estate investment. In the recent past period of lower interest rates, senior housing was easier to be thought of as primarily a real estate investment. Future investors will need to be mindful of what it takes to run an operating business. One issue that comes to mind is the demand of having an excellent team at the property on a daily basis. Finding, hiring, training and constantly motivating a team in different locations is difficult and not always a skill found in new senior housing investors. Senior housing will need many more trained people at each level in the organization.
We will also need additional amounts of equity to be delivered and hopefully from more patient investors. Owners need to invest in more technology to manage the residents’ needs and contain costs than ever before—alerts, monitors, tracking devices, etc.
