COVER STORY, FEBRUARY 2009

SENIOR HOUSING FINANCE
This sector should provide a surprising range of options for well-capitalized owners and developers in 2009.
By David Shillington

The evidence is clear that capital availability will be a major challenge in 2009 for the entire commercial real estate industry. This will apply to almost all capital providers, including local and regional banks, life insurance companies, Fannie Mae and Freddie Mac. With that said, affordable housing for our aging population is a top priority for the U.S. government — as was seen during the fall presidential campaign. This political priority should benefit Fannie Mae, Freddie Mac and FHA programs designed to support projects that provide housing in this sector.

Construction financing will be much more difficult to obtain across all real estate sectors during 2009 given our current economic environment. Senior housing, assisted living facilities and skilled nursing homes will not be immune to this phenomenon. However, funds should be available for strong projects in excellent locations with well-capitalized sponsors. The primary capital providers will include large regional banks with strong conduits to the Agencies, as well as a select group of local and community banks that focus on the healthcare industry. It should be noted, however, that the limited supply of capital for new development is more a function of the poor health of the financial system than issues with the demographics tied to senior housing. As problems in the financial system are gradually resolved and capital ratios are restored, we should see an influx of new capital into the sector.

There are several key differences between senior housing and other segments of commercial real estate, which should support a continued supply of capital for established and stabilized senior housing in 2009. Thanks largely to the involvement of Fannie Mae, Freddie Mac and FHA, there is a surprisingly robust array of options for those seeking longer-term, permanent financing for senior housing. These options include shorter-term, floating-rate executions with more flexible prepayment structures, longer-term, fixed-rate loans with maturities ranging from 7 to 10 years and highly leveraged, fully amortizing 35-year loan term. Structures include financing for standard, single-asset transactions as well as larger, more complex portfolios with creative solutions, such as substitution rights and release provisions.

One example of a recent financing solution centers on a combination of shorter-term bank debt and longer-term, permanent debt. A strong senior housing operator needed financing to acquire a large portfolio of properties from a REIT. Some of the properties in the portfolio were better suited for immediate Agency funding, and others need additional time to qualify. By partnering with a bank that offered both on- and off-balance sheet solutions, the company was able to optimize its capital structure by financing the more stable assets via Freddie Mac and those properties in need of more seasoning via the bank’s short-term balance sheet. The lender’s flexibility and in-house Agency lending capability made the deal possible.

There are also substantial differences in the underlying market fundamentals between other commercial real estate sectors and senior housing. Many multifamily markets, for example, are suffering from slower-than-expected absorption, increased vacancies, limited to negative rent growth and overall value deterioration. Revenue growth for senior housing, however, is still positive in many markets. And due to the fact that senior housing contains a larger component of needs-based demand, occupancies have fared much better than conventional multifamily. These market fundamentals should have a positive impact on the availability of capital in the senior housing sector.

Evidence of these stronger senior housing fundamentals is especially true in markets like Dallas, San Antonio and Houston, which are performing well relative to economic conditions. A statistical examination of the development portfolios of the top 31 metropolitan statistical areas (MSAs) reveals that Dallas and San Antonio are in the top 20 percent for a number of factors used to measure the senior housing market, and Houston is in the next quintile. The most relevant of these factors — occupancy, affordability and penetration — paint a positive portrait of the viability of Texas’ senior housing market. Relative to other markets, occupancies are high. The affordability index (residents’ income divided by monthly cost) is also high. And, the penetration rate — that is, the percentage of seniors who will consider living in an assisted community — is good. All of this adds up to a population that is willing and able to consider senior housing, and it has been doing so. For established operators who have a history of working with these factors to create successful senior living communities, long-term permanent financing has been and should continue to be available in 2009.

All demographic signs point to a potential boom in the senior housing industry within the next 10 to 15 years, as millions of Baby Boomers approach 80 years of age. Developers, owners and operators of senior housing are positioning themselves to be ready for that wave; however, they will need to weather the current storm. One step companies can take now is to partner with an experienced lender. A bank that has been in the business for several decades and has experienced similarly challenging situations in the past will be able to offer good counsel. Additionally, a lender with a broad financial platform including Agency lending , balance sheet solutions, talented professionals, and the ability to use capital creatively will be better equipped to provide financing both now and as the landscape changes going forward. Beginning or strengthening a relationship with such a lender now will enable senior housing companies to survive this year and thrive in the future.

Operators and developers with proven track records and well-located assets will be able to find financing in 2009 for senior housing projects. The terms may be more stringent, but the capital should be available.

David Shillington is the managing director of the Agency Lending Division for KeyBank Real Estate Capital in Dallas.

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