The past several years saw a glut of refinancings in the seniors housing and care sector as providers sought to take advantage of the historically low interest rate environment and lower their debt service. As much of that economically driven refinance activity has slowed down over the past year, many signs are pointing to a considerable uptick in new construction and substantial rehabilitation as the next trend in seniors housing.
Findings from the CBRE’s 2014 Cap Rate Survey reveal that demand for seniors housing new construction is ample. According to the survey’s findings, current supply will have to increase approximately 150% to meet demand in 2044, with a substantial shortage appearing in 2024. CBRE reports around 40,000 senior living dwellings must be added each year to meet demand. For comparison, the current construction rate of senior living units is about 16,000 units each year.
Most providers are well aware of the benefits of U.S. Department of Housing and Urban Development /Federal Housing Administration financing, particularly when it comes to refinance. Low interest rates, long terms and amortizations and the nonrecourse feature are among the advantages that providers have enjoyed while refinancing their facilities over recent years. However, those same benefits can also be experienced with FHA financing of new construction or substantial rehabilitation. In fact, many providers are already doing so, as reflected in data derived from the FHA Lean mortgage insurance program in fiscal year 2014. Approximately 9.6% of the Lean volume in 2014 was new construction or substantial rehabilitation transactions, an increase of 90.9% from 2013, proof that the increase in new construction and substantial renovation financing with FHA has already begun.
In a recent survey conducted by Lancaster Pollard of 244 seniors housing and care providers, 62% of respondents indicated they are extremely likely to pursue a new construction project in the coming 12 months. Another 18% indicated they are somewhat likely, resulting in a total of 80% who may pursue a new construction project in 2015. How can such projects be financed? Below we take a look at two distinctly different examples of financing new construction using the FHA Sec. 232 program.
Early Commencement Financing
HHHunt is a large provider and active developer of assisted living (AL), Alzheimer’s and memory care (MC), as well as multifamily projects throughout the mid-Atlantic region. In 2012, HHHunt was seeking long-term, non-recourse financing for two new construction projects that would further its ability to serve the seniors housing and care market. The first project, Spring Arbor of Fredericksburg, located in Fredericksburg, VA, is a 79-unit/90-bed AL and MC community and the second, Spring Arbor of Severna Park, located in Severna Park, MD, is a 78-unit/91-bed AL and MC community.
HHHunt worked with its lender to pursue the FHA Sec. 232 program to fund the new construction projects as it provided many sought after benefits; including high loan-to-value ratio, long term (40-year) and nonrecourse financing. At the time of submission, however, the FHA Sec. 232 new construction firm application queue length was in excess of 12 months. As an alternative to waiting in the queue, HHHunt’s lender was able to expedite an Early Commencement approval for the projects. As a result, HHHunt was able to begin construction prior to HUD issuing a firm commitment.
By utilizing the Early Commencement process, HHHunt was able to expedite the construction completion and project lease-up by 15 months. Spring Arbor of Fredericksburg was completely built and leasing was under way prior to the FHA Sec. 232 loan closing. The construction of Spring Arbor of Severna Park was approximately 40% complete when the FHA loan closed. This not only prevented HHHunt from wasting time waiting in the queue but it also allowed for substantial savings on construction costs and interest payments.
The successful closings of the two FHA Sec. 232 loans, $14.1 million for Fredericksburg and $20.3 million for Severna Park, funded all the construction and soft costs as well as the land sale purchase. The loans are nonrecourse, carry 40-year terms and low fixed interest rates. In addition, HHHunt’s lender was able to obtain reductions in ongoing reserve requirements, allowing HHHunt to achieve perpetual savings.
Consolidating Multiple Outstanding Loans
Located 10 miles west of downtown Portland, OR, Laurel Parc at Bethany Village offers both independent living and AL. The facility was originally constructed in 2009 using a separate loan type for each acuity; a FHA Sec. 221(d)(4) loan financed the IL units and an FHA Sec. 232 loan financed the AL units. In its early years, during the height of an economic downturn, the facility experienced a longer lease-up timeframe than originally anticipated. As such, ownership structured two operating loss loans with HUD to help the facility minimize losses until stabilization.
By 2013, Laurel Parc was performing extremely well and had waiting lists for both its IL and AL units. That success led the ownership group to pursue a new construction project that would add a total of 69 units. The expansion would fund the construction of additional IL and AL space as well as the addition of memory care units which were not previously available at the facility.
As Laurel Parc already had an outstanding FHA Sec. 232 loan, its original plan was to finance the expansion using the FHA Sec. 232/241(a) program. Upon further examination, however, Laurel Parc’s lender worked with HUD to pursue an alternative structure that would use the FHA Sec. 232 program to consolidate the four outstanding loans while simultaneously financing the new construction project.
By prepaying Laurel Parc’s existing loans and working with HUD to obtain certain waivers, the lender was able to use the new HUD Lean underwriting guidelines to structure a financing solution using a blended rate for the combination refinance and construction loan. In addition, the lender worked with HUD to facilitate an early start on construction. That allowed Laurel Parc to keep its favorable construction pricing and stay ahead of the notoriously wet Oregon fall weather as they were able to begin construction during the application process.
The successful blended rate financing via the FHA Sec. 232 program resulted in a $50 million loan−$14 million for the new construction project and a refinance of $36 million that consolidated Laurel Parc’s four outstanding HUD loans. The result is a much simpler and more cost-effective permanent financing structure that allows Laurel Parc to not only lower its interest rate but alleviate much of the accounting and administrative burden caused by holding multiple loans.
As illustrated in the two examples above, the FHA Sec. 232 program can be an extremely valuable funding source for new construction or substantial rehabilitation. And with the demand for new seniors housing and care facilities not expected to taper any time soon, the increase in FHA financing for new construction seen in 2014 will likely continue in 2015 and beyond.
Tom Gale is a vice president with Lancaster Pollard in Philadelphia. He may be reached at firstname.lastname@example.org.
Matt Lindsay is a vice president with Lancaster Pollard in Columbus. He may be reached at email@example.com.