Repurposing Aging Senior Living Facilities to Affordable Senior Housing

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Background

Older senior housing communities, in particular skilled nursing facilities, face numerous financial and operational challenges.  For example, combinations of changing neighborhood demographics, shifting care option preferences, the presence of newer, modern competition and constraints on third-party reimbursement have increasingly caused nursing homes to struggle to maintain healthy occupancy ratios and cash-flow.  Often, when cash-flow is tight, repairs and improvements are delayed, if done at all; senior housing property executive management and their governing boards can reasonably ask:

  • Does it make sense to invest in a component of our campus that no longer may be as relevant?
  • Is our mission as an organization being limited or compromised because of an inefficient physical plant that no longer serves the needs of residents and potential new residents?
  • Are there repurposing options for older, inefficient buildings, and if so, how can they be financed?

These questions, important to all senior housing operators, are perhaps more acute for not-for-profit, mission-based organizations, who generally operate on tighter operating budgets.  Moreover, the option of selling a building on campus to outside, third-party interests, may be counterproductive to the overall reputation of the community, as the buyer may not operate the property in a manner consistent with the original charitable mission.  With so many aging senior living facilities facing financial hardship, creative measures must be taken to avoid eventual closures and bankruptcies.

One Solution: Conversion of a Portion of a Senior Housing Community to Affordable, Low-Income Senior Housing

The way forward may be the conversion of older, less-functional components of a senior housing campus, like a skilled nursing facility, to an affordable assisted living or age-restricted multifamily housing.

Such a conversion could serve the dual purposes of: (1) expanding the mission of a not-for-profit provider whose primary operation is in the market-rate sector and (2) addressing a dramatic shortage nationwide of affordable housing, especially for lower-income seniors.

Consider that the National Low-Income Housing Coalition reports that there are 7.2 million affordable housing units needed for low-income families and individuals across the country. By re-purposing healthcare or other older buildings on campus to affordable housing or assisted living, not-for-profit sponsors can avoid closures, unwanted sales to unrelated buyers, and financial hardship.

Key Element of Affordable Housing Finance: Low – Income Housing Tax Credits (LIHTCs)

One of the major challenges to the development of affordable housing is that there is typically a large gap between the costs of the project and the amount of financing that can be supported by operational cash-flow. In many affordable transactions, the gap is filled with equity generated from the procurement of Low-Income Housing Tax Credits (LIHTCs). These credits can significantly lessen the financial burden of conversion or repurposing senior living facilities into affordable assisted living or age-restricted senior housing.

LIHTCs provide developers and owners with a significant equity contribution towards the new construction, substantial rehabilitation, refinance, or acquisition of affordable housing projects. The program is administered by the Internal Revenue Service (IRS) through State Housing Finance Agencies and local Development Agencies. LIHTCs connect investors with sponsors and developers, providing the investors with considerable tax benefits over a period of approximately 10 years in exchange for their investment into the creation or preservation of affordable housing properties.

LIHTCs are generally available under two programs: 9% credits and 4% credits. The 9% credits cover more development costs but are extremely competitive to secure and often require a sponsor to commit to a higher degree of affordability with respect to rents and income limitations of residents. Moreover, the highly competitive and limited-supply 9% credit is typically reserved for new construction without any other federal subsidies.

The 4% credits, which often are accompanied by an allocation of tax-exempt multifamily housing revenue bonds, is typically allocated on a non-competitive basis. The 4% credits are considered part of the bond allocation, and given these credits are more accessible than their 9% counterpart and are available for repurposing existing buildings, the 4% execution will likely be the more likely product available.

In a typical LIHTC transaction, the credits would produce equity that covers anywhere from about 30% – 70% of the development costs associated with repurposing existing facilities into affordable housing. The LIHTC is equity, not to be repaid by the Project Owner. The typical Project ownership structure for LIHTC transactions is a Limited Partnership or Limited Liability Corporation, with the not-for-profit sponsor serving as a general partner or managing member and the tax credit investor acting as a limited partner or member. The not-for-profit sponsor can earn a development fee in a LIHTC transaction.

Debt Structures: HUD Mortgage Insurance as a Complement to 4% Credits/Tax Exempt Bond Financing

LIHTCs provide the equity for an affordable senior housing development; however, additional sources of financing will be needed to complete the capital stack.

Three HUD-insured mortgage loans can provide a source of financing for the debt component of a LIHTC transaction: Section 221(d)(4); Section 223(f); and Section 232 (assisted living). While a modest number of affordable assisted living facilities have been financed under the Section 232 program, the vast majority of HUD transactions that involve LIHTCs occur with the Section 221(d)(4) and Section 223(f) multifamily programs. (For a detailed summary of HUD’s mortgage insurance programs, please visit www.simsmortgage.com.)

The HUD 221(d)(4) program is the most likely option to accomplish the goals of a senior living sponsor to repurpose to affordable housing when the cost to renovate the property is higher than $40,000 per unit. This program is used for new construction and substantial rehabilitation and combines construction and permanent financing into one mortgage with an amortization and term of up to 40 years. Interest rates for the 221(d)(4) loans are currently in the low 3% range. The industry-best 40-year amortization lowers debt service payments, enhancing the feasibility of the Project.

Section 223(f) can be used when the cost of the renovation is less than $40,000 per unit. This program features a maximum 35-year amortization and current interest rates in the range of 2.50%. Both Section 221(d)(4) and Section 223(f) have .25% annual mortgage insurance premiums for affordable projects. These premiums are payable on the unpaid principal balance throughout the life of the loan.

A HUD-insured loan typically complements the tax-exempt bond financing that is needed “up front” to qualify for the 4% LIHTCs. That is because bond proceeds must be disbursed to pay project costs. However, the tax-exempt bonds are of limited duration, typically maturing after the rehabilitation is completed and the project is placed into service. The HUD-insured loan becomes the long-term financing after the bonds are redeemed post-rehabilitation.

LIHTC transactions often need additional sources of funding beyond the equity and tax-exempt bond/HUD debt. This funding can come from a variety of sources such as state grants or supplemental financing programs, Federal Community Development Block Grants (CDBG), HOME funds and deferred development fees.

Are LIHTCs for You?

The LIHTC process is complex and involves significant administrative and reporting activities once the project is placed into service; however, if utilized properly, tax-credits can be a uniquely beneficial tool to preserve or create affordable assisted living or age-restricted housing. This process is further complicated if the converted units are part of an existing building financed with taxable or tax-exempt debt under a Master Trust Indenture (MTI). While it’s not impossible to layer tax-credit debt into the existing capital stack, additional legal and advisory work would need to be done to determine the correct path forward.

Due to the highly complex nature of these transactions, LIHTC consultants are typically used to assist with the tax credit application and ensure IRS compliance issues are followed. Not-for-profit sponsors without LIHTC experience may partner with an experienced developer, who becomes part of the ownership structure, albeit in a limited control setting.

Sims Mortgage Funding, Inc. (SMF) would perform the upfront screening of the transaction from the LIHTC and HUD-insured loan perspectives, and would coordinate with our parent company, HJ Sims, on the identification of tax-exempt bond issuing agencies with access to 4% credits and the selection of the agency most suitable for the sponsor’s needs. Moreover, we may be able to recommend specific LIHTC developers, consultants and attorneys based on the sponsor’s geographic location. Finally, SMF would help the provider identify legal help to ensure the new debt works with the existing MTI debt on the campus.

For more information, please contact Johnny Sears at [email protected].

Sims Mortgage Funding, Inc. originates, underwrites, and funds loans for Healthcare, Multifamily and Hospital projects. We have completed over $2 billion in HUD-insured transactions and are an approved LEAN (healthcare) and MAP (multifamily) lender.

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Market Commentary: Investment Ballpark

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The investment ballpark, much like every stadium across the country, looks different at this point in the season. It has changed as a result of the coronavirus and is still morphing as major players study the whole lineup of social unrest, campaign platforms, and this start-and-stop economic recovery with its unprecedented unemployment, school and business closures, and financial pressures that caused nearly one third of all Americans to miss their housing payments due on July 1. In the same way that Major League Baseball has been struggling with health and safety issues affecting players and fans to determine the future of the game amid alarming increases in cases, conventional financial analysts taking in all these unsettling conditions might deem most investments ill-advised at this time, perhaps none more so than the obligations of state and local government whose revenues have plummeted alongside incomes and sales.

There are some 65,000 individual municipal borrowers with about a million different credits outstanding. Many are general obligations of state and local governments stressed by six months of tax streams that have dried up and a gush of unexpected social spending. Some are backed by specific revenues that have been more impacted than others. Common problems for all are compounded for some by issues stemming from trade wars, court decisions, violent crime, and population moves. Many government and nonprofit borrowers began the year with robust rainy day funds — but plenty of others did not and their best laid plans have been scuttled by Covid-19 related shutdowns. Urgent needs and wish lists have been exchanged with Congress, but the terms of a fifth federal aid package have yet to be determined at this writing. In the meantime, in spite of all the facts and headlines, the 11-week rally continues and municipal bonds are advancing steadily once again. Last week, the 10-year tax-exempt AAA general obligation benchmark yields fell another 4 basis points to 0.71% right alongside U.S. Treasuries, which fell like a sinking fastball from 0.63% to 0.59%. The 30-year muni yield also dropped 4 basis points to 1.43% while the long bond boosted its slugging percentage such that its yield fell a full 10 basis points to 1.23%.

Several factors contribute to the string of rising bond prices. First, the Federal Reserve has not only held rates near zero but also positioned itself as the equivalent of a baseball backstop for both municipal and corporate bonds with liquidity programs that have lulled markets into thinking they are protected from wild pitches. Second, whether or not historic data is relevant to the current times, analysts continue to point to an “error rate” for munis that remains extremely low. Moody’s data from 1970 through 2019 shows that the average five-year annual default rate for its rated municipal bonds was 0.08%. Corporate bonds, which have lower ratings, had a 6.7% default rate over the same period. Third, cash that has been sitting on the sidelines continues to pour into the mutual funds and ETFs from households and institutions; Lipper reported $2.1 billion of municipal inflows and $11 billion of taxable bond fund inflows for the week ended July 22. Fourth, many corporations have paused or cut stock dividends, causing some to exit the equity markets and look to the bond markets for less volatile and more reliable sources of income.

A fifth factor, and one of the most significant, involves the supply/demand imbalance. The low rate environment and need to bolster liquidity to survive a pandemic of uncertain length and effect, has caused a record surge in taxable bond issuance. The U.S. Treasury has borrowed more than $3.4 trillion as of June 30 and plans another $677 billion of debt issuance by the end of the third quarter. Corporation have issued more than $1.2 trillion of investment grade debt and $230 billion of below-investment grade debt so far this year. The year-to-date supply of municipal bonds totals $239 billion, up 25% from last year at this time, despite the pullback in issuance during volatile conditions in March. But an increasing percentage of this debt is coming in the form of taxable issues for hospitals, colleges and large borrowers refinancing debt under the 2018 tax law. So far this year there have been about $69 billion of taxable munis issued; this month, taxable munis are expected to exceed 50% of new issuance according to Municipal Market Advisors. This exacerbates the supply/demand imbalance for tax-exempts which are being sought in great part to offset the loss of state and local tax deduction. The loss was felt by millions again on July 15, the tax filing deadline that was extended due to the coronavirus.

Major bondbuyers — life, property and casualty insurers, pension funds, and foreign institutions have become switch hitters — crossing over into the muni space historically dominated by U.S. households. As sovereign and corporate yields have plummeted under fiscal and monetary policy, and negative yielding debt approaches $15 trillion, tax-exempt and taxable U.S. muni yields are waving buyers in like a third base coach. The 30-year A rated taxable muni yield was 2.94% on Monday, versus 2.76% for the comparable A rated corporate maturity and 1.88% for the comparable A rated tax-exempt.

As we approach August 1, the municipal market is expected to see the largest of the year’s major coupon, call, and principal maturities deliver even more cash to an undersupplied market. Investors will not find as much in the way of pinch runners as they would like. Yields are lower across the board. Dealer inventories are at also at historic lows. Many of the bonds in the few bid-wanted “rosters” in circulation have yields so low that they are in fact negative after accounting for fees and inflation.

The new issue market has been the only game in town for buyers of yield. This week’s calendar will likely come in under $7 billion, so there will not be enough to go around. Last week in the high yield sector, we saw five charter schools. Warren Academy of Michigan came to market with a non-rated $9.6 million limited offering structured with a 30-year maturity that priced at a premium 5.50% to yield 5.45%. Landmark Academy in Michigan sold $13.4 million of BB rated bonds that had a maximum yield of 5.00% in 2045. The College Prep Middle School in Spring Valley, California placed $12 million of non-rated bonds at par to yield 5.00%. MAST Community Charter School in Philadelphia had a $27.7 million financing with BBB-minus rated bonds structured with a 2050 term maturity priced with a 5.00% coupon to yield 3.32%. And Renaissance Charter in Florida borrowed $66.1 million in a non-rated financing that included 30 year bonds priced at 5.00% to yield 4.375%. The Sweet Galilee at the Wigwam assisted living community in Anderson, Indiana brought a $22.4 million non-rated transaction priced at par to yield 5.375% in 2040. The White River Health System in Arkansas had $32.6 million BBB-minus rated bonds issued through the City of Batesville that had a final maturity in 2032 priced with a coupon of 3.25% at a discount to yield 3.35%. McLean Affiliates in Simsbury, Connecticut brought a $64.8 million BB+ rated bond financing due in 2026 and priced at par to yield 2.75%. And Navistar International Corporation had a $225 million B3 rated financing priced at par to yield 4.75% in 20 years.

U.S. Corporations are in the process of reporting second quarter earnings which, while devastating, are in many cases slightly better than feared. Through last Friday, more than a quarter of S&P 500 companies have announced results. Losses larger than those taken at the height of the last recession have not, however, steered investors away from the stock or corporate bond markets. The Dow gave up 202 points last week to close at 26,469. The index is down 7.25% on the year but has crawled back from its March low of 18,591. The S&P 500 lost 9 points but has erased nearly all its early season pandemic loss and is nearly flat in 2020. A handful of all-star technology stocks have caused The Nasdaq to outperform; although the index fell 140 points last week, is up 15.5% this year. Oil held steady at $41.29 but is off 32% since January. Gold has rallied to record highs; last week prices per ounce rose $92 or 5% and are currently 28% or $473 higher than where they started the year.

HJ Sims has been working with a number of nonprofit and for-profit borrowers to help them take advantage of current market conditions and opportunities. Our traders and advisors have been proactive in working with our investing clients on portfolio reviews, swaps and recommendations for strategically putting free cash to work. We are closely following some of the trends in credit impairments and encourage careful and regular professional surveillance of holdings to ensure that current risk limits and future income needs are in line. Those taking summer staycations, those with time to spare when MLB games are postponed, and those doing quarterly or mid-year reviews can benefit from a conversation with their HJ Sims advisors.lk