BOTTOM LINE : MARKET OPPORTUNITIES

APARTMENT FINANCE TODAY • July/August 2008

Seniors Headache

Lender skepticism and sagging markets mean higher interest rate spreads and tougher terms for seniors housing projects.

By BENDIX ANDERSON

East Moriches, N.Y.— This summer, Landmark Properties plans to start building 408 seniors condominiums at Heritage Square, an independent and assisted living development planned here.

However, with only weeks left before the close of its financing, Landmark is facing a tougher environment than the Rocky Point, N.Y.- based developer is used to. Local banks have refused to lend more than 60 percent of the $125 million cost to develop the project’s townhouses.

Before the capital crisis, construction loans for both rental and condo projects typically covered 80 percent or more of the cost of seniors developments, according to Bill Sims, president of Herb J. Sims & Co., which provides debt and equity financing to seniors housing projects.

“Just like the rest of the real estate markets, financing seniors properties is more difficult today than 12 months ago,” said Sims. A capital crisis on Wall Street has made financing scarce. Sagging prices have also deflated the once-firm market for both rental and condominium seniors housing. Lenders have responded by becoming much pickier about where they put their money and charging higher interest rate spreads with tougher terms.

Lenders now typically charge interest rates between 250 and 300 basis points over London Interbank Offered Rate for construction loans covering up to 75 percent of the value of seniors rental housing development. Seniors condominium projects like Heritage Square have been hit even harder, with leverage shrinking down toward 60 percent. Before the capital markets crash, interest-rate spreads were 50 basis points lower and leverage was much higher, reaching up toward 80 percent, said Sims.

Fortunately, cuts to short-term interest rates have made up some of the difference, so all-in interest rates have stayed level or dropped slightly.

Lenders have cut back on interestonly financing, in which borrowers pay only the interest and none of the loan principal for a period of time, and they’re requiring more recourse from borrowers. They are also refusing to lend to weaker projects or developments in weak markets.

“In the last six or nine months, the lenders [would] not pay any attention to Class B,” said Michael Berne, managing director of the seniors housing group for Jones Lang LaSalle, which is arranging the financing for Heritage Square.

Heritage Square has an advantage in the fight for financing because of its Class A location in a strong market. East Moriches shares Atlantic Ocean beaches with its neighbor, the resort town of Westhampton. The area has an aging population, with nearly 20 percent of residents older than 55, according to Census data. Its 51-acre site will include indoor and outdoor swimming pools, a spa, and what the developer says is a dining room styled to match a “world class hotel.”

“It’s Class A,” said Berne. “Wellsited, well-priced, and well-thought out.”

Another hurdle for lenders is the softening market for seniors properties. Prices have dropped because, with financing scarce, fewer potential buyers are bidding. Cap rates for assisted-living and independent-living properties have risen more than 150 basis points over the last year, said Sims. A cap rate represents the net operating income from a property as a percentage of the sales price; they tend to rise when sales prices drop.

Demand from seniors has also declined. The percentage of occupied rental apartments in independentliving and assisted-living properties has fallen by about 2 percent over the last 12 months, according to Sims. The occupancy rate remains in the mid-90 percent range in most markets.

Industry participants predict the seniors occupancy rate will recover as the first baby boomers reach their mid-60s in the next couple of years. “The good news is the demographics just keep chugging along,” said Mel Gamzon, president of Fort Lauderdale, Fla.-based Senior Housing Investment Advisors, Inc.

The ranks of seniors are swelling by millions every year, but for now, the majority of seniors are staying in their homes, in part because of falling home values. Seniors properties like Heritage Square typically draw residents from aging singlefamily homeowners who live within a 30-miles radius of the proposed project. To make the move, these seniors usually have to sell the homes they’ve lived in for years, even decades. Even in a strong housing market, seniors typically take months to decide, visiting the site over and over before making a decision.

Many seniors are already inclined against moving into seniors housing. Nearly two-thirds of homeowners aged 75 and older expect to stay in their single-family houses for 10 years or more, according to a survey for the American Seniors Housing Association.

Now the weak housing market has given seniors another reason to wait before giving up their homes. Prices have fallen more than 15 percent over the last 12 months, according to the Case-Shiller Index, which analyzes sales of existing homes in 20 cities.

When that trend reverses, simple demographics—the rising number of seniors—will point more people toward seniors housing.

“It’s like water behind a dam,” said Berne. “The demand is building up.”