Operators and developers of senior housing assets can attest mortgage financing has been relatively scarce of the past few months. These can be traced to three factors:

• Lack of new investment in bond and fixed income funds (because most of the money is headed into equities);
• Continued debt "back-up" within conduit and select commercial lenders (left over from the near collapse of the conduit markets last Fall0, with several of those lenders over-extended on higher cost short term credit lines; and
• Investor and lender "flight to quality as global financial markets remain shaky. Senior housing debt, especially with the weak performance of senior housing and long term care stocks, is commanding a higher risk premium.

Changing Players. The list of active capital sources for senior housing real estate will place a decidedly lesser weight on several capital sources that have helped fund the past growth of the industry, notably:

Real estate investment trusts (REITs), and

Conduit lenders (also known as Real Estate Investment Mortgage Conduits or REMICs).

Many industry watchers predict consolidation among the nearly 20 health care focused REITs, with a few strong REITs (such as Health Care REIT Inc.) leading the sector. The investing public has largely shunned REIT stocks, with no inflation threat to hedge against and returns that behave like annuities rather than exhibiting real growth. Some health care REITs also suffer from certain owners’ deteriorating credit quality, especially skilled nursing operators negatively impacted by Medicare changes.

Active Players. Look for increased senior housing lending activity from the following sources:

• Opportunity funds;
• Commercial banks;
• Government and quasi-government programs such as the Dept of Housing and Urban Development mortgage insurance, or Fannie Mac senior housing lending programs; and
• Insurance companies.

Opportunity funds (typically associated with investment banks) were created to invest on behalf of pension funds and wealthy individuals. Most have a very strong cash balance, profiting handsomely from the strong stock market, with an increasing percentage earmarked for investment in senior housing (and long term care) companies, seeking the required above market returns through funding operating platforms and participatory mortgage financing.

Commercial banks, especially the larger nationals and super-regionals, must lend money to make money, especially with shareholder earnings pressure. Underwriting standards are more restrictive than in the recent past, but spreads should ease over the next few months. The development pipeline has been building for the past three to six months, so there are enough quality deals to foster renewed lending.

Insurance Companies are a noted barometer of market equilibrium. The increased activity in credit enhancement of senior housing debt will help broaden and enhance liquidity of the secondary market. Credit enhancement also helps calm the nerves of pension fund managers, who will be looking to diversify equity (stock) market risk.

The Public Debt Markets. With strong corporate earnings and rising personal income levels, many thought that tax-exempt band issues would attract increased investment. However, most of the mutual funds purchasing new issues appear to be utilizing reinvestment dollars, with much of the new capital market cash inflow heading for equities. Look for a steady flow of new bond financings, driven by established underwriters.

A Look Into the Future. For the next few months, it appears that the constriction in the capital markets is beginning to ease for senior housing providers. Look for spreads to narrow as the year goes on, depending on how Russia and other foreign countries deal with maturing obligations. Look for increase in the use of credit-enhancement vehicles to minimize risk and expand the secondary market for debt instruments. Borrowers, however, should be prepared to contribute more equity when securing permanent financing and realize that underwriting standards are tighter than in recent memory.