Why HUD Financing May Be the Vehicle to Drive Skilled Nursing Innovation

If there’s one financial backing source that’s become a favorite among nursing home owners it’s U.S. Department of Housing and Urban Development (HUD) funding.

Even still, it may come with some limitations.

HUD loans can be used to purchase, build, refinance or remodel nursing homes, among other health care facilities, and their utilization in the long-term care sector specifically continues to grow, according to a recent analysis from ATI Advisory.

HUD insured more than 2,300 active mortgages in 2019, ballooning from about 800 in 1995.

While HUD’s “longstanding prevalence” in the nursing home industry proves its reliability as a long-term funding source, the program could better service residents by incentivizing innovation, researchers noted.

The analysis, commissioned by the National Investment Center for Seniors Housing & Care (NIC), specifically noted that HUD has been an “inefficient vehicle” to pursue growth and innovative investments in the sector.

While HUD’s stability is what makes it an attractive option to so many providers, such financing typically takes up to one year to secure due to a lengthy administrative process — often longer than traditional debt financing or equity investments.

Also, HUD loans are geared toward the property side of the nursing home business which has led to a relatively prescriptive underwriting process. However, that may not necessarily incentivize innovative investments, such as communication and technology upgrades, that would benefit the operational side of the business, according to ATI researchers.

Bob Kramer, NIC founder and strategic advisor, said while he was not surprised by the rise in HUD lending, he believes that its focus is more so on getting repaid instead of care quality.

“There are no incentives given for modernization, improvements, like 5G, or air quality and purification system, let alone moving three and four bedroom wards to semi-private and private rooms, creating neighborhoods, as opposed to long corridors,” he said.

Kramer thinks more should be done to make the program a tool used to drive innovation and modernization in the sector.

Conner Esworthy, ATI Advisory researcher and one of the authors of the report, told SNN that “at best the program [currently] is neutral towards incentivizing growth, because innovative and non-innovative borrowers can access loans at the same rate.”

“There are many operators today who are already investing in innovative projects (e.g., I-SNPs, technology upgrades) and an updated HUD program that rewards these operators could accelerate these investments,” Esworthy said.

Not everyone agrees with these points, however.

Steve Kennedy, executive managing director at VIUM Capital, “pushed back” on the notion that HUD doesn’t stimulate innovation within the industry.

“Earlier this year [HUD started] allowing owner-operators to access decreased mortgage insurance premiums if certain energy efficiency building thresholds are met,” Kennedy told Skilled Nursing News. “I think it’s a nice way to emphasize becoming more energy efficient in projects by tying it to an economic incentive.”

The reality is that HUD remains one of the strongest sources of capital for the skilled nursing sector, and ATI researchers believe that – with some tweaking and adjustments – HUD could be well-positioned to drive growth and innovation in the industry.

“This would entail a more direct approach to influencing operator capital choices, compared to certain payment policy changes (such as reducing reimbursement) that are indirectly aimed at disincentivizing certain investors, and ultimately penalize operators,” researchers wrote in the report.

Limitations of HUD

Operators need to be stabilized as a property before going to HUD for financing, otherwise they won’t meet the criteria.

“HUD’s health care leadership is very focused on not only the trailing 12 months of cash flows, but the most recent three months that will be covering the proposed debt service,” Kennedy explained.

He said a number of closings have been put on hold as Covid recovery continues. During that time interest rates have only gone up, which doesn’t help that ability to cover debt.

He said the program is geared towards successful operators and facilities that are already performing well.

“You do not look to HUD financing as a way to save nursing homes, you look at HUD financing as a way to best assist relatively strong performing facilities with proven operators,” he said.

Timing has always been the biggest challenge with HUD funding.

“It just takes longer to get a HUD deal done than bank financing or a finance company financing or an execution through other agency alternatives like Fannie or Freddie, which are active in the assisted living and memory care and independent living world,” Kennedy said. “When rates are rising, and you have margins that are as thin as they are, everyday matters.”

Therefore VIUM works as a bridge lender to ensure that there is flexibility within the bridge product for owner/operators to have the time they need to operate these projects in a way that they are ultimately going to be “HUD-able.”

Has HUD funding peaked for nursing home owners?

It’s easy to see why the HUD program has become such an integral part of the skilled nursing space given its long-term, fixed rate, no recourse securities, according to Esworthy.

Though the program has represented a vital lifeline for steady-state operators, HUD loan amounts are based on the “estimated value of physical improvements and major movable equipment,” Esworthy added.

“Many innovative investments – such as an air purification system or 5G infrastructure – could be achieved without changing a facility’s exterior yet they tend to fall in a gray area where they are either not eligible for separate HUD funding, or difficult to finance within HUD’s substantial rehabilitation requirements,” she said. 

For some rural, single-facility operators, HUD remains the only affordable and attainable debt option and a consistent and important source of capital, even for operators who have not previously utilized the program, according to Esworthy.

“The continued high volumes of HUD lending during the first half of the pandemic – when other private lenders remained on the sidelines – suggests that HUD financing was a reliable lifeline for operators during a very precarious period,” she said.

After exploding in recent years, Kramer thinks HUD funding may have peaked.

“There’s so much uncertainty right now about interest rates,” he said. “I think that the heyday of the rush to HUD was probably in the last couple of years, when everyone said these historic low interest rates aren’t going to last forever. Now we see there, they aren’t lasting forever.”

Kramer thinks the federal government will continue to raise interest rates as a tool to try and tame inflation.

Kennedy is also seeing a decrease in the number of deals that are approved and closed, due to HUD being very cautious in how they underwrite projects.