Overview

The shortage of affordable housing units, along with increased demand for such units, has long been a challenge in the U.S. During the COVID-19 pandemic, an increasing number of households became significantly cost burdened because of rising unemployment rates, rent inflation, and other economic hardships, which spurred demand for affordable units. Considering the number of housing-burdened households has reached an all-time high, we think demand for affordable housing units is unlikely to change despite abatement of some of the economic issues associated with the pandemic.

Despite ongoing expense pressure, financial performance, as measured by S&P Global Ratings-calculated average debt service coverage (DSC), has improved slightly over the past 14 months, when considering bonds across the non-military rental housing sector. Despite the stability in financial and operating performance in 2023, S&P Global Ratings is monitoring the following for the non-military housing rental housing bond sector:

As of May 2024, S&P Global Ratings maintains 59 non-military stand-alone rental housing bond (RHB) ratings, a decline from 65 ratings in the previous year because it withdrew six ratings across five transactions following defeasance or redemption of the outstanding bonds. This report provides more detail to how each property type subsector performed during the past year, and what S&P Global Ratings expects in the coming year.

Age-Restricted Housing

Rating Actions Were Generally Negative Despite Occupancy Improvement

We maintain 14 ratings across six transactions in the age-restricted housing sector. Overall, rating actions in the sector were largely negative including multiple downgrades on Great Lakes Senior Living Communities' various liens. On Dec. 21, 2023, we placed the ratings on this issuer's first-, second-, and third- lien bonds on CreditWatch with negative implications (see report). On March 14, 2024, we resolved the CreditWatch placement and lowered our rating on the first-lien bonds to 'CC' from 'CCC-', with a negative outlook, and lowered the ratings on the second- and third-lien bonds to 'D' (default), following draws on the reserves and a missed principal payment on the second and third liens in January 2024 (see report). We also revised several outlooks on other transactions in this sector, including four to negative from stable, and one to positive from negative.

Expenses Stabilize And Rental Revenue Grows

In previous years, operating pressures stemmed from labor and food costs and management's difficulty in controlling expenses. Over the past year, costs have eased with owners and operators reducing employee turnover and reliance on contract labor while more tightly controlling food costs. These efforts could indicate that owners and operators are adapting to the persistent inflationary environment. Furthermore, stabilized occupancy combined with increased rental rates has contributed to improved financial performance for the age-restricted housing subsector.

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Table 1

Overall, this subsector appears to be stabilizing four years after the start of the pandemic. According to the U.S. Census Bureau, the 85-year-old-plus population is expected to more than double by 2040 and triple by 2060, which we expect could vastly increase the demand for age-restricted housing, potentially improving occupancy levels and profitability. But ongoing inflationary pressures for costs of goods and services, labor shortages, and payroll expenses continue to hamper operating margins.

According to the National Investment Center for Seniors Housing & Care (NIC), senior housing occupancy across the U.S. increased to 86.8% in 2023, from 84.7% in 2022 and 82.4% in 2021. According to the NIC, occupancy of senior housing units remains at a record high through the first quarter of 2024. We expect that demand will continue to rise, and although higher interest rates have led to slower new unit construction, supply is still outpacing demand (both at a slower rate). We expect the difference between supply and demand will narrow in the medium and long term because of the expected increase in the aging population over the next 10-to-15 years.

The ability to hire and retain skilled nursing labor through the pandemic and beyond remains a key challenge for the sector, but the level of assisted-living jobs topped pre-pandemic levels as of first-quarter 2024. When considering the mix of age-restricted units on which we maintain ratings, independent units account for 51%, assisted-living units make up approximately 40%, and memory care units account for the remaining 9% of the ratings. As a result, filling skilled nursing positions is integral to successful operations, and staffing assisted-living and memory care units poses the greatest difficulty due to the low supply of qualified, licensed, and willing applicants. The age-restricted housing industry's responses include focusing and investing in work culture, education, and other employee benefits to recruit and retain workers. These responses have resulted in an increase in payroll and benefit expenses, and will ideally contribute to stabilizing the workforce, which could reduce expenses related to employee attrition and the need for contract staffing, which tends to be substantially more expensive than in-house staff.

Market forces have also required operators to focus on residents' life quality and wellbeing through higher-quality facilities, quality of services, and increased resident engagement. If this trend continues, we expect the changes could materially influence performance of the related bond transactions. In our view, transactions with the best performance have dedicated, experienced, and proactive management teams, as well as involved ownership entities that support the transactions operationally or financially where necessary, to cover cash shortfalls as the sector emerges from these years-long challenges.

Table 2

Mobile Home Parks

Ratings And Outlooks Remain Stable, Although Coverage Increases

We maintain 20 ratings across 18 mobile home park (MHP) communities offering mobile-home housing for low-and-moderate-income individuals and families. The rated universe of MHP transactions is stable in terms of financial and operational performance, with 100% occupancy across rated entities and virtually unchanged year-over-year average DSC of 1.63x, up from 1.59x the previous year.

We took one positive rating action over the past year: We raised our rating on Caritas Affordable Housing Inc.'s class II 2021B bonds to 'BBB+' from 'BBB', reflecting improved maximum annual debt service (MADS) coverage, which was spurred by growth in revenue outpacing growth in expenses (see report, published Aug. 22, 2023).

The Unique Features Of This Subsector Provide Rating Stability

The stability in the MHP subsector reflects its unique operating model, where tenants own the physical unit but rent the lot on which the unit is located. This provides lower operational expenses compared with other RHB subsectors because the operator is not responsible for the maintenance of the physical units. Due to lower maintenance and repair and labor costs, the MHP subsector benefits from greater financial flexibility relative to other RHB subsectors.

Due to the complications and expenses associated with moving a physical unit from lot to lot, tenants choosing to move typically put the unit up for sale, continuing to pay lot rent and fees until they sell the unit, at which point the new tenant establishes a new lease on the lot. This unique rental structure contributes to an occupancy rate that historically has remained high and stable. Overall, the combination of stable occupancy and lower operational expenses has resulted in steady profit margins, which is reflected in key rating factors across the subsector. Our coverage and liquidity assessments, which generally incorporate a positive adjustment to account for the stability of cash flows are, on average, strong for the entities we rate. In addition, all rated issuers maintain a debt service reserve fund sized at or above MADS and therefore do not typically have negative liquidity adjustments, which in our view is a credit strength of the subsector.

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Table 3

Section 8 Housing

Mixed Rating Actions Across The Section 8 Subsector

We maintain 21 ratings across 18 Section 8 transactions (see table 4), down from 25 ratings across 21 transactions the previous year. From April 2023 to June 2024, we withdrew four Section 8 ratings. All of the withdrawals followed the redemption of the bonds. For three of these withdrawals (associated with two transactions), the bonds were redeemed on the sale of the underlying property.

The ratings in this subsector range from 'A+' to 'CCC' (see chart 3). Subsidized Section 8 rental contracts provide for stable operating revenue, but for transactions with lower ratings, we generally observe erosion in coverage and liquidity and management and governance. In addition, some Section 8 properties in the subsector are characterized by high levels of deferred maintenance and below-average physical condition that we capture in our view of the property's market position assessments.

Since April 2023, the rating actions on four transactions in this subsector were mixed. There were two multi-notch upgrades, one of which also included an outlook change to positive from stable:

• The two-notch upgrade on Chisom Housing Group to 'BBB' from 'BB+' on June 4, 2024 (see full analysis) followed a sharp year-over-year strengthening in MADS coverage and improved operational effectiveness contributed to a revision in our view of management and governance. Furthermore, positive trends in the project's property-specific characteristics led us to view Chisom's market position as strengthened. The outlook remained positive.
• The two-notch upgrade to 'B-' from 'CCC' and outlook revision to positive from stable on NV Homestead Apartments on July 17, 2023 (see report), reflect the transaction's material improvement in DSC following renewal of the transaction's Housing Assistance Payments contract, receipt of low-income housing tax credits allocation, and increased rental revenue that, together, we believe would likely lead to ongoing improvements in credit quality and financial performance.

We also took a negative rating action on one Section 8 issuer and revised the outlook on another transaction to negative from stable:

• Our downgrade on CHC Trestletree LLC to 'B-' from 'B' was due to persistent cash flow pressures in conjunction with certain elevated operating expenses, resulting in MADS coverage of 0.07x and our expectation that coverage will likely remain below 1.0x in fiscal 2023 (see report published Aug. 9, 2023).
• The outlook revision to negative from stable on the 'A+' rated Los Angeles Housing Authority series 2021A and 2020AB mortgage revenue bonds, issued for the Union Portfolio Project, reflects our expectation that operating expenses will continue to pressure cash flows in 2023, culminating in a MADS coverage ratio below 2.0x (see report published Aug. 21, 2023).

Stable Financial Performance Underpinned By Improved Occupancy

This year marked an improvement in financial and operational performance in this subsector, leading to greater rating stability for the Section 8 transactions, compared with 2022. Average first-tier DSC improved slightly to 1.25x from 1.23x and occupancy increased to 96.4% from 94.8%. The primary driver for occupancy increases was units coming back online following the completion of planned renovations and required improvements from damages incurred from natural disasters and other destructive events. Although there are high costs associated with unit turns and renovation, as repairs are completed, properties can generate more revenue and improve margins and coverage.

We expect the robust demand for subsidized rental units will continue to keep occupancy and revenue trends stable and strong for the subsector. In our view, the primary challenge for these properties is management and governance, which materially contributes to the success or failure of Section 8 properties. For example, in the upgrade on Chisom, improved management and governance underscored the overall change in the credit fundamentals. Generally, when we observe weaknesses in management and governance, it reflects one of, or a combination of, the following: lack of experience, resources, or willingness to effectively manage the projects; limited evidence of or execution of strategic or organizational plans; and/or the ability or willingness to meet performance and financial benchmarks, and, in the worst cases, financial obligation.

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Table 4

Unenhanced Affordable Housing

Stability Across This Small Subsector

We maintain ratings on four unenhanced affordable housing transactions (table 5), down from six the previous year. Our ratings range from 'A+' to 'B+', and the average rating for this subsector is 'BBB-' (chart 4). Since April 2023, we withdrew two ratings in this subsector. One withdrawal was due to defeasance of the bonds following the sale of the property and the other followed redemption of the bonds. There were no rating changes or outlook revisions across the four transactions.

Operators and owners of unenhanced affordable rental housing projects have greater flexibility to adjust rents and implement increases more quickly compared with the Section 8 subsector. This flexibility allows the owners and operators to manage revenue, cover rising expenses, and adapt to changing economic conditions without regulatory oversight. However, units do not receive a governmental subsidy. As a result, when occupancy falls and expenses rise, financial performance could experience greater volatility.

The average DSC for the four transactions increased materially to nearly 2.0x from 1.7x and average occupancy remained relatively stable. The strong demand for moderate- and low-income rental units across the U.S. will likely keep occupancy levels high as units come back online following rehabilitation and repairs and because construction of new affordable housing units remains slow. Average debt per unit increased to $51,226 from $44,194, but this primarily reflects the low debt levels on the defeased and redeemed bonds where we withdrew ratings. Despite this increase, average debt per unit remains relatively low. In addition, in our view, debt obligations shouldn't pressure cash flow if they are properly managed, thereby providing resources for owners and operators to improve, repair, and maintain the assets as well as adequately cover rising expenses.

As with all asset-backed debt, damage or deterioration to the asset would likely affect financial performance. As weather events occur with more severity and frequency, the risk of asset impairment becomes higher and insuring potential losses becomes more expensive. Without a federal subsidy to help bridge the gap, unenhanced affordable properties could be more exposed to financial disruption in such extreme weather events.

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Table 5

Geographical Distribution And Extreme Weather Events

Natural disasters and extreme weather can destroy and disrupt infrastructure assets including affordable housing rental housing stock. We incorporate these evolving risk exposures into our view of the market position for RHB transactions. We typically weaken the market position for properties located in areas highly susceptible to climate hazards such as wildfires, flooding, and hurricanes and other events like earthquakes. As these events become more frequent and severe, we are applying the negative adjustment to more transactions.

Historically, we have focused our discussions with management teams that own or operate properties in coastal areas where the physical impacts from climate change are generally more acute and visible. That said, physical risks are becoming more geographically widespread, with acute and chronic hazards affecting all regions in the U.S. In addition, as discussed in "U.S. Rental Properties’ Expense Trends: Insurance Costs Are Rising Significantly" (June 12, 2023), several insurers have raised premiums or discontinued coverage where severe weather events have occurred to limit their insured losses. S&P Global Ratings continues to observe the effects of rising insurance costs, which are unlikely to abate, across all property types. To maintain credit stability, owners and operators might consider incorporating higher insurance premiums into long-term financial forecasts and quickly adapt to an alternative if insurance coverage becomes unavailable.

The map shows the concentration of age-restricted, MHP, Section 8, and unenhanced rated RHB transactions across the country.

Chart 5

Related Research

• U.S. Public Finance Housing Outlook 2024: A Stable Foundation Despite Emerging Risks And Slower Economic Growth, Jan. 24, 2024
• U.S. Rental Properties’ Expense Trends: Insurance Costs Are Rising Significantly, June 12, 2023