A growing number of portfolio deals are winding their way through the queue, driving up volume.
By Matt Valley
As small operators increasingly get squeezed out of the skilled nursing business in favor of regional and super-regional players with economies of scale, a new breed of borrowers is turning to the HUD Lean 232 mortgage insurance program to satisfy their financing needs.
“There used to be a lot of individual deals — mom-and-pop type operators that went to HUD — but now we’re seeing more large borrowers and operators coming to HUD and financing portfolios. That seems to be the trend,” says John Stibley, senior vice president and FHA healthcare deputy chief underwriter at KeyBank Real Estate Capital.
For example, early this year KeyBank Real Estate Capital provided an $84.7 million loan to refinance a six-property, 722-bed skilled nursing portfolio in Texas through the HUD Lean program. The properties are located in Brownsville, Weslaco, Harlingen and Edinburg.
In a deal nearly three times as big, KeyBank Real Estate Capital last summer provided $249 million in financing to Formation Capital, a large private investment management firm. The financing was used for a 22-property skilled nursing portfolio.
Seventeen of the facilities are located throughout Florida, while the remaining five are located in Mississippi. The properties had a combined total of 2,682 beds at the time the deal closed. Proceeds of the loan were used to pay down an existing bridge loan, which funded the acquisition of 66 facilities.
Inside the numbers
The HUD Lean program provides mortgage insurance for nursing homes, assisted living facilities as well as board-and-care facilities. Funds may be used to acquire a property or portfolio, refinance assets, undertake new construction or substantially rehabilitate a project.
In fiscal 2016, deal volume in the HUD Lean program hit $2.83 billion, a five percent increase over the prior year. Based on deals already closed or in the queue awaiting approval from HUD, the consensus among lenders is that loan production in fiscal 2017 is likely to meet or exceed last year’s total. (HUD’s fiscal year runs from Oct. 1-Sept. 30.)
Recent changes to the HUD handbook also are expected to help generate more loan production. High-quality, stable, cash-flowing projects previously subject to debt seasoning for two years are now immediately eligible for HUD financing in many cases.
Of the 182 loans closed through May of this fiscal year, 157 were 232/223(f) loans for the acquisition or refinancing of healthcare properties new to HUD; 17 were 232/223(a)(7) loans, the refinancing of existing HUD loans; and eight loans were for new construction or rehabilitation of existing facilities.
Another 80 loan applications were in the underwriting review stage and 70 applications were in the queue but not yet assigned.
“In addition to the abundance of portfolio deals, the increase in assisted living loan volume from the first half of HUD fiscal year 2016 to 2017 really jumps out to me,” says Michael Gehl, chief investment officer at Housing & Healthcare Finance LLC. “The increase in loan volume has been driven not so much by the number of deals, but by the loan amount per unit. Last year it was closer to $100,000 per unit, and now you are at $130,000 per unit, which is a result of more transactions involving new construction of assisted living in primary markets that typically require a higher cost per unit to build.”
Housing & Healthcare Finance closed 28 loans totaling $335.9 million through the HUD Lean program in fiscal year 2016. Gehl expects a similar result this year — about 30 deals totaling between $350 million and $400 million. “We’re pretty steady. We don’t like surprises, we like consistency,” says Gehl.
Through April of the current fiscal year, loan commitments across the HUD Lean platform for new construction totaled $192.7 million, up from $91.6 million during the same period a year ago, a clear sign that HUD has become more of an option for construction financing.
Welltower, one of “Big Three” healthcare REITs, touched on the hot-button topic of construction activity in assisted living during a recent earnings call, says Gehl.
“On the earnings call, they indicated the cost of non-recourse construction financing was up 150 basis points between spreads widening and the increase in LIBOR, and some banks have had trouble syndicating their construction loans. So, if you’re having trouble with the local or regional banks getting your construction loan, HUD then becomes an attractive alternative,” points out Gehl.
“It is a little more time-consuming going through the HUD approval process, but from our perspective we are seeing people approach us on assisted living and nursing home construction deals, and you can see that in the production numbers,” adds Gehl.
HUD hones its skills
The financing of seniors housing portfolios through HUD has gained momentum during the past few years, driven by larger borrowers coming into the program and generating bigger deals, says Erik Howard, managing director of real estate finance at Capital Funding LLC.
“As HUD continued to work with the lenders to expand its knowledge of the seniors housing industry over the past decade and gained expertise in underwriting, it became more comfortable with these larger transactions. One thing we expect to see over the next six to 12 months is a number of larger portfolios working through the system.”
Thanks in part to the strength of its “Bridge-to-HUD” lending platform, Capital Funding is on track to provide about $400 million to $500 million in loans through the HUD Lean program this fiscal year, says Howard, up from $261 million in fiscal year 2016.
Most bridge loans today are for a period of 12 to 18 months, says Howard. “We’re starting to see the fruits of the strong historical production that Capital Funding had in the bridge loan program in particular as those facilities hit their stabilized cash flow numbers and are now rolling to HUD.”
Howard sees a trend in regional as well as super-regional owners and operators acquiring nursing homes that are financially struggling. Those buyers are potentially a great fit for the bridge-to HUD program.
As an example, a buyer may pay $10 million for a skilled nursing facility that’s worth only $7 million on a cash flow basis, explains Howard. “That new owner or operator is thinking, ‘I can reduce some of my expenses because I have a lower cost structure. I also can bring a little different level of care to the revenue side, and this building can be worth $12 million within 12 to 24 months.’”
Capital Funding validates those assumptions, determines what it will cost for the property to reach stabilization and lends money based on a percentage of the purchase price.
In fiscal 2016, KeyBank closed 54 loans totaling $521.8 million in seniors housing financing through the HUD Lean program, second only to Lancaster Pollard Mortgage Co., which topped the charts at $555.4 million. KeyBank’s goal in fiscal 2017 is to close 60 loans for $1 billion.
“We have $800 million in loans in the pipeline right now that HUD is reviewing. We are pretty confident that we will close that $800 million in the current fiscal year,” said Ed Foulon, senior vice president and FHA platform manager/chief underwriter at Keybank Real Estate Capital, during an interview in the middle of May. Through the first half of fiscal 2017, KeyBank closed 19 loans totaling $183.1 million.
The combination of mounting revenue pressures, increased reporting requirements and difficulty in attracting and retaining staff has forced out many mom-and-pop operators of skilled nursing facilities and raised the bar on overall performance. Those issues have become magnified as the healthcare industry moves from a fee-for-service model to an outcome-based model.
“One of the things we look at is risk management and STAR ratings,” says Stibley. The Five-Star Quality Rating System developed by the Centers for Medicare & Medicaid Services evaluates a skilled nursing facility in three areas: state health inspections, staffing ratios and quality measures. Nursing homes with five stars are considered to be much above average in those areas, while nursing homes with one star are considered to be much below average.
“The small owners were good owners, but they just didn’t have the technology or the procedures in place,” says Stibley. “With the larger organizations, you have a more well-thought-out risk management plan and better resources.”
Assisted living in catbird’s seat
Everyone knows that the HUD Lean program is the only game in town for nursing homes when it comes to securing long-term, fixed-rate financing. While the skilled nursing sector still accounts for the lion’s share of activity in the program, the assisted living segment is making inroads, according to an analysis by Lancaster Pollard of HUD data over a period of more than two years.
For example, assisted living’s share of the total dollar amount of loans closed versus nursing homes through the HUD mortgage insurance program increased from 28 percent for all of fiscal year 2015 to 31 percent for all of fiscal year 2016 and to 40 percent year-to-date through April of fiscal year 2017.
“The good news is that if you are an assisted living provider, the world is your oyster when you talk about funding alternatives,” says Steve Kennedy, senior managing director at Lancaster Pollard, the top HUD Lean lender in fiscal year 2016. Among the many capital sources available in the assisted living segment are government-sponsored enterprises Fannie Mae and Freddie Mac.
But Kennedy is quick to point out that Fannie and Freddie don't offer a 35-year term with a matching amortization at a fixed interest rate as low as the HUD Lean program offers.
“For that reason we feel like the HUD Lean program has got to be an option that's out there for assisted living providers.”
‘Trump trade’ wanes
In the months just after the election of Donald Trump as president, the 10-year Treasury yield rose from approximately 1.8 percent to as high as 2.6 percent, but has since retreated and closed June 23 at 2.14 percent.
The conventional wisdom in the financial markets had been that the main pillars of Trump’s economic agenda — infrastructure spending as well as tax reform — would stimulate the economy, create inflationary pressures and push up interest rates. But his agenda is mired in gridlock in Washington, D.C., amid partisan bickering.
The “Trump trade” was a little overblown, says Gehl. “We did see interest rates shoot up to over 2.6 percent in the hope of economic growth from the Trump administration, but we have now settled back in to under 2.20 percent as those hopes have subsided somewhat. I don’t think the increase in loan volume is primarily a result of people rushing to lock in their long-term financing because of what happened with the new presidency.”
Gehl points out that the HUD Lean program had roughly $2.08 billion in loan commitments in the pipeline at the end of April, up from $1.41 billion a year ago. “We’re talking about almost a $600 million difference, and a lot of it is portfolio transactions,” says Gehl.
In short, the bridge loans put in place a few years ago for a lot of properties have seasoned and now it’s time for those loans to get refinanced on a long-term basis with HUD, he adds. “That’s what is really pushing a lot of the volume this year.”
While HUD is poised for a strong close to the current fiscal year, the harsh political climate in Washington, D.C. could impact the agency negatively, says Foulon of KeyBank Real Estate Capital.
“HUD is working under a continuing resolution right now, as all the government is. What keeps me up at night is what’s going to happen Oct. 1, the start of HUD’s new fiscal year,” says Foulon. “Are the doors going to be open? Will Congress and the president get on the same page and pass the budget?”