An active bridge financing pipeline plus large portfolio deals keep hopes alive for total deal volume to reach $3.4 billion again in fiscal year 2018.
By Matt Valley
As lenders in HUD’s Lean program enter the homestretch of fiscal year 2018, all indications are that they are on pace to approach or possibly even surpass last year’s financing total of $3.4 billion.
The healthcare mortgage insurance program serves as an important vehicle for borrowers seeking long-term, fixed-rate debt to refinance or acquire residential care facilities, including skilled nursing and assisted living properties.
Michael Gehl, chief investment officer for North Bethesda, Maryland-based Housing & Healthcare Finance, anticipates a 10 percent increase in loan volume for the HUD Lean program as a whole in fiscal year 2018, which ends Sept. 30. His projection is based on the number of deals that have already closed through the first half of this fiscal year, plus outstanding HUD commitments and applications received.
“Digging into the numbers a little bit further, there are a number of portfolio transactions and transactions with large dollar amounts that have helped drive that overall loan volume,” says Gehl, who expects Housing & Healthcare Finance to close about $300 million in loans through the HUD Lean program in fiscal 2018.
Among the highlights in the data:
• The average deal size of 232/223(f) loans — new loans to the HUD mortgage insurance program used to acquire or refinance skilled nursing and assisted living facilities — was $12.3 million during the first half of fiscal year 2018, up from $10.5 million a year ago. That’s a 17.5 percent increase in deal size, Gehl points out.
• About two-thirds of the 153 initial endorsements made by HUD during the first half of fiscal 2018 were for skilled nursing facilities. The rest were for either assisted living communities or some other form of residential care.
• The amount of construction financing for new ground-up development and additions to existing facilities has risen slightly, but still only accounts for about 10 percent of annual deal volume in the HUD Lean program. Most HUD-insured loans are used to either refinance or acquire properties.
“Those numbers don’t surprise me. I think it’ shaping up like a typical year,” says Josh Rosen, senior vice president with Capital One Multifamily Finance, who leads the company’s seniors housing and healthcare practice and is based in Chicago.
“HUD has always been used much more for existing properties in the healthcare space, whether it be for refinancing or acquisitions. Development has always been way behind with regard to HUD and the borrower’s level of interest,” adds Rosen.
Fly in the ointment?
One wild card this year has been the movement in interest rates. In late April, the yield on the 10-year Treasury note breached 3 percent for the first time since 2014 and stood at 2.9 percent as of June 25. That’s up about 50 basis points from the start of the year. Because HUD financing is inextricably linked to movements in the 10-year Treasury yield, the sudden increase was a wakeup call for borrowers, says Rosen.
There was a one- to two-month span earlier this year when interest rates for HUD jumped 75 to 100 basis points, explains Rosen. “We haven’t had an increase like that in several years.”
As a result of the rising 10-year yield, the interest rate on a HUD loan to refinance or acquire a well-stabilized property has climbed from approximately 3.5 percent to 4.25 percent.
“There is no way to say for sure, but you could see a 5 percent rate by next year,” says Rosen.
Many borrowers who may have been on the fence about refinancing through the HUD 232 program are now motivated to act. Their mindset is “let’s get this done,” says Rosen. Because it takes six months on average to close a HUD loan, a significant number of loans in the deal pipeline won’t be completed until fiscal year 2019, according to Rosen.
“I think if rates continue on the trajectory they are on now, you are going to see next year be a much bigger year for HUD than the past couple of years,” says Rosen.
Chris Fenton, principal on the seniors housing team at Newark, New Jersey-based PGIM Real Estate Finance, believes that borrowers are not so sensitive to the interest rate changes that it will affect their strategy.
“Even with rates ticking up, you can still close a HUD loan in the low 4 percent range today for a term of 35 years, which is about 100 basis points inside of agency loans,” emphasizes Fenton. “What we might see is borrowers who have historically used agency loans migrate back to HUD for higher proceeds and a lower rate.”
Gehl of Housing & Healthcare Finance reminds borrowers that the benchmark 10-year Treasury yield is still well below historical averages. “In the years prior to the Great Recession, we saw a 10-year Treasury yield in the low- to mid-4 percent range.”
Although borrowers may have a sense of urgency to refinance properties sooner than later in a rising-interest-rate environment, HUD’s programmatic lending constraints could hinder their efforts to refinance newly built skilled nursing or assisted living facilities, says Steve Kennedy, senior managing director at Columbus, Ohio-based Lancaster Pollard Mortgage Co. In fiscal year 2017, Lancaster Pollard was the top lender in the HUD Lean program with 79 loans closed for a total of $769.3 million.
“You can’t refinance a newly constructed facility through HUD until you have had your certificate of occupancy for three years,” explains Kennedy. “There is a large volume of seniors housing properties that have been delivered to the market over the past year, or will be in the coming year. Those properties are just not going to be able to get to HUD in the near term because they have to stabilize and await the passage of time.”
While borrowers are sensitive to rate hikes, Kennedy believes that HUD financing provides more “cushion” than traditional private-sector financing alternatives. For starters, HUD’s fixed rates are typically lower than rates offered by private-sector sources. Additionally, HUD’s term and amortization for a refinancing, for example, extend up to 35 years.
By stretching out the loan payment and low fixed rate over that term and using relatively conservative cap rates in valuing projects, the effect out of the gate is that a HUD deal is typically going to have a debt-service coverage ratio of nearly 2.0, which means the property is generating substantial positive cash flow after debt service, according to Kennedy.
“When you have that much excess cash flow coming from an asset, you have more capacity to absorb higher interest rates compared with not only private sector sources of capital, but also other asset classes that might be underwritten at lower cap rates and tighter debt-service coverage ratios,” says Kennedy.
Sampling of deals
Last year was a record year for Greystone with regard to the amount of 223(f) loans that it closed. This year the company hopes to surpass that unspecified total, says Nikhil Kanodia, head of HUD loan production at Greystone.
“We’ve also seen more acquisition financings, specifically portfolio financing transactions. We’ve had a lot of requests where a borrower says, “Hey, we’re acquiring this three-, four- or seven-property portfolio. We’d like to take it to HUD.”
This spring, Greystone provided three HUD-insured loans totaling $75 million to Avenir Healthcare Group for the acquisition of three skilled nursing facilities in New York.
Known as the Optima portfolio, the properties include Brookside Multicare in Smithtown; White Plains Center for Nursing and Rehab in White Plains; and Little Neck Nursing Center in Queens. All totaled, the Optima Portfolio includes 561 beds. The loans carry a low fixed rate with 35-year terms and are fully amortizing.
“The process of taking three deals all at once through HUD with a single borrower was intense but we got it done,” says Kanodia.
What made the acquisition financing for the Optima Portfolio particularly unique in New York was that these were not bridge-to-HUD loans, adds Kanodia. Typically, a lender provides a bridge loan to a borrower as a short-term financing solution that is a prerequisite to the borrower securing permanent financing through HUD. “This was acquisition financing that went straight to HUD,” says Kanodia.
In fiscal year 2017, New York City-based Greystone closed 15 loans totaling $376.7 million through the HUD Lean program. The company is on track to nearly double its transactions in fiscal year 2018 and boost the total loan amount by 80 percent, says Kanodia. “It’s been a significant focus of Greystone to grow our presence on the healthcare lending side.”
About 70 percent of the loans that Greystone closes through the HUD 232 program are a direct result of its bridge lending platform, which Kanodia describes as a critical part of the company’s business. Greystone’s bridge loans, which range from $5 million to $35 million, carry a loan term of up to 36 months.
As a result of a recently closed debt fund, Greystone now has about $3 billion in lending capacity for bridge and mezzanine lending exclusively, a significant increase from last year.
In July 2017, Greystone closed on a $78 million HUD loan to refinance Boro Park Center for Nursing & Rehabilitation, a 510-bed skilled nursing facility in Brooklyn. The transaction marked one of the largest-ever HUD loans for a skilled nursing facility.
The borrower, Centers Health Care, acquired the property more than six years ago when the facility was struggling financially and subsequently invested more than $20 million in renovations. The investment helped transform the underperforming property into one of the finest facilities in the country, according to Greystone.
On a roll in FY 2018
Erik Howard, managing director of real estate finance at Baltimore-based Capital Funding Group, says the company is on pace for a banner year in terms of deal volume. In fiscal year 2017, Capital Funding Group closed 28 loans totaling $266.9 million through the HUD Lean program.
Through June of fiscal year 2018, Capital Funding had already closed $350 million of loans and Howard expects to close another $250 million over the next few months. “We expect that we will be in excess of $600 million for HUD’s fiscal year ending in September.”
The reason for Capital Funding’s surge in annual deal volume is twofold: continued growth and expansion of its bridge-to-HUD lending program and a large portfolio deal in excess of $250 million that involves the refinancing of several properties by a national owner and operator of skilled nursing facilities.
“We’ve seen a number of loans move from temporary bridge financing that we provided to permanent financing with HUD,” explains Howard. “As we continue to expand our bridge-to HUD platform, we expect to see continued growth in our HUD volume and the refinancings that we’re putting together.”
Howard says it’s no accident that about two-thirds of the deal volume in the HUD Lean program is tied to the skilled nursing sector versus assisted living or other forms of residential care.
“We generally see owners and operators of skilled nursing facilities as longer-term investors. If your investment horizon is 10 years or greater, you are going to look for corresponding capital to match to that hold period,” explains Howard.
Serving as a “one-stop shop,” Capital One Multifamily Finance’s bridge-to-HUD program provides the biggest potential for growth, says Rosen. “We have existing Capital One clients with loans on the balance sheet and a lot of them are now turning to HUD as their exit [strategy]. Having a continuum of capital available is a good opportunity for our growth.”
In June, Capital One closed on a $20.8 million HUD loan to refinance a 313-bed seniors housing facility in Tucson, Arizona. The facility opened in 1964, with additions completed in 1977 and 1990. The property features 24 independent living units, 19 assisted living units, and 270 skilled nursing beds spread across 132 units, making it one of the largest facilities in the Tucson area. The operators have invested in newly redesigned therapy center and are installing LED lighting to reduce energy consumption.
The HUD 232/223(f) loan enabled the borrowers to replace bank debt with low-rate, long-term financing, recoup their capital expenditures, and retire partner debt.
Hybrid housing models emerge
One emerging construction and permanent financing opportunity for HUD lenders is the fledgling affordable assisted living sector, according to Kennedy.
Lancaster Pollard recently provided Gardant Management Solutions and Horve Builders with a $19.9 million construction loan to build Heritage Woods of Noblesville, which will be a 124-unit affordable assisted living facility in Noblesville, Indiana.
The loan features a low, fixed interest rate and 40-year term. The permanent financing allows Gardant, a repeat client of Lancaster Pollard, to focus on operations and avoid interest rate risk in the midst of a rising rate environment.
Once complete, Heritage Woods of Noblesville will serve the community’s need for affordable assisted living. Brett Murphy led the transaction for Lancaster Pollard.
Indiana historically has not been a big player in the affordable assisted living space, but the state has continued to make changes to its Medicaid waiver program to accommodate the need, according to Kennedy.
“Now there is a growing market for those kinds of projects in that state. There are folks within Indiana, and in other states such as Illinois, that know that product well, know how to build those type of units and know how to operate them successfully.”
Housing & Healthcare Finance recently closed a $55 million HUD-insured loan to refinance a four-property portfolio of supportive living facilities in Illinois, a transaction that Gehl describes as “exciting and challenging.” Supportive living facilities (SLFs) in Illinois provide long-term care for persons in need of assistance with activities of daily living.
Illinois developed the Supportive Living Program as an alternative to nursing home care for low-income, older persons and persons with disabilities under Medicaid. SLFs can accept both private pay and Medicaid residents. The SLF program also has a program for adults ages 22 to 64 who have physical disabilities or who are blind. The state has also created a pilot program for licensed SLF dementia units.
Two of the facilities in the four-property portfolio were for the disabled and processed as HUD board and care facilities. The two facilities for the elderly were processed as assisted living communities.
What keeps them up at night?
Gehl acknowledges that the seniors housing industry is facing several headwinds. In the assisted living sector, overbuilding concerns persist in certain markets. Meanwhile, the skilled nursing industry is grappling with several issues, including the continued shortening of the length of stay, a shift to Managed Medicare from Medicare, and labor shortages.
And now there’s another potential problem looming for the skilled nursing sector. “We see more of the bigger players reducing their portfolios, while the smaller regional players are absorbing more assets,” observes Gehl. “I am becoming more concerned that growing too fast will be an added problem in the space.”
Fenton of PGIM Real Estate Finance says that staffing issues at seniors housing communities can keep lenders up at night. “A lot of good owner/operators are having difficulty finding and retaining good quality employees, from the executive director on down. As skilled nursing communities need staff, they often turn to high-priced nurse agencies. That cuts directly into the bottom line.”