Barring any unforeseen macroeconomic events, seniors housing lenders forecast a healthy year for loan production.
By Matt Valley
All indications are that seniors housing lenders have the wind at their backs as 2015 kicks off. The U.S. economy grew at an annualized rate of 5 percent in the third quarter of 2014, the fastest pace in more than a decade. Nonfarm payroll employment increased by 353,000 in November, the best figure in nearly three years based on revised figures from the Bureau of Labor Statistics.
The positive economic trends will likely give a boost to housing demand and home prices, which in turn will benefit elderly people who are considering transitioning out of their homes into a senior living community.
Meanwhile, interest rates remain incredibly low. The 10-year Treasury yield, a benchmark for long-term permanent financing, stood at 2.17 percent at the end of 2014, down from 3.04 percent a year earlier.
Against that backdrop, Seniors Housing Business asked five lenders to forecast trends in deal velocity in 2015 and identify some of the market drivers. The lenders also were asked to identify which segments of seniors housing they believe provide the greatest lending opportunities. What follows are their edited remarks.
Roundtable participants
Michael Gehl, Chief Investment Officer, Housing & Healthcare Finance LLC
Tim Lex, Chief Operating Officer, Executive Vice President, Oxford Finance LLC
Len Lucas, Senior Director, Love Funding
Mike Lugli, Executive President, National Manager, KeyBank Real Estate Capital Healthcare
Chris Taylor, Managing Director, GE Healthcare Financial Services
Seniors Housing Business: Is the following statement true or false? It is the perfect time to be a borrower in the seniors housing space. Capital is plentiful, interest rates remain near historical lows, and consumer demand for seniors housing is strong.
Michael Gehl: True. Across the board the space is awash in capital. Sources of direct lending include banks, finance companies, CMBS, Fannie Mae, Freddie Mac and HUD. The various avenues of capital provide a myriad of alternatives for borrowers at attractive rates and valuations.
We must sound like a broken record by now because we have been saying it for years, but the low interest rate environment will not be here forever. In mid-December, the Federal Reserve removed the language “considerable time” from its statement regarding the forecast for how long interest rates will remain low. Borrowers should not miss the opportunity to take advantage of the opportunity to fix their capital structure at today’s cost of borrowing.
We hear a lot about the impact of the Baby Boomers. Generally speaking, the average age of a senior in an assisted living or skilled nursing facility is above 80, which is not a Baby Boomer. (The oldest Baby Boomers are nearly 70 years old.) That being said, the 80-and-older population is growing substantially faster than the overall population, creating additional demand. While there are pockets of new supply developing — with some markets more of a concern than others — the supply/demand dynamic is still favorable.
Tim Lex: The current market conditions are excellent for borrowers of all types, not just those in the seniors housing space. Interest rate benchmarks are near historic lows and there is a high level of competition among lenders. The supply of capital available to quality borrowers is high but credit standards are also high, making it difficult for marginal borrowers to obtain capital.
The seniors housing industry produces quality credit opportunities for lenders, driven by demographics, the regulatory environment and the profile of the collateral package in a seniors housing transaction. These factors result in a high availability of attractively priced capital relative to other industry groups.
Michael Lugli: True. For established and proven owners and operators, it is a great time to be looking for financing. Interest rates are very low and the banks, REITs, agencies and markets are looking to put their money to work. With that said, it is still difficult for newcomers to the space to get deals done, though not as difficult as it once was.
SHB: How much of your business in 2014 was refinancing versus acquisition financing, construction lending, or some other type of financing? Has that breakdown shifted over the past few years as the effects of the Great Recession fade?
Chris Taylor: Construction lending is limited to funding for repositioning and expansions within portfolios where we have a larger exposure. Currently, GE Healthcare Financial Services does not do ground-up construction financing. Loan volume for 2014 was an even balance of refinancing and acquisition financing. Historically that has been the case.
Len Lucas: In 2014, 76 percent of our business was refinancing, 16 percent was acquisition financing and 8 percent was new construction or substantial rehabilitation. This represented a significant decrease from refinancing activity in 2013, which accounted for more than 90 percent of our business.
Gehl: Ninety percent of our business is refinancing conventional loans into HUD loans versus acquisition financing due to the fact that we are predominantly a HUD lender. While the HUD team has done a tremendous job of improving the HUD queue, the time and variability of a HUD loan from start to finish makes it a more challenging source of acquisition financing. As a result, our financing is predominantly refinancing of bridge loans that come from either our own proprietary lending program or other banks and finance companies. That mix has not changed materially.
Lugli: Acquisitions (70 percent), refinancing (20 percent), construction (10 percent). There has been very little change in the mix. Where there has been significant change is whom we are lending to. Regional and national owners and operators previously dominated our portfolio. Now, based on dollars not deals, more of our balance sheet is going to the REITs and funds. This is largely due to the fact that these players have been driving the consolidation we are seeing in the space.
Lex: The majority of Oxford’s 2014 origination activity was acquisition financing. Oxford does not provide construction financing and saw limited refinancing opportunities in 2014 due to the competitive environment. Acquisition activity has increased over the past few years in the seniors housing space and has created opportunity for lenders that understand how to appropriately underwrite the risks of a seniors housing acquisition.
SHB: According to Real Capital Analytics, U.S. property and portfolio sales in the seniors housing space totaled nearly $19.4 billion during the 12-
month period ending Oct. 30, 2014, up 36 percent from the prior 12 months. Has this sharp uptick in property and portfolio sales resulted in a big increase in demand for debt financing at your firm?
Taylor: Over the past 12 to 24 months, real estate investment trusts (REITs) have been responsible for a significant portion of the acquisition activity in the seniors housing space. It is common for the REITs to finance their acquisitions with bonds or lines of credit that are not secured by specific properties, and therefore do not need traditional financing. We tend to finance primarily private equity buyers and operators, both of whom have been active as well. We expect that when the final numbers are tallied, we will have closed both a record number of loans and achieved a record on-book debt volume in 2014.
Lucas: Yes, the uptick in property and portfolio sales has resulted in increased demand for debt financing, although the mix of loan types has changed. In prior years, lower rates drove the refinancing of existing HUD-insured debt. Today, the business is dominated by the refinancing of non-HUD insured debt. There is also increased interest in the HUD new construction program. HUD has made great strides toward improving the execution of this program.
Gehl: From a bridge lending perspective, we have absolutely seen an increase in demand for debt financing. We have seen a lot of acquisitions come our way, particularly repositioning of assets. The statistic that you cite reflects growth predominantly from independent living and assisted living sales, with some growth from nursing home sales, but to a lesser extent.
Our HUD volume is predominantly from nursing home refinancing, so demand has been steady, but there has not been a sharp uptick. However, the increase in repositioning of assets on the bridge lending side should lead to an increase in the HUD business in the future.
Lugli: Demand has been consistent for the past several years. What has changed most is the size of the loans we are looking at. Again, I believe this trend is due to the large number of portfolio sales we are seeing occur. The larger loan size has required us to underwrite, or arrange, significantly more debt for our borrowers. Indeed, our syndication revenue has tripled since 2012.
Lex: The robust acquisition activity in 2014 has resulted in a moderate increase in origination activity for Oxford. However, Oxford is a credit-focused institution and is very selective in its pursuit of investment opportunities. Oxford anticipates continued opportunity to make loans to quality borrowers in the seniors housing industry.
SHB: Do you expect the total amount of financing that your firm provides to seniors housing to increase, decrease or stay the same in 2015 compared with 2014?
Lex: We see no reason to believe that the pace of seniors housing acquisitions will slow, and we expect origination volume to increase steadily for Oxford in 2015. At the end of 2014, Oxford’s new business pipeline was strong and new opportunities were continuing to materialize. That being said, Oxford does not stretch its credit standards and will scale back origination volume if good credit opportunities become scarce.
Taylor: Our expectation for volume in 2015 is in line with our 2014 production as we anticipate continuing strong demand for assets in the seniors housing space. A meaningful increase in interest rates, unforeseen macroeconomic or political events could impact demand in the sector.
Lucas: We expect a solid 20 percent increase in 2015. This is driven by the continued low HUD interest rate environment, as well as the senior housing and healthcare industry’s ability to help meet the global demand for yield.
Gehl: Housing & Healthcare Finance is coming off a banner year as the No. 1 LEAN lender for HUD’s fiscal year 2014 by loan volume, accounting for almost 20 percent of the HUD’s loan volume. That being said, based on our current pipeline, I would expect the HUD loan volume to be down some, but anticipate making that up with our bridge and mezzanine lending product. The driving factor for lower HUD volume would be less large portfolios impacting volume.
Lugli: I would expect a modest increase of perhaps 10 percent. While that does not seem like a large number, one has to remember that due to KeyBank’s highly integrated platform, we recycle our capital very quickly. For example, in 2014 we did just shy of $800 million in new production, yet our commitments only increased by $200 million as we placed a little less than half of our existing book with the agencies, life companies and HUD or facilitated portfolio sales through our investment banking team.
SHB: As a direct lender, which segment(s) of seniors housing are you most bullish on and why? Which segment(s) of seniors housing are you least bullish on and why?
Lucas: I am most bullish on assisted living new construction and skilled nursing acquisitions — skilled nursing acquisitions because investors worldwide are looking for yield. The relatively high cap rates that skilled nursing facilities trade at make these assets a great vehicle for yield. This is especially true when transactions come with leases to qualified operators. This reduces some of the operational risk. Demand for assisted living will continue to grow with changes in demographics.
I am least bullish on independent living as this is more of a luxury than a necessity. A stutter in the economy most directly affects independent living.
Lugli: All sectors are strong and we remain committed to all of them. We watch independent living carefully. It is the most discretionary asset class and is attracting multifamily and hospitality owners and operators to the space, potentially causing oversupply in the future.
We also watch standalone memory care closely due to the smaller size of the facilities in general and the fact that a lot of new product is being brought to market. All of that said, we are active in each sector and like them all.
Lex: Oxford sees the most opportunity in the skilled nursing segment. These facilities generally have a high percentage of their revenue generated by government reimbursement, as opposed to commercial insurance or private pay. The result is a predictable, non-cyclical revenue stream. Oxford’s management team possesses an understanding of the complex government reimbursement environment and can underwrite the associated risks.
Gehl: I am most bullish on two segments: skilled nursing facilities in concentrated states with operators that have a strong presence in the market; and assisted living facilities in gateway cities with a high cost of construction that acts as a barrier to entry and reduces the threat of overbuilding.
As we move to a more integrated model that includes accountable care organizations (ACOs), it is critical to demonstrate a strong clinical performance in the market, such as low rehospitalization rates. Also, an operator with a cluster of facilities in a market is better able to handle the post-acute resident and command a seat at the table in an integrated care paradigm.
I am less bullish on two segments: small nursing homes run by mom-and-pop operators in primarily rural markets; and assisted living facilities in markets such as Dallas and Houston where there is a high amount of new construction.
I am concerned that the inevitable movement to a more integrated care model — the ACO model, for example — will shrink the number of nursing homes that will receive referrals. The bigger players that have invested heavily in technology and have a larger presence in the market could have a crowding out effect on the small mom-and-pop operators.
SHB: Do you believe that lenders in the seniors housing space are well disciplined, that their memories of the most recent downturn are still vivid, or are underwriting standards starting to ease and perhaps even slip now that the U.S. economy is growing at a fairly healthy clip?
Taylor: We work hard to remain disciplined in our approach to underwriting in the seniors housing space. During positive cycles like the sector is currently experiencing, there is often pressure on capital providers to be more aggressive in terms of pricing, advance rates/leverage, recourse and covenants. Every day we do our best to manage these competing pressures. We believe the very low loss rate we have experienced in our portfolio across cycles will bear that out.
Lucas: HUD remains very disciplined. What concerns me is the conduit world. Conduits typically shy away from senior living/healthcare. They are now joining the party, and this causes me concern.
Lex: Credit standards have certainly loosened compared to the period immediately following the credit crisis. The market endured periods of dysfunction, both in the years leading up to the credit crisis and also during the few years afterward.
Oxford believes that the current market is healthy, with sufficient capital available to quality borrowers. As competition remains strong, certain players will stretch their credit standards to win transactions, and we will likely see a repeat of the classic credit cycle.
SHB: With borrowers having plenty of financing options available to them today, has debt financing become a commodity product? How does your company distinguish itself from the competition?
Lex: Borrowers have more financing options available to them today than they have had in quite a few years due to the surplus of capital, but debt financing to the seniors housing market is not a commodity. Many institutions choose to avoid the industry altogether for a variety of reasons, including a lack of understanding of the risks, fear of government reimbursement, or aversion to real estate in general. The result is a relatively small community of lenders with a specialized expertise.
Oxford differentiates itself from competitors through its reputation as a steady and reliable capital partner. Oxford is committed to working collaboratively with its borrowers in times of adversity and is flexible and thoughtful in its approach to underwriting and portfolio management.
Gehl: The lending business has always been about relationships, and we spend a lot of our time and effort fostering our customer relationships, whether it is pre-qualifying deals in their infancy, exhausting all options with financing requests that other lenders say can’t be done, or providing additional financial products that our borrowers require (bridge, mezzanine, accounts receivable, for example).
Lucas: In theory the HUD product is a commodity, but not in practice. We sell expertise, relationships and service. Love Funding specializes in the HUD product. We do a lot of upfront work to ensure the transaction is viable. The result is that the borrower understands upfront what the HUD programs can accomplish relative to their specific transaction.
Lugli: We believe our long tenure, national coverage and commitment to the space — coupled with our ability to provide a continuum of financing ranging from balance sheet to agency financing, life company financing and CMBS — distinguishes us. We have a very active syndication team that allows us to handle even the largest loans. We know most of the regional and national owners and operators in seniors housing, and we care about this industry deeply.