Billy Meyer, managing director of Seattle-based Columbia Pacific Advisors, doesn’t mince words when talking about the bridge lender’s cautious approach to financing seniors housing product today. “We don’t underwrite hope as a strategy anymore. It’s just not a good execution strategy, we believe.”
Against the backdrop of elevated levels of construction, rising interest rates and operational challenges in seniors housing, Columbia Pacific Advisors is scrutinizing operators heavily before providing funding. “We’re bridge lenders. That is all that we do. Our average loan is 19 months. It’s a short horizon of how far away our exit is, so we need to make sure that [pathway] is very real and clear,” said Meyer.
Meyer’s insights on the loan underwriting process came during InterFace Seniors Housing Midwest on Thursday, June 7. The one-day event, which took place at the recently opened four-star Marriott Marquis Chicago at McCormick Place, drew 372 professionals from across the region. Panel discussions focused on everything from design to development to growth strategies for operators, in addition to the state of the capital markets.
Moderated by Mike Taylor, senior vice president and group manager for healthcare lending at First Midwest Bank, the capital markets panel also included Ari Adlerstein, managing director, Meridian Capital Group; Jeff Gardner, director, BMO Harris Healthcare Real Estate Finance; Brian Robinson, senior vice president, MB Financial; and Charlie Shoop, senior mortgage banker, KeyBank Real Estate Capital.
Opting for stress tests
Through its debt fund, Columbia Pacific Advisors provides short-term bridge loans, ranging from $5 million to $75 million, across the whole spectrum of commercial real estate property types, including seniors housing.
Fifty percent of the company’s deal flow involves value-add acquisitions. The borrower uses the bridge loan to stabilize the property before pursuing long-term permanent financing.
Given the large amount of capital flowing into seniors housing, along with the entrance of new owners and operators into the burgeoning property niche, Taylor asked the panel what they are doing differently today from an underwriting perspective when poring over loan applications.
“The difference now is you stress test,” explained Meyer, in reference to today’s choppy seniors housing market that is facing declining occupancies nationally.
That means Meyer and his team ask themselves some key questions when reviewing loan applications. What happens if the operator can’t get the rents that it was hoping for, or if occupancy is softer than expected, or if interest rates rise more quickly than projected? “These are the types of questions that we have to feel comfortable with, knowing that if all of [these events] happened, are we still OK? Do we still like the opportunity?”
Gardner of BMO Harris Bank said that eight years ago the operating margins for seniors housing (excluding skilled nursing) were 40 percent on average. Today, the norm is about 30 percent. In a follow-up interview, Gardner explained that the lower margins are the result of three factors: (1) limits on rent growth within the primary market areas; (2) lower occupancies on average; (3) increases in variable and fixed-rate operating expenses, especially labor costs.
“What we’re doing is really honing in on the fundamentals — understanding pro formas, understanding how rent increases and operating expense cuts are going to be achieved. Those types of things,” said Gardner.
The alignment of the operator’s core competency with what it is trying to achieve is critically important from BMO’s point of view, said Gardner, especially at a time when boosting rents can prove to be quite challenging in certain markets. Similarly, cutting operating expenses comes with its own set of issues. “We want somebody that has been effective at doing that in the past.”
Adlerstein of Meridian Capital Group said that much of his job today as a mortgage banker is to manage borrower expectations — perhaps even tamping them down a bit. “Back in the day when we first started, we had people throwing deals at us,” recalls Adlerstein who joined Meridian in 2011 and has closed about $3 billion in the seniors housing and healthcare space over the course of his career.
At one point it was not uncommon for borrowers to seek 95 percent loan to cost on transactions, he said. In short, borrowers sought and often received maximum leverage and cheap pricing.
“We had a good run with that for awhile, but there is no question that the market has changed,” said Adlerstein. Today, 85 percent loan to cost would be a stretch, even for skilled nursing properties. Such a deal would likely involve a value-add play in a submarket where the upside potential is clear and imminent, and the facility is aided by favorable demographics and fills a void in the marketplace in terms of delivery of care.
Construction dollars available
BMO is still doing construction lending all over the country, but the bank is requiring “at least some recourse” on all of its construction deals, said Gardner. “I don't think that we're doing anything differently. We're just doing a deeper dive in our due diligence to make sure that the joint ventures have the collective expertise and experience to execute on their business plan.” BMO also makes sure the project is adequately capitalized to withstand any “hiccups” that are bound to occur, he added.
Robinson of MB Financial said the company has a bucket of dollars available for making construction loans to borrowers that it has a relationship with and that have a proven track record of success. “We're being fairly guarded, but we're open for business.”
Taylor, the panel moderator, said that for every five proposals to finance seniors housing development projects received by First Midwest Bank, his team takes a pass on four of them. Why? The market studies are typically dated and the bank often knows more than the developers about the markets in which they seek to build.
“Yet those projects are still getting financed and still getting done,” said Taylor. “So, it kind of speaks to the amount of capital that is chasing the sector.”
— Matt Valley