As an intermediate step to securing permanent financing through HUD, many owners and operators opt for bridge loans
By Matt Valley
Borrowers in need of financing to close quickly on the purchase or recapitalization of a skilled nursing or assisted living facility will often opt for a bridge loan as a short-term solution that precedes the ultimate end game — take-out financing through HUD. In today’s borrower-friendly market, qualified lenders are increasingly competing for their business.
Because it generally takes at least six months to close a 30- to 35-year, fully amortizing HUD-insured loan, the bridge-to-HUD option is an invaluable tool for buyers who need loan proceeds sooner rather than later, says Michael Gehl, chief investment officer of Housing & Healthcare Finance (HHC) based in Chevy Chase, Md.
“If you are dealing with an acquisition, that time frame of six months or more creates uncertainty, which is sometimes unacceptable to the seller,” says Gehl, particularly when many sellers want to close a transaction in 60 to 90 days.
Beyond timeliness, another reason a borrower may pursue bridge financing is that HUD doesn’t underwrite loans based on pro forma, but a bridge lender may do so in certain instances, says Gehl.
In the skilled nursing sector, for example, buyers are often acquiring properties with the intent of improving their performance operationally. If the borrower has a proven track record of turning around other properties in the region by bringing expenses in line with the rest of the market, then the bridge lender may give some credit to that business acumen.
“That difference in cash flow can mean all the difference in the amount of proceeds the borrower needs to close on a transaction,” says Gehl.
M&A momentum
A confluence of factors has led to an uptick in bridge-to-HUD lending activity over the last 12 to 18 months at Capital Funding LLC, according to Erik Howard, managing director of real estate finance for the Baltimore-based firm.
For starters, M&A activity during the past few years has been robust, totaling tens of billions of dollars. Real Capital Analytics reports that U.S. property and portfolio sales in the seniors housing sector totaled $14.48 billion year to date through August, up 32 percent from the same period a year ago.
“We expect to continue to see industry consolidation going forward for a number of reasons, including ongoing challenges in dealing with Medicare [reimbursement] for traditional, smaller operators, plus economies of scale,” points out Howard. “We think that the industry continues to be a prime candidate for M&A activity.”
It’s also a good time to be a seller with prices rising and cap rates falling, notes Howard. According to Irving Levin Associates, the skilled nursing market set a record for the second year in a row in 2014, reaching an average price of $76,500 per bed, or 4 percent higher than in 2013. The average cap rate in the skilled nursing market fell 60 basis points to 12.4 percent but did not set a record, which was last set in 2007.
The year-over-year change was even more dramatic in the assisted living market where the average cap rate dropped to a record low of 7.75 percent in 2014, reports Irving Levin Associates. The average price per unit in the assisted living market soared by 25 percent in 2014 to a record $188,700 per unit.
“The demand for product remains high, in particular with the publicly traded REITs as well as some private REITs. So, you’ve got tremendous demand and low cap rates putting sellers in a good position,” says Howard.
In 2014, Capital Funding provided about $350 million in bridge loans and $300 million in HUD loans, including loan modifications, according to Howard.
“We’re doing higher-leveraged deals and more creative deals in conjunction with an active market that’s really fueled our growth over the last 24 months,” adds Howard.
At HHC, bridge-to-HUD loans represent about 10 percent of the $748.8 million in lending volume the firm generated in fiscal 2014 through the HUD Lean mortgage insurance program, says Gehl.
“It’s definitely an area for us to grow, and it’s part of our business plan. We need to be more active in the space, and it does feed the HUD business,” emphasizes Gehl.
The challenging part for finance companies is lining up capital. Because they are not banks, they rely on outside capital such as warehouse lines to finance their loans. HHC has been successful in attaining this type of capital to provide a bridge product to its clients.
Deal size, terms vary
The sweet spot for Capital Funding when it comes to bridge loans is $5 million to $20 million, but the deals can run the gamut from $3 million on the low end to greater than $50 million on the high end.
In April, Capital Funding provided a $13.9 million bridge-to-HUD acquisition loan to a large California-based private investment group for Braswell’s Colonial Care, a skilled nursing facility in Redlands, Calif. At 243 beds, Braswell’s Colonial Care is one of the largest skilled nursing facilities in the state.
Braswell’s Colonial Care offers rehabilitation, memory care, assisted living, independent retirement, post-acute rehabilitation, skilled nursing, long-term care and hospice care. Howard of Capital Funding originated the transaction and Capital Funding served as the agent and co-lender in the transaction. The borrower is expected to go to HUD for the take-out financing within 18 months.
Although the exact terms differ from one lender to the next, bridge financing is typically a three- to five-year loan product that is LIBOR-based with a prescribed interest-only period, up to two years in the case of Capital Funding.
While the interest rate is variable, in some cases floors are established to give borrowers comfort that their interest expenses won’t reprice with day-to-day changes in the 30-day LIBOR rate. (The 30-day LIBOR was 20 basis points as of Sept. 4.)
Here’s how a lending floor works: Suppose the all-in rate to the borrower is 30-day LIBOR plus 300 basis points, but there is a LIBOR floor of 100 basis points. That means LIBOR can never be less than 100 basis points.
The floor of 100 basis points, plus the 300 basis point margin results in an interest rate of 400 basis points, or 4 percent. That rate will remain fixed at 4 percent, so long as LIBOR stays below 100 basis points. “You’d have to have a significant move in LIBOR to be able to make that rate actually float,” says Howard.
Recapitalizations aplenty
While the majority of the bridge-to-HUD loans that Capital One Bank provides are for acquisitions, a close second are recapitalizations, not refinancings, says Keith Kodrin, senior director of healthcare real estate at Capital One Bank.
“I would define them more as recapitalizations than refinancings because the borrowers are looking to maximize leverage and then take the long-term money through HUD,” explains Kodrin.
Under this scenario, the borrower has already acquired a property or portfolio and is in the process of repositioning or turning it around operationally. “Then the borrower comes in and wants to leverage up the property or portfolio and go to HUD,” says Kodrin.
Capital One’s bridge lending program does not operate within a defined box or set of parameters because each deal and each borrower is different, says Kodrin. “We are a regulated institution. Our loan has to stand on its own when we’re looking at it, irrespective of whether or not we’re going to get the agency/HUD execution on the back end.”
In late 2014, Capital One Bank provided a $60 million secured term loan to an undisclosed borrower for the acquisition of a portfolio of 19 skilled nursing facilities in Indiana and Iowa. The five-year, floating-rate loan was structured as a bridge to permanent HUD financing. The portfolio included 1,163 licensed beds.
Kodrin refers to Capital One as a one-stop shop when it comes to executing bridge-to-HUD loans, which he believes gives the bank an edge in what has become an extremely competitive environment among lenders.
“It’s a good business to be in,” says Kodrin. “Our competitive advantage is the ability to leverage our balance sheet as a top 10 bank (as ranked by total deposits), and our internal capabilities to do the bridge loan and then take ourselves out with the HUD loan.”
Two buckets of bridge financing
Douglas Korey, president of Columbus, Ohio-based Lancaster Pollard Finance Co., says bridge financing can be grouped into two buckets relating to the duration of the bridge.
The first bucket includes customers who are seeking short-term bridge loans (with a maturity of less than one year) for either an acquisition or a refinancing in advance of an upcoming maturity, or to obtain a lower rate for a short interim period.
“The loan characteristics include current appraised value and debt-service coverage, among other factors, that will meet an agency’s financing criteria,” says Korey. “The customer will select our bridge loan because of an immediate need that may not be able to be met by going through an agency’s process.”
The second bucket is for those loans that will require some seasoning, but will have a maturity of three years or less, according to Korey.
The customer will use this bucket for cash-out financing (in order to maximize agency proceeds), or for an acquisition or refinancing where the cash flow exists but may need to season prior to taking it to an agency for longer-term financing.
“Lancaster Pollard’s bridge product can meet both these needs and terms, and pricing is designed in a flexible way to allow for a relatively seamless process to an agency takeout,” says Korey.
Lancaster Pollard recently provided the owner of an assisted living facility on the East Coast with $10 million to refinance a maturing loan. The facility was stabilized and had adequate cash flow to cover the debt, but there was a question on what HUD would value the facility based on its age and operating margins.
“We provided the customer with a $9 million senior mortgage and a $1 million mezzanine mortgage to ensure that the refinancing could be completed within a very short period of time (30 days) and without having the full HUD underwriting completed,” says Korey. “In the end, the loan is about to be repaid by FHA financing.”
In another transaction, Lancaster Pollard Finance Co. recently helped an experienced seniors housing operator acquire Gardens Assisted Living and Guardian Skilled Nursing in Lake Charles, La., by providing a senior mortgage loan and a mezzanine loan totaling $9 million.
The financing structure is expected to be refinanced using HUD/FHA within 18 to 24 months of the bridge lending.