Owners of distressed seniors housing communities continue face a challenge in refinancing bridge loans due to tightened lending standards and cap-rate uncertainty. However, this month’s long-anticipated Fed interest rate reduction will help shrink the gap between earnings and debt service, offering owners and lenders more flexibility in crafting solutions for distressed loans.
One option to meet the debt-service shortfall challenge is for borrowers to explore a loan restructuring with their lender. A restructuring, while unpleasant, may be the best option for both borrower and lender. The other options — litigation, receivership and bankruptcy — are expensive and time-consuming paths that eat up critical bandwidth for operators.
A loan restructuring that is well planned and executed can allow a borrower sufficient time and resources to recover the value of the assets, benefiting the lender and the borrower.
Who are the candidates for restructuring?
Bank regulators are encouraging lenders to work out loans if the borrower is unable to meet their payment obligations but is ultimately willing and able to repay their debts. A restructuring may be the best option if the borrower has a realistic plan to return value to the community and the underlying mortgage.
There are several critical steps a borrower should take before opening a dialogue with the lender.
Team formation
It’s important to have the right team in place for a successful restructuring. The team should include a restructuring advisor who has financial expertise in seniors housing, a bankruptcy attorney who has healthcare expertise, an internal operations point person (CFO) to help navigate the process, and (eventually) a point person from the financial institution.
Loan document review
One of the first steps is to loop in the attorney to review the loan documents. Review key items including any cross-collateralization, guarantees, covenants and default triggers. At some point later in the process, the parties may put in place a pre-negotiation agreement to allow open discussions without concern that information can be used in future litigation.
Obtain a third-party valuation
One option is to secure a broker’s opinion of value (BOV) to determine the current “as is” market value. Both borrower and lender should have a realistic market value of the assets in order to have a productive conversation.
Identify the challenges
Every distressed community has a unique market and unique problem that demands a customized solution. Properly identifying the problem is one of the most important first steps.
In order to identify the problem, the borrower should work with its advisor to complete a detailed community and market analysis. This assessment will inform the borrower of its current positioning relative to its prime competitors and help clarify where the opportunities are to improve cash flows.
Examples of some challenges that are “lighter lifts” include an over-leveraged property (where the percentage of debt is too large relative to cash flows), bloated operating costs (where expenses are above industry standards), or the property has burned through lease-up reserves.
Heavier lift problems include sustained low-occupancy, high-profile regulatory or care issues, an overbuilt market and functional obsolescence.
While there may be a strong financial upside for a community with a patient lender, in some cases the asset value may be permanently impaired. A problem may be so challenging that an owner may ultimately decide that a community is no longer a good match rather than attempt a restructuring and turnaround. In this case, the owner may consider either a sale or a negotiated give-back to the lender (deed in lieu).
Develop a plan
If the borrower decides the team can resolve the problem and wants to pursue a possible restructure, the next step is to develop a detailed and well-supported plan to return the value to the asset(s) before opening discussions with the lender.
Examples of some turnaround plans include recapitalization, where the capital stack is adjusted to conform to the current cash flows of the property. This may mean an infusion of preferred equity and adjustment to the debt terms.
Another example of a turnaround plan is operational fine-tuning, where the marketing program is adjusted or outsized expenses are reduced through new vendor relationships. The discussions with lenders may center around temporary debt relief sufficient to execute the operational fine-tuning.
The most challenging and time-consuming turnaround plan is a community repositioning. This could include providing new services that are underserved in the market, updating the common areas or moving to a higher acuity model. The repositioning requires great lender cooperation, and there may be an expectation that the borrower brings in new equity or additional collateral.
Be prepared to support the pro-forma value of your turnaround plan with extensive data including historical and pro-forma income statements, actual and pro-forma rent rolls by unit type, competitive market data, demographic information, pipeline information, competitive unit descriptions and rents, lead generation data, and capital expenditure plans. If the plan requires new key personnel, be prepared to identify the candidate and timeframe.
The turnaround plan should have a specific request of the lender. It should provide detail on how and when the borrower proposes to repay the lender. The borrower’s restructuring advisor will be instrumental in formulating the financial plan and optimizing the asset value. Some of the levers for modification include loan interest rate (possibly moving from floating to fixed), term, bifurcating the loan between current pay and preferred equity, loan paydowns and new guarantors.
Meet with your lender
The borrower should be both transparent and proactive in communicating with the lender. The borrower should present the plan — and all supportive materials — to the lender as compared to the consequences of no restructuring. The lender may require additional supportive materials, and then negotiations will begin. Ideally, the borrower and lender will both be pushing in the same direction to bring value back to the asset.
If the plan requires additional cap ex, the borrower may be expected to secure fresh capital or new guarantors. If the borrower is both the owner and the management company, the borrower may be asked to defer management fees and be prohibited from distributing dividends. If owner and management companies are completely different entities, the borrower may be asked to change management companies. The borrower may be required to set up a cash sweep account with the lender.
If the borrower and lender agree to new restructuring terms, the lender’s attorney will amend the loan documents. The borrower will be required to pay lender legal fees as well as a loan modification fee. Make sure the restructured loan has revised covenants that can be met, so as not to trigger technical defaults.
With positive demand demographics and limited new seniors housing supply, the tailwinds are strong for value to return for many distressed seniors housing communities if the lender and borrower work together to provide the resources for a turnaround.
Adam Heavenrich is founder and managing principal of Heavenrich & Co. For 30 years, Heavenrich & Company has advised seniors housing owners and operators. Services include debt restructuring, investment sales and capital formation.