A New Finance Landscape

Bridge lending spikes as owners and operators look for short-term solutions coming out of the pandemic, which could portend an increase in permanent and agency loans.

By Jeff Shaw

Although senior living occupancies remain low and have been slow to recover in the wake of the COVID-19 pandemic, many owners and operators are looking to execute long-term business plans. Whether for renovations, expansions or simply operating capital to ride out the pandemic’s long-term effects, borrowers need bridge loans to achieve this goal.

Average private-pay seniors housing occupancy increased 20 basis points in first-quarter 2022 to 80.6 percent, according to the most recent data from the National Investment Center for Seniors Housing and Care. This is above the pandemic low of 78 percent in the second quarter of 2021, but still well below the pre-pandemic level of 88 percent in the fourth quarter of 2019.

While there is no central data tracking financing transactions in seniors housing, anecdotal evidence points to a big increase in bridge lending. At New York City-based real estate finance company Greystone, for example, healthcare bridge lending volume tripled to $660 million in 2021.

“COVID has affected communities, and owners and operators need more time to execute their business plans,” says Matt Miller, a managing director with Greystone. “We’ve been very active with our clients providing bridge solutions.”

“The acquisition market has been robust, so the bridge lenders have been busy,” adds Michael Gehl, chief investment officer of FHA lending at NewPoint Real Estate Capital.

Don Pelgrim, CEO of Wilshire Finance Partners, notes that he has observed an uptick in a variety of financing types: cash-out refinancings for struggling communities to help improve performance; borrowers looking to restructure to receive cash prior to an agency refinancing; and acquisition financing for value-add purchases.

“Wilshire was financing those types of acquisitions pre-pandemic, and we believe there will be additional lending and investment opportunities for those types of transactions as we continue to move forward from the pandemic,” says Pelgrim.

In an interview for the February-March issue of Seniors Housing Business, Steve Schmidt, national director of seniors housing loan production with Freddie Mac, suggested that this increase in bridge lending portends a spike in takeout refinancing loans from the government-sponsored entities (GSEs) Freddie Mac, Fannie Mae and HUD.

The GSEs slowed their lending in the seniors housing space during the pandemic, with the deal volume of Freddie Mac and Fannie Mae dropping 45 percent and 71 percent, respectively, from 2019 to 2020.

“Given the rising interest-rate environment projected, I think you will continue to see a spike in permanent loans — particularly with the GSEs, as we have seen over the prior 24 months — as borrowers continue to lock in long-term, historically low interest-rate financing,” says Marty Koutsky, senior vice president of healthcare finance at First Midwest Bank.

However, the actuality of GSEs taking on those loans depends largely on how much the properties improve their occupancy and revenue during the one- to two-year seasoning period, according to Curtis King, executive vice president at HJ Sims.

“Whether there’s a spike in permanent financing over the next 12 to 24 months is largely going to be tied to the performance of the underlying assets. We’ve financed some assets in strong markets that we expect will stabilize within the next 12 to 18 months. For many of our investments, however, we’re anticipating that it’s going to take over 18 months to reach stabilization. If it does indeed take that long, it’s still going to be two years or longer until the assets are ready for permanent financing.”

“In order to refinance those bridge loans, the occupancy needs to continue to recover and wage inflation/use of [temp] agency labor will need to be kept under control,” adds Gehl. “The in-place NOI needs to get to the point that substantiates a Fannie, Freddie or HUD takeout.”

Close partners close the deal

There’s an old saying that tough times reveal who your real friends are. This sentiment could also be applied to finding financing partners during this period of historically low occupancy in seniors housing.

“The strength of relationships is built during the challenging times in our business,” says Cary Tremper, head of Greystone’s seniors housing capital markets team. “Those that take the long-term approach and lean in during these difficult times will reap the benefits for a long period of time.”

“When you think about the pre-pandemic [lending environment], when capital was plentiful and predictable and consistent, it became transactional,” continues Tremper. “When you got to mid-pandemic, you found out where the strength of your relationships lay.”

One boon for lenders during this period: As those not committed to the space fled temporarily, it meant less competition for deals. As a result, lenders were able to dictate more of the terms of the loans, such as higher spreads, lower leverage and more recourse.

“In addition to getting great terms and looking smart today given the bounceback in occupancy, clients were incredibly appreciative of those lenders that said, ‘We’re going to partner with you, ride through this and not run to the sidelines,’” says Tyler Armstrong, managing director with Greystone. “It gave those lenders a lead position on future business with their customers or prospects by stepping up.”

Lenders were also in a better position to pick their own clients during this period, notes Gehl.

“The companies that continued to lend were predominantly focused on their best relationships. These clients were well-capitalized and strong operators, so they fared well. While some lending institutions were on the sideline, the companies that continued to lend were able to develop new relationships with strong sponsors to fill that lending void.”

Those favorable lender terms are just now starting to fade away, slowly returning to normalcy as occupancy rates do the same.

“The changes made by lenders will not go away overnight. However, they will continue to move closer to pre-pandemic approaches over time,” says Pelgrim. “Although the impacts of COVID are still present, and there are economic challenges and geopolitical turmoil, I believe people in the seniors housing sector are looking forward and there is a lot more optimism today.”

Wilshire, being an on-balance-sheet lender, often lands the deals that banks are not interested in, says Pelgrim. In that way, the company serves as a bellwether for how the industry as a whole is faring. Based on that indicator, Pelgrim says the lending environment is not yet back to “full force” in seniors housing.

The lenders who left the industry, though, are back in the game, according to Koutsky. First Midwest posted a record year in lending volume in 2021, he adds, but those lenders that fled have now returned to the fold.

“By mid-2021, it became apparent that the overall sector would be resilient (aided by government stimulus) as many operators were showing signs of positive trends as certain COVID restrictions began to ease. As such, the vast majority of traditional bank lenders that were on the sidelines came back in with a vengeance.”

Rates reroute projections

Of course, all predictions regarding the near-term future of seniors housing finance must consider an important question: How much and how fast will interest rates rise?

In an attempt to curb inflation, the Federal Reserve raised the target for the fed funds rate by half a point to a range between 0.75 percent and 1 percent during its May meeting. It was the second consecutive rate hike and the biggest increase in borrowing costs since 2000. Meanwhile, the 10-Year U.S. Treasury yield was hovering around 2.9 percent as of early June, up from 1.6 percent at the start of the year.

King notes that increasing interest rates have a wide range of effects on lenders. Higher rates mean higher debt service, resulting in lower debt-service coverage ratios. Leverage becomes more limited as lenders consider that increased debt service. Cap rates also increase in this environment, and stabilized values decline.

“Lenders also must consider the economic impact higher interest rates will have on factors that impact seniors housing demand. For example, if rising interest rates drive home prices down, how will this impact the demand for life plan communities where residents are often relying on a sale of their home to pay for the upfront entrance fee?”

The increasing rates could also slow the expected increase in GSE financing as higher rates mean lower loan proceeds, says Armstrong.

“However, the interest rates on bank floating-rate options remain well below the fixed-rate competition in many cases and continue to be a great source of capital for borrowers,” he adds.

Gehl agrees that agency financing could be limited as a result of higher interest rates, as 223(a)(7) HUD loans in particular are sensitive to sudden rate spikes. In the near term, though, clients looking to get a low, fixed rate are scrambling to close transactions.

“Clients are asking more frequently how quickly they can lock a rate, which has resulted in an increased number of early rate locks,” says Gehl. “In addition, we’ve seen a few more Transfer of Physical Assets (TPA) requests, which allow a client to assume a low-interest HUD loan through an acquisition.”

Pelgrim says that rising interest rates are generally good for lenders “if they can control expenses.” However, there is a larger factor that capital providers must consider.

“The bigger question now is whether a recession is around the corner and, if so, how will that will impact facilities and how will lenders underwrite loans for those facilities? There is a growing consensus that the U.S. will enter into a recession; the questions involve the timing, the depth and the duration. Therefore, I believe we’ll start to see lenders tighten their underwriting approach again.”