Despite a turbulent economy, many lenders have continued to put money into seniors housing as the industry’s demographics and metrics improve.
Roundtable participants
Michael Gehl
Chief Investment Officer, FHA Lending
NewPoint Real Estate Capital
Scott Blount
Senior Managing Director
VIUM Capital
Bill Lewittes
Managing Director,
Head of Loan Originations
Kayne Anderson Real Estate
Michael Coiley
Managing Director
CIT Healthcare Finance
Ryan Stoll
National Director of Seniors
Housing and Care
Bellwether Enterprise Real Estate Capital
Ari Adlerstein
Senior Managing Director,
Co-Head of Seniors Housing
Meridian Capital Group
Lawrence Brin
Managing Director,
Head of Healthcare Real Estate
MidCap Financial Services
By Jeff Shaw
The capital markets have encountered some tough sledding in the last 12 months. As interest rates rise at unprecedented rates to cope with equally unprecedented inflation, the economy has been unpredictable — and unpredictability is the enemy when it comes to loans.
Seniors Housing Business spoke with top lenders in the industry regarding what the situation looks like on the ground, what the future holds and how they’re coping with the current state of the capital markets.
Seniors Housing Business: How are you adjusting to the historic run-up in interest rates over the last year?
Gehl: There are certain products that are just no longer feasible to offer clients, such as HUD (a)(7) loans and loan modifications, as interest rate savings are no longer there. For higher-end assisted living deals — where we used to be loan-to-value constrained — we are now constrained by debt-service coverage ratios (DSCRs), which has not happened for some time with the run-up in rates.
Some adjustments that we have been making:
• While paying slightly higher interest rates, some borrowers are opting to take a lighter prepayment penalty — so if rates do come back down, the loan modification or (a)(7) will be less punitive.
• When feasible, borrowers have been examining Green Mortgage Insurance Premium (MIP) requirements, which can, depending on the program, bring down the annual MIP and lower the upfront MIP.
Brin: The rapid rise of interest rates during the last year has impacted the volume of transaction activity across the market. The scarcity of debt options and the higher cost of capital have contributed to an environment in which owners and sponsors are hesitant to sell absent a need to transact.
As a lender, we have been cognizant of the dampening effect higher interest rates have had on valuations. We have approached every transaction with a focus on the financial strength and liquidity of sponsorship, appreciating that there could be a need for additional capital infusions into any asset as management implements its business plan during the next few years.
Blount: VIUM is still active in the market and leaning into the market disruption alongside our clients. We utilized this same approach when the COVID-19 pandemic rocked the senior living industry in 2020. One adjustment example is incorporating interest rate caps on our variable-rate loans to mitigate interest rate risk over the term of the loan.
Lewittes: We are a floating-rate lender, and the vast majority of our loans are priced as a spread over SOFR. The steep and rapid increase in that underlying index (like in all indexes) has put pressure on the viability of some transactions as the overall cost of debt has increased. We have worked to keep our spreads from gapping out too much, but with added market risk, both on a macro level and within seniors housing, there’s been some widening.
Perhaps the biggest change we’ve seen and adapted to is the dramatic increase in interest rate cap costs. It’s no secret that these have become a more meaningful component of overall deal costs, in some cases prohibitively so.
The dilemma is that while we want to be as flexible as possible for our borrowers, we still need interest rate protection to maintain a responsible lending profile. We’ve tried to be as creative as possible, combining less expensive caps with escrowed interest reserves. At the end of the day, the goal is to find a solution that works for our borrowers and our investors.
Coiley: Quite frankly, a number of transactions just don’t pencil out in a rising rate environment. The need for more equity in a transaction is often what it takes to make it work, combined with some form of interest rate protection. Generally, we’ll include some form of earn-out if the property performs.
Stoll: In this interest rate environment, we work collaboratively with all partners in the capital stack to arrange creative solutions for our clients. As debt service increases on non-stabilized assets, some need to bring in new lenders with fresh eyes and patience — some form of subordinate financing.
Others are considering bringing in new equity partners to recapitalize deals that are now over-leveraged compared with when they were built or bought. Much of this activity is driven by interest rates significantly above what was originally underwritten and reserved for.
Also, with the inverted yield curve and recent disruption in the bank market, we are working with the agencies and some life companies to offer more creative, shorter term, fixed-rate debt products with flexible prepayment options. This helps take near-term interest rate risk off the table while still giving them flexibility to recapitalize, sell or permanently finance in a better capital markets environment in the coming years.
SHB: How have your underwriting standards shifted as a result of the turbulent economic environment of the last year?
Adlerstein: There is no question that we have generally taken a more conservative approach in our underwriting over the last 12 to 18 months as the economic environment continues to experience volatility. We are constantly in close contact with our buyers, sellers and lenders to retain an intimate understanding of how each of them are adjusting their underwriting approach so we can fine-tune our valuations and pro formas.
While buyers remain aggressive in the space, they are also keenly aware of potential issues at play, namely staffing struggles and interest rates, and are weighing them heavily in the decision-making process when considering new acquisitions.
Additionally, lenders have taken a more conservative approach in their underwriting of new opportunities and their willingness to pursue certain deals.
Blount: VIUM’s underwriting standards have not materially changed over the past year. We want to see in-place cash flow (incorporating any immediate expense cuts from the acquirer) cover interest expense.
Lewittes: I would not say that our underwriting standards have changed. We are still intently focused on real estate fundamentals, the risks to those fundamentals, basis, the business plan and the ability of the borrower/operator to execute. There are certainly factors in the capital markets and overall economy that put added or different pressures on those factors that we have to account for, and we certainly scrutinize those factors more closely, but we have not made a wholehearted change to overall underwriting standards.
Coiley: There has been a flight to quality in terms of seniors housing. We have seen many operators that have had strong absorption and have found a way to navigate through this challenging time.
Stoll: Agency underwriting standards remain relatively stable. Since there are fewer stabilized deals that qualify for permanent financing, we are seeing the agencies get aggressive to win deals that are eligible.
Close attention is being paid to labor and inflation as reflected in the financials. This includes clearly understanding staffing levels, agency usage, in-place collections, concession schedules and insurance increases.
For HUD, more credit is being given to recent financial and operational trends instead of always relying on the last 12 months. This is in response to recent Medicaid rebasing, where applicable, as well as modest softening of the labor market and decline in agency and payroll expenses.
SHB: The talk of last year was how it was hard to underwrite for seniors housing as the timeline of post-pandemic recovery was so unclear. Is that picture still blurry as the industry continues its recovery?
Gehl: The picture is improving but still a little blurry. It is important to recognize that the FHA refinancing product is for stabilized assets, so we are not projecting achievement of certain occupancy levels or that agency staffing utilization will go down. The cash flow needs to be in place to support the loan, and the trend needs to be in the right direction.
Blount: The post-pandemic recovery has varied across markets and operators. In general, tertiary markets have rebounded slower (staffing shortages and lower absorption rates), but some of our clients have already surpassed pre-pandemic levels (in both tertiary and urban markets). Those facilities that opened shortly before or during the pandemic have generally taken longer to build up occupancy.
Lewittes: Seniors housing’s outlook has cleared some from last year. There are still hangover effects from the pandemic, mostly on the expense side where the cost of labor and supplies rose rapidly. We expect overall expense levels to remain, although we are seeing some moderation of the overall expense burdens.
The last year has clarified the picture and made it easy to distinguish when an asset is held back by post-pandemic recovery, and when the issue is something more fundamental.
Stoll: Underwriting of top-line trends is less difficult now than last year because we’re seeing the industry make relatively stable and steady gains in both rate and occupancy increases. There are several factors, however, that are still blurry.
• What is a realistic expectation for stabilized margin in the near to medium term? Some operators, assets and markets are still able to drive pre-COVID margins, while others are struggling to service debt, even with well occupied communities.
• It is becoming more difficult to underwrite asset values due to unpredictability of cash flow, as well as unprecedented interest rate hikes and corresponding cap rate expansion.
• It is also a challenge for lenders to effectively underwrite interest rate movement through the term of the loan, estimating reserve needs for pre-stabilized communities, and exit interest rates/cap rates.
SHB: What impact could there be on seniors housing from the bank collapses in mid-March?
Brin: The seniors housing markets have been hampered by a lack of debt capital during the past few years. One major contributor to that trend has been the reduced lending appetite and stricter underwriting parameters of banks, which were previously very active in the sector.
An environment in which banks are under additional stress related to their own balance sheets will likely exacerbate a situation that, to date, has largely been driven by credit standards and asset performance.
Gehl: Unfortunately, a mismatch between short-term liabilities and longer-term assets can lead to these situations in challenging financial markets.
Signature Bank just last year launched a national healthcare banking and finance team. From the company’s 10K, that group had done several hundred million dollars of business.
There are several lenders out there to fill that void, but it is never good to see a source of capital put to the sidelines in the seniors housing space.
The banking impact does seem to be isolated specifically to a bank with outsized crypto exposure and another bank with outsized venture capital exposure, plus some poor asset/liability management as well. I wouldn’t expect that to create contagion for other players in the space, as the regional banks that were hammered in the equity markets have begun to see a recovery in their stock prices.
At the moment, I don’t see a material impact to seniors housing financing.
SHB: As a lender, which seniors housing property types are you most bullish and bearish on currently and why?
Adlerstein: We like them all so long as they can pencil out.
The one factor that is driving our pipeline is debt. Our general feeling is that investors’ appetites remain robust, but the returns need to work, and debt is currently the biggest hindrance to that.
We don’t see this as a debate between purchasing active adult versus assisted living properties, or buying an asset constructed in 1980 versus a brand-new asset that has never been leased for cost. Rather, most of the conversations we are having focus around where we can find yield.
Unless you’re a REIT paying cash, you need asset-level debt. Deals that we see trading have existing debt that is easily assumable or have a sponsor that is on board with some level of recourse and a strong balance sheet to back that up. If the stars align, folks still want to do deals.
Blount: We’re bullish on established operators in core markets, well capitalized projects, projects that have raised rents without negatively impacting occupancy and projects in primary markets with newer buildings.
We’re bearish on projects that utilize agency staffing without implementing strategies to reduce or eliminate their utilization of it; projects that opened prior to or during the pandemic with lagging lease-up rates; new entrants without an established brand; third-party managed properties without proper lease-up and NOI incentives (no skin in the game); and any project that is over-leveraged (over 80 percent), especially with variable-rate mezzanine debt.
Stoll: We are not bullish or bearish on certain property types, rather certain owners, operators and markets. There is a place in the market for every product type along the acuity spectrum. The trick is identifying the right sponsor, operator and location to be successful.
SHB: What has surprised you the most regarding the seniors housing lending environment in the last 12 months and why?
Gehl: I’ve been in the seniors housing lending space for over 20 years, so I wouldn’t say the current lending environment is surprising me.
In a rising-interest-rate environment with challenging industry fundamentals, you would expect to see bridge lending be harder to come by, which it is. You would expect volumes to be down for agency financing as deals are tougher to pencil out.
Adlerstein: It’s surprising (but in a very positive way) to note that lenders have continued to move forward despite the headwinds. They have stepped up to the table and continued to close strong deals for sponsors with solid track records.
The regional banks and even some local banks have played a huge role in keeping our industry moving forward through COVID, staffing concerns and now interest rate pressure. This really demonstrates the strong fundamentals of our industry and that we are here to stay.
Blount: I’m surprised by the pace of increasing interest rates and the number of lenders that have retreated or made terms unpalatable. Those terms can include lower leverage, higher recourse, higher cost of capital, treasury management requirements, interest rate caps funded out of pocket and higher thresholds for future distributions from excess cash flow.
Lewittes: The continued high volume of loan requests and capital activity is demonstrative of the continued growth of the industry. Despite significant hurdles over the past three years, the supply and demand story is still extremely compelling, thereby continuing to support high levels of investment in the sector.
Stoll: We have been pleasantly surprised by the number of regional and local lenders that have stepped in to provide liquidity to the market when most of the large national lenders have been unable to lend to the space.
SHB: Any predictions on what might happen in the next 12 months?
Gehl: I think 2023 loan production will be lower by over 10 percent as an industry. As the fundamentals remain challenging, the refinancing market will see fewer opportunities.
Blount: There will be several projects that are close to stabilization but still not meeting DSCR requirements. The patience of lenders will be tested, and some will not provide loan extensions, especially as rates continue to rise. It’s going to get worse before it gets better.
Expect delays in new developments due to higher cost of capital and construction costs, along with lenders requiring more equity for deals. This trend will result in pent-up demand for new developments.
Operators will be forced to pass along some of the higher costs to residents via increased rents. To date, most of our clients have been successful in increasing monthly/annual rates.
Stoll: It’s hard to predict the next 12 hours at the moment, let alone the next 12 months since things are evolving so quickly in this market.
At the time of writing this response, Silicon Valley Bank and Signature Bank have failed, the yield curve continues its inversion, and signs still point to a recession. This is both good and bad for our industry.
In the near term, financial instability will continue to reduce the available commercial bank capital for interim financing and result in increasing loan spreads. On the other hand, a modest recession is not necessarily a bad thing for our industry since it has been historically a counter-cyclical real estate play.
The Fed is now more likely to cease rate hikes and potentially cut rates sooner than previously expected to avoid further instability in the financial markets. This will provide some near-term relief to seniors housing owners that have been burdened by rising rates.
A modest recession will help check inflation and labor expense growth at the community level.
All seniors housing, but especially needs-based senior housing and care properties, will continue top-line growth driven primarily by occupancy improvements.
A decrease in interest rates, coupled with improving community fundamentals will result in more deals qualifying for permanent financing. This may relieve some of the bloated bank and debt fund balance sheets and eventually provide liquidity to the industry late this year and into next.
Lewittes: Given the volatility in the capital markets, the economy and geopolitical instability, it’s a bit tough to make predictions. But I do know that based on well documented demographic trends in this country, the demand for seniors housing will continue to increase and the long-term outlook for the sector remains quite strong.