Capital Stack Shifts

Seniors housing lending isn’t dormant, but lenders and borrowers alike rethink their strategies as the pandemic continues.

By Jeff Shaw

The COVID-19 pandemic has been a shock to the entire seniors housing industry at every level, and capital providers in the sector are no exception. 

With occupancy at record lows, lenders and investors understandably have changed strategies to protect their investments. Occupancy continued its free-fall in first-quarter 2021, falling 870 basis points year-over-year to 78.8 percent for private-pay seniors housing, according to the National Investment Center for Seniors Housing & Care (NIC).

“We certainly tightened up our underwriting, avoided any turnaround situations, added additional debt-service reserves, implemented additional stress testing on projections and took a closer look at a sponsors’ overall portfolio and their ability to support their overall operations,” says Donald Clark, senior vice president at lender Old Second National Bank.

“Greater emphasis was placed on underwriting to a sustainable net operating income (NOI), taking into account increased operating expenses and limitations on new leasing activity,” adds John Powell, executive vice president at Bellwether Enterprise. 

“Fannie Mae, Freddie Mac and FHA have implemented debt-service reserves to help guard against reductions in NOI. While strength and experience of sponsorship has always been an important component of underwriting, it has and will continue to take on greater importance going forward.”

Despite the upheaval caused by the pandemic, several capital sources provided more funds to the seniors housing sector in 2020 than in 2019, including Greystone, Locust Point Capital and Wilshire Finance Partners. Locust Point reports that its total investment commitments were 70 percent higher in 2020 compared with the previous year.

Greystone credits low interest rates and high demand for seniors housing as driving factors.

“We also saw a rise in bridge lending as part of a transition process for many investors, whether it was for immediate acquisitions or to build occupancy before pursuing a permanent financing option, such as HUD-insured financing,” says Cary Tremper, head of seniors housing lending at Greystone. “The fundamentals for seniors housing are strong, such as interest rates and demographics so we expect demand to continue to grow.”

As some traditional lenders fled the sector, capital providers that specialize in seniors housing suddenly heard the phone ringing more often, according to Don Pelgrim, CEO of Wilshire.

“We saw a dramatic increase in inquiries during the pandemic as certain lenders pulled back or stopped lending entirely. Wilshire is a portfolio lender that does not sell, securitize or leverage its loans. As a result, there was little to no impact on our ability to lend throughout the pandemic. That said, our advance rates and loan-to-value ratios were moderated, and more structure was employed to ensure that borrowers had sufficient capital and reserves to weather the unknown impacts of the pandemic.

“We generally reduced our loan-to-value (LTV) ratio to 60 to 65 percent across the board on first liens and stopped making second liens entirely. Prior to the pandemic, we would consider LTV up to 75 percent.”

However, he adds that Wilshire’s terms have come back to near pre-pandemic normal.

“Today, we are using lending parameters that are closer to, but not exactly the same, as the pre-COVID parameters for strong sponsors on purchase transactions in primary and secondary markets. It is the same on value-add opportunities where the path to stabilization is short, involving loan requests just outside the banker’s credit box.”

Strong operators survive

In short, for many lenders, the strength of the seniors housing sector was clearly visible despite the challenges presented by the pandemic.

“We saw the seniors housing sector adapt quickly to operational changes, and found that quality sponsors and operators were well positioned to make those changes,” says Tremper.

As far as new lending requirements, Clark says borrowers have to prove that they have their ducks in a row when it comes to handling COVID-19 in their communities.

“In all cases, we require from management a plan to deal with COVID issues as well as how management intends to deal with infection going forward,” says Clark. “This includes vaccinations, visitor management and HVAC systems.

“In addition, we generally decreased leverage and were more selective in choosing those deals that we ultimately pursued, looking for operators that had long track records of success and the financial wherewithal to survive a sustained slowdown, as we ultimately have seen. Finally, we did not close on any development/construction transactions during the year.”

Where does mezz fit in?

With lenders requiring more leverage, some traditional banks staying out of the sector and construction lending hard to come by, could mezzanine lending be the glue to bridge that gap? Experts had varied responses.

Eric Smith is CEO and managing partner at Locust Point Capital, which offers mezzanine financing. He says mezz lending is a great opportunity to allow borrowers to reach their preferred amounts of debt.

“In general, we have seen senior mortgage leverage come down anywhere from 5 to 15 percent on loan-to-cost ratios for new construction. Over the last several months, we have seen traditional construction lenders have a difficult time achieving the borrower’s leverage ask. Our capital can help bridge that gap not just for the borrower, but also for our senior lending partner.

“Total leverage (senior loan plus mezz) has dropped from pre-pandemic to post-pandemic by approximately five to 10 points. Besides total leverage, other mezzanine terms have not changed significantly from pre-pandemic to post-pandemic. Rates have generally held steady in the low to mid-teens, covenants have tightened slightly and recourse is more prevalent.”

Old Second, meanwhile, declined to pursue most opportunities that involved mezz lending, according to Clark. In most cases, debt funds and other non-bank lenders stepped up to complete the capital stack, he points out.

Pelgrim says he did not see much difference in the total amount of mezzanine financing before the pandemic compared to now.

“We have not seen a dramatic uptick in lenders willing to provide mezzanine and other forms of subordinate financing. That said, for the right sponsors and facility, mezzanine and other forms of subordinate capital are available, albeit not at pre-COVID levels.”

‘Capital on the sidelines’

So what does the future look like for lending in the seniors housing sector? Experts disagree on the exact timeline, but all expect a turnaround is imminent.

“Greystone is optimistic on seniors housing lending volume for 2021,” says Tremper. “We are finding that sponsors and operators are adjusting to a new normal and are planning for how to grow their portfolios. There is certainly available capital on the sidelines, and we are working with clients to find the best financing solutions to achieve their goals.”

“We think construction lending will continue to be tight through the end of 2021, with possibly some loosening toward the end of the year, depending on how occupancies recover,” adds Smith.

That slowdown may have some long-term benefits for the sector, though.

“Overall, with the slowdown of new construction starts, we expect to see some benefits to occupancy levels in general,” continues Smith. “But we would caution that with development timelines of 14 to 24 months, it will take some time for the current dynamics to effect new openings as those projects opening today were by and large started pre-COVID.”

The pace of vaccine rollout is the real key to long-term recovery, says Powell.

“We expect lending activity will remain slow for the first half of 2021. However, we expect activity to pick up in the second half as the rate of vaccinations continues to increase, resulting in improved leasing activities as properties are able to open up.”

Clark agrees that vaccination will eventually bring up occupancy levels — but notes that everyone will have to be patient until that  happens.

“We are hopeful that occupancy levels return to pre-pandemic levels once vaccinations reach higher levels and fear of the virus subsides, but expect that this will take some time,” says Clark. “It appears that many projects that were put on hold during the height of the pandemic are being pulled off the shelf and are now looking for financing.

“We are being selective, but entertaining construction deals on a limited basis, with the hope that by the time these projects are underwritten and built that the worst of the current environment is behind us.”