Loans to build new seniors housing are smaller and more difficult to find, but projects are still coming out of the ground
By Bendix Anderson
Time to send some flowers to your favorite construction lender. With many banks declining to make construction loans or refusing to lend as much as they did just a year ago, seniors housing developers are carefully cultivating relationships with debt financing sources.
“Financing is getting harder to come by,” says Fred Moon, principal with developer and owner Capitol Seniors Housing (CSH) headquartered in Washington, D.C., which owns 24 communities in areas including the Pacific, Atlantic and Gulf coasts and Chicago.
Lenders now worry about the risk of overbuilding and restrictions on bank capital due to government regulation. Many banks are making fewer construction loans. Others are making smaller loans and demanding more guarantees from developers, implementing tougher underwriting standards and requiring more detailed market studies.
“Winter is coming,” says Moon. “We are going to get to the point where many lenders will say they are not taking on new relationships.”
Developers cling to lender relationships
To make sure that it has access to the money it needs to build, CSH is focusing on relationships with larger regional and national banks, which are likely to continue lending even as the real estate cycle progresses.
A year ago, CSH might have been more willing to do business with smaller banks, which sometimes offered interest rates as much as 25 to 50 basis points lower than national lenders for construction loans and streamlined approval processes. “Now, we are looking less for new relationships,” says Moon. “Instead we focus on relationships that we are looking to fortify.”
Banks are also increasingly wary of providing loans to developers without some kind of guarantee. These loans are still available, but banks now make smaller non-recourse loans relative to the size of the property.
“We remain cautious as we move further into the cycle,” says Kevin Murray, senior vice president at Cleveland, Ohio-based KeyBank Real Estate Capital. “We want our borrowers to have skin in the game.”
Overall, banks now offer non-recourse construction financing that covers 50 to 65 percent of the cost of seniors housing developments, down from 65 to 70 percent earlier in the recovery. “We’ve seen a lot of banks pull back,” says Russell W. Dey, vice president of real estate finance for Walker & Dunlop.
CSH now has 14 seniors housing projects in its development pipeline, with an additional two properties currently under construction. It needs non-recourse construction loans to satisfy the requirements of its equity investors. It is still able to
find non-recourse construction loans that cover 55 to 60 percent of the cost of its projects in strong, high-barrier-to-entry markets.
The loans get larger if developers are willing to offer guarantees pledging they will successfully complete their projects.
In April, Balfour Senior Living, based in Louisville, Colo., broke ground on a 78-unit assisted living and memory care community in Denver, Colo., called Balfour at Stapleton. Community & Southern Bank, based in Atlanta, provided a $15 million loan that will cover 70 percent of the cost of development. Balfour received a larger loan because its capital partner agreed to put up its balance sheet as security and accept financing with 100 percent recourse.
“A year ago we could have had a non-recourse loan on the project for about the same loan-to-cost, or maybe 5 percent less,” explains Michael Schonbrun, CEO of Balfour Senior Living. “Or we could have had a loan with full recourse, like this ended up being, at 75 percent loan-to-cost, rather than 70 percent.”
Quality matters to lenders
Banks may also hesitate to lend at all, especially to developers who lack experience with seniors housing.
“Lenders are much more picky this year than last. They want to know you have a track record,” says Mark Myers, executive director in the Chicago office of Institutional Property Advisors, a division of Marcus & Millichap.
Lenders also prefer borrowers who have experience in the particular market where they want to build. “We would rather see a sponsor have three properties within close driving distance of one another versus one property in each of three non-contiguous states,” says Erin Peart, senior vice president for Wells Fargo in Washington, D.C. “We like borrowers who have local knowledge of their markets.”
That knowledge will also help borrowers navigate the local labor markets to make sure their communities are properly staffed on opening day. Developers knowledgeable of the area will also be more likely to be aware of any proposals to raise the local minimum wage.
Borrowers with strong balance sheet and long track records are attractive to lenders. “The sponsors we work with are generally well capitalized” says Murray. In this case, ‘sponsors’ refers to the partners who have created a development project and own a stake in its limited liability partnership, even if they have declined to guarantee the construction loan.
For example, CSH only uses non-recourse debt for its properties. It can’t be forced to pay if a loan fails — the bank’s only recourse is to take the property, which may be unfinished. However, lenders still favor sponsors that have strong reputations and strong balance sheets that could potentially be deployed to shore up troubled development projects.
“Banks are asking for stronger sponsors who can solve problems,” says Jonathan Voight, director of KeyBanc Capital Markets Real Estate Syndications Group.
Banks under pressure
New financial regulations have put pressure on the commercial banks that make most construction loans. These rules effectively limit how much risk they can absorb on their balance sheets.
“The regulatory environment is having an impact,” confirms KeyBanc’s Voight.
Years after the global financial crisis, bureaucrats have finally implemented regulations like the international Basel III banking standards and the Dodd-Frank Financial Reform and Consumer Financial Protection Act in the United States.
Among other things, the rules require banks to hold capital in reserve to cover potential losses on investments, including loans to commercial real estate.
As these rules finally begin to be implemented, many banks are finding they have already lent up to their limits. They will need to make fewer or smaller loans unless they put more money in reserve to cover the risk of the loans, or until borrowers pay back the loans lenders have already made.
Overbuilding threat gives pause
Lenders also worry that developers have already started construction on too many seniors housing communities.
“The suspicion in the industry is that lenders are concerned about the overall state of the economy and that in selected markets overbuilding may be exceeding demand, at least until the Boomers arrive in the next seven to 10 years,” says Schonbrun of Balfour Senior Living.
Developers had 496 seniors housing properties under construction, totaling 50,000 seniors housing units, in the top 99 markets tracked by the National Investment Center for Seniors Housing and Care (NIC) in the second quarter. These projects represent 5.8 percent of the existing inventory of seniors housing, including independent living, assisted living and memory care.
From a historical perspective, that’s a lot of new construction. Since 2008, the number of units under construction as a percentage of total inventory has averaged 3.5 percent.
Until now, strong demand for seniors housing has helped operators lease up their properties. “There doesn’t seem to be any letting up of demand for good projects,” says Myers.
In the second quarter, 89.7 percent of seniors housing units were occupied in the United States on average, according to NIC data, including both assisted living and independent living properties in the 99 largest metro areas.
The occupancy rate has fluctuated little since 2012. “It’s been moving around that level for a while,” says Beth Burnham Mace, chief economist and director of capital markets research at NIC. The highest occupancy rate was 90.4 percent in 2014.
Over the last year, developers seem pulled back on the number of new projects they have planned.
“There has been a leveling off,” says Mace. For example, the number of units now under construction is equal to 5.8 percent of the current inventory, down slightly from 6.0 percent at the beginning of this year.
Still, certain markets are overbuilt, says Murray. San Antonio, Houston and Dallas are near the top of the list for the amount of new seniors housing now under construction (see tables, page 38). All three markets already suffer from occupancy rates well below the national average.
“Texas has a lot of new construction,” says Myers. “There are some markets in Texas that are already overbuilt that everyone says are going to get worse.”
However, the dynamics of individual submarkets are much more important than the balance of supply and demand across an entire metro area, say industry experts. That’s largely because seniors and their adult children often want to live near each other. Often, the adult children of seniors start their search with communities that they see on their drive to work or while running errands near their home.
An ideal location, near many of these adult children, may perform well even if competing properties are opening nearby. “An amazingly located property in Austin, Texas? Despite the competition, I’m sure you’re going to be fine,” says Myers.
Other lenders are concentrating on markets where new construction is likely to be difficult to undertake. “We are focused on markets with long barriers to entry,” says Wells Fargo’s Peart. “It takes a long time to get through entitling.”
Lenders are now paying extra attention to market studies, looking carefully at particular submarkets and the data concerning penetration rates around a planned project, says Myers.
A penetration rate shows what percentage of the seniors in an area already live in seniors housing. Across the largest 99 metro markets in the U.S., the average penetration rate is around 10.7 percent, according to NIC. Usually, experts would consider a market with a high penetration rate to be potentially already saturated with seniors housing.
However, a penetration rate can mean very different things depending on the opinion that local seniors have of seniors housing. “You have to be careful with market studies,” says Myers. “One market with a high acceptance rate for seniors housing may have 15 percent penetration rate and still benefit from additional seniors housing development. In another submarket, where seniors have other options or is not as popular, a 7 percent penetration rate may be too high.”
As occupancy rates sag and more new seniors housing communities compete to fill new units, lenders expect the cost of leasing up a new seniors housing property to increase. “For a good sized project, the cost of competing now results in lease-up costs that can far exceed the $1 million traditionally used in underwriting for lease-up costs,” says Myers.
Construction lenders are becoming increasingly skeptical about operators’ rent projections for properties under development.
“We want to be careful what rents we are underwriting to. We underwrite to existing rents and occupancy rates,” says KeyBanc’s Voight. “If rents grow 3 percent a year during the planning stage, don’t assume rents will be 10 percent higher during lease-up. That is a lesson we learned from the last downturn.”
Tougher underwriting from banks may help keep some markets from getting as overbuilt as they otherwise might. “This is actually a good thing for everyone,” says Moon. “Marginal projects and first time or less experienced developers may not get funded, creating another barrier to entry.”