If refinancing or developing, organizations must assess their appetite for risk
By Dan Hermann
The capital markets for not-for-profit senior living providers are as attractive as they have ever been, reflecting both a strong bank market and favorable conditions in fixed-rate bonds. Nearly six years of Federal Reserve measures to hold down interest rates are driving exceptionally low borrowing costs across the entire yield curve as well. This backdrop creates enticing financing options for seniors housing providers.
Determining the ideal financing source depends on the risk tolerance and preferences of the organization and its board, on the financial health and borrowing capacity of the organization, and on the purpose of the financing, such as new construction or refinancing. Clearly, financially strong organizations will have more options and fewer lending restrictions than those deemed riskier borrowers.
Bank lending versus fixed-rate bond markets
In recent years, the bank markets in the senior living sector have grown increasingly attractive. Prior to the economic crisis, the national or international banks largely drove bank lending in the sector. Today, a flood of regional and local banks has joined in. New players have been drawn to the sector by consistent asset performance, the growth of senior living communities and demographic trends showcasing the aging population boom.
Today, banks are generally providing loan terms of 10 or even 15 years, compared to pre-crisis terms of three to five years. Banks currently offer rates of 2.5 percent to 4 percent for 10 or more years, and borrowers can negotiate the best deal through competitive bidding by banks.
The fixed-rate bond market has also returned to all-time lows, with the exception of a few quarters in 2007 and 2012 when rates were even lower. Today, more institutional and retail investors seek higher-yielding paper. The fixed-rate bond market offers long-term rates on terms of 30 or more years in the low 4 percent to 5 percent range for investment grade-rated borrowers, and in the mid 5 percent to 7 percent range for non-rated borrowers.
What option is best?
If providers are planning large campus expansions requiring significant capital, or proposing to develop a new campus, then the bank market isn’t likely to be an option in most parts of the country. This reflects appraisal guidelines, which have become more stringent for bank lending since the economic crisis.
Another factor in choosing a source of financing is the flexibility of lending terms and covenants. In general, the fixed-rate bond market is the more flexible in its covenant terms, where banks can be more restrictive.
This is a key consideration in long-term growth and strategic planning, as borrowers consider how lending terms may impede or support future growth. Also remember that with a number of seniors housing providers now carrying both bank and fixed-rate debt, it is imperative to fully disclose debt to all parties.
For facilities that qualify for various FHA programs, such as licensed assisted living and skilled nursing, as well as for affordable senior housing properties, interest rates are around 4 percent for 35-year terms.
While this type of funding is appealing for some organizations, it is important to understand that future debt needs may be locked in to the FHA funding. Borrowers must consider how loans and covenants will impact future options.
Providers should prepare for a capital event
To access the lowest cost of capital, organizations eligible to secure a credit rating should consider doing so. Rates are clearly lower for rated debt than non-rated debt. A BBB rating can shave 25 to 75 basis points off capital costs. In the sector, the BB rating has become increasingly accepted and there are more BB issues today than there were a few years ago.
Second, focus on operational and financial improvement. An investment banker can guide the organization as to what metrics, such as days cash on hand or net operating margin, need to be improved or scrutinized in order to be a strong candidate for lending.
Lastly, assemble a strong team of qualified in-house experts or industry consultants and advisors. Ideally, every project should have a team of experts in construction, design, marketing and sales, and financial forecasting.
The biggest flaw that Ziegler finds among less-sophisticated organizations is the lack of a robust financial forecast. Be accurate and realistic in assumptions to achieve a successful financing. Industry experts can be the barometer as to what forecast is appropriate.
Refinancing considerations
It is a great time to refinance existing debt, and there are numerous opportunities to improve a capital structure by refinancing in today’s market. For those seeking financing for new development or campus repositionings, it might make sense to explore refinancing other existing debt at the same time. This refinancing can provide lower interest rates for the organization, and potentially more favorable covenants.
The not-for-profit senior living sector is open for business and highly attractive for both borrowers and investors, but seniors housing providers need to do their homework and evaluate options. In addition to the fixed-rate and bank market options, specialty structures are bringing more flexibility to the marketplace, working as customized tax-exempt structures that combine bank and fixed-rate characteristics.
Providers need to assess where they have internal expertise and fill in any gaps with the expertise of outside professionals. These experts not only assist in executing a successful project, but will advocate for the best interest rates and capital structure.