Overall deal volume through the Section 232 LEAN program is on pace to fall sharply in FY 2014, but lenders are still seizing opportunities.
By Matt Valley
After achieving a record $5.8 billon in loan production for seniors housing in fiscal year 2013, the U.S. Department of Housing and Urban Development’s Section 232 LEAN Program has hit a wall.
The latest forecast calls for HUD LEAN lenders to close $3 billion in loans during FY 2014 (which ends Sept. 30) based on the current pace of activity. That’s nearly half the loan volume achieved during FY 2013, according to Lee Delaveris, a director with Columbus, Ohio-based Red Capital Group. The total number of loans projected to close this fiscal year, 400, also is down substantially from 766 in FY 2013.
Delaveris attributes the lighter volume to a precipitous drop in the refinancing of existing HUD loans — otherwise known as 232/223(a)(7) loans — for skilled nursing and assisted living facilities. Many HUD borrowers took advantage of the opportunity to refinance in FY 2012 and FY 2013, a period when interest rates were at historical lows, so that business has largely dried up.
“Red Capital is right in line with the trend. We’re seeing the (a)(7) portion of the business, the refis of existing HUD loans, declining as a proportion of business,” says Delaveris. “Dur-ing the last few weeks, however, as interest rates have come down again we’re revisiting some deals that were put on the shelf in the middle of last year.” (Red Mortgage Capital, the mortgage banking arm of Red Capital Group, closed more than $450 million in HUD LEAN loans in FY 2013.)
About 80 percent of the HUD LEAN loan volume during FY 2014 has been tied to 232/223(f) loans for acquisitions and refinancing. Construction financing also is picking up, but it still represents a small portion of the business. That’s a stark contrast to FY 2013, when (a)(7) loans accounted for the lion’s share of the business (61 percent), says Delaveris.
Rush to refinance
The industry will look back at FY 2013 as a high-water mark for HUD lenders active in the seniors housing space, says Leonard Lucas, senior director with Love Funding based in the Boston office. “If you didn’t make money in this business in fiscal year 2013, you have a problem.”
In September 2012, the 10-year Treasury yield fell to as low as 1.76 percent. (As of press time, the 10-year yield, a benchmark for permanent, fixed-rate financing in commercial real estate, was
2.6 percent)
Such incredibly low rates not only motivated property owners to refinance, but they made it possible for more loans to be “refinanceable,” says Lucas. Borrowers facing prepayment penalties could afford to take the hit and still come out ahead financially in the long run.
In 2013, Lucas closed a $120 million HUD refinancing transaction involving six skilled nursing facilities. The borrower elected to refinance, even though the existing loan was not nearing maturity. The borrower faced a combined $17 million in assorted termination and loan defeasance fees to get out of the existing loan.
“Some of these fees were not eligible to be paid out of the proceeds from the new HUD loan because of HUD regulations,” recalls Lucas. “The borrower had to pay about $1 million of those $17 million in fees out of pocket. He elected to go forward with this because in his mind, and I think correctly so, he saw this as a once-in-a-lifetime opportunity to obtain the lowest rates possible on a 35-year, fixed-rate self-amortizing loan.”
Even though the LEAN program’s loan volume is down overall this fiscal year, some lenders are bucking the trend and reporting an uptick in lending business. KeyBank Real Estate Capital closed 14 loans totaling $130 million through the LEAN program in FY 2013, says Allison Holland, the company’s national sales manager for healthcare mortgage banking based in Dallas.
“We’re on track this year to do about 40 loans at approximately $370 million in volume. That’s a pretty substantial increase from last year. We’re hoping that may put us in the top 10 list of LEAN lenders based on where the production ends up in FY 2014,” says Holland. KeyBank’s LEAN deal volume in FY 2014 is almost exclusively acquisition financing and refinancing, but there are no (a)(7) loans in the pipeline.
KeyBank is in the process of refinancing one of the most high-end skilled nursing and rehab facilities in the country in Princeton, N.J. Holland declined to name the community because the deal is still pending. The facility is located on a hospital campus that is extremely green and captures a high-end, affluent market for skilled nursing and rehab services. The sponsor is Windsor Healthcare.
“Keybank financed the construction of the project and has seen it come full circle and now we are underwriting it for a HUD takeout, and it’s one of the most impressive skilled nursing and rehab projects that I’ve ever walked during my career. It’s going to be a star in HUD’s portfolio for sure in 2014,” predicts Holland.
High-touch approach pays off
A boutique company specializing in financing HUD-insured healthcare facilities and multifamily properties, Housing & Healthcare Finance LLC (HHC) is enjoying a great run. Through the first half of FY 2014, the Chevy Chase, Md.-based lender accounted for 23 percent of all loans closed through the HUD LEAN program, or more than $600 million. The firm said in mid-June that it expected to close an additional $125 million in loans within 45 to 60 days.
In HUD’s FY 2013, HHC closed nearly $500 million, so the company is clearly ahead of last year’s pace, even as the overall lending volume through the LEAN program in the seniors housing space is on track to drop sharply.
HHC founder and CEO Erik Lindenauer, who has worked in the mortgage and investment banking industry for the past 18 years, credits the firm’s strong deal pipeline in FY 2014 to the high-touch approach it has with borrowers.
“We do a fair amount of upfront work in pre-qualifying deals, and we go deep with our borrowers,” he explains. “We try to form very tight relationships with them, and we go the extra yard for them when it comes to other products — non-HUD options, such as mezzanine, bridge, or accounts receivable financing, which helps create a deeper relationship.”
Lindenauer estimates that 60 to 65 percent of HHC’s deal volume stems from repeat business. “The rest of it is all word of mouth.”
HHC recently closed the largest HUD 232/223(f) loan ever provided. The nearly $68.7 million loan was used to refinance Lincoln Park Care Center, a 547-bed, 234-unit skilled nursing facility in Lincoln Park, N.J. The facility, which is the largest privately operated nursing home in the state, is currently 98 percent occupied.
Center Management Group, which purchased the Lincoln Park Care Center in December 2012, was the borrower. Not only did the HUD loan refinance all of the existing debt on the property, it also financed capital expenditures, according to HHC.
HHC also recently closed the largest HUD-insured portfolio this year, which consisted of 25 skilled nursing facilities located in the Southeast totaling approximately $204 million. The 232/223(f) loans refinanced existing conventional debt placed on the properties. The HUD loans will provide stabilized, long-term debt at a fixed interest rate and fund capital expenditures.
The deal had to clear a number of hurdles before coming to fruition, according to HHC, including adapting to new HUD documentation required as part of the financing process and a simultaneous close on 25 properties in three states.
While the refinancing of existing HUD loans accounted for 61 percent of all deal volume in the HUD Section 232 LEAN Program during FY 2013, that was not the case at HHC where such loans represented only 16 percent of its overall lending total during the same period.
“We not only do one-off deals,” emphasizes Lindenauer. “We’re one of the few firms that have closed numerous portfolio transactions, ranging from $90 million to $250 million. That has obviously helped our production, it’s helped our market share.”
A lender financing a portfolio of properties versus a single asset has to go through two different approval processes, points out Lindenauer. “We have a portfolio team that focuses on either large loans or multiple transactions.”
Banner FY 2013 for Capital Funding
Baltimore, Md.-based Capital Funding LLC closed 342 deals total-ing $2.2 billion from the inception of the HUD LEAN program in 2008 through FY 2013. That’s more deal volume than any other HUD healthcare lender during that period.
During HUD’s FY 2013, Capital Funding closed 112 loans totaling $669.4 million, second only to Lancaster Pollard, which closed 118 loans for $811.7 million in volume.
Capital Funding, which targets all long-term segments of seniors housing, enjoyed a record year in FY 2013 as a mortgage lender in the LEAN program. “We were north of 10 percent of HUD’s healthcare volume last year. We expect to probably be north of 10 percent of HUD’s healthcare volume this year,” says Erik Howard, managing director of the real estate finance group at Capital Funding.
Through June 30 of FY 2014, Capital Funding closed approximately $200 million in mortgages. The 232/223(f) loans accounted for $117.1 million of that total. Meanwhile, the 232/223(a)(7) loans represented only $7.6 million of that total.
The balance of Capital Funding’s deal volume through June 30 was split between new construction ($20.6 million), loan modifications ($35 million), and supplemental loans or secondary loans for renovations or additions to existing HUD-insured facilities ($20 million).
Brisk business for bridge loans
Many of the 223(f) loans that Capital Funding provided in fiscal 2013 were refinancings of bridge loans originated by affiliates of Capital Funding. For example, through its affiliates, Capital Funding will lend a buyer money to acquire a skilled nursing or assisted living facility. To the extent required, once the facility reaches a level of stabilization it can be refinanced using HUD debt.
“Capital Funding will take that loan to HUD and submit an application to refinance the bridge debt of its affiliated companies,” explains Howard. “We have a bank, CFG Community Bank, that provides real estate and accounts receivable financing. Through Capital Lending and Mortgage Group, our commercial finance company, we also provide bridge real estate financing as well.”
Earlier this year, Capital Funding closed a $36.8 million bridge loan and $7.5 million accounts receivable line to finance the acquisition of a skilled nursing portfolio in Massachusetts. The bridge-to-HUD loan involved four facilities. The borrower acquired all four properties from a single “mom and pop” who was looking to sell.
“The borrower/operator will basically bring its economies of scale to the facilities to add expense savings as a multi-facility owner and operator, as well as make some renovations and upgrades to each property,” says Howard. “Once the borrower/operator completes the plan to add additional value to the facilities, we will take them through the HUD application process, close and then continue to service the loan.”
Capital Funding services more than $2 billion of loans in its portfolio, a point Howard drives home to prospective clients.
“As important as it is on the front end to pick the right lender that can help you navigate the process, dealing with that same lender for potentially five, seven or 10 years after the loan closes is equally as important,” says Howard. “You need to have someone who is an advocate for you and who understands the HUD asset management program, who understands how to work with you on any challenges that may arise.”
Who is the prototypical borrower?
Historically, the HUD lending program was intended for moms and pops who were able to borrow at low rates and who may have had no other alternative to secure a low cost of capital. “As the program grew over the years, it became a program that was more for long-term holders of assets, which again typically were relatively smaller, private entities,” explains Howard.
“A lot of that had to deal with the way the deals were structured. If you look back at 2000–2004, when you did a HUD loan you were precluded from prepaying that loan for 10 years.”
As the program has become more widely used over the past five to seven years, and owners of facilities have different investment horizons, those prepayment penalties have continued to change, adds Howard. “You can actually close a HUD loan and it can be fully pre-payable in that first year.”
From his point of view, Lucas of Love Funding says the prototypical HUD borrower is simple to sum up: “It’s everybody but the REITs. The REITs have easy access to very inexpensive capital and they head in that direction.”
Delaveris of Red Capital says that the last few years have shown that HUD can work for any borrower. “The program has attractive terms that are enduring in any interest-rate environment: non-recourse, long-term, fully amortizing, fixed-rate. Our client composition shows that to be the case — from small mom and pops, owners of one or two facilities, up to some of the largest regional and national operators.”