Influx of Capital Is Double-Edged Sword

Availability of financing leads to overbuilding in markets with low barriers to entry.

By Matt Valley

ATLANTA — An interesting conundrum is unfolding in the seniors housing lending space today, observes Ari Dobkin, a managing director with Meridian Capital Group. On one hand, there is a lot of overbuilding taking place in the market. On the other hand, there is an incredible amount of debt capital pouring into the space in the form of not only senior debt, but also mezzanine financing. 

“From an advisory perspective, we see a lot of liquidity in the market for the construction deals, and to that effect we’re able to get better deals for our clients,” says Dobkin.

His comments came recently during InterFace Seniors Housing Southeast. Hosted by France Media’s InterFace Conference Group and Seniors Housing Business at the InterContinental Buckhead Atlanta, the one-day conference attracted 436 professionals from all corners of the industry. Conference-goers gathered to network and attend a variety of panel discussions that focused on timely issues and trends.

Moderated by Richard Thomas, senior vice president and seniors housing product manager for Grandbridge Real Estate Capital, the capital markets panel participants in addition to Dobkin included: Paul Di Vito, senior vice president, KeyBank Real Estate Capital; Neil Gamss, senior vice president, Housing & Healthcare Finance; Dave Harper, senior vice president, Capital One Healthcare Real Estate; Adam Sherman, senior vice president, Live Oak Bank; and Derek Zeller, director of healthcare real estate, BMO Harris Bank.

Where to build?

If he were a developer, Dobkin said he would be targeting states known for high barriers to entry — those with high land costs or a challenging municipal approval process.

In New York, developers have to basically secure the equivalence of a Certificate of Need in order to build an assisted living facility, and that approval process alone can take a year-and-a-half, said Dobkin. 

Other panelists pointed out that the entitlement process in California for a seniors housing development can take as long as three to five years. “If you get approval to build in California, it’s amazing,” said Gamss.

Oversaturated markets are generally the easiest in which to build because the barriers to entry are comparatively lower, Dobkin pointed out.

In a press release from NIC addressing occupancy and construction trends in the third quarter, Chuck Harry, NIC’s head of research and analytics, stated the following: “San Jose retains the distinction of having the highest occupancy rate of any major market in the country, as significant barriers to entry constrain development. Houston, on the other hand, places fewer restrictions on development, which is pressuring occupancy.”

Of the 31 metro markets that comprise NIC’s primary markets, San Jose and Minneapolis posted the highest occupancy rates in the third quarter at 95.5 percent and 91.3 percent respectively. Las Vegas and Houston posted the lowest vacancy rates at 82.3 percent and 81.5 percent respectively.

Live Oak Bank favors markets with diverse local economies, said Sherman, but they don’t necessarily have to be big metro areas. His reasoning is that even a small market with a strong economy can help grow the base of adult children, which in turn can help attract seniors who want to be located near them. 

Conversely, some markets in Florida give Sherman cause for concern because of the possibility that a portion of retirees who relocated from the north to the Sunshine State years ago may opt to not reside there permanently.

“We are looking for more of a defensive play with respect to the local economy and surviving what might be coming down the line,” he added.

Based in North Carolina, Live Oak Bank has a national seniors housing platform that focuses on the “small loan space,” which it defines as loans under $15 million. “Think of us as an alternative to a community bank,” said Sherman. 

Irrational exuberance?

One troubling trend that Dobkin sees taking place across the industry today is developers’ tendency to be overly optimistic when it comes to lease-up rate projections for newly constructed facilities. “They are being too liberal on their projections for the actual fill-up rate, and that is causing a lot of issues with their lenders. And do [borrowers] have enough cash reserves to deal with that?”

Some banks in Florida are feeling the stress of protracted lease-up periods for newly opened facilities, said Dobkin. Trying to avoid loan workouts if possible, the banks have reached out to Meridian for help. 

“It’s not that they don’t believe in the longevity of the project. It’s just taking too long to get there. We’re seeing two-and-a-half and three years and [these facilities] are still not filled up,” pointed out Dobkin.

Dobkin’s comments sparked several questions from Thomas. If a project fails to lease up quickly and misses its pro forma plan, are lenders requiring the joint venture developer, the partner in the project, to provide some capital infusion? How flexible are lenders willing to be?

KeyBank is looking for some sort of validation that the proposed turnaround plan — such as bringing in a new operator — makes sense and is likely to work, said Di Vito. “What does the horizon look like for the turnaround plan? We’ll take the added risk if there is smart equity validating the turnaround plan. If it’s the same developer or operator with just the ‘we’re going to add this service’ type of approach, that is a very tough sell.”

Harper of Capital One Healthcare Real Estate says his team has looked at plenty of stalled lease-up deals. “The good news is that construction costs have gone up so much over the past two to three years. Many 2015 or 2016 vintage properties that are experiencing issues leasing up were built well below current replacement cost. Therefore, our loan is so much lower than what anyone else can build it for today; we’re willing to take some risk on that. We may require a reserve or a guarantee depending on whether the property can cover our debt service, but those are pretty good deals for us.”  

Resurgence of independent living

After being overshadowed by the assisted living and memory care segments of the seniors housing industry over the past several years, independent living is enjoying renewed interest from developers and investors, according to Dobkin, who says Meridian is currently working on some large independent living finance deals.

“Cap rates are coming back down on the independent living product. It’s a product that has been overlooked in the market until now,” pointed out Dobkin. “I think we can all agree that the standalone memory care facility experiment has gone pretty badly for most people that have tried it. We’re starting to see a lot more people go to the lesser services end of the market as opposed to more services.”