As lenders look for safe, secure deals in a turbulent environment, strong partnerships are a larger consideration than geography, age or care type.
By Jeff Shaw
In times of trouble, we look to the people we trust.
That’s certainly the approach of many lenders in the seniors housing space. As the recovery from COVID-19 continues, and occupancy rates remain well below pre-pandemic levels, financing has become dangerous terrain. So when looking for who should get favorable rates and terms, lenders are looking to the operators and markets they know can deliver results in the long term.
That was the message from many of the lenders Seniors Housing Business spoke with regarding the current and future state of financing in the seniors housing sector. Below are edited transcripts of the discussions.
Seniors Housing Business: What is your lending specialty within seniors housing? Also, do you have a sweet spot in terms of deal size?
Lawrence Brin: MidCap Financial is uniquely positioned in the seniors housing capital markets as a non-bank bridge lender with a robust balance sheet that can also offer all the HUD and agency loan products.
MidCap typically serves higher-touch situations for which conventional financing is not available or optimal — value-add acquisitions, recapitalizations of properties prior to stabilization and other complex situations that require creativity and deep industry expertise.
MidCap has had a dedicated business focused on the seniors housing market since its inception in 2008, and its management team has been active in the sector since the early 1990s. As such, we have strong command of the asset classes, operators, markets, business cycle, opportunities and risks, all of which enhance our ability to underwrite and execute. Moreover, we hold all our loans on balance sheet and service all our relationships in house.
Our minimum transaction size is $10 million; there is no maximum transaction size.
Brendan Healy: We have a proprietary bridge loan platform on balance sheet, as well as two different debt fund vehicles. We utilize our debt funds and balance sheet for acquisitions, refinances, recapitalizations and renovations. The diversity of our bridge platform allows us to offer limited recourse and nonrecourse financing, as well as higher leverage options for value-add acquisitions.
On the permanent financing side, we are an FHA/HUD LEAN lender, and can execute on GSE (government-sponsored enterprise) products through our correspondent lending relationship. One of the most significant benefits of the combination of our balance sheet and debt funds is that we have the ability to execute on small and very large transactions well in excess of $100 million. We have several strong syndication partners, but generally don’t have the need to syndicate our loans.
Mike Coiley: As a national platform for First Citizens Bank, a top 20 U.S. bank, we’re actively engaging with our clients on deals from construction through long-term stabilized financing. We’re most comfortable with an “age-in-place” component; therefore, we prefer an acuity mix where the residents’ average length of stay can be extended as their needs evolve.
Our sweet spot is constantly evolving along with the market. We have a strong capital markets team, which allows us to execute large, complex transactions alongside the traditional “cookie-cutter” opportunity.
Dave Harper: Our team has nearly 20 years of lending experience within the seniors housing space. We continue to be active utilizing our balance sheet and originating on behalf of GSEs.
Our ability to work alongside our clients to understand their goals has set us apart. We adapt our offerings to suit their business plans rather than focusing on any specific product or structure. While most of our deals are in the $20 million to $60 million range, we are also able to finance larger commitments over $100 million for the right transactions.
Ryan Stoll: Our platform is unique in that we can provide debt capital to owners of all seniors housing and care asset types/acuities from construction to permanent financing. BWE is a Fannie Mae DUS lender, Freddie Mac Optigo lender and FHA/HUD LEAN lender. We can provide direct construction, acquisition and bridge balance sheet capital for all seniors housing and care asset types through our minority owner, Fifth Third Bank. Finally, we have the expertise and capabilities to provide financial intermediary services to source project level and programmatic debt and equity.
Depending on the nature of the engagement, deal sizes for single assets are typically $20 million to $100 million, with some variance. Portfolio deal sizes can stretch well into the hundreds of millions.
Rich Malloy: Synovus Bank’s Senior Housing & Healthcare Lending (SHHL) line of business is primarily focused on rental, private-pay seniors housing communities that offer independent living, assisted living and memory care services; and skilled nursing facilities that are owned/operated by experienced sponsors with longstanding track records.
With regard to commitment hold positions:
• Construction Loans: Targeted maximum hold position of $40 million.
• Term Loans — Single Property: Targeted maximum hold position of $50 million.
• Term Loans — Multiple Properties: Targeted maximum hold position of $50 million, but if sponsor is an existing long-term client of Synovus, the bank has more flexibility.
SHB: What did your volume look like in 2021 compared to previous years?
Brin: MidCap had a very active year during 2021. We originated over $460 million of healthcare real estate loans, of which approximately $345 million was attributable to seniors housing assets.
During the past couple of years, MidCap has offered the market alternative debt capital to enable owners and operators to navigate the multiple obstacles the senior living sector has faced. During 2021, MidCap financed newer developments that faced construction loan maturities and needed additional time to stabilize; opportunistic acquisitions by institutional sponsors; and portfolio recapitalizations for established owner-operators.
Healy: Our company is relatively young, launching in April 2020. That said, we financed over $600 million in 2020, nearly $700 million in 2021, and have a $1.2 billion engaged financing pipeline currently. This spans the whole range of balance sheet, debt fund, FHA and GSE financings, and has a nice balance of skilled nursing versus seniors housing.
Our engaged deal sizes range from just over $2 million, all the way to well north of $100 million.
Harper: In 2021, there was less activity across the industry, similar to 2020. Our volume was down on the agency side, which tracked with industry-wide trends, and our balance sheet volume was similar to what it’s been in previous years.
Stoll: Our deal volume was up significantly compared to previous years. However, we attribute this increase to an expansion of market share rather than general market conditions.
Malloy: For full-year 2021, SHHL closed on $1.2 billion in new loan production versus the full-year 2020 production of $924 million.
2020 and 2021 were record-breaking production years for SHHL as our group continued to lend during the pandemic while other lending institutions strategically decided to pull back on new volume until the pandemic showed signs of subsiding. Prior to the onset of the pandemic, the average loan production for the five-year period of 2015 to 2019 was $685 million.
COVID leads to change
SHB: Have your underwriting standards shifted back to pre-pandemic norms?
Healy: We have continued to evaluate financing opportunities with a focus on what was achieved historically, through the pandemic, and what can realistically be achieved in the near-term and upon re-stabilization. We focus heavily on the operator as a whole, their experience in the space, strategies during and coming out of the pandemic, and their vision for the particular asset we are financing.
We don’t expect the in-place cash flows to support a permanent takeout on day one, and focus more on the trend line of the particular asset, as well as the market that asset is in. So our focus really is: Is there cash flow? How viable is the pro forma/budget? Do we believe strongly in the story and the ability to stabilize this asset to execute on the permanent takeout of our loan?
Coiley: Seniors housing is a very local business. While a handful of markets appear close to pre-pandemic norms, many others remain under heavy pressure from the expense side combined with soft/inconsistent absorption rates. While we continue to include these factors in our analysis, we are long-term lenders and remain optimistic on the sector.
Harper: We’ve continued to actively lend in the seniors housing space over the past 24 months while taking a slightly more conservative approach to leverage and loan structures. We’re seeing more opportunities for lease-up deals today compared to pre-pandemic, and we’re adapting to that change.
As a whole, we work with sponsors and operators with a solid track record and strong experience in the seniors housing space, which goes a long way when it comes to underwriting a property.
Stoll: Broadly speaking, Fannie, Freddie and HUD’s underwriting standards, while not as conservative as during the height of COVID, are not yet back to pre-pandemic norms. For example, Freddie Mac is starting to consider near-stabilized deals on a very select basis for very strong sponsor and deal profiles.
Fannie Mae is beginning to consider higher-leverage deals for similarly strong deal profiles, and the competitive landscape seems to be improving.
HUD is still taking a cautious approach to COVID expense underwriting and requiring escrows where appropriate.
Malloy: We continue to be consistent in our underwriting benchmarks and conservatively underwrite in regard to absorption, rental rate growth and a tighter focus on operating expenses (primarily labor) and how they impact operating margins going forward in a challenging labor market.
SHHL’s ability to manage its portfolio and be disciplined with its underwriting standards has allowed the bank to successfully respond to the challenges brought on by the pandemic.
SHB: When borrowers inquire about where interest rates may be headed, what answer or advice do you give to them?
Healy: This is certainly a hot-button topic right now. With the Fed already raising rates once, and the expectation of several more near-term rate raises to fight inflation, we are looking closely at forecasts, budgets and whether we should structure any caps or derivatives on future and existing balance sheet loans.
What is interesting is that, in the past when the Fed has raised rates multiple times in a year, we have seen a flattening of the yield curve, which makes permanent financing much more appealing. Normally this would lead to an aggressive push to get to HUD or the GSEs involved, but many facilities don’t have the cash flow yet to support the underwriting criteria for those programs.
Harper: The market expectation is that rates are going to increase. In conversations with our borrowers, we focus on ensuring we can provide derivatives to help them remain resilient against those increases. Additionally, we recommend borrowers consider the risk of a potentially rising-interest-rate environment when evaluating new opportunities.
Stoll: It seems that both short- and long-term interest rates will continue to go up in the near future as the Fed tries to get a handle on inflation. The Federal Open Market Committee (FOMC) is projecting at least six more rate hikes in 2022. Many leading economists expect the May and June hikes to be 50 basis points rather than 25. This would leave the federal funds rate at 2 to 2.5 percent by the end of the year.
This increase in short-term lending rates most significantly impacts floating-rate borrowers on construction and bridge deals; they will need to be intentional conducting interest-rate sensitivity analysis during their investment period. It has also increased the cost of hedging interest rate risk (i.e. interest-rate caps and swaps), which more construction and bridge lenders will require because of the rising rate environment in which we find ourselves.
The permanent debt market closely watches the 10-year Treasury yield. As of close of business on April 1, the 10-year, at 2.83 percent, was higher than it has been since 2018. For the permanent debt market, this movement in the Treasury is causing some deals to no longer pencil out for cash-out or cash-neutral refinances, especially if the borrower received higher-leverage bridge loans.
We believe construction and bridge lenders will eventually react to this increase in long-term rates by tightening their exit underwriting analyses, making sure stabilized underwritten NOI can easily cover a permanent amortizing loan at higher projected rates. Also, floating-rate agency borrowers will need to price in much more expensive interest rate caps.
For permanent loan borrowers with near-
stabilized or stabilized assets, our advice would be to work with your bank and banker to develop strategies to balance your near-term NOI projections against rising interest rates to find the right time to maximize the permanent loan according to your goals.
Malloy: Synovus does not provide guidance on forecasting interest rates over a future time period, but we do inform our clients that Synovus has a wide range of interest-rate hedging products to address their clients’ concerns of managing potential future interest rate increases.
Playing favorites
SHB: As a lender, which seniors housing property types are you most bullish and bearish on currently and why?
Healy: We are bullish on the whole continuum, but certainly very focused on the sponsors we work with and the assets we are financing. The trend has been long developing, but asset quality, unit mix and facility-specific market dynamics are critical to making smart lending decisions. Functional and economic obsolescence are real factors now.
The biggest concern is the staffing crisis. This is not necessarily unique to healthcare, but the mass exodus from the space in the last two years is a major concern, particularly with the White House’s focus on enhanced staffing requirements.
Harper: As the industry starts to return to pre-pandemic occupancy levels, we’re seeing activity levels pick up. While new properties are performing well, we take a holistic approach to assessing any deal.
We focus on finding experienced, successful operators to work with, regardless of a property’s geography or age. Over the past few years, we have been more active in independent living, assisted living and memory care than we have in skilled nursing.
Stoll: We are not bullish or bearish on certain property types, rather certain owners, operators and markets. There is a place in the market for every product type along the acuity spectrum, from trophy-asset active adult to full-continuum communities to Medicaid-heavy skilled nursing facilities. The trick is identifying the right sponsor, operator and location to be successful.
Malloy: SHHL focuses its lending primarily on three property types:
• Communities that offer the continuum-of-care services that let the residents age in place, with a range of 150 to 200 units.
• Assisted living/memory care communities ranging between 80 and 130 units.
• Skilled nursing facilities, focused on multiple asset pools with strong in-place cash flows and history of consistent occupancy trends (excluding the pandemic).
SHHL does not lend on standalone memory care communities. Most of them have fewer units (40 to 60) and very high turnover. Operating margins can be negatively impacted if there is a significant decline in occupancy. Memory care absorption can be very cyclical and without a “feeder” source from adjacent assisted living residents, the absorption time period to achieve higher occupancy rates can be much longer.
Make a comeback
SHB: What has surprised you the most regarding the seniors housing lending environment in the last 12 months and why?
Brin: The biggest surprise to me has been the market’s reception to new alternative debt lenders targeting the seniors housing space.
I am not surprised that alternative capital providers such as debt funds have pursued opportunities in seniors housing. There is still a relative lack of debt capital available in seniors housing, unlike other asset classes, which are once again quite competitive. I am, however, surprised that sponsors are in certain cases opting to take financing from such lenders.
If the past two years have demonstrated anything, it is that seniors housing is a unique asset class that requires knowledge and expertise. The seniors housing market is recovering but is still prone to revenue and expense shocks as well as generally choppiness. In such an environment, it is paramount to have a capital provider that understands and is dedicated to the sector. It is also imperative that a lender has patience and discretion over the servicing of the loan so that disruptions in the recovery can be handled constructively.
Healy: The lending market is back to full throttle. Much like we saw coming out of the financial crisis, there was a short pause in lending, then a gradual re-entry of many of the traditional players with conservative underwriting criteria, and then a quick shift to aggressive lending from those same groups. I think we have swung almost all of the way back to seeing a very hot lending environment in the space right now.
Harper: There continues to be a number of active lenders in the space and a significant amount of debt capital available in the market, despite terms moving and tightening.
Stoll: We’ve been pleasantly surprised by the number of alternative lenders who have stepped up to inject liquidity into the bridge loan market when many banks have either chosen to or been forced to step back due to market and/or regulatory pressures. Although the cost of capital is slightly higher, the flexibility and availability of capital has helped many borrowers that might have otherwise struggled to maintain control of their investments.
Malloy: Pricing has very quickly become more competitive. As mentioned, lending institutions that had limited or no capacity to lend over the past two years are now looking to re-enter the market and to help generate loan growth. They have become more aggressive with pricing based on strong sponsorship, equity and market demographics.
Crystal ball is blurry
SHB: With occupancies recovering from record lows, how do you lend for seniors housing when the pace of economic recovery within the sector is still unclear?
Brin: MidCap is committed to the seniors housing sector and understands the value proposition enough to have confidence that the sector will recover and thrive. Yet it is impossible to know precisely when individual assets will rebound.
As such, our focus has been to structure loans to provide enough flexibility for operators to navigate the immediate distress, while ensuring there is ample liquidity to get through the uncertainty.
The dislocation in the debt markets has translated into more conservative financing requests in general, characterized by less financial speculation and better equity alignment. As a result, those credits should be sized comfortably once performance recovers.
Healy: It is all about the sponsor, operator, market and asset. If those factors are all strong, then we can get comfortable with the strategy and projections. Does it still work if we sensitize for some downside? Assuming all of these boxes are checked, we will aggressively pursue the financing.
Coiley: Lending is a combination of art and science. While we have always leaned on strong sponsorship in our transactions, that is increasingly important today.
We also seek to ensure alignment of interests between the property owner and the operator leading to an effective sponsorship team. Ideally, that team has executed multiple transactions together.
There is a wealth of local market data available to inform our analysis, but we do a fair amount of modeling with the absorption and cost assumptions to determine how tight the project is and whether it can withstand some hiccups.
Harper: First, our team has a robust risk management framework around underwriting that leverages multiple data sources throughout the process. Because seniors housing is an operating platform on top of a piece of real estate, we tend to work with operators that have a similar approach to risk, are resilient, can navigate the market through its cyclical nature and have a strong track record of success in their specific market.
Additionally, we take a long-term approach to our loans within the industry. With changing demographics driving more demand for seniors housing and less development over the past two years, we ensure we’re aligned with borrowers on the long-term outlook for their properties and for the market.
Stoll: Now is the time to continue to stay disciplined and laser focused on sponsor, operator and market selection. We can get behind sponsors and operators with a strong track record of through-the-cycle performance as well as markets that were strong pre-COVID and are demonstrating meaningful absorption today.
Malloy: Lending in the space during continued uncertainty is based on the bank’s client relationships. Relationships with proven track records of performance, significant liquidity to support its investments and a balanced operating model have been successful in securing debt from Synovus since the onset of the pandemic in first-quarter 2020.
SHB: Any predictions on what might happen in the next 12 months?
Healy: We believe census will continue to rebound, and we are seeing organizations having success in implementing rent raises, so revenues will continue to climb. That said, the downward pressure on margins from inflation, rising labor costs and rising interest rates will play a huge role in whether providers can fully turn the corner.
I think we will see record application volumes to HUD and the GSEs in 2023 to lock in the cost-of-capital piece of the puzzle, and remove any contingent liabilities. I also think the record M&A activity will continue through the next 12 months and beyond.
Harper: Overall, we’re optimistic that deals will continue to increase in 2022, just as we saw in 2021.
We anticipate occupancy rates will continue to grow as the industry makes steps toward stabilization. Costs will continue to be a challenge, and we anticipate operators will need to find creative ways to save costs and generate additional revenue.
Stoll: We believe there will be a steady recovery in top-line revenue due to continued demand for the hospitality and care that our industry provides. However, this will be mostly offset by inflationary expense pressures, labor first and foremost, which will continue to challenge NOI growth for our clients. Those operators that can continue to aggressively push rents in the face of inflation and/or lead their markets in recruiting and retention through great culture will prove to be winners over the coming years.
Malloy: We will see continued compression on operating margins due to tight labor markets. The lack of new development projects will continue due to inflation, supply chain issues and increased material costs. n