Lender Q&A: Capital Markets Are Up to the Challenge

by Jeff Shaw

Even in the face of low occupancy, overbuilding, labor issues and a global pandemic, lenders have faith in seniors housing as an asset class.

By Jeff Shaw

There’s no doubt that seniors housing faces challenges that other sectors do not. An
operations-intensive business, seniors housing managers must recruit and retain good staff while fighting off a glut of new competition.

Meanwhile the global COVID-19 pandemic has a much higher mortality rate among seniors versus younger sufferers, adding a new layer of difficulty and fear. A recent survey by SeniorList shows that 43 percent of people now have a lower impression of the safety of seniors housing following the outbreak.

Despite all these challenges, the fundamentals are still positive. The last recession showed that, because of its needs-based nature, seniors housing is better equipped than other sectors to handle economic turmoil. The demographic wave of baby boomers entering seniors housing is still a few years away, but it is coming. For this reason, capital continues to flow into the sector.

Seniors Housing Business spoke with 10 major lenders within the senior living space. With the exception of the question specifically about COVID-19, these responses were all submitted before the pandemic began. Many of the predictions for 2020 have been removed since so much has changed. Please take that into account when reviewing answers.

Roundtable Participants:

Chris Taylor, Managing Director, Capital One Healthcare Real Estate

Erik Howard, Managing Director Real Estate Finance, Capital Funding Group

Mike Taylor, Senior Vice President, Head of Healthcare & Capital Markets, First Midwest Bank

Scott Thurman, Chief Credit Officer, Healthcare, Greystone

Jeffrey Davis, Chairman & President, Cambridge Realty Capital Cos. 

Eric Halpern, FSVP and National Head of Healthcare, Bank Leumi USA

Steven Muth, CPA, Vice President, M&T Realty Capital Corp.

Billy Meyer, Managing Director of Real Estate Lending, Columbia Pacific Advisors

Lawrence Brin, Managing Director – Head of Healthcare Real Estate, MidCap Financial Services

Jason Schreiber, Senior Vice President, Manager of Seniors Housing Finance, PNC Real Estate

Seniors Housing Business: What is your lending specialty within seniors housing? Also, do you have a sweet spot in terms of deal size?

Chris Taylor: At Capital One, we specialize across lending products in seniors housing both on our balance sheet and agency (Fannie/Freddie/HUD) financing. 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.

Erik Howard: CFG’s main focus is on bridge, HUD and working capital lending in the skilled nursing and assisted living sectors. We have no size limitations; we will entertain a $2 million deal as well as a $100 million deal.

Mike Taylor: First Midwest Bank specializes in financing skilled nursing, independent living, assisted living, memory care and CCRCs for both for-profit and nonprofit providers. Although we have a national footprint, we focus on the geographic areas that we know best given the nuances to each market. While we have closed loans as small as $250,000, our typical deal size is $10 million to $25 million.

Scott Thurman: We finance all types of assets in the continuum of care within seniors housing, from independent living to skilled nursing facilities. There are financing products specific to each asset as well, and we have developed a bridge-to-HUD financing platform that can help investors go from acquisition to permanent, long-term financing seamlessly. On the independent living side, we are helping owners, investors and REITs develop and expand their portfolios with construction financing and facilities with Fannie Mae or Freddie Mac.

Jeffrey Davis: Our lending specialty revolves around licensed facilities, which primarily includes assisted living, memory care and skilled nursing. 

Skilled nursing is a significant amount, primarily through our HUD unit. We do not have any maximum amount, and have completed portfolio deals in excess of $100 million. However, on a practical basis, $5 million is our minimum.

Eric Halpern: Our loan portfolio is largely concentrated in skilled nursing (80 percent), and assisted living (15 percent). In addition to acquisition finance, refinance, bridge-to-HUD and recapitalization, we also offer revolving lines of credit. Our sweet spot is in the $10 million to $25 million range.

Steven Muth: M&T RCC is one of a few banks that possesses all three permanent debt licenses, Fannie Mae, Freddie Mac and HUD. Our specialty is seniors housing and all the complexities within each level of acuity from standalone independent living to skilled nursing. We’ve done four-property portfolios averaging less than $4 million per building, single transactions north of $60 million and $100 million, and multi-state portfolio bridge loans. 

Billy Meyer: We are exclusively bridge lenders in the $5 million to $75 million range nationwide. We really like the $25 million to $75 million range in the 12- to 24-month timeframe. 

Lawrence Brin: MidCap Financial is 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 yet available — value-add acquisitions, construction loan take-outs prior to stabilization, and other complex situations. We hold all our loans on balance sheet and service all our relationships in-house. Our minimum transaction size is $5 million; there is no maximum transaction size.

Jason Schreiber: PNC is primarily focused on
private-pay seniors housing, and very selectively pursues skilled nursing opportunities. The bank sees typical transaction size in the range from $10 million to $150 million with an average in the mid-$30 million range, but can serve as an agent for even larger syndicated, portfolio transactions.

SHB: What do you expect to be the long-term effects of the COVID-19 outbreak on the seniors housing capital markets?

Mike Taylor: Long-term, the need and demand of senior care facilities will still remain. We are at the front end of the baby boomer wave, and as a result, the demand for these facilities will continue to rise. Here in the near term, there will be pockets of stress/distress that may force additional consolidation. The strong, well-capitalized providers are likely to be able to weather the storm and will see additional opportunities arise as a result of COVID-19 and its impact on the market.

Thurman: We are still early in realizing what the impact of COVID-19 will be on our industry, and our lives. What we do know is that our economy and the capital markets are resilient, and we will likely recover from any setbacks we are seeing and anticipating in the short term. 

The federal agencies continue to back loans today and rates are historically low, so right now we are seeing a lot of refinance activity, which we believe will continue.

Davis: I think the long-term impact will validate even more scrutiny of confirming that a facility is paying lots of attention to the clinical side of its business, not solely the financial side.

Ultimately, when the clinical side turns south, the financial side will follow. The clinical part of the underwriting should never be taken for granted.

Muth: To think about the long term, I think we need to first address where we are in the near term, which is rapidly changing by the hour. Our company is intensely focused on supporting our customers during this period of extreme disruption. The banking industry is in a position of great strength with capital levels at their highest since 1940, liquidity approximately at its strongest level since the early 1980s, and credit quality at its healthiest level since 2006. The Fed’s commitment to a proactive and aggressive approach to supporting credit markets and the strength of the banking sector gives me confidence we’ll be able to weather this storm and the industry will resume normal activities once COVID-19’s spread has leveled off.

Assuming successful navigation of near-term capital markets stress, we see the COVID-19 outbreak as an opportunity for the seniors housing sector to prove its benefits and be in a position for heightened long-term growth. We’re hearing from our clients that building staff, residents and families have rallied together to fight the virus. I expect the benefits to being cared for in a seniors housing community will shine even brighter once the pandemic has passed.

In terms of talent availability, seniors housing should have an opportunity to attract talent from the hospitality sector during this time. The needs-driven stability of seniors housing offers an attractive career path for workers.

Overall, I expect that seniors housing will outperform other sectors during this period of crisis, as there are no other real estate asset classes better suited to manage through this period.

Howard: Temporarily we expect to see an increased demand for long-term care beds as hospitals try to place patients in long-term care facilities to create capacity for potential COVID-19 patients. This is expected to occur relatively quickly in particular due to the Centers for Medicare & Medicaid Services (CMS) waiving the three-day-stay rule with respect to a qualifying hospital stay. 

We don’t believe there will be a long-term negative impact to the overall industry as it relates to demand and need for long-term care. However, we are already seeing increased regulations from CMS and state agencies as it relates to requiring more robust infectious disease programs and similar measures. With that, lenders and investors are going to want to see that operators are prepared and well equipped to deal with potential future pandemics like COVID-19.

As the operational nuances of the industry become more and more complex due to changes to reimbursement models, increased local and state regulations, and a greater need to have the ability to quickly adapt operational modalities, this will most likely accelerate the momentum that we’ve seen in the industry over the past couple of years. Smaller-sized operators will continue to exit the market. 

We are seeing a trend of regional operators acquiring these assets, typically within their existing operating footprint. These operators are generally large enough to have economies of scale and a strong corporate back-office, allowing them to run these facilities more efficiently while still being able  to focus on the local, micro-operational aspects of healthcare that make a facility successful. This will likely cause acquisitions activity for single-facility and small-portfolio assets to increase, in particular for those that were unable to weather the COVID-19 crisis. 

Going forward, we expect lenders and investors both to take additional steps to validate the operational and financial strength of an operator in which they are financing or partnering. This will be a long-term benefit to the industry and the residents; companies that are well capitalized and provide superior care and will survive.

SHB: As a lender, which seniors housing property types are you most bullish and bearish on currently and why?

Chris Taylor: Over the past few years, we have been bullish on independent living, assisted living and memory care. As the fundamentals for well-positioned seniors housing properties remain strong, and demand remains robust, we have been most active in these areas.

On the skilled nursing front, we have been selective in our balance-sheet approach and continue to look for HUD financing opportunities.

Howard: All of our bridge loans are underwritten to a HUD takeout and HUD only allows 25 percent of the units in its communities to be independent living. Therefore, our primary focus is skilled nursing and assisted living.

Mike Taylor: We like CCRCs and communities that have multiple levels of care on a single site.

That said, skilled nursing is another area where we continue to be active. Skilled nursing providers have had a number of challenges to overcome, including the uncertainty surrounding the impact of the Patient-Driven Payment Model (PDPM). While the regulatory environment continues to pose challenges, providers seem to have navigated through the shift to managed care contracts and the implementation of PDPM. 

We are less bullish on high-end assisted living and standalone memory care buildings. With increased supply in the market, a challenging labor market and economic uncertainty surrounding the election and a global pandemic, we see a number of challenges that will impact either the fill-up of new units or put pressure on rents. This will make it hard for the facilities to hit their targeted cash flow and performance targets.

Thurman: Based on demographic and economic projections, we are bullish on all seniors housing property types. There are new trends evolving, such as aging-in-place, which can be incorporated into other provider offerings, and we are also seeing more demand for middle-market services, so providers are adjusting to the changing trends in the sector.

Davis: I would say I am bullish on every seniors housing property type for a variety of reasons. Each property type fits a specific niche; as such, there is no reason to be bearish on any types.

Muth: We’re bullish on owners and operators that focus on quality of care and the resident experience. We think that if the resident is the focal point of the community, it’ll be a successful loan/borrower irrespective of property type. 

Meyer: We are bullish on buildings that have independent living, assisted living and memory care with private pay and over 100 units in core locations. They provide sufficient economies of scale on a one-off basis and are desirable to buy in the open market.

Brin: We have observed in recent years that properties with a full continuum of care from independent living through memory care seem to demonstrate better performance. As seniors continue to enter seniors housing communities at older ages and often through independent living, the continuum creates an internal, organic referral source for assisted living and memory care. 

Conversely, we are careful when it comes to standalone memory care communities. With exceptions, they face greater headwinds with respect to occupancy as it relates to attracting new residents and the lower average length of stay. Moreover, memory care tends to demonstrate higher sensitivity to new supply entering a market, regardless of whether that new supply is in the form of a new standalone facility or the addition of memory care beds to an existing seniors housing facility.

Schreiber: PNC remains bullish on the development of rental continuums. Independent living, assisted living and memory care on a single campus would be the preferred asset class. However, we have seen strong performance for standalone independent living, as well as smaller assisted living/memory care projects. These assets have generally showed strong lease-up and rate growth, but site and market selection remain critical factors for success, as does operator experience and capability.

The one sector that PNC tends to steer clear of is standalone memory care. It appears to be oversupplied in many markets, which, coupled with smaller community sizes, leaves little margin for the occupancy fluctuations that naturally occur given the relatively short resident lengths of stay.

SHB: When underwriting an acquisition, which performance metric(s) do you zero in on the most?

Chris Taylor: We zero in on a number of performance metrics, including occupancy rate, revenue per available room and rent growth, as they are all important to our valuation and underwriting. We also focus on ensuring those metrics align with the property type, property age, and submarket where the property is located.

Howard: CFG takes a holistic approach to underwriting. Initially we evaluate the operating company and look at the track record. Next, we focus on the operator’s budget and how it intends to enhance operations, whether it be revenue-driven or expense-driven. Having access to existing comparable buildings that the borrower is already operating can be extremely beneficial during this process.

Mike Taylor: When viewing an acquisition, we first and foremost look at the historical performance achieved under the prior operator and compare that to the pro forma performance of the acquirer. We look to understand the bridge between the two. If projecting revenue growth or expense reductions, we evaluate if the geographical market can support the assumptions and the sponsor’s track record of achieving them.

Davis: When it comes to underwriting any acquisition, we pay the most attention to occupancy growth and rent growth. Rarely, if ever, do we deal with the revenue per available room matrix. With seniors housing and all of the different services provided in each unit, it is great to look at revenue, but the costs to get the higher revenue may be another matter.

Halpern: When underwriting an acquisition, we zero in on a multitude of factors, both on the revenue and expense side, as well as the bridge between the current performance and the projected one. We look to see how each assumption compares with the performance of the acquirer’s other properties in the area, as well as the performance of other competing nursing homes. There is no one measure that we zero in on to the exclusion of others.

Muth: Net operating income (NOI) is always a good place to start. From there we’ll look at NOI margins, rent concessions, Department of Health surveys and the operator’s characteristics. Talking about the current operator and post-acquisition operator is critical. If there’s going to be a change, we need to talk about the transition strategy very early in the process.

Meyer: We look at all the variables you can think of, and the most important variables vary from market to market — the supply and demand, new product pipeline, market occupancies and other operators. We have to observe each deal with a microscope every time.

Schreiber: The one we probably ignore is rent growth. If a transaction is not supported by current market rates, we are not going to underwrite rent growth to make it work.

SHB: What has surprised you the most regarding the seniors housing lending environment in the last 12 months and why?

Chris Taylor: In the last 12 months, it’s been surprising to see the lending environment become more aggressive in certain areas despite what appears to be a strain in overall seniors housing metrics, like net operating income, occupancy and wage pressures. While the industry is certainly resilient, we have seen these two seemingly conflicting trends for at least 12 months, which could point to a new normal in the market.

Mike Taylor: The amount of equity that continues to chase this market has overshadowed some of the distress in the new construction market. Given the aggressive assumptions that were being underwritten two, three and four years ago, we expected to see stress related to slower fill-ups and tight liquidity. However, there are multiple groups who have sold at certificate of occupancy or during the fill-up stage, which has relieved some of the pressure from the original projections.

Davis: I continue to be surprised by the resilience of seniors housing. Additionally, I also have questions regarding how new construction can continue, especially when the lease-up periods over the last 24 months have been extended from initially two years in 2015 or 2016 to four years in 2018 and 2019.

Muth: The amount of moving and consolidation amongst some of our competitors in the space has been surprising. It has been disruptive, and we’ve benefited from some of those transitions. Borrowers value consistency and tenure from their lenders. It’s tough to help your customer when a loan is on the books and the company changes names or the borrower’s main contact isn’t there anymore.

Brin: I have been surprised by some of the lenders and real estate debt funds that have recently waded into the seniors housing lending space. On the one hand, I understand that there has been a glut of debt capital in the real estate capital markets, which has driven down yields, and that seniors housing offers the opportunity for enhanced yields relative to multifamily and other conventional asset classes. However, seniors housing remains an operating business that is much more nuanced than most real estate asset classes. We have built and refined our perspective on seniors housing over decades. We understand the nuances, we know the operators and we appreciate the operating fundamentals.

Schreiber: No significant surprises — lenders generally are behaving rationally and pursuing solid opportunities with experienced borrowers. The only real surprise would be the allure of a few select markets for new development, many of which are financed by smaller, less experienced lenders. 

As the headlines scream about occupancy softness, new supply — often only a mile or two from other construction projects — continues to move ahead. This phenomenon appears especially acute in Florida, where enticing demographics outweigh rate and occupancy softness in already existing supply. As any experienced seniors housing investor knows, those demographic numbers can be fool’s gold, as many retirees will return north to be close to family when they elect to make a move to a seniors housing community. n

SHB: What impact, if any, could the results of the presidential election and congressional races have on the capital markets in the seniors housing space?

Mike Taylor: The joke that “the one thing that is constant in seniors housing is change” definitely holds true today with the presidential election. 

All politics aside, this industry has been facing changing or increased regulatory pressure for a number of years. Providers’ ability to adapt and handle this change is ultimately what weeds out the good from the bad. 

Seniors housing is a very diverse ecosystem with a blend of need-based services and residential options. The presidential election and any additional healthcare reform that results from the election’s outcome may impact one part of the ecosystem, but may not impact the entire ecosystem. We monitor not only healthcare reform, but also any changes to social security, the shift away from pensions to 401(k) and other global challenges and their impacts on this sector.

Davis: The results of the presidential election and to a lesser extent, the congressional races can have a significant impact on the seniors housing space, especially skilled nursing.

There is a tremendous amount of discussion going on to eliminate all of the different inter-governmental transfer programs, which exist to permit operators to generate more money through a complicated formula so they can take care of the residents to the requirements and needs they have.

Other than that, I am not really that focused on the presidential election, so I will not talk politics any further and focus on keeping the seniors housing space fluid — and keeping the reimbursement world continuing in a positive direction.

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