Lender Q&A: ‘Cash is King’

Capital sources continue to put money into seniors housing, but have strengthened underwriting and encourage developers/operators to be more conservative on their assumptions.

Roundtable participants

Kristen Ahrens, Managing Director, Capital One Healthcare

Ashley Wilkens, Senior Vice President, Ziegler

Lawrence Brin, Managing Director – Real Estate, MidCap Financial Services

Mike Taylor, Head of Healthcare Lending, First Midwest Bank

Mordecai Rosenberg, President, Greystone Lending

Kathryn Burton Gray, Head of Health Care and Senior Managing Director, Hunt Real Estate Capital

By Jeff Shaw

Seniors housing fundamentals are still strong and lenders are more than happy to continue putting money into the space — but not blindly.

As occupancy drops and interest rates rise, capital sources have strengthened underwriting standards, helping lead to more stability. Not only are they cautious, but they’re also warning borrowers to tighten their own assumptions on subjects such as lease-up time and cash on hand needed.

Seniors Housing Business contacted a panel of notable lenders in the seniors housing space about the hottest topics driving how and with whom they use their capital.

Seniors Housing Business: What is your lending specialty within seniors housing?

Rosenberg: Greystone lends across the entire seniors housing spectrum, from private pay independent living to Medicare/Medicaid skilled nursing facilities and rehabilitation centers. Our expertise lies in having a range of finance platforms that will fit a particular property type, region and investor, from short-term bridge financing to life company loans to long-term HUD financing.

Taylor: First Midwest Bank is active across all of the various seniors housing sectors. We have a diversified portfolio of properties that span both nonprofit and for-profit providers.

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 yet available — value-add acquisitions, construction loan takeouts prior to stabilization, and other complex situations that require creativity and deep industry expertise. We hold all our loans on balance sheet and service all our relationships in-house.

Wilkens: Ziegler is a full-service specialty investment bank primarily focused on the seniors housing, long-term care and healthcare sectors. Our financing experience includes all sectors of the industry — continuing care retirement communities (also known as life plan communities), single- and multi-site senior living providers, assisted living and personal care facilities, acute care hospitals, multi-hospital systems, rehabilitation hospitals, skilled nursing centers, clinics, and other specialty healthcare providers.

Ahrens: We specialize in providing a one-stop shop for our seniors housing clients, including balance sheet, bridge-to-agency/HUD and direct-to-agency/HUD loans.

Gray: We serve all asset classes: independent living, assisted living, memory care and skilled nursing.

SHB: How did your 2018 lending volume stack up to the previous few years, and what is 2019 looking like so far? What does that change (or lack thereof) say about the state of seniors housing?

Taylor: The number of transactions that we saw seemed to be consistent with prior years. We have started off 2019 with a fairly robust pipeline and are working to meet all our clients’ needs. Given the capital-intensive nature of the sector, coupled with the volume of M&A activity and new development activity, we anticipate that there will continue to be a healthy amount of volume in 2019.

Rosenberg: For Greystone, 2018 seniors housing lending was up over prior years, as overall lending volume was up in general. We saw more activity on our bridge-to-HUD platform with skilled nursing facilities due to our increased capacity for balance sheet lending after closing our first fund at $750 million in 2018.

Gray: Seniors housing was a new product for Hunt in 2018, so we don’t yet have comparison data.

Wilkens: In 2018, Ziegler financed over $2.1 billion within the seniors housing and long-term care industry across all financing product types. In addition, our team completed the largest single-asset, board-and-care mortgage loan to be financed by HUD under Section 232/223(f) by taking a unique approach to HUD’s underwriting criteria, which may open the door for other seniors housing borrowers. We are still finding significant amounts of capital flowing into this sector that needs to be put to work, which continues to support a strong outlook for the industry.

Brin: It was a strong year for MidCap’s healthcare real estate group in 2018. We closed far more volume than during the previous two years. Our collective expectation is that 2019 will shape up to be similar to 2018. We will close some smaller bridge-to-agency deals (as low as $5 million) in tandem with our HUD program and our Fannie Mae and Freddie Mac correspondent relationship with Bellwether Enterprise. We will also close some larger strategic transactions ($50 million and above) based on our institutional relationships and ability to be creative. 

The increase in our production volume relative to a few years ago reflects some of the softness that has crept into the seniors housing markets. Our platform is positioned to offer a stronger value proposition when the market is more volatile, and we expect we will see more opportunity in the near term.

Ahrens: From a balance sheet perspective, 2018 was in line with the previous year. We continue to grow our book on the agency and HUD side. More specifically, we were named the No. 3 seniors housing lender with Fannie Mae in 2018 and the No. 5 lender for HUD in the healthcare category. Our pipeline of potential transactions remains strong across all product types, which is reflective of the overall seniors housing market.

SHB: A burst of development recently reduced occupancies in seniors housing to historic lows. Though we seem to be recovering now, has this changed your lending practices at all within the sector?

Brin: Our approach to opportunities in softer markets embraces a perspective of realism. If a market has softened due to new supply, there should ultimately be some winners and some losers. Ultimately, we understand that it is not realistic to underwrite every — or even most — opportunities on the assumption that the property will likely stabilize at 95 percent in 24 months. Some properties may never achieve occupancy above 90 percent, and it can take years for properties to fully stabilize. So long as the loan is appropriately approached and structured, those outcomes can be perfectly acceptable.

Ahrens: From a supply and demand standpoint, we take a close look at every market that we lend in. We are also being more conservative on lease-up projections for assets that are pre-stabilization. Borrowers need to have the financial wherewithal to withstand longer-than-expected lease-up time frames.

Taylor: The amount of development in certain markets is a cause for concern. First Midwest puts heavy emphasis on the project participants’ experience (equity and operating partner), the structure of the transaction, and the projections and assumptions used therein. We then sensitize it to account for slower fill-up assumptions. There will be projects within a given market that will struggle to fill or will see a decline in their historic occupancy rates given the new product entering the market. 

Market demographics continue to be favorable, so in any given market it is not a question of if the units will be absorbed, but rather how long it will take. Overall, penetration rates for seniors housing continue to be relatively light across most markets. With increased development and increased education in the market, I suspect that penetration rates will increase as the senior population continues to grow.

Wilkens: We have been taking a more cautious approach to assets located in some of the markets where we’ve seen a large amount of overbuilding and slow fill-up.

SHB: We often hear there are many companies looking to enter seniors housing due to its high return on investment and recession-resistant nature. How do you choose to whom you lend among these new entrants to the sector?

Gray: We seek experience in this sector coupled with a proven track record, strong sponsorship and no pro-forma lending.

Rosenberg: As a lender, we look to work with experienced sponsors who have knowledge of the local markets in which they’re acquiring. There are many barriers to entry for success in seniors housing investment, and having knowledge of state regulations as well as a relationship with a very reputable operator are two things we look at.

Taylor: Experience is key in this sector. We have largely stayed away from new entrants on the operating side. For those equity providers that are looking to deploy capital in this sector, partnering with experienced operators that have a track record in the asset class you wish to invest in is key. 

Brin: MidCap has always been highly focused on alignment and experience with respect to its borrowers. Seniors housing is still fundamentally an operating business. We do not necessarily have an aversion to lending to new entrants to the space, especially when that capital is in the capacity of an investor or landlord. We do, however, generally feel that it is imperative for the operator to have a strong track record. 

Even if the operator is a relatively upstart brand, it is important for the management team to have experience in the sector. In fact, we have seen some very strong outcomes from relatively new operating platforms with smaller portfolios. Those groups tend to be led by ambitious management teams that cut their teeth at more established operating platforms, and bring experience and innovative spirit to the communities they operate. In general, we also prefer situations in which the operator has some level of investment in the property so as to create “skin in the game.”

Wilkens: Ziegler takes a holistic approach to a transaction and its execution. At the outset, we frame out the range of potential alternatives and work closely with our clients to ascertain their goals, objectives, concerns and risk tolerance. Ziegler leverages its transaction experience, market knowledge and data-driven analytical expertise to quantify for our clients the risk/reward trade-offs of each alternative, enabling clients to make informed decisions. 

Key “ingredients” we evaluate and find important when creating a “recipe” for success are location, relevant experience, strength of the management team, available equity, historical financial performance, budgets and overall credit support available.

Ahrens: Sponsor and operator experience are paramount to our risk assessment and underwriting. We want to work with borrowers who have a track record in the space and who truly understand the complexities of seniors housing.

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

Wilkens: Seniors are living longer, healthier and more active lives. Consequently, the need for active adult seniors housing models with the ability to add services as a resident’s needs increase will continue to be a trend that gains momentum as the “silver tsunami” continues to age. Assisted living today is what independent living looked like 25 years ago. Seniors housing operators will need to adapt their care models to accommodate the changing resident population.

Ahrens: We feel optimistic about newer assets in high-barrier-to-entry markets and assets that offer a continuum of care so that residents can age onsite and not be faced with continual relocation challenges.

Taylor: While we are active across the entire spectrum, our preference is to have multiple levels of care in a single location, or to finance portfolios of facilities. We tend not to do as much standalone assisted living or memory care unless it is part of a broader portfolio. 

The same is true of skilled nursing. Single-asset skilled nursing transactions pose a lot of risk, so our preference is multi-site transactions with experienced operators. There continues to be a lot of change across the entire industry, which creates both challenges and opportunities. First Midwest is positioned to continue to work with our clients to capitalize on those opportunities as they arise.

Gray: We believe all asset classes are viable despite the recent negative press with regard to skilled nursing facilities. We keep leverage standards to meet permanent financing options. 

When we provide bridge financing to our clients we consider the permanent take-out financing. Therefore if the take-out for the bridge loan we are providing is a Fannie Mae loan, we need to make sure the loan meets the requirements of 65 to 75 percent of the perceived value of in-place cash flow. In the same example, if the take-out is an FHA loan, there are higher advance rates so the take-out permanent loan would be 80 percent of in-place cash flow.

Brin: Seniors housing tends to be a micro-market business compared with many other real estate asset classes. Successful property types may vary greatly between the suburbs of Minneapolis on the one hand and Phoenix on the other. Moreover, even within given markets, communities compete in bands based on age and design.

In the abstract, 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 clear exceptions, standalone facilities tend to face greater headwinds with respect to maintaining occupancy. Most seniors who would be good candidates for a senior living option are not in need of a secure memory care environment. Moreover, seniors who demonstrate sufficient acuity to require such an environment generally would experience a shorter average length of stay compared to more active seniors entering through independent or assisted living.

Rosenberg: We see growing opportunities across the entire seniors housing spectrum. Greystone is a top HUD lender partly because of our bridge-to-HUD platform, where we provide a short-term loan with a permanent exit to long-term, fixed-rate FHA financing. This product is well suited for skilled nursing facilities. We are quite active in the skilled nursing space because a 35-year loan is quite attractive for an investor.

SHB: If you were asked to give only give one piece of advice to borrowers today, what would it be?

Taylor: Whatever level of working capital you think you need, plan to have double that on hand. Cash is king. We are going to continue to see pressure, not just from increased competition, but from other outside factors like wage creep and employee shortages. These challenges will require capital. You need to have money on hand to weather any downturns in operations or challenges that may arise. You don’t want to have to go looking for capital when you need it the most.

Brin: The seniors housing sector has been robust for the past eight years. Therefore, it has attracted equity and debt providers offering aggressive terms to win business. My advice would be to focus on the fact that the loan you are closing today is the loan you plan to have during the next two to five years, and not the past five. 

Seniors housing markets are showing some strain from the new development that has been introduced. The demographics surrounding seniors are mired in a temporary plateau before the so-called silver tsunami begins to manifest itself. Cap rates remain at near historic lows for the property sector. When there is a market correction, you will experience a better outcome when your lending partner is dedicated to the seniors housing sector, has experienced the highs and lows of past cycles, and is empowered to work through challenges by virtue of controlling its own capital.

Wilkens: The economy is changing. Since the downturn in 2008-2009, the overall recovery and performance of the seniors housing industry has been one of the steadiest in the country’s history. However, the industry is definitely becoming fragmented. Labor continues to be an issue. Occupancy rates are lagging. Interest rates are slowly rising. Borrowers need to plan for the future now in case the market takes another downturn. No one wants to be caught waiting too long and then finding themselves undercapitalized and scrambling for acceptable financing terms.

Gray: Stay the course, watch expenses, retain employees and provide best-in-class operational excellence.

Rosenberg: In today’s unpredictable market, it’s smart to think long term about one’s portfolio and lock in long-term, lower-rate financing where possible for assets you plan to hold. HUD financing is a fantastic option for owners to consider.

Ahrens: If something seems too good to be true, it probably is. n