Although the pandemic tested the systems, many lenders actually provided more capital in 2020 than in previous years.
Roundtable Participants:
Mike Taylor, Senior Vice President, Head of Healthcare & Capital Markets, First Midwest Bank
Sarah Duggan, Senior Director, Seniors Housing & Healthcare Lending, Synovus
Lawrence Brin, Managing Director, Head of Healthcare Real Estate, MidCap Financial Services
Eric Smith, CEO, Managing Partner, Locust Point Capital
Ashish Shah, Managing Director, MONTICELLOAM LLC
By Jeff Shaw
While COVID-19 has caused a wide variety of struggles for the seniors housing industry, capital has continued to flow.
Many lenders report their volume actually increased in 2020. However, they also report that they have become much pickier about who they work with. The ideal borrower is one with a high level of experience within seniors housing, and proven success through the pandemic.
Seniors Housing Business spoke with some of the top lenders in the seniors housing sector to take the pulse of the industry.
Seniors Housing Business: What is your lending specialty within seniors housing? Also, do you have a sweet spot in terms of deal size?
Duggan: The core team joined Synovus in 2011 and has been a consistent lender to the seniors housing industry for over 35 years. We focus primarily on licensed facilities (assisted living, memory care and skilled nursing), but we do lend to independent living as well.
Taylor: First Midwest Bank covers all aspects of seniors housing, from CCRCs to skilled nursing and everything in between. In addition to refinancing existing debt, we provide HUD and non-HUD operating lines, as well as acquisition, construction and bridge financing, including recapitalizations for both for-profit and nonprofit providers.
Our typical transaction size is $30 million to $35 million, but we often syndicate larger transactions by acting as an agent bank and bringing in one or more participant banks to support the deal.
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.
Shah: MONTICELLOAM LLC and its affiliates, casually referred to as Monticello, provide a range of capital solutions ranging from first mortgage and mezzanine financing to joint venture equity for development, acquisition and recapitalization. Transaction sizes are typically total capitalization over $10 million with demonstrated expertise in executing on larger transactions.
SHB: What did your volume look like in 2020 compared to previous years?
Duggan: I am proud of our seniors housing team‘s performance in 2020. Our closed commitments were 30 percent higher in 2020 versus 2019; we achieved our highest loan production year since joining Synovus in 2011. In 2020 we closed $923.6 million in loan commitment compared to $711.3 million in 2019.
Taylor: Total volume in 2020 was down slightly from prior years. The bank was coming off a record year in 2019 and 2020 started off strong. But like most companies, we had to quickly pivot our focus and priorities to navigate through the pandemic and adapt to the new operating environment.
We were proud to have helped 9,000 companies through accommodation and fee assistance programs, and we also provided more than $1.2 billion in Paycheck Protection Program loans to small businesses in need, including many of our seniors housing providers.
Transaction volume increased the second half of the year as providers adapted to the new operating environment and worked to keep COVID-19 under control. As such, we began to see deal volume pick up with M&A, bridge and construction volume coming back strong.
Smith: We certainly saw an uptick in inquiries and deal volume as a result of capital providers pulling back and/or taking a pause. Our total investment commitments made during 2020 were 70 percent higher than in 2019. Our team and resources have also grown in the past 12 months, so how much of that uptick can be attributable to capital markets disruption from COVID is tough for us to pin down.
Shah: Monticello originated nearly $1 billion in volume in 2020, which is slightly higher than previous years.
COVID-19 adjustments
SHB: How did your underwriting standards shift as a result of the pandemic?
Duggan: We saw heightened focus on liquidity and capital strength relative to sponsorship and guarantors. There was a focus on personal protective equipment (PPE) expense and the continuation of incurring some level of PPE in the future. However, we recognized the inflated cost incurred in the early months of the pandemic were not necessarily representative of future expense levels.
We reviewed monthly move-ins, move-outs and net occupancy prior to and during the pandemic to identify the low water mark and focus on recovery — the net fill now being experienced is probably representative of the next 12 to 24 months.
The pandemic has impacted markets differently, so we have to drill down into each specific market as to timing of cases, peak levels of cases and how state-by-state regulatory restrictions on seniors housing properties vary.
Taylor: There has always been a focus on the operators and their experience level as we have analyzed credit historically. In many regards, the pandemic highlighted operating challenges either within an organization or within a geographic region.
The level of liquidity available to support operations, the depth of the team, ability to shift resources and how quickly operators could adapt all factored into how they performed and the level of stress they were under. These factors impacted our confidence level in any given relationship or transaction.
We have all heard the saying “cash is king,” and right now liquidity is definitely an area of focus. Making sure that people have enough resources to support operations while they look to recover from the pandemic is crucial.
For construction deals, increasing reserves to account for slower fill-ups and requiring guarantor support to stay on longer all factor into the overall structure of the transaction. We still feel that there is demand for the industry, but the recovery is not going to be “V” shaped; it is going to take time.
Smith: We have seen a bifurcation by deal size given the activity, or lack thereof, from some of the larger national banks. For transaction sizes less than $50 million we continue to see significant activity. As the deal size increases, there appear to be fewer participants.
Locust Point Capital focuses on relationship lending. Those borrowers who have built strong relationships with their capital providers are able to execute on their business plans. We believe the more transactional-focused groups that are always seeking the cheapest capital may be finding this environment a little more challenging than our typical borrower.
Shah: Our standards have not changed since our portfolio is always based on underwriting high-quality borrowers, operators, assets and markets.
Due to pull back from senior lenders, overall leverage available has decreased slightly from 2019 levels.
SHB: What will the post-pandemic lending atmosphere look like for seniors housing?
Duggan: I think the ice is starting to break and many of our fellow competitors who chose not to lend during the pandemic will reenter the market. HUD remained consistent during the past 12 months while Fannie and Freddie definitely slowed and tightened requirements. We are expecting more payoffs this year from Freddie and Fannie as properties re-stabilize.
Brin: MidCap is very optimistic regarding our seniors housing lending prospects. We believe we are uniquely positioned to provide capital solutions in the wake of an extraordinary market event. We have strong expertise in the seniors housing market, and understand that beyond the near-term volatility, seniors housing is an asset class with a very bright future.
We have experienced a dramatic increase in deal flow and anticipate that we will be able to provide real value to owners and operators for new acquisitions of unstabilized assets, as well as legacy assets that need patient and pragmatic debt to enable management to navigate back to stabilization.
During the next 12 to 24 months, alternative lenders will be able to offer better structured and more flexible capital for assets that require time to stabilize.
Taylor: The capital markets are going to be tighter than they were pre-pandemic, at least in the near term. We are seeing pricing going up, leverage coming down and more structure being put into deals given the heightened risk in the sector.
Strong operators/sponsors are still going to get their deals done, but those that are either newer to the industry or have had significant challenges in their portfolio are going to find it much harder to secure traditional financing. There are still going to be financing options available to them. However it will come with a cost, as traditional bank financing may not be available.
Shah: Lending options overall will be limited due to ongoing uncertainty, particularly regarding census development and some lenders experiencing significant portfolio issues. We believe that credit availability will continue to be limited for 2021.
Who struggled; who thrived?
SHB: As a lender, which seniors housing property types are you most bullish and bearish on currently and why?
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 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.
Taylor: Overall, First Midwest continues to be cautiously optimistic across all asset classes. Our opinion is that each of the different product types, from independent living to assisted living to memory care to skilled nursing, will all have different recovery times.
There continues to be demand and a need for seniors housing and services broadly, but individual properties, markets and regions may see varying near-term results depending on the supply/demand characteristics of the area. We are taking a long-term view of the sector and continuing to add experienced owners and operators to our portfolio.
Shah: Memory care census appears to be improving slightly faster due to “needs vs. wants” concept of this asset type, similar to that of nursing homes. We expect the rest of seniors housing should also begin to recover, but at a slower rate. That said, we believe 2022 should see much of the industry return to stabilized levels, before potential new construction starts to come online in late 2022 through early 2023.
SHB: What has surprised you the most regarding the seniors housing lending environment in the last 12 months and why?
Taylor: Inconsistency in appraisals and methodology surprised us. Generally, we have seen cap rates used in appraisals increase for each level of care. That being said, the levels of increase have varied significantly, and it has not been necessarily tied to the differences in operations, the impact of the pandemic on a facility or the geographic location.
In addition to elevated cap rates, we have seen varying approaches to adjustments in the operating profiles that appraisers are assuming. In some instances, providers are being double dinged by having their cap rates increase and their EBITDA/NOI adjusted downward from their current or historic levels, which is suppressing facility values.
Providers need to understand this dynamic as it impacts their loan-to-value ratio and their ability to secure financing.
Shah: Lenders retreated very quickly from business development activity, even for better existing clients at more conservative deal terms. That said, lenders have not yet taken an aggressive approach in resolving problem accounts.
Plans for an uncertain future
SHB: With occupancies at record lows, how do you lend for seniors housing when the pace of economic recovery within the sector is still unclear?
Duggan: We focus on strong, well-capitalized sponsors and operators that have been in the industry for several cycles and are committed to the space.
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. During the near term, our focus has been to structure loans to provide enough flexibility for operators to navigate the immediate distress of the pandemic, while ensuring there is ample liquidity to get through the uncertainty.
The longer-term perspective for seniors housing financing is actually much easier to underwrite. Based on the efficacy of vaccines in long-term-care settings, the sector as a whole should eventually recover from the damage caused by the pandemic. Well-designed, relatively modern facilities with capable operators should recover progressively during the next 12 to 36 months.
Taylor: It is a balancing act. For communities that have historically had strong performance, we look at this period as a bridge between historic norms and what we expect future performance to be. We structure the transaction to support them in the recovery and to ensure they are making the progress they anticipate operationally.
For providers or communities that struggled prior to the pandemic, we are less optimistic they will recover or rebound as quickly. These facilities may need to de-leverage or not take on as much debt as they would have historically and wait to leverage up once operations begin to improve.
Shah: Our lending standards focusing on high-quality borrowers, operators, assets and markets remains unchanged. We believe the overall recovery will occur and are overall bullish on the future. We expect 2021 should see an increase in capital deployment into seniors housing in both debt and equity investments.
SHB: We’ve heard from many sources that construction financing has been very hard to achieve. Is that an accurate assessment and, if so, when do you expect that type of financing to open up again?
Duggan: Yes — currently commercial banks have tightened lending parameters and limited construction financing. Many core industry professionals have recognized that a slow-down in development at least in the short term may help with post-pandemic recovery.
Taylor: First Midwest has continued to look at and finance new development and expansion projects, but we are definitely being more selective in choosing the organizations that we work with and putting more structure in place for these transactions. We are stressing the fill-up assumptions and requiring higher levels of reserves upfront to support the initial operations of the facility.
That being said, we have passed on a lot of construction transactions, as the cost of construction relative to the market in which the project is being financed seems to be out of sync. Much of this, in my opinion, is being driven by the escalating cost of materials for projects that were conceived prior to the pandemic.
Smith: We do a fair amount of upfront due diligence on new construction projects — from running our own internal market analysis to calling the local zoning and planning boards to see what type of activity is going on in the market. Our biggest challenge is trying to get our arms around the current and future supply and ascertaining which projects in the pipeline will actually get built and compete with the facility we are financing.
Another key tenet of our investment philosophy, when it comes to financing new construction, is ensuring the project is properly reserved. We want to make sure there is enough capital to achieve stabilization. We never want to run into a situation where additional capital is needed during fill-up to stabilize the facility.
Given the drop in occupancy that occurred as a result of COVID, we have seen a significant increase in the number of new construction deals that have exhausted their reserves and are looking for fresh working capital in order to achieve stabilization.
Shah: Lenders continue to be reluctant to provide financing, and construction financing is among the least favored loans. Only the best sponsors providing significant equity contributions and strong guarantees are currently successful at arranging financing.
More credit will become available when debt and equity capital providers begin to resolve portfolio issues, and lenders see less uncertainty from the pandemic. Development capital should begin to become more readily available as market occupancy levels are near stabilized levels.