Although there is unpredictability in the economy, lenders are upbeat and see mostly upside.
James F. Sherman, Senior Vice President, Seniors Housing, Dougherty Mortgage, LLC
Kathryn Burton Gray, Head of Seniors Housing & Healthcare and Senior Managing Director, RED Mortgage Capital
Kevin McMeen, President, Real Estate, MidCap Financial Services
Brian Robinson, SVP Commercial Banking, MB Financial
Trace Wilson, Director, PGIM Real Estate Finance
Eric A. Halpern, FSVP and Head of National Healthcare, Bank Leumi USA
Charles Dabich, Director of Business Development, Housing & Healthcare Finance
Chris Taylor, Managing Director, Capital One Healthcare
Tracy Maziek, Healthcare Services Managing Director, Oxford Finance LLC
By Jeff Shaw and Matt Valley
Although mergers and acquisitions in seniors housing have cooled over the last 18 months following a particularly feverish pace, lenders in the sector have managed to keep up their volume.
Taking advantage of near-record-low interest rates, many owners are taking opportunities to refinance. New construction activity has also kept a healthy pace within the sector, fueling construction loans, bridge-to-HUD financing and permanent HUD loans.
Seniors Housing Business asked veteran lenders to share their insights on the current state and the future of seniors housing. What follows are the edited responses:
Seniors Housing Business: What is your company’s specialty in the seniors housing space as a provider of capital? For example, do you have a preference for which types of seniors housing properties you will finance? Is there a sweet spot in terms of deal size?
Sherman: The sweet spot is somewhat dictated by the individual market. There are markets that are saturated with one type of seniors housing type, but there is a market for another type of property.
With that said, there have been a large number of seniors housing memory care properties constructed during the past two or three years. With this level of construction either recently completed or about to be completed, we are being cautious with memory care. Properties that provide more than one service (e.g. independent living along with assisted living or assisted living along with memory care) seem to be less risky to finance than one-service properties.
As far as Dougherty is concerned, we will look at most types of seniors housing properties including independent living, assisted living, memory care and skilled nursing facilities.
Maziek: We focus on skilled nursing and high-acuity assisted living. Our ideal transaction size is $20 million to $25 million.
Wilson: Our preference is for private-pay seniors housing properties across most acuities, excluding skilled nursing. We finance the whole continuum of care, but don’t prefer standalone memory care.
In terms of deal size, our smallest loan of the last several years has been around $10 million, while largest was approximately $220 million. The average is in the $20 million to $30 million range, including portfolio loans for multiple properties.
Dabich: Our company runs the gamut of seniors housing finance, including mortgage brokerage, balance sheet mortgage, mezzanine lending and HUD execution. We lend to nursing home owners and assisted living owners with an eye toward HUD financing for an eventual long-term solution to their capital structure. We do not have a sweet spot, per se; we can do any type of deal size from smaller one-off deals to large portfolios.
Halpern: Leumi typically finances acquisitions, bridge-to-HUD loans and refinancings for skilled nursing and assisted living facilities. We do not do construction financing in the seniors housing space.
Our sweet spot depends on many factors. However, the general range would be $10 million to $25 million, with outliers in both directions.
McMeen: MidCap has a team that is dedicated to the seniors housing and long-term care space. We provide loans ranging in size from $5 million to over $100 million. While we focus on using our balance sheet to provide senior debt for value-add transactions, we have also made mezzanine loans on large portfolios. We are also a HUD lender and thus can provide both shorter-term bridge loans and then longer-term take-out financing via HUD.
Taylor: Capital One is very fortunate in being able to provide our clients a full range of financing options.
In addition to lending from our balance sheet, we also offer Freddie Mac, Fannie Mae and HUD financing solutions. There is no real preference in terms of product type. Our primary focus continues to be on the quality of the sponsor and operator.
SHB: As you reflect on deal volume in the seniors housing space during the first half of 2017, what jumps out at you? Any surprises, good or bad?
Sherman: It seems there is a bit less volume for new financing currently than during 2016. Since the amount of new construction has expanded materially there should be a stronger market during 2018/2019 for new and permanent financing. Also, the number of acquisitions has slowed during 2017, which has also influenced the number of financing transactions being completed during 2017.
Acquirers are being cautious with their underwriting. There is a heightened concern about potential rising interest rates and the effect it may have on profitability, as well as the impact it will have on potential residents’ sale of their homes.
Maziek: We are surprised by the continued buyer interest in skilled nursing facilities.
Wilson: Transaction volume, especially in the Class B+ and Class A space, has been down in 2017, but seems to have picked up recently.
Dabich: From the NIC data, what really jumps out is the drop-off in deal volume from the public players, which has continued from 2016. The second quarter of 2017 saw the public buyers represent $269 million in deal volume versus an average quarterly volume of $3 billion from 2011 to 2015. The decline is dramatic as the public players — REITs specifically — reposition their portfolios amid declines in their cost-of-capital advantage.
Halpern: No surprises, per se. We continue to see healthy deal flow from the market, consistent with previous years.
Robinson: Despite reimbursement uncertainty, opportunities abound. New operators are entering the market with capital behind them while existing operators acquire additional properties to take advantage of the potential efficiencies a larger portfolio creates in their back offices.
McMeen: Deal volume has been soft. The quality of transactions that are a true fit for MidCap (slightly higher leverage than banks and non-recourse) have been lower and therefore we have quoted fewer transactions. While disappointing, the soft or low quality volume is not surprising. This has been a trend for at least 18 months.
Gray: Most of the transactions over the past three years have been development/construction loans with agency/FHA permanent financing at the end of the mini-perm cycle. Lenders have been slowing down on their respective appetite of construction dollars, so the transactions being completed by banks and finance companies are lower leverage with recourse to the principals.
Taylor: In the market overall, deal volume has been slightly down for the first part of the year. However, we have seen a wide variety of opportunities, from single-asset deals to very large portfolios.
SHB: Has the total dollar amount of seniors housing loans closed so far by your company in 2017 increased, decreased or remained about the same compared with the same period a year ago? By how much has it changed? What have been the driving factors?
Sherman: The number of deals has remained about the same for 2016 and 2017.
Maziek: We are slightly up, approximately 10 percent to 20 percent higher. We’ve been able to take advantage of other lenders’ inability to deliver as promised.
Wilson: Volume so far is on par with last year.
Dabich: For the first six months of HUD’s fiscal year, we’re almost identical to last year at approximately $192 million. We continue to see our borrowers lock in long-term financing once turnaround situations have stabilized.
What has increased is our bridge-to-HUD and asset-based lending business lines, as we have really ramped up those businesses. Year-to-date through June, we closed $270 million compared to $180 million at the same time last year. The increase has been driven by our greater commitment to the business, as well as deal volume increases as larger players sell off non-core assets.
Halpern: The amount of seniors housing loans booked in the first half of 2017 increased relative to 2016 by 35 percent. The increase is centered on certain larger, individual skilled nursing deals that were booked.
McMeen: Dollar volume is slightly off from last year (approximately 10 percent). The main drivers for the lower volume are deal quality and competition.
The quality of the transactions is not as good. The risk relative to the leverage and pricing on the loan is not attractive enough to quote or to quote at the level the borrower wants. In some cases, those transactions get done with other lenders we believe are mis-pricing risk. In some cases, the deals simply don’t get done.
Taylor: For the first half of 2017 our deal volume is up about 10 percent. This has been driven primarily by an increase in our agency and HUD volume as compared to prior years.
SHB: What’s the outlook with regard to deal volume in your shop in the seniors housing space during the second half of 2017 compared with the second half of 2016, and what are the variables at play?
Sherman: Currently, we are evaluating a larger number of potential transactions than we did for the first half of the year, so the second half of 2017 should be stronger.
It seems that certain owner-operators have completed new properties and they are filling as budgeted, so they are looking at strengthening their financial position. Refinancing is one way to achieve this objective. Also, there are a few properties that are expected to change ownership for which we plan to provide the acquisition financing.
Maziek: We expect it to be slightly up as a result of regulatory/legislative changes.
Wilson: I think it largely depends on the amount of transaction volume.
Dabich: Our customers don’t like surprises and neither do we, so we are projecting, like last year, around 30 HUD deals for between $350 million and $400 million — more or less the same run rate as the first half of the year.
From a bridge-to-HUD and asset-based lending business basis, we expect the second half to outpace the first half of the year as we close some larger portfolios. I would say $300 million in the second half of the year versus $270 million in the same time period last year.
Halpern: Leumi is more selective in the deals that it is approving. As such, expectations are that the percentage growth for the second half of 2017 will be somewhat more conservative than in previous years.
Robinson: Anticipate continued choppiness in deal flow in the second half of the year. Headwinds face skilled nursing, with shorter quality days and increased expenses being the primary factors. Combine that with regulatory uncertainty on both federal and state levels, and everyone is taking a harder look at opportunities.
McMeen: I don’t anticipate a significant change in volume for the second half of the year.
Taylor: Based on our current pipeline, I would expect a very strong second half of 2017. This is driven by the relationships we have been fortunate enough to cultivate with owners and operators in the space and the variety of solutions we offer.
SHB: What has accounted for the lion’s share of your business during the first half of 2017: refinancing, acquisition financing, construction financing, bridge lending, etc.?
Sherman: Refinancing has been about 50 percent and new construction has been the other 50 percent.
Maziek: Acquisition and bridge lending account for 75 percent of our volume.
Wilson: We are more active in the permanent loan space as opposed to bridge and construction financing.
Dabich: The bridge-to-HUD and asset-based lending is predominantly done with acquisitions, while the HUD business is predominantly refinancing. Through the first half of 2017, we were about 60 percent bridge-to-HUD/asset-based versus 40 percent HUD business.
Halpern: A combination of acquisition, refinancing and bridge-to-HUD makes up our business, with the majority in acquisition and refinancing.
Robinson: We are about 30 percent refinancing, 25 percent acquisition, 10 percent construction and 35 percent bridge.
McMeen: Our business has been predominantly refinancing (approximately 80 percent). This has been split 75/25 between shorter-term balance sheet loans and HUD loans.
Taylor: The majority of our financing so far in 2017 has been providing capital for acquisitions.
SHB: The 10-year Treasury yield, a benchmark for long-term, fixed-rate financing, closed at 2.31 percent on July 17, 2017, up from approximately 1.6 percent a year ago. The three-month LIBOR stood at 1.30 percent as of July 12, 2017, up from 0.67 percent a year ago. What impact, if any, has the rise in these rates had on both deal volume and borrower strategies?
Sherman: Seniors housing operators have not significantly been concerned about what they feel is only a small increase in interest rates as compared to a year ago. What they are more concerned about is the potential for interest rates to increase significantly in the future.
With the number of newly constructed properties, there is some concern that if interest rates increase materially, the owners will not be able to fully refinance their construction loans into permanent debt.
Maziek: There has been surprisingly little impact, as far as we can tell.
Wilson: I think that in the short term, such as when the 10-year dropped roughly 15 basis points from May 1 to June 2, there are short-term increases in lending volume. But in general I think the belief is that long-term rates will remain at lower levels for the foreseeable future. Most owners are not rushing to rate-lock transactions when there are short-term dips in Treasury rates.
Dabich: I wouldn’t say the increase in rates has had a dramatic increase in deal volume — 2.31 percent is still low by historical standards. In the years prior to the Great Recession, we saw a 10 Year Treasury yield in the low to mid-4 percent range. Over the last 20 years, even taking into account the Great Recession, the average is still around 3.8 percent. The three-month LIBOR was at 5.36 percent prior to the Great Recession and, over the last 20 years, averaged approximately 2.5 percent. We have seen some borrowers ask about fixed rates versus floating, a little bit more than in the past, but nothing overwhelming in that respect.
Halpern: Deal volume has not decreased. However, Leumi’s stress-test modeling has expanded to include further potential increases in interest rates. Borrowers have typically locked in rates, reducing further exposure to interest rate increases by entering into swap agreements.
Taylor: So far we have not seen the rising interest rates over the past 12 months have a meaningful impact on deal volume or on our clients’ strategies. While rates have increased, they are still near historic lows and are very attractive. The fundamentals of the seniors housing sector continue to be very appealing for both debt and equity capital.
SHB: Which segments of seniors housing (independent living, assisted living, memory care, skilled nursing, etc.) are you most bullish and bearish on as a lender and why?
Sherman: During the past several years there have been a lower number of independent living properties constructed compared to the number of assisted living and memory care properties. The demand for independent living properties has increased, and the sense is that as long as housing markets are strong and the number of Baby Boomers looking for a carefree lifestyle remains stable or increases, this trend will continue. There are owner-operators who have not been in the independent living space but have focused on assisted living and memory care, but are now constructing independent living properties to complement their existing business.
Maziek: We’re bullish on high-acuity or government-reimbursed assisted living and/or reasonable payor mix skilled nursing. These areas are needs-based and offer a lower cost of care compared to alternatives.
Wilson: I think there is reason for optimism in each of the acuity types with the caveat that we are less involved in the skilled nursing space. You can point to, among other things, aging trends, lengths of stay and delivery of care as potential factors that will lead to increased demand for independent living, assisted living and memory care.
Dabich: Each of the segments are having their challenges — from new construction in the assisted living space to shortening length of stay, shift to Managed Medicare from Medicare and labor shortages in the skilled nursing space. I would not say we are necessarily bullish or bearish, but just sticking to the basics: the strength of the operator. That is the best mitigant to potential challenges.
Halpern: Due to all the changes being discussed in Washington, Leumi has a positive-but-cautious outlook for the industry. We continue to support our clients and the industry at large, as we have for the last 30+ years.
McMeen: We are most bullish on rental seniors housing properties with a mix of services — independent living, assisted living and memory care. We believe that these are the most appealing and most competitive assets in the market. We are least bullish on skilled nursing, though we are still originating new loans on nursing homes. The reason for our relatively bearish outlook has been the pressure on revenues, staffing challenges and the ability of operators to maintain margin/cash flow.
Taylor: Skilled nursing is the area with the most challenges right now. While the long-term viability of the sector is still good, and we continue to lend in the space, the impact of changes to managed care models and uncertainty around payment structures for both Medicaid and Medicare have caused some to hit the pause button. Despite recent concerns around overbuilding in certain markets, the assisted living and memory care segments continue to be very strong.
SHB: During this expansionary phase of seniors housing, have underwriting standards changed, and, if so, how?
Sherman: Underwriting has remained mostly the same, but there has been a greater emphasis placed on the financial strength, experience and background of the owners and operators. Cash reserves and liquidity have become more and more important when evaluating a lending opportunity. For the most part, the loan-to-value ratios and debt-service coverage ratios have held steady for permanent financing, but have changed for construction financing. While construction financing has been more difficult to find and close, there is typically a higher level of equity being required — usually in the 30 to 35 percent range, versus 25 percent just a few years ago. There is an emphasis on the liquidity and potential availability of cash if there is an unforeseen problem.
Maziek: Loan-to-value ratios have held consistent, but capitalization rates have progressively gotten more aggressive.
Wilson: Underwriting standards in our experience are holding for the most part, maybe with the exception of the very high-end, Class A+ assets. This is driven by cap rates. So if cap rates are lower today than they were, say, 12 to 24 months ago, then the loan-to-value may be the same coverage and other cash flow metrics could be tighter.
Dabich: HUD does distinguish between new construction lending and financing of existing facilities; leverage is 5 percent lower from a max of 80 percent to 75 percent. That reflects not only the added risk of construction, but loan performance on new-construction assisted living facilities not meeting the performance of the rest of the HUD portfolio. On the bridge-loan side, I wouldn’t say that leverage and coverage have changed that much — there’s just more scrutiny of the market (potential new entrants) and operator experience.
Halpern: While we have seen some banks loosen their standards, we have maintained our underwriting standards. If anything, we’ve tightened them in appropriate cases.
McMeen: Underwriting has definitely gotten looser as more lenders compete for transactions.
Taylor: As markets heat up I think there is always a tendency for underwriting to loosen somewhat. We see this in lenders moving to “covenant light” and even no-covenant loans. With the abundance of equity capital available today, we have not seen much of an increase in borrowers seeking higher leverage.
SHB: What keeps you up at night as a lender these days?
Sherman: Too much new product opening in a market at the same time could be a potential issue. While the market for seniors housing is expanding and will expand more rapidly in a few years, there will be some overbuilding in certain markets in the short term.
Also, the trend of higher minimum wages for employees is becoming a major issue for some operators. As wages increase, resident rates have to increase to cover the costs. This could become a significant issue during the next few years.
Increasing wages, difficulty in recruiting qualified persons to manage properties in some markets, and recruiting marketing persons are the things that keep lenders awake at night.
Maziek: Macro-economic or legislative changes could have a sweeping effect on reimbursement.
Dabich: For assisted living — and this is not a real surprise based on all the press coverage and the NIC data — overbuilding in certain markets.
For skilled nursing, there are a number of headwinds: the continued shortening of length of stay, the shift to Managed Medicare from Medicare and labor shortages. But as we see more of the bigger players reducing their portfolio, some of the smaller regional players are absorbing more assets. I am becoming more concerned that growing too fast will be an added problem in the space.
Halpern: To a great extent, whatever keeps our borrowers up at night keeps us up at night. This includes potential unsatisfactory surveys or other similar events that may affect the operation or cash flow of an otherwise well-run skilled nursing facility.
Robinson: In the skilled nursing sector, shorter quality days, increased labor costs and regulatory uncertainty are creating issues for even the best operators. The general consensus is that Medicaid expansion has to be checked, but doing something about it clearly easier said than done.
McMeen: Owners have to find ways to grow their portfolio without taking inordinate risk. Aside from that, the usual concerns of operators losing focus on any given asset or portfolio of assets can result in weak cash flows and value impairment.
Gray: The flat yield curve this past year sends the message that the minimal differences between long-term committed debt and short-term debt is similar. Therefore, why lock down long-term financing?
However, we look at all of the market dynamics, including SWAPs, micro and macro economics, global stability and monetary policy. We understand increases in interest rates are inevitable, especially given the unpredictable financial markets. RED Capital bankers suggest permanent financing options should be considered sooner rather than later.
Taylor: If I have any concerns they are probably around the economy in general, both in the U.S. and worldwide.
The seniors housing space is comprised primarily of people with a genuine desire to serve the population they care for. The fundamentals from a demographic perspective are irrefutable. It’s the “black swan,” if you will, from outside our sector that is my biggest concern.