It’s rare for a lender to close over $1.03 billion in financings in a single day in two separate transactions. But that is exactly what transpired on Sept. 7 of this year for Berkadia’s Seniors Housing and Healthcare Group.
The first financing was over $995 million for Columbia Pacific Advisors’ (CPA) acquisition of Hawthorn Retirement Group’s properties, and the second was a $35 million bridge loan financing for a repeat Berkadia client.
Prior to being acquired by CPA, Hawthorn ranked as the 25th largest seniors housing owner and 18th largest operator in the United States as of June 1, 2017, according to the American Seniors Housing Association. The company owned and operated 6,373 units spread across 53 properties as of that date.
Managing Directors Lisa Lautner and Heidi Brunet completed the transaction for CPA, arranging a $951 million 10-year, variable rate Fannie Mae Master Credit Facility and a $44 million bridge loan through Berkadia’s proprietary lending program.
Brunet also closed the $35 million bridge-to-permanent loan for a 180-unit Virginia community, which includes independent living, assisted living and memory care.
Year to date through mid-September, Berkadia’s Seniors Housing and Healthcare Group closed nearly $1.8 billion in new loan originations. Seniors Housing Business interviewed Lautner at the recent NIC Fall Conference in Chicago to discuss the CPA mega deal and trends in debt financing across the senior living industry. What follows is an edited transcript.
Seniors Housing Business: The CPA deal has given Berkadia’s Seniors Housing and Healthcare Group plenty of momentum heading into the homestretch for 2017. Does the group have any specific goal for annual deal volume this year, and is there a sweet spot in the types of loans that it originates?
Lisa Lautner: We’ve done over $1 billion each of the last four years. We always try to do better. To hit those volume numbers, you need one or two large transactions typically. It’s hard to hit that number doing singles and doubles. Every year we seem to find a couple triples, maybe even a home run. This year we’ve hit a couple home runs, so we’ve been very fortunate. We’ll finish the year over $2 billion in volume.
Next year, we won’t budget $2 billion. We’ll probably budget to close over $1 billion. That is always a good number for us, given the number of producers and the underwriting staff that we have. It’s always a good mix of Fannie Mae, Freddie Mac and HUD financing. In terms of a sweet spot, our bread and butter is good old-fashioned refinancings and one or two portfolio acquisitions. Like most lenders in our sector, those are nice doubles to hit.
SHB: What stands out to you most about the Columbia Pacific Advisors/Hawthorn deal other than its sheer size? Was it the complexity of the deal that stands out?
Lautner: You are buying an entire development and operating company. So that means you are buying assets across the country in multiple states. You are buying independent living assets, but there is some assisted living thrown in there as well. And the real complexity was that a number of those assets had either just received their certificate of occupancy or were in lease-up, and then you had the whole development pipeline.
So, what’s the best way to finance all of that? It took us awhile to figure out what the client wanted, what its long-term strategies are. The Fannie Mae credit facility was the absolute perfect vehicle. It offered the borrower a ton of flexibility. It offered the borrower the ability to put assets back in the credit facility pool as they stabilized.
SHB: In a loan closing are large as this one, how many people are in the room?
Lautner: We used to physically go to closings before everything became electronic. Now everything is done via e-mail, but we had weekly calls on this deal, which involved Berkadia and legal counsel and underwriters; Fannie Mae, legal counsel and underwriters and producers and the whole team from CPA. Typically those calls would have somewhere between 25 and 30 people on them. It’s a lot of complexity.
SHB: So, the closing occurs in stages?
Lautner: It has to on a deal of that size. The minute the borrower picked the Fannie Mae credit facility and signed an application, the attorneys got to work immediately. On the borrower side, they are setting up all their buying entities so they are creating brand new entities to buy assets. The attorneys have to approve all the formation documents.
SHB: By definition, the Fannie Mae credit facility provides both long-term and short-term flexible financing at a competitive price for one or multiple borrowings over the term of the facility, secured by a single pool of cross-collateralized and cross-defaulted multifamily mortgages. But how does the credit facility work exactly?
Lautner: Typically, the Fannie Mae credit facility is for large-pool acquisitions. So, it’s seeded with the initial group of properties that are being bought or refinanced. These are typically longer-term holds — let’s say 10 years. A lot of things can happen in 10 years.
Within that group of properties, you may decide at some point that four or five don’t fit anymore and you want to sell them. Normally, if you just have a regular loan secured by four assets and you want to sell two of those assets the lender says, “I don’t want you to sell the best two and leave me with the dogs.” They put covenants and restrictions on loan-to-value and debt coverage. So, sometimes it makes it almost impossible to sell when you want to sell.
With the credit facility, if you release one asset it’s much easier to do because you have the overall coverage and the overall loan-to-value. You don’t have to get so granular on each release. You can add to the pool.
If you want to go and buy another asset and put it in the pool, you already know what the underwriting parameters are. It’s kind of pre-approved if you meet the underwriting parameters. It’s easy to slide in because the documents are already done. You don’t need to do all new loan documents.
The best thing about the credit facility is that this is a long-term transaction for anybody — 10 years. If the performance is there, equity builds up in those assets. Maybe you want to tap that equity and go buy something else. This vehicle makes it much easier to do so. You are not looking for one asset to perform to tap into its equity. You have a pool of assets that are generating equity that could be pulled out and used for whatever purpose it is. It’s a flexibility feature.
SHB: Have these credit facilities been around for a long time?
Lautner: These are relatively new products. I would say Freddie Mac is also rolling out a similar-type product. I’m assuming they have been around for the last three or four years. Both GSEs (government-sponsored enterprises) are responsive to the borrower. When the borrowers get into these credit facilities and things don’t work well, they will make suggestions to Fannie Mae and Freddie Mac. Typically those suggestions are heard by the agencies and they make tweaks along the way.
SHB: Are there any trends that you are seeing in the marketplace among borrowers? What are their wants and needs today?
Lautner: Borrowers are still looking for development money, and I think the development money is starting to stay on the sidelines a little bit. We’ve seen some overbuilding in the industry and we know that’s been coming on for the last 18 months or so. We’re seeing softness in occupancy across the board.
I’d say that two years ago at the NIC conference anybody developing properties probably had eight or 10 lenders they could go to at any time. That’s probably down to three now. The lenders are waiting to see how some of these properties fill up. They are getting a little more cautious about whom they are doing business with. Most of the banks that do the majority of the construction financing have been around for awhile. They were around when we allowed overbuilding to happen 15 years ago. They are a little smarter the second time around, but there are still a lot of folks developing.
SHB: Industry leaders emphasize that the overbuilding occurring today is limited to a few submarkets in major metros and that the NIC MAP data helps the industry avoid irrational exuberance. Does that combination of factors give lenders a little more confidence than they might otherwise have?
Lautner: Absolutely, but lenders have to do their due diligence. They have to really dig into the submarkets and comb through the available data. Pick Tulsa, Oklahoma, for example. The northwest Tulsa market is totally different than southwest Tulsa. People in southwest Tulsa don’t want to go to northwest Tulsa. You need to really get in there to peruse and shop the market to understand what it’s about.
Even though there is overbuilding occurring, there are absolutely great pockets still available for building that will be very successful projects. The lenders need to hold firm and conduct their due diligence and tap into the data that is out there, as you would assume the developers would do.
SHB: How much stock do you put in feasibility studies?
Lautner: We review feasibility studies, then we look at the data and we do our own due diligence. Every lender should do that. The feasibility study may get the developer in the door and perhaps make you spend more time on the front end than you would normally. The feasibility study should be from a reputable firm that is tapping into all the same information you can tap into. You better do your homework and talk to some of your clients who are in those markets where a project is being proposed.
At Berkadia, we have an $8 billion loan-servicing portfolio. We have properties everywhere. My guess is that if someone is going to build in a Raleigh, North Carolina, we probably finance some assets within that market. We probably have some good data ourselves, and we should use that data.
SHB: Berkadia is headquartered in Ambler, Pennsylvania. Where is the seniors housing group based?
Lautner: Interestingly enough, most of the professionals in our seniors housing group work out of our homes as do a lot of our underwriters. Mind you, most of us have worked together for 20-plus years. It’s almost like we can complete each other’s sentences.
Berkadia has more than 30 offices across the country on the multifamily side. But on the seniors housing side, for whatever reason the way the group came together is that we all work out of our homes. That setup works well for us because we have such seasoned people. All the producers in our group have been doing this for 20-plus years. Our senior underwriters have been doing this before they were married and had kids.
We’re hiring some new, young talent on the analyst side of the business that we hope to eventually train to be underwriters. We’ve put all of them in our Dallas office so they can learn from one another. It’s an easy place for all of us to travel to, so we can meet on a regular basis with them and teach them the business.
You can’t have young talent working out of our home office with no support. They really need to be there to see and hear conversations. We always have a weekly group call that everybody joins to discuss where the deals are, what problems we have, who needs some equity, whatever the issues may be. So, it’s good for the younger people to hear that exchange and ask questions.
SHB: When we talk about underwriting on the finance side in commercial real estate, what does that entail exactly? Do the underwriters shape the terms of the loan?
Lautner: I bring in the deals. I have a good idea of what an existing asset is worth. So, if the property is worth $11 million, I could probably lend $7 million on it. Our underwriters and analysts collect all the financial information and the rent rolls, plus the market information, and they make a determination about the loan.
The underwriting team may say, ‘Lisa, I know that you believe you can get $7 million for the borrower, but I really think because of X factor, you are going to need to take that into consideration, and the trend has been negative.’ The underwriters are the ones who will actually submit the request to Fannie or Freddie on our seniors housing side to say X,Y,Z client is buying a particular building, and we think it’s worth less than $7 million of debt. And then Freddie or Fannie will come back with a loan amount.
SHB: When it comes to a proposed ground-up development, where can a project feasibility study go awry? What does it fail to take into account?
Lautner: It’s probably new competition, projects the developer doesn’t know about. There is only so much information you can get, particularly in independent living. When you finish your feasibility study, you may now know that there is a guy in line behind you who is seeking a building permit for a project.
SHB: You pointed out that construction lenders have tightened their purse strings. This industry goes in cycles. How long will we likely be in this expansionary cycle?
Lautner: Dan Baty, who is like the godfather, talks about 10-year cycles. And he is probably right. (Baty is founder of Seattle-based seniors housing investment company Columbia Pacific Advisors and formerly co-founder of Emeritus Corp., which merged with Brookdale Senior Living in 2014.)
Every cycle is a little different. When all the assisted living companies went public back in the late 1990s, with that fresh cash everybody built like crazy. Then we were in a cycle of way too much overbuilding (and an economic slowdown ensued). That was a big dip. I don’t think the overbuilding in this cycle is going to be followed by a big dip.
The lenders were smarter this time around. The operators and the developers were a little smarter. Sure, some markets have gotten overbuilt. There is a lot of money interested in this space that is going to find a way to get out the door. Developers like to build, it’s a newer, pretty and shiny product. But there has been a little more discipline this time.
SHB: Where do you think cap rates are going, and are cap rates and interest rates inextricably linked?
Lautner: We do think interest rates are going to go up. Therefore, we assume that some six to 12 months behind this tick-up in interest rates we’ll see cap rates start going up. We thought that interest rates were going to start ticking up 18 months ago. I’m not a prognosticator, however.
SHB: If lenders have been underwriting deals conservatively with the idea that interest rates are going to tick up, is that a positive development for our industry?
Lautner: We’re not a bank, so we're not doing a lot with short-term money. We’re placing deals with Fannie and Freddie. With Fannie and Freddie underwriting, you don’t underwrite to today’s interest rates. The agencies give you a higher rate to underwrite to, so you’ve got that cushion. The banks in general — the shorter-term bridge lenders — are LIBOR-based, and short-term rates have gone up [more quickly] than the long-term 10-year Treasury rate.
The deals are getting a little tougher to get done. I definitely believe that we’re going to see long-term rates going up probably in the next year. I can’t imagine anyone who wouldn’t say the same thing.
Our company recently invited 50 of the newest analysts across the country to Dallas. We provided different breakout sessions, and one of those sessions was educating them on seniors housing. I put up a chart on cap rates in the seniors housing space from 2012 to now, and frankly we’re about where we were five years ago. We had a little bit of a dip when interest rates fell through the floor in the Great Recession.
In 2011 and 2012, we saw a little bit of a dip, but for the most part the average cap rate for skilled nursing facilities was 13 percent in 2012. The cap rate is about 13 percent currently.
SHB: Fast forward to a year from now. What do you think will be the state of the industry in 2018?
Lautner: The occupancy issue is going to be soft for probably the next four to eight quarters. That is going to cause a lot of folks to maybe exit the space. A lot of money has poured into this industry over the last couple of years. [Investors] hear about the better returns, but they don't quite understand the operational risk. The transaction volume will be pretty healthy because a lot of these people will exit the market and there will be a lot of activity.
SHB: Is the softness in occupancy simply a function of supply exceeding demand, or are there other factors at play?
Lautner: From what we can tell, the softness has more to do with the supply. With regard to the standalone memory care, there may be other issues at play in that segment. I’m not sure because the data hasn’t proven that out. Standalone memory care is really getting hurt by buildings that combine assisted living with memory care.
SHB: Why would an operator want to be in the standalone memory care business as opposed to assisted living and memory care? Isn’t it riskier for an operator to have all its eggs in one basket?
Lautner: Memory care is a very specialized operation. The caregivers in those facilities are specially trained to help people with severe dementia. And that’s what the operators of these facilities sell to the adult sons and daughters of seniors. It’s a whole program. And there are a couple different operators that do it very well.
Most of those standalone memory care facilities are smaller in terms of the number of units. If you lose a couple of residents when they die, it affects your occupancy rate and your bottom line much quicker unless you have a waiting list.
It’s an easier marketing strategy to have a building that provides a combination of assisted living and memory care. Although you will have turnover in your memory care wing, you have a natural born feeder coming from the assisted living side of the business.
Still, if I had a parent with dementia I may want to put him or her in a standalone facility that specializes in that type of disease. It might make me feel better.
— Matt Valley