Seniors Housing Business

MAY-JUN 2018

Seniors Housing Business is the magazine that helps you navigate the evolution of the seniors housing industry.

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Capital Corner 10 Seniors Housing Business n May-June 2018 Amid Maturing Cycle, Construction Loan Terms Tighten By Matt Valley If a borrower today complains about the growing challenge of securing construction financing for a seniors housing project, the like- lihood is that what he really means to say is a non-recourse loan at 75 percent loan-to-cost is no longer available. "That's true, thankfully," said Brian Heagler, senior vice president with KeyBank Real Estate Capital, who focuses exclusively on skilled nursing and seniors housing. "Terms are tightening up a little bit — more equity, more recourse, maybe more conservative 'burn-off' provisions on the recourse." Who's filling the gap? Amid overbuilding concerns and falling occupancies — the NIC data shows occupancy at seniors housing properties fell to an aver- age of 88.3 percent in the first quarter — most commercial banks today are proceeding with extreme caution by thoroughly vetting spon- sors and operators alike. However, the demand for construction financing remains high in the development community. "You have seen a lot of the local banks, or maybe smaller regional banks, backfill some of that demand on a specific relationship basis with a developer or operator," according to Heagler. The insights from Heagler came during Inter- Face Seniors Housing West, which took place March 1 at the Omni Los Angeles. The event drew nearly 400 seniors housing executives from a variety of commercial real estate disci- plines, including brokerage, development and finance. Moderated by Ross Holland, vice president with Lancaster Pollard, the capital markets panel addressed a number of timely topics: the overall climate for construction financing; changes in loan terms; the ripple effects of rising interest rates; and new entrants to the seniors housing sector. Joining Holland and Heagler on stage were Tim Bernier, executive director, healthcare credit and underwriting, Oxford Finance; Stu- art Oswald, senior vice president and manag- ing director, NorthMarq Capital; and Dague Retzlaff, senior vice president for real estate at Capital One Healthcare. Oswald of NorthMarq said that while he focuses primarily on arranging permanent debt for his clients, a few operators in the North- west region of the country have reached out to him in recent years to source construction debt for their projects. These operators typi- cally are managing between five and 20 build- ings, which means the ideal leading providers of debt financing in this case tend to be smaller or regional-type banks. "With my recent deals, we have been for- tunate enough to have a really strong second, third or fourth partner step up and share on the personal guarantees. That guarantee strength has been huge in attracting interest from lend- ers," explained Oswald. (A personal guarantee pledges the private assets of an indi- vidual borrower to secure a commercial mortgage.) Having a strong guaran- tor in place protects the construction lender in the event the property doesn't perform as expected, emphasized Oswald. A construc- tion lender typically has two to three weeks to quote a deal, and then it takes another month for the loan request to work its way through the credit committee, he explained. Given that compressed time frame, the underwriting is not always foolproof. "Predicting which buildings are going to be successful and which aren't is such a mystery in this business to me," said Oswald. "We've seen examples where you have a market that is not that well occupied, say 85 percent, and the demand numbers aren't all that enticing. But the property performs really well because maybe everything else is a little bit functionally obsolete. A new property came into the mar- ket and offered something new. And vice versa, we've seen a well-occupied market where a property came in and failed." The HUD attraction The pullback by many banks in the seniors housing sector has driven many developers to explore construction financing through the U.S. Department of Housing & Urban Devel- opment's mortgage insurance program, accord- ing to Holland of Lancaster Pollard. HUD/ FHA Section 232 provides rehabilitation and construction loans for healthcare properties, including skilled nursing, intermediate care and assisted living facilities. Borrowers who qualify receive low, fixed- rate loans for up to 40 years and loan proceeds up to 90 percent of the estimated project cost. That's enticing, but HUD requires "prevail- ing wages" to be paid in accordance with The Davis-Bacon Act. Specifically, the act requires the payment of prevailing wage rates to all laborers and mechanics on federal or federally assisted con- struction contracts. In some markets, the use of "prevailing wages" can increase the project's hard costs by as much as 20 percent, according to Holland. "The reality is that once you factor in the need to use prevailing wages, the actual lever- age point ends up being pretty darn similar to a bank. And while a HUD loan is non-recourse financing, [the transaction] takes a little longer to get done," said Holland. Lancaster Pollard recently helped Gardant Manage- ment Solutions and Horve Builders obtain construction financing to build Heritage Woods of Noblesville, which will be a 124-unit afford- able assisted living facil- ity in Noblesville, Indiana. Lancaster Pollard obtained a $19.9 million loan insured by the FHA/HUD Section 232 program to fund the new construc- tion project. The loan features a low, fixed inter- est rate and 40-year term. The permanent financing allows Gardant to focus on operations and avoid interest rate risk in the midst of a rising rate environment. The targeted completion date is January 2019. Results vary for new entrants Several investors and developers with exper- tise in other property sectors, most notably multifamily, have entered the seniors housing sector in the last few years and the results have been mixed, said Heagler of KeyBank. In some cases, these new entrants have had to recali- brate their expectations. "Maybe the return hurdles weren't as strong as they thought, or the time it was going to take to realize those returns may not have fit their time horizon, particularly if they were doing a development model," explained Heagler. Some entrants dabble in the seniors hous- ing space for a year or two and then exit stage right. Others take a little longer to get started but stay the course. Regardless of whether the borrower is new to the industry or not, the lender's initial focus has to be on the sponsor, the lead investor, Hea- gler emphasized. "What is their experience level? What's their access to capital? And who's the operator? You really start with the question of whether they have done their due diligence on the operator." Retzlaff of Capital One said that given the ample amount of new construction that has already occurred in this real estate cycle, the bank only provides construction loans to bor- rowers with a proven track record in seniors housing development. "On the acquisition and investment side, I don't worry as much about their experience in the space," explained Retzlaff. "You are going to want someone well-heeled financially and is partnering with a good operator. Their actual experience in the seniors housing space is a little less important to me. Now if it's a deal where they are transitioning a unit to memory care — where they are doing something unique — that's a little different story." n Brian Heagler KeyBank Real Estate Capital Ross Holland Lancaster Pollard

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