The SeniorCare Investor: Construction Financing 101
Commercial Banks, HUD and REITs Still In The Market
Everyone has been complaining about the lack of debt financing for acquisitions, or when available, that the terms are too stringent or the equity required is too high. Well, welcome to the new reality, and unless memories are short (again), and lenders recover and return to their aggressive ways in a year or two (which no one is predicting), we will be in a fairly tight debt capital environment for a while. This should make the health care REITs happy, because they have been providing 100% financing for 20 years, arguing that they were always cheaper than the blended cost of debt and equity, and you really didn’t need much equity. That was fine unless you wanted to own your real estate.
Borrowers, however, scoffed, when at the market peak it was not unheard of to obtain debt financing from 85% to 110% of the cost of an acquisition when everyone believed the wonderful pro formas. One of the unfortunate results was that more than a few buyers who excelled on the deal side but fell short on the “provider” side obtained more debt than they should have, and paid more than they should have for a few too many acquisitions. An Oregon-based company comes to mind, but there are others. But when it comes to construction financing, we don’t hear that it is tight; we hear that it is just not available. We also hear that it’s not relevant because there is no new development going on. We beg to differ.
On January 21, we held an audio conference on the topic of seniors housing development finance (CDs are now available), and despite some snide e-mails calling it an oxymoron, the reality is that there are providers building and there are lenders providing the capital, even traditional commercial banks. There is a difference from a few years ago, however. First of all, real equity is required, and usually more than what was often the inflated value of the land. For commercial lenders, it is 25% to 35%, or more if you want better terms. Second, they will not lend to just anyone who wants to put up a new building. Not only does the particular project have to make a lot of sense, but the provider has to make a lot of sense as well. Sure, lenders will say that was always the case, but just look at our friends in Oregon who had no shortage of lenders willing to provide capital, and maybe the property made sense (or not), but they often forgot the second half of the equation.
Our panelists included Colleen Mullaney of TD Bank in Florida, Thilo Best of Horizon Bay Management, Nick Gesue of Lancaster Pollard and Chuck Herman of Health Care REIT (NYSE: HCN). Each of them had a particular story to tell of what they are doing in the development finance side of the business. In the case of TD Bank, they recently provided a $30.2 million construction loan to build a 172-bed skilled nursing and assisted living facility in southeast Florida for Palm Health Partners, which has two additional developments in Florida under way. That loan is for $175,000 per bed, and in a state that has had its share of “real estate” problems. But the facility will truly be state-of-the-art in more ways than one, and the company is picking and choosing where it will build and with whom it will partner in a systematic way, and all in Florida with no plans to go beyond the state borders.
Will TD Bank do another loan for Palm Health? Probably, but the developer had to put up some real money and had to personally guarantee the loan, which is more common these days. Horizon Bay has a few developments in the works, and one in the Tampa, Florida area involved a commercial bank and it also required a 35% equity commitment. But the loan was done and the community will be the company’s showcase.
We also learned that HUD, despite some of the backlogs occurring with the 232 LEAN program, has been expanding its construction financing activities. In its fiscal 2008, HUD committed to about $300 million in construction loans, which grew to $560 million in 2009 and is on track to be about $700 million in this fiscal year. Most of this is for assisted living development. HUD has tightened its underwriting criteria a bit, including a recently imposed moratorium on “pre-application submissions” for new construction, which we assume will remove some of the less serious borrowers from the growing queue. This should be a good thing in the near term for the HUD program, if not for the long term as well.
On the REIT side of the business, Health Care REIT is still in the construction lending business. Most people would be surprised to learn that in 2009, construction-in-progress advances represented more than 75% of its total gross investments of $716.6 million. Of this amount, more than $300 million was for CCRC development projects, both rental and entrance fee, including some expansion projects. Two fast-growing, private assisted living companies have received most of their development financing from Health Care REIT, and while the owners do have equity, they have been able to grow faster using the REITs more highly leveraged development finance program.
Tax-exempt bond financing was not really the focus of the audio conference, but it should be noted that from the summer of 2008 to the summer of 2009 that market virtually shut down with bond financing at a near-term low. According to Dan Herman of Ziegler Capital Markets, this has completely reversed itself since the summer of 2009. If the statistics were not based on calendar years, he believes the period from July 1, 2009 through June 30, 2010 will end up being one of the most active ever for seniors housing bond financings.
Many of these will be for new CCRC projects that were put on hold when the housing market collapsed and bond investors disappeared, not to mention residents. Now, as consumer and investor confidence has risen in the past six months, sponsors and underwriters are dusting off their construction plans and offering memorandums. How long it will last is anyone’s guess.
Although it may seem to be a little counterintuitive to be talking about construction financing in this market environment, those who plan ahead today, both on the development and lending side, will be able to take advantage of the mini-surge in building when it comes. According to the recent construction report from ASHA and NIC, in the March 2008 to March 2009 period, the number of new construction starts in independent living, assisted living and memory care combined plunged by more than 50% to just 9,900 units compared with the previous 12-month period. And when the numbers come out for the 2009 to 2010 period, we expect the drop will be even more dramatic.
In 47 of the largest 100 metro markets in the country, there was not one assisted living facility under construction during the March 2008 to March 2009 period, according to their statistics. While this is good news for the providers with units in place, given what we know about demographics, the demand will eventually begin to outpace supply in several markets at this current level of development, so there will be significant opportunities. The problem is, you have to plan today to get the shovel in the ground two to three years from now. That is why we think it is important for those in the development business to start thinking about it now and be well-positioned for the next bull market in development.