Senior Living Business: Development: Confronting The Credit Crunch
October 1, 2008
The capital market has virtually shut down for new development, according to William B. Sims, CEO of Herbert J. Sims & Co. "People are still buying and selling and are continuing as planned if a project is underway," he said, "but if they want to come to market this minute, they can’t."
Sims, a self-described optimist, expects capital to become available again for new development later this year, but credit will be tighter and more expensive. "Fewer borrowers will qualify," he predicted. "We expect to see more restrictions — such as the amount of debt that can be raised relative to the cost of the project — and the weeding out of weaker borrowers, particularly those without experience and without some resources. Eventually, when rates stabilize, developers will be able to plan more realistically."
Sims suggests keeping an eye on short-term rates. "It’s hard to get 30-year fixed rates when the 7-day variable rates with a letter of credit are paying 6-8%," he said. "We need the short-term market to level out — perhaps at 4-5% — so we can begin to price the longer term fixed rate."
From the perspective of Joe Wagman, CEO of Wagman Construction, a number of interrelated dynamics are simultaneously impacting senior housing development: the housing meltdown, the rapid escalation in energy costs, the cost of construction materials and now the credit crisis. Wagman’s senior housing clients are still going forward with projects that were already in the pipeline or pretty far down the development path before the credit markets shut down. For projects that haven’t yet teed up, though, providers and developers must first address today’s challenges.
Whether the project is new construction or a renovation, Wagman recommends moving in the direction of "green" construction to lower both operational and energy costs and to impact marketing efforts. "Getting in gear on the issue of ‘green’ is becoming more than just an environmental nicety," he said. "It’s becoming fundamental from the standpoint of both cost and competition. Increasingly, prospective residents will ask about your carbon footprint and energy-saving measures deployed in your project. So you’ll want to have a much tighter envelope, install or replace appliances with energy-efficient models, and do an energy audit of existing buildings that is based on a bang-for-the-buck priority."
The cost of construction materials has become a real challenge for large projects that require products such as steel and concrete that have radically escalated in price. "This may be the time to focus on stick-built products — smaller apartment buildings or cottages that can be built with lumber, which is one of the few materials that has actually gone down in price due to the residential housing crisis," Wagman added. Cottages, in fact, may offer financing flexibility. A provider with a line of credit with a bank, for example, could work with the developer to time construction costs to entrance fee receipts.
People are reluctant to move into a CCRC without first selling their house, yet many markets where senior providers operate are far less negative than, say, the worst-case scenarios of Miami, Phoenix, and California. And the longer people bide their time hoping that housing values will go up, the more likely the cost of the senior community will also increase, Wagman suggested.
Meanwhile, demographics remain strong and demand should continue for products that consumers need (such as skilled nursing and assisted living) and want (such as independent living communities). "We don’t know what the next six months will bring," he said. "It has always been hard to make ends meet on skilled nursing, with a deficit of $30 to $50 per day between Medicaid and the cost of running a typical licensed bed. Even in assisted living, it’s hard to throw positive cash to the bottom line. Providers realize that they must broaden the base of the pyramid with independent living products to support the higher levels of care and to keep operations running."
If you build a CCRC today and receive entrance fees that come close to the cost of the project, it could take several years to start turning over those units and see an economic boost. But in a communty that is already experiencing turnover, Wagman said, "expanding is one of the few ways that it can supplement its revenue stream."
‘No problem’ for Ecumen’s rental-only projects
"From the standpoint of deals in the pipeline, we’ve never been busier in terms of inquiries, predevelopment agreements, and development agreements," according to Steve Ordahl, Senior Vice President of Business Development for Ecumen, which provides senior housing in 100 different communities and consulting and development services for other organizations. "We’re affiliated with the Evangelical Lutheran Church in America (ELCA), and a lot of ELCA congregations are very interested in developing senior housing communities as an adjunct to their missionary ministry."
The typical Ecumen products are rental-only assisted living, memory care, or other market-rate facilities without significant entry fees or buy-ins, and that model apparently resonates with ELCA communities. "We currently have deals in six or eight states in addition to Minnesota, with three under construction or about to start," said Ordahl.
Ecumen’s two-step contracts with third parties include a predevelopment phase that involves a market assessment, schematic design, a preliminary pro forma, an examination of zoning and entitlements in the community and regulatory issues. If the customer then decides to proceed, financing gets squared away.
Financing the deals
Ecumen, a non-rated borrower, financed about $100 million for internal projects in the last three years, including $4 million that closed at 6% in late September to finance an expansion in the Twin Cities area of Minnesota. A similar deal is pending but imminent.
"Obviously, we’re finding that rates are higher," said Dennis Johnson, CFO, "and the days of very narrow credit spreads between rated and non-rated paper are certainly gone. We hope the financing that will close in late October, which is at least twice as big a deal as the September one, will close at 7% or less, but we won’t know until we go to market. We have a strong local retail consumer market, so those banks generally take the bonds at competitive rates if the deal is small enough." Also, one of Ecumen’s third-party projects, which will open shortly, was financed last year with private financing through Thrivent Financial for Lutherans rather than through tax-exempt bonds.
Typically, a rental model is financed based on the strength of the market, the management team, and the timeline for fill-up and for hitting a pro forma set of numbers. And people don’t necessarily need to sell a home in order to move into rental housing that has a reasonable rent. Ecumen’s rents average about $2,500 per month, for example, depending on the level of care.
"Another key component for making future projects fly in terms of financing will be an equity component," added Johnson. "The days of 100% financing have pretty much dried up. Organizations will have to come up with some equity — perhaps 15-30% — through fundraising, available land, or other assets. That’s a big change."
Johnson expects to have to try a lot of different avenues later this fall and into next year when seeking financing for the third-party projects now in progress. "We’re hopeful that the markets will have sorted themselves out by then," he said, "and that we’ll be able to access a good cost of capital funds — though I’m sure there will be some challenging discussions."
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