Limited in recent years by a domestic recession, capital for new development and expansion/renovation projects has been tight in the senior living sector. Changes in lending and reimbursement have only compounded the credit crunch. Despite these uncertainties, there are some attractive financing opportunities for new development, renovation and expansion.
Demographics and Current Inventory
Beginning in 2011, and continuing for the next 18 years, about 8,000 Americans will turn 65 each day, according to the American Association of Retired Persons. Many of the individuals will eventually need some form of assistance in daily living and entertain the idea of moving into a senior living community where many amenities are offered that make daily living easier than homeownership.
The 1980s and 1990s saw a boon in the development of senior living projects from independent living to Continuing Care Retirement Communities (CCRC). These developments filled the void between traditional, institutional-style skilled nursing facilities and various governmental safety net programs like Sec. 202 of the Housing Act of 1959. Nowadays, population shifts are emerging—most notable is the migration of Midwesterners to the south and east coasts as well as an increasing concentration within urban areas across the country.
The lack of new inventory presents both opportunities and challenges as it suggests that certain markets are underserved. Likewise, much of the existing stock was built more than 10 years ago and may lack the features and amenities preferred by the next wave of retirees. Accordingly, capital will be required to renovate and expand the older housing stock.
Supply and Demand
Across the industry, average sales prices fell during the Great Recession due to the decreased demand and the lack of available capital. While the effects of the recession were significant, the downturn in activity within this industry is likely only temporary, especially in light of the aging population.
Although prices for senior living assets dropped, they have largely returned to their prerecession averages. However, there will come a point when the more prudent use of capital will be to build a new facility rather than purchase an existing facility in certain markets. All things being equal, the principle of substitution states that well-informed buyers will not pay more for an asset than it would cost to reasonably develop a competing facility. As prices have increased and capitalization rates have fallen (down 20 to 40 basis points across all segments), many urban markets are already seeing prices near this conversion point.
Salus Valuation Group, a national appraisal and market study group based in Miami, sees more increased demand for new construction in certain geographic locations like Chicago and Texas. “In select urban markets, there is the opportunity to collect monthly rents in excess of $6,000 per month for Class A assisted living properties,” said Michael Baldwin, executive vice president at Salus. “Construction costs aren’t proportionately as high, so there’s a good margin to collect upon stabilization. With the opportunity to refinance at record-low interest rates upon stabilization, the opportunity for quality returns is encouraging new construction projects.”
New construction is an option in strong markets for experienced owners/operators looking to expand therapy space, add units or undergo a major cosmetic upgrade. Lenders are recognizing the need for more specific, need-based treatments like subacute rehabilitation centers and, in particular, Alzheimer’s/dementia units. Just do the math: the Alzheimer’s Association projects that as baby boomers age the number of people with Alzheimer’s disease will triple to16 million by 2050. Alzheimer’s/dementia care then appears to be an appealing opportunity as it caters to a higher acuity resident versus the traditional assisted living facility resident.
“We are seeing a trend to Alzheimer/dementia and rehabilitation skilled facilities that are targeting a higher Medicare mix,” said Dan Storer, a senior vice president at Huntington. “We also see activity at CCRCs with expansion and renovation projects to reposition assets in the market or upgrading the physical plant to become more competitive.”
Nationally, lenders are looking for strong operating histories. Regional and local owners/operators with a track record of development and solid credit histories can expect to be able to finance their project. However, each financing source has its strengths and limitations, so owners/operators must balance the tradeoffs accordingly.
When it comes to funding that new build or renovation/expansion project there are a number of financing choices for borrowers:
The U.S Department of Housing and Urban Development (HUD)/Federal Housing Administration (FHA) and the U.S. Department of Agriculture (USDA) offer several programs for construction financing. Low, long-term fixed interest rates and flexible terms make financing options from these agencies more affordable and attainable for many borrowers, provided they meet program requirements.
HUD/FHA has two construction financing programs—Sec. 232 and Sec. 241. Both offer construction and permanent 40-year nonrecourse loans with interest rates currently below 4%, including the mortgage insurance premium. For certain renovation/expansion projects, Sec. 232/223(f) may also provide a viable funding option; however, under this refinancing program the total repairs/improvements must be less than 15% of the project’s current market value. As such, it works best for small projects.
USDA finances senior living projects under the Community Facilities (CF) and Business and Industry (B&I) Loan Guarantee programs. The CF program, available to public borrowers and nonprofit organizations in rural areas of up to 20,000 in population, provides both direct loans and guaranteed loans for up to a 40-year term. The CF program is limited to permanent financing, so borrowers will need to obtain a construction loan with the CF loan as the takeout mechanism to the construction financing. The B&I program, available to both for-profit and nonprofit organizations, guarantees loans made by eligible lenders for up to 30 years. B&I loans, generally limited to a maximum of $10 million, can be used for the construction of senior housing facilities in rural cities with up to a population of 50,000; however, priority is given to applications for loans in rural communities of 25,000 or less.
For experienced owners/operators with multiple sites, commercial banks serve as a viable source of capital for new construction and renovation/expansion projects. In general, construction loans will price at some spread above a benchmark index like the one-month LIBOR with a term between 18 months and five years. Like many other financing options, commercial banks will require a first mortgage on the real estate and equipment, security interests in facility’s licenses and accounts receivable and a priority claim to existing leases and management contracts in the event of a foreclosure. Unlike agency financing, however, a commercial bank will likely require guarantees from the borrower and operating company until the newly constructed facility is fully leased.
Public and Private Offerings
Unenhanced, rated and nonrated bond offerings and private placements also are potential sources of capital. However, much has changed as a result of new regulations. Variable-rate demand bonds (VRDB) enhanced with a letter of credit (LOC) or standby purchase agreement (SPA) have lost favor with many lenders. For borrowers with expiring credit enhancements, there are several solutions to roll over the outstanding debt, including a traditional bank loan, an agency refinancing program or structuring new bonds to be directly purchased by a bank or financial institution.
While most public offerings feature a majority refinance component, the low interest rate environment can fetch attractive financing terms for greenfield and expansion/renovation projects. In searching for yield, investors have pushed interest rates lower for the senior living industry and depending on the capitalization of the borrower/obligated group and pledged collateral, covenants can be negotiated to arrive at an optimal financing structure even for noninvestment-grade credits.
Within the senior living industry, new construction seems to focus on the expansion of therapy space and memory care units for existing providers as well as new developments in select markets. As with many endeavors, the key to a successful financing begins with planning. For owners/operators considering expansion or new development, involving a lender to explore specific financing options is advised as early as possible. Lenders will have knowledge of how similar transactions are getting done within a market and can help structure the deal accordingly. Similarly, lenders can give specific guidance on certain nuances, particularly within agency financing, in order to minimize delays in securing the desired financing structure.
Kyle Hemminger is an associate with Lancaster Pollard in Columbus. He may be reached at firstname.lastname@example.org.
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