The biggest surge in commercial mortgage debt in 10 years was waning. Census rates fell and public debt lenders hibernated. Early tax reform talk made many owner-operators skittish. Overreacting? Perhaps so, says Beth Burnham Mace, chief economist at the National Investment Center for Seniors Housing & Care: “Anecdotally, we don’t see any pullback yet and there’s still a lot of capital out there on both debt and equity sides.” Experts offer advice here on how borrowers can survive, and possibly thrive, the rest of this year.
1. Most of the federal tax reform benefits are positive.
Even though early legislative iterations that would have terminated private activity bonds for senior living died, the jitters they caused will lead lenders like HJ Sims to likely evaluate more and more HUD mortgage insurance alongside tax-exempt and taxable financing options, says Anthony Luzzi, president of subsidiary Sims Mortgage Funding.
Still, a healthier economy is what’s driving greater transaction volume more than anything, according to Imran Javaid, managing director at BMO Harris Bank.
“Tax reform seems to be contributing to the upward momentum in interest rates,” adds Lancaster Pollard Senior Vice President Bill Wilson HJ Sims Managing Principal Aaron Rulnick notes that, since tax reform, “bank debt isn’t as cheap as it once was.”
Meanwhile, some lenders are taking a wait-and-see approach. Nick Stahler, senior vice president of JCH Senior Housing Investment Brokerage, hopes owner-operators will use their tax reform windfalls to hire more staff in the second half. Adds Jeffrey Sands, HJ Sims managing principal, “While the tax changes will have an impact on the tax rates paid by corporate and individual tax payers that own nursing homes, we have not seen a trickledown effect.”
2. Don’t read too much into a sagging census.
“While occupancy pressure exists, due largely to a historic number of units entering the market and this pace exceeding units absorbed, there are definitely markets where the supply and demand scenario is either balanced or positive,” observes Jeff Binder, principal and managing director of Senior Living Investment Brokerage Inc.
What can operators do to combat anemic census? Luzzi believes that for borrowers “to be able to maximize leverage opportunities in an overall environment of declining occupancy, they will need to concentrate on marketing, revenue-enhancing and cost control strategies.”
3. As always, focus on the fundamentals.
Experts urge keeping an eye on these key indicators:
• Quality of operations and the ability to retain key labor
• Interest rates, competitive market balance and more importantly, ensuring floating rate debt combined with increased pressure on operating costs, do not push coverage ratios into possible covenant breaches
• Operator track record, financial performance and reimbursement
• The pace of integration of nursing homes into accountable care organizations
• Overbuilding and across-the-board labor shortages.
• Market depth and quality of management teams
4. Knowing the extremes in availability is going to matter.
Difficult financing options the second half are numerous. Steve Kennedy, senior managing director of Lancaster Pollard, points to “higher leverage bank construction financing due to tightening underwriting due to rising interest rates, depressed occupancy and over-supply in some sub-markets,” while bank and non-bank capital will continue to be plentiful for proven operators that exhibit strong cash flows and good operating histories.
“Conventional long-term commercial loans, non-agency debt, are still somewhat elusive in the sector, and we don’t see that changing anytime soon,” says Stahler.
The JCH senior VP adds that easier options should include bridge loans and long-term HUD debt. Sands believes operators who have shied away from tech upgrades could find lending difficult for certain projects, and rehab-only loans could be scarce in markets lacking certificate of need restraints. Overall, Javaid believes “continuum of care facilities will continue to attract the most dollars.”
5. Lenders could soon swoon over ‘people’ investments.
Binder believes owner-operators should focus on staffing issues such as recruitment and retention as part of a “pay now or pay later” scenario.
Javaid agrees: “Time and again, most operators report labor challenges as the biggest threat to their margins. Ultimately, labor challenges and an operator’s abilities to attract and retain talent in a tightening labor market will drive sustainable results.”
“The best advice we can give is to stay focused on operations,” adds Stahler, warning operators to not allow themselves to be distracted by “all the institutional debt and equity chasing the senior housing space.”
Mistakes to avoid
1. Assuming short census lags are a reason to avoid borrowing. Experts all agree the issue was a blip.
2. Ignoring the key indicators. Sticking to the fundamentals is always a safe bet in any lending environment.
3. Ignoring the “people” dividend. Lenders love operators who are investing in staff recruitment and retention.