Bankers say long-term care borrowers would do well to tend to their knowledge of financial fundamentals as much as they do the physical appearance of their landscapes and reception areas when it comes time to sell or refinance.
Remarkably, many owner-operators lack a grasp or confidence with even the most basic financial concepts and terms. Their inability to speak the language of lenders can have dire consequences, or at least near disasters, leaders on the money side confide.
Consider one operator who valued his property at $60,000 per bed after blithely taking a fellow operator’s offer to buy his facility at face value.
“He was offered the price from another operator he knew and liked, and he thought the offer was fair because the price per bed was near the average price for beds trading in the market,” explains a lender who asked to not be named.
The problem? The seller’s ignorance of earnings before interest, taxes, depreciation and amortization (EBITDA), a clunky alphabetic mouthful but basic term in any lending transaction.
Based on the “proforma,” or standard, EBITDA of his property after right-sizing some of the operating expenses, the lender easily saw that the seller could market his facility for more. The lender found a party to buy the facility for $100,000 per bed, “ensuring the asset traded at a price reflective of its true value.”
Consider another borrower’s failure to understand the fundamental value of complete financial reporting disclosures, which all lenders rely heavily on to properly underwrite projects and maximize the amount of leverage they can obtain.
Only days into a nursing home refinancing, HJ Sims had to put the project on hold, in part, due to lack of clarity and transparency in the facility’s historical financial statements.
“As a result, the loan underwriting was based on what at first appeared to be a reasonable interpretation of the historical financial statements, but in fact, had led to an overvaluation of the project and a loan sizing that could not be supported by the most recent historical cash-flow, which the lender only was able to determine after the financial statements were ‘untangled,’” the firm said.
For now, the borrower’s plans are on hold until it attains a level of performance consistent with its untangled financial data — an unfortunate delay that exposed it to interest rate risk.
“A well-educated borrower is much more likely to succeed with the loan, which is what every lender wants,” notes Cindy Hazzard, broker/president of JCH Senior Housing Investment Brokerage.
Coming to terms
Many operators fail on transparency, but many also stumble on presentation.
“If a borrower is unable to produce financial statements in a standard format that shows the expenses by the respective categories or departments over comparable periods, that is a cause for concern,” says Imran Javaid, managing director for BMO Harris Healthcare Real Estate Finance. “Any lender or investor needs to see the expense or revenue categories year over year and ask questions on the causes of individual variances period over period.
Ask 10 lenders which terms are most misunderstood and you’re likely to get 10 different answers.
The following is a recap of the biggest pet peeves, grouped by general categories those terms most often fall into.
Most owner-operators can quickly tell you what their current bank balance or average daily income is, but often stumble when calculating how revenue relates to other key metrics. This brings us back to EBITDA and its similar-sounding metric, EBITDAR (earnings before interest, taxes, depreciation, amortization and rent). Many bankers say it is interchangeable with the term NOI, or net operating income, which is gross project income less a vacancy/collection loss factor, less operating expenses exclusive of debt service, taxes, depreciation and amortization, adds Anthony Luzzi, president of Sims Mortgage Funding, a subsidiary of HJ Sims. Both terms deal with recurring operating cash flow.
Javaid considers these terms the most essential to know because most lenders need to understand operational revenues before additional streams generated by financing or investing activities. The initial EBITDA revenue calculus provides the most accurate picture of a borrower’s ability to retire debt and precisely value property, adds Steve Kennedy, senior managing director of Lancaster Pollard. Luzzi places high value in the term debt service coverage, or DSC, which is a measure of how much NOI is available to service debt. A positive DSC is required to underwrite any loan, he adds.
Javaid calls the cap rate “the biggest source of consternation between sellers and buyers. Think of this as an expression of risk associated with the assets. The riskier the asset, the higher the cap rate.”
Bill Wilson, senior vice president of Lancaster Pollard, believes the cap rate is an important term used to value a business based on net operating income. And it can be wildly misunderstood and interpreted.
“Different lending sources use different methodologies for determining cap rates, which can lead to significant value variations,” Wilson says. “As a result, while interest rate and terms are always important, senior housing and long-term care owners must be aware that different funding sources can lead to significantly different proceeds.”
Valuation can be determined various ways. One method involves dividing the cap rate by operating cash flow (revenue minus expenses), according to Conner Girdley, vice president of Lancaster Pollard. Another involves taking the most recent 12 months (otherwise called “trailing 12” or “T12”) of EBITDAR and dividing by the cap rate, says Tony Ruberg, vice president of Lancaster Pollard.
“This calculation can be done very quickly to give you an idea of the value of a stabilized facility from a lending perspective,” Ruberg says. “The metric ‘price-per-bed’ is used by a lot of borrowers, but lenders will only use that as a gut check for valuation.
“Cap rates are largely impacted by current interest rates and the perceived riskiness of the operating cash flows of the business,” Girdley says. In general, cap rates tend to correlate with the level of senior care, the highest being skilled nursing care.
Leverage is one of the most powerful terms in any kind of financing. It means the ratio of a provider’s debt to equity. As a verb, it can mean using borrowed money for an investment in hopes the investment profits exceed payable interest on that borrowed money. In any context, it is the basis for a common arguments between borrower and lenders, says Hazzard.
The most fundamental leverage metrics are the ratios loan-to-value (LTV) and loan-to-cost (LTC). Lenders rely on these two metrics to determine the amount of debt a borrower can handle. LTC is typically calculated for construction project lending. LTVs generally directly correlate with loan amounts, and of course, risk, says Luzzi. And the calculations often venture in the realm of subjectivity.
“Because different lenders have different perceptions of risk, the appropriate leverage of a facility is really a judgment call,” Javaid observes.
Jeff Binder, principal and managing director of Senior Living Investment Brokerage, says owner-operators’ grasp of three of these terms — LTV, LTC and DSC — is essential for securing loans for everything from building a new wing or undertaking a renovation project to buying and selling.
“Usually, the smallest number determined by these three concepts is your maximum loan amount,” he says. “Probably the biggest misunderstanding is believing these concepts ensure that a borrower will automatically get a loan if it ‘passes’ these three tests.”
Other mitigating factors include, but aren’t limited to, things like property type and payor mix, experience, external cash flow, market characteristics, ownership structure and clinical quality and regulatory reports.
Many borrowers can get confused about the actual types of loans.
“Agency/Fannie Mae, Freddie Mac vs. HUD debt is often confused,” said Hazzard. “While both are insured loans, they are insured by various sources.”
LTV and LTC can also get confused for each other, and amortization and maturity dates are not typically identical, she adds.
Luzzi agrees: “We sometimes see loan term and loan amortization misunderstood. A loan term is the duration that a loan is scheduled to be outstanding. Amortization is the repayment of a loan over a given term.”
“FHA and HUD loans are used interchangeably,” Kennedy adds. Moreover, borrowers should know that fixed rates are only fixed for the term of the loan, or until an interest rate reset period.
Luzzi says borrowers should also understand the differences between loans that are underwritten based on “as-is” value (which is generally based on a property’s current, or historical performance, with no major changes), and “as-stabilized” value, which is typically based on a property reaching certain level of improved performance (and therefore higher value) in the future.
Other notable loan terms include “lock-outs,” a period of years where a loan can’t be prepaid; prepayment penalties, which are additional charges a borrower incurs to pay-off a loan early; and yield maintenance provisions, which require a borrower to incur a charge to pay off a loan before maturity, regardless of when the loan is prepaid.
WHERE TO GET HELP
There are numerous ways to bone-up on critical lending terminology.
Every lender in long-term care advises consulting the National Investment Center for Seniors Housing & Care, a nonprofit organization that provides data, analytics, and connections.
NIC typically holds a “boot camp” each fall in conjunction with its annual conference. “We generally send any new junior members to this boot camp as a great way to immerse oneself in the language of the lending and financing world,” says Imran Javaid, managing director for BMO Harris Healthcare Real Estate Finance.
Other sources include the American Senior Housing Association (ASHA), Leading Age, and the American Health Care Association. Industry consultants and the array of webinars they host can also provide value.
Finally, there are people, one of the greatest resources of all.
“Short of going through the financing process, the best way to learn is from an industry expert,” says Conner Girdley, vice president of Lancaster Pollard.