In the latest in a series of dialogues with key players regarding the current capital environment in the seniors housing and care industry, Michael Hargrave, NIC’s Chief Market and Data Strategist, recently interviewed Brian Pollard, Senior Managing Director at Lancaster Pollard & Co.
NIC: Lancaster Pollard is an active HUD/FHA lender to the seniors housing and care industry. Can you provide a brief overview of your book of business?
Pollard: We have focused on seniors housing finance since our founding in 1988, and our activity in the HUD program has been very high, given the considerable benefits it provides in today’s economic climate. We have also been busy with other funding programs, including FNMA, USDA, tax-exempt municipal bonds, as well as several proprietary programs that can often provide preferable solutions to our clients depending on their needs. However, HUD has certainly represented the lion’s share of our activities in recent years.
NIC: I believe Lancaster Pollard was the number one (by loan volume) HUD 232 lender in 2012. Can you give me the details on that? How is 2013 shaping up (please also describe what is driving volume)?
Pollard: According to HUD data, Lancaster Pollard closed 98 loans totaling $738 million in the LEAN Program during the 2012 fiscal year, which did place us well ahead of all other lenders participating in the program. This year is shaping up even stronger, and we are expecting to close the year with a nice increase over last year’s volumes. The primary driver for this volume continues to be the low rate environment, which is giving operators a unique opportunity to better position their facilities for changes in care models, consumer demand, and government payor sources that are inevitable in this space. Industry consolidation is also driving volumes, as is an increasing amount of new construction and renovation funding.
NIC: Of the 706 HUD 232 loans closed in 2012, just 24 were for new construction or substantial rehabilitation. What does it take to get a construction deal through HUD?
Pollard: Certainly HUD’s resources have been concentrated on handling refinance volumes, and that’s a bit unfortunate given the dearth of overall new SNF construction in recent years and the competitive advantages newer properties provide for operators. Successful new construction funding for SNFs must incorporate experienced and proven development team members and operators, a healthy amount of real cash equity, preferably a CON or other limitation on new bed supply, and some patience on the part of the borrower. HUD has recently devoted more personnel to help eliminate what has been an untenable waiting period for processing these loans, and we are starting to see some tangible results from their efforts.
NIC: Some of the recent cuts in Medicare reimbursement have caused SNF coverages to trail down marginally within some of the REIT portfolios. What are you seeing with regard to debt service coverage ratios and how is it impacting underwriting?
Pollard: Operating margin compression has occurred and will likely continue for SNF operators. However, the exceptionally low interest rates available with agency debt financing have allowed debt service coverages to remain remarkably high, typically ranging from two to three times annual debt payments, which has moderated the impact on this key underwriting metric. Compressed margins are causing more concerns with valuation outcomes as loan-to-value more often tends to be the limiting factor on loan sizing.
NIC: The 10 year Treasury recently ended around 2.14%, which is up roughly 55 to 60 basis points from a year ago. Several forecasts call for the rate to climb further towards yearend. What impacts would rising interest rates have on agency debt financing?
Pollard: While the benefits of the long duration funding available with HUD are maximized in a low rate environment, other loan features, such as non-recourse, ability to assume, and lack of financial operating covenants will keep the program relevant as rates rise. The changes HUD has made over the years to improve the consistency and timing of the application process will also endure as rates rise. A surprisingly small number of our loans are being driven by economic feasibility alone. With that said, approximately half of HUD’s overall production volume in recent years has occurred in the 223(a) (7) program, which is a refinance of an existing HUD insured loan, and there is no doubt that there will be reduced activity in that program as rates rise.
Benchmark interest rates have risen over the past few months, as the yield on the 10-year treasury has risen 50 basis points since mid-April on speculation that the Federal Reserve will ease their asset purchase program in the near future. The market consensus is for the Federal Reserve to begin scaling back its program either late this year or early 2014. The rise in the 10-year treasury has already begun to impact mortgage rates, as the 30-year conventional mortgage has rebounded to nearly 4%. Even though this will impact home affordability, most economists do not see this as hindering the housing recovery. Moody’s Economy.com’s current forecast calls for the 10-year to hit 2.4% by yearend and exceed 3% by the middle of 2014.
While interest rates have begun to rise, inflation remains relatively anchored. As of May 2013, the annual rate of inflation for all items (i.e., the headline number) was 1.4%. The modest gains in employment and income have been somewhat offset by soft demand and household deleveraging, which is expected to continue to temper overall inflation in the near-term. Asking rent growth for seniors housing properties has slightly outpaced inflation recently and was 2.3% as of the first quarter of 2013.
Insights from iGlobal Forum’s Non-Core Real Estate Opportunities Summit
NIC MAP® staff attended the day long iGlobal Forum’s Non-Core Real Estate Opportunities Summit in New York City on June 12th. There were over 100 debt and equity providers in attendance, who heard participants on nine panels discuss various topics related to strategies for investing in non-core real estate assets as a way to increase the level of total return on invested capital. The panelists differed on many points of view and strategies; however, there was unanimous consensus on four topics:
- Access to Capital: There is sufficient capital available in the debt, equity and CMBS markets to fund real estate development and real estate transactions.
- Returns on Investment: Investments in non-core real estate assets are higher risk, and therefore warrant a higher cost of capital when compared to core real estate assets.
- Interest Rates: Interest rates are beginning to rise.
- Existing CMBS Loans: There are significant amounts of commercial property, CMBS loans that will need to be refinanced in 2015 – 2017 where the value of the properties will be below the amount of the debt.
Every other topic on the agenda was subject to discussion and interpretation, including the definition of non-core real estate. Some of the panelists believed that non-core real estate includes anything other than the four main property types included in the NCREIF commercial real estate index: office, retail, industrial and multi-family. Even the four main property types located in secondary and tertiary markets were considered non-core by some.
Non-core asset types discussed included seniors housing, healthcare, hospitality, marinas, self-storage and timber. One investor even mentioned gas stations and police stations in Europe among their non-core real estate holdings. Another panelist described non-core assets as those that require significant services provided by experienced operators in order to be successful. That same panelist described a strategy of investing directly in operators rather than owning the real estate (no position in the capital stack) as a way to generate higher returns to the investor. Finally, a third group viewed non-core assets as those that offer higher returns through ground up development, purchase of distressed properties and/or debt and value add/redevelopment/adaptive reuse strategies, all irrespective of property type or the market (primary, secondary or tertiary).
In response to a question from NIC MAP® staff about the possibility of seniors housing moving from the non-core asset class into the core asset class, panelists responded that institutional investors require a verified historical performance standard (index) tracked over a number of real estate and economic cycles in order to be able to predict the performance of the asset class. NIC MAP® staff made attendees aware that NIC MAP® reports on eight years of historical quarterly seniors housing market fundamentals data and that NIC is actively working with NCREIF to get seniors housing investment performance trend data reported as an NCREIF index.
Follow up comments by attendees confirmed that increased transparency of performance in the seniors housing sector would enable investors to lower their expectations of total returns required due to the mitigation of risk provided by the availability of accurate historical trend information. One investor already committing capital to seniors housing suggested that an argument could be made that seniors housing is already a core asset given the stability of the sector through the recession and the cap rates that we are now seeing in seniors housing transactions. The attendees acknowledged that increasing competition for traditional core assets is motivating investors to pursue what previously were considered non-core property types, including seniors housing.
Registration is well underway for the 23rd NIC National Conference, and registered attendees now have access to our exclusive online conference community for the deal making event of the year for the seniors housing and care industry. The online conference community enables registered attendees to connect to other attendees before, during and after the conference. By joining the online conference community, registered attendees can:
- View the attendee listing and profiles of other attendees
- Build a personalized schedule of sessions to attend and schedule meetings
- Download speaker presentations
- Participate in on-line discussions
Registered attendees can also access the mobile app and have the community at their fingertips.
Register now and start networking today. We look forward to seeing you online and in Chicago!