Alternative senior housing funding options
Over the past few years, the financing landscape for both for-profit and nonprofit senior living providers has changed dramatically. Underwriting standards have become more stringent across the board, emphasizing the importance of adequate capital planning. Further, the end of 2010 saw the expiration of a number of options for nonprofit providers seeking financing for capital projects. These temporary measures stemmed from the American Recovery and Reinvestment Act (ARRA) and other congressional action, and their expiration leaves providers with yet another shift in the financing landscape that requires re-examination of available avenues. And while for-profit providers could not take advantage of some of these tax-exempt options, their very presence in the market impacted investor interest in senior living debt.
Yet the changes to these options have not left holes behind. Rather, they leave a different set of financing options for nonprofit providers and changing investor attitudes that impact all providers. Although most conventional avenues have been slow to recover to more affordable levels, numerous other options are still available. Senior living providers can use these financing options on their own or combine them to create an affordable, tailored debt structure.
FEDERAL AND GSE PROGRAMS
Federal and GSE-or government-sponsored enterprises-financing remains a viable option through the Federal Housing Administration (FHA), Fannie Mae and the U.S. Department of Agriculture (USDA).
Strong demand since 2009 has led to an FHA loan processing backlog, though this is expected to ease in 2011-2012 with the addition of HUD staff and the use of private sector contractors to process applications. For many borrowers, the wait is worth it: While the pricing of credit enhancement via conventional or private financing methods is subject to market whims and has increased compared to recent years, the fee for FHA mortgage insurance is fixed at half a percent per year, and the fixed rates are some of the lowest available in the market.
The various FHA insurance programs offer amortizations and corresponding insurance commitments of up to 40 years (though this maximum is subject to FHA scrutiny of the project’s useful life and depends on which program is used). The debt is non-recourse and assumable, providing borrowers flexibility to accommodate future financing or divestiture plans. Programmatically, FHA options can allow providers to borrow up to 90 percent (for-profit) or 95 percent (nonprofit) of a construction project’s appraised value or 100 percent of substantial rehabilitation costs, though practically, few borrowers are attaining these borrowing levels of late.
The Fannie Mae Seniors Housing program is available for the acquisition or refinance of stabilized independent living, assisted living and Alzheimer’s care properties to borrowers with a minimum of five years’ experience in the seniors housing industry and a minimum of five stabilized properties. Continuing care retirement communities (CCRCs) and properties with skilled nursing units may be considered only after a discussion and authorization to pursue the business with Fannie Mae. Flexible loan terms are available, ranging from terms of five to 30 years and amounts of up to 75 percent of the value of the project, 80 percent for tax-exempt bonds.
These ceilings remain realistically attainable in the 2011-2012 market. In addition, Fannie Mae recently enhanced their adjustable-rate mortgage (ARM) loans offering a variable rate/flexible prepayment option called Fannie Mae ARM 7-6. This could be an attractive option for use in independent living and assisted living/Alzheimer’s care acquisitions and refinance transactions because of its non-recourse nature, attractive pricing and the flexibility it provides.
The USDA offers its Business & Industry (B&I) Program to for-profits and nonprofits and its Community Facilities Program for nonprofits. The programs are restricted to use in communities of fewer than 50,000 and 20,000 people, respectively. The guaranteed and/or direct loan proceeds can be used for new construction, rehabilitation, acquisition or refinance along the continuum of care. Amortizations of up to 30 years for the B&I program and 40 years for the Community Facilities Program can help make borrowing more affordable to rural providers. Because the loan guarantee applies to only a portion of USDA loans, it is helpful to work with a lender that can underwrite the debt, complete all program application requirements, sell the guaranteed portion of the loan into the markets and secure a lender for the non-guaranteed portion of the debt.
A lesser-known option available to both for-profit and nonprofit providers is Federal Home Loan Bank (FHLB) credit enhancement. The FHLB consists of 12 independent entities that lend to local community banks. Most are rated AA+ by S&P. For the past couple of years, the FHLBs have been permitted to credit enhance both taxable and tax-exempt healthcare debt when an unrated or low-rated bank provided a letter of credit. This meant local banks could provide senior living providers investment-grade credit enhancement usually available only from larger banks. A local bank’s familiarity with a provider’s community impact may make it more willing than a large bank to participate in a project.
The FHLBs’ ability to provide letters of credit for tax-exempt debt expired at the end of 2010, but they can still enhance senior housing providers’ taxable debt issuances, and taxable debt is currently comparable to or less costly than tax-exempt debt due to inefficiencies that presently exist in the markets. Further, taxable bonds require fewer upfront closing costs, and there are fewer restrictions on the use of bond proceeds. This is a lesser-known option that may require investigation and research on the part of the borrower and the local bank.
Private placement (or direct placement) of tax-exempt bonds has been a successful structure for several providers despite the markets. In this structure, an investment banker and borrower negotiate directly with a bank (or banks) to purchase the bonds, as opposed to selling them into the general market. This path requires a lender with a firm grasp on local, regional and national banks’ appetite for purchasing certain types of debt. Private placements, with their limited public disclosure, less onerous bond documentation and the ability to be structured as interest-reducing draw-down bonds, can be a particularly cost-effective way to fund capital projects-especially construction-by eliminating negative arbitrage.
When tax-exempt bonds are designated bank-qualified, banks can deduct 80 percent of their cost of buying and carrying them. Banks pass along the savings to borrowers by way of a reduced interest rate. Normally, only $10 million can be designated bank-qualified by any bond issuer in one year, meaning if a municipality had commitments for the full amount of this limit, the non-profit provider would be shut out of funding from that source that year.
Borrowers can get creative, though, by looking for bond issuers other than the provider’s traditional municipal source. If providers can find more than one issuer with bank-qualified capacity, they may be able to combine those sources to overcome the $10 million limit. Providers should keep in mind that the more funding sources involved, the more legwork and project management required. Alternatively, nonprofit providers can consider phasing their projects over multiple calendar years to stay within the $10 million limit. Discussion is under way in Washington to consider raising the bank-qualified limit to $30 million.
Lastly, off-balance sheet financing and real estate investment trusts (REITs) are also potential financing alternatives for both nonprofit and for-profit providers.
Access to capital will remain competitive, particularly given the unusually high number of letters of credit expiring in 2011 and 2012, which will bring borrowers to market to seek either extensions or revised debt structures.
Some borrowers must finance during the next year, but they may not be able to access the ideal debt structure at an affordable cost of capital. For those who must proceed with financing at less-than optimal terms, special consideration should be paid to incorporating flexibility into debt covenants, prepayment penalties and other terms. The borrower may find that, for example, paying a higher interest rate is worth the benefit of future flexibility to refinance early. Borrowers may also be able to negotiate smaller periodic enhancement fees, rather than annual fees, to smooth cash flows.
While the loss of the ARRA provisions narrows the financial options available to nonprofits seeking funding for capital projects in 2011 and 2012, there are still ways to get projects done. A good knowledge of all possibilities will be critical in obtaining required financing at reasonable terms.
Thomas B. Gale is a Vice President for Lancaster Pollard, an investment banking, mortgage banking and investment advisory firm that offers debt financing solutions to senior living providers. Reach him at (614) 224-8800 or
firstname.lastname@example.org. Long-Term Living 2011 October;60(10):32-34
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