Senior housing developers may still encounter difficulty obtaining financing for ground-up projects despite reports of the increasing availability of capital, and future growth plans play a crucial role in what kind of capital they pursue.
Just because real estate investment trusts (REITs) enjoy a low cost of capital doesn’t mean they’re the best source of new construction financing—something the REITs themselves will acknowledge.
For Sabra Health Care REIT’s pipeline agreement with First Phoenix, for example, the REIT is supplying a relatively small amount of pre-development financing—just enough to get the project off the ground—with plans to buy the asset upon stabilization.
“With our purchase option on the back end, it provides them with leverage for a traditional mortgage lender to provide them with more reasonably priced mortgage financing for development,” says Harold Andrews, CFO of Sabra (NASDAQ:SBRA).
While the Department of Housing and Urban Development (HUD) and government sponsored entities Fannie Mae and Freddie Mac are highly utilized for acquisition and refinancing loans, developers are largely turning to regional banks to finance new senior housing projects.
The vast majority of development that’s being done is capitalized with private equity from individuals or investors which is then paired with small or community-size banks who are doing construction lending, says Zeke Turner, chairman and CEO of private development company Mainstreet Property Group.
Because of the risk involved with new projects that aren’t stabilized, REIT financing generally bears a higher interest rate compared to a community bank. But it also generally eliminates the need for the developer to come up with any of their own equity, and when that’s factored in, the rates can become more similar, says Turner.
“If a REIT is going to be involved, they’ll finance a majority of the real-estate. They’re taking development risk, and putting dollars in during construction, buying into a project like any other investor would,” he says.
Rates aside, a developer’s objectives can determine whether REIT financing is preferred above bank financing.
“If you have the equity [needed to put into a project] and you’re happy with doing a single project with no regard to volume, you’re probably better off doing it on your own books through a mezzanine program, and then sell the project when it’s stabilized,” Turner says. “If you don’t have the equity or want to do development at a certain pace because you see opportunity in the industry, you’re much better off to pair with a REIT.”
The Leo Brown Group, a relatively new entrant into the senior housing space with two projects in the works and a couple more recently completed, has been utilizing regional bank financing so far for its projects. But it hasn’t ruled out a REIT relationship for future projects, says the company’s vice president, Michael Wagner.
The company operates its completed projects through a subsidiary, Traditions Management, which Wagner says has contributed to its success with obtaining financing for new projects despite being an industry newcomer, entering the market in 2006. The development-and-operations model is also part of the reason the company has been using bank financing to keep control over its assets.
“We’re not looking to build our projects and then flip them,” Wagner says. “We want to continue operating them, and in some markets we may want to hold on to the real estate and operations.”
However, there are “ongoing discussions” with certain REITs, Wagner says, as in some circumstances it could make sense to sell the underlying real estate of an asset while still managing the community.
“We think there is more activity out there. In the last couple years you’ve seen these big portfolios get purchased by some of the REITs, and there aren’t as many opportunities for investment-grade assets,” he says. “REITs are recognizing that, and are turning to new opportunities on the development side.”
Retaining ownership of assets is key for the LaSalle Group, a developer with a 14-year track record and a similar development-and-operations structure through its affiliated management company, Autumn Leaves.
“Historically, we have not been sellers,” says Brenda Brantley, CFO at memory care community developer The LaSalle Group. “The REITs are very aggressive right now, but can’t always [accommodate for] start-up costs and lease-up risk. You still have to bring in an equity partner or fund the equity yourself. Historically, our interests have not been aligned to make that structure work.”
Instead, she says, The LaSalle Group provides repeat business to its “long-lasting” relationships with banks that are generally community-size and larger.
Written by Alyssa Gerace
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