In the current credit environment, financing through the U.S. Department of Housing and Urban Development (HUD) has become a favorite of borrowers. With its low, long-term fixed rates, flexibility, nonrecourse feature and other benefits, HUD is often the best available option for a borrower seeking to refinance or finance new construction or rehabilitation of a senior living facility.
Consequently, more and more health-care operators and owners are considering HUD to finance multiple properties simultaneously. Financing a portfolio presents different challenges than financing a single property, but if done diligently, the benefits can be ample.
Portfolios Come in Several Sizes
When preparing a portfolio for HUD financing, an important consideration is the size of the portfolio. HUD currently defines a large portfolio as one that contains 50 or more projects and a combined estimated mortgage amount in excess of $250 million. A midsize portfolio is defined as one that contains 11 to 49 projects and a combined mortgage amount of $75 million up to $250 million. A small portfolio is defined as one with up to ten projects and a combined mortgage amount up to $75 million.
The key word in the definitions above is “and.” A portfolio has to meet both of the requirements to fit into the higher portfolio category. For instance, if a portfolio has 11 projects but a combined mortgage total under $75 million it can still qualify for the small portfolio categorization. A small portfolio does not require a corporate credit review, whereas mid-size and large portfolios require a corporate credit review. A corporate credit review is by no means a death knell; however, it is something that most borrowers would prefer to avoid if possible since it adds costs, time and additional work to the application process. Using an experienced mortgage lender for the corporate credit review can minimize the time and work required for this report.
Of importance, HUD is currently contemplating a revision to the definitions for portfolios and the manner in which portfolios are categorized. Under the proposed changes, a portfolio would have to meet only one of the requirements to achieve a certain categorization. That is, a facility that meets the small-size in regard to combined mortgage amount yet has more than the allotted number of facilities would be categorized as a mid-size portfolio and subject to the corporate review. Softening the blow, HUD also is contemplating an increase to the classification thresholds. More specifically, HUD would allow portfolios with up to 15 facilities and $90 million in estimated debt to be classified as small and portfolios with $90 million to $250 million and 16 to 49 facilities to be classified as mid-size. Regardless of if and when these changes take effect, it is vital for a borrower to be aware of its current size classification and prepare accordingly.
Benefits in Numbers
Once a borrower has initiated the application process, they will find there are numerous benefits to financing a portfolio through HUD, the flexibility of prepayment options being one of them. Each facility has its own mortgage and interest rate. That allows the owner to adjust the lock-out period and prepayment penalties for each facility to fit the long-term plans for that facility. While the lender will have an extensive list of information that is needed for each application, there are economies of scale for the borrower when multiple projects are being submitted at one time. The application sections related to the parent entity can be duplicated for all the applications and save the borrower time. In addition, HUD typically assigns a team of underwriters to review and process the portfolio. Thus, when the applications are submitted in “batches,” which usually range between eight to-12 facilities per batch, the same team of HUD underwriters will be assigned to all of the batches. That approach provides efficiency and economies of scale for the lender, HUD and the borrower after the first batch has been processed-resulting in much faster processing times for the remaining applications.
Furthermore, many of the benefits of HUD financing for portfolios are analogous to the benefits of HUD financing for single properties. These include a nonrecourse, fixed interest rate at a time when interest rates are at historical lows and a term of up to 35 years. Also, the mortgages are assumable, so an owner could still do a sale or lease-back with a real estate investment trust (REIT) in the future. In addition, HUD financing eliminates interest-rate risk and renewal risk inherent with shorter term bank financing.
One concern when financing a portfolio with HUD that borrowers should prepare for is the length of time it takes to close a deal. Although the HUD queue has steadily improved and currently does not have a backlog of portfolios waiting for review, the HUD legal review takes longer for portfolios and there could be issues coordinating the closing of multiple loans on the same day.
THM: A Case Study
An example of a successful small-sized portfolio financing can be found in the case study of Tennessee Health Management (THM), an employee-owned organization that manages more than 30 skilled nursing facilities throughout Tennessee and Alabama. THM was seeking a permanent fixed-rate funding structure to refinance 13 of its facilities. To qualify as a small-size portfolio, there must be either 10 or less facilities or a combined total mortgage amount under $75 million. The combined mortgage amount on the facilities was $69 million, thus THM qualified as a small-sized portfolio and did not have to go through the corporate review process.
THM was able to refinance the 13 properties using HUD’s Section 232/223(f) mortgage insurance program. THM’s debt structure included one cross collateralized note for all of its operating entities. The firm was able to allocate portions of the pooled debt to each of the facilities being financed with a HUD mortgage.
The financing was not without challenges. HUD requires the operator to maintain a professional liability insurance policy that complies with its guidelines as it relates to domicile and rating. THM’s non-rated offshore insurance captive structure was not compliant with the HUD guidelines. To remedy this, THM put in place a rated fronting paper that was agreeable to both HUD and THM. This fronting paper provides a policy written by a U.S.-domiciled-rated insurance company to act as a “front” for the captive to comply with HUD’s guidelines.
THM was able to obtain a fixed-rate, long-term financing that reduced its annual debt service and provided a structure without any ongoing financial covenants. In addition, THM was able to use some of the proceeds to fund its replacement reserves accounts for those facilities and perform some capital improvements in conjunction with the refinance.
A portfolio financing through HUD can be a smart move for the right borrower. With its nonrecourse, fixed rate and up to 35-year term and amortization, a HUD portfolio financing can allow the operator to make long-range financial plans without interest rate and renewal risks. Because each facility carries its own assumable mortgage, an operator retains the ability to make strategic decisions, such as selling one of the properties. Additionally, the absence of financial covenants eliminates the need for the borrower to manage to the loan covenants, allotting them even more options. In sum, if done correctly, a portfolio financing through HUD can save a borrower time and money while enhancing flexibility for future strategic decisions.
This article was written by John Hink and Scott Blount, and reprinted with permission from The Capital Issue at www.lancasterpollard.com.