The availability of real estate investment trust (REIT) financing for new senior housing projects is highly dependent on not just the REIT’s relationship—future or existing—with the developer, but also both parties’ goals and objectives, builders and capital sources say.
Most healthcare REITs have some level of involvement in senior housing construction financing, but it’s rare to see aggressive new development programs as most stick to repositioning, replacing, or modernizing assets.
The REITs who are dipping their toes into development waters from a financing standpoint, says Zeke Turner, chairman and CEO of private development company Mainstreet Property Group, are “very few and far in between.”
“Of those who are actually doing upfront, new construction, there are probably only two or three,” he says. Of those, “HealthLease is probably the most aggressive.”
HealthLease Properties Real Estate Investment Trust, a Mainstreet-affiliated REIT that went public on the Toronto Stock Exchange in August 2012, has a rare willingness to take full construction risk during the development phase versus supplying a mezzanine loan, according to Turner.
The relatively young REIT currently has somewhere between $500-600 million in new development projects either under construction or in planning stages in several states, Turner says. He believes there’s “tremendous” opportunity for new skilled nursing and assisted living developments.
Turner estimates that HealthLease’s current investment ratio is about 50/50 between new development and acquisitions, and its affiliated development group Mainstreet is on pace to start a new construction project every two and a half weeks.
The development versus acquisition ratio for most REITs is much different.
Sabra Health Care REIT’s (NASDAQ:SBRA) involvement in new construction has been fairly consistent—and limited—to about 3% of its balance sheet, which today translates to just under $30 million of its approximately $1 billion in total assets. The REIT “doesn’t provide debt financing just for the sake of having mortgage loans on our books for investments,” according to CFO Harold Andrews.
Last year, Sabra committed to a forward purchase program with First Phoenix Group, LLC in which it will eventually purchase up to 10 pipeline assisted living and memory care communities, along with provide some pre-development funding for the projects. First Phoenix will operate the new assets under its Stoney River Assisted Living brand under a triple-net lease structure with Sabra.
“We’re a REIT that ultimately wants to be an equity holder in the real estate we invest in, so we try to be somewhat creative with our operators and developers we have relationships with to help them fund their growth operations,” Andrews says. “The way we like to structure financing is to just provide a small piece of the capital stack, then have a purchase agreement to buy the asset outright upon stabilization.”
With the First Phoenix/Stoney River deal, Sabra has agreed to provide a small amount of predevelopment financing—around $1 million or less, Andrews says, just enough to get the project off the ground. With Sabra’s purchase option on the backend, the developer has leverage to get “more reasonably priced” mortgage financing for the development from a traditional mortgage lender.
Sabra plans to keep its new project financing to a small percentage of its overall portfolio, but it could grow to 4-5% over time, if “meaningful opportunities” arrive. “We don’t want to tie up a lot of dollars where there’s not a more immediate return,” Andrews says.
Other REITs stick almost exclusively to repositioning or replacement financing that’s available only to existing operator relationships.
“We have a very stringent program for our senior housing partners,” says Jeff Miller, executive vice president of operations and general counsel for Toledo, Ohio-based Health Care REIT (NYSE:HCN), which has a market capitalization of more than $18 billion. “It’s not a major part of our portfolio.”
Miller estimates only about 3-5% of the REIT’s balance is tied up in construction projects at any one time, encompassing repositions, expansions, and ground-up development. “We are very selective with the operators for whom we provide it,” he says. “Generally speaking, it’s for proven operators who are already in our portfolio, in existing strong markets, that have met our underwriting criteria.”
HCN made about $338 million in construction commitments in 2012, and Miller expects it will stay in that same general range in 2013.
Omega Healthcare Investors (NYSE:OHI), a REIT that specializes in long-term care and skilled nursing facilities, similarly recognizes the need for investing in existing properties.
The age of OHI’s portfolio of skilled nursing properties is growing, says Vikas Gupta, director of facility investments at the Baltimore, Md.-based REIT, and as things get older, they need improvements.
While Health Care REIT provides new construction financing along with financing for repositioning or updates, OHI primarily sticks with a CapEx program, although it will sometimes provide mortgage financing for new projects.
OHI’s CapEx balance sheet “doesn’t compare to acquisitions,” Gupta says, but the REIT does a “sizable amount” every year. A lot of money was put out in 2012, he says, and this year and next are expected to either “be in line with 2012 or grow.”
“We understand it’s important for our facilities to stay competitive in the market, and we see demand [for our CapEx program] increasing, especially as new facilities pop up, says Gupta.
Sabra is also open to helping existing tenants reposition an asset, Andrews says, but hasn’t done that yet. Those types of projects could look like transitioning an existing asset to be more Medicare-oriented with a short-term stay focus, for example, making it more competitive within a given marketplace.
“We’d structure that by financing the construction, and increasing the rent, maybe by 9 or 10% yield on those invested dollars,” says Andrews. “In that scenario, everybody wins: [The operator] gets higher opportunity to derive revenues and earnings with an improved asset, and we get a return on our investment and higher rent.”
Written by Alyssa Gerace