Senior housing companies may soon have a number of new financing options through the popular Section 232 program, thanks to a proposal recently released by the Department of Housing and Urban Development (HUD).
In the days since HUD first released its new draft Handbook containing the proposed changes, capital providers have been taking a closer look at what is being floated. To learn more, Senior Housing News recently spoke with Jason Smeck, managing director of seniors housing and health care for RED Mortgage Capital LLC, and Lee Delaveris, a director of the firm’s housing and health care group. Based in Columbus, Ohio, RED Capital has provided more than $72 billion overall in integrated debt and equity capital since 1990 across four property specialties, including senior housing.
Smeck and Delaveris singled out three of the most significant new HUD proposals and offered some specific scenarios in which senior living companies might be able to benefit from the changes.
SHN: What proposed changes stand out to you as most important?
Delaveris: There are numerous changes, some big, some small. Three of the most impactful changes are related to cash-outs, operator debt, and identity of interest purchases.
SHN: Let’s start with cash-outs. Can you provide an example of how the changes would work?
Smeck: We want to be mindful that HUD still cannot and will not allow cash-outs to be directly financed with an FHA-insured loan. What they will now allow is reduced debt seasoning timeframes for debt which resulted in cash-out.
Delaveris: Some borrowers have deferred their HUD permanent financing and instead used bridge financing with the goal of maximizing leverage on their properties. Those borrowers have been subject to market and interest rate risks prior to moving to the lower-cost, non-recourse HUD financing. Under the proposed HUD guidelines, those risks can be minimized. For example, if you built a property a few years ago and created significant value over and above your construction costs, the changes now create an opportunity to do a very short-term bridge financing to re-leverage, and then immediately refinance with HUD.
Another cash-out scenario, versus the new property, is an older property that has had debt amortization and value creation over a longer period of time. Now, the owner’s able to tap into that some equity with a bridge loan and does not need to delay refinancing with HUD.
The new guidance allows for cash-out bridge loans to be refinanced up to 70% loan-to-value without any debt seasoning, so you can increase leverage and then quickly obtain permanent financing. And you could overlay much of the HUD application process with the bridge loan process in order to minimize the time you’re in the bridge loan.
SHN: What about the changes related to operator debt?
Delaveris: Debts of an operating entity, even if the proceeds of the debt were used for the facility being refinanced, have historically been ineligible to be refinanced with HUD. The new guidance would change that.
SHN: So operating companies would now be allowed to refinance debt with HUD, when before only property owners were able to. And what type of debt is eligible?
Delaveris: Under the proposed guidance, HUD would allow loans which funded capital improvements, FF&E purchases, and working capital related to the lease-up of a property to be eligible for refinancing.
Smeck: For example, we’ve had situations wherein clients have separate owner and operator entities, and when the original construction loan was put in place, lease-up expenditures created debt for the operator. Historically, that debt—because it was in the operator’s name—was ineligible to be refinanced. Under the new guidance, that debt would be eligible.
Also, pursuant to a lease with a related party operator, you may have your operating company funding capital improvements. If the owner company had funded those, they had always been eligible for HUD refinancing. If the operating company had funded those, they were ineligible. The new guidance would eliminate this hurdle as well.
SHN: And the third big change? Identity of interest purchases?
Smeck: This is a situation in which family ties or financial interests between the buyer and seller gives rise to a presumption that the entities may not operate at arm’s-length. An example, which we frequently see, is the buyout of a partner. Historically, the debt associated with such a transaction has been required to season for two years before being refinanced with HUD. Under the proposed rules this debt would be eligible immediately.
Delaveris: With most of these scenarios, short-term financing is needed to take advantage of the new parameters. A lot of things can’t be done directly with HUD financing because of their regulations, but they’re certainly opening up the market to more opportunities for borrowers.
SHN: We’re in a comment period for the proposed rule. Anything strike you as likely to change or create controversy?
Smeck: The industry, we included, will have comments to clarify some of the ideas that HUD is advancing. But in the end, we believe it’s going to be a net positive for borrowers and lenders.
Written by Tim Mullaney