There are growing signs of stability in senior housing capital markets, which should bode well for construction projects slowed by Covid-19 over the past 12 months.
More banks are returning to the space and underwriting financing for construction and development, but they are demanding some form of recourse from borrowers in return, according to panelists from Locust Point Capital, Integral Senior Living and Alliance Residential, who spoke Thursday as part of the Capital Quarterly webinar series from Senior Housing News.
Recourse requirements are beginning to lessen, which could result in a resumption of lending activity and an uptick in new construction starts. When that happens, though, will depend on several factors including increased confidence in vaccination efforts, and when pent-up demand for senior housing breaks through.
Meanwhile, some owners and operators are prioritizing their development pipelines, focusing on projects in markets where demand tailwinds are strong and stabilization can occur sooner.
But the good news is that already, the vaccination effort is returning confidence to the capital markets, Alliance Residential Regional CFO – East Coast Christie Jordan said. This is poised to solidify once the impact from the $1.9 trillion American Rescue Plan is felt.
“I have a feeling that a year from now — maybe a little sooner — we’ll get back to normal in terms of what we’re seeing from the debt [markets], particularly,” she said.
Recourse requirements take root
A year ago, the debt and equity markets retreated to the sidelines and opted to wait out the disruption wrought by the first wave of positive Covid-19 cases.
Many lenders soon returned to the markets, structured deals gained favor among underwriters, and private debt filled much of the void left by national and regional banks.
Regional banks, in particular, returned to the space in the third quarter of 2020, Locust Point Capital Managing Director and Founding Partner Dan Contardi said. But they demanded some measure of recourse, depending on how much equity the borrower brought to a development. Pre-pandemic, banks offered non-recourse loans with loan-to-cost ratios in the 55% to 65% range. Today, non-recourse loans are offered with loan-to-cost ratios in the 40% to 50% range, at best. This will be standard for the near- to medium-term future.
“The higher the leverage you’re looking for, the more recourse you can expect,” he said.
National and larger regional banks opted to service existing clients with proven track records of development throughout the pandemic, creating a bifurcation in deal size. Projects requiring construction financing less than $25 million were able to secure loans. Developments with total costs in the $40 million to $50 million range were more likely to require some sort of syndication to lock in financing.
Red Bank, New Jersey-based Locust Point has successfully filled that gap over the past 21 months. Contardi estimates deal volume and inquiries increased between 60% to 70% last year, compared to 2019. And the firm is finding more opportunities to partner with growing owner-operators across a wider swath of the capital stack.
“We’re bullish on new construction, and we continue to pursue those opportunities,” he said.
The increase in recourse requirements by banks opened up opportunities for private debt funds to offer non-recourse debt, albeit at higher rates, Jordan said. Private funds are currently offering non-recourse debt at rates ranging between 75 basis points and 100 basis points higher than the interest rates banks are offering recourse debt.
“So you weigh a little bit more expensive [non-recourse] deal with a debt fund, over recourse [from a bank],” she said.
Phoenix-based Alliance Residential is working with a couple debt funds on construction financing placements that presented opportunities last year, when the banks were still on the sidelines. These lenders are not looking to place capital for the sake of placing capital. They are asking questions, looking at market demographics and double-checking construction and lease-up pro formas to ensure the risk is worth underwriting.
“We are all in data seeking mode,” she said.
Prioritizing strong markets
The combination of tighter lending requirements and due diligence is forcing developers and operators to evaluate their development pipelines, prioritizing projects in markets with high degrees of success.
Many of Locust Point’s clients are focusing on the top third of their development pipelines, Contardi said. Most of these projects are in markets with high barriers to entry and conducive to growth, based on demographic trends. Additionally, existing stock in the markets is mostly outdated and cannot compete with new deliveries.
Alliance Residential’s senior housing portfolio consists of 16 communities in mid- to high-end markets from the Pacific Northwest and California, through Texas and up to New York, Jordan said. And the firm is seeking out opportunities in overlooked markets, as well. She cited Tennessee as one area with untapped potential, and Alliance is consistently finding markets in Georgia with significant growth potential.
“They’ve been very well received in terms of opening these new communities, even during a pandemic,” she said.
Integral Senior Living had very little slowdown with its development pipeline in 2020, Senior Vice President of Operations Mike Zeug said.
The Carlsbad, California-based operator, which has begun to invest in development through its ISL Ventures arm, has a portfolio of 80 communities and has a robust development pipeline. Last year, Integral delivered six new buildings and completed three transition deals. Furthermore, it is on pace to complete 15 new projects by the end of 2021.
Zeug is particularly intrigued by future transition opportunities. Integral has experience in hotel- to-senior housing conversions in the past, but Covid-19 has hit retail real estate especially hard. There is a growing footprint of dark space that can be put to different use, and the company is looking at several opportunities in markets where municipalities are willing and able to rezone property for use as senior housing.
But pushing new developments over the finish line will require alignment between owner and operator, and the pandemic has opened opportunities to achieve that. Zeug recommends owners and operators begin discussions early in a project to find areas of improvement. Operators, especially, can share their experiences with community layouts to plan new developments that are poised for success once doors open, and long-term. This will be beneficial as more baby boomers age out of the work force and eventually gravitate to senior housing.
Boomers are expected to have a variety of demands in unit size and common spaces, but with a constant through line of expecting quality. Ongoing trends such as centralized common spaces, swimming pools and modern fitness centers, and well-programmed outdoor spaces will only increase in demand in the future.
“It’s important to get involved with an operator early, because they can find areas of opportunity in terms of the design elements of your community,” he said.
Having teams with experience in specific locales will help the speed-to-market process, as well. Alliance Residential has been able to leverage its existing multifamily platform by hiring experts at the corporate and local levels with expertise in senior housing operations and development. This has helped the company scale its senior housing footprint over a five-year period.
“Our senior housing expertise teams know these local markets really well,” Jordan said. “It’s been a very good synergy.”