The summer months have brought millions of dollars in skilled nursing refinancings and loans insured by the federal government. And though the overall activity level for loans from the Department of Housing and Urban Development (HUD) is roughly on par with the past few years, the ongoing regionalization in the space is a driver of much of the recent HUD activity.
Part of the reason activity has stayed strong in the skilled nursing space is the fact that HUD is the only takeout option for permanent financing for skilled nursing, Greystone & Co. managing director in bridge finance Luann Gutierrez told Skilled Nursing News.
“You do have other finance options for short-term needs,” she said. “Banks can do that, finance companies like ourselves can offer that … but in terms of long-term, put-it-to-bed sort of financing, HUD is the only option for skilled nursing.”
REIT asset disposal drives activity
The Federal Housing Administration’s (FHA) fiscal year ends on September 30, and so far in fiscal 2018, production is meeting expectations, on pace for a decent increase from fiscal 2017, Michael Gehl, chief investment officer at Bethesda, Md.-based lender Housing and Healthcare Finance, told Skilled Nursing News.*
At that point, the balance for FHA Section 232 refinancings was roughly at $3.4 billion; Gehl said he expects the balance for fiscal 2018 to be about $3.7 billion or $3.8 billion. The FHA, which falls under the larger HUD umbrella, provides mortgage insurance on loans that cover residential care facilities, and these Section 232 loans specifically help finance nursing homes, assisted living facilities and board and care facilities.
Fiscal 2018 does show a slight uptick, but Gehl doesn’t think that increase is particularly unusual.
“I think it’s just portfolio deals that were done a year or two ago that are just ready to go to HUD,” Gehl said. “There’s a lot of transitional deals, where a lot of people are either getting out of the space, or REITs divesting or bigger players divesting [facilities] that are turned around, and once they’re turned around, they want to lock in long-term financing with HUD.”
John Randolph, senior mortgage banker at the commercial mortgage group at KeyBank Real Estate Capital, echoed Gehl’s assessment of normal activity levels in the HUD space. Loans numbering in the high 200s or near 300 has “kind of been [HUD’s] sweet spot over the past four years, anyway,” he told SNN.
He also sees the activity as a result of what’s been happening in the world of skilled nursing transactions, where regional operators are increasingly becoming buyers from major real estate investment trusts (REITs).
“You have multiple loans that have been refinanced with HUD-insured financing,” Randolph explained. “I think a lot of this is just stemming from what’s happening in the M&A market in general. If you look at the big public REITs, health care REITs, they’ve been net sellers, and they’re just looking at diversifying some of their real estate holdings away from skilled nursing for whatever specific reason each one may have.”
Gutierrez also cited the REIT selloff as a key factor in the HUD space. Regional buyers are starting to step up and take on properties from the more national players, she said, particularly as the REITs come to grips with the fact that skilled nursing “is truly an operating business environment” and the national players try to focus on their strongest regions.
Mark Myers, executive managing director of Institutional Property Advisors, a mergers-and-acquisitions advisory firm in Calabasas, Calif., cited the REIT sell-offs as a reason to expect HUD activity to stay strong throughout the rest of the year — particularly in the form of bridge-to-HUD loans. Because the REITs “are disgorging assets, and they don’t have debt on their assets,” buyers who want to put HUD debt on those purchases will likely go the bridge-to-HUD route, he explained.
HUD loans take considerable time to close — Gehl estimated the typical gestation period from signing a term sheet to closing is about six to seven months — which drives the need for bridge loans to span the gap. Most sellers and buyers don’t want to wait that length of time for an acquisition to close, Myers told SNN. That’s where the bridge lenders, who are not necessarily senior housing lenders, come into play, and their focus is eventually getting the HUD origination fees.
“As long as they get the HUD business, they’re happy,” Myers said. “They won’t charge a lot for the bridge, as long as they can get the HUD business.”
But sometimes a delay between the initial bridge loan and HUD is inevitable, especially since a fair number of skilled nursing transactions necessitate turning around a facility’s operations — and the federal government won’t insure a loan that isn’t associated with a strong facility.
To qualify for HUD financing, a borrower has to show a minimum debt service coverage ratio of 1.45, according to the Loan Sizing chapter of HUD’s Healthcare Mortgage Insurance Program Handbook (4232.1). Looked at another way, the owner-operator has to have net operating income that is 40% more than the mortgage payment, Myers explained.
As a result, it can take anywhere from a year to 18 months for those operational improvements to manifest, Gehl and Neil Gamss, senior vice president at HHC Finance, both said.
“We’re definitely seeing that a lot of our operators are purchasing facilities that, for whatever reason, are underperforming very often,” Gamss told SNN. “Even if expense-wise the facilities weren’t doing well — and it’s a relatively quick fix on the expense front — they still have to wait that time for it to flow through on a consistent trailing basis. So even if they’re improving performance very quickly after they take over, from a HUD perspective, it still takes time.”
Written by Maggie Flynn
*The article has been updated to more accurately reflect Gehl’s comments about HUD activity being at expected levels, up from last year.