The Department of Housing and Urban Development’s (HUD) lending program for skilled nursing facilities grabbed some negative headlines earlier this year, but a key financial player in the space says that demand for the products remains strong — though the government has placed increasing focus on star ratings and care quality when underwriting deals.
“The best option for anything long-term and non-recourse is still HUD,” Fred Levine, managing director at major HUD lender Greystone & Co., told SNN during a recent interview. “So the demand is there.”
Section 232, the specific HUD program that insures low-interest loans of up to 40 years for senior housing and health care facilities, came under national scrutiny back in June after the release of a so-called “secret list” of properties considered for inclusion in a program for the nation’s most troubled nursing homes.
The New York Times identified 74 properties on that “secret list” that had received HUD funding, and also reported on an Illinois operator’s record-setting default on a skilled nursing loan of $146 million — with the implication that the government was propping up subpar facilities.
In response, the HUD-backed lending industry noted that few other options exist for nursing home operators looking to expand or improve their properties, and that the 232 program overall makes money for the government; HUD itself cited statistics showing that less than 1% of loans in the program, which has total outstanding balances of $20 billion, ever enter default.
For more insight into current HUD lending trends, SNN sat down with Levine during the National Investment Center for Seniors Housing & Care’s (NIC) annual fall conference in Chicago earlier this month.
Mark Jarrell, head of Greystone’s portfolio lending group, also joined the conversation to provide insight into the current state of the bridge and mezzanine lending market for skilled nursing operators.
What trends are you seeing in the HUD lending space? There was a lot of controversy earlier in the year with the so-called “secret list,” but a lot of folks in the industry rallied to point out that there aren’t a ton of options.
Levine: That’s why I’m good at it. I’m not the best salesperson in the world, but there aren’t that many options. The best option for anything long-term and non-recourse is still HUD. So the demand is there. And rates are so low today — rates have come down dramatically. But the key point: Even outside of rates, the demand is there for non-recourse, long-term money, and it’s the only option.
I don’t think the demand is changing at all. The environment at HUD is changing a little bit.
In what ways?
Levine: They’re a little bit more focused on star ratings and care issues. In the past, it wasn’t a big focus in underwriting alone. So now they look at that, which is good for the industry.
I know there’s been a push to increase the regular inspections under HUD loans.
Levine: There’s been talk about changes in that policy for a long time, but I don’t know of anything that’s been implemented. Changes move slowly in that world. Most of the inspections are really done by local departments of health, and that’s the most important. That’s really focused on care, which is the most important piece.
For HUD to get in the business of focusing on care — [they’re] the lender. The department of health takes care of the care issues. But there is a focus on star ratings, and that’s something that the department of health covers, and HUD relies on it. We rely on it in underwriting to look at it as a measure of the quality of care that’s being given in the buildings that we finance.
What does this increased focus look like? Is it causing problems in deal processes?
Levine: It’s added some time. If the star ratings aren’t as good as they could be, then it does add some time in the underwriting process. It doesn’t stop us from moving forward in most cases, unless it’s on the special focus list or the candidate list. But HUD has been very good at structuring financing to encourage improving your star ratings.
There are a few things in place in many deals — an increase in third-party risk management, which is something that’s coming into a lot of the commitments now that you get from HUD. You bring in a third party to review the risks in the business related to care, and then there are some escrows, sometimes, that are being set aside. It [gives] a financial motivation to improve it.
Where are you seeing the most demand for bridge, mezzanine, and HUD financing? Regional players or big national corporations?
Jarrell: Not so much the latter, very much the former. Most of what we see, in terms of clients coming in looking for bridge or mezzanine financing … takes the form of one of two types of transactions.
Type number one is: As you alluded to, there are a lot of folks who are trying to be large, national players over the last 10 years. Most, if not all, of them have figured out that this is not a good national-scale business. Too much of your success is determined by local market factors, state-by-state regulatory reimbursement systems. It’s hard to be good at it in 50 states.
A lot of the national players are breaking down their portfolios into core and non-core. They’re selling non-core assets where they feel that they can’t achieve the operational objectives that they originally thought they could, and those assets are moving downstream from big national players to mid-sized regional players.
On the other end of the spectrum, you have smaller — either mom-and-pop, one or two property operators — or government or non-profit institutions that only own a single property. They can’t compete effectively without some scale, so those sellers are upstreaming their properties to those mid-sized regional players. We finance a lot of those transactions with bridge and mezz as well.
County-owned facilities tend to come up in our coverage of nursing home transactions, and it seems like a lot of local governments are struggling with being health care operators — with new payment models, they just can’t maintain the kinds of relationships you need to succeed.
Jarrell: Same thing on the expense side. Food contracts, labor contracts, anything that you can buy more cheaply in bulk is going to make a mid-sized operator more efficient than a single-property operator.
What’s the ideal size?
Jarrell: I think it is very much a function of who you are, what your level of experience and longevity in the business is. We finance some folks, younger people, who start with two or three properties. When they grow to 10 properties, we probably take a little bit of a breather as a lender, because they’ve 3x’ed or 5x’ed the number of beds under their supervision. They haven’t been doing it for 20 years. That’s a big lift for a smaller, younger, leaner organization.
But then moving from 10 properties to 25 properties, for someone with more experience and a longer track record, might not be that big of a deal. It’s hard to put a cap on it. I think it depends on who you’re lending to — who’s your owner-operator?
Levine: It’s not so much size or number of deals that limits you. It’s region. When you expand and start leaving the state where you have relationships with the department of health, and you understand the local market, that’s where some of the trouble comes in, because it’s a whole different ballgame.
We’ve seen a trend separating operations and real estate, because guys that want to grow nationally, be a little bit bigger and expand to different states, the first stop would be maybe to buy the underlying real estate and hook up with an operator who has local experience. That’s the key: that local operator experience.
Are you seeing a lot of owners and operators trying to expand into multiple states?
Levine: It depends. The operators are trying to be more local. There’s a move to being more local. At some point, though, you reach your max in every state, and you expand if you see opportunity. I think the smartest of the guys understand their limitations, and stay in their footprint for operations, and if they want to expand, they find somebody local to help them.
Jarrell: One of the things that we’re evaluating is, if somebody is expanding from state A to state B: How are they doing it? Is it an adjacent state where they have some kind of relationships with — if not a separate operator, they’ve got relationships with regional suppliers or other components of their business plan? Going from Massachusetts to Rhode Island might be very different than going from Massachusetts to Tennessee, for example.
In general, these days, not only Greystone but a lot of lenders are going to be more cautious about rapid expansion and expansion well out of [footprint]. I think those are two watchwords that you’ll hear about from others.
How can in the industry create interest and excitement around investing in long-term care beds? There’s clearly an opportunity, but most new investment hasn’t been in that space.
Levine: There’s a lot of states that think they’re over-bedded and are trying to take beds back. That’s also an issue. If you think there’s a wave of this coming, and states are taking beds back, it could be even worse.
Jarrell: This is just a guess. In the bridge space, balance sheet lending, we don’t really do construction and development lending, so I personally don’t see those trends. My guess, though: You’re going to see a forced change to increase Medicaid, because that’s the only answer at some point — is to make it marginally more attractive to keep those beds in Medicaid status.
We don’t have any choice. We’re not going back to family care for elderly relatives in this country. That’s a 50-, 100-year-old model. We’re not going back there. For better or for worse, we have an institutional model for care of the elderly, by and large. By and large, it’s financed — at least in that that middle market — by government reimbursement. Ergo, at some point, government reimbursement has to cover the cost at a modest profit, or you get supply [issues]. As a social policy matter, this country’s not going to tolerate that.
Anything else you’d like to add?
Levine: When [government officials] don’t perform, they should be criticized. When they do perform, they should be complimented.
HUD has promoted liquidity, and provided liquidity to take care of hundreds of thousands of senior citizens, and it’s self-funded. When you see articles that say “taxpayers are bearing the brunt,” it’s not true. It’s funded by everybody who borrows a loan; they pay for the insurance. All of this negativity around HUD; you read articles about not enough focus on care issues or other things — default, or things that are costing taxpayers.
It’s just not true. It’s not costing the taxpayers. In fact, the government is performing at a very high level. They’re providing liquidity for people to take care of our senior citizens, and they’re self-funded. So why the negativity? It’s just wrong.
This interview has been edited and condensed for clarity; Maggie Flynn also contributed reporting to this story.
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