Lenders and investors provide mid-year review of seniors housing and care

Nursing Homes, Sept, 2006

How has the seniors housing and care industry performed during the first half of this year? What new debt and equity players are entering the market? Which operating issues concern investors? And how will they affect financing decisions moving forward? These questions and more were recently answered by five of the country's most active lenders and investors--from three of the top commercial finance companies, one of the largest REITs, and one of the largest institutional equity investors--on a quarterly conference call presented to Executive Circle members of the National Investment Center for the Seniors Housing & Care Industry (NIC).

The following are highlights from the call, as moderated by Anthony J. Mullen, NIC research director. Guest panelists were Raymond W. Braun, president of Health Care REIT; Sarah Sumner Duggan, senior vice-president of Senior Housing & Healthcare Finance for Capmark Finance Inc. (formerly GMAC); Kevin J. McMeen, managing director at Merrill Lynch Capital; James J. Pieczynski, copresident of the HealthCare & Specialty Finance Group at CapitalSource; and Kathryn A. Sweeney, principal at AEW Capital Management, LP.

How competitive is the financing environment today?

McMeen: It's definitely been a competitive market over the past 12 to 18 months where everybody's struggling to deploy capital. Because it's a very attractive industry right now based on the fundamentals, it's drawing in a lot of new capital providers, both larger national money-center bank types and investment banks, as well as some local and regional banks. That's resulting in competition for individual transactions, which is pushing spreads down and leading to situations where leverage is more aggressive. And so we're seeing challenges--and losing transactions--in situations where others will offer more proceeds than we're comfortable with.

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Sumner Duggan: I agree. In prior years, there's always been competition on the good deals. What's interesting now is that we're seeing a lot of companies taking deals on weaker transactions that we would not have seen in the past. We have seen a lot of success, though, with the agencies having a strong appetite right now for seniors housing. There's been a lot of business placed with Freddie Mac and Fannie Mae. And we've had some foreign banks that are new to the industry entering in the past six months.

Braun: As a REIT, we're in the business of buying buildings and then leasing them to operators, which is viewed as an alternative to doing a mortgage financing transaction. In the past couple of years, we've seen capitalization rates compress dramatically by 300 basis points for modern, purpose-built portfolios of assisted living and independent living. As cap rates have declined and people are willing to pay more, we're seeing increasing competition even outside our space to buy and own buildings and lease them to operators.

How about in the nursing home space?

Pieczynski: We have about 80% of our business in nursing homes and have seen a lot of different competitors come into the space. The Wall Street firms are back in the business, for example, in the deals with Beverly and Mariner, both of which went private. They were both financed in the CMBS market with institutional equity coming in to do the deal. In addition, a lot of the small lenders are entering into the business. Unfortunately, I think there's a risk with some of the small lenders who haven't been involved in this sector before, in that a lot of them will get caught up in the appraised value of the real estate. In comparison, the people who have been in the industry for a long time recognize that the value of the real estate is going to be a function of the underlying operations.

Since most institutional-quality groups have stayed away from nursing homes, this could be looked at as the most attention that they have received in the past 10 years.

Pieczynski: I think it's a strong vote of confidence in the industry that you've got quality institutional groups that are stepping up and saying, "I want to participate now on the equity side." And I think GE Capital's purchase of Formation Capital's nursing home portfolio is going to have additional institutions looking at the nursing home industry. As it relates to skilled nursing and the cost of capital associated with that industry, I think it is going to definitely be a benefit, and you're going to start to see more competition going forward.

Are more pension funds coming in?

Sweeney: There's certainly been a number so far this year. As pension funds that are committed to the real estate industry look at the more traditional real estate asset classes and are not able to hit their returns in those product types, it's caused a significant amount of interest in seniors housing. But I think we'll see more entrants to the business in the upcoming 12 months.

What other industry issues concern you?

Sumner Duggan: Well, on the skilled side you've got obsolescence of buildings. You're going to have a huge need for replacement facilities and the question of how the states are going to be willing to pay for them. But to be able to go in and replace some of those facilities is a true need on both the physical and operating sides. Another issue is labor in certain pockets and sectors of the industry. This is a concern from a cost-control standpoint, since borrowers expect expenses to only go up 2 to 3%.