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Financing for assisted living and memory care developments and acquisitions is gradually becoming easier to secure, but high construction costs and continued pandemic-related uncertainty remain challenges.
Developers with proven track records of success, however, have had little trouble putting together their capital stacks over the past year. And creative new avenues of lending, such as ground leases, are beginning to make inroads in the space, according to panelists from Aegis Living, The Dover Companies and Twain Financial Partners, who spoke last week as part of the Capital Quarterly webinar series from Senior Housing News.
The good news for developers is that more lenders have returned to the space and are relaxing their recourse requirements, said Joshua Jennings, founder and CEO of The Dover Companies. The fully integrated firm consists of a development arm, a construction company, a capital markets line and an operator, Cedarhurst Living, which owns and operates 53 communities in the Midwest, Mid-South and Southeast. Dover also has six communities under construction in Illinois, Indiana, Kansas and Kentucky, and plans to start developing five new communities a year, starting in 2022.
Jennings estimates that 75% of the lenders and capital sources his firm deals with are back to offering term sheets at pre-pandemic terms, and the remainder will return within the next 12 to 18 months.
“Based on our memories [of the 2008 financial crisis], [lenders] forget very quickly,” he said.
Although Covid-19 led to a slowdown in new construction starts, construction costs maintained their pre-pandemic upward trajectory, Aegis Living Senior Vice President of Development Walter Braun said.
The Bellevue, Washington-based company operates 33 communities, has eight more in varying stages of development, and remains on track to double its scale within the next decade. Its newest community, Bellevue Overlake, is 25% occupied with another 10% committed in down payment reservations, which is ahead of projections. Another community is set to open later this year, and two more are expected to break ground in 2021.
Materials costs and a shortage of construction labor were already in place prior to Covid-19. But lockdowns resulted in an uptick in home improvement. Coupled with a reduction in production and disrupted global supply chains, costs for oil, steel and especially lumber skyrocketed.
“In Seattle, construction is so hot that none of the costs have come down,” Braun said.
Rising costs have had an impact on Dover’s pipeline, which has been mitigated somewhat by what Jennings calls a “tertiary-plus” development strategy, and the size of Cedarhurst communities — a typical development costs between $20 million and $30 million. Land costs tend to be less in these markets, and Dover has not experienced a decrease in access to capital.
“Our bite size is a bit smaller,” he said.
Dover’s development pipeline showed no signs of slowing last year. The company opened five new communities, broke ground on four new developments and transitioned 11 buildings — some it had acquired over the years, others that were pure management transactions with existing partners.
The five new communities opened to depressed occupancies ranging from 20% to 30%. A few have improved since.
”We learned to live with it,” Jennings said. “We anticipate the same for this year.”
Access to capital continues to improve and expand as lenders express confidence in a recovery and return to the space.
The tighter lending environment has made it tougher for developers to pencil in their construction pro formas. Lenders are asking for more recourse and nursing existing relationships with proven developers — but even those clients are finding it difficult to secure funding in the current environment.
Aegis focused on relationships with three to four key banks while putting together the capital stack for Laurelhurst, its upcoming $100 million development in Seattle. Lenders scrutinized the project in detail before signing off on the loans, and the operator shared details on occupancy rates for comparable communities to give the banks a measure of confidence that the project is solid.
Laurelhurst is expected to break ground in mid-June.
The tighter lending environment and the pandemic forced Aegis to revisit plans for upcoming projects, as well. It is looking at fewer amenities, more multipurpose rooms for programming, and adding more rentable space. It is also minimizing expensive finishes while still having an impact on prospective residents’ first visits to a community, emphasizing what Braun calls the “Aegis ‘wow factor’” within the first 90 feet of entering a building, and in their first 90 seconds at a community.
“We’re still wanting people to live with us just by looking at our spaces,” he said.
Jennings estimated that 50% of lenders that Dover deals with continued business as usual during the pandemic’s initial disruption. Regional and community banks, notably, were closing with the company at pre-pandemic terms.
Dover responded to the disrupted landscape by erring on the side of transparency. It shared its modeling scenarios with lenders, as well as updated occupancy at comparable communities and positive Covid-19 cases, showing banks how seriously Cedarhurst Living took the safety of its communities.
“Even that question is dying down,” he said, of inquiries about active Covid-19 infections.
A flood of new lenders has entered the space, primarily private equity offering non-recourse debt at slightly higher interest rates, as well as short-term mezzanine debt.
Twain Financial Partners gained entry to the space last year by offering ground leases to developers as a mechanism to complete capital stacks, Director of Strategic Investments David Taylor said.
The St. Louis-based firm closed five ground lease deals since July 2020, putting around $7 million in proceeds to work. Twain also has another $35 million invested through property assessed clean energy (PACE) financing mechanisms.
Ground leases, in which a developer leases the ground on which it is building, is a popular financing tool in other real estate asset classes. Taylor realized there is a substantial runway for the tool in senior housing a couple deals in, and took a closer look at the industry for ways in which the firm’s products could fit.
What Twain discovered was a lot of projects, particularly new developments, were limited by loan to cost. The firm can buy the ground, and lease the development rights and improvements to the developer for up to a 99-year period. This provides the developer with leverage, and reduces the amount of equity that needs to be raised.
There are additional benefits. Cost of capital is currently low — Taylor estimates Twain’s cost of capital is currently in the 5% range, at a lower debt constant compared to senior lenders. Its lease rate is an interest-only payment, where a senior lender — even if a borrower gets a lower rate — will underwrite it as an amortized note. As a result, the principal and interest payments from senior lenders are going to be higher.
Twain also gives its development partners opportunities to buy back the ground after three years, at a pre-negotiated price. This gives the developer time to either bring in more efficient capital to replace the ground lease proceeds, or sell the building upon stabilization.
“Our structure allows developers flexibility,” Taylor said.
The firm approaches ground lease deals similar to other capital providers. Because of where ground lease proceeds sit in the capital structure, however, Twain has a low loan to value ratio, generally between 30% and 35% of the stabilized value of a development, because the firm knows there is a senior lender in place.
“As long as the developer can put their full capital stack together, we have interest in those deals,” he said.
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