Materials costs weigh on supportive housing construction, creative loans emerge
Funding for developments and acquisitions of assisted living and memory care is gradually becoming easier to secure, but high construction costs and the lingering uncertainty associated with the pandemic remain challenges.
Developers with a proven track record of success, however, have had little trouble raising their stacks of capital over the past year. And creative new avenues of lending, such as land leases, are starting to make their way into the space, according to panelists from Aegis Living, The Dover Companies and Twain Financial Partners, who spoke last week in the Part of Senior Housing News’ Capital Quarterly webinar series.
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 business consists of a development arm, construction company, capital markets line and operator, Cedarhurst Living, which owns and operates 53 communities in the Midwest, Mid -South and South East. Dover also has six communities under construction in Illinois, Indiana, Kansas and Kentucky, and plans to start developing five new communities per year, starting in 2022.
Jennings estimates that 75% of the lenders and sources of capital with which his company deals are back to offering term sheets on pre-pandemic terms, and the rest will come back in the next 12 to 18 months.
“Based on our memories [of the 2008 financial crisis], [lenders] forget very quickly, ”he said.
Construction costs continue to climb
Although Covid-19 caused a slowdown in new construction starts, construction costs have maintained their upward trajectory before the pandemic, said Walter Braun, senior vice president of development for Aegis Living.
The Bellevue, Wash., Based company operates 33 communities, has eight more in various stages of development, and remains on track to double its scale over the next decade. Its newest community, Bellevue Overlake, is 25% occupied and an additional 10% is committed to deposit bookings, which is ahead of projections. Another community is slated to open later this year, with two more slated to lead the way in 2021.
Material costs and a shortage of construction labor were already in place before Covid-19. But the closures have resulted in an increase in home improvement. Coupled with reduced production and disrupted global supply chains, the costs of oil, steel and especially lumber have skyrocketed.
“In Seattle, construction is so hot that none of the costs have come down,” Braun said.
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The rising costs had an impact on the Dover pipeline, which was somewhat mitigated by what Jennings calls a ‘tertiary plus’ development strategy and the size of the communities of Cedarhurst – a typical development costs between $ 20 and $ 30 million. of dollars. Land costs tend to be lower in these markets and Dover has not experienced a decrease in access to capital.
“Our bite size is a bit smaller,” he said.
The Dover development pipeline showed no signs of slowing down last year. The company opened five new communities, inaugurated four new developments and transferred 11 buildings – some it had acquired over the years, others which were pure management transactions with existing partners.
The five new communities opened up to depressed occupancy rates ranging from 20 to 30%. A few have improved since.
“We’ve learned to live with it,” Jennings said. “We are planning the same for this year.
Creative lenders are coming
Access to capital continues to improve and expand as lenders express confidence in a recovery and a return to space.
The tighter lending environment has made it more difficult for developers to write their construction pro formas. Lenders are asking for more recourse and nurturing existing relationships with proven developers, but even these clients are struggling to secure financing in today’s environment.
Aegis has focused on relationships with three to four key banks while building equity in Laurelhurst, its next $ 100 million development in Seattle. Lenders reviewed the project in detail before signing the loans, and the operator shared occupancy rate details for comparable communities to give banks a measure of confidence that the project is sound.
Laurelhurst is expected to lead the way in mid-June.
The tighter lending environment and the pandemic have also forced Aegis to revisit plans for upcoming projects. It envisions fewer amenities, more multi-purpose rooms for programming and the addition of more rental space. It also minimizes costly finishes while having an impact on potential residents ‘first visits to a community, focusing on what Braun calls Aegis’ ‘wow factor’ within the first 90 feet of the community. entering a building, and in their first 90 seconds to a community.
“We always want people to live with us just by looking at our spaces,” he said.
Jennings estimated that 50% of the lenders Dover does business with as usual during the initial pandemic disruption. Regional and community banks, in particular, were closing with the company on pre-pandemic conditions.
Dover responded to the disturbed landscape by fishing on the transparent side. He shared his modeling scenarios with lenders, along with updated occupancy in comparable communities and positive Covid-19 cases, showing banks how seriously Cedarhurst Living takes the safety of its communities.
“Even this issue is disappearing,” he said, of the investigations into active Covid-19 infections.
A flood of new lenders have entered the space, mostly private equity offering non-recourse debt at slightly higher interest rates, as well as short-term mezzanine debt.
Twain Financial Partners entered the space last year offering land leases to developers as a mechanism to supplement capital piles, said director of strategic initiatives David Taylor.
The Saint-Louis-based company has entered into five land leases since July 2020, putting around $ 70 million in revenue to work. Twain has also invested an additional $ 35 million through Property-Rated Clean Energy (PACE) funding mechanisms.
Land leases, in which a developer leases the land they are building on, are a popular financing tool in other real estate asset classes. Taylor realized that there is an important lead for the tool in senior housing in which a few transactions are made, and took a closer look at the industry to see how the company’s products might fit. ‘adapt.
What Twain found was that many projects, especially new developments, were limited by lending at cost. The company can purchase the land and lease the development rights and improvements to the developer for a period of up to 99 years. This gives the developer leverage and reduces the amount of equity that needs to be raised.
There are additional benefits. The cost of capital is currently low – Taylor estimates that Twain’s cost of capital is currently in the range of 5%, with constant debt lower than that of senior lenders. Its lease rate is an interest-only payment, where a senior lender – even if a borrower gets a lower rate – will buy it in the form of an amortized note. As a result, senior lenders’ principal and interest payments are going to be higher.
Twain also offers its development partners the option of buying back the land after three years, at a pre-negotiated price. This gives the developer time to either bring in more efficient capital to replace the land lease proceeds or to sell the building after stabilization.
“Our structure allows developers flexibility,” Taylor said.
The company approaches land leases in the same way as other providers of capital. However, due to the position of the land lease proceeds in the capital structure, Twain has a low loan-to-value ratio, typically between 30% and 35% of a development’s stabilized value, because the company knows that ‘there is a primary lender in place.
“As long as the developer can raise all of their capital, we are interested in these deals,” he said.