Today's financing state-of-the-art: interview with Jeffrey A. Davis, Chairman, Cambridge Realty Capital Ltd.

Interview with Jeffrey A. Davis, Chairman, Cambridge Realty Capital Ltd.

1995 was what Chicago-based merchant banking firm Cambridge Realty Capital Ltd. called a year of "many exciting developments" in financing for nursing homes, assisted living and health care real estate in general. Decreasing interest rates made previously non-financeable projects attractive financing opportunities, real estate investment trusts (REITs) strengthened and consolidated, HUD initiated the 232/223(f) program to refinance existing properties, new institutional lenders were drawn to senior housing, and commercial banks and other funding sources continued to expand their support of health care real estate financing and development.

So what does this mean to the would-be long-term care borrower this year? According to Cambridge chairman Jeffrey A. Davis, many of those "exciting developments" will continue to evolve - and that is, in general, good news for the LTC industry.

In a recent interview, Nursing Homes Managing Editor Laura Bruck asked Davis to share his views on the state of long-term care financing, as well as his advice to providers on navigating the often intimidating waters of the LTC lending stream.

Bruck: How would you describe the overall status of long-term care financing at present?

Davis: Things look very positive right now, due in large part to what lenders view as the excellent performance of LTC facilities over the last three to four years. There are many types of funding sources available to industry borrowers right now, ranging from banks, to Wall Street investors, to HUD - which is a very active player - to REITs, and even some credit company-type players.

Bruck: What are some of the driving forces behind these positive trends?

Davis: I think there are a few parts to the equation, one of them being increased knowledge and understanding of the LTC industry on the part of lenders and bankers. That increased awareness is coming from groups like the National Investment Conference (NIC), which puts on a lender/investor show every year in Washington, DC, and trade groups like the American Health Care Association, which have done a good job of educating lenders and investors.

Another driving force is the lack of other desirable investment opportunities, which causes lenders to view nursing home operations in a positive light. Also, because there haven't been a large number of new nursing homes built in the last ten years, lenders have a sense that they're dealing with a somewhat mature industry today, with experienced providers and a lot of government control and regulation.

Bruck: Where do interest rates fit into the picture?

Davis: As of April, fixed-rate financing is at about 8% for HUD-financed transactions. Conventional rates are at least a point or two higher. While rates change constantly, the attitudes of investors remain positive with respect to financing senior housing and health care properties. We've been encouraging all our clients not to wait for interest rates to go down, since we feel they're more likely to move upward over the coming months, although they'll remain relatively stable through the Presidential election. It's also an excellent time for multi-facility owners to lock up these low rates by "bundling" facilities in a single conventional loan package. Lenders are motivated to provide multi-facility financing programs to make larger loans and deal with a greater number of facilities simultaneously.

It's important to understand that, in addition to their intrinsic value, low interest rates also give borrowers the chance to improve all other terms and conditions of refinancing.

Bruck: How can borrowers best take advantage of those opportunities?

Davis: There are several issues, in addition to interest rates, that the borrower needs to consider. Amortization and loan constant is one of the most important, and one that nursing home owners often fail to fully consider. When given the option, you should always take the lower loan constant rather than the lower interest rate. For example, a 9-1/2% interest rate with a 15-year amortization has a loan constant of 12.53%, while a 10% interest rate with a 20-year amortization has a loan constant of 11.58% - almost 1% lower, reducing monthly payments by nearly $800.

Borrowers should also get the longest term possible. Locking up the longest term, especially when the business is doing well, is optimal considering the volatile nature of both the LTC business and interest rates. Also, longer terms can eliminate the costs of frequent refinancing - legal fees, appraisals, and loan points must be paid each time.

The amount of the loan is especially important when interest rates are low. Loan proceeds can increase while interest rates are low if coverage remains constant with higher interest rates. In short, you get more money with the lower interest rate.

It's also important to analyze your floating versus fixed-rate loan options. While floating interest rates may look attractive, they can move very quickly in response to the financial markets. Today's low interest rates should be applied long-term, rather than short-term, to take advantage of long-term rates, rather than what some have called short-term "fool's gold" rates.

Prepayment ability, which can be very restrictive on a refinancing, is another important variable to consider. As a borrower, you're always better off negotiating fixed prepayments based on a declining percentage year-by-year, if lenders will agree. That is easier for the borrower to understand than many of the complicated formulas out there.

Finally, whenever possible, borrowers should try to negotiate a loan without personal recourse. When interest rates are low in the absence of strong demand, there is much more flexibility with respect to personal recourse issues.

Bruck: Are there any "rules of thumb" with respect to choosing the lender that best meets your facility's financing needs - especially since some lenders seem to have adopted a narrow focus, i.e., wanting only to finance subacute or assisted living?

Davis: That's a very real tendency. Lenders, by definition, are narrowly focused, primarily because their loan committees don't permit them to think any other way. Just like anyone else, lenders are going to set their priorities according to what's worked for them in the past. In other words, they'd rather not push rocks up a hill. The result is that they tend to get pigeonholed.

Unfortunately, financing tends to be a very complicated process for people who don't operate in that sphere very often and there's no fool-proof way to simplify what's unfamiliar. To make matters worse, LTC providers are used to structure, and financing usually isn't as structured as they would like it to be - lending committees tend to change their minds more often than not.

There are, however, some relative constants in this maze of options. HUD is probably the closest thing to a "given" out there. It's been around for a long time and while its future - specifically its 232 senior housing and health care programs - seemed in doubt for a while, things look brighter for the program now, if only because HUD is not under the gun as much in Washington as it was a year ago.

The HUD 232 program can relate to any form of senior housing and health care real estate, including refinancing, new construction, rehabbing and expansion. Their 232/223(f) program provides fixed-rate, non-recourse, long-term funding with 85% loan-to-value, 35-year amortization, current interest rates of 8%, no short-term balloon and flexible prepayment-all characteristics that we advise borrowers to look for.

Bruck: In the absence of any formal guidelines, is there anything that LTC borrowers can do to simplify, or at least facilitate, the financing process?

Davis: The more you can do upfront, the better you're going to do as you go through this process. The key is to prepare ahead of time, to formulate a financing plan before you sit down with a potential lender. We've developed what we call "The Cambridge Financing Commandments" to help borrowers with this preparation process (see "Commandments of Financing").

Bruck: What about legislative and regulatory developments in Washington and their effect, if any, on the LTC lending stream?

Davis: There's nothing in Washington that is too negative right now. There was concern late last year about the block grant idea, but that seems to have run out of steam. There is, of course, the ever-present budget battle over Medicaid and Medicare, which is a constant concern to people in the industry. But basically, the feeling in Washington is that, even though they're not happy about paying for long-term care, or at least serving as one of the main payer sources, they really haven't come up with a very good alternative yet. And the prospect of cutting too much is a frightening one for the decisionmakers.

Bruck: What would you say is the industry's biggest challenge with respect to financing right now?

Davis: The greatest challenge is really two-fold. First, there's the constant constraint on costs from revenues being so tightly managed. Those constraints place a lot of stress on the industry, in terms of the inability to pay staff commensurate wages, and right down the line. So your "basic" LTC facilities are really squeezed both upwards and downwards, and figuring out how to work around that is, indeed, a challenge.

The other part of the challenge has to do with the large number of older, dated facilities in need of remodeling and repair. Unfortunately, most states don't have a capital component formula that encourages that kind of investment.

Bruck: What do you do if you happen to be the administrator/owner of one of those facilities?

Davis: Right now, it's a matter of doing your best with what you have. Ultimately, however, the states are going to have to start figuring out a way to give operators the right kind of incentives to make needed improvements and updates to their facilities.

Bruck: What is your outlook for the remainder of 1996? Will the positive developments of the past year continue to have an impact?

Davis: We believe they will. One of our predictions for '96 is that we'll see mergers and consolidations among REITs trying to find a niche in the market. Many of the original reasons for the formation of REITs have diminished in importance, and while they were, at one point, among the sole sources of capital for senior housing and health care financing, today, there are numerous alternatives.

We also believe that HUD financing will continue to grow in popularity, by virtue of its efforts to become more competitive and compatible in the marketplace. I am referring to the creation of the 232/223(f) financing programs for existing properties and fast-track processing in some regional offices. In fact, Cambridge is one of a few firms that have positioned senior HUD processors to work solely on nursing home and senior housing financing.

Funds from a variety of sources will continue to be available for assisted living, which lenders view as bridging the gap between heavily regulated skilled nursing and subacute facilities and essentially unlicensed congregate/boarding care facilities. We also expect to see more consolidation on the provider side in an attempt to raise equity more easily, to more efficiently share economies of scale in home office costs, to utilize people and resources more efficiently and to enhance credibility with lenders and financiers.

RELATED ARTICLE: "Commandments" of Financing

As chairman of Cambridge Realty Capital Ltd, Jeffrey A. Davis fields hundreds of financing inquiries yearly. What he's found is that too many borrowers want to talk about financing before they even have a "financing game plan." To help bring loan prospects up to speed, Davis developed what he calls "The Cambridge Financing Commandments," providing needed advice to borrowers:

Understand your financing needs. Before beginning discussions with your lender or financial intermediary, make sure you understand the type of loan you seek: construction, permanent or rehab/expansion. At the same time, assess the urgency of your needs. Do you have time to consider a government program and obtain those benefits?

Understand your lender/investor's needs. Lenders want to get your loan completed, if it's realistic, but it's up to you to qualify for a good loan. Also, lenders who feel that you're just "picking their brains," or using them as a feasibility consultant, development consultant or even an architect, are likely to be turned off.

Be realistic about timing. Even fast-moving transactions take 90 to 120 days. To make sure your loan is on the fast track, have all materials assembled in advance and ready to present upon request.

Research the alternatives and choose the best lender/financial intermediary to deal with. Since most borrowers don't feel comfortable dealing directly with lenders, they choose to have a consultant/financial intermediary represent them. If, however, you will be making direct contact, speaking to a decision maker rather than a low-level loan officer will improve your chances of succeeding.

Thoroughly understand your facility. You are the "expert" on your facility, and any lender's questions about the facility are fair game: numbers of units, current reimbursement rates, expenses, census breakdown, etc. The more you know and understand and are able to articulate, the better impression you'll make.

Make sure your data are accurate. Submitting inaccurate data is a good way to disqualify yourself as a borrower. Review in advance all statements and census data and assemble all legal data. Also, make sure you have reviewed in detail all current debt. If you will be paying off the debt, make sure that debt is open to prepayment.

Process lender/investor requirements promptly. More than half the responsibility for prompt loan closing lies with the borrower. When a lender requests updated numbers or additional data, it's up to you to deliver them. You should have three years' historical data up to speed, copied and ready to present. In addition, put together enough area data to provide your lender sufficient information about the context of your loan.

Be open-minded during financial discussions. Respect your lender's expertise. Borrowers who come off as if they know it all about financing may turn off lenders, who are the real experts. Inquiries are accepted and encouraged.

Stress material, not conversation. Talk doesn't make deals, a quality presentation with excellent material does. It's all about quality paperwork.

View the relationship as a long-term one. Your first loan may lead to an ongoing relationship with your lender. Go into every talk with the idea that this may be the beginning of a long relationship. That being the case, be prepared, listen and learn.