Lenders returning to the space are chasing core deals, while value-add deals are harder to complete. But a historically low interest rate environment, coupled with stabilizing expenses, may help facilitate value-add deal volume moving forward, Newmark Knight Frank (Nasdaq: NMRK) Vice Chairman, Health and Alternative Assets Chad Lavender told Senior Housing News.
“We’re seeing controllable expenses across the board moderate. There are so many more people in the labor pool that we’re seeing costs of labor go down for the first time in five years,” he said.
Low Treasury rates
The Federal Reserve’s moves to stimulate the economy as the coronavirus spread across the U.S. appear to have had their intended effects. The Fed lowered interest rates on 10-Year Treasury bonds to near zero in mid-March. Additionally, the bank launched a quantitative easing program where it pledged to purchase up to $750 billion in corporate debt issued by highly rated companies including real estate firms.
The “Big 3” health care real estate investment trusts — Welltower (NYSE: WELL), Ventas (NYSE: VTR) and Healthpeak Properties (NYSE: PEAK) — received funding from this program. That, in turn, contributed to investor confidence in core senior housing assets.
Newmark facilitated Kayne Anderson Real Estate’s August acquisition of 34 Welltower properties, which included seven senior housing properties in Florida. The deal originally priced in early April, when lenders were still on the sidelines. Once capital returned to the markets, however, the transaction took 45 days to close, which Lavender attributed to the creativeness of the parties involved, as well as steps taken to inject confidence into the markets.
“It took a creative seller, buyer and third parties and to do that first Covid-19 deal,” he said.
Treasury rates remain near historic lows. The 10-Year note carried an interest rate of 0.68% as of September 14. Correspondingly, LIBOR rates are also near record lows, The 30-day LIBOR rate currently stands at 15 basis points, a significant drop from 2.06% a year ago. As a result, net funds are where they were, pre-pandemic.
“The LIBOR curve has flattened. Net funds are where they were. Permanent financing is so efficient,” Lavender said.
Value-add deals struggle
The efficiency with which core deals are being financed has not yet trickled down to value-add deals, but that is poised to change as more capital flows back into the markets, and lenders and third-party consultants become more comfortable with working in a virtual environment, JLL Capital Markets (NYSE: JLL) Senior Managing Director Ted Flagg told SHN.
Operator relationships will be essential to complete value-add deals. Investors typically pencil in a set capital expenditure per unit price, required to stabilize cash cash flow on a distressed asset. Having a solid operating partner in place is critical for the buyer, especially when Covid-19 has added to other obstacles to stabilizing occupancy and operations.
“A strong operator is going to be a significant percentage of the overall purchase price,” he said.
Brokers continue to struggle to close value-add deals. Debt funds remain highly active, placing money in these deals, but banks remain hesitant to deploy capital to the senior piece of the capital stack, without a strong operating partner.
Bridge funds have filled the void, but are requiring higher equity commitments and loan to value ratios. As national banks begin to reenter the space over the next two quarters, however, it will spur competition with regional banks and bridge lenders, and benefit borrowers in the form of favorable terms, Lavender said.
“We’re seeing that open up, but it’s still tough,” he said.
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