by Kevan McCormack, Senior Director
The commercial real estate banking community is truly in its worst condition in several generations. So what is the most favored product type getting done in today’s commercial real estate finance environment? Healthcare.
The healthcare real estate market has emerged as likely the most financed property type during this latest real estate cycle. The macro-economic fundamentals behind the growing demand for healthcare related real estate have never been better. But before you go out and make plans to build the next $500MM medical campus, there are a few things to consider:
Legislation – Healthcare is one of the most heavily regulated industries in the United States. This is one of the few property types where the economics surrounding the success or failure of the operations in the facility can be changed for the better or worse at the stroke of a pen. The recent passing of Obamacare in early 2010 changed the ownership structures of most Medicare and Medicaid reimbursed hospitals overnight. With its passing, referring physicians can no longer own any portion of the operations in a licensed hospital that receives Medicare or Medicaid reimbursement due to the broadening definition of the Medicare Self Referral Rule.
Operator Partner Credit – Most healthcare real estate is 100% pre-leased prior to loan closing. Given that the success of the project is entirely dependent upon the successful operations of the business (i.e. hospital, surgery center, etc…), lenders are more focused on the operator than any other factor. Operating Partners, as tenants, should have a clearly defined track record and solid financials in proportion to the size of the new venture.
Experience – Expect lenders to be just as or more focused on the developer’s experience in this sector than other property types. The specialized nature of this product demands that the developer understand more about the industry than typical commercial real estate developers. Developers should have a detailed understanding or even experience in the operations side of the healthcare business.
“Cash is still King” – just because lenders are more likely to lend money for a new hospital project as opposed to an un-anchored retail center, does not mean they will stretch to get a deal or overlook a developer’s lack of financial wherewithal to stand behind the development or personally overcome deviations from the business plan.
Lenders – Many lenders are still hesitant about lending in the healthcare market due to several factors including: a lack of expertise in understanding risk factors, the large size of transactions prevents most lenders from participating due to lending limitations, a lull of activity in banking participations, and just a general lack of liquidity to make any loans. However, banks are generally more able to lend in healthcare real estate than other property types because loans for single tenant healthcare properties such as hospitals do not always count against a bank’s commercial real estate lending capacity, but may fall under their business lending allocations. Still look for many banks to lend in the 70% loan to cost range; however, for the right deals with the right tenants and sponsorship, there could be higher leverage loans available.
Property Type – Healthcare is still specialized real estate that houses extremely expensive finish-out with some uses requiring upwards of $1MM per bed to construct. This factor alone will make most healthcare real estate property types one of the last to be picked up by the CMBS market. So while you will find more money available at the banks for construction loans, you will find difficulty finding a permanent loan once the construction loan matures. Look for the very liquid and active Healthcare REIT market to be your most likely exit from a construction loan.
In summary, while healthcare real estate may be the darling of the commercial real estate finance market today, it does not mean that just anyone can get financing. One must assemble a financially solid and highly experienced team on all three sides of the transaction…the tenant, the developer and the capital partner. To increase your success, it is critical to understand all the potential issues surrounding healthcare legislation, finance and development before reaching out to any capital provider whether a lender or an equity investor.
Want to learn more about this? Feel free to contact Kevan McCormack, Senior Director.