Monthly Archives: April 2017

How Healthcare Is Borrowing From Retail, Hospitality

IRVINE, CA—No longer sterile, institutional-looking properties, today’s healthcare facilities are borrowing from the warm, lifestyle-inspired and community-oriented designs of modern retail and hotel development, LPA Inc. executives tell With higher healthcare costs and low occupancy rates, healthcare facilities are being forced to rethink how healthcare is delivered in their community.

LPA’s designers have noticed healthcare facilities are now looking to retail and hospitality design to give their facilities a fresh look that caters to the new lifestyle design trend that is sweeping the nation. This means a shift away from the “big box” hospital to community-based spaces with updates to their interior design—with emphasis on better lighting and fresh interior-design elements and furnishings. We spoke with the firm’s senior medical planner Marcus Thorne and project director Gigi Bainbridge about how healthcare facilities are changing the way they deliver services to communities and the crossover between healthcare and other real estate sectors. How are healthcare facilities changing the way they deliver healthcare to communities?

Thorne: Healthcare facilities are responding to consumer demands by offering community-based outpatient clinics in retail/commercial settings where their patients live and work. This makes providing healthcare more affordable for their patients, instead of the traditional “big box” hospital. The current trend is fewer acute-care patient beds, smaller hospitals (micro hospitals) and more community-based services. What guiding principles are these providers using to help them create more effective solutions in delivering healthcare?

Thorne: One such guiding principal is to think of healthcare as a “lifestyle” choice. Healthcare’s past goal has been to get you in and out as quickly as possible. Now patients are considered consumers who have a choice as to where they go for their healthcare needs. They are now looking at making the patient more comfortable, while addressing specific healthcare needs. There seems to be a lot of crossover among the various commercial real estate sectors in terms of design solutions? What is causing so much crossover?

Bainbridge: The recognition by the healthcare community that the patient/client is much more than the medical treatment required at the time of service has pushed service delivery into realms previously not considered. Architects, in collaboration with caregivers, are looking to the hospitality sector for improvements to group waiting spaces—taking advantage of the calming environments in restaurants; using the genius of retail marketing to organize, present and market wellness equipment provided by the healthcare facility; using gaming principles to get patients recovering from surgery moving around and tracking their movements. There are so many exciting current examples of cross-pollination and many more yet to be introduced.

Thorne: Design is now about “lifestyle,” where the focus is on creating an environment that is centered on how people live, work and play. What else should our readers know about changing healthcare design?

Thorne: Healthcare facilities across the country are faced with a variety of dynamics that are changing the way they do business:

  • Consumer oriented patients; more convenient services. As an example, Millennials are expecting services that are convenient to their lifestyle and located where they work, live and play. Healthcare providers are listening and taking services out of the hospital into retail, education, and commercial settings.
  • Reducing expenses. Moving services out of the costly hospital space and into outpatient clinic spaces is a big savings of which providers are taking advantage.
  • Changing healthcare environment. The Affordable Care Act or ACA is requiring healthcare providers to be responsible for their patient’s successful outcome, by providing a higher level of care. Hospitals are now following up with patients to make sure their needs are being met and scheduling additional follow up meetings.

CMBS Originators “Test the Waters” on Risk Retention

New CMBS risk retention rules set to go into effect December 24th have been stirring concerns across the capital markets for months. Some of that anxiety has been put to rest with a warm reception from investors on the first conduit CMBS risk retention transaction to test the waters.

The WFCM 2016-BNK1 deal hit the market in early August. Originated by Wells Fargo, Bank of America Merrill Lynch and Morgan Stanley, the conduit was intended to gauge the pulse of both investors and regulators. Although the jury is still out on how regulators view the structure in relation to the new risk retention rules, the deal proved to be a hit with investors.

The conduit drew the most favorable pricing in more than a year, notably on its AAA piece, which priced at swaps +94. That price is three points tighter than expected and 14 basis points lower than the last CMBS conduit to price, according to research firm Trepp. In addition, pricing on the bonds lower in the stack was also encouraging, including AA- at swaps +125; A- at swaps +170; and BBB- at swaps +425.

The conduit likely priced well for three key reasons, notes Joe Franzetti, executive vice president of capital markets at Berkadia, a real estate services firm that handles mortgage banking. One is that per the new risk retention rules, the sponsors have skin in the game and shared a 5 percent ownership stake in the deal, which has a collateral balance of $870.56 million.

Sharing the risk on a shoulder-to-shoulder basis is not only in the spirit of Dodd-Frank, but unique for CMBS investors,” says Franzetti. So that gave investors more confidence in the deal.

Two, the transaction included high quality real estate collateral backing the loans.

Three, there is pent-up demand from investors because of lower CMBS issuance. New issuance is running about 43 percent behind the pace of last year, notes Orest Mandzy, managing editor at Commercial Real Estate Direct, a Trepp subsidiary.

There were a lot of tailwinds behind the pricing, adds Mandzy. The collateral loans were very conservatively underwritten as it relates to metrics such as loan-to-value (LTV) ratios, debt service coverage and debt yields. For example, the LTV ratio on the portfolio was 55.6 percent compared to the other conduit deals this year that averaged about 61.0 percent, he says.

Despite the success among CMBS bond buyers, the more critical test for CMBS lenders—and the broader commercial real estate industry—is whether regulators will view the structure as meeting risk retention guidelines, and ultimately, whether regulators will view that structure as a loan or securities. That will be a critical distinction for the entire CMBS market going forward.

The risk retention rules give originators three options. One option is to retain a vertical strip, basically carving out a 5 percent ownership across all of the bond classes. The second option is that a 5 percent horizontal strip could be retained by a third party B-piece investor. One distinction of the horizontal strip is that it is held based on market value and not face value. The third option would be some combination of the first two.

In the case of WFCM 2016-BNK1, originators will hold the 5 percent vertical strip—$43.53 million, which is designated as a separate RRI bond class. Each originator will hold their own pro rata share of that $43.53 million depending on the amount of loans that each submitted to the pool. Wells Fargo Bank will hold the biggest stake at 39.4 percent, followed by Bank of America at 35.5 percent and Morgan Stanley at 25.2 percent.

Going forward, one question for bank originators will be whether they have the balance sheet that allows them to hold the vertical strip. “I think each conduit sponsor is going to have to make that determination based on their own balance sheet and their own cost of capital,” says Franzetti.

Another question that is unrelated to risk retention is whether bank regulators will view that vertical strip as a security or a loan participation. That will be a critical decision with significant implications for the broader CMBS industry, because the capital treatment is very different. A bank will have to retain more capital on its balance sheet if it is a security as compared to a loan.

If the regulators say this is a bond, and not a loan, then this becomes undoable in the CMBS market, because there won’t be enough capacity,” says Mandzy. “Folks like Wells Fargo and Morgan Stanley won’t want to set aside whatever the regulators will want them to set aside. It just won’t be economical for them to continue playing in that role,” he adds.

It is also important to note that the WFCM 2016-BNK1 conduit was structured so that the risk retention owners have consultation rights, which is what a bank would have on a loan participation. So originators did make an effort to structure it to look like a loan participation, says Mandzy.

The industry will have to wait and see how regulators react to the structure of this first risk retention deal. In addition, there likely will be one to two more conduit CMBS deals put together this fall to further test different risk retention structures. After years of talking about the potential impact of risk retention rules, it is positive step that sponsors are now getting out ahead of the deadline to find solutions, notes Franzetti.

I think a lot of people were really tolling the death knell for CMBS,” he says. “You have to give credit to the creative minds that put this deal together, because it does show that there is a way for CMBS to continue.”

Why Aren’t More Small Apartment Projects Built?

Large, luxury apartment and condo developments have been dominating headlines and casting a big shadow over the “little guys” in rental housing. A new report released by Enterprise Community Partners and Bedrosian Center on Governance at the University of Southern California aims to call attention to this overlooked segment of the market.

Understanding the Small and Medium Multifamily (SMMF) Housing Stock emphasizes the formidable size of this segment of the market and its importance as a source of naturally occurring affordable rental housing. SMMF properties with two to 49 units account for more than half (54 percent) of all rental housing in the United States, according to the report. Many of these properties were originally built in the 1960s, 1970s, and 1980s. That aging inventory, along with limited amenities in many cases, contributes to lower average rental rates compared with those obtained by its larger, newer competitors.

The SMMF sector currently, and in the future, will act as a relief valve due to its relatively affordable nature in urban and suburban areas and in small towns,” says Seva Rodnyansky, one of the report authors and a PhD candidate in urban planning and development in the Price School of Public Policy at USC.

One goal of the report is to encourage policy makers to support the development of financial tools to preserve existing properties as they age and reduce barriers to production of new SMMF properties. Some buildings are aging and dropping out of the market due to redevelopment, and the concern is that those units are not being replaced with similar building types, notes Rodnyansky. SMMF accounted for more than a quarter of all units built in the 1970s and 1980s, but since 1990 it has represented only about 15 percent of new construction, according to the report.

Developers Face Big Obstacles

The report underscores the challenges that exist to develop new small and medium-sized rental properties in many metro areas, notes Stockton Williams, executive director of ULI’s Terwilliger Center for Housing. “That is problematic, because there is real demand for that kind of missing, middle-market housing in various configurations,” he says.

It has become much less economical for the development community to produce small and even medium-sized apartment communities in many cities. From the developer’s perspective, building large, high-end and luxury apartment projects is delivering the best competitive return on investment. “The other side of the coin is that there has been substantial demand for Class A and luxury apartment units in larger, typically more urban settings,” says Williams.

Given rising construction and land costs, many developers aim to maximize density and scale in order to make the numbers work. “Overall, a 50-unit project requires about the same amount of development work to execute as a 150-unit project, but the margins for the developer on the 50-unit project are lower and the cap rates/valuations are also generally lower,” says Curt Gunsbury, owner of the Solhem Companies, a Minneapolis-based developer that specializes in building sustainable residential properties.

The smallest apartment project that Solhem has completed is the 48-unit Cozē Flats, which opened in 2014. That project worked financially only because the site was sloped in a way that allowed for a very inexpensive underground garage and foundation system, and it also had superior views that commanded high rents, says Gunsbury.

Solhem is currently evaluating a 60-unit project in Minneapolis that likely will not work financially due to a requirement to include first-floor retail that would significantly lower the gross rents for the project. The project also has contaminated soils that will require remediation. “Small projects have a hard time paying their way in a cost and regulatory environment that requires such a high level of developer sophistication, capital, and risk,” says Gunsbury.

Changing the Regulatory Environment

The report makes a strong argument for the important role that SMMF properties play in providing a more affordable housing option. Properties with more than 50 rental units command the highest average rents at $978 per month. Specific to SMMF properties, average rents decline along with the size of the properties. Properties with 40 to 49 units reported average rents at $948 compared with rentals with two units that averaged rents of $750, according to the report. The sector also accounts for 56 percent of all subsidized units, according to the report.

Certainly, the smaller size of a property does not automatically dictate affordability. Location and land prices also factor into the equation, and some smaller apartments do charge high rental rates. “However, advocates of affordable and workforce housing are hopeful that if some of the barriers to producing more small and medium-sized properties can be removed that there will be new development of properties in that size that will serve a broader range of price points,” says Williams.

The regulatory environment is one of the major impediments to SMMF development. Securing the necessary city approvals and entitlements can be more time consuming and complex. Many cities also have new energy codes, parking fees, and higher standards related to exterior finishes—all of which can add time and cost to a project and affect rental rates.

Clearly, policy is going to have to be part of the solution to making it viable for the private sector to produce more small and medium-sized properties,” says Williams. The public sector also can provide financial and other development incentives for the kinds of projects that it wants to support. “So, really being creative with that at the local level, and potentially at the state and federal level, is an opportunity, and I think the report does a service in pointing that out,” he adds.