Securing a Commercial Real-Estate Loan

By James Eagan, Parallel Capital Corp.

Owners and operators of healthcare facilities are an important and growing part of the commercial-mortgage finance industry. For example, in addition to the large assisted-living facilities owned and operated by public corporations, there are 14,000 assisted-living facilities with fewer than 25 beds. There are also as many as 3,200 skilled-nursing facilities in the United States with fewer than 50 beds. Yet, operators of these facilities continue to struggle to secure appropriate mortgage financing for their facilities.

Legacy of Neglect from '80s Real-Estate Crash

Just a few years ago, it was difficult­ sometimes impossible--for borrowers in almost any industry to get a commercial mortgage. The commercial real-estate crash of the late 1980s and early 1990s drove traditional lenders away from the business.

Commercial banks, formerly a core source of commercial mortgages, were focused on working out their problem portfolios, not on making new commercial-property loans. Not only that, but the savings-and-loan industry had collapsed, and institutional lenders, including life-insurance companies and pension funds, were preoccupied with working out delinquent loans and examining the status of existing portfolios.

In addition, there were no standardized financial products created from the securitization of commercial mortgages. This was true even though the mortgage-backed securities market (through such public-private entities as Freddie Mac and Fannie Mae) had years earlier brought liquidity to the residential-finance industry. For one reason or another, Wall Street perceived the securitization process for commercial mortgages as insurmountable.

Adversity Yields Opportunity

In 1991, the scenario changed. Congress established the Resolution Trust Corporation (RTC) to work through the tens of billions of dollars of loans from failed, federally insured savings and loans. To efficiently handle the commercial mortgages held by those institutions, the RTC issued the first publicly rated Commercial Mortgage Backed Securities (CMBS). CMBS proved to be solid securities for investors; by the end of 1995, the RTC had issued $17 billion of securities backed by commercial mortgages.

Its mandate fulfilled, the RTC ceased operation at the end of 1995. Its legacy is a new industry that finances commercial real estate through the securitization of commercial mortgages.

Filling a Void in the Market

At the core of this new industry are "conduits." Conduits are organizations that make commercial mortgages with the intention of turning them into securities for investors. Conduits are not like banks; they do not rely on a base of deposits to fund loans.

In the last several years, conduits, and the CMBS they issue, have helped provide needed liquidity in the commercial-lending market. The growth of the industry has been quite dramatic. CMBS issuance jumped to $44 billion in 1997 from $17.5 billion in 1993, according to Commercial Mortgage Alert. The size of individual transactions also has increased dramatically. In 1997, 11 CMBS issues each surpassed $1 billion.

In addition, Wall Street investors and commercial-property borrowers, including healthcare-facility operators, are recognizing the value of loans from conduits. The securities, comprised of conduit loans, are attractive to investors because the securities offer good returns with risk rated by such agencies as Standard & Poor's, Moody's Investor Service, Fitch or Duff & Phelps.

Conduits May Be Only Alternative for Healthcare-Facility Operators

While banks and institutional lenders have, to some degree, returned to booking traditional commercial mortgages, they tend to shun healthcare properties such as assisted living and other specialized-care facilities.

Banks and other lenders are often unwilling to invest the time and personnel necessary to develop the expertise in financing healthcare properties. Most bankers say they don't know enough about the healthcare business and its risks to originate a large enough volume of these types of mortgages. Lenders argue that too much "due diligence" is required to understand the operating and business ramifications--not to mention the real-estate ramifications--of healthcare facilities.

Clearly, owners and operators of skilled nursing, congregate care, assisted living--as well as specialized centers treating chemical dependency, Alzheimer's and psychiatric patients--would be well-advised to consider a conduit for their real-estate lending needs.

Industry trends point to increased demand for loans for assisted-living facilities as states across the country move to provide Medicaid waivers and steer away from the higher cost of care in a skilled-nursing facility. This trend will also expand the role of financing sources--such as conduits--to meet owner and operator real-estate finance demands.

Tips for Seeking Loans Through Conduits

Borrowers, as well as mortgage bankers and brokers, should be prepared to ask certain questions and have a certain level of knowledge as they pursue commercial-property loans from conduits.

It is important to note that some conduits are actually run by banks or investment banks. Other conduits operate as stand-alone businesses dedicated to commercial-mortgage finance and asset securitization. In all instances, borrowers should look for organizations committed to the commercial-mortgage business.

There are other factors and issues that borrowers should keep in mind when working with conduits:

• The best service and rates come from conduits that are direct lenders as opposed to intermediaries for conduit products.
• It is important that borrowers make sure the conduit has a good track record in closing loans funded by the CMBS market; this kind of up-front homework can save time and money.
• All commercial-property loans with conduits are subject to risk criteria established by the rating agencies in the CMBS markets; not every potential loan will fit these criteria.
• A conduit with a dedicated, in-house team of underwriters is more likely to understand the conduit process and how to get loans closed than a conduit that "outsources" underwriting to contractors.
• It is important to get from the conduit a clear idea of the legal fees and other costs associated with environmental, engineering and appraisal reports that must be performed for most commercial mortgages.
• Borrowers seeking small commercial mortgages--under $1.5 million--should look for a conduit that has a streamlined program, including reduced fees for the reports mentioned above.

Most importantly, borrowers, mortgage bankers and brokers should work with conduits that are responsive and understand the nuances of each commercial-property finance situation, especially in a highly specialized area like smaller-scale healthcare.

James Eagan is managing director at Parallel Capital Corp., a commercial-mortgage conduit based in New York City that operates more than 20 lending offices throughout the country. Parallel is a direct lender and operates a Healthcare Finance Group dedicated to providing commercial mortgages of all sizes to owners and operators of a wide range of healthcare facilities. As a direct lender, Parallel controls the lending process from origination, through underwriting and securitization. Underwriters are educated to understand Medicare and Medicaid reimbursements, staffing requirements, expense structures and other operating issues, enabling the company to offer appropriate mortgage solutions for facility operators. For more information, call (212) 972-7600.

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