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Healthcare: Are We Headed Into an M&A Boom or Bust?

The coronavirus pandemic has upended lives and industries, and the senior housing market remains in the crossfire. The pandemic started as a public health issue that has also become an economic issue, and the senior housing industry has felt the impact on both fronts.

As senior housing providers continue to battle the public health and economic impacts of the pandemic and face the prospect of new federal regulatory burdens, some may look for an exit. And with changes in the credit market and broad opportunities for financing, the industry is ripe for additional merger and acquisition (M&A) activity.

Credit Market Changes

The pandemic has attacked senior housing providers in the healthcare space from both sides of the financial equation: Expenses are higher, and occupancy and staffing are lower. Those pressures ultimately affect financial ratios and the ability to service debt. As a result, credit availability from conventional sources such as banks has become tighter, causing greater scrutiny on typical deal dynamics such as loan-to-value, debt service coverage ratio, and liquidity.

However, senior housing providers have other financial options beyond traditional lenders. Investor cash has never been more readily available to the sector. Investors are pulling back from the commercial and industrial sectors, and leaning more towards multi-family housing and senior housing sectors.

Investor interest isn’t guaranteed, of course. The credit markets scrutiny will still temper the infusion of investor cash by project of the sponsor, financial metrics, and market feasibility of a financing project.

For the right project, not only is investor cash readily available, but also, there’s an increasing trend toward using alternative financing arrangements through programs such as PACE and Land Lease arrangements. While conventional bank financing will still play a key role in the sector, it will remain ever vigilant around the C’s: Cash Flow, Collateral, Capital, Character, and Capacity.

In addition, HUD and other agency financing will still play a key role in the senior housing segment, as the Baby Boom generation continues to march on for the next 10 to 15 years towards this sector.

HUD and other federal agencies are already easing their qualification requirements, which indicates there will be an uptick in lending from these agencies. Rather than broadening their mandate, we believe they will just deliver relief sooner. These programs are attractive for owners due to the ability to lengthen the amortization period, attractive rates, and non-recourse to the borrower.

Increasing Regulations

The COVID-19 crisis demonstrated to federal legislators and policymakers the important role of assisted living and other senior housing communities in caring for vulnerable older adults. The crisis revealed that the care provided by senior housing communities could greatly influence rates of hospitalization and healthcare spending. As a result, the senior living industry became eligible for federal financial support during the crisis—and is expected to become subject to new federal regulations.

We cannot yet quantify the impact that a federal regulatory burden will have on the sector, but it clearly will place additional expense burden on stretched providers in the form of increased staffing costs, physical plant adjustments, and IT enhancements. Some smaller operators will not have the efficiencies to survive, and this will drive sales and affiliations in the sector as well.

Looking to the Future

Moving forward, the senior housing segment will continue to need further investment to meet the demands for senior housing, which were not diminished due to the pandemic. We expect to see continually evolving senior housing models to meet the demands of a more active, technologically savvy, and refined senior population.

Costs to build and costs to operate will continue to rise, which will have an impact on smaller providers and those with older, outdated models. As a result, M&A activity will continue at a brisk pace, especially as financing options have never been broader.

Despite the stress of the pandemic and the resulting financial and regulatory burdens, the silver lining is the increased focus on meeting the needs of senior adults. In adversity, there is always an opportunity, and the greatest benefit to date of the pandemic has been to focus attention on seniors and their needs.

Talk with Don Woods to discuss financing options for your business: Donald.Woods@FirstMidwest.com

Learn more about First Midwest’s Healthcare Finance group here:
https://www.firstmidwest.com/commercial/specialized-industries/healthcare-finance/

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