Cain International’s Graham Keable explains why the firm recently wrote a £56m loan against a London care home.
In June, real estate debt and equity investor Cain International provided a £56 million (€61 million) loan to finance the Landsby, a high-end senior living project located in north west London, being developed by Elysian Residences. Graham Keable, principal with Cain, explains why the firm lent in a sector many lenders remain wary about.
There are nearly 12 million people over the age of 65 in the UK; a number set to grow by approximately 2.5 million in the next decade. The demand for suitable care and the need for a strong national healthcare service will only increase.
This is driving the robust fundamentals underpinning the senior living sector, which saw record investment of £1.2 billion in 2018, according to Savills. Yet, for all that equity, there is a dearth of debt in the marketplace.
There are several reasons why it is difficult to secure construction financing in the UK’s senior living sector, and the market is relatively nascent and thinly capitalised as a result. The UK lags the USA, Canada and Australia in the evolution of this sector, meaning there are fewer proof points to reassure lenders. Also, senior living projects do not generate significant pre-sales, unlike the conventional residential development market where they are often a requirement to raising debt.
We decided to evaluate the transaction through the eyes of the purchaser. If you think of yourself as a senior citizen, about to move into what may be your last home, then it’s a lifestyle choice about an environment that should cater to your social, economic and health needs. Consequently, prospective purchasers are less inclined to buy off-plan as they want to see and experience the product. They want to understand the operator’s long-term commitment and the flexible and varied service offering.
Other interrelated factors make this market difficult to get comfortable with. First, it is a slightly divergent economic model. While a normal housebuilder generates profits when the homes it builds are sold, the model for investors in the build-to-sell senior living market is predicated upon selling the same unit multiple times over its lifetime as and when the resident passes on. Each transaction of this kind will normally generate an income of 15-25 percent of the sales price, known as an ‘event fee’. Therefore, a lender must consider the fact that the equity gets repaid over a much longer period and thus they must hold their investment for longer.
In addition, as generating profits in this area is directly related to the passing on of residents, some developers and debt providers are concerned about possible reputational risk and have shied away from fully engaging in the sector. Some are also concerned about the risk of needing to enforce a loan should the product not sell and the borrower default.
So, how does a lender overcome these concerns?
It is essential to work with equity providers that understand the time frames involved. Without an experienced partner, there is a risk that the product will be less attractive. In our recent deal, we spent a significant amount of time with the sponsor’s team and those marketing the product. We had to understand and get comfortable with a financial structure which is shaped by event fees.
The most important part of our underwriting process is developing a detailed understanding of the sponsor’s business model. Unlike some traditional lenders who tend to underwrite based only pre-existing models, we took a fresh look at the opportunity, learned the ins and outs and the market opportunity and quickly became very comfortable. Ultimately, working with partners who share this long-term view is what underpins the ability to underwrite a deal in this sector.
Investor demand for the sector will continue to increase and we have been early movers on the debt side. We expect to see significant product supply enter the market in the short to medium term. Inevitably, this will be followed by debt providers. Where we are now in the financing market feels highly reminiscent of the purpose-built student accommodation debt market of circa 10 years ago.
The need for a strong partner and a thorough understanding of the operator will remain, but there is much to be gained for lenders in this emerging market.
Graham Keable is a principal at Cain International and a senior member of its real estate debt team. This article first appeared in Real Estate Capital on 23 July 2019 and can be found here.