CapitalSource's Steve Gilleland

The company has just finished divesting itself of most of its health care assets in a $1 billion sale to Omega. That move, though, should not be interpreted to mean the company is exiting the category, which includes assisted living, skilled nursing and senior housing, Gilleland tells GlobeSt.com. Instead it will focus its fire power on health care first mortgage lending. In fact next year it plans to invest between $200 million to $300 million in such a manner.

GlobeSt.com: CapitalSource has gone through some changes over the pastfew years. Can you walk me through those to explain how you got toyour current strategy?

Gilleland: Sure, we launched in December 2000 and started focusingmore on health care in 2002. We were classified as a REIT in January2006 and then we de-REITed in January 2009. We did that because inJuly 2008 we acquired Fremont Investment, which at the time had $5billion in deposits. Under US law, you know, a bank holding companycannot hold a REIT. So we are morphing into a bank holding company –right now we are still considered a small finance company, though,until we wind down that part of our portfolio.

GlobeSt.com: Tell me more about Fremont's deposit base. Has that been lent out?

Gilleland: Not completely yet. We've pushed about $2 billion to $3billion in loans out the door but we still have about $1.8 billion incash for which we are trying to find a good home.

GlobeSt.com: Now you've also sold off several hundred skilled nursingassets recently.

Gilleland: Yes, we acquired about 181 properties over an 18-monthperiod from January 2006 to July 2007. We sold most of it to Omega for$1 billion, a deal that generated about $450 million to $500 millionin liquidity for us. We also recently completed a separate sale of therest of our assets in a $100 million transaction. Most of those assetswere based in Texas.

GlobeSt.com: So you are exiting the sale leaseback market?

Gilleland: Yes, that piece of it but we are still very bullish onfirst mortgage lending to skilled nursing and other health care. Thatremains a core area for us. We will be doing between $200 million to$300 million of deals like our recent Formation Capital transaction[a competitive transaction in which CapitalSource provided $37 million in first mortgage debt as part of a total $50 million healthcare acquisition loan].

GlobeSt.com: How do you see lending environment for health careshaping up next year?

Gilleland: Like most of asset classes it has been slow – there havenot been a lot of mergers and acquisitions to finance. The maindriver, instead, has been refinance or deals like Formation where aREIT sells off properties. I think M&A activity will pick up with somelarge deals closing.

GlobeSt.com: I know you said the health care sector is stronger thanthe general commercial real estate market but there must be some areasof concern for an underwriter.

Gilleland: Oh sure. There were pockets of poor deals done here andthere. Any acquisitions that were financed at the height of the market– and done with extremely high leverage – will be trouble.

GlobeSt.com: Do you see a debt maturity crisis looming for health care?

Gilleland: Certainly not to the same extent as other asset classes,but, again, there will be some problems, probably starting in 2011 and2012. The underwriting on some of those deals just won't pass thesmell test when they come up for refinancing.

GlobeSt.com: For instance?

Gilleland: For instance, nursing homes usually trade on a cap ratebasis but people also look at per bed numbers. In Texas, they usuallytrade, for example, at $50,000 to $60,000 per bed. I saw one deal,which I passed, that was underwritten north of $100,000 per bed. Therewere some crazy deals done at multifamily cap rate loans – say 6 or 7cap rates. Now those cap rates are at double digits, at 10 or 11. Justto put that in perspective, even in the hey day, the typical cap raterange for skilled nursing was 12. In the worst days it can be 14.

GlobeSt.com: But despite those issues, you think health care is faring well.

Gilleland: I think we are in the best shape of all the real estateasset classes. Most of the folks did stick to prudent underwriting.