A distinctive outlook: industry financial benchmarks support 'asset quality' in assisted living.

How did the senior living industry perform during the first part of 2003? Did the assisted living and skilled nursing sectors improve or were they negatively affected by the economic and international situations present at the time? And, are we beginning to see a real distinction between two different "asset classes" of assisted living properties?

Answers to these questions can be found in the Key Financial Indicator[TM] compiled through the first quarter of 2003 by the National Investment Center for the Seniors Housing & Care Industries (NIC). These financial and performance indicators, reported quarterly to NIC by the nation's leading lenders, owners/operators and appraisal professionals in the senior living industry, have been gathered and posted free of charge on www.NIC.org since 1999.

Loan performance improving

For the first quarter of 2003, performance of short-term and permanent debt loans to borrowers in the assisted living category saw a continuing trend of improvement from the previous quarter. The numbers also showed improvement compared to a year earlier.

For assisted living, the amount of long-term debt (greater than 10-year loans) foreclosed was 0.32 percent of the outstanding balance and the amount with delinquent payments was 0.22 percent. For short-term debt, 0.64 percent of the reported loan balance was foreclosed and 0.7 percent delinquent. And the amount of loans restructured was 4.39 percent. Although we did see a slight increase of short-term, foreclosed loans from the fourth quarter (at 0.33 percent) to this quarter (at 0.64 percent), the numbers overall were still at very low levels.

Those assisted living numbers were vastly better than loan performance in skilled nursing. Although loan delinquencies in nursing home permanent debt dropped to 9.75 percent from 10.31 percent last quarter, the short-term debt delinquency nearly doubled from 3.75 percent to 722 percent. In fact, these results were predominantly responsible for driving up the industry-wide delinquency rate to 2.3 percent, which is higher than the 1.75 percent or lower than the secondary market would generally like to see for any real estate asset class.

Fortunately, the overall rate for the senior living industry rose to 96.3 percent of all loans performing for the quarter. And, loan performance was up substantially compared to a year ago, when the first quarter of 2002 was at 89.3 percent.

The amount of capital placed during the quarter at $527 million was down about $300 million for all property types compared to the fourth quarter of 2002. However, such declines tend to be a normal seasonal pattern for most years' first quarters, as a consequence of lenders rushing to close deals by the end of the calendar year.

Low-rate loans and LTV ratio

One factor that has proven to be an advantage for providers in the last couple of years has been the extremely low interest rate environment, especially as reflected in short-term loans with variable-rate interest. For many operators, refinancing to a lower rate has meant the difference between covering--or not covering--debt service and thus not defaulting on the loan.

Another area of concern, especially for nursing homes where capitalization rates have increased, is the effect on the loan-to-value (LTV) ratio when refinancing.

For example, take a community that has been open for mare than 2 years and has been "stuck" at 83 percent occupancy. Maybe it has a very low, short-term interest rate mortgage and therefore has been making its debt service but is not generating any equity return. What happens when that short-term note expires? And at what new value will the property be appraised for refinancing?

In all likelihood, the value of that facility will go down. And if seen as more risky, the LTV, even on that reduced value, may be less generous on refinancing. Will the operator then be faced with needing to put in significantly more equity in the project?

So, although interest rates may currently be working favorably, some operators need to ask serious questions about what may happen when the note comes due.

Occupancy rates dropped

The assisted living sector saw a sizeable drop in occupancy rates during the quarter, with median occupancy declining 3 percent from 86 to 83 percent and the mean dropping from 85 percent to 83.5 percent. Owners and operators of more than 1,300 assisted living properties reported their data to NIC in the first quarter, representing almost 95,000 units.

Other likely factors were the war with Iraq, which took place at the end of the first quarter, and the economy. These factors could have had a negative psychological impact on consumers, delaying their decisions to move loved ones into--or prompting moves out of--assisted living facilities.

Lastly, this drop provides further evidence that there are still a number of distressed assisted living properties pulling down the industry's overall occupancy. Median occupancy of 83 percent means that half the properties reported occupancy rates below 83 percent--a number considered inadequate to generate any kind of equity return.

Two classes of asset quality

Interestingly, the occupancy rates for the top quartile of assisted living properties showed healthy performance at 89 percent and above.

So, what we have is a separation of at least two different classes of properties. (NIC reports occupancy rates only for properties that have been open for at least 24 months.) That is, the top half did reasonably well--the top 25 percent did very well--and the lower half struggled at 83 percent or lower. And, until the troubled properties work their way through the system, the overall numbers for the assisted living sector are unlikely to improve significantly.

In fact, the median occupancy rate in assisted living dropped back this quarter to where it was a year ago. But even then, it was considered to be a low and unsatisfactory level of occupancy.

In comparison, occupancy rates for skilled nursing held steady from the fourth quarter of 2002, with the mean at 85 percent and the median at 86.5 percent.

Cap rates reflect investor anxiety

Capitalization rates for assisted living basically stayed the same in the first quarter.

The story was different for skilled nursing, which showed a significant increase of 110 basis points in the average (mean) compared to the last quarter, and an increase of 170 basis points compared to the same period in 2002. This reflects that investors perceived nursing homes to be a more risky investment than assisted living.

Still, the capitalization rates for assisted living had a fairly wide range of 400 basis points. Although not as great as the spread in skilled nursing, it again showed evidence that the market recognizes two types of properties. For example, a community that trades at a 9 capitalization rate--versus one that trades at 13--does so because it has a different risk assigned to it, and therefore, a different perceived property value.

Future outlook

The number of transactions reported by appraisers to NIC during the first quarter doubled from the previous one. That means the industry is seeing a lot of activity, which could also indicate that a number of these more troubled properties are beginning to move. And, this may also mean that the "log jam" is breaking between lenders and providers, caused by differences about the perceived value properties.

In fact, in a second-quarter poll that NIC conducted with major industry financiers and providers, 86 percent of the assisted living operators--compared to only 57 percent of the financiers--reported that they thought the equity investor sentiment was favorable. Understandably, most operators were bullish on the current financing environment.

That may be good news for those providers with stable, cash-flowing properties in their portfolio looking to acquire distressed ones. But the question is, although successful at operating their existing properties, how well will they be able to digest taking on additional turnaround properties? Clues should surface in the results reported to NIC that will be reflected in future Key Financial Indicators.

Occupancy Rates: For Stabilized Properties
(those open 24 months or longer)

Assisted Living Properties

Quarter Ending    Mean Occupancy Rate (%)

12/31/1999        89.6
03/31/2000        86
06/30/2000        86.9
09/30/2000        88.7
12/31/2000        87.4
03/31/2001        85.6
06/30/2001        85
09/30/2001        85.5
12/31/2001        84.5
03/31/2002        84
06/30/2002        84.5
09/30/2002        85.5
12/31/2002        85
03/31/2003        83.5

Note: Table made from bar graph.

Capitalization Rates from Transactions
Involving Major Appraisal Firms Specializing in the Industry

Nursing Homes

Quarter Ending    Mean Cap Rate (%)

12/31/1999        14
03/31/2000        13.2
06/30/2000        13.5
09/30/2000        12.4
12/31/2000        12.9
03/31/2001        12.9
06/30/2001        13.9
09/30/2001        13.4
12/31/2001        12.9
03/31/2002        12.4
06/30/2002        12.8
09/30/2002        13.9
12/31/2002        13
03/31/2003        14.1

Note: Table made from bar graph.

Robert G. Kramer is president of the National Investment Center for the Seniors Housing & Care Industries (NIC). For more information about NIC's Key Financial Indicators[TM] research and NIC's annual conference set for Oct. 15-17 in Washington, D.C., visit www.NIC.org or call 410-267-0504.