Investment capital: all conditions are "go" (for those in the know).

What's ahead for long-term care investment capital in 1998? The outlook is, if anything, better than ever. To find out why, let's look back a moment.

Professional senior housing, as we now define it, has been actively established for nearly two decades. Some key operators in this field have developed considerable expertise over the years in dealing with institutional lenders and investors. They have also created numerous professional organizations, including the National Association of Senior Living Industries (representing senior housing), the American Senior Housing Association (primarily representing congregate housing and assisted living), the Assisted Living Federation of America (representing assisted living providers), the American Health Care Association (representing nursing homes and long-term care providers, with a small but growing assisted living component) and the National Investors Conference (founded in the early 1990s to work with commercial and institutional investors). And they have developed a product that has grown in attractiveness.

Senior housing continues to offer lenders a pricing premium. Depending on the product, it ranges from 25 to 150 basis points. Historically, this is an industry that has had fewer foreclosures than has had fewer foreclosures than the four major property types (apartment buildings, industrial buildings, office buildings and retail), even during the volatile 1988-93 period, according to the Mortgage Bankers Association of America. Traditionally, once a senior healthcare project is leased, its income stream has remained strong, with less volatility to potential economic downturns than other properties.

This income stability has several causes: Senior housing residents maintain their units better, move out with considerably less frequency and have incomes that are relatively shielded from economic downturns. Average turnover in an assisted living or independent living complex, for example, ranges from 25 to 45%, compared to as high a rate as 75% for garden apartment complexes.

As we move through the late 1990s, investors have developed a new comfort level with senior housing investments of all kinds. This was reflected in 1997. As interest rates declined and loan spreads narrowed, amortization increased significantly, and all forms of fixed-rate permanent mortgage financing became available for assisted living, nursing homes, congregate care and other forms of senior housing. Relatively new investment entities, such as real estate mortgage investment conduits, have matured. Assisted living has become an accepted institutional product. Wall Street has embraced assisted living and senior housing, and traditional lenders have made great strides in understanding this field.

We look for this situation to continue in 1998. There is no discernable inflationary trend or sign of upward pressure on interest rates. Even the nursing home industry's worrisome loss of the Boren Amendment does not appear to pose a threat; operators and states are not carrying on any pitched battles over rates at the moment, and there's a sense that, as long as the economy remains strong, states will not feel compelled to squeeze nursing homes' Medicaid payments.

Assisted living is still viewed very positively, primarily as a relatively upscale market. Overbuilding does remain a concern in some markets, and the industry faces such issues as aging in place and demands for expanded access to moderate- to lower-income groups. But there is nothing inherently wrong with this from the investment standpoint. It is conceivable, as time goes by, that operators will find it less expensive to provide healthcare services than to bring in new residents, and that more modest projects offering perhaps fewer amenities than usual will be economically viable. These questions will be worked out throughout the industry in 1998 and in coming years.

An investment potential that may or may not begin taking off in 1998 is the senior living campus. Admittedly, these are relatively major investments - perhaps a $40 million project instead of a $5 million project. But if owner-operators are well-capitalized and come up with well-thought-out plans for integrating the various levels of care, they will find ready and willing investors.

Let's focus in on the various types of investors in this market and how their near-term activities shape up. The most active investors in long-term care today include:

Commercial banks. Like most major lenders in this field, these institutions remain very sensitive to an operator's experience and put a high premium on this underwriting component. They provide both term loans, usually up to five years, or construction/permanent loans that float over prime. They tend to compete extensively for certain operators' business rather than to serve as "project lenders." Their pricing for permanent mortgage loans (as of December 1997, was U.S. Treasuries plus 225-275 basis points, and for construction loans prime plus 1-2%.

Initial Public Offererings (IPOs). These have been a very active part of senior housing funding for the past two years. Many nursing home companies, and now assisted living companies, have tapped the largest bull market in history to take advantage of inexpensive capital from Wall Street. Indeed, the Street has "fallen in love" with assisted living companies because of their comparative lack of regulation, reduced medical intensiveness and absence of certificate-of-need controls. Assisted living companies should be aware, though, that Wall Street is very sensitive to their maintaining earnings projections, and has already substantially penalized operators who didn't meet them.

Real Estate Investment Trusts (REITs). Like commercial banks and Wall Street, REITs are oriented toward individual operators. Though oriented historically toward nursing homes, REITs now participate quite progressively in assisted living development. The preferred long-term care vehicle is a sale/lease-back, although they will offer permanent mortgage loans in selected situations. In any event, their pricing is more aggressive than that of the commercial banks or the Department of Housing and Urban Development (HUD) - typically, 300-400 basis points over matching Treasuries.

Conduits/Debt Securitization Programs. These relatively new programs, created to fill the investment capital void of the early 1990s, have historically been attracted to senior housing because of the high yields available. Their spreads over Treasuries range from a low of 180-220 basis points on low-leverage, large loan packages to 350 basis points on smaller single-asset properties. Among particularly experienced investment firms, Nomura Securities International was especially insightful during the early 1990s and was able to structure large portfolio financing with experienced and qualified operators at very aggressive spreads.

HUD. A dominant presence in senior housing for 40 years, HUD has provided construction / permanent loans and, since 1995, straight permanent mortgage loans. HUD has consistently offered the most favorable lending terms of any capital investor, including 35- or 40-year term and amortization, 85-90% loan-to-value, non-recourse, with very attractive interest rates (U.S. Treasuries plus 120 basis points, as of December 1997). In contrast to the more operator-oriented lenders, HUD focuses on individual properties, primarily nursing home developments and, in recent years, assisted living. A note about the latter: Judging by a recently published White Paper, HUD is not about to repeat the mistakes with assisted living that it made during the 1980s with CCRCs. Clearly, the agency understands the criteria for quality investment and the requirements of due diligence for assisted living.

Among significantly less actively involved investors we find:

Insurance Companies. These have been slow to embrace senior housing, with the exceptions of Prudential and Pacific Mutual. They loan exclusively on congregate care facilities, either free-standing or with assisted living attached. Their spreads are considerably lower than those of conduits - 150 basis points over Treasuries to 250 basis points. Their underwriting, again, tends to be strongly operator-focused, and typically requires 75% loan-to-value and 1.3-1.4 minimum debt service coverage ratios.

Credit Companies. Although their participation is limited - generally congregate housing and, to a lesser extent, assisted living - these institutions continue to be intrigued with senior housing. Companies relatively active over the past three years include GE Capital (a quarter-billion dollars in senior housing financing in 1993-95, including a $120 million transaction with Sunrise Assisted Living), as well as Heller Financial and Finova Capital.

Finally, it will be as important in 1998 as it ever was for borrowers to understand the key components that attract investment capital to their projects. These include: operators' direct (as opposed to contract) management experience (this can't be emphasized enough); relationship with the state regulatory climate (including, for nursing homes, survey and deficiency reports); and the general real estate investment criteria of market competition and strong business planning.

Other key ingredients for borrowers include a thorough understanding of financing needs, a realistic sense of timing (even fast-moving transactions take from 60 to 120 days) and rapid processing of lender information. Would-be borrowers should assemble all due diligence materials before discussing financing; this includes market research, feasibility studies for new construction, year-to-date statements and three-year historical data on the property, state survey results and updated financial statements.

In sum, 1998 will continue to offer great investment opportunities for long-term care development. But these opportunities will be available only to those operators who focus on the key ingredient to success in this field: the provision of quality services and housing for seniors in an attractive living environment.

Jeffrey A. Davis is President of Cambridge Realty Capital Ltd., a merchant banker with long experience in conventional and HUD-financed long-term care projects. based in Chicago, and with offices in Albuquerque, Atlanta, New York, Dallas, Detroit, Houston, Los Angeles, Portand and San Francisco, the firm has financed 100 senior housing and healthcare facilities for over $500 million. For further information, [phone]; fax [phone]; web site: www.cambridgecap.com.