REITs and assisted living.

THE EVOLUTION OF A NEW FINANCING SOURCE

Financing for assisted living facilities is undergoing a major change as REITs (real estate investment trusts) enter the market in a substantial way. "Local financing may be the case for the individual mom-and-pop operator and for very small chains," explains Ray Lewis, an analyst for NatWest Securities Corporation, an investment banker with a strong specialty in health care, "but I think the emergence of national assisted living chains, such as Assisted Living Concepts, Sterling House, and Emeritus, has accelerated the role of REITs in the past year."

According to Lewis the main health care REITs active in the assisted living market are Meditrust, LTC Properties, Inc., Health Care Property Investors, American Health Properties, and Health Care REIT.

Reinforcing Lewis' view are the actions of Meditrust, the nation's largest health care REIT. "Meditrust," says the company's Chief Financial Officer Lisa McAlister, "did a small amount of investing in the assisted living industry in 1995, but through 1996 I think you will see us invest probably $100 to $150 million out of an investment total somewhere around $350 to $400 million."

In the past primary financing for assisted living facilities has come from commercial banks, tax exempt bonds and savings and loan institutions. Financing for new projects through these channels often has been difficult to obtain, with traditional lenders shying away from assisted living because of unfamiliarity with what is a fairly new and complex industry. Among principal concerns: buildings designed for a single and special purpose, and the fear of potential negative publicity associated with any foreclosure action against a "home for the elderly."

According to NatWest's Lewis, assisted living projects that target lower income markets and are located in states that have Medicaid waiver programs are able to tap into state bond issues for financing. Of the large publicly traded chains, Lewis says that Assisted Living Concepts, based in Costa Mesa, CA, is specializing in this market.

"Banks," says McAlister, "haven't been doing the type of financing that REITs are willing to do. They tend to want to do business with the strong public companies, and they tend to want to do lines of credit rather than basic development financing."

For assisted living chains looking to go public, the entry requirements are rising rapidly. NatWest has taken three assisted living chains public - Sterling House, Emeritus, and Assisted Living Concepts. Last year, for a public offering priced on anticipated 1998 earnings, Lewis says a chain needed at least 25 facilities. This year's minimum is about 50, he says.

REITs provide financing for both new development and acquisitions, and that makes them attractive to players in the assisted living industry. A REIT will hold a mortgage on a property or work out a purchase/lease-back arrangement in which the REIT will, with the assistance of an operator, acquire a property and then lease it back to the operator. Meditrust's operations are mainly leaseback but they also carry mortgages. Which route they go depends on the operator and what it wants - for example, a lease-back arrangement gives the operator back its money to reinvest in another facility.

"It is a kind of financial recycling," says Lewis. "Once you get your working capital and the cash you need through a REIT, you don't need to look for additional capital unless you make a significant acquisition, such as a large chain."

Health care REITs are being drawn to assisted living facilities by their high occupancy rates, good lease payment coverage ratios, and low default risk. All of these factors combine to make assisted living a growth area for the REITs. However, according to Lewis, the players are almost exclusively health care REITs. Other REITs have not been active in this area.

And, to health care REITs, the future for assisted living looks particularly rosy. "The demographics are amazing," says McAlister. "The baby boomers are just beginning to turn 50. With certificate-of-need requirements, there just aren't going to be enough nursing homes for everybody, and managed care is bringing about earlier discharge of patients from hospitals into those limited nursing home beds. So where do the elderly go? Into assisted living facilities. Assisted living is going to be taking care of what they used to call the 'level four' patient. It is going to be replacing the typical geriatric nursing home."

The health care REITs see assisted living as one part of the continuum of health care to be provided to the elderly -and a natural business opportunity for nursing home operators. The health care campus concept, serving all the needs of the elderly, is one that appeals to both managed care and health care REITs, and it is a strategy REITs see as wise for nursing home operators.

Summing up the health care REIT viewpoint, Lisa McAlister says it best: "Assisted living is opening up a new profit center for Meditrust, and I see it going forward as a very important one - as important as nursing homes."

David Patterson is a frequent contributor to Nursing Homes.