SOFs STILL A SAFE BET.

The smart money is on these two words: due diligence

HOW ATTRACTIVE DO SKILLED nursing properties appear to lenders and investors? To find out, Contemporary Long Term Care went to a leading commercial mortgage company and a senior living developer for commentary.

Sarah Sumner Duggan has been senior vice president of Birmingham, Ala.-based GMAC Commercial Mortgage Corp. for the past five years. Her company finances commercial properties including the seniors housing industry under health care as a specialty. She is also the current vice chair of the NIC Board of Directors.

Paul Diaz, formerly a COO of Mariner Health Group, is now chairman and CEO of Columbia, Md.-based Capella Senior Living. Capella looks to acquire assets out of companies in receivership primarily on the East Coast.

WILL SNFS YIELD HEALTHY RETURNS?

Duggan and Diaz agree that there are plenty of investment opportunities in the SNF sector. "Opportunities in this industry are abundant," says Duggan. Bug with reward comes its price.

Lenders need to disregard the general news of SNF bankruptcies to focus on the strong regional players who have been able to maintain consistent cash flows from their properties. "However," Duggan adds, "because of the bankruptcies, there will be an increased number of acquisitions in the market, so potential purchasers will have to have adequate cash equity and adequate working capital to be realized as a sound investment opportunity by a lender. There is a greater demand for more cash in today's market."

In years past, lenders may have been more willing to leverage up a property because there was a more competitive environment among lenders. The public markets also created a type of frenzy by "having to get the deal done quickly," Duggan explains. But that attitude doesn't exist anymore.

"Traditionally, lenders could look to the industry to be very stable. Defaults were very low and the supply side was very stable," Diaz notes. "But it's a very different industry than it was even five years ago." Today, an owner is going to have to have lots of equity standing in front of that debt. Transactions are going to be more conservatively underwritten.

Nonetheless, if you're in the market for lending to SNFs, you will have unlimited investment opportunities because there are fewer lenders active in lending to SNFs at this moment. "There's a huge need for capital and debt on the SNF side," Duggan says.

DUE DILIGENCE

To those wishing to invest in skilled nursing properties, the smart money is on these two words of advice: due diligence.

"Take the lender on a tour of your facilities, show them operations, and let them interview key staff such as your DON to establish the working environment," says Duggan. "Let investors review your state surveys and allow them to talk with hospital discharge planners about your reputation. With this type of industry, lenders can't just read about your company on paper. They must perform due diligence and confirm facts. This allows them to establish a trust that the manager is a good manager."

Diaz concurs: "People need to go into this with their eyes open. Owners and operators are going to have to answer some very tough questions."

He continues, "With more due diligence, lenders can command a premium right now. There are fewer lenders in the market, so they can look at more product and can price it accordingly. This is where people like GMAC have a lot of experience in lending to the senior living sector. The void of other lenders makes for great opportunity to lenders like GMAC."

To perform this due diligence, lenders and investors would be well advised to obtain guidance--such as that contained in the upcoming Fitch/NIC Investment Analysis of Nursing Home Properties--about how to account for the myriad factors necessary to successfully underwrite a specific investment opportunity.

LOOKING GOOD

To look attractive to a lender, Duggan explains that the SNF owner needs to show things like a tradition of operating well with state surveyors. "For instance," she says, "show you respond quickly and that your plans of correction are made quickly. Also, show that performance on a cash-flow basis is proven and consistent. You must also show that, on a corporate-wide basis, you exercise prudent cash-flow practices."

Diaz also emphasizes the importance of distinguishing your property from those that have gone bankrupt. "You can make your case by explaining that what you're looking to acquire or build should not be lumped into the broad demise that has taken place in the industry," Diaz says. "Of course, it all starts with a good price," he adds.

Both Duggan and Diaz agree that the SNF operator needs to be able to demonstrate that he has a solid track record. This means lenders are looking for a successful history; conservatively underwritten transactions; and a management team that will answer how it will handle things like the insurance scarcity, compensation issues, recruiting, and staffing its facilities.

The number-one inherent risk that SNFs face is a change in Medicaid reimbursement. Now, for the past few years most states have had very good Medicaid reimbursement. But this is important because this can impact the cash flow of a particular nursing home. "It's something that is hard to predict and is out of the control of the borrow," says Duggan. "So you must educate the lender as to your state's current reimbursement program."

She continues: "Educate the investor about the state nursing home association's strength: has it been able to lobby to either maintain or increase nursing home funding in that state? Are there current bills pending in the state that might impact Medicaid funding for SNFs? Showing you are abreast of these facts will demonstrate to the lender your efficacy as a borrower.

Duggan adds, "It also shows the lender that you have been able to operate under changes. Medicaid is definitely a friend of the SNF industry. In their underwriting, lenders should be able to assess the stability of a state's reimbursement and whether that state has historically either cut reimbursement to nursing homes during a budget crisis or held back payments to SNFs during a crisis."

Diaz underscores this point: "While I think there's a big disconnect between the cost of care and what Medicaid is willing to pay in some states, I think that if you're a lender, you need to know what state you're lending in and what the Medicaid issue is in your state. It's state-specific."

FINAL WORDS OF ADVICE

Diaz summarizes how to make the best approach to a lender: "The SNF owner needs to overwhelm the potential investor with answers and information on how he's going to deal with the tough issues. He needs to be forthcoming with information on how he fixes that which he hadn't anticipated. It's not always going to be good news. It's how one deals with the bad news that gives one credibility."