Where Are the Investment Opportunities?

With the recent instability in the nursing home environment evidenced by upheavals in the public equity markets, stringent governmental regulations, malpractice litigation, labor shortages, etc., one wonders whether financiers will again feel confident lending to and investing in the long-term care sector.

Indeed, NIC's 2000 Lender Survey Results, an annual publication that polls financiers known to actively lend to the seniors housing and care industry, reported that 25% of those lenders plan to decrease their future volume of funding to nursing facilities. And, for the first time in five years, nursing homes have fallen to rank fourth as a favorite investment choice for financiers. (From 1996 to 1999, nursing homes tied with assisted living as financiers' first choice within the sector.) A majority (62%) of the polled lenders now considers nursing homes to be "worse" or "much worse" investments than traditional real estate. And this perception has worsened since one year ago.

Some would say that times look bleak for skilled nursing financing. And, in fact, capital is harder to obtain. But, the survey results don't show a wholesale withdrawal of financing from the field. In fact, 23% of survey respondents plan to increase their financing of nursing properties over the next year. And nearly $4.7 billion of capital infusion is expected for nursing, assisted living and Alzheimer's projects this year--although approximately two-thirds of that amount will be given to acquisitions and refinancing, not to new development.

So what criteria are financiers using to acquire or invest in properties? Insights to this question were revealed at NIC's recent conference session entitled "Investing Successfully in Skilled Nursing Today: Oxymoron or Possibility?" with Dale Thompson, COO of Benedictine Health Services; Murry Gunty, CEO of Ballantrae Healthcare; and Howard Widra, executive vice-president of Heller Healthcare Finance.

More than ever, these presenters made clear, successfully attracting capital means having a successful operating track record, i.e., having experience in the region or locale of the nursing home, knowing the referral sources and state regulators and making healthcare your primary focus. This change in focus toward healthcare is a reversal from a few years ago, when the emphasis was on financially engineered deals. "Today you need to be focused on operations first," said Widra, "for a litany of reasons...the most important being that quality of care is going to drive everything, including your access to the capital markets."

How do lenders define a well-managed operation? Put another way, what operational changes do investors want made to turn a poorly run facility into a good one? Here are some key recommendations made at this session:

* Rethink the configuration of the skilled nursing product. "The 100-unit SNF that has developed over the last 30 years," said Thompson, "where two to three people share a bedroom of 200 to 300 gross square feet and a bathroom with four to six other people has become unacceptable by today's 'quality of life' standards." He suggests these facilities be reconfigured to 50 private rooms of no less than 500 square feet each. By doing this, not only will consumers' expectations be met, but the facility will have a better chance of being profitable. This is because fewer units mean fewer beds to fill, less staff and lower overhead. And private rooms earn more money, because seniors' baby-boomer children are willing to pay more--and even to supplement Medicaid--in order to enhance their loved ones' lifestyles. You'll also be in a better position to compete with assisted living facilities, because the product will look similar, but you'll have the advantage (presumably) of a proportion of Medicare reimbursements.

* Take a cue from the hospitality industry. By scaling down, you'll have the space to add amenities that not only enhance residents' quality of life--e.g., private dining, retail shops, an ice cream parlor, a florist--but add to revenue and the bottom line.

* Create an environment that enhances privacy, dignity and respect. Is the public address system blaring messages? Are nursing carts strewn in the halls? Is the overall atmosphere noisy and chaotic? Management should try to view the environment through a visitor's and resident's eyes, then make the necessary adjustments to get it right.

* Bring therapy and ancillaries in-house. Contract consultants cost more money than providing the same services yourself. Also, using too many consultants tends to make it harder to keep control over expenses. Institute budgets with spending logs that are monitored on a daily and weekly basis.

* Resolve employee issues. Is morale poor? Are union negotiations hostile? Not surprisingly, the happiest employees work in the best-run companies. Company culture starts from the top down. And investors put a high value on a stabilized labor force.

* Clear survey deficiencies. Although a few tags here and there do not overly concern investors, they tend to stay away from those facilities with a history of problems.

* Develop the right mix of Medicare and non-Medicare patients. Although PPS has caused margins to come down, you can still make money with Medicare patients. Gunty admits that this is hard to do with all RUGs of the PPS. "Some categories are tougher to make money on than the highest RUG categories where we can provide therapy in-house," he said.

* Know your critical mass. Don't get so big that you become two to three management levels away from any facility. Manage your risk by not being overconcentrated in any one state. Focus on urban and suburban markets near a hospital where you can attract higher-acuity residents. Have a manageable business plan.

What other operational aspects do lenders consider important for financing? Lack of cash flow variability. A successful transition to PPS. Knowledge of and ability to meet liability insurance needs. Consistent census trends with no less than 70% occupancy. Reasonable and consistent expense ratios.

But even operators with well-run facilities will find it harder to get financing than in the past. That's because almost every lender has been involved directly or indirectly (for example, through REITs) with the bankruptcies of the large, publicly traded operating companies that have plagued the industry over the past year.

"Properties that get financed are ones that are either unbelievably low-priced, and therefore the lender's risk is low," said Widra, "or have very stable performance on both the revenue and expense side, so lenders can understand what the future is going to be for a particular property.

Acquiring needed capital also means having an established relationship with your lender, so that he/she will be more willing to work with you when things take a downturn. "The transactions that get done today require more creativity: layers of debt, more seller take-back, some Mezzanine debt and the ability to find reasonable amounts of equity," explained Widra. "Or transactions are done on an asset-based basis, by leveraging the assets with some earnouts back to the owner or lease-to-own, which could be a really good opportunity for a lot of operators."

Harvey N. Singer is research director for the National Investment Center for the Seniors Housing & Care Industries. Founded in 1991, NIC serves to facilitate efficient capital formation for the seniors housing and care industries through research, networking, and providing strategic business and financial information.