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Need Capital? Know How Lenders Assess Your Operations

June 1, 2004
by root
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A real estate financial expert shows how to accentuate the positives of your operation by James J. Pieczynski
BY JAMES J. PIECZYNSKI

Need capital? Know how lenders assess your operations

You're sure you qualify-but how do you convince lenders of that? With the population aging and the economy steadily improving, the outlook for the senior housing sector appears to be the brightest since the mid-1990s. In fact, owner/operators who have streamlined operations out of necessity are now well-positioned for strategic growth. Although a surge in new construction is unlikely, acquisition activity will pick up, and new entrants may aggressively pursue consolidation strategies in selective markets.

However the scenarios play out, though, one thing is certain: The senior housing sector will need more capital. Not only will more properties change hands, but many operators will require refinancing because the 10-year mortgages so prevalent in the mid-1990s are about to mature. Fortunately, capital markets are showing increased confidence in the entire senior housing and care industry. Capitalization rates for assisted living facilities are dropping below 10%-an indication that both operators and debt providers are recognizing sustainable profit potential for high-performing properties. Also having a positive impact are the Medicare rate adjustments of last October that increased reimbursement by more than 6%.

What should operators who believe they are qualified do to get the capital they need at the most favorable rates and terms? They should start thinking like lenders-understand what they value and make certain the facility meets their most stringent criteria for creditworthiness. Below are some of the key factors CapitalSource considers as part of its evaluation process.

The Intangibles: Reputation, Hands-On Management Philosophy
Most nursing homes and assisted living facilities are small, local businesses run by operators who often began their careers at a large public chain. In a business where everybody seems to know everyone else, an operator's reputation is practically public knowledge. What may surprise some is how much weight the strength of the local management team carries in loan assessments.

As in any small business, the top managers need to be intimately involved in all aspects of day-to-day operations. In this business, the administrator (or program director) should have command of detailed information on the payer mix, census trends, local market occupancy rates, competitors' strategies, and other developments likely to have a significant impact on revenues and profitability. For nursing homes, the director of nursing (DON) should be up to speed on key clinical performance measures (e.g., pressure sores, fall incidents, restraints, etc.) and have a well-defined strategy on how to achieve better resident outcomes. This plan should address the principles and processes of the Minimum Data Set (MDS) and quality monitoring by surveyors and consumers.

On-Site Inspections
To evaluate the management team's capabilities, lenders often will conduct face-to-face interviews at the property. These site visits also provide them with an opportunity for a visual inspection, which can help reconfirm a property's fundamental strengths or expose its weaknesses. A clean, well-kept, and adequately lighted property with active residents, for example, is an indication that the administrator is concerned about residents' quality of life. Such a facility also signals that this administrator understands how critically important visceral impressions are to families who must decide where their loved ones will live.

For nursing homes, an on-site inspection enables lenders to assess the size and quality of the therapy room-important considerations, given that therapy services are the key to maintaining a stable and profitable Medicare census. For all facilities, lenders will also confirm whether the building has an adequate sprinkler system, which has become an absolutely essential precaution in the wake of several well-publicized nursing home fires.

Lastly, a site visit gives lenders a real-world view of operations that helps to answer fundamental questions concerning the management team. For example, do top personnel and their staff have good rapport with other employees and the residents? Do they know them by name? Are they respected and well-liked? How much time do they spend in their offices versus "walking around"? In the nursing home and assisted living business, management-by-walking-around often goes a long way toward creating a successful operation.

Market Factors
External factors that affect financial stability (and creditworthiness) include the competitive landscape, demographics, and local economic conditions. For example, lenders usually will compare a facility's census and payer mix to that of its local competitors'. Obviously, a consistently high census shows that the property is a facility of choice. Lenders also prefer nursing homes with a high Medicare census and low Medicaid census because Medicare services generally have higher profit margins and Medicaid programs are the lowest-paying revenue source.

Community demographics will also affect a facility's ability to attract and retain sufficient numbers of residents. The National Investment Center for the Seniors Housing & Care Industries (NIC) provides useful benchmark data to help determine a property's variance from local and national norms on such factors as geographic distribution, net worth, education levels, and general health and disability assessments.

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