Long-term care on the mend in 2004

Nursing Homes, March, 2004 by Raymond J. Lewis

The senior living industry experienced the beginning of a turnaround in 2003--particularly in the skilled nursing sector. But what can providers learn from their collective experience last year? And more importantly, what can the industry expect in 2004?

The seniors housing industry as a whole witnessed the beginnings of a recovery across all sectors last year. The upturn was led by the skilled nursing sector, which benefited from increased Medicare funding as a result of market basket rate adjustments and partial restoration of the "cliffs." Furthermore, while many believed that the year would bring substantial cuts in Medicaid funding because of state budget shortfalls, the cuts never materialized in most states. Although liability insurance and litigation costs continued to pressure skilled nursing operators, we began to see real progress in tort reform with the passage of a $250,000 hard cap on noneconomic damages in Texas. The passage of real tort reform legislation in Texas and several other key states may signal the return to a more rational operating environment as other states follow their lead.

[ILLUSTRATION OMITTED]

Positive signs of recovery were witnessed in other industry sectors, as well. Sectors such as assisted living, for example, continued the theme of limited building and steady lease-up contributing to improved occupancy rates and financial performance.

2003: Setting the Stage for Consolidation

A number of events last year helped to set the stage for future consolidation. First, the industry continued to work out of its financial problems. Several companies such as Alterra Healthcare Corp. emerged from bankruptcy, creating platforms that will begin looking to acquisitions to grow as they return to financial strength, or become an attractive merger partner for other regional providers.

Second, there were several significant capital events in the skilled nursing industry. Trans Healthcare, Inc.'s acquisition of Integrated Health Services, Inc.'s facilities brought those facilities out of bankruptcy, creating overnight one of the top five largest nursing home companies. Fountain View, Inc., emerged from bankruptcy, and Centennial HealthCare Corp. filed for reorganization under Chapter 11. Genesis HealthCare Corp. spun off its nursing home operation from its pharmacy company to create a significantly capitalized and strong operating company that should be able to aggressively seek growth opportunities. These events will set the stage for the nursing home industry to accelerate its consolidation in 2004.

At the same time, we saw a sizable increase in the number of equity financing sources and the appetite for investment, particularly in financing property acquisitions or refinancing stabilized assets. An outgrowth of the more competitive financing environment was a modest relaxing of underwriting standards (capitalization rates and valuation multiples), as well as some compression in pricing. Interest rates compressed between 50 to 75 basis points on average, while lending multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization), the approximate measure of a company's operating cash flow, expanded by 0.5 to 1.0 times.

Key Financial Indicators Show Positive Trends

In reviewing last year's Key Financial Indicators--industry-wide statistics compiled quarterly by the National Investment Center for the Seniors Housing & Care Industries (NIC)--there were even more reasons to feel optimistic about heading into 2004.

As 2003 came to a close, occupancy and move-in rates continued to show signs of improvement in the industry. In skilled nursing, average occupancies rose from 85% in the second quarter to 87% in the third quarter. For assisted living median occupancy rates were somewhat bleak at 83% in the first quarter of 2003 and 84% in the second. However, rates improved slightly to 85% in the third quarter. The average net move-in rate (for properties open less than 24 months) was also more positive, increasing to 4.8 from 4.3 in the previous quarter. In congregate care the median and average occupancy rates held steady in the third quarter at 89%. And for this sector, the average net move-in rate increased compared to the previous quarter, rising from 4.8 to 6.1.

Perhaps most encouraging was the overall drop in the delinquency rate for permanent debt, which went from 5.4 to 3.6% for the entire seniors housing and care industry. Decreases in permanent debt delinquencies in the assisted living and congregate care sectors were the leading contributors to the improved third quarter results. Permanent debt delinquencies dropped from 10.01 to 4.30% in assisted living and from 1.94 to 0.25% in congregate care. These drops signified that many of the troubled properties were continuing to work their way through the system for the remainder of last year. On the skilled nursing side, permanent debt delinquencies actually increased from 8.41 to 12.71% during this period, showing there is not a lot of room for error in this sector.