Borrowing for an expansion: today's basics - financing nursing home construction and expansion - includes related article

Nursing Homes, Sept, 1994 by Roderic L. Rolett

There are four main ways of debt financing nursing home construction and expansion: bank loans, tax-exempt bond issues (non-profits only), Federal Housing Administration (FHA)-insured mortgages, and loans from real estate investment trusts (REITs). Your choice will depend on many factors and local circumstances, although these tend to fall into ten general categories (see "10 Keys to Financing," p. 42). Before analyzing the choice to this extent, however, some familiarity with the basic ground rules of each type of financing will be helpful.

Basic Information Required

In order to properly prepare to apply for a construction or refinancing loan you first want to analyze your projects's financial feasibility and pull together the basic information that a lender will need. The primary tool for this analysis is a realistic--not optimistic--five- to ten-year financial forecast which includes a balance sheet, income statement, and cash flow statement. For refinancing, expansion, or renovation of an existing facility, three years of occupancy and payor mix data and audited financial statements will need to be included. Also you will need to explain any future assumptions that differ from the facility's past performance. Other important information includes a summary of competitor facilities and their occupancy levels and, if available, payor mix and proposed expansion projects. Finally, resumes of key management and development team members, a detailed list of proposed project costs, and a project timeline are essential.

Bank Loans

The key step in obtaining a bank loan is to familiarize yourself with the bank's credit criteria. Determine the bank's loan-to-cost and loan-to-value requirements, its parameters for amortization and maturity, and its collateral requirements. Loan-to- cost and -value requirements will determine how much equity versus debt the bank will let you use in financing your project.

Amortization parameters determine how rapidly your project will pay back the bank's principal. Generally, the longer the amortization period, the lower the annual debt service requirements. A lower debt service helps make the project more financially feasible. The bank's maturity requirements in conjunction with its amortization parameter determines your project's refinancing risk. If the bank loan amortization period extends beyond the bank loan maturity, you will need to refinance the remaining principal at the maturity of the loan. Refinancing could present problems if at the time of maturity your project is not meeting its financial forecast, lenders are generally reticent to lend to nursing homes, or interest rates have increased significantly.

Collateral requirements determine whether a mortgage on your project's property, together with a lien on its revenues, is deemed to be sufficient security for the loan. The advantages to bank loans include a relatively simple application and credit review process, fast approval or disapproval, straightforward documentation, and relatively simple debt structures. Disadvantages include banks' reliance on appraisals, unfamiliarity with state reimbursement systems, short amortization and maturities, and confusion over whether to treat the loan as a real estate loan or one to a health care corporation.

Tax-Exempt Bonds

Tax-exempt bonds are issued by a municipality, state, or government authority. That entity then loans the proceeds to a nonprofit nursing home corporation. Typically, an investment bank purchases (underwrites) the bonds from the government entity and resells them. Bond issues usually contain 30-year maturities and are structured with level debt service payments (similar to a house mortgage). Most are secured by a first mortgage and lien on project revenues. Because the interest income is tax exempt for the investor, interest rates are lower than those of bank loans.

The primary advantage of bonds is that they provide access to a segment of the capital market different from that of a commercial bank. When banks are suffering from capital shortages, regulatory pressure to reduce loan volume, or lack of capacity for new health care loans, bond investors will still typically want to buy bonds and finance nursing homes. Also, underwriters examine feasibility studies rather than real estate-based appraisals to determine adequacy of loan security and project credit. The primary disadvantages of a bond issue are the number of entities and complexity involved in structuring the various documents and the time required to prepare and review those documents.

Real Estate Investment Trusts

Generally REITs obtain their capital by selling stock, or debt, to the public. The funds obtained are then lent to borrowers. Several REITs specialize in nursing home loans. Most REITs prefer to lend for refinancing, expansion, and renovation, rather than start-ups. A significant part of their capital is obtained from short- and medium-term debt offerings (one to ten years), so they prefer to make loans with medium-term maturities (five to ten years). The key feature distinguishing REIT loans from other sources of financing is the participation terms. A borrower generally is required to pay a portion of the project's positive cash flow in addition to the upfront points and ongoing interest payments.