Troubled Times Don’t Necessarily Mean Gloom and Doom

Troubled Times Don’t Necessarily Mean Gloom and Doom

Joseph T. Iii Resor

Normally, annual conferences are upbeat events. They are a time to make new contacts, re-establish relationships and generally use the experience and the information to re-energize and refocus. It’s not uncommon for people to return to their offices with a greater sense of enthusiasm.

But a different kind of mood was felt at the most recent annual conference sponsored by the National Investment Center for the Seniors Housing & Care Industries (NIC), an important annual event at which suppliers of capital–lenders and investors–make contact with users of capital, such as developers, owners and operators of senior housing and long-term care properties. The only way I can describe it was somber–not depressed or elated, just neutral. I think this sedate mood was a reaction to the general industry slowdown and what many might perceive as bad news during the previous 18 months. It’s not surprising when you consider the following industry developments:

* The contraction of capital markets starting with the CMBS (Commercial Mortgage-Backed Securities) slowdown.

* Slower fill-up of some new assisted living facility developments.

* Earnings disappointments by publicly owned skilled nursing and assisted living companies.

* News that several of these publicly owned companies declared bankruptcy.

* Continuing labor issues, including only a small pool of already-trained workforce and rising costs of labor.

* Changes in Medicare reimbursements. These changes have had a double impact on the industry. First, providers are concerned from an earnings and operational standpoint. Second, credit sources are more cautious and concerned about making the right decision when extending credit. Though these changes generally affect skilled nursing facilities, I see a definite downdraft impacting upon operational and financial issues at some assisted living operators, too.

* Increased regulatory pressures–particularly highly publicized government enforcement of Medicare fraud that creates skeptical and overly cautious investors.

* Declining market capitalization in the public equity markets that, in turn, causes the cost of capital to increase and slows the pace of developing new facilities and refurbishing existing buildings. For example, stock market value for publicly held skilled nursing companies declined from $13 billion in 1996 to $2.3 billion last October–only 18% of what it was. And stock-market value for assisted living facilities is only 26% of what it was at the end of 1997. Risk profiles and the cost of capital both increase as a result–something that any intelligent investor simply cannot ignore.

So there appears to be cause for doom and gloom. Actually, though, there are positive aspects to what might appear on the surface as setbacks or negative news. And just as important, there are ways those owners and operators of skilled nursing and assisted living facilities can manage in this environment and still attract credit.

I think the current state of the industry is actually in a much-needed, self-imposed slowdown. There’s no doubt that the market has contracted, but that’s a blessing because it slowed development of new properties and facilities before there was dangerous overbuilding.

Additionally, property is not being sold at levels that are greatly below original market value. There are no mass foreclosures, and no one is gobbling up property at 60 cents on the dollar. In essence, property values and prices are holding up. Although the industry is contracting, it’s not rolling over into credit losses that could affect future willingness of lenders to be a part of the industry.

In fact, the market adjustments have been fairly orderly and conducted in the way that most people would hope an industry would act. After all, most people would trade the sharp and dramatic peaks and valleys of economic cycles for the more orderly situation we’re seeing for skilled nursing and assisted living operators. I look at it this way: The industry financial markets applied the antilock brakes before hitting the proverbial wall.

An additional silver lining is that lower REIT revaluations might reflect capital market uncertainty, but not poor credit quality. Skilled nursing and assisted living facilities are obviously undervalued. But that just means that more capital will be available to the industry as they bounce back.

And remember, though development of property and facilities has slowed, it hasn’t stopped altogether. There is still a demand for credit, and there are still lenders willing to work with facilities. The key is for owners and operators to know how to get the credit they need. There are a few ways to do this.

First, develop an ongoing relationship with your banker, and pick one who is committed to financing the industry and not someone who whipsaws in and out based on the current industry climate. Many financial institutions, including Key, have tightened their standards and structure, but they’re still in the business and willing to work with owners and operators. I occasionally hear comments about Key being out of the healthcare finance industry because a borrower sees us tightening our standards. Nothing could be further from the truth.

Second, be prepared to be more selective when choosing a development project. A quality, well-thought-out project becomes a winner for both the client and the lender. Financial institutions are simply looking for good projects to support.

Third, business should be left to the operators. I personally like to support people who own and operate their own facilities, not necessarily combinations of owners, financial buyers and managers who all want a slice of the profit pie. Pure bread-and-butter owners/operators have vested interests in the success of their facilities.

In fact, I like privately held platforms rather than publicly held platforms for ownership. Why? The controls are more effective for long-term success of the business. Investors and lenders can be seduced by public ownership because it sounds as though it would have access to capital, professional management teams and sophisticated systems. But a public company’s whole enterprise is built on other people’s money, not their own. The people who own and operate their own skilled nursing and assisted living facilities decide to build when the time is right, and it makes good business sense. As a lender, I like that commitment and feel good about investing in it.

If I’d had a crystal bail 18 months ago and had foreseen the events that have occurred since, I would have predicted a much more dire situation than actually exists today. Not everything about the current environment for skilled nursing and assisted living facilities projects gloom and doom, and the big picture is certainly much more positive than many people might realize. I believe that successful publicly and privately held companies have–and will continue to have–access to capital when they need it. The key is to know how to manage during tough times and succeed.

Joseph T. Resor, III, is senior vice-president and managing director, Key Healthcare Finance, Cleveland, Ohio, and a board member of the National Investment Center for the Seniors Housing & Care Industries (NIC), based in Annapolis, Maryland.

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