Need Capital? Know How Lenders Assess Your Operations

Need capital? Know how lenders assess your operations

You’re sure you qualify-but how do you convince lenders of that?

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.

State Surveys
The golden rule of senior care facilities is no different from that of physicians: Do no harm. Lenders can easily assess how well a facility complies with this by closely examining the state’s annual inspection survey results. A series of clean reports (or ones with minor deficiencies that are subsequently corrected) indicates a facility is in good standing with its primary source of revenue, the government. Conversely, major deficiencies-particularly those that show up on two or more consecutive surveys-are red flags that warrant immediate concern. For nursing homes, receiving “G tags” can result in denial of Medicaid payments or prohibition from accepting new admissions. When we encounter such a situation during the due diligence process, our clinical nurses will talk to both the nursing home operator and state regulators to better understand the extent of the problem and what’s been done to rectify it.

Cash Flow, Reimbursement Issues
Any financial analysis for a loan necessarily focuses on cash flow, the lifeblood of any business and a prerequisite for reliable debt repayment. A lender’s due diligence process involves:

• Comparing historical collections to revenues recorded in the income statement to ensure that revenue is in fact being collected
• Reviewing accounts payable to ensure they are kept current-an indicator that service will not be interrupted
• Analyzing the rates being recorded from third-party payers to ensure their accuracy
• Examining and evaluating major fluctuations in the balance sheet

On the other side of the ledger, an excessive number of litigation cases against an operator can adversely affect stability. Lawsuits not only influence the views of state regulators but, if made public, can greatly damage a property’s reputation and diminish its customer base. Lenders also must take into consideration the fact that some states (mostly in the South or Southwest) have proportionally higher numbers of successful lawsuits than other regions in the country.

Know Your Financing Options
The good news for assisted living facilities and nursing facilities is that, on the whole, capital markets are beginning to view their sectors in a more favorable light. Even though Medicaid reimbursement for nursing homes is under pressure this year, the draconian cuts feared last year didn’t happen; moreover, new tort reform laws adopted in Texas and Florida hold open the promise of welcome relief on the liability front.

To take advantage of today’s improving conditions, operators should be aware not only of how lenders evaluate their creditworthiness, but also of the available financing options. For example, an entrepreneur interested in an acquisition strategy might consider a short-term (three to five years) variable-rate bridge loan. When the loan matures, he can either cash in the profits from selling the business or obtain permanent debt financing (for example, 10-year loans with Fannie Mae and Freddie Mac and 30- to 35-year loans from HUD) at relatively low interest rates.

As the boom/bust cycle sparked by the overbuilding of assisted living facilities in the mid-1990s nears the end of its course, many experts believe the assisted living sector is already in the early stages of a strong, sustainable recovery. Operators who seek capital will be well-served by gaining a better understanding of how lenders determine value and by knowing their financing options. Any operator who can align his operations to meet these criteria will be well-positioned to succeed when the market expands.