To a lender, nursing facility loans may closely resemble multifamily housing, hotels and other hospitality real estate models. Simply put, this is not the case. Nursing facilities must comply with nearly as many government regulations as the nuclear power industry.

When reviewing single-use real estate, there are simply no other options for debt repayment than the proceeds of the business. Although nursing facilities may look like real estate, and are often appraised as real estate, they are truly business loans and must be evaluated as such.

The evaluation of this business loan should begin with a careful examination of whether the borrower is equipped both legally and experientially to successfully run the business.

1) First and foremost, proof of state approvals for the project should be reviewed. In the vast majority of states, a Certificate of Need (CON) is required to approve new construction. In the few states where CON regulations have been allowed to sunset, the various health or human services departments have adopted other restrictions on certifying facilities to make construction difficult if not virtually impossible.

Governmental approval also applies to acquisition of facilities. CON boards have ultimate approval on purchase price and ownership. States without such power have restrictions on reimbursement or recapture of depreciation regulations which may be prohibitive.

In the case of construction, a CON or similar document should always be part of the lender's due diligence. In the case of an acquisition of an existing facility, proof of the transfer of a CON, as well as a Medicaid rate letter which defines the state's calculation of the buyer's per diem revenues, should be solicited by the lender.

2) Once it is determined that operations comply with government regulations, the abilities and experience of the borrower should be assessed. Nursing facility operations are complicated, with facilities having to comply with a myriad of regulations. Good businessmen without nursing facility experience should not attempt operations without engaging a professional management company.

A professional management company should be able to supply references as well as financial statements from other clients or other owned properties. The lender should carefully review these statements for signs of good revenue production and consistent cost controls. State agencies and trade associations are good sources of information regarding operators within their states. Due diligence would not be complete without some historic information on the intended manager of the project.

3) The next step in the appraisal of a nursing facility property does, in fact, revert back to the real estate model of appraisal. Location is key to successful operations.

Historically, nursing home residents originally resided within 10 miles of the facility. Demographic information on the numbers and average income of people over age 65 can be found at the local library as part of U.S. Census data. Additionally, the number of facilities and their capacity can also be found in county directories, usually classified by zip code. A quick test of expected occupancy can be calculated by taking 10% of the senior population in an area divided by the number of beds in that area. If the result is less than 85%, you should realize that the area is already over-bedded, and the target project will have a slow fill-up and will always have to compete for its share of the revenue base. Such a bleak projection will seriously affect the value of the property.

4) Also, in keeping with real estate model evaluation, the size, condition and decor of the property should be assessed. As the "baby-boomers" move into their 50s, expect consumer demand for long-term care services to increase drastically. The newest, most modern and best appointed facilities are always first choice in the marketplace. Amenities within the property are also a consideration which increases the facility's value. Chapels, libraries, ice cream parlors, private dining rooms, number and size of private bedrooms, gardens, courtyards and transportation are all amenities that consumers will demand.

5) Competition within the market area should also be considered. There are several national nursing-home operators who have refined marketing techniques and low cost of capital for advertising and property enhancement. It is difficult for even the most experienced operator to compete with some of these giants unless they have taken this competition into consideration in their proforma and have adequate working capital to open their doors on the right footing.

6) Finally, the operational status and history of the target property affect its value. A report is available from the Health Care Financing Administration's (HCFA) regional offices which details a three-year trend of all deficiencies, penalties and complaints lodged against any licensed nursing facility. This HCFA report, referred to as OSCAR, can be obtained by the Freedom of Information Act and can be requested by calling the agency. The report not only details the history of a given property but also contrasts the results at that home to those found within the state, federal region and nation.

Facilities with poor performance histories should be devalued. Repetitive deficiencies are likely to bring substantial fines and/or actions against the facility's license. Because this is a business loan, the license to operate is the life blood of the organization and the only source of loan repayment.

Detailed, realistic cash projections based on history are the definitive tool in the appraisal of a nursing facility. Such cash projections are complicated by third-party-payment programs, which can be as complicated as IRS rules. However, competent professionals can develop such projections with accuracy. These projections are the determining factor in debt service coverage and, therefore, are the key to the facility's value. Typically facilities sell for five to eight times their cashflow. The variable used is dependent upon all the other issues cited in this article.

Joan M. Dugan, N.H.A., is chief executive officer of Sage Health Services Inc., an Evansville, Ind.-based company that specializes in the financial and operational aspects of troubled long-term care debt.