The market for the seniors housing and care industry as a whole has been on an upswing for more than a year now. Data from the third quarter of 2006 show that loan volume and loan performance were at record highs. But looking a bit deeper, trends are emerging from the data—some good and some not so good—of which nursing home owners and operators should be aware.

Key Insight No. 1: Increasing Investment Appeal of Nursing Homes

First of all, the good news. National occupancy rates in nursing homes are up significantly year over year—about 250 basis points to the highest since the National Investment Center for the Seniors Housing & Care Industry (NIC) has kept track of its Key Financial Indicators (KFIs) starting in 1999. During the third quarter of 2006, the sector had a median occupancy rate of 88.5%. That compared with 86% in the second quarter of 2006 and also in the third quarter of 2005.

Also, loan volume in nursing homes has increased by almost 200% year over year. This has made nursing homes much more appealing to institutional investors, who honestly have been scared away from them until now. Most recently, JER Partners, one of the major real estate opportunity funds in the country, invested in the sector. It joins venture funds (including JPMorgan), private family investment groups, and finance companies (such as GE Healthcare) that have been involved for some time. So there’s no question that new money is starting to flow back into the nursing home segment.

Much of the increasing investment is “retrading” into existing properties as the value of these properties goes up. But we are now starting to see more and more people looking to invest in renovations of existing nursing homes, and that is definitely a trend that we believe will continue and grow at a very fast rate over the next five-year period.

Key Insight No. 2: Growing Capitalization Rate Differential

The second trend that has emerged from our KFI data is the indication of a growing capitalization rate differential. During the third quarter, cap rates were at or near historic lows with one reported independent living property given a low rate of 5.8%. The lowest for nursing homes was 10%, which was down from 12% in the previous quarter.

But operators who expect to receive similarly low capitalization rates need to be realistic and understand that the 80/20 rule is at work here. That is, only the very best properties, the newest ones, or those in very large portfolios that are stabilized—or about 20% of all properties—will get the lowest rates. In fact, most nursing properties are going to trade at the mean capitalization rate, which was 12.7% for skilled nursing during the third quarter. By the way, this distribution of how properties trade at various cap rates is natural in almost any real estate sector, such as in apartments, industrial, office, and retail.

Key Insight No. 3: Change in Medicare Mix

In addition to the national KFI statistics, NIC also analyzes quarterly data from the top metropolitan areas. In looking at these NIC Market Area Profiles (NIC MAP) across the top 30 metro markets, one of the most intriguing observations is the strong downward trend of private-pay residents as a percentage of total residents in freestanding nursing homes.

Back in the first quarter of 2004, the percentage of residents who primarily paid out of their own pockets was 14.9%. By the third quarter of 2006, it was down to 10.8%—a 400 basis point difference or a 27.5% relative decrease.

Interestingly, many of the top chains are not necessarily noticing this trend, as they are doing a good job of targeting private-pay and Medicare residents. Also, rate increases in these properties may be offsetting the overall decline. Of course, what’s likely really masking it is the 250 basis point increase in occupancy. But 40% of all the nursing homes in the top 30 metros are owned by companies that have just one nursing home and are likely feeling this change in resident mix.

Why is this happening? One answer could be that more and more assisted living and dementia operators are adding ancillary services, such as rehab care, to keep residents in their properties for as long as possible and even right up until their deaths, if their state legally allows them to do so and if they are professionally equipped to do that. But this is not a strategy to be pursued by operators who are not legally or professionally capable of keeping residents in the best possible situations for their conditions.

What Operators Can Do to Improve Census

Whether this decrease in private-pay mix will continue remains to be seen, but the reality is that it has accelerated since the third quarter of 2005. Most of it has actually happened just in the past year. As a result, operators really need to be focused on this trend to improve their results.

Operators can also improve their census by how well they train their staff to become a professional selling organization. Right now, for instance, we as an industry are only closing one out of every six people who come in to visit an independent living community. The typical nursing home has historically not thought there was a need to be a professional selling organization. Those days are over forever.