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Introduction
There has long been a question as to whether senior living and long-term care is a business, real estate or both. The answer has important implications, since real estate valuation is different from business valuation. The answer is particularly important to debt investors. Real estate debt investors typically lend up to 75% of the value of the property, which is a three to one debt to equity ratio. Alternatively, debt investors in a health care service business, where there are few assets to be secured, will normally loan two times cash flow; which translates into a loan of 50% of the value of the business, where the business may often be valued at four times cash flow. Thus, an average health care service business (in the private market) might have a debt to equity ratio of 1 to 1.
Thus, a health care service business might have a debt to equity ratio that is 67% lower than a real estate property, due to the increase in perceived risk by debt investors.
Therefore, debt investors must make the correct allocation between real estate and the health care service business in order to arrive at the correct valuation of the "asset" that they are loaning against in the seniors housing and care industry, since seniors housing and care is correctly defined as a "real estate-based business."
Hypothesis
Is there a mechanism that gives precise allocations? I believe there is. The analytical framework begins with the supposition that apartments are viewed by market participants as real estate with no true "business" component (other than that unique to real estate such as property management, leasing, etc). If apartments are "pure" real estate then we can construct a methodology that allows for separation of the real estate from the business component.
In Exhibit 1, a detailed analysis of the revenues and operating expenses of apartments, congregate properties, assisted living properties and nursing homes is presented.
This information is taken from the best sources available. For apartments, the information comes from Dollars and Cents of Multifamily Housing 1997:...