1997 RETURNS ARE IN, PROVIDERS HAD GOOD YEAR The results are in, and it looks like 1997 was a good year for senior care providers, particularly assisted living companies. That's according to the January 1998 issue of The Senior Care Investor, a newsletter published by Irving Levin Associates Inc., New Canaan, Conn., which notes that a total of 10 companies had returns of 50% or higher in 1997, compared to none in 1996. (See table at right.)

Seven of the top performers in the larger cap category, according to the newsletter, were assisted living companies, and one-half of them posted returns of 50% or more. The average return for the group, not weighted by market cap, was 47%.

For more information contact Irving Levin Associates at (203) 966-4343.

LEGG MASON ANALYZES SENIOR HOUSING REITS Senior housing REITs are a safe haven in a turbulent market, according Legg Mason Wood Walker Inc. Real Estate Research Group, Baltimore, Md. In a recent overview of industry trends and company performance, Legg Mason employs a four-stage model to analyze the senior housing industry.

Real Estate Market Cycle. There is a strong demand for senior housing, the company states, and the property market cycle has been in an expansion phase since the early 1990s. Skilled nursing facilities are restricted in supply by state requirements for a certificate of need to be issued before a new facility can be built. The number of assisted living facilities is expanding rapidly, but this segment has not become oversupplied due to strong demand. Legg Mason does not foresee widespread overbuilding over the next several years. Senior housing has become much more widely accepted by financial institutions and investors, and the number of senior housing REITs has risen since 1990. This has increased competition among capital sources and reduced returns on investments made by senior housing REITs.

Management & Growth Strategy. The managements of senior housing REITs are pursuing three strategies for growth: (1) lowering their cost of capital in order to remain competitive at a time when investment spreads are narrowing, (2) differentiating themselves with value-added services and niche financing products, and (3) diversifying into operating companies (Meditrust) and into real estate investments outside the senior housing field (Meditrust and Health Retirement Properties Trust). Differentiation strategies include: transaction structuring, providing venture capital, providing operating assistance to start-up assisted living companies, construction financing and pre-construction permanent commitments.

Capital Structure. Differences among the capital structures of senior housing REITs are narrowing as the smaller, younger companies (founded since 1990) are reaching the size at which they can obtain credit ratings and being to issue unsecured debt. The top rating provided by S&P to senior unsecured debt issued by a senior housing REIT is BBB+ (Healthcare Property Investors Inc.). Most REITs are rated BBB- by S&P, and Legg Mason expected the two senior housing REITs without an investment-grade rating to obtain one from S&P or Moody's over the next 12 to 24 months. This will narrow current differences in credit quality and cost of capital.

Capital Markets' Assessment. Valuations for senior housing REITs are now highly correlated with size as measured by market capitalization. Valuations are not correlated with historical or projected total returns. Nor are they correlated with credit quality or lower payout ratios. Legg Mason believes current pricing offers investors an opportunity to acquire smaller-cap senior housing REITs with well-defined growth strategies and high total returns at attractive valuations. For conservative investors, it also offers the opportunity to acquire, at what the Legg Mason reports as attractive prices, slower-growing but high-quality stocks with low payout ratios and proven track records.

All-in-all, Legg Mason reports that supply and demand in the seniors housing industry are moving together, placing senior housing REITs in the expansion phase of the real estate cycle, and the company does not see widespread overbuilding as a short-term risk. Senior housing REITs are facing a more competitive financing environment and are developing new strategies to achieve continued growth. Differences in capital structure and the cost of capital for senior housing REITs are narrowing, but current valuations continue to favor large-cap REITs without regard to credit quality or size.

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