Nursing facilities: assets, interests, and ownership structures.

This article discusses the assets, interests, and ownership structures of nursing facilities. The appraisal of a nursing facility typically involves the valuation of the total assets of the business, including the real estate interest and the tangible and intangible personal property assets. The assets may be held by a single entity or the ownership may be fragmented for economic and legal reasons. In performing an appraisal, it is important to identify, understand, and properly treat the assets being appraised. For consistency purposes, the appraiser should verify the assets and liabilities that are included in the transactions that are used to develop comparable sale and lease data.

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Most appraisal assignments relate to the sale or financing of nursing facilities. Typically, a combination of the fee simple interest in the real estate, tangible personal property or furniture, fixtures, and equipment, and intangible assets are included in the purchase price or as security for the mortgage or loan agreement. However, there are many instances in which the appraiser will be requested to estimate only the value of a specific interest in the real estate or intangible personal property assets. For instance, property tax assessments should exclude the value of the intangible assets. FHA-insured mortgages obtained through HUD are underwritten on the value of the tangible assets (real estate and major movable equipment), but this agency also requires the appraiser to estimate the value of the total assets of the business. The valuation of nursing facilities with a leased fee or leasehold interest may or may not include the tangible or intangible personal property.

A nursing facility's assets include:

* Real estate-fee simple, leased fee, or leasehold

* Tangible personal property-furniture, fixtures, and equipment

* Intangible personal property--including assembled work forces, licenses, certifications, approvals such as certificates of need (CON), patient records, goodwill, and management

Note that most appraisal engagements and sales transactions exclude current assets (working capital, cash, accounts receivable, etc.) from the purchase price consideration. Similarly, seller liabilities stay with the seller, and the buyer or successor in the business typically gains indemnity for the seller's liabilities. It is important to confirm what current assets and liabilities, if any, were included in the consideration.

Definitions of going-concern and total assets of a business follow:

Several terms are used to describe this value and will be used interchangeably in this discussion. Business enterprise value is defined as:

Real Estate Assets

Real estate interests may include fee simple, leased fee, and leasehold interests.

A fee simple interest is found when the ownership of the real estate and the operating rights for the facility are controlled by the same party or closely related parties, whereby agreements between related parties can or will collapse into a single entity for purposes of conveyance to a new party. Fee simple estate is defined as:

The leased fee interest is the interest held by the lessor or landlord. The interests of the landlord include the right to receive rent during the term of the lease plus the right to receive the leased assets back at the lease termination. Typically, nursing facilities are leased on an absolute net basis, whereby the tenant is responsible for expenses associated with the leased premises and the landlord has little or no responsibilities. The assets leased may include the real estate, tangible personal property, and intangible assets. Note that many nursing facility leases are vague or silent regarding successor rights to licenses, certifications, and other necessary intangible assets for the continuation of the business. In leases in which the tenant is required to cooperate with the landlord in transitioning the facility to the next operator, the landlord may be required to compensate the tenant for the tangible personal property. Leased fee interest is defined as:

The leasehold interest provides the tenant with the rights to use the property to operate the facility, hopefully for a profit. The tenant may have the right to sublease the facility, changing this interest to a "sandwich" leasehold. The tenant, acting as the operator, will be the licensed entity and will possess the certifications, provider agreements, and other formal responsibilities in operating the nursing facility. Since most facilities are leased on an absolute net basis, the tenant is typically responsible for all maintenance and capital expenses during the lease term. The tenant will typically invest fairly substantial capital (working capital, replacement funds, and additions of building and equipment assets) in the enterprise over the lease term, so the lease should be long enough to fully recover the capital investment. Most leases include renewal or extension options, and some grant the tenant purchase options and first rights of refusal. Leasehold interest is defined as:

Tangible Personal Property--Furniture, Fixtures, and Equipment

Personal property is defined as:

Nursing facilities require furniture and equipment in nearly every area of the building(s). Patients typically bring only some of their personal items with them; beds and room furniture is typically provided by the facility. The operator may lease some equipment and fixtures such as vehicles, computer systems, dishwashers, and perishable decor items (plants and aquariums) that require frequent, specialized servicing. Outside providers, such as therapy companies and pharmacies, may provide their own exercise equipment and medicine carts.

Intangible Personal Property

Several definitions are fundamental to any discussion of intangible personal property.

The intangible assets of a nursing facility typically include:

* Licenses, certifications, and approvals (such as certificates of need) from government agencies and regulators

* Assembled workforces, including licensed, certified, and trained employees

* Patient records

* Goodwill

* Management

* Vendor contracts

* Trade names

Nursing facility operators enter into a series of agreements with government authorities. These agreements include a licensure agreement with the state agency responsible for licensure (typically within the state department of health) and provider agreements with the state agency that administers the Medicaid program (often contained within the state department of social services) and with Medicare. Other licensing and certifications are required at the facility level. Staff and consultants may need certifications issued at local, state, and federal levels. Local licensing and other regulations may be required for fire and safety, food services, and zoning compliance. Verification that the facility remains in compliance with various licenses, certifications, and other regulations is essential for the operator, investors, major creditors (mortgagee or landlord), and those underwriting and evaluating the assets of the business. The appraiser typically does not confirm or verify that all necessary licenses and certifications to operate the facility are current, but the appraisal report should include a stated assumption that those items are current and complete.

While licensed or certified staff and outside consultants (administrators, nurses, nurse aides, therapists, physician consultants, social workers, dieticians, etc.) are directly or indirectly employed by the operator of the facility, they also must adhere to the licensing laws and standards of their respective professional licensing agencies and professional organizations. Violations of laws and standards can result in disciplinary action against the facility and/or individuals, which will often have an adverse impact on the value of the assets of the going concern.

Allocation of the Assets of the Business or Going Concern

USPAP does not specifically require that an allocation of assets be made, but it does require the appraiser to analyze the effect on value of non-real property items. (8) As required by Title XI of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), the market value of the real estate must be identified and valued separately. Methods for allocating the going-concern value of a nursing facility or any other real estate-intensive business continue to be debated. Under typical circumstances, the going-concern value for a highly profitable nursing facility will exceed the depreciated cost of the tangible assets, which suggests that there is intangible value.

In most cases, the whole is greater than the sum of its parts. The business could not operate if any one of its major assets were absent. If a facility loses its license because of inadequate care or a tenant terminates a lease taking the license (sometimes referred to as the certificate of need) and/or the patients and staff to a replacement facility, the value of the whole and the individual assets are suddenly and severely diminished. In fact, the value is often reduced to a small fraction of the physically depreciated cost if a new license for the building cannot be obtained.

Ownership Structure Issues

The ownership of a nursing facility enterprise is often fragmented, with an operating entity in possession of the license(s), certifications, and business operations, while the ownership of the tangible assets (real estate and personal property) and the management are controlled by other related or unrelated parties.

In 2005, 66.0% of Medicare- and/or Medicaid-certified nursing facilities were owned by for-profit concerns; 27.9% were owned by private non-profits; and the other 6.1% were government-owned. (9)

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