CHICAGO-The health-care sector of real estate is experiencing a mortgage delinquency rate of 1.8%, more than three times the rest of the commercial sector, with both operators and lenders discovering there are more challenges than they might have anticipated. Problems with the health-care sector–actually more of a business than it is pure real estate–dominated morning sessions Thursday at the seventh annual commercial and multifamily administrative conference of the Mortgage Bankers Association of America.

The hotel sector also is coming under scrutiny, with the record 654 attendees having to look no further than Downtown’s star-crossed Block 37, where the developers’ inability to finance the hotel component of a proposed $250-million has killed their plan. However, problems owning hotel properties pale by comparison to owners of health-care and assisted-living facilities, as well as their lenders who might become reluctant owners of the underlying real estate.

“I think it’s probably No. 1 on the list in terms of special servicing, and one area where investors may want to look at loss severity,” says Henry J. Bieber, senior vice president of San Francisco-based GMAC Commercial Mortgage Corp.

Occupancy rates for skilled-nursing facilities already has dropped to 83% in 1999 from 90% in 1991, according to Lawrence D. Katz, president of Birmingham, AL-based Survey Capital LLC. Much worse, the market capitalization of publicly-held skilled-nursing companies plummeted from $13.4 billion in March 1998 to $2.3 billion in January 2000, as a few large operators have entered bankruptcy. “To say this asset class is out of favor is an understatement,” Katz says.

A shortage of operators presents a challenge to special servicers, adds Michael O’Hanlon, vice president and director of special servicing for Lend Lease Real Estate Investments. “That’s one of the things all special servicers run into–finding someone to run the operation,” he says. “We don’t have a stable of receivers or operators to go to. They all have enough problems of their own.”

At best, negotiations with a would-be operator turn out to be one-sided, O’Hanlon says, as their stance is they will operate under an agreed-upon fee high enough to ensure a strong upside.

However, foreclosure may be the least of the problems involving health care properties as they are heavily regulated by state agencies. If the agency shuts the facility down because of mismanagement, or denies new operators a certificate of need, the value of the property may likely plummet by 50% with empty rooms and beds.

“It’s just one hurdle on top of another,” Bieber says. “If (state health officials) go in there and see there are not enough nurses, not enough workers, lack of cleanliness, they can shut them down. There’s just no practical way to respond… The residents are all gone, and we’re left with an empty building. We can’t control them from going in and taking all the residents.”

Katz advises servicers to monitor regulatory issues closely as they frequently are an early warning of financial difficulties “If you start seeing financial problems, you better get into the facility,” he adds. “You can’t just look at it once a year.”

Finding and retaining quality employees is a challenge for health-care operators, O’Hanlon and Katz say. Assisted-living facilities have exacerbated the labor shortage, Katz adds.

There are rays of hope on the horizon, however. Katz points out the continued graying of the US population will increase the need to provide care to the elderly, which is becoming generally wealthier. There also is the cyclical nature of business, be it health care or real estate.

“The industry eventually will come up,” Bieber says. “People had the same discussions we’re having now about health care that they had 10 years ago about hotels. But now hotels are one of the best performers in CMBS.”

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