ADAM D. LYNCH PRINCIPLE VALUATION

TABLE OF CONTENTS LONG TERM CARE INDUSTRY OVERVIEW, MEDICARE REIMBURSEMENT UPDATE & A VALUATION DISCUSSION ADAM D. LYNCH PRINCIPLE VALUATION TABLE OF CONTENTS Industry Overview... 2 Skilled Nursing Facilities... 2 Assisted Living Residences... 4 Independent Living Communities... 6 Senior Apartments... 7 Continuing Care Retirement Communities... 8 Medicare Reimbursement Rate... 10 Appraisal Procedures... 15 Cost Approach... 16 Land Valuation... 16 Building & Site Improvements... 16 Estimated Depreciation... 18 Physical Deterioration... 18 Functional Obsolescence... 18 External/Economic Obsolescence... 18 Income Approach... 19 Capitalization Rate Derivation... 20 Sales Comparison Approach... 21 Sales Grid Analysis... 22 EGIM Analysis... 25 Reconciliation of Value... 26 1

INDUSTRY OVERVIEW The long term care industry provides both housing and a wide range of services to seniors, generally those over the age of 75. Care segments within this industry include skilled nursing facilities, assisted living residences, independent living communities, senior apartments, and continuing care retirement communities. Care services vary, as shown in the following chart: Source: NIC Investment Guide: Investing in Seniors Housing and Care Properties, Second Edition SKILLED NURSING FACILITIES Skilled nursing facilities (SNFs), or nursing homes, provide residents with routine long-term care, including daily dietary, social, and recreational services, and a full range of pharmaceutical services and medical supplies. A nursing home provides skilled nursing and rehabilitation services to people who are unable to care for themselves. Nursing homes are predominantly stand-alone facilities, but may also be part of a hospital or retirement setting. Sub-acute care is generally for patients who have been discharged from an acute care hospital but are too sick to return home and need continued complex and intensive medical services. Skilled 2

nursing units resemble hospital rooms with most residents residing in semi-private rooms. Payment for these services is primarily from Medicare (federal government) or Medicaid (state level). The Managed Care Digest Series/ Public Payer Digest 2012-2013 notes that the total number of licensed nursing home beds in the U.S. increased to 1.67 million in 2011 from its low of 1.65 million in 2009; this is still, however, significantly lower than the high of 1.72 million beds in 2002. This decline, coupled with an evergrowing elderly population, led to a five-year low in the number of nursing home beds per 1,000 people age 65 and over, at just 40.4. Nearly half (47.6%) of all nursing home residents suffered from some form of Alzheimer-type dementia in 2011, making it the third most common patient condition in such facilities after bladder incontinence (56.4%) and depression (52.3%). According to the NIC Investment Guide: Investing in Seniors Housing and Care Properties, Second Edition, in the fourth quarter of 2011 nursing facility occupancy was 88.2%, down from a high of 90.7% in the first quarter of 2007. Typical monthly operating expense ranges from $4,626 per bed in the lower quartile to $7,133 per bed in the upper quartile with a median of $5,758 per bed. Operating margins range from 3.1% in the lower quartile to 22.6% in the upper quartile with a median of 12.9%. Since most facilities rely heavily upon government reimbursement (Medicare or Medicaid) changes in reimbursement policies can materially impact facility profitability. Although a notable 96.0% of all U.S. nursing homes were Medicarecertified in 2011, this percentage was down from 98.1% in 2008. In the future, health 3

care reform legislation may continue to expand the requirements that nursing homes need to meet in order to become Medicare-certified. Nursing homes are reducing their exposure to Medicaid revenue. According to the Managed Care Digest Series/Public Payer Digest 2012-2013, the number of Medicaid admissions per nursing home fell 1.6% between 2010 (56.5) and 2011 (55.6). Total admissions per nursing home spurred by higher Medicare admissions rose 2.1%, to 277.8 admissions per facility from 272.2 in 2010. Medicare Part A covers a patient s stay in a nursing home for up to 100 days, but only if the care required can be provided solely in this type of facility. Various provisions of the Patient Protection and Affordable Care Act (which is arguably aimed primarily at the nonelderly population) that address payment and delivery systems reform are expected to have some impact on nursing homes and their residents. ASSISTED LIVING RESIDENCES Assisted Living Residences (ALRs) are hotel-like facilities which serve elderly individuals who need assistance with the tasks or activities of daily living but do not require 24-hour skilled nursing care. Many facilities offer separate areas for Alzheimer s residents or other forms of dementia, as these individuals do not require round-the-clock skilled nursing care but do require more intensive supervision than typical assisted living residents. The objective of assisted living is to maintain or enhance residents ability to live as independently as possible in a homelike environment that offers on-site medical services. Services are provided largely to private-pay, long-term residents, but many states have developed regulatory 4

structures to provide some assisted living reimbursement under Medicaid for lower income seniors. The Managed Care Digest Series/ Public Payer Digest 2012-2013 notes that in the past five years, the number of ALRs operating in the U.S. has climbed a substantial 11.1%, to 15,727 in 2011 from 14,157 in 2007, with corporately-owned assisted living facilities accounting for nearly four of every ten assisted living beds in 2011. Assisted living facilities continue to provide a welcome alternative to nursing homes and other forms of institutionalized care for many seniors and individuals with disabilities. Industry analysts indicate that while many residents have postponed their admission to an assisted living facility, daily care challenges eventually necessitate moving into a facility that offers such services. The postponement of admission to assisted living facilities has become a growing concern. While many seniors make the transition in a relatively healthy state, delayed admission may lead to higher concentrations of residents suffering from chronic diseases that require higher levels of care. The cost of this additional care would place an even greater strain on the Medicaid program seeking to assist these populations. Looking ahead, Standard & Poor s expects the assisted living sector to grow, as individuals aged 85 and older a group representing the largest number of users of long-term healthcare services are currently the fastest growing segment of the US population. According to the NIC Investment Guide: Investing in Seniors Housing and Care Properties, Second Edition, in the fourth quarter of 2011 assisted living occupancy was 88.6%, down from a high of 90.6% in the third quarter of 2006. 5

Typical monthly operating expense ranges from $2,806 per occupied unit in the lower quartile to $3,861 per occupied unit in the upper quartile with a median of $3,321 per occupied unit. Operating margins range from 21.4% in the lower quartile to 38.4% in the upper quartile with a median of 32.3%. INDEPENDENT LIVING COMMUNITIES Independent living communities (ILCs) significantly grew in popularity in the 1980s due to increasing demand for senior accommodations. They operate identically to assisted living residences but do not provide assistance with activities of daily living. They often contain all of the same amenities as assisted living residences but may also include swimming pools, covered parking, and a higher quality dining experience. ILCs are physically similar to hotels and typically range in size from 150 units to 300 units. Similar to apartment complexes, units contain separate bedrooms and kitchens. However, most residents choose to use the community s dining room which typically prepares three meals per day with one or two meals per day included in residents monthly fees. Additional resident meals and guest meals can almost always be purchased separately. Monthly fees typically include two daily meals, all utilities except telephone, maintenance, weekly housekeeping and linen service, social activities, and use of community amenities. The primary difference between ILCs and ALRs is that residents who locate in an independent living community must be physically and mentally capable of performing all of the activities of daily living (ADLs). Marketing is more intensive at independent living communities because occupancy is less need driven and more of 6

a personal lifestyle choice for seniors. Modern development trends include cottage or villa style units apart from a main building housing more hotel-like independent and/or assisted living units. Furthermore, most communities offering independent living also provide some form of assisted living component to offer a continuum of care. According to the NIC Investment Guide: Investing in Seniors Housing and Care Properties, Second Edition, in the fourth quarter of 2011 independent living occupancy was 88.0%, down from a high of 92.6% in the first quarter of 2007. Typical monthly operating expense ranges from $1,334 per occupied unit in the lower quartile to $2,527 per occupied unit in the upper quartile with a median of $1,976 per occupied unit. Operating margins range from 26.1% in the lower quartile to 47.5% in the upper quartile with a median of 38.3%. SENIOR APARTMENTS Senior apartments are typically referred to as rental active adult communities. Physically and operationally, they are a blend between apartment complexes and independent living communities. Unit doors are typically accessible via the interior but can also be accessed by the exterior of the building, and meals or housekeeping services are not offered. However, social activities are almost always available. Unit amenities typically include a full kitchen, washer and dryer, balcony or patio, and window treatments. Senior apartments can be either market rate apartments or subsidized, affordable housing alternatives. Affordable senior apartments are age-restricted apartments that generally take two forms of age restriction. One type is for seniors 7

age 55 years or older; these apartment complexes require that at least one person in each apartment be age 55 or older and that no more than 20% of residents in the entire complex be under the age of 55 years. The second type is restricted to seniors of age 62 years or older, and no residents may be under this age. Rental rates for these affordable senior apartments are typically 30% of a resident s income with various levels of income qualifications depending on the facility and location. CONTINUING CARE RETIREMENT COMMUNITIES A Continuing Care Retirement Community (CCRC) is a seniors housing community offering a continuum of care among all three traditional levels of seniors housing: independent living, assisted living, and skilled nursing. CCRCs are designed so that residents typically move into the community s independent living component and age in place through to the assisted living and skilled nursing components. CCRC pricing structures take two broad forms: rental or endowment (entrance fee). Buy-in / entrance fee communities do not directly compete with rental communities because the two pricing structures attract different profiles of residents. The rental format is identical to typical seniors housing fee structures whereby residents pay monthly market rent depending on the level of care that they require. Residents enter the facility at any care level, but admission priority is given to current residents moving from a lower level of care to a higher level of care. In the endowment / entrance fee structure, residents move into the independent living portion of the community by paying a buy-in fee ranging anywhere from $25,000 to over $1 million depending on the quality of the facility, 8

amount of refund offered, and level of healthcare benefits included. The endowment fees typically provide residents with guaranteed residency at the community regardless of changes in health conditions or the exhaustion of their funds as in most not-for-profit communities, transferring the risk of healthcare cost inflation to the community. The refundable portion of the endowment is traditionally reduced by 10% upon move-in and 2% per month thereafter, but many communities also offer plans which guarantee refunds of 50%, 90%, or 100% of the endowment / entrance fee upon resale; however, some communities may require higher entrance fees for higher refund percentages. Furthermore, buy-in / entrance fee CCRCs are classified as either Type A, B, or C depending upon the amount of healthcare benefits included in the entrance fee. Type A CCRCs are referred to as Lifecare communities because the entrance fee includes all future healthcare costs. In the 1970s and 1980s some communities underestimated future healthcare costs of its residents and did not have enough financial reserves to pay for its resident healthcare obligations. These communities now frequently seek accreditation by various agencies such as the Continuing Care Accreditation Commission (CCAC) to assure residents that they offer high quality services and will have sufficient reserves to provide the promised healthcare. Communities offering a modified healthcare contract are referred to as Type B CCRCs. These contracts guarantee access to skilled nursing care but only pay for a certain number of days per year or per lifetime. Use of skilled nursing care beyond the included number of days is typically provided at a discounted rate. Since 9

these contracts provide for less healthcare benefits, entrance fees are lower than in Lifecare formats. Finally, Type C CCRCs are fee-for-service communities which do not provide any healthcare benefits and correspondingly have the lowest entrance fees. However, monthly fees may be higher to reflect the current service components delivered to each resident. According to the NIC Investment Guide: Investing in Seniors Housing and Care Properties, Second Edition, in the fourth quarter of 2011 CCRC occupancy was 88.9%, down from a high of 93.7% in the first quarter of 2007. Typical monthly operating expense ranges from $2,802 per occupied unit in the lower quartile to $4,552 per occupied unit in the upper quartile with a median of $3,581 per occupied unit. Operating margins range from 16.2% in the lower quartile to 34.3% in the upper quartile with a median of 28.4%. MEDICARE REIMBURSEMENT RATE Overview: Medicare medical insurance is divided into two parts: Medicare Part A and Medicare Part B. Medicare Part A is the basic part of the Social Security health insurance program. It is designed to help patients defray the cost of hospitalization and related care. In addition, it covers most post-hospital extended care in skilled nursing facilities. Payments for services are made directly to the provider of care. Medicare Part B is the portion of Medicare available usually as optional insurance for a monthly fee, designed to assist in paying up to 80% for physician services and other services and supplies not covered under Part A. Medicare does not pay for custodial or intermediate level nursing home care. Medicare covers skilled nursing care in a semi-private room for up to 100 days when 10

skilled care is medically necessary (there is no co-insurance for the first 20 days). However, such care must meet strict requirements to be covered. For example, the care and treatment must be related to the reason the patient was hospitalized and must be intended to aid in the recovery of the patient. Admission of Medicare residents to certified nursing units must be ordered by a physician. Major services that are covered by Part A include: 1. Semi-private room with all meals (including special diets) 2. Injections 3. Intravenous and tube feedings 4. Preventative or palliative skin care 5. Drugs and medical supplies 6. Rehabilitative services 7. Blood beyond the first three pints 8. Appliances such as a wheelchair Medicare A will not cover amenities such as telephones, television rental or beauty/barber services, nor will it pay for care rendered by a personal physician or private duty nurse. Medicare B will pay a portion of physician fees and certain other services such as: 1. Diagnostic X-rays and lab tests 2. X-ray, radium and isotope therapy 3. Surgical dressings, splints and casts 4. Prosthetic implants and devices 11

Blood transfusions and drugs are not covered by Part B in a nursing home nor can Part B be used to cover standard daily charges in a nursing home. Those who need short-term skilled nursing care on an inpatient basis following a hospital stay of at least three days are eligible to receive covered services in SNFs. The Medicare SNF benefit covers skilled nursing care and rehabilitation services and pays facilities a pre-determined daily rate for up to 100 days of care. The prospective payment system (PPS) rates are designed to cover all of a facility s costs in furnishing most SNF services, with certain ancillary services paid separately. The base payment rates are computed separately for urban and rural areas and are updated annually based on the projected increase in the SNF market basket index, a measure of the national average price level for the goods and services SNFs purchase to provide care. Daily payments to SNFs are determined by adjusting the base payment rates for geographic differences in labor costs and case mix. The daily base rates are then adjusted for case mix using a system known as Resource Utilization Groups (RUGs). Each RUG has associated nursing and therapy weights that are applied to the base payment rates. The daily rate is the sum of three components: 1. A nursing component, reflecting the intensity of nursing care; 2. A therapy component, reflecting the amount of therapy services; and 3. A component reflecting the costs of room and board, linens, and administrative services. 12

The nursing component is case-mix adjusted for all RUGs. The therapy component is case-mix adjusted for rehabilitation RUGs and is a constant amount for non-rehabilitation RUGs. The payment for room and board is a constant amount for all RUGs. The 66-group RUG classification system went into effect October 1, 2010, replacing the prior 53-group RUG system in an attempt to improve the ability of the prior RUG-III classification system to explain non-therapy ancillary (NTA) costs. The new reimbursement system uses MDS 3.0. Payment under RUG-IV will be effective October 1, 2010, so providers will be paid under the 66-category RUG-IV classification system. According to a synopsis published by the Healthcare Financial Management Association (HFMA), the essential change is that the value among certain RUG categories has shifted such that rehabilitation services is worth less under RUG-IV, but non-rehabilitation services such as extensive and medical conditions are worth more. Therefore, SNFs adversely impacted are those with a high percentage of X s and L s (rehab and extensive category residents) that are based on extensive services provided in the acute care hospital and those with a high percentage of rehab category residents. However, therapy reimbursement remains very attractive and will continue to be a major element of Medicare reimbursement. Under the RUG-IV system, overall payments to SNFs were expected to be budget neutral with a significant re-shuffling of the payments among categories. There has been reshuffling, but with the move directly to RUG-IV the overall cost to the government was not actually budget neutral and essentially represented a 13

windfall to the skilled nursing industry. Comparing the Fiscal Year 2010 rates to the Fiscal Year 2011 rates, there was a very significant overall rate increase. However, under MDS 3.0 and the new rules about therapy minutes and look back periods, it will be much more difficult to achieve the higher RUG categories and to get therapy minutes recorded. To date, the vast majority of the extensive qualifiers occurred in the acute care hospital before admission to the SNF. Look back periods are now modified to prohibit providers from taking credit for certain services (specifically the extensive qualifiers) that occur in the acute care hospital before admission to the SNF. For RUG-IV purposes, the look back period for section P1a items does not include any services rendered before the patient was admitted to the SNF. Services prior to admission (those provided in the hospital) are still recorded, but only for care planning purposes, not for reimbursement purposes. Additionally, the number of extensive qualifiers is reduced. The remaining extensive qualifiers for care provided only in the SNF are tracheotomy care, ventilator / respirator care, and isolation/quarantine for an active infectious disease. Some of the services that were formerly extensive qualifiers are moved to other categories. Medicare Rate Estimate: CMS has implemented significant payment reductions effective October 1, 2011. The following analysis fully incorporates the recent Medicare payment policy changes found in the SNF PPS final rule for fiscal year 2012 that was issued on July 29, 2011. The final rule and our rate analysis illustrate the net impact of a 2.7% increase in rates for the market basket update, a 14

1.0% reduction in rates due to the Accountable Care Act (ACA) mandated productivity adjustment, and a 12.6% reduction in rates due to the recalibration of the parity adjustment, for a net 11.1% reduction in SNF PPS rates for FY 2012. APPRAISAL PROCEDURES Developing a reasonable opinion of a Seniors Housing business value generally involves considering these appraisal techniques: Cost Approach: Considers the current cost of replacing a property, less accrued depreciation in the property. A summation of the market value of the land assumed vacant and the depreciated replacement cost new (RCN) of the improvements provides an indication of the total value of the real estate. This method does not take into consideration the business component. Income Approach: Inherent in this approach are the principles of substitution and anticipation: it is assumed that an investor will pay no more for a center than for an alternative investment that produces an equivalent return with equivalent risk. This approach can be accomplished in two ways. A discounted cash flow analysis can be performed on cash flow before debt service, depreciation and income taxes or a direct capitalization method is used which applies a current capitalization rate to stabilized net operating income. Sales Comparison Approach: Produces an estimate of value by comparing the sales and/or listings of similar facilities/operators in 15

the same area as the center or in competing areas. This technique is used to indicate the value established by informed buyers and sellers in the market. After considering these three approaches, the appraiser critically examines and weighs their value indications in a reconciliation of value before reaching and presenting a final conclusion of value. The following sections further discuss the application of each approach. COST APPROACH In the cost approach, the appraiser derives an opinion of a property's value by estimating the market value of the land plus the replacement cost new (RCN) of the improvements and equipment then deducting the estimated accrued depreciation. LAND VALUATION The most common way of developing a market value estimate for land involves collecting and analyzing sales and listings of vacant land comparable to the subject property. The appraiser may adjust prices for market conditions, location, physical characteristics, available utilities, zoning, and highest and best use. BUILDING & SITE IMPROVEMENTS Estimating the Replacement Cost New (RCN) entails calculating direct (or hard) costs, indirect (or soft) costs, and entrepreneurial (or developer's) incentive. Several methods of estimating the RCN of a building exist: the 16

comparative unit method, the unit in place method, and the quantity survey method. After inspecting the improvements, an estimate is prepared using a cost manual such as Marshall Valuation Service. According to the Winter 2012 Special Issue Brief prepared for the American Seniors Housing Association by Larry Graeve of Weitz Senior Living, over the past quarter there has been a 4.5% increase in material costs and a 1.9% increase in labor costs. However, overall construction prices are relatively low since aggressive competition for construction work is forcing contractors to absorb these costs themselves. Prices for concrete, steel, and other materials increased in 2012, and drywall prices increased by as much as 35% in certain markets. The following chart displays current average construction costs per square foot for various types of seniors housing communities: Comparable Construction Costs per Gross Square Foot Mid-Level High-Level Low High Low High Independent Living $118 $129 $133 $180 Cottages $98 $112 $133 $156 Assisted Living $122 $167 $190 $238 Skilled Nursing $147 $171 $193 $247 Underground Parking $66 $92 $101 $129 * Component costs include full burden of general condition, insurance & tax, but do not include site costs. For the above survey data, mid-level projects generally are of woodframed construction with standard amenities and finishes and typically target the 17

more moderate income senior. High-level projects generally are of steel or concrete construction with high-end luxury amenities and finishes and typically target the higher income senior. ESTIMATED DEPRECIATION As an improvement ages, it typically loses value, or depreciates. Accrued depreciation reflects the difference between the RCN of an improvement and its market value as of the date of an appraisal; this difference in value may result from physical deterioration, functional obsolescence, external obsolescence, or any combination of the three. Physical Deterioration Physical deterioration is wear and tear due to a combination of the action of the elements, age, and use of the improvement. Functional Obsolescence Functional obsolescence is a loss of value normally due to deficiencies within the premises itself that impair the optimum utilization of the center. Causes for such losses in value include: poor floor plan or design functional inadequacy over capacity (in size, style, and/or construction) External/Economic Obsolescence External or economic obsolescence is a loss in value stemming from influences outside the center itself and over which the ownership has no control. 18

Some examples are population shift significant changes in the economy that lowers desirability transitions in the immediate environs of the center other forms (governmental restrictions, excessive taxes, or adverse economic trends). INCOME APPROACH Depending on the scope of the engagement the appraiser applies the income approach to estimate the value of the total assets of the business. Inherent in this approach are the principles of substitution and anticipation: it is assumed that an investor will pay no more for a center than for an alternative investment that produces an equivalent return with equivalent risk. There are two techniques commonly applied: 1) a discounted cash flow analysis and 2) the direct capitalization method. The discounted cash flow analysis assumes that the value of the total assets of the business equals the present worth of anticipated cash flow before debt service, depreciation, and income taxes, plus the present worth of the projected center s value, or reversion, at the end of the holding period. The reversion value is based on capitalization of a projected net income. The appraiser then discounts the reversion value to a present value estimate and adds it to the present worth of the cash flow to indicate the value of the total assets of the business. The second approach, the direct capitalization method involves applying a current capitalization rate to stabilized net operating income. 19

CAPITALIZATION RATE DERIVATION In selecting an appropriate capitalization rate for a subject, the investor survey, the comparable sales, the band of investment method, mortgage-equity method, and the debt coverage ratio method are typically considered. The primary method is the investor survey where appraisers utilize journals and publications that includes the participation of owner/operators, financial institutions/investors, brokers/mortgage bankers, and appraisers/consultants. These surveys are typically updated on a quarterly and annual basis. The other methods such as the band of investment, mortgage-equity, and the debt coverage ratio are appraiser generated and used for additional support. TABLE 1: INVESTOR SURVEY OVERALL CAPITALIZATION RATE 2012 All Responses 2012 Adjusted Responses Range Avg Range Avg Basis Point Change From 2011 Age Restricted Apartments 6.0-9.0% 7.2% 6.0-9.0% 7.2% -30 Unlicensed Congregate Care (IL) 6.0-12.0% 7.9% 7.0-11.0% 8.0% -20 Licensed Assisted Living 7.0-12.0% 8.6% 7.0-11.0% 8.5% -30 Licensed Alzheimer/Dementia 8.0-12.0% 9.2% 8.0-12.0% 9.2% +10 Licensed Skilled Nursing-Long Term Care 8.0-15.0% 12.2% 10.0-15.0% 12.2% -30 Licensed Skilled Nursing-Subacute Care 7.0-20.0% 12.3% 10.0-15.0% 12.2% -80 Continuing Care Retirement Community 7.0-15.0% 9. 5% 8.0-12.0% 9.4% -40 * Spring 2012 Senior Housing Investment Survey Overall, capitalization rates for seniors housing communities are higher than more traditional multifamily housing. In fact, as care level increases, rates generally increase. All seniors housing types of communities have demonstrated significant drops in capitalization rates from 2002 through mid-2007 until the credit market tightened and financing became less available. Seniors housing capitalization rates then rose from 2007 through 2009 back to their 2004-2005 levels before again dropping steadily from 2009 through 2011. As shown in Table 20

1, capitalization rates have started to rebound over the past year. While sales volume has been low since 2008, conversations with seniors housing brokers and data from sparse sales throughout the country indicate that current capitalization rates are approximately 50 to 100 basis points higher than their lowest points in 2007 across all seniors housing types of communities and activity is picking up. In Table 2, The Senior Care Acquisition Report, 17 th Edition, published by Irving Levin Associates, Inc. reports capitalization rates and prices per unit for 2011 and 2012: TABLE 2: ACQUISITION MARKET INDICATORS ACQUISITION MARKET INDICATORS 2012 Avg. Price / Unit 2012 Cap Rate 2011 Avg. Price / Unit 2011 Cap Rate Price / Unit Change Since 2010 Basis Point Change Since 2011 IL & AL $175,206 8.3% $162,400 8.8% +$12,806-30 AL $179,895 8.6% $156,900 9.0% +$22,995-40 SNF $49,600 13.0% $51,100 12.6% -$1,500 +40 *The Senior Care Acquisition Report, 17 th Edition, published by Irving Levin Associates, Inc. Table 2 shows a year-over-year comparison indicating that average capitalization rates have continued to decrease for combined IL and AL. Stand alone AL decreased by 40 basis points while SNFs were 40 basis points higher to 13%. SALES COMPARISON APPROACH The market approach postulates that the total value of the business directly relates to the prices of comparable centers. The reliability of the approach depends on (a) the degree of comparability of the center appraised with each sale or listing, (b) the length of time since the sale, (c) the accuracy of the sale data, and (d) the absence of unusual conditions affecting the sale. 21

The sales comparison approach draws heavily on the principle of substitution, which states that a prudent investor will pay no more for any particular center than it would cost to acquire an equally desirable alternative center. The process involves making adjustments between the subject and comparable centers, with the subject as a standard; the appraiser adjusts the sale price of the comparable center to arrive at an indication of market value for the subject. SALES GRID ANALYSIS The following are characteristics and elements of comparison as described in The Appraisal of Real Estate, 13 th Edition. Real Property Rights Conveyed Financing Terms Conditions of Sale Market Conditions (Time Adjustment) Location Physical Characteristics Economic Characteristics Use/Zoning Non-Realty Components of Value Comparable sales typically vary with respect to physical aspects such as the location, size, age, condition, and construction quality, as well as with respect to the operations such as the acuity of residents and the management team s experience. Other factors include specific conditions of the particular sale such 22

as financing arrangements, the sale date, the supply/demand relationship within the PMA, and barriers to entry such as licensing requirements. Since there are so many variables impacting each center s sale price and few comparable transactions, the most supportable and reliable adjustment method is a net operating income adjustment which is a single adjustment that inherently recognizes all of the differences between the subject and the comparables. The adjustment formula is as follows: Subject s Historical NOI per unit/bed Comparable NOI per unit/bed Comparable NOI per unit/bed This is an appropriate adjustment for operating seniors housing communities with a business component because when market participants price these communities on a per-unit basis, their primary consideration is the profitability of the units, not necessarily the number of units or other features of the community. 23

Table 3 24

EGIM ANALYSIS In addition to making adjustments to the improved sales, one additional technique examines the indicated EGIM and NOI per bed of each sale comparable. This method compares the subject s income characteristics with those of the comparable centers and develops a revenue multiplier that is appropriate for the subject. Typically, higher NOI per bed is correlated with higher EGIMs, which supports the validity of the EGIM analysis. Table 4 and 5 shows the regression analysis of the EGIM to NOI per bed based on our study of approximately 150 assisted living transaction and 60 skilled nursing transactions: TABLE 4: CORRELATION OF EGIM TO NOI PER BED ASSISTED LIVING $30,000 $25,000 $20,000 $15,000 NOI/Bed $10,000 $5,000 $0 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 25

TABLE 5: CORRELATION OF EGIM TO NOI PER BED SKILLED NURSING $16,000 $14,000 $12,000 $10,000 $8,000 $6,000 NOI/Bed $4,000 $2,000 $0 0.00 0.50 1.00 1.50 2.00 2.50 RECONCILIATION OF VALUE Depending on the circumstances of an appraisal, these approaches to value apply to various degrees. Cost approach usually receives the most weight when the improvements are new or nearly new and when they are fully utilized. Income approach indicates the amount at which a prudent investor might be interested in acquiring the center. Sales comparison approach reflects demand and reasonable selling price expectancy as evidenced by sales and listings of similar centers. The As-Is value is based on the current operations and unit count, while an As-Complete and Stabilized is based on the proposed unit count and the forecasted stabilized operations. 26