10-K405: Annual report [Sections 13 and 15(d), S-K Item 405]

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K

(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

Commission file number: 1-11314

LTC PROPERTIES, INC.
(Exact name of Registrant as specified in its charter)

MARYLAND 71-0720518
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

300 Esplanade Drive, Suite 1860
Oxnard, California 93030
(Address of principal executive offices)

Registrant's telephone number, including area code: (805) 981-8655

Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange on
Title of Stock which registered
-------------- -------------------------
Common stock, $.01 Par Value New York Stock Exchange
9.50% Series A Cumulative Preferred
Stock, $.01 Par Value New York Stock Exchange
9.00% Series B Cumulative Preferred
Stock, $.01 Par Value New York Stock Exchange
8.50% Convertible Subordinated
Debentures due 2001 New York Stock Exchange
7.75% Convertible Subordinated
Debentures due 2002 New York Stock Exchange
8.25% Convertible Subordinated
Debentures due 2001 New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark whether the Company (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the Company
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this 10-K or any amendment
to this Form 10-K. |X|

The aggregate market value of voting stock held by non-affiliates of the
Company is approximately $303,587,000 as of March 19, 1999.

27,407,096
(Number of shares of common stock outstanding as of March 19, 1999)

Part III is incorporated by reference from the Company's definitive
proxy statement for the Annual Meeting of Stockholders to be
held on May 25, 1999.

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Item 1. BUSINESS

General

LTC Properties, Inc., a health care real estate investment trust (a "REIT"), was
organized on May 12, 1992 in the State of Maryland and commenced operations on
August 25, 1992. We invest primarily in long-term care and other health care
related facilities through mortgage loans, facility lease transactions and other
investments. During 1998, we began making investments in the education industry
by investing in private and charter schools from pre-school through eighth
grade. Our primary objective is to provide current income for distribution to
stockholders through real estate investments in long-term care facilities and
other health care related facilities managed by experienced operators providing
quality care. To meet this objective, we attempt to invest in properties that
provide opportunity for additional returns to our stockholders and diversify our
investment portfolio by geographic location, operator and form of investment.

In accordance with "plain English" guidelines provided by the Securities and
Exchange Commission, whenever we refer to "our company" or to "us," or use the
terms "we" or "our," we are referring to LTC Properties, Inc. and its
subsidiaries.

We were organized to qualify, and intend to continue to qualify, as a REIT. So
long as we qualify, with limited exceptions, we may deduct distributions to our
stockholders from our taxable income. We have made distributions, and intend to
continue to make distributions to our stockholders, in order to eliminate any
federal tax liability.

At December 31, 1998, we had a gross investment portfolio (adjusted to include
mortgage loans to third parties underlying our investment in REMIC certificates)
of $918,085,000. Our investments consisted of $636,774,000 in 274 skilled
nursing facilities with 31,276 beds, $254,861,000 in 90 assisted living
facilities with 4,301 units and $26,450,000 in six schools. The properties in
our portfolio are operated by 74 healthcare providers and two education
providers in 36 states.

Owned Properties. During 1998, we acquired seven skilled nursing facilities with
a total of 816 beds, 23 assisted living residences with a total of 1,500 units
and five schools for a gross purchase price of $161,001,000 (includes the
conversion of construction loans of $7,301,000) and invested approximately
$3,624,000 in the expansion and improvement of existing properties. We also sold
three skilled nursing facilities in which we had an initial investment of
$7,654,000 for gross proceeds of $16,706,000.

Our long-term facilities are leased to operators pursuant to long-term operating
leases that generally have an initial term of 10 to 12 years and provide for
increases in the rent based upon specified rent increases, increases in revenues
over defined base periods, or increases based on consumer price indices. Each
lease is a triple net lease that requires the lessee to pay all taxes,
insurance, maintenance and other costs of the facilities.

Mortgage Loans. As part of our strategy of making long-term investments in
properties used in the provision of long-term health care services, we provide
mortgage financing on such properties based on our established investment
underwriting criteria. (See "Investment and Other Policies" in this Section.) We
also provide construction loans that by their terms convert into purchase/lease
transactions or permanent financing mortgage loans upon completion of
construction. During 1998, we originated mortgage loans of $47,452,000, net of
construction loans of $5,467,000 that converted to permanent mortgage financing,
secured by six skilled nursing facilities with 762 beds, 11 assisted living
facilities with 471 units and one school.

We maintain a long-term investment interest in mortgages we originate either
through the direct retention of the mortgages or through the retention of REMIC
certificates originated in our securitizations. We are a


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REIT and, as such, make our investments with the intent to hold them for
long-term purposes. However, we may securitize a portion of our mortgage loan
portfolio when a securitization provides us with the best available form of
capital to fund additional long-term investments. In addition, we believe that
the REMIC certificates we retain from our securitizations provide our
stockholders with a more diverse real estate investment while maintaining the
returns we desire.

REMIC Certificates. We complete a securitization by transferring mortgage
loans to a newly created Real Estate Mortgage Investment Conduit ("REMIC")
which, in turn, issues mortgage pass-through certificates aggregating
approximately the same amount. A portion of the REMIC certificates are sold
to third parties and a portion of the REMIC certificates are retained by us.
The REMIC certificates we retain are subordinated in right of payment to the
REMIC certificates sold to third parties. A portion of the REMIC certificates
we retain are interest-only certificates which have no principal amount and
entitle us to receive cash flows designated as interest. In 1998, we
completed the securitization of approximately $129,300,000 of mortgage loans
and $26,400,000 face amount ($20,700,000 carrying value) of subordinated
REMIC certificates retained from a securitization we completed in 1993. In
the securitization, we sold approximately $121,400,000 face amount of senior
certificates at a weighted average pass-through rate of 6.3% and retained
$34,300,000 face amount of subordinated certificates along with the interest
only certificates. The subordinated and interest only certificates we
retained had an aggregate fair value of approximately $41,400,000 at the time
of the securitization and a weighted average effective yield of 18.9%. Prior
to 1997, we securitized mortgage loans with an aggregate outstanding
principal of approximately $354,827,000. At December 31, 1998, we had
investments in REMIC certificates with an estimated fair value of
$100,595,000.

Financing and Other Transactions. During 1998, we issued 2,000,000 shares of
8.5% Series C Convertible Preferred Stock in a private placement at $19.25 per
share for net proceeds of $37,605.000. The Series C Preferred Stock is
convertible into 2,000,000 shares of our common stock, has a liquidation value
of $19.25 per share and has an annual coupon of 8.5% payable quarterly.

We have a $170,000,000 Senior Unsecured Revolving Line of Credit that expires on
October 3, 2000. As of December 31, 1998, borrowings of $100,000,000 bearing
interest at LIBOR plus 1.25% were outstanding under the revolving credit
facility. Subsequent to December 31, 1998, we obtained a $25,000,000 term loan
that bears interest at LIBOR plus 1.25% and matures on October 2, 2000.

Distribution of LTC Healthcare, Inc. During 1998, we acquired 4,002 shares of
LTC Healthcare non-voting common stock for $2,001,000 in cash. We also
contributed equity securities with a book value of $788,000, 13 real estate
properties with a net book value of $61,462,000 that were encumbered by
mortgage debt of $29,263,000 and a minority interest liability of $3,461,000
on seven of the properties, and other related assets and liabilities with a
book value of $93,000 in exchange for an additional 36,000 shares of LTC
Healthcare non-voting common stock and borrowings by LTC Healthcare under an
unsecured line of credit provided by the Company of $21,396,000. Subsequent
to the contribution of the above assets and liabilities to LTC Healthcare,
they obtained mortgage financing of $17,400,000 from a third-party lender on
four of the unencumbered properties. LTC Healthcare utilized proceeds from
the mortgage debt and cash on hand to repay borrowings of $17,668,000 under
the unsecured line of credit. On September 30, 1998, the 40,002 shares of LTC
Healthcare non-voting common stock we held were converted into 3,335,882
shares of LTC Healthcare voting common stock. Concurrently, we completed the
spin-off of all LTC Healthcare voting common stock through a taxable dividend
distribution to the holders our common stock, Cumulative Convertible Series C
Preferred Stock and convertible subordinated debentures. One share of LTC
Healthcare common stock was distributed to each holder of LTC common stock,
Series C Preferred Stock and convertible subordinated debentures for each ten
shares of our common stock owned or that would have been issued upon
conversion of the convertible subordinated

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debentures and Series C Preferred Stock. Upon completion of the distribution,
LTC Healthcare began operating as a separate public company.

Investment and Other Policies

Objectives and Policies. We currently invest primarily in income-producing
long-term care facilities. Our investments consist of:

o mortgage loans secured by long-term care facilities;

o fee ownership of long-term care facilities which are leased to operators;
or

o participation in such investments indirectly through investments in
partnerships, joint ventures or other entities that themselves make direct
investments in such loans or facilities.

In evaluating potential investments, we consider such factors as:

o type of property;

o the location;

o construction quality, condition and design of the property;

o the property's current and anticipated cash flow and its adequacy to meet
operational needs and lease obligations or debt service obligations;

o the quality and reputation of the property's operator;

o the growth, tax and regulatory environments of the communities in which
the properties are located;

o the occupancy and demand for similar facilities in the area surrounding
the property, and

o the Medicaid reimbursement policies and plans of the state in which the
property is located.

We place primary emphasis on investing in long-term care facilities that have
low investment per bed/unit ratios and do not have to rely on the provision of
ancillary services to cover debt service or lease obligations. In addition, with
respect to skilled nursing facilities, we attempt to invest in facilities that
do not have to rely on a high percentage of private pay patients. We seek to
invest in facilities that are located in suburban and rural areas of states with
improving reimbursement climates. Prior to every investment, we conduct a
facility site review to assess the general physical condition of the facility,
the potential of additional sub-acute services and the quality of care the
operator provides. In addition, we review the environmental reports, state
survey and financial statements of the facility before the investment is made.
We prefer to invest in a facility that has a significant market presence in its
community and where state licensing procedures limit the entry of competing
facilities. Historically, the majority of our investments consisted of mortgage
loans secured by skilled nursing facilities. Due to our belief that assisted
living facilities are an increasingly important sector in the long-term care
market, the majority of our investments in recent years has consisted of direct
ownership of assisted living facilities. We believe that assisted living
facilities represent a lower cost long-term care alternative for senior adults
than skilled nursing facilities. We invest primarily in assisted living
facilities that attract the moderate-income private pay patients in smaller
communities, preferably in states that have adopted Medicaid waiver programs or
are in the process of adopting or reviewing their policies and reimbursement
program to provide funding for assisted living residences. We believe that
locating residences in a state with a favorable regulatory reimbursement climate
should provide a stable source of residents eligible for Medicaid reimbursement
to the extent private-pay residents are not available, and should provide
alternative sources of income for residents when their private funds are
depleted and they become Medicaid eligible.


4

The only limitations regarding investments in any one type of property or joint
venture are:

o our Board of Directors has authorized us to invest up to 30% of our
adjusted gross real estate investment portfolio (adjusted to include
mortgage loans to third parties underlying the investment in REMIC
certificates) in assisted living facilities, and

o the terms of our existing revolving credit facility limit our investments
in the education and child care industry to $75 million and limit our
investments outside of health care real estate and the education and child
care industry to $20 million.

Borrowing Policies. We may incur additional indebtedness when, in the opinion of
our Board of Directors, it is advisable. We may incur such indebtedness to make
investments in additional long-term care facilities or to meet the distribution
requirements imposed upon REITs under the Internal Revenue Code of 1986, as
amended. For other short-term purposes, we may, from time to time, negotiate
lines of credit, or arrange for other short-term borrowings from banks or
otherwise. We may also arrange for long-term borrowings through public offerings
or from institutional investors.

In addition, we may incur mortgage indebtedness on real estate which we have
acquired through purchase, foreclosure or otherwise. We may also obtain mortgage
financing for unleveraged or underleveraged properties in which we have invested
or may refinance properties acquired on a leveraged basis. There is no
limitation on the number or amount of mortgages that may be placed on any one
property, and we have no policy with respect to limitations on borrowing,
whether secured or unsecured.

Prohibited Investments and Activities. Our policies, which are subject to change
by our Board of Directors without stockholder approval, impose certain
prohibitions and restrictions on various of our investment practices or
activities including prohibition against:

o acquiring any real property unless the consideration paid for such real
property is based on the fair market value of the property;

o investing in any junior mortgage loan unless by appraisal or other method,
the directors determine that

(a) the capital invested in any such loan is adequately secured on the
basis of the equity of the borrower in the property underlying such
investment and the ability of the borrower to repay the mortgage
loan; or

(b) such loan is a financing device we enter into to establish the
priority of our capital investment over the capital invested by
others investing with us in a real estate project;

o investing in commodities or commodity futures contracts (other than
interest rate futures, when used solely for hedging purposes);

o investing more than 1% of our total assets in contracts for sale of real
estate unless such contracts are recordable in the chain of title;

o holding equity investments in unimproved, non-income producing real
property, except such properties as are currently undergoing development
or are presently intended to be developed within one year, together with
mortgage loans on such property (other than first mortgage development
loans), aggregating to more than 10% of our assets.

Competition

We compete with other REITs, real estate partnerships, health care providers and
other investors, including commercial banks, institutional banks and insurance
companies, many of which will have greater financial resources and lower cost of
funds than we do, in the acquisition, leasing and financing of long-term care


5

facilities. The operators compete on a local and regional basis with operators
of facilities that provide comparable services. Operators compete for patients
based on quality of care, reputation, physical appearance of facilities,
services offered, family preferences, physician referrals, staff and price.

Insurance

We obtain title insurance with respect to each of our investments. We
generally require: (i) with respect to each owned property, an American Land
Title Association Extended Coverage Owner's Policy of Title Insurance with an
insured amount equal to the purchase price, insuring that we hold fee simple
title to the property subject only to those liens and encumbrances approved
by us; and (ii) with respect to each mortgaged property, an American Land
Title Association Extended Coverage Lender's Policy of Title Insurance with
an insured amount equal to the loan amount, insuring our first-lien security
interest in the property subject only to those liens and encumbrances
approved by us. However, American Land Title Association Extended Coverage
Policies of Title Insurance are not available in all states, in which event
we require the broadest form of title coverage available in the particular
jurisdiction.

In addition, we require that our tenants (in the case of owned properties) and
borrowers (in the case of mortgaged properties) maintain comprehensive liability
insurance and casualty insurance with policy specifications and insured limits
customarily carried for similar properties and cause their insurers to name us
as an additional insured, loss payee and/or mortgagee, as appropriate depending
on the particular type of policy. In the case of casualty insurance, the insured
limits may not be less than the full replacement cost of the improvements
constructed on the property, and coverage is typically provided in the form of
an "all-risk" policy. However, there are certain types of losses that may either
be uninsurable or not economically insurable. For example, we generally require
our tenants and borrowers to carry flood insurance if the property is located
within a flood plain area as designated by the applicable governmental
authority, and earthquake insurance if the property is located in a state, such
as California, where the risk of earthquake damage is high. Such flood and
earthquake coverage is not always an insurable risk or may not be obtainable in
amounts at least equal to the full replacement cost of the improvements
constructed on the property. Accordingly, there is no assurance that adequate
coverage exists with respect to each investment should there be serious
flooding, seismic activities or other uninsurable casualty in the areas where
the properties constituting our investments are located. Should an uninsured (or
less than fully insured) loss occur, we could lose its investment in, and
anticipated profits and cash flow from, a property.

Employees

We currently employ 21 persons.

Government Financing and Regulation of Health Care

General. Both the federal and state governments are significant sources of
revenues for the operators of skilled nursing facilities who lease properties
from us or who have borrowed money from us and used their properties as
collateral for those borrowings. In addition, the skilled nursing facilities and
our other tenants and borrowers who provide health care related services are
often subject to extensive government regulation.

Government Financing. Medicare is a federal program that provides certain health
care benefits to beneficiaries who are 65 years of age or older, are disabled,
or qualify for the End Stage Renal Disease program. Historically, Medicare
covered the reasonable costs of certain post-hospital extended care services
furnished by skilled nursing facilities, including capital-related costs,
subject to limits on routine operating and capital-related costs.


6

Medicaid is a program of medical assistance, funded jointly by the federal
government and the states for certain needy individuals and their dependents,
and certain other eligible persons. Under Medicaid, the federal government
provides grants to states that have medical assistance programs that are
consistent with federal standards. Medicaid programs or the equivalent are
currently in existence in all of the states in which we have nursing facility
investments. While these programs differ in certain respects from state to
state, they are all subject to certain federally imposed requirements, as a
substantial portion of the funds available under these programs is provided by
the federal government. Medicaid programs provide for payments to participating
health care facilities on behalf of the indigent and certain other eligible
persons. California and Texas provide for reimbursement at flat daily rates, as
determined by the responsible state agency and depending on certain levels of
care. In all other states, payments are based upon specific cost reimbursement
formulas established by the applicable state.

Up until July 1, 1998, Medicare and most state Medicaid programs utilized a
cost-based reimbursement system for skilled nursing facilities which reimbursed
these facilities for the reasonable direct and indirect allowable costs incurred
in providing routine services plus, in certain states, a return on equity,
subject to certain cost ceilings. These costs normally included allowances for
administrative and general costs as well as the costs of property and equipment
(depreciation and interest, fair rental allowance or rental expense). In certain
states, cost-based reimbursement was typically subject to retrospective
adjustment through cost report settlement, and for certain states, payments made
to a facility on an interim basis that were subsequently determined to be less
than or in excess of allowable costs could be adjusted through future payments
to the affected facility and to other facilities owned by the same owner. State
Medicaid reimbursement programs varied as to the methodology used to determine
the level of allowable costs which were reimbursed to operators.

o Prospective Payment System

Beginning on July 1, 1998, the congressionally mandated prospective
payment system was implemented for skilled nursing facilities. Under the
prospective payment system, skilled nursing facilities are paid a case-mix
adjusted federal per diem rate for Medicare-covered services provided by
skilled nursing facilities. The per diem rate is calculated to cover
routine service costs, ancillary costs and capital-related costs. The
phased-in implementation of the prospective payment system for skilled
nursing facilities began with the first cost-reporting period beginning in
fiscal years starting on or after July 1, 1998. The prospective payment
system is expected to be fully implemented over three such cost-reporting
periods. The effect of the implementation of the prospective payment
system on a particular skilled nursing facility will vary in relation to
the amount of revenue derived from Medicare patients for each skilled
nursing facility.

Skilled nursing facilities may need to restructure their operations to
accommodate the new Medicare prospective payment system reimbursement. In
part because of the uncertainty as to the effect of the prospective
payment system on skilled nursing facilities, in November 1998, Standard
and Poor's, an international rating agency that provides credit analysis
and information through the rating of financial instruments, placed many
skilled nursing facility companies on a "credit watch" because of the
potential negative impact of the implementation of the prospective payment
system on the financial condition of skilled nursing facilities, including
the ability to make interest and principal payments on outstanding
borrowings. In early March 1999, Standard & Poor's lowered the ratings of
several skilled nursing facility companies, including companies that
operate skilled nursing facilities in which we invest, because of the
impact of the implementation of the prospective payment system,
particularly those companies with substantial debt.


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o Balanced Budget Act of 1997

The Balanced Budget Act of 1997 signed by President Clinton on August 5,
1997 is expected to produce billions in net savings for the Federal
government. In addition, the Balanced Budget Act repealed the Boren
Amendment under which states were required to pay long-term care
providers, including skilled nursing facilities, rates that are
"reasonable and adequate to meet the cost which must be incurred by
efficiently and economically operated facilities." As a result of the
repeal of the Boren Amendment, states are now required by the Balanced
Budget Act to:

o use a public process for determining rates,

o publish proposed and final rates, the methodologies underlying the
rates, and justifications for the rates, and

o give methodologies and justifications.

During rate-setting procedures, states are required to take into account
the situation of facilities that serve a disproportionate number of
low-income patients with special needs. The Secretary of the Department of
Health and Human Services is required to study and report to Congress
within four years concerning the effect of state rate-setting
methodologies on the access to and the quality of services provided to
Medicaid beneficiaries. The Balanced Budget Act also provides the federal
government with expanded enforcement powers to combat waste, fraud and
abuse in delivery of health care services. Though applicable to payments
for services furnished on or after October 1, 1997, the new requirements
are not retroactive. Thus, states that have not proposed changes in their
payment methods or standards, or changes in rates for items and services
furnished on or after October 1, 1997, need not immediately implement a
Balanced Budget Act public approval process.

The Balanced Budget Act also created the Medicare+Choice program which
provides a variety of options for individuals entitled to Medicare Part A
and enrolled in Medicare Part B. The options include coordinated care
plans (including provider-sponsored organization plans), private fee for
service plans, and medical savings accounts plans. Medicare+Choice is
effective as of January 1, 1999. It is not possible at this time to
predict with any certainty the effect of Medicare+Choice on our tenants
and borrowers.

Both the Medicare and Medicaid programs contain specific requirements which must
be adhered to at all times by health care facilities in order to qualify under
the programs. The Medicare and Medicaid programs are subject to statutory and
regulatory changes, administrative rulings, interpretations of policy,
intermediary determinations and governmental funding restrictions, all of which
may materially increase or decrease program reimbursement to health care
facilities. No assurance can be given as to whether the future funding of such
programs will remain at levels comparable to the present levels.

Anti-Fraud Laws and Regulations. There are various federal and state laws
prohibiting fraud by health care providers, including criminal provisions which
prohibit filing false claims or making false statements to receive payment or
certification under Medicare and Medicaid, or failing to refund overpayments or
improper payments. Violation of these federal provisions is a felony punishable
by up to five years imprisonment and/or $25,000 fines. Civil provisions prohibit
the knowing filing of a false claim or the knowing use of false statements to
obtain payment. The penalties for such a violation are fines of not less than
$5,000 nor more than $10,000, plus treble damages, for each claim filed.

There are also laws which govern referrals and financial relationships. The
federal Anti-Kickback Law prohibits, among other things, the offer, payment,
solicitation or receipt of any form of remuneration in


8

return for, or to induce, the referral of Medicare and Medicaid patients. A wide
array of relationships and arrangements, including ownership interests in a
company by persons who refer or who are in a position to refer patients, as well
as personal services agreements, have under certain circumstances, been alleged
or been found to violate these provisions. In addition to the Anti-Kickback
Statute, the federal government restricts certain financial relationships
between physicians and other providers of health care services.

State and federal governments are devoting increasing attention and resources to
anti-fraud initiatives against health care providers. The Health Insurance
Portability and Accountability Act of 1996 and the Balanced Budget Act expand
the penalties for health care fraud, including broader provisions for the
exclusion of providers from the Medicare and Medicaid programs. Further, under
Operation Restore Trust, a major anti-fraud demonstration project, the Office of
Inspector General of the U.S. Department of Health and Human Services, in
cooperation with other federal and state agencies, has focused on the activities
of skilled nursing facilities, home health agencies, hospices and durable
medical equipment suppliers in certain states in which we have properties. Due
to the success of Operation Restore Trust, the project has been expanded to
numerous other states and to additional providers including providers of
ancillary nursing home services.

Based upon information we periodically receive from our operators over the terms
of their respective leases and loans, we believe that the nursing facilities in
which we have investments are in substantial compliance with the various
regulatory requirements applicable to them, although there can be no assurance
that the operators are in substantial compliance or will remain in compliance in
the future.

Other Regulatory and Licensing Requirements. In addition to the requirements to
be met by skilled nursing facilities for participation in the Medicare and
Medicaid programs, skilled nursing facilities are subject to regulatory and
licensing requirements of federal, state and local authorities. The operator of
each skilled nursing facility is licensed annually by the board of health or
other applicable agency in each state. In granting and renewing licenses,
regulatory agencies consider, among other things, the physical buildings and
equipment, the qualifications of the administrative personnel and nursing staff,
the quality of care and continuing compliance with the laws and regulations
relating to the operation of the facilities. State licensing of facilities is a
prerequisite to certification under the Medicare and Medicaid programs. In the
ordinary course of business, the operators receive notices of deficiencies for
failure to comply with various regulatory requirements and take appropriate
corrective and preventive actions. We believe that the nursing facilities in
which we have investments are in compliance with the applicable licensing or
other regulation although there can be no assurance that the operators are or
will be in compliance at any time.

We have increased our investments in assisted living facilities in recent years.
Assisted living facilities are subject to certain state regulations and
licensing requirements. To qualify as a state licensed facility, assisted living
facilities must comply with regulations which address, among other things,
staffing, physical design, required services and resident characteristics.
Assisted living facilities are also subject to various local building codes and
other ordinances, including fire safety codes. These requirements vary from
state to state and are monitored to varying degrees by state agencies.

Currently, assisted living facilities are not regulated as such by the federal
government. State standards required for assisted living facility providers are
less stringent than those required of other licensed health care operators.
There can be no assurance that federal regulations governing the operation of
assisted living facilities will not be implemented in the future or that
existing state regulations will not be expanded. In addition, only certain
states have adopted laws or regulations permitting individuals with higher
acuity levels to remain in assisted living communities who may otherwise qualify
for placement in a nursing facility. While only certain states presently provide
for any Medicaid reimbursement for assisted living residences, several states
are currently reviewing their policies and reimbursement programs to provide
funding for


9

assisted living residences. There can be no assurance that such states will
adopt the Medicaid waiver program.

Uncertainty of Health Care Reform

The health care industry is facing various challenges, including increased
government and private payor pressure on health care providers to control costs.
The pressure to control health care costs intensified during 1994 and 1995 as a
result of the national health care reform debate and continues into 1999 as
Congress attempted to slow the rate of growth of federal health care
expenditures as part of its effort to balance the federal budget.

The Balanced Budget Act enacted significant changes to the Medicare and Medicaid
programs designed to "modernize" payment and health care delivery systems while
achieving substantial budgetary savings. In seeking to limit Medicare
reimbursement for long term care services, Congress established the prospective
payment system for skilled nursing facility services to replace the cost-based
reimbursement system. In addition, there are numerous initiatives at the federal
and state levels for comprehensive reforms affecting the payment for and
availability of health care services. Congress and state legislatures can be
expected to continue to review and assess alternative health care delivery
systems and payment methodologies. Changes in the law, new interpretations of
existing laws, or changes in payment methodology may have a dramatic effect on
the definition of permissible or impermissible activities, the relative costs
associated with doing business and the amount of reimbursement by the government
and other third party payors.

In light of forthcoming regulations and continuing state Medicaid program
reform, no assurance can be given that the implementation of such regulations
and reform will not have a material adverse effect on our financial condition or
results of operations.

Taxation of our Company

General. Our management believes that we have been organized and have operated
in such a manner as to qualify for taxation as a REIT under Sections 856 to 860
of the Internal Revenue Code of 1986, as amended, commencing with our taxable
year ended December 31, 1992, and we intend to continue to operate in such a
manner. No assurance can be given that we have operated or will be able to
continue to operate in a manner so as to qualify or to remain so qualified. This
summary is qualified in its entirety by the applicable Internal Revenue Code
provisions, rules and regulations, and administrative and judicial
interpretations.

If we qualify for taxation as a REIT, we will generally not be subject to
federal corporate income taxes on our net income that is currently distributed
to stockholders. This treatment substantially eliminates the "double taxation"
(i.e., at the corporate and stockholder levels) that generally results from
investment in a corporation. However, we will continue to be subject to federal
income tax under certain circumstances.

Requirements for Qualification. The Internal Revenue Code defines a REIT as a
corporation, trust or association:

(1) which is managed by one or more trustees or directors;

(2) the beneficial ownership of which is evidenced by transferable
shares, or by transferable certificates of beneficial interest;

(3) which would be taxable, but for Sections 856 through 860 of the
Internal Revenue Code, as a domestic corporation;


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(4) which is neither a financial institution nor an insurance company
subject to certain provisions of the Internal Revenue Code;

(5) the beneficial ownership of which is held by 100 or more persons;

(6) during the last half of each taxable year not more than 50% in value
of the outstanding stock of which is owned, actually or
constructively, by five or fewer individuals (including specified
entities); and

(7) which meets certain other tests, described below, regarding the
amount of its distributions and the nature of its income and assets.

The Internal Revenue Code provides that conditions (1) to (4), inclusive, must
be met during the entire taxable year and that condition (5) must be met during
at least 335 days of a taxable year of 12 months, or during a proportionate part
of a taxable year of less than 12 months.

Income Tests. There presently are two gross income requirements that we must
satisfy to qualify as a REIT:

o First, at least 75% of our gross income (excluding gross income from
"prohibited transactions," as defined below) for each taxable year
must be derived directly or indirectly from investments relating to
real property or mortgages on real property, including rents from
real property, or from certain types of temporary investment income.

o Second, at least 95% of our gross income (excluding gross income
from prohibited transactions) for each taxable year must be derived
from income that qualifies under the 75% test and all other
dividends, interest and gain from the sale or other disposition of
stock or securities.

A "prohibited transaction" is a sale or other disposition of property (other
than foreclosure property) held for sale to customers in the ordinary course of
business. Any gain realized from a prohibited transaction is subject to a 100%
penalty tax.

Asset Tests. We, at the close of each quarter of our taxable year, must also
satisfy three tests relating to the nature of our assets.

o First, at least 75% of the value of our total assets must be
represented by real estate assets (including stock or debt
instruments held for not more than one year purchased with the
proceeds of a stock offering or long-term (at least five years)
public debt offering of our company), cash, cash items and
government securities.

o Second, not more than 25% of our total assets may be represented by
securities other than those in the 75% asset class.

o Third, of the investments included in the 25% asset class, the value
of any one issuer's securities owned by us may not exceed 5% of the
value of our total assets and we may not own more than 10% of any
one issuer's outstanding voting securities.

Ownership of a Partnership Interest or Stock in a Corporation. We own interests
in various partnerships. In the case of a REIT that is a partner in a
partnership, Treasury regulations provide that for purposes of the REIT income
and asset tests the REIT will be deemed to own its proportionate share of the
assets of the partnership, and will be deemed to be entitled to the income of
the partnership attributable to such share. The ownership of an interest in a
partnership by a REIT may involve special tax risks, including


11

the challenge by the Internal Revenue Service of the allocations of income and
expense items of the partnership, which would affect the computation of taxable
income of the REIT, and the status of the partnership as a partnership (as
opposed to an association taxable as a corporation) for federal income tax
purposes.

We also own interests in a number of subsidiaries which are intended to be
treated as qualified real estate investment trust subsidiaries. The Internal
Revenue Code provides that such subsidiaries will be ignored for federal income
tax purposes and all assets, liabilities and items of income, deduction and
credit of such subsidiaries will be treated as assets, liabilities and such
items of our company.

We further own 100% of the nonvoting preferred stock in one subsidiary, LTC
Development Company, Inc., which represents approximately 99% of the economic
value of all classes of stock of LTC Development. LTC Development does not
qualify for treatment as a qualified REIT subsidiary.

If any partnership or qualified real estate investment trust subsidiary in which
we own an interest were treated as a regular corporation (and not as a
partnership or qualified real estate investment trust subsidiary) for federal
income tax purposes, we would likely fail to satisfy the REIT asset test
prohibiting a REIT from owning greater than 10% of the voting power of the stock
of any issuer, as described above, and would therefore fail to qualify as a
REIT. We believe that each of the partnerships and subsidiaries in which we own
an interest (except LTC Development) will be treated for tax purposes as a
partnership or qualified real estate investment trust subsidiary, respectively,
although no assurance can be given that the Internal Revenue Service will not
successfully challenge the status of any such organization.

President Clinton's fiscal year 2000 budget proposal contains a provision which
would amend the Internal Revenue Code to prohibit REITs from owning stock of a
corporation (other than a qualified real estate investment trust subsidiary)
possessing greater than 10% of the voting power or value of all classes of stock
of such corporation. This proposal would be effective with respect to stock
acquired on or after the date of the first Congressional committee action with
respect to the proposal. In addition, to the extent that a REIT's ownership of
stock in a subsidiary corporation is exempt from this proposal by virtue of the
proposal's effective date, such "grandfathered" status would terminate if such
subsidiary corporation (1) engaged in a trade or business in which it was not
engaged on the date of the first Congressional committee action on the proposal,
or (2) acquired substantial new assets on or after such date. In the event that
such grandfathered status were so terminated with respect to LTC Development,
and we did not dispose of our interest in LTC Development, we would fail the
third asset test discussed above and therefore fail to qualify as a REIT.

REMIC. A regular or residual interest in a REMIC will be treated as a real
estate asset for purposes of the REIT asset tests, and income derived with
respect to such interest will be treated as interest on an obligation secured by
a mortgage on real property, assuming that at least 95% of the assets of the
REMIC are real estate assets. If less than 95% of the assets of the REMIC are
real estate assets, only a proportionate share of the assets of and income
derived from the REMIC will be treated as qualifying under the REIT asset and
income tests. We believe that our REMIC interests fully qualify for purposes of
the REIT income and asset tests.

Annual Distribution Requirements. In order to qualify as a REIT, we are required
to distribute dividends (other than capital gain dividends) to our stockholders
annually in an amount at least equal to

(1) the sum of:

(A) 95% of our "real estate investment trust taxable income"
(computed without regard to the dividends paid deduction and our net
capital gain); and


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(B) 95% of the net income, if any (after tax), from foreclosure
property; minus

(2) the excess of certain items of non-cash income over 5% of our real
estate investment trust taxable income.

These annual distributions must be paid in the taxable year to which they
relate, or in the following taxable year if:

o declared before we timely file our tax return for such year;

o paid on or before the first regular dividend payment date after such
declaration; and

o we so elect and specify the dollar amount in our tax return.

Amounts distributed must not be preferential; that is, every stockholder of the
class of stock with respect to which a distribution is made must be treated the
same as every other stockholder of that class, and no class of stock may be
treated otherwise than in accordance with its dividend rights as a class.

To the extent that we do not distribute all of our net long-term capital gain or
distribute at least 95%, but less than 100%, of our "real estate investment
trust taxable income," as adjusted, it will be subject to tax on such amounts at
regular corporate tax rates. Furthermore, if we should fail to distribute during
each calendar year (or, in the case of distributions with declaration and record
dates in the last three months of the calendar year, by the end of the following
January) at least the sum of:

(1) 85% of our real estate investment trust ordinary income for such
year;

(2) 95% of our real estate investment trust capital gain income for such
year; and

(3) any undistributed taxable income from prior periods;

we would be subject to a 4% excise tax on the excess of such required
distributions over the amounts actually distributed. Any real estate investment
trust taxable income and net capital gain on which this excise tax is imposed
for any year is treated as an amount distributed during that year for purposes
of calculating such tax.

Failure to Qualify. If we fail to qualify for taxation as a REIT in any taxable
year, and certain relief provisions do not apply, we will be subject to tax
(including any applicable alternative minimum tax) on our taxable income at
regular corporate rates. Distributions to stockholders in any year in which we
fail to qualify as a REIT will not be deductible by us, nor will any
distributions be required to be made. Unless entitled to relief under specific
statutory provisions, we will also be disqualified from taxation as a REIT for
the four taxable years following the year during which qualification was lost.
It is not possible to state whether in all circumstances we would be entitled to
the statutory relief. Failure to qualify for even one year could substantially
reduce distributions to stockholders and could result in our incurring
substantial indebtedness (to the extent borrowings are feasible) or liquidating
substantial investments in order to pay the resulting taxes.

In addition, President Clinton's fiscal year 2000 budget proposal includes a
provision which, if enacted in its present form, would result in the immediate
taxation of all gain inherent in a C corporation's assets upon an election by
such corporation to become a REIT in taxable years beginning after January 1,
2000, and thus could effectively preclude us from re-electing to be taxed as a
REIT following a loss of its REIT status.


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State and local taxation. We may be subject to state or local taxation in
various state or local jurisdictions, including those in which we transact
business or reside. The state and local tax treatment of our company may not
conform to the federal income tax consequences discussed above.

Statement Regarding Forward Looking Disclosure

Certain information contained in this annual report includes forward looking
statements, which can be identified by the use of forward looking terminology
such as "may", "will", "expect", "should" or comparable terms or negatives of
those terms. These statements involve risks and uncertainties that could cause
actual results to differ materially from those described in the statements.
These risks and uncertainties include (without limitation) the following: the
effect of economic and market conditions and changes in interest rates,
government policy relating to the health care industry including changes in
reimbursement levels under the Medicare and Medicaid programs, changes in
reimbursement by other third party payors, the financial strength of the
operators of the Company's facilities as it affects the continuing ability of
such operators to meet their obligations to the Company under the terms of the
Company's agreements with its borrowers and operators, the amount and the timing
of additional investments, access to capital markets and changes in tax laws and
regulations affecting real estate investment trusts. Exhibit 99 to this annual
report contains a more comprehensive discussion of risks and uncertainties
associated with our business.

Item 2. PROPERTIES

Investment Portfolio

At December 31, 1998, our real estate investment portfolio consisted of
investments in 274 skilled nursing facilities with 31,276 beds, 90 assisted
living facilities with 4,301 units and six schools in 36 states. We had
approximately $410,659,000 (before accumulated depreciation of $26,972,000)
invested in facilities we own and lease to operators, approximately $180,964,000
invested in mortgage loans (before allowance for doubtful accounts of
$1,250,000), and approximately $100,595,000, at estimated fair value, invested
in REMIC certificates.

Skilled nursing facilities provide restorative, rehabilitative and nursing care
for people not requiring the more extensive and sophisticated treatment
available at acute care hospitals. Many skilled nursing facilities provide
ancillary services that include occupational, speech, physical, respiratory and
IV therapies, as well as provide sub-acute care services which are paid either
by the patient, the patient's family, or through federal Medicare or state
Medicaid programs. Assisted living facilities serve elderly persons who require
assistance with activities of daily living, but do not require the constant
supervision skilled nursing facilities provide. Services are usually available
24-hours a day and include personal supervision and assistance with eating,
bathing, grooming and administering medication. The facilities provide a
combination of housing, supportive services, personalized assistance and health
care designed to respond to individual needs.

The schools in our real estate investment portfolio are charter and private
schools. Charter schools provide an alternative to the traditional public
school. Charter schools are generally autonomous entities authorized by the
state or locality to conduct operations independent from the surrounding public
school district. Laws vary by state, but generally charters are granted by state
boards of education either directly or in conjunction with local school
districts or public universities. Operators are granted charters to establish
and operate schools based on the goals and objectives set forth in the charter.
Upon receipt of a charter, schools receive an annuity from the state for each
student enrolled. Unlike public or charter schools, private schools receive a
majority of their revenues from the students' parents.


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Owned Properties. At December 31, 1998, we owned 54 skilled nursing facilities
with a total of 6,535 beds, 74 assisted living facilities with a total of 3,402
units and five schools in 24 states, representing a net investment of
approximately $383,687,000. The properties are leased pursuant to non-cancelable
leases generally with an initial term of 10 to 12 years. Many of the leases
contain renewal options and some contain options that permit the operators to
purchase the facilities.

The following table sets forth certain information regarding our owned
properties as of December 31, 1998: