With a growing number of operators and owners pruning their portfolios due to mounting financial pressures, regional players are uniquely poised to benefit
By Jane Adler
The skilled nursing sector is having a glass half-empty, half-full kind of moment. Some big providers are exiting the business figuring things can only get worse. They see real trouble ahead amid concerns about reimbursements, the growth of bundled payments and managed care, rising labor costs, and declining occupancies as payors send patients directly home rather than to nursing facilities.
Throw in the results of a national election that raises the uncertainty of the government’s role in elder care and the future of skilled nursing doesn’t look so bright.
But where some see nothing but pain, others see opportunity.
New investment groups are forming to pick up the pieces of large skilled nursing portfolios. They see an overwhelming demographic tide of needy seniors that will eventually boost the sector no matter which policies prevail. That, coupled with little new supply, means the operators and owners that tough it out could be rewarded handsomely down the road.
Regional operators are potentially emerging as the saviors of the sector, leveraging their local market knowledge and streamlined business systems. Small investors are picking up some of the slack too, as they chase the higher yields of skilled nursing compared with other commercial real estate segments.
“Long term, I’m bullish,” says Ray Lewis, CEO at Care Capital Partners (NYSE: CCP), a Chicago-based real estate investment trust (REIT) focused on skilled properties that was spun off in 2015 by Ventas, the big seniors housing and healthcare REIT.
As long as CCP picks and supports the right operating partners, Lewis predicts that those operators will make money while providing a high level of care to elders. “The industry will be terrific,” he says. “That is my fundamental belief.”
There’s little doubt that a massive reorganization is already underway. Consider the following developments:
•Kindred Healthcare, which runs 91 nursing homes and once had as many as 300 facilities, announced in November that it would exit the skilled nursing business after reporting a loss of $685 million in the third quarter of 2016. Kindred subsequently announced that it would acquire 36 skilled nursing facilities it leases from Ventas for $700 million and then find new buyers or operators.
Kindred expects to complete its exit from skilled nursing by the end of 2017 and focus instead on its home health, hospice and long-term acute care hospitals. In a third-quarter earnings call, Kindred CEO Benjamin Breier cited headwinds facing the industry as the reason for the decision, including high labor costs.
• Sabra Health Care REIT announced plans in October 2016 to sell 29 skilled facilities leased to Genesis HealthCare. Sabra CEO Richard Matros said at the time of the announcement that the sale would leave the REIT with “stronger assets.”
• HCP, a healthcare REIT, spun off its troubled HCR ManorCare portfolio in late 2016 into a new entity, Quality Care Properties, which now trades on the New York Stock Exchange under the symbol QCP.
• Welltower, a large healthcare REIT, plans to sell a 75 percent stake in a portfolio that includes 28 long-term, post-acute care facilities leased by Genesis HealthCare to Chinese investors for $930 million. The deal was expected to close by the end of 2016. Separately, Welltower is selling 64 skilled facilities for $1.1 billion to a joint venture that includes Omega Healthcare Investors.
Nursing home sales rise
Plenty of skilled nursing properties are changing hands. Transaction volume has remained fairly strong since the second half of 2014, topping more than $1 billion each quarter, according to the National Investment Center for Seniors Housing & Care (NIC) based in Annapolis, Md.
Skilled nursing transactions hit an all-time high in the second quarter of 2011, totaling $6.17 billion with an average unit price of $118,000.
The pace of transactions has increased lately, rising from $1 billion in the second quarter of 2016 to $1.2 billion in the third quarter. However, the price per unit during the same period dropped from approximately $92,000 to $89,000, according to NIC.
Anecdotally, real estate brokers say they’re flooded with skilled nursing properties for sale. “In the last 30 to 60 days we’ve been inundated with proposals from sellers,” says Ryan Saul, managing director at Senior Living Investment Brokerage headquartered in Glen Ellyn, Ill.
Private investor Michael Zamir, principal at New York-based Next HealthCare Group, is aggressively pursuing deals that make sense. “It has been somewhat challenging to close the gap between seller expectations and the true value of the business,” he says, adding that Next HealthCare is positioned to execute deals quickly and aggressively, even in today’s market.
Broker Ben Firestone observes that large portfolios no longer carry a price premium. “The sum of the parts exceeds the value of the whole (portfolio),” says Firestone, senior managing director and a founding partner at Chicago-based Blueprint Healthcare Real Estate Advisors.
Slumping occupancy numbers go a long way toward explaining the changing market dynamics in the sector. According to the NIC Skilled Nursing Data Report — which has tracked key metrics at 1,500 skilled nursing properties since 2011 — the occupancy rate fell to 82.2 percent in the second quarter of 2016, the lowest recorded level and down 156 basis points from the previous quarter. The third-quarter report, issued in December, showed a slight uptick in the occupancy rate to 82.5 percent.
Lower occupancies are widely attributed to a reduced length of stay in nursing homes due to changes in the Medicare payments system, many of which have been instituted under the Affordable Care Act (ACA). For example, managed care contracts and bundled payments, based on an episode of care, seek to shorten nursing home stays and rely more on home care in order to cut costs. The new payment models also promote narrowed provider networks, which can leave some nursing homes without referral partners.
Assuming current payment models persist under the Trump administration (see sidebar, page 27), nursing homes will have trouble filling beds, according to Sheryl Skolnick, director of research and managing director at New York-based Mizuho Securities USA. She downgraded healthcare services stocks the day after the presidential election. “It’s not a good outlook,” she says. “There is no silver lining.”
Regional companies thrive
Despite concerns, no one believes skilled nursing will disappear. There will always be seniors who need around-the-clock care. But observers expect more nursing homes to be shuttered if occupancies remain weak, raising questions about which operators and owners are best positioned to survive.
According to the most recent data available from the Centers for Medicare & Medicaid Services (CMS), in 2014 there were about 15,600 nursing homes. That number has declined over the last 10 years with the biggest decrease among large nursing homes, those with more than 200 beds.
The skilled market is valued at about $120.5 billion, according to NIC. Operators with 10 or more properties currently manage about 33 percent of skilled nursing facilities. Another 26 percent are operated by entities with two to nine properties in their portfolios, leaving 41 percent of all properties run by an individual operating company.
Single-site operators and very large operators will be challenged, say sources. Large, national companies will find it difficult to manage local markets that vary widely. Small operators may not have the resources to successfully handle a business growing in complexity. They’re also unlikely to have the resources to invest in and upgrade properties, many of which are 30 to 40 years old.
“A single property in a rural market will have a hard time,” says property broker Saul.
Regional operators that can dominate the market share in their community should do well, says Bill Kauffman, senior principal at NIC. “That’s the sweet spot.”
Skolnick, the stock analyst, says the ultimate winners in the skilled nursing space may surprise some observers. “We in the public markets underestimate the power of local operators. Their resilience is greater sometimes than the corporate owner.”
The consensus among industry experts is that the winning strategy going forward will be to concentrate holdings in certain geographic areas, thereby providing some economies of scale without the burdens of trying to manage a national portfolio. The prevailing thought is that operators poised to survive will be those that understand the local healthcare market and can deliver quality outcomes.
“We like regional operators who are well positioned,” emphasizes Lewis at CCP. He seeks operators that are experts in their local markets and provide a high level of care. Sophisticated information systems are needed to track patient outcomes — data that can be used to demonstrate value to payors and referral sources.
Avamere Health Services, a large operator for CCP, is a prime example. The Wilsonville, Ore.-based company has 42 buildings in its portfolio, 28 of which are skilled nursing communities. The properties are located in Oregon, Washington, Idaho and Colorado. Avamere also operates home health, hospice, rehab, home care and pharmacy businesses across 11 western states.
“We are able to focus time and attention on understanding specific states where we operate,” says John Morgan, CEO at Avamere. He explains that the company’s narrow geographic scope enables it to concentrate on building strong relationships with payors, regulators and health systems. “We want discharge planners to understand that if they discharge a patient to skilled nursing that we are the best choice,” says Morgan.
Avamere opened a new 60-bed skilled facility in Tacoma, Wash., in December 2016. Designed for short-term stay patients, the building is about half the size of a typical 120-bed nursing home. The company opened a facility in Salem, Ore., about 18 months ago with 80 beds.
“Appropriate sizing of the building is important,” says Morgan, explaining that skilled nursing referrals are declining overall as healthcare providers seek to reduce costs. He adds that Avamere is able to keep its buildings mostly full because of robust ties to local hospitals and physician groups.
Investors choose carefully
National Health Investors (NHI) made a regional play in April 2016. The REIT purchased eight skilled nursing facilities in Texas for $118 million. NHI partnered with The Ensign Group to operate the properties.
“We are not being scared out of the sector,” says Kevin Pascoe, executive vice president of investments at Murfreesboro, Tenn.-based NHI, which owns 73 skilled properties. He acknowledges the sector is currently facing a number of challenges, but he still believes quality operators will fare well in the long run.
The Texas portfolio gave NHI some newer assets that are positioned to compete well into the future, says Pascoe. He adds that any additional investments in skilled nursing must be a “Goldilocks scenario,” or just right.
Other investors agree. “We’re very deliberate and cautious,” says Clint Malin, executive vice president and chief investment officer at LTC Properties Inc. (NYSE: LTC).
Approximately 55 percent of LTC’s revenues are derived from skilled nursing centers, comprising 97 properties in the portfolio as of third-quarter 2016. The company, based in Westlake Village, Calif., isn’t seeking large transformative transactions, but rather quality assets located in strong markets with experienced, regional operators, says Malin.
Meanwhile, private investors are snapping up small assets. Next HealthCare Group is focused on the mom-and-pop segment and has purchased about $100 million in skilled nursing assets in the last 18 months, according to Zamir.
Why does he like skilled nursing?
“From a macroeconomic perspective, skilled nursing has some of the best indicators of any comparable investments,” says Zamir. He points to an aging Baby Boomer population that will eventually need nursing care.
By 2030, more than 20 percent of U.S. residents will be age 65 and older. Coupled with little new supply, the increase in demand will be so strong that better quality nursing homes will continue to operate at high occupancy levels, he says.
Echoing the views of other private investors, Zamir says yields on skilled nursing properties continue to be higher than that of other commercial real estate investments. “Compared to other options of where to place capital, skilled nursing facilities are the best option,” says Zamir.
The average cap rate for skilled nursing facilities is currently approximately 11.4 percent. That compares with 7.6 percent for assisted living properties and 6.8 percent for independent living buildings. The average cap rate for multifamily apartments is about 5.7 percent.
Recognizing that a building will be affected by factors outside the operator’s control, such as government reimbursements, Zamir offers his tenants what he calls “smart leases.” These flexible agreements do not feature an automatic annual 3 percent escalation, but vary based on market conditions.
“When times get tough the operator is protected,” says Zamir. “As a landlord, we sleep better at night knowing that our operators are making a fair profit. Leases need to be balanced and make sense for both parties, and they need to be structured in a way that’s sustainable.”
Owners and operators expect a few challenging years ahead due to relatively low occupancies as payors and referral sources continue to shorten the length of patient stays, or skip nursing homes altogether. But they strongly believe that hospitals and physician groups will eventually begin to see that a nursing home stay will decrease the chances for readmission to the hospital.
Skilled nursing facilities will benefit in the long run if they can track patient outcomes and prove that their readmission rates are less than that of other settings, according to Lewis at CCP. “Over time, all of this will get figured out.”