Unlocking the hidden value in skilled nursing

Aviv REIT recently financed the construction of Bath Creek Estates, a new 100-bed facility in Cuyahoga Falls, Ohio. Saber Healthcare Group, which is based in Bedford Heights, Ohio, near Cleveland, operates the property. Aviv REIT recently financed the construction of Bath Creek Estates, a new 100-bed facility in Cuyahoga Falls, Ohio. Saber Healthcare Group, which is based in Bedford Heights, Ohio, near Cleveland, operates the property.

Savvy owners and operators capitalize on the need for short-term rehab and seize acquisition opportunities in a changing market.

By Jane Adler

Is the glass half full or half empty? The answer for skilled nursing depends largely on whether building owners and operators can navigate a tricky landscape fraught with risk, but which also provides a smattering of new opportunities. Government reimbursements that provide the bulk of revenue for skilled facilities remain in flux because of budget pressures at both the state and federal levels.

Healthcare reform is already shifting the role of skilled nursing facilities in the care continuum as they take on duties previously performed by hospitals. The uncertainty has left skittish lenders and investors on the sidelines, including the large healthcare REITs, which have made a big splash in seniors housing but have been cautious on the nursing care side.

Many insiders predict a new wave of consolidation as small operators find it difficult to adjust to the new realities. But experienced owners and operators could benefit as they purchase and roll up properties into efficient operations.

Owners with capital could also gain by offering a new type of product to replace the 30-year-old outmoded nursing facilities common today. At the same time, close relationships with hospitals are already starting to provide a steady flow of Medicare dollars as skilled facilities become the low-cost care option of choice for post-hospital stays.

"We like skilled nursing because of the fundamentals," says Craig Bernfield, chairman and CEO at Chicago-based Aviv REIT. "New supply is limited and demand is obvious."

According to the National Investment Center for the Seniors Housing & Care Industry, the average occupancy rate in the third quarter of 2013 for nursing care projects in the top 100 metro areas registered 87.6 percent, a slight drop from 88 percent during the same period the previous year.
Aviv owns 274 properties with 37 operators in 29 states. About 88 percent of the company's rents come from skilled nursing facilities. "Our DNA has been as owners of skilled nursing facilities," Bernfield notes.

About half of the seniors in Aviv properties are long-term care residents. The others stay for a short term after a hospitalization, such as for a knee replacement. Bernfield notes that the company is serving two growing populations: baby boomers who need short-term rehab after surgery, and the increasing number of seniors age 85 and over who require 24-hour care.

The company raised $303 million in an initial public offering last March, with the stock opening at a price of $22.20 per share (NYSE: AVIV). At the close of business on Dec. 6, the stock price stood at $24.55 per share.

Since going public, Aviv has been a strong performer financially. The company's adjusted EBITDA for the third quarter of 2013 was $32.2 million, compared with $28 million for the corresponding period in 2012. Net income for the third quarter of 2013 was $10.1 million, or 20 cents per diluted share, compared with $1.8 million, or 5 cents per diluted share for the same period in 2012.

As of early December, the company had purchased properties year-to-date totaling about $204 million. More acquisitions were expected to close before the end of the year, according to Bernfield.
The company has approximately 20 renovations of skilled facilities underway at any one time. Aviv is also tackling new construction, and recently financed the construction of Bath Creek Estates, a new 100-bed facility in Cuyahoga Falls, Ohio. Saber Healthcare Group, which is based in Bedford Heights, Ohio, near Cleveland, operates the property.
Aviv plans to continue its expansion. "With 16,000 skilled nursing homes in the country and only 10

percent owned by public REITs, we see significant consolidation opportunities," says Bernfield. "With our experience and source of capital as a public company, we're excited about our track record of investing in this sector."

In defense of skilled nursing
Recognizing that investors tend to shy away from the segment, the National Investment Center for the Seniors Housing & Care Industry (NIC) is developing an investment case for skilled nursing facilities, which was previewed in October at the organization's annual convention in Chicago. "There are risks in skilled nursing, but there are opportunities too," says Bill Kauffman, senior research analyst at NIC.

NIC is collecting data on the skilled nursing sector to provide timely and transparent information for investors. Market information gathered by The Centers for Medicare and Medicaid Services is generally 12 to 18 months old, notes Kauffman. NIC plans to gather data relevant to investors such as revenue by patient day and by payer class. "Our goal is to bring more capital to the industry," says Kauffman.

Cap rates for skilled nursing facilities haven't changed much over the years, holding at about 12 percent, according to NIC research. That compares to approximately 8 percent for seniors housing properties. While nursing home cap rates take into account the risks of potential reimbursement cuts, the opportunities associated with the changing healthcare landscape have not been figured in, according to panelists at NIC's October presentation.

"There's room for skilled nursing facilities to get better on pricing," notes Jerry Doctrow, a participant on the NIC panel and senior advisor at St. Louis-based Stifel, Nicolaus & Co., an investment banking firm. He notes that assisted and independent living properties with cap rates of 10 percent in the 1990s now have rates below 7 percent, an indication that educating the market about the property type has helped to improve values.

While nursing facilities may be undervalued in general, pricing tends to be deal-specific, sources say. As of the third quarter of 2013, the rolling four-quarter average price per bed was $69,344, down about 2 percent from the year prior, according to NIC. Total sales volume for the sector during the past 12 months as of the third quarter was approximately $2.5 billion, a decline of about 6 percent from the previous year.

Prestige Healthcare recently bought a portfolio of skilled nursing homes from the MediLodge Group, a private company based in Southeast Michigan. LTC Properties Inc. (NYSE: LTC), a publicly traded REIT, funded the $126 million deal for 16 buildings, doubling the size of Louisville-based Prestige Healthcare. Evans Senior Investments arranged the transaction.

Jason Stroiman, president at Evans Senior Investments, who worked on the Prestige Healthcare deal, has another transaction closing soon for $130,000 a bed. He expects a project in Colorado to sell for $300,000 a bed.

"A few years ago, it was unheard of to get $60,000 a bed," says Stroiman. "Now there is no cap on price." He notes, however, that the Colorado project is a state-of-the-art rehab facility, adding, "That's where the money is."

Rehab rules
Medicare reimbursements for short-term stay residents are generally higher than reimbursements for long-term care residents, whose bill is often paid by state Medicaid systems. "Rehab facilities have stronger cash flow, and the margins are higher," says Stroiman.

Formation Capital owns about 120 skilled nursing facilities, as well as two operating companies, Genesis HealthCare and Consulate Healthcare. "Short-term rehab is where we are focused," says Brian Beckwith, CEO at Formation in Atlanta.

Although most of the buildings serve both long-term care and short-term stay residents, Formation and Genesis are rolling out PowerBack Centers. The facilities focus on short-term stay residents generally reimbursed by Medicare and private insurance.

As the name suggests, PowerBack facilities aim to return patients to their own homes as quickly as possible. The buildings cater to seniors on Medicare, but are also designed to attract aging baby boomers who are now candidates for common surgeries such as knee replacements. The buildings are equipped with a state-of-the-art gym, private rooms, flat screen TVs and lounges. The food service, run by an executive chef, resembles a restaurant more than a hospital cafeteria.

The PowerBack centers employ a large clinical staff that includes doctors, nurses and rehabilitation specialists. The 100-bed PowerBack facility in Maryland records approximately 140 admissions a month.

The centers are doing well, according to Beckwith. Medicare reimbursements are higher than they were two to three years ago, he says, noting that rates rose 1.3 percent in 2013. Medicaid trends are also positive as state budgets recover from the recession. Beckwith expects more pressure on reimbursements, however. "We are focused on managing expenses," he says.

It's the operator
Lenders seek experienced operators that understand the reimbursement systems and have multiple properties, which can lead to operational efficiencies. Sophisticated operators are also more likely to implement the kinds of information technology systems that can track resident outcomes, measures that are increasingly important under the new healthcare law.

"We spend a lot of time looking at the operator," says Jim Seymour, senior managing director of healthcare real estate at GE Capital Healthcare Financial Services, a lender to skilled nursing facilities.

GE Capital finances portfolios of skilled nursing facilities, not single properties, and prefers an operator with a pool of at least four to five buildings so one troubled property doesn't impact the loan repayment. Operators with some geographic distribution of properties are preferred over those with multiple buildings in a single market. "Our loss rates on loans to skilled nursing facilities are low," says Seymour, who is based in Chicago.

The operator is also the focus at Capital One Financial Corp., a McLean, Va.-based lender that provided $2 billion in loans to the healthcare market in the last two years. In early November, Capital One acquired Beech Street Capital, a privately held originator and servicer of Fannie Mae, Freddie Mac and FHA multifamily commercial real estate loans.

Capital One determines whether the operator can withstand changes in reimbursements, invest in infrastructure and keep up with new technology. "We want to do business with operators who are tying the pieces together," says Imran Javaid, managing director of commercial and specialty finance at Capital One.

About 18 months ago, Capital One also began reviewing nursing home quality measures and public health survey records during its underwriting process. "We look at how many complaints were substantiated," says Javaid.

Underwriters also analyze how quickly complaints or violations are addressed. Another relatively new underwriting consideration is the readmission rate of residents to the hospital. Medicare penalizes hospitals for readmitting patients less than 30 days after their release.

As a result, hospitals are looking to partner with nursing facilities with low readmission rates. Javaid gets "nervous" when nursing facilities have a readmission rate more than 20 percent, or if a facility has only recently started to track readmissions.

Lenders are also tracking the spread of Medicaid managed-care systems, which are being rolled out in several states. In Florida, for example, the plan is to move 90,000 people who need long-term care, including those in nursing homes, into a system where private insurers coordinate care for Medicaid recipients in an effort to lower costs and improve care.

"We are taking a close and hard look at states that have switched to managed care and which facilities have done well and which have not," says Javaid. "Good operators evolve."