Owners, Operators Design Plays for $100 Billion Skilled Nursing Market

With a new pure-play real estate investment trust on the hunt for acquisitions and public policy providing tailwinds for the sector, it appears that a flurry of transactions could bring significant consolidation to the skilled nursing industry in the near future. And with $100 billion of skilled nursing assets currently in private hands, according to a recent report from Green Street Advisors, these early plays could merely jumpstart a more long-term realignment of this part of the senior care continuum.

“Unlike the current state of senior housing, skilled nursing is a low new supply business,” analysts with Green Street wrote in their recent research note. This lack of expanding inventory, coupled with a cost-of-capital advantage that SNF-focused public REITs enjoy, means that over time they theoretically should be able to make “headway” in consolidating the industry.

Long-time stalwart Omega Health Care Investors Inc. (NYSE: OHI) and newcomer Care Capital Properties Inc. (NYSE: CCP) headline the list of public REITs focused on the skilled nursing space, but they are hardly alone. This crowded field of REIT players, coupled with industry trends incentivizing operators to consider mergers and acquisitions, suggests that owners and operators alike are moving now to seize on opportunities and gain advantages going forward in this evolving part of the senior living space.

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The REIT Stuff

As of August 18, Care Capital Properties officially began trading on the New York Stock Exchange. The market promptly entered a period of historical turbulence, with share prices diving across the board; this has made it somewhat difficult to gauge the early performance of CCP, the pure-play skilled nursing REIT spun off from “Big Three” giant Ventas (NYSE: VTR).

“The greater equity market volatility has made for a noisy start,” Green Street analyst Kevin Tyler tells SHN.

Still, CCP has traded roughly in line with Omega during this period of instability. And Green Street still expects that CCP will move quickly to close on its $450 million pipeline of transactions in middle to late stages.

With CCP’s entry, there now is a crowded roster of REITs in the tier just below the so-called Big Three, which in addition to Ventas include Health Care REIT (NYSE: HCN) and HCP Inc. (NYSE: HCP). And while CCP and Omega are characterized as the only two “pure play” SNF REITs, some of their peers in the market also are eyeing skilled nursing transactions and strategizing about how to build this part of their portfolios.

For instance, Sabra Health Care REIT Inc. (Nasdaq: SBRA) recently announced a $234 million SNF acquisition, and CEO and Chairma Rick Matros said that the company intends to keep SNF exposures to around 50% of the overall portfolio. Furthermore, that recent acquisition came in at a whopping $234,100 per bed. The high per-bed price is justified because these SNFs focus on high-acuity residents with specialized needs, such as ventilators, and they bring in premium reimbursements as a result.

Matros believes that the future of skilled nursing lies in this type of specialization, and he said that Sabra’s strategy is to build a portfolio of SNFs reflecting this “new world order.”

National Health Investors (NYSE: NHI) and LTC Properties Inc. (NYSE: LTC) are among the other REITs in this cohort. If it seems that there might be too many players on the field, that impression might be justified. Mizuho analyst Rich Anderson last week suggested that one of these REITs might acquire another—with CCP appearing as a likely buyer and NHI, or at least its skilled nursing assets, being a potential target.

In fact, Anderson name-checked six REITs in this peer group, arguing in his report that this might be “one or two too many.” The actual current total arguably could be seven or eight, he tells SHN, including New Senior Investment Group (NYSE: SNR) and CareTrust REIT Inc. (Nasdaq: CTRE).

A large-scale REIT acquisition, similar to Omega’s purchase of Aviv REIT Inc. last year, is obviously speculation. Still, there’s at least chatter that the REITs not only will be driving industry consolidation by acquiring skilled nursing properties, but by consolidating among themselves and putting these real estate assets into fewer hands.

Favorable Tailwinds

Sabra’s Matros is not alone in seeing that part of the SNF opportunity stems from an industry shift away from long-term care residents toward higher acuity patients.

Many providers were compelled to make this shift out of necessity, to bring in more Medicare dollars for post-acute care as a way to compensate for abysmal Medicaid margins on long-term care—but the strategy appears to have paid off. Even as government policy such as sequestration eroded reimbursements and overall SNF occupancy decreased from 91.9% in 2010 to 90.4% in 2014, facilities have managed to improve key financial metrics, according to a newly released benchmarking report from professional services and accounting firm CliftonLarsonAllen (CLA).

The median EBITDA ratio for facilities increased from 6.2% in 2010 to 6.4% in 2014, while days cash-on-hand increased from 36.2 days in 2010 to 45.7 days in 2014, the report states.

Source: CliftonLarsonAllen
Source: CliftonLarsonAllen

The shift to more Medicare-reimbursed services likely is at least partially responsible for these figures, Jeffrey A. Vrieze, CLA managing principal for senior living, tells SHN.

There is a potential flip side to the post-acute story; continuing investigations by government enforcement agencies into potential Medicare fraud, such as through inflated billing for post-acute therapy to juice profits. HCR ManorCare, the nation’s largest skilled nursing provider, currently is under such an investigation, creating at least temporary instability for its major landlord, HCP, and providing a cautionary note to those who are bullish on the skilled nursing sector, Green Street noted in its recent report.

Still, adding to the current attractiveness of SNFs is a more favorable overall picture from a government reimbursement perspective. Or, as Green Street Advisors put it, prospects at least seem “less bad” than they did in recent years. For instance, the Medicare formula for determining physician payment rates has been eradicated—for decades, SNFs’ reimbursements were threatened as policymakers deferred physician payment cuts and “offset” that by reimbursing other provider types at lesser rates.

And health care reform has created incentives for more coordinated care across acute and post-acute settings, and made SNFs increasingly important players for hospitals and health systems eager to avoid Medicare penalties for having too many patients readmitted.

These policy changes have made it increasingly important for SNFs to be able to interface with the health care system writ-large, and to do so, they see the need for achieving critical mass in a given market, says CLA’s Vrieze.

“There’s more conversation around that then there ever has been,” he says. “I’ve seen joint ventures, affiliations to create critical mass that you haven’t seen in the past.”

It’s a phenomenon that CCP is well aware of.

“There’s favorable tailwinds from a consolidation perspective as operators look to build up scale in core markets to be prepped for bundled payments and ACA changes,” CEO Raymond Lewis told Senior Housing News, as CCP was about to begin trading. “There’s a tremendous opportunity for us to provide capital to these operators to acquire properties and grow their businesses.”

But while a merger of REITs and blockbuster transactions such as the Genesis Healthcare’s 2012 purchase of Sun Healthcare Group are certainly not unprecedented, Lewis says to expect gradual consolidation of the industry. Still, he sees consolidation as inevitable, with the REITs playing a significant role.

“I think there’s a lot of opportunity for local market consolidation to occur before we may start seeing some of the larger operators consolidating and coming together,” he said. “We think that over time, we’ll be the most efficient holder of real estate because of our cost of capital, and we should see good deal flow and opportunities as a result. I would think properties would continue to migrate toward REITs.”

Written by Tim Mullaney

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