3 Lessons for a Firmer Grasp of Skilled Nursing Risks

At the outset of the year, it appeared investors might find skilled nursing sexy again in 2016. One quarter in, skilled nursing is garnering a lot of attention, but some investors are attracted while others appear to be rejecting these assets as too risky.

At least, that’s judging by questions asked and some heated discussions that took place among equity analysts and top industry executives during first-quarter earnings calls this week.

Investors in the public markets have been swallowing “misinformation” about the risk of skilled nursing operators facing consequences for over-billing Medicare, executives with real estate investment trust Welltower (NYSE: HCN) said Tuesday on that company’s earnings call.

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However, players in the private markets may have a firmer grasp of the skilled nursing value proposition, and are seeing an opportunity given that skilled nursing stocks are taking a beating as investors in the public markets seem to perceive greater risk.

“There are more inbound calls regarding … interest in selling skilled nursing today than senior housing,” said Welltower CEO Tom DeRosa.* “I think there are a lot of investors out there in the private markets … that are seeing the headlines, seeing how some of the misinformation that has been put out there has created some tremendous volatility, and they’re looking to take advantage of that, or at least it has raised the idea of buying skilled nursing to a higher position in the queue for how they might deploy capital.”

The Welltower discussion was only the beginning, as skilled nursing was a hot topic on subsequent calls, as well. These are three of the key takeaways for coming to a firmer understanding of this potentially misunderstood asset class.

1. Lower Occupancy, Higher Profits

Those who are well-versed in senior housing are keyed-in to occupancy numbers, but being too fixated on these can blind you to the bigger picture in skilled nursing, according to Rick Matros, chairman, president, and CEO of Sabra Health Care REIT Inc.(Nasdaq: SBRA).

“There still seems to be something missing as people look at occupancy in the skilled portfolio,” Matros said Tuesday on Sabra’s earnings call. “You have to look at occupancy in conjunction with skilled mix.”

That is, as skilled nursing facilities move away from traditional long-stay residents to take on more short-stay, post-acute patients, occupancy numbers may dip—but bottom-line results may actually improve because this means the facility is getting more reimbursement from Medicare than Medicaid, which pays at lower rates.

It’s a point also recently made by Robert Kramer, founder and CEO of the National Investment Center for Seniors Housing & Care (NIC). Skilled nursing occupancy decreased by 180 basis points between October 2011 and December 2015, according to sector-specific data NIC released for the first time in March.

However, this does not mean that profits necessarily suffered as a result, due to the increase in short-stay Medicare patients, Kramer emphasized to Senior Housing News. Medicare revenue was more than double Medicaid revenue for skilled nursing facilities on a per-patient-day basis for the timeframe considered by NIC.

2. Medicare Advantage is Slow-Growing

There’s no doubt that Medicare Advantage (MA) has gained a tremendous amount of steam since being introduced a decade ago. It now enrolls 31% of the Medicare population, noted Taylor Pickett, CEO of real estate investment trust Omega Healthcare Investors Inc. (NYSE: OHI), during that company’s earnings call on Thursday. With a market cap of about $11 billion, Omega is one of the major skilled nursing-focused REITs, with SNFs comprising a majority of its 969 properties.

The growth of MA has been seen as ominous for skilled nursing. Under MA, private companies contract with the government to enroll and manage Medicare beneficiaries, and they have financial incentives to control costs. So, they exert pressure on skilled nursing facilities’ length of stays and in other ways challenge their margins.

Determining how much more growth to expect from Medicare Advantage is a big issue looming over the skilled nursing sector—a point made Thursday during the earnings call for post-acute giant Kindred Healthcare (NYSE: KND) by CEO Benjamin Breier. Kindred operates 92 skilled nursing facilities.

“The problem and the question for the nursing center industry is where is the bottom as it relates to the payer mix shift, [and] length of stay challenges that each of them face,” he said.

The potential good news from a skilled nursing risk perspective: Some projections show that MA has reached a ceiling and now growth will slow considerably—to as little as 1% a year. These are the projections that Matros and Pickett pointed to in their calls with analysts.

MA is growing at a “snail’s pace,” Matros said.

The very gradual shift toward Medicare Advantage is in fact one of the “compelling” factors making him bullish on the skilled nursing industry, Pickett said.

“From now through 2020, this percentage [of MA enrollment] is only projected to increase from 31% to 34%,” he said.

3. Star Rating Limits

While the growth of Medicare Advantage and other forms of managed care may be seen as an industry challenge, it also is an opportunity. Skilled nursing companies that can deliver quality outcomes at a lower cost have a chance to become preferred providers, increase referrals, and become more influential players in the health care ecosystem.

So the challenge then becomes identifying these top operators. One available tool is the government’s Nursing Home Compare website, where Medicare-certified SNFs are rated on a five-star scale.

But the star ratings are a flawed system and may not accurately reflect quality, warned Omega’s Pickett.

“Maybe five star is out there as a measure that anybody knows about, but I think to focus on that as the only quality indicator that we’re going to look at and think about [for] a portfolio is just wrong and misleading,” he told analysts.

Some evidence of this is the fact that the Centers for Medicare & Medicaid Services (CMS) is seeking to add new measures, such as rehospitalizations, to the star rating formula, Pickett said.

It may be in Omega’s interests to downplay the star ratings—the REIT does not disclose the ratings for the SNFs in its portfolio, but up to 50% may be one- or two-star facilities, according to calculations shared by UBS analyst Nick Yulico.

Still, Pickett’s point is backed up by other leaders in the industry, including Mark Parkinson, president and CEO of the largest skilled nursing provider association, the American Health Care Association/National Center for Assisted Living.

“We’re not helping patients and their families get the information they can trust when the star rankings don’t match the quality care being delivered,” Parkinson stated after CMS enacted changes to the five-star system in early 2015.

So, investors would be wise to use star ratings as only one of many indicators of quality.

“There’s a lot more detail to get into in terms of how quality is measured,” Pickett said.

*Editor’s Note: A previous version of this article attributed this quote to Green Street Advisors Analyst Kevin Tyler. Senior Housing News regrets the error.

Written by Tim Mullaney

Photo Credit: “The Market” by Iman Mosaad, CC BY-SA 2.0

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