Fitch: REITs to Steer Clear of Skilled Nursing for ‘Forseeable Future’

Facing lower margins for the foreseeable future, real estate investment trusts (REITs) are doing their best to put underperforming skilled nursing assets behind them, according to a special report from Fitch Ratings.

The news comes just after HCP, Inc. (NYSE: HCP), one of the “big three” health care REITs, announced it is spinning off its struggling skilled nursing portfolio into a separate REIT. Its skilled nursing tenant, HCR ManorCare, reported poor financial results through the end of 2015, and is facing other challenges, including a Department of Justice investigation into billing practices.

As REITs are dealing with a changing patient mix with lower reimbursements rates, new payment models as a result of the Affordable Care Act (ACA) and ongoing federal investigations, skilled nursing exposure is continuing to shift.

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Margin Pressures

HCP is not the only REIT managing an underperforming skilled nursing portfolio. Several businesses with large skilled nursing portfolios have struggled to stem losses in recent quarterly earnings, including from Kindred Healthcare (NYSE: KND), the primary tenant of Chicago-based health care REIT Ventas (NYSE: VTR). Kindred reported a 1% decline in revenue for its nursing centers in the first quarter of 2016 and contributed to 15% of the company’s overall revenues in 2015, according to Fitch Ratings.

REITs have been dealing with a number of headwinds related to skilled nursing assets, including increased exposure to Medicare Advantage (MA), with lower rates and shorter stays. Hospital stays for MA recipients were between up to 26% shorter, depending on the patient’s age and facility type, relative to Medicare in 2013, according to data the Fitch report cited from the Agency for Healthcare Research and Quality. The mean cost per stay was up to 14% lower.

“The shorter stays and lower rates have negatively impacted SNF earnings as MA enrollment has grown,” the report reads. “In 2015, Medicare private health plan enrollment was 16.8 million people, or 31% of all Medicare beneficiaries, up from 6.2 million and 15% in 2001, respectively, according to the Kaiser Family Foundation.”

Fortunately, some ACA changes could life margins, Fitch Ratings predicted. Shared savings programs present an opportunity for skilled nursing to capitalize if they can become a risk-bearing entity in these programs. Bundled payments and pilot programs already underway could make skilled nursing facilities (SNFs) an important partner in care coordination efforts. However, maintaining a market share in these programs is essential, according to the report.

Billing Practices Under Scrutiny

Investigations into billing practices by the Department of Justice (DOJ) have also dampened revenues and cost REITs, Fitch Ratings found. Specifically, SNFs have come under fire for overbilling Medicare for “ultra-high” therapy, which comes with the highest reimbursement rates.

In January, Kindred agreed to pay $125 million to the DOJ settle False Claims Act allegations. The DOJ has ongoing investigations with HCR ManorCare and Genesis HealthCare, Inc. (NYSE: GEN), which has faced its own struggles with its skilled nursing tenants.

A Pure Play Advantage  

HCP’s latest spin off might be the right move for the company, which has suffered from a drop in its stock price amid its skilled nursing woes. Ventas has limited exposure to SNFs following its spin off and creation of a separate skilled nursing REIT, Care Capital Properties (NYSE: CCP).

However, “its leverage remains near the rating sensitivity for negative momentum,” according to the report. Ventas has noted it is working to reduce its leverage through asset sales, according to Fitch Ratings.

While a spin off will reduce its exposure to these persisting headwinds, its SNF tenant is still expected to operate within thin margins.

The challenges facing the skilled nursing sector identified by Fitch also were raised in the earnings calls for several of the REITs and operators involved. However, leaders of these companies downplayed some of these threats—for instance, pointing out that Medicare Advantage may be entering a very slow-growth phase.

Written by Amy Baxter

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