Health care real estate investment trusts (REITs) underwent major refocusing last year, creating skilled nursing cast-offs, spinoffs and pure plays. Now, skilled nursing has slipped away from senior housing-focused REITs and is up for another year of challenges.
While the rest of the health care system inches toward integration amid the ongoing shift toward value-based care, skilled nursing is increasingly being held at arm’s length in REIT portfolios. And the sector’s problems aren’t likely to be alleviated any time soon as health care remains at the center of an ongoing policy storm in Washington, D.C.
Only Thing Certain Is Uncertainty
There’s no doubt about it—volatility on Capitol Hill is the new normal. Some believe SNFs dodged a bullet with the recent failure of the American Health Care Act, which included Medicaid changes that could have hit the sector hard. But repeal or reform of the Affordable Care Act (ACA) also could bring benefits to SNFs, which have been struggling under some Obamacare policies.
ACA changes have led to everything from lower reimbursement rates to shorter lengths of stays and a changing patient mix. The vulnerabilities of SNFs (skilled nursing facilities) in this squeeze are separating the strongest operators from those that are not able to adapt to the new demands of the business. These effects are among the factors to influence health care REITs to distance themselves from the skilled nursing sector over the last few years and diversify their portfolios to lessen the blow.
Chicago-based Ventas (NYSE: VTR) led the charge by spinning off its skilled nursing assets into a separate entity, Care Capital Properties (NYSE: CCP), back in 2015. At the time, the skilled nursing sector wasn’t in the same dire straits, and Ventas cited a desire to increase its private pay exposure and keep government reimbursed assets separate, as well as realize more value in the sector as a different entity. Ventas has an enterprise value of $34 billion and owns roughly 1,300 health care and senior living properties. Its skilled nursing protégé, CCP, has an enterprise value of roughly $4 billion and 345 health care properties, according to a March investor presentation.
More recently, another major health care REIT, HCP (NYSE: HCP), followed suit and spun off its skilled nursing assets in late 2016 after its tenant, HCR ManorCare, struggled with sustained declining occupancy rates and difficulty meeting its lease obligations. The tenant, which made up more than 25% of HCP’s portfolio before the spin off, also was the focus of a lengthy investigation by the Department of Justice (DOJ) over its billing practices. The new skilled nursing REIT, Quality Care Properties (NYSE: QCP), has an enterprise value of $1.8 billion and 262 skilled nursing assets, as well as 61 memory care and assisted living properties, one hospital and one medical office building, according to SEC filings.
In contrast, Welltower (NYSE: HCN) has opted not to spin off its SNF assets, though it has taken significant steps to refocus and manage troubles by reducing exposure to its major skilled nursing tenant, Genesis Healthcare (NYSE: GEN). Welltower announced target dispositions of $4.1 billion at the end of 2016 and recently completed a $930 million sale of 28 Genesis properties in January 2017.
The REITs made these moves prior to the election of President Donald Trump, and there have been some glimmers of optimism since the new administration took office in January. Health and Human Services (HHS) Secretary Tom Price has become a beacon of hope in the SNF world as a staunch opponent of the ACA. Price, prior to becoming HHS Secretary as a Representative from Georgia, introduced a bill in the House to repeal the ACA and has singled out programs that specifically impact the skilled nursing sector, including the Comprehensive Care for Joint Replacement (CJR) model, which encourages hospitals to bypass SNFs and send orthopedic patients to the lower-cost home setting.
However, recent developments have raised questions about the ability of Price and the Trump administration as a whole to reverse unfavorable policies to SNFs and foster a more friendly environment.
Health care, in particular, has become a focal point of political battles, with the Republican party marching toward its long-standing promises to repeal and replace the ACA. As we saw on March 24, the first push to reform health care failed on the House floor, with Speaker Paul Ryan (R-WI) pulling the Republican plan before a vote could be held. The numbers wouldn’t have held water. The votes weren’t there.
Markets soared at the start of 2017, in what has been dubbed the “Trump Rally,” as investors hedged their bets that Republican control across the White House, Senate and House of Representatives would gut regulations around businesses. Following the failure of the Republican health care bill—the American Health Care Act (AHCA)—the stock market faltered.
At the same time, the Federal Reserve has continued to raise rates as expected, bumping up interest rates a quarter of a percentage point in early March. Following this fiscal policy change, REIT stock prices surged, in contrast to investors’ reactions in December 2016, when the Fed raised for the second time in a decade.
While the Fed’s actions signal strength in the economy and optimism for long-term, sustainable recovery to a normal interest rate environment, the failure of the Republican health care bill—the first attempt of the new Congress and White House to put forth major reform—has since rocked investors’ confidence that the administration can deliver on its pro-business agenda or health care priorities, meaning big question marks still hover over the SNF sector and associated REITs.
Skilled nursing has seen a steady decline in occupancy rates over the last few years and hit the largest year-over-year decline in the fourth quarter of 2016. The occupancy drain has been one of the changing factors as the sector experiences shorter lengths of stays and reimbursement shifts.
By the end of 2016, skilled nursing occupancy reached just 81.8% nationwide, per data from the National Investment Centers for Seniors Housing & Care (NIC). Occupancy dropped 0.8% from the third quarter of 2016 to the fourth, hitting the lowest level since NIC began tracking skilled nursing occupancy in 2011. By comparison, national private-pay senior housing occupancy dropped just 0.1% from the third quarter to the end of 2016, according to NIC data.
Health care REITs are also betting on the long-term strength of senior housing, as evidenced by a rise in operating interests. In 2016, all three of the “Big 3” health care REITs— HCP, Ventas and Welltower—crossed a new threshold in their Senior Housing Operating Portfolio (SHOP) assets. By the end of the year, RIDEA senior housing assets were above 30% of portfolio shares for all three REITs, signaling greater confidence in the sector long term.
ACA policies incentivize pushing patients out of high-cost settings and into lower-cost settings; meaning SNFs that serve patients for high quality, short-term rehabilitative services will more likely be able to withstand the sector pressures. Those operators that can’t deliver better care more efficiently won’t make the cut.
Operations will likely change hands, and long-standing relationships may continue to be cast off unless operators can improve care with tighter margins. Kindred Healthcare’s (NYSE: KND) decision to exit the sector at the end of 2016 could be a prime example of the fight or flight response to the sector’s pressures. Over the past few years, the post-acute care company has downsized its SNF exposure from 300 properties to fewer than 100, as well as become the nation’s largest home health care and hospice provider. The operator’s departure will further erode Ventas’ exposure to SNFs, as the REIT held onto its Kindred properties after spinning off its other skilled nursing assets.
The End of Pure Play?
With multiple pressures unlikely to let up on the sector, pure play SNF REITs could be on the lookout for other options. CCP, for one, has hinted its interest in investing in other sectors.
“There are a lot of other sectors that are adjacent to and if not complementary to skilled nursing, we are still looking at,” CCP CEO Ray Lewis said during the company’s end-of-year earnings call for 2016. “Some examples would include behavioral psych, geri-psych you know, juvenile psych, addiction and those sorts of things that are also highly fragmented industries. [They] tend to have a little bit better margin and definitely have favorable political tailwinds. So, those are the types of assets we think are pretty interesting and you might see us into in the future.”
Omega Healthcare (NYSE: OHI), another REIT with a significant concentration of SNF assets, branched out from its pure-play roots in 2014 when it acquired Aviv REIT (NYSE: AVIV). The REIT owns 981 properties, 835 of which are SNF assets, and has a market cap of $6.49 billion. The AVIV purchase gave the pure-play REIT some seniors housing assets, and Omega has since continued to pick up senior living properties, including in high-barrier markets like Manhattan.
Omega has also experienced trouble with one of its skilled nursing tenant, Genesis Healthcare, which settled a DOJ investigation late last year and announced employee layoffs in its most recent quarterly earnings call as part of a $50 million cost-cutting measure.
The relationship between REITs and SNFs is evolving under industry pressures, and while REITs may be looking to other sectors that face fewer headwinds, skilled nursing isn’t going anywhere. Not to mention, SNF M&A prices reached an all-time high last year for the fourth year in a row, according to data from Irving Levin Associates.
Long term, REITs may be able to weather the storm by working with tenants to achieve leaner operations and gutting rising rent obligations. With efficient operators, skilled nursing REITs are likely to be the consolidators and survivors.
Written by Amy Baxter
This is a version of an article that appeared in The Forbes Real Estate Investor, edited by Brad Thomas.