The Bottom Line: LTC Properties Expects REITs to Benefit As ‘Undisciplined Capital’ Feels Pain

Pam Kessler joined LTC Properties (NYSE: LTC) during a time of crisis for the real estate investment trust and the whole senior housing and care industry. After that trial by fire, Kessler helped lead the REIT through a long period of industry stability — but that has ended.

Having started in accounting with Ernst & Young, Kessler went on to a career in real estate. She was happily working for a diversified, privately held developer when a friend encouraged her to take a meeting with LTC, which was seeking a controller.

At that time, senior housing was struggling with oversupply, and the skilled nursing industry was reeling from changes to the Medicare payment system. Despite these huge challenges, Kessler joined LTC and has not looked back, becoming CFO in 2007.


The last few years have once again brought industry dislocation in the form of oversupply and new payment models, she said during a recent interview for Senior Housing News’ Bottom Line series. Though the disruption has not been as severe as in the early 2000s, it has prompted REITs — including LTC — to transition operators, change lease terms and switch to RIDEA structures.

From this period, Kessler is taking away several lessons, including the need to be more proactive after recognizing the signs of distress. Leases also need to be treated as “living, breathing” arrangements that are actively managed, or more good operators could be hamstrung by escalators and other provisions.

Kessler anticipates ongoing dislocation in senior housing as “undisciplined” new capital learns some hard lessons, which should open up opportunities for LTC to acquire properties at reasonable prices in the coming years.


The following has been edited for length and clarity:

How was LTC doing when you joined in 2000, and what were your first priorities?

Skilled nursing operators were not businesses, as they were structured at the time, that were sustainable. You have all your publicly traded operators in bankruptcy. And then on the senior housing side, there was an oversupply. Assisted living began in the 90s, and like any new asset class, was on fire. The development industry at the time was very frothy, and capital abounded, and assisted living was being built everywhere. So, there was oversupply. Those two things hit at once, so all the health care REITs were in full workout mode.

From the ashes rises the phoenix, right? I think out of the things we learned through that time, we have made health care REITs stronger, and LTC especially.

You knew this was the situation and you took the job with LTC anyway?

I knew the situation.

We were in a stalemate with our banks. One of our issues was we had a big wall of debt coming, a big maturity, and the banks at that point — because of other things going on in their business — weren’t wanting to refinance. So, we had to engage in a difficult negotiation with our banks, and eventually we got it worked out, but there’s a lot of posturing that goes into negotiations, and it was my first couple weeks there. I was drinking from a firehose. But, I learned so much.

Why did you believe in the future of LTC despite those immediate issues?

I had studied the cash flow statement. As a CFO, my favorite statement is the cash flow statement — how much cash we have, what’s coming in, what’s going out. That’s how I judge the health of a company. So, I studied the cash flow and, okay, there’s money to meet current and future obligations. There’s this maturity, there’s operators in bankruptcy, there are these issues out there, but as long as the cash flow is there, the rest we can solve for. We can solve that maturity problem … the big question is, how painful will it be or not be to the REIT?

At the end of the day, through all the posturings and negotiations and heated discusssions and being thrown into different banks’ workout groups — you never want to be in a bank’s workout group — we were able to reach a resolution. And we had several of our current banks in our capital stack came in early, and they also studied the cash flow statement, and were willing to lend into that and help us restructure. We’re very loyal to those banks.

You mentioned lessons learned, which made LTC stronger. What were they?

In 2000, we were more highly leveraged, and we had financed ourselves with traditional, secured mortgage debt. We had the wall of maturities because we had not staggered. In good times, you can’t imagine that one day you will [want to] refinance and there might not be a refinance market available, or that the price might be so high that it would be a hard pill to swallow. So, a few things we had to work out on our balance sheet.

Out of that, came the discipline that we have today. We carefully manage maturities to match our projected free cash flow, so that there’s virtually no refinancing risk. We run a very low-levered balance sheet. We target about 30% debt to enterprise value and less than 5x debt to EBITDA. And we do not use secured debt to finance ourselves. We finance through a private placement market, which is insurance companies. We have gotten very good pricing from them, because the NAIC, which is the rating agency for the insurance companies, rates us at NAIC 2 flat, which is like BBB flat. So it’s very competitive pricing. They allow us to name our maturities.

Another lesson we took was to morph the portfolio into roughly 50/50 skilled nursing and senior housing.

Have there been other moments of challenge or change since that dark time in 2000?

It’s been pretty steady up until recently. We’ve had a lot of change recently. It’s not turmoil like it was in the early 2000s. It echoes a little bit of that time, in terms of the oversupply, primarily in standalone memory care but also the assisted living markets.

So, we have a new product, standalone memory care, and we were one of th efirst out of the gates on that. We recognized the need for more memory care developments six, seven years ago, and rose to the challenge to meet that need. Certainly, the first developments we had out of the gate were leasing up, were beating pro forma, which spurs you to do more, right? And then —- we were not the only geniuses. Everybody was on to it. We’re all rushing to meet this projected demand, and certainly the cost of capital was very low. So, the green light was on for development.

Then, we hit the wall of oversupply. And the average age of entry is getting higher. Having a standalone memory care product is not as flexible in terms of fill-up as an AL/memory care combination property.

So, hitting the brakes on that, we had two operators we had chosen to do most of our memory care development with, who the same year, almost at the same time, hit the bumps. Anthem a little earlier than Thrive.

We said, we’re going to stop development and focus on leasing these up, and then we’ll assess going forward.

Anthem has done a great job — closed down their development arm, focused on leasing up, and had really good results.

With Thrive, they had other capital partners, and so the brakes weren’t applied quite so hard on them, because we could only influence so much. So, with them, the continued distractions of developments and other things they have going on we felt was pulling them away from the focus on our properties. We ended up transitioning them out of all our properties and putting in three other operators.

What are some lessons from going through the memory care challenges?

When you’re looking at replacing an operator, that’s nothing that a capital partner does lightly. We gave it the old college try. When they were unable to make any strides forward, that’s when you say that this isn’t going to work. So, one of the learnings from that is trying to get out in front of these things — recognizing the signs earlier, being more proactive versus reactive. That’s something we continue to do through our asset management process.

LTC seems to take a conservative approach to doing business. Is it a challenge to be quicker to replace operators, because you want to give the current operator more time and exhaust all options?

I definitely think so. It’s also part of a mindset of being customer friendly. Our health is reflective of the health of our operators, so it’s incumbent on us to help them be healthy.

I imagine you wish that you had ended the Senior Care Centers relationship earlier, too?

We had an operator ready to take the properties … the problem was Senior Care had not defaulted on our lease. They had not committed a monetary default prior to missing the December 2018 rent payment concurrent with their bankruptcy declaration. Since they wanted to assume the leases in bankruptcy and continue to operate our properties, they continued to pay us rent. Because they were paying our rent, the bankruptcy court would not let us have our properties back to lease to someone else.

There have been a lot of operator transitions among the REITs lately.

There are always going to be incidences here and there where you have to … that is just a regular part of asset management for REITs or public or private capital.

The thing that’s happened now that’s caused more dislocation in the market is all these things happening at once, not just with LTC but with all of our peers. You talk to every public REIT right now, and there are operators that are underperforming that they’ve had to transition. I don’t perceive that changing. You’ve got to be constantly evaluating and working with your operators to try to make them stronger. We do as much as we can from the capital provision standpoint and the structural standpoint to help our operators be strong.

I think we’ve been really creative over the past six years now. We’ve introduced a lot of different product types, because we’re hearing the desire for something more than what’s been traditionally provided in mortgage debt, triple-net, sale-leasebacks. I think a strong operator uses multiple financing structures and multiple financing sources. I don’t advocate for big operators to only have one capital provider. You need flexibility and choices.

Have operators started to prefer RIDEA to triple-net?

For our operators, we’ve listened to them and [heard] their desire to retain some ownership in real estate. So, you’ve seen that in RIDEA — retaining ownership in the PropCo and selling a substantial portion of the operating company, which has not traditionally been what operators want to do. That’s been a new development in financing structures that I find interesting, because I generally think successful operators want to control their destiny and not have a lot of involvement from the capital provider.

But listening to our operators, we said, okay, we’ll construct some joint ventures that retain 5% to 10% interest in the PropCo. But, we haven’t taken any interest in the OpCo.

I think both RIDEA and triple-net are wonderful products. It’s really dependent on what the customer’s needs and desires are. I think a smaller, growing company is probably going to opt for triple-net, because they’ve got a business plan they want to execute on. They don’t want or need any capital partner telling them how to do their operations.

I think the flip side is some operators saying, okay, I’ve given up a lot of control over my destiny for the security of being with the REIT. They’ve essentially monetized their operations and now are in for a retained interest in some upside without any risk to the capital they’ve just taken out of the properties. When I look at the companies that like RIDEA and are doing it, they’re more mature companies, where the principals have monetized the value of their company.

With the tough operating environment, we’ve heard from providers that lease escalators are a problem.

I would say to that, another flexible part of triple-net is aligning the bumps to CPI versus stated bumps. I know some of these triple-net leases that converted to RIDEA had big bumps of 3%, 3.5%, 4%. And in a low interest rate environment, low inflation environment, these bumps aren’t going to be sustainable because they’re not getting that [increase] through their operations.

It’s certainly a loud talking point right now for those that I think kind of got burned in the triple-net structure. Maybe this is a lesson out of this, as we look at why did these triple-net leases have to be converted to RIDEA. Maybe the REIT wasn’t proactive enough in getting out in front and restructuring the lease. You have to be open to that as you go forward as a REIT and a capital partner. I think if you have the mindset of, we have this triple-net lease and it’s frozen in time, you’ll run into these problems.

When I look at the leases that have gotten worked out and turned to RIDEA, these are for the most part operators that have a great reputation. It’s the capital structure that kind of brought them down. The over-leveraging of the leases … the operator over-monetized. They pulled out all the money from their real estate and all the money from their operations — for the most part, their operations were getting a real estate multiple, so they got a healthy payment — and then they’re left with this company that’s completely leveraged with these high leases. That’s not sustainable, especially in this environment that maybe revenue isn’t growing as rapidly as projected.

… A continued low interest rate environment is good for the capital markets, good for us to continue to put out capital, but we need to be mindful that to our operators that means we have to be careful about the rent bumps. CPI escalators might be better than the fixed bumps. A lot of our leases now have 2% escalators. I don’t know if anyone’s started leasing in the 1% [range] yet.

In terms of M&A, you’ve said that pricing is the highest it’s been in maybe 10 years, do you see that continuing?

It remains competitive and has been for the past few years, and I see it remaining very competitive because of the low interest rate environment. And, there’s a lot of capital in this market.

How are you thinking about growth given those prices? Are you looking for more off-market deals and expanding existing operator relationships?

And new operators. These relationships that we have, we cultivate these relationships with operators over years and years. Many times, we’ve had a relationship for three to five years before we’re actually able to find an opportunity together that works for both of us … so, finding that Goldilocks deal, that takes time. We’re certainly committed to that as part of business development, and having those long-term relationships is helpful when you’re looking at your portfolio and talking about an opportunity because you like this particular region, and you have an upgraded relationship because maybe an operator likes that region because it fits their footprint.

Another takeaway from what’s happened recently in our space, not just with LTC but when I look at our peers, is concentration risk rears its head in a very ugly manner in the down times. If you look at the magnitude of problems, they have been because of concentration. You can withstand a smaller operator [stumbling] if you don’t have a big percentage — they’re having an issue, it’s not reflected in a large manner in your results. I think all of our peers say the same thing. For a CFO, concentration is something that they’re very aware of and trying to work that down. Our goal is not having an operator be more than 10% of our revenues.

How you do that is by expanding to operators outside of your existing operator base. So, to your point of growing with existing customers, yes, we love growing with our existing customers because that’s the most value-add form of growth. Underwriting the first deal and getting the first deal off is the most labor-intensive and costs most in terms of focus from management from the REIT. After that, adding on is so much easier because you’ve already done all your initial underwriting. You’re just doing that specific property’s underwriting, you’re not underwriting the whole operator, which is time consuming and takes a lot of resources.

What do you make of all the capital coming into senior housing from private equity and other sources?

A lot of this capital, I’m calling it undisciplined, because I think they’re allocating capital into the space without really understanding the space. So, capital providers that haven’t been through multiple [skilled nursing] reimbursement cycles, development cycles from the senior housing side, I think they’re mispricing their risk. They don’t have this high appreciation for the risk that’s involved in both asset classes, and therefore they’re willing to pay more than the property is worth. We certainly see that.

I don’t understand paying for a stabilized value on an asset that’s not stabilized. I’m not even saying close to stabilized — 50% stabilized, you’re halfway there, in this environment, you’ve probably got another 18 or 24 months. There are [lease-ups] that have been stalled for four years, they’re sitting at 50% occupancy. What’s leading you to think [this property] is going to get to 90% occupied and why in the world are you paying like it’s 90% occupied?

Those are big stressors on the system, and I do think from that dislocation, there might be opportunity for us. These new entrants are not appreciating the risk and they’re thinking, oh, it’s going to be easy. We’re just going to cut pricing a little bit and put in these new programs and we’re going to lease up. And when that fails, they might be looking to monetize, and we might get a property at a reasonable value. It’s going to take a few more years, I think.

So now is a time to be patient, and you’re anticipating the ability to get some deals done down the road?

The potential for some dislocation in both markets presents opportunities for LTC, for a patient capital provider. Dislocations are where we can step in and create value.

PDPM is just in the early stages, so the 50% of our business that’s skilled nursing-focused, we certainly think that there might be some operators out there that [PDPM] presents a challenge for them, and they’ll want to monetize their assets. And then from the senior housing side, we do think there will be the funds that don’t have the stomach or ability to hold through a protracted lease cycle and will need to monetize, and hopefully at that point, at the right price, we will be there. So, I’m cautiously optimistic.

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