Despite optimism about the Patient-Driven Payment Model (PDPM) and demographic trends, there’s never been a more difficult time for investors to determine which operators will win and lose in the skilled nursing space — at least according to the leader of a major lender in the industry.
Capital One Healthcare Real Estate closed 95 deals in calendar 2018, but senior managing director Jim Seymour emphasized that his group — part of the McLean, Va.-based banking giant — has taken a cautious approach when approaching the skilled nursing marketplace.
SNN spoke with Seymour about the year ahead in SNF lending, including his takes on the appropriate balance between short- and long-term rehab, Capital One’s underwriting process, and the future of Department of Housing and Urban Development (HUD)-backed lending.
What’s your outlook for the skilled nursing space in 2019?
I don’t do a lot of forecasting, but my view is, and our view is: I think the market conditions will remain what they are, at least through this year. We watch very closely skilled mix, the percentage of total days that are either Medicare or commercial, and occupancy — those are the two primary drivers that we think are most correlated with skilled nursing performance.
Skilled mix continues to drift down. Now NIC is reporting occupancy, for the first time in years, was flat or maybe even a few basis points up in the third quarter, so we’ll see if that’s just a quarter or if that’s a trend. But until those two metrics stabilize, I think we’re going to see more of the same, which is continued pressure on operating performance — driven primarily by the variety of bundled payment initiatives.
Deals will continue to happen, as they have happened, but I think in the near term, it’s still going to be pretty choppy. Longer-term, I think we very much see a real role for the asset type in the health care delivery system, and we absolutely expect to be a part of that. But I think there’s still going to be a lot of noise in the short term.
What’s the proportion of skilled deals in Capital One’s pipeline and portfolio?
Because of what I just described, and as a lender in particular, it’s harder with so much going on in the market to pick the winners and the losers. We’ve been very, very selective in the skilled nursing deals that we’ve put on our balance sheet over the last year or two. So it’s been a smaller percentage of the total in the last couple years. Capital One is still a significant originator of HUD transactions for skilled nursing, [but] we haven’t put anywhere near on the balance sheet in the last year or two as we had done historically.
Is the future of skilled nursing short-term rehab, long-term care, or a mix of both?
We react to the market and what our investors are doing. I wish I had a crystal ball, but I don’t. The truth is that there’s a need for both. You need that long-term care, where in a lot of cases, it’s the only place that these patients can go, and obviously there’s a tremendous need for rehab.
With the system we have today, you really have what are two very different businesses housed under one roof. You’ve got a longer-stay, lower-turnover, lower-margin business and a much more operationally intensive, higher-turnover, higher-margin business under one roof.
They both need to be served going forward, whether they continue to be served under one roof, or whether they become two bifurcated business models where you’ve got facilities that focus on the higher rehab, higher-turn, higher-margin patients, and those that focus — and maybe with a whole different overhead structure — on the lower-margin, longer-term care patients. That’ll be very interesting for us to see.
As a lender, we don’t really drive that. We lend against both, as long as we think the business models are sustainable and well-run and built to withstand what’s going on in the markets today. It’s a very good question you’re asking, because they really are two different businesses. And most skilled nursing facilities still do both. And what happens with the Medicaid program? You will see a significant amount of Medicaid waivers in the assisted living space in certain states, given all the building in assisted living. Does that take more of the load over time with the longer-term patient? That’ll be very interesting to see.
That’s one thing I frequently hear covering the industry alongside our sister sites — this idea that the barriers might be breaking down as we head toward the future.
It’s quite possible. It’s very different state by state and market by market, but the point you made about the high-rehab — you are seeing newer, specialized facilities built for that purpose. You’re not seeing new development going toward the longer-term patient. Most of the new money seems to be going toward the high-rehab type facility.
What’s the outlook for HUD lending in the space? It’s obviously an attractive financing vehicle for skilled nursing investors and operators.
I don’t see any signs that HUD is wavering in its commitment to the sector, so I don’t see a reason that HUD financing for the space would diminish in the short term.
We merged Capital One and GE Capital’s health care finance business [in December 2015]. I was with GE when we were combined about three years ago, and the agency lending side of the house — both HUD, primarily in skilled nursing, and Fannie and Freddie in the senior space — was not what we did at GE.
But it’s a significant part of what we’re doing today. It’s basically a collaboration between ourselves, who focus only on the health care, and Capital One Multifamily, which is where the agency operation is housed. We are a significant player today. We expect to be a much more significant player over time as we learn to collaborate better and gain more market share.
But we’re very happy with the way that’s progressing. Both on the HUD and the Fannie/Freddie side, we think that’ll be a bigger and bigger part of what we do over time alongside the balance sheet lending, which we remain committed to.
That’s in our DNA. That’ll continue to be a big part of our story as well. But we found that customers really like the capability to be able to do both, so that they can pick and choose which is best for their business plan — whether they want to do a bank financing or a longer-term agency financing, the ability to do both, and to do it in kind of a product agnostic way, we’ve found is a big hit with customers.
Are you seeing a growing backlog in HUD deals amid the record-long government shutdown?
I assume there is, because as you know, HUD lending has a big share of the permanent financing in the skilled nursing space.
Relative to years past, that process has gotten a lot more efficient. Years past, you would have very long backlogs, and the process has gotten considerably more efficient. I’m sure there’ll be a few hiccups as it gets up and running [again], but I would expect — especially if it doesn’t drag on for months and months — that within a very short period of time, they’ll be up and running and processing transactions as they have been. It’s one we’re all watching, and certainly our customers are watching with great care: When are we going to get back to business as usual?
What does Capital One look for when evaluating potential deals?
We do a very through underwrite, and I think in skilled nursing, just like in any real estate transaction, you’ll look at all of the real estate fundamentals in terms of each market and the supply and demand, and how much new product is coming on. What’s the occupancy rate? What are the demand factors?
But I think the biggest factor in skilled nursing has been, and it’s even more important today, is [that] we really focus on the operator: Who is the operator? What’s their track record? What do their referral networks look like? What do their IT systems look like? Are they able to track the outcomes and show the data that needs to be shown in order to survive in this world today?
We’ve seen a significantly reduced deal flow over the last couple years, and NIC will tell you that deal activity last year was down 20 or 21 percent versus the prior year, and I think we’ve probably seen that. Like I said earlier, while we remain committed to the space, we have been very selective with the new stuff. We’ve been doing this for over 15 years, but we’ve never seen a market where it’s harder to figure out who the winners and losers are going to be, because there’s so many variables that factor into what we think the winners are going to be in this market. But those variables I just listed, we think, are the characteristics of those that are going to survive.
We announced the sale of a portfolio of skilled nursing loans in the fourth quarter. That probably illustrates as well as anything how we’re viewing the world. On the one hand, we sold 11 or 12 loans that, in our minds, had become a little higher leveraged over time than we were comfortable with, so we sold those to a non-bank lender [White Oak Healthcare Finance]. On the other hand, we financed the transaction on a pooled basis, which allowed us to stay in the space, remain committed to the space, albeit at a lower leverage point, and also make the impact to our financials relatively minor. In other words, we reduced our last-dollar risk to a big pool of loans, but we stay in the space, and we continue to support it going forward.
That’s the kind of caution we’re proceeding with in the current market. It’s complicated right now, but it will get sorted out, and it looks like we’re getting close to stabilization, and folks can start growing from that lower base.
This interview has been condensed and edited.