Omega Healthcare Investors, Inc. (NYSE:OHI) once again ran into problems with skilled nursing tenant Daybreak Venture in the fourth quarter of 2018, with the Denton, Texas-based operator underpaying about $4 million in rent.

The Hunt Valley, Md.-based real estate investment trust (REIT) reported fourth-quarter net income of $64.9 million, or $0.31 per common share, compared with net income of $65.2 million, or $0.31 per common share, in the year-ago period.

“As investors are aware, Daybreak’s rents are accounted for on a cash basis and so this rent shortfall immediately impacted our fourth quarter revenues,” Omega CEO Taylor Pickett said in the REIT’s fourth quarter earnings press release. “While Daybreak has implemented many favorable changes to their business, the operating environment in Texas remains challenging near-term, with low occupancy and one of the lowest Medicaid reimbursement rates in the country.”

Texas troubles

With those challenges in mind, Omega is working with Daybreak to provide a $2.5 million rent deferral for each of the first and second quarters of 2019. Daybreak’s request of a partial rent deferral was the second such request in the span of about five quarters, Omega COO Dan Booth noted. Omega will defer about $4.2 million in the fourth quarter of 2018 and one month’s rent — approximately $2.5 million — in both the first and second quarters of 2019.

“These deferrals were granted for a number of reasons,” Booth said. “First, to allow Daybreak to continue to embark on certain operational improvements, which are already starting to yield positive results in the form of improved operating performance. Second, to give Daybreak time to reap the benefits of a significant increase in participation in the Texas [Quality Incentive Payment] program, which is similar to what other states commonly refer to as a UPL program.”

The term “upper payment limit,” or UPL, refers to extra cash that brings Medicaid payments up to the level offered by Medicare via a program offered through the Centers for Medicare & Medicaid Services (CMS). Daybreak, which operates 57 Omega properties, currently has 16 of those facilities enrolled in the Texas QIP program, and has applied to enroll an additional 31 facilities, Booth noted on the call. This is projected to increase annual revenue by between $5 million and $7 million.

The deferrals are also designed to help Daybreak benefit from the Nursing Facility Reinvestment Allowance (NFRA) bill, if it passes, Booth said. This would provide for an enhanced Medicaid rate and other improvements, at least in its current form. And though the outcome of the initiatives and the bill is uncertain, he said Omega believes the rent deferrals are crucial to allowing them to “reach their full potential.”

Omega executives stressed that Texas is a challenging environment for operators overall, even though the long-term picture is more positive, with favorable demographics and the coming of the new Patient-Driven Payment Model.

“Daybreak’s current liquidity issues reflect the particularly difficult operating environment in Texas, where the combination of relatively low statewide occupancy of 70%, and a Medicaid rate that is the second-lowest in the U.S., has resulted in a number of restructurings both in and out of bankruptcy court,” Pickett said on the REIT’s earnings call.

Booth echoed these remarks, noting the bankruptcy of “the largest operator in the state” — Senior Care Centers — and shrinking margins for Omega’s operators due to such factors as “woefully low state Medicaid rates.”

Traditional REIT-SNF model isn’t broken

Analysts referenced comments Genesis HealthCare (NYSE: GEN) CEO George Hager made at the eCap Healthcare Summit in Doral, Fla. on Monday, in which he argued that the traditional REIT structure in skilled nursing has proven to be a failure.

Omega executives pushed back against that characterization on the call, though they acknowledged some rent escalators can pose problems for operators.

“In the face of occupancy and demographic challenges, and a tight reimbursement environment, there are lease structures that can catch up to you, and that has happened in the Genesis portfolio,” Pickett said on the call. “But our view is: 2% escalators which reflect inflation and tie basically to rates … we don’t think that model’s broken.”

Genesis operates 59 Omega properties.

In his remarks at the eCap conference, Hager specifically called out deals with lease coverage in the 1.2 to 1.3 times range, coupled with annual rent escalators of 2% or more, and Pickett agreed those pose problems.

“I think the broken models are the ones where you saw escalators at 4%, 4.5%, that way outpaced inflation,” he said. “That does eat into coverage; there’s no way to get around that.”

Deals, Orianna and realignment

Omega recorded a restructuring charge of $2.5 million mainly from severance payments and office closure expenses, as it is embarking on an “internal realignment” that will entail the closure of Omega’s Chicago office and the elimination of some positions effective February 15.

The REIT also saw the finalization of the restructuring of former operator Orianna Health Systems, which resulted in higher general and administrative expenses, according to Pickett’s remarks in Omega’s press release.

Omega in the first quarter of 2019 entered an agreement to acquire MedEquities Realty Trust, Inc. for $600 million. That transaction is expected to close in the second quarter, Omega executives said on the earnings call.

Omega shares closed at $36.86, down $2.42 or 6.16%.