From the outside looking in, the flood of capital in the skilled nursing space may seem strange. After all, the main Wall Street headlines about SNFs and their publicly traded landlord partners always come with a heavy dose of caution: Reimbursement pressures, staffing strains, and liability risk make nursing care a bitter pill to swallow for some potential investors.
In fact, public skilled nursing giant The Ensign Group (Nasdaq: ENSG) faced so much skepticism over its SNF assets that it spun off all of its other business lines into a separate company earlier this month, claiming that the value of its home health and hospice operations was unfairly burdened by their association with skilled nursing.
To probe this disconnect, we decided to dedicate the latest edition of our Confessions series to a mergers-and-acquisitions executive on the front lines of skilled nursing dealmaking. As an anonymous participant, this leader was able to give an unvarnished look at the challenges and victories that buyers and sellers face on the marketplace — and why he or she remains all in on the skilled nursing space.
What are some of the top reasons that investors are looking to buy in today’s market?
There are a few reasons. First, new entrants chasing yield: They are looking elsewhere due to yield or cap rate compression in their current asset types, such as multi-family, hotel, et cetera.
Some are current operators trying to care for more lives in a tight geographic footprint, so they have more leverage with the payers in those markets. Others desire to grow their ancillary businesses, such as buying a facility to get all the vendor contracts. The primary driver is the facility, but they are taking the ancillary businesses into consideration when buying.
Some people just want to make a good investment — but ancillary to that is putting a new generation into business, typically in wealthy multi-generational families with deep industry expertise.
What about top reasons to sell?
There are many: It could be distress, such as around the real estate investment trusts (REITs), lenders, or regulatory issues. It could be a non-core asset within a larger portfolio, a functionally obsolete building, or a property with operational or clinical issues. There could be a lack of succession planning or options available for a refinance — but it could also be that the owners received an unsolicited offer that they couldn’t ignore, or forged a strategic joint-venture partnership opportunity.
What are common reasons why deals fail to go through?
There could be an inexperienced buyer — buying communities in this industry is very challenging, so new people to the industry sometimes struggle with market terms in the contract, or navigating regulations.
We could uncover something in diligence — major deferred maintenance, a new competitor in the market, or maybe the insurance is much more expensive than you thought. And then sometimes financial performance falls way off during diligence: Transactions can take three to six months, so performance can really fall off in some cases, especially when people are knowledgeable about a sale. Major clinical issues could occur during diligence as well.
Sometimes, the parties can’t agree to major contract points like successor liability protections. And the number-one reason deals fall apart: Debt or equity doesn’t show up at closing to get the deal done.
What are some of the top things you look for when evaluating a property?
Great leadership, great culture. A lack of functional obsolescence in the building, like six-foot corridors or no bathrooms in the units — which can still be common. Good location — the facility’s in a nice part of town and well supported by the community.
Lack of clinical and culture problems — these are the two hardest things to turn around, and take the longest amount of time to fix. And finally, market demand for the service offerings at the community — or at least other programming the community could use that the building could potentially fulfill.
Would you yourself put money in a nursing property as a personal investment?
I’m about as all in on the SNF business as you can get — personal capital, personal guarantees on debt and vendor contracts, name on licenses, et cetera.
There’s often a lot of talk about constricted Medicaid rates and staffing pressures making life hard in the industry, but clearly there’s plenty of capital chasing SNFs in the marketplace. How do you explain that disconnect?
It is not an easy business. It is one of the most regulated and complicated businesses out there. To further complicate things, one senior housing community or nursing home impacts the lives of hundreds of people — residents, employees, resident and employee families, vendors, management companies, investors, lenders, community stakeholders — so a lot can go wrong. The proliferation of managed care and labor tightening only exacerbates the issues we face.
With all of that said, I think this business is very durable over the long term. We are caring for increasingly medically complex residents — care that cannot be delivered in a lower-cost setting. Additionally, one of the attributes I like most about this industry is that if you are disciplined about the price you pay for a community, there are so many different business lines you can launch within that building. The ability to develop specialty programs specific to market demand makes senior housing and nursing very attractive over the long term — especially relative to other commercial real estate assets types that aren’t need-based and dynamic, especially during times of recession.
What’ll be the bigger driver of deal flow over the next few years: PDPM issues, or Medicaid problems? PDPM has gotten all the attention, but Medicaid has been just as disruptive, if not more so.
If I can only choose between these two, I think Medicaid problems — but not rate volatility as much as collections issues. As an increasing percentage of SNF revenue migrates to third-party administers for payment, many owners will face working capital distress that will lead to more sales.
Staying on the Medicaid topic for another point, Medicaid rate increases — especially substantial increases — will actually lead to more sales. The increases will allow legacy owners the ability to sell at a level that mutes the impact of stagnant or declining performance from the previous years.
Without giving away too many details, what’s the worst experience you’ve ever had with a particular deal?
When I was first starting off on my own; you have to fake it until you make it. I had a really complicated deal that had been in process for months. We had accumulated huge diligence and legal bills in preparation for closing. In the 11th hour, I had a larger investor say they weren’t going to be able to fund, so had to find backup equity within days of closing.
I didn’t know if the equity was going to show up, but it ultimately did on the day of closing, and we were able to close. That deal went on to be our worst deal by far, with about everything that could have gone wrong happening. Very painful learning experience, but we are much better for it today.
And the best?
We work on really complicated deals that typically have some level of distress to them. Given all the stakeholders we have to deal with — lenders, investors, sellers and internal fights within the seller group, government, employees, vendors — it has been really satisfying getting some of the deals closed that we have.
We have purchased communities out of bankruptcy, deals where the seller hadn’t paid payroll taxes in years, deals where the operator and real estate owner were no longer on speaking terms, others where the seller was trying to fleece his investors with the sale — so we had to keep him in check and also get the deal done so we wouldn’t be sued post-closing.
[We had] another where the seller was using hard money loans to fund working capital, so we had to manage the hard money lenders to ensure they didn’t shut down the operations, and some with highly complex and distressed ownership structures.
There are numerous examples where it is 100% chaos and fighting among various parties leading up to closing. Closing on a transaction like that, where the distress disappears, and you have hopefully found a transaction structure that works for all parties, is really gratifying.
This interview has been condensed and edited for clarity.
