When the Dallas-based skilled nursing operator Senior Care Centers filed for Chapter 11 bankruptcy protection last December, management placed the blame firmly on its leases with its real estate investment trust (REIT) and other landlords, specifically calling them “expensive.”
But Wendy Simpson, president and CEO of SCC landlord LTC Properties, Inc. (NYSE: LTC), says the operator wasn’t talking about her leases — which, she says, the company plans to reorganize around once it emerges from bankruptcy. That said, on the most recent episode of SNN’s podcast “Rethink,” Simpson expressed frustration with the pace of the Chapter 11 process, which has seen SCC take its time when deciding to either affirm or reject its leases with LTC, a key step in the restructuring process.
Since the conversation was recorded on July 15, Senior Care Centers provided an updated Chapter 11 plan on August 2, and the process continues to wind its way through the courts; LTC has filed an opposition motion that will be heard later this week, Simpson said.
Representatives for SCC declined to comment on the record as of press time.
In the episode, Simpson lays out a case for the continued viability of the REIT-skilled nursing model, as well as a call for more younger operators to join the industry — and inject it with some fresh ideas.
Edited and condensed excerpts from the conversation are below, and be sure to head over to SNN’s pages on SoundCloud, Apple Podcasts, and Google Play for the full episode. If you like what you hear, make sure you subscribe on the service of your choice so you don’t miss one of our twice-monthly episodes.
What’s your pitch for the REIT model in an era when they’ve come under fire from struggling operators?
I think it’s the best way for them to go unless they have a very friendly bank in the neighborhood, or they’ve done some business with them before. But to access a few million dollars for an acquisition or to finance their operations by selling out some of their equity and using it to either grow the business or reinvest, I think that the REIT structure is still very viable for the skilled nursing sector.
Now, we’ve heard several operators sort of blame the REIT structure for their operational problems. It’s not the REIT structure. It’s the amount of money that either they took out or their prior owners took out when they sold the asset to a REIT — and when the REIT underwrote it, whether the REIT underwrote it at a decent margin after management fee to have the operator have a profit in addition to the management fee.
And then the ups. We hear: “REITs always have ups, and that’s not fair, because we can’t always increase our revenue because so much of it is government-based and it’s hard to get the government to give us an increase. We’ve got increased costs.” That is an issue, too, but historically, SNFs have been able to absorb a 2% to 2.5% rent bump every year — if, indeed when they wrote the lease, they had a margin of profit and they didn’t take the last dollar off of the table.
It’s the structure of the lease when it goes in, and not the fact that it’s a REIT at all. A couple of the high-profile companies that we’ve been involved with that have filed for bankruptcy — Preferred Care, first, was because they got involved with a lot of litigation in the states of Kentucky and New Mexico. It had nothing to do with our leases; our leases were profitable. But it got caught up in that bankruptcy, and then Preferred Care eventually totally reorganized or are in the process of it.
In the case of Senior Care Centers, they did a lot of leases outside of our leases that were with sort of affiliates of their equity owners, and they, I think, set their rents way too high for those non-arm’s-length leases. Our leases, as we’ve been caught up in this bankruptcy, are part of what they would like to reorganize against.
So it’s not our leases that caused them. There were other leases that were, we feel, badly structured. To put a negative against REIT financing for SNFs, I think, is way too onerous on the SNFs and the REIT relationship.
What are some ways that SNFs and REITs can get on the same page before and after the underwriting stage?
When you underwrite it, you really need to underwrite it with a cushion. We underwrite it to a 1.5 coverage ratio on the trailing 12 months, and that historically has been a good lease; the operators have been able to make profit on that. But then again, it’s only the lease that you’ve written — operators go out and find leases with other companies, whether it’s a private equity owner or another REIT, and they don’t get the same underwritings.
I can’t think, right now, of a way that a REIT should do it differently than what we’re doing in giving the operator plenty of operating margin.
Everyone I speak with says success or failure is all about the operator anyway.
The traditional triple-net lease means that they pay property taxes, repairs and maintenance and capex and insurance. Our old leases didn’t have this provision in there, but for capex items — like you need a new roof, you need a new boiler, or something like that — we will, as a REIT, fund that for a return.
One of the problems, or one of the criticisms — which was fairly a criticism of the industry, the traditional triple-net lease — was that the operator was putting actual equity money in if it was a capex type of expenditure, which had to come from his bottom line.
We’ve recognized that. We started many, many years ago offering our operators the capex they needed. Not the repair and maintenance money, but the capex they might need to improve or just maintain the building. But of course we have to have a return on that. It’s always cheaper than their equity dollars. So that’s one area that has been changing over the years.
How’s the SCC bankruptcy process? Are you pleased with the progress so far?
No, I’m not pleased with the progress of where we’re at, because we’re still embroiled in it.
The debtors, the operator, filed a plan a week or so ago [Editor’s Note: This interview was recorded July 15] — their deadline for affirming leases, I think, was July 2, and they filed what we consider sort of a placeholder affirmation of the leases without actually affirming them. It was sort of like: We want to keep them until we have more time to make a decision on what we can do, because we don’t have financing in place, and we need some more time for financing.
On the plus side, they’re paying rent. They’re maintaining the buildings. On the negative side, they’re asking for more and more time to try to figure out where they can go forward, or if they have to turn to a Chapter 7.
We would just like an answer. We would like a definitive: What’s going to happen with our asset? And are we happy with what’s going to happen with our asset? Right now it’s hard for us to be awful when we’re still being paid, and other leases are not being paid, but we’re still embroiled in it.
Nursing home bankruptcies are such special cases, with vulnerable people and government reimbursements — it’s not as easy as liquidating a food distributor or something.
One of the things that we’re doing, and we’ve said it on our calls, is: We, at this point, have an operator that wants to take all of these assets and would be a fairly quick transition. One, for everybody who’s working in the facility and everybody who’s having care in those facilities; and two, for our shareholders. They’ve been experiencing this uncertainty since last December — probably even a little before it, because the industry always hears the drums before something actually happens.
Can you name the operator?
No, we can’t, because I’ve been told that LTC’s comments are chilling the process. So I don’t want to chill the process any more.
What’s the ideal mix in a REIT of SNFs versus other asset classes?
Either go big or share. Omega, I guess, is the one that is most SNF in terms of percentage. We have, over the last maybe seven or eight years, enjoyed about a 50-50, which has seen us through difficult times — the recession and that sort of thing.
I think a 70-30 is not a good position to be if you’re high on the SNF side. I think NHI probably is a good example of having a significant investment in SNFs, but higher in assisted living and independent living.
I think the most you should go on the SNF side is no more than 50%, unless you go big like Omega has done.
What’s LTC’s current mix?
Right now, we’re about 50-50, but as we’ve mentioned, we have several assets that we’re selling, and we’ll talk about that more on our earnings call.
It’s mostly the Preferred assets. I think by the end of the year, we’ll be less than 50-50 independent memory care and assisted living. The private-pay side of our business will be more than 50%, I believe, if these assets that we are in the process of selling actually close and get sold.
Where are you seeing the most interest from buyers?
It’s predominately private equity. Within any portfolio, you’ll have a couple of very nice assets, and they will draw the attention — and I’m not saying it’s Ensign — of somebody like an Ensign who might be looking to add to a footprint that they have in a particular state. But predominately we are seeing private equity interested in these assets — and a significant number of private equity. I’m amazed when I get the first list of who’s asked for the book, the number of people who ask for it. Now, that quickly whittles down, but there’s still significant interest in the older, regional skilled nursing assets.
Is it good for the industry to have this influx of private equity?
The challenges are new owners who don’t really understand the business. It’s a very specific business, and over my career, I’ve seen various types of equity come into the marketplace. Years ago, GE was buying everything that they could buy, and where are they today? Private REITs, several years ago, were buying everything that they could buy, and where are they today? Formation was buying everything they could buy, and where are they today? Formation, at least, understood the business; they’re just not a force in the industry anymore.
The force in the industry seems to be private equity. Now, some of the private equity people may actually have owned nursing homes before and actually understand the operations of a nursing home and the challenges of the regulations and the reimbursement — and others may just see it as real estate that can be levered. And getting money cheaply today at a fairly high leverage, you can get a good return if you don’t intend to reinvest in the asset.
I’ve seen some private equity, and we’ve talked to some private equity, that actually have some experience in the industry. And other private equity are actually looking at it like apartment buildings that have older people in them. So my concern is that level of investment, that’s just looking at these assets as real estate.
Operational experience always seems to be the common denominator among the top performers — it’s not even easy to make the leap from senior living to skilled.
Our concern is that they put finance people in charge that don’t understand the finances — the reimbursement, the technicalities of accessing government funds, whether it’s state government funds or federal government funds — and the rules and regulations that an operator has to do. And [they try] to impress upon an operator: They need to cut here and cut there, because they really don’t understand the dollars that have to be spent to maintain the quality of care that every operator is trying to maintain.
Where do you see the business going over the next five to 10 years?
I think there’s going to be more of an asset class that’s more the custodial nursing home, rather than the nursing home that’s going to be for everyone. There’s just a level of people that just need a safe place and care to be given to them that is not assisted living. It’s a little bit more intense than assisted living — but they are not going to rehab and move out of the location that they’re in.
I think we’ll have more closures of nursing homes, and I think we’re seeing that in some of the rural areas. What concerns me is getting the newer generation interested in operating skilled nursing facilities. You don’t see many younger management teams. We’ve accessed a couple, and they’re more of a rehab operator than the traditional long-term skilled nursing operator. Hopefully we can do some deals with some of these younger operating teams.
I see a bit of a bifurcation of the skilled nursing. I don’t fully understand what the benefit of the new dialysis rules are, but that seems to be very exciting if you’re going to have a more acute skilled nursing platform than just the custodial. So that’s a new line of business, new care that can be given in the skilled nursing facility.
I don’t see a lot of new building going on. If it’s a new build, it’s going to probably be one of the transitional, short-term stay, which will not be a big facility. Not 120 beds or something like that, but more toward what used to be considered a rehab hospital, now will be a rehab skilled nursing type of hospital.
I think Mainstreet tried to do that a few years ago, and they were really big into that, and probably a little ahead of the time — or what they build was too encompassing … But a couple of the things that we’ve looked at are kind of Mainstreet-lite — taking the Mainstreet idea and paring it down to the actual parts that did work.
Bridgemoor took over some of those former Mainstreet facilities, and they’ve seen success with a smaller, more focused footprint.
A lot of good ideas might be just a little ahead of their time.