With capital chasing upside and new development dominated by high-end “medical resorts,” the availability of long-term care beds has emerged as a big-picture issue for the skilled nursing industry.
While it may not be a nationwide problem just yet, certain markets — from Wisconsin to California — have begun to show the early signs of bed shortages for residents who require long-term custodial care not covered under Medicare, and tough Medicaid margins in a variety of states make the business line particularly precarious.
The problem is also a compounding one: As insufficient Medicaid reimbursements force operators to shut their doors, the number of beds in many regions could be on the decline just as demand for the services begins to pick up from an aging baby boom population.
But Taylor Pickett, CEO of Omega Healthcare Investors (NYSE: OHI), believes that a Medicaid-focused model can work under the right conditions — specifically where census is high enough to help offset some of the costs that come with caring for a long-term population.
Pickett touched on the long-term bed issue during a wide-ranging discussion with SNN during the National Investment Center for Seniors Housing & Care’s (NIC) annual fall conference in Chicago last week — which also saw the CEO offer a peek into the real estate investment trust’s (REIT) recent deal to purchase 58 skilled nursing facilities for $735 million.
What made that deal attractive?
Every year, we’ll have four or five bigger type transactions flashed in front of us, and we do our underwriting as we always would. Seventy-five percent of the time, nothing happens. The transaction never trades anywhere.
I think we’re at a point in time where, given our cost of capital and where cap rates are in the business, we were able to get a price that made sense from our perspective. The seller was prepared to sell. I don’t think there’s anything unique or idiosyncratic about that transaction that made it special at this point in time.
For the seller, the time was right, and we could get to the right price. We love the Southeast; that’s where these buildings are.
Can you offer any more detail about the transaction?
We’re under a [confidentiality agreement]. We pretty much said what we could. We wanted to make sure our investors understood the economics of the deal.
The only other thing I would say is that the HUD consent process has two potential pathways. One is a relatively rapid corporate consent. If we’re able to achieve that, we’ll have the opportunity to close the deal this year. We haven’t modeled any of our numbers thinking that it would close this year. The second, more traditional, pathway is much slower and would push us into the first quarter, maybe even the early second quarter, of 2020.
Do you have any interest in similarly sized deals coming down the turnpike?
Oh yeah. We love that. We’ve set our balance sheet up to put ourselves in the position to do that size deal or bigger by just being able to write the check off our credit facility. To the extent that we see stuff that makes sense, we’ll do it.
I will say we don’t have anything in our pipeline today like that. That being said, inevitably stuff crosses our desk, and we’ll do our normal work.
What do you think of the current state of the SNF-REIT relationship? Does it need to evolve?
I think where you need to be careful is: There have been transactions that were structured Day 1 that presented risk of performance over time.
Rent as percent of revenue is a pretty good metric. If rent as a precent of revenue is 15%, 16% in an industry where good operators operate at mid-teens margins, you have to think about: Structurally, did I start off at the wrong spot?
And then the second piece is: Do you have escalators that exceed inflation? We’ve seen deals structured with 4% escalators in the past, and they will catch up. My personal opinion is that if you structure the deal correctly up front, and you have 2% or 2.5% percent escalators, that’s going to mirror inflation over time. That’s a sustainable model. We really believe that.
A little bit of the proof is in the pudding in that we have lots of long-term relationships, and they have been sustainable. We’re doing new transactions today with exactly that model.
So I don’t know that it’s broken, but you need to do it right Day 1.
What’s your take on PDPM and M&A activity? How long will we have to wait to see the effects?
I think PDPM is just one component of decision-making. Every time we’ve had reimbursement changes in this industry — and over the last two decades we’ve had a number of relatively big changes — those changes tend to create a little more activity. But I still think it’s against the backdrop of someone looking at monetizing for lots of other reasons. This might just be the last little nudge of: Am I really prepared to operate in yet another new environment that is a little bit more complicated?
I think it probably creates incrementally a little more deal flow, but in the past we haven’t seen an enormous amount of deal flow. When RUGs [Resource Utilization Groups] came in, we saw a little more deal flow. We didn’t see gigantic amounts of deal flow. I’m probably in the opposite camp from some folks who say: This is going to accelerate a lot of activity.
If it does, great, but we’re not banking on it.
There’s a general wait-and-see approach about all of the PDPM impacts.
I personally think PDPM, by January of 2020, will have really good visibility on what it means for every operator. They’ll have had a few months to work out whatever kinks there might be. My personal opinion is they won’t be that significant. We’ll start to see clean numbers beginning January of 2020.
And we talk to our investors about how, as soon as we have reasonably good visibility, we’ll start to communicate to the market: Is it the positive that we thought it would be? We don’t think it’s a gigantic positive, but we’ve talked about it improving coverages overall in our portfolio by .05 or .06. So it’s helpful.
How do you approach distressed situations? You’ve gone through it recently with Daybreak Venture.
From our perspective, step one is: Is it an operator management issue? And in some cases, you’ll see that, but more often than not, the issues are either temporary — where you’ll see just a shift in reimbursement. We’ve had issues in Illinois in the past, and Ohio. Are there things that you can work your way out of?
Or are the issues component parts of bigger portfolios — where you still have faith in the operator, but maybe there’s a certain piece of what they’re operating that can be moved to someone else or sold, and just improve the overall landscape.
Diversicare and the Kentucky sale we just did is a pretty good sample of [that]. A component of that master lease wasn’t working well within Diversicare’s universe, but other people saw value in that portfolio, and it made sense to carve it away. It didn’t make sense for any of the parties to say: “We’re going to just pull this whole master lease away.”
You still work with Diversicare in other markets, correct?
We do. We still have a reasonably big relationship with Diversicare. They’re not a top 10 anymore .. but we’re in the mid-20s, facility count-wise.
What does the skilled nursing product look like in 10 years? Still two models under one roof, or do we start to see a bifurcation of the Medicare and Medicaid businesses?
We’ve already seen a little bit of bifurcation of the model. About a decade ago, I was asked to speak about real estate at a NIC, and I talked about the sorting of properties — where you’ll see more emphasis with certain facilities on Medicaid, and some where it’s Medicare.
I don’t think you have complete bifurcation. I just don’t see that as the answer, mostly because the market density — it’s very difficult to have a Genesis PowerBack in many communities. You just can’t support the volume that would go through one building.
So I think we’ll still see the skilled nursing facility model with Medicare and Medicaid, but I also would add that I think that there’ll be buildings that are virtually all-Medicaid buildings. And we’re moving in that direction already.
What would it take to generate investor interest in that? New development is almost always beautiful, high-end Medicare properties.
Medicaid, at certain occupancy levels, works. We know it works. It’s not dissimilar from senior housing, where if you get occupancies below 80%, it’s difficult to cash flow, but when you get above 80%, the cash flows are pretty significant. There’s more direct operating costs in a Medicaid model, but there’s similar math around it. An 85% occupied Medicaid facility might not make money, but a 95% facility probably will.
I don’t know that it’s new building interest, but I think when you look at the whole landscape of a portfolio, there probably are certain buildings where you can say: I’m going to dedicate principally to Medicaid, and that will work.
I think the other thing we look forward 10 years from now: I don’t think technology disintermediates the industry, but I think we’ll see technology in a variety of forms outside of the hands-on care part of what we do — to the extent that technology can be beneficial on the housekeeping front, on the dietary front.
And then as an adjunct to the hands-on care — whether it’s embedded technology to monitor vital signs, to monitor patient movement, to monitor falls, to prevent falls — I think there’s a lot of aspects of that that we’ll see in our business. Ultimately, the direct hands-on care, 10 years — that won’t go away. Forty years from now? Maybe robotics get to the point where even that changes.
That’s definitely not 10 years from now, based on what I’ve seen.
It’s not 10 years. No, it’s going to take a lot longer.
I think the other thing, 10 years from now — and I know you’ve seen it — is the demographic work that we’ve done. There’s going to be another element of markets that literally have no free supply, and it’ll be interesting to see how states and the federal government react to that.
LeadingAge Wisconsin has predicted that it’ll happen in that state as soon as next year in certain markets.
We’re already seeing it in California. The governor of California formed a committee to study seniors, including senior care, in the state. And it’s a reaction to the fact that there are a couple of counties in California that are basically 95% occupied. There’s no beds. And the politics of: How do we care for the population that we’ve committed, as a society, to care for? That’ll be really interesting to watch.
This interview has been lightly edited and condensed for clarity.