Capital Continues to Chase Skilled Nursing, But PDPM Could Take Aggressive Buyers By Surprise

As more and more capital enters the skilled nursing sector, buyers and sellers have plenty of options when it comes to financing — and the market only stands to heat up as the Patient-Driven Payment Model continues to play out in practice.

That’s according to Ari Dobkin, co-head of the senior housing and healthcare team at New York-based Meridian Capital. The division has clocked $2.31 billion in transactions across the senior housing and care spectrum in 2019 thus far, with activity in the fields of assisted living, independent living, and memory care in addition to skilled nursing.

The transactions have included a range of multi-state SNF deals — the most recent of which was a $241 million deal spanning Massachusetts, New Hampshire, Pennsylvania, Delaware, Maryland, and West Virginia.

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Skilled Nursing News caught up with Dobkin to talk about the state of M&A and the effects of PDPM, as well as the changes in the world of SNF buying and selling in the years since the senior housing and health care platform launched.

Meridian’s senior housing and healthcare platform has closed $2.31 billion in transaction volume in 63 transactions through 27 states year-to-date this year. How does that compare to years past?

As much as volume is up, I think there have been years that the volume has been higher than this year. With us specifically, I think it is up significantly; in 2017, we did just over a billion dollars in the space, last year in 2018, full calendar year, we did $1.6 billion. Year to date, we’ve closed a few more deals since the last press release, so it’s actually up to $2.4 billion with some very large transactions behind them that are still slated to close for 2019.

It’s a combination of two things that we’re seeing. When we first got into the business, you didn’t have the acceptance of the concept of brokers in the health care space as much as you’ve seen with the conventional assets such as multifamily, office, retail, hospitality. At the beginning of our career, we were not only trying to pitch clients, but we were also trying to pitch people the idea that there’s value in an advisor. That’s shifted in the last few years, and I think it’s due in large part to the fact that deals have gotten more complicated. As there’s been compression in margin and other things in the industry, the financing solutions tie almost directly into solving for those problems: Like how are you are getting lenders comfortable with headwinds, when you’re going out to market and there’s something called PDPM, but you’re still six months out?

So as there have been complications in the industry, the value of an advisor has become that much more pronounced. We’ve been very blessed to have a great reputation, and this is such a small industry that reputation, I think, is better than any marketing that we can get. As our reputation has grown, the institutional players have come to realize that there’s a tremendous benefit in the advisory work. I don’t just mean brokers.

Because our whole career started rooted on the debt side, you really have to think as an operator when you’re approaching the market. With that perspective, it’s all about the narrative of what the facility’s doing and how that connects to the actual numbers. Many times we’ve seen deals that have fallen apart that we’ve had to pick up, where they need to re-tenant an asset or there’s specifically a rough story on a potential sale. There’s a lot of value to really being able to understand that narrative behind the numbers, and how that directly connects with the numbers. As people have seen the benefit of that, I think that’s what’s driven our volume this year.

That’s something I heard a lot when I first began covering skilled nursing — that operations are paramount.

We take that very much to heart. We can just take the approach of: “We’re brokers, we’re representing the banks, we’re on the capital side of the business, we’re not on the operations side.”

And it’s true, we’re not operators. But the biggest compliment to us when we’re doing a deal is there’s an acknowledgement of: “You guys know our numbers as well as we know our numbers, and you guys know what’s going on in our portfolio as well as we know what’s going on.”

We’ve had deals that literally are losing $3 [million], $4 million a year EBITDAR, and we can still obtain 90%-loan-to-cost on the acquisition price, because we’re able to tell the story of: This is what’s going to happen Day One, this is why this operator’s different.

Honestly, that could a lot of times be the difference between a deal getting done versus a deal not getting done at all — let alone with good terms.

Meridian has announced quite a few multi-state skilled nursing portfolios. Is that par for the course, or is there something particular driving these deals at this particular point and time?

When you have these larger [private equity] firms and REITs shedding assets, they’re likely to be spread out over larger states just because of the sheer size of the portfolios that we’re looking at. The value-add that we add as advisors, I would say, is a little bit different for each profile of the borrower.

For the institutional guys, it’s a lot of structuring, it’s a lot of thinking outside the box, it’s a lot of things that they might not have seen in the industry — because a lot of times those guys have their one to two go-to lenders. But there’s so much liquidity and capital out there right now, that without running a full-blown process in my opinion, you end up leaving terms on the table.

I tell people all the time: The same way you’re a nursing home guy, and for me to school you on operations would be preposterous, this is what we do all day; we’re finance guys, we’re in the market every day. We have so much volume going on we almost instantly know right away where the right fit is for that particular lender, for that particular borrower, for that particular deal, based on what they need.

Do the buyers of these SNF portfolios have any common characteristics that you can share?

To be clear, a lot of the multi-state deals that you’ve seen, that we’ve financed in the market, a lot of them is the incumbent operator is staying in. So we did a big Consulate deal [in which] Consulate was staying in the operations. We did a large Genesis deal, where Genesis was staying in the operations, and other national operators [did the same].

But generally staying on the acquisition side, I would say the profile of the buyer where you’re really getting that value is regionally based. You have your guys in the Northeast, and even sub-markets within the Northeast; you have your Jersey guys, you have your Maryland guys and the rate methodologies in each of those particular states are so nuanced that without really having a team on the ground, it’s really hard to take advantage of the rate — if you’re not really focused on it and monetizing it at every second.

As changes come in, the more spread out you are, it’s the difference between turning around the Titanic versus turning around a sailboat. Generally speaking, a lot of the value-add deals that we’re seeing out there are typically going to regionally based operators.

Is PDPM going to have any effect on the M&A landscape? If it is, how long is it going to take for that to start manifesting?

I wish I had a crystal ball, because I think knowing the answer to that question definitively could help make somebody a lot of money. From our perspective, I see this is akin to 2011, and I mean that in the positive way and perhaps the negative way.

CMS has been very clear that the net effect of PDPM should have nothing to do with the nature of care that happens at the facility level. There’s a ton of upside right now with PDPM coming in. There’s a ton of expense savings potential on the board, which means you’re just going to see margins go up, and I think it’s going to be another excuse for mom-and-pop folks who just don’t have enough resources and economies of scale to react adeptly to something like this.

So I think it is going to spur along the M&A market. But I’m also cautious about what happens in, say, two years from now when the government says, “Okay there were all these expense reductions — shouldn’t we reduce the revenue side of the equation as well? Why should we give operators all this margin?” That’s my concern for PDPM, and kind of the forward lookout.

That’s just my opinion, but it was similar in 2009 through 2011 where you had that massive increase, and people started taking advantage of therapies and everything. And then the government said, “Well, we’re going to roll it back 11%.” For the folks who weren’t prepared for that, they got caught with their pants down.

I’m a little nervous that something similar could happen over here, but in the short term, I think you’re going to see a huge kick on the M&A side because of it, because I think people are going to see a lot of opportunity.

What’s different, if anything, about SNF deals that you’re working on now compared with those that have closed in the past?

There’s been some really funky structuring things, but as a common trend, I think the amount that operators are willing to stretch, based on their experiences and their confidence and their own ability to operate — sometimes I think it’s getting a little scary out there, just because of how much you have to stretch.

We were just talking to a real estate guy who happens to own a nursing home last week, and we were saying that the market has always remained consistent about what the cap rate is. No one’s come out, no lender or buyer or REIT has come out and said: “We like nursing homes so much we’re willing to buy them at 10 caps.”

But what they are willing to do is stretch more within their underwriting and say, “No, we’re still valuing them at that 12.5, 13 cap range, but here’s how we’re going to achieve that valuation.”

I think that correlates directly to PDPM. Whenever you have these big mass rate methodology changes, everyone’s going to be the ultimate optimist on this — and maybe they’re all right. It’s just hard to imagine. Literally every operator we speak to believes they’re going to make more money under it. The government does a lot of things well and terrible, but they don’t make budget changes to spend more money; they make budget changes to spend less money.

So right now they’re saying all the right things, but what’s creeping around the corner, what’s really happening? If you have people that over the course of the next year and a half, two years are buying aggressively based on a decent Medicare population and reducing expenses by 20% or 25% — we’ve heard estimates as much as 30% — and they’re stretching on that and then the government responds to what they’ve done two years prior, what happens then? Someone’s going to be left holding the bag.

The one trend that we’re seeing is that more and more banks and finance companies are just coming into the space. Every other day we get approached by another bank: “We’re opening up a health care division. We’re looking at the space now — keep us in mind, put us on your list!”

Listen, more optimism is better for us and better for our clients, so we’re ecstatic with that.

Do you have anything you’d want to add as we wrap this up?

The one thing that I keep on saying is — and obviously this is somewhat self-serving: use an advisor. It doesn’t have to be us. But people are slowly starting to migrate away from the idea that HUD is the best long-term execution of assets, and with all the bad press that HUD has gotten recently in the NYT and everything like that, we’re excited about it because change typically represents opportunity for us.

So when people are getting spooked by HUD, and HUD is getting more difficult in their underwriting and requiring debt service reserves — there’s long-term, fixed-rate financing options that frankly didn’t even exist 18 months ago. We have probably four to five nationally based lenders that are telling us we don’t mind keeping it on our balance sheet; we’re not pushing it off to HUD.

People are starting to look for it, they’re starting to ask the right questions. But if you’re an aggressive operator that really takes the capital side of the business as seriously as he does the operational side of the business, you should really be looking for some options in the market. Because they exist out there, and I think long-term it’s a much easier interface, with banks; it affords you a lot more flexibility on both the front end and the back end and what you can do with your portfolio. Those would be my parting words.

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