How LTC Properties Worked Through Tenant Bankruptcies to See Skilled Nursing Opportunity Ahead

For the past few public earnings calls, analysts have peppered executives at LTC Properties (NYSE: LTC) with questions about the ongoing bankruptcies of skilled nursing tenants Senior Care Centers and Preferred Care, which have proven to be long-running issues for the real estate investment trust (REIT).

But with a plan in place to sell off its former Preferred Care buildings, and with Senior Care Centers set to emerge from bankruptcy with a smaller footprint, LTC Properties sees mostly promising signs ahead for their skilled nursing assets and the industry at large — with particular optimism around the Centers for Medicare & Medicaid Services’ (CMS) approach to rolling out major industry changes, such as the Patient-Driven Payment Model (PDPM).

The company has also been willing to bet on new skilled nursing developments, a relative rarity in the current marketplace; LTC this past summer invested $38 million to purchase a recently-constructed SNF and a second site under construction, both operated by Ignite Medical Resorts.

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SNN sat down with LTC chief financial officer Pam Kessler and chief investment officer Clint Malin at the company’s headquarters just north of Los Angeles to discuss the REIT’s strategy for navigating its operator bankruptcies and vetting potential partners, as well as the leaders’ outlook for the industry heading into 2020 and beyond.

We’re starting to see some early returns with PDPM, with one analysis showing that about 90% of buildings are seeing gains so far. What are you hearing from your operators, and did you build any potential increases into your outlook for the year?

Kessler: As intended. Revenue-neutral.

Malin: It’s obviously still early on; people are evaluating. As we talked to operators before our earnings call, at that point in time, they were still going through October — they weren’t going to submit billing until the first part of November. And so now, at this point, really they’re going into their second month. It’s still in its infancy.

But I would say generally, there’s not as much concern on the operator side; people have planned for the implementation of it. I think we’re excited about the opportunity looking forward to that implementation.

Right now, back from the holiday, we’re looking into the next round of billing: What are people seeing now? But generally speaking, I think overall, people are prepared for, it or excited about it being implemented.

Kessler: We plan for it, long-term, to be neutral. We know we know if it’s not, it will be recalibrated.

What about therapy changes? Are they making major moves, or waiting to see more results?

Malin: Mostly holding off and phasing it in. It depends, obviously, if you have in-house staff or you’re doing contract therapy. If it’s contracting, you’re just going to try to renegotiate your pricing as appropriate. It really depends on which side of the table you sit on with in-house therapy or contract. Companies I’ve talked to are also cognizant about [not wanting] to just drop off therapy immediately.

Kessler: Your outcomes have to be the same — or hopefully they’re even better, but they’ve got to at least be the same. You can’t just drop off therapy and have worse outcomes. Then CMS is really going to look at the whole philosophy.

I would think you would have to phase it in a little bit. Maybe dial it back a little bit, and let’s see: “Are we still getting the same outcome?” I don’t think, under the old rules, there was really a barometer for how much you need. It was kind of like: Well, these are your tranches, and this is where you operate in. I don’t think there was a way for people to calibrate — they weren’t incentivized to calibrate.

Malin: You’re phasing in all of this at one time — the new reimbursement mechanism under PDPM, then going and adding in the concurrent therapies on that. Most companies we talked to, they’re phasing that in, and being very cognizant about that approach. You’re going to need, three, four months, five months under this to see really where it’s going to shake out. But I think overall, the operators we talk to feel positive about the long-term benefit of where this restructured reimbursement system will end up for the industry.

Ultimately, I think it’s good. Listen, you’re taking on a more complex care resident and you’re putting somebody in a lower-cost setting, which I think for the overall health delivery system is a positive.

It’s funny, amid the push to home, SNFs are considered the high-cost setting — it’s always interesting to hear folks in the industry talk about how it’s the lowest-cost compared to the other options.

Malin: Think of LTACs, and the idea of a site-neutral payment. Why are rates in an LTAC that much higher than rates in skilled? What is the most efficient, cost-effective delivery? So that’s where I think it’ll, long-term, be beneficial for the industry.

And the shifts don’t always have to be cuts: The Ensign Group, for instance, has focused on shifting some of its therapists into other modalities, like outpatient therapy, instead of laying them off.

Malin: That’s going back to looking at: How do you partner with health systems and hospitals — and if you can reduce readmission rates, you’re going to be viewed as collecting data and having outcomes that can can prove out your capabilities as an operator. Ultimately, that could speak well to your ability to partner with those systems.

Moving away from PDPM, I wanted to check in with some of the distressed situations you referenced on the last few earnings calls.

Malin: Distress is a strong word.

Well, bankruptcy situations. It’s been a problem across the industry, with operators folding due to low Medicaid rates and other headwinds. Have you changed the way you vet potential partners, either when you evaluate new relationships or expanding existing ones?

Malin: I’d say the first thing is that concentration to an operator is key — because obviously when you have larger relationships, and they’re impacted by items like bankruptcy, that can have impact to us as a capital provider. Being cognizant of that is important.

When it comes to Senior Care and Preferred Care, the circumstances upon which they went into bankruptcy are unique to each company, and were driven by specific issues.

Preferred Care, obviously, goes back to the judgment in Kentucky, which has been a challenging state from a tort perspective. But that one judgment they received really was what catapulted them to where they’re at in the the bankruptcy.

Again, they only filed on a portion of their company. They didn’t file on the entire company. So it was a very strategic bankruptcy to try to address that judgment — because they were current on their obligations. They paid us rent before they went into bankruptcy, which in a normal bankruptcy filing, you wouldn’t find. So the aspects that drove Preferred Care into bankruptcy were very targeted, very specific to the litigation in Kentucky.

On Senior Care, it was a bad capital structure with the related-party interest between [landlord] Granite and Senior Care — and that significant growth that they took on. But that conflict of interest on the ownership side, I think, was the one of the main items that drove that into its predicament.

Do you probe those related-party interests when vetting deals? That’s something that comes up a lot in distressed situations — including the Skyline collapse.

Malin: Absolutely. So in the case of Senior Care, with Granite, that’s why we had our lease with Senior Care Centers, the parent company, as a direct obligor on our lease — as opposed to a subsidiary. We wanted to make sure we were at the overall credit of the organization. So absolutely, that’s an important aspect: knowing who you’re doing business with, and where you fall within the organizational chain.

It’s something that the government might be looking into more, the connections among nursing home operating and ownership companies and their subsidiaries. We always joke that we’re a team of trained journalists and we can spend days trying to figure out who owns properties with little success.

Malin: This goes back to, on the skilled nursing side, people are always looking for insights into operators — and there’s not many public operating companies, obviously. And that goes back to some of the liability issues, which causes some of these issues where it’s not as transparent on the operator side.

You’re definitely correct that operators don’t have much of a baseline for comparing themselves against others in the space. What are some of the ways an operator could appeal to LTC, or another REIT, and show that they’re worthy of investment?

Malin: A lot of that, for us, is looking at the capital structure of the operating company. Can we, as a capital provider and a financing company, get comfortable and understand what their capital structure is? How do they invest their capital that they have access to? Are they reinvesting in buildings?

We spend time with companies building relationships before we actually make the investment, and tour buildings they operate that we may not invest in, but we see what their business model is, how they’re investing. What kind of employee-based programs do they have? What kind of technology do they invest in? Those reinvestments into that organizational structure are a key aspect. It takes a lot of time to get to know organizations beforehand, to understand: How do they operate their business?

How long does that take?

Malin: It can be as little as six months, sometimes; it can be five, six years other times. It really just depends on finding the right opportunity at the right time.

A great example: Juniper Communities, with Lynne Katzmann. We did our deal with Lynne back in 2012; we started talking to Lynne probably five years before that. Then there was a tax change in 2012, and she was working on a sale; they were looking at a RIDEA structure deal. It got to be October, and she wasn’t able to complete that RIDEA structure.

So [CEO] Wendy [Simpson] got a phone call — it was like the first of October — and [Lynne] said: “Can you close by the end of December?” So we had three months, but we developed that relationship over a five-year period, looking at opportunities with Lynne, going out and touring her buildings.

Kessler: At that point, the underwriting was already done.

Malin: It’s a huge investment in time with operating companies, and understanding what they do — so when the opportunity is right, you feel confident in who to go to.

Kessler: I think this is the frustrating thing in our industry, and all landlords probably share this frustration: The company you underwrote five, 10 years ago, as it grows and morphs, might not be that same company today.

That was kind of where we were with Preferred Care, because they grew outside of our relationship. And it was that growth in those two states — Kentucky and New Mexico — that kind of was the downfall. The same with Senior Care: They grew outside of our relationship.

It’s always good to have multiple capital sources; we certainly have multiple capital sources. I think any strong company does, and that’s true for our lessees. But the flip side of that is that some of that growth they do outside of you could cause [problems].

Malin: The unfortunate part is it’s hard to restrict. If you put a restriction on the growth of an operating company, with all the choice of capital in the marketplace —

Kessler: You will not get a deal. I mean, if a person providing us capital tried to restrict us — outside of market terms, all leases and loans and mortgages have normal market restrictions on them. But if you try to put some overarching restriction on a lessee, that relationship will go nowhere.

That risk you mention, of a company changing over time, is something that I think about every time the public REITs report their quarterly earnings — the skilled nursing industry is complicated and reliant on so many outside factors, but there’s a lot of focus on swings in quarterly lease coverage.

Kessler: It’s so funny, because it’s not a quarterly business — this is long-term care, and these are long-term operations. The focus on quarterly coverage, I think, is really outsized from the analysts, but I see their point of view — that’s all they have, because there’s very few public companies. There’s no visibility into our lessees other than the coverage that we give.

In general, you don’t see a ton of investment in developing new long-term health care properties — specifically Medicaid-focused properties, but across the post-acute and long-term industry as a whole.

Kessler: It’s hard. We’re probably one of the REITs that’s done the most actual de novo development of skilled nursing. It’s hard; we love to do it, but those transactions are hard to find.

Malin: We’ve been fortunate to partner with some of our operators to do replacement buildings, and some operators that have secured CONs [certificates of need] — like CareSpring in Ohio. We’ve done two brand-new buildings with them where they actually acquired the CON.

We’ve been trying to source relationships and opportunities where we can do that. But the scale of it, on the skilled side, is hard — especially when you’re in the Eastern states with CONs. It’s a challenge to be able to buy the CONs, and be able to move them into the right location. So we have been fortunate to build a number of new skilled nursing centers over the past seven, eight years, but it’s just not as readily available an option as it is on the private-pay side.

I’ve been with company 15 years, Pam 19, Wendy 19 as well. So we’ve got a long tenure in the industry, and we’ve seen where our portfolio has evolved — especially on the skilled side over the years. Now that we’re selling the Preferred Care portfolio, which is definitely a legacy part of our skilled portfolio, we really are seeing that we are decreasing the average age on the skilled side. Fortunately, right now, we’ve got a very strong cost of capital that allows us to be able to invest — like in the Ignite opportunity. So we’re excited about where it positions us for skilled nursing in the future.

What’s your general feeling about the state of the skilled nursing industry, and where it’s going into the future?

Malin: I was involved back in the PPS [Prospective Payment System] days, and that changed back in the late ’90s without any telegraphing how it was going to happen.

But CMS giving direction and letting people migrate, and phase in how to prepare for PDPM — that was the complete opposite of what happened under PPS, so I think [there’s been] an evolution of how the industry and CMS work together.

Kessler: How many pilot programs have they run in the past five years? They run the joint program, they run all the value-based payment programs — and test cases and test markets. One thing we know is health care is very local, and what works in one area might not be scalable and workable in all areas — especially when you look at rural versus urban. CMS, I applaud them for being much more thoughtful in rolling out new systems.

Malin: Compared to [the transition from] cost-based to PPS, to this? Tremendous difference, and it’s really just the industry and CMS working together, which has been a positive.

This interview has been condensed and edited for clarity.

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