Low Stars, Citations, Medicaid Problems: HUD Lenders Share Top Skilled Nursing Dealbreakers

Lenders who offer Department of Housing and Urban Development (HUD) loans consider skilled nursing financing to be a long-term relationship, so choosing clients carefully — and thinking about deals as partnerships for the long haul — is crucial for good-decision making.

Because the federal government backs these products, which feature low interest rates and a non-recourse component, HUD lenders have to take a deep dive into an owner and operator’s financial and clinical history — and be on the lookout for red flags that may ultimately turn into dealbreakers.

Not that these deals are impossible to pull off: HUD’s 232 program for nursing homes and other institutional care sites recorded $3.7 billion in total initial endorsements during fiscal 2019, which ended September 30 at a slight increase in volume over the previous year.

Advertisement

SNN sat down with lenders at ORIX Real Estate Capital — a combined company of Lancaster Pollard and RED Mortgage Capital — as well as Housing & Healthcare Finance and Greystone & Co. to hone in on the potential landmines that make a lender think twice about closing a deal with a particular owner or operator.

Low star ratings

Star ratings continue to be a key measurement used to determine the financial and clinical health of a nursing home company — both for the primary audience of potential residents and their families, and the lending community as a whole.

The Centers for Medicare & Medicaid Services (CMS) has made improving the star ratings a main focus of its recent attempts at beefing up nursing home safety, introducing separate ratings for short-and long-term services and making it more difficult for operators to achieve and maintain high marks.

Jason Dopoulos, senior managing director at Lancaster Pollard, stressed that good star ratings are a priority consideration for lenders. If a given facility has only one star, the reasons behind the low scores call for assessment before making a final decision. Generally one-star ratings are red flags, especially if connected to resident harm — and may cause the lender to pass.

Scott Thurman, CCO, FHA lending of Greystone & Co., agreed that star ratings are a big factor, particularly for refinancing deals, and not just for a given facility — but the aggregate star rating of the operator’s entire portfolio. 

“If you have an operator or management company that’s a four-star facility, but when looking at their portfolio, they are [only] averaging 1.7 stars or 2.3 stars, there’s going to be questions,” Thurman said. “It’s not necessarily insurmountable though, but it goes towards a closer look at the quality of care that’s being provided.”

For that reason, not all low star ratings are alike.

“The story is easier if someone’s acquiring a building, and they’re planning to fix it. But one-star surveys that actually show harm to residents make it much more difficult to get a HUD loan. You have to see improved star ratings in their portfolio,” Dopoulos said.

Lenders need to dig into the owner’s past to ensure consistent cash flow, as well as healthy operations, to avoid a poor choice in lender, he added.

“You take the trailing 12 months, and you kind of put a cap rate on it, which is usually a little more conservative for HUD than the general market,” Dopoulos said.

As opposed to a typical bank, which typically underwrites based on three to six months of financial history, both the clinical and the long-term historical financials are a must for HUD-backed skilled nursing loans, he noted.

Lancaster Pollard uses a specialty underwriter to assess star ratings and the clinical past of the borrower, which is intricately tied to the financial performance of skilled nursing facilities.

Brad Granger, an operational and clinical underwriting specialist at Lancaster Pollard, said he’s uniquely positioned to determine the true meaning of a facility’s five star-rating, health inspections, and reimbursements — and find ways to help a facility improve so that the company might meet the loan criteria.

When a facility with one star comes across his desk, Granger will go back and look at the ratings over the last five years, and all of its components, including health inspections.

“There are 15 quality measures that the facility is rated on, and they’re updated on a monthly basis. There’s also a staffing rating. We want to know how the rating is trending, so if a facility just became a one star, and it used to be really good, why did that happen? Was there a change in the facility? Was there a change in leadership?” Granger said.

Sometimes one health inspection will contribute to a lower rating, or there might be a month of bad staffing stats, Granger said, pointing to the importance of understanding the narrative — and if there’s a consistent problem or just a blip in time.

Lenders also work with some third-party risk management groups to tell them what they should look for when going to a facility for assessment, and even make suggestions that may help improve star ratings in the long run.

“But we’re not trying to play the system, and these assessments are about improving overall care and coming up with improvements so that we have confidence in them and HUD has confidence in them,” Granger said. “And once the loan has been made, we still follow up with our in-house asset management and myself and my clinical ops team to make sure they’re following through the plan of correction.”

Risky business in certain states

Some states are associated with higher risk due to lower or slower Medicaid reimbursements, such as Illinois, Washington, and a few others, said Dopoulos.

State budgets set Medicaid reimbursement rates, so being cautious when underwriting specific states is in a lender’s best interest, Thurman said.

I know New York recently reissued some rates, and the industry has been fighting that. And for a long time Illinois didn’t have a budget. And so we’re very, very cautious about the way we underwrote those transactions, and they were slow to pay,” Thurman said, adding that Illinois seems to be paying on time now.

On top of varying Medicaid budgets, certain states have laws that encourage residents to leave institutional settings of care and receive treatment in the lower-cost home setting. New York, for example, recently offered a $27 million grant for a non-profit that can assist long-term nursing home residents return to thee community.

De-bedding is also a problem in certain states, Thurman added.

“If your occupancy suffers for a while, they may take some licensed beds away,” he said. “There’s a lot to keep track of, which is why it’s key to be so cautious if you’re a new entrant in real estate.”

Growing too fast

Thurman also noted problems with operators expanding too rapidly with too many leases in a short time in several states.

“They’re just not just equipped to operate that many buildings,” Dopoulos said, adding that some of their best operators concentrate in one or two states where they know the reimbursements in that region.

In fact, some deals have run into a snag when an operator with global problems had become too big too fast, taking on bad leases in the process — which inhibits their ability to pay the lender.

“State reimbursements have been an issue in some places — and slow to pay like Illinois, or California. We’ve had problems where the operator just had issues outside of our deal that has caused strain,” Dopoulos said.

Avoiding a situation where suddenly the owner won’t be able to operate — or worse, file for bankruptcy is best — In seeing more third-party operators than before, Thurman warned that moving too quickly could result in additional problems.

“I’ve had some situations where an owner has a third party-operator that’s coming in. And when I looked at the third party operator, their portfolio has 10 deals that are losing money, and I don’t see where they have the financial strength to do those — and maybe they have some backing somewhere,” he said. “I hate saying no, but at some point, you have to say no because you’re worried.”

Staffing problems

Texas, particularly in rural areas, suffers from a low volume of available staffers — which can break a deal, Granger said.

When he looks at a building, Granger makes an effort to determine if the staffing problem is due to the operator not being able to keep good workers, or whether it’s a geographical market issue.

“To overcome low staffing, they need to have enough RNs to help offset the problem,” Granger said, noting that CMS’s adjusted star ratings, implemented a few months ago, give more credit to facilities with additional RNs in the building. “If a facility has low staffing everywhere else, but has good health inspections and quality measures, we can usually explain it to HUD.”

Survey bias can also be an issue in specific geographies, Granger said. In certain parts of Pennsylvania, for instance, there are survey districts that rack up significantly more citations than in other areas.

Under state law, Pennsylvania’s survey teams grade on a curve, with the number of facilities that can receive a given star rating capped at a specific amount, Granger said — for instance, only 10% can receive the highest rating.

“If some of the counties in Pennsylvania’s have really good surveys, that means there are other counties in Pennsylvania that are having really bad surveys,” he said.

Recently, Lancaster Pollard/ORIX conducted a few loans in some Pennsylvania counties and found there were “a lot of poor surveys.”

“We’re not going to discount the fact that they might have had a poor survey, but we’re going to look at the citations individually and ask: ‘Hey, do you just have a lot of really what we call benign sites, or do you really have citations that have actual harm to patients?’” Granger said.

Michael Gehl, chief investment officer of Housing & Healthcare Finance in Maryland, also emphasized the importance of quality — and that seeing immediate jeopardy or harm tags are dealbreakers unless an operator is turning around a prior property.

But being penalized based on an old operator’s performance is not an immediate dealbreaker.

“If it’s an operator that has been in the facility for several years, and I’m seeing a lot of immediate jeopardy tags over a sustained period of time, that is definitely a huge red flag — because to me, quality of care is paramount. And if we’re seeing a number of bad tags over a period of time, I want to hear the story, but that’s definitely going to be a big red flag to me,” Gehl said.

When Gehl spots a harm tag in one of the higher categories, he reads the report from the CMS website to understand the narrative, which will increase or reduce his concerns about the operator.

“Typically, if it’s J, K, or L tag, it’s going to be a pretty ugly incident. And if I see that multiple times over multiple survey periods with the same operator, that would be a red flag on the quality of care side,” he said.

For instance, he once looked at a facility with multiple J-tags, and the operator alleviated the situation by replacing leadership. Gehl then asked to see a new standard survey.

“In those situations where you’ve had a bad survey, I’ve heard at least the operator telling me the right answers that I like to hear about, and changes to make sure it doesn’t happen again,” he said. “But at the end of the day, I sometimes like to say, all right, well: I’m going to wait until I get a new survey to show to see how you’ve performed by this day.”

More recently, Gehl dealt with a site with a J-tag related to a vent resident with sleep apnea. The clinical staff didn’t respond to the resident, and there had been a complication where the resident had to go to the hospital.

“You know, if you have vent residents, that shouldn’t happen. They understood they needed to fix that and so looking at their new survey was important,” Gehl said.

Other red flags include abuse of a resident, a medication error, or other health and safety problems.

“You read through the reports and try to understand what happened and what they do to fix it. And you try to make your judgment accordingly,” Gehl said. “Sometimes using a third party as an outside expert is also helpful to understand if they’ve really fixed a problem, and sometimes getting that extra person to take a look is helpful.”

Newbie operators

The wrong answers to a borrower’s financial and clinical track record, including how many facilities they own and how long they’ve been in the space, may result in red flags.

“If it’s their only facility, and they don’t have a long track record in this space, that’s a red flag,” Gehl said. “Hopefully they have multiple facilities, and they’ve been in this industry for five to 10 years.”

Being cautious about new operators in the industry comes with the lending territory, Thurman said. Although not necessarily a deal-killer, Greystone may call in consultants to partner with a new operator — especially if he or she is new to the state — in order to understand the dynamic is a particular geography.

“It’s important to understand the reimbursement in certain states, so it’s going to be harder to be a new entrant into that state without bringing some kind of expertise in with you,” Thurman said.

Real dealbreakers

Aside from the factors that make lenders think twice, there are a few factors that will immediately derail a deal.

If a facility is on the federal government’s list of Special Focus Facilities — or even on the formerly “secret” list of potential candidates for special focus status — it’s going to be a definite no.

“I can’t even lend to you as a HUD lender even if I wanted to,” Gehl said.

HUD also won’t back a borrower who has been in bankruptcy for the last five years. More specifically, if an owner is in bankruptcy and recently reorganized, there’s a five-year window where they can’t receive a HUD loan.

“It’s a non-starter for HUD,” Gehl said, adding that even bridge loans, which aren’t as stringent, still call for a well-researched narrative of the operator’s financial history as to why the bankruptcy occurred.

Thurman agreed that “the biggest showstopper for us is any bankruptcies that the owner or operator or the principles or any other affiliates have had, that are either ongoing or within the last five years.”

But aside from all of the financial considerations, when visiting an operator, the interaction between employees and residents often stands out in a positive way that’s hard to quantify.

“There is something that’s nice [about] when you see the administrator walking around and saying hello to Mrs. Smith, and they know each other,” Gehl said. “When the operator knows all the people that work at the facility, there’s a kind of homey-type feel, and always a good thing to see. It’s qualitative thing.”

Companies featured in this article:

, , , ,