Fitch: 30% Rent Cuts for Skilled Nursing Facilities May Be Necessary, But Not for All Operators

Major skilled nursing landlords are likely to institute rent reductions over the course of 2021 in order to help keep them afloat, according to Fitch Ratings — but the effect won’t be equally felt across all operators.

In affirming twin BBB- ratings for Omega Healthcare Investors (NYSE: OHI) and National Health Investors (NYSE: NHI), Fitch acknowledged the substantial positive effects that CARES Act funding has had on skilled nursing operators’ short-term financial stability, but was also conservative about any future help.

“Fitch does not assume any incremental government relief beyond what has been committed to date,” the ratings agency wrote in its analysis of Omega. “This heightens the risk that some operators might require significant rent relief before occupancy and, consequently, underlying cashflows recover to pre-coronavirus levels. Since leases tend to be operators’ largest form of financing and one of the largest expenses, REITs are an obvious partner to provide relief if government funding runs out before underlying cashflows rebound to pre-coronavirus levels.”

Part of that uncertainty also has to do with the uneven way that providers capitalized on existing CARES Act funding, which the Department of Health and Human Services (HHS) has sent to providers in a wide array of separate distributions — from targeted nursing home programs to more general relief tranches open to all providers who receive reimbursements from Medicare and Medicaid.

HHS on Thursday, after the publication of the Fitch notes, announced another $20 billion in aid open to a wide swath of health care providers including nursing homes, though the exact amount available to the sector remains unclear.

Based on limited information from the handful of publicly traded skilled nursing operators, Fitch observed that some have relied on the federal largesse to cover vital “business continuity” expenses, while others have returned them outright.

Specifically, the Ensign Group (Nasdaq: ENSG) made headlines in August when the skilled nursing heavyweight announced the return of all $110 million in CARES Act funding it had received, citing another record quarter of revenue.

“These funds were meant to cover lost revenue and increased expenses tied to the COVID-19 pandemic,” CEO Barry Port said at the time. “And we want to underline that our results do not include any benefits related to those distributions. As you all know, most of our revenue comes to us from sources that are funded by taxpayer money, and as stewards of those funds, we know that there’s a high degree of responsibility that accompanies government reimbursement.”

Due to the high concentration of Ensign facilities in NHI’s portfolio — along with the relative stability of National Healthcare Corporation, which did use its CARES funding — Fitch was less concerned about skilled nursing rent cuts for the Murfreesboro, Tenn.-based real estate investment trust (REIT).

“NHC has a strong liquidity profile due to its significant cash balance,” Fitch wrote. “This significantly reduces the risk of rent deferrals for most of NHI’s SNF tenants, as ENSG and NHC leases make up over three quarters of NHI’s SNF rental income.”

But because NHI also maintains a portfolio of private-pay senior housing properties, which have received far less direct federal aid, Fitch predicted oncoming rent cuts next year.

“Fitch assumes that a 30% permanent cut in rents might be necessary to stabilize the rents for around one-third of senior housing and skilled nursing operators (excluding Ensign & NHC) in the long-run, which equals to a permanent reduction in rental revenues of 10% starting in 2021,” the ratings agency wrote. “In addition, Fitch assumes temporary one-time rent reliefs will equal around 9% of 2021 revenues from senior housing and skilled nursing operators (excluding Ensign & NHC) as operators’ underlying NOI recovers to pre-coronavirus levels.”

For Omega, which derives 82% of its revenue from skilled nursing facilities, the impact on the nursing portfolio was more direct, with Fitch predicting the same 10% permanent rent reduction as well as a 9% revenue decline associated with one-time breaks in 2021 — and not including qualifiers for specific tenants.

Despite that prospect, the ratings remained stable due to the REITs’ leverage “headroom,” which Fitch predicted would allow both to weather the storm without significant negative effects.

The publicly traded REITs have largely avoided any major rent reductions or lease restructuring efforts so far, consistently receiving the vast majority of rent due each month and at most fielding one-off requests for deferrals. But the first rumblings of potential future distress came in late September, when both Omega and Sabra Health Care REIT (Nasdaq: SBRA) took steps to address doubts about the futures of operators Genesis HealthCare (NYSE: GEN) and Signature HealthCARE.

Omega converted both tenants — in Signature’s case, a holding company for its operated properties known as Agemo — to a cash accounting basis and implemented a $140 million write-down. Sabra is mulling a similar move that would come with a $14 million write-off if implemented.

Genesis publicly announced “substantial doubt” about its ability to continue as a going concern over the coming year, while a third-party auditor is set to release a similar conclusion about Signature; both operators have cited skyrocketing coronavirus-related expenses as significant hardships, even with federal aid.

That said, Fitch asserted in its ratings analyses that the support for skilled nursing facilities “far exceeded” its estimates, and concluded that the setting remains a permanent part of the continuum.

“Fitch believes that SNFs retain their place in the continuum of care in the U.S. health care system,” the agency wrote. “Fitch believes that sufficient volumes of need driven and complex post-acute care will continue to be best delivered in a SNF setting. Therefore, Fitch considers the current declines in occupancy rates temporary, and expects an eventual restoration of operating fundamentals to pre-coronavirus levels.”