COVID-19 is upending operations in the skilled nursing world, but when it comes to the business side of running a SNF, upheaval was taking place well before the pandemic.
This was particularly true when it came to ownership of the real estate and operations. Well before the new coronavirus reality, real estate investment trusts (REITs) that owned skilled nursing properties were selling the assets, and that could create an opportunity for private equity firms looking to put their capital to work, according to experts speaking at the virtual Skilled Nursing News RETHINK summit on the evolution of private equity in skilled nursing.
“I think the traditional REIT deal with a lease escalator of 3% has gone the way of the dodo bird,” David Reis, the CEO of the Harrison, N.Y.-based firm Senior Care Development, said during the panel discussion. “And I think that as money and the cost of money has come down, many more private equity players are playing in the market.”
Several of the major REITs, such as Sabra Health Care REIT (Nasdaq: SBRA) have been offloading their skilled nursing assets over the past few years, he pointed out, and private equity is filling that void.
The interest of private equity investment in SNFs had come up on earnings calls held by the major health care REITs, with LTC Properties (NYSE: LTC) CEO Wendy Simpson noting in the spring of last year that closing transactions in the senior housing and care sector was becoming difficult “as private equity continues to pour money into the marketplace at what we believe are unreasonable valuations and risks.”
In SNN’s 2020 outlook survey — which admittedly did not predict in any way the rise of a global pandemic — 34% of respondents predicted that private equity would be the largest buyer of SNF assets.
Private equity’s involvement in nursing homes had also fallen under intense government and public scrutiny even before COVID-19, with a group of Democratic lawmakers last fall demanding detailed information about nursing facility holdings from four large players: The Carlyle Group, Formation Capital, Fillmore Capital Partners, and Warburg Pincus LLC.
That scrutiny has only intensified since the pandemic revealed long-standing issues with staffing and infection control at facilities nationwide, with studies — both pre- and post-pandemic — suggesting poorer performance on several metrics by PE-owned facilities.
The COVID-19 stressors led Simpson in April to predict less competition from PE firms in the wake of the pandemic, though Blue Moon Capital Partners managing partner and co-founder Kathryn Sweeney was more measured in her prediction.
“I think committed private equity will not — knowledgeable, experienced private equity will not,” Sweeney said during the webinar, referring to departures from health care. “But what I absolutely agree with Wendy on is that those private equity ‘tourists,’ who were really looking more opportunistically at the sector, that they will. They did not anticipate how hard something like this could be, and just are not prepared. I think we are going to see an evaporation of that cohort of private equity suppliers.”
‘Friends and family’
Chad Buchanan, the managing partner at the private equity firm Twin Light Capital, agreed with Reis’s point about increased PE interest, though he pointed out that the term “private equity” can sometimes be used more broadly in the skilled nursing world than in other contexts.
“I think a lot of people also refer to private equity in our space and include more of the independent operators that use ‘family and friends’-type of capital to acquire facilities and grow their portfolios,” Buchanan pointed out. “So there’s two sides to what most people, I would say, refer to [as] private equity in our sector — and I think the independent operator, the more locally-regionally focused operator has been a big part of the sector’s growth as well.”
Reis held that many of the regional players are indeed turning to “friends and family-type capital,” as Buchanan put it, or aligning with larger private equity firms to make purchases, at pricing that appears to be holding up to pre-pandemic levels.
Buchanan was somewhat more cautious in assessing the state of purchasing by private equity, noting that many transactions that have closed were under contract before COVID-19 — with sellers and buyers legally bound to close. He argued that more transparency on prices would come as deals set up during COVID-19 wound through the system.
Still, as Reis pointed out, seller expectations remain high on price, “and there seems to be a plethora of buyers who are still looking to buy.”
But as with many aspects of skilled nursing, region and state matter, he added. Some operators are looking to add incrementally to existing footprints, and operators generally are still interested in ancillary businesses.
“If anything, a lot of ancillary businesses are now kind of moving to the fore, for example, telemedicine,” Reis said. “When I look at Third Eye [a skilled nursing-focused telehealth provider backed by Reis] and other companies like that, they have a more meaningful presence in nursing homes. So I think people are sensing a lot of different opportunities that maybe didn’t exist as of March 1.”
Government aid helps — with strings attached
The skilled nursing industry has been propped up with several streams of federal aid from the CARES Act coronavirus stimulus package, with multiple rounds of relief funding going to SNFs and to Medicare and Medicaid providers, nursing homes included.
And even before COVID-19, the skilled nursing industry was well-supported with debt backed by the Department of Housing and Urban Development (HUD), from the standpoint of liquidity and capital markets, Buchanan said. He also pointed out that many of the private equity players are focused on management fees, viewing growth primarily through an increase in those funds.
“They have a certain amount of fixed expenses at the corporate level. They’re able to further support their corporate operations and expand their regional and facility-level operations with improved management fees, and the cash flow is a bit of a bonus,” Buchanan said. “The cash flow and the cash yield is is the bigger focus, rather than, ‘What basis am I buying at and what basis will I be able to exit at?’ like a more traditional PE buyer or investor would be focused on.”
When it comes to the COVID-19 aid, the government assistance has helped operators in the short-term to “keep the doors open,” he said, though a survey from the American Health Care Association that found 40% of providers cannot sustain operations at the COVID-19 pace without financial help was “one of the biggest shocks that we had.”
In the long-term, such government aid always comes with more scrutiny and regulation, though Buchanan noted this is not new for the SNF industry.
“In my mind, the question is: When the money stops from the government, how fast will people get their occupancy back up to where it was?” Reis said. “That’s really going to separate the men from the boys in all of this, because no one can profitably run at a 74%, 75% occupancy; that would wipe out 100% of the industry, let alone the 40% that’s quoted.”
The good operators are using the aid to try to account for that, he said, and for his part, Reis is focusing on the markets that will return to 85% to 87% occupancy the fastest.
That might take different forms depending on locations. Much of the occupancy is driven by referral sources and the referrers in specific markets, Reis argued, and the value of a given SNF will depend greatly on the availability of SNFs in the location.
Twin Light also focuses heavily on the local angle, particularly examining local relationships that SNF operators have. Operators who demonstrate the ability to have a strong referral volume, and can adapt clinical programming to respond to the needs of those referral sources or hospitals while having a strong admission rate, are attractive. The demonstrated track record is critical, Buchanan said.
“During a growth period, while you’re trying to be selective in investment opportunities and partnership opportunities, what operators have shown that they can do that in multiple types of clinical specialties, multiple locations within a market, or multiple markets within a certain region?” he asked rhetorically.
Reis also noted that buyers have to be examining their exit timeframe and who would be buying the nursing home asset at that point — COVID-19 or no COVID-19.
“I really only buy nursing homes in CON [certificate of need] states,” he explained. “I like the high barriers to entry. Would I be looking to buy, let’s say in Texas, right now? Probably not at any cost per bed. Do I like Florida? I love Florida. There’s a lot of states to like, and there’s a lot of states to avoid until this sorts itself out.”