To Build the Next Generation of Nursing Homes, Players May Need to Live with Lower Profits

The COVID-19 crisis exposed countless vulnerabilities in the nation’s long-term care infrastructure, but the design of the buildings themselves might loom the largest: With multiple-person rooms the norm in aging physical plants across the country, today’s nursing homes simply weren’t built with infection control in mind.

And as the industry and the government look ahead toward potentially embracing innovative new designs to prevent future disasters, one leader in the space says that players up and down the development pipeline may need to learn how to survive with lower profits to achieve that goal.

“The only way I can see this working is for everybody along the chain to take less,” Wendy Simpson, CEO of LTC Properties (NYSE: LTC), said earlier this month during the virtual Skilled Nursing News RETHINK conference. “So the developer is not taking as big of a profit on making the development. The person selling the land is not making as big of a profit.”

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Simpson was in particular discussing the development of cottage-style nursing home developments, a model exemplified by the Green House Project — a non-profit that supports the construction of post-acute and long-term care campuses that feature multiple small buildings housing low numbers of residents, each in their own rooms.

The model has gotten increasing attention — and glowing press — during the COVID-19 pandemic, as facilities built on Green House principles experienced substantially fewer COVID-19 infections and deaths than their traditional institutional counterparts.

But building such projects from scratch had been a significant challenge even in pre-COVID times, with investor skepticism over such factors as increased staffing and development costs, and even pushback from state and local regulators who don’t know quite what to do with a facility that doesn’t match the traditional image of a nursing home.

That said, believers in the model insist it’s possible with the right vision and the right team.

“I would also offer to operators who are considering this: You can pencil this out. It’s not hard to pencil out,” John Ponthie, managing member of the Arkansas-based Southern Administrative Services, told SNN earlier this year.

With interest rates low, there could be an opportunity for innovative development right now, Simpson noted — but with a caveat.

“Private equity should not be expecting to get 24% or 17% return on things,” she said. “It’s got to be more of a community-driven thing than an investor-driven thing.”

Kent Eikanas, CEO of the Lake Forest, Calif.-based Summit Healthcare REIT, laid out some of the concerns that a real estate investment trust (REIT) would have in evaluating a cottage-style deal, including elevated ongoing staffing expenses for the operators.

“It’s going to be … extremely difficult for us to underwrite an opportunity like that, because we have to structure a lease that’s going to work on a long-term basis with the operator,” Eikanas said. “And if we can’t underwrite it, it’s going to be difficult to get the proper lease coverage ratio that we’d want associated with a transaction like that.”

The two REIT leaders didn’t shut the door completely on the potential for innovative deal structures, with Simpson noting that one-off opportunities with the right group of players have succeeded, and will likely continue to happen; Eikanas indicated that a cottage-style investment could be a good play for Summit once the immediate stress of COVID-19 has passed.

But such deals won’t be as easy to pull off on a wider scale.

“On a large scale, the profit motive is an American way of life, and I don’t envision when this would be a major area that REITs could get involved in,” Simpson said.

Of course, ground-up development doesn’t represent an immediate solution to the problem of infection control in nursing homes, especially as the sector stares down a long winter and flu season ahead. Operators have turned to “decompressing” their rooms, temporarily making them single-occupancy, to weather the storm, Simpson noted. And while that’s an essential step for ensuring resident safety, it makes investment in the space a bit more complicated in the near term.

“How would you value the number of beds you’re going to buy? Is it one bed per room now, and then in two years, when COVID is under control, you could increase the number of beds in the facility?” Simpson said. “So I think the valuation and the underwriting of skilled nursing is going to be very difficult, but the market will come back.”

The pair of REIT leaders also stressed that while diversions from skilled nursing to home health remain a concern for operators in both the near- and long-term, institutional nursing care’s position as a necessary service for a portion of seniors makes it a long-term investment.

While people may be more available now to care for family members at home after a hospital stay, with flexible work-from-home options and children learning remotely, an eventual return to normalcy will take away that option.

“I just don’t think the labor force is there to get rid of skilled nursing and have everybody taken care of at home,” Simpson said. “Some people are fortunate enough to be able to have skilled nursing rehab at home. But that’s not the total public. I think it’ll always be a preference, but it’s just not viable for everybody.”

Eikanas even predicted that a growing governmental bias toward home health could actually work out in skilled nursing operators’ favor.

“It’s going be a competitive advantage for the nursing facility because they’re more equipped to care for the patient or resident,” he said. “Once it’s more regulated, the home health, I think that will start to give the advantage even more to skilled nursing facilities that are more fit for a resident.”

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