Operators of skilled nursing facilities for years have dealt with the aging post-acute and long-term care infrastructure across the U.S., coping with problems ranging from multi-resident rooms to poor plumbing to outdated building design.
During the COVID-19 pandemic, it became apparent that poor building design was more than a headache for cash-strapped operators; in the case of multi-resident rooms and a lack of places to cohort patients, it could become a matter of life or death.
The clear need for design overhauls and capital expenditures in SNFs, however, does not necessarily mean that they will materialize. For a new model and type of SNF to be more widely adopted, new investors and operators alike will have to emerge, according to Brad Haber, principal and co-founder of Innovative Health — which operates three SNFs in Illinois under its Thrive brand. The company focuses solely on the short-term, post-acute patients, with the facilities self-managed through affiliate ownership entities.
Speaking at Skilled Nursing News’ virtual Payments, Policy, and Capital Summit earlier this month, Haber talked about how the regulatory and investment landscape has shaped — literally — the structure and design of SNFs, and how the pandemic might impact the way buildings are designed and operated in the post-COVID-19 era.
“We think there’s a huge need,” he said at the summit. “The infrastructure’s getting old, and — as our company name indicates — there’s been no innovation in the industry, and we feel like it has to be done. For decades, nothing has been done. And we feel like now is the time. Truly, the past was the time.”
Can you talk how you navigated the financing process for the three Thrive facilities?
In terms of the financing and the regulatory difficulties, in my opinion, the financing side is probably the least of the two difficult things to do. I was in the finance side business for one of the larger lenders for more than 10 years, so the experience I have there has proven to be at least somewhat helpful on the financing side.
But I think there’s a fallacy that lenders are not active in the space. The lenders are active in the skilled nursing space — it’s a select few, it’s the same ones that have been doing it for a while. I think they’re always going to be active in the space.
The challenges are the ones that are active, they have a certain credit box, and if you don’t fit that credit box, they’re very inflexible in going outside of that. … The lenders that are active, I think they’re relationship-driven. So if you’ve worked with them in the past, they’re more inclined to work with you again, especially during the pandemic. If you have not had a relationship with the lenders, then they are really not inclined to start a relationship during this time. It’s a difficult time in skilled nursing.
The equity side’s a little bit more of a challenge because you obviously have to be more precise. So leverage is one of those key factors. Personal guarantees — all the lenders like personal guarantees, [though] that’s the investors’ decision on whether they agree or want to do that. Our personal take is we prefer not to do personal guarantees for obvious reasons. Not because we don’t trust or support the deal or believe the deal — it’s just a philosophy, they would prefer not not to do that.
Then obviously, portfolio transactions are easier. Smaller deals, in my opinion, are probably a little harder to get done as one-off deals; that portfolio effect has a positive effect on getting a transaction done.
In our case, if you’re not looking to sign recourse other than carveouts and so forth, the only non-conventional type thing would be HUD [the Department of Housing and Urban Development]. HUD is a great source of debt. The advantages of HUD are: It’s great debt, it’s long-term debt, it’s non-recourse, the terms are pretty nice — because if you want 40 years, the rates are low. It enhances the overall economics of the transaction.
The downside of doing that is the process is it’s tedious. It’s very hard to get through. It’s a lengthy process; it doesn’t always work for everyone, especially in the acquisitions phase. If it takes months to get financing complete, and sometimes more than that, a deal might not happen. So once again, there are people out there that will finance in the space. It’s not easy, but it can be done.
How about the regulatory process?
The regulatory side, I’d say that’s a whole other issue. Our experience on the regulatory side, from Innovative Health’s perspective, is really in Illinois. Illinois is a CON [certificate of need] state. Everyone knows CON states, in general, are pretty difficult to develop in. We’re ground-up developers, because we don’t like some of the more archaic-type buildings; they’re not as flexible. We like the newer product, the short-term post-acute side of the business.
In general, the biggest issues are the timing associated with [the CON requirements]. When you go for a CON, the delays can be extensive. Especially in Illinois, the application for a CON — they’re not really so specific. It’s almost like one CON application fits all projects, whether you’re doing a hospital, or an LTAC [long-term acute care hospital], a medical office, or skilled nursing — it’s really the same application. So a lot of the difficulty is getting through that approval process.
One example would be: There’s a financial section on the CON application that might be [asking for] average days’ cash on hand. That’s a very relevant fact for a hospital because they need to have — pick your flavor, but say 180 days’ cash on hand. There’s no skilled nursing operator in this country that’s going to have 180 days’ cash on hand. So then you’re trying to explain to a CON board why you don’t have that, and why it doesn’t fit the criteria.
Getting through that process is difficult. Getting to that meeting is quite honestly very difficult. It’s timely; you can have what I consider a pretty extensive amount of money out there to get to that meeting. A lot of people spend upwards of $200,000, $300,000 or more just to get to that meeting, between attorney fees, applications, time and so forth. You have to have landowners that are willing to option that land for a period of time; if they’re not willing to, you have to be willing to take down the land.
So there’s a lot of factors that come into play. We at Innovative Health, we like CON states. We like the high-barrier-to-entry model. We’ll fight the fight. At the end of the day, once the product is built, we think there’s a huge advantage to having those barriers to entry.
The difference from a state like Texas where there is no CON — there has to be a middle ground. Illinois is so restrictive, Texas is not. I think CONs are great; it does limit the overpaying. But that middle ground really has to be met in all these states for everybody.
What has the CON process done in terms of the infrastructure itself, particularly in a more restrictive state in Illinois? How does it contribute to the aging infrastructure problem that’s become apparent with COVID-19?
I would say the actual CON regulations don’t contribute to that directly. Where it does contribute to it is there are less investors and operators willing to go build new product in the market. So what happens is: There are archaic buildings, and really that’s for two reasons.
One — and this will get into an operator’s perspective a little bit — people simply just don’t have the money to invest into buildings. That’s a payment issue, and what the CON laws do — because they limit the ability of new product to come into the market, there’s really no reason for people to put money into buildings, because there’s no new competitor.
Between not having the reimbursements and not having a new competitor open down the street, there’s no return on that investment. So putting that money in really does nothing for you. You could probably go back and do research on when SNFs were approved in Illinois: There was very little capital improvements to buildings that are in that periphery or 10-mile zone around that building. The minute a building gets approved and they start to build it, the competitors will then start to put money into their building, because they want to remain competitive.
The one issue is going to be: It’s very hard to maintain that competitive advantage in a building that’s 50 years old. On those older buildings, you can make them look nice; you can paint them, you can put new carpet in, you can put new furniture in. But at the end of the day, they were designed very differently. From an operational perspective, they were different. You can’t change the walls internally. A lot of them have more … quads or even triples, and that’s not the market right now.
So you do have that competitive advantage when you build a new building. But that’s really why the product is so archaic: At the end of the day, if you can’t build new product, why put the money into it?
Jumping back to that finance side for a second, a common hurdle to new investment that I’d hear cited at conferences and such was the “stroke of the pen” risk, given the SNF sector’s reliance on government reimbursement. Is that still something that people are concerned about still, especially since the government has supported SNFs in 2020?
The stroke of the pen risk has been around forever; 15 years ago, when I was financing properties, everyone had that concern. Does it still exist? The answer’s yes, and I think people are just either comfortable with it or not comfortable with it.
At the end of the day, how we look at it is: This is an industry that can’t go away, there’s a need, you have to serve this population. I think we need to serve this population of older people in a better way than we have in the past. The best analogy I can give you is the airline industry; it is essentially too big to fail. You cannot have the airline industry go out of business because that would have a cratering effect on the economy in our country and around the world.
So does it exist? Yes. As you said, 2020 actually proved that more people realize we need to support this industry more than we had in the past. There’s tons of stimulus programs out there; the government supported us throughout 2020, providing stimulus money for not only additional expenses — PPE [personal protective equipment] and such, additional wages — but they’ve done it through programs where you can get reimbursement for dropping census, and the average census is down pretty significantly over the last year, though we think it’ll start to go up in the near-term.
2021, I think, will be interesting. I think they’re going to have to put some more stimulus out there, because there’s no way that a lot of these operators will be able to survive 2021 without more stimulus money. You see reports of 200 or 300 buildings will have to close in 2021 if this continues. They just can’t allow that to happen.
Does the pandemic make investment in SNFs more difficult, especially given struggles with occupancy and the question of how permanent diversions to the home health setting are?
I think the last year has definitely brought to the spotlight the need for a new model, there’s no doubt. If you ask me what that new model is going to look like — I’ll pat ourselves on the back a little bit — you can go and look at our buildings. That’s what the new model looks like to us.
I think there’s two things you have to look at with these new models. It’s the overall infrastructure I talked about, which is more private and semi-privates with bathrooms in every unit for more dignified living. There are other items; everyone talks about new air filtration systems, and so forth. I call that the general bones of the building. Those are the items that you have to plan for up front.
The interior stuff, you can evolve those over time, but at the end of the day, a lot of older SNFs have got air filtration systems that really just recirculate air. In our buildings, air is actually exchanged; fresh air is exchanged with the old air in the building six to 10 times per hour, and the systems are very adaptable.
The other thing — and maybe it’s a little bit of dumb luck — we made one of our buildings very flexible, so we’ve got wings that can be cordoned off or segregated from other populations, and they can use different areas of the building. We were able to use that for COVID, so we were able to segregate these populations, and the nursing staff can be completely separate. Those are things that you can’t really change later.
Most investor interest to date has focused on the post-acute patients, but over the course of the PPC Summit most speakers seem to agree that long-term care patients are the ones who are going to be constant in needing care. Can future SNFs be designed around that patient?
There’s still always going to be a need, but again, I believe that the trick is, people don’t want to live in these quads, they don’t want to live in triples. They want semi-privates, they want privates, and that’s what they need.
The biggest obstacle, to be quite honest, with the long-term care, the non-high-reimbursement type beds, is there’s just not enough money. You can’t really build, right now at least in Illinois, because of the cost of building new — financially you cannot build a new building with just long-term care and survive.
So the first thing that has to happen is there has to be an overhaul of the reimbursement system. It has to be a value-based system. Everyone’s not created equal, and if you’re providing a certain service, you need to get paid a certain way. I think the minute you can prove that system has changed, people will build in that industry. But right now the numbers just don’t make sense.
We focus on the short-term, but we actually will partner with some of the long-term care providers, even [independent living] or [assisted living] in the market. Because if they don’t have that continuum, we can act as that continuum for them, and residents don’t get lost in the system.
This interview has been condensed and edited.