Even before the COVID-19 pandemic trained an intense spotlight on the financing of nursing home operations and real estate in America, private equity investors in the sector found themselves under the microscope.
Moving forward, the pandemic will likely have a double-barreled effect on PE interest in the space, with a more selective crop of companies looking to make deals centered on quality operations, a pair of private equity leaders said during SNN’s virtual Payments, Policy, and Capital summit last week.
“Private equity interest has definitely tapered a bit, but it’s still out there,” Elliot Mandelbaum, managing partner at Eagle Arc Partners, said. “What I think has happened is that there’s really been a flight to quality, where private equity is still interested — but they’ll probably be more discerning around the operator, around the state, around the facility type than before.”
The storyline was written months before the first COVID-19 cases cropped up at nursing homes in the United States. Sen. Elizabeth Warren, along with a pair of other Democratic federal lawmakers, sent letters to executives at four major private equity firms with post-acute and long-term care holdings — The Carlyle Group, Formation Capital, Fillmore Capital Partners, and Warburg Pincus LLC — in November 2019, demanding information about their investments.
A March study from Wharton, New York University, and the University of Chicago identified a series of negative trends that commonly follow a PE firm’s pickup of a nursing home, including declines in staff and quality ratings — coupled with increased bed utilization.
The scrutiny continued as the pandemic dragged on, with an August study from the Americans for Financial Reform Education Fund finding higher rates of COVID-19 infections and deaths at PE-owned nursing facilities in New Jersey; a broader nationwide study from Weill Cornell Medical College saw no significant differences in PE-owned facility performance relative to other for-profit and non-profit buildings, though PE properties were more likely to experience shortages of personal protective equipment (PPE).
And as early as the second week of April 2020, LTC Properties (NYSE: LTC) CEO Wendy Simpson was predicting that the stress of COVID-19 would push PE investors out of the market and make life easier for public real estate investment trusts (REITs) like her company.
“We are thinking that maybe private equity is not going to think that this is a great industry in which to invest in the future, and so maybe we will have less competition when this finishes, this crisis is over,” Simpson said at the time.
While it’s still too early to determine how lawmakers and regulators may attempt to crack down on private investment in the sector — or how the pandemic will permanently change the financial landscape of post-acute and long-term care — some patterns have already emerged.
Jonathan Slusher, head of senior living and health care at the Northwind Group, divided PE’s presence in nursing homes into two distinct camps: wealthy families or individuals who generally back facilities as owner-operators, and large institutional PE firms.
“Those owner-operators have been the most active throughout COVID, and we expect them to continue to be, over the next year, the primary source of demand for driving good transactional volume,” Slusher said. “Private equity that writes a big check, that’s a little more institutional, we expect to follow as the owner-operators prove that doing a deal now, coming out of COVID and the recovery of 2021-2022, wind up being a very unique opportunity to acquire good assets for long-term holders.”
Slusher acknowledged that the track record of large private equity firms in the space has brought a stigma that has lingered, pointing to Formation Capital’s 2007 purchase of the since-turned-public Genesis HealthCare (NYSE: GEN).
That case study still shows up in discussions of PE’s influence in the nursing home sector to this day, though Slusher said most of the volume has come from smaller owner-operators since then — and that the Formation-Genesis deal is a relic from a bygone era in the space where historic capital structures no longer match reality.
“Take the capital structure away from Genesis — the people that run the business day to day, from the top down to the regionals to people in the buildings, anyone could argue in the industry that those are many of the best talent that exists,” he said. “They just happen to be at a Genesis building. That building is doing well if you were to take away the rent structure that was put into place for some of the large transactions that were done quite some time ago.”
While the best investors had always emphasized the importance of pairing real estate with a top-flight operator that understood the market and put clinical performance first, those factors will only loom larger in a post-COVID world, Mandelbaum noted.
Eagle Arc made its initial big splash in skilled nursing with the 2017 acquisition of Kindred Healthcare’s post-acute business for $700 million, under its former name of BM Eagle Holdings; the company went on to buy a portfolio of properties operated by the bankrupt Senior Care Centers for $282 million in December 2018, and last November added 18 facilities across the South in a $317 million deal.
In the past, the company may have been more willing to take a flier on turnaround projects, Mandelbaum said, but that prospect has become more daunting during the pandemic.
“Things are still evolving, but probably number one is the quality of their clinical capabilities, the tenure of their staff — particularly on the nursing side — and how they’ve done [on] COVID and infection control management,” Mandelbaum said of his top areas of focus when evaluating properties in 2021.
The staffing piece in particular may serve as an even clearer bellwether of both operational and financial success: While buildings in different parts of the country saw wildly varied COVID-19 situations at different points in the year, they all received the same fire hose of federal support — and it will become immediately clear to curious observers how any given operator decided to deploy that money.
“Given the amount of access to funds through the various government programs that have hit the facilities, that’s where you really see the operators that are highly focused on making sure that their buildings are going to be positioned really well long term, that they’re taking care of their employees,” Slusher said.
Mandelbaum agreed.
“Nine times out of 10, if you had long-tenured staff on the nursing side and administration side, it was a good building — and it was a good building from a clinical perspective, it was a good building from a satisfaction perspective, the residents and the staff, and it was a good building from a financial perspective,” he said. “If you had a lot of turnover, nine times out of 10, it struggled in all of these areas. That was true before COVID. It’s true even more so now.”
No matter the exact metrics that private equity investors will analyze moving forward, it’s clear that the scrutiny from outside the space isn’t going away — and folks looking for a quick buck at the expense of quality are unlikely to last long.
“That’s something that really needs to continue to be at the forefront: We generally believe that a cost-cutting strategy to create value is not a good idea,” Slusher said. “Sure, you generate short-term cash flow, and you may be able to sell a building for more than you bought it for a year ago. But it’s just fundamentally not the way the space should be owned and operated.”
