With Covid-era federal financial support trailing off for skilled nursing operators, leaders in the space, including Sabra Health Care REIT (Nasdaq: SBRA) CEO Rick Matros, are increasingly turning a hopeful eye to Medicaid funding relief at the state level.

Specifically, Matros believes more permanent relief is a function of how state budgets are shaping up into 2023 and beyond. On a temporary basis, the Families First Coronavirus Response Act provided a 6.2% increase in Federal Medical Assistance Percentages (FMAP) retroactive to Jan. 1, 2020 and continuing through the end of the year.

State support gives operators some breathing room, while Medicare also received a boost in the form of the Centers for Medicare & Medicaid (CMS) final rule outlining a 2.7% increase in the market basket rate and spread out cuts tied to the Patient-Driven Payment Model (PDPM) over two years.

The final rule provided a 340 basis point improvement over what was initially proposed, according to Matros, with 110 of those basis points specifically due to capturing inflationary costs.

“Obviously that doesn’t capture all of inflation, but at least it’s a step in the right direction,” added Matros during the real estate investment trust (REIT)’s second quarter earnings call on Thursday. “We should expect to see inflation captured in next year’s market basket as well.”

Sabra’s portfolio consists of 272 SNF and transitional care facilities, 105 senior housing communities, 14 behavioral health facilities and 15 specialty hospitals across the U.S. and Canada.

State Medicaid momentum

Matros expects continued SNF occupancy issues to drive state Medicaid movement this year and into 2023.

“Some of these states are starting to have some pretty serious access issues. That’s going to create a lot of bad headlines, so that will be a factor as well,” said Matros. “I think all of that is positive, and should go toward continuing the momentum.”

In the last six months, for example, about 10% of Montana’s nursing home beds were taken offline with the closure of seven SNFs, while Iowa saw 11 nursing homes close in the past year.

Meanwhile, states like Texas, Kentucky and North Carolina all continue their Medicaid percentage increase at least through the end of the year at 12%, 12% and 15%, respectively. Out of Sabra’s SNF properties, these states saw the highest increase to Medicaid.

For context, states have averaged 1.7% Medicaid increases per year over the past decade according to NIC MAP data. Medicaid reimbursements accounted for 43% of revenue for Sabra’s skilled nursing and transitional care tenants for the last 12 months.

While Medicaid increases aren’t happening in all states, Matros believes it is happening in enough states to be helpful to national REITs like Sabra.

The Irvine, Calif.-based REIT beat analyst expectations in normalized funds from operations (FFO) at 39 cents for 2Q ending June 30, according to a note published by BMO Capital Markets on Wednesday. That’s a decrease compared to normalized FFO during 2Q 2021 at 41 cents, according to Sabra’s earnings report.

In an Aug. 3 note to investors, BMO analysts said they were pleasantly surprised that occupancy continues to improve across all of the REIT’s asset classes, although SNFs only saw a 1% increase between the first and second quarter for the year.

Matros confirmed the one barrier holding back occupancy is “purely labor” despite reporting net hires slowly returning and agency reductions.

“We are seeing a slowing down in July, both due to seasonality and continued labor pressures. Labor pressures are not as bad as they were at their worst, agency has come down and hiring is up but it’s still going to be a slog for a while; it’s tough,” Matros noted. “It has hampered the rate of recovery relative to how quickly patients could be admitted.”

Sabra did not provide guidance for the next quarter or for the year again, an outlier compared to other REITs, BMO analysts said.

Sabra reported $924.8 million in liquidity as of June 30, broken down into unrestricted cash and cash equivalents of $67.2 million, available borrowings of $857.7 million in its revolving credit facility.

Doubling down on behavioral health, as SNFs fetch a fair price

Sabra executives continue to shift the REIT toward a more diversified portfolio as the company invests more in senior housing and other asset classes, like behavioral health.

Matros announced plans earlier this year to divest between $100 million and $300 million in Sabra skilled nursing assets.

During the second quarter alone, Sabra generated $40.2 million in gross proceeds from the disposition of eight facilities, in addition to the sale of two facilities completed after June 30.

“People came just short of flying out here to our corporate office and hanging us by our necks – that’s the kind of reaction that we got,” added Matros. “For us, we’re not selling assets that you’d think are fantastic assets. Some of it obviously got made worse by the pandemic … doing this is going to improve the long term durability of our earnings stream.”

Still, Matros said Sabra remains bullish on the skilled space. Even with its diversification, skilled nursing will still make up more than half of the REIT’s portfolio, he said.

Currently, Matros isn’t seeing much opportunity to buy assets in the SNF space compared to behavioral health and seniors housing, although there are plenty of other buyers interested in Sabra’s SNF assets, he added.

CIO Talya Nevo-Hacohen said the move aims to diversify projected payer volatilities across Sabra’s asset classes, including fluctuations to Medicare or Medicaid.

“Seniors housing is obviously private pay, skilled nursing is primarily government payers, and behavioral is sort of a mashup of all the above, although for us it’s more commercial insurance, a little bit of government pay,” said Nevo-Hacohen. “When investors get nervous about Medicare changes or Medicaid changes, this should help mitigate the amplitude of that risk.”

The REIT also has six more facilities under contract for sale, and collectively, sales so far for the year add up to more than $210 million. Year-to-date, Sabra has transitioned or are in the process of transitioning 25 triple-net leased assets to existing and new operators, including the Ensign Group (NASDAQ: ENSG).

Meanwhile, Sabra acquired 12 Canadian senior housing communities in the second quarter as part of a joint venture with Sienna Senior Living (TSX: SIA) for $147.4 million.

The company’s growing behavioral health portfolio represents a total investment of approximately $730 million. Nine properties have been converted or are in the process of being converted to addiction treatment centers, while Sabra leadership negotiates several additional conversion opportunities.