On Friday, news broke that the Ohio House approved $615 million in funding for the state’s skilled nursing facilities. Also on Friday, stocks were roiled by a better-than-expected federal jobs report, which stoked expectations of further interest rate hikes from the Federal Reserve.
These dynamics — funding measures at the state level and rising interest rates — will shape skilled nursing investment activity as 2022 concludes and the new year begins.
Michael Segal, executive managing director at Blueprint, anticipates interest rate hikes will continue to introduce a lot of uncertainty in capital markets, particularly on the debt side.
“For lenders, it has required a lot of deal structuring creativity, to be able to successfully close transactions in light of those challenges,” Segal told Skilled Nursing News. “Those challenges are going to persist through the end of the year – we have another Fed meeting coming up in December, where there’s more anticipation for another rate hike.”
The level of volatility that VIUM Capital has seen, according to Kass Matt, executive managing director for the financial services firm, has been “tremendous.”
“We’re watching the Fed really closely … I expect the Fed to start to slow down but not stop the increases,” said Matt.
Coupled with interest rates, providers simply can’t seem to solve current market challenges, in turn leading to more distressed properties coming up for sale, according to Erik Howard, executive managing director of business development and marketing for Capital Funding Group.
“A lot of [operators] seem tired … that has continued to drive opportunity in the space over the last three years since Covid,” Howard told SNN. Still, Medicaid rate hikes in some states offer a glimmer of hope to meet such financial challenges even as many have staffing initiative strings attached.
What investors saw in 2022 was somewhat of an extension of the last few years, Howard said; that is, “tremendous opportunities” for operators willing and able to change the paradigm.
Changes can take many different forms, he said, from embracing technology to implementing patient-driven care models.
“We’ve seen a number of transactions and financed a number of transactions over the last three years that have really been able to enhance profitability but also results for patients, which is the most important thing that I think everyone is looking for, better outcomes,” said Howard.
How investors look at Medicaid rates
Medicaid reimbursement rates will continue to have a direct impact on transactions, valuations and pricing in the market, Segal said. Kennedy and Matt with VIUM agreed, adding that any sort of rate rebasing at the state level will be “critically important” as the sector heads into 2023.
There’s attractiveness for buyers in states with permanent rate increases already in place and those primed to pass similar increases as state legislative sessions convene.
“How we structure deals is going to be very important relative to revenue enhancements,” said Matt. Uneven Medicaid rebasing compounds existing fragmentation of the skilled nursing market, added Kennedy, with “winners” or “survivors” in states that have raised their base Medicaid rates appropriately; investor capital will follow suit, flowing into these states.
Other states haven’t provided any type of increased reimbursement for operators, Segal said, in turn putting a lot of pressure on facilities operating in these states.
“It’s going to be one of the challenges going forward as costs continue to increase for operating these types of businesses, and reimbursement that is not being increased at the same clip to allow for those costs to be absorbed,” said Segal. “It’s putting pressure on operators to the point where some simply have to exit.”
States that have not or do not plan to rebase appropriately present “big time risks,” added Kennedy; it’s another challenge for dealmaking specific to SNFs, with the private-pay seniors housing market being a “little more uniform.”
Difficult capital markets
Challenges investors will face in 2023 will center around working through increasingly difficult capital markets, Howard said, as the sector juggles rising interest rates and less than stellar reimbursement support, despite some states rising to the occasion.
“The [Federal Reserve Board’s] very quick and aggressive action on short-term interest rates has created some challenges in the financing world,” said Howard. “There’s a pretty significant interplay between the cost of capital that owners and operators need to seek in acquisition financing, and what they’re willing to pay in sales proceeds.”
In other words, as interest rates go up, the amount of cash flow available to an owner or operator decreases, he added. There is a great deal of pressure in trying to determine what costs will ultimately be, as new owners take over operations and continue improving census and operational cash flow against the interest rate backdrop.
“Without any clarity as to when these rate hikes will stop and when interest rates will level out or stabilize, it’s very hard for some of these lenders and also borrowers to underwrite acquisition opportunities,” added Segal. “ … That collective level of uncertainty in the market has made dealmaking more challenging.”
Uncertainty will lead to more creative dealmaking in the new year, he said. Instead of a traditional loan from a commercial bank coupled with equity from a buyer, different levers are needed to be pulled from all sides.
“It’s more so just restructuring the capital stack for these types of skilled nursing transactions,” he said.
Skilled nursing operators can’t pass the burden of rising costs on to residents like those in assisted living and seniors housing, due to SNFs’ heavy mix of Medicare and Medicaid beneficiaries – it’s up to operators to figure out how to continue innovating and acquiring properties.
“Willingness to pay the prices we may have seen earlier this year and over the last few years becomes a little bit more challenging,” added Howard. “That’s one of the items that we think we’ll have to continue to work through probably for the next couple of quarters.”
While Howard is confident there will continue to be opportunities for buyers in the year ahead, it’s unclear at what price and with what leverage the banks will be willing to provide financing.
But investors will continue to get a better sense and visibility on what the Fed’s action is going to be, and how that’s going to impact short-term interest rates and borrowing, along with overall impact on the mergers and acquisitions market. The next meeting of the Federal Open Market Committee (FOMC) is scheduled for Dec. 13 and 14.
Companies featured in this article:
Blueprint Healthcare Real Estate Advisors, Capital Funding Group, VIUM Capital
