To build relationships that can weather hurdles and succeed in a “new era” for nursing homes, owners and operators should focus on how they can drive mutual growth over time, through symbiotic, creative deals generating long-term value.
That’s according to executives with Omega Healthcare Investors (NYSE: OHI) and Providence Administrative Consulting Services (PACS), who spoke Thursday at the National Investment Center for Seniors Housing & Care (NIC) conference in San Diego.
“When we ultimately are looking at the life of the relationship, we’re not looking at anything on an asset-by-asset basis, really, anymore,” said Vikas Gupta, senior vice president of acquisitions and development at Omega.
Rather, Omega is focused on establishing operator relationships that offer an array of mutually beneficial options for growth over time, in a variety of situations and deal structures — and when problems arise in particular facilities, this strategy is driving decision-making about potential resolutions. Omega is the largest owner of nursing homes in the United States, with a portfolio of about $10 billion worth of real estate, 80% of which is skilled nursing.
PACS operates 177 skilled nursing centers across the country, is among the roughly 60 operators working with Omega, and is aligned with the REITs’ approach to building and maintaining strong ties, said Derick Apt, executive vice president of corporate finance at PACS.
“A lot of time, if you’re just looking myopically for one deal, you’re going to burn a lot of time and a lot of legal dollars that — if you can’t expand upon that relationship — it’s kind of a finite return on investment,” he said.
The current environment for skilled nursing is creating myriad challenges that are testing the strength of owner-operator relations, Gupta and Apt agreed.
“Coming off a pandemic, liquidity has been tight for nursing homes, stimulus money has dried up, we’re in kind of a new era, and occupancy isn’t back yet,” Gupta said.
These challenges are demanding that capital providers and operators work together creatively to resolve some difficult situations — but the ability to successfully engage in these efforts is predicated on these relationships having strong foundations that can be traced back to the origins of the partnerships.
When Omega initially connects with a potential operating partner, the REITs’ leaders are evaluating a few key factors to determine the likelihood of a sustained and fruitful relationship, Gupta said.
Understanding the operators’ long-term strategy and reasons for seeking capital are crucial. For instance, an operator may have a stronghold in a particular geography and want to expand in those markets. This gives Omega confidence in the operators’ expertise in the dynamics at play in their core market areas and opens up the potential for mutual expansion — the REIT might be able to tap the operator to take on more leases in this geography in future, or draw from the operator’s knowledge base to help other operating partners working in the same region, Gupta said.
Conversely, if an operator came to Omega with the goal of entering a brand-new state, this might raise some “red flags.”
“I’d say, well, why? What’s going on, what’s the story there?” Gupta said. “If there’s a good story, then we listen and we learn.”
The REIT is also looking for a track record. Many operators say they “like turnarounds,” but Omega wants to know the operator’s history of turnarounds and see demonstrable success.
And then there’s the conversation related both to what the operator is seeking from the REIT most immediately as well as the desire and ability to expand the relationship over time.
The relationship with PACS, for example, did grow to the point where the REIT and operator now are working together in four states.
From the operator perspective, Apt cited a few elements that PACS is looking for when starting a relationship with a capital partner, including reasonable expectations for performance.
“When it’s a difficult turnaround, if a capital partner thinks you’re going to turn around in two months, then that’s not a partner you want to be with, because there’s going to be road bumps along the way to get assets to stabilization,” he cautioned.
PACS also wants to know that a partner is willing to step up on capital expenditures for a wide variety of physical plant upgrades that might be deemed necessary — from a new roof or boiler, to remodels of nurses’ stations or employee locker rooms, to technology upgrades.
Apt also advised operators to be sure “the covenants and the constraints inside the lease, or whatever kind of document that’s governing that capital that you’re taking, is giving you the bandwidth to make operational improvements.”
Like Omega, PACS is targeting partners that are “in it for the long haul,” look “holistically” when evaluating situations and strategies, and are interested in scaling together, Apt said.
The scalability of an owner-operator partnership is a priority not only to drive value creation for both enterprises, but because scale enables greater creativity for problem solving when issues inevitably arise.
“There’s fewer chess pieces” in partnerships that lack scale, commented Joel Mendes, managing director at JLL and moderator of the NIC panel involving Gupta and Apt.
When Omega has a more extensive relationship with an operator, such as with PACS, the companies can explore many more routes to resolve challenges, increasing the likelihood of a mutually beneficial solution, Gupta said.
For example, Gupta described potential dialogue that might occur if PACS were to encounter problems with three hypothetical buildings in California:
“It’s a conversation — ‘Hey, can you get me out of this building, and we’ll look to do this other one with you,’ or, ‘I actually know there’s a better operator down the street, you might give them a call and see if you can lease that building to them, because this just isn’t our market.’”
Omega does not relish selling more than it buys, which sometimes happens when dispositions end up being the best solution to get an operator out of challenged properties, Gupta said. But the downside of any particular sale is outweighed by the benefits of maintaining a strong partnership, when the REIT has a programmatic relationship with an operator such as PACS.
“We understand if Derick’s having a problem in three buildings in California, that it’s better to get him out of those buildings than to create pain for all of us forever; it just messes up the relationship, messes up the lease, messes up everything,” Gupta said.
This is not to say that Omega spends less time on issues confronting its smaller operating partners or is less invested in their success, Gupta clarified. But the difficult conversations can play out differently when the metaphorical chess pieces are less numerous, and challenges sometimes lead to the end of smaller relationships more quickly than is the case with larger-scale partnerships.
He also emphasized the importance of trust, given that Omega relies on operators’ assessments of what is realistically achievable and on what timelines, including occupancy improvements or rent increases.
“For me to go put projections together and shove them into an operator’s face doesn’t help anyone,” he said. “It doesn’t help me, because ultimately they won’t hit those projections. And, ultimately, they’ll be calling me when they have a problem.”
When problems do arise, having a strong operating team that can quickly identify the issue and devise a potential solution is critical, Apt said, so that execs like himself can communicate with capital providers as soon as possible to “get on top of it early.” Such problems might involve additional building improvements that are needed, or expense line items that were not diligenced accurately or that spike unexpectedly, as agency usage did in the recent past.
Possible remedies vary depending on the nature of the issue, the structure of the deal, and the types of capital partners involved, with CapEx investments, loan extensions and rent resets or deferrals among the possibilities, Apt said.
Gupta joked that as a REIT exec, he does not understand the concept of rent deferment. But he also stressed that economic considerations are real and cannot be sacrificed in the name of relationship maintenance.
“I have a cost of capital; when I deploy capital, Omega really has to make certain returns,” he said. “And those are tough conversations a lot of times, and you have to work around it, and look at creative ways to preserve that return for everyone.”
He also pointed out that operators also are driven by economics, and sometimes choose a capital partner primarily on the rate being offered. But this can be part of the myopic approach that will not pay off in longer-term, larger-scale value creation, he argued.
For instance, a REIT might be able to offer benefits that a cheaper source of capital cannot, including more options for future financing structures and the insights gleaned from a large stable of operators.
“I might be a smidgen more expensive than somebody, but that might be worth it,” he said.
“Maybe economics are more expensive on this side, but you’re going to get a better relationship, or you’re going to get something in return that, ultimately, in the holistic picture, it’s better off for your operations,” he said.