Amid a banking and credit crisis, financial backers of the nursing home industry are seeing less stable assets, a product of volatility in the market.
And even as some states are now responding with Medicaid reform and rebasing to mitigate the sector’s losses, many operators were struggling financially prior to the pandemic, and the sector’s recovery simply hasn’t been robust enough to draw investors back in.
In fact, many banks are choosing to sit on the sidelines while less stable regional lenders grow their presence in the space, according to experts. Moreover, standalone and smaller skilled nursing facilities (SNFs) are under the greatest threat of shuttering, while the industry can also expect a reduction to the number of beds, especially in certain states, they say.
Stephen Taylor, senior living and care segment leader for CliftonLarsonAllen (CLA), said he’s seeing a continued regression of operating margins among those in the SNF industry, leading to product volatility. Margins continue to digress from 2018 and 2019, with balance sheets and capital depleted over the past couple years.
“Nationally speaking, pre-pandemic operating margins were essentially breakeven. Then the volatility of Covid hit and there were some significant short-term funding sources created in response to the pandemic,” said Taylor.
Out of about 15 listings, maybe three are making money, Patrick Byrne, founder and principal of Missouri-based Eads Investment Brokerage, said of stabilized assets in the Midwest. And, those that are breaking even could potentially make money in future if there are ancillary services attached, he said.
It’s still an opportune time to sell, he said, but it’s not an easy choice for many operators.
“It’s coming out of this environment … I have a handful of standalone nonprofit deals,” Bryne said, adding, ”Standalone operators are endangered – it’s very, very difficult for them to continue to exist in this environment.”
Cap rates for the skilled space, Byrne added, are driven more by what’s on the market rather than external factors, and are otherwise pretty resilient.
The banking environment and SNF assets
Meanwhile, banks and other financing institutions appear unwilling to lend. Even strong operators have had to “hustle” to get the financing they need, Byrne said.
However, banks new to the industry are showing interest in the space as well in the last year or so; Byrne said it’s a trend that makes him nervous. It’s been mostly regional institutions that have money to spend and are willing to lend in the skilled space for the first time.
Skilled nursing providers with variable rate loans are in a significantly different position than they were a year ago, with credit tightening and banks not willing to extend loans or lend at all.
Many are concerned that Covid recovery just isn’t happening as quickly as everybody thought it would. The industry is not in the clear, and it’s showing up in so many different ways, REIT leaders said.
“There’s a whole segment of the population that is waiting for the other shoe to drop, and some of those people are bankers,” said Byrne. “I don’t know what exactly is going to make those people more comfortable to come back in [to the SNF space], maybe it’s transaction volume, and then they see that other borrowers are having success, or, it’s this change in occupancy. I think there are positive signs out there,” he said.
Sponsorship changes for operators
Stabilized deals will be achieved when stability and predictability are prioritized, said Taylor, but the industry is still facing “significant volatility,” especially with economic, operational and regulatory pressures.
“I am a significant believer in the long-term need for SNFs. However, draconian policies and pressure on reimbursement have not created an environment of positive compounding investment into the industry,” he said.
The nursing home business is hyper local, he said, with median operating margins in neighboring states varying wildly. Washington is seeing about a -6% operating margin among its SNFs, while Oregon is broadly seeing an approximate 1% operating margin. Indiana is seeing approximately a 2% median operating margin while Ohio is dealing with approximately a -8% median operating margin.
Moving ahead in 2023, Taylor said he anticipates further sponsorship changes in the SNF world.
A two-and-a-half year period of Provider Relief Funds, the Paycheck Protection Program and Employee Retention Credit came and went, he said, leaving such operators in an “even harder financial position than they were then.”
This time period also saw drastic reductions in occupancy and continued pressure on average length of stay, along with pressures on reimbursement, staffing and inflation, added Taylor.
Looking ahead, operators may need to make a “sponsorship change” as a best path forward, Taylor said, in order to make strategic investments, workforce and other operations.
Still, Taylor said the level of activity will vary between states. Texas and Oregon, for example, have seen significant differences in ownership changes.
Taylor anticipates less owners and operators with fewer than three SNFs in the long term, and a continued reduction in bed count, as scale will continue to be of importance. But, getting back to the hyper local tendencies of the industry, he said this may look very different from state to state.
In terms of acquiring or extending credit, Taylor believes it all depends on debt service coverage. The Federal Reserve approved another interest rate hike in July, he said, taking the benchmark borrowing costs to heights not seen in more than 22 years.
But, working with an institution that understands the industry is key.
“Lenders and capital providers are focused on the quality of operators, with some of the key focus areas being agency utilization, occupancy, and EBITDA margin,” Taylor said.
The harsh reality of owning a SNF
Interest rates have continued to climb to levels not seen since 2001, Taylor said, and the economics of borrowing and servicing debt become strained if increased interest expense isn’t covered by increases in revenue.
“SNF revenue sources are significantly dependent on government sources, and there is certainly continuous pressure on reimbursements,” he added. “There are opportunities out there, but you need to know the state’s reimbursement system and have a plan to address contract labor utilization and workforce for it to be a strategic opportunity that you can handle the leverage on.”
At the same time, owning and operating a SNF is a “capital-intensive business,” he said. Substantial initial investments are needed to acquire a facility, then funding is needed to maintain and upgrade infrastructure, equipment and technology, according to Taylor.
Meanwhile, SNFs also require investment in human resources to recruit and retain staff, and a continuous financial demand is needed to keep up with strict regulatory requirements.
“Surveyors are coming in and they feel like they need to get three years worth of tags. It’s especially burdensome on the regulatory side,” added Byrne.
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