Executives at CareTrust REIT (Nasdaq: CTRE) believe that the acquisition market for skilled nursing assets should heat up in 2024. And they highlighted the company’s robust financial position to be able to make investments, with $600 million available on their line of credit and nearly $300 million in cash.
“We expect 2024 to be a strong year of investments,” CareTrust CEO David Sedgwick said Friday on the company’s Q4 2023 earnings call. “And we positioned ourselves accordingly.”
Recent activity has largely revolved around loans, with $170 million in loans made since 2022 and demand remaining strong. Sedgwick said the company’s investment philosophy includes a focus on loans that meet specific criteria, with an eye on future real estate acquisitions.
“The investment will be run by a top shelf operator with whom we want to start or expand our relationship,” he said. “Second, the investment meets our historic underwriting criteria, and is accretive in year one. And third, the transaction provides for a path to future real estate acquisitions, either built into the deal directly or simply from the relationship.”
In terms of the existing investment pipeline, Chief Investment Officer James Callister put it at about $250 million, which could be supplemented with some “chunkier regional opportunities.”
“We expect the skilled nursing transaction market to become increasingly active, with the continued bifurcation between assets that are cash flowing and distressed product,” he said.
Meanwhile, CareTrust executives were fairly bullish on operating fundamentals, with Sedgwick noting that the “worst is behind us” on labor. And investors also seemed upbeat on the latest earnings results and commentary, with CareTrust shares up 7.14% as regular trading came to a close on Friday.
Recent investment activity
In Q4, the company closed on funding for mortgage loans and mezzanine loans, securing opportunities in California, Virginia, and Missouri.
Notable among acquisitions were the purchases of two skilled nursing facilities in California, a continuation of the company’s strategic focus.
Additionally, in Q4, CareTrust finalized a $6.3 million mortgage loan for an existing tenant relationship, supporting a senior community in Vista, California. Callister said this loan, secured by a 26-unit assisted living facility, will “help further synergies” with a nearby skilled nursing facility in San Diego County that the company acquired in Q3 of last year.
The company anticipates continued growth in the skilled nursing acquisition market to be driven by regional operators’ interest in health care real estate investments, buoyed by favorable market dynamics and increasing state Medicaid rates.
In addition to these ventures, Callister discussed the recent closure of funding for over $52 million in mezzanine loans, secured by portfolios of skilled nursing facilities across Virginia, Missouri, and California. These investments included financing approximately $45 million for Virginia and Missouri loans, and a $7.4 million mezzanine loan was extended to facilitate the acquisition of a skilled nursing facility in Pasadena, California.
Stifel analysts stated that if the cash on the balance sheet is invested, funds from operations (FFO) could potentially increase by $0.11 per share on a full-year basis, which is not accounted for in the guidance.
“CTRE has essentially taken the funding pain today for acquisitions in the future. And it locks in the REIT’s cost of equity at an attractive price,” they wrote.
This marks the first time that CareTrust has issued guidance since the fourth quarter of 2020.
Room for enhancement
Executives also addressed various topics, including the competitive landscape, the labor market, and the potential impact of pending CMS rulings on staffing. They also discussed the operator “watch list” and the possibility of acquiring long-term care real estate under different structures.
“Of course, everybody’s looking at Eduro with their coverage that has trended down,” Bill Wagner, Chief Financial Officer at CareTrust, said. In the last earnings call, CareTrust noted that there were challenges with Eduro Healthcare, whose lease coverage trended downward for the last couple of quarters.
Eduro’s coverage fell to 0.96x from 0.98x in Q3 of 2023, the Stifel analysts noted. However, two Eduro facilities are slated to transition to another operator by March 1, which would push Eduro’s coverage just north of 1x, Sedgwick noted on the earnings call.
“I think what we’ve learned over the past 10 years here is that there’s probably always going to be a small handful of operators in any portfolio which we would call the watch list, and the art here is just to manage that risk down as best we can,” he said.
Sedgwick noted that while there has been improvement in labor conditions compared to the peak of the challenges faced during the pandemic, there remains room for further enhancement in labor costs.
He highlighted a specific data point regarding agency costs, indicating a significant reduction from $13 per patient day (PPD) in the third quarter of 2022 to $8 in the third quarter of 2023, but said that before the pandemic, it was as low as $3.
“So there’s still quite a bit of fat, excess labor costs built in there, that we hope will continue to decline as time goes on,” he said. “So, it’s actually pretty encouraging to know that there’s some opportunity there going forward for our operators to continue to improve there; having said that, it’s still a difficult labor market.”
Analysts also asked whether operators were able to pass Medicare and Medicaid hikes directly into wages.
“Our operators in this space really got ahead of those rate increases,” a CareTrust executive said. “They really had to because we lost so many employees in the skilled nursing space due to the pandemic.”
Yet they noted that by and large, operators adjusted well before those rates caught up with them.
“So last year’s rate resetting and increases in activity by the state, I think recognized that those costs have gone up significantly,” Sedgwick said. “And because of that, those states had a lot of rationale for making the adjustments they did to those rates.”
Analysts also inquired whether the competition from levered private buyers for larger deals has decreased due to changes in capital markets.
“There’s a pretty active, private equity buyer pool out there right now, especially on the bigger stuff that is still very active,” Callister said. “I think that you definitely have an absence of smaller owner-operators who really can’t get financing right now that works for them, and they’re really out. But, I think some of the larger players are still in and still competing.”
