Challenges in securing capital in the nursing home sector have grown over the last year even as the deal pipeline has remained steady, with success heavily dependent on the right alignment of operators, real estate, and certain regional markets.

Moreover, a consolidation of skilled nursing assets among primary owner-operators is currently underway, marking a shift toward recapitalization and a focus on adding assets strategically in certain markets.

According to Vikas Gupta, SVP of Acquisitions & Development at Omega Healthcare Investors (NYSE: OHI), it’s a “mixed bag” as far as investment opportunities go, but SNFs have, nevertheless, fared better relative to other spaces in long-term care.

“It’s far worse on the senior housing side right now,” he said at the recent Capital and Strategy Conference in Washington, D.C. “People are trying to refinance senior housing deals, and it’s very difficult. They have loans that are not current…People are trying to shift to long-term financing. ”

This trend has created a “log-jam” where alternative financing is seeing greater prominence, Gupta said at the event, put on by Skilled Nursing News and other WTWH Media publications. 

Gupta was joined by industry leaders Moishe Gubin, CEO of Strawberry Fields REIT, and Jonathan Slusher, partner and head of Senior Housing & Healthcare at Northwind Group, in a discussion about deal flow, valuations, capital availability, operator alignment, and government financing programs.

Industry consolidation

Consolidation in the industry is mainly driven by founding families exiting and larger operators recapitalizing, leading to the creation of scale, infrastructure, and talent within these operators, Slusher said.

“Many of those who [were] active, say, three to four years ago, and even the past two years, have become really significant in terms of enterprise value and have created the scale and infrastructure needed to attract very good talent,” he said. “Now they’re focused on adding one asset at a time in certain markets, still looking for portfolio transactions that are a little more complex, given the state of the capital markets and access to liquidity.”

The current activity revolves around recapitalization of assets from previous transactions and operators exercising purchase options negotiated during COVID, Slusher said. And while the market has been quieter, he expects increased activity in the second half of the year.

“However, the environment is definitely much choppier than it was a year ago or two years ago, when there was a significant flow of capital into the space,” he said.

For Strawberry Fields REIT, Gubin said his acquisition strategy revolves around a disciplined buying practice focused on cash flow and existing properties. The Indiana-based real estate investment trust (REIT) approaches each prospective transaction by envisioning itself as an operator, making sure there is an alignment with potential tenants on operational strategies, Gubin said.

This mindset allows the REIT’s leadership to assess deals based on cash flow potential, with a straightforward valuation model. Despite soaring prices in the market, Gubin said this disciplined criteria yields viable deals and increased transaction activity.

“We also push the virtue of not owning the real estate,” Gubin said, referring to the advantage that operators gain in lease structure, in order to have more working capital available towards operating more facilities.

Capital availability

While skilled nursing loans generally perform well, seniors housing loans are more akin to commercial real estate and face increased risk ratings due to interest rates and debt service coverage ratios, Slusher said.

Yet experienced lenders familiar with the volatility of both skilled and senior lending continue to lend.

“The lenders, the ones who have been in this space for a very long time, understand the volatility and what skilled nursing really entails,” Slusher said. “They continue to lend, focusing more on stabilized portfolios and cash flow. Strong sponsors with various sources of capital and track records are preferred. [But] we’ve seen more banks coming back in the past three months.”

Other factors at play in the availability of financing for deals include improved reimbursement from the major government payers in the sector. A better understanding and appreciation of skilled nursing’s role, particularly during the COVID-19 pandemic, has led to better Medicaid rates and enhanced operational strategies by owner-operators, Slusher said.

“The Medicaid rate progression you’ve seen, and all the lobbying efforts of many states that have pushed rates significantly, is because of a clarity of understanding of what the asset is, what it does, and how it supports patients,” he said. “That Medicaid rate progression is extremely important.”

Changing the ownership mentality toward valuing both real estate and operational aspects of skilled nursing has led to increased investment and capital flows into the sector, he said. This growing understanding of the SNF’s role in the healthcare continuum, coupled with an awareness that SNF assets possess infrastructure-like qualities and increased long-term financing, has contributed to the appreciation and valuation of skilled nursing assets.

“The assets are financed with long-term debt backed by HUD,” Slusher said. “It’s infrastructure. It’s very important to understand that relative to senior housing, because they’re really two completely different asset types that happen to serve a similar consumer.”

Valuation strategies

That said, valuations for SNF assets in the past few years have become inflated, although there has been a correction this year, Gupta said.

“At Omega, we’re pretty disciplined,” he said. “One of the things we look at is the price per bed. We always try to determine what’s a reasonable price per bed and then compare that to what a replacement cost would be. Because we’re always thinking, we won’t pay more on a per bed basis if you can build it at a cheaper price.”

Valuations are complicated by regional dynamics that affect the construction of new SNFs, including certificate of need laws and Medicaid rates.

“It comes back to who your operator is and how you feel about the reimbursement environment, [and whether] that’s going to stick around,” Gupta said.

In West Virginia, Omega was at the helm of many deals that happened in the last two years due to the stability of rates in the state.

“We were involved in those deals. And, we felt comfortable because West Virginia hasn’t changed its Medicaid system in many years,” explained Gupta.

Owner-operators now tend to buy assets for the entire enterprise, including the real estate, therapy, and pharmacy businesses, Slusher said. This integrated approach leads to better management of staffing, investment in building renovations, and enhancing the overall value of the assets.

“[Those operators] are more likely to spend more dollars on renovating the buildings,” Slusher said.

Indeed, new renovations may be on the horizon. Despite challenges like COVID and tough operating conditions, occupancies are returning to pre-COVID levels, and use of agency is going down, Gupta said.

“I think it’s an exciting time,” he said. “This industry isn’t going anywhere. And then you add demographics, which COVID really just set us back a little bit, but it’s going to come … and our buildings are going to get fuller and fuller; there’s going to be a need for new developments.”