REITs Gain a Bargaining Edge and Will Pursue Valuable Relationships with Qualified Nursing Operators
Real Estate Investment Trust (REIT) arrangements for the remainder of this year and into 2023 will largely be driven by a desire to deepen existing partnerships or forge new ones with skilled nurse operators who have “ weathered the storm exceptionally well”.
That’s according to Michael Segal, executive managing director and partner at Blueprint Healthcare Real Estate Advisors.
And rising interest rates will level the playing field in favor of REITs, with private equity investors seeing a substantial increase in the cost of capital.
According to Steve Kennedy, Executive Managing Director of VIUM Capital, the change in Medicaid reimbursement rates, the stabilization of net hires and current inflation costs also play a role in REITs’ trading plans for the remainder of this year and until 2023.
“Rising inflationary costs, but especially this rapid rise in interest rates, is bringing some caution, as well as some reality, back to the M&A market,” he added.
For Zach Bowyer, senior managing director and head of housing sectors at Cushman & Wakefield, interest rate hikes have actually “tipped the scales” by giving REITs more buying power. The cost of capital is no longer necessarily determined by the debt market.
Much of the real interest going forward, in terms of acquisition targets and opportunities, will be in favor of communities and suppliers with a sustainable and strong financial position at this stage of the pandemic, added Segal.
Another benefit for REITs are operators who want to grow and who have a smart strategy in mind for the markets they want to enter.
A good example is Ensign Group (Nasdaq: ENSG) and its captive REIT, Standard Bearer. Ensign is the perfect example of an operator that has changed its strategy to better adapt to the changing landscape of the sector. Ensign reported a 14.7% increase in year-over-year revenue despite a continued challenging operating environment for nursing homes, and adjusted EBITDA growth of 15% in its latest results report.
Its small-market model, which focuses on having leadership teams specific to each major market within their footprint, has been adopted by other large operators, including Genesis HealthCare.
Standard Bearer added six new SNF real estate transactions, which capture the upside created by Ensign subsidiaries.
In another example, LTC Properties (NYSE: LTC) and PruittHealth entered into a joint venture to purchase three facilities in Florida for $62 million. LTC’s chief financial officer, Pam Kessler, said the company was tied to flexibility on LTC’s part and listening to Pruitt, meeting their needs and what they wanted to accomplish.
LTC has also taken steps to strengthen its ties with another operator the REIT considers a superstar — Ignite Medical Resorts — in a $51.5 million deal involving four Texas facilities.
“REITs will reward their operating partners who have remained vigilant and disciplined throughout this market downturn and the COVID-19 pandemic,” Segal said. “Those who have remained disciplined and committed to a consistent business plan without pushing themselves will have the best opportunities for growth.”
Ready for competition in 2023
While there has been some REIT acquisition activity this year, both public and private REITs have been defined by portfolio “pruning,” shedding underperforming facilities.
Sabra Health Care REIT (Nasdaq: SBRA), for its part, announced earlier in 2021 its intention to divest between $100 million and $300 million of its skilled nursing assets. In the second quarter alone, Sabra generated gross proceeds of $40.2 million from the disposal of eight facilities, in addition to the sale of two facilities completed after June 30.
However, Sabra is still very bullish on the SNF sector and has pursued these deals largely to achieve a more desirable portfolio balance with other types of assets, CEO Rick Matros said at the Skilled Nursing News event. RETHINK in Chicago about a month ago.
As the sector heads into a new year, Segal believes pruning has set up REITs perfectly to deepen relationships and build new ones with operators they believe have potential.
Over the past five years, but especially during Covid, REITs have optimized their portfolios based on challenges from a market or operational perspective, Bowyer added. While not divesting properties completely, REITs have restructured leases to gain positive coverage.
Ultimately, Bowyer agrees that REITs’ pruning of underperforming assets, coupled with rising interest rates, has put a positive spin on deals for 2023 and created opportunities in a normalizing market.
“I think it’s the desire of REITs to eventually be more active on the acquisition side; to this day, that is certainly their intention,” Segal noted. “You may see some sellers more attracted to the ‘cash buyer’ profile of a REIT, compared to private equity investors who are exposed to the risk of debt markets.”
In recent years, pricing has been dictated by the amount of rent their operators are comfortable paying, which has limited REITs in their ability to obtain more aggressive pricing and compete with the private capital market. , did he declare.
As the private market feels the pressure of rising interest rates, this shift is also making trades more difficult to execute – targets are shifting for some lenders, which in turn is shifting targets for capital requirements.
“I think it all comes down to the cost of debt and how much leverage your private equity buyer will want to invest with,” Bowyer said.
It is more difficult for buyers to fully capitalize on these transactions.
Kennedy said REITs will have the opportunity to acquire projects at a reasonable price; they tend not to use as much leverage as independent sponsors or private equity.
“When the Fed raises rates every two months, it creates a lot of volatility and movement on the lending side, which then changes capital requirements and makes trades harder to close, but they’re still in course,” Segal added.
For the remainder of 2022, rising interest rates have caused a small pause on both the private equity and REIT side, according to Bowyer. Financial players in the sector are slow to understand the impact of interest rates on valuations.
Medicaid Pricing: Uncertainty versus Incentive
The skilled nursing sector is different from the private seniors’ residence sector in that the costs associated with rising interest rates cannot be passed on to the consumer. SNFs are mostly paid for through Medicare and Medicaid reimbursements, so services and bed rates are dictated by state and federal agencies.
Depending on the state, Medicaid budget increases could be seen as an incentive or a pain point; it depends on what support facilities have seen before and during the pandemic.
“Several states have increased their Medicaid budgets and are increasing their facility Medicaid daily reimbursement rates,” Segal said. “It’s been very helpful in weathering the storm a bit for operators in particular, but the increased interest rate environment is only putting even more pressure…it’s also moving up the ladder to ownership real estate.”
There has always been a risk of pencil strokes in the skilled nursing industry, Bowyer said. He can’t remember a time in his 20 years working in the industry when the space actually saw the level of increase in reimbursement rates that it is currently seeing.
“The question still remains – how long is this going to last? We are also seeing an increase in operating costs,” he added. “But those reimbursement rates are really prolific for the bottom line.”
It’s ultimately a sign of some level of confidence on the government’s part, Bowyer said, and that margins will be able to stay relatively intact even with the costs of inflation.
Sabra is very sensitive to different refund environments in different states. The REIT released a summary of rate increases in its key states as part of its Q2 2022 earnings report. Some increases were state-allocated additions to nursing home reimbursements, relying on additional funds from the Federal Medical Assistance Percentage (FMAP) through the Family First Coronavirus Response Act. Other rate increases were aimed at basing Medicaid rates.
“Medicaid is an important source of revenue for the skilled nursing industry and we are very pleased with the increases we are seeing in these rates, which creates a smoother path to recovery as the federal assistance we have been on regulars expires over time,” Matros said in the earnings release.
Meanwhile, a slow increase in net hires — and a decline in contract labor — has helped bolster confidence in REITs as spending on operator budgets begins to normalize, Kennedy told SNN.
This is in addition to the Centers for Medicare & Medicaid Services (CMS) decision to give SNFs a 2.7% increase in payments for 2023, he said, and the two-year phase-in of an adjustment to the patient-oriented payment model (PDPM).
“We avoided what the Biden administration originally planned — a decrease in Medicare,” Kennedy said. “We put that in the rearview mirror and now we see Medicaid rates going up state by state; these increases are really significant just to try to offset some of these cost increases.