Just like the average cap rate, the average expense ratio in the skilled nursing market for facilities sold has been very consistent. For the past five years, it has had a low of 88.2% and a high of 88.7%, for a very small 50 basis point spread, according to the 2017 Senior Care Acquisition Report. It was 88.5% in 2015 and 88.6% in 2016, just to show the consistency. Obviously, this excludes expenses such as interest, depreciation, amortization, taxes and rent. When these are all included, it is clear to see why the skilled nursing industry complains to their elected representatives as well as CMS that it is difficult to make money. And future cuts to Medicaid (as promised by both the House and Senate versions of their health care bills) do not help the matter. In those transactions where the existing expense ratio is 95% or higher, obviously the buyers believe they can reduce it by either cutting expenses, changing the census mix or by just increasing occupancy in general. But with labor costs rising, and the supply of trained labor not expanding as much as is needed, the average expense ratio will continue to be high.
But to the all-important question: how did operations affect value? Even though the operating margin (the inverse of the expense ratio) is important and can impact value in the acquisition market, it is the absolute level of cash produced at the facility that is always the most important factor. If there is a low expense ratio (high margin), then the value should rise. As such, the average price per bed in 2016 dropped as the average expense ratio increased, averaging $130,550 per bed for facilities with expense ratios below 85%, $86,300 per bed for those with expense ratios between 85% and 89%, and $72,200 per bed if the expense ratio was at 90% or above. That makes it the fourth year in a row there has been a perfect correlation between average expense ratio and average price per bed. While this makes logical sense, it is not always the case when you have several lower margin facilities sold that may nonetheless produce significant levels of absolute cash flow. In 2016, all three groupings of facilities based on their expense ratios increased in price compared with 2015. While the upper two were reasonably close ($128,100 per bed and $85,300 per bed in 2015), those facilities with the highest expense ratios increased in average value the most, rising from $46,000 per bed in 2015 to $72,200 per bed in 2016. Part of the explanation was a smaller number of lower-end properties sold in 2016, which helped drive average prices up in general.
