Skilled Nursing Values Stabilizing

You know us. We have always been bullish on the long-term prospects of the skilled nursing sector. You have read on these pages how investment interest never slowed even as average prices dropped in the past few years from the record peak of just over $99,000 per bed in 2016, a level that we thought was not sustainable, at least not in the short term.

After two years of declines, there has been a slight turnaround. According to our rolling four quarters statistics, for the 12 months ended June 30, 2019, the average price per bed was $79,950, which is a 3.1% increase over calendar year 2018. This could just be a quirk in the numbers, as in a few higher prices in the second quarter of this year, or some lower-priced sales in last year’s second quarter falling out of the trailing calculation. But, an increase is an increase.

On top of this, the trailing four quarters average cap rate was 11.9% compared with 12.9% in calendar year 2018. We will see how this holds up over the next two quarters, and whether we will settle back to the norm of closer to 13%. But with HUD still active as a lender, and the 10 year-Treasury rate falling below 1.75%, equity returns for skilled nursing acquisitions remain high. Where else can you borrow for 30 years at less than 4% with no personal guarantees?

One of the problems is that the media does not like to leave the sector alone. The biased and in some ways incorrect story about a large HUD default related to a portfolio of midwestern nursing facilities is a case in point. Some people fear that the front-page New York Times story a few months ago may pressure HUD to slow down its SNF lending program. We believe those fears are overblown. Or NBC Nightly News with Lester Holt’s recent story about Skyline Health and its disastrous growth from 10 SNFs to more than 100 in less than two years. Well, that bad publicity was well deserved, and we hope the owners start looking elsewhere for their fame and fortune. They succeeded in destroying a few too many nursing facilities with their reckless financial mismanagement, and only succeeded in giving the sector yet another black eye it does not need. We keep on waiting for the time when skilled nursing is not the media’s healthcare punching bag.

There is one trend that is getting some people worried and others smiling. That is the slow decline of the number of skilled nursing beds. The worry is that there will be a shortage just as we will “need” more beds as the baby boomers start to age into their eighties. First, we don’t think that skilled nursing is where many boomers think they will be spending their final days. Assisted living will certainly pick up some of the slack, especially as acuity levels in AL continue to rise.

Second, the push has been away from skilled nursing for long-term stays. The future is short-term episodic post-acute stays, and that is where providers should excel. The problem, or the good news (depending of your perspective) is that we don’t need 1.4 million beds for that, and probably won’t in 10 years either. Consequently, as the number of beds declines, and if demand does increase slowly, that is what most people would want: less availability with more potential patients. Lenders and investors like that as well.

Third, a lot of the nursing facilities that are closing down are small and very old, and are often the ones that make the industry look bad. Their occupancy levels are not usually very high as well, so they are usually inefficient. Removing them from the nation’s inventory has more positive benefits than negative problems, unless they are the only care facility in a 50-mile radius. Meanwhile, as you will see below, acquisitions continue on for SNFs, for the good, the bad and even the ugly. It has not hurt that most everyone thinks the new PDPM reimbursement system will be a benefit, and definitely more rational. Plus, the 2.4% Medicare rate increase effective October 1, while slightly lower than originally expected, will result in about $851 million more flowing into skilled nursing facilities. Better than nothing.

 

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