Every now and then, we like to look back at what the senior care industry was dealing with in past decades, which helps give us perspective on the problems of today and shows us lessons that are never learned by some. Looking at the market for skilled nursing facilities 10 years ago, we see a lot of similarities, from the high investor interest amid threats of reimbursement cuts and staffing issues (sound familiar?) to allegations of inappropriate use of Medicaid and Medicare funds by providers. Check out this lead story from the June 2013 issue of The SeniorCare Investor, and you’ll almost wonder if you were reading the June 2023 issue.
- From “The Skilled Nursing Market Enigma” in the June 2013 issue of The SeniorCare Investor.
Years ago, the once nursing home magnate and former Forbes 400 member, Abe
Gosman, delighted in telling audiences that there were only two institutional living environments that were always full but where no one wanted to be: prisons and nursing facilities. While a bit harsh on the skilled nursing side, and said 20 years before the skilled nursing business really became a short-term-stay health care business, for the consumer the skilled nursing facility is still regarded as “The Home” that no one wants to move to.
For the provider, skilled nursing has become more technical where success is measured not by how well you can take care of someone until they die, but how quickly you can rehab them from their acute episode, move them out to a lower care setting or back to their home (not in quotes), and prevent future re-hospitalizations that would start the cycle all over again. That’s not an easy thing to do, especially when you have so many (44) Resource Utilization Groups in which to “place” a patient for Medicare billing, and so many gray lines that can be crossed. A case in point is the Department of Justice allegations against Life Care Centers of America for inappropriate therapy protocols and usage.
Did the company merely cross a “grayline,” or did they commit fraud to maximize reimbursement and profits, as has been alleged? That is not for us to determine, but it does highlight some of the issues when getting involved in complex levels of care. Are there any “gray lines” or similarities in assisted living? Not quite, but perhaps the closest is the old “bait and switch,” where the resident moves in under one level of care and price plan only to find they are quickly upgraded to a higher level of care (and cost), with little choice but to stay. While this ploy may not be kosher, no crime has been committed and there is no governmental interference either, at least on the revenue side.
The skilled nursing business is the most difficult sector in the senior care spectrum, and becoming increasingly so. Providers must deal with multiple infirmaries, long-term stay residents and short-term stay patients, and a geriatric population that is not known to be easy to deal with, and their family members can be worse. The staffing of skilled nursing facilities is very difficult, especially at the prevailing wage rates. Even during the Great Recession, when unemployment soared and remained high, staffing turnover remained high. Why? Because every employee was looking for that extra $1.00 per hour increase, and had no problem switching jobs or industries for it. Unfortunately, it probably wasn’t worthwhile to keep that employee for an extra $1.00, sad as that may be.
It is not easy to raise wages of employees when MedPAC continues to advise Congress that Medicare rates for SNFs continue to be much too high and should be cut further. This has been a broken record for many years, and Congress has pretty much ignored the advice every year, because at least someone realizes that Medicare rates can’t be looked at in a vacuum without considering Medicaid, which funds the majority of skilled nursing patient days. And MedPAC thinks Medicare rates are still too high even after the cuts and changes in rehab methodology that went into effect in October 2011.
On the other hand, a new report issued by van der Walde & Co. claims that the skilled nursing industry’s median net income margin was reduced by almost 50% from 2010 to 2012 to 0.99%. Worse yet, the report claims that about one-third of the nursing facilities in the study had a zero or negative total net profit margin, which we believe is after taxes, capital costs and all operating costs, including non-cash items such as depreciation. And this is before the 2% Medicare cuts that recently went into effect! The Alliance for Quality Nursing Home Care, which represents several of the largest skilled nursing chains, funded the report, which basically concluded that without changes and funds to reinvest in facilities and programs, the skilled nursing business “will have difficulty providing its service and may not survive.”
What is interesting is that the report drew from data supplied by the members of the Alliance (less than a dozen chains), and not the general skilled nursing facility population. While it is disheartening to learn that one-third of the skilled nursing facilities operated by what are presumed to be some of the better and more sophisticated operators are losing money on a GAAP basis, it is also hard to believe. If the county-owned facilities with their sometimes seven-digit cash losses, other not-for-profits, inner-city facilities as well as those facilities with fewer than 50 beds had been included in the study, an average 0.99% net income margin might have made sense. But the big boys? Is this something they want to share with their investors? We think not. And as an aside, the Alliance is re-joining the American Health Care Association (AHCA), the organization these large members left seven years ago because their interests differed from the smaller AHCA members. This means that HCR ManorCare will be re-joining AHCA, which will be a big boost to the organization. That also means that HCR ManorCare’s financial results were presumably included in the study, and we just don’t believe its facilities have an average 0.99% net profit margin. Try explaining that if the company ever wants to go public again.
The fallacy, of course, of the entire study is that no one looks at net profit margins anymore, they look at net cash flow (duh). By focusing on a 0.99% net profit margin, the authors of the study, as well as the Alliance, actually hurt their case and, dare we say, must assume the readers of the study are idiots (well, some of them may be). The operating margins before capital costs are low enough, especially relative to the risks, that there is no need to make it look worse artificially. The second point is that by using a net profit margin, they are including capital costs as well as all non-cash deductions. By choosing one capital structure over another, a company can impact its “net” income margin. What do you think HCR ManorCare’s margin was before The Carlyle Group sold the real estate in a sale/leaseback transaction to HCP Inc. (NYSE: HCP) several years ago, with high lease payments and annual escalators? Higher than it is today. But that’s because the owner (Carlyle) took cash off the table in the sale, which was their choice. Or what about an owner with 50% leverage who then decides to increase the debt to 80%. Does that now-lower margin mean the facility is in worse financial shape? Only because of the capital decision. So to look at net income margins without understanding the capital structure is misleading at best and just not necessary. Remember, the only one who thinks that the skilled nursing sector is making too much money are the people at MedPAC, and that is only in the vacuum of Medicare payments.
Whatever the truth is, it is hard to imagine that overall skilled nursing profit margins will be increasing any time soon, other than some very good operators who snare a growing share of the most profitable subacute-care segments, despite recent cuts to Medicare reimbursement. Unfortunately, there are not many people at the federal level who want to see higher Medicare payments to SNFs at a time when the patient population is going to do nothing but increase. And without coordination between CMS for Medicare and the 50 states for Medicaid payments, it is hard to imagine ever seeing an even playing field (until Medicaid managed care takes hold for skilled nursing, and that is coming). State budgets are improving, so there will be decreasing pressure on Medicaid rates and funding, but Medicare will always have pressure.
Should any of this be of concern to assisted living providers? As one former politician liked to say, you betcha. As residents with a need for assistance with two or three ADLs turn into five or seven ADLs, as assisted living providers get increasingly active in memory care and Alzheimer’s care, as assisted living providers continue to bend the “care curve,” and as states like Rhode Island begin to relax their care restrictions (yes, we hear Rhode Island still requires a licensed nurse to administer a Band Aid), the true nature and feel of assisted living communities will change, as they already have. Anyone who thinks that assisted living communities in 20 years (if not sooner) won’t be the nursing facilities of 20 years ago is deceiving themselves. Assisted living is a private pay business, but the majority of the baby boomers will not be able to afford it, so start paying attention. Things will change
This report from van der Walde & Co. also stated that skilled nursing cap rates are two percentage points worse (meaning higher) than they are for seniors housing. First of all, that is just plain wrong. They are about four percentage points higher and that spread has been widening. Why? Because skilled nursing cap rates have been between 12.5% and 13.5% for years, with changing interest rates and demand in the market having little to no impact, while seniors housing cap rates have been decreasing, and they tend to be affected by changing interest rates. The skilled nursing sector has always been considered a riskier bet because of volatile reimbursement and the highly regulated nature of the beast. This is nothing new, and one only has to look back less than 15 years ago when up to a third of the nursing facilities in the country were operated by a company in bankruptcy protection. This risk factor is nothing new. The report also concludes that the debt market “has priced significantly higher risk into SNF bonds due to government payment risk – raising borrowing costs.” Really? They just discovered this? This has always been the case and may always be the case, as anytime you rely on government reimbursement (or any third-party reimbursement that you can’t control), the risk level goes up, as it should. Reimbursement and regulation equals risk, plain and simple. The SNF sector could be like a utility, but utility rates only go up, and the private sector is the one that pays them.
But enough of this editorializing. The point is, if the skilled nursing industry is so bad, with so much risk, with capital costs too high and profit margins approaching zero, why do so many buyers want to add to their pain? Are we living in a world of masochists? Of course not. Believe it or not, there are many people who see a lot of opportunity in the skilled nursing business, even today. They know how to turn around that county-owned facility (why else would they pay $70,000 per bed for it?), they know how to negotiate managed care contracts, they know how to integrate subacute care, skilled nursing, outpatient rehab, hospice care and home health. And most of all, they are planning for the future role of skilled nursing in what may be a new payment methodology, and if they save the “system” money, they will make more money to grow and reinvest. Not everyone will be this forward thinking, or competent, but some will and the others will just do what they have been doing: tweak costs and increase the most profitable part of their census that they can. The market is alive and well, and for the better properties, there can be up to a dozen competitive bids.
