The shifting skilled nursing landscape has forced the major real estate investment trusts (REITs) to change their game plans — and led some industry-watchers to question whether their time is coming to a close.
But there’s still a role REITs can play in the long-term care space, an industry that might actually be more attractive than the far larger and flashier world of private-pay senior living.
“The spread between the debt and cap rates on nursing homes lend themselves to a triple-net lease scenario, and I think that’s why it’s here to stay,” Jeremy Stroiman, CEO of the Chicago-based Evans Senior Investments, told Skilled Nursing News*.
This year has so far seen one of the most significant commitments by a REIT to the skilled nursing space: Welltower, Inc.’s (NYSE: WELL) move to buy the SNF-heavy Quality Care Properties (NYSE: QCP) in a joint venture with non-profit hospital operator ProMedica.
The move raised eyebrows, as the REIT would be taking on a portfolio dominated by troubled operator HCR ManorCare — which filed for bankruptcy protection in March after nearly a year of missed rent payments and other turmoil with former landlord QCP. Under the terms of the Welltower deal, ProMedica also agreed to purchase ManorCare’s operations.
At the time, Welltower CEO Tom DeRosa blamed private equity for the industry’s woes; ManorCare had been owned since 2007 by the Carlyle Group, a Washington, D.C.-based alternative asset management firm.
“Anybody who knows the ManorCare real estate knows it’s really good-quality real estate in really good markets,” DeRosa told SNN in April. “It was just capital-starved, because the skilled nursing industry had been taken private by private equity firms, and what does a private equity firm do? They over-lever businesses in order to [take] cash out of them. The REITs got left holding the bag here when reimbursements changed.”
The counterpoint, of course, is that publicly traded REITs also played some role in the difficulties facing individual skilled nursing operators: In a world of changing reimbursements, staffing pressures, and regulatory scrutiny, the skilled nursing model has become increasingly difficult to reconcile with annual rent escalators and quarterly scrutiny from shareholders.
That’s why Stroiman sees an opportunity for smaller, private REITs that have a more intimate knowledge of the particular challenges and benefits of investing in the skilled nursing space — without the immediate pressure of needing to deliver returns to investors clamoring for information every three months.
For instance, private REITs would be more receptive to an operator that promised an 18-month turnaround period in exchange for lower up-front rents, Stroiman said.
“The operator says: I have $600,000 of upside within 18 months. I’ll pay you an additional rate [after 18 months], but out of the gates, will you give me a break so I can find the upside?’” he said. “And the privately-owned REITs say: ‘That’s a no-brainer.’”
That spirit of experimentation can also extend to different kinds of partnerships between REITs and facilities, according to Cambridge Realty Capital Companies chairman and CEO Jeffrey Davis.
In his senior housing and health care finance practice, Davis has increasingly seen operators buy back a portion of their real estate from REITs, which still maintain a presence going forward. One recent 10-facility deal saw an operator secure a $26 million acquisition loan to regain a stake in their facilities from a major national REIT, Davis said.
“All of a sudden, the REIT goes from having $40 million invested in those 10 buildings to having only $10 million invested in those buildings,” he said. “I think there’s different ways that the REITs can trim those [portfolios], and that, I think, is a way they can go about trimming their assets.”
Still a place for the smart ones
These new strategies don’t mean there isn’t a place for the major skilled nursing REITs that have an intimate knowledge of the business. Stroiman pointed to Sabra Health Care REIT (Nasdaq: SBRA) and CareTrust REIT (Nasdaq: CTRE) as examples of publicly traded REITs with a strong grounding in the industry, in part due to the skilled nursing experience of CEOs Rick Matros and Greg Stapley, respectively.
“They understand the operations behind the nursing homes, and they structure deals like that all the time because they can, because they understand it,” Stroiman said.
In addition, the favorable ratio of cap rates to lending rates means REITs might be more interested in SNFs than senior housing properties, where the upside isn’t as clear — despite the fact that the assisted and independent living industries come with significantly less regulatory scrutiny and the additional stability of private-pay residents.
“The difference between current debt rates and cap rates, it works,” Stroiman said. “It works so much better than senior housing.”
But Davis also emphasized the growing importance of the regional investor and operator in a landscape torn by local-level reimbursement issues and regulatory changes — especially in a narrow-margin environment where residents and investors want “Four Seasons service for the cost of a Holiday Inn.”
“It’s very difficult to run your business with all these different people’s oversight,” Davis said. “And I think the REITs have found that out, and let’s face it — this kind of environment really puts national players at a huge disadvantage, because you just can’t be as efficient as a national player as a regional [operator] or someone who focuses on one or two states. You just can’t.”