Making economic predictions is a risky business. Calling an inflection point is downright chutzpah. So let me go ahead and predict anyway: Sale prices for skilled nursing facilities have peaked. I expect that sale prices for skilled nursing facilities will persist at their current high level for a while and slowly drift downward. However, I do not see a precipitous drop in sale prices in the near future. For individual deals, the high sale prices for skilled nursing facilities are already beginning to soften, despite the overwhelming imbalance of more buyers seeking purchase opportunities than sellers. While the “seller’s market” in the sale of skilled nursing facilities will persist, buyers and bankers are showing more resistance to pay and underwrite at these rarified price levels. Thus, it is highly probable that longer term trends will pull prices for sales of skilled nursing facilities lower and perhaps much level from their current high level. Here are some of the compelling factors that will contribute to a stabilization or slowdown of acquisition prices of skilled nursing facilities:
- Trend of Decreasing Lengths of Stay – There are more rehab patients today in skilled nursing facilities than ever before. The idea is to treat and rehabilitate them and discharge them quickly. In addition, Medicare is aggressively working on policies to lower lengths of stay, that is, to decrease the stay from say 20 to 15 days, which would save Medicaid hundreds of millions of dollars. This means lower revenue for nursing home, only to be offset by increased volume as it materializes. However, in the short run, the smart money says that the volume offset will not be sufficient to make up for the lost revenue. In the longer run, the increased demand from aging baby boomers will provide the greater patient volume. However, as the economist John Maynard Keynes said – “in the long-run, we’re all dead.”
- Managed Care– Many states are moving to Medicaid managed care. Under this model, there are winners and losers, but generally managed care means lower reimbursements.
- Changes in Payment Model, Care Pathways & Bundled Payment– As total Medicare days decline, accountable care organizations will channel patients to only certain skilled nursing facilities. These facilities would be part of the network and would be committed to lowering lengths of stay and hospital readmissions; they would have to have the subacute and rehabilitation capabilities to handle these Medicare patients, both clinically and documentation-wise, to be eligible to be a part of these local and regional networks. There will be new risk-sharing payment models for skilled nursing facilities. A lot of skilled nursing facilities will be left out in the cold and become more dominated by lower-revenue and lower-margin long-stay Medicaid patients.
- Growth of Alternatives – Home care has grown dramatically and more increasingly offers a viable non-institutional alternative for post-acute patients.
- REITs are Becoming More Cautious in Underwriting – Many of the large REITs have some troubled operators with underperforming facilities, the result of overaggressive growth and acquisition pricing. Some of the REITs are so large and diversified, the effect of underperforming facilities on their whole portfolios may be minimal in the short-run, but could the cancer could grow. The HCP REIT recently spun off its troubled HCR ManorCare skilled nursing facilities into a separate REIT, which its competitor Welltower described as “a leaking, steaming bag of real estate.” Thus, to compensate for these underperforming assets, the REITs are ratcheting up their debt service coverage standards, which results in lower prices in the sales of skilled nursing facilities. If you read or listen to any of the REIT conference calls with analysts, the message is clear, they are adopting more stringent underwriting and credit standards.
While it is true that the cost of capital is historically very low, thus enabling skilled nursing facility buyers to afford high prices, I think that moving forward, the macroeconomic trends discussed herein will exert a stronger downward pull on skilled nursing facility sale prices. For owners contemplating sale of their skilled nursing facilities, who are sitting on the sidelines waiting for prices to go higher, it is not going to happen this time. It is prudent to sell now at the current attractive and historically high price levels and multiples before skilled nursing facility prices decline dramatically as the cascade of factors described above play out. Or in the words of one my favorite philosophers – William James – “Woe to him whose beliefs play fast and loose with the order which realities follow in his experience; they will lead him nowhere or else make false connections.”