Skilled Nursing Facilities, 2017: Creative Destruction for some, Going from Good to Great for others

What is going on in the skilled nursing facility industry?  How is that affecting the market for the purchase and sale of skilled nursing facilities?  Genesis, this week, indicated they may be on the verge of bankruptcy; they issued this dire warning regarding industry conditions:  “The negative impact of continued reductions in skilled patient admissions, shortening lengths of stay, escalating wage inflation and professional liability losses, combined with the increased cost of capital through escalating lease payments accelerated in the third quarter of 2017.”   Below analyzes skilled nursing facility industry conditions and trends as we see them:

1. Divesting and Consolidation –  Large national skilled nursing facility providers are divesting major parts of their empires.  Kindred Healthcare is exiting the skilled nursing facility sector entirely.  Golden Living has done the same.  Genesis, HCR ManorCare, Consulate and other national providers are selling off whole-state portfolios and troubled skilled nursing facilities.  These companies seek to streamline their operations and focus on the most desirable markets and most successful operations.   The national skilled nursing facility chain model simply does not work anymore.  At the same time, while the national chains are divesting, the freestanding, standalone operator continues to be challenged by compliance, reimbursement and market forces, and  is selling out to larger groups.  These buyers are typically state or regional focused multifacility providers.  Thus, while the big national chains are coming apart, the instate and regional multifacility providers are healthy and are consolidating and growing.  These are the new market leaders.  This bipolar trend is a shift from centralized national skilled nursing facility operators towards bottoms-up, decentralized instate or regional multifacility chains.  Why is this happening?   Healthcare is local, chain of command challenges with centralized decision-making, and ACO/bundled payment models that favor strong local ties and affiliations.

2. Lower Census – There has been a long-trend of declining patient occupancies, indicating lower demand, and the increased availability of alternatives to skilled nursing facility care, such as home health, hospice and assisted living.  The increased population of aged persons, and growing number of aging baby boomers, has not translated into higher demand for skilled nursing facility care.  One can argue that at some point in the future increased demand from population in need will materialize, but in the short-run, this has not happened, at least yet.  However, that does not mean every skilled nursing facility has lower census.  It means that there is more competition for patients, with resulting winners and losers and everything in between.   Accordingly, the problem is for the average and marginal facilities that are losing out to the better, well-run facilities.

3. More Knowledgeable and Discriminating Consumers – Today’s consumers of skilled nursing facility care are more knowledgeable and discriminating.  They go online and review a facility’s rating on the Medicare Compare system.  Or they look at Google and Yelp.  Consumer ratings are abound on the internet.  Woe to the facility that suffers with a one-star rating.  Who wants to be in a below-average, one-star facility?  You want to place your mother or grandmother in a five- or at least four-star facility?  In the early days of the Medicare Compare systems, providers poo pooed the program as unreliable, and believed  it would have little impact.  The Medicare rating system is imperfect, but patients and their families rely on it.  In addition, patients want better accommodations.  As a result, four-bedded and three-bedded rooms are difficult to market, except to the least desirable long-stay Medicaid patients.  These types of rooms do not appeal to the higher margin Medicare and short-term private rehab patients.  From an M&A standpoint, having three- and four-bedded rooms in a skilled nursing facility, diminishes its valuation.  In summary, consumers want more, they want better and if you don’t have more and better, your skilled nursing facility will not be a competitive facility of choice and will gradually lose market share.

4. Numerous Outmoded, Ugly Physical Plants – There are still a lot of old and outmoded buildings masquerading as modern skilled nursing facilities.   These facilities are falling behind.  Many of these skilled nursing facilities, as indicated above, has three- and four-bedded rooms, with few or no private rooms.  Part of this problem is regulatory in that Certificate of Need regulations preserve and franchise existing providers and shield them from competition.  In a free market, many  buildings would not be competitive and would fail.  At the same time, land is scarce and expensive in some markets, and thus natural real estate economics limit the construction and expansion of skilled nursing facilities, over and above Certificate of Need regulations.  Nonetheless, I am convinced that at least twenty-percent of the existing skilled nursing facilities are inadequate, that is, in old buildings, limited in size, are inefficient and not fully competitive relative to newer and better offerings.

5. REITs are not Insulated from Trends – The SNF REITs are not immune to the foregoing trends, just because they are landlords.   They have a lot of inadequate, old skilled nursing facility physical plants in their portfolios.  They also have troubled national operators as tenants.  They also have operators fighting lower market demand, meaning their cash coverage ratios are shrinking.

6. Many New Operators Lack Requisite Industry and Management Experience – There are many new entrants buying skilled nursing facilities, thinking that it is good investment, easy to operate, with much appreciation potential.  These groups have little or no background in healthcare and operate the facilities without an infrastructure.  They are running skilled nursing facilities, deciding on life and death issues, via the seat of their pants.  This is management by texting.  This is scary, but true.  These new groups are simply naïve and have no appreciation of the complexity and difficult of the clinical, reimbursement, management and compliance issues.  Unfortunately, they grow rapidly without understanding that  management infrastructure and expertise is required.  Many of management and healthcare services are unbundled and contracted out to various vendors, with no coherence or communication between the parties.   It’s a mess.   This is no way to run skilled nursing facilities.

Do these foregoing storm clouds and problems foretell the end of the skilled nursing facility industry?  Not at all.  The capable and successful skilled nursing facilities who reinvest in their properties and who are continuously seeking improvement are fine and will be fine. These typically local and regional operators are mission-directed and foster a culture committed to going from good to great.  However, for the others, going from average to failing, the foregoing problems are creative destruction forces that will undermine and possibly eliminate a whole segment of the skilled nursing facility industry.

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