On Skilled Nursing Headwinds & Tailwinds

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If you invest in skilled nursing operators or real estate, you’ve seen the almost automatic drop in stock prices with every new “headwind” headline.  And, they come frequently.  Most recently: RAC Audits, CJR, Bundled Payments, DOJ Investigations.  I gotta admit, it’s frustrating to see the stocks move as soon as the weathervane moves.  Frustrating, because the best post-acute companies are able to adapt and thrive, or to put int terms of headwinds, they change tack…”

A keel enables a sailboat to sail diagonally into the wind. As the sail moves into the wind, it “feels” a faster wind on its face. This is called the relative velocity of the wind with respect to the sail. A wind of larger relative velocity exerts a larger force on the sail, which accelerates the boat. The boat moves faster, which increases the relative speed of the wind, which increases the wind-force, which accelerates the boat, and on and on. However, the resistance of the water slows down the motion of the boat. Eventually, a balance is reached between the force of the wind and the force of the water, and the boat moves at a constant velocity, diagonally into the wind. That final constant velocity may be greater than the wind velocity with respect to the water. Whether a boat could reach such final velocity will depend on the characteristics of the boat. [source]

Can a sailboat sail forward against the wind?  Yes.  You need a great captain and crew who know how to adapt, “change tack,” and move forward.  In a boat race, is there a huge difference in the boats themselves?  Not so much.  It’s the captain and crew you’re betting on.  Not just the collection of their individual talents but their chemistry.  Headwinds in skilled nursing provide more opportunity for the best SNF crews to differentiate themselves from the also-rans .

Because of the risks (headlines, stroke of the pen, state budgets), investing in skilled nursing facilities commands a higher, risk-adjusted return than almost any other real estate investment.  It’s not for the faint of heart.  The security of the rents produced by skilled nursing is more a function of the culture, engagement, and sophistication of the operator than of the latest wind of change.

Does the size of the boat matter? Not as much as you might think. When there was a  seismic shift to the industry in 1999 with the move from a cost plus basis to a prospective payment system (PPS)  several of the very large, “more sophisticated” operators failed to move quickly. It appears that their size,  bureaucracy may have prevented them from changing tack quickly enough. On the other hand, often times smaller operators  lack the resources and sophistications to change tack as well. So, it is less about the size of the company and more about the management teams and the culture/structure of their companies that will predict their ability to move forward.

There are two headlines I saw today that would suggest some tailwinds are in store for a change.

Possible delay two of joint replacement bundle

Pilot program to pay skilled nursing more (site neutral)

No doubt stock prices will tack up, right?  Riiiiiiiiiiiiiight.

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