“Oversupply”

At the last NIC in Dallas, I caught up with an owner/operator of mid-market seniors housing. He has successfully made the transition from owning and operating hotels to assisted living and memory care.  We talked a bit about his hotel business and I found an interesting corollary to how I look at investing in the assisted living space.

There have been a lot of concerns about oversupply in seniors housing.  Newly developed and opened properties take market share from competition and both REITs (particularly those in RIDEA deals) and operators struggle, at least in the short-run, until occupancy stabilizes again.  I get asked this question a lot, “how are you looking at the over-supply concern?”  I like the question because it provides a forum for talking about the mid-market, B to B+ quality properties that is generally ignored by other REITs.  The beauty of investing in the mid-market seniors housing segment is

  1. you avoid the new construction pressures as the vast majority of new supply is A to A+ quality with all the bells and whistles, and
  2. if you invest primarily in secondary markets you further protect yourself from new construction risk.

In addition, the demand for quality seniors housing at the $3,500/month vs. $6,500/month (depending on the market) price point is huge and growing.  There’s a recent housing study by Harvard that highlights the growing supply/demand disparity for lower-income seniors housing.  So, to invest in a Ritz Carlton or Holiday Inn?  There’s certainly a market for both.  My recovering hotel investor friend in Dallas shared his experience, “I’d convert the hotel into a Holiday Inn; put out some coffee, juice, and bagels in the morning and you’re good.”  Luckily for investors and residents who choose to live there, there are quality operators who have figured out the recipe for providing a great place to live and work at an affordable price.

 

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McKnight’s Guest Column: Bundled Payments

McKnight’s is a leading skilled nursing industry news source that I’ve written for in the past.  This is my first guest column since moving to the REIT side of the business.  We meet with investors and analysts a lot and one of their most pressing questions lately is around bundled payments/comprehensive care for joint replacements (CJR) so I wrote about my take on it for McKnight’s.  Click on the article below to read the full text.

Dave Sedgwick McKnight's CJR Skilled Nursing article

 

Or read it below …

“What’s your take on bundled payments?”

About a year ago, investors and analysts would occasionally ask us some form of that question. Now, virtually every time we talk with investors, analysts, and bankers, they ask. At the end of answering questions on the topic for 45 minutes during one of these recent meetings, the investor laughed and incredulously said, “So, basically you’re the only ones saying, ‘No big deal. Nothing to see here. Business as usual.” Well, yes. And, no.

There’s a lot of hand-wringing in the post-acute world these days as observers try to predict just how material the constant changes to reimbursement will be for the operators. It seems generally believed that bundled payments expansion is a net-negative for the industry since it partly exists to lower Medicare payments. There will be “losers” who don’t adapt to the changes. But, there will also be “winners.” There always have been. As a former operator and current investor in the space, I have a positive view on what these changes mean for the profession.

Context Is Key

Viva-La-Evolution

I entered the skilled nursing profession as an administrator-in-training at The Ensign Group in California in 2001. Back then, one of the first themes I picked up on from the seasoned ED/DNS/DORs around me was that, “this isn’t your grandmother’s nursing home anymore.” “No, you see, while we still provide long-term custodial (I will always hate that term) care, we now specialize in providing short-term rehabilitation for Medicare and HMO patients.”

For the last 15 years, the best operators have been adapting to the demands of the hospitals (higher acuity, readmission rates), CMS (MDS/RUGS changes, 5 star ratings, compliance), and HMOs (shorter length of stay, case management, collaboration).

“So are you worried about this Joint Replacement thing?

On April 1, 2016, the Comprehensive Care for Joint Replacement (CJR) went into effect in 67 markets. Briefly, the CJR holds the participating hospitals financially responsible for the episode of care from the day of admission until 90 days later for major joint replacement or reattachment of lower extremity joint replacements (LEJR), hips and knees. If a hospital can lower the cost of that 90 day episode of care below targets set by CMS, they will reap the financial rewards with a bonus. The opposite is also true. Some warn that allowing hospitals to waive the required three night hospitalization before discharging CJR patients to SNFs rated 3 star or better will crush the 1-2 rated facilities. Others warn that hospitals will be incentivized to send CJR patients directly home with Home Health, bypassing SNFs altogether, because of the cost savings. In my opinion, these predictions have been overblown. The sky is not falling.

Now sing it with me … “You Tell Me That’s It’s Evolution”

evolution-darth-vader

I understand why outside observers worry that this as a seismic shift for skilled nursing (and HH for that matter). How, then is CJR not the end of the world for post-acute facility providers? Again, I see CJR as a positive step for post-acute care because it advances trends that level the playing field for stronger operators, ultimately benefiting the patients. Here’s what I mean.

  • Length of stay: HMOs have been pressuring SNFs to shorten length of stay for many years. The last facility I personally ran was 100% short-term rehab. Our combined Medicare/HMO average length of stay was in the mid-teens. Strong providers have been equipping themselves to shorten length of stay for years. They will employ similar practices on these LEJR Medicare patients that they have been using on HMO patients, thus gaining CJR market share from those who don’t.
  • Case Management/Data Reporting: Try competing in a market where your competitors employ the hospital Discharge Planners as part-time Social Workers on the weekend or pay kickbacks for referrals. What? It happens. Today. I’ve competed against it. The only way we could “level the playing field” was to be BETTER. We had to build strong, data-driven (readmission rates, satisfaction scores, survey results, clinical outcomes) relationships with the hospitals that earned our admissions. We had to reach out to hospitals years before ACOs or BPCI to “show them the data!” How does CJR impact this? It should put a vice on the unethically influenced placement of patients and make the market for post-acute patients more merit based. For the many hospitals that didn’t care about their post-acute discharge system, now they will. Stronger operators are poised to gain CJR market share because of it.
  • CMS Star Rating: As soon as the star ratings came out years ago, we complained because the system doesn’t necessarily reflect quality care. In the short-run, hospital may use star ratings in their discharge calculus. But, they’ll evolve as well. SNFs who are 1 or 2 stars can still receive joint-replacmenet patients. And, here’s the thing, patients who are ready to be DC’d from the hospital after a night or two have already been heading home with HH for years. Patients that have to go to the SNF have an initial hospital stay past 3 days anyway.
  • Readmission Rates: At the end of the day, the cost of caring for that patient for 90 days depends greatly on whether or not the patient is readmitted to the hospital. Hospitals are going to be very sensitive to which post-acute location gives them better odds of not having a re-hospitilization. Where would you send them? To the strong SNF provider with 24-hour RN coverage, a medical director, in-house therapists, wound care professionals, etc. or the patient’s home with her elderly husband to care for her in between the hour or so/day she gets from HH. Both graphics below from Avalere, show hospitals the need to partner with SNFs with the lowest readmission rates. It’s no wonder CMS is adding readmission rates to the star rating system this summer.

Screen Shot 2016-03-27 at 3.09.39 PM Screen Shot 2016-03-31 at 3.49.54 PMWhile there may be a slight tightening on the flow of LEJR patients for the general industry (only for 67 markets for now), the strong providers will be able to capture greater share of that theoretical smaller piece. But, let’s not forget the rest of the pie! Sometimes it seems that outside observers focus so much on the joint-replacement piece of the patient pie that they forget a few key points:

  • SNFs are taking care of sicker and sicker patients every year (the kind that absolutely require 24-hour nursing care)
  • Seniors demographics haven’t changed. The numbers of SNF-age patients is growing and will continue to grow for many years to come. While a piece of the pie might shrink, the overall pie will be expanding for years to come.
  • As a general rule, the highest Medicare reimbursement occurs at the start of the SNF stay, sometimes “stepping down” towards the end. So, as providers shorten length of stay, they may see a slight increase to their average medicare reimbursement rate.

So, What?

So, what does this all mean for investing in skilled nursing real estate? It has always been true that in healthcare real estate, the operator matters most. The playing field has been changing for the last 15 years. BPCI/CJR actually has the potential of slightly leveling the playing field in behalf of stronger operators. BPCI/CJR can’t be ignored and should be a factor in underwriting acquisitions. Higher lease coverages and cap rates are in order for facilities with lower star ratings and higher readmission rates as those metrics become more and more impactful on a provider’s ability to shift patient mix and capture short-term rehab market share.

Today (and tomorrow), more than ever before, your SNF real estate investment will hinge on the quality, sophistication, and culture of the operator running it.

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.

Investing in Skilled Nursing – The Basics

I just finished a two-day non-deal roadshow.  Princeton, Philly, and Boston.  Now headed south for a property tour of a couple buildings we have under contract.  As usual, the insititional investors we met with were impressive.  Everyone has their investment “box” that they’re trying to see if we fit in.  This trip, we spent a fair amount of time educating analysts and portfolio managers on the some of the fundamentals of the skilled nursing business.  That got me thinking it would be helpful to provide a high-level intro to the business for investors wanting to get up to speed on the basics.

20 Years of History in 175 words

Skilled nursing facilities exist to provide 2 types of healthcare:

  1. Custodial” (worst term ever), long-term care for “residents” who live in the facility and
  2. Short-term rehabilitative care for patients who are transitioning from hospital to home.

Historically (20 years ago), a “nursing home” or skilled nursing facility (SNF) was where grandma went to live the rest of her life if she needed more assistance with activities of daily living (ADL) than she could get living alone or with family.  For the last 20 years there has been a massive shift in the purpose of SNFs.  With every passing year, they have focused more on caring for higher acuity (clinically complex), short-term rehab patients.  The patients in the SNFs’ rehab units today were treated in acute hospitals 20-30 years ago.

Hospitals and health plans (HMOs) are incentivized to lower the cost of healthcare by reducing the time of inpatient care, thus hospitals have been pushing higher and higher acuity patients out faster and the stronger SNF operators have equipped themselves to meet that demand.

Who Are You?

To understand why SNFs have been willing to adapt to meet the demand of sicker, more clinically complex post acute care (PAC) patients, let’s take a look at the universe of possible patients a SNF cares for …

Medicaid is healthcare for the poor.  In a SNF, Medicaid pays room & board and medications for long-term residents.  Generally speaking, these are NOT the “patients” in the facilty receiving physical therapy (PT), occupational therapy (OT), or Speech therapy (ST).  Rather, they live there.  It’s their home.  Medicaid reimbursement varies by state.  Some pay a fixed rate.  Others pay based on a case mix index (CMI).  The CMI states recognize that the amount and cost of care for all Medicaid residents is not equal.  The more assistance a resident requires, the higher the CMI, and therefore, the higher the reimbursement.  Medicaid reimbursement is the lowest of any type within a SNF.

Medicare is healthcare for seniors (65+).  In a SNF, Medicare pays for short-term rehab for patients who had to be in the hospital for at least 3 nights.  These patients are usually receiving “Skilled Services” from therapists (PT, OT, ST), and/or from nurses (IVs, tracheotomy care, wound care).  The length of stay (LOS) could be anywhere from less than a week to 100 days (Medicare covers 100 days of a SNF stay) depending on the the patient’s needs and prognosis for improvement.

Managed Care or HMO, like Medicare, pays for the same short-term rehab skilled services.  These patients are Medicare eligible people who have signed over their Medicare benefits for a Medicare-replacement type of insurance product offered by health plans like Aetna, Kaiser, etc.  The reimubursement is lower than Medicare (though in some cases the HMO rates pegs to Medicare rates).  And, because it’s “managed” care, case managers at the HMO push on SNFs to care for these patients faster.  HMOs make more money if the length of stay is shorter since inpatient care costs more than care provided in the home (home health, HH).

There are also Private Pay residents.  Expect this to be a shrinking piece of the census pie as assisted living facilities have continue to adapt to provide more assistance today than 20 years ago as well.

The Numbers

Now, let’s take a look at a hypothetical facility through financial eyes.

Let’s call it Dave’s Rockin’ Rehab Facility (anything other than Dave’s Gardens, Village, or Manor, please!). The vital statistics are these:

  • 100 bed facility with the following mix of residents and patients
    • 50 Medicaid residents
    • 20 Medicare patients
    • 10 HMO patients

Now, let’s do some simple math.

50 Medicaid residents x $180/day x 365 days/year = $3,285,000

20 Medicare patients x $525/day x 365 days/year = $3,832,500

10 HMO patients x $420/day x 365 dats/ year = $1,533,000

Total Annual Revenue: $8,650,000

What does is take to run Dave’s Rockin’ Rehab?

Labor is, by far, the biggest expense.

  • Nursing (Registered Nurses, Licensed Vocational Nurses, Certified Nurses Aides)
  • Rehabilitation (PT, OT, ST)
  • Dietary (Cooks, Dietary Aides)
  • Housekeeping (Housekeepers, Janitors)
  • Laundry (Laundry workers)
  • Maintenance (Manager, assistants)
  • Social Services (Social Workers)
  • Activities (Activities Director, assistants)
  • Business Office (Biller, Accounting)
  • Human Resources (HR/Payroll rep)
  • Marketing/Admissions (Admissions coordinator, external marketer)
  • Medical Records (dept. head)

Other primary expenses include:

  • Medications
  • Food
  • Medical Supplies
  • Paper & Plastics
  • Insurance
  • Chemicals
  • Linens
  • Electronic medical record system
  • Marketing
  • Oxygen
  • Labs
  • X-Rays

Let’s put it down on a simplified P&L:

Revenue  

Medicaid       3,285,000

Medicare       3,832,500

HMO              1,533,000

Total               8,650,000

Operating Expenses

Labor             6,000,000

Supplies         700,000

Ancillary        500,000

Food               200,000

Other              200,000

Total               7,600,000

EBITDAR:     1,050,000

EBITDAR%: 12%

Rent:                 750,000

EBITDA:          300,000

So, we see the financial levers are

  • Census (overall occupancy)
  • Skilled mix (percent of patients on “skilled services” aka short-term rehab patients aka Medicare + HMO divided by total census)
  • Daily rates (Medicare RUGs/ADLs — we’ll cover this another time; private pay — again, a shrinking % of the SNF census and so less of a lever than in assisted/independent living/memory care)
  • Labor — staffing efficiently
  • Medication management
  • Expense controls for purchasing

Investors New to Skilled Nursing

Needless to say, there’s a lot that goes into efficiently operating a high skilled mix, profitable facility. This isn’t your grandma’s nursing home.  Or Buick.  And, there’s a huge difference between the blue-chip operators like The Ensign Group and folks still clinging to maintain the status quo from 20 years ago.  I frequently see small owner/operators deciding to sell their facilities because they realize they haven’t kept up with the constant changes and it’s too late (or they’re too tired) to re-tool.

  • There are over 15,000 skilled nursing facilities in the country.
  • Somewhere around 25% of those are owned by large chains.
  • And, somewhere around only 20% are owned by REITs.

It’s a very fragmented industry that has been under pressures to provide better, faster, and cheaper care to sicker and sicker patients.  That trend has been accelerating over the last couple years with bundled payments (I’ll write about that soon).  The only thing that hasn’t changed is that the operators (of all sizes) who are sophisticated, engaged, and committed to quality care are able to adapt to the changes and win and those operators (of all sizes) who don’t adapt, lose.

Why Don’t He Write?

I just thought of a scene from Dances With Wolves.  Not because it takes place at “Fort Sedgwick” — though can there be a better reason?  Not, because it inspired me to write this.  But, because it’s been too long since I’ve written here.

“Why don’t he write?”

As a facility executive director and chief human capital officer at The Ensign Group for 13 years, there seemed to be endless material to write about.  Since moving to the investing/financing side of Seniors Housing/Healthcare, I haven’t taken the time to write as often as before.  But, I think that’s going to change.

I get asked regularly by analysts, investors, bankers, and other industry observers what I think about the constant breaking waves of news and changes in the skilled nursing business. Candidly, I’m frequently disappointed to see the over-reaction to those headlines by the market (and even by other REITs).  Industry observers are quick to declare the death of the skilled nursing operators.  It seems like there’s been some headline to that effect every year for the last 15 that I’ve been in the business.  I add my voice to Mark Twain’s off-misquoted correction …

mark-twain-skilled-nursing-death

I remain as bullish as ever on skilled nursing because the best operators always find a way to adapt and thrive while the weaker ones fall.  And, not that it takes one to know one, but it certainly helps.

Topics on the table right now include: Changes to the 5 star program, CJR (Comprehensive Care for Joint Replacements), Bundled Payments, ACOs, etc.

CareTrust REIT

It’s hard to put in words what the last 12.5 years at The Ensign Group have meant to me (though I’ve tried many times to share bits and pieces on this blog) …

20 days ago, Ensign completed the spin-off of its real estate into a new, separate, independent real estate investment company specializing in senior housing & healthcare called CareTrust REIT.

CareTrust Logo Black-02

The CEO of CareTrust is Greg Stapley.  He’s an Ensign founder, primarily responsible for acquiring the portfolio Ensign has today.  Early last year, as we were headed towards a sale of Doctors Express, Greg told me about the plans for the REIT and his likely departure from Ensign to run it.  He asked me to join him.  At that time, I joked that I still had PTSD from the prior 12 months (moving my family to Baltimore to run a business that we ended up selling a year later … and all the accompanying ups and downs) and that I needed time to clear my head before making a long-term decision.

Immediately after the sale of DRX, I went to work for Ensign in skilled nursing operations again in Colorado to fill in for a couple guys who left their buildings in Denver at the same time.  What was to be a 30-60 day interim project turned into an 8 month assignment — that I absolutely loved (except for the commute).  It was GREAT to be back in daily operations, especially with the devoted and talented “Ensignistas” in Denver.  Ensign asked me to move to Colorado and oversee operations there after a short time but I felt like I needed more time to decide.  I genuinely didn’t know what I wanted to do next.

After our relatively short time in Maryland, my wife and I wanted to stay here for many years to come.  By the end of the summer, I had narrowed down the decision to 1) join Greg and build CareTrust together or 2) open a new market for Ensign’s operations here on the east coast.

Ultimately, I concluded that CareTrust was the right course for me and my family.  Even though it’s based in So. Cal. like Ensign, I’ll be the east coast office as we look to acquire senior housing and healthcare properties nationwide.

When it comes to real estate, they say its location, location, location.  But when it comes to skilled nursing real estate, its really operator, operator, operator.  In a way, my role at CareTrust is similar to one of my roles at Ensign for those 5 years I led the new leader selection & training (AIT) efforts.  Ensign’s growth strategy depended on the pipeline of homegrown talent to lead its new acquisitions.  My role(s) at CareTrust will be to build a bullpen of exceptional operators across the country who we can confidently lease our new acquisitions to.  After a couple of operator “interviews” its pretty clear to us that it “takes one to know one.”  I commonly hear, “You’re the only REIT that’s asked us about X, Y, Z (In-house rehab, centralization v. decentralization, RU%, Culture, turnover, clinical support, PPDs, readmission rates, etc.)” So, I’ll be working on operator relations, business development, investment underwriting, and oversight of our 3 operating independent living facilities in Dallas and Salt Lake.

When I made my decision last fall to go to the REIT, I did so with mixed emotions.  I have and will retain deep, meaningful friendships at Ensign.  Today, I’m thrilled for this opportunity to build on what we built at Ensign with new partners, in new places, and in a new way.