HUD leads in lending
HUD leads in lending
With its low interest rates and easy accessibility, the U.S. Department of Housing and Urban Development is far and away the biggest source of capital for SNF operators. The agency has been a prolific underwriter of long-term care financing projects since other sources dried up with the Wall Street collapse of 2008.
Financial conditions have improved to the point where private lenders are once again interested in the SNF side of the eldercare industry and activity has noticeably picked up. Even so, HUD — that port in the economic storm for so many operators — continues to be the lender of choice.
As of mid-2012, HUD had closed 523 transactions for its HUD 232 program during the year, up dramatically from 88 for all of 2009. Section 232 FHA loans can be used to purchase, refinance or construct a facility that benefits the frail elderly.
Bill Mulligan, head of senior living corporate finance for Ziegler Investment Banking, says his firm is a HUD lender and understands the appeal for SNF operators.
“It's good, cheap long-term care financing,” he says.
Yet, even with the seemingly massive volume of HUD transactions, the agency still handles only about 11% of all SNFs in deals around the country, Mulligan says, citing some strict elements in the HUD criteria.
“Borrowers must have a good trailing 12-month cash flow to determine value and debt capacity,” he explains.
“There are no exceptions. By contrast, if you've had a blip over that time and have a good reason for it, a bank or private equity lender might accept it.”
With interest rates in the 3% to 4% range, HUD, along with public counterparts Fannie Mae and Freddie Mac, have a distinct advantage over private lenders, says Steve Gilleland, managing director for real estate at CapitalSource.
“I can't compete with HUD, Fannie or Freddie,” he says. “They are a full two percentage points below what I can offer.”
Jason Dopoulos, vice president for Lancaster Pollard, says HUD is a great option for small and large operators because “HUD understands how they operate and realizes that the operations matter a great deal.”
At this point, there appears to be no ceiling for public financing, says Robert Kramer, president of the National Investment Center for the Seniors Housing & Care Industry, because long-term care and seniors housing has been its most profitable portfolio.
“They are going to want to write as much business as they possibly can,” he says. “I don't see them stopping any time soon.”
Clouds of uncertainty
As an investment opportunity, skilled nursing is still seen as desirable due to its need-driven component. Yet it has lost some of its appeal due to the uncertainty that has enveloped the market since the 11% Medicare cut in October 2011 and the possibility of more cuts in the future.
“The dramatic cut in reimbursement for SNFs has driven back the availability of capital,” says Claudia Gourdon, senior vice president and national marketing manager for Healthcare Finance Group. “I don't think there will be the same sorts of cuts going forward, but we won't go back to what people consider a level of normalcy.”
Companies that specialize in SNF financing realize the fiscal and regulatory challenges their customers face and even though levels of investment may not be what they once were, there is still plenty of activity in the sector, says Jason Stroiman, president of Evans Senior Investment.
“Our confidence isn't shaken,” he says. “Those outside the industry may have reservations, which is understandable. But at least 50% of our work is in SNFs and we understand the nuances. We realize that the 11% cut had an impact, but we also know that there are plenty of operators who have figured out how to handle it and have minimized the cut to low single digits.”
Medicaid remains a concern as well, as states grapple with ways to make the program more manageable and cost effective. Complicating matters is that every state seems to have a different formula, Gourdon says.
“It remains a state-specific issue, so what is true in one state may not be true in another.”
Resident acuity and the services a facility offers factor greatly into how investors perceive each sector. At this point, assisted living with higher acuity services such as memory care are drawing the lion's share of investment dollars because lenders view the model as need-driven, but without the dependence on Medicare and Medicaid. Overall, Kramer sees an industry-wide shift in acuity.
“The skilled nursing unit of today is the old med-surg unit of the hospital 10 years ago,” he says. “Likewise, the assisted living building of today is the skilled nursing building of 10 years ago, with residents being older and frailer.
Some would also say that the independent living model of today is the assisted living model of 10 years ago.”
Imran Javaid, healthcare real estate director for Capital One, says Kramer's description makes perfect sense.
“I have seen it — the people who are now in assisted living are the same ones that skilled nursing facilities are losing,” he says. “Even independent living facilities are migrating toward higher acuity residents that are in assisted living.”
This eldercare evolution is causing facility operators everywhere to re-think their models while the competition between categories grows in intensity, says Doug Korey, managing director of Contemporary Healthcare Capital.
“Operators in all markets are doing everything that they can within the bounds of their state licenses to maintain their residents,” he says. “Many skilled nursing operators recognize this transformation and have changed themselves into higher acuity facilities. They seek the rehabilitation patient being discharged from the hospitals and have re-tooled their facilities to focus on the Medicare business. This evolution will continue to grow and put additional pressure on skilled nursing operators who have not adapted.”
The various forces rippling through healthcare are causing providers at all points along the continuum to re-think their care models, service levels, payer mixes and business relationships.
That includes accountable care organizations, created under healthcare reform and meant to promote care coordination that will also reduce costs. Provider organizations in across the country are exploring different ACO formats, discussing how to build networks that best serve patients while being financially responsible.
This effort to transform care delivery presents a unique opportunity for SNF operators looking to enhance their business model and attract investor interest. In fact, SNF participation in ACOs is a widely supported idea in the financial community.
“There is a shift in the playing field and it comes down to who can make themselves look attractive to the acute care player as part of an integrated network or ACO,” Kramer explains.
One of the ACO focal points is caring for chronically ill patients who put a severe cost drain on the healthcare system with constant rehospitalizations. By offering specialty services to patients with Chronic Obstructive Pulmonary Disorder, Congestive Heart Failure, hypertension, diabetes and post-surgical rehabilitation, SNFs could become a desirable target for investors, Kramer says.
“No question there is a market for specialized services, but you need to have enough mass to support it,” he says.
SNF operators looking at branching out into other areas also should remember never to lose sight of their original mission, says Mark O'Brien, vice president of sales and marketing for Gemino Healthcare Finance.
“Operators cannot be all things to all people,” he warns. “It is best to focus on their region, improve quality and work with providers of complementary services to show they can provide consistent results.”