Rents are likely too high in the skilled nursing industry and will need to drop to foster a healthier relationship between owner and operators, a new report advises.
In the analysis, Green Street Advisors urges landlords “don’t be greedy.” It suggests that SNF rents may need to drop by 10% on average to strike the right balance where both parties benefit.
“The key takeaway is that ‘win-win’ relationships are the optimal outcome for skilled nursing operators and landlords,” Lukas Hartwich, lead healthcare sector analyst for the Newport, CA, firm and author of the report, told McKnight’s. “An important factor in ‘win-win’ relationships for SNFs is a sustainable level of rent coverage.”
The report notes that nursing facilities are typically subject to long-term, triple-net leases where tenants are required to cover all operating and capital expenditures. But that coverage has been “squeezed” in recent years because of slumping demand, swelling labor costs and managed care plans putting pressure on lengths of stay.
Green Street urges landlords to set “sustainable” rent levels, that both allow their tenants to profit, and collect enough cash to fund capital expenditures — around 2% to 3% —for those buildings.
“Facilities that fall short in these two areas are destined to spiral downward,” they write. Calculating profitability can be tricky, but the firm estimates that a tenant’s share of facility revenues should be about 7% to make its operations sustainable.
Four prominent real estate investment trusts must drop their rents to strike that win-win balance, the report notes: LTC properties (6%), Sabra Health Care (7%), Omega Healthcare Investors (11%) and Welltower (12%). Sabra and Omega have notably feuded with tenants in the past year over rent costs, with the former’s largest operator, Senior Care Centers, filing for bankruptcy in December, citing ballooning lease costs.
The authors also note that their analysis does not account for “dramatic changes in the operating environment,” such as government reimbursement levels, and assumes inflationary growth of revenue and expenses over time.
The SNF industry will remain “under pressure” if the revenue side of the ledger fails to grow to keep up with rising rents, said Dan Hermann, president and CEO of Ziegler.
“The REIT model — forget whether it’s nursing, just any real estate asset — is premised on continuous escalations,” he told McKnight’s. “Your question when you have continuous escalations is: How will the balance of your expenses be escalating, and can your revenues escalate at the same level?”
He added that when REIT executives factor in inflation and flat revenues it is understood that “eventually the model is going to break.”
“And that’s why people have been exiting the nursing home industry for years on the REIT side,” Hermann added.
