Most long-term care observers expect industry consolidation to continue in 2018, but the number of super-sized players doing the merging and acquiring may decline.
In the quest to find skilled nursing’s sweet spot, investors are shying away from massive portfolios that reach across too many state lines and undermine potential gains that come with market dominance.
Sabra Health Care REIT CEO Rick Matros made bold headlines when he predicted as much, pronouncing at the NIC fall annual conference that “national companies can’t do it anymore.” The comments came as Sabra announced its plans to spin off the remnants of its Genesis HealthCare portfolio and pick up two dozen smaller skilled-care providers.
Matros created buzz at the conference — which also included a session on scaling up operations — but others in the finance world say they, too, have seen large investors thinking about going small.
“We’ve seen that even larger owners and operators are willing to look at ‘one-off’ acquisitions if the opportunity and portfolio fit is right,” says Michael Vaughn, senior vice president of real estate finance at Walker & Dunlop. “Mid-size portfolios may also be seen as attractive acquisitions if they represent a geographically and operationally coherent opportunity. To me, the larger portfolios are more difficult to manage successfully.”
While most interviewed for this article agreed at least in part with Matros, many also say a growth mindset continues to be wise for a particular group of owners and operators.
“Those providers that have a chance to expand within markets or even states in which they currently thrive are well-positioned to grow as long as management has the bandwidth to operate additional communities,” says Curtis King, senior vice president of underwriter HJ Sims. But he also says operators too large to be intimately involved in day-to-day operations of all their facilities “have to consider a change.”
Some HJ Sims clients have brought in new operators with expertise in specific regions where they are at a comparative disadvantage. Others are disposing of communities — creating opportunities for regional companies that need greater mass to create economies of scale or brand recognition.
Many of the remaining independent, small operators are also jumping out of the industry because there’s “not a place for them anymore,” says Nick Stahler, vice president of JCH Senior Housing Investment Brokerage.
Imran Javaid, managing director of BMO Harris Real Estate Finance, says those mom-and-pops will become good takeover targets for operators who want to grow and counter the impact of managed care programs.
“Larger regionals or midsize companies will have these operational advantages,” he explains.
Small vs. large
Goals for growth depend on each operator, REIT or other investor and the arenas in which they operate, of course.
Bill Kauffman, NIC’s senior principal, says the industry is so fragmented and portfolios so mixed that there’s not even a consensus around what “large,” “midsize” or “small” look like.
Small could be a one- or twolocation, mom-and-pop business or the two-to-five facility minichains favored by Matros. A medium chain might have five to 40 properties, but a regional operator with 40 locations would consider itself large. And that number is easily dwarfed by a national company like Genesis.
“If you get to a certain size, you might be able to scale based on your region,” Kauffman says. “But if you have 25 properties, being spaced out can be very difficult from a management standpoint. Healthcare is local. You have to be able to be on the ground and make those decisions quickly.”
For his part, Matros says he doesn’t see the economic or leadership advantages to national chains, and that small ones are more nimble and able to react to market changes.
“In many cases, the economies of scale from days past for large operators do not hold true today,” agrees Don Kelly, senior director of Healthcare Finance for CapitalSource. “Operators that are focused on a reasonable number of properties providing a high level of care with niche specialty programing in defined market areas or states can be more competitive and have their arms around the changing dynamics in those target markets.”
HJ Sims’ King views it much the same way. “If you’re too large, your key executives can’t be involved enough in the day-today oversight of the facilities,” he says. “It was that involvement in the first place which allowed you to be successful.”
Leadership is a big issue to Stahler and his senior vice president, James Hazzard. Stahler says many companies grew into behemoths because of someone’s Wall Street dream of bigger-is-better.
But he says he’s seen many begin to struggle operationally at around 50 facilities. Those clients often find themselves putting in too much effort to keep quality at consistently high levels across locations. If you need 100 regional directors of operations, “How many very good people can you really attract? How do you instill the corporate culture leadership?” Hazzard asks.
It also becomes more difficult to institute programming, such as uniform infection control strategy, when buildings in different markets have different leadership styles and regulations to follow, he adds.
Jeff Binder, principal and managing director for Senior Living Investment Brokerage, says he’s seen a greater appreciation for regional operators and their attributes.
“Financial buyers have become more cognizant of … the value in local knowledge when it comes to long-term care, whether it be from a variety of perspectives, i.e. regulatory, Medicaid reimbursement, referral networks,” he says.
An active 2018 predicted
In a survey conducted by Capital One, 89% of senior housing and long-term care executives predicted the overall pace of mergers and acquisitions will maintain or exceed the current pace over the next year.
Kelly says the number of portfolios currently being divested is an encouraging indicator for Q1 merger and acquisition volume. “I would expect an increase in M&A activity fueled by property divestitures by the REITs and Brookdale,” Kelly says. “The activity level will be, in part, dependent upon various REITs choosing to either divest SNFs versus making a choice to portfolio manage assets [including replacing existing operators at underperforming properties].”
Vaughn sees current trends continuing, with the number of transactions increasing but the dollar volume possibly declining if fewer large portfolios are acquired as blocks.
“Large ownership groups, private and public, will continue to subdivide their portfolios into manageable operating blocks and cull their properties with limited upside, operational difficulties and those outside a geographical focus,” he says. “Small operator/ owners will continue to sell out to middle-sized and larger entities with greater economies of scale and marketing relationships with healthcare networks.”
As more investors think of solidifying regional advantages, some areas will see more activity than others. In the Capital One survey, executives expressed strong interest in the Southeastern (26%) and West Coast (22%) markets. JCH works extensively in California, and with high demand.
Stahler predicts plenty of opportunity for regional chains to snatch up former competitors. Javaid says interest rates are likely to continue rising, putting downward pressure on the marginal projects and keeping the bigger REITs on the sidelines.
But he predicts the liquidity of both private equity and foreign capital will spur more mergers and acquisitions, with public, non-traded REITs being acquired through private equity transactions and by publicly traded REITs.
Others were more cautious in their projections due to looming uncertainty about tax reform at press time and changes in state and local minimum wage rates.
“From an acquisition standpoint, as long as there is opportunity there, it certainly is possible to grow their portfolios,” Kauffman says. “The thing that could throw a wrench in that is any kind of economic downturn or if the capital markets freeze up.”
Workforce and other woes
Labor costs are top of mind for some of JCH Consulting’s clients, Stahler notes. Any Medicare or Medicare rollbacks would be even more challenging to areas facing minimum wage hikes, many stakeholders believe.
In the Capital One survey released in September, about one-third of respondents said labor costs and supply-and-demand imbalances are a 2018 concern. Absorption is more an issue in assisted living and seniors housing, where talk about market penetration is increasingly concerning to investors.
But litigation threats are another reason massive, publicly owned chains could be on their way out. The perception that they may have deeper pockets makes large providers more attractive targets for litigators who specialize in elder abuse claims, Stahler says.
“Even though a national brand doesn’t possess any special benefits,” Javaid adds, “there are some very public examples of problems of managing a high-quality workforce in a very personalized, people-oriented business.”