​Even as skilled nursing and assisted living providers see opportunities for growth, and financing experts talk of a new, albeit cautious optimism in the marketplace, the long term care business faces serious challenges to owner/operators’ bottom lines.

The challenges most front and center on provider minds are actual and proposed cuts in Medicaid reimbursement and figuring out what impact the adjustments under Medicare’s new Resource Utilization Groups-IV (RUGS-IV) and Minimum Data Set (MDS) 3.0 system will have. The Great Recession may officially be over, but aftershocks are being felt at all levels of government, notably in states where pre-recession revenue is not likely to return for some time.

The full pain of these budgetary woes was soothed for a time by federal stimulus dollars, but like most stop-gap measures put in place in 2009, beneficial adjustments to the FMAP (federal medical assistance percentages) program are ending, eliminating extra federal aid for ballooning state Medicaid commitments.

Still, the potential pitfalls and talk of congressional rewriting of reimbursement policies in general have not dampened the views of many financial experts and providers who see a bright present and future for long term care. They note that the 24/7, round-the-clock care provided by skilled nursing facilities (SNFs) will be of even greater value as the baby boom generation swells the ranks of elderly Americans in the coming decade.

Bullish But Braced For Changes

The allure of the sector as a commodity was highlighted by Ventas Healthcare’s recent deal to spend $7.4 billion for Nationwide Health Properties, creating the largest real estate investment trust (REIT) in the nation, says Steve Gilleland, senior director for the healthcare real estate group at CapitalSource, a bank and major investor source for seniors housing based in Chevy Chase, Md. Steve Gilleland

“I am very bullish,” he says, noting that even during the most trying times of 2009-2010, it was the long term care sector and its “need-driven” business that proved recession-proof in the financing markets. And, more of that need-driven business is on the horizon.
Beyond the markets, however, there is a cold reality that caring for the nation’s elderly and frail, notably in small and rural communities, is a daily battle to stay afloat for some as reimbursement simply does not match the cost of providing care. Long term care, as highlighted below with a look at the Good Samaritan Society–Wagner, S.D., skilled nursing and assisted living facility (ALF), continues to face obstacles that force the administrator to find new ways of doing business to survive.

Most Markets In Recovery Mode

For market experts, there is a mix of optimism, caution, and even some forbearance when asked about the state of the capital markets these days. The trauma of the recessionary months has left an indelible mark, but the fog is lifting in many areas, while others remain in an unsteady state.
Doug Korey, managing director of Contemporary Healthcare Capital in Shrewsbury, N.J., sees a split picture, with parts of the market stabilized or improved and other parts just the opposite.
“Certainly we are seeing more financing come into the market than in 2009/early 2010 for facilities with positive historical cash flow that are operated by management teams who are well known to the investment community,” he says.
Doug Korey“However, for construction and turnaround lending we don’t see much improvement at all. After the capital markets crash in 2009, a number of finance companies stopped lending altogether, and banks pulled back sharply. Now, some of these finance companies are beginning to finance transactions with adequate historical cash flow, as are banks, but neither seems willing to take the risk of construction or turnaround facilities.”

Banks More Cautious, But Have Cash

Gilleland notices that banks are coming back to the SNF lending space on a more selective and sometimes more conservative basis. He says there are around 25 banks that currently lend to SNFs—per the National Investment Center (NIC) for the Seniors Housing & Care Industry’s Lender Locator.
“If underwritten correctly and using historical guidelines, SNF loans provide above average yields and plenty of cushion in debt service coverage and other bank metrics,” Gilleland says. For Korey’s firm, today’s market has not forced it to change the basics, with Contemporary maintaining the same credit and pricing policies as before the crash, but that is not true for other players.
“Since we have never been the least expensive lender in the industry, our pledge to our customers is to treat them the same whether the capital markets are healthy or not and to certainly not take advantage of them when the market turns on them,” Korey says. “That said, there are banks in the industry that relaxed pricing in 2007 and 2008 that have now increased pricing to reflect risk.”
CapitalSource has seen a major difference in why it lends. From 2003 to 2008, 90 percent of loans were for acquisition financing and 10 percent for refinancing deals. For 2009 and 2010 there was an exact flip, with 10 percent for acquisitions and 90 percent for refinance, Gilleland says.
Richard SuttonIn California, Richard Sutton, vice president at California Bank & Trust, sees a rise in liquidity for banks and opportunities aplenty for “best-of-class” owners/operators.
In a talk given at a NIC conference in Los Angeles in March, Sutton said while 157 banks shut operations or merged in 2010, of the 6,000-plus remaining, many are flush with cash, and some are selectively lending to the seniors housing industry.
“We are seeking [at California Bank & Trust] ‘banking relationships’ with top-tier operators,” he says. One of the lender’s recent closings involved a $1 million working capital line to an operator taking over an underperforming property with an 85 percent advance rate on a new account receivable. The deal was done at the prime interest rate plus three-quarters of 1 percent, with a 5.5 percent floor.
“I believe you will see the banks more involved in lending in 2011,” Sutton says.

Outlook Includes Number Of Factors

As far as Robert Kramer, president of Annapolis, Md.-based NIC, can see, the seniors housing sector felt less of an impact from the recession and thus has had a quicker recovery time per capital markets. SNFs and ALFs are recovering or maintaining their strength, though independent living has been more of a challenge, with more seniors postponing a move because of nervousness about selling their homes.
For SNFs, it is paying to diversify by offering more services in the way of therapy and rehabilitation, attracting a new base of clients able to leave the facility in a matter of days and weeks instead of months or years, or permanent residence, Kramer says.
“Additional revenue lines are being found in pharmacy, home health, and hospice” for the larger national and regional operators, he notes.
Gilleland echoes this sentiment, saying it is definitely necessary to branch out. “You have to be less reliant on state funding. There is no way to build a Ritz-Carlton [modern facility] and only get paid meat-and-potato rates,” he says.
SNFs are also finding value in shrinking the number of beds in their facilities, making room for more private rooms, rehabilitation wings, and short stays in general.
“This means [total] occupancy is down, but that doesn’t mean overall financial performance has gone down,” Kramer adds.

Changing Long Term Care Profile

Another trend, at least for some of the larger players like Kindred Healthcare, is to tie together care, bringing a health system to bear in the dawning world of accountable care organizations. “This gives providers control over services, and all of this is tied back to unnecessary hospitalizations,” he says.
Medicaid pressures will be intense over the near- and intermediate-term, not only with cuts but with longer-term policies designed to keep people in home- and community-based care and not in a nursing facility.
This issue is going to be tricky at the state and local levels, Kramer notes, likening the situation to what happened to the de-institutionalization of people with mental illnesses in the 1980s, which resulted in scores of new homeless individuals living on the streets with no care.
States and localities need strong services at the community level to even begin to make something like that work in the long term care sector, as in solid transportation and therapy programs, not to mention the medical attention the frail and elderly must have, Kramer says. “To say someone does not need 24/7 care doesn’t mean to say they don’t need any care,” he says.

Get A Deal Now, Then Negotiate

Contemporary is providing more gap and bridge financing than ever before, marking a trend in creative financing seen across the sector.
“Borrowers obtain whatever level senior deal that they can get and then fill the gap with our mezzanine [a hybrid of debt and equity financing] and preferred equity,” Korey says. “A 50-70 percent LTV [loan-to-value] senior deal is better than nothing, and with our pre-payable mezzanine and equity products, that financing package is able to be refinanced as soon as the capital market becomes healthier.”
His firm has also provided capital to complete a transaction from its mezzanine and equity funds. “This capital has been used to acquire or begin construction on time-sensitive transactions for several transactions this year and late last year,” he says.
Borrowers immediately begin discussions with senior lenders to pare down such financing and get a better blend of rates. “We provide them with a certain amount of our loan with no prepayment fees to accommodate the senior transaction. As the construction or turnaround improves or stabilizes, that same senior lender can ratchet up its loan to take out more of ours, or the borrower can refinance the whole loan with a more conventional structure,” Korey says.
“Either way, the borrower has taken advantage of the market in terms of getting in the ground with a new building or acquiring an underperforming or nonperforming facility at far less cost than waiting until a year or two from now.”
Meanwhile, with little construction occurring in the market today, occupancies are quite high, even within older facilities, he says. “A new or substantially renovated facility in that market, regardless of the cost of capital to enter that market [if well operated] generally becomes the facility of choice,” Korey says.

The Medicaid Threat

If challenges to the long term care sector could be categorized like those used for hurricanes, proposed deep cuts in Medicaid in many states would be a looming Category 5 storm with the potential to rewrite forecasts and business plans in a dramatic way, watchers posit.
Even the bullish Gilleland puts it bluntly. “The head wind is Medicaid cuts. Almost every state is looking at these; New York … Ohio has a potential 7 percent cut. Texas, there is talk there of a 30-33 percent cut,” he says. If that happens in Texas and is not mere posturing by lawmakers, “all bets are off,” Gilleland says, as up to 600 nursing facilities could be forced to shut without proper reimbursement for their Medicaid residents.
Korey says the risks are both global and local in nature, meaning the global economy and unrest seen of late could derail growth for the overall economy, but it is the states and potential Medicaid cuts that are the top priority in need of addressing.
“The next 12 months will continue to yield a certain wariness by lenders in general until budgets are passed and lenders can underwrite the full impact of any cuts made,” he says. “Lenders and investors can’t stand uncertainty, and until we see clarity in the jobs market, health care reform, inflation, and the recent global events [Middle East, Japan], no lender or investor will or should be lending or investing at terms based on ‘normal’ years,” he says.

Texas Proposed Massive Cuts

When Provider went to print, it was the talk in Texas that was making the most headlines, since the cuts there could be mind-boggling in size.
Opponents of the cuts believe the ripple effect of a one-third reduction, pegged at around $7.6 billion to almost $10 billion of Texas’ Medicaid spending (for fiscal years 2012 to 2013), will not only hurt providers but endanger lives, eliminate jobs, and cost the state more money in the long run.
On the economic impact alone, the numbers are large. A statistical analysis by the American Health Care Association/National Center for Assisted Living (AHCA/NCAL) showed Texas in 2010 with 168,830 jobs directly tied to long term care, with that number growing to 239,300 overall jobs associated with the sector.
Labor income topped $5 billion, and state and local tax revenue were at nearly $623 million, AHCA/NCAL said. The analysis examined the economic impact of long term care for the country as a whole, and individually in all 50 states.
Texas is considering the Medicaid cuts and other changes to the reimbursement system to help close a $20 billion budget gap.
Other states like Oregon and California are considering 10 percent-plus rate cuts, as 45 states had general fund expenditures below fiscal year (FY) 2009 levels. Even with improved revenue projections for FY 2011, the loss of FMAP-plus will dampen those numbers.

State Budgets Just One Challenge

The significant risk of Medicaid rate cuts and the use of provider taxes as a key funding source to maintain rates is just one issue providers will have to adapt to in coming months and years, says James Carlson, chief executive officer (CEO) and president of the Oregon Health Care Association.
He listed the renewed push to home- and community-based services (HCBS), the waiver potential under federal health care reform, and more managed care initiatives that focus on dual eligibles as big issues.
“The combination of budget pressures, federal emphasis on integration of care for dual eligibles, and potential waivers is pushing managed care proposals to the forefront of state strategies,” Carlson says.
The ramifications of these trends will affect each provider differently, but it will pay to be abreast of market changes.
“Smart organizations will continue to position themselves to serve the post-hospital, short-stay, transitional care patient, even for Medicaid,” he says. SNFs should look to make strategic alliances with acute care and HCBS providers, enhance clinical capabilities, provide modern physical plants, measure and track clinical outcomes, invest in information technology and electronic health records, and try to move away from Medicaid as the primary revenue source over the next five years, experts say.
Repositioning is vital for providers in the evolving health care system, Carlson says.

Providers Diversify

Neil Pruitt, chairman and chief executive officer at Norcross, Ga.-based provider UHS-Pruitt, says the climate for his firm remains very challenging, noting the dual issue of adjusting to the Medicare payment system under RUGS-IV and MDS 3.0, as well as the state Medicaid pressures.
“These increased pressures come at the same time we have higher-acuity patients,” Pruitt says. “We can’t take high-acuity patients if we are not paid appropriately.”
UHS-Pruitt has 76 SNFs and four ALFs totaling more than 8,600 beds and units. The provider operates in North Carolina, South Carolina, and Florida, as well as in Georgia.
Pruitt notes the company has an array of supplementary resources, including home health care, end-of-life care, rehabilitation, veteran care, and consultative pharmaceutical services. UHS-Pruitt also offers business-to-business services.
These additional business lines help to offset concerns about reimbursement issues, while moving the provider into care management, ensuring continuity of care and high-quality services, Pruitt says.
By offering more than just skilled nursing, UHS-Pruitt is also able to look at tie-ins with hospitals. “We are having thoughtful conversations with hospitals to partner together,” he says. “What we are really going to focus on at our company is the spectrum of services. We are also focused on getting rid of three-bed wards,” adapting to consumer demand for more services, such as rehabilitation, and an updated look and feel for buildings.
“We have three small children, and we didn’t want to share a room with someone else when we were in the hospital” for their births, Pruitt says.

A New World

That spectrum of care continues to expand for many providers. The olden days of care were based on independent and assisted living, along with skilled nursing and acute hospitalization. Now, the spectrum consists of dozens of potential offerings, from health and wellness centers (preventative) to adult day care, dementia assisted living, palliative care, hospice, sub-acute rehab, and the list goes on.
As for financing, Pruitt points out the availability of credit through government programs like the Department of Housing and Urban Development’s (HUD’s) 232 program, which offers “low rates for an extended period of time,” even when other credit outlets are tight.
The HUD 232 program insures mortgage loans to facilitate the construction and substantial rehabilitation of nursing facilities, intermediate care facilities, board and care homes, and ALFs. The program allows for long-term, fixed-rate financing (up to 40 years) for new and rehabilitated properties and up to 35 years for existing properties without rehabilitation that can be financed with Government National Mortgage Association Mortgage- Backed Securities.
“Traditional lenders are more cautious. Generally, though, they are open to good projects,” Pruitt notes, reflecting the views of the bankers mentioned above.

What’s To Come

As for the outlook ahead, Pruitt sees much opportunity, noting his company has expanded from 42 SNFs in 2002 to nearly 80 SNFs in 2011, a trend he wants to continue.
“The potential for our profession is better than it’s ever been,” he says, stressing that quality improvements across the sector have made facilities more attractive for residents and their families.
He does hope the implementation of health care reform, and the policy decisions around Medicare and Medicaid reimbursement, can find some sort of steady ground, Pruitt says. “What we really need is a system that is fairer and more stable.”