Nursing Home Investment: A Brighter Day Ahead?

INTERVIEW WITH ROBERT G. KRAMER AND HARVEY N. SINGER

One popular image of nursing homes is as "the last place I would want to put Mom," and Wall Street investors have been saying pretty much the same thing about their money. Evidence is growing, however, that the latter perception is no more accurate than the former. Just as there are many decent and supportive nursing homes available, so are there attractive opportunities for return on investment (ROI). Much of that evidence emerges from two analyses published recently by the National Investment Center for the Seniors Housing & Care Industries (NIC): The Impact of PPS on Nursing Home Profitability & Debt Coverage (in conjunction with PricewaterhouseCoopers) and the Fitch/NIC Investment Analysis of Nursing Home Properties.

The PPS (Medicare Prospective Payment System) study showed nearly half of the small- to regional-sized nursing home companies surveyed actually increasing net operating income (NOI) under PPS, and suggested that the infamous bankruptcies of major nursing home chains resulted, in large part, from their overinvesting in ancillary services for which PPS underpaid. In short, PPS was not a uniform disaster. The Fitch/NIC analysis moved on from there to address other factors causing negative and damaging perceptions of an industry in trouble and out of favor with investors. The upshot: The nursing home industry offers a complicated landscape, leaving plenty of openings for more knowledgeable investors to do well. Recently, NIC Executive Director Robert G. Kramer and Director of Research HarveyN. Singer discussed these analyses in an interview with Nursing Homes/ Long Term Care Management Editor Richard L. Peck.

Peck: What were the key factors in those smaller to midsize nursing homes doing relatively well under PPS?

Kramer: First we should make clear that most of the facilities studied had their revenues reduced under PPS. Those that still managed to increase NOI did so by reducing expenditures enough to more than compensate for the reduced revenues.

Singer: An interesting finding was that, while overall expenses went down, nursing expenses went up. This could indicate that an important way in which nursing homes were reducing overall expenditures was by taking ancillary services in-house. It might be that service utilization decreased as well, but we didn't study this.

Kramer: We do know that a wholesale shift away from Medicare patients did not occur in these facilities. There was little overall change in the usual reimbursement mix of Medicaid, Medicare and private-pay. The study did not go into great detail on these issues, though, because it was designed to address the financial community's perception that all nursing homes were suffering under PPS. We know now that this was not the case.

Peck: The Fitch/NIC report looks at other perception problems and sounds a similarly hopeful note.

Kramer: Because PPS is not the only risk for investors, the Fitch/NIC study attempts to give investors a comprehensive overview of both the risks and the opportunities in this field. Readers will find that it is a complex picture. The inexperienced investor looking for a quick in-and-out profit-taking in this market can lose his or her shirt. But, for the savvy investor who knows the field, there are a lot of signs that the industry might have hit bottom and is starting on an upswing.

Peck: But what about the apparently continuing adverse trends of declining occupancy and intensifying pressure by the market and by government to diversify senior care options?

Kramer: There is evidence that the rate of nursing home occupancy decline has slowed and might have hit bottom, and that assisted living's effect of draining away census might have run its course. There's no question that Medicaid waivers for home- and community-based (HCB) care and improvements in home-care technology pose genuine long-term occupancy risks for this field. On the other hand, you have such countertrends as states starting to tighten their restrictions on who can be placed in an assisted living facility. And, despite the push for HCB, there's no denying the reality of complex, high-acuity residents needing chronic care, who can't effectively be cared for at home, and whom most assisted living operators have no intention of serving.

Singer: From an economic standpoint, there's a limit to how far states can go with "cost cram-down"; that is, trying to provide care for people in the least costly settings. Nursing homes are set up to handle some chronic cases more cost-effectively than any other setting. In fact, some states are starting to increase Medicaid rates because they realize that you need staffing sufficient to care for these frailest of residents; they're enacting Medicaid passthroughs to support required staffing and better wages.

Kramer: But this situation will vary from state to state. That's why it's important to investors that skilled nursing home companies have management that's both knowledgeable and flexible, especially if they're managing multifacility operations across state lines.

Peck: You're assuming that the overall financial structure of long-term care won't change over the next few years?

Kramer: I don't see major change in long-term care financing happening for at least 5 to 10 years. And, when changes occur, we won't see their full impact for another 10 to 15 years as the dramatic demographic shift takes place. Nor do I see technology causing a significant shift any time soon in people's ability to care for seniors at home safely and inexpensively. We're talking about an investment outlook that is more near-term than that.

Peck: Your analysis devotes considerable space to the issue of management and administrator qualifications as an investment factor. Would you elaborate on that?

Kramer: As I mentioned, the ability to be flexible is a very important factor. Administrators or managers also need the knowledge and skill to deal with such challenges as minimum staffing ratios and liability insurance costs. Mind you, they don't need all the answers to these problems; they do need a track record of anticipating crises and stepping up proactively to address them.

Singer: We also hear that investors are looking for a sense of caring and commitment by managers who understand their local markets, residents, families and referral sources, and who respond to their communities' needs.

Kramer: The administrator or corporate manager who behaves as though the government is his or her only customer won't be very attractive to investors. These managers become so focused on responding to government demands that they lose sight of their real customers. You need leaders who have a passion for the business, who understand that if you take care of your residents and staff, your business will prosper. This isn't "fuzzy thinking." It's staying customer-focused.

Peck: The Fitch/NIC analysis notes that although there has been a liability insurance crisis in some states, investors are reporting that, overall, relatively few facilities as yet have actually been hit by judgments. Are you saying that the problem is overstated?

Singer: Investors do indicate very strongly that they did not want to put money into facilities in states where liability insurance issues exist--Florida, Texas and California, specifically. If the crisis is allowed to spread beyond those states, and no reforms or compromises are enacted, this could become a much broader problem.

Peck: When all is said and done, what types of private investors seem most likely to stay committed to nursing homes?

Singer: For any loans of 10 years or longer, the current market will be almost exclusively those providing FHA loans or underwriting services for HUD. Other than that, private-equity investors are taking a new interest, now that high-tech, electronic and "Rust Belt" stocks have shown how cyclical they can be. Given the demographics, nursing homes are not as cyclical, and that makes them potentially attractive in today's market.

Kramer: Opportunity funds are taking an interest, because there's a sense that the industry is on an upswing, and there are some market inefficiencies that create opportunities for those who understand the field. The healthcare REITs are also starting to come back. All of these investors are able to get very good interest rate differentials for investing their money. This means that there is money available to nursing homes, but it won't be inexpensive. NH