JP LoMonaco, President of The Valuation & Information Group, provides a Question and Answer opinion piece on the impact COVID has had on LTC real estate transactions. Mr. LoMonaco and his team provide specialized, expert valuations and services to facility operators, lenders and their advisors through appraisal and market feasibility assignments for a wide variety of property types in the senior housing industry.
Question and Answer:
How has the pandemic impacted value in the skilled nursing markets?
To answer this question, we first need a common understanding of what makes up value. I like to think of value as the worth of all the benefits and rights arising from ownership. Value by nature is a longer-term concept; it is not determined by the benefits derived today or the performance over the past few weeks. Value is created by the long-term anticipated benefits of ownership, but it can be affected and adjusted for by short-term cash flow disruptions.
For example, vacant land doesn’t typically provide an immediate or short-term cash flow. The value of land is determined by the long-term potential to generate profits once it is developed or put to use. Certainly, short-term events can impact value: if a hurricane damages a roof, the repair cost and the anticipated loss of cash flow will need to be deducted from the long-term value to determine the as-is value.
In the beginning of the pandemic, most market participants anticipated that it was a short-term disruption rather than a long-term structural change. There was absolutely uncertainty in the early days of the pandemic, and we saw most transactions that were not directly impacted by an outbreak were delayed. Discounts in the 5% to 10% range were common when a transaction had a highly motivated seller.
How was transaction volume impacted?
Initially, transactions were delayed or cancelled outright. We found that market participants simply put the brakes on transactions because there was a high level of uncertainty about how the pandemic would play out. With stay-at-home orders in effect throughout the country, people had to figure out how to complete the basic logistics of any typical transaction.
In 3Q20, transaction volume started to increase and by 4Q20 our firm was extremely busy with transaction valuations. The gradual ramp up of sales had several drivers including:
Federal Government Support – almost no one could have predicted the programs and stimulus that was enacted for the overall economy and the skilled nursing industry. The Federal Government created the skilled nursing industry in the 1950s with the advent of Medicare and Medicaid and they stepped up big time to make sure it would survive this pandemic. In general, we noticed balance sheets were much stronger than normal with most operators having ample cash on hand ready to deploy during the operating uncertainties that the pandemic would bring.
Interest rates dropped and HUD gave an early indication they would remain a reliable source for the long-term care industry. Bridge lenders now had the confidence to make loans with a sound exit plan.
Less sophisticated operators felt more pressure to exit the industry as operating complexities increased. We also saw a number of operators decide now was the time to retire rather than retool for the new realities of the industry.
What has happened to capitalization rates?
That is a tricky question because I have found that the underlying investment criteria really has not changed, but an emphasis on short-term cash flow has become more important. Many assumed that capitalization rates would dramatically increase because of the higher level of risk associated with the pandemic. However, lower interest rates help boost equity capitalization rates and keep overall capitalization rates relatively stable and within the long-term range (12% to 14%). The good operators were finding ways to adapt their operating model to the circumstances. Temporary emergency changes to Medicare eligibility, Federal stimulus funds and temporary state Medicaid enhancements provided the cash flow band-aid that investors and lenders needed to proceed with transactions.
What has been the impact of vaccines?
The good news is that vaccines were widely distributed and accepted in nursing homes and new cases and deaths dropped quickly. Many saw drops in excess of 90% within the first four to six weeks after vaccines were introduced.
However, the introduction of vaccines has not meant a return to business as usual. Many nursing homes experience COVID cases, but traditional Medicare patient admission volumes have not yet recovered. Historically seniors are eligible under Medicare after a three-day hospital stay. Emergency rule changes waived the three-day rule and allowed for Medicare eligibility for those seniors that exhibited symptoms. With a decline in “elective procedures”, the typical pre-pandemic Medicare patient volume decreased but was offset by temporary eligibility rules. Many facilities are now reporting that with the sharp reduction in COVID cases, the emergency rule Medicare patient volume has decreased but the long-term, typical Medicare volume has not yet returned.
Has the home health alternative emerged as a threat to the long-term care industry?
That seems to be a favorite topic of many articles these days and those that make the argument that the long-term care industry is becoming obsolete. My view is different. The long-term care industry has been evolving as part of the larger U.S. healthcare industry over the past 20 years. The much larger overarching theme in U.S. healthcare policy has been to provide the most effective care in the lowest cost setting.
Twenty to 30 years ago, some predicted that assisted living was going to make nursing homes obsolete. It is true that lower acuity, private patient patients left nursing homes for assisted living, but the well-run nursing home adapted by taking on more complex patients. Nursing homes were a more cost-effective setting compared to rehabilitation or acute care hospitals.
The care that nursing homes provide is dictated by how they are reimbursed. About six months prior to the pandemic, CMS introduced PDPM (Patient Driven Payment Model), a significant overhaul to how Medicare pays nursing homes. One of the key goals of PDPM is to reimburse nursing homes for the care of more medically complex patients.
Getting back to the original question—if home health will take some traditional nursing home patients away—I say the answer is yes, but the good operators will adapt and take on more complex patients that they would not have considered under the old Medicare reimbursement system.
What is one key takeaway you have you have seen over the course of the pandemic?
The long-term care business is all about people and the way to provide good care is through effective operations. The stronger operators have weathered the pandemic better than the weaker operators. The pandemic has made the difference between strong and weak more evident. This is not new to the industry, but I suspect that it will accelerate the longer-term trend for weaker operators to exit the industry.
More information about V&IG can be found at their website, V & IG | Valinfo, or by contacting JP LoMonaco at jp@valinfo.com.