Lument: Reasonable Optimism: Skilled Nursing Outlook

As 2023 progresses, what is the skilled nursing outlook following years of disruption? The industry continues to benefit from a positive long-term outlook, largely due to strong industry fundamentals and favorable demographics, with growing demand over the foreseeable future and a limited supply of new construction. In the near-term, improvements in operations and steady occupancy gains are additional sources of optimism, as occupancy across skilled nursing reached 81% as of April 2023.

Challenges clearly remain, however, in the form of an interest rate environment that has widened cap rates, the rising cost of labor and agency staffing, a pending federal staffing mandate, and an evolving regulatory environment. Likewise, deal activity remains hampered, evident in the fact that year-over-year (YoY) transaction volume dropped by 36% in the first half of calendar year 2023. These factors have taken a toll, leading investors to employ an increasingly conservative underwriting approach.

Nevertheless, real estate investment sales activity continues to persist, with a significant number of transactions being executed in which buyers are seeking value-add or distressed investment opportunities. As the second half of 2023 unfolds amid this rapidly changing uncertainty, there is cause for reasonable optimism, as some key takeaways from the first half of the year demonstrate.

Staffing Pressures Persist, Mandate Looms
The industry has continued to face sustained labor pressures, forcing a reliance on agency labor to meet demand. Recent reports indicate significant increases in agency pricing, as evident by wages for travel nurses in skilled nursing facilities (SNFs) going up by 3.2% month-over-month in June. Further, providers in Iowa reported agency hourly rates went up 40%, and in Pennsylvania, rates increased by as much as 400%. Increased prices have led to 11 states investigating whether temporary staffing agencies are engaging in price-gouging, according to McKnight’s Long-Term Care News.

Adding to the industry’s staffing stress is the looming federal minimum mandate. After decades of debate, operators are expecting the Centers for Medicare & Medicaid Services (CMS) to finally implement a minimum staffing rule, and sentiment across the industry is mixed. The National Center for Assisted Living (AHCA/NCAL) penned a letter to the Biden administration in July stating its opposition to the planned mandate, which could potentially require operators to provide four hours of direct care per resident per day. In its letter, AHCA/NCAL stated that although the idea may sound good in theory, in practice, it will not be successful, arguing that “proceeding with this mandate would worsen access to care for our nation’s seniors and be a disaster for poorer residents who rely on Medicaid.”

Further, AHCA/NCAL pointed out that nursing homes still need nearly 190,000 workers to return to pre-pandemic levels. The challenges of recruiting and retaining are well documented. Adding to that a mandate that many SNFs would not be able to meet would only exacerbate an already difficult situation, as research indicates only 29% of nursing homes would meet a standard of four hours. The mandate would lead to more nursing home closures; the group believes.

Instead, the nation’s largest association representing long term and post-acute care providers recommends the administration focus on other commonly discussed industry reforms, such as changing immigration policies to attract international nurses, leveraging innovative technology, and reforming training and support programs for caregivers.

Advocates see the mandate as a massive win for patients’ protections, and perhaps the most important nursing home reform on record. Regulations have not changed since 1987, so many argue the minimum is needed to ensure patients receive adequate care.

Dynamic Regulatory Landscape
Operators continue to deal with an ever-evolving regulatory landscape, as enhanced public reporting requirements, continued reimbursement scrutiny, and changing interpretations of resident elopement are current challenges. In one example, the Department of Labor’s Occupational Safety and Health Administration (OSHA) recently announced the final version of a rule enhancing injury and illness reporting requirements, effective January 2024. The rule is expected to make reporting requirements more burdensome for many operators.

Given the mounting pressures, average margins across the industry have compressed to 5.6%, or 280 basis points (bps) behind the fourth quarter of 2019, according to LevinPro data. To counter, SNFs continue to focus on operational transformation in order to accelerate recovery and mitigate cost increases.

Pressured Operations Driving Limited Supply
Compressing margins and lack of capital have led to mounting closures, largely in rural markets, where access to labor remains tight. Texas and Nebraska led the nation in facility closures in 2022, predominantly driven by the inadequate reimbursement environment. In another example, Iowa has seen 26 SNF closures since June, 2022, particularly noteworthy given the state was recently found to have underfunded Medicaid by approximately $30 per day. This demonstrates the seriousness of the challenge, as even states with federal assistance are seeing SNF closures. Without reimbursement increases and more public sector support, industry pressures may continue mounting, thereby driving further closures.

Specialized Programs Drive Diversification
On the positive side, operators are finding success in initiatives that drive specialized care to increase occupancy and expand margins, focusing largely on dementia and behavioral health care services. For example, many SNFs are investing in interdisciplinary care teams and dedicated centers devoted to specialized care to better serve residents. Other techniques include life enrichment activities such as onsite child daycare.

On the payment side, institutional special needs plans (ISNPs), which can offer a clear transition from Medicaid fee-for-services, continue to gain traction.

REITs Positioned to Capitalize on Opportunities
There have been approximately 89 transactions close in the SNF sector as of August 22, 2023, a 32% YoY decline, according to Levin. Transactions are driving an increasingly conservative underwriting approach, with investors anecdotally relaying that deals have been terminated across all stages of the pipeline. However, continued M&A activity throughout 2023 is anticipated, as buyers seek value-add or distressed investment opportunities. Real estate investment trusts accounted for 12.3% of total year-to-date transactions and remain positioned to capitalize on the current environment throughout the remainder of 2023, given enhanced access to capital.

Despite the serious sector challenges and continued economic uncertainty, consensus seems to be that the worst is behind us, as resilience and reasonable optimism reign as powerful themes of 2023 and in to 2024.