Why Do People Invest in Skilled Nursing Facilities (SNFs)?

chart01.pngHere is a real estate investment proposition that might spark your interest. You will own facilities whose tenants serve an increasing amount of elderly patients in the United States. The majority of the patients will pay your tenants through government program reimbursements. Remember, governmental programs depend on federal and state budgets, some of which may have shortfalls. Over the past years, the reimbursements have increased by a compound annual growth rate (CAGR) of 2-3%. Tenant profitability is low, and in a previous budget sequestration, government programs have not been preserved and Medicare has suffered cuts. Would you invest in skilled nursing facilities?

The skilled nursing facility industry today provides many excellent benefits but also downfalls. One of the best aspects of the industry is the future demographics. As the baby boom generation ages, they will need to visit healthcare facilities more frequently. The United States census notes that the number of citizens older than 85 years will increase significantly in the coming decades.

On the other hand, there is a highly regulatory aspect of the business. Obamacare increased the number of insured citizens; however, the healthcare system has suffered regular changes and scrutiny has intensified. The Center for Medicare and Medicaid Services (CMS), a federal agency within the United States Department of Health and Human Services (HHS), has been executing details of Obamacare. CMS is trying to increase transparency within the industry by tracking payroll, staffing and number of penalties (see website here). They are also looking to contain growth in Medicaid expenditures and control daily rates which affects SNFs’ revenues and profitability.

The performance of Genesis Healthcare Inc. in the financial market may reflect the invest mood of the SNF industry. Genesis Healthcare is a publicly-traded company and one of the largest post-acute care operators in the United States. Genesis Healthcare is a tenant of healthcare REITs Omega Healthcare and LTC Properties. In January 2015, it was downgraded by Standard & Poor’s to B- for challenging prospects in the SNF industry. Their year-to-date share price has plummeted by almost 50%.

In Standard & Poor’s January 2015 report, they highlighted the following: “The downgrade follows a review of the industry prospects for nursing facilities and reflects our assessment that Genesis will be challenged to generate substantial free cash flow on a sustained basis,” said credit analyst David Kaplan. Our rating on Genesis reflects our assessment of its business risk profile as “weak” and the financial risk profile as “highly leveraged”, and our view that the company’s financial risk is comparatively weak within the highly leveraged assessment. Our outlook is stable, reflecting our view that industry headwinds will offset margin expansion initiatives, leading to thin margins near current levels, and that the company will generate only modestly positive free cash flow.”

In summary, the SNF business offers excellent demographic fundamentals with minor upside and major downside as a result of constantly changing government regulations. If that is the case, why invest in the industry? First, healthcare REITs have historically been immune to the swings of the stock market. Second, yields have been one of the highest among equity REITs. Furthermore, if we saw less regulatory impact and revenues continued to grow incrementally, healthcare would be the ideal REIT stocks. They would provide stable, gradually-increasing dividends over time.

Source: Omega Healthcare Investors, Inc. (NYSE:OHI), Standard & Poor’s, Genesis Healthcare, Inc.(NYSE:GEN), LTC Properties Inc.(NYSE:LTC), CMS, Ventas, Inc.(NYSE:VTR)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

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