Over my career, I have done a fair amount of M&A work….CCRCs, SNFs, HHAs, Physician practices, hospice, etc. While each “deal” has lots of nuances, issues, etc. none can be as confusing or as tricky to navigate as the federal payer issues; specifically, the provider number. For SNFs, HHAs, and hospices, an acquisition not properly vetted and structured can bite extremely hard post-closing, if provider liabilities existed pre-close and were unknown and/or unknowable. Even the best due diligence cannot ferret out certain provider number related liabilities.
The Medicare provider number is the unique reference number assigned to each participating provider. When initially originating as a provider, the organization must apply for provider status, await some form of accreditation (for SNFs it is via a state survey and for HHAs and hospice, via private accreditation) and then ultimate approval by Medicare/DHHS. As long as the provider that has obtained the number, remains in good standing with CMS (hasn’t had its provider status/agreement revoked), the provider may participate in and bill, Medicare and Medicaid (as applicable).
Provider numbers are assignable under change of control, providing the assuming party is eligible to participate in the Medicare program (not banned, etc.). Change of control requires change of ownership or control at the PROVIDER level, not the facility or building level. The building in the case of an SNF, is not the PROVIDER – the operator of the SNF is. For example, if Acme SNF is owned and operated by Acme, Inc., then Acme, Inc. is the Provider so long as the SNF license in Acme’s state is to Acme, Inc. Say Acme decides to sell the SNF property to Beta REIT and in turn, Beta leases the facility back to Acme. Acme no longer owns the building but remains the Provider as it continues to hold the license, etc. consistent with the operations of the SNF. Carrying this one step further. Acme decides it no longer wants to run the SNF but wishes to keep the building. It finds Zeta, LLC, an SNF management/operating company, to operate the SNF and leases the operations to Zeta. Zeta receives a license from the state for the SNF and now Zeta is the PROVIDER, even though Acme, Inc. continues to own the building.
In the example above regarding Zeta, the typical process in such a change of control involving the operations of a SNF is for Zeta to assume the provider number of Acme. The paperwork filed with CMS is minimal and occurs concurrent to the closing creating change of control (sale, lease, etc.). What Zeta has done is avoid a lengthier, more arduous process of obtaining a new provider number, leaving Acme’s number with Acme and applying as a new provider at the Acme SNF location. While taking this route seems appealing and quick, doing so comes with potential peril and today, the peril is expansive and perhaps, business altering.
When a provider assumes the provider number of another entity at change of control, the new provider assumes all of the former provider’s related liabilities, etc. attached to the number. CMS does not remove history or “cleanse” the former provider’s history. The etc. today is the most often overlooked;
- Star ratings
- Quality measures including readmission history
- Claim error rate
- MDS data (submitted)
- Federal survey history
- Open ADRs
- Open or pending, probes and RAC audits
The above is in addition to, any payments owed to the Federal government and any fines, forfeitures, penalties, etc. The largest liability is or relates to, the False Claims Act and/or allegations of fraud. These events likely preceded the change of control by quite a distance and are either impossible to know at change of control or discoverable with only great, thorough due diligence. The former in my experience such as whistleblower claims may not arise or be known until many months after the whistleblower’s allegation. During the interim, silence is all that is heard. Under Medicare and federal law, no statute of limitation exists for fraud or False Claims. While it is possible via indemnification language in the deal, to arrest a False Claims Act charge and ultimately unravel the “tape” to source the locus of origin and control at the time of the provider number, the same is not quick and not without legal cost. Assuming the former provider is even around or can be found (I have seen cases where no such trail exists), winning an argument with CMS that the new provider is blameless/not at fault is akin to winning the Battle of Gettysburg – the losses incalculable. Remember, the entity that a provider is dealing with is the Federal government and as such, responsive and quick aren’t going to happen. Check the current status of the administrative appeal backlog as a reference for responsive and quick.
Assuming no payment irregularities occur, the list preceding is daunting enough for pause. Assuming an existing provider number means assuming all that goes with it. On the Federal side, that is a bunch. The assuming party gets the compliance history of the former provider, including the Star rating (no, the rating is not on the SNF facility but on the provider operating the SNF). As I have written before, Star ratings matter today. Inheriting a two Star rating means inheriting a “dog that doesn’t hunt” in today’s competitive landscape. It also means that any work that is planned to increase the Star rating will take time especially if the main “drag” is survey history. The survey history comes with the provider number. That history is where RAC auditors visit and surveyors start whenever complaints arise and/or annual certification surveys commence.
The Quality Measures of the former provider beget those of the assuming provider. This starts the baseline for Value Based Purchasing. It also sets the bar for readmission risk expectations, network negotiations and referral pattern preference under programs such as Bundled Payments. Similarly, all of the previous MDS data submissions come with that same provider number, including those that impact case-mix rates under Medicaid (if applicable). And, not exhaustively last but sufficient for now, all claims experience transfers. This includes the precious error rate that if perilously close to the limit, can trip with one more error to a pre-payment probe owned, by the assuming provider. Only extreme due diligence can discover the current error rate – perhaps.
Avoiding the peril of all of the above and rendering the pursuit or enforcement of indemnification (at the new provider’s expense) a moot issue is simple: Obtain a new provider number. It is a bit time-consuming and does come with a modicum of “brain damage” (it is a government process) but in comparison to what can (and does) happen, a very, very fractional price to pay. In every transaction I have been directly involved with, I have obtained a new provider number. In more than one, it has saved a fair amount of go-forward headache and hassle, particularly on the compliance end. Today, I’d shudder to proceed without a new provider number as the risks of doing so are enormous, particularly in light of the impact of Star ratings, quality measures and survey history. Additionally, the government has never been more vigilant in scrutinizing claims and generating ADRs. Inheriting someone else’s documentation and billing risks genuinely isn’t smart today.
While inappropriate for this post, I could list a plethora of examples and events where failure to obtain a new provider number and status has left the assuming provider with an absolute mess. These stories are now, all too common. Even the best due diligence (I know because my firm does it), cannot glean enough information to justify such a sweeping assumption of risk. Too much cannot be known and even that which can, should be rendered inconsequential by changing provider status. Reliance on a definitive agreement and litigation to sort responsibilities and liabilities is not a prudent tactic. Time and resources are (always) better spent, applying for and receiving, a new provider number and provider status.
In my consulting career, I’ve done a fair amount of feasibility work (market, economic, etc.). Similarly, I’ve done a fair amount of similar analyses, primarily related to M&A activity and/or where financing is involved (debt covenant reviews, etc.). Heck, I’ve even done some bankruptcy related work! I’m also queried fairly often about feasibility, demand, market studies, etc. such that I’m surprised (often enough) that a gap still exists between “proper” analysis and simplified “demographic” analysis. Suffice to say, feasibility work is not a “one size” fits all relationship.
I’ve titled this post “CCRC feasibility” principally because the unique nature of a true CCRC project provides a framework to discuss a multitude of related industry segments simultaneously (e.g., seniors housing, health care, assisted living, etc.). Starting with the CCRC concept, a set of basic assumptions about the feasibility process is required.
- Demographics aren’t the arbiter of success or failure – feasibility or lack thereof.
- Demand isn’t solely correlated to like unit occupancy, demographics (now or projected), or for that matter, how many units are projected to be built (following the Jones’ as a qualifier).
- Capital accessibility isn’t relevant nor should it be.
- National trends for the most part, are immaterial. Local, regional and state are, however.
- Projects pre-supposed are projects with inherent risk attached. This isn’t an “if you build it, they will come” type exercise. The results shouldn’t be thought of as a justification for a “specific” project already planned.
The last point typically generates a “heresy” cry from folks and certain industry segments. Regardless, I am adamant here in so much that true feasibility analyses determines “what makes sense” rather or as opposed to, justifying that which is planned (or the implication that the client is paying for a study to justify his/her project). Remember, I am a fan of the fabled quote from Mark Twain attributed to Benjamin Disraeli (the former Prime Minister of Great Britain): “There are three types of lies….lies, damn lies and statistics”. As an economist, I have deep appreciation for this as all too often, I see analyses that smack of this latter type of lie.
(Note: The source of the actual “lies, damn lies” quote is still a mystery…thought initially to be said by Lord Courtney in 1895 but since, proven invalid.)
Carrying this feasibility discussion just a bit further, the approach that I recommend (and use) incorporates the following key assumptions about seniors housing (CCRCs) and to a lesser extent, specialized care facilities (Assisted Living, SNFs, etc.).
- The demand for seniors housing, true housing, is very price elastic. Given the elasticity, all demand work must be sensitized by price. The more specialized or unique the project might or may be, the more sensitive the demand elasticity becomes (greater or lesser).
- Local economic conditions matter – tremendously. This is particularly true for CCRCs and higher-end seniors housing projects, especially real estate conditions.
- Regional and state trends matter particularly the migration patterns, policy issues, job issues, etc. Doubt me? Let’s have a discussion about the great State of Illinois (for disclosure, I have a home and office in Illinois).
- Location(s) matter. I incorporate location/central place theory elements in all of my feasibility work and analyses.
- Demographics are important but not in the normative sense. Yes, age and income qualified numbers are important but education and real estate ownership, location and years residency in the market area(s) can be as impactful.
- Competition is important but in all forms. Given the demand elasticity of seniors housing, the higher the price, the greater the wealth status required of the potential consumer, the greater the options available to that same consumer.
- Ratios matter. The demographics are important but the ratio within the demographic correlated to the project, within various locations, etc. is “money”. (Sales folks love this stuff). How many seniors does it take to fill a CCRC?
Because no one project is equal to another, feasibility work and like analysis is both (an) art and a science. I liken the process to cooking. Recipes are key but taste and flair and creativity are important as well. Honestly, knowing the industry well from an overall perspective is ideal – like being a chef trained by the masters! When I see flawed analysis, it typically comes from a source that follows a recipe; a recipe for market analysis, etc. Knowing the industry, having operated organizations or facilities, being trained in quantitative analysis, etc. separates good or great from average. Remember Twain/Disraeli.
So to the title of this post; the correct or proper methodology for feasibility studies and similar analysis (sans some detail for brevity and not in any particular order)….
New Facility/New Location
- Location Analysis – in economic parlance, the application of elements of Central Place Theory. This includes a review of the site in relationship to key ranked variables such as market/demographics, accessibility, staff/employment access, proximity to other healthcare, other services, etc.
- Pricing – what is/are the core pricing assumption(s)….I’ve written on strategic pricing models on this site. If I am doing the pricing work, I apply the concepts in the Strategic Pricing presentations and worksheets found on the Reports and Other Documents page on this site.
- Demographics – I’ll use my pricing data and my location analysis to frame my demographic analysis. Aside from age and income, I’ll look at migration patterns, education, career history, etc. plus I’ll review the information on a geocoded basis to refine market relationships between customers and other competitors.
- Demand Analysis – From the demographic data and tested against the pricing, I’ll build a demand analysis and a penetration analysis that provides a range of likely target customers, within the market areas, give the pricing information, for a particular product. Historic migration and market area occupancy of like accommodations is used to sensitize the demand analysis.
- Economic Analysis – This is a review of current market conditions and trends that can impact the project’s feasibility, positively or negatively. Real estate, income, employment, business investment, economic outlooks, policy implications such as tax policy, etc. are all key elements reviewed.
- Competitive Analysis – What is going on within the area/regional competition of like or quasi-comparable projects is important as a buffer or moreover, a stability (or lack thereof) check. I like to look at all potential or as many as practical, comparable living accommodations – not just seniors housing (condos, apartments, etc.).
I will complete a major portion of the above with less time spent on location analysis and pricing work (though pricing is still key for accurate demand). I have watched organizations cannibalize their own market share and occupancy levels with expansion projects so accurate gauging of current and pent-up demand is critical along with conditional trends (economic, competitive analysis, etc.).
M&A, Financing, Etc. Projects
Again, all of the above work is relevant but depending on the circumstances, I will incorporate benchmark data from industry sub-sets. For example, for SNFs I look at compliance information, CMS star ratings, staffing numbers, payer mix/quality mix and of course, federal and state reimbursement and policy trends. When I review covenant defaults and provide reports, I narrow the analysis based on the core nature of the default but most often, the issues of late are occupancy, pricing, and revenue models versus fixed and variable cost levels. Pricing work is often key along with a review of marketing strategies.
Is there more to this topic area? Of course and this post isn’t meant to be exhaustive nor a text-book supplement. It is however, a ready framework that can provide guidance to those looking at conducting or contracting for, a feasibility, financing or market analysis. My advice: Getting it done right the first time saves money, prevents future problems, and assists with positive outcomes for any project or purpose.
In news just released, Kindred (the post-acute, skilled, rehab and LTAcH behemoth) has made two separate offers to purchase control of Gentiva, the latest a $14 per share offer consisting of half cash, half stock ($7 and $7). An earlier offer of $13 per share was rejected and it appears the $14 offer will see the same fate. Prior to the news, Gentiva stock was trading in the mid $6 range, down 20% over the preceding 12 months. The value of the “deal” is pegged at $1.6 billion with $533 million of the total in cash and stock, the balance in assumed Gentiva debt. On a combined basis, Kindred/Gentiva would weigh-in at $7.2 billion in annual revenues, operating in 47 states.
To date, Gentiva has held fast that it is not for sale and that its present plan, implemented as One Gentiva will create more shareholder value over-time than the Kindred offer. In December, I wrote a similar analysis post on Gentiva/Harden (the merger) and the home health industry. The post can be found at http://wp.me/ptUlY-fV . In this post, I commented on the clear flaws in the One Gentiva strategy; principally the broadening of reimbursement risk strategy that is at the core of this strategy. While Gentiva posted a modest recent quarter profit after $180 million loss, virtually all of the reported gain was a result of accretion from the Harden transaction, not improved operations. For example, adjusted income attributable to Gentiva shareholders for the first quarter 2014 was $4,8 million compared to $7.1 million twelve months prior. Net cash provided by operating activities for the first quarter was negative $17.7 million vs. negative $20.6 million one-year prior – not a resounding improvement. Essentially, the fundamentals of the company are not improving and in some cases, set to erode going forward as the lion share of its revenues are Medicare home health and Medicare hospice (Odyssey) driven (88.5%). Both Medicare programs face down reimbursement trend pressure, home health dramatically more so than hospice. Hospice however, is under enormous industry-wide pressure due to continued fraud investigations among major players and the loom of federal program reform (the Medicare hospice benefit). Essentially, hospice is a no-growth industry now.
Reviewing multiple factors and general industry trends plus the health policy and economic outlooks for both companies and the post-acute industry globally, below is my analysis of the factors influencing (or should influence) the Kindred and Gentiva position.
Kindred: Where Gentiva has a reimbursement risk concentration problem, Kindred has a location of care or outlet concentration problem. Kindred is brick and mortar deep/heavy, actually too heavy. Institutional outlets, especially in-scale and capacity are shrinking. The revenue needs required to support institutional care, on a post-acute basis, are increasing while reimbursement is flat to falling. The LTAcH and SNF trends are flat and the operational efficiencies available to any provider are minimal, save offloading or minimizing debt. The quality expectations evidenced in regulation and pay-for-performance models won’t allow any significant reductions in variable costs today. To be an institutional player of success, one must have broad clinical capacity, right-sized bed compliments that match payer demand (occupied by the highest payers at high occupancy levels) and non-institutional outlets to capture discharge revenues plus participate in global contract arenas and networks (ACOs, etc.). Kindred lacks the home health/hospice scale, especially on a matching outlet basis in its respective markets. Gentiva adds this element, though at a bit of a risk via the amount of debt that Kindred would assume. The acquisition is not without risk or a sure-winner. True Gentiva brings the home health/hospice/community care component that Kindred needs as well as the scale to be immediately impactful, it simultaneously adds another level of reimbursement risk and industry risk that Kindred already has on a large-scale. Managing and integrating the Gentiva elements into Kindred’s longer range provider of choice model will not come easy. Likewise, the Gentiva acquisition will only mask temporarily, the fact that Kindred needs to right-size its own portfolio post its acquisitions of Rehabcare and Integracare (the latter a Texas limited home health/hospice provider) while still holding and operating, too much inpatient real estate that isn’t optimally performing in many markets. In essence, the play makes sense but not fully positive until all the pieces are brought tightly together; a difficult and time-consuming endeavor.
Gentiva: Gentiva has the same problems that Amedysis has and had – it needs to shrink but it can’t. Gentiva has too much debt and in a reimbursement environment that trends flat to down, it cannot grow itself out of its debt problem by “more of the same”. It’s diversification strategy through the Harden acquisition is too little, too late and not scalable fast enough to have meaningful impact. It similarly, can reduce expenses fast-enough via consolidation as it must chase revenue growth to survive and the revenue growth that pays the most is Medicare – a risk concentration it already has too much of. It needed to re-tool 8 to 10 years ago, balancing its revenue model and expanding its clinical capabilities beyond the typical home health outlet. Additionally, it needed to become more local-market centric and not simply a Medicare reimbursement machine like Amedysis (an accident waiting to happen). The notion that its One Gentiva plan can create more value for Gentiva shareholders that the Kindred offer is wrong-headed. Sans takeover talk, Gentiva trades between $6 and $8 and no upward trajectory is visible. A simple return analysis illustrates that a Gentiva shareholder will wait at least 18 months or more to equal a return of $14 today, excluding opportunity costs on the investment. Similarly, the risk concentration elements that could turn such an outlook even more dire are more than double on the Gentiva holding than on a comparable dollar for dollar holding with Kindred. Kindred simply has more ways to generate revenue, a more stable expense base, lower fixed costs and less reimbursement risk concentration than Gentiva. If Gentiva chooses not to sell, holding out for more than $14, I think the shareholders will pressure such a move in the near-term future. The Kindred offer, with debt assumption is in my opinion, a max value offer that 12 months from now, is off the table.
Back after a week of vacation (sort of) and then a week of scramble to catch up, here’s the latest that I am watching and that I find trending from readers and clients.
Medicaid and Health Care Reform: Oddly, this has been a Medicaid week for me on a number of fronts. The Supreme Court decision that caught most policy folk off-guard regarding the constitutionality of the PPACA “mandate” provision included a delightful twist on the implementation of the Medicaid expansion provisions within the Act. Effectively, the Supreme Court said that the Federal government has no authority to force states to implement Medicaid expansion via the threat of funding cuts. The net result is that states now have the option to determine whether they expand coverage in accordance with the PPACA or not. Just this week, we began to get a glimpse of how this nuance from the Supreme Court might play out in various state capitols.
The crux of the debate erupting in states like Kansas, Wisconsin, Texas, Ohio and Arizona (others likely within the next months) is whether abdication from Medicaid expansion is a good idea given the provisions within the Act (PPACA) which provide full federal funding for the expansion for the first three years and then a triturated level of funding (though still higher than current FMAP funding) for succeeding years. Estimates suggest that the additional funding for Medicaid expansion will cost the Federal government $1 trillion over the ten-year period, commencing with the start of expansion. To the point: States such as those mentioned above are justifiably leery that the Federal government may not have the fiscal capability of sustaining the expanded funding and of course, the added unfunded cost that states that adopt expansion will occur as the full funding pledge devolves after the third year. Present Medicaid deficits expanded dramatically in recent months as a result of the sunset of the enhanced FMAP provided under the ARRA (Stimulus). States like Kansas and Kentucky have moved away from fee-for-service Medicaid to a managed, privately insured option in order to control and hopefully, reduce their Medicaid deficits.
Personally, I think this issue is going to loom large this fall as clearly, states governed by Republicans are setting-up a Medicaid expansion “boycott” for various political and policy reasons. DHHS Secretary Sebilius warned this week that while not participating in expansion is an option, cutting or constraining eligibility, including the expanded eligibility provided under the Act would not be permitted. DHHS’ take is that states don’t have to provide expanded insurance coverage as provided in the Act but the eligibility for Medicaid coverage would expand regardless – a potential odd mix of “I’m eligible but not in this state” kind of equation.
Psychoactive Medications and Nursing Homes: Topically, this issue is like a song I hear on the radio and then, can’t get the tune out of my head. This week, the DHHS OIG issues a report based on a review of assessments and documentation (sample) of nursing home residents medicated with psychoactive drugs and states that fully 99% of the assessments did not support the clinical use of a medication or category of medications that are by definition, psychoactive. Over and over again in some policy discussion or report, the issue of misuse of antipsychotics/psychoactive medications in nursing homes pops up. The Senate sought to attach an Informed Consent provision on a bill that would require further substantiation and discussion prior to the use of psychoactive drugs. Earlier, DHHS/CMS sought to create a requirement via rule making separating dispensing pharmacy duties from consulting pharmacy duties, under the guise that when the two are connected, inappropriate psychoactive medication issues proliferate (nonsensical but still, another measure designed to curtail inappropriate drug use in nursing homes).
Given how frequently this issue continues to arise, I’m watching for some sort of enhanced regulatory scrutiny and enforcement action to come forth. The Federal Conditions of Participation require that psychoactive medications not be used inappropriately and for restraint purposes, limiting to use to true, clinically justified mental illness. I know, and so does CMS, that all too often in all too many facilities, this is not the case and clearly, the documentation does not exist to support the medications used. Generally, when issues repeat in multiple modalities, something is brewing. For SNFs, get on this or trust me, the surveyors will soon get on you.
Medicare Claim Scrutiny for SNFs: Over the last six months, I have lost track of how many times I have warned providers about this; focused reviews of Medicare rehab claims. This enhanced contractor focused activity is based on two CMS conclusions. First, there is program fraud occurring, particularly focused on SNFs that continue to ramp-up therapy claims seeking higher reimbursements. Second, CMS is looking at RUG refinement and rebasing. Here’s the take-away and this advice hasn’t changed. SNFs need to carefully monitor their RUG distributions and particularly, their therapy contractors if they are using one. Additionally, get current MDS training and certifications in-place for your MDS Coordinator and any other clinical staff integrated in the MDS/Medicare reimbursement process. Use an external auditor to review your claims on a periodic basis to detect billing and coding abnormalities. Failure to minimally take these actions means a significant risk area is open. What I have seen to date in terms of probes and audits is nasty and in virtually every case, deserved by the SNF.
Fall Out Issues of the Week:The following are issues/trends that I’ve watched this past week that are worth briefly noting.
- Wellcare Medicaid Fraud Qui Tam settlement across nine states. Wellcare is one the big players in Medicaid managed care and it will be interesting to see how the news of the settlement impacts their viability in their existing states and in states where they are bidding for additional managed Medicaid contracts.
- The Wellpoint acquisition of Amerigroup also is interesting. Amerigroup was continuing to push for managed Medicaid contracts in various states and Wellpoint clearly interested in market share in this Medicaid environment, took a moderate sized competitor out of the mix.
- In an above comment I noted how scrutiny of SNF Medicare claims is on the rise. The source of this anti-fraud activity is private contractors called ZPICs or Zone Program Integrity Contractors. These entities are specifically engaged by CMS to detect Medicare claim fraud. In a recent study released by OIG on ZPICs, it was noted that many of the contractors had conflicts of interest which could question their impartiality. I find this fascinating as in typical fashion, the government uses a methodology to combat fraud whereby its own program is far from impartial or clean.
A regular, although not necessarily routine, exercise that I go through is a re-evaluation of recent acquisitions in the senior housing/long-term care industry to see “how they are doing or performing” post transaction. Perhaps the primary reason that I do this is my curiosity regarding the effectiveness of the due diligence process and the accuracy of the valuation or economic value proposition created by the acquirer as translated into purchase price. In short, I’m always curious as to whether the buyer got what he/she/they expected at the anticipated cost (purchase price plus other investments required over the first year or so) he/she/they expected to pay. As the mechanics and theory behind valuations and due diligence vary between deal to deal (from what I have observed), it is interesting to look at “how things are turning out” once the feeling of accomplishment and the haze of the deal have passed.
When things don’t go well or aren’t going well at the one year mark, something I find more common in health care transactions (SNFs, Home Care, Hospice, etc.) and less so in Assisted Living or Senior Housing, it nearly always seems to a be a flawed due diligence process that led to an over-estimation of value. More succinct: Because the due diligence process missed too many issues the price became over-stated as the costs associated with achieving stable operations were under-estimated or the classic, “he/she/they paid too much for what they got”. Where I notice the largest number of errors occurring during due diligence is when the due diligence is treated as a justification for the purchase price or, a process of validation rather than a process to quantify the economic risks and benefits that are modifiers to the valuation and ultimately, to the negotiated price. Proof of a what a friend of mine always says; “It doesn’t take a rocket scientist to overpay”.
Separating the issues a bit, valuation is effectively a financial quantification of the relative worth of the business as it stands today, including business/commercial value (cash flow, revenues, expenses, etc.) and tangible and intangible asset value (bricks and mortar, equipment, trademarks, name, etc). When Buyers capably test the values against their own business models and the available universe of comparable values, the Buyer has established a range of possible purchase price points. Ideally, within this range lies a number that the Seller will accept or that matches closely, the Seller’s asking price. At this stage, I would argue that a Buyer should never impute any assumptions on a go-forward basis about “how much” expenses could be lowered or revenues increased to massage an improved value. A wise Buyer would best assume that upon acquisition, almost all aspects of the business “as is” are set as constant and these same constants are the financial constraints that place the boundaries on the project’s range of values. This is not to suggest that a pro forma assumption about “go forward” operations that assumes lower debt costs (if applicable), some efficiencies via scale and some reduction in overhead may not be applicable (if in fact they are real and quantifiable). It is however, a caution based on too many valuations completed at the behest of or by Buyers, that include unrealistic assumptions of census increases, revenue increases, expense reductions, etc., that are hardly quantifiable or even in fact, justified for the particular transaction. To illustrate: A few years ago I helped an out-of-state buyer get into a particular nursing home transaction (nursing home was for sale). The buyer owned nursing homes in other locations so the industry was not totally foreign. The location of the facility was decent but the plant was old and the facility’s reputation marginal. The asking price had yet to be set “in stone”. The buyer, accustomed to paying higher prices in other areas, began talking numbers that were far too high for the project, justifying the price with claims of significant improvements in Medicare census and Medicare revenue per day that were unrealistic for the facility (never happened at this location before) and were beyond the norms of the market area. While I tried to counsel the buyer to be more judicious, the buyer went ahead and acquired the facility. Within two years, the buyer abandoned the site, having substantially over-paid, never achieving the projections for revenue and census “touted” for the facility.
Due diligence encompasses the financial valuation but extends the tasks into a level of greater detail that adds or subtracts (creation of debits and credits) from the range of possible values/prices. In the best of due diligence processes, the methodology also incorporates a review of risks and assists in quantifying costs associated with these risks. In reality, due diligence should attempt to paint a complete picture of all elements of the transaction, providing final quantification of the price and qualifications to the transaction that must be accounted for by the buyer. Thought of or approached this way and using the example I presented above, the buyer would never have paid what they paid for the facility and would have realized that achieving a stable, successfully operating SNF in that location would take them years and significant financial and human capital investments.
While buyers tend to approach due diligence and valuation different, each varying upon a theme and using their own methodology and checklists, I’ve found that the problem transactions that I follow each tend to miss one or more of the following elements. Some of these elements are absolutely critical if the buyer is out-of-state or out of the area and the acquisition represents his/her/their first foray into a given market area.
- Economic Location Analysis: Not to be confused with market research principally relying on demographics, this analysis looks deeper into the key economic location elements that are critical to the success or failure of the transaction at the given purchase price. For example, location analysis would quantify labor resources and costs – key elements for a healthcare provider. Location analysis would also quantify the strength and depth of referral patterns and the quality of such referrals by desired economic value (payer sources, etc.). Location analysis also examines the market economy and the up or downward trends that are present. Too many providers over-estimate the value of a particular location without understanding the economic factors that create or detract from the project’s value.
- Provider Status Assumption Risks: Buyers that are acquiring healthcare projects with existing Medicare business and expecting to assume the former provider’s Medicare number (most common in acquisitions) need to understand that the assumption of the Medicare number brings the assumption of risk. While it is true that lawyers will create indemnities and warranties that seek to limit the buyer’s assumption of risk, using these clauses to enforce terms when risks are present or encountered is often an expensive and fruitless exercise. In other words, the seller may no longer exist or as is often the case, will require the buyer to use an expensive legal process to enforce the indemnity and warranty provisions, all while the compliance requirements are inescapable to the current owner. Preferably, although not an expeditious process, buyers should obtain a new provider number and status for the project from CMS, targeted effective on the change of ownership – for Part A and Part B as applicable. It can be done as I have done it with each of my “former” acquisitions. By not assuming an existing provider number, the buyer avoids a whole host of issues and compliance problems that may or may not be disclosed or even known by the seller. CMS, as one would suspect, will only chase the “owner” of the existing provider number when problems arise or are detected and if that is the new owner, regardless of whether the issues pertained to a former operator/owner, the new owner is expected by CMS to be the sole source of remedy. CMS does not care about the terms of the deal between private parties.
- Billing Risks and Revenue Accuracy: This is a problem area that I see all to frequent. The buyer relies on the seller’s representation of revenues and does no further testing. I lost count of how many times buyers relied on accountant prepared or audited statements as being “gospel” only to find upon ownership that the revenues were over-stated. Why? First, even during an audit, accountants do not devote sufficient time or have often, sufficient expertise to analyze, the accuracy of the Medicare claims submitted by the seller. The typical tests are for basic paper-trail elements such as RUGs groups in SNFs matching the billing, matching the revenue postings. What needs to occur is a much more in-depth, technical review to determine if the Medicare claims that correlate to patients are in fact, correct. Again, I have seen circumstances where the Medicare revenue per day is grossly incorrect as the seller had no idea how to properly bill Medicare claims. Last, I rarely see buyers benchmark the revenue and occupancy numbers against area comparables. Payer mix and revenue per day numbers across the industry tend to fit pretty narrow ranges and when, in any transaction, they are out of this normative range, a red flag should rise.
- Compliance Risks: Another area that I see cause buyers problems time and time again. Compliance with certification, survey and accreditation standards is a function of past and yet to be. Acquiring a provider with past problems in these areas requires very careful analysis and discussions with regulatory authorities. Regulators need to be queried extensively and even, negotiated with when the buyer is acquiring a provider with a record of moderate to serious non-compliance. Don’t have the discussions or do the additional analysis and assuredly, run into compliance problems that cannot be deemed as “owned” by the prior owner/operator. Likewise, acquiring a provider with a reasonable or decent history doesn’t mean that the current status of compliance is clean. Sellers tend to wane on their commitments to compliance the closer the time comes to deal “certainty” or closing. A fair amount of time may also have passed since the current owner was re-accredited or surveyed. Complaints may be pending requiring regulatory review. What is certain is that once the acquisition is complete, regulators/surveyors will descend on the new owner in fairly short order. Take the time necessary to thoroughly review the past and current status of compliance.
- Market and Reputation Risks: Simply stated: How is the current provider viewed within the market? New ownership doesn’t mean new perceptions about the quality of the current operation. If the current operation is viewed marginally or even negatively, a new owner will have a great deal of work ahead to establish an improved or new reputation. If the business relies heavily on referrals (and most health care provider organizations do), it pays to check referral sources and other common influencers to understand the “market” perception that is in place.
- Environment and Infrastructure Risks: Assuming that acquiring an existing provider means that existing brick and mortar and equipment doesn’t require improvements immediately can be a false assumption. Existing providers may operate under waivers or as in some states, new ownership necessitates that the entirety of the project be brought to current code with the issue of a new license. Such is the case in Wisconsin. A thorough review of the environment and the infrastructure tied to building code requirements, completed by qualified individuals/organizations will minimize this risk.
- Employment Related Risk: Here I am not talking about the legal risks associated with handling employment issues during the closing processes. The risk that I am talking about occurs when buyers make one of two (or both) assumptions about the quality and stability of existing management personnel and/or, their own management personnel. The error I see too often made occurs with out-of-state buyers not acquiring sufficient local or area expertise and/or, having enough local support available via contractors (consultants, etc.) to ease the transition. Each market area and certainly, each state brings forth nuances and issues that require stable management and unique knowledge requirements. I’ve seen too many new owners underestimate the resources needed and over-estimate the ability of their management to handle new areas and states foreign to them.
In Part I, I wrote about my last week’s conversations, etc. regarding the home health industry, specifically Amedysis, the Senate Finance Committee inquiry, the industry impact via the PPACA and the likely consolidation and merger trends that are approaching. Suffice to say, not all of last week’s news and conversations focused on the home health industry as over the last thirty days, much has happened in the hospice industry as well. The difference between the two industries is that in hospice, the major news involved a significant merger and in home health, the major news involved the legal and compliance issues of the largest provider entity – Amedysis.
The hospice industry saw, via the merger between Gentiva and Odyssey, the creation of the largest home hospice company in the industry. Gentiva, while also a provider of home health, clearly chose to direct more of its attention to the hospice industry, moving from a moderate player in the industry to the predominant player via the acquisition of Odyssey. Odyssey, while not as large as Vitas (the former largest hospice provider), held substantial market share and presence and in many regions and distinct market areas, competed head to head with Vitas for patients. For more information on the Gentiva/Odyssey transaction, see a related article in my company’s E-Newsletter at http://wp.me/pD9Ac-4Q .
Analyzing this merger leads me to a series of assumptions about where the hospice industry is at present and where it is likely headed.
- Hospice is now clearly a mature market or in other words, a market that is unlikely to grow significantly over the near to intermediate term horizon. Despite a fairly profound demographic shift occurring over the next twenty to thirty years (the maturation of the baby-boomers), there is no real indication even with this influx of older adults, that hospice as model of care, will gain in referral popularity. While seniors utilize hospice more in total numbers than any other age cohort, as a percentage of the total cohort, utilization trends show little forward growth. There are a number of reasons why;
- Culturally, U.S. medicine and the U.S. population still values the process of cure or health restoration far greater than the concept of natural death. As hospice is a downstream referral (the referral comes typically from non-palliative medicine trained physicians or via hospitals and/or long-term care providers), the hospice industry relies on the referral source to be; a) knowledgeable about the value of hospice and how it works for patients and their families, b) willing to forego potential incremental revenue for continued care by making the referral to a hospice, c) willing to engage the patient and the family in a difficult conversation regarding end-of-life and treatment futility. As long as these dynamics remain in place to the extent they presently are, the growth of utilization will remain fairly stagnant.
- Financially, the incentives for referrals to hospice don’t truly exist within the current U.S. system. There are no barriers in-place to reduce the reward (payment) for continued acute, diagnostic or curative care (choose your own verbiage) and as a matter of fact, the reimbursement systems (private and public) pay incrementally more for more intense care than palliative care, even if arguably, the care is futile. As only patients and their respective treating health professionals can conclude that continued curative care is futile or unreasonable, the process of garnering more money for more treatment remains intact as a perverse incentive.
- While not for hospice people or physicians trained in palliative medicine, terminality remains an uncomfortable and even disputed condition for many physicians. Patients and there families still wish to avoid discussions far too long and in some cases, avoid the discussion altogether. While in-roads are perhaps being made in some medical centers and in certain communities, these in-roads are miniscule and not evident of a ground-swell movement toward open discussions regarding end-of-life decisions.
- As with the home health industry, the movement in Washington is toward curtailing the growth of hospice spending. The prevailing feeling in Washington policy arenas, supported by Medpac, is that the hospice reimbursement under Medicare is too generous and the benefit itself, easily manipulated and poorly defined. While the PPACA did little to negatively impact the hospice benefit or payment, the recommendations directed to the Secretary of HHS in the language intones significant changes forthcoming.
- Reimbursement under Medicare will change such that early days in the initial benefit period will be paid more as will days at the end of the patient’s stay (proximal to death). Days during the interim, longer stays will be reimbursed with lower payments. The point here is supposedly a recognition that patients with long stays have periods of stability necessitating far less care from the hospice.
- More emphasis will be placed on denying stays for non-specific terminal conditions or denying portions of stays. CMS has determined that too many longer stays are related to diagnoses such as terminal dementia, failure to thrive, etc. In order for these stays to be covered, the onus will fall on the hospice to provide very detailed documentation supporting patient decline.
- More emphasis will be placed on physicians to document terminal conditions and to prognosticate length of likely survival, especially at recertification periods. More direct “hands-on” involvement of physicians will also be required (physically seeing the patient).
- Certain types of stays and relationships between hospices and nursing homes will be closely monitored and reviewed. CMS and Medpac have determined that hospice stays in nursing home environments on behalf of nursing home patients are considerably longer and possibly in many cases, in violation (the hospice) of the conditions of participation as hospices utilize nursing home residents as sources of revenue but often, fail to meet the care requirements (using the nursing home as the source of care and service) under the hospice federal code. Additionally, CMS and Medpac have placed the target for reform squarely on the large for-profit hospices such as Vitas, Gentiva and Odyssey which have typically used nursing homes as major sources of referrals for hospice patients.
- The PPACA, while not bending the cost curve or reducing the overall level of national expenditures on health care, does change in the interim, the overall health care economy. Providers are re-positioning and re-grouping to combat what they perceive, and in some cases know, will be negative changes to how they presently do business. Providers which rely heaviest on Medicare as the bulk of their overall revenues will move the fastest and the most aggressively to alter their current business practices, knowing that regardless of the overall status of the PPACA (repeal, restore Medicare cuts, etc.), the health care economy is entering a long period of fiscal constraint – payments will never be as high or as fluid as they once were.
- Because of points 1, 2 and 3 above, the industry will head into a period of consolidation and even, contraction. The Gentiva/Odyssey merger is a signal of the maturity of the industry and the trend toward tighter regulation of hospice stays under Medicare (the bulk of the hospice revenue) and less economic value per each stay. Lower future revenues per stay, either via reimbursement cuts or regulatory constraints placed on the length of stay, means more overall stays are required to equal the same or greater revenues going forward. As the growth curve of new “potential” referrals is flat, the only real source of new business or referrals for a provider is acquisition of existing market share (buying someone else’s referrals). In order to maximize profitability in an environment where the market is mature and the total revenue per each case is flat to shrinking, providers will have to adopt one of the three strategies below.
- Acquire other providers to build more referrals or volume. While each patient stay will be economically less valuable, increasing the total number for a provider while maintaining expenses on a ratio basis, lower than revenue, will provide a method to achieving overall net income targets – critical for publicly traded provider organizations.
- Shrink the organization to fit the new revenue and length of stay realities that are in place and forthcoming. An organization that can right-size its operations to fit the new business paradigm will be smaller but potentially equally or perhaps, more profitable. The risk here is that provider organizations that are acquiring market share may marginalize some markets such that a shrinking provider (by choice) loses desirable market share.
- Expand non-Medicare business and add complementary businesses that may provide incrementally equal or more revenue than that which is lost under Medicare. Arguably, this strategy may only work for regional or single market providers and those that have strong system ties (hospital owned, etc.).
One final point to note concerns the economy. Absent from the above factors I laid out influencing the hospice industry is the stagnant economy. With recovery a daily discussion regarding likelihood and timing, current uncertainties persist that impact hospice providers rather dramatically.
- The overall number of paying patients available to all providers within the health care economy has shrunk in recent years. This shrinkage is primarily due to job losses and benefit losses. Until employment rebounds and jobs with benefits become more plentiful, consumers for health care in the form of paying patients will remain down.
- When fewer paying patients are in the queue, those patients that do have a payer source, even a less than optimal government payer source, are prized commodities. Each provider wants a piece of the same paying patient.
- Hospice is as I pointed out, a downstream referral. When the upstream referral source, principally hospitals, lacks sufficient paying patients in the queue to replace current patients it “may” customarily refer downstream, it holds the paying patient longer, either delaying the referral and the portion of revenue that comes with a longer stay or avoiding the referral all-together. Similarly, all downstream referral sources such as nursing homes compete aggressively for the referrals even though a referral of a terminal patient (or potentially terminal patient) is ordinarily, not a prize catch for most nursing homes. This competition erodes the number of total possible referrals available to a hospice.
- Each patient has an economic value to a provider. When a patient with a higher economic value (a better payer source) are lacking, providers sort down to the next patient level. This sorting process occurs as a result of too few patients with payment sources available to match the supply or capacity within the existing provider universe. Some markets hit hardest by the downturn will evidence this reality in greater depth and unfortunately, with greater persistency. For hospices (and all downstream providers) in these heaviest hit markets, referrals have trended down and will stay down until the supply of patients with payment sources increases and specifically, the supply of patients with better payment sources and today, deferred health care needs (e.g., elective surgeries such as joint replacements, etc.).
The title of this post likely appears a tad bifurcated but as you read through it, the title should make a bit more sense. In the past two weeks, I’ve had numerous conversations with potential buyer’s looking at or for (to acquire), senior housing projects (AL, IL, some CCRC and a few SNFs). Invariably, the conversations center around the current prevailing notion that “now” is a good time to buy. The most salient reasons I hear to support this belief are “values” are plentiful and capital is coming back to the industry. Alas, I guess it is my job to be the bearer of “bad news” or, not really bad news but “truth”. This is where the Fitch part of the title comes into play.
Fitch, the ratings agency, released its industry outlook for Senior Housing in mid-March and as suspected by most, the outlook remains negative. This said, it should be noted that Fitch does somewhat confirm the belief that capital is returning, albeit slowly to the sector, and that the industry as a whole has “shown suprising resiliency”. Still, as detailed within the report, 2010 contains (likely) more negative or static news for the industry than positive or encouraging news. Principal to Fitch’s outlook is its prognostication on ratings of debt issues (new and existing) and in this case, Fitch is predicting that the majority of rating decisions will be affirmations of existing ratings and when changes to ratings occur, Fitch is predicting more downgrades than upgrades. For Fitch, the ratings outlook plus the overall sector economic outlook and trend is the basis for their sector outlook.
Overall, the report presents a great deal of carry-over of issues from 2009, namely the taint in the industry left over from the Erickson collapse. Per Fitch, little has changed across the industry dynamic that caused Erickson to melt-down. In specifics, their conclusions are;
- Current economic recovery laxity and a slow and very limited recovery in the real estate sector will continue to hurt the industry.
- Letter of Credit repricing risk in the next 12-24 months is high as current Letter’s of Credit renewal, banks that previously extended credit either may pull away entirely or provide renewals at significantly higher prices. Today, the going rate trend for renewals is running at 50 to 200% higher for investment grade debt (BBB or better).
- Weaker liquidity levels for the industry will continue throughout 2010. Since 2008, liquidity levels have dropped in the key measures of days cash on hand (down by nearly 75 days), the cushion ratio (down by nearly a full point) and cash to debt (down by 10%). The concern as expressed by Fitch is for continued slow economic recovery or the potential of an additional market downturn, shocking liquidity again.
- Cost of capital continues to run higher than periods prior to the economic downturn. This is particularly true for non-rated debt and floating-rate debt and less so across a broader horizon for fixed rate debt. In reality, fixed-rate debt today is priced attractively, considering the cost of variable-rate debt and LOC (Letter of Credit) fees.
- The real estate recovery is barely, if at all visible, and for Fitch, this trend foretells occupancy fortunes for the sector. The biggest impact on occupancy remains for new projects or projects with recent sizeable expansions. Occupancy in general is down by 3 to 5% and for established providers, the trend has remained stable to marginally improving.
So the Fitch tie-in in the title? What is known by Fitch is known by lenders and the capital markets and thus is known by investors. In reality, a willing buyer and a willing seller today is only 50% of the deal; the other half is capital – unless the buyer is in an all-cash position. I’ll elaborate a tad more at the end.
As I indicated earlier, my job is to be the bearer of the truth when I talk with buyers or interested acquirers. The truth regarding the M&A scene today for senior housing is that the real value plays are projects that are small or distressed and those are virtually impossible to finance (notice I said “virtually”). When and where financing can be obtained, if needed, for these distressed or smaller projects, the terms are stiff (rates, covenants, term, overall costs). Where buyers are assuming more discounts should be available, sellers are not cooperating. In short, there is a pretty solid gap between a seller’s valuation and a buyer’s valuation of the same project or group of projects. Sometimes, this gap can be overcome but most often, for solid projects with decent cash flow, it cannot. Sellers today have precious little incentive to reach down to buyers, especially if their project (single or portfolio) is stabilized, cash-flowing, and has a solid balance sheet (average or better than industry average capital and liquidity ratios).
Another complication for buyers is the lack of decent comparable transaction data over the past two years, especially in certain areas or regions. Comparables drive valuations/appraisals and of course, valuations/appraisals drive lending terms and limits. I have seen a pretty decent disconnect between deal terms and valuation results over the past two years and in a large part, due to a lack of decent, reasonable and recent comps. Lenders, skittish as they are about the sector, are highly wary of comps from deals completed three or four years ago when the market was frankly, a tad over-heated and the economy, over-bloated. Summary: Throw out the comps that may have made sense on a representative basis three to four years ago and try to find representative comps that are from a period of market stagnation and recession – the alchemy for a valuation disconnect.
For buyers, the reality is that the market is still seller-driven and I don’t see a dramatic change occurring throughout 2010. Perhaps the most investment-ripe play is in the SNF sector as volumes are slightly up, bed prices are slightly up (albeit fractionally compared to a double-digit decline from 2008). In 2009, AL prices per unit continued to decline (30% aggregate since 2008). Note: The price suppression is a reflection again on the weakness of the housing market plus the deals completed comprised primarily of weaker projects. What the SNF sector offers today is “known” external variables and a disconnect from the real estate market. With health care reform complete, the SNF sector is essentially “stable” for investment. What this means is that revenues are easier to forecast and operating ratios quicker to analyze. The prospects in other words, of a transaction are more tangible and easier to quantify. This said, I still don’t see a ramp-up of activity, more perhaps a gradual increase with modestly rising or stable per bed prices and effectively, stable cap rates.
The AL and IL sectors will still remain a bit problematic for buyers unwilling to put a fair amount of cash into a deal or unwilling to use enough cash to create a financeable transaction for a distressed project. Value buyers are going to continue to find that sound projects are few and far between on a true value play and the stickiest issues regarding valuations and financing will remain.
The conclusions I draw and the counsel I provide today is rooted in basic economics (my history).
- Buyers and sellers exist across the entire price/value continuum. At times, the proportion of one versus the other (sellers vs. buyers) creates different strength/weakness propositions hence when a market becomes a buyer’s or a seller’s market. Most often, historically, the market is neutral. There is not enough volume today to characterize the market as predominantly strong for either side (buy or sell) but the dynamics are such that sellers with good projects have an upper-hand for the time being.
- The near term trend also favors sellers, especially as buyers begin to gain access to reasonable cost capital. Initial cycles where capital becomes cheaper or easier to access favor sellers as buyers typically will use the new-found access to buy at price points recently considered by them as too high.
- The intermediate term will favor buyers as the market seeks to return to “neutral”. Sellers, seeing deals done at increasing prices and with increasing volumes, will shift their positions from hold to sell, trying to reap a piece of the action. Too many sellers will enter the market and buyer’s will be favored.
- The credit markets will continue to gradually loosen but again, cautions regarding valuations need heed. Buyers with solid credit, cash to add equity and sound balance sheets will find fixed rate deals more and more attractive. New bond deals will also find fixed rate deals almost as attractive if not as attractive as floating rates with LOC enhancement, given the rising prices of LOCs.
- As a rule, properties that are stabilized are likely at or just beyond their low census point. I think occupancies will or have stabilized and start to trend back-up, although the slow to non-recovering real estate market will keep progress gradual. Some markets will fare better than others. I also see these same properties in a better overall position financially in 2010 than last year or the year before. Providers have done a decent job getting “lean”, save perhaps their debt load. The good news is that rates are not under pressure to rise so even potential increased LOC costs (as applicable) won’t alter too many balance sheets among the stabilized provider group.
According to the most recent release of the Dealmakers Forum published by Irving Levin Associates, July witnessed a sizable increase in transaction volume across the long-term care sector. As I noted in my last post on Assisted Living and Senior Housing, we have begun to see some volume pick-up in these segments although modest in comparison to prior years. What we have yet to see, and confirmed by Levin Associates, is stabilized deal pricing and closings involving traditional lending channels.
The SNF deals that were closed in July demonstrated to us, only a modest rebound within the segment and principally driven by a couple of one-off deals and the continued shedding by Golden Living (f/k/a Beverly) of certain groups of facilities that are either marginal performers or facility sales driven by financial statement and balance sheet needs on behalf of Golden Living. The interesting factors in these deals are the demographics of the facilities and the metrics of the deals.
Consistently, the facility sales that are occurring show low occupancies (60% to 85%), high Medicaid census and are in markets that tend to be more rural to suburban than urban. In some cases, the deals are structured around facilities that have financial troubles or have been in default or close to default. Not too surprising, the pricing has reflected the sub-par conditions of these properties, significantly below 1x revenue. In summary, these transactions still support a low pricing period for facility sales; below the typical industry norms.
Is the market back? The answer is simple – nowhere near. There are factors on the horizon that support some additional volume movement such as buyers gaining access to the HUD Lean program for financing, slightly loosening lending provisions, and suppressed prices sufficient to stir buyer interests. Across the broader market, concerns remain however for the immediate industry future. Chief among these concerns is Medicare with an initial payment reduction certainty looming (see post on SNF Update) and the prospect of additional cuts arising out of the healthcare reform proposals pending in the House and the Senate. Secondary in concern is the financial woes of state Medicaid programs. Many states have bolstered their programs temporarily via Federal stimulus funds but without a source for additional, long-term funding beyond the stimulus dollars, the deficits in these programs foretell certain fiscal woes in the Medicaid program. In short, the revenue side of the industry looks rather dreary in the near future and of course, this dread will continue to fuel lender caution.
For buyers, this may be an excellent time to bargain shop provided they are well capitalized and capable of securing funding for the acquisitions. While there likely will not be a plentiful source of “A” properties or for that matter, “B plus” properties, there will be sites available and likely, more forthcoming. The prices should remain on the better side of a bargain (below traditional norms) and most properties should have more up-side potential than down-side. The key for buyers however is to have a solid turn-around strategy and an ability to drive a more diverse and deeper payer mix than likely exists in the facility that is being acquired. It also should be noted that buyers that can quickly integrate additional product or service lines such as in-house rehab services and specialized care services such as ventilator or dialysis have a better chance of success than buyers deploying a traditional SNF/Medicare improvement strategy.
For the past nine months we’ve watched the cap rates trend up, occupancy trend down and the transaction market remain stagnant. The credit crisis of one year ago definitely chilled the “buyer” side and as a result, shoved values downward. The deals we did see done were few and far between, lots of one off deals in regional markets and clearly, value plays. Where we did see some larger deals in the works, these deals were slow in closing and in some cases, did not close at all due to appraisals that did not support the purchase price or sellers that were unrealistic about values once the appraiser confirmed the “lower” market value.
Despite the fact that the credit markets haven’t really expanded dramatically and lenders are still a bit gun-shy and conservative on terms, we are seeing the makings of more deals and predict that the third and fourth quarter will see more closings. The two biggest factors contributing to this “modest” rebound in market dynamics and deal dynamics are sellers coming to terms with where the values are today and occupancy rates that have moved upward (in general) across the industry. This is not to say that these occupancy increases have come without a price as many providers have been forced to get creative in terms of discounting and packaging to fill incremental units. Incidentally, as the residential real estate market is still lagging in most geographies, we don’t see the discounting trend to fill units abating any time soon. Many markets are border-line overbuilt and/or close to saturation and as a result, demand is still lagging compared to the supply of units available at traditional, pre-recession price per unit levels. In short, providers will still be challenged to stay creative if they wish to keep their occupancy numbers trending upward or stable. Interesting to note is that in comparison to a year or so ago, the incremental additional unit sales for most providers are not contributing to profitability at the same rate as a result of the discounting that was required to fill these units. We believe that it may take as long as an additional year to wash this effect through the market, essentially returning to post-recession per unit pricing levels in mid 2010 or the third quarter of 2010 (of course, some regional markets may take longer and some may recover a bit quicker).
On a product level, Assisted Living facilities that offer a higher-level of care within a more bundled pricing structure have tended to weather the down times better. For example, we have seen better performance and stronger occupancy levels from facilities that “specialize” in areas such as memory care and/or are specialized to a targeted population such as extremely frail elderly. Additionally, facilities that are connected with an SNF, CCRC or hospital have performed better than those that are free-standing. This trend may remain for quite some time as the maturity of the market implies that the next step toward success for the Assisted Living industry is less real-estate focused and more program and product specific. Without question, values in the industry will rebound but likely not soon to the to the pre-recession levels witnessed in 2007 and early 2008. For free-standing facilities, especially those that are non-distinct in terms of their product via a specific program or other twist (connected to a CCRC or SNF), their value expressed in a CAP rate may not return anytime soon to 2007 early 2008 levels, especially if they continue to struggle for occupancy or have to discount fees to attain higher occupancy levels.
In specifics, this remains a Buyer’s market for Assisted Living facilities. Sellers should continue to be prepared to be creative and reasonable if they wish to sell their property. What is reasonable? As few sellers are attempting to rid themselves of Grade A properties, the majority of the market is full of product that quite honestly, has some “hair” on it. By “hair” I mean either a dated building or a building in need of some improvement, one that has some occupancy problems or both. Sellers also need to be conscious of the market area in which they are attempting to sell their properties. Regardless of what anyone quotes as deals done with a particular cap rate of “X”, the reality is that cap rates are regionalized and definitely market specific. In other words, a deal done at an 8 cap in suburban Illinois does not translate to the same cap rate for a deal looking for a buyer in suburban Green Bay, Wisconsin. Similarly, rural markets and even over-bedded suburban and urban markets can dramatically influence pricing and valuations. Even facility size and of course, age of plant can have a dramatic impact on what a Buyer is willing to reasonably pay for a particular property. In some cases, Seller creativity can also play a role in what level of deal is attainable. Sellers, for example, that have some wherewithal to assist with financing either via a land contract or a similar lease to own or installment sale clauses can add value to the transaction without taking a “price haircut” to get the deal done.
On the Senior Housing side (non- ALF), the market remains rather tepid. Similar to the ALF side, financing is difficult to obtain and values are down, though not as dramatic as in the ALF market. Perhaps the strongest product remains the CCRC and as such, precious little volume in terms of transactions is occurring. Occupancy rates in this product are wide-ranging with nearly all markets seeing a continued softness in demand, though some far less so than others. Free standing, older congregate style (apartments) remain the most common type of property on the market and cap rates seem to have stabilized for the most part, north of 9. Again, markets and regions play a major factor as does the actual property, in terms of what cap rates are tied to what deals. For example, I have seen listings with occupancy problems seeking a 7 cap that have been on the market for a substantial amount of time – wholly unrealistic. I’ve also seen decent properties, solid A minus or B plus facilities that as little as a year or so ago that would have sold in the 8.5 cap range sit, even though the pricing is negotiable above a 9.5 cap. And still, I see properties close at 10 caps and higher; deals that literlly make sense. Projects that remain fairly attractive in the market are modest to lower income sites with stabilized occupancy, a clean building and are tax-credit financed or HUD financed. As the initial owners/operators explore the “out” windows in these deals, buyers still seem willing to step in and pay solid prices for these properties (no wonder).
Where the ALF market will take perhaps another year or more to recover, the Senior Housing market appears to be less far away from recovery. New development is still occurring, though not at the pace it was a couple of years ago. Lenders also seem to be a little more willing to work on straight senior housing projects, perhaps because the real estate component is the majority of the finance. Older projects with deferred maintenance or occupancy issues will still encounter wary buyers and depressed prices. A seller needs to be particularly cautious and understanding of the economics of the market and his/her property. If for example, the project is older and needs some upgrades, a buyer will be looking to acquire the property based on the “up-side”, necessitating a pretty solid discount to replacement cost. If the market area has a depressed economy and modest to declining wealth demographics, the buyer will be cautious and may have to seriously consider a re-development or re-packaging stategy to turn the project to profitability post-deal, again necessitating a more sizable discount than perhaps, the seller had considered. In summary, the projects most likely to find buyers are those that are priced at 50% to 60% of replacement cost, in decent economic markets with solid demographics, and can be viewed as having “up-side” potential, either in terms of additional occupancy, additional room for expansion, or capital upgrades that can position the project for new, higher rent paying occupants. A final word of caution for sellers is to be extremely cautious about current pricing for current tenants and the occupancy demographics thereto. Depressed rents, while presenting an up-side to a buyer in theory, may also foretell a problem that a buyer does not wish to inherit; having to play market “catch-up” with a tenant base that cannot afford it or within a market area that will view rapidly rising rents as “negative”.
On a final note, for non-profit owners of ALFs and Senior Housing projects, the most fertile ground for transactions today remains sales to or mergers with, other non-profits. The economics make far more sense for a non-profit to seek another non-profit as a partner and value can be extracted out of the deal for the “seller” in ways that a true asset sale to a for-profit buyer would never allow. This is not to say that a non-profit owner should seek exclusively a non-profit buyer, especially if the product for sale has solid occupancy and is well positioned in the market. It does mean however, that non-profits can leverage value and take advantage of a presently, more flexible and fluid market for transactions, by exploring a transaction (merger, other) with another non-profit – food for thought for non-profit buyers and sellers.