August 26, 2018, Maggie Flynn, Skilled Nursing News - Danny Prosky, one of the co-founders of American Healthcare Investors, Inc. (AHI), has spent more than 20 years in the field of health care real estate investment — and he remains solidly upbeat about the future of the skilled nursing industry.
Skilled Nursing News spoke to Prosky about the state of skilled nursing industry in his capacity as managing director at American Healthcare Investors, which along with Griffin Capital Corporation is a co-sponsor of the Griffin-American Healthcare REITs. In addition to his role as managing director at AHI, Prosky currently serves as president and COO of Griffin-American Healthcare REIT IV, Inc. and as the president, COO and director of Griffin-American Healthcare REIT III.
Prosky began work in the health care real estate investment trust (REIT) space in 1992 as an accountant for American Health Properties, which was acquired by HCP (NYSE: HCP) in 1999. He remained with HCP through 2006, and then joined Triple Net Properties, which merged with Grubb & Ellis Company. In 2011, he left to found American Healthcare Investors with Jeff Hanson and and Mathieu Streiff.
How do the Griffin-American REITs assess skilled nursing properties?
I would say first of all, we still like the skilled nursing space. We still feel it is the low-cost provider for patients who need that level of care, and we think it will continue to grow.
I think what we look for has changed a little bit over the past 25 years. We look for probably initial higher cash-flow-to-rent coverage than we used to get in the past. We used to be okay with 1.4x to 1.5x cash flow to rent coverage. Now we look for coverage north of that.
We look for operators that have the ability to move up the acuity chain to improve their quality mix. We look for operators who have good market presence, good size of scale within their markets, as well as good quality outcomes, which I think is more important now than ever.
What do AHI and the Griffin-American REITs look for in a SNF acquisition? What do you consider in a portfolio?
We certainly prefer to buy portfolios as opposed to single assets. We typically have them in master lease structures where the leases will be cross-defaulted and cross-collateralized across the portfolio. That gives us an additional layer of protection in case there’s an issue at one of the facilities.
We’re not typically a one-off buyer. And I think if you look at the deals we’ve announced recently, those are certainly portfolio deals.
What are some of the issues would cause you to walk away from a portfolio?
We’ve avoided deals many, many times. Certainly if someone is facing regulatory issues, that is going to affect our willingness to move forward on a transaction. If we see that occupancy and cash flow is dropping, that’s probably not going to help as far as moving forward on closing a deal.
We certainly like to see folks that are improving their market share as opposed to losing out [on] market share. But if you don’t have good outcomes and good market share in your markets, it’s going to be tough when you’re negotiating for Medicare Advantage, etc. It puts you in a weak position.
We typically offer on about 10% of what we see. The last two years we’ve looked at north of $20 billion of assets each year, and we’ve submitted offers on less than 10% of that. We’re certainly an income buyer; we’re not a value-add buyer, so we’re looking for stabilized assets that are well-leased and have good strong rent coverage.
Has the profile of the sellers you work with altered in the years you’ve been doing this?
I don’t think tremendously. When I look at the deals we’re doing now, compared with what we did 10, 20 years ago, they’re not that dissimilar. I would say sale-leasebacks are pretty common, sometimes we’ll do a transaction that’s under lease and we’ll just assume the leases.
But keep in mind, we’re portfolio buyers. I think maybe for the folks that are doing more one-off transactions, I think you probably see more changes there as opposed to the portfolio buyers who are really just buying stabilized assets and then leasing them back to the seller. I think for the one-off buyer, things have changed. It’s gotten harder for the smaller one-off facilities to survive or thrive, and I think you’ve seen some of them capitulate in a sense and sell out to larger operators. But that’s not really what we buy.
What do you look for in terms of skilled nursing operators, especially given that, as one executive recently said, skilled nursing “is truly an operating business environment?”
There’s no question that’s true. This is an operating business, first and foremost. You can buy fantastic real estate in great locations, but if your operator is not good, they’re not going to do well there.
We look at the strength of the operator and their ability to cover the rent. That’s the first thing we look at before we look at the quality, the location of the real estate, etc. Because if the operator can’t operate profitably, it doesn’t matter how nice the real estate is; it’s going to give us a problem at some point.
We look for operators that have shown consistent ability to adapt and to thrive. Any time there’s a change in the payment paradigm [and] they’ve been able to adapt and adjust and thrive, those are the kind of folks that we like to work with.
It’s typically the folks that have got better facilities better outcomes and better market concentration. I’d say those things were always important, but they’re more important now than they’ve ever been.
From an investment perspective, what are some of the biggest misconceptions about skilled nursing?
Many people are very concerned about the fact that there’s significant government reimbursement, right? Medicare, Medicaid are going to be a significant percentage of the revenues that you’re going to see within a skilled nursing facility. Of course, those of us who’ve been in the industry for a while can think back to periods of time when there’s been adjustments to those reimbursements and it’s had a negative effect on the operators.
I think the better operators have been able to adjust. I think that there’s a limit to how much can be cut, and I think a lot of the good providers that we’re working with are moving up the acuity chain and they’re taking more private insurance and Medicare patients as opposed to Medicaid patients as they’ve done in the past. That’s how they’ve adjusted; they’ve taken higher-acuity, shorter length-of-stay patients, and that’s how they’ve done well.
What are some of the greatest risks of the space, and some of the greatest rewards?
I’d say the biggest risk is that they are heavily reliant on where there’s government reimbursement, Medicare Advantage. It’s unlike many other businesses, where costs go up [and] you can raise your rates. It’s harder to do that within skilled nursing.
Your rates are oftentimes set by a third party and you kind of have to adhere to those rates You can adjust your mix, there’s things you can do. But you don’t have the flexibility to just raise your rates. That’s always been an issue with skilled nursing, and remains one.
I think from the other side, from a demographic perspective, I think skilled nursing facilities are well-positioned as far as increasing demand for their services. I think there’s a lot of consolidation in the space. I think there’s a lot of opportunities there.
Have we hit bottom in terms of occupancy for SNFs?
I think that’s probably true. I don’t necessarily expect skilled nursing occupancy to rebound by 5% over the next few years, but I think we’ve seen the bottom.
You’ve had some of the REITs culling their portfolios, and I think if you look at a lot of the transactions, they’ve been REITs selling a leased asset to another buyer.
I think you’ve seen a lot of people — maybe smaller portfolios, or even onesie, twosie-type deals — look at the environment and what’s going on and say, “Hey, this is a tough business, and it’s getting tougher. I don’t have pricing power in my market, so I’m going to sell to someone who does.”
The changes in reimbursement, the shorter length of stay, I think has driven a lot of that. You either need to adjust or sell out. I think without doing either one of those, it’s going to be tough.
Anything else you’d like to note?
Those folks working within the industry are more bullish than those working outside the industry, is what it feels like to me. If you look at our operators, even the REITs themselves, when you talk to them in private, they’re more bullish on the space than when they’re out there publicly.
I think those within the industry feel good about it long-term.