December 9, 2018, Alex Spanko, Skilled Nursing News - Tempted by demographic trends and a new reimbursement system, private equity has taken a keen interest in the skilled nursing industry over the past year. But executives at these investment vehicles would be foolish to think they can plug their existing models into nursing home business and expect the same kind of success they may have found elsewhere.
“It can lead to a lot of challenges down the road if you’re not investing in the business, you’re not investing in the people, and you’re not approaching it the right way,” Frank Small, chief investment officer at Greystone Healthcare Investments, told Skilled Nursing News.
Those challenges became national news last month when The Washington Post ran a deep dive on the problems that had plagued skilled nursing chain HCR ManorCare under the ownership of The Carlyle Group, a $201 billion private equity firm with holdings in industries as disparate as aerospace contractors, consumer goods manufacturers, and fast food chains.
But that stance isn’t just the perspective of investigative journalists reporting on patient abuse and neglect. After his real estate investment trust (REIT) purchased the properties associated with ManorCare’s operations earlier this year, Welltower Inc. (NYSE: WELL) CEO Tom DeRosa made a strikingly similar argument when describing the buildings as attractive targets for investment.
“Don’t confuse over-levered skilled nursing deals that were done by private equity groups with the operating viability of this post-acute care business platform,” DeRosa said at a REIT industry event back in June. “Remember, post-acute care is a very viable and important component of health care delivery. Because of the leverage that private equity firms who owned these businesses put on these businesses, the operations became unsustainable.”
The problem comes from the fact that certain standard aspects of the private equity playbook — streamline operations by cutting costs, layer on high amounts of leverage, and hopefully sell for a profit — just don’t work when the end product is health care delivered to vulnerable, elderly residents. But the financing structure also has a distinct set of advantages that, experts tell Skilled Nursing News, can create real advantages when deployed properly — and with a health care-first mindset.
And with the Patient-Driven Payment Model (PDPM) taking effect next fall, private equity — with its emphasis on finding value in upheaval — will likely take up an even greater share of the marketplace in 2019 and beyond.
“Any kind of new regulatory environment is a big opportunity,” Chad Elliott, managing director of mergers and acquisitions at investment and advisory firm Lancaster Pollard, told SNN. “I expect to see private equity come in pretty big here in the next six to 12 months.”
Take Michael Smith’s experience as a division president at provider Marquis Health Services, a subsidiary of the Brick, N.J.-based private equity firm Tryko Partners, LLC. Smith has worked in the nursing home industry for nearly 20 years, rising from a charge nurse to an administrator. He came to Marquis in 2015, attracted in part by CEO Norman Rokeach’s similar experience running facilities in New Jersey.
“If you look at the private equity structure, there are clinicians involved at the ownership level. They are experts in the field. They wanted to invest in something they knew about,” Smith said.
When he worked for larger corporate entities with different ownership structures, Smith said, implementing new programs — or even just the acquisition of a necessary piece of medical equipment — often took the approval of multiple parties along the bureaucratic flagpole. With Marquis’s private-equity ownership, administrators can make one phone call to a division president or Rokeach himself, Smith said, and get what they need immediately.
“We have so much more freedom and access to real-time improvement,” he said.
At a previous job, it took Smith six months to roll out a new cardiac care program. At Marquis, local administrators have driven the creation of market-specific niche services — such as bariatric and chronic kidney disease care programs — in just a few weeks’ time, helping to set the company’s facilities apart in their individual communities.
“These are things that were honestly impossible with large organizations that weren’t forward thinking,” he said. “It’s a huge advantage.”
Of course, not every private equity investor interested in the skilled nursing space has experience at the building level, and that’s why Small emphasized the importance of linking up with the best partner possible.
“Without a good operator, who’s got expertise and experience in a specific state, with the specific strategy you’re trying to execute, there will be challenges that you didn’t expect,” he said.
This contrasts with other targets of private equity investment, such as multi-family housing or commercial real estate, where snapping up the most attractive physical asset is usually the path forward to success.
“Who the management company is doesn’t really matter, because I have the best asset. In skilled nursing, it’s down to your operator,” he said.
Still, Small emphasized that the real estate itself still can affect the eventual success of an investment even with a strong operating team. It’s a strategy that Tryko has taken to heart, with director of acquisitions Uri Kahanow asking of each facility that comes across his desk: Is this a property we’d be proud to own, once we institute the necessary upgrades, for the next 20 years or more?
“We probably pass on 75% of opportunities that come our way,” Kahanow said.
Private equity firms more accustomed to other types of investments might blanch at the upfront costs required to bring a particular building up to speed, but Small said the smart ones would recognize that it’s worth it as a long-term play.
“You really have to provide a high-level of quality of care, which in the short term appears to cost you more money, through hiring more staff or training staff and retaining staff — but long-term will create more sustainable value and more bottom-line value if you can consistently provide a high quality of care,” he said.
McDonald’s model doesn’t work
But perhaps the overarching theme of SNN’s conversations with private equity players and other industry analysts was a truism about the modern skilled nursing industry at large: Local is king, and a nationwide model just doesn’t work anymore.
“I don’t believe that owning 50 facilities in 50 states has any kind of benefit whatsoever,” Elliott said.
Instead, private equity can find a niche in the space by identifying and purchasing certain pockets of buildings that may perform well but may no longer fit into a larger REIT’s overall plans — then replicate that success elsewhere.
“You can apply it to another region that has a lot of similar characteristics,” Elliott said of that growth strategy. “That makes a lot of sense to grow that way. And if you’re able to leverage any of the expenses across more beds, that’s the definition of how economics of scale work in our sector.”
Acquiring a deep knowledge of those local markets is vital, according to Small, as the reimbursement intricacies of a specific state can be vastly different — even among adjacent states.
“I might be a great operator in New Jersey, and think I’m going to go to Pennsylvania, and it’s right next door, and [I] get killed,” he said. “It’s a different business, it’s a different market. Sometimes it can be: I’m great in North Jersey, and go to South Jersey, and it’s a completely different market.”
That focus ideally should narrow down to the facility level, according to Smith.
“A better analogy to running a nursing facility in the year 2018 and forward is to look at it as an individual restaurant rather than a McDonald’s,” he said. “The McDonald’s model will not work for long-term care. I don’t think it ever did, but it especially won’t now.”