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Senior Housing Experts See Rewards -- And Potential Risks -- in New Health Care Law

Operators of Assisted-Living and Skilled-Nursing Facilities Could See a Boost in Patient Volume. But Declining Medicare Reimbursements Could Cause a Hit to the Bottom Line For Some.
May 26, 2010
The passage of reform legislation and the prospect of millions of newly insured patients coming into the health-care system are generally seen as a net positive for medical office building owners and investors. Less tangible, however -- and more difficult to untangle from ongoing demographic and economic trends -- are the effects the new law is expected to have on senior housing and nursing facilities.

Given the need to reduce health-care system costs, Medicare and Medicaid reimbursements will generally see a per-capita decline, adversely affecting revenue at skilled-nursing facilities, long-term acute care hospitals and other specialty care facilities, Fitch Ratings said in a recent analysis.

Hospitals and senior care and housing facilities dependent on Medicare and Medicaid revenue streams could see lower revenues and profits and declining values as the new law reduces government reimbursements -- in turn, restraining future rent and income gains for owners. One silver lining, according to Fitch, is that REITs and other real estate investors and lenders, acknowledging the perceived risks associated with changing government reimbursement rates, have structured leases and loans on those facilities "in a more conservative manner than is seen with facilities that rely on private sources of revenue."

"We don’t really see much change with respect to assisted living facilities" from the legislation in the near term, according to Douglas Pasquale, president and CEO of Nationwide Health Properties (NYSE: NHP). The REIT has a portfolio 75% composed of assisted-living and skilled-nursing facilities. About half of NHP’s investments in 600 assets across 43 states valued at $5 billion are assisted-living facilities, with 25% in skilled nursing, with the balance in MOBs.

Editor's Note: This week CoStar covers the potential impacts of the health care legislation on senior housing and care properties. For more coverage, see last week’s article, "Second Opinion: Real Estate Operators, Analysts See Wide-Ranging Impact of Health-Care Legislation"
On the plus side, changes in some services eligible for Medicaid could eventually shift some of the demand for lower-level rehabilitation care away from hospitals to assisted-living and home-based services as operators seek the lowest cost providers, Pasquale said during a roundtable for health care REIT executives hosted by BMO Capital Markets last month.

Skilled nursing homes may also see a boost in demand as a lower-cost alternative for certain types of post-acute care services or short-term-stay rehabilitation and related care, he said.

One element of the new legislation that analysts will closely watch is the Community Living Assistance Services and Supports (CLASS) Act, a national insurance program aimed at helping cover the cost of long-term care at lower premiums than private plans. More than two-thirds of those over age 65 will need long-term care, according to government estimates. Supporters say CLASS would provide insurance solutions for middle-class Americans who aren’t low income enough to draw Medicaid and aren’t well off enough to afford private care.

The CLASS act "may create additional demand over time, but it’s probably a half-dozen years out and was happening anyway. This [health care legislation] would add a little extra positive momentum to that," Pasquale said.

Because the precise impacts of reform can't be accurately forecast by even the brightest minds in health-care financing at this point, many senior care REITs and investors are listing health care reform as a risk factor in their prospectuses and "forward-looking statements" disclosures, even as some of those firms seek to raise money through public offerings.

"At this time, the effects of the legislation and its impact on our business are not yet known," said Orlando, FL-based Legacy Healthcare Properties Trust Inc., which filed with the SEC last month to raise up to $250 million in an IPO to acquire independent and assisted living, dementia care and continuing-care facilities.

Legacy Healthcare said results and investor returns could potentially be materially and adversely affected by the legislation and future governmental initiatives. Cost control and other health care reform measures may reduce reimbursement revenue available to Legacy Healthcare’s senior housing facilities, the company acknowledged in its filing.

"The health care industry is facing various challenges, including increased government and private payer pressure on health care providers to control costs and the vertical and horizontal consolidation of health care providers," the company said. "The pressure to control health care costs has intensified in recent years as a result of the national health care reform debate." That pressure will continue as Congress attempts to slow the growth of federal health care expenditures as part of its effort to balance the federal budget, and similar ways to cut costs are being debate by many states as well.

"These trends are likely to lead to reduced or slower growth in reimbursement for services provided by our operators at some of our senior housing facilities, and could therefore result in reduced profitability."

Fitch Ratings, however, believes that many health care facility operators, particularly larger owners, have become adept at "managing through" changes in reimbursements and other revenue in recent years. Good operators should be able to adjust to the legislative changes by reducing expenses and creating other revenue sources, Fitch said.

Even as Congress approved reform legislation in late March, the health care REIT sector, including companies focused on senior housing and care, posted relatively strong first-quarter results.

That's welcome news for investors for whom seniors housing has been a sore spot in many health care real estate portfolios since early 2008. Occupancy and rents are down because seniors haven’t been able to sell their homes as a result of the recession and soft housing market, delaying their move into assisted living, independent living facilities, dementia care and continuing-care retirement communities (CCRCs), which is a hybrid of assisted and independent living.

Despite the solid performance by REITs, fundamentals are still lagging, though they may be turning a corner. Occupancy of seniors housing fell in the first quarter while rent growth continued to slow, according to a new report by the National Investment Center for the Seniors Housing & Care Industry (NIC). Average occupancy fell to 88% for seniors housing, which includes both independent living and assisted living properties, down from 88.3% in fourth-quarter 2009. Data for the top 31 metro markets also showed continued declines in construction starts shrinkage of the construction pipeline.

"There's been erratic absorption over the last four quarters, and inventory growth has outpaced demand, but overall absorption has developed a marginally positive trend," said NIC Vice President Michael Hargrave. "Although rent growth has slowed, it has continued to remain positive. This is in sharp contrast to what we have seen in other forms of commercial real estate, and it indicates that seniors housing continues to grow and perform as a real estate asset class."

Skilled nursing ended a streak of 11 straight quarters of negative absorption, registering its first positive quarter in three years, with occupancy rates rising marginally to 89% compared to 88.8% in the fourth quarter, Hargrave noted.

As with other asset types, liquidity concerns and declining cash flows have hurt owners and investors in senior housing, especially those that over-leveraged at the peak of the market. Other investors, however, led by such savvy veterans as Legacy Healthcare’s Thomas J. Hutchison III, the former CEO of CNL Retirement Properties Inc., see that as an opportunity.

They hope to tap the public market for equity to pick up those facilities at attractive prices, believing that trends will reverse course as economic conditions improve, residential real estate values stabilize and consumer confidence rises. That should enable the growing number of people age 65 and over to sell their homes and move into senior housing. Limited growth in new supply will also drive demand.

Hutchinson’s Legacy Healthcare Properties hopes to use the proceeds from its IPO to acquire six senior housing facilities.

"We expect to benefit from a rebound in facility-level cash flows, which will improve our investment yields and enhance our total returns to stockholders," Legacy Healthcare said in its filing, outlining the business case for acquiring senior care facilities from over-extended owners.

The weakened economy and constrained capital environment presents a "compelling opportunity for well-capitalized companies to acquire high-quality, private-pay senior housing facilities at attractive prices," Legacy said.

What’s more, Legacy Healthcare believes that senior housing investors will face less competition compared to other CRE sectors because "generalist real estate investors have refocused on distressed markets and core real estate asset classes." The specialized expertise needed to underwrite such assets will restrain demand for senior housing facilities, Legacy said.

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