Revenue pressure climbs for skilled nursing facilities − what does this mean for healthcare REITs?

Health Systems Alert

Healthcare real estate investment trusts (REITs) invest in healthcare-related property types, among them skilled nursing facilities (SNFs), senior housing facilities, hospitals and medical office buildings.  Healthcare REITs own the underlying real estate property and lease the property (usually through triple-net leases) to the actual healthcare operators.  The performance of healthcare REITs depends on an array of factors, such as the operators’ occupancy rates and fees and receipts from third-party payors, including reimbursements under Medicare and Medicaid programs. 

Many healthcare REITS have performed successfully over the years. But reductions in Medicare reimbursement rates − which primarily impact SNFs and hospitals − as well as shifts toward alternative care providers such as home health agencies may lead to increased revenue pressures on these REITs.

SNFs face the highest levels of government reimbursement risk, because Medicare and Medicaid typically account for the vast majority of SNF revenue.  Cuts in these reimbursement rates could jeopardize the facility’s ability to pay rent. This in turn negatively impacts revenues for the healthcare REITs that own the properties. 

This risk can be compounded by federal and state laws that complicate a healthcare REIT’s ability to exercise remedies against a tenant that defaults under a lease agreement.  For example, the Internal Revenue Code provisions on REIT qualifications limit a REIT’s ability to actually operate and take control of the particular healthcare facility.  A defaulting operator also may have Medicare recoupment obligations tied to its Medicare provider number, which could discourage any replacement operator.  Further, state regulations may delay the healthcare REIT’s ability to replace a defaulting licensed operator.  Many states have certificate-of-need laws requiring a healthcare property owner to demonstrate a need for a particular facility, such as an SNF, before any transfer of operating control can occur.  As a result, if an operating tenant vacates or is forced out of a property, a healthcare REIT property owner may face regulatory delays in placing a new operating tenant.

Due to these restrictions and a need to maintain occupancy at the applicable premises, healthcare REITs may have little choice but to support a defaulting tenant for a period of time and/or agree to grant rent relief to a defaulting tenant, with the healthcare REIT absorbing the accompanying decreases in revenue.  Further, pressures on SNFs may lead to bankruptcy filings, which create a new set of issues for Healthcare REITs.  The automatic stay in place under section 362 of the Bankruptcy Code will prevent any post-filing exercise of remedies (unless the healthcare REIT obtains bankruptcy court relief from the stay), and the defaulting tenant will have the ability under section 365 of the Bankruptcy Code to reject the lease agreement in the bankruptcy case, leaving the healthcare REIT landlord with a unsecured damages claim against the bankruptcy estate and a vacated property that, as described above, may take some time to re-let to a new occupant. 

Many healthcare REITs continue to perform well and have positive long-term outlooks, not least because of favorable demographic changes in the United States.  Indeed, the Administration on Aging, an agency of the US Department of Health and Human Services, projects that by 2030 there will be approximately 72.1 million persons 65 years or older − more than double the number in 2000 − and that persons 65 or older will represent nearly 20 percent of the US population by 2030.  These figures suggest a great deal of potential for SNFs and senior living facilities and, relatedly, revenue for healthcare REIT landlords. However, healthcare REITs must be mindful of the challenges they may face due to other changes in the healthcare environment and constantly shifting federal and state law regulations on healthcare operators.

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