VTR Ventas Inc

By Esther Fung 

Senior housing, medical-office buildings and hospitals all have generated big gains for commercial-real-estate investors in recent years, but skilled-nursing facilities have gotten short shrift.

A revenue squeeze stemming from a change in medical billing practices suggests that corner of the health-care sector could continue to face pressure.

The problem: Payments from Medicare and other government insurance programs make up the bulk of the revenue at skilled nursing facilities. Landlords say their tenants are battling with shorter lengths of stay and lower rates as billing practices focus more on the value of care delivered than earlier models based on the volume of services the facility provided. Now, some big real-estate investment trusts that focus on health care are starting to pare their skilled-nursing holdings.

Chicago-based Ventas Inc. in August 2015 spun off 355 skilled nursing facilities and outpatient recovery centers into a new REIT. Irvine, Calif.-based HCP Inc. is carrying out its own separation, while Sabra Health Care REIT Inc. is trimming its exposure and is now in the process of selling 29 of these assets.

"It's a turning point for health-care REITs," said Britton Costa, director in Fitch Ratings' U.S. REITs group.

For REITs, heavy exposure to skilled-nursing operators that might face pressure in their ability to pay rent adds a layer of risk that, in turn, makes it costlier for them to raise funds. Medical office buildings and hospitals, which have steadier income and more control over billings, are seen as better bets.

"The spinoff will improve our portfolio quality...and reinforce the stability and growth profile of our cash flow," said Mike McKee, executive chairman of HCP in June when the company announced the spinoff of its HCR ManorCare portfolio of skilled nursing and assisted-living assets. ManorCare has been struggling with operational missteps and headwinds from reimbursement changes.

After its 2015 spinoff, Ventas enjoyed stronger growth and achieved a greater portion of its net income from so-called private-pay assets, said Chief Executive Officer Debra Cafaro. Private-pay assets largely serve those who pay out of pocket or have coverage from commercial insurers rather than the government.

Some investors have been more hesitant about parking money in health-care REITs that contain skilled-nursing facilities, because landlords face the risk of their tenants struggling with rent payments if government budgets tighten.

But real-estate investors and analysts also say it is unlikely the market would see a resurgence of bankruptcies among these facilities that occurred in the late 1990s, when the operators then were more highly leveraged.

"It's not going to be as bad as what's perceived out there, but it's going to be bumpy for a while," said Jerry Ehlinger, managing director at Heitman, a real-estate investment-management firm, which has been underweight on health-care REITs for the past five years. It has $250 million invested in health-care REITs, which account for about 12% of its U.S. REIT investments.

"Health-care REITs had been on an enormous pie-eating contest for market share six, seven years ago. These billion-dollar deals have to come to an end," Mr. Ehlinger said.

To be sure, there is still potential for growth in REITs specializing in skilled-nursing centers, given rising demand from aging demographics and their position as a cheaper alternative to prolonged hospital stays. Investors now pay twice as much to invest in skilled nursing facilities as they did a decade ago. Last year, the average price of a bed in a skilled nursing property priced above $1 million was $78.28, double the $37.74 recorded in 2005, according to data from commercial-real-estate firm Marcus & Millichap. The numbers aren't adjusted for inflation.

Omega Healthcare Investors Inc., the largest REIT focused solely on skilled nursing properties, saw its net income nearly double in the first half this year compared with the same period last year, mainly from acquisitions and other investments. Its share price is down around 7% over the past year.

"Most of our tenants are experiencing modest earning pressure as a result of CMS's [Centers for Medicare & Medicaid Services'] continued push towards episodic payment systems," but lease payments aren't affected, said Omega spokesman Thomas H. Peterson. The Centers for Medicare & Medicaid Services' has been moving away from a fee-for-service payment model for years now, but the vast majority of Omega's tenants have cash flow that exceeds their rent obligations, he said.

Write to Esther Fung at esther.fung@wsj.com

(END) Dow Jones Newswires

October 11, 2016 13:08 ET (17:08 GMT)

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