CareTrust REIT (Nasdaq: CTRE) discussed efforts to de-risk its portfolio, detailing plans to repurpose 32 of its assets while still remaining active in the market, during a fourth financial quarter earnings call on Thursday.
The 32 assets – a mix of skilled nursing and seniors housing – represent approximately 10% of the real estate investment trust’s contractual cash rent and will be sold, re-tenanted or repurposed, CareTrust CEO Dave Sedgwick said.
Most notably, the REIT aims to repurpose a minority of the 32 assets into behavioral health facilities, an endeavor that is expected to take anywhere between 12 to 18 months.
CareTrust has been “stress testing” its portfolio, updating for impacts from the delta and omicron variants, labor costs and dwindling Provider Relief Funds (PRF).
“We feel like there’s a bit of inevitability for risk of default in the future, according to these stress tests,” Sedgwick said. “Our thinking is, instead of playing the ‘defer and hope’ game with folks that have been on our watch list for so long, it makes more sense to remove the uncertainty.”
Even prior to the pandemic, San Clemente, Calif.-based CareTrust made efforts to de-risk its portfolio. In August 2019 the REIT terminated its master lease with skilled nursing operator Trillium Healthcare Group and sold three of its seven facilities operated by Trillium.
“I think if we had not done that work in 2019, that we would not have had the performance that we have had through the pandemic so far,” Sedgwick said. “We’re trying now to take care of the cracks in the foundation so we can see out in the future.”
CareTrust reported 100% of contractual rents collected for Q4 during the call, although the REIT only collected 93% of rent for January of this year. Net income was $18.3 million for the quarter, a 13.3% decrease compared to the fourth quarter in 2020. Normalized funds from operations (FFO) was $37.3% for the quarter, a 9% increase from 2020’s Q4.
Results matched analyst expectations, although BMO Capital Markets said in a Wednesday analyst note that the 32-asset repositioning was a “negative surprise” despite expecting “some SNF pain.”
For the year, CareTrust generated $72 million in net income and $143.9 million in normalized FFO.
Investment in a seller’s market
Sedgwick said CareTrust intends to take advantage of the seller’s market, with a lot of distressed products, although it’s not normally a place the REIT “likes to play.”
Plans may include redeploying proceeds into new investments “underwritten for today’s realities,” Sedgwick added. Given the early stage of its investment strategy moving forward, CareTrust postponed guidance until more progress has been made.
CareTrust’s pipeline sits at $75 million to $100 million, according to Chief Investment Officer Mark Lamb, made up mostly of skilled nursing facilities and a few seniors housing assets.
Lamb and Sedgwick said the REIT is excited to partner with a “leading lender” in the space to fund loans for future growth into target markets with select operators.
“Market pricing on nursing homes has never been more robust,” Lamb said. “We’re cautiously optimistic that the reality of [Provider Relief Funds] drying up and a tighter than ever labor market will force owners into selling their assets.”
Lamb believes a low market supply, deal-hungry private liquidity and operator post-pandemic strength and efficiency all contribute to robust nursing home market pricing.
SNF market supply may pick back up as the investment community continues to highly value nursing home assets, Lamb added.
“We should look back on 2022 as a pivotal year in our history,” Sedgwick said during the call. “We’re as enthusiastic as ever about our expanding mission of matching high quality operators with great skilled nursing, seniors housing, and now behavioral health opportunities for many years to come.”
CareTrust also sees opportunities to deploy more capital this year, with all options on the table especially when it comes to redeploying the 32 assets; the REIT is considering redeployment into not just behavioral health, but skilled nursing and seniors housing too.
Its stock repurchasing program approved in 2020 is still a “significant lever” available to CareTrust, Sedgwick said.
Post-Q4, the REIT acquired a 155-bed skilled nursing facility in Ennis, Texas for $8.9 million, transaction costs included. Eduro Healthcare took over operations on Feb. 1 after adding the property to its master lease as one of CareTrust’s growing relationships.
The REIT also acquired two vacant seniors housing and memory care facilities in New Jersey at $12.4 million, also including transaction costs – the acquisition brought total investments in 2021 to $200 million.
Behavioral health as new growth vertical
Sedgwick considers CareTrust’s behavioral health repurposing initiative a “powerful new asset management tool” to prioritize and strengthen master leases in future. It’s an asset class the REIT has been looking to enter for years now, he said during the earnings call, and will provide the company with a new growth vertical.
A considerable number of skilled nursing and assisted living properties are hitting the market fairly distressed, Sedgwick explained, leaving the REIT to pick up properties at a good price and underwrite for behavioral health.
Sedgwick said negative earnings before interest, taxes depreciation and amortization (EBITDA) can be removed from facilities converted to behavioral health.
“That seems like a no-brainer, especially if the yield that you’ll get from that asset is competitive if not better than what you would get from re-tenanting or redeploying sales proceeds,” Sedgwick said.
Stabilized lease coverage for behavioral health properties is expected to be three times that of skilled nursing facilities, if not more, Sedgwick said.
For now, CareTrust’s entry into behavioral health will be from repurposing the minority of its 32 assets mentioned for restructuring.
Repurposing to behavioral health may take between 12 to 18 months before rent will come online, Sedgwick explained, between signing the lease, redeveloping the asset and getting zoning and licensing permits.
Cost to renovate properties to meet behavioral health standards depends on the scale of renovations needed – some might take $1 million to $2 million, and others $3 to $4 million, Sedgwick added.
“Unlike skilled nursing and seniors housing, there’s a gating item of zoning that’s really important,” Sedgwick said. “That zoning, that preliminary diligence work is being done right now on a handful of these properties.”
Behavioral health operators already licensed to run facilities in a state means less time needed to repurpose an asset, Sedgwick said.
“It feels like the nursing home industry did 30 to 40 years ago, in terms of regulations and licensing requirements,” Sedgwick said of the behavioral health asset class.
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