With increased operator investment, Welltower treads lightly in skilled nursing

Welltower Inc. is selling dozens of its U.S. skilled nursing facilities as occupancies in the sector reach a new low, but is increasing its ownership stake in the troubled company that has operated the properties.

The real estate investment trust moved to end one part of its relationship with Genesis Healthcare Inc., the largest skilled nursing operator in the country, by selling 42 skilled nursing facilities that Genesis operates. Welltower will retain an ownership interest in the properties through a joint venture with Aurora Health Network and Peace Capital, and new operators will take over for Genesis.

Genesis has received robust government assistance tied to the COVID-19 pandemic — roughly $339 million in state and federal grants as of the third quarter of 2020, not counting more than $150 million in advanced Medicare payments — but the properties' earnings fall well short of covering the rent the company pays to Welltower.

Welltower is keeping an 80% stake in nine other properties that Genesis runs under its PowerBack Rehabilitation brand, a more lucrative business line focused on short-term stays that do not involve Medicaid funding. The REIT is also increasing its Genesis ownership stake to 15% from 6%, in exchange for forgiving roughly $170 million of Genesis debt.

The series of transactions shows Welltower, like its peers among the largest healthcare real estate owners, maneuvering to deal with an asset class that was strongly impacted by tenant deaths and limited move-ins over the last year and was on shaky footing even before the pandemic. It also raises questions about how much value market participants see in Genesis, which announced March 2, as part of a recapitalization, that it will be de-listed from the NYSE.

U.S. skilled nursing occupancy fell to 71.7% in December 2020, down 13.3 percentage points from February 2020, the month before the pandemic started, according to NIC MAP Data Service.

In recent years, Genesis has struggled with high debt and corporate overhead, and most skilled nursing operators have faced unpredictable government reimbursements. While some healthcare REITs, such as Ventas Inc. and Healthpeak Properties Inc., have opted to divest their nursing portfolios, Welltower has sought to thread a needle, maintaining skilled nursing exposure through structures it says are safer than traditional property leasing.

In 2018, Welltower and ProMedica Health System Inc. formed an 80/20 joint venture to buy the skilled nursing landlord Quality Care Properties, while ProMedica purchased HCR ManorCare, which had operated the portfolio. Welltower executives maintained at the time that the deal should not be considered a skilled nursing investment, because the REIT's income was backed by ProMedica's corporate credit, and did not flow directly from property rental streams.

In the latest transaction, Welltower is contributing the PowerBack assets — the few Genesis-operated properties in which it is keeping a stake — to the ProMedica joint venture.

SMBC Nikko analyst Richard Anderson called PowerBack a "crown jewel" among Genesis brands in a March 3 note, citing the ways in which PowerBack properties differ from traditional skilled nursing facilities: They focus on patients seeking short-term rehabilitation and therefore accept Medicare — but not Medicaid — funding. Traditional skilled nursing properties draw revenue from both government programs, but Medicare funding, which lasts less than a month, is generally more robust while it exists. Medicaid, which operators use to fund longer-term stays, has a lower reimbursement rate.

The Genesis properties Welltower is shedding were generating earnings before interest, taxes, depreciation and amortization of roughly $40 million annually, or only about half of the rent the operator owed to Welltower on the properties, Mizuho Securities analyst Omotayo Okusanya said. Analysts say giving up those properties and some older ProMedica properties, while adding the PowerBack facilities to the ProMedica venture, will strengthen Welltower's overall skilled nursing investments.

"They are consolidating around which operators they're going to bet on in skilled nursing, and I think they've clearly said, 'Within the portfolio of operators we want to be part of, ProMedica is our big bet, and we're going to rally and consolidate around that,'" Okusanya said in an interview.

"You're starting to see some of these larger landlords saying, 'Genesis is not an operator we want to have a long-term relationship with,'" he added. "So I think it's more of an indictment on Genesis than anything else."

Welltower declined to comment on the Genesis transactions. The REIT comes out of the transactions with an increased ownership stake in Genesis, however, and market participants appear to differ on what the operator is worth.

Forgiving $170 million of Genesis debt got the REIT an additional 9 percentage points of ownership in the operator, which means that transaction appears to value Genesis at $2 billion dollars in total, Okusanya said. In contrast, he noted, ReGen Healthcare LLC agreed to invest up to $75 million for a one-third ownership stake in Genesis in the recent recapitalization, which appeared to value the operator at $225 million.

Public market investors do not appear to share either valuation: Genesis had a market capitalization of roughly $90 million immediately before the recent transactions were announced.

"It's kind of odd to me," Okusanya said. "If the stock's total market cap is $90 million, why are you suddenly agreeing to do this transaction at close to a $2 billion valuation of the company?"

The answer, he suggested, may lie in the fact that Welltower has already written down its loans to Genesis — which originally totaled $400 million — to zero. As a result, its interest may not be in a precise valuation, but in keeping Genesis alive to fight another day.

While the REIT could logically have demanded a larger ownership stake in Genesis, or even total control of the company, in exchange for its $170 million in debt forgiveness, Okusanya said if Welltower had taken a hard line it could have prevented the recent recapitalization of the company.

Equity investors do not appear convinced that Genesis is poised for a turnaround: Its market capitalization dropped sharply, to roughly $45 million, in the wake of the recapitalization, Welltower transactions and de-listing announcement.

Yet, with a substantially lower share price, a lower debt load and a new equity infusion, the operator may have some upside for hardy investors, Okusanya said.

"I think that what's more critical with them than anything else is time to really restructure the company," he said. "And I think that they've gotten that time now, with this restructured deal that was done with Welltower."