When it comes to picking investments, many often find themselves following a macro-level thesis. Often, a macro-level thesis appears to be so blindingly obvious that an investment in a certain industry "can't lose". It is often used as a reason to overlook the immediate difficulties that might otherwise suggest a more cautious approach because the gain when the macro-thesis is proved true will outweigh any loss in the near term.
Examples of macro-theses are "electric/self-driving cars are the future", "everyone has to eat" and the one I am addressing today, the "Silver Tsunami".
These theses promise significant growth in the future. Unfortunately, while certain events are very easy to predict at the macro-level, it is often difficult to predict how those events will play out at the company level. Those who were investing during the dot-com bubble most likely had at least a few duds. The thesis that the Internet was going to revolutionize our entire society was absolutely correct. Yet for every Amazon (AMZN), Alphabet (NASDAQ:GOOG) (GOOGL), and Netflix (NFLX), there are dozens of companies that went to zero.
The macro argument was dead on. The internet was our future, it would become a powerful economic driver and there were fantastic returns to be found from internet-based companies. Yet despite the radical changes the internet has made to our daily lives, numerous companies in the sector have gone belly-up. Clearly, a strong macro-thesis is not enough to justify overlooking company-specific fundamentals.
Going one step further, what happens when a macro-thesis is flat out wrong?
The Silver Tsunami
The "Silver Tsunami" is a macro-thesis advocated by Brad Thomas and others in support of healthcare REITs. Particularly those that have exposure to Skilled Nursing Facilities (SNFs) like Omega Healthcare (OHI), Sabra Healthcare (SBRA), or Care Trust REIT (CTRE).
The idea is straightforward, the aging baby boomer generation will significantly increase the 65+ and 85+ populations, which will, in turn, will cause a rising demand for services provided by SNFs. Brad says:
Baby boomers" started to turn 75 in 2016 and the age 75+ cohort will grow on both an absolute and relative basis through at least 2040 as the baby boomers replace the baby bust generation within the 75+ population. The percentage of hospital discharges to skilled nursing facilities has remained steady in recent years, suggesting they are in a prime position to benefit from this demographic wave, aka the Silver Tsunami.
The thesis is built on several undeniable facts. The Baby Boomers is a very large generation which is aging and aging inevitably causes a significant increase in health problems. It seems to be nothing but common sense that companies positioned to take care of those health problems should prosper with increasing demand. By extension, the landlords of those companies should benefit as those companies go from being considered uncertain tenants to stable sources of revenues.
The Early Results Are In
There is one core assumption that might or might not prove true: the assumption that SNFs will be used more. The growth of the 65+ and 85+ age groups is not just starting this year. It has been going on for quite some time.
Above is a comparison of the annual growth rates of the 65+ age group, the 85+ age group, and changes in the SNF population taken from the Nursing Home Data Compendium which is provided annually by CMS.
Over the 2009-2016 period, the 65+ population grew an estimated 21.7%, the 85+ population grew 14.5%, yet the SNF population declined 4.5%. While a new compendium is not yet available, it is likely that the decline in SNF populations have continued to decline given that occupancy rate surveys are suggesting 5-year lows in 2018.
Source: Census Projections Chart Authors
Using projections from census.gov, I calculated the CAGR using the projected population the first year and the last year by decade. As you can see, the population boom for 65+ has been substantially experienced and the growth rate is projected to decline slightly in the 2020s and significantly in the 2030s. With early Baby Boomers in their 70s, the significant uptick in the 85+ population growth is not expected until the 2030s.
Current population growth has been unable to overcome the headwinds for SNFs that should introduce at least a little skepticism that growth in the 2020s and 2030s will be different.
So far, the premise that aging Baby Boomers would drive demand for SNFs has not played out. The million dollar question is "why not?". To answer that question, the most logical place to look is where the funding is going. SNFs are more than 50% funded by Medicaid.
Source: Medicaid.gov Chart Authors (Inflation adjusted 2014 dollars)
Looking at Medicaid spending, we can see that spending on certified nursing facilities has been flat since 2003. Over the same period, total Medicaid spending on Long-Term-Services and Support increased from $120 billion in 2003 to $151 billion in 2014.
The primary cause has been a shift of funds away from institutions and to HCBS-Home and Community Based Services.
Wenzlow, Eiken, and Sredl wrote an excellent paper "Improving the Balance: The Evolution of Medicaid Expenditures for Long-Term Services and Supports (LTSS), FY 1981-2014" which includes the graph above. Through a series of legislative acts, Medicaid has increasingly funded non-institutional solutions.
The other major source of funds for SNFs is Medicare.
We can see that SNFs have been flat, while outpatient spending has increased significantly. Baby Boomers are getting more and spending more on medical care, SNFs just are simply not the first option.
SNFs do provide a level of constant care that cannot be provided by HCBS options. In the comments of many articles on healthcare REITs, various readers have told anecdotal stories of situations where an SNF was the only viable option. Those cases exist, the question is how many and whether the current supply is enough to meet that demand.
Pages 240-243 of the 2015 Compendium detail the population levels from 2011-2014 by the number of ADL impairments. According to the Compendium:
This includes bed mobility, dressing, eating, transferring and toileting; a resident is considered dependent in a given activity only if s/he required extensive assistance or required full staff performance of the activity; additionally, if the activity occurred two or fewer times during the seven days prior to the assessment and/or the resident's family or nonfacility staff provided total care during that time, the resident was considered dependent.
The majority of the SNF population decline has come from those with 0 ADL impairments, although the population even declined for those with 1-3 impairments. Those with 4 impairments were the only population to increase and the population with 5 impairments remained relatively stable.
This supports the idea that much of the decline in SNFs is due to alternative options. A person with 0-1 ADL impairments is a much better candidate for alternatives than someone with 4+ impairments.
With almost 20% of residents having 0 ADL impairments, there could be more room for the SNF population to decline in the near future.
A macro-thesis should always be approached with a level of skepticism. "Everybody knows" a lot of things that are not a complete picture of reality. In the case of the Silver Tsunami, we know that the elderly population is going to increase and it is safe to assume, that population will require additional medical care.
However, it is far from guaranteed that SNFs will be the primary beneficiary. Elderly people have increasingly sought alternatives to SNFs and changes in Medicare and Medicaid policies have made additional funding available for those alternatives.
The early result for the Baby Boomer generation is that SNF demand has dropped, even as they age. SNFs have only seen demand rise among those with 4 or more ADL impairments. So far, that growth has been unable to offset the decline of residents with 3 or fewer ADL impairments.
SNFs have been faced with declining populations and an increasing amount of their revenue dependent on Medicaid. It is no wonder that margins have been compressing for the industry.
The 85+ population is projected to start increasing much more rapidly in the 2030s. I cannot totally discount that during that period demand for SNFs will spike.
At the same time, many headwinds will continue over the next decade. The government will continue funding alternatives and with approximately 20% of SNF residents having 0 ADL impairments, there is plenty of room for that group to decline.
SNFs remain predominantly funded through Medicaid and Medicare. Political discussions surrounding those programs often center around how to reduce costs. Even with increasing demand, SNFs do not have the power to raise prices, they get paid what the government tells them they get paid. Not to mention that there is a political movement that believes private for-profit businesses should not be involved in healthcare at all.
Baby Boomers are aging, but it is far from guaranteed that the event will be profitable for SNFs. Those looking to invest in SNFs, whether through a REIT or directly through a company like Genesis (GEN) or The Ensign Group (ENSG) should recognize that this is a beat-up sector and the headwinds could continue. The Silver Tsunami might not be the savior it has been trumpeted as. It could lead to a smaller occupancy increase than believed, and even if it does, margins could continue to be compressed.
Disclosure: I am/we are long AMZN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.