Sabra Health Care REIT Inc

NASDAQ:SBRA

Earnings Call Transcript 2022-Q1

[Operator]

Good day, ladies and gentlemen and welcome to the Sabra Health Care REIT First Quarter 2022 Earnings Conference Call.

I would like to turn the conference over to your host, Lukas Hartwich, EVP, Finance. Please go ahead, Mr. Hartwich.

[Lukas Hartwich, Executive Vice President-Finance]

Thank you, and good morning. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our expectations regarding our future financial position and results of operations, including the expected impacts of the ongoing COVID-19 pandemic, our expectations regarding our tenants and operators and our expectations regarding our acquisition, disposition and investment plans. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the year ended December 31, 2021 as well as in our earnings press release, included as Exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday.

We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances, and you should not assume later in the quarter that the comments we make today are still valid. In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as the explanation and reconciliation of these measures to the comparable GAAP results included on the Financials page of the Investors section of our website at sabrahealth.com. Our Form 10-Q, earnings release and supplement can also be accessed in the Investors section of our website.

And with that, let me turn the call over to Rick Matros, CEO, President and Chair of Sabra Health Care REIT.

[Rick Matros, President and Chief Executive Officer]

Thanks, Lukas. Good day to everybody. Appreciate everybody joining the call. Let me start off by talking about guidance though, as everybody knows, we haven't issued guidance. It's really specifically because of the managed portfolio, even though it's recovering, it's been a pretty short period of time that we've seen recovery. So we just need a little bit more a trajectory over a longer period of time so that we have a strong level of confidence and get back to providing guidance.

That said, Mike in his talking points will give some direction on with the triple net. With triple net numbers will look like over the course of the year. Our strategy for this year is pretty simple. We're focused on diversifying the portfolio with smaller deals in our existing asset classes, primarily in behavioral addiction treatment and assisted living.

And that combined with SNF asset sales will leave us we believe by the end of the year, having skilled nursing exposure, either close to or at or all-time lows and as a result of expected asset sales, our existing cash position, how low our leverage is and the volume of deals that we think we could get done this year. We have no expect – there's no expectation that we'll have to access the equity market.

Moving on to COVID related data, despite post-Omicron variants. The portfolio has not been impacted at this point. Our tenants have had an insignificant number of positive cases among staff and residents, and that's really all over our geographic areas in the states and in Canada.

Moving on to tenant’s health. Portfolio continues to be stable with no discussions with tenants on restructuring leases, the proposed CMS rule on the skilled nursing market basket, if it were to become final, would reduce our skilled rent coverage by 0.02. Our occupancy gains for our top seven skilled operators increased 190 basis points from January through March. So a really terrific recovery from the hit we all took with Omicron.

The wholly-owned AL portfolio showed similar trends and Talya will spend more time on that. Our independent living portfolio hasn't shown that level of movement, but it never really dropped it significantly. So it's been a relatively stable portfolio for us. It's not a need based asset class.

Moving onto Medicaid rates, you may recall on our year-end earnings call, I noted that with federal assistance tapering off, the industry is more focused now on the state assistance going forward. We are starting to get a lot more information about what Medicaid rate increases will look like over the course of the year. Most of which happen over the summer, nine of our states with 167 of our skilled nursing facilities will have larger than historical rate increases this year.

Most have already been approved. There are a few that are still pending legislation, but we're optimistic about them. As for PHEA and there's a lot of questions on the public health emergency access to whether it will get extended. We should know by May 15, if it gets extended in additional quarter, it currently expires July 15. The states have been assured by the administration that they'll receive a 60 day notice if it is to expire. So that's where the 5/15 date comes in.

Just want to make a couple of comments about asset class outlook, and it's really a lot of it's revolves around skilled nursing. In the five years, prior to the pandemic, just under 800 nursing homes closed. Over the course of the pandemic, 300 more closed with 400 additional nursing homes set to close. So in other words in 26 months, we've had almost as many nursing home closures as we had in the five years prior to the pandemic. That combined with demographic growth, renovating facilities and taking beds out of service will propel occupancy above pre-pandemic levels as we look out over the next several years.

We're also positive on senior housing occupancy trends. As we see a window of several years of occupancy growth before the supply dynamics at hampered growth pre-pandemic begin to have an impact. And finally, just a couple of comments on our ESG initiatives, probably noted our press release, we are really excited about this partnership we have with Well Living Lab and Delos partnership. Phase 1 of the partnership is going to be focused on the physical environment and the facilities and specifically portable air filtration, Phase 2 will focus on employee stress and burnout which obviously is a critical issue for the industry. Our second ESG report is expected to come out this summer.

And with that, I will turn the call over to Talya.

[Talya Nevo-Hacohen]

Thank you, Rick. First, I'm going to make some comments on the performance of our managed senior housing portfolio. And then I will highlight some of the initiatives that we've undertaken over the past few years to diversify our portfolio and improve the durability of Sabra’s revenue.

In the first quarter of 2022, we saw continued improvement in the operating performance of our wholly-owned, managed senior housing portfolio despite the surge in the Omicron variant, which worsened the labor challenges already being felt. As occupancy and rates continue to rise, we have reached the point where operating leverage is a benefit providing a lift to net operating income. The headline numbers on the same-store basis are occupancy for the first quarter of 2022, excluding non-stabilized assets with 79.3% driven by a 190 basis point increase in our assisted living communities and partially offset by a 30 basis point decline in our independent living communities compared to the prior quarter. Comparing the quarter to first quarter of 2021, occupancy in our assisted living communities increased 640 basis points and 140 basis points in our independent living communities.

Spot occupancies as of the end of April in our larger portfolios have grown between one and two percentage points above the average for the first quarter. REVPOR for the period, excluding non-stabilized assets with $6,279 in our assisted living portfolio, a 5.6% increase over first quarter 2021 and $2,578 in our independent living communities, a 1% increase over first quarter 2021. Cash NOI for the quarter, excluding any government stimulus funds increased 10% over the prior quarter and 18% over first quarter 2021.

Our Enlivant joint venture showed the same trends of increasing occupancy REVPOR and improving cash NOI. Occupancy with the first quarter of 2022 with 74.2%, a 1.6% increase over the prior quarter and 6.2% over the first quarter of 2021, spot occupancy at the end of April was 75.7%, a 150 basis point increase since the end of the first quarter. REVPOR for the period was $4,733, a 6% increase over first quarter 2021. Cash NOI for the quarter increased 16% over first quarter of 2021, excluding any government stimulus funds.

Emerging from the Omicron surge of early 2022 operators are addressing three key factors, hiring and retaining staff, REVPOR and leasing velocity. Our largest operators are seeing wage rate increases for frontline staff of 13% to 15% compared to early 2021 and achieving positive net hires. Offsetting this increased cost is occupancy growth coupled with higher rate increases. Our operators have raised rates 5% to 7% for current residents and are resetting rates even higher for new move-ins as leasing velocity continues to rise.

We’ve undertaken a systematic review of our portfolio to identify properties within our portfolio, which are candidates for sale or conversion to an alternate use. While the market for skilled nursing properties has been active and pricing robust, we have looked to sell certain properties in our portfolio to recycle capital. For those properties identified for conversion, we have found that the residential format of skilled nursing and senior housing sets up well for inpatient behavioral health assets, specifically addiction treatment.

In 2019, we made our first investments in standalone addiction treatment facilities, acquiring three buildings leased to two different operators. All three of the buildings had been built for other uses such as medical office and long-term acute care and were repurposed to serve as inpatient addiction treatment facilities. Our investment in behavioral health now totals about $730 million with weighted average yield of 8.3% comprised of 13 owned properties and two mortgage loans.

Behavioral health facilities now represent 13.4% of our annualized cash NOI. In addition, Sabra controls a pipeline of future deals. Eight of the 13 properties and all of the properties ensuring the mortgages are case studies for adaptive reuse, including three that are Sabra-owned properties that we targeted for conversion to an alternate use. We currently have four or more owned skilled nursing and senior housing properties that are under letter of intent with an operator and will be modified for use as addiction treatment facilities.

Upon completion of the conversion of these four properties, as well as the conversion of an asset acquired at the end of 2021, we anticipate that our investment in the behavioral health sector will increase by about $75 million. Our mortgage loan to RCA has a second tranche, which when funded will increase our investment in the space by another $35 million. We believe that investing in the behavioral space, particularly in addiction treatment accomplishes several important objectives.

Increases our investment in an area of healthcare, which has enormous unmet demands, creates organic growth through a proprietary pipeline of owned assets adapted for a new use, a process which is in Sabra’s control, allowing us to grow net operating income without competing for assets and with less additional capital, delivers assets at better economic returns for both Sabra and the new operators. So that services are accessible financially, as well as geographically to those who seek care, further diversifies the revenue streams in our portfolio by adding commercial insurance at in network rates as a primary payer at most locations, allows us to repurpose existing structures, mitigating the environmental impact of greenhouse gas emissions associated with new constructions.

We continue to meet and explore relationships with sophisticated operators in the behavioral space who have scalable platforms and evidence based results. By providing capital and real estate to expand community based care for commercially insured patients, we are participating in the democratization of behavioral healthcare in our country.

And with that, I will turn the call over to Mike Costa, Sabra’s Chief Financial Officer.

[Mike Costa, Chief Financial Officer]

Thanks, Talya. For the first quarter of 2022, we recognize normalized FFO per share of $0.38 and normalized AFFO per share of $0.38. Compared to the fourth quarter of 2021 normalized AFFO per share increased $0.01 primarily due to higher NOI from our wholly-owned managed senior housing portfolio, higher normalized AFFO from the Enlivant joint venture and the recognition of Avamere’s December 2021 rent obligation upon receipt in the first quarter.

As we discussed on last quarter’s call, we amended the Avamere lease effective February 1 and during the first quarter we received December 2021 and January 2022 rent at their previous lease rate. Compared to the fourth quarter of 2021 normalized FFO per share decreased $0.01, primarily due to an increase in weighted average shares outstanding. On an absolute dollar basis normalized FFO increased by $627,000.

Cash NOI for the quarter totaled $123.5 million compared to $109.2 million in the fourth quarter. Included in cash NOI for the fourth quarter is $7.4 million of support payments made by our unconsolidated joint venture to Enlivant. The $7.4 million represents Sabra’s share of the $15 million support payments made by the joint venture, which were entirely funded by a contribution from TPG to the joint venture. Said differently, Sabra did not contribute any funds towards the support payment made to Enlivant. After normalizing for these support payments, cash NOI increased $6.9 million sequentially.

As of March 31, 2022, our annualized cash NOI was $449.6 million and our SNF exposure represented 61.7% of our annualized cash NOI, down from 65.5% a year ago. G&A costs for the quarter totalled $10.4 million compared to $8.2 million in the fourth quarter of 2021. G&A costs for the quarter include $2.5 million of stock-based compensation expense compared to $900,000 of stock-based compensation expense in the fourth quarter.

The current quarter stock-based compensation expense of $2.5 million is more indicative of a go forward run rate as the fourth quarter expense reflects truing up payout estimates at year end. Recurring cash G&A, which is historically higher in the first quarter with $8 million or 6.4% of cash NOI and in line with our expectations. We were in compliance with all of our debt covenants as a March 31, 2022, and continue to maintain a strong balance sheet.

Our liquidity as of March 31, 2022 totaled approximately $1 billion consisting of unrestricted cash and cash equivalent of $24.8 million and available borrowings of $983.2 million under our revolving credit facility. As of March 31, 2022, our leverage was 5.11x well below our maximum of 5.5x. As I noted last quarter from time to time, our leverage may tick up above our long-term target of 5x as it did this quarter, but we would expect leverage to come down naturally over time as we recycle capital and as performance and our managed senior housing portfolio recovers for the pandemic.

Given the current cost of our equity capital, we will only be using available liquidity and capital recycling proceeds to fund investing activity and manage our balance sheet. Further, we are not focused on being a material net acquirer of assets until our cost of debt and equity improve. On March 4, 2022, our Board of Directors declared a quarterly cash dividend of $0.30 per share of common stock. The dividend will be paid on March 31, 2022 to common stockholders of record as of the close of business on May 16, 2022. The dividend represents a payout of 79% of our normalized AFFO per share of $0.38.

Lastly, while we are encouraged by the positive occupancy momentum and slow easing of labor pressures in our portfolio, the overall uncertainty regarding the recovery, including the ultimate outcome of the proposed CMS reimbursement changes remains at a level at which we are unable to confidently provide earnings guidance at this time. For some additional color on our cash NOI from our triple-net portfolio, we feel a reasonable run rate would be the triple-net cash rents noted on Page 20 of our supplement and adjusting that amount for the extra months of Avamere rents included in that number and the January rent paid by Avamere at their old rate. As a reminder, our triple-net cash NOI amount is subject to some variability because of the cash basis tenants in our portfolio.

And with that, we’ll open up the line for Q&A.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Nick Joseph from Citi. Your line is open.

[Michael Griffin, Citi]

This is Michael Griffin on for Nick. I’m curious I’d like to get your thoughts just with this proposed CMS ruling. Do you anticipate any changes coming out of the 60 day comment period?

[Rick Matros, President and Chief Executive Officer]

Well, I can tell you that the comments are all primarily focused on trying to provide CMS with the right data that will help them to come to the realization that we would all be better off if they could spread this out over two or three years. So that’s what the focus is on the part of the industry. And we’ll see what happens. We went to the point out with the impact on coverage was for us just in the event that that didn’t happen. But certainly that would be a much better outcome.

And part of the disappointment, I think that we all had was that we felt like based on prior dialogue with CMS, that’s really the approach they would take given everything else the industries been going through. And by the way, there is a precedence for phases like this. So we’re not asking for something that hasn’t happened before.

[Michael Griffin, Citi]

Got you. That’s helpful. And then just turning real quick to the addiction recovery side. I’m curious what the timing on those conversions are? And then sort of bigger picture, how big you think behavioral will grow as a part of the portfolio?

[Talya Nevo-Hacohen]

So for the conversions that are under LOI are due to commence fairly soon. Those are all assets we currently own, so we control timing and it’s – we want to make sure that the operator has the bandwidth to address several assets at a time and lease up. But that’s all moving forward and it’ll just take time to get architectural drawings and all that. That’s the easy part.

There’s an asset that I referenced that we bought for convert – we bought late 2021 for conversion, from hotel to addiction treatment. That preconstruction is already underway and that will take longer because it’s a longer – it’s a larger building. It’s like 138 or 132 units. So that’ll take longer than these smaller sniffing assisted living conversions. I’ll let Rick address scale of behavioral health overall.

[Rick Matros, President and Chief Executive Officer]

Yes. So we’ve got as Talya noted, a pretty healthy pipeline but it’s still young, it’s new and it’s a little bit hard to predict how quickly it can get to a certain size. We haven’t set any internal guidelines as to sort of capping where our exposure will be. We see it one as a really healthy growing industry that gives us one more avenue to diversify the portfolio. And so, we’ll take these things as they come.

The other thing I would note also is that because of the exposure that we’ve had and the recent deals that we’ve announced, we are getting more deal flow. But you’ve got to be careful, it is a young industry and you’ve got to do really good diligence on the operators and things like that. So we’re very cautious about how we approach all these deals.

[Michael Griffin, Citi]

Yep. I got you. Well, that’s it for me. Thanks for the time.

[Rick Matros, President and Chief Executive Officer]

Thanks.

[Operator]

Thank you. Our next question comes from Juan Sanabria of BMO Capital Markets. Your line is open.

[Juan Sanabria, BMO Capital Markets]

Hi, good morning. Thanks for the time. Just curious on the watchlist, if you can give us a sense of how that’s changed over the last couple months, given Omicron? And in your sense, have we passed the worst and coverage should improve from here? How are you thinking about potential downside risk absent a new profit wave that none of us really ever want to think about again?

[Rick Matros, President and Chief Executive Officer]

Right, right. So the watchlist hasn’t really changed partly because the hit to Omicron actually happened really quickly and then there’s been a really quickly recovery. So it’s really been pretty steady safe for us and actually comes very close to mirroring what was on our watchlist pre-pandemic. I mean, you’ve covered it for a long time, Juan. So I think once we went through all the repositioning at the end of 2017 and 2018 and did all the big asset sales we wanted, we really had taken care of the things we wanted to take care of. So things were pretty stable throughout 2019 for us and our coverage going into the pandemic, I think was at its highest point. So there’s just been a lot of consistency there for us.

[Juan Sanabria, BMO Capital Markets]

And then just on the deemphasizing or diluting of the SNF exposure. So could you just be a little bit more specific on where you think as a percentage of the portfolio you get to – I’m not sure what the historic low would be that you’re referencing? And would that be through asset sales and/or conversions? And if so, asset sales, what’s the quantum and like the yield that you’re targeting on SNF dispositions and how we should think about that?

[Rick Matros, President and Chief Executive Officer]

Sure. Our low point on skilled exposure was about 57%, which was right prior to the announcement of the CCP merger. So we think we have an opportunity to be there or better by the end of the year. And it’s a combination of a number of things. It’s a combination of where we are doing acquisitions, which right now isn’t in the SNF arena simply because there hasn’t been much availability out there. And the private market is able to pay much more than the reach because these are operators that have ancillary businesses and a lot more synergies and things like that. So the opportunities that we have for growth are in senior housing and behavioral. So that’s one piece.

And the other is asset sale. So we are going to be doing more asset sales than we had anticipated, just because of the strength of the private market. We don’t have – we’re having number of conversations right now. So we don’t have a solid number to give you in terms of what our expectation is. But I would say that I think last year we did about $100 million in asset sales and we would expect it to be quite a bit more than that this year,

[Juan Sanabria, BMO Capital Markets]

Any range, could it be like $100 million to $300 million?

[Rick Matros, President and Chief Executive Officer]

Yeah. Not more than $300 million, but more than $100 million. How about that?

[Juan Sanabria, BMO Capital Markets]

It works. Thank you.

[Mike Costa, Chief Financial Officer]

Yes. And Juan, one other thing I’ll add to that that’s going to also bring down our SNF exposure over time is going to be the recovery in our senior housing managed portfolio, because as that contributes NOI that’s more NOI from that portion of our portfolio compared to SNF, right? So that’s also going to have a positive benefit in getting our SNF exposure down.

[Juan Sanabria, BMO Capital Markets]

Thank you.

[Operator]

Thank you. Our next question comes from Rich Anderson of SMBC. Your line is open.

[Rich Anderson, SMBC]

Thanks. So you didn’t mention conversions as a mechanism to reduce your SNF exposure? Are none of the conversions that you have on top right now? SNFs, or are they other asset types?

[Rick Matros, President and Chief Executive Officer]

No, it’s not – they are SNFs, but they’re going to take a while to get done. So in terms of having a material impact this year, the conversions and sales will have an impact over time, but it won’t be – it wouldn’t be material this year.

[Rich Anderson, SMBC]

Okay. Rick, you just – you walk through the reduction and then stock of skilled nursing. I think you said something like 700 facilities closed during the pandemic testing, what it was five years prior. If that’s the case and demand’s going up and you see occupancy lift, I mean, I understand balance. How do you reconcile what looks like a decent runway for skilled nursing in the next year or two with reducing your exposure there?

[Rick Matros, President and Chief Executive Officer]

So I’d say a couple of things. One it is going to be beneficial to the business. And I would note that in additional to facility closures, the other reason that you’ve seen a lot of decline in the number of available beds is most nursing homes are really old, right? 40, 50 years old. And as people – as operators modernize them, they take beds out of service to reduce the multi-bedrooms and have just privates and semi-private and more common areas.

So in other words, a way of example, 100 bed facility after a modernization program may have 75 beds. So just to give you just a little bit more color on that. In terms of, if we think there are tailwinds to the industry, why would we want to reduce our exposure? It’s pretty simple when we’re viewed as a more diversified REIT we trade at a better multiple. And it isn’t as if we’re going to have no nursing homes. I mean, if we get down to 50%, that’s still half the portfolio, it’s still material.

But we want to be more diversified, as we’ve seen with the glorious 19 seconds during the state of the union, no matter how well we think things may be going for us, or in terms of future opportunities, this industry gives bad headlines. And most of the time undeserved, you see all the COVID related stuff, the hospitals don’t get that, but nursing homes do, and it’s really a shame. So we just don’t want to be overly dependent on what asset class would be viewed as being a single asset class REIT.

[Rich Anderson, SMBC]

Okay. That’s fair enough. And my last is, I don’t if it’s a question or a comment. But on the whole CMS clawback and trying to push for a phase in, I can’t disagree with that. Because all you’re doing then is, is extending them this negative narrative into future years. Why not while the industry is still sort of crawling out of its own hole? Why not throw the kitchen sink out and get it done all at once so that when 2023 and 2024 roll around, this whole CMS narrative is done with? So again, I don’t know if I’m asking a question or making a comment. But I don’t know, where you stand on it with that kind of mindset that I’m sharing.

[Rick Matros, President and Chief Executive Officer]

Yes. So I’ll comment on your comment. So if they spread out, there’s not going to be uncertainty. We’re going to know exactly what the impact is of spreading it out over the next two years. And spreading it out over the next two years will result in positive rate increases over the next two years and will have better than average market baskets in the near future anyway, because of the inflationary component being so high.

And look, if in the absence of everything else, the industry was dealing with Rich, with Phase 4 being the last phase and how long PHE is going to be around. And occupancy is still well below pre-pandemic levels. It’s like one more thing. And you’ve got so many operators out there that are just hanging on. If you think about maybe close to half the industries, small mom and pops, they don’t have good capital partners. It’s just horrific. And that was one of the reasons I made the point about how many nursing home closures we’ve had accelerated because of the pandemic.

So I get your point completely. And normally I would be right where you are, if all else was equal, let’s just take it and get it over with. But in the current situation, so for me, it’s not really a Sabra issue. I just look at it in terms of the entire industry and all those operators out there that are kind of out there on their own.

[Rich Anderson, SMBC]

Yeah. Fair enough. That...

[Rick Matros, President and Chief Executive Officer]

Does that give you more empathy Rich?

[Rich Anderson, SMBC]

I do feel better now. Thanks. That’s all I got.

[Operator]

Thank you. Our next question comes from Steven Valiquette of Barclays. Your line is open.

[Steven Valiquette, Barclays]

Great. Thanks. Hello everybody. So I guess, as you talked about the greater opportunity in behavioral, can you just remind us how many current operating partners you have for this asset class? Are you seeking additional high quality operating partners, or just looking to expand the number of properties with your existing partner or partners? Thanks.

[Talya Nevo-Hacohen]

We have three operators with whom we have worked on a repeat basis so far. And as I mentioned in my remarks, we continue to look to meet sophisticated operators who have scalable platforms. I think this is an incredibly fragmented industry with very few operators having scale. And so the real question is finding those that have the ability to have scale and operate at a level today that we feel is sophisticated enough to have a capital partner like us that is really going to want to grow with them. We have that with the current operators in our portfolio, and we have – are in discussions with a handful of additional operators that we think fulfil those prerequisites.

[Steven Valiquette, Barclays]

Okay. Yes, that’s what I was going to ask as a follow-up actually, is that the feedback from our side too, is that there is a fairly finite list of high quality guys that can scale. So, to that end, it could be of kind of a first mover advantage that you’re one of the earlier companies taking advantage of this. I don’t know if you agree or disagree, I don’t think you probably do, but just wanted to confirm your view on that as well.

[Rick Matros, President and Chief Executive Officer]

Yes. No, we completely agree with that. And that’s why I made the comment earlier that even though the pipeline is looking more robust, we’re really cautious with new operators because there aren’t that many true operators out there. We spent six months with Landmark before we did our first deal, just spending time getting to know them and understand their model and all that, which we never would’ve done skilled nursing or senior housing because we’d either know everybody or there’d be two degrees of separation.

[Steven Valiquette, Barclays]

Yes. Okay. Perfect. Okay. Thanks.

[Operator]

Thank you. Our next question comes from Vikram Malhotra of Mizuho. Your line is open.

[Vikram Malhotra, Mizuho]

Just maybe first one to revisit, you mentioned the uncertainty around the public health emergency. I guess, declaration going away, what are you monitoring? And what are you focused on in terms of the associated waivers that were given or benefits that existed for skilled nursing? And what's – maybe what's on your top of the list?

[Rick Matros, President and Chief Executive Officer]

Well, the top of the list is really what the states are going to do. They'll have some flexibility on FMAP. And that's why I made the comment in my opening remarks that – and to back up, I think over the last two to three quarters, I've talked about how the tone has changed at the state level. If the pandemic has really demonstrated how underfunded Medicaid is, state budgets were much healthy than anybody anticipated at the beginning of the pandemic, and many states were really generous with FMAP, which we greatly appreciate. And so going forward to see that states that comprise the majority of our skilled facilities are going to have outsized rate increases compared to past years is a huge positive.

So we're going to keep our eye on that. There are a couple of states within those nine that haven't formally approved legislation yet. So we're monitoring that. And then the other states that they don't have the same level of impact, because we don't have as many operators in those other states, but we're monitoring that as well. In terms of the three day waiver, which has been really beneficial, certainly to the Sabra portfolio during the course of the pandemic, now that acuity has migrated closer to normal levels, it's not as impactful as it was when we saw this over 2021. We saw skilled mix get closer and closer to pre-pandemic levels as acuity normalize. And then when Delta and Omicron hit obviously it spiked up again and we're still at elevated levels, but it's not like it was.

[Vikram Malhotra, Mizuho]

Okay. That's helpful. And then I just want to revisit your comment about the watch list being back to pre-COVID levels. I mean, we're in a different occupancy environment, you just laid out a lot of issues that you're monitoring. So I'm just kind of wondering what gives you confidence that there are no more tenant issues or minimal from here on?

[Rick Matros, President and Chief Executive Officer]

So when we say consistent, when we look at the operators that were on the watch list, pre-pandemic, it's really been the same operators throughout the pandemic. The reason we have a level of confidence is because we've already been through the lowest points of the pandemic from an occupancy and cost perspective. So we're in a better place now, obviously I don't want to jinx it, right. Fingers crossed that we don't have another bad variant, the variant – the post Omicron variants have been very similar to Omicron in terms of mortality and infection rates. So that's been a positive.

But I did give a cautionary note on the last call and I'll say the same thing on this call and that is there could be a gap as assistance, declines, and where people are in their recovery. So it's certainly possible as we look out the next several months that we may have to provide some rent referrals but it's going to be short-term and we don't see lease restructurings.

[Vikram Malhotra, Mizuho]

Got it. Okay. And then just last one in terms of just capital allocation between the various businesses, just obviously behavioral is very interesting as you've laid out. I'm just wondering on the senior housing side specifically, given the tailwinds in front. Can you just comment on how you're thinking about capital allocation between both and specifically just update us on your views on Enlivant?

[Talya Nevo-Hacohen]

I'll let Rick discuss the Enlivant joint venture, which is I think what you're referring to, but I will comment about senior housing. We continue to like senior housing and we'd like to be buying it. I think it's a cost of capital question at the moment because there are a lot of buyers for senior housing and cap rates have really compressed in that sector as we all know. It is our expectation that pricing may shift somewhat given the cost of debt, if that's out there right now for everybody, particularly for levered buyers that may make a difference in their analysis. But we still like the sector.

We had already announced that we are in a joint venture with Sienna Senior Living, looking to acquire with a deal in hand in Canada. So we continue to be active in that sector when it makes economic sense for us, but we're going to be cautious with how we deploy capital. Given that capital for us is a scarce resource.

[Rick Matros, President and Chief Executive Officer]

In terms of the Enlivant process, TPG is held off on a marketing process, wanting to have more time to see how the managed portfolio – how the portfolio is recovering. The portfolio has been recovering really nicely. Occupancy gains have been material since Omicron. And so I think we're getting close to the point where TPGs going to want to actively market the portfolio, but from the timing perspective, what that means is that it's not going to happen this year, because you've got months of regulatory approval as you find a buyer. So we anticipate having those facilities still in the portfolio through the remainder of 2022 and my guess is through first quarter of 2023.

[Vikram Malhotra, Mizuho]

Great. Thanks so much.

[Operator]

Thank you. Our next question comes from Austin Wurschmidt of KeyBanc. Your line is open.

[Austin Wurschmidt, KeyBanc]

Great. Thank you. I was wondering if you could provide some details behind the CMS assumptions underlying the 0.02 impact that you referenced in the release. And then, any tenants today that stand out specifically at risk from the current CMS proposal?

[Rick Matros, President and Chief Executive Officer]

Yes. So no tenants are currently at risk because of the CMS proposal. Essentially we were going to receive a 3.9% market basket increase that was sort of buoyed by inflation to a large extent. And the parody adjustment was 4.6. So that got you to 0.7% decrease from current rates. That would be effective October 1, if the proposal becomes final. Now that 0.7% decrease in rates translates to the Sabra portfolio in the aggregate is a 0.02 decrease in coverage. It's a little bit different from tenant to tenant. Skilled mix is a big differentiator. And so for example, I know when you all look at North Americans' coverage, you wonder if it's getting too tight, but North American has by far the highest skilled mix of any of our operators.

And so if you assume the difference between EBITDARM and EBITDAR is 40 to 50 basis points for most operators in the case of North American, it's closer to 30 basis points. So pretty big difference there so their dog coverage is higher than you would think it is just looking at EBITDARM coverage. But 0.02, there's not a big variance between our tenants on the 0.02 decrease.

[Austin Wurschmidt, KeyBanc]

Okay. And then just wanted to follow up on the timeline for conversions to behavioral health, how long is the stabilization period on some of these conversions. And then I'm also curious if you could give a little more color on, how you're discerning between the operators that kind of have the expertise in this business and to be winners over the longer term?

[Talya Nevo-Hacohen]

Sure. So first, on the conversions and stabilization, so it really is dependent on the size of the building and the payer mix that's happening there. So in some of our smaller buildings, depending on what state they're in, we actually have some buildings that have Medicaid and those as a payer for addiction treatment, those buildings essentially fill up almost immediately because that is an underserved client base. And in certain states, it actually is almost the reimbursements basically the same it's parity to commercial insurance.

So it can make economic sense. So stabilization can occur within three months of when you open the building two months, it can be very quick. The commercial insurance takes longer because but it's all around the contracts and the length of time it takes to negotiate the contracts with the insurers.

So it's less about marketing and more about – marketing to the customer base. It's more about actually getting the payers lined up in that case. And really the construction is actually not going to be the driving force on getting the buildings open – the converted buildings reopened. It's going to – it's typically been licensure, other sort of regulatory check the box items that take time. And sometimes we find ourselves waiting for that, which is not uncommon across our other property types as well.

You had a sec – how do we discern, you visit properties, you spend time with management, you listen to, we ask a lot of questions and listen to what they do clinically, how they market themselves. What is their customer acquisition approach? What are their results and how they understand the business and frankly, whether they can operate at a scale of more than let's say, 20 beds if they are looking to open facilities of 150 beds. So it's in the end – it's not that different from discerning capabilities of a skilled nursing operator or a senior housing operator or a hospital operator. It really is asking similar questions along the same vein understanding their commitment and their investment, not capital necessarily, but their investment in their underlying business and process.

[Austin Wurschmidt, KeyBanc]

I appreciate the thoughts. Thank you.

[Operator]

Thank you. Our next question comes from Omotayo Okusanya of Credit Suisse. Your line is open.

[Omotayo Okusanya, Credit Suisse]

Yes, good afternoon. I just wanted to follow up on Vikram's question. I think the comments Rick you made about North American were very helpful, but in regards to other tenants that I think, investors worry about, could you just give a little color more around Healthmark, and also even with the Enlivant JV, you kind of have a quarter where again, it delivered 1% NOI margins, which – and still very low occupancy. So just longer term kind of work could potentially happen with that portfolio.

[Rick Matros, President and Chief Executive Officer]

So one Healthmark is hanging in, they have a pretty decent skilled mix as well, so we don't expect to have to do anything different there from a long-term perspective. They are really fantastic operators, one of our strongest operators. So we really don't have concerns about Healthmark in terms of what specifically is your other question about?

[Omotayo Okusanya, Credit Suisse]

Yes. Enlivant, again, the NOI margin was just 1%, this quarter occupancy is still kind of lower versus some of your other shop operators. It just feels like it's lagging a little bit versus everybody else. And then you kind of have the auditors talking about the whole issue about whether it's a going concern or not. So just general, how does that living kind of recover or turn around and what are your expectations there?

[Rick Matros, President and Chief Executive Officer]

Enlivant got hit pretty hard by Omicron. And so you've got first quarter here in March and April, we saw a lot of momentum. Talya I think may have mentioned in her talking points. So they've already – they're showing great gains in their spot occupancy show, tremendous gains as well. So that was really – the first quarter was really a low point for them and really driven by Omicron in January and a good chunk of February. So they're well past that.

[Omotayo Okusanya, Credit Suisse]

Got you. Thank you.

[Operator]

Thank you. Our next question comes from John Pawlowski of Green Street. Your line is open.

[John Pawlowski, Green Street]

Thanks. Maybe just a follow up to that conversation. I just have a question on the month to month occupancy trends, you laid out in Page 2, your press release for Healthmark and Avamere. So I know Healthmark, you don't have long-term concerns, but any color on why occupancy kind of stuck in neutral at sub 66%. And again, Avamere is still well below the portfolio average, any comments would be helpful.

[Rick Matros, President and Chief Executive Officer]

Yes, there really isn't anything specific there, it's really specific to their markets. Healthmark is primarily Texas. So it's been a tough go there. Their skilled mix has been really helpful. Avamere’s skilled mix has been really helpful as well. And part of the issue with Avamere is their COVID units, which became a larger part of their business in the latter part of last year and early in this year have now started dwindling.

And so that's really been the driver there and why occupancy has been flat. Occupancy has come down because of all the COVID units that they have, they've had and trying to build occupancy. So they've basically been holding, replacing sort of one tranche of patients, if you will, with another tranche of patients as they get through that process. I think they'll be fine. And they've got obviously some really nice breathing room for how we restructure them. And the other thing I would point out on Avamere is they're getting really strong rate increases much more than anticipated Washington state and Oregon from Medicaid this summer.

[John Pawlowski, Green Street]

Okay. Your comment on Healthmark, having a tough go in Texas is that labor shortages capping emissions. What's the tough go exactly?

[Rick Matros, President and Chief Executive Officer]

Yes, to a large extent, they're starting to see some improvement in that, but that's been a big driver there.

[John Pawlowski, Green Street]

Okay. And then just one final housekeeping item, any color on the 7% sequential cash NOI decline on the behavioral health segment you saw this quarter?

[Talya Nevo-Hacohen]

I think that's – we have one operator that was more affected than –comprises most of that. And that operator had was impacted by Omicron. And to some extent, by labor as well, but occupancy in the sector usually pops in January. And Omicron really affected that, there wasn't a pop and that pop happened much later and into March. So that's what's going on there.

[John Pawlowski, Green Street]

Okay. Thank you.

[Operator]

Thank you. I'm showing no further questions at this time. I'll turn the call back over to Rick Matros, CEO for final remarks.

[Rick Matros, President and Chief Executive Officer]

Yes. Thanks. And Talya on your question, I also want to – the other issue that hurt Enlivant in the first quarter, that's now improving is if there the issues they have with labor and how much temporary agency they were using. So that's been coming down, so that'll be a positive contributing factor going forward as well.

So with that, thank you. I want to thank everybody for their time today and their attention and support. And as always, we're available to talk offline. Look forward to seeing a lot of you at Nareit. Take care.

[Operator]

Thank you, ladies and gentlemen, this does conclude today's conference. Thank you all participating. You may now disconnect. Have a great day.