OREANDA-NEWS. REITs continue to distance themselves from disappointing skilled nursing operating fundamentals that continued in 1Q16, based on the expectation that these challenges, which have been recognized for some time, will persist indefinitely, Fitch Ratings says.

Fitch expects skilled nursing operators' margins will be pressured for the foreseeable future due to increasing coverage under Medicare Advantage (i.e. shorter stays and lower rates); Department of Justice investigations into billing practices; and various pilot programs related to the Affordable Care Act. These factors led Genesis Healthcare to report that 1Q16 adjusted EBITDA declined 19% year-over-year and to reduce guidance for the year by 21% at the mid-point. Kindred Healthcare reported that similar factors drove the 1% decline in its nursing center revenues (15% of total for 2015).

The cost of capital for healthcare REITs with meaningful exposure to skilled nursing has become increasingly tethered to operator market sentiment. REITs that can reduce their exposure have done so, but some likely will not. Of the 'Big 3' healthcare REITs, Ventas ('BBB+' / ROS) spun off the majority of its skilled nursing investments in 2015 and HCP ('BBB' / RWN) announced intentions to follow suit.

We do not foresee Welltower ('BBB+' / ROS) pursuing a similar course due to the ongoing strategic and structural integration of its post-acute investments (principally related to Genesis). Welltower's investment thesis of operator connectivity along the continuum of care with select partners shapes its strategic rationale while the REIT's ownership of Genesis real estate, its equity stake in Genesis and its role as a lender to Genesis all provide structural disincentive to reduce its exposure.

Healthcare REITs' spinoffs may portend future changes to their portfolios beyond simply reducing post-acute exposure. Healthcare REITs have historically argued for portfolio diversification and exposure across the continuum of care, eschewing the specialization adopted by most other REITs in industrial, multifamily, office and retail.

By spinning off an entire segment on the continuum of care, healthcare REITs are tacitly acknowledging that they can operate with more focused portfolios, Fitch says. Ultimately, this may mark when the industry began to focus and adopt more meaningful capital recycling policies. If the sector can spin-off skilled nursing, for example, it could become difficult to argue for the relevance and purported synergies of life science buildings in their portfolios.