Sabra Health Care REIT - Q4 2023

Transcript

Operator (participant)

Good day everyone, my name is Mandeep and I will be your conference operator today. At this time I'd like to welcome everyone to the Sabra Fourth Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer session. If you'd like to ask a question during this time simply press star followed by the number oneon your telephone keypad. If you'd like to withdraw your question simply press star followed by one on your telephone keypad. I would now like to turn the call over to Lukas Hartwich, SVP Finance. Please go ahead Mr. Hartwich.

Lukas Hartwich (SVP of 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 our earnings guidance for 2024 and 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 31st, 2023, as well as in our earnings press release included as Exhibit 99.1 to the Form 8-K we furnished 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 investor section of our website at sabrahealth.com. Our Form 10-K earnings release and supplement can also be accessed in the investor section of our website. With that, let me turn the call over to Rick Matros, CEO, President, and Chair of Sabra Health Care REIT.

Rick Matros (Chairman, President, and CEO)

Thanks Lukas. Good day everybody. Appreciate you joining us. We're pleased to report continuing stability and organic growth in our portfolio. In our skilled portfolio, occupancy is up 50 basis points sequentially and 290 basis points year-over-year. Our EBITDA on rent coverage is up 0.10 sequentially with similar improvement in our top 10 in the aggregate. While labor is tough, the improvement over the last year is material. Contract labor is down 29% on a per-patient day basis, and nursing all-in is up just 4.3% on a per-patient day basis. And the combination of that coming down and our revenue per patient day growing at the rate that it's been growing in the skilled portfolio has put us in a position where in the aggregate our portfolio's margins are pretty much where they were at pre-pandemic.

So the really good news there is we're not even at pre-pandemic occupancy. So we see a really, really terrific opportunity ahead of us in terms of margins improving over where they were during pre-pandemic. We also continue to see improvement in the senior housing lease portfolio. Occupancy is up 130 basis points sequentially, and DARM rent coverage jumped 0.11. Talya will talk in detail about our SHOP portfolio. For both the skilled and senior housing portfolios, we expect occupancy to exceed pre-pandemic levels, as I said, but the reason is different for each of the two different asset classes. So for skilled, it's the demographic coupled with the declining product, and for senior housing, it's the demographic combined with the negligible new supply for the foreseeable future.

We appreciated that CMS and numerous states have been capturing cost increases and reimbursement rates, and we're optimistic that will continue at the state level this summer and for fiscal year 2025 for CMS. Our behavioral and specialty hospital portfolio has had stable performance. We have provided full-year guidance for the first time since before the pandemic with 5% and 6% increases in normalized FFO and normalized AFFO respectively at the midpoint of guidance. We're also starting to see more investment opportunities, but no clear trends as of yet. With that, I will turn the call over to Talya.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

Thank you, Rick. Sabra's entire wholly owned managed senior housing portfolio maintained positive momentum in the fourth quarter with mid- to high-teens % growth in revenue and cash net operating income on a year-over-year basis. This was a function of continued occupancy and RevPOR gains coupled with moderating expenses. Quarterly occupancy in independent living, assisted living, and memory care in our managed portfolio is the highest it has been since the second quarter of 2020. Sabra's same-store wholly owned portfolio currently consists of 51 properties of which 28 are independent living and 23 are assisted living memory care communities. The headline numbers for this portfolio, excluding non-stabilized assets and government stimulus, are as follows. Occupancy for the fourth quarter of 2023 was 81.2%, a year-over-year increase of 130 basis points, the highest occupancy for this portfolio over the past five quarters.

RevPOR in the fourth quarter of 2023 increased by 4% over the fourth quarter of 2022. Current increases for asking rents and renewals are in the 5%-7% range, more moderate than prior years as anticipated. Cash NOI for the quarter grew 12.2% over fourth quarter 2022. More recently, in January 2024, this portfolio's Cash NOI posted an increase of more than 25% compared to January 2023. The performance of Sabra's same-store assisted living portfolio is attributable to strong gains made by nearly every one of the operators managing these communities. While the foundation was set by our Inspirit portfolio, which was transitioned from Enlivant in mid-2023, nearly every operator was able to drive RevPOR while managing ExPOR. The Inspirit portfolio, about half of our same-store assisted living portfolio, experienced cash and NOI growth of 14.5% sequentially and 21% year-over-year.

We continue to see operational, financial, and cultural improvement in these communities since the transition. The same-store pool of properties in our unconsolidated joint venture with Sienna, excluding non-stabilized assets and government stimulus, had 2.5% higher occupancy in the fourth quarter on a year-over-year basis, with a 159% increase in Cash NOI in the same periods. The drivers were occupancy increases and 5.7% higher RevPOR coupled with 9.1% lower ExPOR, leading to Cash NOI margin expansion of 12.7% in the fourth quarter on a year-over-year basis. Our now leased stabilized senior housing portfolio continues to perform well, with occupancy well above pre-pandemic levels and steadily improving rent coverage. At the end of the fourth quarter, Sabra's total investment in behavioral health remained approximately $800 million.

I want to point out that the trailing 12-month statistics in the supplemental, one quarter in arrears for our behavioral health portfolio, shows a slight downward trend over the prior quarter for both occupancy and rent coverage. This is largely a function of changes in the pool of properties, including the addition of our Monroeville Residential Treatment Center to the stabilized pool in the second quarter. Monroeville currently operates at a lower occupancy rate than the rest of the pool but continues to cover its rent payment. With that, I will turn the call over to Michael Costa, Sabra's Chief Financial Officer.

Michael Costa (CFO)

Thanks, Talya. For the fourth quarter of 2023, we recognized normalized FFO per share of $0.32 and normalized AFFO per share of $0.33. During the quarter, we saw an $800,000 decrease in cash rents compared to the third quarter, primarily due to the sale of a portfolio of 13 skilled nursing and two senior housing assets during the third quarter. Also during the fourth quarter, we updated our estimates of performance-based compensation, which resulted in an increase to general and administrative expense totaling $5.1 million, of which $3.8 million relates to the first three quarters of 2023 and is normalized out of our fourth quarter normalized FFO and normalized AFFO. These amounts were partially offset by a $300,000 increase in normalized AFFO from our managed senior housing portfolio as a result of improved rates and occupancy.

This quarter, we are pleased to introduce full-year earnings guidance for the first time since the start of the pandemic. Throughout the pandemic, Sabra and many of our peers did not issue full-year guidance because the uncertain operating landscape in the industry made it difficult to project expected financial performance with a high level of conviction. As the industry enters 2024 with a much improved operational environment and as Sabra specifically enters 2024 with the majority of our portfolio transitions and repositionings behind us, we have a much clearer line of sight into the expected performance of our portfolio for the coming year. Our estimated ranges for the full-year 2024 performance on a diluted per-share basis are as follows: net income $0.53-$0.57, FFO $1.33-$1.37, normalized FFO $1.34-$1.38, normalized FFO $1.38-$1.42, and normalized adjusted FFO of $1.39-$1.43.

As a reminder, our guidance does not assume any acquisition or disposition activity. I also want to point out a few things on our 2024 guidance. At the midpoint of our normalized FFO and normalized AFFO ranges, we expect to realize year-over-year growth of approximately 5% and 6% respectively, which would be the first year of earnings growth for Sabra since the start of the pandemic. Our guidance also assumes a return to a more normalized run rate of cash G&A of approximately $36.8 million in 2024 compared to $39.5 million in 2023. As discussed on previous earnings calls, we have no floating rate debt outside of balances on our line of credit. Therefore, we expect cash interest expense in 2024 to remain consistent with 2023, with any variability coming from changes in outstanding borrowings on our line of credit.

Our current quarterly dividend of $0.30 per share would represent an 85% payout using the midpoint of our normalized AFFO guidance. Our expected earnings growth throughout our guidance range would also reduce our leverage from current levels and closer to our long-term average target. Now, briefly turning to the balance sheet. Our net debt to adjusted EBITDA ratio was 5.74x as of December 31st, 2023. As noted earlier and on previous calls, we expect leverage to naturally decrease as the performance in our portfolio continues its recovery from the pandemic. We remain committed to a long-term average leverage target of 5x and are confident we can achieve that target over time without needing to access the capital markets.

As of December 31st, 2023, we are in compliance with all of our debt covenants and have ample liquidity of $947 million consisting of unrestricted cash and cash equivalents of $41 million and available borrowings of $906 million under our revolving credit facility. Finally, on February 1st, 2024, Sabra's board of directors declared a quarterly cash dividend of $0.30 per share of common stock. The dividend will be paid on February 29th, 2024, to common stockholders of record as of the close of business on February 13th, 2024. The dividend is adequately covered and represents a payout of 91% of our fourth quarter normalized AFFO per share. And as noted earlier, this payout percentage is expected to improve in 2024. And with that, we'll open up the lines for Q&A.

Operator (participant)

At this time, I'd like to remind everyone, in order to ask a question, press star the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from a line of Joshua Dennerlein with Bank of America. Your line is open.

Farrell Granath (Equity Research Associate)

Hi, this is Farrell Granath on behalf of Josh Dennerlein. First question, I wanted to ask about the relationship with Ignite. What are you seeing in terms of opportunities going forward with either expanding or deepening this relationship, or if you can touch on any other relationships you're hoping to expand on?

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

Sure. I'm happy to take that. We have been working with Ignite since we transitioned several nursing home properties in Oklahoma to them before the pandemic and have always been interested in working with them. We did a small tack-on deal to our Oklahoma buildings. We've looked at several other deals. Now, we announced the deal that we closed on last year. We continue to look for opportunities with them. We are not the only REIT with whom they have a relationship. I think they balance us all out and look for the best terms they can get. They like to negotiate. We have tremendous respect for their capabilities as operators and are endeavoring to do more with them.

Farrell Granath (Equity Research Associate)

Great. I know you made a few comments on the SHOP business, but I was wondering if you could expand a little bit on how you're seeing that play out into 2024, either in terms of margins or occupancy?

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

I think we all wish we could see really rapid increases on the revenue side and decreases or no increases on the expense side. What I think what we really are starting to see, however, is consistent growth on the top line through both occupancy and RevPOR growth. And I think, importantly, we're starting to see that expenses per occupied room, ExpPOR, is declining. And I think that's a really key metric, which is why I added it to my talking points this morning. To me, that signals that the break-even point is being moved over so that we are now starting to get the benefit of operating leverage.

Farrell Granath (Equity Research Associate)

Great. Thank you for the color.

Operator (participant)

Your next question comes from a line of Nick Yulico with Scotiabank. Your line is open.

Elmer Chang (Equity Research Associate)

Hi. Thanks for the question. This is Elmer Chang on with Nick, touching on Ignite again in a different way. You had a fairly active quarter acquiring that portfolio. Could you just talk about whether this transaction was more so a credit-driven transaction versus maybe the operator needing capital to expand? And did you assume any mortgage debt in the process?

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

So we did not assume any mortgage debt. That's one. Two, it's not credit-driven. It's really based on operations and their very conservative look forward on what they can do with these buildings. These are newer buildings. They are buildings that the team at Ignite actually had opened when they were at their prior employer. So there's a tremendous amount of familiarity. The two buildings are very close to one another. So there's really good geographic coverage there. Does that help you?

Elmer Chang (Equity Research Associate)

Got it. Yes, that helps. Thank you. I guess just on the seniors' housing management business as well, I know you mentioned maybe seeing increased rent growth in the 5%-7% range. You talked about seeing occupancy gains, hopefully, to pre-pandemic levels. Was that a target for 2024 embedded in 2024 guidance, or is that more so like a two to three-year objective?

Michael Costa (CFO)

Yeah. I mean, I wouldn't say it would be a two to three-year objective. I think the best way to think about it, if you look back over the last couple of quarters where we put that bridge to illustrate the remaining upside in our portfolio, a healthy amount of that upside for the senior housing managed business specifically is captured in our 2024 guidance and particularly in the year-end run rate. So by the time we get to the end of 2024, the vast majority of that upside is already captured with a little bit left to capture in 2025 and beyond.

Elmer Chang (Equity Research Associate)

Got it. Okay. Thank you.

Operator (participant)

Your next question comes from a line of Austin Wurschmidt with KeyBanc Capital Markets. Your line is open.

Austin Wurschmidt (Senior Equity Research Analyst)

Great. Thanks. Just wanted to hit back on sort of the senior housing managed portfolio and maybe put a finer point on what are you assuming for same-store NOI growth for the year within that segment of the business?

Michael Costa (CFO)

Yeah. So I mean, we didn't disclose that, obviously, in our release. And I think if you look at what a lot of our peers have put out, I think just general industry sentiment of, call it, double-digit, low-teens, even mid-teens growth, I think that feels about right for our portfolio. And I think it's probably a good assumption to use when you're looking at our Sabra-specific portfolio.

Austin Wurschmidt (Senior Equity Research Analyst)

That's helpful. And I guess given sort of the acceleration you've seen now in the last couple of quarters, does that certainly a good jumping-off point heading into the year? So from here, I mean, should we assume something more consistent with historical seasonality levels, or do you think you can kind of outperform that historic seasonality just given the strength you're seeing and maybe some of the catch-up from the operator transitions that happened last year?

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

I think that you're always going to have seasonality. I think one of Rick's points at the top of the call was about the lack of new supply. So what you have is you had a larger denominator, call it pre-pandemic. You now have that same denominator, and you have more people in the cohort and more people moving in. So occupancy is increasing. And what I referenced about operating leverage is really going to be part of the story that leads to what Mike was talking about with respect to NOI growth.

In other words, the more you fill the buildings and it's not a completely static pool, but the pool of your audience and your resident numbers are moving up, and your number of beds available remains relatively static at the moment, you're going to get the benefit of operating leverage because that incremental resident has a much higher pull-through to the bottom line.

Rick Matros (Chairman, President, and CEO)

The other point I would make about guidance is, obviously, we've felt that we've had enough trends in our asset classes to provide full-year guidance. It's still impossible to predict as you've been hearing exactly how much or how quickly things are going to improve, continue to improve. Hopefully, if we've erred, we've been conservative in our assumptions.

Austin Wurschmidt (Senior Equity Research Analyst)

That all makes a lot of sense. Just one last one I wanted to hit on was you referenced sort of coverage is certainly trending positively across the overall portfolio. It does look like HealthMark Group has seen kind of continued to trend lower now for several quarters since they've been on that top 10 list. Just wondering if you could share any detail as to what's driving that and when you might expect that to stabilize or even see a reversal.

Rick Matros (Chairman, President, and CEO)

Yeah. They had really been benefiting from PRF, and that's dropped off completely. So that's actually been a big factor. They're a really good operator in a really tough environment in Texas. So we don't have any concerns about them going forward. And we think that things will level out for them and then start improving again.

Austin Wurschmidt (Senior Equity Research Analyst)

Very good. Appreciate the detail. Thank you.

Rick Matros (Chairman, President, and CEO)

Yep.

Operator (participant)

Your next question comes from a line of Michael Griffin with Citi. Your line is open.

Michael Griffin (Senior Analyst)

Great. Thanks. Just wanted to ask about the acquisition environment heading into 2024. I know in the past, you've talked about you potentially being a net acquirer in the year ahead, but you didn't include any acquisition expectations in your guidance. Just wanted to get a sense of how deep the pipeline is and sort of where you see yields for both on the skilled side and then anything on senior housing.

Rick Matros (Chairman, President, and CEO)

So I'll start. So in terms of being a net acquirer, that is our goal for this year in all the asset classes and skilled and in senior housing and behavioral as those opportunities present themselves. So I want to reiterate that even though we've focused a lot over the past year-plus on diversifying the portfolio, and obviously, our skilled exposure is at the lowest point it's been in our history, and we'll continue to drop some, we're not going to bypass doing skilled deals. We're actively looking for skilled deals. And because we're dropping so low on our skilled exposure, we're really able to do more skilled deals and still have a much more diversified REIT than we've ever had before. So everything is really about earnings growth this year.

And so we're not going to put any sort of false guardrails or boundaries around the asset classes that we're currently in.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

In terms of the depth of the acquisition pipeline, there are a couple of things, I'd say. One, senior housing market is very active, or it was very active mid-last year. Since the start of 2024, everyone's reengaged with a different perspective on pricing because there was a bid-ask spread that really made everything come to a halt. But now, it feels like there are a lot of assets on the market. There are groups that have to refinance or sell because of their situation with their lender. And so we're seeing a lot of fairly newer assets on the market on the senior housing front. Skilled nursing, I'd say the dynamic is a little different. We don't see that much product that's quality marketed by the brokerage firms. What we have found is that those transactions are happening off-market.

And it's been incumbent upon us to insert ourselves into those relationships more actively in order to capture opportunities on skilled nursing. And they're competitive as they are on senior housing. But it's active.

Michael Griffin (Senior Analyst)

Great. That's helpful. Then maybe, Rick, just back to your points and your prepared remarks about skilled margins and being back at pre-pandemic levels. I realize I think you're still about 500 basis points of occupancy below where you were pre-COVID. I guess just given, I think, the expectation for more occupancy uplift here in the near and medium term, I mean, where could we see margins get to in that business?

Rick Matros (Chairman, President, and CEO)

I mean, it's hard to predict where they can get to, but a few basis points above where they were pre-pandemic is certainly a few percentage points is certainly not out of the realm of possibilities. The question really is just how long it's going to take to get there. And it's interesting, right, because over the past couple of years, there's been so much focus on senior housing and how it's great because you're pushing through these 10% rate increases, and it's private pay, and it's gotten an advantage over the skilled nursing space. But the fact of the matter is, is the cost report process at the state level and then the Market Basket process at the federal level has a time lag. But that time lag now has been catching up, as we saw this past summer and this past October 1st.

We're going to see that again this year. You're getting some, at least compared to historical trends, some really nice outsized rate increases at a lot of the states and with CMS. Remember, this year's fiscal year Market Basket increase will not have the parity adjustment. That's going to help even more. Our revenue per patient day has really grown very, very nicely over the past couple of years. Our non-nursing labor has been relatively flat. It's been really modest inflation. Now we're seeing, as I mentioned, just under 4.5% inflation all in non-nursing over the last year. That's really helped to compensate for the occupancy. Again, how far occupancy can go, we believe it can go beyond pre-pandemic levels, at least in a number of different markets where we're starting to see access issues.

There, I think the margin uplift will be even greater than a few percentage points.

Michael Griffin (Senior Analyst)

Great. That's it for me. Thanks for the time.

Rick Matros (Chairman, President, and CEO)

Yep.

Michael Costa (CFO)

Thanks.

Operator (participant)

Your next question comes from a line of Vikram Malhotra with Mizuho. Your line is open.

Vikram Malhotra (Managing Director)

Afternoon. Thanks for taking the question. Maybe just first on the guidance. I understand this is obviously the first time post-COVID. So I'm just wondering, can you give us some specifics on what's baked into the low and the high end? You talked about low-teen Same-Store growth, but what else is specifically baked into each either of the low or high end? And is a potential credit issue baked in or not?

Michael Costa (CFO)

Yeah. I wouldn't say there's any credit issue baked in or not. I think the range is largely dictated by what Rick said earlier on the call, which, it's hard to predict where this is going to shake out. If we knew with certainty, we'd just put out one number, right? So there is some uncertainty baked in there of where we're going to end up over the course of the remainder of this year. So we're just providing ourselves some cushion there and a reasonable amount of cushion, but nothing too broad for that. So that's where it's at. It's not any credit issues or anything like that.

Vikram Malhotra (Managing Director)

Okay. And then just on the regulatory side, two things, if you could, any updated thoughts on kind of how you see the minimum staffing final ruling shaking out component-wise or timing-wise? And then, Rick, I think you alluded to the fact that there's going to be a decent Medicare bump. Should we think about it as 4%-5% this year? Is that fair? Thanks.

Rick Matros (Chairman, President, and CEO)

So on the Medicare bump, I don't want to get ahead of CMS, obviously, on anything, but we were at 4.1% last year with the parity adjustment. So I think something north of that is reasonable because there was still a lot of inflation to capture. So I don't think that's an unreasonable assumption. On the minimum staffing, there's no update really in terms of timing. They said in 2024, they'll have the final rule. But I think it's fair to say that at this point, we don't believe no matter how much they water it down, and maybe they don't water it down, but to the extent that they do, we don't think any staffing mandate is acceptable, particularly given the fact that there aren't nurses out there.

So I think the industry will take a very strong stand and do whatever it thinks is necessary to ensure its defeat. We've got bipartisan support in Congress because the fact of the matter is, even though they're not funding let's assume it was in place. Even though they're not funding it upfront, the cost report process at the state level and also at the federal level will eventually capture those increased costs, and that will show up in increased rates. So it actually will cost the government $ billions a year, even if they aren't funding it sort of upfront just because of how the cost report process works. So I think from a legislative perspective, that's a big issue.

I think the fairness of it and the lack of availability of nurses would certainly no movement on the hill relative to even having some controlled immigration for skilled workers. That would be really helpful to us. I think all those factor into why we're getting so much bipartisan support from Washington on there not being a staffing mandate.

Vikram Malhotra (Managing Director)

Great. Sorry, one last clarification. I remember last call, you had mentioned there may be a few more transitions, smaller ones. I'm just wondering if you can help us roughly quantify the benefit of the transition that have already been completed in 2023 and what the benefit is in 2024. Are there any additional transitions planned?

Michael Costa (CFO)

Yeah. I mean, in terms of the transitions that we talked about last quarter, I think if you look at the trend from when we first put out this bridge for the second quarter, and then we put out in the third quarter, you saw that that number came down because we started capturing a little bit of that. It's not a large number in totality. I think it was like $4 million. I think the total upside for that piece of the pie was like $4 million. We captured a little bit of in Q3, a little bit in Q4. I think similar with my comments on SHOP, I think by the time we get to the end of the year, we'll see most of that captured. But again, it's small dollars in the grand scheme of things.

Operator (participant)

Your next question comes from a line of Rich Anderson with Wedbush. Your line is open.

Rich Anderson (Managing Director)

Thanks. Good morning out there. So Rick, you mentioned investment opportunities, but no clear trends. What did you mean by that? I mean, are you talking about what types of assets you might buy? I know there's been some talk about that in this call, but do you have sort of a defined kind of pipeline that you're looking at, or is that still sort of hard to quantify? I'm just curious what more color you can lend on the external growth front for this year.

Rick Matros (Chairman, President, and CEO)

Sure. So one to one of Talya's points, we're not seeing much in terms of quality skilled nursing deals out there. So it's hard to predict kind of the volume and exactly where cap rates are going to settle in, although we think cap rates will stay in the 9%-10% range. I don't think we're going to see the 8-handle stuff that you saw pre-pandemic days. But we just haven't had so we're not seeing enough volume out there in all three of our asset classes. Obviously, as Talya said, we're seeing more on the senior housing side for us to be able to determine what we might be able how much we might be able to get done.

Also because of the pandemic, prior to the pandemic, we never included acquisition assumptions in guidance, but we would sometimes say, "Outside of guidance, we think we're going to get X amount of investments done this year, and we think most of them will be in the third and fourth quarter," or provide some color like that. But given the pandemic, we just don't have enough data, trend data, to even determine, "Are we going to do $200 million this year? Are we going to do $400 million this year?" It's just kind of impossible at this point. Hopefully, as we get a little bit further into the year, we'll be able to have a little bit more granularity on where we think things may go.

We'll have the first quarter earnings call not that far out from now, and hopefully, we'll have a little bit more data then that we can share.

Rich Anderson (Managing Director)

Okay. Excellent. Thanks. In terms of the spread investing opportunity, if you say 9-handle on SNFs, something lower than that on senior housing, but what do you think the range of return spread, the spread to your cost of capital will be? Is it like or should require to be, I should say, for you to pull the trigger on something that you like? Does it have to be 200+ basis points, or is that asking too much? I'm just curious where your mind is at in terms of the accretive nature of your external growth.

Rick Matros (Chairman, President, and CEO)

Yeah. So we don't have a set number. At our current cost of capital, the deals we're seeing are accretive to us. That's the main thing. We just want them to be accretive. And I think as we look out over the course of this year, everybody's still in recovery. So if we can do on the skilled side, like we just did with Ignite, a deal in the 9%-10% range, and we know there's more upside, even though you might say, "Hey, don't you want to start out with the biggest spread?" We're going to get a bigger spread over time as the industry continues to recover. And on the SHOP side, there's still a lot of upside there as well.

So it may be a little bit tighter on day one, but as long as we know the operator, we know the market, and we can see the upside there, we can see what the performance was pre-pandemic, then it's worth it to us because, as you know, as we keep kind of hammering home, we need to get back to strong earnings growth.

Rich Anderson (Managing Director)

Yep. Last question for me. You mentioned in the release 1.72x DARM coverage in your skilled space, excluding provider relief funds. Is that an arrears number? Is that a third quarter or a fourth quarter number?

Michael Costa (CFO)

It's a 12-month number as of September 30th.

Rich Anderson (Managing Director)

Oh, okay. So I took note of the fact that that same equivalent number was 1.61x in their third quarter release. That's quite an improvement. It doesn't get the benefit of the Medicare starting point in October 1 if it starts at the third quarter annualized. So what would you say is the reason for that big pop in coverage? Is there any moving parts in there that we should know about? Thanks.

Rick Matros (Chairman, President, and CEO)

Well, there are a couple of things. A lot of our operators experience larger-than-average Medicaid rates in July and August. So that starts to impact it. And labor really has moderated quite a bit. And again, and we always keep saying this, it's still really tough out there. I don't want to make light of it, but it has moderated, I think, a little bit more than we would have expected. So I think the combination of slower labor growth and stronger revenue per patient day growth, particularly on the Medicaid side, is what contributed to it.

Michael Griffin (Senior Analyst)

Could you be starting to tease a 2x number if things continue to go in the right direction?

Rick Matros (Chairman, President, and CEO)

From your lips, Rich.

Rich Anderson (Managing Director)

Thank you.

Michael Costa (CFO)

Thanks.

Operator (participant)

Your next question comes from a line of Michael Stroyeck with Green Street. Your line is open.

Michael Stroyeck (Equity Research Analyst)

Thanks and good morning. Maybe one on the SHOP portfolio. So coverage levels are now back to 2019. Are spot levels mostly captured in that trailing 12-month figure at this point? And if not, should we expect any more meaningful improvement in coverages in that business?

Michael Costa (CFO)

Sorry, for which portfolio?

Michael Stroyeck (Equity Research Analyst)

For the SHOP portfolio or the senior housing lease portfolio.

Rick Matros (Chairman, President, and CEO)

Oh, got it. Got it.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

Okay. I got caught. I'm sorry. Could you repeat the question? Because now that I know what portfolio you're talking about, I can probably be more constructive in my response.

Michael Stroyeck (Equity Research Analyst)

Yeah. Sorry about that. Coverage levels, they're back to 2019 in the senior housing lease portfolio. Are spot levels mostly captured in that trailing 12-month figure? And if not, should we expect any more meaningful improvement in coverages in that business?

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

I think we're optimistic that coverage will continue to improve as operating leverage continues to drop more NOI to the bottom line. That's a very healthy portfolio.

Michael Stroyeck (Equity Research Analyst)

Okay. Good to know. And then maybe one on contract labor. I know you mentioned it's down pretty meaningfully in aggregate, but have you seen any pockets in your portfolio that have started to see agency labor utilization maybe come back up in recent months?

Rick Matros (Chairman, President, and CEO)

Not offhand, coming up. We certainly have markets where it's still bad, but we're not seeing increases. I mean, anecdotally, there may be a facility here or there, but by operator, we're not really seeing increases over the past few months in temporary labor. I think over the holidays, there was a little bit of a spike, but that's not atypical for the holidays, but it came right back down.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

We're really seeing on the senior housing front almost zeroing out of agency or at least back down to sort of so-called normal levels, sort of unaffected by the last few years because we're seeing also at the same time more net hires filling positions that had been vacant for some time, better retention, which is what the net hires is about, and overall just stronger ability to hire, retain, and compensate permanent employees.

Michael Stroyeck (Equity Research Analyst)

Great. Thanks for the time.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

Thank you.

Operator (participant)

Again, if you'd like to ask a question, press star and then the number one on your telephone keypad. Your next question comes from a line of Connor Siversky with Wells Fargo. Your line is open.

Connor Siversky (Senior Equity Research Analyst)

Hi. Thank you for the time. Maybe just to bounce back on the investment environment, it's been a pretty common theme among healthcare REIT earnings that the propensity to invest in 2024 is a dramatic improvement from, say, years prior. And in that context, it seems like Sabra's messaging here is maybe a little bit more conservative than others. So I'm wondering, when you say that in skilled nursing in particular, there are less high-quality opportunities coming across the desk, do you feel that that's more due to increased competition in the space, or is that more of a function of just a pricing disconnect between potential sellers and buyers?

Rick Matros (Chairman, President, and CEO)

I don't think it's necessarily either. I think that for those that don't have to sell, they've just been waiting for more recovery. We really think it's as simple as that. So we fully expect to see more opportunities in the skilled space and better quality opportunities. But if you haven't had to sell, you might as well have hung in there and wait for top line and margins to improve more.

Talya Nevo-Hacohen (EVP, CIO, and Treasurer)

The other thing I'd add to that is we had a lot of buying by private investors in the skilled space when debt rates were really cheap and bridge to HUD was flowing in unprecedented amounts. That, of course, has shifted in the last, whatever, six to eight months. And now the opportunity to provide debt or to sometimes provide equity in a sale lease back format has reemerged, which is where the REITs can play. And so I think that explains why you're seeing other REITs provide various levels of debt in terms of the cap stack and then why you're seeing us probably have seen more opportunities on sale lease backs.

Rick Matros (Chairman, President, and CEO)

For you to note, Connor, that we're more conservative than our peers, I guess, shows the impact of the pandemic on our mentalities because we've never been accused of being more conservative than our peers.

Connor Siversky (Senior Equity Research Analyst)

Understood. I appreciate the color there. And maybe one more. This is taking a bit more of a long-term forward outlook. I have seen on NIC MAP, for example, some markets where occupancy is getting quite high. And I'm wondering if we could expect to see certain states release some certificates of need within the next several years and allow for some more construction activity. And saying that under the context, too, of knowing that it's cost prohibitive at the moment to really generate a return off construction activity, but it seems like there are some markets where you're kind of hitting carrying capacity. So just curious to hear any thoughts you have on that dynamic.

Rick Matros (Chairman, President, and CEO)

Yeah. So yeah, one, I would say, yeah, obviously, there are actually quite a few markets like that. I think our portfolio in the aggregate is getting closer to 40%. 40% of the operators are or close to it are where their occupancy was pre-pandemic. But there is no talk right now in the states relative to changing CON. Obviously, there's going to be a huge crisis in the country. And as you know, we're already seeing it in terms of the access problems in certain markets. And so there's going to have to be something different at the state level and perhaps the federal level as well. The cost of building skilled nursing facilities is exorbitant given the level of regulation. Some states, obviously, have additional regulation on top of federal regulation, so it makes it even more expensive. California's a great example of that.

So you've got that issue. Then you've got the CON issue as well. So yeah. So it's hard to see anything proactive happening at the level of the government until things get really, really bad, and you have a bunch of bad headlines because people can't get access to care. I just don't think everything is more focused than ever on the election cycles and the short term, and I just don't. We haven't heard it, and I just don't see it. Connor, I think it's just we'll keep on growing occupancy. And then, as I said, there'll be some really bad headlines, and then maybe there'll be some changes, which will probably take years, right? So I think you've got a really nice run ahead of you on the skilled side for occupancy.

Connor Siversky (Senior Equity Research Analyst)

Right. Appreciate the color. I guess all roads lead to increasing occupancy in the years ahead. Thanks for the time.

Rick Matros (Chairman, President, and CEO)

Yeah. And remember, before the pandemic, the industry, just based on demographics and at that point, what was the current rate of decline in supply, which has obviously accelerated, the industry was projected to be effectively full 2025, 2026. So the pandemic has pushed that out, but nothing's changed since then except that the number of closed facilities has actually increased, right? So yeah. And effectively full is a little bit different for different buildings, but it's sort of low to mid-90s.

Operator (participant)

There are no further questions at this time. I will now turn the call back over to Rick Matros.

Rick Matros (Chairman, President, and CEO)

Thank you for joining us today. As usual, we're all available for follow-up. For those that are going to be in Florida, we'll be focusing everybody at the conference next week. Thank you.

Operator (participant)

This concludes today's conference call. You may now disconnect.