Nursing Home Profits in New York? A Developing Question

New York was set to cap nursing home profits and enforce new revenue spending rules on nursing homes at the beginning of 2022. However, due to lawsuits filed by over 200 nursing home providers and several trade associations, Gov. Kathy Hochul signed an executive order on December 31, 2021, suspending enforcement of portions of the Cuomo-era law through January 30, 2022. She then extended it another 30 days until March 1, 2022. Should Gov. Hochul allow enforcement to continue beyond that point, industry providers in New York face a lot of uncertainty and concern over the impact.

Both legislatively and through executive action, the State of New York began introducing fresh proposals impacting nursing homes in March 2021. The goal of the legislation was to ensure nursing homes, which receive government funding, spend at least 70% of their revenues on direct resident (patient) care, 40% being utilized directly to pay staffing costs for resident-facing staff such as registered nurses, licensed practical nurses and nursing aides, with requirements on the minimum number of hours such staff need to spend with a patient per day. Additionally -- which is the larger concern of the two items -- New York decided that nursing home businesses should not be operated for profit and, effective January 1, 2022, has capped allowable profits for nursing home businesses at no more than 5%, as determined by revenue and expenses reported on Medicaid cost reports. It is unclear on the face of Gov. Hochul’s executive order whether this portion of the new law was suspended, but we have not seen evidence of its enforcement to date. It is a significant piece of the litigation filed against the state with allegations it may be unconstitutional.

The 5% profit cap excludes revenues considered extraordinary gain. Examples of expenses that will not be allowed for inclusion in the profit calculation are (i) any related party transaction or compensation if the value received from the transaction is greater than fair market value, and (ii) compensation for employees who do not actively work in or for the nursing home facility. Any profits received above the 5% amount will need to be remitted to the State of New York by November 1 in the year following the year in which the expenses are incurred. These funds are to be deposited into the Nursing Home Quality Pool pursuant to Section 2808(2-c)(d) of the New York Public Health Law.

The New York State Department of Health (NYSDOH) has been tasked with establishing civil penalties for facilities that are out of compliance with the spending requirements beginning on April 1, 2022. The regulations set forth by the department provide for penalties of up to $2,000 per day for each day the facility is deemed to be out of compliance. These penalties can be reduced to no less than $300 per day if there are mitigating circumstances, as set forth in the regulations and determined by the department. In determining whether to impose penalties, the NYSDOH may also consider mitigating factors, including catastrophic events that require unanticipated expenses, frequency (or infrequency) of non-compliance by a provider, and the existence of acute regional labor shortages, which have been a continuing concern for many facilities in the last two years.

Nursing home real estate and operations financing, as with certain other commercial real estate financing, is dependent on cash flow from the operations of the property tenant, operations often made possible by such financing. However, New York’s new spending requirements do not permit the inclusion of debt service, rent and leases, capital costs, capital depreciation or many administrative costs to be included in the expenses counted toward the required spending levels for nursing homes. This puts pressure on tenants under standard triple net leases, where tenants are responsible for paying all of the expenses of a property, as the tenant operators of the nursing homes – the licensed nursing home providers – may have to choose between suffering penalties or having sufficient cash flow to pay the rent required by the property owner’s lender to cover debt service, real estate taxes, capital expenditures, and other excluded expenses.

Another issue with the cap on profits is what this does to the value of the property. This matters from both an acquisition and a financing perspective. From an acquisition perspective, the inability of the for-profit business developed or acquired by the current owner to continue to be reasonably profitable going forward likely diminishes the anticipated appreciation of the going concern, making it a less appealing business model in the State of New York for experienced nursing home operators.

On the financing side, borrowers and lenders alike will have to evaluate how this new law will affect loan-to-value covenants. Cash flow projections are key to appraising the value of a nursing home business. If cash flow is capped at levels less than projected when a loan was obtained, this could potentially put a borrower in default due to its need to comply with the law.

Aside from the spotlight the COVID-19 pandemic shone on the nursing home industry, this new law appears to have been justified by the fact that nursing homes are the recipients of state Medicaid funding. However, revenues are also derived from private insurance, private resident pay, and Medicare. These sources of revenue are not taken into account in the cap on profits and recoupment of excess monies by the State of New York above the 5%. Time will tell, therefore, whether this law will be able to withstand the pending legal challenges based on a regulatory takings theory.

We will know very shortly whether the governor of New York will continue to suspend the enforcement of this law pending the outcome of the filed litigation or allow it to be enforced unless and until an injunction is ordered. Details set forth in the lawsuit filing show the potential monetary impact to nursing homes should enforcement occur. It will be interesting to see how the courts deal with the various aspects of this law. Regardless, nursing home staffing questions will continue to occupy important discussions in government and the private sector. The cap on profits and remittance of overages is an entirely different issue that this author imagines will receive careful analysis by the court. Stay tuned…