REAC Massacre

Failure on the REAC Inspection: A Looming Crisis in HUD Financing for Health Care Facilities

(This is a story I am working on, and would like to bring to the attention of health care industry publications. It is an absolutely real situation. I am not a journalist, I'm a consultant in this field - I'd like to see this taken up by the Wall Street Journal, and NOT because I am looking to gain business from it. I'd sincerely like to help honest business people avoid a very costly and unjust impact to their businesses. Thanks - Mike)

Skilled nursing facilities and other types of health care facilities whose physical plants are financed with HUD insured or related mortgages are creating a particular nightmare for owners and managers in this industry, in the form of the REAC Inspection.

The inspection, conducted by REAC (the Real Estate Assessment Center, a department of The U.S. Department of Housing and Urban Development) is an annual evaluation of the physical plant, conducted according to the Uniform Physical Condition Standards (UPCS) developed by REAC. This inspection protocol was developed to help HUD ferret out bad landlords with poorly managed low income and affordable housing projects, and to identify corruption and mismanagement in America’s huge public housing industry.

REAC’s mission is stated as “assuring safe, decent, sanitary housing in good repair. With the impact that the inspection has on the health care industry, they might have as well added, “putting private hospitals out of business.” Because the inspection is required for most low income and affordable apartment properties which receive HUD funding in the form of project based Section 8 rent subsidies or HUD mortgages, health care facilities which are funded by HUD mortgages are included, along with public housing projects in the process. The resulting turmoil for some health care providers may be surprising to the casual observer, who expects that private hospitals are generally safer, more decent, and more sanitary places than the typical public housing project or low rent apartment complex down the street.

The shocking reality is that private hospitals such as skilled nursing facilities and geriatric nursing homes are failing this inspection at a higher rate than “the projects.” In an informal study of scoring data in public records available on HUD’s website, of properties for which records exist for 3 inspections since 2003, 3456 of 23,172 properties, only about 15% have failed one or more inspection. When easily identified health care related facilities in the same sample are isolated, 150 out of 641, or about 23%, have failed one or more inspection. These facilities have failed at an 8% higher rate than the overall sample.

Failure on the REAC inspection has dire consequences for the ownership entity and the management entity. The failure can affect either party’s entire portfolio of HUD financed assets due to the placement of a 2530 “Prior Participation Clearance” flag in the entity’s HUD records. The 2530 Flag can prevent the owner and manager from acquiring, selling, or refinancing any other HUD related property. If the entity is a management company, it can be disqualified from signing any new HUD related management contracts. Failure on a second inspection at the same property can result in foreclosure or a forced sale of the property under distress.

Are America’s nursing homes and private hospitals statistically in significantly worse condition – less safe, sanitary and decent - than its low income housing projects? It depends on how you evaluate the condition of the real estate. If the REAC inspection is to be considered an objective and reliable measure, then the apparent answer is, “Yes.”

This answer comes as a surprise to the industry, to the communities in which such facilities are housed, and even to the HUD Field Offices that are responsible for administering programs and monitoring compliance. The parent companies of such facilities are often shocked and dismayed at the REAC scores they receive, feeling that they have been accused of being “slumlords.” Their Field Office representatives often visit facilities that have failed an inspection to find them in apparently much better condition than their scores would indicate.

“How can this happen?” is a frequent first question when an apparently high quality facility fails this inspection. There could be more than one answer.

One answer could be that health care companies are not primarily real estate management companies, and that they are actually failing to properly maintain their bricks and mortar assets. If asset management is secondary to the primary mission, perhaps this explains the low REAC scores.

Another answer could be that the inspection protocol has some built-in bias that puts these properties at a disadvantage. That is the theory of one not-so-casual observer, a self styled “REAC Consultant,” Michael Gantt, who does business under the name REACSolutions. Representing one of a handful of small companies that has sprung up in a cottage industry created in a reaction to the development of REAC’s inspection process, Mr. Gantt has provided UPCS compliance advice and training to the housing industry since 2003.

“Health care facilities are usually single building properties. The inspection protocol and the scoring system that REAC uses create a severe disadvantage for single building properties, especially when they are complex, with a lot of common areas, and technology. It’s possible for such a property to fail this inspection on as few as 3 or 4 issues, that might only require an hour or two of labor and a few hundred dollars worth of materials.”

“It is my belief that in 2009, the failure rate for this type of property will increase dramatically. REAC issued guidance to inspectors, effectively changing a few rules, that will result in a catastrophic number of failures, which will require REAC to either make more changes to ease the pressure on these properties, or which will cause a mass exodus away from HUD financing for health care facilities.”

“I have been contacted by at least 6 new clients, just in the Baltimore/DC region, who have had unexpected REAC failures at health care facilities and single building senior housing properties. I’ve picked up another new client in Chicago. I’ve been turning down business with established clients due to overbooking – something I have never done. I’m expecting to have a deluge of new inquiries, and to become more specialized in the health care field, or to have to expand my consultancy and hire help of refer work off to other people. The problem is, there are only a few independent experts, and none of us really needs new clients.”

“The big thing this year is sprinkler heads. If a property has one sprinkler head with a speck of paint on it, or with a missing escutcheon – the little trim ring that hides the rough hole in the ceiling above the sprinkler head – the property loses 17 or 18 points, out of 100. With anything below 60 being a failed inspection, an 18 point loss is truly a disaster. Then, if there is one electrical hazard in a hidden storage room, a screw hole in a door, and a 3 inch deep tire track at the edge of a driveway – that property will fail. All my new clients have been affected by this small change in the rules. If this new rule stands, more than half of properties like nursing homes might fail their inspections. One failure affects an entire portfolio. If every company with 4 or 5 properties has one failing score, I see a massacre coming.”

copyrighted material - please obtain permission for re-print or use of excerpts from Michael Gantt - see contact page