Merrill Gardens CFO: Past Strategic Shifts Are Paying Off Today

In a 20-year career with Seattle-based Merrill Gardens, CFO Doug Spear has played a leading role in re-shaping the senior living company, ushering in changes that are bearing fruit in the current competitive marketplace.

Spear was at the negotiating table hammering out the first RIDEA partnership in senior living in 2010, with the real estate investment trust now known as Welltower (NYSE: WELL). Three years later, 38 of those RIDEA properties transitioned to a different operator — creating a leaner Merrill Gardens that doubled-down on technology to create a data-driven organization.

Those changes were not simple but they were successful, Spear said during an interview for Senior Housing News’ “Bottom Line” series of CFO interviews.


Today, Merrill Gardens is leveraging its tech infrastructure to maintain strong financial performance and occupancy across its portfolio of 33 U.S. communities, despite increased competition and ongoing labor challenges. Merrill Gardens is also pursuing new development with a focus on urban markets, including projects in conjunction with multifamily developer Pillar Properties — which, like Merrill Gardens, is part of the R.D. Merrill Company, a family-owned enterprise that originally began in the timber business.

Has senior living has gotten more operationally and financially complex over your time at Merrill Gardens?


I started with the company in 1999 and took on the CFO role in 2002. At that point in time, we were pretty overt that this is just not a technology-oriented company and industry. That’s probably the main thing that’s evolved. We’re much more technology-oriented. We use that technology, both internally as well as resident-facing, to make our business more efficient, more effective, more focused.


Certainly, there’s also margin pressure and increasing expenses. And so, in order to continue to make the community affordable to our resident population, we need to make sure that we are efficient with expenses. That’s another area of focus and change.

There’s a lot more competition that continues to develop. I think it’s a cool industry because it’s fairly collegial and there is a lot of information sharing. At the same time, we’re all competing, particularly in certain geographies and local markets.

That competitive environment, the expense pressures, and the further development of technology are the areas of complexity.

Can you talk about a period of challenge or change during your time with Merrill Gardens, and what you learned from that?

In 2013, we had a transaction in which 38 of our properties moved to Emeritus. (Editor’s note: Emeritus has since merged with Brookdale Senior Living.)

They were part of a joint venture with Welltower. We owned 20%, so [we negotiated and] Welltower bought our 20% and then moved the operations over to Emeritus.

That downsized us to about 20 properties from 58, roughly, prior to that. It gave us the ability to, at that smaller size, deploy a lot of new technology. We deployed Yardi, which is one of the companies that really is continuing to advance and develop technology and is focused on the senior living space.

We also deployed UltiPro from the HR management side, and a new online learning management system, as well.

Those hit three major areas for us, being able to have an integrated enterprise system that not only addressed accounting, but sales and marketing and care on an integrated basis.

That major downsize was certainly on the top of the list as far as a real inflection point of change, but to see that happen in a purposeful and intentional way was a very positive experience. It wasn’t out of our control, where we had to really downsize out of desperation or because of financial need. We both capitalized on a good transaction from a proceeds perspective, as well as then had the cash available to invest in technology — and in further development of new communities.

So, we’ve been a fairly steady developer of new communities from that point forward, and have built some of the best-in-class communities in great markets, and our occupancies are running at 95%, 96% on our stabilized community [portfolio] , which outperforms the industry averages by probably 700 basis points.

Nonetheless, it’s hard when you have communities that you’ve worked with, people you’ve worked with for a number of years, great people, and it’s a difficult thing to part ways in a transaction like that.

As you mentioned, Merrill Gardens was the first provider to enter a RIDEA relationship with a REIT. Can you talk about going through that process with Welltower, then known as Health Care REIT?

That’s correct. In 2010, we put together the first RIDEA structure with Welltower. [There were] a lot of late nights doing that deal in a fairly exhilarated manner. I’d be shooting emails off at night and getting responses in real time [from Welltower]. That really solidified that relationship.

We’ve been working with Welltower since ’99, and that really moved it to another level where we became operating partners with them, and that became a formula, or a mold, for the way they put together a top-tier group of operating partners that they have been working with since then. So it was fun to be a part of that cutting-edge structure.

It has a little tension there, between their quarterly earnings perspective as a public company and us as a private company. But ultimately, both of us have a long-term perspective in investing in the industry, so we’re not faced with a fund that has a lifecycle that needs to recapitalize and move on, but [are] able to be invested in some super communities that can be a long-term investment.

It must have been somewhat risky to be the first to do a RIDEA deal?

That coincided with some of our broader investment decisions.

We started Pillar Properties back in that same timeframe … When we looked at Merrill Gardens’ overall holdings, the senior housing investment component had performed so well from from 1993 to 2010, that it was really over-weighted in our overall investment holdings. [And it] was an opportunity for us to change our investment model from what had been predominantly 100%-owned investment of the properties, where the R.D. Merrill company had capitalized its growth primarily with just the family investment.

Typically, we’ll [now] have 20%, sometimes more, investment in properties, partnered with an institutional investor or some other investor. That allows us to both redeploy capital over into the apartment operations held by Pillar Properties and also to have plenty of capital to do further development. It enhances returns to us through promote structures, as well as yields great returns for our partners.

We’ve typically had investment returns for our investors that run in the 16% to 18% IRR range, and so we’ve got a group of investors that are very pleased with the results, and looking forward to continue and invest with us.

Do you have any properties in triple-net leases?

We do not.

Is that a strategic decision?

Primarily, it is. We did have a few of those in the early 2000s; those rolled into the RIDEA structure, and we haven’t had any since then.

I would say that yes, philosophically, we prefer to be low to moderately leveraged, and to not have the operations have a necessity of generating cash flows that can fund essentially a fully-leveraged asset under a triple-net lease structure, or even under a mortgage structure.

Our loans typically run about 65% loan-to-cost on our development, and probably a similar sizing for permanent debt. We’re cash flow-oriented, and we prefer not to have those higher levels of leverage that, if they’re to dip in operating cash flows, that’s going to drive us to be more desperate in our decisions of how we would run a community.

You’ve mentioned Pillar Properties. What motivated the formation of that part of the company?

I’d like to say that we knew that the Seattle apartment market was going to boom for 10 years, and we’re just brilliant [laughs]. But, we did see it as a good opportunity, and it is our backyard.

The senior housing industry is, as I’ve already mentioned, complex and has risk factors … even though the building construct itself may be very similar [to multifamily], the operational intensity of a senior housing community and the risk factors are exponentially more.

[Pillar] gave us a way for the family investments to diversify into another complementary area of real estate, to leverage our back office system and support and teams … and also enhance our ability to have some internal development resources for the development activities we’re doing in senior housing.

That’s essentially what we were after, and it’s played out better than expected. We’re really pleased with it.

Given your expertise in both multifamily and senior living, are you thinking of pursuing any active adult development?

We are. It’s an area that we’re keeping our eyes open to, and seeing what is available there.

I would say that we do have a number of our communities [with] a small number of independent units, say, a cottage product, casitas, those residences that can be feeders for the community, or a nice complement, that just spreads out that independent spectrum a little bit wider.

It’s not the same as a pure active adult play. I think we continue to be a little skeptical about whether those units can command real premiums and rents, and to the extent that they can, then I think it can be a very viable, nice bridge between traditional multifamily residential and senior housing.

As with our other investments, we have this mix of being cautious, but innovative. We like to try new things, but we also want to do it in a way that we expect to be successful.

I assume the rent premium for active adult needs to be there because there is more cost that goes into those buildings than traditional multifamily?

That’s correct. The amount of amenity space that’s incorporated into the building and the cost of that, labor costs, and finding that mix that differentiates the community in a way that attracts that resident population.

Even in our independent living, we will license the whole building so that our residents can age in place and not have to move to a separate building, or separate wing, or a segregated area; because we want to, as I said, give them independence, and choice, and a lifestyle that is as accessible and simple for them as possible.

That whole idea of active adult that doesn’t have the ability to seamlessly transition to other care needs when necessary is just kind of different than what we’ve traditionally done. Not to say it’s not a good product or something that’s going to continue to evolve. We think it has potential.

What’s the current environment for senior housing development? We’ve reported that construction costs are high.

That’s true. Construction costs are a big issue. There is a labor cost factor. There’s tariffs, and materials, and things that are impacting that. So, the costs have not moderated.

It causes us to be more selective about where we do development, and we have, as a private company, the ability to look long term, and we’re not as IRR-driven as we are just looking at getting a good return on our costs, in our capital. We don’t know what the exit cap rate is going to be at some point in time. We just want to build in a place where we can get it filled and generate good cash flows.

There’s a lot [of equity] that’s chasing deals, and we certainly hear from a lot of different equity sources. We’re able to be pretty selective about who we partner with, and the lenders that we’re working with. Those top-tier lenders that know this space, I think are being reasonably selective about their underwriting of projects. There are obviously a lot of smaller and regional banks in the country that find the industry appealing, see that it’s performed better than a lot of other real estate sectors through the cycles, and don’t fully understand the risks, and will then be much more free with their funds.

So, there’s a lot of concern about overbuilding. We’ve seen that in some of the markets that we’re involved in.

It’ll eventually get absorbed, and I think we can all do well, but if you’re not well-capitalized, that can create failures and … we have our ear to the ground for value-add acquisition opportunities.

It kind of depends on how those deals come through. If they hit the market, I still think there’s a lot of buyers, and they get bid up and priced at a point that’s not attractive to us; and so, I think it’s just an area that we have to be cautious in what we look at and be selective.

You’re open to acquisitions, but most of Merrill Gardens’ growth has been through development since you restructured the portfolio in 2013?

Yes, since that time, it’s been development.

We’re developing roughly two to three properties a year … Sometimes they get punched up a little bit more than we’d like, and we opened seven properties within about a nine-month period. Five of those seven leased up within 12 months, which is unheard of, but we did.

But our typically pace of development is about two to three a year.

We have a number of sites that we own and [are] moving towards those construction starts, and probably half a dozen sites that we’re looking at currently.

The seven properties that opened within nine months, when did those openings happen?

The end of 2017 to early 2018.

Are you looking at new markets or do you want to keep your footprint where it is today?

That would be another change that transpired with those 38 properties that we transitioned out of in 2013.

A lot of those properties were more suburban-oriented communities that were outlying major metro areas, and since then, our focus has been more on urban town center developments.

We really look at the walkability factor. It’s a very different experience for, particularly, an independent resident, to be able to live in a community where, within a few blocks of them, they have a lot of things that they can access and do.

If you’ve got to get on a bus or get in your car, that’s a barrier that can be very significant to that enhanced lifestyle of being able to really enjoy the community amenities; and so, we focused our developments primarily, not exclusively, on these urban town center locations; and that, I think, has been one of the catalysts of this incredibly powerful lease up that we’ve seen in those communities.

And those mixed-use communities create an intergenerational experience, too?

The location that a Millennial enjoys is the very same location that a senior resident is looking for. We have two side-by-side communities in Burien [Washington], that we built about the same time.

One of them is one of our Pillar Properties communities that’s multifamily apartments, and right next to it, a Merrill Gardens community.

There are shops and cafes on the main street there. There’s a transit center a block away.

It’s been very successful to focus on those areas. The cost of land can be more expensive, and sometimes it’s underground parking versus surface parking, and all those things that add up to the cost of the community, but it’s in a location where we find that the resident population is willing to pay for that.

If you found a site like that in the Northeast or the Midwest, geographies where Merrill Gardens isn’t operating right now, would you consider that?

Our operating model includes our regional support teams that are very involved in the communities. I wouldn’t say we would never do something outside of our current footprints. But, it is more challenging. Our focus is primarily on the West Coast and the Southeast.

Looking at the balance sheet, what are areas of concern? Labor costs?

Labor is a top-of-the-list [concern] for all of us [in the industry]. That encompasses minimum wage movements that drive up costs not just in the lowest level but throughout the organization.

I think what it does is give us more of a laser focus on how to manage those costs. It goes all the way from hiring the right team members, to how to assess them and understand them, and how to be clear with them about what the job is, how to create opportunities for them to grow and progress, to be able to retain them so they don’t need to leave to find advancement and opportunities.

I think there are tangible ways that we can make a difference in that, and that has a real bottom-line effect. The other thing I would say is the general manager, the ED, is absolutely critical in making the right hires in that area, as well as sometimes making the right changes, if someone’s not the right fit.

Other focus areas?

The other area of operational focus is in care … making sure that we are assessing the residents properly and providing the care that they need, and that we’re staffed appropriately for providing that care and not overstaffed.

That’s another area of labor that we can manage … We don’t want to be understaffed and we don’t want to be overstaffed. You know, having excess hours for staffing costs money. At the same time, we want to make sure that we are billing for the care that we’re providing.

Maintaining that balance is really important, and we spent a lot of time and money working with Yardi to help further develop their care module and make sure that we have tools at our fingertips, and to be able to have that on an enterprise basis, where we can have visibility to that.

Another technology piece that I neglected to mention earlier is Tableau. We’ve deployed Tableau as our business intelligence tool, and that pulls in our data from other areas, if we need it, to create dashboards that have drill-down capabilities and community comparisons and benchmarking. It gives our Seattle office team a very visual perspective on what’s happening at the communities.

I think we’re ahead of the curve by having that data and information that’s in a very useful format versus being in a reactionary mode.

Is Merrill Gardens looking at Medicare Advantage as a potential payer for senior living services?

At this point in time, we’re pretty much 100% private pay, so that hasn’t been an interface that we’ve been engaged with. We certainly have our ear to the ground to see where there’s going to be reimbursements available to our residents in the environment that we have.

Merrill Gardens has been an early mover in China. Have you been involved in those efforts, and how do you view them from a financial standpoint?

I’ve been reasonably involved in that, and it’s an exciting and fascinating line of business.

We oftentimes find that the environment [in China] is a lot like what senior housing in the U.S. was in the 1980s … There’s an incredible demographic, and then, trying to discern how much of that translates into demand is part of [the challenge].

Our model has been one of senior housing being a part of a larger residential development, which has, I think, a great potential to fit with their societal norm of their elderly family members being in community with them. And, they predominantly have a for-sale residential model. They don’t have a lot of rental residential, and so when communities are being built out and they’re selling the units there, the developers find it a particular enhancement to be able to have senior housing. It differentiates them from another community that may be developing and selling.

We were able to generate branding fees by being affiliated with development there.

Another interesting comparison is, over in China, we will have an offer where you can come live with us for a couple of days — bring your suitcase and move in — because it’s such a different and unique experience for them, and it’s hard for them to grasp and understand the nature of it.

We’ve had a presence over there for about seven years now, so that’s a long time to currently have three buildings … but it’s just characteristic of our commitment, as well as our patience and our long-term view of the market. Our goal is to create alignments with key partners that we can have a broader, long-term relationship with.

We’ve been able to generate fee income, as I mentioned, through branding fees, through consulting and market studies and those type of things, which is not our normal business here in the U.S. In China, we accomplish two things. One, we pay for our overhead and minimize the amount of overall investment we’ve needed to make over there. Plus, we have this broader network of investors and people who are looking at and considering investments in senior living over there, and we develop rapport with them.

What advice would you give a business student who is interested in being a senior living CFO? It seems important to be a strategic thinker, more than a financial number-cruncher?

Yes, I think it’s a good insight, because there’s a lot more to it than generating the financial statements and running the accounting software and systems. It depends upon the organization and how their team is constructed, and there’s a lot of different sizes of senior housing owners and operators. But I think most people are trying to grow.

I find that my day-to-day job is complex financial transactions, and I have to have super quality people that are doing the number crunching. So … it has to do a lot more with partnership development between the lenders, the equity sources, the investors … that convergence of investor relations and raising capital, of working with and understanding insurance, and that changing dynamics are happening with different markets, and making sure we’ve got the right coverage in place, and many lines of coverage.

It’s really at the center of a whole lot of things that are going on, and I don’t do any of it single-handedly. It’s a lot of fun when you’re working with a great team — both internal as well as that broader team of partners and vendors.

How do you balance the mission of senior housing with driving toward a healthy margin?

I think there’s clearly a tension there that’s inherent in the business, but I don’t personally feel that tension in our organization.

We try to be pretty transparent about the financial aspects of the company, and I think everybody understands we’re a for-profit company.

At the same time, we are a private company, so we’re not having to deal with the quarterly earnings expectations, and the analysts drilling in and challenging our decisions.

We like to remind people that the company started as a timber company back in the late 1800s and the trees we grow out here have a harvest cycle of about 50 years. So we’re on our third harvest cycle … we’re pretty patient and we take a long-term perspective.

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