With 82 recently hired executive directors on board and an updated revenue management system in place, Five Star Senior Living (Nasdaq: FVE) is focused on driving operational improvements in the year ahead.
The Newton, Massachusetts-based provider is coming off a major restructuring with Diversified Healthcare Trust (Nasdaq: DHC), a real estate investment trust also based in Newton. Leaders with both companies painted a picture of how they want to move forward as they reported their respective Q4 2019 earnings on Monday.
In 2019, Five Star and Diversified terminated master leases for all 261 properties that the REIT owned, putting in new management contracts that took effect as of January 2020. Diversified also increased its ownership stake in Five Star and has been pursuing about $900 million in dispositions. Five Star now manages 166 previously leased communities.
This restructuring effort came after years of struggle for Five Star, which saw its share price dip so low that the company was in danger of delisting on the Nasdaq. A new CEO, Katie Potter, took the helm in January 2019, followed by Jeff Leer coming on as CFO in May and Margaret Wigglesworth joining as COO in August.
With the restructuring in the rear-view mirror, the new C-suite team believes that a fresh chapter is underway. They struck an optimistic tone on the provider’s earnings call on Monday, while acknowledging ongoing headwinds and uncertainties — including the spread of the COVID-19 coronavirus.
The completion of the DHC transaction “marked a pivotal milestone in Five Star’s transformation as the company ushered in a new era of stability and growth,” Potter said on the call.
Five Star’s woes stemmed in part from challenges that affected the entire senior living industry. Potter name-checked three on the call: oversupply; unfavorable demographics prior to the surge of baby boomer demand; and historically tough labor market conditions.
While the Diversified restructuring was being hammered out, Five Star was taking steps to address these challenges, with workforce being a top priority. The company has made a slew of hires to beef up its talent pool in senior living operations, including:
— a divisional vice president
— three senior regional directors
— five regional directors
— 82 new executive directors
“Five Star believes that recruiting and retaining the best talent will drive results at all levels of the organization, but it is particularly important at the community and clinic level to support exceptional resident and client experience,” Potter said.
All this hiring has come at a cost, with $39 million invested in salaries and wages in 2019. In the fourth quarter, overall senior living wages and benefits increased 3.2% year-over-year to $135.1 million, which represents about 52% of senior living revenue, Leer said on Monday’s call. That overall wage and benefit number included contract labor costs.
In addition to the hiring push, Five Star made other workforce-related changes and investments. These included a new executive director incentive plan, a new learning management platform and a new communication function.
The company also identified certain locations where labor challenges are steepest, and took steps such as forming interdisciplinary teams from operations, human resources, health/wellness and finance.
“Over Q4 and into Q1 of this year, we are working towards stabilizing the labor force in these regions, and most critical positions have been filled,” Wigglesworth said. “We are following up with targeted training to ensure that we continue to provide an exceptional resident experience and secure the future growth of our communities.”
Executives with Diversified Healthcare Trust are encouraged by these efforts and believe that the higher short-term labor expenses will pay off in revenue growth down the line, although they said it is too early to tell when that might occur. Meanwhile, the labor expenses are dragging on DHC’s senior housing operating portfolio, where Q4 EBITDARM was down about $11 million or 16.3% on a year-over-year basis.
The SHOP performance dropped “meaningfully,” RBC Capital Markets Analyst Michael Carroll wrote in an investor note on the earnings.
Other REITs, notably Ventas (NYSE: VTR), have also reported challenges in their SHOP assets and cited many of the same challenges described by Diversified Healthcare Trust, including on pricing and labor.
A better balance on occupancy, rate
Five Star’s occupancy was unchanged on a year-over-year basis in Q4 2019, at 82.9%.
Going forward, the company is focused on driving not only occupancy but rental rates, and has implemented a “more pragmatic” revenue management system to achieve this goal.
“At the end of the fourth quarter, we were able to establish a company-wide sales rate increase to take full-year effect beginning in 2020, and set standards related to community fees and room discount practices,” Potter said. “We estimate that our strategies will take hold during Q1 2020 and achieve normalized benefits starting in Q2 2020.”
Executives with Diversified Healthcare Trust endorsed this approach.
“The [Five Star] team is intentionally deemphasizing occupancy and focusing on profitability,” Seidel said. “We had come to realize that there [were] a number of properties in the portfolio that were fairly well occupied that just weren’t generating the contribution margin we were looking for.”
Striking the right balance of driving occupancy and net operating income (NOI) has been a challenge across the industry in recent years, as supply pressures have caused some communities to dramatically discount rents.
Five Star posted a Q4 2019 net income of $16.1 million, compared to a net loss of $23.7 million for the same period in 2018. This is due largely to a decrease in rent expense resulting from the DHC restructuring.
South Carolina will be a particularly stern test for the new Five Star sales approach, as this market has seen annualized inventory growth of 8%, compared to a national growth rate of 3.2%, DHC CEO Jennifer Francis stated. The Palmetto State is one of Five Star’s biggest markets, with 23 communities.
Coronavirus preparations underway
The Five Star and Diversified earnings calls took place in the wake of news that the novel coronavirus known as COVID-19 had hit a skilled nursing facility in Washington state, leaving one resident dead.
Leaders with both companies emphasized that they are preparing for the potential spread of the coronavirus to other senior living and care settings, emphasizing that high-quality providers already have robust flu protocols in place.
“The safety of our team residents and residents is paramount,” Potter said. “We’ve enhanced our processes and procedures related to contagious viruses like the flu to adapt to the circumstances.”
Five Star has assembled a task force with strategic sourcing, clinical and operational expertise, Diversified’s Francis said. Supply chain integrity is one issue that should not be overlooked, she pointed out.
Other leaders throughout the industry spoke out on coronavirus Monday. The industry’s experience with the flu gives it an advantage over sectors that have never had to consider the impacts of a contagious disease on their operations, Welltower CEO Tom DeRosa said. Toledo, Ohio-based Welltower is the largest senior housing owner in the United States.
Synergies with active adult, rehab
Coming out of the Five Star restructuring, Diversified Healthcare Trust has been focused on its $900 million in planned dispositions. The REIT has $800 million worth of assets either sold or under agreement to sell, Francis said.
While the REIT’s funds from operations of $0.30 per share met consensus expectations, this is due largely to a delay in expected disposition activity, RBC’s Carroll noted.
But the company also has started to expand in one new direction, picking up its first active adult rental community in late 2019. The 169-unit building is in Plano, Texas, and is being operated by Five Star.
“As we transition out of high acuity standalone skilled nursing, we’re excited to turn toward what some in our industry refer to as independent living light,” Francis said. “We believe that the active adult market will fill the gap for those members of the aging U.S. populations that don’t want or need the services provided in independent and assisted living communities, but desire the activities and socialization provided in active adult residences.”
The Texas community is close to two senior living communities owned by Diversified, and the REIT expects synergies among the communities. Other REITs — most notably Welltower — are also making active adult plays.
Active adults communities are also a ripe market for Ageility, Five Star’s rehab business, Potter noted.
“Ageility, our rehabilitation wellness division, continues to be a focal point of growth for Five Star, as it not only diversifies the company’s revenue streams but also acts as a critical touchpoint to source new residents to our communities,” she said.
Revenue for Ageility increased 13% sequentially and 44% year-over-year to hit $13.6 million in Q4 2019, as 13 new clinics opened in that time period.
As the active adult and Ageility initiatives might demonstrate, Potter and her team are seeking ways to move Five Star forward, even though their near-term focus is on “operational improvement and stability” as market pressures continue.
“Despite these vigorous conditions, Five Star will be nimble and innovative in devising a unique, comprehensive approach to meeting the ever-changing needs of older adults,” Potter said.