Covid-19 has disrupted senior living providers’ balance sheets, and it’s clear that the pandemic will have lingering effects — but some companies are seeking to limit the pain and believe they can avoid permanent margin compression.
A similar story has played out in U.S. senior living companies since March: as communities went on lockdown to stop the pandemic’s spread, move-ins stagnated and occupancy fell, driving down revenue. At the same time — particularly early on in the pandemic — expenses ballooned as hazard pay, personal protective equipment (PPE) and Covid-19 test kits became new and significant budget items. Insurance premium costs have also emerged as a pain point for some providers.
Some senior living providers are coping with assistance from financial or ownership partners, while others received much-needed federal funding. But as more providers come to terms with the fact that this pandemic is far from over, they are left wondering about the long-term effects on the industry and their organizations, particularly on operating margins.
Although it’s clear the industry is heading toward a new normal, it’s not as clear what that new normal will look like, or for how long adverse conditions might last. There are also some factors that could offset some of those pressures. Pandemic or not, long-term demographic trends are still expected to boost the industry’s fortunes going forward. And providers are thinking about, and starting to implement, cost-cutting measures, rates and new fees to cover some of the additional costs they are facing today.
Although the pandemic’s effects are hard to predict and measure, current trends indicate the senior living industry could ultimately see a negative impact on margins of about 1% to 2%, according to Capital One Analyst Daniel Bernstein. That could last until there is an effective treatment or vaccine for Covid-19 that allows for more normal operations.
“I’m somewhat hopeful that the margin impacts won’t be quite as dramatic as what we saw in March and April, and maybe what we’re seeing right now,” Bernstein told Senior Housing News. “I wouldn’t extrapolate what we see today as what normality might be two or three years from now, but I do see increased levels of PPE, increased levels of infection control, staffing needs, potentially during the fall to winter seasons.”
Current state of play
Senior living companies big and small have seen revenues drop and expenses rise in recent months, and the public disclosures and filings of the largest players in the industry provide a window into these financial challenges.
Brentwood, Tennessee-based Brookdale Senior Living (NYSE: BKD), for instance, spent $10 million responding to Covid-19 in the first quarter of 2020, with much of that related to the procurement of PPE, with expenses likely to reach about $50 million in the second quarter of this year, the company projected in June. At the same time, the company’s occupancy dipped in March and April as move-ins slowed — although move-ins have picked up steam since then, Baier said in June.
Toledo, Ohio-based real estate investment trust Welltower (NYSE: WELL) expects its total senior housing operating (SHO) portfolio will see 5% higher expenses in the second quarter of 2020 than in the first, according to a June business update. And Chicago-based REIT Ventas (NYSE: VTR) was in June anticipating about 100 basis points of sequential average monthly occupancy loss for its senior housing operating portfolio (SHOP) assets, equating to about a $2 million to $3 million revenue loss each month. Like Brookdale, both companies saw their senior housing occupancy dip at the outset’s pandemic.
As operating margins tighten, there is the related concern about valuations. Although Bernstein thinks the pandemic and its effects will negatively impact real estate values and cause cap rates to rise, it’s not certain those trends will hold in the long-term.
“Assuming loan-to-value and lending comes back to normal in the next 24 months, and interest rates stay low, upcoming positive supply-demand [trends] will attract buyers and keep cap rates low if not compressed from where they are today,” he said.
And if future demand holds true and occupancy rises as supply dynamics balance out, small ongoing impacts to margin could be minimized in the long run.
“Our guess is that cap rates rise slightly and then compress once you have some clarity on operations, post-Covid,” Bernstein said. “If you have 500 basis points of margin drop, that might not be the case, but small margin drops will get washed out behind the potential for 100 or 200 basis points of occupancy growth for a couple years.”
There are still some factors yet to be seen that complicate the forecast. For example, another major infection spike similar to the one in March and April could toss the industry back into much choppier waters. And, while there are also signs that senior living providers are more well-prepared against future outbreaks than they were earlier this year, infection control measures are not free, and senior living companies can expect elevated costs in labor, PPE and insurance premiums for the foreseeable future.
“We have said that there’s a high likelihood of a second, third, even fourth wave, and it could come all in a short period of time, up and down like a ‘W,’” Bernstein said. “That’s why I also do believe there are going to be some ongoing costs.”
Despite a higher cost of doing business in the age of Covid-19, senior living providers are optimistic that the temporary impact to margin can be overcome with some effort.
For Fee Stubblefield, Founder and CEO of McMinnville, Oregon-based The Springs Living, there is a clear distinction between margin compression and value compression. While margins are taking a hit in the short-term, he questions whether that will equate to dips in valuation down the road.
“If somebody needs to sell right now, they’re probably going to see people being a little more cautious, building in margin and looking at the discounted cash flow,” Stubblefield said. “But our point of view is that, with the demographics coming, we expect values to maintain, if not get stronger [long-term].”
The provider expects to spend about $500 to $750 per unit mitigating Covid-19 when all is said and done. Stubblefield believes that the elevated costs associated with infection control will ultimately be passed on to residents and their families in the form of higher rates over the next few years. At the same time, he thinks that prospective senior living customers will value and desire safer senior living communities, and there is a bigger risk for providers who don’t follow that trend.
“I think what you are going to see is an increase in capital costs in the infrastructure of retrofitting older buildings, and in building new buildings,” Stubblefield said. “Our customers are going to look to us to have a response on how we’re going to keep them safe … and I think the market is getting more sophisticated.”
While having an outbreak in a building will increase costs, Stubblefield also believes there are certain ways to offset those costs, such as in food or labor.
Another Portland, Oregon-area provider, Frontier Management, has so far spent about $4 million mitigating Covid-19 in its 108 communities. Another area where the company has seen a relative increase in costs is in its insurance premiums, which have risen about 17%.
Still, like Stubblefield, Frontier CEO Greg Roderick doesn’t think there will be a drastic impact to margins in the long-term despite an elevated cost of doing business for the foreseeable future.
Specifically, Roderick believes his company has many tools in its toolbox to mitigate a potential impact to margin, such as rent increases, one-time or monthly assessments and simple cost-cutting measures that don’t affect quality of care. He favored a piecemeal approach to these measures, implementing them at certain Frontier communities on a case-by-case basis.
“We went right to the executive directors and the regional vice presidents, and we let them talk to residents, to family members, among themselves, for two full weeks before we made any decisions,” Roderick said. “[We asked things like] can this one handle a $100 increase per month going forward? Can this one handle a 1% rent increase? Can this one handle a $1,000 assessment over the next four months? Can this one do $500, and that’s it?”
Frontier is not alone in passing on some costs to residents, but as providers go down this path, a careful approach appears to be advisable. USA Today recently ran a critical article about assisted living providers assessing Covid-19 fees.
Frontier also has trimmed costs from nonessential areas, such as corporate travel, and has implemented its own in-house health screening technology.
“That’s saving each community probably $200 to $500 a month, depending on the building, by doing everything in house,” Roderick said. “We have definitely found smarter ways and more effective ways to do things.”
Roderick added: “We will probably not see a margin reduction if this proves out to where we’re trying to take it.”
The Springs Living and Frontier Management are two for-profit providers that enjoy the support of well-capitalized real estate investment trusts (REIT) and finance partners. Others in the senior living industry, particularly on the not-for-profit side, don’t see the same level of support.
United Methodist Retirement Communities (UMRC) and Porter Hills — a $150 million nonprofit created out of an affiliation last year — is projecting a $3 million to $3.5 million budget gap for 2020, according to CEO and President Steve Fetyko. Much of that is due to the virus’s impact on the nonprofit’s skilled nursing referrals as hospitals halted elective procedures. And restrictions on visitors have slowed move-ins in general, he added.
While Fetyko believes that Covid-19 could depress margins between 1% and 5% in the short-term, he doesn’t think it will be a “death knell” for the senior housing industry.
“I think it’s a significant inflection point where we need to learn a lot of lessons and be able to be prepared for if an event like this happens in the future,” Fetyko told SHN. “But we can clearly differentiate how we’re making lives better for the people we serve by giving them easy access to the care and services that they need.”
Unlike its for-profit counterparts, UMRC/Porter Hills has fewer tools when mitigating a long-term hit to margins. For instance, Fetyko doesn’t think a Covid-19 surcharge would work well for the provider, given the fact that many of its residents are on fixed incomes. So, the provider has become more careful about its spending on things like travel and education.
But the nonprofit also has some strengths that will help during the new pandemic era, such as savings it can lean on during tough times and a diversified list of offerings that includes home-based care and home health services, hospice and a Program of All-Inclusive Care for the Elderly (PACE) partnership. The affiliation between UMRC and Porter Hills 16 months ago also helped prepare it for a more uncertain period down the road — and that could help drive similar trends among nonprofits elsewhere.
“We had more resources available, we had a deeper bench of expertise, and we had gained some efficiencies,” Fetyko said. “So, I think that’s a trend we’re going to see continue, and people will explore affiliation, merger and acquisition opportunities to gain some of those economies of scale.”
In the end, Fetyko believes that, as long as the provider can stay the course, there will be ways to thrive after Covid-19. And the 114-year-old organization has survived one pandemic already: the influenza outbreak of 1918.