Senior Living Communities CEO: Providers Face Margin Compression Crisis As Labor Expenses Rise

With Covid-19 challenges receding, senior living providers are now facing another crisis: margin compression, driven mainly by sharply rising labor costs.

I would argue that any operator out there is probably looking at around a 4% or 5% decrease in margin just due to labor,” Maxwell Group Founder and CEO Donald Thompson said during a recent appearance on SHN+ TALKS.

Charlotte, North Carolina-based Maxwell Group develops, owns, and manages senior living communities, and is the parent company of Senior Living Communities (SLC) and Wellmore. Those brands have continuum of care communities across Connecticut, Florida, Georgia, Indiana, North Carolina, and South Carolina. Maxwell Group also is the parent company of Live Long Well Care, which offers private duty home care services.


The immediate labor crisis could ease within a year to 18 months, as pandemic-related unemployment benefits phase out — but, Thompson believes that workforce issues run deeper, with higher wage rates coming, as well as an epidemic of burnout among managers and leaders.

We are pleased to share the recording and this transcript of the SHN+ TALKS conversation with SHN+ members. Read on to learn about:

— How SLC managed to gain occupancy in the midst of the pandemic, thanks in part to a recently revamped sales and marketing process


— Why Thompson is bullish on active adult and how the CCRC model might evolve

— How Maxwell Group’s home care arm went from losing millions to being profitable

— The need for more robust CapEx in senior living

The following has been edited for clarity.

Tim: I want to start off just by tackling the big topic that I know is on your mind, which is hiring and staffing. I know you really consider this a crisis situation. Can you talk about why you think things are so dire?

Donald: Clearly, we just came out of Covid, which was a temporary crisis. I think it’s in the rearview mirror now, but staffing is a bigger deal.

Your labor force determines the quality of your services and it really determines the cost of your services, at the end of the day. Labor is about 50% of the cost of operating in senior housing because you provide a lot of labor to provide personal care services, whatever it might be — serving, housekeeping, toileting, and health care-related services. Labor is the biggest driver of cost. Heck, it’s one of the only controls in our entire business.

People talk about what can they control and they’ll talk about, “Oh, I control food. I control utilities.” No, you can control labor. That’s about really the only controllable cost in our business … Yes, you can turn off the light a little better. You can put an LED bulb if you had an incandescent to try to lower your total cost of utilities, let’s say. Use less water, maybe have more efficient chemical usage in washing dishes. But labor is the key driver.

Right now, there’s a tremendous amount of workforce determining not to work, I think mainly because of two reasons. One, they’re being paid not to work. That’s ending very quickly as state governments shut down this excess bonus payment for unemployment. The other reason I believe people are choosing not to work is because of the COVID crisis. People didn’t want to take undue risk as they were told every day, “You’re going to die from COVID,” even though that was probably false, unless they were older.

In coming back into our industry, everybody tags us with COVID. “You’re more likely to get COVID living or working in seniors’ housing.” Not really true. The reality of it is older people and any dense concentration of older people are going to experience higher rates of COVID mortality.

The issue with staffing, the issue with labor is — this current problem I think goes away over the next four or five months. I think we start getting labor back in. Two things occur. One, is people return to the market, but the second part is, I think we’re going to see — and we are seeing — rapidly rising wages.

If wages rise rapidly for these frontline workers, which I’m kind of in favor of from a citizen perspective, [but] as a business person, it’s an issue because our payer source, private pay residents … they have fixed incomes. Their fixed income for the last five years has been going down, not up, as their bonds are redeemed, as people have refinanced their outstanding debt issues. If you have fixed sources of income, your income is probably going down, not up, and that’s a major issue.

Even if it has held the same, let’s say, for an average 80-year-old, that’s okay, but if the labor costs go up fairly significantly in our care settings and we’re taking care of that person, their income is not going to rise at the same rate. That’s the real crisis. I really think it’s going to become an inability of the consumer to pay what we as providers are going to have to charge because of the increase in labor costs.

We’re predicting about a $3 per hour increase in total labor cost now through this time next year, maybe even as fast as now through Christmas. That doesn’t sound like a lot, $3 an hour, but like I explained to some of our residents the other day, if you’re an independent living [resident] with us, we have six-tenths of an employee per resident in independent living. Six-tenths of an employee, $3 an hour, and it’s $1.80. Plus your labor cost add-ons, so it’s about $2 an hour. $2 an hour is $80 a week, that’s $5000 a year. That’s a significant rate increase to our residents to pay for this additional labor cost that’s going to be filtering through. That’s the crisis.

[00:06:59] Tim: Can you speak a little bit about this issue across your portfolio because, for instance, you’ve got buildings in Connecticut, which grabbed a lot of headlines recently because, on the nursing home side, there were threats of strikes, and wage rates were definitely part of that issue and conversation. Are there some states where the [labor] situation is better or worse than others?

[00:07:25] Donald: I think the situation is a little better in Connecticut. From our perspective, we have fairly high-paid staff. I’m not sure what our average rate is up there, but I think our average starting wage is $16, $17 already. Our average starting wage in other areas was between $14 and $15 an hour, depending on how rural, how urban it is. Our average starting wage across the whole company is about $15.25 an hour right now. That’s starting, so our average wage we pay people is much higher.

We think the problem is more in the high-growth areas, because that’s where you’re seeing a tremendous demand for service workers. If you’re in a beach area or a resort area, or if you’re just in the high-growth areas in the Southeast, or I’m sure if we are in Texas … any area where you’re seeing a lot of growth, you’re seeing a lot of demand for restaurant workers, for hotel workers, resort workers, you name it in the service industry. That’s the same folks that encompass 75% of our workforce. I think those are where the problems are.

[00:08:41] Tim: I hear from people who say the average operating margin for senior living is 30% plus. Why can’t operators just take a smaller operating margin and increase wages? What’s your response to that question?

[00:08:56] Donald: Well, they’re starting from the wrong base. The average operating margin is 30%. Great, that’s wonderful. That’d be like saying that my house, if I ignore my mortgage cost and ignore my capital expense cost of keeping that house, that the cost to keep my house is my utility bill, my water, and sewer bill, my cost of the insurance, ignoring all the cost of the money to buy the house, to pay the mortgage, and to fix and replace things as they go bad, or just to fix the iterative items that occur. A good example is a water heater.

If you have a house right now and you’re paying $200 to $400 per year for a water heater, whether you know it or not, because the day that thing breaks, you’re going to pay that money. Same thing for your roof, repairing it, and other expenses like that occur, or just replacing a washing machine that goes bad. If you have 10 years out of a washing machine, that’s $8.50 per month that you’re actually paying.

When you say the margins are 30%, that’s 30% of total revenue minus direct expenses on labor, utilities, food, and interest, and not looking at the other real cost, which is the capital cost and CapEx cost.

I’m not sure that a person making a 30% margin is actually making that much money. I sometimes wonder if 30% isn’t the starting margin, at least in standalone assisted memory care, and probably in CCRCs, the margin needs to be about 25% or more to have any return on capital at all.

[00:10:37] Tim: You bring up CapEx. That’s an issue that we’ve been reporting on for the last few years, because we’ve had some calls from people in the industry that historical CapEx spending or budgeting in senior living is way too low. I’m curious what you think an appropriate CapEx budget is at SLC and Wellmore?

[00:11:00] Donald: Well, in our case, we spend between $3,000 and $5,000 per unit per year, and we average around $4,400 I think. We’ve tried to bring that down to around $4,000. We think that it’s important that you continue to spend on CapEx, [because] if you don’t, your product just gets older. It doesn’t compete with all the new bright shiny pennies up and down the block, so you have to spend.

I know our lenders make us analyze it based on $1,500 per unit in CapEx spending, and I don’t think it’s a joke, I’m happy that’s all we have to shoot for to maintain our numbers or our covenants, but the reality of this is $1,500 is just too low.

There’s no way you can run a building in today’s cost environment … I’m not even sure what the right number is right now. It might be $6,000 a unit because of the acceleration in building and construction costs, but it’s certainly not as low as $1,500 if you’re going to keep that building up to speed and keep it competitive with the new guy down the street.

[00:12:05] Tim: We’ve heard about the increase in material costs for construction projects. I think you’ve also experienced some increased costs for goods that you need. You shared an anecdote with me about talking to someone about needing to order I think it was golf carts. and I thought that was interesting. Can you share that story?

[00:12:29] Donald: Well, there’s this theory in manufacturing that you’re always looking for what is your, what’s it called, an EOQ, an economic order quantity that you want to buy and hold on the shelf.

I actually think we’ve been going through something for about six months now because of what we see as shortages of materials … We call it economic inventory quantity, it’s just a made-up term from my perspective, but it’s the fact that you’ve got to have things on the shelf to provide services.

Golf carts seem kind of odd, but in our case, we buy 60 golf carts a year. When we had to buy some three or four months ago, I was talking to our purchasing guy about it and I said, “By the way, I want you to buy another 15, 20 golf carts on top of what you’re already buying.” He said, “Why would I do that?” I said, “Just try to buy some right now.” He called and said, “Well, the next time I need a golf cart is October.” This is a couple of months ago. I said, “Well, buy 10 more, we’re going to need 35 to 50 golf carts. If you’re going to order 30, order about 70, that way when they do come in, we can at least satisfy our demand and start thinking about having items on the shelf to get through this.”

Golf carts are obviously a bigger number, but it cuts back to even little items like having enough light bulbs on hand … If you look at what happened with COVID, we never ran out of PPE. We always stock a fair amount of stuff, what we call our economic inventory level. and we never ran out, we were very fortunate in that matter because we already had stockpiles up.

I like to have stockpiles because when [a resident] calls our maintenance guy and says, “Hey, my light bulbs run out, my bathroom fan doesn’t work, my faucet’s leaking, I need a new refrigerator,” I want to fix that right then. That’s the service level we want to hit and you cannot do that without having inventory on the shelf. If you wait to order like you would have two years ago, you’re going to have quality issues and service issues with your residents.

[00:14:41] Tim: That makes sense. Part of that anecdote with the golf cart is that you were talking to whoever was doing the ordering at the office. I believe it was kind of a happenstance conversation. Can you talk a little bit about what the office situation is? Because I know that different providers are coming back into their corporate office at different rates coming out of the pandemic.

[00:15:01] Donald: We went back into our corporate offices last May, actually in April, when we realized that it was just an overblown — the media made COVID sound like some massive problem. I think a lot of society overreacted and it wasn’t good.

My favorite example is a guy — I’m not on his side, Governor Cuomo, but you cannot beat the man up. He overreacted sending people back into skilled nursing. Should he have done that in hindsight? No. But at the time, look what that man was facing. He was elected to be a leader of a state and he’s out there doing what he thought was the right thing.

He put those people back in skilled nursing, which was the wrong move as we now know because they never ran out of ICU space in New York City, but what decision would any one of us have made in his boots back on April 20th? In our case, we started realizing in mid-April, beginning of May, there’s something not adding up here. The problems are with the elderly, it’s not with younger people. We started going back in our office last year. I agree with Jamie Dimon over at Chase, you’ve got to have face-to-face time with people in offices.

Now, does that mean you cannot use Zoom and cannot use two-day-a-week work from home? That’s what we’ve gone to. We’ve gone to three days a week mandatory in the office, and two days can be in the office or in your home. We do mandate everybody’s on video, but we’ve been using video for 14 years now. That seems to work but it doesn’t replace person-to-person conversations.

That golf cart conversation was because I was moving past in the lunchroom where a person, a man was sitting down eating some food and I couldn’t help but disturb him and ask him a question about the golf carts and about light bulbs at the same time.

I think face-to-face [interactions] in offices count. We’re in the office, generally, right now, we have everybody in the office on Monday. Then we have Tuesday, Wednesdays are office time for marketing and accounting people. Then some departments are in the office all the time, like IT. We can’t do that from home because of the assembly process we do, but we do allow people to work from home two out of five days. That seems to be working basically from a lifestyle perspective, not because we want to do it as a company.

[00:17:32] Tim: We sort of got a little off track from the topic we started on, which was workforce. I’ll come back to that. A lot of the focus on the workforce crisis is on the frontline workers, but I’m curious, does it go beyond that? Is it becoming harder to retain people at the management level as well?

[00:17:53] Donald: Yes. I was on a call that Mark Woodka at OnShift had organized. We love his software, we think it’s brilliant. Somebody brought up they were losing middle management, another CEO brought up they were losing middle management at a rate they hadn’t seen. I was thinking, “I wonder if that’s true for us?”

It is true for us. We’re losing middle management. We’ve got lots of candidates for those jobs so they’re easy to backfill, but we’re losing experienced, quality people who’ve been with us for — We lost a wellness director the other day, she’d been with us nine years, just an absolutely excellent person, to go into real estate.

What’s causing this is burnout. They’re not leaving for competitors, they’re just leaving the industry. We’ve never seen this much of our department heads and middle management folks decide, “Hey, I’m no longer going to be in senior housing,” and they’re just walking out the door and they’re becoming realtors and working for hospitals, but they’re no longer in senior housing. We’ve never quite experienced anything like that.

Obviously, the frontline is a different matter. In the frontline, we have a little over 200 open jobs right now. We normally have between 80 and 100 open jobs at any one time in our system. The frontline, we’re not even seeing the candidates walk in the door, we can’t get them to respond.

In the director level, middle management, the jobs that are paying $40,000 and up, we have plenty of candidates, but a lot of times they’re new to the industry. People in the industry, I think they have just had the toughest year in their lives. I think that’s true for a lot of people in many industries, and they decided it’s easier, the grass is greener, on the other side of the fence than what we do in senior housing.

Part of that is, and I think it’s just the last three to four months, is because if you’re a manager right now and you’re dealing with this shortage of frontline workers, you’re having to work harder, you’re putting in more hours, you’re having to figure out solutions to problems. You’re having family members complain to you, residents complain to you about services, legitimately complain to you, and you’re trying to solve for it. It’s on you … I think that’s how everybody is right now.

[00:20:13] Tim: How about even higher? One of our trends that we were anticipating for this year was that we’d see more CEO turnover just for all those same issues. I imagine even CEOs are feeling that burnout.

[00:20:25] Donald: Yes. It’s funny you say that because I had a CEO of a public company call me last week to talk about that very issue. It was an interesting conversation and, I haven’t seen it, but he and I think it might occur.

I think right now, people that are running these companies, they’re so financially invested in it, they can’t, there is no solution for them to go somewhere else. It’s not like the wellness directors and the social directors or the DONs or the career services administrators, or head chefs. Those folks have other opportunities, not in senior housing.

I think the guys that run these businesses many times don’t have other opportunities outside senior housing or don’t perceive that they do, so we’re not seeing them jump.

[00:21:15] Tim: Do you think that’s an issue for the industry if it means that there’s not fresh blood coming into the top leadership roles at a rapid enough pace?

[00:21:27] Donald: Well, I think you it said wrong. I think you said they’re not fresh blood flowing out. I think when people leave at the top, it’s like when people leave our company, I always write them a handwritten note and just tell them I’m very happy. I’m sad for us, happy for you. Let me know if there’s anything I can ever do for you. Because the reality of it is, we just have the greatest people in our industry, whether they work for our company or other people’s company, they’re really great people. Who else would be in senior housing? You either have to love other people and really care, or this is not the right place to be.

When someone leaves at these upper levels, I’ve always looked at it as, I really hate to see them leave, but then I realize there’s somebody under there that’s going to rise up and it’s an opportunity for them and their family. I actually see a little bit of clearing out the top is not necessarily a bad thing in terms of letting some other people get their shot.

We’ve got a guy right now that’s an executive director for us. He started out three levels below that. My problem is can I make him into a regional soon enough because he’ll be a regional chief operating officer over the next eight years. This guy’s brilliant and are we going to have a spot for him? It may not be with us. It may have to be with somebody else. We’ve had those discussions with him. The door shuts, the door opens.

[00:22:47] Tim: You mentioned that for those management positions, you are seeing candidates lined up, so you’re not so concerned about back-filling them. Are those quality candidates? Are they coming from the hotel industry because it’s been so hard hit?

[00:23:01] Donald: Actually, yes, we’re seeing a fair amount of hotel industry people because they think they went through a bad time in the last year. I hate to burst their bubble, but I’d much rather be in the hotel industry faced with not moving people in my door and just having to deal with layoffs and temporary shutdowns than deal with what we’ve been dealing with for the last 10 to 12 months. They think it’s easier. The grass is greener … The reality of it is, it isn’t, but yes, we are seeing more hotel applicants, but we are seeing a lot of middle management.

One, we can attract them from other companies, we can attract them from outside our industry. We just don’t see the problem with finding applicants … through that process. It’d be nice if everybody that worked for you had been in that same job eight years, nine years, but there comes a point where you want people to get some fresh blood in, but, we’re just not seeing a problem with the middle management.

Where we do see issues are finding directors of nursing. A DON right now, a good one, you want someone who’s had experience. Well, if they’ve had experience, they’ve been burned out and that’s probably the problem right now, that and also nursing home administrators, we see those folks as being really burned out too.

[00:24:25] Tim: Maybe just one more question on workforce, since it’s a big topic, before we move on. You mentioned the big issue might be that you just can’t raise rates enough to cover the cost of wage increases, but I guess something has to give at some point. Are there things that you can do or that you’re trying to do at senior living communities specifically to try to address the situation if you can’t raise rates enough?

[00:25:01] Donald: Well, margin compression’s the name of the game. It’s been there now for the last really 18 months to 24 months. I think we’re going to see a pretty severe, for lack of a better word, margin compression time for the next 12 months, and then I think it’ll ameliorate. I believe there’s a rate, a jump in wages that’s going to occur and needs to occur. I do think that $15 an hour, somewhere in there, is probably an appropriate starting wage to be able to live in our country right now. It’s not that I’m in favor of mandated minimum wages, but you do need pay that attracts and keeps people and allows them to support their families.

This wage increase that’s coming through right now is a large wave let’s say, and then I think the wave height will come down starting next spring. The Fed is also telling us inflation’s way up now, it’s going to fall back down as people stop having all this free money and the pent-up demand from a year of savings goes away. I think those are two factors in what’s going on.

[00:26:19] Tim: How much do you think margins are going to compress over the next 12 months?

[00:26:22] Donald: I would argue that any operator out there is probably looking at around a 4% or 5% decrease in margin just due to labor.

Let’s just analyze that and think through it. Your starting wage also pushes the other wages up of your existing workers. In our case, if we raise our starting wage from $15 to $15.50, everybody that’s making $18 in that building goes from $18 to $18.50 because we push people so that you have this value for being there longer, hopefully, knowing more, doing a better job.

If you just step back and analyze, if your labor force is say, two-thirds frontline, your frontline goes up $3 an hour. It’s about $6,000 a year, plus another 11% for all the add-ons, so $6,600, and you get that $6,600 coming through, and if you’re in memory/assisted where your labor-resident population is almost one-to-one, then you’ve just got a $500 increase. If your average charge is $5,000, you’re looking at a 10% increase on your residents.

If you think you can get 5%, which is what we think is probably going to be the rate increase that we’re thinking is going to occur that’s workable, that means your overall margins come down the other 5% is wages, [and] half of it being allocable to your full cost means that your overall margin would come down 2.5%. That’s before allowing for other costs increases in insurances, utilities, and materials, foods, and then you’ve got rent increases if you have leased properties with REITs.

[00:28:27] Tim: Those other costs, we should just note, are pretty substantial. Insurance, I think I saw something like the average is a 22% increase. Also, I guess I’m curious on the marketing side too … I imagine that marketing costs might also go up higher than usual as everyone’s trying to gain occupancy back. Is that fair to assume?

[00:28:55] Donald: I think so. I know we spend a little more on marketing right now, but we increased our marketing spend. Our big change was two years ago, before COVID, the fall of ’19, and I’m glad we did it. What happened with us is our actual sales, our leads went up 2% in 2020 during COVID, and our sales went up 2% during the year of COVID of 2020.

The place we’ve been hurt is skilled nursing. Skilled nursing’s been taking it in the shins, for lack of a better phrase.

Then this year, we’re up about 50% in leads so far after the last year being up, and our sales are up 38% this year, year-to-date, over the last year, and the last year we were up. We spent more, we were trying to position ourselves to get more sales and looking at this as being a much more highly competitive industry. Because we look back 18 months ago, there was a tremendous amount of new construction coming online, at least in most of my markets, all but one or two.

We have people offering memory care at $3,700 a month. That’s the cost of labor in memory care. They were doing this in brand new buildings just to try to fill it up and then raise the rate. If you’re an existing building in that same market, you’re going to have a tough time attracting new residents. Even if you’re [not] building [new], you spent the CapEx to keep it up with your competitors.

[00:30:26] Tim: You mentioned skilled nursing is taking it in the shins. We’re seeing other companies — like Five Star, most notably — phasing out all of their skilled nursing at their CCRCs. Have you thought about reducing or completely phasing out skilled nursing in any of your properties?

[00:30:43] Donald: Every minute of every day of every second, you want to be out of skilled nursing. The skilled nursing businesses is one of the toughest businesses out there. However, it’s hugely attractive to people who live in our communities because in our case, we have skilled nursing everywhere but three of our properties. If you move in, we’re able to tell you, you and your mom will never go through this move again. We can take care of her till end of life. That’s, we think, a real competitive advantage. That’s why we continued to fill during the COVID crisis. We think it’s a real positive over people who cannot say that.

The offset of that is it’s a very tough business. It’s a low-margin business, it’s rapidly changing. I think it’s going to become much more of a — It wouldn’t shock me to see hospitals get back into skilled nursing again. They’ve sold them off in waves. I can actually see if I was a hospital administrator, where I might want more skilled or I’d want to be closely aligned with a skilled operator so that I can control my discharges and their care to avoid rehospitalizations.

The government waived that [Medicare] penalty but I think the penalty is back in force now for readmissions. Anyway, the skilled business is going to be tough. It’s definitely a terrible thing to be in from a GL/PL perspective. Then insurance is going up and up just because of plaintiff demands. Look at the, I don’t want to say the foolishness of the media, but there’s no other word for it. They’re going out there and claiming, look at all the people that died in skilled nursing from COVID.

Well, everybody dies in skilled nursing, and in a very short period of time. The average length of stay in skilled nursing is about a year. If you have 500 beds of skilled nursing, you’re going to lose 500 people this year. It sounds terrible, but that’s just the business. When people talk about all the deaths in skilled nursing, I’m sitting there wondering how many of those people were going to pass away anyway? It’s just hard to talk about it.

Look at my wife, her dad, my father-in-law passed away back in late April last year, early May. He was termed a COVID death because he died with COVID. He didn’t die from COVID. He was in hospice, really on his last week of life, and had no symptoms whatsoever. It’s just, when they pass away, they test them. Yes, he had COVID, therefore he’s termed a COVID death even though it had nothing to do with his death. I think that occurred a lot more than the media would ever talk about in their statistics.

[00:33:37] Tim: Skilled nursing obviously is difficult and is a part of the continuum of care community, but I think it’s interesting that CCRCs as a segment have actually been a real bright spot in terms of pandemic performance. You shared some of these numbers maybe already. We just got these from Ben Thompson, the president of Maxwell Group recently, so I’ll share these.

Correct me if I’m wrong but SLC shed about 2% in occupancy over the past year. A lot of that came from the skilled nursing units, and in assisted living, you added 1% occupancy and 6% in memory care units, which seems remarkable to me during the pandemic. Can you talk a little bit about what was going on? How did you actually gain occupancy?

[00:34:27] Donald: Well, we gained occupancy in everything but skilled. That’d be true today too, we’re still frustrated with skilled occupancy.

One, we spent a lot of money back in late ’19 changing — We use a software called Sherpa, David Smith, his software. One of the theories there — and we’ve been following, using David for consulting work for 15 years, maybe 20 years — is that you try to get more time spending with the customer.

We’ve gone to that, we added several things. One is we added more lifestyle advisors, salespeople. Second, we added our own call center, which we run internally but it is not just a call center, these are trained lifestyle advisors, trained salespeople sitting here in my office building, 100 feet that way. We set it up where they could work from home so we could work all seven days, this is before COVID. It was pretty seamless. If you call to talk to one of our folks in our communities, you’re actually talking to somebody in Charlotte, North Carolina. If you’re looking in Connecticut, someone in Charlotte’s helping.

That way, we controlled what occurred with the first contact with the customer. The only way you sell this service is physically get that prospect to come tour your building. Then of course get a [high] conversion ratio of tour to move in, or tour to contract, and contract to move in.

We were doing that, and then the other thing we did prior to COVID that I think had a tremendous benefit to us is that we have always been focused on what’s called home visits. We really push that, because we took away people having to worry about phone calls … What we told them is, “You no longer have people calling you, you no longer need to call out, we can do that out of the home office. We want you to go out and see people constantly.”

We were driving them out to see people. When things were shut down at the end of March last year, many people, many prospects, were still willing to see you in their home. They weren’t willing to come to your building. Of course, you were prohibited from touring them through your building by various state regulatory authorities but yet you can go talk to them in their home. We maybe did a couple of things that really worked for us well when COVID hit and I think that helped us. I also think people see the value in the lifestyle in a CCRC because even during COVID, our folks were not shut in their homes, they were having a good time.

These folks talk to each other, they Facebook, they FaceTime, they’re all the time talking to other folks that they know. What they were saying is, “I’m shut in my home but those folks over at that community, they’re still having parties. I’d rather be over there.” I would have felt that way. I can’t imagine not feeling that way.

[00:37:20] Tim: I’ve got a question based on something you said a little while ago, which is that you could see hospitals getting back into owning SNFs. I’ve also heard from different senior living providers that they’re looking to get into home care or home health.

Some of them have done that in the past, and now they want to restart it. We’ve reported on this in the past, that senior living providers historically haven’t done a very good job of running home health or home care companies. Hospitals have not historically done a great job of running SNFs, and now it seems like everyone’s eager to get back in those games. Do you think that history’s going to repeat itself or do you think it’s likely the lessons have been learned? Maybe hospitals will do better at SNFs and senior living will do better at home care this time around?

[00:38:25] Donald: I think history will repeat itself and that means the same errors will occur.

I think hospitals are terrible at running SNFs. They can’t avoid the overhead that they have in the hospital and try to bring it down to a very much lower-paid care setting. I think in home health, it’s just a tough business. It’s different. We started our home health business several years ago. It’s been a real positive but I also lost $5 million getting started. As [inaudible 00:38:56] once said, he did better off with his business if he drove down the street, drove past, and threw $100 bills out every morning.

Well, mine, would’ve been in the $1,000s. We lost $5 million for the first three years to start our home health business. Nowadays, it makes money. We’re very happy with it. It does a couple of things. It keeps people living longer independently in their home, avoiding a transition to a higher tier level. If they’re in assisted, we keep them longer in assisted before going to skilled. If they’re in their independent living home, we keep their independent home way longer before they go to assisted. It keeps us fuller. I think that home health is a real key.

If we look at where this industry is going to be in 5 years or 10 years, I believe you’re going to see home health much more highly integrated into what we offer … It could be that some of that product is offered outside the walls of a traditional building, where you’re providing services out a core building … think that’s what you’re seeing. I think you’re going to see operators get into it, but then you also see operators — I mean, LCS sold off two-thirds of their home health company several years ago, Brookdale sold off two-thirds or three-fourths, I think they announced two months ago. I assume those were for reasons because they felt like it wasn’t exactly the perfect fit. They want to keep their fingers in it, but it wasn’t a perfect fit … and they could monetize it.

[00:40:36] Tim: What turned the tide in terms of going from losing so much on the home health to actually now making money on it?

[00:40:44] Donald: We stopped trying to be everything. We started subcontracting a lot of the services to home health providers … The problem with home health is you need a critical mass. It’s like a lot of things we’ve got to get … like [leasing up] assisted living buildings. If you’ve got 60 beds, you’re going to lose your shirt until you get to at least 45 filled beds. If you’re starting out and you only have 5 or 10 beds in that building, same thing in home health. If there are 5 or 10 people you’re caring for, it’s impossible to make money because your care manager has to be paid. You still got the marketing, the administration, home office.

Then you’ve got the licensing aspects of providing effectively skilled nursing services to Medicare, out into a distributed area that’s not physically in one location where it can be supervised, and that’s tough. We started contracting out all sorts of things. Ask me about my time building a DME business back in the nineties. Our pharmacy, of course, Randy Bufford is doing great pharmacy, I salute him for it. We did well in pharmacy too, but they’re just different animals and different mindsets. If you don’t have that concentration or background, you’re going to pay to learn. I paid to learn home health.

[00:42:04] Tim: Are you Medicare-certified or is that a private-

[00:42:06] Donald: No. In fact, that was where we were paying. We were focused on Medicare certification. Medicare certification is easier just to hire in. If we had a community that say had 500 people in it, or 600, that’s probably a CCRC or any larger community, that’s probably the resident population where you want to be a Medicare-certified provider. Below that there isn’t enough volume to justify the additional overhead it takes to operate, I think, profitably.

[00:42:37] Tim: Got it. Let’s see. I guess I’m curious. How distressed do you think the senior living market is? We see surveys that 50% of providers are afraid they’re going to go under within 12 months without more federal aid, things like that. We haven’t seen so many bankruptcies or real distress situations. Do you think they’re coming? Do you think that the workforce issue might increase distress over the next year?

[00:43:09] Donald: I think it’s probably not the case. There’s two things.

One, I believe the lenders and capital providers have in 98% of the cases or certainly over 90%, taken some hits themselves over the last 12 months to make sure their operators stayed in business. They extended some payment terms to help you now financially, but five years from now, you got to pay back. I think that’s helped the industry tremendously.

The other reason I say, I don’t think we’re going to see a lot of huge failures is this. If you went out right now and you had to recreate — let’s take an operator [I know of]. They had a lot of buildings. Those buildings, if I had to replace them, you financially couldn’t do it. In this case, it’d be I think about $3.5 billion. It’s on the books, it’s $2.5 billion of this entity … Why would I get rid of something if replacement is three and a half billion and I’ve got it for two and a half? Maybe I’m better off finding a way to run it, because I’ve got a huge built in value versus somebody who has to charge the cost of capital to replace it at three and a half billion. I think that’s the whole senior industry.

There was a building we looked at, for instance, in Connecticut, it was going to sell for $22 million. It needed a couple of million upside, so $24 million total. I remember it was built 20 years ago. I knew the person who built it. She did a great job behind the walls, terrible job [in front of] the walls as a developer. For $24 million, in this case, $22 million purchase, $2 million upside, the replacement cost would have been $35 million. That’s a home run. I actually think a lot of the existing product, while they may be aged and need a fair amount of capital investment, could be worth a whole lot more versus trying to build something new.

We went to build a house the other day. I wish I’d ordered and build 150 houses back in November of last year. As it was, we had this section of lots in one of our CCRCs. We ordered five houses spec, we want to try some new floor plan and we just thought, “Oh, we’re going to open those in May or June right now. It’s going to be really interesting because we’re going to see how this product line sells.” It’s another slight variation on the product line. Sure enough, it’s doing well, we started selling. They’re just now opening as models and specs and we sold them. We went to try to build new ones, the costs have gone up $40,000 and $50,000 a unit in just six months.

People say, “Well, it’s lumber, it’s temporary.” Yes, $10,000 [increase in] lumber, there’s no question. The other stuff is not lumber, and it’s not timber. The cost to replace is just consuming.

[00:46:20] Tim: Maybe this is a good segue into just talking about the future of the CCRC model or the senior living model. It sounds like you’re experimenting with new floor plans. CCRCs obviously did well as a category during COVID. I’ve also heard increasing chatter about maybe the model needs to change, we need more a la carte pricing, entrance fees aren’t as attractive, et cetera, et cetera. How do you see CCRCs evolving?

[00:46:47] Donald: Well, I think you’re going to see CCRCs evolve away from type A and type B contracts. You’re seeing that very rapidly.

We’ve looked at a couple, three distressed ones in the last six months. In every case, the new provider, or a new sponsor, if it was a nonprofit, was going to convert from a type A, Type B contract to type C. Type C is pay fee for services, A and B are guaranteed life plan. I think you’re going to clearly see a move away from guaranteed life plan at least in the next two to three years. I also think you’ll see CCRCS potentially evolve into something that doesn’t look like a CCRC of today.

People always talk about the NORC, the Naturally Occurring Retirement Communities, The Villages in Orlando. That’s huge now, of course, but there’s a lot of those in towns all across America, where it’s basically a big ZIP code area. You could start providing services outside your walls and build a CCRC without walls. I think you’re going to see all sorts of modifications to provide more care and services for people in aging.

There’s this massive boomer quantity coming through right now that we’ve all been planning on and wishing it was here. Well, the ones that are coming through, let’s say they are 75 years old today, or 78 years old, they don’t want to live in what we have today. They want to live in what we have today when they’re 85. What they are thinking of, they’re looking more like a 65-year-old would 15 years ago. Remember how Del Webb started absorbing all the 55 to 66-year-olds 20 years ago, and how it really boomed in the last 20 years. I think that’s what you’re going to see, that age group is now aged up, and you’ve got another wave of people coming through. Even through age 75, 80, they’re not looking to live in a pure retirement community that doesn’t have more vibrancy to it.

I see the CCRC industry becoming more and more an industry of 80-year-olds and 90-year-olds as people live and age longer. I think the product that replaces it is going to be some of what you’re seeing people build — these 55-plus, they’re really all 65-, 70-plus rental projects. I think you’re going to see more of that with more services.

[00:49:23] Tim: That was my next question in terms of the growth for your company specifically and what areas do you see that happening? Are you developing? Are you looking to acquire and what’s the model?

[00:49:34] Donald: Well, for us, we’ll acquire.

We’d like to quickly find something that’s got hair on it, that’s got problems we feel like we can add some value. We’d like to do that. We would also acquire a standalone assisted and a memory care because we like that product. We keep finding we can fill it.

Also, in terms of development, instead of building standalone assisted/memory, all of our development right now would be [active adult], whether it’s single-family or apartments meant for older folks with limited services.

We’ve also in our CCRC model started allowing more limited-services people to live there, where they don’t take advantage of, say, the food or all the social programs. It’s helped us. We’ve been attracting some people in their late 50s and in their 60s to move into our communities. It creates more vibrancy in what we do.

[00:50:30] Tim: Are you actually in the process of developing those apartment-style communities, or is that more theoretical?

[00:50:36] Donald: We’re actually working right now on land acquisition for that, and product design. It’s part of what we’ve been doing some test models with. Part of the issue is it’s a tremendous capital investment, like everything in our business is, and the timeframes.

Right now, if you started today, you’re going to open in five years, maybe seven years, if you want a really great spot. If you’re into something that zoning is easy, the construction is easy, you’re still three years away, which means you’re five years from real profitability. Does that make sense?

[00:51:11] Tim: Yes.

[00:51:11] Donald: A long time horizon.

[00:51:18] Tim: I think it’s interesting you’ve got the Senior Living Communities brand, and also Wellmore. We’re seeing more multi-brand-type portfolios. Can you just talk a little bit about how you think differently about or operate differently an SLC community versus a Wellmore community?

[00:51:44] Donald: Our SLC communities are true CCRCs or look like a CCRC. They’ve got skilled nursing, memory care, assisted, rehab, home health, apartments, houses, and cottages on bigger properties.

Our Wellmore product is a CCRC without independent living, it’s got skilled rehab, hospice, memory-assisted. Those memory and assisted units look like one-, two- and three-bedroom apartments. They are places we could all live if we wanted to. In fact, they look like a regular apartment in many ways. We feel that those are two brands, they’re very different models, in a way, because a CCRC is integrated, you’re basically running about five businesses in one spot, which has a lot of advantages in terms of economies of scale, in particular.

Then we look at home health as its own brand because it has its own services that it’s selling to people. I think that you’re seeing some of these companies talk about we’re going to build this brand and that brand because they’re striating their product by price point, or by type. I actually think that’s pretty smart.

I go back and look at the three big failures in our industry, about a decade and a half ago, you had three companies get really huge, four really. Three failed and one merged with somebody else. If you look at what occurred with them, in every one of their cases, they got very large, and in an industry that’s a service business, they might have been better breaking their product up into smaller regional operating units. Look at the brilliance of how well Ensign does in skilled nursing right now, for instance. I think there’s companies that think about how to do that, and I think that they’re going down the right path.

[00:53:40] Tim: Maybe relatedly, one topic of conversation that’s come up in a lot of my recent interviews is about the real estate developer and investor mindset versus the operator mindset in senior living. There are some points of friction there, and maybe going forward, are new expectations needed, are new capital structures needed? I don’t know, do you have any thoughts on that?

[00:54:12] Donald: I’ve been thinking about that issue a lot the last two years because what you’re saying is, I think the old dogs, that’s what I call people like myself, are slowly disappearing.

I think you’re seeing the industry turn into really two groups. You really are seeing a group of operators, and they’re different than the developer/investors. I think you’re going to see more growth along those lines, where they’re very much a different animal. I think a lot of it’s going to be due because the capital cost of building and operating these communities is becoming so much more important. It’s also important, how do you run it? I think the skill sets are so dramatically different.

How do you train in the finance world and train in the operating world? If you started down an operating path with me you probably have no idea what’s going on over in finance. If you start down finance, you think you know [operations] because you’ve read a budget, but there’s a hell of a difference between reading a budget and actually implementing it with real people — someone’s mom, and taking care of her right. I think we’re going to end up very much siloing these people more than people maybe my age who came through and we’re doing a lot of different things and we’re seeing a lot of different parts of it. That’s my point of view.

[00:55:39] Tim: I think we’re also seeing a trend of some outfits trying to do both, like CA in for instance started an operating company called Anthology and they’re doing development on the CA side … I think trying to do it in such a way that the left hand knows what the right hand is doing. Do you think that model can be successful? Do you think that’s going to be harder than maybe people think it’s going to be?

[00:56:08] Donald: Go back to my example of me thinking I can operate a home health company. $5 million later, I learned my lesson. I was not able to operate what I wanted to and had to morph into something else.

I think if you’re going to do a quality job in operations and you’re a developer, you’re going to find some expensive education. Will you get there? Yes. You’ve got to get there. You can’t fail to do the right things taking care of people. I think it’ll be an expensive education.

I also know of two companies out there that have been developing their operations more because they wanted to do that versus spend the money to hire operations talent or contract it, partner with them. They’re both failing pretty miserably right now from what I’ve seen. It’s a school of hard knocks.

[00:57:03] Tim: One other thing I’ve heard is that historically, operators have just been undercapitalized and real estate returns have been really high. Do you think that there’s going to be a part of the maturation of the industry is going to have to be readjusting expectations about how much it takes to run a management company?

[00:57:37] Donald: Are you talking about reallocating the pie? [laughs] I think a lot of people would wish that would occur but I don’t foresee that occurring.

At the end of the day, it’s the golden rule. I think the capital partners are going to continue to drive the business. I believe operators will always have low margins and I think it’s going to be not impossible to get larger margins but tough.

On the other hand, if you look at return on investment, our management company makes a lot of money because of how much capital is in it. If there was capital in it, I probably took it out as the owner. The ROI is infinite, I guess. It is highly profitable.

Whereas on a community that you develop, trying to get a 20% IRR, with leverage, you can do it. I think IRR is gonna continue to sink or they might go up with inflation, but we’ve seen IRRs now where if you propose to somebody, you could get a flat cash on cash, 12% IRR, people will think that’s pretty darn good. With leverage, you’re going to, what 18% to 23% … Even at the worst of those times, we were returning 7% cash on cash on our real estate.

With the leverage, you have a nicer return but I think you’re going to continue to see the margin compress, even on the capital side. I think on the operator side, they’re never going to make any more money than what they otherwise made but there’s no capital required to invest to start it off unless you’re just going to go out and scale one very quickly, very big, in which case, bring a big checkbook.

[00:59:38] Tim: I’ve got one more big picture question to close on which is, if you could get all your peers, say the CEOs of the hundred largest provider companies, in a room at the same time and ask them one question, what would your question be?

[00:59:57] Donald: I don’t know. I’ve thought about that question. Yes, the reality of it is, what I love about our industry is if I go talk to the next 99 people in the industry, they’re all doing something different and 95 of them are going to be doing a good job, if not all 99.

My goal is to find out what they’re doing right and see if I can emulate it and avoid doing what they’re doing wrong. I love the fact that we have all this diverse talent all across the country doing different stuff and it’s very interesting.

When you think about this industry, you’re about to see the demand for the industry quadruple effect over the next six years. What other industries face that kind of growth and demand?

It’s a great time to be in the business and it’s kind of fun that everybody’s got a different pathway to success.

[01:00:57] Tim: Great. If you don’t mind sticking around just maybe one more minute, we did get a last-minute question from the audience. I’d like to take that if you don’t mind.

This is on rental rates. You mentioned that they need to rise because of wage pressure going up, but this question is also pointing out that there’s a lot of pressure to lower rate, maybe because of discounting happening as everyone tries to lease-up after losing occupancy during COVID. Which way do you think rates are going to go overall, down or up?

[01:01:29] Donald: I actually think rates have to go up. I would have told you four months ago, five months ago, that rates would be holding flat to slightly decreasing, because of the competition and the fact that everybody’s sitting there in fill up mode.

Normally, there’s five buildings in the market, one or two in fill up mode, the other are just stabilized. Everybody’s in fill-up mode right now. I think that’s going to keep rates compressed, [but] at the same time, everybody’s got the same problem with labor. You’ve got to retain them, you’ve got to keep them engaged and that requires pay.

That’s why I’m saying, I think the crisis right now, the labor crisis, the labor crisis and getting enough staff to maintain quality of service, that’s a problem. The real crisis is the margin compression that will be coming over the next 18 months because as the person who asked these questions rightfully noted, all the competition — which is everybody now — and you’ve got this tremendous increase in cost [and] your prospects aren’t getting those sorts of increases in their income.

[01:02:44] Tim: Alright, thanks for taking that last-minute here, and thanks so much for this conversation, it was really interesting, I appreciate your candor.

[01:02:52] Donald: That was fun talking to you.

[01:02:55] Tim: Great, love to do it again, soon. Thanks, everyone for tuning in and my next chat is with Rick Matros, the CEO of Sabra.