Senior Living Operators Financially Squeezed But Target Aggressive Margin Expansion

Early in 2020, senior living operators had hoped the pandemic would result in only a temporary hit to margins. They are still under bottom-line pressure as the pandemic enters its third year.

The industry is reeling from a one-two punch of depressed occupancy and elevated expenses, with inflation on the rise and workforce challenges leading to higher labor-related costs. As a result, widespread margin compression for senior living owners and operators is complicating the ongoing senior living recovery in the early part of 2022. This has been a hot topic on recent public company earnings calls with investors and analysts, with executives vowing to expand their companies’ operating margins in the months ahead.

At the same time, the industry is better equipped to navigate these waters than in 2020, and looking ahead, many are optimistic that favorable occupancy, rate, construction and demographic trends will carry margins back to pre-pandemic levels.

Although getting a snapshot of margins today is important, industry-watchers should pay attention to where they are trending, according to Capital One Director and Senior REIT Analyst Daniel Bernstein. And at the moment, there appears to be a significant runway for margin expansion in the months and years ahead as long as operators can grow occupancy in the future.

“Many REITs and many operators are feeling confident that there will be occupancy gain [and that] margins will expand very rapidly,” Bernstein told Senior Housing News.

Similarly, leaders with senior living companies that include operator The Springs Living and public non-traded REIT Healthcare Trust, Inc. (HTI) are optimistic that rate increases and occupancy gains will bolster margins in the months and years ahead.

Margins at a glance

Recent data from the State of Seniors Housing 2021 report showed where margins ended up at the end of 2020 — and the good news is, they weren’t far off from where they were nearly a decade earlier. However, the 2020 margins were lower than margins were in the industry’s earlier days.

For majority independent living properties, operating margins registered at 25.2% as of the end of 2020, while operating margins for assisted living properties sat at 30.3% as of the end of 2020.

Margins for all types of senior living communities was 26.1% at the end of 2020, according to the report.

Overall, margins in 2020 were only slightly down from where they were in 2011, according to HealthTrust Partner and COO Colleen Blumenthal, who compiled the data for the State of Seniors Housing report. But they are more significantly compressed now compared to those seen a couple of decades ago.

“I … have seen time and time again that when margins get too fat, developers figure out how to tap that market, increasing competition and effectively bringing margins down, whether through more competitive rates, slightly lower occupancy and/or higher wages,” Blumenthal told SHN. “In the 1990s, it was common to see a new assisted living and memory care property in the Northeast generate margins of 40% to 50% — now, even the pro formas I see are closer to 35% to 40%, with only the most aggressive/optimistic approaching 45% and above.”

Given the fact that occupancy is low across the entire senior living industry, it is hard to tell where margins are going, according to Don Husi, managing director with the for-profit senior housing and care finance team at specialty investment bank Ziegler.

Husi said that some operators are seeing relatively normal occupancy, with typical operating margins to boot. But overall, he estimates that higher expenses in labor, food and insurance are leading to margin compression in the 2% to 6% range on average, depending on the market.

“There has to be some margin compression, but it’s hard to tell exactly how much until we get to more normal occupancy levels,” he told SHN. “Most of your margins come from occupancy above 80% to 85%, really.”

On the nonprofit side, profitability ratios saw a widespread decline by the end of 2020, according to Ziegler Managing Director Amy Castleberry.

“Single-site organizations experienced widespread [operating margin] decline at the top and bottom quartiles … indicating that acute margin pressure affected organizations weak and strong,” Castleberry told SHN. “In the case of the net operating margin adjusted, which measures core operating profitability including entrance fee turnover, the median ratio declined for the fifth year in a row.”

A recent Pulse survey conducted by Senior Housing News gave a window into current margins. Though unscientific and relatively small in size, the survey showed that the industry is indeed feeling optimistic about margin growth this year and beyond.

Among the survey’s respondents — 25 in all from mid- and large-size operators — 64% said that their operating margins have decreased in the last six months.

Slightly more than half of respondents reported current margins between 15% and 25%, while a little more than 14% of respondents said their current margins were between 26% and 35%.

Although most operators reported margins below the typical 25% to 35% pre-Covid totals, they are also overwhelmingly optimistic about their prospects in 2022. Nearly three quarters (70%) of the survey’s respondents said they think margins will increase this year.

‘Tailwinds are there’

That optimism also was reflected in recent earnings calls held by publicly traded owners and operators.

For instance, Brookdale Senior Living (NYSE: BKD) CEO Cindy Baier said last month she is focused in the first quarter of 2022 on accelerating occupancy growth and driving revenue growth to expand margins at the nation’s largest senior living provider.

Similarly, executives with Ventas (NYSE: VTR) are “expecting significant revenue growth” of 10% in the first quarter, year-over-year, as operating partners grow occupancy and rates.

And leaders with Welltower (NYSE: WELL) also are bullish on margins recovering to and eventually exceeding pre-pandemic levels, in part through more sophisticated operating approaches that the REIT intends to help devise and support.

Welltower CEO Shankh Mitra spoke forcefully about his expectations on margin during the REIT’s Q3 2021 earnings call, saying:

“Welltower’s stabilized SHOP margin post-Covid will be higher than that of pre-Covid margins.”

He returned to this theme in the Q4 2021 earnings call, noting that labor costs were the main hurdle to margin growth.

“To the extent that you have higher pricing power in excess of higher labor costs, you will see upside to that margin,” he said.

Pricing power typically is tied to occupancy, with the assumption that occupancy increases give senior living operators more flexibility to raise rates. Thus, if average industry occupancy grows quickly in 2022, 2023 or 2024, Bernstein believes margins will expand in tandem.

“Whatever the expense pressures that are out there, I do think the industry is going to have the rate power to go ahead and match inflation, or even possibly exceed it,” he said.”All else equal, margins could actually return back to pre-Covid levels.”

The Springs Living, which owns and operates 18 senior living communities in Oregon and Montana, has seen a 3% compression to its margin overall since the start of the pandemic. Even so, CEO Fee Stubblefield told SHN that the company’s leaders are still “very optimistic about the future.”

“It will take a while to absorb the inflationary impacts to the economy and our business, but our long-term fundamentals, including the demographic trends, will lead us to even better financial results in the sector,” Stubblefield told SHN.

That is a view also shared by John Rimbach, who is president of healthcare facilities with the advisor of New York-based Healthcare Trust, Inc. (HTI). Although higher expenses and lower occupancy have compressed margins across the industry, Rimbach is not as concerned about margins in the long run.

“I’m more interested in positioning our properties with the right people and the right teams for long-term success,” he said.

Stubblefield believes that rate increases and investments in new and efficient technology can help the operator meet its goal of growing margin 3% annually. And he is encouraged by the fact that there are still many baby boomers yet to reach senior housing entry age in the years to come.

“We are presently fully staffed and are restoring services to the high standards our residents expect and deserve,” he said. “Once the quality of our services and offerings are closer to pre-pandemic levels, we can focus on driving margins back to stabilized levels.”

Looking ahead, Stubblefield believes inflation and margin compression are transitory forces for the industry, and that operators will be able to make up the difference in part by raising rates.

“It will just take some time for the run-up in real estate and investment values seniors have enjoyed to migrate to increased rental rates in senior housing,” he added.

The focus on rate growth was also reflected in the recent SHN survey, with 61% of respondents indicating that they believe rates will increase by 6% to 10% in 2022.

While HTI is not an operator, the company works closely with its primary operating partners, Jaybird Senior Living and Senior Lifestyle. In 2022, the company is focused on revenue growth, particularly those driven by recent rate increases of about 8% to 10% among its operators.

And like others in the industry, Rimbach believes the fundamentals for senior living will improve in the years to come.

“We’re looking at … a year-and-a-half to 3.2 years to fully recover,” he said. “But the tailwinds are there.”