Management Contracts Are Broken. Senior Living Operators Must Realize ‘Power of Their Flag’

Doubts about the viability of standard management fees in senior living are increasing and — after years of debate and hand-wringing — the time has come for a more sustainable contract.

As investors pour capital into the industry and owners continue to assemble portfolios, some are forging management agreements with new operators. For owners and developers, these are usually set at favorable terms; but for senior living operators, a management fee coupled with a meager promote is often barely enough to make the math work these days, if at all.

Some senior living operators — especially the smaller upstarts — might consider these sort of arrangements the table stakes for working with established companies, or a price to pay for building out an initial base of operations with which to grow down the road. And to that end, many companies have grown at breakneck speeds using this strategy, adding dozens of communities to their portfolios in a span of only a year or two.


But I believe that this could be setting up the industry for a rash of failures down the road, if a whole crop of senior living communities carry a ticking time bomb in the form of unsustainable agreements. Recent conversations with senior living CEOs have only emboldened my view that this is a big problem for the industry, and one that must be solved sooner rather than later given how the industry is evolving.

In this week’s exclusive, members-only SHN+ Update, I analyze the state of management fees and offer key takeaways for senior living providers, including:

  • Rapid cost inflation makes these kind of agreements unsustainable in the short-term
  • Current management fee structures could hurt the industry in the long-term
  • What healthier management fees for operators would look like

Costs continue to rise

Cost inflation is doing a number on the senior living industry, with senior living CFOs identifying staffing and food as among the top sources of financial pain for operations.


As operating expenses rise, they could limit the degree to which margins will grow in the next six months. More than half (55%) of operators who responded to a recent NIC survey said they only expect to see margins tick up between 1% and 5% during that period.

At the same time, it is often said that the industry standard for management fees is around 5%, with a certain percentage of promotes built in. For operators with quality and scale, a typical management fee coupled with anemic promotes are not enough to turn a worthwhile profit.

Take Aegis Living. CEO Dwayne Clark said the Bellevue, Washington-based operator’s management fees these days are north of 6% — close to a breakeven price, given the cost of operations. At the same time, he routinely sees deals elsewhere in the industry with promotes in the range of 3%, which is hardly enough for a worthwhile operator like Aegis to spend the time and energy to take over a community.

Aegis doesn’t move forward with development deals unless the company can reasonably expect to make at least $20 million in net profit in five years. Even under a more favorable management agreement than what is typically in the market — say, 15% as opposed to 6% — the company would still stand to make far less than it otherwise would, Clark said.

“If somebody comes in and goes, ‘I want you to manage this, I’m going to give you 15% of that $20 million,’ why would I do a deal for $3 million?” Clark said.

Of course, Aegis is among the stronger, well-established operators in the industry today, and one that is able and willing to put skin in the game on new developments and can command decent returns. And Clark has long been a critic of the management contract. But his point is less opinion and more hard math: Even for operators in lower return thresholds, these kinds of management agreements might not be worth it, and could be risky. So, why do it?

The Springs Living CEO Fee Stubblefield recently told me that he sees quality operators get paid through a combination of incentives, asset management fees, promotes, development and acquisitions. But that obscures the true cost of senior living operations, which is likely closer to the equivalent of 10% to 14% in management fees, he said.

And as far as the 6% fee goes, he added that “I could not, would not, run a senior living management company for that.” But, he also said he lacked the empirical data to declare such fees completely unviable.

Other industry executives are sending the same message. Cedarhurst Senior Living recently exited its only third-party management contract, shedding 20 communities, and the company’s leadership has decided to move away from management fees going forward.

Cedarhurst CEO Joshua Jennings is particularly concerned that 5% management fees could “almost disincentivize” providers from bolstering their workforces given current high labor costs. And Covid-related expenses and overall cost inflation only add to the margin pressures.

“I don’t think the economics can be done,” he recently told SHN. “Maybe at scale, if you’re managing 200-unit independent living buildings where you have a lot of units and not a lot of staff.”

Industry veteran Lisa Brush, president and founder of Symphony Senior Living and Blue Lotus Senior Living, also is concerned about the future of the third-party management model.

“I am a firm believer that senior housing management companies need an association to themselves; one that shares best practices in management contracts — the dos and don’ts and warnings about unscrupulous partners,” she told SHN in an email. “Like Cedarhurst, we also have moved away from 5% and less management fees; [there] is no money in it and a ton of headache … but there will always be a new passionate operator willing to take the money to get started, until they get beat up and spit out and lose their shirt in the process.”

Long-term harm

Clark said he sometimes speaks with leaders of other senior living operators who are growing through management agreements. In one recent encounter, he spoke with the owner of a young company that had added dozens of communities in just a few years’ time.

Although the operator was signing new contracts at a steady clip, it was only making about a 3% promote on each community — a pittance in terms of dollars made. The operator’s reason for doing so was that the company was building up its base of operations. But to Clark — whose company over 25 years has slowly built up a base of about 40 communities — this amounted to a “doomsday strategy.”

He pointed out that having a large base of operations can’t save a company from failure, and that senior living operators need only look at companies such as Kmart and Sears for examples of that in practice.

He shared an example of a project on the West Coast with a reputable developer and strong national operator involved, but carrying the typical 6% management fee and similarly meager inventives.

“Guess what’s going to happen? [The operator] is going to give you their C-team and try to collect their fees … with as minimum energy as possible,” Clark said. “I can give you five other incidences where the same thing is happening: The promote is so small that the operator has no incentive to perform.”

As he looks across the industry, Clark sees many other companies growing quickly using these kinds of strategies. But this gamble is unlikely to pay off, particularly given current market dynamics, he argues.

“It’s a broken strategy,” he said. “The building that should have been filled in 25 months is now going to take four or five years.”

Unlike at the beginning of the pandemic, access to capital is no longer scarce in the senior living industry, and construction is again ramping up in many markets across the U.S. as more companies attempt to invest now to get ahead of an incoming demographic wave. What is scarce right now is the number of quality senior living operators — made evident by the fact that Aegis is often now being approached for management deals with 15% to 20% promotes built in. But even that is not going to be enough to entice an operator like Aegis, Clark said.

Until operators start to charge closer to what their operations are worth and capital providers take note of that, the discrepancy between good operators and bad ones will continue to grow, harming the industry’s health — and community values — in the long run.

“You just can’t take your fairy dust wand and say, ‘Okay, there are going to be 10 great operators tomorrow,’ it takes time and experience and knowledge,” Clark said.

An alternative model

Of course, the management contract is but one way senior living communities can operate, and in recent years operators and owners alike have found success in models that carry “sink or swim” incentives for both parties, such as RIDEA — although there is concern about the tradeoffs that operators make. And some industry leaders, including Juniper CEO Lynne Katzmann, are considering even more creative structures to appropriately capitalize operations while aligning incentives across all stakeholders.

One solution is for senior living operators to charge management fees closer to the true cost of operations, which Stubblefield pegged at around double where they are today, at about 10% to 14%. But he pointed out that “just because you pay folks more does not mean they will do better.”

“Besides, you would see a huge decline in values if you doubled the management fees,” he said. “The market won’t sustain that direct increase.”

But Clark believes there is a better way to structure the senior living management contract than just increasing management fees wholesale. He imagines a world where management fees stayed where they are, but where operators won promotes of 40% or more. Under that model, operators would be incentivized to deliver the best results possible in order to make the most value, instead of minimizing their losses.

And although developers and investors are used to 5% promotes, they can stomach far higher. For instance, Aegis takes promotes of close to 50% on deals that it finances with friend and family capital. In return, investors get a 7% preferred “right out of the blocks,” with IRRs of between 13% and 15%, depending on the building.

This kind of arrangement does involve some give and take, and Aegis and Clark invest some skin in each project. But he sees this as a far more attractive opportunity for quality operators such as Aegis.

As for how senior living operators might command these kinds of promotes, Clark thinks they should lead with quality. For example, high-end hospitality companies such as the Four Seasons and Ritz-Carlton charge rates based on the fact that their name carries power.

“You want the power of the flag, you have to pay for the power of the flag,” Clark said. “We have not adopted that concept yet.”

To that end, Aegis has established a relationship with one outside capital source, Blue Moon Capital, which “pays us a substantial amount for the power of our flag.”

“That’s the issue: you have to realize what flag you’re buying and what it costs,” Clark said. “And until you realize that, you’re going to be on the Kmart blue light special.”

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