Inflation, Interest, Innovation: Senior Living Recovery Becomes More Painful

The senior living industry is in a tough spot and will be for the immediate future, facing challenges that could impede longer-term success unless more innovation flourishes across the sector.

This is one of my main takeaways from last week’s National Investment Center for Seniors Housing & Care (NIC) conference in Washington, D.C.

The good news is that many conference attendees were upbeat despite the challenges of the present and uncertainties about the future; Covid-19 seems to have put all other issues into a new perspective. As Health Dimensions Group CEO Erin Shvetzoff Hennessey told me, nothing scares her after running senior housing and care communities during the height of the pandemic.

In this week’s exclusive, members-only SHN+ Update, I offer my analysis of key ideas from the NIC conference and offer takeaways, including:

• Inflation and interest rate hikes are stalling a more robust recovery
• Innovation — not just patience — is needed to regain margin
• Significant constraints on innovation exist and must be removed

Inflation vs. interest rates

It’s no secret that senior living operators have been dealing with dramatically elevated expenses as inflation has soared in 2022, and this was a hot topic at NIC.

Labor costs have been a particular pain point. The employment cost index was up 5.7% year-over-year in Q2 2022, Jason Schenker, president of Prestige Economics and chairman of the Futurist Institute, pointed out at NIC.

Senior living providers are bracing for labor expenses to keep rising.

“I’d love to see if anybody knows exactly where labor is going to be in 12 months — my guess is it’s going to be higher than it is today, in terms of the cost,” Cindy Baier, CEO of Brookdale Senior Living (NYSE: BKD), said during a NIC panel.

This sentiment is shared by leaders at HDG, Shvetzoff Hennessy told me. And Maplewood Senior Living CEO Greg Smith also believes wage rates will continue to “slightly rise,” he said during a panel.

The cost and availability of certain goods has improved thanks to supply chain stabilization that has occurred since earlier this year, but global instability — particularly the war in Ukraine — is casting major doubts over what the future holds in terms of shortages and cost run-ups.

The treatment for inflation, in the form of the Fed’s interest rate hikes, is also causing pain for senior living and other industries.

“I use this analogy, because it’s so real and visceral: 300 years ago, the medical men or women were using hot irons to burn out infection. And now we have sophisticated technology … but our Fed is still using the hot iron,” David Selznick, chief investment officer of Kayne Anderson Real Estate, said on a panel.

Every point of interest rate growth will cost Brookdale about $15 million, despite the company having a large proportion of debt at fixed rates, Baier said.

Rising interest rates and elevated construction costs also are constraining senior living development, with new starts “falling off a cliff,” in Selznick’s words. Developers like Ryan Cos. that have well-established debt and equity relationships — and vertical integration to manage costs — are still seizing opportunities to build, but are being forced by cost considerations to focus on higher-end product. So, intentions to serve the vast middle market are being stymied.

Indeed, affordability in senior living is becoming ever more elusive, as operators have aggressively hiked rates to preserve margins in 2022.

On a positive note, operators have demonstrated great pricing power, notching occupancy gains while also getting little pushback from existing residents over rent hikes.

But expense pressures have mounted to historically high levels, and at some point rate increases will not be able to keep pace.

As Brandywine CEO Brenda Bacon put it: “The [question] becomes pricing power to what?”

Innovation becomes imperative

Some current challenges will fade over time, but at NIC, I also heard widespread recognition that the playing field has been altered in long-term or permanent ways.

Interest rates are normalizing closer to historical levels over the last 50 years, and the industry will need to accept that cap rates will rise, Priority Life Care CEO Sevy Petras observed.

Workforce dynamics also have permanently shifted, and staffing shortages will be chronic, several industry leaders argued. Even before Covid-19, senior housing and care was facing worker shortages, and pandemic-related labor market disruptions have only accelerated this issue, HDG’s Shvetzoff Hennessy said.

Assumptions that workers would return to senior living after Covid-19 faded and enhanced unemployment benefits ended have proven false, Brandywine’s Bacon said.

“I think the workforce has been fundamentally changed by Covid,” Bacon said.

If providers hope to drive occupancy back to 90% or higher, with margins at pre-pandemic levels, she argued that innovation is necessary.

“We have to think, how do we get there and beyond, and not think if we just settle down, it’ll go back to normal,” she said.

On a positive note, ideas about how to adjust and innovate were shared in abundance at NIC. These ideas included:

Utilizing technology to drive operational efficiency and attract the future consumer. There is a huge gap between senior living and other industries in terms of tech investment. As Baier said: “Whether it’s health care, where now you can have an app that diagnoses skin lesions with over 90% accuracy, or if you look at the latest news from Starbucks, where they’re going to have new technology that makes your custom iced coffee in just seconds, every other industry is invested in the technology. Now, we’re very much a relationship business. But there are ways to bring technology into our industry to make our services more affordable, so that we can spend time on truly what matters for the residents.”

Finding the senior living equivalent to such technologies will drive revenue-per-square-foot, noted RSF Partners Managing Partner and NIC Board Chair Kurt Read.

More creativity to achieve scale. There was much discussion about the increasing need for the cost and operational efficiencies enabled by scale. I wouldn’t be surprised to see some notable management company consolidation occurring in the near future. Building bigger, to achieve scale at the community level, is another area ripe for innovation.

RSF’s Read floated the idea of having clusters of smaller memory care assets in a given market. A cluster could help spread fixed costs and reduce the risk of being “crushed” by losing a small number of residents from, say, a single 30-bed community. And he believes a group of assets with scale in a market is also more likely to attract a “true CEO” to lead on the ground. “The standalone memory care model — although from an operational standpoint it has some wonderful benefits for the staff, the consumer — just has some challenges from a capital formation standpoint,” he said.

Taking a larger role in value-based health care. New research unveiled during NIC highlighted that the average assisted living resident is diagnosed with more than 14 chronic conditions. These findings underscore the huge role that senior living providers can play in population health efforts by managing this high-needs and high-cost population. Finding ways to participate in value-based care arrangements has been a major trend in the senior living industry for years, with pioneers breaking important ground. But this remains a major frontier for senior living, and one that Baier sees as a key driver for growth, saying, “We’ve been investing in innovation, [including] new, innovative care models that help our residents live healthier lives, better manage their chronic conditions, that’s resulted in them staying with us longer and lowering the cost for the health care system.”

Barriers to innovation

Many other creative ideas were under discussion at NIC, which makes me hopeful for the future. But there also was much talk about the barriers to innovation that exist.

Changing the owner-operator dynamic ranks highly on the list of issues that have to be addressed in order for innovation to flourish.

I heard from one provider CEO who is frustrated with a large, institutional capital partner. Operational innovation is essentially being tangled and choked in red tape, with the capital partner placing significant demands on the provider’s team to make a case for proposed ideas, without high-touch engagement from the investor leadership, the CEO told me. This is far from the first time I have heard such complaints.

And after a panel of provider CEOs — including Baier, Bacon, Petras and Smith — told moderator Read how they would utilize dollars of free cash flow, he offered this takeaway:

“I didn’t hear one real comment about real estate … what I heard is that these CEOs are going to invest in their product, their people, innovation, efficiency, things that make them a better operating company. What this says to me is the dialogue between investors and operators needs to change to reflect that.”

To this, Bacon asked whether the industry is ready to have this conversation. Read half-joked that he “doesn’t care” and is willing to be the “punching bag” if people are uncomfortable — but I think Bacon’s question reflects how difficult it will be to shift investors’ focus and drive more dollars to operations.

Another issue facing senior living is lack of transparency, and several panelists practically pleaded for more robust data sharing across the sector. In just one example, Ryan Co.’s EVP of Senior Living Julie Ferguson said:

“Certainly as an industry, we need data sharing … How powerful that would be, if we all shared where our residents actually came from. And this notion that 70% of them came from the PMA [primary market area] in most market studies, it would be amazing to find out where our residents are actually coming from.”

After taking a massive hit in the early 1990s, the hotel industry adopted “radical transparency” by working with organizations such as Smith Travel Research, Read said.

“Within five years, you had new brands, you had capital formation, you had loans, you had stunning innovation,” he said.

For hotels, pain led to progress. Having just gone through the dark days of Covid-19, I only hope that the senior living industry already has endured enough pain to motivate changes and clear the way for its own stunning innovation.