Margins have taken precedence as a top industry issue in recent years as operating costs have skyrocketed. But that doesn’t mean pre-pandemic margins are out of reach.
To Cogir USA CEO David Eskenazy, senior living operators still have a chance to regain margins in excess of 40% — the catch is, it won’t come easy.
“Can we possibly run a building at 40% or higher margins? We’ve done that for years, it’s still possible,” Eskenazy said on a recent episode of the Senior Housing News podcast Transform. “The way you do that is with significant discipline.”
And discipline is what Cogir — the senior living arm of Montreal-based Cogir Real Estate — is focused on in the aftermath of its acquisition of fellow senior living operator Cadence Living. The merger of the two companies created a new operating company with 60 communities and many more on the way.
Top of mind for Eskenazy and Cadence co-founder Rob Leinbach in 2023 is combining the strengths of both companies so that “two plus two equals five.”
“There’s not a lot you can do in terms of being aggressive in the current market,” Leinbach said. “So why not take that time to pause, sit down, take a deep breath and say, ‘How can we get strong, so that when those opportunities do come up in the future, that we’re ready to go?”
On how the Cadence-Cogir merger has gone since the announcement last year:
Eskenazy: Rob and I worked through the transaction for quite a number of weeks. Early in the transaction, we had set a November 1 date for closing, I think because we felt like if we try to close something in the middle of December, we may both get killed by our CFOs, if nothing else.
[We figured] if we could close the transaction before year-end, we would have time to organize our thoughts and still be able to manage through the budget season and year-end process, but also be able to hit the ground running when we come to January.
So, the timing was something that both Rob and I talked about along the way. And I think we did hit our November 1 closing. And we’ve really gotten a lot done in two months, probably more, more than I would have expected.
Leinbach: Cogir is the acquirer and Cadence was the acquirer. You never know how the rest of the company is going to respond. I’ve been pleasantly surprised with how the Cadence employees have all embraced the new organization. They’ve seen the synergies in terms of the culture, they’ve seen the synergies in terms of the operations, and have really jumped with enthusiasm to what is now the new Cogir entity. And I’m excited about what 2023 will bring from that perspective.
There were certain things that Cedence had accomplished in our short five-year history, but there were certain things that we needed to accomplish going forward. And so we were looking for recapitalisation of the company. And we were looking to add operational expertise at the highest level, the CEO level. We were looking to solidify our geographic footprint, which is the ‘southern smile,’ but we had areas in that ‘southern smile’ that did not have economies of scale, such as the Northwest, such as Northern California. And so, we were looking to solve those things, and it just so happened that all of the things that we were looking for in what we considered to be Cadence 2.0, in a combination with Kojiro, we could accomplish those things and create that long-term sustainability that we were looking for.
The pieces just happened to fit. We originally were out looking to do it on our own, we were not looking to come together. Cogir brought Dave’s operational experience, which we were looking for at the CEO level. And Dave’s organization had substantial assets in Washington and Northern California, which are the two areas that we needed to solidify. So, it all just came together really nicely.
Eskenazy: From our standpoint, it was less about having more. We weren’t at all looking for an acquisition. It’s been talked about in this industry sometimes that you either need to be really small or really big, but I don’t know that I subscribe to that. Really big hasn’t necessarily been better, either. I think being really small can be okay, if you want to own one or two buildings and try to self-manage them or something.
It’s a very operationally intensive business, and it ain’t getting any easier. It’s a very difficult business to operate. When you care about having a management company that’s fiscally responsible — some management companies are not, some management companies are there because the companies also own the real estate and they self-manage. And so the management company doesn’t necessarily have to be profitable, they can lose all kinds of money, as long as they’re making money in the building. So they’re not necessarily profit motivated or efficiency motivated, they’re just there to support the real estate investments that they have.
Now, pure third-party managers can’t really operate that way. We’re somewhere in between. We have investments in many of the properties that we manage, but not at all. We also have a discipline about ourselves that we think you shouldn’t have to choose. We should be fiscally responsible, have a reasonable profit margin at the property and management company level, and also be able to hit our margins as initially intended by the investors at the building level.
To do that, you need to have certain areas where you have good leadership in sales and marketing, compliance and care, and in memory care. If you’re going to have memory care programs, you have to have leaders that lead those things. Those are not inexpensive. Facilities management — we have some buildings that are not brand new, they’re a little bit older. And so turning the units and doing remodels and things like that requires internal expertise. Nursing, dining, both those take leadership and really solid people and those people are expensive.
So, you have to have a certain amount of scale to be able to get that quality of leadership that you need inside an operating company. We like to run lean, but you have to be responsible as well if you’re going to have properly managed buildings, which is what your owners expect of you.
We were wanting and needing some growth. Geographically, we were in Washington and Northern California, not so much in Southern California. And there would be other geographical markets that would be interesting to us. A Cadence was in Southern California. They also had operations in Phoenix and in Denver, which were also out west and in nice markets that we had been somewhat eyeing. And they had people in these key areas that I was describing — memory care, compliance, facilities, development; they had people in those places. So, this thing just fit nicely for us as opposed to just any old M&A transaction. It wasn’t like that. It was like we were filling a lot of our gaps.
On “stupid M&A” vs. “smart M&A”
Eskenazy: It depends on why you’re doing an M&A transaction in the first place. In our case, we were looking for something that we thought we were going to find from our own growth, and Rob was doing the same thing. We were just on tracks that happened to be leading roughly to the same place, and we got there two completely different ways.
You could have a different situation — for example, you’re a company that has some difficulty and you feel forced into something because you have to do something. You may find yourself in the middle of a transaction, maybe for all the wrong reasons.
But there are good transactions and bad transactions and it’s not just our industry. M&A happens all the time. We see companies get together and then we see them breaking apart again. Disney has done dozens of transactions over the years, I’m sure they would look back at them and say, ‘You know, in some cases, this was smart, in some cases not so much.’ We see that all the time.
We didn’t do this for synergy. Synergy is one of those words that’s used in M&A transactions as code for, ‘We can cut the overhead by 30% because we have all this duplication, wouldn’t that be great?’ Well, if that’s the reason you could do a transaction, that is fool’s gold. Most of the time people look back and say, ‘Yeah, we didn’t really find those synergies. And if we did, it took us five times longer than we ever thought in the first place.’
Most of the time, M&A transactions are because you believe it’s going to make your organization stronger for some reason. If you’re forced into something, you may talk yourself into that, because it’s stronger than the death knell that you’re facing at the time. But it is possible that there will be some stupid M&A in 2023.
It may be because there’s going to be a lot of pressure on a lot of companies in this cycle. We haven’t really seen the full end of this cycle yet, we’re in the kind of halftime. The other half is still left to be played out, and that could cause some organizations or some transactions to happen in a way that were not conceived to begin with.
Leinbach: Neither of us were going in here looking to cut a deal. We were both just working on our own, in our respective companies, trying to make them stronger. And it was only when we determined mutually that we could get there together that we said, ‘Okay, this is something that makes sense instead of doing it ourselves.’
And that’s a very different approach from the trying-to-get-together-to-survive moves. I’ve been through those. I worked at a dot com in the 2000 to 2001 timeframe where we merged with another company simply to survive, because everybody was dying. And that, of course, is not a strategy, it’s a life-preserver to try and swim to shore.
Dave and I truly believe that two plus two is going to equal five here, and what better time to strengthen an operator when there aren’t really transactions going around at the property level? There’s not a lot you can do in terms of being aggressive in the current market. So why not take that time to pause, sit down, take a deep breath and say, ‘How can we get strong, so that when those opportunities do come up in the future, that we’re ready to go, and we are prepared to take advantage of those opportunities?’ Whether that be acquisitions, new developments, or whether it be new management contracts.
I specifically remember Mathieu Duguay, the CEO of Cogir in Canada, saying that it’s like this is the perfect time to look inward and do whatever it takes to get stronger as a manager. We’re obviously only two months in, but I think both Dave and I can see what the potential is on the other side once we get through the integration process.
On staffing in 2023:
Eskenazy: It’s still a challenge. I think it’s getting better. We talked a lot about agency staffing, and we had done a pretty good job of minimizing agency. But that’s in our markets. All of the markets are very different. This is a very localized issue.
I think we may start hearing about layoffs at organizations like the Targets of the world. We compete for those same people, because they’re in our price range. We have something like 23 states that have increased their minimum wages. It’s states, it’s cities, it’s counties, we have minimum wage increases all over the country that are very localized. And one of the terms that I’d like to use and we’ll be utilizing as we go forward is something I call the ‘effective wage.’
It’s not that agency staffing is always more expensive. When you start getting into overtime, that’s expensive, too. And so if you’re paying $18, and you get into overtime, now you’re paying, time-and-a-half for some of those hours. Now you’re into the mid $20s per hour, and you go to an agency, but you’re also paying your indirect burdens. So what we’ll be looking at from a staffing standpoint is that we have to have our shifts covered. The thing about having your own employees is no employees care like our own employees care. And part of the thing about agency isn’t financial, it’s the fact that these are not your employees, and it matters. It really matters on a day-to-day basis to get to know the residents. They develop relationships with each other. And that’s sort of a big thing.
I think it’s important that we understand what labor is really costing us on an effective basis, taking all the dollars and putting in the numerator; and all the hours and putting it in the denominator. Wherever those things come from, whether your own employees or agency, you’re seeing what kind of effective wage we’re actually paying. At the end of the day, when you have so many different kinds of regular time, overtime, outside labor, these things are all meshed together. And pretty soon, it’s hard to even understand what you’re paying anymore. But I do think the number of open positions is starting to decrease and the number of people that are responding to the open positions is starting to increase. And so we’re trending in the right direction. I would not say that we’re out of the woods.
Leinbach: The good news is, we saw our agency use cut in half over the last six months. So, that is a positive. At the conference where Dave and I met, when I was a panelist, I was sort of the Debbie Downer of the conference, and a little bit morose. When I stated that I saw no real answers to the labor challenge that we have — because our government policy is just not letting the workers in that we need to have in, period — I don’t see that changing on the horizon. And so to Dave’s point, it is going to be a challenge.
In my opinion, going forward period, it’s how you manage that challenge and how you are able to use other factors, such as culture, to try and be the most attractive in the industry. And we’re and we’re working through all those things. We have seen even at the regional level, wage inflation is still there. Even though there are better candidates, we are seeing that it’s still very competitive to try and recruit and bring the best people over to your organization. So, those costs are still there.
On the state of margins in 2023:
Leinbach: From a big-picture perspective, you capture as much as you possibly can on the revenue side through the rents, and then you just try to become as efficient as possible in every aspect of the organization to improve that margin around the edges because every little bit counts right now. You can slowly build that margin back up to hopefully historical levels. But again, I do think that labor is going to continue to be a challenge for this industry going forward.
Eskenazy: I think margins are going to vary based on where you’re operating. You need to pick your ZIP codes carefully, because the cost pressures are still there. In fact, in our business as an operator, we typically manage right down to the NOI line; that operating income, the profit that we can generate in the building. And oftentimes [as an industry], we stop right there and we expect the investor to deal with it from that point forward, because they’re going to capitalize those transactions however they’re going to do that.
But like most of our household budgets, when we look at our budgets, the biggest expense we have is our mortgage. Well, mortgage rates doubled. If you think about interest rates, most of the new buildings that are built in our industry are on variable-rate mortgages. And when mortgages go from 3.5% to 7%, that’s double. So imagine your household budget having double your mortgage payment all of the sudden. The income that you’re using to pay that mortgage is under margin pressure, that’s our NOI.
So our investors are not terribly sympathetic to a contracting margin. In fact, they’re saying, how can we get more NOI, because investment costs have doubled our mortgage. And that’s difficult. The sort of story that hasn’t broken yet is just how in the world these are investors going to deal with double the cost of holding the investment with a reduced margin, or profits from the operation. This is the squeeze. That’s what’s going to happen.
But with respect to margins themselves, I have not abandoned the notion that we can still make the same margins [as before the pandemic.] Our goal has always been to see if we can figure out how to get a four in the first digit on our margins. Can we possibly run a building at 40% or higher margins? We’ve done that for years, it’s still possible. And if we miss that, we’re hitting the mid 30s.
The way you do that is with significant discipline. We talked about staffing, the two areas of staffing are primarily in the dining department and in the care department. We should make a profit on care, period. We deliver care, we deliver great care. And if we do that, I think residents and families are quite happy to pay for services that are rendered and in a good way. Why wouldn’t they be?
So, if we charge $1,000, we should be able to render those services for less than $1,000. If we can do that, then for every resident that we have on care, we should be making $100 a month or $200 a month or $300 a month or $400 a month — something accretive to the overall profitability. Now, that may drive margins down. Margins in the care department might be 25% to 35%, whereas margins in an independent building may be higher. But the question is, how many NOI dollars per unit can we drive to the bottom line? That’s what pays the bills at the end of the day.
If we’re gonna go through all the brain damage, let’s call it, of the regulation and the labor involved in delivering care, we sure as heck better make some sort of a profit in that department, or what are we doing there?
Oftentimes we give the dining away as part of the rent. Well, if that’s going to be the case, then we better be very diligent about what we’re spending in that department relative to what we’re charging. If we’re charging $10,000 a month for rent, then we better have a pretty darn good dining program, because these people are paying a lot of money. If we spend $1,000 or $1,500 a month on dining, that’s 10% to 15% of rent. But if we’re only charging $3,000 in rent, we can’t spend $1,000 a month on the dining, that’s giving 33% of the rent away to dining.
So it’s very relative. But you have to manage the dining department in that way. The devil is in the details of a management company in how you operate. And we have to double down on our efforts to make these buildings as profitable as we possibly can if we’re going to be considered a top-notch operator in the environment that our investors are in, whether they like it or not.
Leinbach: We haven’t really seen the real meat and potatoes of the fiscal crunch from the debt markets moving. I think you’re going to see a lot of inability to hit covenants, a lot of difficulty in getting NOI up high enough to meet some of those variable interest charges. We’ll find out whether it’s going to be ‘extend and to pretend’ from the banks, and whether they’re going to give everybody the time to to get through this.
Somebody told me the other day, to think about what senior housing has gone through over the last five years. Starting in 2017, we experienced two to three years of overbuilding, and then two years of Covid. And now we’re in year one and a half of ridiculous wage inflation; I mean, over 50%.
If you look at the frontline workers in terms of wage inflation; and now you’ve got, as Dave said, a doubling of interest, … it is going to take some time to work through the system. And whether or not the financial institutions allow for that time is going to be an interesting thing to me in 2023. And both Dave and I believe strongly, which is why we came together, that whoever executes the most efficiently at the highest level at the property management side of things is going to have opportunities come their way during this time. But those things are coming.
On what’s ahead for Cogir:
Eskenazy: One of the things we were eager to embrace from the Cadence side was their programs. Their programs are exceptional. We can’t forget how you win in business. Apple reminds us that you please the customer. Apple has been able, over the years, to charge what they need to charge to be able to do that. But above all else, Steve Jobs was very focused on making sure the customer has an amazing experience. We cannot forget that. We have to make sure our customer has an amazing experience. Cadence is very good at that with their programs.
So, we will be rolling out as soon as possible the memory care programs and some of the in-building programs that Cadence has really done an amazing job with. We’re eager to do that.
When I said we’re going to take a full year to complete the entire integration, that doesn’t mean everything happens in December of 2023. A lot of things that can happen can be rolled out, like these programs. That may not be terribly visible from the outside, but it’s going to be very visible from the inside.
Internally, we’ll be taking some of the disciplines and processes around efficient operations over to many of the buildings that Cadence has. And a lot of our portfolios are quite different, really in their lifecycle. They have a lot of new-builds, they have lease-ups, and the age of their buildings is fairly young.
In terms of new management agreements, there’s going to be a lot of movement in the industry. I think a lot of operators are struggling. I think that the investment community, as I mentioned, is only going to have so much patience to be able to withstand operators that are’t operating efficiently. And I think there will be some rotation in investors and owners looking for new operators.
What we need to do is continue to establish ourselves as a high-quality, efficient operator. And then, from our standpoint, be selective on choosing where we grow through new agreements; not just take everything, but consider the clustered approach to where the markets we’re in and having tuck-ins. So we’re in Denver with a number of properties, building out that market further with perhaps opportunities that come our way in those markets and the markets that we’re already in.
If we go into a new market, we would want to make sure that that’s a market we believe we can be successful in in the long-term. For us, it’s about playing the long game much more than it is about playing the short game. And so I think those opportunities will be available. I do think this is a kind of an environment that separates the men from the boys in terms of operators. This is a tough business. And those that thought it wasn’t are waking up to a pretty rough reality. And so, we don’t get comfortable in this environment, we get busy.