By Aaron Rulnick, Managing Principal of HJ Sims
Aaron serves as co-leader of HJ Sims’ investment banking team and sits on both the firm’s Executive Operating Committee and Board of Directors. With more than 30 years of experience in the senior living field, Aaron has financed more than $7 billion for the development, expansion, refinancing, acquisition and divestiture of nursing homes, Life Plan Communities, senior housing, assisted living and memory care facilities for both not-for-profit and for-profit clients.
Are you apprehensive about 2023? You are not alone. During the latter half of this year, we have heard a lot from our clients about the extraordinary challenges they are continuing to face. I’d like to share some thoughts on the senior living trends and market forces at play in 2022 and my early insight into the carryover effect into 2023.
Let me begin by saying that I expect 2023 to be a year of continued uncertainty and challenges, but with some positive trends emerging and opportunities ahead. “Strong” organizations continue to demonstrate that they are in a better position to weather the storm and take advantage of the disruption. But the real concern is that organizations that are “resource constrained” may not be equipped to manage through the continued challenges ahead and may have waited too long to raise their hands for help. As such, we will continue to see a lot of transitions within and among organizations.
- Impact of rising inflation, construction costs, wage rates, and interest rates
Anyone who has been trying to get a project through the pipeline and under construction is familiar with the current state of affairs. Construction and labor costs, as well as interest rates, have increased dramatically, and the rate of inflation, while waning a bit, is still relatively high. These factors cumulatively threaten the viability of certain projects. Capital is tightening on the for-profit side of our business, too, slowing down the pace of new development. In addition, higher interest rates minimize the ability to refinance—a tool many organizations took advantage of in the prior lower interest rate market to generate savings to offset rising operating costs or to generate debt capacity for new borrowings.
Besides past construction and financing challenges, will the rise in mortgage rates cause the housing market to soften? Will that have a negative impact on communities’ occupancy, putting further pressure on financial recovery? The flip side is that a slower pace in new development activity relative to the pace of growth of the senior population should help enhance occupancy of existing communities and improve absorption rates of new product. We saw a similar trend coming out of the financial crisis over a decade ago. It will also be interesting to see if the tightening of capital within the for-profit sector will continue to create opportunities for non-profit organizations to grow and diversify through acquisition of these predominately rental assets.
Where might interest rates go in 2023? The conventional wisdom is that the Fed will continue to raise interest rates but at a slower rate of increase, with a potential interest rate cut by the first quarter of 2024. It’s more difficult to predict the effect that world events will have on the financial markets. So many things are out of our control—and fear of the unknown is exactly what drives market volatility.
- Reliance on government funding
Certainly, most organizations feel that the proverbial Band-Aid has been pulled off in terms of government relief funding/grants in response to the pandemic and the labor crisis. The continuous flow of government programs and funding relief in various forms was a great help during the pandemic, but at this point most of those options have been exhausted. Unfortunately, it comes at a time when organizations continue to deal with intense pressures on operations along with a decline in their investment performance.
- Margin compression
Communities are getting hit on all fronts. Staffing costs are certainly one of the most important contributing factors to the pressures constraining margins, along with supplies and capital costs. Conversely, in an attempt to preserve margins, providers need to increase fees at significantly higher levels than in years past. Even with that, it’s not enough to offset all these other costs. At the same time, communities are still dealing with occupancy recovery, which is improving but not at the pace people had hoped.
- Organizational exhaustion
Coming out of the pandemic, we saw that retirements and exits from the workforce increased. Some people noted that their investments were doing well and felt they could afford to retire, and it was the right time. There was and is an enormous fatigue factor, from the CEO all the way down. Boards are exhausted, too. It has been hard on everyone—they may have survived the pandemic, but there’s little relief to the challenges that remain.
During the financial crisis of 2008/2009, and in the early days of the pandemic, we saw a lot of resiliency in not-for-profits. The current environment feels different because the pressure is coming from all sides. While data from organizations like NIC show continued positive occupancy trends, occupancy recovery alone will not alleviate margin pressures, demanding a continued intense focus on expense management and growth of ancillary business.
So what is an organization to do?
Right now, organizational leadership should be actively monitoring and managing their cash flow situation. Ask the difficult questions even if you feel you’re not quite in crisis. In reality, organizations should always be in a cycle of regularly asking, “Where are we, and where are we going? Are we in a solid place to perpetuate our mission and vision for the organization?”
Invest and manage in such a way that you maintain viability. Another way to look at this is the contrast between being in survival mode versus being in success mode. If you are in survival mode, it can be difficult to envision what success looks like. It’s a matter of acknowledging that and realizing you may need help recognizing if there is a realistic path to success either alone or in some form of partnership.
Our primary recommendation to our clients going into 2023 is to ask themselves the tough questions. Keep an open and transparent dialogue with your Board. There is more need than ever to be disciplined and to monitor everything closely. And finally, do not wait until it’s too late to ask for help. The bright side is that the pandemic forced us to bridge gaps and to learn to pivot quickly. We are all facing these same challenges. Opportunities abound for ways to partner and collaborate. I am optimistic that this spirit of partnership and collaboration will carry us over into 2023—and that we can work together to continue to demonstrate the resiliency of the senior living sector.
HJ Sims is a SEC registered broker-dealer, a member of FINRA and SIPC. This material was prepared for informational purposes only and from sources believed to be reliable but is not guaranteed as to accuracy and it is not a complete summary of statement of all available data. Information and opinions are current and are subject to change without notice. The opinions expressed by Mr. Rulnick are strictly his own and do not necessarily reflect those of HJ Sims or its affiliates. HJ Sims is not providing any financial, economic, legal, accounting, or tax advice or recommendations.
