Five Star Sees Deep Concessions From Competitors, Resists Discounting

Leaders with Five Star Senior Living (Nasdaq: FVE) are focused on maintaining rental rates in the face of steep concessions that competitors are offering in some markets, as they seek to rebuild occupancy that has eroded due to Covid-19.

The strategy to prioritize rate over occupancy could weigh on near-term results for Diversified Healthcare Trust (Nasdaq: DHC), which owns about 260 Five Star communities in its senior housing operating portfolio (SHOP). But, Diversified endorses the approach.

“In the past, we’ve seen that sacrificing rate for occupancy has led to long-term revenue deterioration,” Diversified CEO Jennifer Francis said Thursday on the Q3 2020 earnings call for the Newton, Massachusetts-based real estate investment trust.

About eight months into the Covid-19 pandemic, discounting appears to be on the rise across the senior living industry, according to recent survey findings from the National Investment Center for Seniors Housing & Care (NIC). Five Star and Diversified executives confirmed that this trend is playing out in some of their markets.

Five Star — also based in Newton, Massachusetts — is offering some discounts to stay competitive in certain locations where other providers are offering “deep concessions,” COO Margaret Wigglesworth said on the company’s Q3 earnings call. But she and other Five Star leaders believe that they can largely hold the line on rates and still improve occupancy, given current sales and move-in trends.

A targeted approach

As of September 30, 2020, occupancy for Five Star’s managed communities was 75.2%, down from 78.7% on June 30. That’s against a backdrop of historically low occupancy across the senior living industry, with average third-quarter occupancy of 82.1% across 31 primary markets, according to NIC data.

The good news is that occupancy erosion is slowing. Occupancy in Diversified’s SHOP portfolio fell by about 27 basis points per week in the third quarter, but current trends suggest that is slowing to about 24 or 25 basis points per week, Francis said.

Average sales leads per month increased 33% in the third quarter compared to the second quarter for Five Star, and conversion rates were about even with pre-pandemic levels, Wigglesworth said.

Barring disruptions from increased Covid-19 activity, the companies are anticipating that they can build fourth quarter occupancy without resorting to steep discounting. However, market dynamics in certain locations are forcing a targeted approach.

Discounting is easier to avoid in more needs-based levels of care such as assisted living and memory care, and more widespread in active adult and independent living, Francis observed. When some sort of price incentive is introduced, the favored approach is to offer a period of free or reduced rent upfront, rather than lowering a base rate.

“I think some competitors are offering lower rates and maybe a shorter free rent period, so the net effect might be the same,” Francis said. “But we find that our average length of stay has now increased and is about 28 months or so, and so with that longer length of stay, having a reduced base rent doesn’t work. We’d rather see free rent upfront and then move on to a higher base rate.”

Despite Five Star’s efforts to protect rental rates, the occupancy declines are dragging down revenue per available room (RevPAR). Comparable community RevPAR in Five Star’s managed portfolio was down 9.5% compared to this period last year, Wigglesworth stated.

But other metrics were more positive in the Q3 earnings report, including 170% operating income growth in the company’s Ageility rehabilitation and wellness division. The operator beat consensus estimates for earnings per share and revenue. Its shares were up 6.56% at the close of regular trading on Thursday.

Diversified’s disposition push

Diversified has been pursuing a plan to dispose of about $900 million in assets, and that process is ongoing.

Since July 1, 2020, the company has sold nine properties for an aggregate price of $61.4 million, including six senior living communities. As of Nov. 2, the REIT had 21 properties under agreement to sell for an aggregate price of about $167.4 million. These properties are a mix of senior housing and medical office.

In terms of further sales, Diversified likely will wait until market conditions improve — hopefully by the second quarter of 2021 — to begin marketing more properties, Francis said.

In addition, Diversified had 10 senior living communities scheduled for closure or sale as of Sept. 30, 2020, and recorded an associated impairment charge of $59.8 million.

The communities recorded $4 million in operating losses during the third quarter, Diversified CFO and Treasurer Rick Seidel said on Thursday’s call.

“We and our operator concluded our portfolio would be stronger without continuing to operate these communities,” he said.

The progress in the dispositions should modestly improve the company’s leverage and liquidity, RBC Capital Markets analyst Michael Carroll wrote in a note to investors. The REIT’s leverage is higher than expected given the quarter’s weak SHOP results. Net operating income dropped 57.9% in Q3, excluding a compliance reserve/charge, which was higher than the 49.1% that Carroll anticipated, largely due to elevated insurance costs.

Diversified shares ended regular trading down 2.51% on Thursday.

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