Senior Living Business: Outlook For 2009: A ‘Difficult’ Year--

Established Defensive Strategies Help ACTS To Remain ‘Stable’

January 2, 2009

The weak economic environment has been reverberating throughout the senior housing market for some months now. Throughout the industry, conducting business as usual has become a challenge.

Most observers will agree that the effects of the economy will vary from market to market. Nevertheless, most operators are feeling at least some pressure on demand and on their occupancy statistics as prospective residents are either unable to sell their homes or are holding back from selling in the current market.

"We and other senior living providers are feeling two significant challenges," said Gerald T. Grant, Executive Vice President and CFO of ACTS Retirement-Life Com-munities, Inc., of West Point, Pennsylvania. "First and foremost, the slowdown in the real estate market since the mid-2007 time period has put pressure on our ability to maintain stable occupancy in our independent living units. Where, historically, we would have retained 95% occupancy across the company, we’re now down to about 92% and have even gone as low as 91%." For ACTS, units used to be resold as quickly as they became available and re-occupancy took place within a short period of time.

ACTS has analyzed the various marketplaces in which it operates CCRCs, and individual markets are acting in very different ways. "Florida, for example, is clearly impacted by the slowdown in home sales and overall decline in home values," Grant said, "but we haven’t seen a significant dropoff in occupancy or demand in our community in Charlotte, North Carolina. Having 19 communities spread across six states [Pennsylvania, Florida, Georgia, North Carolina, South Carolina, and Alabama] clearly makes a difference in terms of maintaining a stable occupancy level throughout the organization and minimizing what could be a worsening situation."

The financial markets represent the second significant challenge impacting the senior housing market, and ACTS is not entirely immune to what has been occurring in the banking industry. For all intents and purposes, the bank letter-of-credit support for not-for-profit tax-exempt bonds has been locked out or severely restricted for the past four to six months. And when that support is available, it’s at a very high cost. Desperate financings are being completed, but you’re better off waiting it out if you don’t have a desperate situation, according to Grant.

ACTS has always maintained a healthy cushion of capital that has proved to be a huge benefit in relieving financial stress in troubled economic times. "Your disciplines of the past either rise to support you or stick out as areas that you need to rethink," said Grant. "For us, one area that is working to our benefit is our commitment in good times to increasing our days cash on hand, which has been a focus for many years." That liquidity has become increasingly important these days.

Coping strategies
"Nobody ever thought we’d get to this point," noted Stephen Infranco, Director of Public Finance at Standard & Poor’s. "Interest rates are high even for stronger rated credits, so weaker credits may have no access at all. That would become a serious issue if it continues. All in all, I expect we’re in for a pretty difficult 2009."

Defensive policies or corrective actions will be different for each provider. In general, though, most organizations will first have to reassess their budgets and look for ways to contain expenses. Then, because of occupancy pressures that some organizations are experiencing, some resources will likely have to be redirected. That might mean spending more money on marketing initiatives to make sure demand continues at a relatively stable level or perhaps offering incentives or reassessing contracts to lure new move-ins. And organizations with flexibility in their fee structures may have to implement higher than average fee increases.

ACTS management had the foresight long ago to develop a financial action plan that documented corrective actions to implement in challenging economic scenarios. "Based on that plan, we’ve embarked on a variety of actions," said Grant. "The most significant ones focus on expense control and pulling back on discretionary spending. We’ve also implemented a hiring freeze when there is employee turnover or attrition in non-critical (not directly care-based) positions."

On the marketing side, ACTS has historically operated at 95% to 96% occupancy on a stabilized basis, meaning its communities are virtually full. But instead of allowing its sales force to relax during prosperous times, ACTS built a very deep waiting list. That has made it easier to fill up units during a slow period, such as the industry is experiencing now, by reaching further down into the waiting list. "Communities that haven’t had that discipline are now feeling the pain of a significant drop in occupancy," said Grant."

Incentive programs help, too. Offering marketing assistance, deferring entrance fee payments, providing assistance with the cost of moving or closing, reducing the first couple of months of fee payments, and even offering unit upgrades are some of the options that the ACTS sales force is using to encourage new move-ins.

In addition, ACTS has pulled back on its capital plan that involves continued renovation and expansion of its communities. "We’re taking an approach of addressing emergency situations and those to which we’re committed," said Grant, "but we’ve pushed back on planning and undertaking any new initiatives. We have no projects coming out of the ground right now and no large communities opening that we have to worry about filling up or meeting occupancy projections, but we want to be fully prepared when things turn around."

And while that may seem like a stroke of luck, given the meltdown in the financial markets, it really results from a shift in growth strategy over the past five years or so from developing new communities to acquisitions of existing communities. "Nevertheless, as stand-alone communities are starting to struggle, acquisitions become more plentiful," Grant explained. "So while we want to be cautious in our growth and development, we also recognize that this is clearly a period of opportunity to help the seniors who find themselves in communities that are having difficulties. If we can leverage our financial strength and provide them assistance, everybody wins."

How long organizations can hold off on their capital projects is hard to predict. Senior living is a lifestyle choice, and campuses must be kept up-to-date, positioned well, and marketed properly so people will want to move in. Without access to the necessary capital to complete refurbishing projects, many providers are simply applying a fresh coat of paint here or a touchup there but not embarking on any major renovations.

Across the industry, according to Infranco, major development projects that weren’t already underway before this fall have been shelved or put on hold until the market appears to be on the way back or unless it’s absolutely necessary to get them done. Projects that were already started may be reworked—scaled back to fewer units, for example. For projects that are underway, the developer and the senior living provider must manage construction carefully to minimize any cost overruns, construction delays, change orders and so forth. "You don’t want to come in over budget in an environment like this," he stressed.

Ratings considerations
In recent years, not-for-profit senior living providers have benefited from and, in many cases, relied heavily on non-operating income from investment, which is off for everybody. Diminished investment income is hurting some key ratios considered by rating agencies, according to Infranco. Coverage of debt service is certainly off due to the market decline, and he’s seeing a lot of erosion in liquidity and in cash balances. "We certainly hope the market will come back at some point," he said, "but we don’t know how quickly that will happen."

Just last month, Standard & Poor’s affirmed ACTS’ BBB+ credit rating with a "stable" outlook, which was very good news for ACTS but perhaps not a surprise. The organization’s commitment to a conservative investment policy has paid off, according to Grant. "Some providers were a little too aggressive in their investment approach," he said. "As the markets have tumbled, those organizations have seen their reserves deteriorate." ACTS has 98% of its investment portfolio in fixed-income type instruments, with only 2% exposed to equities. So for the most part, its reserves have stayed safe.

"When the economic slowdown and the housing decline began, we tried not to overreact as far as ratings were concerned," Infranco explained. "We knew the market would fluctuate and investments would go down. If the economic slowdown is so prolonged that it really impacts the financial aspect of a new development—or if an organization is not able to fill up the new development, which then impacts its ability to pay back some of the debt—then those types of situations will certainly impact a rating."

Rating agencies do analyze credits individually and apply different financial benchmarks, depending on whether a provider is subject to life-care risk and whether it is a stand-alone community or part of a multi-facility organization. Multi-site operations typically benefit from revenue diversity, risk dispersion, and management depth, thereby making them less vulnerable than stand-alone operations in a softening economy.

Large organizations such as ACTS that are managing their situations well, that have geographically diversified operations, and that have a strong enough balance sheet to weather the downturn are still not fully immune from the effects of the current environment, but they are likely to have their ratings affirmed. Those that do not have strength in their balance sheets and have relied instead on revenue from their operations or on now-underperforming investment income may trip financial covenants such as debt-service coverage or days cash on hand.

Infranco is already beginning to see downgrades and expects to see some rating pressure in 2009. "That’s not unexpected in this type of market," he noted. "The longer term view is still somewhat positive, based on the overall demographic trends, the aging population, and the need for senior services. But senior housing is such a capital-intensive sector that we expect to see difficulties in the near term."

For his part, Grant is "cautiously optimistic" that the financial markets will begin to show some improvement and that we’ll see a lot more activity from the banking side in the second half of 2009. "That should free up some of the capital that is so desperately needed by many organizations," he said. "I’m hopeful."