April 11, 2021, Ben Swett, The SeniorCare Investor - Five Star Senior Living is making a complete exit from the skilled nursing sector and restructuring its portfolio to focus more on larger, lower acuity seniors housing properties. It looks like an acknowledgment of the company’s weakness, and its strengths, to focus on what it does best, at a smaller, more manageable size.
Its landlord, Diversified Healthcare Trust, agreed to amend its management agreements and transition 108 smaller senior living communities totaling approximately 7,500 units to other operators by the end of the year. DHC will not have to pay a termination fee and will also no longer have the right to sell up to $682 million worth of senior living communities and terminate Five Star’s management of those communities without paying a fee.
Across the CCRCs that Five Star will still operate for DHC, the company will close and reposition all skilled nursing units, numbering around 1,500 units. We haven’t seen that too often at CCRCs, but we imagine the communities will partner or develop relationships with locals SNFs to helps its current residents expecting a continuum of care.
Five Star’s presence in the SNF sector was already minimal, with SNF revenues falling from $138.2 million in 2019 to just $4.4 million in 2020 (across just nine properties by Q4). But occupancy in that sector was certainly a sore spot for the company, averaging just 64.2% in the fourth quarter of 2020, down from an average of 68.8% in Q3, 70.1% in Q2 and 73.3% in Q1. Spot occupancy was even lower at the end of Q4, at just 60.3%. Occupancy at its managed CCRC portfolio, where Five Star operated more than 2,000 skilled nursing units, was not in as bad shape, averaging 72.8% in the fourth quarter, down from 75.6% in Q3, 79.1% in Q2 and 83.4% in Q1.
As a result of the restructuring, Five Star’s incentive fee calculation will no longer have a cap placed on any incentive fee earned by Five Star in any calendar year and will exclude from the calculation senior living communities that are undergoing a major renovation or repositioning. DHC will also assume control of major renovation and repositioning efforts at all Five Star managed communities, and the term of the management agreements between DHC and Five Star will be extended by two years to December 31, 2036.
Moving forward, Five Star will continue to operate 144 senior living communities with about 20,200 units, including managing 120 properties with close to 17,900 units for DHC. That still represents 66% of DHC’s SHOP portfolio. Beginning in 2025, agreements for up to 10% of the senior living communities managed by Five Star, based on total revenues, can be terminated by DHC without payment of any termination fee for failure to meet 80% of a targeted EBITDA in prior years. In 2020, that retained portfolio outperformed the total DHC managed portfolio, averaging 110 basis points higher in occupancy and a 280-basis point higher EBITDA margin. But who knows where the industry will be (and Five Star, for that matter) in four years?
Meanwhile, the communities to be transitioned represent approximately 40% of Five Star’s management fee revenues from DHC, but less than 12% of Five Star’s total management and operating revenues in 2020. Five Star expects to incur net non-recurring restructuring costs of up to $5.5 million in connection with plan.
This seems like a win-win for both companies. Five Star gets out of a sector that it didn’t want to operate in and becomes a leaner company in the process. Its new focus on lower acuity seniors housing also means Five Star is more protected from the mounting labor costs facing the industry and will sooner benefit from the oncoming baby boomers.
On the other hand, DHC can diversify its operator base, including transitioning those skilled nursing facilities to operators more experienced in that sector, all without paying a termination fee. With increased rates (and obviously improved occupancy), there is plenty of upside with the skilled nursing assets. And if Five Star does better, so does DHC.