Is It Time to Renovate?

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Owners and operators of older skilled nursing facilities face a tough call in a challenging market. 

By Jane Adler

In an environment of low occupancies and thin margins, the decision of how much to spend on the renovation of a skilled nursing facility can be especially difficult since many of the buildings are inching toward obsolescence. 

A total gut rehab can cost millions of dollars. Less expensive cosmetic changes might not make enough of a difference to attract more patient volume. The addition of a new clinical specialty, such as cardiac care, not only requires new staff but also more space, which may not be available in the existing footprint. 

If a building has only shared rooms or units without showers, there may be little choice but to invest capital in order to avoid an accelerating downward spiral. A competitor that upgrades its facilities adds another twist. Owners and operators must reconsider their market position and how other providers will impact their properties.

Decisions about capital expenditures depend on a lot of factors, sources say. Healthcare REITs that own nursing homes are under pressure and have seen their stock prices drop lately, cutting into their ability to finance big overhauls. Other owners are under financial pressures, too.

Even so, the primary consideration is the building’s local market position and its ability to respond to changing dynamics among healthcare providers and other referral sources, such as accountable care organizations (ACOs), and payors, including Medicare and Medicaid. 

“This is a very tough business,” says David Eppers, CFO at Loveland, Ohio-based Carespring Health Care Management, an operator with 10 skilled nursing facilities in Ohio and Kentucky. “You have to know what you are doing and get everything right.”

Carespring’s oldest facility was built in 1986 and sold in 2007 to a Florida pension fund and NHP, a REIT that was later sold to Ventas. Carespring poured hundreds of thousands of dollars into the building at the time to improve the floor plan and overall aesthetics of the property. 

As many single rooms as possible were created, taking into account the constraints of an older building with a layout that could not be radically altered, says Eppers. More gym space was added to accommodate therapy treatments for the patients. New TVs were also installed in the rooms. 

“The cost you have to put into older buildings to make them relevant is one of the big challenges,” says Eppers. Many of the improvements to older buildings are unseen, he adds. People walking through the facility will notice new carpet and floor tiles, but the same can’t be said for a new HVAC or electrical system, even if it creates a better overall environment. “It’s a hidden cost that must be done,” says Eppers. 

Aging stock meets new realities

In the 1950s, seniors who were admitted to the hospital often stayed there for a long period, according to a history of nursing homes on the website In response, the U.S. government provided grants for the construction of nursing homes as an alternative to long hospitals stays. The number of nursing homes nationally grew from about 6,500 in the 1950s to about 16,000 in the 1970s. 

There are currently about 15,600 nursing homes nationwide, according to the Centers for Medicare & Medicaid Services’ (CMS) Nursing Home Data Compendium, 2015 (the latest available figures). The number of nursing homes has gradually declined over the last decade, though the decline has halted over the last five years, the CMS report indicates.

Nursing facilities in the top 140 metro markets are now, on average, about 40 years old, according to the National Investment Center for Seniors Housing & Care (NIC) based in Annapolis, Maryland. 

The need to renovate older buildings comes at a time when operators are being squeezed.

Most nursing homes have a mix of patients whose bills are reimbursed by Medicare, Medicaid and private insurance. Medicaid pays for long-term care and accounts for about 65 percent of nursing home revenues. Medicare and private insurers pay for seniors who need a short stay. 

Patients with Medicare or private insurance are highly sought after by nursing homes because their bills are reimbursed at higher rates than those of residents in the Medicaid program. But Medicare has been cutting back on the length of stay allowed at nursing homes. Patients are now often sent directly home with home healthcare, or they are sent home sooner than they previously would have been. Outpatient total joint replacements are on the rise, skipping the need for a hospital or nursing home stay altogether.

“Everyone is getting dinged by length-of-stay issues,” says Talya Nevo-Hacohen, chief investment officer at Sabra Health Care REIT (NASDAQ: SBRA) based in Irvine, Calif. The company currently owns 409 skilled facilities that are, on average, about 30 years old.

Occupancy rates at nursing homes are dropping, reports NIC. The occupancy rate decreased to 81.6 percent in the third quarter of 2017, hitting its lowest level in five years. 

The occupancy rate in the third quarter of 2016 was 83.2 percent. At the end of October in 2012, the occupancy rate stood at 86.1 percent. (The figures are based on NIC’s Skilled Nursing Data Report, which surveys more than 1,400 mostly free standing skilled nursing properties.)

At the same time, managed care programs and ACOs are narrowing their provider networks, referring patients to the best nursing facilities in order to reduce hospital readmissions. An out-of-date facility probably won’t be the top choice of referral sources. Patients with private insurance usually don’t want to stay in an older facility either.

Strategies emerge

Local market conditions typically determine the best course of action, owners and operators say. 

Omega Healthcare Investors, a publicly traded REIT (NYSE: OHI) based in Hunt Valley, Md., owns a portfolio of 999 properties, of which about 85 percent are skilled nursing facilities. 

Omega recently renovated its 50-bed facility in Columbus, Wis., a town of 5,000, in conjunction with the transition of the property to a new operator, Mission Health Communities. Mission Health is one of the portfolio companies of Windward Health Partners, a Tampa, Fla.-based private equity firm.

Omega reviewed market conditions and decided there was upside that the previous operator had not realized. A short-term stay Medicare wing with private rooms was added, along with a bistro and lounge space. The physical therapy space was renovated and expanded. The renovation included new finishes, lighting and furniture throughout the facility. 

The construction cost was $1.9 million. Additional costs such as furniture, fixtures and equipment, design and legal fees associated with the project brought the total cost to about $2.3 million, or $46,000 per bed. 

“We try to focus renovations to be market appropriate,” says Steve Levin, senior vice president at Omega, whose office is in Chicago. Market analyses include a review of hospital admissions and discharges, as well as the services provided by local hospitals and competing skilled nursing facilities. That information is used to create design plans to prevent the risk of overbuilding. 

To simplify the process, Omega developed a standard design package for operators that specifies the details, such as type of furniture and flooring. “We know the costs up front,” says Levin.

Next HealthCare Capital, a private company based in New York City, ensures that its operating partners refresh their skilled nursing facilities with basic cosmetic upgrades on a regular basis. However, larger, more costly renovations require an analysis of why a particular building needs an upgrade. 

“We are not looking to impress anyone,” says Michael Zamir, managing principal of Next HealthCare, whose company has a large portfolio of skilled nursing facilities nationwide. “We are thinking about what we are gaining for the dollars spent. Our goal is to ensure continued success and growth for our operating partners in each of our facilities.”

“The physical plans needs can vary considerably for each building or market, and needs to be studied on a case-by-case basis,” adds Zamir.  

Not all older buildings make bad investments. A facility built in the 1980s in a market where the other skilled properties mostly handle long-term care Medicaid patients can do well and have little downside risk. “Investors may frown on it for not being a trophy asset, but there’s a beauty to investing in that kind of building and not being exposed to some of today’s post-acute market headwinds,” says Zamir.

Loans for renovations are available for the right operators. 

CapitalSource, a division of Pacific Western Bank, finances the acquisition of skilled nursing facilities, which sometimes includes a renovation. 

“We have to understand the business case,” says Don Kelly, senior director of the healthcare group at CapitalSource. His office is in Sarasota, Fla., and CapitalSource is based in Los Angeles. 

Borrowers are typically adding therapy gyms, private rooms and new dining venues and lobbies, notes Kelly. The operator is a big factor, too. 

“Who we do business with is more important than the property,” emphasizes Kelly. 

Consider the competition

The decision of whether to renovate an older facility often boils down to what the competition is doing. If a competitor installs a 5,000-square-foot, state-of-the-art therapy gym, it’s best to renovate, say sources. A homelike environment with private rooms and top-notch care can attract the more lucrative Medicare and private pay patients.

Competition can be especially tough in states without certificates of need (CON) programs. These laws require government approval before a facility can expand, or a new one can be built. Some forms of CON laws are currently in effect in 34 states. 

Operating a facility in a non-CON state means a competitor can open a new facility across the street. That can trigger the need for a renovation at an older property. 

But if the older building is in a state with a strict CON, renovations may not be as necessary provided that competitors haven’t all renovated their buildings, according to Zamir at Next HealthCare. “One has to be aware of one’s surrounding competition at all times,” he says. “And this can change on a regular basis.”

Carespring operates in CON states, which helps keep competition in check. It also has provided a creative expansion strategy in a business environment where it’s hard to financially justify abandoning an older building. 

The company was able to purchase the CON license for a 236-bed skilled nursing facility in Kentucky that had closed. The license was split in two, allowing Carespring to build a new 143-bed facility, which opened in 2014 in Campbell County, Ky. Another 143-bed facility is now under construction in Boone County, Kentucky. 

Quality first

The quality of care is more important than the physical plant, owners and operators say. Beautiful buildings will sit empty if they cannot provide the type of care demanded by local hospitals and other referral sources. 

In markets where all the nursing homes have high quality ratings, it makes sense to invest significant dollars to create private suites and/or care specialties to have an edge over the competition, says Zamir. But he is quick to add that, “in today’s market, a nice building without great quality of care is not a recipe for success. You really need both to be in good balance, and quality of care and outcomes should be the first priority.”  

Outdated buildings can impact the staff and clinical programs, which drive building revenues. “If you have a beat down physical environment, it’s not a pleasant environment for anyone,” says Sabra’s Nevo-Hacohen. 

Investing in renovations, both cosmetic and more substantial, makes a lot of sense, she says. Buildings don’t necessarily need a fancy lobby and trendy bistro, but they do need spaces like therapy gyms to deliver care. “The best outcomes we see are when you have a building that is well kept and looks nice,” notes Nevo-Hacohen. “If you have that and great clinical support with a good staff, that’s a successful approach.” 

Nevo-Hacohen says the best strategy is to provide the right product for the market and understand the competitive landscape. “If you are providing the same thing everyone else is, it will be a struggle. There is no magic here. You reinvest in your building like you reinvest in your clinical staff.”