Owners and operators test new strategies and scrutinize all expenses as the number of financially beleaguered assets multiplies.
By Jane Adler
Despite encouraging signs of a seniors housing turnaround, the challenging operating environment is creating an uptick of troubled properties in need of their own turnaround.
The triple whammy of the pandemic, rising interest rates and higher expenses has hit the sector hard. Margins are squeezed and valuations are depressed. What’s more, the recent banking crisis and the growing prospects for a recession have added to financial pressures.
“There’s a lot of distress out there,” says Clare Moylan, principal at Gibbins Advisors, a Nashville-based advisory firm that specializes in restructurings and turnarounds in the healthcare sector. She quickly adds, “There’s a lot of opportunity too.”
Owners and operators with troubled properties are considering their options. Investors are replacing operators. Portfolios are being reshuffled.
While no statistics are available on the number of troubled properties, warning signs are everywhere.
The Chicago-based commercial real estate investor Waterton, owner of a controlling interest in long-time senior housing operator Pathway to Living, is transitioning all its Pathway-managed properties to other operators.
Sabra Health Care REIT (NASDAQ: SBRA) recently exited its Enlivant joint-venture agreement with TPG, transitioning a portfolio of assets to lenders. Sonida Senior Living, previously Capital Senior Living, has defaulted on several loans.
Lenders are losing patience. While many lenders eased loan covenants to work with borrowers during the pandemic, now they want to be repaid.
Reliable industry lender Fannie Mae, for example, recorded a write-off in the first quarter of a $237 million seniors housing portfolio. The agency’s 10-Q statement says its multifamily serious delinquency rate increased to 0.35 percent at the end of the first quarter, compared with 0.24 percent as of the fourth quarter of 2022, largely driven by seniors housing. The agency adds that it continues to closely monitor seniors housing and actively manage loans that may be at risk of further deterioration or default.
Of Fannie Mae’s seniors housing properties with an unpaid principal balance, 38 percent had adjustable-rate mortgages subject to higher debt costs.
Separately, billions of dollars of senior housing loans are coming due in the next few years to be refinanced at higher rates.
Some lenders now require borrowers to purchase interest rate caps on floating-rate loans to hedge against rate hikes. But the cost of caps has risen at least 10-fold in the last year, sources say.
“The cash needed to buy those caps really hurts the borrowers,” says Moylan. “They can’t make ends meet.”
The problems aren’t evenly distributed. Some markets are more troubled than others. Rural markets and those with new competition from recently opened properties are under the most stress, sources say. Skilled nursing in rural areas and older buildings of all types are especially challenged.
Choppy waters are expected for the next 12 to 18 months. Beth Mace, chief economist at the National Investment Center for Seniors Housing & Care (NIC), predicts that the market could be entering a period of “creative destruction.” She explains that growth in an industry is often catalyzed by tumult. In seniors housing, we are likely to see a change in the value proposition and product offerings as demographics unfold and the baby boomer becomes the new customer. “We are also likely to see changes in the product offering and its delivery in the aftermath of the pandemic and now capital markets disruptions,” she adds.
The seniors housing occupancy rate increased slightly from 82.9 percent in the fourth quarter of 2022 to 83.2 percent in the first quarter of 2023, according to data from NIC MAP Vision. The occupancy rate has increased 5.4 percentage points overall from a pandemic low of 77.8 percent in the second quarter of 2021, but remained four percentage points below the pre-pandemic high of 87.2 percent in the first quarter of 2020.
Data from Trepp, a data analytics company, and NIC MAP Vision indicates that slightly less than 1 percent of properties in the primary and secondary markets are currently delinquent. A little more than half of the delinquent properties opened between 1990 and 2009.
Brokers say they’re getting more calls from investors. In some cases, the only option is to sell properties because of the lack of available debt and its high cost.
Properties began trading below replacement cost late last year, according to appraiser Colleen Blumenthal, chief operating officer and partner at HealthTrust, a Sarasota, Florida-based analytics and advisory firm.
Reviewing preliminary data from the 2023 “State of Seniors Housing Report,” a research study her firm prepares, Blumenthal expects to see increases in cash flows and profitability. But she notes that profits and margins may not reach pre-pandemic levels. “Some properties in strong markets might get there,” she says. “The rest of the country? I just don’t know.”
For example, stabilized assisted living properties in high-barrier-to-entry markets could still see a margin decline of 5 to 10 percent compared to 2020. Other properties could be down 15 to 20 percent.
Blumenthal adds that the seniors moving in today are quite frail and are likely to have a shortened length of stay.
Some private equity investors are aggressively pushing operators to improve occupancies by offering significant discounts. “That reduces the bottom line and it’s hard to make that back up,” says Blumenthal.
The type of discount matters. Turnaround specialists tend to recommend a month’s free rent or waiving the community fee. That way a low rent isn’t locked in for the term of the lease.
Properties that are 20 to 25 years old represent a special challenge. They often compete with newer communities that have features consumers want such as big units, high ceilings and wide hallways.
Valuations of older properties could be discounted as much as 30 percent. Owners aren’t sure whether it’s worth a big capital expenditure, even if the property needs it.
Older properties may have to be rebranded to serve the middle market or even accept Medicaid reimbursements, if waivers are available from the state. Other buildings may have to be converted for other uses. Sabra REIT, for example, is converting underperforming assets to behavioral health and addiction treatment centers.
Signs of trouble at the property level include strained finances, declining census, rising move-outs, a high percentage of agency staffing and low satisfaction among residents and staff.
The changing environment opens new opportunities. Savvy operators are likely to be the turnaround winners.
Investors appear to be gravitating toward a regional strategy. Operators with a strong footprint in a specific geographic area are winning assignments.
Take, for example, Health Dimensions Group, a Minneapolis-based operator that manages 50 communities in nine states. The company also offers turnaround consulting services nationwide.
In March 2021, Columbia Pacific Advisors hired Health Dimensions Group to turn around a troubled assisted living facility it owned in Appleton, Wisconsin. Health Dimensions Group operates communities in the area.
“We never want to be more than two hours away from another one of our communities,” says Erin Shvetzoff Hennessey, CEO of Health Dimensions Group. The proximity to other communities helps management to closely monitor operations and instill the company’s culture, she explains.
The Appleton property had experienced plenty of problems. Outside agency staffing accounted for about 90 percent of the workers in the building, adding to labor costs. Annual turnover among the permanent staff was 140 percent. Occupancy was 66 percent.
Health Dimensions Group hired new executive leadership for the building. The operator also introduced its proprietary management program called “Caring Above & Beyond.” The approach focuses on four pillars of excellence: quality/customer experience; people; financial; and sales and marketing.
“If you can get your hands around census, revenue and labor, a lot of the other things can get figured out,” says Shvetzoff Hennessey.
The property was rebranded as Dimensions Living Appleton. All aspects of operations were assessed, including workflow, labor patterns, wages and vendors.
Changing the culture at the property was a top priority. The new management team collected feedback from residents and employees to improve the retention and satisfaction of both groups.
By July 2022, the property’s census had grown to 82 percent. Current occupancy is nearing 90 percent. The use of staffing agencies has been reduced to zero. There are more sales leads and fewer move-outs. “We were laser-focused on what had to be done,” says Shvetzoff Hennessey. The first priority was to build its own team without workers from staffing agencies. “With an engaged team who was committed, we could drive customer service and quality, and then drive occupancy,” she says.
A rigorous market assessment is key to success. “You need to drill down on the competitiveness of the property,” says Ronald Winters, principal and co-founder of Gibbins Advisors. The firm assesses how communities are positioned in relation to competitors.
Services and the condition of the building are evaluated to determine whether rents can be raised or need to be discounted. Sales and marketing processes are analyzed. “Nothing gets done without an improvement in the topline,” says Winters.
It’s a slog
Turnarounds take time and patience. “It’s always harder than it looks and takes longer,” says Larry Rouvelas, CEO of IntegraCare, Wexford, Pennsylvania. The company operates 18 communities in Pennsylvania, Virginia and Maryland. IntegraCare typically co-invests with its capital and development partners.
In April, IntegraCare opened a new building in York, Pennsylvania, that offers independent living, assisted living and memory care. The company’s goal is to grow by two to three communities annually, half by acquisition and half by development.
The volume and quality of properties for sale this year is growing, says Rouvelas. But IntegraCare sticks to its footprint. He agrees with other operators that quick access to a property is crucial.
Rouvelas takes a strategic approach with turnarounds. Other industries often rely on cost cutting or cross selling of services to fix a troubled company, he explains. “That doesn’t work in seniors housing.”
Instead, Rouvelas needs a thesis on why his company can do a better job of managing the property than the previous operator. He notes that troubled properties are in need of a turnaround for one of three reasons: a bad market, a bad building or bad management.
A bad market could be one with three new competitors opening in the last two years. The problem isn’t just a lack of demand, but also a potential shortage of labor.
A bad building is easy to assess by walking around the property. But if the market and the building look decent, then the problem must be management, which can be a good opportunity for a new operator (see sidebar).
Financial patience should be modeled into the pro forma. “You’re not going to turn it around in 90 days,” says Rouvelas, likening a seniors housing turnaround to a garden that takes time to cultivate and grow.
It’s also important to set realistic expectations with the capital partner. Experienced capital partners tend to be patient. It takes at least a year to grow net operating income.
Eliminating the use of staffing agencies is a good start. But a successful turnaround depends on changing behaviors, which also takes time.
Online reviews are an example. Satisfied families should be encouraged to post reviews. Bad reviews require a rapid response. “You need time for good reviews to accumulate,” says Rouvelas.
How to manage expenses
Expenses must be scrutinized, but Rouvelas is careful not to cut too quickly or too deeply. An example is food costs. A skimpy food budget can lead to resident complaints, move-outs and staff resignations.
“Understand the situation before you start making pronouncements,” says Rouvelas. He adds that the goal is to paint a picture for residents and staff that the future will be more vibrant under the new management.
Expense management is the focus of turnarounds handled by Priority Life Care based in Fort Wayne, Indiana. The company operates 44 communities, which include some joint-venture and ownership arrangements. Priority Life Care has largely focused on the affordable and middle-market private pay sector.
“Our group is good at managing communities struggling with cash flow,” says Sevy Petras, CEO and co-founder of Priority Life Care.
Financial data is collected daily. The books are closed on the first day of the month. The information is shared with the regional and building managers. That way, they know how the building performed in the last month and how much cash is available to pay outstanding bills. “It sets the tone and helps everyone stay on budget,” says Petras.
Priority Life Care retooled its corporate structure during the pandemic. In addition to regional managers, specialists in specific areas — such as clinical operations and marketing — work with the department heads to keep them on budget.
Petras emphasizes the importance of teamwork with the capital partner. It must be willing to support the turnaround financially. Needed changes are written into the management contract. “Everyone has to work together,” she says.
Operators that take on turnaround situations typically charge more for their services because the work is difficult and prolonged. The customary management fee for seniors housing is 5 percent of annual rental income, compared with 6 to 8 percent for a turnaround.
Or operators may ask for an additional fee to provide extra resources for nursing, operations and sales. The fee depends on the size of the property and how much additional support is needed, but could be as much as several hundred thousand dollars, sources say.
“The path forward requires maximizing revenues,” says HealthTrust’s Blumenthal. “I just don’t know if capital — debt or equity — has the patience to see the improved results realized.”