Value-Add Strategies Fit the Times

by Jeff Shaw

As land and construction costs soar, developers find success with repositioning projects despite the risks.

By Jeff Shaw

Ground-up seniors housing construction is arguably more difficult now than it has ever been, forcing developers to come up with an alternative game plan to stay active.

The producer price index for new building construction — a measure of the price that contractors say they would bid to build a fixed set of buildings — increased 19.8 percent year over year in June, according to the Associated General Contractors of America (AGC). As of June, costs rose faster than bid prices for a variety of inputs in the index, including diesel fuel, prepared asphalt, concrete products, plastic construction products and insulation materials.

Lead times for materials can be over a full year in some cases, and that’s all on top of contractor labor shortages throughout the country. The unemployment rate among job seekers with construction experience tumbled from 7.5 percent in June 2021 to 3.7 percent in June 2022, the lowest rate for the month of June in the 23-year history of data from the AGC.

“The current construction environment is absolutely reining in construction projects,” says Bryan Schachter, chief investment officer at Watermark Retirement Communities. “We’re seeing a really meaningful shift in construction costs. That is either putting things on hold or having them be called off entirely. The numbers don’t work anymore.”

The net effect of these challenges is evident in new seniors housing construction starts. The most recent data from NIC MAP Vision, showing results for second-quarter 2022, has annual inventory growth at a modest 1.7 percent. Units under construction in the second quarter were the lowest they’ve been since 2015. New construction starts screeched to a halt in 2020 as the COVID-19 pandemic hit, and never fully recovered. 

In response to these headwinds, many owners, operators and developers are pursuing value-add repositioning opportunities. Especially in the wake of depressed occupancies due to the pandemic — that same NIC report shows the occupancy rate for private-pay seniors housing has rebounded to 81.4 percent, still well below historical averages — turnaround projects allow savvy developers to acquire communities below replacement cost, implement modest capital expenditures and potentially bring it back to life.

“It makes more business sense in the current environment to acquire established communities at a large discount (with a quality operating partner) than pay the soaring construction and development costs today,” says Scott McCorvie. The REIT veteran recently founded Vita Senior Living, a boutique investment, development and management company with a focus on value-add opportunities in Florida.

“As an example, we can acquire established, well-designed communities in Florida at $80,000 to $120,000 per unit and add an additional $10,000 to $30,000 per unit in new renovation, engagement and IT infrastructure. Even using the high end of our total repositioning cost, we are still far below the current development cost basis of $500,000 per unit in Florida,” explains McCorvie.

What’s more, the seniors housing industry as a whole improves when all properties — not just the newest, shiniest developments — offer good service and comfortable living, says Stephanie Harris, CEO of Arrow Senior Living, a St. Charles, Missouri-based owner-operator.

“It’s important, both from a financial and environmental perspective, to utilize what we already have,” says Harris. “We often find that so many of the properties we turn around have ‘good bones.’ It’s just that the day-to-day needs of maintenance and upkeep have been ignored. As we grow, we’re looking to new ways to ensure good environmental stewardship.”

But what makes a community a good candidate for a turnaround, and what are the keys to a project’s success?

Get your hands dirty

Rick Shamberg, managing director of Scarp Ridge Capital Partners, a New York City-based investment firm, knows what it’s like to live in a seniors housing community. That’s because, for many years, that’s exactly what he did. He and Harris both spent the early years of their careers living in the facilities they were tasked with turning around.

“Living the resident experience in an apartment at the community has shaped so many aspects of how Arrow operates and what we learned about turnarounds,” says Harris.

While making upgrades to the physical plant is surely part of any repositioning effort, the most important aspect is the operations, says Shamberg.

“Why did the Cubs not win a World Series for 100 years? It’s culture,” says Shamberg. “There’s so much to understand about a building that hasn’t worked. It’s almost like being a psychologist to understand the dynamics at play and the change that’s needed.”

“A lot of people fashion themselves as turnaround experts, but that doesn’t necessarily make them so,” continues Shamberg. “It’s oftentimes a heavy lift. It’s hard to take a losing building and make it a winner.”

The investment thesis sometimes goes against an owner’s natural impulses — to put more money and effort into what appears to be a failed business model, says Shamberg.

The signs of a community ripe for a repositioning include high turnover of staff, poor resident outcomes, inefficiencies in staffing, lack of transparency, lack of planning, lack of alignment with ownership and weak expense management protocols, notes Shamberg. 

The results are usually low occupancy, high resident turnover and short resident stays (less than a year). None of those problems are solved by a renovation.

“A turnaround starts with the plan, and the plan starts with picking the right operator for the turnaround,” says Shamberg. “This is an art. Picking the best operator for a particular project in a particular location at a particular moment in time needs to be carefully considered.

“The right operator, and hence the right leadership, will make or break any acquisition, but especially a turnaround that has suffered from high resident turnover, low morale, a revolving door of staff, unsatisfied family members, and a poor reputation among influencers, referral sources and community members.”

Make more workers happy

A common refrain one may hear in seniors housing is that a happy, effective staff leads to happy, healthy residents and, by extension, better occupancy. Quality labor and a high census are inextricably linked.

“A commitment to the existing staff including incentives, higher pay, retraining, personnel development and articulating a focused, concise, and clear vision and strategy that fosters improved culture and confidence is critical,” says Shamberg. 

“Additionally, a robust recruitment machine to identify, hire and train new staff who were not a part of a failing culture is important. Not all existing staff will make the transition, and striking a balance between rotating and recruiting new talent is key.”

Schachter says that Watermark often sees improvement simply by bringing in its more robust benefits package to what might have been a mom-and-pop outfit before the acquisition. For example, the company offers Dayforce Wallet, which allows employees to be paid immediately after a shift rather than a week or two later.

“In certain instances, we also offer tuition reimbursement and student loan forgiveness,” says Schachter. We’re hoping to improve employee satisfaction. If our workforce has higher satisfaction, that translates to better care and resident satisfaction, and ultimately performance. Fostering a positive culture for our associates is our primary focus to create an extraordinary community.”

Vita’s McCorvie says one of the first expenses that can be cut to improve performance is overtime and agency staffing.

“This is the lowest-hanging fruit that can be quickly improved through enhanced recruiting, training and scheduling models. Overall, I believe in leveraging the power of experience and industry benchmarking tools to uncover and model the operational inefficiencies and create tailored corrective action plans that we implement upon closing.” 

Shamberg recalls several properties where major staff changes were required. His first turnaround as an owner and investor was The Atrium of Belleville in Belleville, Illinois, a suburb of St. Louis. Arrow was the operational partner. 

Approximately 90 percent of the staff was replaced in the first six months. With only $1.5 million in capital expenditures, occupancy went from 60 percent to 90 percent in less than three years. It was the cultural change more than the physical changes that made the difference, says Shamberg.

“Many operators fail to correctly adjust staffing patterns to reflect the moving occupancy, rental rates, acuity and desires of the residents,” notes McCorvie.

“Culture is generally the number one cause of low occupancy,” says Harris. “Communities fill up when staff are engaged and leadership is providing an exceptional customer service and sales culture.”

Get with the program

Another way to improve satisfaction is through programming, which can include wellness initiatives, educational opportunities and activities. Several sources cited dining programs as a top priority upon acquiring a value-add property.

“One of the big things we look at is the dining program within a community,” says Schachter. “Maybe we are looking to implement our flex spending program for dining, giving more options and a better product to residents, or even add an additional venue or two.”

McCorvie says Vita looks at ways to refresh shared spaces, such as converting unused libraries into yoga rooms or meditation spaces.

“We review the current offered amenities and look for ways to revise the amenities to target the desires of the new baby boomer generation.”

At The Atrium of Belleville, Arrow improved dining, while adding a bistro and a library. “Arrow enhanced the programming through our capital expenditures,” says Shamberg.

Another common trait of struggling senior living communities is lackluster marketing and sales programs. Several sources interviewed for this article said that a refreshed marketing brand — and importantly a sales approach that matches the brand — is key to a successful turnaround.

In the case of The Atrium of Belleville, Shamberg says Scarp Ridge “went to all the referral sources, the influencers, and told a new story.”

“Operations has to ensure sales can stay in the selling zone and not be drawn into operations,” says Harris. “Too many operators see sales teams as quick solutions to plug operational holes. Staying in the selling zone matters, and lost minutes are consequential. Freeing up 15 minutes that were previously distracted by operations can add up to an additional move-in each year.”

Harris also notes that previously cold leads can become very hot very quickly if the prospective residents are informed of the changes at a community.

“To reinvigorate the sales pipeline, we look for any reason for someone to reconsider the community. It can be anything from an added service, a new model or the plans for a building refresh. Most new move-ins during a sales turnaround effort are from older leads that were underworked.”

Let’s get physical (plant)

While culture may be the most important part of a turnaround project, that doesn’t mean changes to the physical structure aren’t crucial.

Schachter says Watermark often focuses on the “first impression” opportunities first.

“A lot of times when we’re buying a property, there are significant improvements needed to the main entry and common areas to elevate the quality of the community. Obviously, there may be unit upgrades needed such as carpet, paint, cabinetry and countertops.”

McCorvie says Vita also focuses on the outdoor areas, followed by those “first impression” interiors such as lighting, integrated audio and technology improvements like digital signage.

“We initially target upgrading the landscaping, signage and overall curb appeal. Surprisingly, many communities today still fail to maintain proper curb appeal, which leads to poor market reputation and occupancy.”

The physical changes are often most needed at communities that are 15 to 20 years old, notes Harris.

“With more new competition, we are finding older communities simply can’t demand the premium rents they once could. With smaller units and fewer amenities, these communities need to add larger units by combining smaller apartments and add more affordable pricing options.”

Shamberg adds that it is imperative for the capital expenditures to match the market. If an investor wants to create a Class A product, it had better be certain that residents in the surrounding area have the money to support such a facility. 

Scarp Ridge recently decided against an investment opportunity where the physical changes — adding buildings, moving walls, extensive deferred maintenance — would have come to over $15 million in expenditures. The numbers didn’t add up.

“If you’re not careful, you’ll over-improve,” he says. “You have to ask: What kind of rent can I get, even at its nicest? That’s where you back into how much to spend to get maximum rents for the people you’re trying to serve.”

At the end of the day, a value-add acquisition can be extremely lucrative, but the work that goes into it is not for the faint of heart.

“It’s about the people, the management, the systems, the culture, the story, the methodology of sales and marketing,” says Shamberg. “You have to pay really close attention to the value proposition to families, particularly the programming, the dining and the care, then bring it all together with that winning culture.

“The dirty little secret about a turnaround is you often have to change everything.”

Kristin Hiller contributed to this article.

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