Feature: Built for success

Providers who wait too long to upgrade physical plant elements could find their market’s competitive balance out of favor. Those that forgo capital expenditures may find themselves unable to appeal to
Providers who wait too long to upgrade physical plant elements could find their market’s competitive balance out of favor. Those that forgo capital expenditures may find themselves unable to appeal to

The long-term care industry has issues with aging that go far beyond people. Among them are infrastructures and physical plants. 

Since the end of the Great Recession in 2009, scientists and engineers have been wringing their hands over America's long-neglected and aging system of roads, bridges and tunnels. But in an industry facing declining reimbursements and higher cash flow priorities, it's not surprising that many are trying to push boilers and coolers to their lifespan limits.

Timing is important: Many use renovation or add-on projects as an opportune time to take on more debt to upgrade heating, ventilation and air conditioning systems, among other things. Many facilities are finding that physical plant upgrades quickly meet with banks' approval if they can demonstrate a good-faith intent to keep their buildings whole, and downstream benefits like increased future market share strong.

Strapped for cash

The reasons physical plants have been neglected are complex, but most come down to money.

“Many operators find the cost of retrofitting or replacing obsolete facilities prohibitive,” says Kathryn Burton Gray, senior managing director/head of seniors housing and healthcare for RED Capital Group. “Nursing care is a highly regulated, small-margin business and few providers can justify rehab investments by the incremental revenues that can be generated. This is especially true of properties operating in the primary markets where land costs are high or assisted living competitors are gaining market share among the high-acuity resident pool.” 

The tax code is another disincentive for facilities, as the American Health Care Association noted when it petitioned Congress to establish a statutory, 15-year tax depreciation schedule for qualified long-term care facilities. AHCA argued that Medicaid funding increases allow for few, if any, funds for physical plant improvement, “particularly for the more than 10,000 long-term care companies that own one to three facilities and are truly considered small businesses with limited access to capital.”

Many lenders say the issue is most acute in facilities that are heavily reliant on Medicaid dollars. Imran Javaid, managing director of BMO Harris Commercial Real Estate Healthcare, calls it “a bifurcation of care” in the sector. 

“The facilities that are unable to spend on [capital expenditures] are caught in a spiral where they are unable to get funds for financing a rehab that will allow them to appeal to the post-acute residents,” he says. It's a Catch-22 situation. “But without this funding, they are unable to attract the short- term stay residents because their amenities and just curb appeal is unable to keep up with the market demand.”

In short, facilities with higher Medicare and private pay populations generally have more cash to fix things. Others can be at a disadvantage and “find credit more difficult to come by, especially for cosmetic improvements that are unlikely to translate to materially greater revenues,” according to Burton Gray.

Jeff Binder, principal and managing director for Senior Living Investment Brokerage Inc., agrees.

“When the average unreimbursed allowable Medicaid costs per day exceeds $22, there typically is not a lot of capital available for the physical plant,” he says. “Quite frankly, the more dependent a skilled nursing facility is on Medicaid, the more likely it is to be in poor condition. Conversely, those SNFs benefiting from a higher quality mix typically are in better condition. It is somewhat of a ‘chicken or the egg' scenario. It typically takes capital to enhance the aesthetic and operational appeal of a SNF to garner private-pay and Medicare residents, but it also takes this payor source to generate the capital to be able to invest in your buildings.”

Many financially strapped facilities cave in and invest further only when competition mounts.

“Some facilities, threatened by new construction or nearby competitors being renovated, will be pressured to act or risk census or quality mix declines,” says Jason McMeen, managing director, real estate for MidCap Financial Services, LLC. “For others located in secondary or tertiary markets with no threat of new competition, the pressure will not be there.”

Keith Kodrin, senior director of healthcare real estate at Capital One, concurs.

“The best indication that a facility may have waited too long to upgrade is when a new competitor opens up next door,” he says. “In that scenario, someone has concluded that they can provide a higher level of care in a more efficient manner. The newer physical plant is a major factor in that equation.”

Moreover, many facility owners are unlikely to fix plants if they see little or no payback from borrowing money.

“In certain markets dominated by Medicaid, it's hard to justify making investments in property and plant when it will not result in an increase in revenue,” notes R. Jeffrey Sands, managing partner and general counsel for HJ Sims. “In these cases, the properties go on until someone shuts them down or they are purchased by a larger operator that can justify the expense of a change of ownership because of economies of scale.”

Sometimes the return on investing in an upgraded plant isn't there. 

“Operators are now grappling with the question of whether it is more advantageous to refurbish or replace obsolete sites with facilities equipped to meet the needs of the post-acute and transitional care markets and more effectively compete for the baby boom resident,” says Burton Gray. “We expect many to elect to follow the latter path and the credit markets generally favor that option.”

Many facilities with aging physical plants often find that there are few options between an overhaul and closure. 

“Many traditional nursing facilities can neither provide the required level of care nor meet the specifications necessary to attract an acute-care partner,” Burton Gray adds. “Some operators have found that the best way to resolve these challenges is to close.” About 28% of facilities built in the 1970s have done just that, she adds.

Facilities risk a “downward spiral almost solely dependent on Medicaid” if they don't take the plunge to borrow money for plant upgrades, says Binder. He calls it an increasingly “non-viable long-term” plan because of the widening gap between reimbursement and actual costs.

Swaying lenders

“Defensive capital spending” on a plant project can be a tough sell for low-margin businesses. 

“From a lender's perspective, the capital for plant upgrades needs to come from the owners as it is necessary capital but has a longer recovery period to realize a return on investment,” says Javaid. “If a facility is performing well, a smart administrator or owner would keep good tabs on the market and monitor any major rehabs/renovations or new builds coming online. If the property occupancy has started to slip and the new facility is already making a dent in the earnings, it might be too late for the lending or investing community to extend additional funds and the operations may have to dig through a deeper hole before spending on plant improvements or upgrades.”

Some lenders, meanwhile, look favorably on nuts and bolts projects like physical plant upgrades because they are a safe bet.

“Lenders can be more receptive to approving capital for plant upgrades versus new projects because credit decisions are easier to make based on historical cash flow than projected cash flow,” says Steve Kennedy, senior managing director for Lancaster Pollard. “Investing in the existing story, rather than rolling the dice on a new story, can be easier for lenders, particularly senior debt lenders, to get behind.”

Almost guaranteed to be green-lighted are proposals that address deferred maintenance issues, footprint retrofits that add to rehab capacity and IT enhancements that provide the infrastructure to deliver and account for new high-value services, says Burton Gray. 

Nearly sure things

In many respects, an upgrade can almost sell itself. 

“Even if you are not growing your quality mix, you will need to have a solid physical plant to stay competitive,” says Sands. “And there can be significant operational cost savings generated by physical plant improvements.”

There are options even for highly leveraged properties unable to attract financing unless the lender is convinced the improvements would draw increased profitability. It's easier for a single-site provider to get financing based on current cash flow than to get financing based on new market share, Sands says.

Of course, a good track record always helps.

“If the lenders believe in the operator, the market and the viability of the plan, the more receptive they will be to funneling capital into the facility,” says Binder. 

But the numbers must add up. 

“Analytical data that supports any upgrade is ideal,” notes McMeen. Even then, lenders are looking for an overall commitment to growing the business. “Investment in staff, training and programs to deliver high quality care and build strong referral sources can be the driver to justify further physical plant improvements,” he adds.

McMeen says he once worked with a borrower who acquired a portfolio of underperforming nursing homes and physical plant upgrades were part of the turnaround equation. 

“The upgrades not only showed a commitment to the staff but helped establish and strengthen existing referral relationships within the community,” he notes. 

Sidebar: State of physical plants ‘staggering'

According to the National Investment Center for Seniors Housing & Care, the average age of freestanding nursing homes is 37 years.

That's a number R. Jeffrey Sands, managing partner and general counsel for HJ Sims, calls “staggering.” With the average lifespan of boilers and coolers about 15 years, it's no overreaction.

“Some of these facilities have kept up with the times but many, especially the ones built in the 1960s and 1970s, are facing functional obsolescence,” notes Imran Javaid, managing director of BMO Harris Commercial Real Estate Healthcare.

three: living architecture, a 30-year-old firm rooted in the “boutique” and hospitality resort business, has become immersed in senior living in recent years. Rocky Berg, principal and director of business development, is witnessing the decay up close. 

“Central plants in the more hospital-modeled nursing homes are getting quite old,” he observes. “There are countless communities that were built in the '70s and '80s, so they are in their 40th or 50th year of utilization and have attempted to evolve. Some of them are addressing it very pragmatically and carefully, and some of them have let things slip. It's really the behind-the-scenes stuff that tends to be out of sight, out of mind, and it's easy to see why maintenance is deferred.”

In many instances, facilities have had no choice but to patch the problems, according to Kathryn Burton Gray, senior managing director/head of seniors housing and healthcare for RED Capital Group. 

“Although many skilled nursing facilities operating for more than 15 years have undergone some level of renovation, much of the work has been cosmetic in nature, leaving the same basic designs and operating strategies in place that were current when they were constructed,” she says.

Vulnerabilities exposed

Owners and administrators, meanwhile, understand the risks of tabling improvements.

A recent spate of natural disasters have led many to consider whether their physical plants could survive or even withstand the ravages of a disastrous flood or fire. 

Short of rare instances requiring major overhauls, few mandates have been issued to address aging physical plants. 

Over the years, federal agencies have intervened to address specific issues, like the Centers for Medicare & Medicaid Services did late last year when it issued regulatory updates requiring automatic sprinkler systems in facilities taller than 75 feet and established evacuation plans if the systems are disabled for more than 10 hours.

The Joint Commission recently issued new rules for emergency power systems. Last year, CMS promulgated an extensive overhaul of the Life Safety Code.

Perhaps the most compelling evidence came two years ago, when the Facility Guidelines Institute, an independent, widely followed resource for healthcare designers, architects and builders, published its “Guidelines for Residential Care Facilities” — the first time FGI has developed guidelines specifically for senior living. 

The guidelines, which were developed “in response to the widespread adoption of person-centered care and deinstitutionalization,” provide minimum recommendations for new construction and renovation of nursing homes, hospice and assisted living facilities, among others.