Almost two years ago exactly, “The Forgotten Middle” report quantified the enormous, imminent demand for senior living at a middle-market price point.
Since that time, many providers have set their sights on this part of the market. But most of their early-stage work has been done behind closed doors, with only occasional hints as to the specifics of their emerging middle-market models.
But this month, Merrill Gardens became one of the first large operators to officially launch a new middle-market brand, Truewood.
Merrill’s Truewood portfolio will provide an example to the industry as other groups consider their approaches to serving the middle market. Obviously, it remains to be seen whether Truewood will be successful, but already, I think there are some insights to be gleaned from how Merrill is approaching real estate and operational components of the middle-market brand.
Converting older buildings
Repositioning existing market-rate senior living communities is the most promising strategy for creating middle-market product, according to findings from the 2021 industry outlook survey that SHN did earlier this year with Lument:
Although the company has focused on ground-up development in recent years, Merrill Gardens opted for the repositioning strategy to create Truewood: In late 2019, Merrill formed a joint venture with ReNew REIT to acquire a 28-property portfolio from New Senior (NYSE: SNR), with the intention of converting some of those communities to a middle-market model and brand.
The portfolio was well-suited for repositioning because the properties were 26 years old, on average. That’s past their peak years; most senior housing properties reach their strongest occupancy and performance when they are between 10 and 17 years old, according to data from the National Investment Center for Seniors Housing & Care (NIC).
“We’re taking these communities that were developed a couple decades ago and making them relevant again,” Merrill Gardens President Tana Gall told SHN, in an interview about the Truewood rollout.
From a financial perspective, repositioning existing assets makes sense for creating a middle-market product. The per-unit cost for the New Senior portfolio was roughly $135,600. Buying at that price makes charging a lower rent easier, compared with ground-up development that in 2019 was averaging $196,800 per unit on the low end, according to CBRE.
While Merrill Gardens is currently focused on getting the first 23 Truewood communities up and running, Merrill Gardens does believe there is “plenty of opportunity” to expand the brand through acquisition. Data support that idea: As of Q3 2019, the average age of senior housing stock in the 31 primary markets tracked by NIC was 21 years.
But while there are plenty of older buildings to consider for middle-market conversion, one caveat is that the amount of CapEx required for such repositionings could in some — or many — cases be prohibitive.
The New Senior portfolio required minimal CapEx, Gall said. But that might not be the case for many older buildings, because across the industry, senior housing CapEx per-unit allocations have remained in the range of $300 to $500 a year, according to CBRE. This level of CapEx might be insufficient.
LCB Senior Living CEO Michael Stoller believes that is the case, and that seriously obsolescent buildings are all too common as a result. LCB allocates an average of $1,200 per unit per year on CapEx. Green Street believes 20% to 25% of NOI is an appropriate long-term CapEx reserve.
But for investors and operators looking to make a middle-market play by acquiring older buildings, now could be the ideal time to buy. While pricing has largely held steady for high-quality product, lower-quality communities have been selling on the cheap during the pandemic, with average AL prices falling 20% in 2020, according to Irving Levin.
Getting a property at a bargain price with relatively low census could be ideal for middle-market conversion, as the buyer might then have more capital to address long-deferred CapEx, while fewer residents on site makes such renovation projects easier to accomplish quickly.
More transparency is key
Confident that the former New Senior real estate was a good fit for a middle-market product, Merrill Gardens’ major effort was in creating the right operating model, including setting monthly rates and figuring out how to deliver needed care and services at that price point.
In this effort, I think the provider was wise to listen carefully to consumers. Over the last two years of our “Changemakers” series, many transformative leaders have said that listening to the consumer is key to successful innovation.
Gall went so far as to host focus groups in her own home, and the results were eye-opening, she said.
In one example, the focus groups initially said that transportation was a “very important” service provided by a senior living community. But after Gall explained the high costs involved in providing bus or car service, the consumers decided that they could do without this amenity and rely on ridesharing services or other options.
This demonstrates the importance of transparency. Historically, senior living providers have not been transparent when it comes to pricing, often not even posting rates on their websites. That is starting to change, and I think it will be crucial to middle-market success.
Middle-income consumers will be more price-conscious, and therefore want clear and quick information about rates — but that’s only the start. As Gall’s anecdote illustrates, they likely will respond well to knowing more about the finances of senior living communities, in order to understand the value they are getting.
The focus group input also clarified what monthly rates middle-market consumers viewed as ideal: $3,000 to $3,500 a month, with some variation by market.
To achieve that number, Merrill Gardens is pursuing various strategies, such as streamlined dining that includes just one full meal per day, as well as a new position known as the “resident experience partner,” who works across multiple departments.
Managing resident acuity
What is most notable to me is that the monthly rate is inclusive of both rent and care. By cutting costs in areas like dining and transportation, Truewood communities can continue to invest in the costlier realm of care, offering assisted living as well as independent living (and memory care, although monthly memory care rates can be as high as $6,500). Up to this point, many middle-market experiments — such as welltowerLIVING — have focused on low-acuity active adult or independent living, where care costs are not a factor.
But, Truewood’s level of care is “moderate” at the moment, which is appropriate to the acuity of current residents.
“For the model to work most efficiently, we do need to ensure we are managing our acuity,” Gall acknowledged to me.
I think that over time, managing acuity will be one of the foremost challenges for Truewood and any middle-market operator. The good news is, there are an increasing number of strategies, including:
- Harness technology and health care partnerships to provide more targeted and preventive services
- Incorporate robust wellness programs to maintain resident health
- Leverage expanded flexibilities in programs like Medicare Advantage that reduce residents’ out-of-pocket costs.
Shrewdly selecting and executing such strategies will be key, in order for Truewood communities to continuously generate their targeted operating margin, which is between 25% and 30%. That compares to a median margin for IL/AL communities of 31%, according to the 2020 State of Seniors Housing report.
The ability to attract capital for middle-market senior living has been an open question, given the higher returns that are available for market-rate and luxury properties. But if Truewood communities can generate their solid target margin consistently, it’s easy to see why ReNew views the Merrill Gardens JV as an attractive play — a majority of the Truewood communities are part of that JV, the REIT confirmed to SHN.
No doubt, other capital providers and operators are looking to see whether Truewood can deliver on expectations, to get a sense of what to emulate and what pitfalls to avoid. And the leaders of Merrill Gardens and ReNew have been trailblazers before — in 2010, they struck the industry’s first-ever RIDEA deal, when ReNew CEO George Chapman was leading the REIT now known as Welltower (NYSE: WELL).
Today, RIDEA has become the dominant structure for senior housing REITs and operators. I’m sure that the leaders of ReNew and Merrill Gardens hope and believe that in another decade, their middle-market strategy will also be seen as a watershed moment in an industry-wide transformation.
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