Why Alarm is Rising Over Amount of Obsolete Senior Housing Properties, and Looming Shakeout

The increasing obsolescence of U.S. senior housing stock was a growing concern prior to the Covid-19 pandemic, and the issue has only become more pressing.

As of 2019, the average age of senior housing stock across the 31 primary markets tracked by NIC MAP Vision was 21 years. Today, about 45% of the inventory base across those markets is 25 years or older, NIC Chief Economist Beth Mace told me this week. 

Furthermore, the elevated cost of capital and margin compression are making capital expenditures more difficult.

“That’s going to cause obsolescence to be even more significant,” Mace said.

Executives including LCB Senior Living CEO Michael Stoller and, more recently, Trustwell Living CEO Larry Cohen and Focus Healthcare Partners Co-Managing Partner Curt Schaller have spoken up about this issue, as have industry experts from Plante Moran Living Forward.

In this week’s exclusive, members-only SHN-Plus Update, I analyze the situation and offer key takeaways, including:

• How a years-long sequence of events has led to more obsolete stock and struggles to keep up with needed CapEx

• Why the average age of top-performing communities has remained consistent through market shifts

• How the shakeout from this situation will further stress the sector

Years in the making

New senior living supply surged in the three or four years leading up to the pandemic, but even in that time period, leaders such as LCB’s Stoller were concerned about the issue of obsolescence.

In 2019, he told me that occupancy woes were being blamed on oversupply, but he saw the issue as one primarily of older buildings being unable to compete with new product because they were suffering from years of under-investment.

“I think … there are so many buildings that are at or near obsolescence, that people have not put enough money into upgrading or keeping their properties updated,” he said, noting that some of LCB’s financial partners had envisioned annual CapEx at around $300 or $400 a unit, while he believed $1,200 or more was necessary.

Underinvestment in CapEx is among the “consistent mistakes” that providers have made, Dana Wollschlager, Partner and National Senior Living Development Practice Leader at Plante Moran Living Forward, said at the recent LeadingAge Illinois conference.

Within the CCRC/life plan community sector, the problem is often related to debt: Either campuses have too high a debt load to finance new capital projects, or they are too focused on paying down debt.

“I was working with a client, and the board was so proud of the fact that they were like two years away from paying off their mortgage,” Wollschlager said. “ … But I said, ‘How did you guys pay for all your capital improvements?’ And [they said], ‘Well, we didn’t, I mean, we’ve been worried about paying off our mortgage. And in my head, I’m [thinking] … your building kind of looks like it.”

Certainly, not every property has suffered from lack of CapEx. As of 2021, the unweighted average amount budgeted for capital expenditures across all senior living types, of all ages, was around the $1,200 cited by Stoller, according to the annual State of Seniors Housing report. And the amount of CapEx actually spent in 2020 came in at more than $2,800 per unit on average, unweighted.

But allocating dollars to CapEx has only become more difficult in the past two years, as inflation has soared while interest rates have spiked, and supply chain bottlenecks have led to periodic issues with the cost and availability of building materials.

Providers that haven’t kept up with needed renovations or repositionings are only in a more difficult place today.

“Cost of capital has risen a lot … I think obsolescence will be more of an issue today than it was,” Mace said.

Cohen noted that the “Covid effects” of revenue loss and increased expenses stalled renovations, and that is reflected in the markets and properties that Trustwell currently is evaluating for investment. He’s aware of more instances of owners not being able to undertake critical repairs to address issues such as broken roofs or sprinklers.

“It just seems there are more buildings that are having challenges — particularly older buildings that just may no longer be competitive in the market, whether it’s the size of the building, the size of the units, the fact that buildings just can’t keep up with newer supply,” he told me this week.

Consistent performance

Prior to the pandemic, communities that were 10 to 17 years old typically had the strongest occupancy. This has remained consistent throughout all the market disruptions of the past few years, Mace told me.

As of Q1 2023, buildings that were 10 to 17 years old had an average occupancy of 86.8% across NIC’s primary markets. That compares with average occupancy of 84.4% for properties that were 25 years or older, and overall average occupancy of 83.2%.

Communities that are 10 to 17 years old are in the “sweet spot” for occupancy even across markets with different supply dynamics, Mace pointed out. San Antonio saw a big surge in construction in recent years, but that has now dwindled, with the amount of new development very low. Still, communities that are 10 to 17 years old are posting the strongest occupancy in that market, at 94%.

Washington, D.C. currently is one the busiest construction markets in the country, while 47% of communities are older than 25 years in that metro area. Communities in the 10- to 17-year-old bucket are leading in that metro area with 92% occupancy.

The pattern holds true across different levels of care, as well, Mace noted. The reasons are not hard to fathom: In their second decade, communities still maintain consumer appeal but have had time to lease up and stabilize their workforce and operations — and potential residents are attracted to this stability even in markets with a lot of newer stock, in Mace’s opinion.

“I think newest and shiniest isn’t always best,” she said. “A seasoned team might get more points than a brand-new building that has a staff that isn’t well-integrated or well-formed.”

I think current labor market conditions could be giving older communities a cushion from feeling the effects of inadequate recent CapEx. With hiring being so difficult, if older properties can retain a stable and seasoned workforce — particularly veteran executive directors — they might be able to outcompete newer supply and maintain sufficient occupancy until the financial picture improves and enables overdue capital projects.

But providers cannot afford to wait too long to initiate such projects. Despite the current slowdown in construction, development will inevitably kick back into high gear at some point, to meet the ever-growing, demographically driven demand.

Wollschlager cited the cautionary tale of a community in Maryland that waited too long to reposition, and now is facing 2,200 new units of IL, AL and memory care coming into its market. This community should have shifted its unit mix 10 years ago, Wollschlager believes.

“Oftentimes, we’ve got clients that wait too long, and the market opportunity is gone,” she said.

The shakeout

Increasing obsolescence, coupled with the current state of operating expenses and financial markets, surely will lead to more well-capitalized owners and operators acquiring and refurbishing older properties.

The biggest winners likely will be the organizations that update buildings shrewdly but also create a strong workforce in the midst of ongoing labor difficulties. These are the two components that Cohen cites, when discussing the success that Trustwell is achieving with these types of value-add plays; the company is both investing CapEx to modernize physical plants, and is bringing in new leadership and elevating the talent of the workforce.

“We’re seeing really significant improvement in occupancy, to the tune of somewhere in the range of 200 to 300 basis points of occupancy this month compared to last month,” he told me. “We’re seeing 600 or 700 basis points of improvement a quarter.”

At the same time, Google ratings at these communities are increasing in some cases from around 3 to high-4s and 5s, he said.

I expect that the coming shakeout will also see some older properties repurposed to a middle-market product. This is an outcome that Mace is hoping for, given the huge unmet need for senior living at this price point. And it’s a play that organizations already are attempting, with Merrill Gardens’ reinvention of the Blue Harbor portfolio being one case in point. And of course Atria Senior Living and Welltower are in the midst of a major CapEx program to position the Holiday by Atria portfolio as a middle-market product for a new generation.

Such strategies depend on the new owners being able to acquire properties at a low enough basis. Particularly in secondary and tertiary markets, this might be increasingly possible. Further rent hikes could be difficult or impossible for consumers to absorb in these markets, which could lead to significant distress if operating costs remain high and labor is unavailable. Such scenarios could close bid-ask spreads quickly, in the favor of buyers.

But there is also skepticism about how many older properties are viable for middle-market conversion. Focused Healthcare Partners is actively pursuing investments at the moment and evaluating some smaller, older communities. Older communities that are 40 to 80 units generally no longer work at any basis, given fixed costs and higher interest rates, FHP’s Schaller believes.

Several people I spoke with cited the Enlivant portfolio as a case in point, but Rick Matros — CEO of Enlivant’s REIT partner, Sabra — told me the issue is not with the physical plants or their locations. Covid-related challenges hurt the portfolio, and that was coupled with the downturn in the debt markets, which “knocked out most of the buyer universe,” he said. Currently, much of the Enlivant JV portfolio — with TPG as the majority owner — has been taken back by lenders and is being transitioned to new operators.

In any case, Schaller and a few other industry leaders I spoke with agreed that the sector is about to see many obsolete properties repurposed for uses other than senior housing, with behavioral health and substance abuse treatment centers among the possibilities most often floated. After all the market jolts and dislocations in recent years, that process will create further pressure on the system.

“It’ll be a big strain on residents and a strain on the industry as buildings aren’t viable as senior housing anymore,” Schaller said.