Identifying the Most Critical Projects for Capital Planning
Located just outside of Miami, Vi at Aventura includes a mix of individual apartments for assisted living and memory care. After 15 years, it was starting to show its age. “It was still in good shape, but when carpeting hasn’t been replaced for a number of years, you start getting wear patterns. Couches and chairs don’t look as fresh and crisp,” said Gary Smith, CFO at Vi.
The company spent $5 million to upgrade the property. All of the common areas received fresh paint, new furnishings, and similar enhancements. “It’s a benefit to our current residents and it also speaks to our prospects, who have certain expectations about things like finish. We want to meet their expectations as well,” Smith said.
With many senior living communities edging toward 15, 20, or 30 years of age, operators are putting a range of capital expenditure, or capex, projects into play. With pressure on to renew and refresh, questions arise: Which projects take precedence? How best to prioritize capex? Who gets a say in the process, and what is the executive director’s role?
In this article we’ll start by looking at some of the most common triggers for capital investments, and then dive into questions of process and prioritization.
Consider the four most common triggers for a capex project: The refresh, the urgent situation, improved space utilization, and the competitive landscape.
1. The refresh
The public-space refresh, typically the most common renovation in a senior living community, doesn’t strictly need to be a capex project. It’s possible, of course, to do the carpets one year, furniture the next. Most operators, though, say it makes sense to take a bigger bite.
“Rather than dishing out small amounts every year to do carpet on one floor, to do furniture somewhere else, our strategy is to do all that in one year in a given community. You get a bigger impact,” said Doug Lessard, COO at Belmont Village Senior Living. “If you have a program where you do that every five to six years, improving everything at one time, then it will last until the next time you do it. Otherwise you get a situation where things are piecemeal, they don’t match, and some area or some building inevitably gets left out.”
Depending on the age of the community, a number of variables could trigger a refresh. A property typically won’t be in tatters before management pulls the trigger. Rather, finishes and furnishings may be a bit worn down, or may simply be out of date. “It’s a combination of factors,” said Smith, whose next capex effort will freshen up a circa-2005 California community. “It includes how long it has been since the last time it was remodeled, and whether styles and finish levels have changed since then.”
2. The urgent situation
While most operators would prefer to schedule capex work in cycles, urgent situations sometimes arise that bring a property to the front of the queue.
“We just did a complete restoration of our Autumn Leaves of Cypresswood community in Houston, Texas, and that was because we were flooded in Hurricane Harvey,” said LaSalle’s chairman, CEO, and co-owner Mitchell W. Warren. “We had 18 inches of water in our community, over $2 million worth of damage. Drywall below the handrail all came off, we put in all new flooring, we repainted the whole building, and refurnished the whole building.”
This kind of spending can wreak havoc on capex budgets. “The planned projects are the easiest because they are finite and you can estimate the cost. The hardest part of capex is the unexpected need, the AC unit that goes out, the boiler that goes out, the major repair that you weren’t expecting,” Lessard said.
Senior living executives have learned to expect the unexpected and to build in failsafe mechanisms.
“We allocate dollars to an ‘unplanned budget’ so that we have some reserve to be able to take care of those things. But then you have to check in constantly throughout the year to see how quickly you are spending that down. If you are spending that faster than expected, it may mean that you put some planned projects on hold. So, there’s a balance there,” Lessard said.
3. Improved space utilization
Sometimes a community will take on a major project not in order to dress up an existing space, but rather to reshape that space for some higher and better use.
In 2016, Vi completed an $80-90 million upgrade of a Naples, Fla. community. In addition to creating a new sales center, the project replaced standalone independent living with an independent living building attached to a clubhouse, which marked the first time the company had ever sought to pair those two uses.
“We felt that layout would be more appealing for residents who are attracted to having a shorter journey to the common spaces, so we would be able to attract a different customer than in the past,” Smith said. “The current residents love it, new prospects love it, occupancy is very strong. We sold out all 72 units and are working on a second phase to add new independent living units on the opposite side of the clubhouse, and those have already been pre-sold.”
At Belmont Village, Lessard has been pursuing a similar course, dramatically reshaping existing spaces to better accommodate residents’ evolving tastes and needs. “We call them ‘community refreshes’ but they are more than just a refresh, more than just carpet paint and furniture,” he said.
“We’ve had spaces dedicated to be ‘computer rooms’ and now seniors have their own iPads, so in some communities we’ve combined the computer room with a bistro to make it more like a little coffee shop, and then converted the remaining space to more of a multi-purpose activity space,” he said.
The ongoing trend toward higher resident acuity also has driven remodeling efforts. In some communities the former ‘wellness office’ wasn’t big enough to accommodate the nurses’ growing workload. “You end up with med carts overflowing into the hallways,” Lessard said. “So, we have had a couple of situations where we’ve expanded the nursing office or moved it to another space.”
4. The competitive landscape
For most senior living operators, the emerging competitive landscape is an ever-present consideration, driving not only short-term marketing decisions but also long-term capex plans. There’s pressure to stay current, to offer a look and feel that is not only comfortable and functional, but also on par with the latest offerings.
Nor is the competitive pressure limited just to the emergence of nearby senior communities. “As more money gets put into condos in a market, as more condos are developed and built, that may raise a prospect’s expectations around the kinds of finishes they see,” Smith said. “People have choices when they decide whether to move into one of our communities, including the choice to stay where they live currently.”
There’s a tricky balance involved here. On the one hand there is surely a need to stay current with what others are doing. At the same time, senior living executives say they are eager to chart their own course, to build a business model around their own ideas of service and comfort.
“We believe that if we are keeping up with our own standards, we shouldn’t have to worry about the competition. If we are putting the residents first and have a high standard for them, we will already be at or better than new competitors,” Warren said.
At the same time, he said, LaSalle leadership keeps its eyes open when laying capex plans. “You’ve got to be aware of what your competition is doing, who is coming and going,” Warren said. “We are very aware of when new competitors come in and we do factor that into our budget and our planning.”
At Belmont Village, executives say they tread the same fine line, seeking to balance perceived internal need against external competitive pressures.
“It’s not an exact science, but when you have a new competitor that’s opening up in your marketplace, you want your building to show well. We are always paying attention to that, and we have done renovations where the timing was driven by new competition opening up in the marketplace,” Lessard said. “It helps you to be fresh and shiny like a brand-new competitor, instead of having some aspect of the building that’s a little dated or worn.”
While these diverse factors all help to shape a capex strategy, there’s another principle at play that also carries weight. In the vernacular: Money talks. While it isn’t always possible to chart a direct and measurable return on investment around capex efforts, ROI can be and often is a determining consideration.
The ROI of capex
By definition, capex is capital-intensive: The need for ongoing refurbishments means that senior living executives must regularly build a capex reserve into the annual budget. Across senior living, this reserve typically runs between $250 and $500 per bed per year, said Rudy Trebels, CEO of Wedgewood Investment Group, an investment banking entity focused on financing senior living communities.
That’s a weighty sum, and yet senior living executives often will be hard-pressed to put a number on the payback for a capital investment project. If the aim is just to refresh stale spaces, to sharpen up the décor in order to keep pace with changing tastes, it can be hard to say how much exactly that contributes to the bottom line.
Sometimes, though, ROI is measurable and verifiable.
Lessard for instance has undertaken a number of renovations in which memory care has been converted to secure memory care. “We look at that as an ROI project,” he said. “You do it because you have demand and because it will enhance your bottom line. We run projections: If we take this wing and convert it to 24 units of secure memory care, what is the return on investment and what is the timeline for that?”
When Vi moved to create its new model of a clubhouse adjacent to independent living, the company was pursuing a calculated return. Executives believed that selling 72 residences with an average entrance fee of around $1 million would rapidly offset the construction expense. “Our business model is pretty conservative,” Smith said. “We have no debt on any of our communities and historically we only take on construction debt when it can be repaid through the sale of entrance fees.”
Still, he said, the math isn’t always that straightforward. “It’s difficult to project what your future cash flow will look like if you don’t do a project. That is actually the harder part,” he said. “Sometimes you have to convince yourself that if you don’t do the project you either won’t stay as fully occupied or your pricing won’t be able to grow as much. On the flip side, you have to assume the market will accept what you have to offer.”
Smith’s best guide for making the call: Look at competing projects nearby. “If your project is comparable or superior, that gives you confidence that you could also be successful,” he said.
At the end of the day, though, ROI is only one variable in the complex capex equation. Since capex isn’t always undertaken with a direct financial payback in mind, several other factors also go into the mix. In most senior living operations, a whole host of players will contribute to that discussion, with the executive director playing a critical role in shaping the conversation and ultimately organizing priorities.
The capex process
While a variety of regional and corporate executives typically will help to shape the capex strategy, it is the executive director who often stands on the front lines, offering a firsthand view of a community’s needs and challenges.
Marty Jensen is the executive director at Wyndemere, an LCS community in Wheaton, Ill., offering 237 independent living residences, 65 for assisted living, 12 for memory care, and 115 skilled nursing units—comprising about 460 residents and 400 staff, all told. Over the past three years the company has replaced office and storage space with memory care in a $1.2 million project, and is currently in the midst of a $3.2 million renovation that includes an overhaul of the existing health center.
“The first thing I look at is safety, then I look at security, then I look at first impressions, then I look at resident experience,” Jensen said. Resident committee feedback is key to forming this catalog of needs. “We are always looking for that feedback from residents, what they like and what they don’tlike. I want to involve them in the process, especially in the selections piece: What kind of chairs do we want to use in the dining room? We’ll bring in four chairs and let the residents have the final say, since they are the ones who are going to be using them.”
In conversations with corporate leadership, Jensen advocated strongly for the memory care expansion. “We were already providing that level of service but not always in the most advantageous ways. We would try to manage someone at an assisted living center, or we might even have to send them out to another community. So, we really needed the ability to support those residents in-house,” he said.
He focused on the health center in part because it was the oldest part of the campus, and also because of the nature of the resident experience in this higher-acuity space. “You have someone in the room who doesn’t come out very often, perhaps, so we want to make that living space as nice as possible,” he said.
Executives at the corporate level say this kind of guidance from the community executive director is crucial in helping them to establish priorities.
“They have substantial input,” Smith said. “We go through an annual budgeting process and in addition to setting the operating budget we also set the capital budget, and the executive director really takes the lead in putting together the first draft of the projects that are of interest for the coming year. From there it’s an iterative process: Prioritizing, getting input from headquarters, getting input from residents, and ultimately getting to a capital budget for the next year.”
It’s expected that executive directors will advocate for the needs of their own communities, and corporate leadership relies on them to help prioritize needs. At the same time, corporate executives look to executive directors to offer a balanced view, to look at more than just the frayed carpet and fading paint.
“They should also look at the big picture—not the whole company but at least their whole community,” Warren said. “That means that what they are recommending and asking for shouldn’t be the flavor of the month, but something that will have the best and biggest impact across their whole community.”
That big-picture thinking is something executive directors are uniquely poised to offer, as they are able to view the ongoing and evolving needs of their communities over time.
In addition to cataloging immediate needs, “they can help by looking forward for the next two or three years,” Lessard said. “If they are requesting several things this year, it helps if they can provide input on what is critical for this year versus what can be deferred for a year. If they can be proactive in sharing that information, they are more likely to get their top-priority project approved.”
Experts say that while an executive director’s input is a vital first step, it should be only a starting point—that the capex analysis ultimately needs to go broader and deeper.
If your $200 million community were a $200 million aircraft, you wouldn’t have the pilot working on the engine: You’d have a team of highly skilled technicians and mechanics, said John zumBrunnen, founder of senior living consultancy zumBrunnen. In much the same way, the executive director’s guidance on capex should feed a more thoughtful and complex analysis.
“You start by having a detailed physical assessment of all of the properties, to determine the big capital events for the next 20 years,” he said. “When are the chillers going to go? When are the roofs and the major paving going to be due? If you only look at one-year or five-year budgets, you aren’t considering enough information. If you do a 20-year forward look you can benchmark one property against another, you can drill down to the per-bed price to help determine what you need to reinvest.”
By gathering the input from multiple executive directors for an across-the-board look, a senior living company can realize substantial savings over time. “If this property needs a new roof next year and this other property needs a smaller roof repair, maybe I can wrap all those projects together and get a better price, rather than having the individual community directors negotiating separate deals,” zumBrunnen said.
Ultimately, having more eyes on the problem often is the surest way of getting that big-picture view. Warren for instance has some 25 people engaged in capex planning, including professionals from health care, sales, operations, and other disciplines. “We want the big decisions to be made with input from across the spectrum,” he said. “Then, at the end of the day, the needs of the residents come first. That’s always the motto.”