Ben Seager – Senior Housing Deals Take Longer to Close, Construction Timelines Lag

Senior Housing News

November 5, 2019

The senior housing development landscape is still strong, but many deals are taking longer to close and buildings are taking longer to fill up. Labor shortages are a primary culprit.

“We’re seeing a lot of projects being pushed,” said Douglas Kimes, senior vice president/national director of healthcare for TCF Commercial Banking. He spoke Tuesday at RE Journals’ Chicago Senior Housing Real Estate Conference.

Specifically, construction labor shortages are causing delays of around six to eight months, which is then causing pain in terms of lease-up. TCF typically plans for between 12 and 18 months for fill-up, and this is now getting pushed out to the range of 24 to 30 months, Kimes said.

Chicago-based construction firm Skender is still seeing a lot of opportunities for work in senior housing, but deals are taking longer to close, said the firm’s Project Executive and Partner Joe Pecoraro.

Material costs have risen, with tariffs playing a part, but it is the labor shortage that is really “driving the market,” he added.

In this environment, TCF is tightening its underwriting, requiring “a little bit more” from sponsors and increasing contingencies, in some cases doubling per-bed requirements to cover potential cost overruns, Kimes said.

Despite the lengthier project timelines, TCF is not yet seeing any covenant defaults leading to forbearance situations, he noted.

Early planning is critical if projects are to remain on time and on budget at this point in the cycle. All too often, the projects’ development team does not collaborate closely enough, early enough with the designers, contractor, operator and other stakeholders, said Chris Tritsis, senior managing partner with advisory, tax and assurance firm Baker Tilly.

Communication lapses frequently result in plans becoming too large or grandiose, with the developer not telling the architect that designs are not going to pencil out mathematically based on market needs. Tritsis sees this play out on almost every deal he works on, from one-offs to half-billion-dollar deals, he said.

“The last thing you want is to wait nine months to finally get to a GMP [guaranteed maximum price] to find out you’re 30% over-budget,” he said.

At that point, back-end value engineering has to occur, with decisions being made to cut costs on finishes and in other domains, which is not an ideal approach.

“You don’t want to be there,” Tritsis said.

This lack of communication is a primary reason why deals are taking longer to close for Skender, Pecoraro said. Development teams think they’re in a good place until they discover that costs don’t work, and it sends them back to the drawing board. These situations can cause the project to miss the targeted rent cycle for opening by three or four months, creating setbacks on lease-up.

“That’s a huge deal,” he said.

Indeed, developers must keep in mind that time is money, said Douglas Antonio, partner at law firm Sugar, Felsenthal, Grais & Helsinger.

“These deals are inherently becoming more and more expensive,” he said.

To that point, the bank lender will be kicking in a higher interest reserve as projects are delayed, Tritsis noted.

Further compounding the labor problem, standard construction practices are notoriously inefficient, Pecoraro noted, citing statistics that 20% of materials are wasted on the job site, and 30% of man-hours are non-productive.

There is little that senior housing developers can do to change this status quo, but Skender is pursuing a solution through its recently launched modular construction effort. The company is creating modular units in a Chicago factory, starting with small-scale residential projects but getting ready to take on larger multifamily and hospitality projects that are “on the one-yard line,” said Pecoraro.

Because these modular buildings are largely built in the controlled factory environment before being assembled on-site, timelines are much shorter and easier to predict than in traditional construction. Skender is seeing about a 30% reduction in time, Pecoraro noted. Overall cost reductions are more modest at 3% to 5%, but the company expects those numbers to get larger over time as the process is perfected.

Modular construction does hold promise, agreed Ben Seager, service-enriched senior housing national practice leader at architecture firm KTGY.

The firm is working on 17 multifamily modular projects currently, and Seager sees senior housing as a great application. That’s because senior living buildings tend to have relatively few apartment layouts, which fits the modular process well.

“My hope is that in 10 years, we’ll be talking about this as the only way to build,” said Pecoraro.