When it comes to creating new behavioral health facilities, buying used may be a better bet than building new.
Adaptive reuse conversions involve transforming buildings previously used for another purpose into behavioral health facilities. An increasing portion of the facilities adapted to behavioral health uses are skilled nursing facilities (SNF) or assisted living facilities.
If done correctly, opting for an adaptive reuse conversion can save time and money.
Sabra Healthcare REIT (Nasdaq: SBRA) has 13 facilities that have been, or are in the process of being, converted to a SUD facility for another use. Most of these have been converted from skilled nursing facilities.
Sabra identified substance use disorder (SUD) treatment as an opportunity because of its “enormous demand, limited supply, incredibly fragmented industry with no real market leaders or name recognition,” according to Talya Nevo-Hacohen, chief investment officer of Sabra.
“We started to meet with operators and look at our own portfolio to understand whether there were opportunities to convert some of our existing properties that were not performing and looking to see if we could convert those to do addiction treatment,” Nevo-Hacohen told Behavioral Health Business. “And the answer was, yes.”
Cost of conversion
Swapping underperforming skilled nursing facilities for SUD treatment facilities was not just more profitable for Sabra, but it was also more cost-effective.
Sabra is not the only company choosing to adapt properties to new uses.
Recovery Centers of America (RCA) is an SUD treatment provider headquartered in King of Prussia, Pennsylvania. The company operates 22 facilities, including inpatient and outpatient, across seven states, all of which have been converted from existing facilities.
RCA’s real estate strategy involves snapping up existing facilities previously used for other purposes and then stripping the buildings to either walls or studs, depending on how much work the building needs. The company then completely renovates the facility, including overhauling electrical, plumbing, heating and air conditioning systems, as well as roofing and windows, to fit the building precisely to its needs.
Some facilities are more challenging to convert to RCA’s needs than others. Vintage buildings, some as much as 50 years old, are more difficult to convert. Mullin said his team approaches each building on a case-by-case basis.
Although RCA’s building overhauls are intensive, costing between $10 and $25 million, they are still the most economical option for the SUD treatment provider.
“We looked at [building new facilities] early on, but the cost of construction and the timing for all the permits and working with townships is too time-consuming,” Kevin Mullin, senior vice president of acquisitions at RCA, said. “You probably would spend another year, year and a half, more to go through that process. So we don’t build new.”
Construction costs are only one reason why building new is a less economical option. Adaptive reuse of an existing structure also shortens speed to market, eliminating time spent acquiring land and seeking building approvals.
Why SNF facilities?
Skilled nursing facilities could be prime for these conversions.
“It’s been a tough time for skilled nursing,” Andrew Sfreddo, head of behavioral healthcare at Blueprint Healthcare Real Estate Advisors, told BHB.
Chicago-based Blueprint is a health care real estate brokerage with a division dedicated specifically to behavioral health.
Pressures on the skilled nursing industry mean more facilities have become available for conversions to different uses, including behavioral health.
Some skilled nursing facilities are “antiquated”, according to Mullin, or models have changed.
Skilled nursing is a labor-intensive business, but nurses are in short supply nationally.
“Obviously, the behavioral healthcare industry was not insulated from that, but it really hit the senior housing and skilled nursing space in a big way,” Sfreddo said.
Some senior housing and skilled nursing businesses have stabilized their margins.
“If you’re in a market that is oversaturated with other senior living providers, there’s only so much you can do,” Sfreddo said. “Some of these assets that might be not performing up to standards could be candidates to have a better use and serve a greater population need as a behavioral health care asset.”
The increase in SNF availability has spurred a real estate trend, according to Sfreddo. He said more conversions now utilize buildings previously used for skilled nursing or assisted living purposes.
Nevo-Hacohen agrees there may be a trend, but says it may be a “really tiny one.”
“I think others have seen what [Sabra has] done, frankly, and realized it’s a pretty darn good idea to take a building that’s not readily convertible to something else and convert it to this use,” she said.
Ideal building characteristics
Multiple factors come into play when determining which buildings are a good fit for RCA.
When courting a new inpatient facility, of which RCA has 11, the company typically considers between 30 and 40 buildings before settling on its perfect match.
The perfect structure will be located in an area with a robust staffing pool. The potential for partnerships and referrals in the area is also a consideration.
The size of the building and amenities like parking also matter. For RCA’s inpatient facilities, buildings must be between 70 to 110,000 square feet with ample parking for staff and patients.
Sabra, which does not overhaul facilities to the same degree as RCA, also has to find buildings with the proper layout, including plentiful common areas.
“You need common areas and group therapy rooms, but you don’t need fabulous luxurious bedrooms when you’re providing care for people who are using commercial insurance or Medicaid,” Nevo-Hacohen said. “We’re trying to bring addiction treatment to people in a way that is both geographically accessible and financially accessible.”
The most important of all these considerations, however, is zoning.
Zoning is the first thing to consider when looking for a Goldilocks facility, industry insiders told BHB.
A problem with zoning can be a barrier to entry, according to Sfreddo.
“You can try to change the zoning, do a zoning variance, get a conditional use permit or a special use permit to be able to operate a behavioral healthcare facility,” Sfreddo said. “But a lot of times that may not be successful.”
Sabra has thus far avoided rezoning processes by opting for facilities zoned by-right.
“You don’t need to go in front of a public hearing,” Sfreddo said about by-right properties. “You don’t need to go through a variance application. You can open up that business as long as you can get licensed in the state. From a zoning perspective, the city, county or local jurisdiction isn’t going to shut you down because it’s already in their zoning ordinance that you can operate a business in behavioral health care for that specific parcel.”
RCA, which considers zoning first and foremost when evaluating potential properties, looks for facilities zoned as by-right as possible.
“Early on when we were searching for properties, when the zoning was not by-right it was very challenging to get these approved,” Mullin said. “Now, in certain areas, we look for by-right zoning,” Mullin said.
Finding a by-right site is easier said than done.
“We’ve done over 600 behavioral feasibility analyses,” Sfreddo said. “We have found about a 19 to 20% hit rate on assets that are owned by right.”
Location is a major factor in zoning regulations, Sfreddo said. For instance, Houston has much looser regulations. A church could be next door to a landfill. Many other cities have strict rules and regulations.
Finding the right facility with the right zoning is key for an adaptive reuse conversion, but, in Mullin’s words, it’s “like finding a needle in the haystack.”