Q&A with Paul Gordon of Hanson Bridgett

Successful senior care models in the United States are the by-product of hard won victories and several decades’ worth of insights.  The range of expertise and core competencies these insights reflect can be both impressive and overwhelming.  Combining real estate, healthcare, and hospitality into the current holistic – if still varied – set of models that have been proven to be successful in the United States is no small feat.  As the American senior care business has grown more sophisticated, it has made its share of mistakes, many of which were probably necessary in order for the US market to evolve and mature.

Chief among these lessons has been the challenges unique to real estate, both the transaction made by the developers at the front end of the project, as well as that completed by the customer upon purchase.  With both of these transactions in mind, I wanted to get the thoughts of one of the leading experts in the senior housing real estate market in the United States, Paul Gordon.  I mentioned Paul previously as part of Ambassador Locke’s Senior Housing Trade Mission.  As I pointed out then, he has , and is uniquely positioned to comment on how the American senior care market developed.    My specific area of interest was in learning more from Paul about how the American senior care and senior housing market came to fruition, and what lessons China should draw from any mistakes that were made then.

Paul opened our conversation last Friday afternoon by sharing that to him, “what is going on in China feels a lot like what went on in the US in the mid-80s.  There was a sudden interest in senior housing as if it had not existed – almost as if seniors had not existed – but what happened was this surge of interest from real estate developers that had found a niche market with good demographics that could be developed.”  This echoes a comment he made in Beijing around the observation that American real estate developers had – in general – over-built in the 80s to discover they needed to either convert under-utilized properties, or build new ones in order to keep afloat.  As Paul sees it, this same dynamic appears to be occurring in China:  “There apparently has been over-development in some areas of China’s real estate market and so there may be a similar need for China to find a less-developed niche market.  This is not to say it is bad – it is all good; but, there are going to be some successes and some failures as there were in the US.”

I wanted to get Paul to expand a little bit on what the Chinese should learn from our own experience of seeing developers too aggressively pursue senior care without adequately understanding the market’s needs.  He shared that in his estimation, “What went bad in the US were developers targeting too young of a population to serve and thinking that a 65 year old would respond to the new developments, when the opportunity was actually when these people came closer to 75 or 80 years old. If you don’t understand the market, you build in the wrong place and build too many of the wrong sort of units.”  He went on to make an important caveat:  “Does the US experience transfer 100% to China?  It probably doesn’t.  It may be that a younger age group in China might be more prone to moving than in the US … who knows?  Assumptions about who is going to show up in a community have to be tested a bit before you spend millions building something.”

Let’s pause a bit here and nudge out what I think is an important insight Paul is offering:  as Kevin Ryan shared with me recently, Chinese developers tend to want to talk about building huge communities, a reflection of three factors.  First, it’s how they do business.  They didn’t get to where they are by starting small.  Second, their understanding of the market opportunity and all the “compelling” demographics suggest to them that going big is the natural thing to do.  Third, they think that the “go big or go home” pitch will impress potential western investors and operators when, in particular for the latter group, going big into an untested market without a proven business model is perceived to be the absolutely wrong thing to do!

Paul went on to comment that as he sees it, the other major mistake American developers made was focusing on all the infrastructure and amenity issues at the expense of more important operational issues.  On this point he explained, “The other mistake some in the US made was that a lot of emphasis was put on real estate, architectural design, the ease of developing a particular piece of land, zoning and entitlements, making these processes easy – those were the driving factors for development of some properties.  But the developer didn’t pay sufficient attention to other issues such as competition in the market, whether there is a sufficient population to support it, what percentage do you have to attract to fill the building, what sort of services do you have to offer, does your target audience need care today or 10 years from now?”

Paul added some additional commentary on how the American regulatory system evolved and what China could take from our experience on this front:  “In China I really don’t know what the regulatory situation is, but from what I hear it is a hodge-podge.”  Paul has helped the China Real Estate Chamber of Commerce (CRECC) develop accreditation standards for Chinese senior housing based on a model for assisted living regulations developed by the American Senior Housing Association and US state laws.  With this experience in mind, Paul went on to comment, “China could also benefit from the US regulation model.  Many states have regulations on CCRCs – this would be helpful for China to emulate because despite the differences in culture between the US and China and the underlying laws in the two countries, so many things the regulations need to deal with are about what we have in common related to human interactions:  older people living in a managed residential community, receiving services including healthcare from the manager for a price, under circumstances and rules that are defined in part by the law, and in part by a contractual relationship between the parties.”

That is a mouthful, but it is so important to point out that not only does this sort of regulatory framework not exist in China, but that within the healthcare space itself, paying for services in China remains more of an unknown on both a transactional and reputational level than is widely understood.  American providers eager to expand in China would do well to make sure their contracts and collateral do not make the mistake of over-promising and under-delivering.  Until a more robust regulatory regime is in place in China, much of this will exist in the realm of private contracts, which puts the onus on the operator, not the individual.  As a Western company in China, you can bet the courts will err on the side of protecting the family before you.

I was curious to ask Paul if he saw China making any of the same mistakes we made, and whether anything could be done to prevent these errors from occurring in China.  Paul shared that “there are a number of well-publicized entrance fee CCRC models that failed in the US over the years all the way back into the 1970s.  Also, in the late 1990s, monthly fee based assisted living facilities were overbuilt, and many failed.”  Explaining how this happens, Paul shared that “What tends to happen is a developer goes out and tries to determine if there is a market for a particular facility; they may also get entrance fee deposits from customers before a building is built (typically 10 or 20% of an entrance fee) but then for whatever reason, construction commences, and in some cases deposits would disappear never to be seen again.  In other cases, the building is completed, people paid entrance or monthly fees and moved in, but the development never got beyond 50% occupancy, which in turn drives the whole project into bankruptcy.  Once this happened, in most cases they would then try to change the financial parameters of the deal and allow some new residents to come in on a rental basis, which means the whole model of retirement community that was offered to the group was not the same as was promised.”

What happens when this would take place in the US?  Paul elaborated that “Very often a community like that gets stigmatized and become reluctant to move in. Meanwhile, tens of millions of dollars have been spent on buildings and communities that certainly don’t meet expectations in terms of the sales process.  That is in a mature market like the US.”  Amid stories about China’s real estate bubble, the potential that similar mistakes are being made by developers in China cannot be discounted.  What does this mean for potential investors and operators in the West who want to come into China?  First, due diligence on your potential partners is extremely critical.  That is a very different vetting process in China and is highly reputational versus the more formalized approach possible in the US or EU.  Second, one has to ask about timing.  If in fact this same sort of phenomenon is taking place in China, are you better off studying, researching and circling the field?

On this latter point, Paul added, “Unless you are really lucky, or have a really good handle of what people are going to do when you build your building, it is really important to do your market research.  Be sure you understand what kind of services they want.  I’m a little bit afraid some people are going to build gigantic projects, after all many have a beautiful piece of land and the authority to do it, but the market may not support the price level they need to make the ends meet financially.  It is a human nature issue, not a Chinese issue, not an American issue.”  Paul shared that one way to address this fear would be for China to adopt more of the sort of up-front market intelligence analysis that is now required by many American states.  He explained, “many states require that before you put a stick in the ground you go to the state with your project plan (financial feasibility study and market feasibility study) which looks at what you are going to build and how much it will cost to operate after 5 years.  You have to define your market, how many people in the geographic area are age and income qualified to move in, and then illustrate the penetration rate needed to fill the building.”  Only after these details are provided to the state can you get the necessary approvals to build.

Paul was quick to acknowledge that China will have to find a uniquely Chinese solution to meet its needs, or as he put it “I like to think that China is in a similar position that we were once in, and that there is going to be all kinds of experimentation.  There are going to be failures and successes, but overall it will be good because a vibrant industry will develop there just like it has here.  On my last trip to China I saw a proposed 3,000-unit retirement community.  Will that be successful or an utter failure?  I don’t know, but I do know that already what they are doing is different and I would encourage anyone who wants to get involved to take a hard look at consumer preferences and study demographics to try and figure out if you can fill up a place with that sort of size and scale.”

As happened in the United States, the senior care market in China is big enough that multiple models will emerge, and many players within each divergent model will be successful.  In reflecting on my research thus far, and Paul’s comments specifically, I do wonder if the Chinese real estate market is chasing senior housing as much to keep the proverbial ball rolling, and if so, whether objections from within the Chinese culture about moving into a retirement community have been given enough voice.  If China’s senior housing market is going through a similar hype cycle as we went through in the 80s, will it have the elasticity to absorb excess under-utilized capacity, refine the housing model, and continue on?  Time will tell, but for American investors and operators the message of up-front market research and due diligence hopefully comes across loud and clear after reflecting on Paul’s insights and experience.