I would gather everyone and have the big talk of sharing expenses, if he's capable.
You said your wife bought the house from him. Would she be willing to sell it back to him and both of you buy another? Or just sell the house..period.. and let them buy a smaller place. Obviously, the kids are on their own now so your wife doesn't need for her dad to be that 'close to them'. That's a bit overkill. Many families do very well and grow up just fine even if they live in different states. Nowadays, kids go where the jobs are. You never know when one or more will move away. Ours did and things worked out just fine.