The bulk of my work centers around gathering data, analyzing trends and working with the leadership of various organizations to implement strategy or more centered, strategies. The process is iterative, interactive and always fascinating. Throughout my career, I’ve worked within (virtually) every health care industry segment and seniors housing segment. I also counsel and have worked with entities that buy, sell, invest in, consult with, account for, finance, and research health care and seniors housing businesses. Its my work with the latter that is the genesis of this post and my decades of work with the former that is the “content”.
There are two fundamental reasons why health care leadership is hard and different from leadership duties in other industries: 24/7 demands and the immediacy of the customer to the enterprise. Health care and seniors housing (regardless of the segment specific) never closes, has no true seasonality, and demand can increase and decrease with equal force and equal pace, almost entirely related to external factors and forces. Pricing for the most part, other than seniors housing, is almost immaterial and unrelated to revenue. No other, non-governmental, business is as regulated and scrutinized and mandated transparent than health care. Likewise, no other business has the mandate that the full array and intensity of all services must be available 24/7, on immediate demand, with no ability to defer, fallow, or limit. Even a 24 hour PDQ won’t have all services available constantly (if the hot dogs run out, they are gone!).
While other industries will have close customer contact, health care has a unique, and intimate relationship with its customers. In SNFs, Assisted Living Facilities, Seniors Housing, etc. the customer is present for long-periods (years). In hospitals, the customer is present for hours, days, up to weeks at a time (the latter rare unless we are talking LTAcH). In the health care setting, the enterprise has total responsibility for all needs of the customer – great to small. The quality of care and service to all needs matters and is measured, reported and today in many regards, tied to compensation. Back to the PDQ, the over-done hot dog costs the same and there is no governmental entity that maintains a hotline for customer reports and investigations regarding the quality of the hot dog.
In health care, there is a very unique and in many ways, perverted twist concerning the customer relationship. The customer today is a Dr. Jekyll/Mr. Hyde manifestation. No other industry has customers that are bifurcated as such – the payer being a consumer unique and separate from the actual present being. Health care entities, to be successful, must satisfy both and manage the expectations of both, seamless and fluid to each party. I know of no other industry where on any given day in a hospital for example, where it is likely that of 300 individual inpatients there are dozens more of the payer/insurer consumers requiring unique attention, simultaneously. Miss a step, miss a form, etc. and the payer consumer refuses to pay for the human consumer that is receiving or received the care.
Because of the “constant” nature and customer relationships (coupled with many other reasons of course), health care leadership is hard. It is hard because these two fundamental components are nearly, completely, out of the control of the leader. The leader can only react or respond but truly, never change the paradigm or structure and always, in terms of the payer customer, sit beholding to the rule changing process and bureaucracy of the payer customer. This last element can be unbelievably insidious. For example, in the State of Kansas, dozens of SNFs face grave peril in terms of solvency because the State cannot efficiently certify eligibility for Medicaid for qualified seniors. The delay has left dozens of facilities with Medicaid IOUs at six digits and climbing – the human customer receiving care, the paying customer bureaucratically inept and unwilling and incapable of paying its bills, and the SNF sitting with no real recourse.
Given the above, its frankly easy to see why so many leaders fail or simply, give up. The deck is stacked toward failure. On the expense side of the equation, because of mounting regulation, fewer elements are within a leader’s control. With a rare exception, revenue is completely beyond control in terms of price and reimbursement for services provided. With RAC and other audits, revenue initially earned can be retrospectively recast and denied. (The PDQ six month’s later decides to recoup payment for the hot dog because, in its infinite wisdom, you didn’t need to the eat the hot dog or you should have made a wiser food choice). The overwhelming variables that can contribute to failure in a micro and macro sense for a leader are not lessening. His/her organization is open and under scrutiny, 24/7. He/she must oversee and be accountable for the health outcomes of a human customer that in turn are interpreted by the payer customer (remotely), subject to alteration, and retroactive scrutiny. Today, success isn’t just based on what occurred at the point of service but after the service concluded. The enterprise is at-risk for human behavior (compliance and non-compliance) of the consumer for not just days post service but months. Further, the enterprise is at-risk for the satisfaction of a consumer whose behavior and lifestyle may have significantly contributed to his/her need for care and service initially. As one executive told me recently; “We have to tell people the truth about their disease, figure out how to make it sound good and nice, and hope that we have done so in such a life affirming fashion that the patient will give us 5 stars for service. Figure that one out”. Alas, perhaps failure is inevitable.
Aside from failure correlating to burn out or shear “giving up” (the average large system executive tenure is less than 10 years), the failure in leadership that I see resides primarily in two areas. The first is an inability or lack of willingness to realize that the paradigm is constantly changing today and the pace of which, is accelerating. It is human nature to seek equilibrium; to pursue elements of stasis and calm. The same ( is) anathema to leading a health care enterprise. The second area is aversion to risk. Precisely because of the first point, taking risk or being capable of tolerating large elements of risk is imperative today in health care. The best leaders are true entrepreneurs today. They see opportunity and are willing to pursue it with vigor. They find the niches and pursue them. Every bureaucracy and rapidly changing industry paradigm begets opportunity with equal pace and ferocity. For example, the growing “private, non-reimbursed” service sectors in health care that continue to grow and flourish because of and in-spite of the heavily regulated, price tied market. I know of and have consulted for, provider groups that have moved further away from Medicare and managed care to private payment with phenomenal success. Was the strategy a risk? Yes. Most would not take this type of risk. I am harkened however by the notion that at times, the greatest risk present is the risk of doing nothing.
Successful leadership and leaders today, those that I know, have the ability to think systematically and algebraically – to solve the industry polynomials with all of the variables. They are inquisitive by nature and unwilling to accept the status quo, regardless of where and why. They embrace the famed Pasteur quote: “Chance (luck) favors the prepared mind”. They also have the soul and panache (tempered) of Capt. Jack Sparrow (from Pirates of the Caribbean). They like risk and have the entrepreneurial heart and mind to innovate and move fluidly through problems and challenges such that the same are opportunities. They don’t allow their enterprises to become complacent or bureaucratic.
Today, success is about better – better products, better service, and better care. Payers are demanding accountability and want an increasing level of care and service for lower levels of payment. That is the paradigm and it is moving to higher levels of accountability and lower levels of overall payment. The best execs know this and don’t quibble with it (much). They realize that success if about adapting the enterprise accordingly while finding the pliable spots that such an environment creates. These spots are service lines, system enhancements, productivity improvements, and different levels of patient engagement. Similarly, they realize the risk limits of concentration – too much exposure to certain payers. They have seen this trend coming and have already moved. For those still trying to reverse or slow the trend, this is where failure first begins ( the search for stasis in a rapidly changing world).
In my consulting career, I’ve done a fair amount of feasibility work (market, economic, etc.). Similarly, I’ve done a fair amount of similar analyses, primarily related to M&A activity and/or where financing is involved (debt covenant reviews, etc.). Heck, I’ve even done some bankruptcy related work! I’m also queried fairly often about feasibility, demand, market studies, etc. such that I’m surprised (often enough) that a gap still exists between “proper” analysis and simplified “demographic” analysis. Suffice to say, feasibility work is not a “one size” fits all relationship.
I’ve titled this post “CCRC feasibility” principally because the unique nature of a true CCRC project provides a framework to discuss a multitude of related industry segments simultaneously (e.g., seniors housing, health care, assisted living, etc.). Starting with the CCRC concept, a set of basic assumptions about the feasibility process is required.
- Demographics aren’t the arbiter of success or failure – feasibility or lack thereof.
- Demand isn’t solely correlated to like unit occupancy, demographics (now or projected), or for that matter, how many units are projected to be built (following the Jones’ as a qualifier).
- Capital accessibility isn’t relevant nor should it be.
- National trends for the most part, are immaterial. Local, regional and state are, however.
- Projects pre-supposed are projects with inherent risk attached. This isn’t an “if you build it, they will come” type exercise. The results shouldn’t be thought of as a justification for a “specific” project already planned.
The last point typically generates a “heresy” cry from folks and certain industry segments. Regardless, I am adamant here in so much that true feasibility analyses determines “what makes sense” rather or as opposed to, justifying that which is planned (or the implication that the client is paying for a study to justify his/her project). Remember, I am a fan of the fabled quote from Mark Twain attributed to Benjamin Disraeli (the former Prime Minister of Great Britain): “There are three types of lies….lies, damn lies and statistics”. As an economist, I have deep appreciation for this as all too often, I see analyses that smack of this latter type of lie.
(Note: The source of the actual “lies, damn lies” quote is still a mystery…thought initially to be said by Lord Courtney in 1895 but since, proven invalid.)
Carrying this feasibility discussion just a bit further, the approach that I recommend (and use) incorporates the following key assumptions about seniors housing (CCRCs) and to a lesser extent, specialized care facilities (Assisted Living, SNFs, etc.).
- The demand for seniors housing, true housing, is very price elastic. Given the elasticity, all demand work must be sensitized by price. The more specialized or unique the project might or may be, the more sensitive the demand elasticity becomes (greater or lesser).
- Local economic conditions matter – tremendously. This is particularly true for CCRCs and higher-end seniors housing projects, especially real estate conditions.
- Regional and state trends matter particularly the migration patterns, policy issues, job issues, etc. Doubt me? Let’s have a discussion about the great State of Illinois (for disclosure, I have a home and office in Illinois).
- Location(s) matter. I incorporate location/central place theory elements in all of my feasibility work and analyses.
- Demographics are important but not in the normative sense. Yes, age and income qualified numbers are important but education and real estate ownership, location and years residency in the market area(s) can be as impactful.
- Competition is important but in all forms. Given the demand elasticity of seniors housing, the higher the price, the greater the wealth status required of the potential consumer, the greater the options available to that same consumer.
- Ratios matter. The demographics are important but the ratio within the demographic correlated to the project, within various locations, etc. is “money”. (Sales folks love this stuff). How many seniors does it take to fill a CCRC?
Because no one project is equal to another, feasibility work and like analysis is both (an) art and a science. I liken the process to cooking. Recipes are key but taste and flair and creativity are important as well. Honestly, knowing the industry well from an overall perspective is ideal – like being a chef trained by the masters! When I see flawed analysis, it typically comes from a source that follows a recipe; a recipe for market analysis, etc. Knowing the industry, having operated organizations or facilities, being trained in quantitative analysis, etc. separates good or great from average. Remember Twain/Disraeli.
So to the title of this post; the correct or proper methodology for feasibility studies and similar analysis (sans some detail for brevity and not in any particular order)….
New Facility/New Location
- Location Analysis – in economic parlance, the application of elements of Central Place Theory. This includes a review of the site in relationship to key ranked variables such as market/demographics, accessibility, staff/employment access, proximity to other healthcare, other services, etc.
- Pricing – what is/are the core pricing assumption(s)….I’ve written on strategic pricing models on this site. If I am doing the pricing work, I apply the concepts in the Strategic Pricing presentations and worksheets found on the Reports and Other Documents page on this site.
- Demographics – I’ll use my pricing data and my location analysis to frame my demographic analysis. Aside from age and income, I’ll look at migration patterns, education, career history, etc. plus I’ll review the information on a geocoded basis to refine market relationships between customers and other competitors.
- Demand Analysis – From the demographic data and tested against the pricing, I’ll build a demand analysis and a penetration analysis that provides a range of likely target customers, within the market areas, give the pricing information, for a particular product. Historic migration and market area occupancy of like accommodations is used to sensitize the demand analysis.
- Economic Analysis – This is a review of current market conditions and trends that can impact the project’s feasibility, positively or negatively. Real estate, income, employment, business investment, economic outlooks, policy implications such as tax policy, etc. are all key elements reviewed.
- Competitive Analysis – What is going on within the area/regional competition of like or quasi-comparable projects is important as a buffer or moreover, a stability (or lack thereof) check. I like to look at all potential or as many as practical, comparable living accommodations – not just seniors housing (condos, apartments, etc.).
I will complete a major portion of the above with less time spent on location analysis and pricing work (though pricing is still key for accurate demand). I have watched organizations cannibalize their own market share and occupancy levels with expansion projects so accurate gauging of current and pent-up demand is critical along with conditional trends (economic, competitive analysis, etc.).
M&A, Financing, Etc. Projects
Again, all of the above work is relevant but depending on the circumstances, I will incorporate benchmark data from industry sub-sets. For example, for SNFs I look at compliance information, CMS star ratings, staffing numbers, payer mix/quality mix and of course, federal and state reimbursement and policy trends. When I review covenant defaults and provide reports, I narrow the analysis based on the core nature of the default but most often, the issues of late are occupancy, pricing, and revenue models versus fixed and variable cost levels. Pricing work is often key along with a review of marketing strategies.
Is there more to this topic area? Of course and this post isn’t meant to be exhaustive nor a text-book supplement. It is however, a ready framework that can provide guidance to those looking at conducting or contracting for, a feasibility, financing or market analysis. My advice: Getting it done right the first time saves money, prevents future problems, and assists with positive outcomes for any project or purpose.
Since last week, I’ve fielded a number of questions/inquiries stemming from the PBS segment on Assisted Living. Interesting, a number of the queries have come from sources tangential to the industry (policy folks, trade associations, advocacy groups, etc.). Thematically, these sources are looking for answers as to “why” and “what can be done”. Aside from ill-advised regulations, my perspective is the best fix is an industry driven effort.
One could over-simplify by saying, “don’t take anyone as a resident that needs more care than can be or should be provided in Assisted Living” but that’s not practical. Residents change throughout their stay, sometimes rather abruptly. The most complex changes, and those that represented the focus of the PBS piece, are cognitive and behavioral. While medications exist to ameliorate or control certain behaviors, the medications have side-effects and are ideally, the final, last course of behavior management. In all instances, behavior medication should only be given in a setting where a Registered Nurse is present and assessments and monitoring can occur (remember, only Registered Nurses can assess by license authority).
The lessons learned or should have been learned and the counsel I have provided to clients and inquisitors alike is as follows;
- Be clear with residents and families on admission, what kind of staff are on-site and immediately available. This communication should frame then, the services that can and will be provided.
- Be clear with resident physicians on the same information. Don’t encourage or allow physicians to become comfortable with providing orders for PRN (as needed) medications if the same medications require a professional assessment prior to administration, unless the facility has RN coverage on each shift. Effectively, this means that PRN orders for anxiolytics, hypnotics, anti-psychotics, narcotics, etc. are inappropriate without access to an RN for an assessment.
- Beef-up pre-admission screening and assessments with qualified, licensed personnel to fully understand, prior to admission and re-admission, the care needs of the resident. In many cases, I advise going to the resident’s current place of residency prior to admission.
- Make certain that any public (written in particular) or oral representations of Assisted Living as an alternative to nursing home care are gone and certainly, not made or implied. Assisted Living is not a substitute for institutional care if the institutional care is truly required.
- Create specific assessment and re-assessment periods to address care changes more frequently. I like quarterly reviews for Memory Care residents and no less than semi-annual for Assisted Living (non-Memory Care). I also like mandatory 30-45 days post admission, again at 90 days and then semi-annual. I also like this schedule to repeat whenever a resident is hospitalized and returns or returns after an SNF stay.
- Utilize evidence-based, best practice protocols for AL and Memory Care. AMDA is a good resource. Provide physicians with the information as well.
- Develop and utilize, a solid orientation and training program for staff. For Memory Care, there are some good resources available today from Leading Age, AHCA and ALFA. For facilities and organizations that are heavily invested in Memory Care, I also recommend exploring and using, TCI or CPI to augment training (specialized training in dealing with aggressive and combative behaviors).
- Be focused on staff levels based on care needs of residents. If increasing or integrating more professional staff is not an option, be vigilant on discharge planning or transition planning. Bottom-line: If you can’t effectively meet resident needs 24/7, say so and start discharge planning. Have sufficient numbers of staff trained and available, even PRN if required, to address resident care challenges.
For facilities/organizations capable of going to the “next” level, either by size or by financial status, I recommend the following as true “game-changers” for Assisted Living.
- Contract with a “house doctor” or Medical Director. Build a system that integrates elements of medical oversight and engagement with your resident population and staff.
- Expand the care team to include social workers, in Memory Care a psychologist or psychiatrist (or RN extender), a dietician, qualified activities professionals, and rehabilitation therapists.
- Employ a building or program administrator with appropriate degrees and training plus a demonstrable history of working in a post-acute/long-term care environment. Paying a bit more is worth it for someone with appropriate training and education.
- Become active participants in state and national trade associations. Encourage staff to participate as well. I also encourage networking with other professional organizations such as the Alzheimer’s Association.
- Hold regular family meetings or focus groups to both inform and solicit feedback. I like at least semi-annual.
- Connect with a local home health provider for staff augmentation when residents need more care, temporarily or until discharge. I also recommend connecting with a hospice agency.
- Contract for pharmacy consultations on all residents and if possible, have a pharmacist as a resource to Memory Care staff.
Final Word: Communicate and be clear with residents and families regarding the services that are “truly” available and where the “appropriateness” line resides for the organization/facility. Don’t ever extend beyond what staff can provide and what the organization is capable of delivering on a consistent almost constant basis. Recognize that resident care needs change and that limitations exist as to what ALFs can and should provide. Be clear, be compassionate, and be honest – within the community and the organization.
PBS is planning on airing a segment tomorrow (Tuesday, July 30) on its program Frontline, highlighting Assisted Living care in the United States (titled “Life and Death in Assisted Living”). Much of the content focuses on Emeritus and other large, for-profit operators. A link to the PBS website follows as summary to the broadcast. http://www.pbs.org/wgbh/pages/frontline/pressroom/frontline-propublica-investigate-assisted-living-in-america/
I have seen a first-run of the program on a pre-release basis finding it fascinating, troubling, accurate and inaccurate all at the same time. The core takeaway that I found relates to an issue I have written on, lectured on and consulted on for a number of years now. This issue dominates the conundrum that is Assisted Living. The issue is what I label as “appropriateness”.
Routine readers and followers of mine know that I am of the opinion that the Assisted Living industry is essentially over-developed in most major markets. By over-developed I mean more units than true “appropriate” demand. The PBS piece reflects this to a learned viewer. Like Hospice, the true niche’ for Assisted Living and particularly, Memory Care in Assisted Living, is rather small if we apply the “appropriateness” criteria. Taking the analogy a bit further (Hospice and Assisted Living), the fraud trend that has enveloped a major portion of the Hospice industry via primarily Vitas (and others) bears striking similarity between the PBS/Emeritus feature segment; a large supply of outlets, a drive for continued earnings growth, and a lack of truly appropriate patients and/or residents to fuel the occupancy/encounters required to support continued earnings growth, increasing sales, etc.
While I realize the above is a bit esoteric, the logic is economically sound at all ends. More is often not better and the principal of diminishing utility is easily visible, especially to the customer when supply exceeds demand in health care. The plain fact of the matter is that the Assisted Living market has flourished due to a drum-beat fallacy that it is a suitable replacement in many regards, for structured institutional care. This myth is perpetuated by policy makers who crave relief within their Medicaid programs (transition nursing home residents from institutional care environments to assisted care facilities and save big money). It is perpetuated by senior care advocates. It is fostered by marketers for AL companies that ply families with a mixed message of phenomenal care in non-nursing home settings, etc. In the end, no matter what the rhetoric, the reality rises – appropriateness.
Before anyone assumes that I am a basher of the Assisted Living industry, think again. I have run Assisted Living facilities, developed them and consult for Assisted Living operators, investors and developers. Like Hospice, I think Assisted Living is phenomenal, when used and structured “appropriately” (there’s that word again). The problem is that the “appropriateness” definition has morphed and incorrectly so.
Assisted Living is a growth industry primarily because it remains essentially unregulated in terms of development and minimally regulated in terms of operating. True some states are a bit more rigid than others but for the most part, building an Assisted Living facility is primarily a capital-raise challenge as opposed to a licensing challenge. The sole impediment, once capital is available, is community zoning ordinances in most states. Even then, working with most communities and through zoning is not an insurmountable challenge. With a fueled belief that an onslaught of baby-boomers will chew-up unit supplies (these boomers not yet even close to Assisted Living age profiles), units spring forth.
As units sprung forth, what many developers and operators first noticed is that the promised circle of consumers was a bit “short” for occupancy targets. No problem. Thus, a re-labeling or re-purposing began to take shape. Turn the excess into Memory Care via new labeling and plow another niche’. This re-purposing worked enough to beget a new trend; build new Memory Care Assisted Living units. Fueled by all of the same non-realities as mentioned before and a rather simplistic and easy development environment supply of Assisted Living and Memory Care cranked-up.
By definition in most states, Assisted Living and Memory Care is a non-skilled environment. To that point, most operators don’t consistently staff a registered nurse or other skilled personnel on a daily basis and to this point, they aren’t required to by regulation. The typical model includes varying degrees of professional or licensed presence ad hoc as opposed to directly purposed. In this ad hoc system, professional staff act more like consultants rather than direct caregivers. Most states don’t require a specific license or education component for the building administrator or manager; typically a minimal training or vocational course with a test. I have literally encountered Assisted Living managers who have a high-school education and were formally, food service personnel or in one rather larger organization, a failed insurance salesman. His training consisted of a three-day state endorsed program, followed by a multiple choice test earning him a “license”. He was hired despite never running a facility or working within an elder care environment. The company brought him in as a “trainee” and promoted him within three months to a manager of a 70 unit facility; Assisted and Memory Care.
Where the industry challenges lie are at the appropriateness level. Assisted Living is appropriate, properly structured, for residents requiring minimal to no direct professional care. It exists to provide a structured, non-institutional environment and care level that includes meals, ADL care, cueing, activities, and wellness. The bulk of the care can and should be provided by non-licensed, non-professional individuals. Correlating to regulatory requirements current in most states, this is the basic premise and thus, definition. Given today that in many locations, supply of units exceeds individuals who truly require this minimal level of direct care, operators in need of occupancy and revenue, introduce higher-care level residents. Since the regulatory environment is minimal and structurally, ill-equipped to monitor the number of Assisted Living facilities, operators could freely expand the “appropriateness” criteria to suit their business needs. Unfortunately, as the PBS segment implies, the infrastructure for many operators (particularly staff levels, skill and training levels) didn’t adjust to the actual care needs of residents.
It is important to note, not all operators are guilty or frankly even the majority, of stretching the appropriateness definition and when more challenges arise, they have staff and programs in-place to adjust their care accordingly. As in hospice, the typical bad-actor pattern is apparent arising from a fundamentally flawed business model, incongruous with the customer. I like profit and so do my clients, including my non-profit clients. The problem arises when profit becomes too short-term, short-sighted and drives all decisions separate from the underlying needs of the customer. As in Hospice for certain organizations, the economic realities of the industry that is Assisted Living , primarily supply and demand, are working against it. What I fear most for the industry is a regulatory back-lash that like all back-lashes regulatory, will be onerous, ill-conceived and punitive for the providers doing it “right”.
Last October I wrote a post regarding the development of an Economic Value Analysis and how the same is important for marketing seniors housing and skilled nursing. A couple of weeks ago, I wrote a post regarding feasibility tests key to project success and targeted feasibility. Later this year, in October at Leading Age’s annual conference in Denver, I’ll again cover the concepts in a direct, interactive fashion. Until such time however, I continue to receive dozens upon dozens of inquiries as to how to construct an Economic Value Analysis and a corresponding value proposition. Last October’s post is instructive and can be found at http://wp.me/ptUlY-7G. In addition, and in concert with the post prior to this one on financial feasibility methodologies, I’ve provided below some additional “help points”.
Economic Value Analysis is a fairly simple process that centers on determining the ability or capability of a product or service to satisfy the core demands of a given market; the ability to quantify utility. Utility in this context, simply stated, is satisfaction at a given price. For seniors housing, the struggle always is “how” to demonstrate value to potential consumers in a way that is logical and meaningful. This is acutely problematic in a market that is competitive as the “noise” emanating from all the competitors regarding price and services is constant and at times, deafening. At its core, Economic Value Analysis creates a more tangible constant.
Given that seniors housing has a very elastic demand curve (a great many substitute products provide equal or proximally equal core utility), the devil is creating a comparison basis and this basis is not “stated price or features”. A place to start is completing a simple analysis that equates a seniors housing unit per square foot cost (cost = fixed costs, variable costs, and margin) to the comparable alternatives in the market. In this case, comparable alternatives equal rental housing, other competitors, community dwellings (housing units, condominiums, etc). Ignore your current pricing structure as unless the same is equalized on a square foot basis, this analysis won’t provide a true picture.
Taking the example to the next level, once the cost per square foot is known, determine the relevent market comparables. This does take some homework but it is fairly easy to complete. Via simple survey, one can generally gather enough information from realtors, friends, etc. to determine a community housing cost per square foot (utilities, taxes, rent costs, depreciation/maintenance, etc.). Gaining information from competitors is even easier as typically, they publish the information or a simple “blind shopping” trip gathers all the necessary information.
Once the information is gathered, populate a simple spreadsheet with the data. If the core cost per square foot for the seniors housing option is higher, and it typically is, the analysis must delve deeper. Usually, elements that drive costs for seniors housing come in the form of rate or price inclusions such as meals, cable television, maid/cleaning services, etc. Two approaches to deal with this issue are possible. First, back these costs out of the seniors housing number and re-analyze the comparables. Second, and my recommended method, gather data on these services and develop a square foot comparable. Between competitors, the key is to keep the data as apples to apples as possible so one must be clear that the costs include exactly (or as close as possible) the same features/amenities, etc.
Once all the information is known and “spread” and sorted, the picture should become clear. I like to look closest and hardest at the comparison between living at a seniors housing complex versus living in a market rate situation whether that is home, condominium or rental. The age-old belief among seniors is that a seniors housing community is too expensive. The analysis should detail where the true costs lie. Expect some price sensitivity issues where the seniors housing is a tad more expensive but the difference should be clearly and easily explained (24 hour services, access to care, transportation, etc.). The more than can be quantified in the form of dollars, the tighter the analysis becomes and the easier it is to explain where the salient benefits lies. If the gap between the seniors housing cost and the alternatives is too high, the issue may lie in the structural elements of the equation such as inordinately high fixed costs or variable costs. Becoming competitive may require changing, if possible, the financial drivers of the seniors housing project equation.
Concluding, the square foot model works exceptionally well in this analysis as it provides flexibility to model and to change any number of variables. It also is “non-unit” specific so its data and results aren’t skewed by less-than relevant unit pricing schemes. The difficulty simply lies in taking the time to build the model and to accurately gather solid data from the “universe” of housing alternatives. Assuming costs mirror most of the market, the value proposition thus becomes a powerful tool that can and should be used in market positioning.
A frequent, recurring question that I field, especially for CCRCs and seniors housing providers is “what” financial feasibility tests are most important before a project is started or for that matter, financed. Given that capital is still relatively tight, project feasibility and key financial tests are today, critically important to assure the best financing terms available plus, project viability. Below, I’ve broken out the initial “best” feasibility tools/tests to work through once a scope and general cost is known.
- Revenue Efficiency: This is very simple: How much of the proposed project square footage produces revenue? The more square feet tied to revenue generating functions, the more revenue efficient the project is. For seniors housing, the factor or test is very important. Too often, I see proposed projects that allocate way too much space to commons and other areas that aren’t related to revenue production. While groups will argue that these spaces are necessary to attract prospective renters/residents, the reality is that smaller, more efficient is better from an operating standpoint and frankly, even from a marketing standpoint. Too much space can give the project a “vacant” feel while driving up costs related to heating/air conditioning, maintenance, furnishings, etc. Ratios of revenue producing square feet to common or non-revenue producing square feet of 70/30 or less, tend to work best from a feasibility standpoint. I’ll tie this point tighter in subsequent segments.
- Prospective Rate Test by Square Foot: While rate charged is a function for many providers of market or other perceived and financially tied projections, a first basic test should involve a simple equalization model based on project square feet. In fact, this test is an easily built model that can be used for many rate setting exercises and revenue pro formas. First, total the revenue producing square feet in the project. Next, determine the project’s projected or known, fixed costs, variable costs and desired margin. Finally, decide at what level, stabilized occupancy will occur (e.g, 85%, 90%, etc.). Hint: Amounts or levels greater than 95% are not realistic. Once the aforementioned data is determined, divide the total of fixed, variable and margin (annualized) by the total revenue producing square feet, divided by 12 for a monthly factor or 365 for a daily factor. Finally, multiply this result by the stabilized occupancy percentage. The result is the gross revenue per square foot required by the project to cover the fixed and variable costs plus generate the desired margin. To equate this number to prospective rates, multiply it by the unit square footage for each unit type in the project. Next, analyze the results compared to market. Are the rates calculated attainable? If the rates are ultimately not, can the revenue be picked-up elsewhere via a shift among unit types? Are the costs too high? Back to the first point, is too much of the project square footage not tied to revenue production?
- Occupancy Tests: Knowing what the projected gross revenue is on a square foot basis provides a basis for conducting some simple occupancy tests via adjusting fill-rates, overall occupancy rates, payer mix, etc. Using the same formula above but varying the occupancy, it become easy to see the relationships between square foot expenses, particularly those that are fixed and the revenue levels required to cover these expenses. I like to analyze the ratios between each or, how much occupancy do I need to cover fixed expenses (percentage) and where can I massage variable expenses based on occupancy levels or payer mix. Typically, once a simple spreadsheet with square foot costs and revenues is built, it is fairly easy to do assumptive modeling and analyses.
- Payback Testing: An important analysis or test too often ignored or, assumed to be tied to a debt service amortization schedule, is payback testing. Payback should be factored to occur on or before the point in the project’s useful life, when major improvements need to occur. The point here is that the project ideally is paid-for before major improvements occur, commonly known as the period of re-building. At this point, one shouldn’t look at a scenario of re-building when the original debt or expenditure (if equity is the source) isn’t already recovered or substantially defeased. If this doesn’t occur, the capital improvement process is akin to building the project twice (or major portions thereof). In simple theory, new buildings or new construction provides a window of time where capital infusion for improvements is minimal if almost non-existent. This period is where incremental cash (assuming proper pricing at sustainable occupancy levels) can accumulate, allocated for payback (either via faster current debt repayment or investment for future repayment when the arbitrage is positive). My preferred methodology for this analysis is to develop a cash flow analysis where revenue is netted against cash expenses, including debt service. I set my targeted payoff period as that time in the future where projected improvements via major system, structural, etc. upgrades will occur – typically by years 12 to 14. I also will net my annual cash flow by anticipated or projected capital improvement expenditures that use “cash”. For inflation assumptions, or investment assumptions, I try to use actual or historic data and I err on the side of conservatism. Two methods can be used in this approach. One that negates principal repayment in “real-time” and one that incorporates incremental principal repayment. If debt is involved and on an amortization schedule with principal repayment incorporated, its easiest to assume a declining balance for the payback analysis. If the source of funds is equity or a combination of debt and equity, I assume equity repayment at a current cost of capital rate and while I may not create an amortization schedule with imputed principal payments (equity repayment), I will assume a “balloon” effect by imputing a cost of capital return assumption on the equity.
Ideally, this type of analysis is done sufficiently ahead of project finalization. If such is the case, the project can be adjusted to conform to a proper payback period, be optimally efficient, and have a rate/revenue structure that fits within the target market.
As much as I have focused on keeping this site free from any of my personal agenda, I have encountered a circumstance that bears a one-time exception to my rule. Please bear with me as this will be brief.
I have a colleague and true friend who was recently downsized from a deteriorating health system due to their financial and operational mismanagement. This gentleman was in charge of Marketing and P.R. for this organization. In spite of his best efforts and gifts, he was hamstrung by the financial condition and continued deterioration of the organization, literally unable to do his job due to the reputation and care problems, staff turnover, poor community reputation and consistent resource shortage. He became a victim of circumstances beyond his control.
As I said earlier, I rarely attest for anyone and never in writing of this sort. This is a first. The reason? This gentleman is gifted, a true professional and a consummate, stand-up guy. He became a victim of circumstances because he was too principled to walk when he should have, even in spite of my counsel. He finishes what he starts, even if not given the tools or support to do so.
This all said, here’s the inside information. His name is Steve (I’ll withhold further unless requested). He has thirty years of health care marketing and P.R. executive experience within hospital systems (one being the largest in the state) and in the post-acute environment (seniors housing, assisted living, SNFs, hospice, etc.). He comes from a journalism background originally; television principally. He knows media, public and community relations and can market and sell health care. He is a gifted writer and has worked all angles of health care P.R. and Marketing from spokesperson to damage control to mergers and acquisitions and new product launches. He’s even overseen philanthropy and fund development. Aside from me, his references are impeccable and he’s well-known in the health care community in his market areas. I have recruited him in past positions and would without reservation, hire him again.
To the point, he’s networking and available, including possible relocation. I know of few other health care marketing people with his breadth of experience and track record of success. To my readers, all of whom I appreciate, and my professional colleagues whom I equally appreciate, your leads or insights on Steve’s behalf would be deeply appreciated. If you have any ideas or interests you would like to share and/or learn more about Steve (resume, etc.) or talk directly with him, drop me an e-mail and I will make it happen. My e-mail is Hislop3@msn.com.
Thanks for indulging my deviation in content and again to all, thanks for reading!
Creeping slowly out of a period of recession where financing was nearly impossible to get, providers, operators and developers are starting to look favorably at new development and refreshment of existing properties and infrastructure. Though capital is less than free flowing, money is entering back into the long-term care and seniors housing world fluidly enough that projects once parked in the “back of the lot” are edging closer to the front. Having watched significant failures occur over the past three to four years and/or counseled organizations through some of the rough times, now is an appropriate time to pass along some “learnings” from the failures and struggles that I have seen. Importantly, as the industry and the methods for financing have fundamentally and permanently changed, so have the markers for assuring project (new, redevelopment and remodeling) success.
As a primer or if you prefer place to start, there are three basic elements critical to project (new construction or renovation) success: Market demand, cash flow margins, and project cost. Too many new projects failed to meet occupancy projections simply by misunderstanding market demand dynamics (market demand is not demography). While not universal or sacred to only non-profits, misunderstanding regarding cash flow margins is a common failure item. For example, I don’t know how many projects I’ve looked at, especially on the substantial remodeling side, that incorporated no expectation of new revenue or improved operating margins (either this element was missed or worse, not present/expected as a result of the project). Finally, project cost should always be less a function of funds available but more a function of payback. I’ve seen too many projects that suffer from “scope creep” simply because funds, either via debt or equity, were available. Being able to afford something doesn’t necessarily make it “affordable”, especially when the long range economics of a project are critically analyzed.
Avoiding the common traps, pitfalls, etc. that lead to project failure or in some cases, poor performance, is a function of being clear and knowledgeable about the core feasibility requirements. Being clear up front means not just “knowing or providing lip-service to” but actually investigating and working through each element.
- Market Demand: The presence of age and income qualified individuals is not demand; it is supply. The supply of potential customers only assures that potentially, a large enough universe of people exists that meet the broadest elements of “potential consumers”. Recognition that only so many of this universe will be actual consumers of any long-term care or seniors housing product at a given time is critical to developing the initial framework for market demand. For example, less than 10% of all seniors reside at a nursing home at any given time, whether for short or long-term care purposes. If occupancy rates within the existing supply of facilities are average to low, building more units within such a market is a big step toward potential failure. Simply adding units, even if they are different in size, amenities, etc., doesn’t change the core demand for the product. Success of such a project in such a market is thus fundamentally hinged on “taking existing customers” from an established facility; a risky proposition at best. Even in markets with good demographics (customer supply) and minimal to average supplies of like products doesn’t guarantee that demand is present. This is particularly true for seniors housing where demand is very price elastic. The same is true, though not as directly, for SNFs when demand is correlated to payer source (e.g., a private-pay only facility in a market with primarily a Medicaid demand). Without factoring in price and overall costs plus location and unit features and benefits, demand cannot be truly gauged or determined. The mere presence of a suitable supply of age and income qualified individuals doesn’t guarantee any occupancy of a new project, save that the new project at a given price, given location, with given features and benefits fits an unfulfilled need or want within the universe (supply) of qualified customers. Summarily, no matter how much money someone has or how age appropriate someone is, if that person (or persons) does not possess or find a need for a given product at a given price with desired features and benefits, the mere presence of the product within the market will not promote consumption (or occupancy).
- Financial Feasibility: Interconnected with a fundamental understanding of demand is pricing. Pricing, as I have written before, has two key components. The first is the derivation of price based on the formula of Fixed Costs + Variable Costs + Margin = Price. The second component is strategic, tied to market. In any given market, the supply of like products and programs will dictate the amount of elasticity that exists across the pricing continuum. No longer is “me too”or matching the market a viable strategy for pricing. This said, true financial feasibility is mostly tied to the first pricing component. Where projects tend to struggle is when three core elements are misinterpreted or, over (or in some cases under) estimated. The first core element is fixed cost. Feasibility which doesn’t properly capture the key fixed cost elements of debt, debt repayment and depreciation has the potential for quickly turning a project from possible to impractical. Specifically, I recommend the following approach to structuring the fixed cost portion of the feasibility.
- Debt assumptions, especially those involving floating rate scenarios, need to be conservative and reflective of the true interest rate risk across as lengthy a horizon as possible. Fixed rate scenarios are ideal but terms for the fixed period are generally less than the amortization schedule for the debt.
- Following the point above, debt repayment on a schedule that is more aggressive than the amortization schedule is a must. New projects or substantial remodeling projects carry the mindset that depreciation is a non-event in the initial years; minimal cash outlays. While this may be true, depreciation picks-up rather quickly in terms of cash needs by year 5 and becomes more acute by year 10. By year 15, substantial repairs and upgrades to major elements are a common theme. Carrying debt across a normative amortization cycle without more aggressive repayment means that by year 10, the project is being substantially replaced by the need for upgrades and repairs, all while the first phase is still being paid for at a premium cost (interest on the original debt). I have seen all too often, providers struggle with competing cash needs; debt service vs. capital maintenance. Once maintenance becomes deferred, the ability to compete successfully is hampered. Cardinal rule here: Work the feasibility numbers in terms of pricing to include a debt repayment plan no longer than fifteen years, regardless of the amortization terms, and incorporate a laddered assumption of cash needed (reserves) to replace equipment, upgrade units, etc. within the fixed costs assumptions (cash funding depreciation).
- Margin is the devil in the details. Too much fixed cost and/or too much variable cost eats at needed margins or stresses occupancy assumptions to unrealistic and/or unsustainable levels. Ideally, a forty percent or higher “top line” margin is the target for Assisted Living and Independent Living (marginally higher for Independent). When debt and depreciation (cash funded) is added below the line at stabilized occupancy, the project can create sustainable cash earnings/returns on equity. Lower leverage (debt) levels and lower interest costs can aid in thinning top line margin levels but remember, equity contributions instead of debt still bear a cost in the form of opportunity cost. Repayment of equity infusions need to be factored with an opportunity cost (interest factor). Depending on current interest rate environments, the arbitrage on equity cash can be positive (debt cost is higher) or negative (debt cost is lower). Not always does the provider get to pick the amount of equity participation required as lenders today are far pickier on leverage levels and loan to value relationships.
- Project Costs: Project costs should always be built around the assumption of revenue required to substantiate the project. Renovations that do not incorporate opportunities for new revenue or enhanced revenue (new product/service lines, better payer mix, etc.) will almost exclusively be paid-back through depreciation funding and life cycle cost assumptions. In short, no new money, the project scope needs to be tight. Rarely have I ever seen the purported “efficiencies” used in renovation justifications materialize to the extent that the gains justified the project scope. I also am always wary of renovations that incorporate enhanced or improved occupancy levels. Again, rarely does the cost justify the outcome and almost always, the adage of “we are not marketable” is more a function of other organizational issues (bad reputation, pricing, average care, etc.) than it is a justification for an expensive renovation project. In new projects/new development, building efficiency is the key to adequate payback. Allocating too much space to common areas and non-revenue producing areas increases project costs in terms of building and furnishing (not to mention heating, air conditioning, maintenance, upkeep, etc.) and places more “dead space cost” burden into the pricing equation. Objectively, a building that maximizes the majority of square footage for revenue production pays back investment far faster. In an Assisted Living project or Independent Living project, I think a 65% revenue allocation vs. 35% common allocation is reasonable. Higher allocations to common space strain pricing and definitely, require higher occupancy levels to create break-even and payback targets. Similarly, more common space consumes more “furnishings”, often minimally used. Good focal space done right and space with a multi-purpose use is preferrable over space with singular use or no real defined use at all (i.e., lounge
Recently I gave a presentation on strategic pricing and senior housing (see Reports and Other Documents page on this site for the presentation power-point). A key theme that I often refer to centers around the “value proposition” or in other words, the concept that pricing is both monetary and non-monetary and as such, the value proposition is about not only the price but also about the functional and psychological value of the service or product. In short hand, the utility; how the product/service satisfies both functional and psychological needs at or for the given price. During the presentation and since, I’ve received a fair number of questions regarding “how” a value proposition is determined and thus, how the same is correlated to price. Knowing how complicated senior housing and all forms of long-term care (SNF, ALF, Senior Housing, etc.) are today to market, understanding the core concepts of pricing, economic value analysis, and value proposition can make a real difference in establishing an effective sales and marketing program.
Initially, the primary concept to understand is demand and how demand and price work together. Demand, for purposes of this article and simplicity, is the ability and willingness on the part of an individual to buy something. In general, demand and price have an inverse relationship such that the demand for a particular good or service (the quantity thereof) tends to increase as price decreases. Of course, a variety of factors impact demand including the actual nature of the product or service. Funeral services for example have a fairly steady level of demand and in actuality, the demand only changes by a change in supply of dead people (morbid as this thought is). If for example, a major pandemic began to sharply increase the number of people dying, the demand for funeral services would increase. Conversely, if a break-through in genetic research produced a series of cures for diseases such as diabetes, heart disease and cancer, the demand for funeral services would gradually decrease. In the example of funeral services, price is less of an influencer on demand as once an individual has died, few alternatives exist (legally) to disposition of a corpse. While there may be multiple options for pricing inside the range of possible mortuary services (cremation, caskets, size and style of services such as wakes, etc.), there remains a core price that is basically inelastic; doesn’t really change demand as it rises or falls.
For goods and services such as senior housing and to a lesser extent, other long-term care such as Assisted Living and SNF care, demand is more elastic as price changes. The simple reason is that alternatives exist to each level of care that are available, supply or provide the same basic utility and range in cost (expressed as price). In the case of senior living, many options exist at a great many price points. With SNF care, fewer options exist but still, many providers exist and home care and even in some cases, Assisted Living present alternatives at different prices. The net result is that demand is influenced by price as well as a host of other factors.
- The service’s core price is a factor such that all products and or services have a “going rate” calculation. When demand is highly elastic such as with senior housing, the safest presumption is that the core price is equal to living in one’s existing residence as normally, a move to a senior housing facility is equal to or more expensive per month. If the costs associated with a senior housing option are rising, demand will taper off.
- The price of related or alternative goods will impact demand, especially when substitution products or services are widely available. For example, using the funeral home example, if prices for a particular line of wood caskets drop substantially below the prices of metal caskets, the demand for caskets stays essentially the same but the demand for wood versus metal rises substantially. For senior housing, the demand can be widely impacted by the cost associated with alternatives such as market rate apartments, condominiums, or staying at home with certain services.
- The ability of the consumer to buy in terms of economic resources changes demand. If the consumer’s purchasing power changes as a result of loss of income, lower income or lower overall resource levels, the demand for particular goods and services at current price points declines, perhaps shifting to less expensive substitute products/services.
- An increase or decrease in desire or preference on the part of a consumer can change demand positively or negatively. The greatest mover here is consumer confidence. A consumer with a more positive outlook on the economic condition of his/her situation is simply more motivated to consumer. Consumer expectations about prices also impacts the decision to buy. A consumer that believes that prices will rise in the near future is more likely to buy immediately and conversely, an expectation of falling prices triggers a delay in consumption.
Taking the above into account regarding demand, economic value analysis and the determination of a value proposition is fundamentally about determining the monetary value of the product or service as well as the functional and psychological value. The monetary value is not the product/service price but the value, expressed in dollars, of the total cost of a product or service’s ownership. In this regard, the monetary costs also produce monetary benefits. For example, using senior housing, calculating the monetary costs requires an analysis of the following (minimally);
- Rent or mortgage payment
- Monthly amortized cost of any entry fee including interest cost and negative amortization costs (loss of refund as applicable)
- Other fees such as parking, etc.
- Other cost intangibles such as free health care, reduced cost health care, delivery of medications, meals as part of rent, rent increase guarantees (limits), etc.
Calculating the monetary value thus becomes an exercise in quantifying the above elements over a reasonable period of time such as five years, etc. Once this is complete, the result is used as a comparison against like or alternative options. Below is an example for a non-profit, senior housing provider with a fully refundable entry fee compared to a person remaining in their home in the community, with no mortgage payment (a fairly typical situation). The costs I’ve illustrated are over a five-year period (rent for example is monthly times 60 months).
|Meals (1 x day)||$0.00||$6,400|
|Entry Fee (2)||$18,924||$0.00|
|Home Price +/- (3)||$0.00||$5,400|
|(1) Sr. Housing provides free wellness services such as flu shots, blood pressure monitoring,|
|medication assistance, setting appointments, education, screenings, etc.|
|(2) Entry fee is fully refundable ($150,000) at no interest. Interest yield is assumed at|
|2% compounded monthly|
|(3) The home price increase or decrease reflects what the resident can safely assume|
|the home price will be in five years. A negative number is an increase in value whereas|
|a positive number reflects a decrease in selling price. Price of the home is assumed|
|to be $300,000 in current dollars.|
In this example, the monetary value of the senior housing option is greater (negative) than the monetary value of remaining at home or simply, it costs more to receive the same basic utility to move to the senior housing community. The value essentially becomes negative with the inclusion of the entry fee interest loss or cost. On the surface, this appears to be a negative value proposition for the senior housing community. The key to achieving a balance or a higher proposition value for the senior housing option is to monetize the functional and psychological costs between the two options. Ideally, the spread between the two is worth at least $14,674 or the present negative difference between the senior housing option and remaining at home.
In monetizing the functional and psychological costs and benefits between the two options, the trick or key is to have a clear understanding of the profiled consumer. This means having a true handle on current customers and seniors living in the community. For example, a psychological benefit to senior housing versus remaining at home is security. It is possible to measure the value of security by talking to your current customers and imputing a value for a security service to the remain at home option. A functional value is transportation and convenience. If for example, the senior housing option provides shopping trips to local grocery stores or has an in-facility delicatessen and convenience store, the cost between the two options in terms of convenience and transportation is measurable. Other examples such as activity, access (even at a cost) to prescription drug delivery, on-site medical care, check-in services, laundry, housekeeping, etc. are all items with a potential functional and psychological benefit. Perhaps the most under-valued is the access to on-site, future health care such as an incorporated Assisted Living or Skilled Nursing Facility, even if such access is nothing more than guaranteed accommodation without a price reduction. The important point here is that each functional and psychological benefit that is discernible and tangible to current customers has a value that is quantifiable and comparable across each option or living alternative.
The value proposition is the accumulation of the monetized values for the core product or service plus the functional and psychological factors. Consumption activity incorporates all three elements and effective marketing strategy is grounded in communicating the value proposition of a product/service as compared to all other alternatives. Of course the largest difficulty arises in communicating values ascribed to psychological factors. The key in doing so is the heavy use and reliance upon, current satisfied customers. They are the source of input as well as the ground for determining monetary values associated with the related psychological factors.
As senior housing demand is highly elastic, creating and communicating a value proposition is critical in terms of developing potential customers. I would argue that the same approach is as critical for SNFs that are looking to attract certain types of patients with certain payer sources. In using the above approach, an SNF would complete its economic analysis against its competitors, again monetizing the core service, the functional and psychological factors. In many regards, completing the analysis against existing competitors is an easier exercise as quantifiable data is far more plentiful.
Pricing strategy comes into play when the value proposition is imbalanced. Pricing strategy re-weights variables and allows the value proposition to change favorably against key alternatives or competitors. For example, in the senior housing analysis above, pricing change involving the entry fee instantly changes (positively or negatively) the initial calculated proposition. For an SNF, adding amenities within service offerings or adding clinical competence improves the value proposition, even under a fixed-payment scenario such as Medicare. The objective from a marketing strategy approach is to maximize all elements of the value proposition as compared to the competition or to the alternatives. Taking this approach and then developing an effective sales and communication strategy dramatically improves the opportunities for successful new customer conversions – sales.
A regular, although not necessarily routine, exercise that I go through is a re-evaluation of recent acquisitions in the senior housing/long-term care industry to see “how they are doing or performing” post transaction. Perhaps the primary reason that I do this is my curiosity regarding the effectiveness of the due diligence process and the accuracy of the valuation or economic value proposition created by the acquirer as translated into purchase price. In short, I’m always curious as to whether the buyer got what he/she/they expected at the anticipated cost (purchase price plus other investments required over the first year or so) he/she/they expected to pay. As the mechanics and theory behind valuations and due diligence vary between deal to deal (from what I have observed), it is interesting to look at “how things are turning out” once the feeling of accomplishment and the haze of the deal have passed.
When things don’t go well or aren’t going well at the one year mark, something I find more common in health care transactions (SNFs, Home Care, Hospice, etc.) and less so in Assisted Living or Senior Housing, it nearly always seems to a be a flawed due diligence process that led to an over-estimation of value. More succinct: Because the due diligence process missed too many issues the price became over-stated as the costs associated with achieving stable operations were under-estimated or the classic, “he/she/they paid too much for what they got”. Where I notice the largest number of errors occurring during due diligence is when the due diligence is treated as a justification for the purchase price or, a process of validation rather than a process to quantify the economic risks and benefits that are modifiers to the valuation and ultimately, to the negotiated price. Proof of a what a friend of mine always says; “It doesn’t take a rocket scientist to overpay”.
Separating the issues a bit, valuation is effectively a financial quantification of the relative worth of the business as it stands today, including business/commercial value (cash flow, revenues, expenses, etc.) and tangible and intangible asset value (bricks and mortar, equipment, trademarks, name, etc). When Buyers capably test the values against their own business models and the available universe of comparable values, the Buyer has established a range of possible purchase price points. Ideally, within this range lies a number that the Seller will accept or that matches closely, the Seller’s asking price. At this stage, I would argue that a Buyer should never impute any assumptions on a go-forward basis about “how much” expenses could be lowered or revenues increased to massage an improved value. A wise Buyer would best assume that upon acquisition, almost all aspects of the business “as is” are set as constant and these same constants are the financial constraints that place the boundaries on the project’s range of values. This is not to suggest that a pro forma assumption about “go forward” operations that assumes lower debt costs (if applicable), some efficiencies via scale and some reduction in overhead may not be applicable (if in fact they are real and quantifiable). It is however, a caution based on too many valuations completed at the behest of or by Buyers, that include unrealistic assumptions of census increases, revenue increases, expense reductions, etc., that are hardly quantifiable or even in fact, justified for the particular transaction. To illustrate: A few years ago I helped an out-of-state buyer get into a particular nursing home transaction (nursing home was for sale). The buyer owned nursing homes in other locations so the industry was not totally foreign. The location of the facility was decent but the plant was old and the facility’s reputation marginal. The asking price had yet to be set “in stone”. The buyer, accustomed to paying higher prices in other areas, began talking numbers that were far too high for the project, justifying the price with claims of significant improvements in Medicare census and Medicare revenue per day that were unrealistic for the facility (never happened at this location before) and were beyond the norms of the market area. While I tried to counsel the buyer to be more judicious, the buyer went ahead and acquired the facility. Within two years, the buyer abandoned the site, having substantially over-paid, never achieving the projections for revenue and census “touted” for the facility.
Due diligence encompasses the financial valuation but extends the tasks into a level of greater detail that adds or subtracts (creation of debits and credits) from the range of possible values/prices. In the best of due diligence processes, the methodology also incorporates a review of risks and assists in quantifying costs associated with these risks. In reality, due diligence should attempt to paint a complete picture of all elements of the transaction, providing final quantification of the price and qualifications to the transaction that must be accounted for by the buyer. Thought of or approached this way and using the example I presented above, the buyer would never have paid what they paid for the facility and would have realized that achieving a stable, successfully operating SNF in that location would take them years and significant financial and human capital investments.
While buyers tend to approach due diligence and valuation different, each varying upon a theme and using their own methodology and checklists, I’ve found that the problem transactions that I follow each tend to miss one or more of the following elements. Some of these elements are absolutely critical if the buyer is out-of-state or out of the area and the acquisition represents his/her/their first foray into a given market area.
- Economic Location Analysis: Not to be confused with market research principally relying on demographics, this analysis looks deeper into the key economic location elements that are critical to the success or failure of the transaction at the given purchase price. For example, location analysis would quantify labor resources and costs – key elements for a healthcare provider. Location analysis would also quantify the strength and depth of referral patterns and the quality of such referrals by desired economic value (payer sources, etc.). Location analysis also examines the market economy and the up or downward trends that are present. Too many providers over-estimate the value of a particular location without understanding the economic factors that create or detract from the project’s value.
- Provider Status Assumption Risks: Buyers that are acquiring healthcare projects with existing Medicare business and expecting to assume the former provider’s Medicare number (most common in acquisitions) need to understand that the assumption of the Medicare number brings the assumption of risk. While it is true that lawyers will create indemnities and warranties that seek to limit the buyer’s assumption of risk, using these clauses to enforce terms when risks are present or encountered is often an expensive and fruitless exercise. In other words, the seller may no longer exist or as is often the case, will require the buyer to use an expensive legal process to enforce the indemnity and warranty provisions, all while the compliance requirements are inescapable to the current owner. Preferably, although not an expeditious process, buyers should obtain a new provider number and status for the project from CMS, targeted effective on the change of ownership – for Part A and Part B as applicable. It can be done as I have done it with each of my “former” acquisitions. By not assuming an existing provider number, the buyer avoids a whole host of issues and compliance problems that may or may not be disclosed or even known by the seller. CMS, as one would suspect, will only chase the “owner” of the existing provider number when problems arise or are detected and if that is the new owner, regardless of whether the issues pertained to a former operator/owner, the new owner is expected by CMS to be the sole source of remedy. CMS does not care about the terms of the deal between private parties.
- Billing Risks and Revenue Accuracy: This is a problem area that I see all to frequent. The buyer relies on the seller’s representation of revenues and does no further testing. I lost count of how many times buyers relied on accountant prepared or audited statements as being “gospel” only to find upon ownership that the revenues were over-stated. Why? First, even during an audit, accountants do not devote sufficient time or have often, sufficient expertise to analyze, the accuracy of the Medicare claims submitted by the seller. The typical tests are for basic paper-trail elements such as RUGs groups in SNFs matching the billing, matching the revenue postings. What needs to occur is a much more in-depth, technical review to determine if the Medicare claims that correlate to patients are in fact, correct. Again, I have seen circumstances where the Medicare revenue per day is grossly incorrect as the seller had no idea how to properly bill Medicare claims. Last, I rarely see buyers benchmark the revenue and occupancy numbers against area comparables. Payer mix and revenue per day numbers across the industry tend to fit pretty narrow ranges and when, in any transaction, they are out of this normative range, a red flag should rise.
- Compliance Risks: Another area that I see cause buyers problems time and time again. Compliance with certification, survey and accreditation standards is a function of past and yet to be. Acquiring a provider with past problems in these areas requires very careful analysis and discussions with regulatory authorities. Regulators need to be queried extensively and even, negotiated with when the buyer is acquiring a provider with a record of moderate to serious non-compliance. Don’t have the discussions or do the additional analysis and assuredly, run into compliance problems that cannot be deemed as “owned” by the prior owner/operator. Likewise, acquiring a provider with a reasonable or decent history doesn’t mean that the current status of compliance is clean. Sellers tend to wane on their commitments to compliance the closer the time comes to deal “certainty” or closing. A fair amount of time may also have passed since the current owner was re-accredited or surveyed. Complaints may be pending requiring regulatory review. What is certain is that once the acquisition is complete, regulators/surveyors will descend on the new owner in fairly short order. Take the time necessary to thoroughly review the past and current status of compliance.
- Market and Reputation Risks: Simply stated: How is the current provider viewed within the market? New ownership doesn’t mean new perceptions about the quality of the current operation. If the current operation is viewed marginally or even negatively, a new owner will have a great deal of work ahead to establish an improved or new reputation. If the business relies heavily on referrals (and most health care provider organizations do), it pays to check referral sources and other common influencers to understand the “market” perception that is in place.
- Environment and Infrastructure Risks: Assuming that acquiring an existing provider means that existing brick and mortar and equipment doesn’t require improvements immediately can be a false assumption. Existing providers may operate under waivers or as in some states, new ownership necessitates that the entirety of the project be brought to current code with the issue of a new license. Such is the case in Wisconsin. A thorough review of the environment and the infrastructure tied to building code requirements, completed by qualified individuals/organizations will minimize this risk.
- Employment Related Risk: Here I am not talking about the legal risks associated with handling employment issues during the closing processes. The risk that I am talking about occurs when buyers make one of two (or both) assumptions about the quality and stability of existing management personnel and/or, their own management personnel. The error I see too often made occurs with out-of-state buyers not acquiring sufficient local or area expertise and/or, having enough local support available via contractors (consultants, etc.) to ease the transition. Each market area and certainly, each state brings forth nuances and issues that require stable management and unique knowledge requirements. I’ve seen too many new owners underestimate the resources needed and over-estimate the ability of their management to handle new areas and states foreign to them.