Now that the real estate dynamics have shifted on-balance to par or better (majority of markets can liquidate inventory at stable or rising prices with constant or modestly increasing demand), the outlook for Seniors Housing (IL, AL and CCRC) is less murky. The recessionary of the last 7 to 8 years has lifted. What is visible, while still fairly complex market to market, is a picture that is illustrative for the next ten or so years – ample to adequate supply and average to slightly soft overall demand. Perhaps, this is the Brookdale lesson?
Amplifying the above; what we know statistically is that demand has globally peaked and now, flattened. Recall that Seniors Housing is very much local and regionally biased/impacted so some markets may be hotter in terms of demand than others. By example, in 2010 (full recession impact), occupancy in the sector was 86.7%. By the end of 2014 and since, occupancy has recovered but only to an average of 90% (per the National Investment Center). During this same later period, new unit production has increased to an average of 3,200 per quarter (trailing seven quarters since end of 2016). This is a 50% increase over the prior eight quarters. The cause? Less about occupancy reality, more about a growing optimistic economic outlook, improving real estate dynamics (the leading cause) and more accessible capital, particularly as nontraditional sources have entered the sector with vigor (private equity). A quick translation is for an increase of approximately 5,000 additional units in the top 31 MSAs (could be as much as 6,000 depending on where the units are in the development cycle). This additional inventory is entering a market that is showing signs of over-supply (again, is there a Brookdale lesson here?).
In multiple articles, I have written about phantom or perhaps more accurate, misunderstood economic and demographic trends. Seniors housing global demand is very elastic, particularly for IL and CCRC projects that are at or above market (where the bulk of the industry is). Demand elasticity exists where and when, price directly impacts the number of and the willingness of, consumers to consume a particular good or service. As price rises, the number decreases. As price falls, the number increases. For seniors housing, the elasticity wanes and trends toward inelastic demand when the price mirrors “rent controlled or modest income” housing. In this case, demand is constant and actually inverse proportionately (more demand than supply). Better real estate economic conditions and improved investment market conditions (stock market, investment returns, etc.) influence to a lesser extent, the demand outlook as stronger or stable wealth profiles for consumers reduces the anxiety of purchase, especially where entrance fee models are concerned.
From a demographic perspective, the issue at bear is the actual or real number of seniors in the target age range with an economic wherewithal to consume (have the financial capacity). Only (approximately) ten percent of all seniors 75 and above reside in seniors housing specifically (IL or CCRC) and a slightly larger (aggregate)number now reside in quasi-seniors housing projects (age limited housing developments ala Del Webb). Between 2010 and 2016, the 75 plus population grew at an anemic rate of 1.8%. The expected rate of growth for this cohort over the next five years increases to 3.8%. More telling, for this same period, the subset of 75-79 grows at a rate of 5.7%. These numbers present a bit of optimism but in real terms, the demand change (within the demographic) doesn’t create sufficient opportunities for absorption of the inventory growth, if the same remains at its present pace. The demographic fortune doesn’t really begin to change dramatically until 2021 and beyond. At 2021, the group turning 75 represent the start of the baby boomers (2021 -75 = 1946). Prior to this point, the demographics of seniors 75 and above still reflect the World War II trend of birth suppression.
To Brookdale. The operative lesson is that Brookdale has far too much supply for the real organic demand that exists for plus market rate, congregate seniors housing. In my outlook comments below, readers will note how the demand around seniors housing and the congregate model is actually shifting slightly which has negatively impacted Brookdale. The acquisition of Emeritus has since offered proof of some age-old adages regarding Seniors Housing: local, not conforming to retail outlet strategies, very elastic demand, tough to price inflate for earnings and margin, asset intense and thus capital re-investment sensitive, and of course, full of me-too projects that are difficult to brand differentiate. In the Emeritus acquisition, economies of scale and cultural assimilation proved difficult but frankly, such is always the case. The real crux is that the retail outlets (the Emeritus properties) were not accretive -seniors housing doesn’t quite work that way. While the asset value of Brookdale skyrocketed, the earnings on those assets retrenched. With soft demand and a lot of congregate projects highly similar and no room at the ceiling for price elevation, a fate accompli occurred. The lesson? Certain types of Seniors Housing is about played out (vanilla, above market projects) and a heavy concentration of this in a portfolio will evidence occupancy challenges and rental income return challenges (no price inflation). Demand is also soft for reasons mentioned above, primarily demographic but also still, economic in some instances. Similarly, as I mentioned above, seniors housing is very local. A retail brand strategy simply (the Wal-Mart concept) won’t work. Residents identify brand to local or at best regional – national means nothing. If the market isn’t supportive regardless of who or what it is, the project will be challenged. Emeritus brought too many of these projects into the Brookdale portfolio.
Below are my key outlook points for 2017 and the next five or so years for IL and CCRCs (non-affordable housing).
- Demand across most property types will remain soft to stagnant. This means 90% occupied is a good target or number. Of course, rent controlled projects will continue to experience high demand, particularly if the projects are well located and well-managed. Regional and local demand can and will vary significantly. The projects that will experience the softest demand are above market, congregate, non-full continuum (non-CCRC). Projects with the best demand profile contain mix-use, mix-style accommodations with free-standing and villa style properties. While highly amenitized projects will attract traffic, demand isn’t necessarily better due to price elasticity in the segment.
- Improving economic conditions/outlook will undergird and help bolster demand, though the demographics still trump (no pun intended). Some notes to consider.
- The real estate economy can benefit, even with a slightly higher interest rate trend, if employment and wages continue to strengthen and de-regulation of some current lending constraints occur. I think the latter two points offset any interest rate increases in the near to moderate term.
- Rising interest rate fortunes help seniors more than stock market returns, though this trend is changing as seniors have been forced to equities to bolster return. Still, most seniors are highly exposed to fixed income investments and a somewhat improving interest rate market will improve income outlooks. Better or improved income does psychologically impact the consumption equation, “positively”.
- Capital access will remain favorable/positive and banking de-regulation to a certain extent, may push banks back to the sector (they have been shy to seniors housing for the last 5 to 8 years).
- Even with improved economic conditions, the mismatch between demand and supply (discussed earlier) will restrain rent increases in the near term. This could present some modest operating challenges for the sector as price inflation on wages, etc. will occur before any opportunity to raise fees/rent. The net effect is a modest erosion in margin. I don’t see much opportunity to fight this effect with increased occupancy.
- Increasing occupancy or in some cases, staying at current occupancy levels will continue to require incentives. Incentives negatively impact revenue in the short-run.
- The average age for residency on admission and across the product profile will continue to move up as a general rule. In addition, the resident profile will continue to slide toward additional infirmity and debility. Providers will continue to work to find ways to keep projects occupied by offering aging-in-place services. While this is a good strategy to a certain extent, the same does harm or impact negatively, the ability to market and sales-convert, units to a more independent resident profile. I liken this to a “rob Peter to pay Paul” approach. It works but not without side-effects and perhaps, unintended consequences that can be very deleterious “down-the-road”.
- The additional inventory that is coming into the sector won’t slow down for another two or so years. This is in-spite of a weak to stagnant demand. Some investors and developers are willing to be somewhat ahead of the baby-boomer curve even though I believe this is unwise (see next point).
- The reason I believe the baby-boomer impact for the sector will be modest and actually, disheartening is that the demographic shift doesn’t equate to product demand directly. Boomers have an increasingly different view of the world and a different set of housing and lifestyle expectations plus economic capacity.
- The first group of Boomers was hurt the hardest by the most recent recession. They lost a great deal of wealth and income profile as many were the first displaced as jobs eroded (oldest employees, highest paid). They also have less employment time to recoup any income/savings losses.
- Generationally, their savings rate is significantly less than their parents. These folks, while still more modest in comparison to Boomers born five to ten years later, didn’t delay gratification or extravagance the way their recession-influenced parents did. Less overall wealth negatively impacts their ability to afford higher-end seniors housing.
- Congregate living (apartments) is less their style. They are the first age group (Boomers) used to a more expansive living arrangement. While they’ll move eventually, they will not see 1,200 sq. feet at $4,000 a month as attractive (not even at $3,000). They will have unfortunately, mismatched expectations in terms of “size” versus cost. They’ll want larger but for less rent than realistic.
- They are generally healthier with a different view of age related to retirement and retirement residency. Don’t look for 75 year older Boomers to be horribly interested in a CCRC or Seniors Housing development, particularly if their health is good. They’ll wait until 80 or older to trigger a move.
- Boomers are more mobile and more detached than their parents. This means in-market moves and the traditional radius markets/math will be less applicable year-over-year with Boomers. They will be willing to shop broader and do so more for value and price – more for less or at least, a perception of the same. They are nowhere near as homogeneous by social construct as their parents.
- Greater pricing flexibility will continue to evolve. This means different entry-fee options, monthly service options with/without amenities, more ala carte, etc. Service infrastructure for certain communities may suffer as residents will continue to want more choice but less bundle (won’t pay inflated fees for what they perceive as things they don’t use or want).
- Because the sector is highly influenced and trended local, some markets will continue to thrive while others will continue to struggle, regardless of national trends.
As regular readers know, I speak at a number of conferences annually. Additionally, I work with financiers and investors in the space literally daily. In all my journeys and conversations, I am still faced with some major myth “debunking” about the nature of the seniors housing and healthcare demand, current. The major myth: Baby-boomers are either here, impactful, or here soon enough that additional supply and different supply is necessary. Nothing is further from reality.
The economist in me (and the economist that I am) wants desperately to provide a full-blown lecture here but I’ll refrain and provide a Cliff’s Note version. Demand is a function of supply and to a lesser extent, vice-versa. The two are interdependent. Demand (commercial) requires a supply of consumers, able and willing to pay a price for a given product. Seniors housing and healthcare, especially housing, has a very elastic demand curve. This means that price is a major influencer in demand. The amount of demand for higher-end, above market seniors housing, is less than the amount of demand for moderate and lower-priced seniors housing (at its core).
Demand is also influenced psychologically hence the “willing” component. Seniors housing requires the consumer to make a psychological decision about moving or consuming, a niche’ product. This fact is supported by the demographic reality that less than 12% of all seniors live in a specific “seniors housing” environment. While a greater number reside within a NORC setting (naturally occurring retirement community) such as a condo complex or apartment complex, the reality is that fully 80% of all seniors at anytime, do not reside in seniors housing nor are they “looking”. The core dilemma with seniors housing is that seniors universally, prefer to live in their “residence” in their community. Some, but a rather small number, choose or are motivated to move annually by choice or by need – the latter being the greater motivator (death, family move, health issue, change in neighborhood, etc.).
Consumers, in this case seniors, exist along the full spectrum of age and ability (economic) to pay. Given the elasticity of demand for seniors housing (the higher the price, the fewer number of able consumers) coupled with a plethora of living options for seniors (home, condo, apartment, etc.), measuring the actual demand for seniors housing is a bit more complicated than most want to believe. The complexity lies demographically and economically.
First, the demographics today are not spectacular. While it is true that we have more older adults reaching ages 80 plus than at any time in history, the number of people in this cohort as derived by birth is falling. An individual today aged 80 was born in 1935 – the depression/war years. During this period (depression/war years), birth rates declined precipitously. See chart below.
It isn’t until the post 1945 years and subsequently, into the mid 1950s that birth rates accelerated into what we commonly know as the Baby Boom. Simple math thus tells us that the real expanse of supply of seniors, age appropriate for seniors housing (around age 80) won’t occur for another 15 years minimally. Today, we are actually seeing a reduction in overall “age relevant” supplies of seniors for seniors housing.
Back to the point about seniors housing demand being highly elastic. Fewer consumers (potentially) also means that all consumers by economic status and desire are fewer in number. The point here is that the supply of seniors for higher-end housing is not just smaller in number but smaller in “desire” or motivation. Folks that have the means to spend thousands per month and invest an entry fee of $250,000 to $1,000,000 also have the means to explore multiple different options. In other words, the range of substitute products (alternatives) for this group is plenty and growing. They clearly can afford to remain at home longer, acquire supportive services, or migrate to lifestyle communities or other planned communities that include multiple options and services geared towards “aging in place” (see Del Webb and The Villages as examples).
Today, there is a reason many communities and projects continue to struggle with occupancy. The average nationally remains stuck around 90% and Assisted Living hasn’t broached this level yet – even though projects continue to come forward at a steady clip. A contributing factor? The demographics are not as fluid and as strong now as industry folks want to portray. The industry is in the core openings of the 20th century baby bust. Additionally, not only is this next group demographically smaller, it is economically less well off, by virtue of time of birth, than the cohort preceding and the one following. This is in effect, the double demographic dilemma for seniors housing.
The moral of this present story: Supply of units for the most part, in most regions, is good to surplus. Reinvention in place is what I advise and for growth; acquire – don’t develop. Adding additional inventory is not only expensive it is difficult to support, except in certain markets where certain really good conditions apply, demographically and economically with proper demand analysis. This present condition will last for about the next 10 years and to a certain degree, maybe longer as the age at which seniors seek “seniors housing” elongates – moving into the 80s. Developers need to understand this condition and seek proper demand analysis and economic planning before believing the demographics of “If you Build it, They Will Come!”
Earlier this spring (a couple, three moths ago), I spoke at a marketing/P.R. conference and when my session was over, I sat and visited with a number of the attendees. My presentation was about value propositions and marketing; how to align your organization’s core economic value components within a marketplace, within a customer segment. Within the short additional time I spent with these attendees, I learned that a number of their organizations (CCRCs) were still struggling post the recent economic recession/slow-down. In fact, a number of them expressed that in their areas/region, recovery hadn’t yet begun.
Since that event and over the course of the past three months or so, I took notes on various client engagements, discussions and research reports on how the CCRC industry is fairing these days. Before I break down my conclusions/observations, some general prefacing comments about the industry are required. First, the CCRC industry is truly different by location and thus, it is expected that some areas/regions, etc. are faring better than others. Second, established projects have fared differently than newer projects; not always better but different. Third, the capital structure of a CCRC (how much debt and how the debt is structured in terms of rate, etc.) is a major component of how well or not well, certain projects are doing.
Below are my observations/conclusions of how the CCRC industry is doing mid-way through the third quarter of 2014. As stated, most of my observations are first-hand (client engagements)* followed by research and conversations with those that work in and around the industry. *(My firm and in many cases me specifically, does capital development/corporate development work within the industry including consultant’s reports when covenant defaults occur, strategic planning, turn-around consultation, M&A work, research for banks and investment banks, and economic, market, and financial feasibility studies. My comments do not reflect any specific client or series of clients or any engagement former or current).
- Late 2013/early 2014, Fitch issued their outlook on the CCRC industry as “stable”. Their conclusion was that improving occupancy rates, stable expenses due to the non-inflationary economy and access to low (historically) cost capital was favorable and thus, their rating. In general, I concur that where real estate rebounded (used inventory down, prices stable and climbing) and general economic conditions improved (unemployment falling, commercial activity rising, etc.), demand for units returned to near pre-recession levels and occupancy increased. However, as I mentioned at the beginning of this post, there remains pockets of weakness, some fairly profound, across the country. The regional/local outlook as opposed to the 20,000 foot national trend is more relevant to the success/struggle of any one project. For example, our clients in “rust belt, heavy manufacturing” areas in Ohio, Wisconsin, Illinois, West Virginia and New York would mount a stiff argument that the outlook is far from “stable”.
- Pricing has remained relatively flat and in many areas, occupancy gains have occurred as a result of discounting and promotions. I don’t see this changing any time soon as while demand is good in some areas, demand is tempered by recent events and still, a large amount of economic uncertainty. The wealth profile of the current demographic has shifted, especially on the income component.
- Approximately half of the projects that were in the development queue in 2008 evaporated or re-scaled. Only recently has the industry returned to a somewhat robust, new development outlook. Access to continued low-cost capital is a key element of fuel for this emerging (again) trend and even though rates ticked-up in November/December 2013, they have since stabilized. Rate however, is just one component. Demand for debt on the part of investors is still at low ebb. Suppressed yields have moved investors out of fixed rate, tax exempt debt en-masse. Deals still are competitive but nowhere close to pre-recession levels. Banks are only now starting to revisit commercial lending to the sector and again, not with the same fervor as pre-2008. The overall number of outlets has declined and the debt to equity levels are still conservative (70/30). Valuations remain a bit low as comps are still weighted by one-off deals, distress deals and work-outs and bankruptcies. Book remains the valuation arbiter and as such, cap levels remain in a narrow range. Overall, the capital outlook is fair but caution and uncertainty remain prevalent and thus, valuations are flat and good deals get done but marginal deals still struggle.
- Rising occupancy and improving economic conditions have slowed defaults and tempered bankruptcies but not eliminated them. Again, certain projects in improving economies have rebounded though others in regions/markets of slow to no-recovery languish. Though average occupancy has once again moved into the low ninetieth percentile across the industry, I still see projects below this level on a regular basis and some, profoundly below. In virtually all instances when I encounter low occupancy, two elements are present. First, the market area is struggling economically – real estate, jobs, infrastructure, etc. Second, the project itself is really viable or relevant. More on this latter point toward the end.
- Projects that have done well, rebounded, stayed vibrant exhibit the following key elements, aside from being in a market area that isn’t still declining or not recovering. First, they were not overly leveraged. Second, they had/have investments and cash reserves. Third, they didn’t defer maintenance to any great extent. Fourth, they stayed relatively lean on the expense side. Fifth, they have diversified revenue streams/bases. Sixth, their pricing was market balanced and actuarially sound. Finally, their management was forward-thinking and had plans in place to address the changing environment. They have a good senses of the economic and market conditions impacting their organization and they plan and address these conditions fluidly.
- Projects that haven’t fared well exhibit the opposite characteristics from above and/or, they simply exist in market areas that haven’t rebounded. The most common element of struggling projects that I see is ineffective senior management and governance. They simply never moved beyond a paradigm that was shifting, shifted and won’t ever return. They aren’t relevant and haven’t learned or developed the current competencies required to compete in a different economic and market environment. For many, the writing is on the wall and for some, revival is possible but a complete turn-around is required.
What I have concluded over the last few months is that industry success is a function today of five components;
- Being in a market area that is economically stable and modestly improving. Real estate fluidity and price stability is important but equally important is the general economic outlook, government infrastructure and commercial economy. Projects that aren’t in this type of environment won’t, no matter what they do, improve beyond a point of mere survival (thriving just isn’t possible).
- Marketing and pricing today require a completely different set of competencies and strategies to achieve success. Pricing must be strategic and financially validated and demonstrative of a clear value proposition. No longer can a project succeed on guessing, market comparables and eyeballing what “management thinks” the budget will support. Marketing is different as well. This is no longer a real estate driven sale and the economic axiom of elastic demand applies. CCRCs have a very elastic demand curve and such, pricing and marketing must unite in the creation and communication of the economic value proposition. More leads than ever are required to generate sales and build and hold, market share. Traditional print and media ads won’t get it done.
- A highly diverse revenue stream/platform (multiple service lines) such that liquidity and debt service covenants can comfortably be made within normative occupancy levels (90th percentile or lower is best). If this is the case, the CCRC also tends to be more market competitive and capable of self-referral and internal market development. In other words, it has multiple channels for referral development.
- Strong, capable management/leadership that isn’t necessarily, tied to the industry conventional wisdom. They are adept at planning, forecasting, and keeping operations structured on high-quality, efficient service delivery. They know the market, know their place in it, know the economic outlooks and demand elements and adjust their products accordingly.
- A relevant physical plant environment for the market. A project doesn’t have to be new and/or the most glitzy. It does have to fit the market however and be current – minimal to no deferred maintenance. Economic value proposition are about proper product value, inclusive of warranty, for the customer to evaluate the tangible and intangible relevance. The physical real estate elements are a major component of the proposition and properly positioned within the overall project, priced and communicated correctly, the prospects for sales and success are high.
Using characterizations, 2013 was a year of gradual ascent for the industry but not necessarily, uniformly so. After a series of years preceding classified as industry malaise, occupancy began to trend forward and absorption rates stabilize. Industry wide, overall occupancy is hovering around 90% for CCRCs though again, this number is broadly misleading. Non-profit CCRCs, the bulk of the industry, fell-off slower and less dramatic and thus today, have risen back in generalized occupancy above 90%. For-profits, fewer in number and newer in market, remain below 90% in overall occupancy (88%). Interesting to note is that the bulk of non-profit CCRCs are entrance fee communities whereas the for profit variety trend toward rental models.
The question for 2014 is will a growth trend emerge? My answer is “no” but the tide will remain somewhat positive. What needs expansion is the following;
- CCRCs and Seniors Housing is very local and regional. Effectively, market dynamics at the local and regional level will play more directly than national trends. As each economic region and market have recovered differently and are pacing recovery differently, so are the prospects for Seniors Housing.
- The real estate market, while better, remains vulnerable nationally and moreover, regionally. Some regions and municipal areas have rebounded nicely and days on market have returned to historic lows (averages) and prices, increased to pre-recession levels. Conversely, other regions remain stuck or have only marginally rebounded (the Detroit area, portions of Chicago are current examples). For true CCRC prosperity to return, the residential real estate market must continue to strengthen.
- The overall economy is still mired close to neutral. Job gains are somewhat phantom and Labor Department unemployment numbers a misleading gauge. The job gains made are not career oriented jobs with moderate to high wages and solid benefit packages. The gains are part-time, lower wage, service sector and seasonal/temporary work. The overall participation rate remains at 40 year lows (fewer numbers) and the long-term unemployment number, grudgingly high. Inflation remains low and accommodative monetary policy has suppressed fixed income yields at record lows. Essentially, this means price inflation remains checked, even for seniors housing. With seniors feeling the pinch of income suppression (low social security increases, low fixed income returns, etc.), the income component of the rent equation remains compressed.
- Available product in many markets is still fairly high. While new projects are coming on, the rate is still slow and recent upticks in financing costs have changed the capital components on project cost. Recall that in April of 2013, unrated and rated tax exempt debt was at record lows and volume in terms of issuance on the uptick. Essentially, demand was equal to and often greater, than supply. Nine months later, the cost in terms of interest is 25 to 50% higher across all rated and unrated categories with new project/new campus debt cost today hovering around 8.5%. Though capital markets remain relatively fluid for projects, the costs today have moved high enough to re-shape new product entries in terms of timing and scope. Similarly, the fluidity that does exist is subject to short-term volatility as Fed policy (the degree of tapering), global shifts in monetary fortunes via emerging market currency valuation changes (a far lengthier discussion is warranted for this but not now), and the fixed income bias to “short” duration (fearful of upward rate volatility) shifts liquidity and funding dynamics.
Given the above, my outlook is good but not great. I see continued occupancy improvements but incrementally. I also see continued regional struggles as some locations are just not in recovery mode. I see enough volatility economically to keep things moving cautiously forward. Similarly, the same volatility can rear a period of distraction and even retrenchment, though I think such a period is brief. Projects will emerge cautiously and then again, given funding dynamics, will evaporate and re-scale. I think the wholesale raft of tax exempt debt refinancings will cool substantially as the cost of a refunding without enough interest savings has narrowed or tipped, especially for less than A rated credit. I think price compression will continue as rates will remain suppressed by fixed income fortunes and low inflation. Revenue improvements will continue to come from rising occupancy and improved operational efficiencies though the latter is probably, mostly wrung out.
Non-profits will continue to out perform for-profits in most markets if for no other reason than their time in-market. For consumers, these sponsors and projects have been around long enough to garner trust and build reputational stability. This isn’t to say that for profits can’t succeed and many will but as a generalized industry trend, the non profits are ahead of the curve. This gap however, will narrow if and when, the industry fully rebounds. A challenge for non-profits is that while they lead in reputational time in-market, they do so often with older physical plants.
Where vulnerability for organizations remains is at the capital structure level. I still see a tough year with a continued high volume of technical covenant defaults (usually liquidity covenants). Rate compression and the inability to pass along too much rate inflation (if any at all) coupled with occupancy challenges was the driver in 2013 and will continue to 2014. We saw some salvation with low rate refinancings but that window has closed for the majority. The key solution for most is recovering occupancy and for some, this will remain difficult given regional economic challenges. What I do know however, is creativity in solutions and positioning is key and will continue to be so for at least 2014.
A key element for all providers that seems missed to me in numerous discussions is the true demographic picture and thus demand equation within the market. For lack of a better term (or terms), I call this the Baby Boom Fallacy. Too many developers and providers have reached the conclusion that the market is rich with and growing exponentially because of Baby Boomers. In reality, nothing is further from the truth today, and for the next number of years. The true baby boom period is 1947 to 1963. This means that the oldest Boomers are just above 65 (67 to 68). Using the real age math for seniors housing and CCRCs in terms of average age of initial occupancy (non-hybrid projects like Del Webb communities aise) at 80, the impact of the Boomers is still a decade away. Their impact today is as adult children and influencers of the current resident prospects; not prospects themselves.
The current resident demographic demand is the baby bust generation or war babies. The World War II era babies are part of time where birth rates declined due to depression recovery and the war. The target range lies within the group born between 1930 and 1943 – pre Baby Boom. This period in time is more bust than boom in terms of numbers. The shift in numbers evident within this group (today) over prior periods is evolutionary due to survival, not due to birth rate. There are more of these 75 plus folks than ever before solely due to increased life expectancy; nothing more. Targeting this group, their cultural norms and their experiences (social, economic, etc.) is where marketing and planning should be – not focused on Boomers. The Boomers, contrary to rhetoric, aren’t here yet as the consumer.
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”.
Among the improvement laggards in the current slow economic recovery was the real estate sector of the economy. Despite record low borrowing rates, home sales seemed stuck in neutral even as positive GDP growth resumed, modest gains in employment occurred, and consumer confidence improved.
Starting late summer 2012 and accelerating in to 2013, the real estate economy has strengthened and improved nicely. Historically, a healthy real estate economy correlates to strong seniors housing starts, sales and occupancy. With many major markets over-supplied as of late in terms of seniors housing units (demand perspective), an improving real estate economy, if trends hold true, imparts hope for the seniors housing sector – or does it?
Seniors housing, as I have written before, has a very price elastic demand curve. Essentially, this means that potential buyers and the universe thereof, is directly influenced by the cost of the housing option. Even when costs remain stable, the demand equation changes dramatically if the buyer for the units experiences change (real or perceived) in his/her economic capacity. Negative changes such as falling real estate prices, constrained ability to liquidate real estate, or reduction in the number of potential buyers for the real estate contribute directly to a senior’s ability and willingness to purchase a seniors housing option. The most dramatic impacts occur within projects that are above-market priced or higher-end as the elasticity of demand for the most expensive options is greatest. In effect, the higher the price the more the consumer of the product or service, will shift to lower cost alternatives, if his/her ability or capacity to purchase has changed (again, real or perceived).
What is most interesting about the real estate economy compared to other economic sectors is that national trends don’t play-out directly, in regional or local markets. Take for example, markets or regions where oil and natural gas production has exploded. Even during the slowest, most depressed times for the real estate economy nationally, the real estate sector in these regions and locales was booming. Housing of any form in areas such as Casper, Wyoming and Williston, North Dakota was (and remains) scarce, pricy, and by timing (supply and demand), development scarce. Conversely, some markets fared far worse than national trends in terms of foreclosures, time on the market and price deflation (Las Vegas and Chicago, IL are examples). Given the regional drivers that impact the real estate economy, recovery will vary dramatically.
Correlating a recovering real estate economy to an improving seniors housing sales and occupancy cycle is simplistic from a global perspective but at the site-specific end, a bit more daunting. What we know generally is that a more fluid, stable real estate market generally improves the occupancy, unit absorption and sales results for seniors housing. We also know that in general, by occupancy and ultimately, price inflation, it improves the operating results of seniors housing projects. What we don’t yet know is whether this recovery is a harbinger of longer-term real estate stability and does the improvement tide wash over all markets at some point and in what time frame.
Arguably, this recovery is perhaps different, certainly less uniform and due to other over-arching economic issues, more complex than any post recession period prior. In certain markets, those that were the least impacted by too much existing supply, rapid increases in unemployment and a large number of foreclosures (REO or REJ properties), recovery is impactful for seniors housing projects, especially if the unit supply is normative or about par with pre-recession demand. In other markets where prices fell dramatically, foreclosures were heavy and unemployment greater than national average, recovery will be slow. Even the latest positive economic news regarding the real estate economy is a tad misleading. Yes, most markets are improving. Yes inventory is down, days on the market is improving, listing prices are recovering, etc. (a few markets such as Columbus, OH, Philadelphia, PA and Spokane, WA continue to see price deflation) but the improvements are from a very, low point. In short, the improvements are signs of “recovery” not a validation of stability – yet.
While the road ahead appears somewhat smoother, the opportunity for pot-holes exists and thus, the relationship between real estate fortune and seniors housing is still rocky. My considerations worth noting are as follows.
- Employment and wage growth (personal income) is still stubbornly slow. Under-employment at record highs.
- In some markets, employment and under-employment will never return to post-recession levels. Certain jobs and companies are gone from the landscape for good.
- Interest rates today are less of a function of improving sales even though low rates improve affordability and thus, general increases in eligible buyers. Changes to federal lending laws and mortgage requirements have tightened credit requirements for borrowers. These changes, regardless of how low rates remain or go, preclude a large universe of individuals from securing favorable term mortgages. In short, the supply of buyers has shrunk and permanently so.
- Given how low rates have been and for how long, rate rise to a certain degree is forthcoming. Rising rates inversely impacts the supply of buyers (negatively).
- Price increases for individual homes won’t broach pre-recession levels (actual or inflation adjusted) for years in many markets. In certain markets such as the Metro Chicago region, price increases in terms of realized sales, are years out to achieve pre-recession par.
- The overall economy is still vulnerable and the consumer, still leery of what can lie ahead. Confidence is better but not great. Consumer confidence is critical to a buyer’s willingness to leverage long-term, arguably as critical as financial capability to buy.
- Seniors housing costs are at their low-ebb as expressed by monthly rental and in some communities, entry fees. While costs continue to rise, albeit not dramatically, the pressure to begin to inflate fees is present for many projects. Fee inflation during a recovery period or stabilization period is anathema to improving unit sales and developing new prospects. With the elasticity of the product, rising rates in a market that still isn’t healed can “chill” prospective buyers.
Is the trend improving for seniors housing? Yes but not universally and the real estate economy in many regions remains disconnected. Additionally, I think the direct correlation between a strong real estate economy and the prospect for seniors housing sales has changed. Yes it remains a major factor but property sales cycles will remain slower than prior periods, prices lower than prior periods, and buyers for individual homes, in lower numbers than in prior periods. The take-away is this: The improving real estate economy is good news, not necessarily great news or for that matter, a sign of salvation for projects looking to ramp-up sales with urgency. The trend is improving but full improvement, is still down the road and for certain, the road is different in direction than before.
I have uploaded the Power Point portion of the presentation I did at the recent Leading Age Annual Meeting and Conference in Denver per reader and attendee request. You can find it and download it on the Reports and Other Documents page on this site. The presentation is titled, “Value Propositions and Marketing”. The content essentially covers the application and development of economic value propositions and their resulting use in developing marketing and pricing strategy.
Periodically, the source for a post on this site is the accumulation of thematically condensed questions that I receive regularly and with frequency; what I now call the “buzz”. While the “buzz” for me is fairly constant across the post-acute/seniors housing industry, the pitch does vary, sometimes daily but most often, weekly. I guess it just depends on what is trending and where people’s focus lands. If the buzz is steady enough and the sound-bites within the buzz repetitive, it spurs me to sit and write, perhaps defensively, to quiet the noise from Twitter and e-mails, and re-focus. This post is one of those defensive or perhaps, reactive posts.
Lately (last three to four weeks), I’ve been getting a steadily increasing series of questions regarding CCRC marketing, value (economic) propositions and to a lesser extent, repositioning. The sources of course anonymous, range from established communities to relatively new communities, seeking sales and occupancy improvements. In some form or fashion, I’ve likely addressed most of these issues in pieces via various posts and articles spanning the last two years but alas, I have been remiss in circling back with a condensed and consolidated version. Hopefully, this post will help.
Post recession and into a grinding period of almost unrecognizable economic improvement sprinkled with volatility, CCRCs need to come to grips with four key themes when it comes to marketing.
- Reality has shifted permanently for the industry. This is not necessarily bad but it does mean that every aspect of the sales and marketing cycle once engrained, understood, and successful in terms of selling units has changed. Consider the following;
- Within the last four years, most seniors saw their incomes via investment returns, social security, pensions, etc., flatten and/or trend down. Some saw immediate and permanent reductions (permanent for their remaining lifetime).
- While investment portfolios principally consisting of equity securities have rebounded, the recoupment of loss only occurred for those that remained fundamentally steadfast and did not turn what were “unrealized” losses into realized losses via reactionary selling during the market fall-off and bottom.
- Depending on the individual market, real estate prices fell precipitously or at least modestly and the liquidity of the real estate via a thriving residential market stagnated and declined. Some markets have recovered elements of liquidity and re-sale value (price) but not to the levels prior to the downturn.
- Seniors housing demand has always been elastic but as a result of the three points preceding, it is even more elastic today. Why? Simply, economic fortunes of the consumer shifted downward and thus their real and perceived purchasing capability moved accordingly down while the prices for seniors housing remained stable to modestly higher. We’ve seen a similar effect in new construction vs. existing housing. New construction per square foot costs have stayed relatively flat or slightly higher over the period while existing construction on per square foot basis fell. When the correlation between the two is tighter or even inverted slightly, the demand shifts accordingly. For seniors housing, this added price elasticity, created by a wider gap between the declined consumer’s economic purchasing capability (again, real or perceived) and flat to slightly higher seniors housing prices, creates a different value proposition and purchasing dynamic. For most CCRCs and other seniors housing providers, the best strategy to combat some of this impact in the near term is to hold prices or drop prices; a scenario for many that may be difficult.
- The customer demography has shifted. While this shift has been subtly occurring over the past decade, the recession period sped the movement. Retirement is now more deferred and the economic need or desire to remain in the community for a longer period of time more developed. The customer today is de facto older and more driven by need, predominantly health related.
- In light of number 2 above, even with the constant growth of age bands suitable for seniors housing and CCRCs, a percentage of the market evaporated. This percentage is folk whose economic fortunes changed so profoundly negative or were marginally positive enough to afford a seniors housing product but now no longer so as a result of wealth loss. This segment or percentage was at the normative market age, economically qualified at the time, but four or so years later, outside the age and health profile and/or economically incapable of affording the product. The bad news is, the replacement numbers generated from a cohort behind them are insufficient to make-up for their loss. The market has marginally shrunk, although unit numbers have not and in some markets, have increased during this period.
- Given points 1-3 above, the sales cycle is now longer requiring new approaches, more touches, and revised pricing strategies and product features that realign the value proposition.
Circling back to where this post started, the compendium of current questions I am attempting to defer and answer lie in number 4 above. Specifically; “OK, I get 1-3 but how do I then develop the strategies, etc. dictated by this new sales cycle”. My summarized answer is below.
First, redefine your customer. I like an analytics approach. Who are they? What do they need? What is their economic profile? What are they shopping for (and it’s not the real estate)? What is their background at all (or as many) levels that you can ascertain (education, occupation, interests, locations, current living arrangements, health profile)? The more you know, the better.
What is your community’s economic value proposition? I’ve written on this before and it needs to be clear. Price it and benchmark it across the broadest market segments possible (compared to living in their current home, rental, condo, etc.). How does your product compare to competitors at all levels (features, services, care levels, etc.) on a price basis, quality basis, access basis, etc.? Again, the more detailed this information is, the better.
Generating leads once the above is complete becomes easer. The strategies that work the poorest on a cost per lead basis are newspaper and print media advertising, other media advertising, facility generated brochures, billboards, and events. Events can be helpful in getting people into the community to remove a barrier but in and of themselves, they do very little to turn attendance into prospects without other steps taking place. Strategies and tactics that work best in terms of numbers and on a cost basis are referrals (current residents, families, community members, from other providers, etc.), e-mail contacts and direct mail, website and social media marketing, and co-branding with other organizations where your target market is plentiful and frequent. In this latter strategy, I recommend being present and visible via human presence as well as building joint lists and joint value-added connections (education, support, referral development, resource sharing, sponsorships, etc.). A word of caution here: Make absolutely certain that in co-branding and co-marketing strategies that the other organization is as credible and solid as your organization – the relationship must be value-added not value-dilutive.
Incorporate new math into your thinking. The new math is all about how many touches and presentations are required to make a sale. For most CCRCs and market rate or above market rate projects, 20 or so touches to qualify and close a prospect is the new norm. In short, if you are working on a list of 100, expect five to ten sales (if the list is qualified) from that 100.
Marketing needs to focus on building “volume” thus, methods and analytics need to be at the forefront of strategy. To keep costs manageable and to build fluidity, I recommend strategies that utilize in revolving fashion, the following four elements. First, e-mail blasts and e-mail news letters that go out to target segments on specific interest levels. Second, simple events that are educational, again focused on target market interests. Third, internet and social media campaigns. For internet, I like to make certain that the web pages are clean, focused and have ample opportunities for people to request more information. Fourth, direct mail campaigns.
All campaigns and elements need to focus on a clear, direct distinction between your product and other options. In other words, the goal is to find as many ways as possible to reinforce what the value proposition is and how the same is directly correlated to the interests of your target markets. For CCRCs, the simplest concept is “continuum of care”. The vast majority of CCRC consumers are motivated by health and supportive care access.
The “new” CCRC marketing reality is all about analytics and alignment; narrowing the gap between what your customer wants and how your community is best suited to address the key issues. Touches have to go up to meet sales objectives and contacts need to be weeded through quickly. Building a qualified and fluid prospect list today is all about using multiple methods with fluidity. Finally, I can’t emphasize enough how critical and how granular the marketing analysis needs to be to push forward a successful strategy. Without a full analysis of market targets, customers, prices, product, etc., gaps remain that allow prospects to filter through, resulting in less than effective marketing activity.
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.