Although most of us are clearly aware that our residents age in place, we frequently overlook or ignore another critical aging trend — the gradual deterioration of our physical plants. As our senior living industry matures, significant and innovative improvements are being made in the design and ambience of new senior living communities, responding favorably with the changing value perceptions of today’s senior consumer and their adult children. This new trend is good, but it also represents a major challenge for older communities that are forced to compete with new, state-of-the-art projects. If your community was designed in the mid- to late-1990s or before, chances are your capital improvement needs are intensifying.
This may be a good time to ask yourself three important questions about your property:
- How market-responsive is my property, really?
- Do I compete effectively on product, price, services and value?
- Will I really be able to compete this year and beyond?
Capital investment planning must deal with difficult issues involving both individual units and common/public spaces. Are the needed investments really worth the dollars you would have to commit? How much would you have to raise monthly fees in order to break even on funding the added costs, assuming borrowed and invested funds at today’s typical cost of capital of approximately 5%?
Answering these questions involves a four-step common sense analysis. First, determine the amount that should be invested in each individual living unit. Let’s use $20,000 as an average cost per unit. Some operators are actually upgrading their older units at a cost exceeding $40,000 per unit. Let’s assume you would like to break even on the added cost to spend $20,000 with a 5% cost of capital. The total principle and interest is called the “debt service constant.” We’ll use a 30-year loan term or amortization. Now we must adjust for a debt service coverage ratio (DSCR). That’s because your friendly lender wants you to have at least $1.30 in available cash (after operating expenses) for every dollar you owe in debt payments. This analysis would yield a new annual debt service obligation for a $20,000 investment in each improved unit of approximately $150 per month.
The concept works for both independent living and assisted living. For an older independent living community with a typical monthly service fee of $2,700 per month, the total added cost of the $20,000 investment of $150 per month represents an increase of approximately 5.6%. For assisted living, with a monthly service fee of $3,400 per month, that $150 per month cost represents about a 4.4% increase. The increase may appear modest, but these are obviously additional out-of-pocket dollars for the senior consumer.
Does the increased perceived value in your significantly improved unit justify the increase in monthly service fees? Some existing residents might experience mild sticker shock. However, a new prospect might see considerable value in the improved vacant unit. Many owner/operators are implementing the strategy exclusively for currently vacant units where the price vs. value rationale is clearly favorable.
The analysis for investment in common area improvements is essentially the same as that of a typical unit . . . with one big difference. With a common area investment, you can spread the capital cost recovery across all of your occupied units. For example, a $200,000 common space investment in an 80-unit assisted living community at 93% occupancy and a 5% cost of capital would require each resident’s monthly service fee to be increased by only about $19 per month.
Consider implementing a capital improvement plan in two phases:
- First, the common/public spaces — this offers the biggest bang for the buck at a very nominal monthly cost per resident.
Then . . .
2. Upgrade selected living units — at least on a unit turnover/attrition basis.
Aging physical plants and property improvements may present short-run challenges, but in the long run, benefits can be permanent and significant.