Senior Living Business: Mitigate Risk In Repositioning Projects--
January 1, 2008
While we’re consistently seeing the development of new and innovative approaches to senior living, the overall industry is fairly mature— and so are many of the facilities. CCRCs are increasingly recognizing the need to update and revitalize their campuses in order to remain viable and competitive over the next decade or two, a period which undoubtedly will prove to be the heyday of the industry.
By their very nature, repositioning projects involve considerable capital improvements and/or additions to existing physical plants that are largely funded at a high level of risk — risk that translates to a higher debt burden and increased organizational liability, according to Brian Pollard, president of Lancaster Pollard. “Increased debt service and higher leverage,” he says, “negatively impact the organization’s cash flow at least initially or until the organization can offset the higher costs with some sort of incremental revenue growth — perhaps rental increases, improved occupancy, or filling up a new unit if that’s part of the project. “
In the intermediate term, the dilution of cash flow can be inconsequential if the organization is a well-performing entity when the repositioning is pursued. On the other hand, a reduction in cash flow could be long lasting and debilitating to an organization if the repositioning is undertaken as a defensive measure to stem many years of operating decline.
Differing financial challenges
More care must be provided as a CCRC’s services move up the continuum, and each increment increases the operational risk. A skilled nursing facility, for example, involves government reimbursement risk, additional liability risk, and a more diverse staff than, say, assisted living. To some degree, however, senior care providers looking to reposition any type of facility face similar financial challenges. “Any time you add debt,” Pollard says, “you increase leverage. That inherently entails added risk regardless of your operating profile.”
In some ways, though, the financial challenges differ. “The facility’s ability to offset the additional debt service taken on as part of the repositioning by generating incremental revenues is the key to minimizing risk,” he explains. “For example, a skilled nursing home that derives a large percentage of its revenues from government reimbursement programs may have less opportunity to generate the incremental revenues or the cash flow needed to cover the additional debt service. In that case, the provider may have to either improve occupancy or improve the quality mix.”
An independent living facility may find it equally difficult to pass onto existing residents rental increases in the magnitude that may be necessary to generate enough revenues or increased cash flow to cover the additional debt service. The facility may have to wait until the existing residents turn over their units to new residents who can afford to pay a higher rental rate. “That can be several years down the road,” Pollard says, “so a provider in that situation could experience an extended delay in the ability to generate those important incremental revenues.”
Capital markets seek strength
The perception of risk by the capital markets varies with regard to repositioning projects undertaken by not-for-profit providers. “If the repositioning is a proactive strategy undertaken by a well-performing organization that is looking to maintain a competitive position well into the future, then the project will generally be viewed favorably by the capital markets,” says Pollard. “On the other hand, if the organization has allowed a substantial decline in its physical assets and/or its operating performance over a period of many years, then the repositioning will be viewed as a defensive measure in hopes of saving the organization. The capital markets will have much less interest in that type of project.”
Therefore, much of the perceived risk hinges on whether the organization is operating from strength when it is looking to reposition or whether it has weakened to a point where it must reposition in order to survive.
“On occasion, we have seen organizations that have delayed and delayed and delayed their repositioning projects,” Pollard says. “As the competition around them becomes more formidable, their operations begin to decline. And by the time they realize that they need to take some action, it is often too late. They get into the so-called ‘debt spiral’ and just can’t recover.”
Effective strategies to mitigate risk
Along with acting from strength, Pollard recommends two effective strategies for mitigating risk:
1. Phased approach: Break the repositioning project into several phases in order to seek smaller amounts of capital for each phase. The increments of new debt added for each phase will be more manageable and, therefore, less disruptive to existing operations. Each phase will be able to get up and running before the next phase begins.
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