MDS Strategy of the Month – March / April 2011
Capital Investment; Four Simple Strategies That Can Produce Dramatic Results
This month’s article deals with some subtle, but still important, strategies and how capital investment, on an ongoing basis, is crucial to keeping your senior living community in a competitive condition.
Three Capital Investment Traps
In planning a capital investment strategy, many owners and sponsors frequently commit three tactical errors. They:
1. Spend money on the wrong things
2. Lose sight of their overall strategic objectives
3. Pay too much for less-than-optimum value
Consider Two Important Time Frames
In developing a new senior living community or improving an existing one; capital expenditure decisions must consider two distinct time frames:
- Short-Run: The initial (one time) costs of the capital investment
- Long-Run: The ongoing (perpetual) operating costs of ownership
Cost of Ownership Consideration
To plan effectively, you must carefully weigh the short run capital cost expenditures (immediate capital costs, such as new heating, ventilation and air conditioning systems) against the long run costs of ownership (ongoing operating costs such as maintenance, utilities, and insurance). Investing less in capital improvements in the short run can sometimes be very expensive over your total ownership period. These cost considerations become very important if you plan to hold your property for more than five years. Even if you plan to be a short term property owner, realize that your ultimate sale value can be adversely affected by our earlier “short run” capital investment mentality. The buyer’s sophisticated due diligence efforts will likely detect flaws in your original capital investment planning.
These four simple steps should help you make important cost of ownership trade-off decisions:
1. When considering two alternative capital investments evaluate the payback period and calculate the impact on total community value. How many years of operation are required for the operational savings/benefits to result in financial break-even or recovery of each of your alternative initial cash investment options? This can be a simple arithmetic calculation (dividing the initial cost of the capital investment by the estimated annual financial benefit or savings) or a more sophisticated discounted cash flow analysis that takes into consideration the time-value of money invested. Ideally, your payback period should be between three and five years. From that point forward, there should be an ongoing positive incremental financial impact.
2. Estimate the total impact on community value. To determine the increased intrinsic value of your community, you should capitalize the incremental increase in your net operating income resulting form the capital investment. The capitalization rate is the cash return (percentage) that reasonable buyers or investors would expect to realize on thier cash investment. This would obviously be influenced by their perception of relative risk. (Appendix C of Independent Living and CCRSs; Survival, Success & Strategies for Not-for-Profit Sponsors and For-Profit Owner/Operators briefly describes the capitalization rate concept.)
3. Value engineer your capital investments. This means lowering or controlling capital costs without significantly detracting from the look, operational efficiency or marketplace acceptance of your community. The results of this effort should be largely invisible to the consumer marketplace.
4. Let the “flash value” concept influence capital investment. Flash value is a fairly obscure, but surprisingly simple way of quantifying, and thereby maximizing, perceived value in the eyes of the consumer.
Flash Value Index = What Consumer Thinks an Item Cost / Your Actual Cost
Through consumer testing (focus groups, etc.) you can identify a menu of design features and amenities that exhibit a positive “flash value index” of greater than two to one. This means that the consumer thinks the item is worth at least twice as much as your actual cost. You should incorporate a number of highly favorable flash value items into your community. Typical high flash value items in senior housing include high-quality wood molding or millwork, walk-in closets, unusual (but attractive) public spaces, recessed solid-core living unit entry doors, incandescent or new LED lighting vs. traditional, older fluorescent lighting, wall coverings and artwork, interesting roof lines and breaks in exterior elevations. The list could go on, but the ideal outcome is for a senior prospect and thier family to comment, “The place sure seems to offer a lot for the money!”
Call to Action
Before you move on, remeber you can get very creative with your capital investments by taking four basic steps:
- Evaluate the investment payback period.
- Estimate the total impact on existing operation and long-run community value.
- Value engineer for cost investment savings.
- Invest in flash value to enhance perceived value
[The above was excerpted from the book Independent Living and CCRSs; Survival, Success & Strategies for Not-for-Profit Sponsors and For-Profit Owner/Operators where you can find more details and explanations on the above concepts.]