In most instances, your goal should be to deliver comfortable yet reasonably affordable Buicks – not extravagant Cadillacs. Developing Cadillacs can be a market-responsive strategy, but not for the mass market. A concept called value engineering can help control costs and actually increase a consumer’s perceived value.
Value engineering is the reduction (or control) of capital costs without significantly changing the final “look” of your community. The results of this effort should not negatively impact your competitive position and should be largely invisible to the consumer marketplace. Value engineering starts with an exhaustive review of essentially every line item of capital cost. Through this process, it is not unusual to realize a reduction in total capital costs of between 3 and 7 percent. Sometimes the value engineering exercise actually increases costs – but only when the increase is reasonable, necessary, and competitive. Hopefully, the result is an obvious increase in value, a reduction of ongoing operations expense, or providing specific increased benefits to residents.
Value engineering capital costs is best implemented using a two-tier process:
- Tier 1 – Architect/contractor driven. If you are still in the preliminary design phase, ask your development team what it would take to reduce overall costs by 10 percent and what really would be the impact. If your design and development process is further along, a cost reduction goal of 5 percent is probably more realistic. Your professional team may not reach your total value engineering goals, but more often than not, you’ll be pleasantly surprised with the overall results.
- Tier 2 – Owner/sponsor driven. With the help of your professional design team and staff, next determine what reasonable tradeoffs you are able to make in an effort to reduce ongoing operating costs. If a 150-unit independent living portion of a CCRC community with a preliminary cost of $30.0 million (or $200,000 per unit) could be value engineered by just 5 percent, the savings would be about $1.5 million. Residents could save approximately $60 on their monthly service fee. If your pricing strategy involves entry fees, those fees might also be reduced modestly to become more competitive.
Let’s take a close look at this calculation for the 150-unit community:
- Preliminary all-in cost of the community of $30.0 million, or $200,000 per unit, with a cost of capital (interest rate) of approximately 5.0 percent.
- A 5 percent cost savings realized through the value engineering exercise, or $1.5 million.
- Multiplying the $1,500,000 savings by a 5.4 percent loan constant results in a reduction in annual debt service of $96,620; approximately $715 per occupied unit, or approximately $60 per unit per month.1 Remember, debt service can only be paid by revenues from occupied (150 units @90% = 135 units)
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1Loan constant – A convenient analysis factor which provides a single arithmetic calculation for computing the combination of a specific interest rate (5.0%), principal, and loan term (30 years).
Consider the Big Picture
This savings may not seem like much until you consider the possibility of putting that money to work. You can invest some or all of the savings in other areas to reduce ongoing operating expenses or to realize a much higher impact on value. You might also consider lowering the monthly service fee or entry fee so that it is slightly more affordable and competitive.
Call to Action
Spend considerable time developing your capital budge. First, consider everything and then value engineer with a passion.
Establishing a sound capital budget is literally the financial foundation of your new independent living community or CCRC. Like the original cost of your personal home, you’ll be living with (and paying for) any mistakes made during its creation for years to come.
The above was taken from Jim Moore’s book Independent Living and CCRCs; Survival, Success & Profitability Strategies for Not-for-Profit Sponsors and For-Profit Owner/Operators. Jim Moore is president of Moore Diversified Services, Inc., a national senior housing and healthcare consulting firm based in Fort Worth, TX that has been serving clients for 46 years. He has authored five books about senior living and healthcare including Assisted Living Strategies for Changing Markets and Independent Living and CCRCs. Jim Moore can be reached at (817) 731-4266 or jimmoore@m-d-s.com.