Financial Ratio Analysis, Asset Allocation & Marketing
Financial ratios lie at the heart of many benchmarking studies in the CCRC industry and can be crucial elements with regard to strategic planning, financing and refinancing projects. Are these ratios also germane to how senior living investments are allocated? We have long thought so.
As consumers become more educated and conduct more intensive research into their increasing number of options, will they use these financial ratios in their decision making process? We believe they already are and that the trend will accelerate.
The decision to move into a life planning community is complex. As consumers hand over increasingly significant refundable entrance fees to providers, they are looking for assurances that providers will in fact be able to keep their end of the bargain. To this end, many of these people will engage advisors to guide their decisions. These advisors may be lawyers, accountants, financial advisors, life coaches and adult children, all of whom will seek out data that will help rationalize their role in the decision-making process. So yes, financial ratio analysis may soon become an essential part of the toolkit used by increasingly sophisticated potential residents of life planning communities
What will they look at? For starters they should look at financial ratios (such as debt service coverage and days cash on hand) that communities have typically pledged to maintain at minimum levels. Cash to debt levels may seem important to some while others may want to know what the level of total revenue is relative to maximum annual debt service.
One ratio that we think may be particularly important to both investment advisors and potential residents is debt service coverage without the benefit of counting net entrance fees. In other words this ratio shows the ability to meet debt service using only the revenues of the community. This ratio can you give you an idea of how vulnerable a community is to a slowdown in entrance fee turnover. Roughly half of all life planning communities have revenue-only debt coverage that falls below 1.0, indicating that turnover is essential to meeting debt service.
What could cause turnover to change? Historically there have been several factors. A slowdown in local real estate markets, as people are unable to sell their homes and use the proceeds to move into a life planning community. Higher interest rates have often precipitated a slowdown in real estate activity. Competition is another potential factor, as more senior living options appear, including some that would allow you to continue to live at home. Increases in longevity can also have an impact on turnover, especially considering the relatively small sample size found in most life planning communities.
The business models of most CCRC’s anticipate that refunds will be paid from new entrance fees. However, if there is a slowdown in entrance fee turnover, there is a risk that new entrance fees will fall short. If there were a slowdown in turnover and debt service became difficult to cover, where would the cash to pay those owed a refund come from? The investment portfolio is the obvious choice. How then could ratio analysis impact asset allocation? We have often viewed portfolio risk as a counterbalance to operational or business risk in that if operational risk increases, perhaps portfolio risk should decrease. If, for example, trend analysis of key ratios foreshadows the potential emergence of a turnover problem, asset allocation can be modified to create liquidity or generally reduce risk.
We have long believed that in a complex organization, investment portfolio construction should be integrated with the operating environment of the organization. Just as consumers are now discovering the linkage between operating strength and their financial security, they will also want to know what steps have been taken to integrate portfolio construction and operational risk. At the end of the day the assets of a life planning community and how they are managed is very important to consumers and by extension important to the marketing efforts of the community.
Benchmarking has value because it shows you what your peers are doing and how you are doing compared to them. We have been building peer groups for clients where we compare select financial ratios with asset allocations. If you feel that your organization would benefit from this type of analysis, we would be happy to work with you on that.