CCRC 'phantom income': short-run financial squeeze or bursting bubble? (Seniors Housing).

MANY NOT-FOR-PROFIT CCRCS ARE CAUGHT IN A FINANCIAL squeeze, and typically they are affected by a mix of seven trends: (1) endowment-fund market values are down at least 20 percent during the last 18 months, (2) depressed earnings on these endowment funds and other interest rate-sensitive assets have resulted in dramatic decreases in non-operating income, (3) health care liability insurance is escalating, (4) Medicaid nursing reimbursement is not covering operating expenses, (5) assisted living acuity/cost creep is increasing faster than sponsors can either measure or recover in the competitive marketplace, (6) aging physical plants now offering Chevrolet/ Pontiac-type products are still trying to get Oldsmobile/Buick-type pricing, (7) sub-par sales-and-marketing programs have resulted in the reduction or disappearance of waiting lists.

But many CCRCs have two additional financial challenges. We call one of them the "phantom-income syndrome" leading to cash-flow misconceptions. This problem starts when your new or existing CCRC sells a unit and collects an entry fee. Pressured by the seven trends listed above, it's very common to spend almost all of that new cash immediately. Meanwhile, your accountants appropriately amortize this new entry fee into your income statement over a long tune period based on either the expected life of the resident (for nonrefundable entry fees) or the useful life of the facility (for refundable entry fees), Several hundred thousand dollars of entry fees are reported gradually as "income" in future financial statements when, in fact, the cash was probably spent months ago and is not available for current expenses, debt service, or to pay for promised health care benefits.

The other financial challenge involves CCRC unit turnover and resale. A unit resale generates positive cash flow by reselling at today's pricing while paying off the refundable portion of the previous resident's entry fee. (See "CCRC unit turnover: Financial gain or increasing obligation?", above)

For example, the contractual refund obligation of a $125,000 entry fee collected 4 years ago might decline at 15 percent per month with a guaranteed floor of 80 percent or $100,000. However, that same unit might resell today for $145,000 if your pricing increases at about 4 percent per year. That $45,000 gain on resale frequently is spent almost immediately to fund current operations.

Many CCRCs today count on resident turnover to generate immediate cash (through resales) necessary to fund their current operations. For example, a CCRC may need five unit turnovers (deaths, move-out into the health care center, etc.) so that they can resell those units and realize the cash gain on the sale described above. But many CCRC sponsors no longer have waiting lists and pent-up demand for units that become vacant. Remarketing of these units is taking much longer than in the past. Some CCRCs promise to pay the estate the refundable portion of the entry fee within a period as short as 90 days from move-out. So a community with an average refund obligation of $100,000 can rapidly generate a wide range of cash-flow situations. In this example, a sponsor can either realize $225,000 of new cash or incur an additional $500,000 cash obligation.

Many not-for-profit sponsors count on the gain on unit resales as their cash safety net. But the outcome can be a collapsing house of cards or a bursting cash-flow bubble if the resales do not take place in a timely manner.

As the average age of CCRC residents increases, sponsors will experience increasing annual turnover rates in the range of 17 percent to 22 percent. Timely resale of these units is a critical imperative for paying refund obligations and satisfying operational cash needs.

Several strategies can address this dilemma. Sponsors and owner/operators must sharpen (in some cases, actually initiate) an intensive sales-and-marketing program to accelerate resale of vacant units. Provide a concise, tangible, and specific monthly cash-flow summary, and isolate non-operating income such as donations and endowment proceeds by putting it below the operating-profit line. At every monthly board meeting, review the true operational cash position of the organization.

Many sponsors and boards of directors may get a moderate wake-up call when they realize their true cash position from operations, excluding phantom income and other non-operating income sources.

CCRC unit turnover: financial gain or increasing obligation?


* Original entry fees sold in 1998      $125,000
* Current 2002 resale pricing (@ 4%
  per year increase)                     145,000
* Original entry fee refund obligation
  (@ 80% guarantee)                      100,000
* Gain on resale (after refund)           45,000
* Impact of five unit turnovers:
     Gain - if sold                      225,000
     Obligation - if unsold              500,000

A potential cash-flow swing of $725,000

SOURCE: MOORE DIVERSIFIED SERVICES, INC.

Jim Moore is president of Moore Diversified Services, a Fort Worth, Texas-based national senior housing and health care consulting firm. He is author of Assisted Living 2000 and, most recently, Assisted Living Strategies for Changing Markets.