What is your facility worth?
How much is a nursing home worth? If you are an owner, what could you sell it for? If you are a prospective buyer, what should you pay for it, and at what level will a lending institution or investor extend financing?
In this era of sales and mergers, these are questions many small- to mid-sized facility operators are asking themselves. And, for each nursing home, the answers are different. But the factors used to make the assessment - physical condition, business prospects, location, history - are the same. How do you balance among those factors - and how do professional valuators do it? To get those answers, Nursing Homes Contributing Editor David Patterson turned to two experts in appraising the value of nursing homes - Stephen Monroe, a partner at Irving Levin Associates, Inc. and compiler of The Nursing Home Acquisition Report, and Joseph Lubarsky, national director for long-term care services at BDO Seidman, LLP.
"There are basically three approaches to valuing a nursing home," says Monroe: "cost, sales comparison, and income. Cost is what it would take to replace the facility, less the depreciated value. The sales comparison approach looks at what other comparable facilities and properties are selling for, and the income approach bases the value on the amount of income the facility is expected to generate."
Monroe and Lubarsky agree that one of those approaches outweighs the other two. "When you do an appraisal you typically look at least two of the three approaches," explains Monroe. "When a facility is over ten years old, cost is really not relevant to current value, so income and comparable sales is the most common combination - but income is nearly always the most important factor. After all, lenders and investors get paid out of cash flow."
"Typically valuations of nursing homes are done primarily on the income approach," Lubarsky agrees. "You look at historical financial statements and develop pro formas of what can be expected in the future."
A nursing home's income history can be an important indicator of future performance, but there is danger in simply extrapolating the past into the future or in failing to recognize and respond to change.
"It is very important that you look at trends both within the industry and the area - census trends especially," says Lubarsky. "Has occupancy been dropping or increasing? What about the payer mix? Is it stable or changing? Is the neighborhood changing, making the location less desirable? When you do an analysis of value, you can't just look at last year's information. You definitely need to look at three or four years and see what kind of trends have developed."
"The past is usually the best indication of the future," says Monroe, "but if someone is going to convert 20 beds to sub-acute care or a new nursing home is being built across the street, then the past is irrelevant to the future. Or what if the state lowers the cap on Medicaid? Or how about trends in payer mix? If three years ago a nursing home's private pay was at 30%, two years ago 28% and last year 26%, do you assume it is going to stabilize or continue to decrease?"
Payer mix and changes in third-party rates play important roles in determining a nursing home's value. "I think one of the things you really have to consider is what is going to happen in the future in regard to rate-setting," argues Lubarsky, "especially if the facility has a predominance of government third-party payers - Medicaid and Medicare. Also, you need to take into account what is likely to happen relative to managed care. Traditional systems of cost-based reimbursement formulas are ending, and states are seriously considering transitioning to managed care and moving toward a price, rather than rate, basis. At least in the short run, that will bring down prices and rates. Trying to predict even a little of what is going to happen is the most difficult part of determining value, because in today's environment things are changing so rapidly."
With so much of a nursing home's value based on its income production, owners who have a good history of earnings and who manage with an "ear to the ground and an eye on the future" have the best shot at achieving a high valuation for their facilities when it comes to selling or refinancing them. There are factors that cannot be subjected to a "quick fix" in order to yield a higher appraisal. However, there are physical plant factors that lessen value which can be changed on relatively short notice.
"Deferred maintenance is something we look for," says Monroe. "When I walk into a nursing home, my expectations of what I will find can be set at the front door. If things are shabby, if the place smells, or if residents are parked in wheelchairs in the lobby, then I assume the place is not well run. If it is bright, clean, well decorated, and without an odor, I have a much more positive feeling. Appraiser, buyer, and customer all form lasting impressions on what they first see and smell."
The process of appraising a nursing home consists of three distinct activities: examination of the physical plant, assessment of management, and evaluation of market potential and competition.
"One of the things you have to build into the feasibility analysis of your valuation," says Lubarsky, "is what kind of major improvements are going to have to take place in the physical plant over the next five or ten years. Will substantial upgrades be required, and if so, what will they cost, and what will the debt service be?"
"Generally, we have one or two people walk through a facility," notes Monroe. "We want to have a complete, thorough inspection of the property, including the kitchen and boiler room. We don't go into every single patient bathroom, but into enough of them to assure ourselves of the general level of appearance and maintenance. Is the nursing home small - 200 square feet per bed as opposed to 400? We interview the administrator, and we go through his business. Why are things up or down? How is staffing? Do you have any union problems? Do you see private-pay census going up? Our exploration of the nursing facility and its business is the 'micro' part of the appraisal.
"The 'macro' aspect," he continues, "is the market situation. Is there any competition? How much? What is the likelihood of more competition coming into the market? What is the size of the population center? The nursing home's proximity to hospitals? Is it likely to get more higher-acuity patients? Then we visit the competition, often times pretending to be ready to place grandma. We try to get a sense of which of the nursing homes in the market are the better ones and where our subject facility ranks in quality and rates."
Deferring maintenance and failing to keep on top of changes in the market and industry are mistakes nursing home operators make that lower value, but buyers and investors make mistakes too. "The biggest over-valuation mistake that I see people making," says Lubarsky, "is looking at increased profits in the recent past and thinking that the numbers are going to continue that way in the future, especially in those facilities that have a very high proportion of Medicaid patients. A facility may have lowered its costs and had a resultant windfall profit, but once those lower costs are used for rate-setting a couple of years later, the profit comes down. Also, people think they are going to get adjustments in their property rates under Medicaid or Medicare because of the change in ownership, but then don't, or find it isn't as great as they expected it would be. They forget about the limitations under TEFRA or COBRA which limit the rate adjustments."
"One common mistake that we see," says Monroe, "is when investors and lenders who come into the industry from office or apartment buildings apply a traditional real estate market capitalization rate to nursing homes. The second most common mistake involves a belief that profitability can be dramatically increased through a change in approach. Ten years ago it was, 'I can increase the private-pay census because I am a wonderful manager.' Today it is, 'I can increase the acuity and subacute level and get all that wonderful money in.' Some can and some can't. There are urban or major metro markets bumping up against the maximum number of subacute beds that makes sense. You may think there is a need for x number of subacute beds, but what will you do when you find out that the day you convert 20 beds to subacute care, 20 other nursing homes in your area are doing the same thing?"
Assigning a value to a nursing home is an involved process of appraisal and market evaluation and, in the end, numbers such as the national average per bed price don't mean all that much. "The process and outcome of valuation is locally based," says Lubarsky, "and is highly dependent on factors close to home."
David Patterson is Contributing Editor to Nursing Homes.
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|Date:||Jun 1, 1996|
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