Strategic Forecast

While key elements of today's external economic environment are certainly challenging, the assisted living business and its market fundamentals remain strong. For most senior living companies, 2010 is the year to sharpen strategic focus-laying a solid foundation for a potentially strong future for assisted living- despite being amid the most significant economic recession since the Great Depression. An unemployment rate that hovered around 10 percent toward the end of 2009, a credit crisis, depressed home sales, significant consumer savings/ investment portfolio losses, and low consumer confidence all contributed to a slow-down in business.

Early indicators of a modest recovery are gradually surfacing, but the overall economic recession recovery time will be extensive and largely unpredictable. During this recovery period, consumer spending and the availability of consumer and business credit will likely involve more cautious and conservative consumer and lender decisions.

Supply-Demand Balance

The current economic environment has directly impacted typical senior consumers' saving and investment portfolios and their ability to sell their homes. Thus, the industry is experiencing delayed demand and absorption for senior living units. However, this delayed demand will ultimately result in a relatively strong upside once the housing market stabilizes and senior consumer investment portfolios partially recover from current losses. That's because of a growing assisted living supply-demand imbalance.

Construction of new communities is currently at an all-time low, and there are significant barriers to entry for new projects in terms of production cost and approvals. In terms of pent-up demand, age- and income-qualified demographics continue to grow at a predictable and moderate pace. Plus, the need for assisted living as an affordable alternative to both independent living and skilled nursing continues to increase. Stabilized occupancy for assisted living as reported by the National Investment Center for the Seniors Housing & Care Industry (NIC) was at 89 percent in late 2009-down approximately 0.4 percent from 2008. However, assisted living occupancy declines may have bottomed out as they actually increased in the last half of 2009. Average monthly service fees have increased by 2 percent from late 2008. This favorable supply-demand situation will eventually lead to a relatively strong assisted living recovery.

In 2010, however, the margin for senior living performance error has narrowed considerably. Astute operators realize that while they cannot completely control the external market, they can control and optimize their internal operations. In fact, a number of owner/operators have sustained their operating profit margins by reducing expenses to compensate for declining occupancy. The opportunity for realizing significant growth and upside potential within existing assisted living properties-also known as organic growth-is significant this year. There are two areas offering significant opportunities: optimizing occupancy in difficult markets and operations enhancement through expense reduction.

Optimizing Occupancy

Astute owner/operators know the opportunity cost of a vacant apartment or room. Simply stated, they are investing more in sales and marketing during these difficult times because the potential returns on that investment are very significant. Here is a basic scenario that outlines typical opportunity cost.

OPPORTUNITY COST OF A TYPICAL VACANCY

For every additional occupied room (occupancies in excess of 80 percent), one could assume approximately 30 percent of the additional monthly service fee would go for new, incremental expenses. That is because at relatively high occupancies most operating costs are already "sunk"-they are incurred and covered. As an example, you may not have to buy more raw food or hire another employee for one additional resident.

o Approximately 70 percent of the additional monthly service fee represents a very high incremental profit margin-new cash that drops right to the bottom line.

o For a single community assisted living operator with a typical baseline monthly service fee of $3,300 per month, the 70 percent incremental profit margin results in a new cash benefit of $2,310 per month, or a $27,720 annual increase in cash flow for each additional occupied room.

o If a four-community operator increased occupancy by just two rooms per community, the potential financial enhancement is $55,440 (27,720 ∞ 2) per community per year-times four communities equals $221,760 per year. With a 9.5 percent cap rate, this could increase the value of the four-property portfolio by up to $2.3 million.

Focus on Improvements

If assisted living operators begin to feel a financial pinch, they are forced to focus on existing operations. Why not focus on existing operations more consistently? Here is a typical real world operations enhancement scenario.

TYPICAL SCENARIO FOR OPERATIONS ENHANCEMENT

A typical 80-room assisted living community operates with 26,280 resident days per year (80 units at 90 percent stabilized occupancy equals 72 units ∞ 365 days per year). Typical assisted living operating expenses are currently benchmarked at approximately $80 - $108 per resident-day (PRD). This wide range is influenced by resident acuity and resulting direct care costs.

o An operating expense reduction of just $1 per resident-day (PRD) is a reasonable goal. It represents approximately 1 percent of current total operating expenses PRD. With 26,280 annual resident-days, the $1 cash savings going right to the bottom line would be $26,280 per year.

o With a 9.5 percent valuation cap rate, the cash savings in this scenario could have a favorable increased value impact of at least $275,000 for a single, 80-room, free-standing assisted living community.

For some, this operations enhancement scenario may appear to be a hypothetical exercise in arithmetic. But, if you are a single community assisted living operator, you're probably constantly fighting economies of scale and every dollar really counts. Look for that $1 PRD savings within two of your cost centers: sharpened, hands-on direct care costs and total dietary costs (raw food, labor, etc.), which should not exceed $20 PRD.

A multi-community operator can benefit significantly from operations enhancement. If an operator had a portfolio of four 80-room assisted living communities, that $1 PRD reduction would translate into an increased annual cash flow of approximately $105,120 (four properties Σ 26,280 resident-days per property at a $1 per resident-day expense reduction). Capitalized at 9.5 percent, that would result in an increased portfolio value impact of $1.1 million.

Profit Margin Benchmarks

The ultimate financial performance metric, profit margins are defined as net operating income or EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization, and Rent/ Lease payments). Today, assisted living profit margins are typically ranging between 27 and 30 percent. Some assisted living communities have higher profit margins, but many experience much lower returns while having unrealized upside potential. Savvy owner/operators know they must strike that delicate balance between profit margins, high standards of care, clinical excellence, and optimum resident satisfaction.

Overall, 2010 will likely be another challenging year, but there will also be some real operational opportunities for assisted living operators. While not all of the positive financial enhancements outlined here can be realized simultaneously, just a small portion of each of them can easily have a significant positive and largely permanent financial impact on senior living operations. This year is the year that assisted living owner/ operators must look back with 20/20 hindsight and, most importantly, look forward with an entrepreneurial vision.