How to determine the feasibility of any senior living development project
By Scott McCorvie, CEO, Enhance Senior Living
Enhance Senior Living is a national senior living broker firm specializing in nationwide senior living investment brokerage solutions including active adult brokerage, independent living brokerage, assisted living brokerage, memory care brokerage, and skilled nursing brokerage. Learn more about our senior living broker and operational improvement solutions and contact us today to learn how we can help you enhance senior living today.
To enhance your senior living knowledge subscribe to the Enhance Senior Living Podcast. The show is on all podcast platforms including Apple Podcasts | Spotify | Amazon Music
Industry Trends
The number of senior living transactions trading at a large premium to replacement cost (sometimes double) is rising. However, construction debt is more available, fueling renewed energy in the development space. This raises Senior Living Feasibility questions about project viability.
Simply put, Senior Living Feasibility means a development project yields returns that exceed the weighted average cost of capital.
However, what is the WACC of each project, and how is it calculated?
As an equation, the WACC is the percentage-based average of debt and equity.
It is expressed as WACC = (% debt x cost of debt) + (% equity x cost of equity).
Furthermore, the equity is riskier, so its cost is higher than the debt.
Let’s say you receive a 75% loan-to-cost construction loan with an effective (inclusive of loan fees, etc.) interest rate of 6%. Also, let’s say you were able to secure the remaining 25% equity from an investor expecting to make a total return of 20%. Multiplying these together will give you the implied WACC of 9.5% ((75% x 6%) + (25% x 20%)). In other words, you would need an unleveraged internal rate of return (IRR, or annualized total return) higher than or equal to 9.5% for the project to be feasible.
Since the internal rate of return includes a holding period assumption and uncertain exit senior living cap rate (to be discussed in a later article), another simpler way to analyze the feasibility of the project is to measure the WACC to the stabilized yield-to-cost.
The stabilized yield-to-cost is similar to a senior living capitalization rate, but divides the expected stabilized net operating income by the total development budget (YTC = stab. income / dev. budget). The development budget should include all fees and costs needed to fully stabilize the project (including pre-marketing costs, development fees, and lease-up/interest reserves).
So, for a senior housing development project to be feasible, the stabilized YTC must be higher than the WACC. Also, the selected market rates, care charges, and operating margin should be carefully analyzed to determine the suitability of the proforma assumptions. Since the annual income drives both feasibility metrics, an unrealistic proforma model can artificially inflate or deflate the returns.
Last, one of the most important metrics to determine the feasibility of the seniors housing development project is to analyze the total development budget on a per unit basis. If the development per unit cost is too high, there is risk that another developer will construct a less expensive seniors housing project down the street, be able to charge lower rates/fees, and most likely drive down your operating performance.
What is an appropriate development cost per unit?
Unfortunately, this varies from market-to-market due to land costs, entitlement, licensure, CON, and construction costs.
Additionally, it varies by operator due to pre-marketing costs, management fees, and lease-up reserves.
Nevertheless, it can be compared on a basis by allocating land costs, hard costs, soft costs, FF&E, contingencies, and reserves.
Senior Living Feasibility guides this analysis.
Enhance Senior Living is a national senior living broker firm specializing in nationwide senior living investment brokerage solutions including active adult brokerage, independent living brokerage, assisted living brokerage, memory care brokerage, and skilled nursing brokerage. Learn more about our senior living broker and operational improvement solutions and contact us today to learn how we can help you enhance senior living today.
To enhance your senior living knowledge subscribe to the Enhance Senior Living Podcast. The show is on all podcast platforms including Apple Podcasts | Spotify | Amazon Music
enhanceseniorliving.com | seniorlivinginvestments.com | srgrowth.com | generationalmovement.com