ass isted valuing living fa cilitiesthere are over 31,000 assisted living facilities in the u.s. in...

Assisted Living Facilities

Valuing

AN OVERLY MECHANICAL VALUATION MAY NOT CONSIDER THE SPECIFIC EARNINGS, RISKS,

GROWTH RATES, AND VALUES OF THE COMPONENT BUSINESSES OF ASSISTED LIVING FACILITIES.

Alan B. Simons

VALUATION STRATEGIES 21

They provide more services for resi-dents than are available in most inde-pendent living facilities, but generallyless services than are available in skillednursing facilities (also referred to asnursing homes).

BackgroundThere are no universal definitions forassisted living facilities (also referredto as residential care facilities or per-sonal care facilities). Each state has itsown definition, license requirements,and regulations. Residents usually livein small apartments alone or with theirspouse. Assisted living facilities pro-vide support to residents who needassistance with activities of daily living(ADLs) such as taking medications,bathing, dressing, and transportation.The monthly fee or rent residents paygenerally includes amenities such asthree meals per day, housekeeping,laundry, transportation, 24-hour secu-rity, and social and recreational activ-it ies . In addit ion, res idents canpurchase additional personal care ser-vices to support their daily needsshould they need assistance with eat-ing, toileting, walking, medicationmanagement, bathing, dressing, or cog-nitive functions. Some facilities mayhave special locked memory care unitsfor residents w ith Alzheimer’s ordementia. Physical therapy, physician

services, and hospice services are alsoavailable either at the facility or madeavailable to residents.

Facility Costs. Assisted living facil-ities are predominantly owned andoperated by for-profit companies,many of whom are national chains. For2015, the median annual cost to rent aone-bedroom apartment in an assist-ed living facility was estimated at$43,200.1 This cost is comparable tothe median annual cost of $44,616 forhomemaker services or $45,760 for ahome health aide.2 Median assistedliving costs compare favorably to medi-an nursing home costs of $80,300 fora semi-private room and $91,250 for aprivate room.3

Unlike skilled nursing facilities,room, board, and amenities are notcovered, funded, or regulated byMedicare or Medicaid (except for theMedicaid waiver programs in somestates). As a result, over 85% of assist-ed living residents pay for their basiccare from their personal financialresources.4 Basic costs can also befinanced through long-term care insur-ance, and 41 states offer “home andcommunity-based waivers” that fundassisted living for low-income resi-dents.5 Residents with Medicare, Med-icaid, or other health insurance are stillcovered for traditional medical services(such as physicians, hospitals, skillednursing, physical therapy, and testing).

Assisted living facilities are some-times a component of a continuingcare retirement community (CCRC).CCRCs generally include indepen-dent living facilities, assisted livingfacilities, and skilled nursing facili-ties on the same campus and resi-dents move through these facilitiesas their need for care increases .CCRCs may also have different fund-ing sources than standalone assistedliving facilities. For example, resi-dents of CCRCs may need to pur-chase their initial residence or pay ahefty entrance fee, and pay separate-ly for amenities and higher levels ofcare as they move through the com-munity. All or a portion of the pur-chase price may be refunded to theresident or their estate if they leavethe CCRC or die. This discussionfocuses on the economics and valua-tion of independent assisted livingfacilities that are not part of a CCRC.

Growth in DemandAs the chart in Exhibit 1 demonstrates,starting in 2011 publicly announcedsenior living transaction volume hasgrown beyond the previous high of146 transactions in 2006 (prior to the2008 recession). Low interest rates and

22 VALUATION STRATEGIES March/April 2016 ASS ISTED L IV ING FACIL IT IES

ALAN B. SIMONS, CPA/ABV/CFF, CMPE, is principal in the Health Care Valuation Group of CliftonLarson-Allen LLP. Mr. Simons has prepared hundreds of health care business valuations, and is engaged by health careproviders to determine fair market value in financial transactions. In addition, he has prepared numerous opin-ions as to the reasonableness of compensation or payments paid to clinical, administrative, managerial, andexecutive physicians.

There are over 31,000 assisted livingfacilities in the U.S. In the “continuum ofcare” for seniors and individuals withdisabilities, assisted living facilities fallin between independent living facilitiesand skilled nursing facilities.

an aging population is fueling demandfor these businesses.

OrganizationAssisted living facilities can be man-aged and operated under various struc-tures that include the managementcomponent, the operations component,and the real estate component. Each ofthese components can be a uniquebusiness with its own capital struc-ture, risks, growth potential, and eco-nomic returns. Sometimes they are allpart of the same assisted living facili-ty business and sometimes they areoperated separately; or two of the threeare operated together. Some of the

potential structures are illustrated inExhibit 2.

Assisted living facility operatorsmay set up a separate managementcompany to manage multiple facilitiessimilar to a property managementcompany, as shown in Exhibit 3. Somemanage facilities owned by other non-affiliated operators in addition to onesthat they own. Real estate may alsobe owned by a separate real estateholding company.

Valuators need to evaluate whethermanagement fees and rents paid by theassisted living facility operating entityare at fair market value or whether theyare tax motivated to shift earnings, par-ticularly when the owners of the man-

agement company, real estate company,and operating business are the same.

Market Data. The Senior Care Acqui-sition Report, published by Irving LevinAssociates, Inc., is an important sourceof market transaction data for the seniorcare industry. All transactions and sta-tistical data used in the report includeboth the operating and the real estatecomponents, and earnings are calculat-ed after a management fee, which is usu-ally 6% of revenue for assisted andindependent living facilities. As a result,the financial data for the subject assist-ed living facility may need to be adjust-ed in order to be comparable to thestatistics and valuation metrics used inthe Senior Care Acquisition Report.

VALUATION STRATEGIES 23ASS ISTED L IV ING FACIL IT IES March/April 2016

EXHIBIT 3Use of Management Company

ManagementCompany

OperationsOperations Operations & Real EstateOperations

Real Estate Real Estate Real Estate

EXHIBIT 4Investment Capitalization (Cap) Rates

Apartments 8.06%Healthcare Senior Housing 8.71%Industrial properties 8.85%Motor Home/RV Park 8.89%Office 8.90%Retail 9.08%Self Storage 9.55%Lodging 10.16%Special Purpose 10.98%Golf Course 11.54%Restaurant 11.56%

EXHIBIT 1Transaction Volume

EXHIBIT 2Organizational Structures

Management,Operations & Real Estate

Management

Operations & Real Estate

Management &Operations

Real Estate

Management

Operations

Real Estate

Data from this report is used extensivelyin the discussion below.

Real Estate or Business Valuation?Health care facilities in general andassisted living facilities in particularare on a continuum of investments thatare more real estate-oriented at oneend of the spectrum and more busi-ness-oriented at the other. The sched-ule in Exhibit 4 shows capitalization(cap) rates for various investmentsfrom the RealtyRates.com Investor Sur-vey for the first quarter of 2015 sort-

ed from lowest (least risky) to highest(most risky).

Realty.com defines its “HealthcareSenior Housing” category to includeacute care (hospitals), outpatient care(medical office buildings, freestand-ing diagnostic facilities), congregantcare, and assisted living. Their cap ratesonly include the real estate componentof the investment (not the operatingbusiness). Healthcare Senior Housinghas the second lowest cap rate indi-cating that it is perceived by investorsas a relatively low-risk investment. Eachtype of healthcare real estate has itsown risk-adjusted cap rate. The Janu-


EXHIBIT 5Value Drivers

Earnings Units

Revenue Square Footage

Value

EXHIBIT 6Price Per Unit

EXHIBIT 7Variation in Price Per Unit

per Unit

Upper Quartile $241,400

Median $173,200

Lower Quartile $93,700

per Unit

Single Facility $172,700

Portfolio $206,000

per Unit

Assisted Living $138,500

With Memory Care $215,100

per Unit

"A" Property $244,800

"B" Property $102,300

ary – February 2014 online issue ofCCIM’s CIRE Magazine pegged theassisted living average cap rate in thelow 8% range (independent living waslow 8%; skilled nursing was high 11%range; CCRC was north of 10%).6

Understanding the risk-adjustedreturns necessary for the real estatecomponent can help business apprais-ers value and reconcile the componentvalues (real estate, management com-pany, operating company) that makeup assisted living facilities. An exampleshowing how an assisted living facilitycan be valued with and without realestate will be used below to demon-strate this point.

Facility-based businesses like hos-pitals, skilled nursing, and assisted liv-ing are frequently valued by either realestate or business appraisers. While eachappraisal discipline follows similar stan-dards, approaches, and methods, realestate and business appraisers may eachlook at the problem to be solvedthrough a different filter. Generally, itmay be best to use a real estate apprais-er when valuing a piece of real estate byitself, or when real estate is included inthe valuation of the operating compa-ny and the business is either marginal-ly profitable or unprofitable. In thoseinstances, it is generally the real estatethat will make up all or most of the val-ue. However, if the value is being drivenby the operating business, which is gen-erally indicated when risk-adjustedreturns reasonably exceed those neces-sary to support the real estate invest-ment, then a business appraisal may beapplicable. Generally, only a licensedreal estate appraiser can value realestate. As a result, business appraisers(and real estate appraisers) should care-fully consider which discipline is mostappropriate in each situation.

Primary Value DriversEarnings (free cash flow) generally pro-vide the best indication of value becauseonly earnings are available for rein-vestment and distribution. However,earnings are the result of a facility’snumber of assisted living units, overallsquare footage, and revenue. These dri-vers are illustrated in Exhibit 5.

If a facility’s operations are not opti-mized, non-earnings value drivers may


EXHIBIT 8Gross Income Multiples

EXHIBIT 9Price per Square Foot

EXHIBIT 10Cap Rates

provide a valuator with insight as towhat the facility might be worth ifoperations could be improved. Multi-ples and other value drivers are alsofrequent ly used under a marketapproach, and can provide a sanitycheck for methods under an incomeor asset approach. Assisted living facil-ity operators, buyers, and sellers willfrequently value facilities using rules ofthumb applicable to one or more ofthese value drivers. Some buyers mayignore earnings if they have a provenbusiness model that is more depen-dent on other value drivers.

Pricing DataThe average and median price perassisted living unit for 2014 based onpublicly announced transactions were$188,700 and $173,200 respectively.This was 25% (average) and 15%(median) higher than 2013, when theaverage and median price per unit were$150,600 and $150,300.

The chart in Exhibit 6 shows a sig-nificant increase in prices per unit from2010 to 2011 as the industry recoveredfrom the recession of 2008. Pricesremained relatively flat until 2014. Cur-rent unit prices may reflect increasingdemand for these units but also reflectlow interest rates. When interest ratesincrease, the price per unit may fallunless the demand continues to out-strip capacity. However, if the current

low interest rate environment causesassisted living facilities to be overbuilt,higher future interest rates and excesscapacity could significantly drive downprices.

While average and median price perunit benchmarks are useful, valuators,buyers, and sellers must be careful notto rely on them without further analy-sis and comparison to other valuationdrivers, approaches and methods. Thechart in Exhibit 7 shows how the priceper unit can change depending on: 1. The transaction pricing quartile. 2. Property desirability (“A” versus “B”

properties). 3. Single property transaction versus

a portfolio of properties. 4. Availability of memory care.

The variation in price per unit(illustrated in Exhibit 7) demonstratesthat valuators must understand thedata and use caution when applyingmarket medians and averages to deter-mine value.

Price to Revenue and per Square FootMuch of the published data for assist-ed living is combined with indepen-dent l iv ing. In the Senior CareAcquisition Report, price to revenuemultiples and price per square footdata are published only for assisted liv-ing and independent living combined.One reason for this is that frequently

there are assisted living and indepen-dent living units in the same facility. Asa result, and as pointed out above, thesemultiples and data are informative butnot always reliable for valuing stand-alone assisted living facilities.

The average and median grossincome (revenue) multiples for 2014were 3.9 times and 3.7 times grossincome. This t rend shows a fairincrease from 2010 to 2011 and con-tinues to increase slowly through 2014as illustrated in Exhibit 8.

Exhibit 9 shows the price per squarefoot for the years 2010 to 2014. Theaverage and median price per squarefoot for assisted living and indepen-dent living (combined) were $211 and$180 respectively. Prices per square footappeared fairly flat from 2011 to 2013,but increased significantly in 2014.

Capitalization RatesEarnings capitalization rates are sepa-rately broken out for assisted livingtransactions. The average and medianassisted living cap rates for 2014 were7.7% and 7.6% respectively. The chartin Exhibit 10 shows that cap rates havebeen declining since 2010, and declinedsignificantly from 2013 when they were8.5% (average) and 8.4% (median).


EXHIBIT 11Assisted Living Facility Example

Real Estate Included

Cash FlowNOI to IC

Pretax income $ 403,800 $ 403,800 A+Interest expense 636,800 636,800 B+Current management fee 392,000 392,000 C-6% management fee (345,600) (345,600) D+Rent E———————————————————Adjusted pretax Income 1,087,000 1,087,000 F+Depreciation 623,000 623,000 G+/- working capital (10,000) H-Capital expenditures (200,000) I———————————————————NOI/cash flow before taxes 1,710,000 1,500,000 JFederal & state taxes (434,800) K———————————————————NOI/cash flow to IC 1,710,000 1,065,200 LCapitalization rate 9.00% 5.61% M———————————————————Indicated value $19,000,000 $19,000,000 N

===========================From Market Data

Calculated

EXHIBIT 12Schedule for Example

Amount PercentDebt $ 12,610,000 66.37%Equity 6,390,000 33.63%

——————————————————MVIC $ 19,000,000 100.00%NOI $1,710,000NOI Cap Rate 9.00%

It is important that the capitalizationrate used is matched to the correct lev-el of earnings. The Senior Care Acqui-sition Report uses net operating income(NOI) which it says is “interchangeable”with earnings before interest, taxes,depreciation, and amortization (EBIT-DA) and cash flow. It assumes that thetransaction includes both the real estateand business operations, and is after a6% management fee. Therefore, caprates, as defined here, would not beapplicable to other earnings levels, orbusinesses that did not include the realestate or a management fee.

The cap rate is a debt-free weight-ed average cost of capital (WACC) thattakes into consideration the combinedcost to finance the real estate compo-nent and the cost to finance the oper-ations component. If the real estateand business were separated, each onewould have its own unique WACCbased on its unique risk-adjusted rateof return.

Valuation ExamplePretax capitalization rates are fre-quently used in valuing income-pro-ducing real estate, and often publishedas benchmarks for faci l it y-basedhealthcare companies. They are also

used by lenders and other buyers. TheSenior Care Acquisition Report usespretax capitalization rates as its onlyaggregated benchmark for valuingearnings (NOI). Business appraisersgenerally use after-tax market derivedcapitalization rates or market deriveddiscount rates based on a weightedaverage cost of capital representing therelative mix of debt and equity financ-ing that could be used to capitalizebusiness earnings.

The following example will explain: 1. How assisted living facilities, includ-

ing the real estate, can be valued bybusiness appraisers using market-derived capitalization rates.

2. How the pretax capitalization ratescan be reconciled to after-tax dis-count and capitalization rates.

3. How assisted living facilities can bevalued without the real estate (oper-ating business only) using an after-tax weighted average cost of capital.

4. How the values with and withoutreal estate can be reconciled. Real Estate Included. The assisted

living facility in this example has$5.760 million in revenue, 80 units,and a total of 95,000 square feet. Theschedule in Exhibit 11 shows theadjustments necessary to go fromreported pretax income (A) to pre-tax

net operating income (NOI) (J or L inthe NOI column), compared to theadjustments to determine after-taxcash flow to invested capital (L). The9% pretax cap rate (M) was developedfrom published survey data and reflectsthe risk-adjusted rate of return for thespecific facility. The 5.61% after-taxcap rate (M) was calculated to supportthe same indicated value of $19.0 mil-lion (N).

Adjustments B through E are thosenecessary to calculate debt-free adjust-ed pretax income (F). Since a 9% per-cent capitalization rate derived fromThe Senior Care Acquisition Report isbeing used, actual management feeswere added back (C) and a standard6% management fee was deducted (D)to make it comparable to the to thepublished metrics in the report. Theincrease in working capital (H) was


EXHIBIT 13Cost of Debt and Equity

AfterPretax 40% Tax Weight WACC

Cost of Debt 5.05% 3.03% 66.37% 2.01%Cost of Equity 19.00% 19.00% 33.63% 6.39%

———————————————100.00% 8.40%

EXHIBIT 15Calculation of Other Value Metrics

Gross income $ 5,760,000Gross income multiple x 3.30

——————————Indicated value $ 19,000,000

=========================Price per unit $ 237,500Number of units x 80

——————————Indicated value $ 19,000,000

=========================

Price per square foot $ 200.00Square footage x 95,000

——————————Indicated value $ 19,000,000

=========================

EXHIBIT 14After-Tax Cap Rate

WACC discount rate 8.40%LT cash flow growth rate -2.79%

—––————WACC capitalization rate 5.61%

=========

EXHIBIT 16Required Return for Investors

Estimated value of real estate $17,560,000RE capitalization rate 7.00%

—––———————Estimated rent $ 1,229,200

estimated based on discussions withmanagement. Since rents are collect-ed on the first day of the month, thereis little need for additional workingcapital. Capital expenditures (I) wereestimated based on the age and con-dition of the facility and historical lev-els of expenditures. A 40% blendedfederal and state tax rate (K) wasapplied to adjusted net income.

A real estate appraisal indicates thatthe fair market value of the building is$17.56 million. Research shows that70% is the optimum loan to value ratiofor the real estate. If we assume that

70% of the property value ($12.29 mil-lion) plus 80% of furniture and equip-ment va lue ($400,000 X .80 =$320,000) or $12.61 million total isfinanced with debt, the value of equi-ty would be $6.39 million based onthe indicated value of $19.0 million.

The schedule in Exhibit 12 showsthe market value of invested capital(MVIC), the breakdown of debt andequity financing, net operating income,and the pretax cap rate.

Using this data , the af ter-taxweighted average cost of capital canbe estimated and reconciled. Reason-able ranges for the cost of debt, thecost of equity, and the long-term sta-ble cash flow growth rate were esti-mated using market data and specificcompany risk factors as applicable.The actual cost of debt, cost of equi-ty, and long-term stable cash flowgrowth rate used in Exhibit 13 wereiterated within reasonable rangesdetermined to support and reconcileto the $19.0 million value calculated

using the pretax NOI cap rate. Thisresulted in an 8.4% after-tax WACC.

The WACC discount rate is used topresent value a future stream of cashflows. As a result it cannot be used tovalue a single earnings stream with-out adjusting it by a stable long-termcash flow growth rate. The long-termcash flow growth was estimated at2.79% and it was deducted from theafter tax WACC discount rate to esti-mate the after tax cap rate of 5.61% asillustrated in Exhibit 14.

Sanity Check. The valuator can usethe market and asset approach to eval-uate the value indicated by the capi-talization of earnings methodology. Inthis case, as a sanity check, other val-ue metrics were calculated using the$19.0 million indicated value, includ-ing the gross income multiple, priceper unit, and price per square foot, toevaluate the indicated value under theincome approach. See Exhibit 15.

National Statistics. Gross incomemultiples for assisted and indepen-dent living (combined) for 2014 aspublished in the 2015 Senior CareAcquisition Report showed an aver-age of 3.9 times and a median of 3.7times. Published price per unit datafor assisted living for 2014 showed anaverage of $188,700 and median of


EXHIBIT 20WACC Capitalization Rate

WACC discount rate 18.80%LT cash flow growth rate -2.79%

—––———————WACC capitalization rate 16.01%

=============

EXHIBIT 19Cost of Debt and Equity

AfterPretax 40% Tax Weight WACC

Cost of Debt 5.05% 3.03% 22.22% 0.67%Cost of Equity 23.31% 23.31% 77.78% 18.13%

———————————————100.00% 18.80%

EXHIBIT 18Required Financing

Amount PercentDebt 320,000 22.22%Equity 1,120,000 77.78%

——————————————————MVIC $ 1,440,000 100.00%NOI $480,800NOI Cap Rate 33.39%

EXHIBIT 17Pretax NOI and After-Tax Cash Flow Calculations

Real Estate Not Included

Cash FlowNOI to IC

Pretax income w/real estate $ 403,800 $ 4 03,800 A+Interest expense on RE 636,800 6 36,800 B+Current management fee 392,000 3 92,000 C-6% management fee (345,600) (345,600) D+Depreciation on RE 543,000 5 43,000 E-Rent ( 1,229,200) (1,229,200) F———————————————————Pretax income w/o real estate 400,800 4 00,800 G+Depreciation on F&E 80,000 8 0,000 H+/- working capital (10,000) I-Capital expenditures (80,000) J———————————————————NOI/cash flow before taxes 480,800 3 90,800 KFederal & state taxes (160,320) L———————————————————NOI/cash flow to IC 480,800 2 30,480 MCapitalization rate 33.39% 16.01% N———————————————————Indicated value $ 1,440,000 $ 1,440,00 0

===========================

CalculatedCalculated

$173,200. Published price per squarefoot dollar amounts for assisted andindependent living (combined) for2014 showed an average of $211 anda median of $180. These are nationalstatistics unadjusted for size, location,property class (A or B), and other fac-tors that may affect the price. The val-uator will need to consider all of theevidence available and revise assump-tions or weight the indicated values, asnecessary, to reach a well reasonedconclusion of value.

Real Estate Not Included. The sameassisted living facility will now be val-ued using the same assumptions asbefore, except that the real estate is notincluded in the value. As a result, onlythe operating business is being valued.The real estate had an estimated valueof $17.56 million. It was estimated thatinvestors in the real estate would

require a 7.0% return or $1.229 millionper year in rent assuming a triple netlease, as presented in Exhibit 16.

All of the adjustments to calculatepretax NOI and after-tax cash flow toinvested capital are the same except asfollows. As illustrated in Exhibit 17,depreciation was separated into theamount applicable to the real estate(E) and the furniture and equipment(F&E) (H). Rent of $1,229,200 wasdeducted (F). Capital expenditures (J)were reduced to reflect only the furni-ture and equipment. The indicated val-ue of $1.44 million (O) is the value ofthe business with the real estate of$19.0 million less the value of the realestate of $17.56 million. The pretaxcapitalization rate under the NOI col-umn and after-tax capitalization rateunder the Cash Flow to IC column (N)were ca lculated by div iding theNOI/Cash to IC row (M) by the Indi-cated value row (O).

Debt financing of $320,000 basedon the $400,000 value of furniture andfixtures would result in $1.12 millionof equity financing as shown in Exhib-it 18.

This capital structure was used forthe debt and equity weightings to cal-culate the WACC (shown in Exhibit19). Similar to the last scenario, rea-

sonable ranges for the cost of debt, thecost of equity, and the long-term sus-tainable cash flow growth rate wereestimated and iterated to reconcile tothe indicated value. After evaluatingthe prime interest rate and other coststo borrow, the same cost of debt usedin the “real estate included” scenariowas considered reasonable. The costof equity, however, was increased overthe “real estate included” scenariobecause this is a different businesswithout the real estate. Equity in a ser-vice business not secured by real estatewas considered more risky.

The long-term sustainable cash flowgrowth rate used in the “real estateincluded” scenario was also consid-ered reasonable and deducted from theWACC discount rate. As seen in Exhib-it 20, the after-tax WACC capitaliza-tion rate of 16.01% reconciles to thecapitalization rate calculated under the“real estate not included” scenario.

ConclusionThe purpose of doing this type ofanalysis is to prevent an overlymechanical valuation that may notconsider the specific earnings, risks,growth rates, and values of the com-ponent businesses, and to help the val-uator think through variables andassumptions necessary to value thesecomponents separately. It can also helpthe valuator understand and use datafrom other valuation disciplines cor-rectly (such as real estate or machineryand equipment) to ensure that valuesattributable to one component do notget counted towards another.

Reverse-engineering the resultsfrom a pretax to an after-tax cap ratecan help valuators develop confidencein using market and other third-partydata either as primary or supplemen-tal support for their conclusion of val-ue or force consideration of why thedata may be inconsistent with a con-clusion.

Developing an analysis around asingle-period earnings stream worksbest when an assisted living facilityhas a stable earnings stream. A similaranalysis, however, could be developed,using future after-tax cash flows whenmanagement does not expect stablecash flow growth. �


1 2015 Genworth Financial, Inc., https://www.genworth.com/.

2 Ibid.3 Ibid.4 Assisted Living Federation of America,

http://www.alfa.org/alfa/Assisted_Living_Information.asp.

5 Ibid. 6 Myers and Pardoll, “Healthy Senior Housing:

Investor Demand Revitalizes this Niche Sector,”CIRE Magazine (January/February 2014).

ass isted valuing living fa cilitiesthere are over 31,000 assisted living facilities in the u.s. in...

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