How to Increase the Value of my Seniors Housing Community? – by Jason Punzel
The value of a Seniors Housing Community is derived from the cash flow and rate of return a buyer is seeking to achieve. The common formula is Net Operating Income (NOI) divided by the Cap Rate (unleveraged rate of return). The Cap Rate is a measure of risk, whereas the lower the cap rate the higher the price.
Thus, there are two ways a Community can increase in value:
- A reduction in the Cap Rate (cap rate compression)
- An increase in the Net Operating Income
There are two main reasons for a change in a cap rate. First, a change in the interest rate, the second is a change in the perceived risk of an asset. Cap Rates, or rates of return, are closely correlated with general interest rates. As interest rates increase or decrease so do cap rates. Secondly, investors perception of the risk of an asset can also change. For example, many investors perceive that retail real estate is much risker today than ten years ago, prior the proliferation of Amazon and other on-line retailers. Thus, retail cap rates are higher today, compared to other real estate asset classes, than they were ten years ago.
Changes in Net Operating Income:
The other way to increase a Seniors Housing Community’s value is through an increase of Net Operating Income. If revenue increases by 4% and expenses increase by 4%, then the NOI will increase by 4% as well as the value of the community (assuming the Cap Rate does not change). However, if revenue increase 5% and expenses only increase 3%, the NOI will increase 9%, as will the value. Conversely, if revenue increases 3% and expenses increase 5%, NOI decreases by 1%. Below is a chart depicting the different scenarios.
| Year 1 | 4% – growth | 5%/3% | 3%/5% | |
| Revenue | $3,000,000 | $3,120,000 | $3,150,000 | $3,090,000 |
| Expense | $2,000,000 | $2,080,000 | $2,060,000 | $2,100,000 |
| NOI | $1,000,000 | $1,040,000 | $1,090,000 | $990,000 |
| Value @ 7% Cap | $14,285,714 | $14,857,143 | $15,571,429 | $14,142,857 |
| % Increase | 4% | 9% | -1% |
As one can see, NOI growth can have large swings based upon revenue and expense growth.
Conclusion:
Owners have very little control over the change in Cap Rates, but have much more control over changes in the NOI of their community. It is important for owners to strive for revenue growth to increase faster than expense growth to increase the value of their community.
For more information on how to increase the value of your Seniors Housing Community, please contact Jason Punzel at punzel@slibinc.com or 630-858-2501.
