Nursing home listing values are a mystery to many. Because of that fact, I will share some knowledge about nursing home transactions with you. Previously, I wrote an article explaining how nursing home owners can determine how much their facility is worth. In the same vein, this article will let you know how much to pay for the next nursing home that you want to buy. In other words, you and the owner should be on the same page after you read my articles.
Above all, we don’t value nursing home listings like commercial real estate. Seriously, that would be a mistake. Most noteworthy, a lot of the value may come from real property, but not all of it. Nursing homes have a value that is both tangible and intangible. Hence, we have to dig deeper than just the real estate component.
Firstly, tangible assets comprise real and personal property. Real property is the real estate which includes fixed property, building, land and the bundle of rights that goes along with it. The senior housing industry calls the real estate – physical plant. This is the property that a nursing home owns or uses to serve its residents. An accounting term for the physical plant would be Furniture, Fixtures and Equipment (FF&E) and Inventory.
Secondly, the intangible component of value comprises assets that are not physical. Goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets.
Thirdly, when valuing a nursing home listing, you must factor in the tangible physical plant and intangible goodwill and other things. As you can see, nursing home valuations are much more complicated than a commercial real estate valuation.
10 Step Nursing Home Valuation Process
A formal appraisal by a Member of the Appraisal Institute (MAI) would approach the value from three perspectives. MAIs use the cost approach, sales comparison and income capitalization approach. The method that I recommended for owners is the same one that I suggest for buyers. We will use the income capitalization approach. Specifically, we will focus on discounted cash flow analysis for nursing home transactions. Now that you have the method to find the value, it’s time to identify the steps. Resultantly, these steps will determine the value of this nursing home. You can call this the 10 Step Nursing Home Valuation Process. We break the process up into the gathering stage and the calculation stage. Steps 1—8 involve gathering and forecasting. As a result, you will ask a lot of questions, review a lot of information and forecast the future during this stage.
Step 1 – Previous Years Financials
In this step, you will request financials from the previous fiscal year. In case you didn’t know, these reports are called income or profit-and-loss statements (P&L). Financial statements are formal records of the financial activities of a nursing home for sale. They include four basic statements and we will focus on just one, the income statement or P&L report. The P&L provides information on the nursing home’s income, expenses, and profits over a stated period. The owner will get you the reports from his management company. They should give you the information on a monthly basis with detail. As you have figured out, this is what you need.
Step 2 – Year-To-Date Financials
For this step, you want to request the current year-to-date income statement. After reviewing these financials, you will understand the recent past and the present.
Step 3 – Finanacial Analysis
With this information, you will want to forecast the remaining months of the fiscal year. Doing this, you find trends and patterns in the market.
Step 4 – Previous Years Census
Step 4—6 involves census research. Using the information from The Medical Dictionary of The Free Dictionary by Farlex:
Census is an official count is the total number of patients admitted to the nursing home. Average Daily Census is the average number of patients per day over time.
- Census Reports by Payer Type
- Private Pay
- Census Quality Mix
Next, you will request the previous full years census reports. The census reports will provide information for each month. All nursing home listings provide reports.
Step 5 – Year-To-Date Census
In this step, you will collect the current year-to-date census reports. In short, you will see how it is doing right now.
Step 6 – Census Analysis
Finally, you will use the reports to look for trends, patterns and the quality mix for the market. Based on your observations, you will forecast the remaining months for nursing home census.
Step 7 – Capital Expenditures
During this step, you need three years plus year-to-date capital expenditure reports. We also call this a fixed asset report. They are the items of value that the nursing home has purchased and will use for an extended period. For example, fixed assets include items such as land and buildings, motor vehicles, furniture, office equipment, computers, fixtures and fittings, and plant and machinery.
At this stage, you will identify the capitalized assets. Just so you know, they don’t include the items on the income statement. Based on this review, you will know what your major expenditures will be. For instance, you might have to replace HVAC, water heaters, or other big-ticket items. In contrast, if they replace those items, you don’t have to. In reality, major capital expenditure items drive negotiations in many nursing home transactions.
Step 8 – Financing
In this paragraph, we will talk about banks. You should meet with the ones you plan on using for this nursing home transaction. A good start is to send them the financials you have collected. Given this, they will give you typical loan terms and tell you their ratios. Knowing the ratios, you can better understand the deal. The important ratios are debt service, debt service coverage ratio, and cash flow. Finally, you are seeing some numbers. Consequently, you are knowing if you like this deal or not. Maybe you like it, maybe you don’t. Let’s run more numbers and find out.
Step 9 – Capitalization Rate
Next, you will want to determine the capitalization rate for the sale of this nursing home. If you didn’t know, it’s called the cap rate. The three methods for determining a cap rate are; Sales Comparable, Band of Investments or the Discount Rate. For our purposes, we will use Band of Investments for nursing home transactions.
Step 10 – Discounted Cash Flow Analysis
This is the final step. During this step, you will use the Discounted Cash Flow (DCF) Analysis. DCF is the discounting the annual cash flows (future NOI). Resultantly, we will determine the projected value of the nursing home using a present value calculation.
Finally, we have the value of the nursing home. After that, you will want to ‘sanity check’ your work. You do that by comparing known sales within the same market and adjust for differences.
Congratulations – You have completed the 10 Step Nursing Home Valuation Process. To sum it up, now you know how much the next nursing home listing is worth.