Focus on Fair Deal for Nursing Homes
In 2013 BDO published Health’s Ageing Crisis: Time For Action which outlined the potential demand for nursing home bed spaces in Ireland. Our analysis indicated that 9,572 additional beds would be required between 2012 and 2021 in order to meet the forecasted demand for nursing home care. This equates to in excess of 1,000 beds per year over the period.
During the period from 2000 to 2009 there was a period of rapid growth in the sector, with approximately 800 additional beds per annum being developed over the period, spurred on by the availability of tax breaks for the development of nursing home buildings.
The expansion in the sector has slowed in recent years. The economic downturn and the removal attractive tax breaks meant that many within the sector had difficulty gaining access to the capital required for expansion. As a result, between 2009 and 2014 the annual increase in bed provision slowed to approximately 350 beds per year.
The best estimate of the cost of developing a new nursing home of scale for example 80 beds plus, is in the region of €100,000 to €140,000 excluding the cost of land. We have seen situations where the costs have been higher and instances where the costs have been marginally lower. This has led to a situation whereby the enterprise value of a newly constructed nursing home could well turn out to be below the development cost.
In order to illustrate this issue let us assume a company is seeking to develop an 80 bed home for a cost of €10 million, which on completion will secure a Fair Deal rate in line with the national average of €919 prpw. Taking occupancy of 91% and an EBITDAR margin of 21%, or E730k. As such, the cost of development is a multiple of over 13 times maintainable EBITDAR, whereas current market activity suggests that a quality nursing home outside Dublin would achieve a valuation multiple of between 7.5 and 8.5, suggesting that in this case the maximum value of the new home would be approximately E6.2 million or E77k per bed.
It is clear to see that this would be a difficult proposition for any funder, whether they be providing equity or bank debt. In most cases the level of debt that a bank will provide is limited to 5.5 times maintainable EBITDAR, which in the case outlined above would only provide 40% of development costs. Even if a promoter is capable of obtaining an equity investment to fund the balance, private equity type investments in the industry have in recent years come at a significantly greater cost than bank debt.
Where to next?
It seems clear, therefore, that in order to ensure the delivery of sufficient bed spaces to meet the needs of Ireland’s ageing demographic the Fair Deal rate paid to newly developed nursing homes needs to be at a sufficiently high level to fund the increasing capital costs associated with development.
There are a number of other factors that may alleviate pressure. With replacement cost exceeding the current prices being paid for existing homes, this suggests that existing homes will become more attractive to investors and so may push up valuation multiples, and therefore potentially increasing the proportion of debt banks are comfortable providing against a project. In addition to this, there has been increased interest in the sector from equity providers who are willing to fund development of new homes to be leased to operators. This type of arrangement would provide operators with access to additional bed stock at a lower cost than self-funded developments, albeit with ultimately less upside potential for the operator in the longer term.