Five Best Practices for Financial Feasibility Studies

2014 began with many positive indications for capital projects in the senior living and hospital sectors.  

Several senior housing construction benchmarks tracked by the National Investment Center for the Seniors Housing & Care Industry (NIC) have rebounded in recent years to prerecession levels. According to NIC data for the top 100 metropolitan areas, assisted living construction is at a five-year high with over 13,000 units under construction and independent living is at a four-year high with nearly 9,000 units under construction. 

For health care, the Affordable Care Act (ACA) continues to power through obstacles, and partially as a result, many community hospitals are once again pursuing modernization and growth initiatives. In particular, the U.S. Department of Agriculture (USDA) has funded numerous $25 million-plus critical access hospital projects over the past several years.

With renewed interest in facility construction, expansion or renovation, providers should keep in mind that the fundamentals of developing successful projects have not changed. Even before architectural designs are created, organizations need to assess their market opportunities, develop prudent business plans and monitor execution. The building block for this entire process is a financial feasibility study.

Forecast, Compiled or Examined?

The basic purpose of a financial feasibility study is to determine if a project will be viable for an organization or business. Finding the best answer will depend on commissioning the appropriate level of analysis for the project. The three types of financial feasibility studies, from lowest to highest complexity, are forecast, compilation and examination. A financial forecast may only include a basic cash flow analysis and can be completed by a consultant or management company. Higher levels, such as a compiled or examined report, will include more detailed reviews of operations and market demographics and are completed by certified public accountants. Keep in mind that the higher degree of analysis, the more costly the study.

Additionally, the type of financial feasibility study may be determined by the preferred debt financing structure. For example, HUD’s senior housing mortgage insurance program relies on appraisals, which can use information from financial forecasts. Alternatively, HUD’s hospital mortgage insurance program generally relies on examined analysis. Also, tax-exempt bond interest rates may be lowered if a compiled or examined assessment is included with the bond offering documents. For borrowers and their investment bank, a higher level feasibility study can be cost effective.

Regardless of the level of analysis, a financial feasibility study should act as a business plan and provide clarity and purpose. By pulling the pieces of the project puzzle together, it should allow the steps that follow—financing applications and architecture work—to be undertaken with less wasted investment in unfeasible or unwarranted projects.

The Pitfall of Delay

The most common pitfall with financial feasibility studies is simply not having your financial advisor or lender involved in the early stages of planning. Unfortunately, it is not unusual to see a capital project that has been through the planning, design or project approval phases that has had either no analysis or the appropriate level of analysis completed on the financial feasibility of the project. 

As a result, unreasonable expectations may be set with stakeholders, such as patients/residents, board members, employees and even the community. Whether promising that major organizational changes can be avoided, underestimating the necessary amount of capital or projecting unrealistic timelines, a financial feasibility study should help an organization or business avoid these mistakes that can lead to losing hard-earned support.  

Even if support for a project is particularly strong, a late start on a financial feasibility study often leads to rework of the design, delays in construction and organization issues. While better late than never, all of the delays associated with a tardy study inevitably add project costs and lead to missed market opportunities.

Best Practices

A hospital is approached by a community task force requesting a new outpatient clinic on the opposite side of town. A nonprofit nursing home recognizes a county’s senior population can benefit from an assisted living housing option or perhaps a for-profit operator wants to add memory-care units to existing locations. These are just some common projects under consideration around the nation. As discussed, providers will ideally begin a financial feasibility study to carefully assess risk and opportunity. The following are five best practices for organizations and businesses to pursue:

1. Conduct a Debt Capacity Study.

The first step, before commencing with a financial feasibility study, is to conduct a debt capacity analysis for the organization or business. Much more limited in scope than a full financial feasibility study, a debt capacity analysis will pinpoint financial benchmarks necessary for an organization’s success.

Will an organization's or company’s balance sheet provide sufficient liquidity—cash and investment reserves?  New projects often require significant working capital, whether to fund initial training or to fund operations during lease-up.  These project funding needs generally can’t be borrowed and ample alternative sources must be available. A debt capacity analysis won’t answer all the necessary project questions, but will help establish a framework for more detailed analysis.

2. Identify Key Service Lines.

While a project often represents new opportunities, it is just as important to identify those service lines that an organization may need to discontinue. Service line goals are critical because whether adding or subtracting, the result will be organizational change.  The question for providers is if patients/residents, staff and the community are prepared for the necessary adjustments.

For example, many community hospitals would like to expand their offerings of surgery and orthopedic services.  But are staff prepared for the necessary training and outside assistance to make the goal achievable?  Furthermore, is a community prepared to make a necessary trade-off, such as divesting a costly nursing home to provide the cash flow necessary for an emergency room modernization?

Projects are exciting, but managing change can be complicated and time consuming due to the sheer number of people and processes that may be affected. Smart providers recognize this early in the financial feasibility process and make the necessary accommodations in the change management process.

3. Establish a Coordinated Timeline.

With project parameters and goals determined, an organization should have its financial feasibility advisor, project manager and lender at the table to help outline the time frames and deadline dates for different steps in the project. The project timeline will involve a number of parallel project tasks, some of which are completely independent and some of which may not begin until a previous task is complete.

Often with new construction, for example, a first step is to identify how long it will take to secure the necessary land.  Once that is done, the length of the architectural and construction contract process must be determined, ideally with reasonable expectations for design iterations and, as necessary, value engineering.  Overlaying the whole project is securing funding, the timing of which will be determined by the desired financing structure. To avoid delays and additional expense, a financial feasibility study should be pursued in conjunction with the overall project timeline. [Suggested read: “Managing Costs: The 411 on Organizing Your Construction Project.”]

4. Build Realistic Revenue Projections.

Successful projects are built around a careful examination of the demographics and utilization information that will support the financial feasibility study’s revenue projections. With limited budgets, it’s important that providers concentrate on projects with the greatest revenue potential.

Assessing senior housing demand has become fairly formalized over the past several decades. Although there can be local variables to consider, the key is being honest about the number of income-qualified senior households, as well as likely utilization and penetration rates.

Hospital organizations, on the other hand, are facing more moving targets than ever. With the changing health care industry, including more insured people, how will overall utilization change and what will be the desired services? How will the shift in payor mix to more Medicaid eligible and less private pay affect net revenue? With continued medical advancement, will the inpatient and outpatient mix change length of stay? A financial feasibility study may not be a crystal ball, but it should offer careful analysis of these and many more questions.

5. Recognize Staff as a Key Expense.

Lastly, a provider's primary expense and resource is its staff. Organizations often plan to hold to their full-time employee (FTE) level, noting that the project efficiencies will allow them to achieve the desired result; however, they fail to consider that the number of FTEs tend to increase because existing service lines do not immediately change. Successful organizations understand staffing benchmarks and have adjusted them appropriately for project and operational impacts.

Aging baby-boomers are driving demand for additional seniors housing and care. Hospitals continue to utilize technology and medical advances to shift services towards an outpatient model. Forward-looking providers will continue to be presented with opportunities to grow. A financial feasibility study is not only crucial to the decision-making process, but will help organizations maximize the success of their projects.

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