ArticleIssue #190 | Think Like an Underwriter
I spent a great deal of time over the past few weeks talking to investors + bankers, most in the senior living and age-tech spaces. One of the most illuminating conversations – and the one I’d argue is most applicable to everyone here – centered on their underwriting. I know, I know – that’s one topic just about everyone (including bankers) dreads – but the implications of it are massive.
Hence, this newsletter. Yes, the example will center on senior living, but the entire premise extends to every industry. The terminology changes, but the underlying principle holds. So, with that disclaimer, let’s get to it.
Every senior housing deal gets underwritten on the same number: Net operating income (NOI).
The sponsor (i.e. the person doing the deal) models it, the lender sizes the loan against it & the eventual buyer of the asset prices based on it. NOI is the entire ballgame. And yet, that language is notoriously absent from almost every other operational conversation (especially marketing-sales related ones). What you’ll hear instead: cost per inquiry, lead volume by source, CPL month over month, cost per tour, cost per move-in.
That same pattern happens everywhere else, too – all bankers/acquirers/PE funds deal in some variant of NOI or EBITDA (earnings before interest, taxes, depreciation and amortization). But the people working in all of those industries? Not so much. For example: in SaaS (cost per demo, demo-to-sign up rate, MRR), Home Services (cost per appointment, booking rate, ACV, RCR, etc.), Legal (cost per lead, cost per case, drop rate, Expected Fee Return), even eCommerce (ROAS, CPA, Return Customer Rate, etc.).
That translation gap is expensive. When budgets tighten, marketing gets filed where every other expense lives (somewhere between landscaping and the linen contract) and it gets trimmed accordingly. Nobody in the room can say what the cut costs in the only number the owner actually cares about, so nobody stops it.
Let’s close that gap. The arithmetic isn’t complicated. It’s just rarely written down.
The Formula Everyone Underwrites
NOI = occupancy * rate (less) costs of service/delivery (less) operating expenses.
It all ultimately reduces to four variables: two on the revenue side, two on the expense side (i.e. variable costs + fixed costs). Marketing (traditionally) is incorporated in the final term (operating expenses), which is why most operators treat it as something to minimize.
But – look at the first two: occupancy is a function of how quickly you turn demand into move-ins (in senior living; in home services, it’s how quickly you turn demand into signed contracts; in SaaS, into recurring revenue; in legal, potential new clients into retainers). Rate is a function of whether you have generated sufficient demand to maintain your price, or were forced to increase demand via a discount.
Marketing – at its most fundamental level – is upstream of both. If you evaluate it purely as an expense, that’s the equivalent of evaluating a sales team exclusively on its travel budget. It makes zero sense. Yet, many organizations do it.
Before we move on, add the final piece – which is what transforms NOI into value: the multiple.
In Senior Living, property values trade based on cap rates. At a 6.2% cap, a community is worth its NOI / 0.062. That means every $1 of added annual NOI is worth ~$16 at exit.
The same thing holds true EVERYWHERE else. Home services trade at a 4x-8x EBITDA. Professional Services can be anywhere from 3x – 15x. SaaS can be 5x – 15x (or more). eCommerce 2x – 8x EBITDA. The list goes on and on.
But that insight – that the business is worth some multiple of NOI/EBITDA – is the core concept for this entire argument / line of thinking. If you understand that, the rest of this issue will make so much more sense.
So, What’s 1 Move-In Actually Worth?
Let’s return to the industry that gave rise to this issue – Senior Living.
Take an assisted living (AL) move-in. The base revenue for that – generally speaking – is ~$6,000/mo, plus $500-$1,000/mo in add-ons + upsells (meal plan, services, trips, fall prevention, whatever). Let’s assume the resident is somewhere in-between, so call it $750/mo. Across a typical portfolio, that resident stays ~36 months. That’s $243,000 of expected lifetime revenue from one family saying yes.
BUT: underwriters don’t think in lifetime revenue; they think in annual recurring revenue (ARR). By that measure, the above resident = $81,000/yr.
Now, not every dollar in revenue will become NOI, because a new resident requires staff time, meals, supplies, monitoring costs, technology costs, etc. To make the math easy, let’s assume 50% of the top-line drops to NOI (your number will vary; your CFO will have it). That’s roughly $40,500 of annual NOI. Divide that by 0.062 (from above) and one occupied AL unit is worth something like $653,225 of value at exit, assuming the 6.2% cap rate from above.
That’s….a lot of exit value. If you extrapolate this concept, in a 150-unit community, a 1% improvement in occupancy is worth ~$1M to the people/investors who own the building (150 units * 1.0% * $653,225 = ~$979,838).
If your marketing program can move occupancy at a 150-unit community by 5% a year, that delivers $5M in value. If you can improve it 12% (just 1.5 move-ins per month), that’s $11,758,050 in enterprise value. The honest reality is that marketing is one of the two most powerful levers to move exit valuation (the other being sales).
I’d love to know how many marketing budgets are justified using this approach; in my experience, the answer is very few. The more common situation is marketing leans into CPLs – which only serve to reinforce the notion that marketing is a cost center, not a valuation driver.
Once again, this isn’t unique to senior living; the same thing happens in every other industry. If marketing brings in 50 more cases/month to a PI firm, about 30%-50% of that fee value (itself 35-45% of the total settlement) will drop as EBITDA. A decent-sized firm will sell for 6x EBITDA, so adding 50 cases at $40k fee return each per month = ~$43.2M in incremental exit valuation for the firm. Even if those cases cost me ~$6k/each to obtain (so 50 cases * $6k/case = $300k/mo * 12 months = ~$3.6M a year in marketing) – who wouldn’t make that deal? Spend $3.6M, make $10.8M (30% margin + return of your advertising cost) AND your company is worth $43M more.
It’s a no-brainer to any reasonably business-minded person. Hell, you don’t even have to have a particularly savvy owner; you just need someone who has a handful of functioning brain cells and the ability to use a calculator.
The sooner more marketers learn to connect what they do to what it does to the actual business valuation, the better these conversations will go. What marketers need to learn is how to connect what they do to what it drives.
Lever #1: Speed
Every day an AL unit sits empty is revenue that never comes back. At $6,000 a month, that’s about $200 a day, or roughly $100 of NOI (assuming that 50% number above; again, YMMV). The same is true for every other organization – every day a home services firm has unbooked slots in its calendar is lost revenue they’ll never get back. Every day an accounting firm has staff at 50% utilization is a day of expenses they’ll never get back.
But, let’s stick with senior living – just for the sake of continuity.
Take a stabilized 150-unit community where residents stay an average of ~36 months. Basic math says you’ll need to replace ~50 each year (or ~4 per month). That’s pretty normal.
Now, if faster lead response, improved follow-up & a real waitlist cut 15 days off the average time it takes to refill a unit, that’s 600 more occupied days, $60,000 of added annual NOI and close to $1M of value. 15 days. For most operators, that’s a speed-to-lead problem they could solve with process, not budget.
Lease-up is where it gets dramatic.
A new 150-unit community absorbing 6 net move-ins a month reaches 90% occupancy in about 22 months. At a month, it gets there in ~18 months. That four-and-a-half-month gap is roughly 200 months of occupied apartments, or about $1.2M of resident revenue, on a building that’s carrying construction debt the entire time. Every month a community isn’t stabilized is another month of debt service on an asset that isn’t paying for itself yet.
Lease-up speed isn’t just a marketing metric; it’s a valuation driver.
Lever #2: Rate
If you thought Lever #1 was dramatic, just wait.
Most operators (and virtually every marketer + sales person I’ve ever met) have no idea that $1 of rate is worth ~ $2 of occupancy. If you ever wonder why I’m so anti-discount, that’s why.
When an operator fills a unit, the operator assumes the cost of caring for whoever lives in it (obviously, that’s the whole point). That care cost is largely fixed – there are regulations that govern staffing ratios, food costs are largely fixed, tech costs are set per unit, etc. There are certainly exceptions, but the general rule is that providing a specific level of service (i.e. level of care) has a relatively fixed cost. This is the same everywhere else, too – generally speaking, there’s a relatively fixed cost to installing windows, to litigating a case, to filing a tax return, to servicing a client, to fulfilling an order.
If you accept that premise (and you should), then this is what logically follows: a $500/mo discount doesn’t mean the resident needs $500 less care. Every $1 of “discount” comes straight out of NOI, at 100 cents on the dollar. It’s even worse if your sales team is bonused/commissioned on move-ins, because (1) the discount hits NOI dollar-for-dollar AND (2) their commission further decreases NOI.
It’s a double-whammy ouch.
That’s why I’ve written before that the move-in special is the most expensive line item nobody puts on the marketing budget. When demand is soft, virtually every operator’s reflex is a discount. Why? Because it fills the unit, improves the occupancy report & everyone assumes marketing did its job.
But again – run it through underwriting.
A $500/mo discount held across a 36-month stay is $18,000 per resident. Give it to every move-in for a year (about 50 of them in our 150-unit community) and once they’re all in place, you’ve removed ~$900,000 of NOI (remember, discounts hit NOI dollar-for-dollar). Multiply by 16 and that “small” special cost the owner/investors/operator ~$14.4M in enterprise value.
To earn it back through occupancy, you’d need to fill ~22 more units. For some communities, that might not even be possible.
Compare that to a waived first month’s rent. At $6,000, it’s ~33% the cost of the monthly discount, and it doesn’t attach to the resident for 3 years. Yes, you still take a $6,000 * 50 = $300,000 hit to NOI – but that’s a LOT better than $900,000.
Same intent, wildly different financial outcome.
The implication is that marketing’s job is more than just filling units; its real job is to generate sufficient demand that you never have to buy occupancy with price.
Once again, the same principle applies to every other industry: if you can generate sufficient demand for your products/services that you don’t have to resort to discounts, the impact to enterprise value is staggering. The multiple changes based on the industry, but the principle holds.
Lever #3: The Move-Outs You Can Prevent
Let’s be honest about this one: most senior living move-outs are a function of health, not satisfaction. No amount of marketing or resident engagement changes that.
Nevertheless, there is some percentage that is avoidable. The family that moves Mom to the community down the road. The daughter who never felt like she knew what was happening day to day. The son who grew so frustrated that he wasn’t getting updates on Dad that he switched to in-home care. The independent living resident who moves out at the first rate increase, simply because nobody ever showed them what they were getting for it.
Each of those has a price.
If you assume it takes the median community 45 days to refill the unit (about $5,063 of lost NOI) PLUS the turn cost (usually $1,000 – $3,000) PLUS the sales & marketing cost to land the replacement…the end result is that you’ve spent ~$10,000 – $12,000 per avoidable move-out. Again, not all move-outs are avoidable (just like not all client churn is avoidable in a service business); maybe avoidable churn is 20% of total churn. Maybe it’s 10%. Maybe it’s 12%. The actual number depends on a whole bunch of variables – but the point to internalize is that it’s not zero. It’s not 100%. It’s some number in-between.
The upshot is that this framing provides you (the marketer or CMO or CEO) a clear way to evaluate retention spend. A $40,000-a-year resident and family engagement program (events, regular family updates, resident life content, whatever) has to prevent 4 avoidable move-outs to pay for itself. Everything above + beyond that is NOI…and NOI gets multiplied by 16.
The best part? You don’t need to prove a specific event caused a specific family to stay. You need to know what a move-out costs, estimate the number of preventable move-outs per year (which you can probably do just by talking to your staff + reviewing all of the move-outs from the last 12 months), then design a program that targets the causes of those preventable move outs. Run it for a year & count the number of preventable move-outs. If you spent $10,000 on the program + the number of preventable move-outs went from 18 to 8, congratulations! You made a ~160x return on that $10,000.
That’s how an underwriter evaluates a capital project. There’s no reason marketing should be held to a different standard.
This same math applies to virtually every other industry, too – if a professional services firm implements a program that retains 10 clients that otherwise would have churned, the value created from that program = (revenue * incremental months of retention / 12 * margin * multiple).
For single-event companies (i.e. window replacement, plaintiff’s injury work, dental implants, etc.), there’s two levers: (1) the clients who leave or fire you; (2) the clients that could refer, but choose not to. A retention program moves both numbers in a more positive direction. Again, the math is a different variant on the same theme.
You Don’t Need To Be A Finance Person To Apply This
Before your next budget conversation, work out 5 numbers for your organization. None of them require new software. They just require translating what you already track into the language your owners use.
- What’s one vacant day worth? Monthly rate ÷ 30 × the share that reaches NOI.
- What’s one point of occupancy worth at exit? Annual NOI per occupied unit ÷ est. cap rate.
- What does your move-in special really cost? The monthly discount × your average length of stay * cap rate
- How long does it take to refill a unit? Inquiry to move-in and move-out to next move-in. Multiply those days by #1 above.
- What’s the break-even on each retention program? Annual cost ÷ what one avoidable move-out costs you.
Bring those 5 numbers into the room and the entire conversation changes. Why? Because you’re no longer asking for a budget. You’re demonstrating to the investors/owners/operators what the building is worth with it and (more importantly) what it’s worth without it.
Marketers have spent decades (i.e. my entire career) trying to earn a seat at the “big people” table by getting better at reporting what marketing costs. Honestly, the seat was always available – but getting it requires learning to report what marketing is worth.
So, this is my plea to all of you: stop thinking like a marketer. Start thinking like an underwriter.
Cheers,
Sam
