Recently, we’ve encountered several situations where the existence of deferred maintenance, capital improvement plans, or both have impacted value at private clubs. To clarify, there is a distinct difference between capital used to address deferred maintenance and capital improvements, though they may sometimes overlap. Typically, capital plans are developed for both. In the ever-competitive club universe, enhanced facilities play an outsized role in membership satisfaction, membership stability and economic success. Deferred maintenance refers to club components that may have been neglected or are past their useful economic life expectancy. To be blunt, capital improvements are typically elective while addressing deferred maintenance is usually essential.
Many clubs will develop capital plans which often include both upgrades and repairs/replacement of infrastructure. An irrigation system that’s 30 years old and experiencing failures is an example of deferred maintenance that also requires capital. It requires immediate action. Adding pickle ball courts to enhance the club’s facilities is an example of an elective capital expenditure. The most fiscally prudent clubs will plan for both by establishing a reserve fund so that funds exist to pay for these items. How they impact value is an interesting discussion relating to a dispute in which we’re now involved where the club has an irrigation system that’s past its useful life and has been recommended for replacement. The seller doesn’t feel this situation should impact value because the appraiser (not GPA) included in the valuation an annual reserve contribution but failed to include an allowance for funds to replace the system now, for which no reserve had previously been established.
If the reserve fund takes 20 years to mature to a point where the system can be replaced, it would be 40+ years old, far in excess of the expected life. Thus, allowance is required for both replacement now and establishment of a reserve for future replacement.
The impact on value can be significant. While it could be a roof, HVAC, cart paths, bunker renovation or any other elements of a club’s infrastructure, most of these items are “mandatory” and an irrigation system can cost in excess of $2 million, or more. Those dollars would be deducted from the ultimate value estimate, typically dollar for dollar, especially if it is an immediate need and a prospective purchaser would be inclined to immediately replace. The annual reserve contribution for future replacements is categorized as an expense, annualized and itemized as such in an operating pro-forma. That, too impacts value by reducing the cash flow to be capitalized.
Unfortunately, while some may think there’s a big boost to value from correcting deferred maintenance, few members or patrons really notice or care how new the irrigation system is. The course is expected to have one and it is expected to be functional. No such windfall occurs. If it fails, however, the value of the club could decline precipitously. If the roof leaks it needs to be repaired or replaced.
The trick, as it relates to estimating value is to understand how a typical purchaser would evaluate the situation and how they might plan for future capital expenditures. Many clubs have long term (5 years or more) capital plans and it’s the analyst’s job to measure how the typical buyer would address these items. If, for instance it’s determined that bunkers can be done this year, cart paths next year and irrigation system two years later, then the costs can be appropriately scheduled and discounted based on when they are expected to occur.
At many clubs, older members seek to defer these costs and pass them on to the next generation. Some members seek to accelerate capital expenditures and improve the club as quickly as possible. There is no one right answer. It depends on the club’s specific challenges, issues and competitive market. If an assessment or dues increase is necessary, the club will need to be in a position where the members are willing and able to pay. That’s not always the case and even the most successful clubs need to be aware of economic fluctuations that can change their market dramatically when making decisions on elective capital expenditures.
Such value decisions aren’t limited to those instances where the club might be sold. If a club requires assessments, dues increases or debt financing the cost of membership may increase beyond its perceived value. If the club already has debt, the club’s value may limit how much can be borrowed for improvements. Understanding the club’s value can be critical in decisions on capital expenditures and which might be mandatory versus elective.