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The Economics and Realities of Club Renovations

Private clubs are capital-intensive facilities, in terms of both operations and physical improvements.Buildings, grounds and outdoor facilities generally have a fixed life span and require continuous attention. Maintaining and improving a club’s facilities can involve some of the most expensive, and difficult decisions a club can make. The average useful life of these assets dictates careful resource planning and allocation. All clubs should have a long range planning committee dedicated to analyzing the needs of the club.

The recent recession has placed an additional burden on clubs as reduced membership and, in many cases, lower initiation fees, has reduced the pool of available funds for capital improvements. In addition to long range planning, a number of capital needs arise on a yearly basis. During the recession, many clubs adopted a “fix only if broken” philosophy. The problem with this is twofold. First, duct tape only goes so far and lasts so long. Second, not replacing assets that need to be replaced does not remove the expense; it just pushes it off, potentially at a higher cost. This does not address the need for actual renovations at some time in the future.

The club must develop a plan that analyzes these capital needs on an ongoing basis as well as into the future. This list should include all items that need replacement as well as any future renovations or additions. As part of the plan, the club
must distinguish between needs and wants, project future resources and determine how it is going to fund any deficits. Often, members’ desires exceed the amount that they are willing to spend. During this phase the board should look at past performance and take note of any changes since the last period of capital budgeting. It also should look at its position in the marketplace. As the recession ends, more clubs are reevaluating the facilities and going forward with projects to improve the clubs’ standing in the community. Improvement of a club’s facility can dramatically alter a club’s prospects in the community. Refashioning a club’s facilities can attract members,launch new services, and change the
atmosphere and energy that pervades the club environment.

NCA’s Club Director Reference Series publication, “Capital Budgeting Guidelines for Private Clubs,” lists five items that clubs should consider in the planning process:

1. Consistency with the club image. Why did members join the club in the first place? Will the proposed changes alter the perceived image of the club both among the members and in the community? This may be a good thing because
the area may have changed and the members and proposed members may want a different experience now. However, members want a distinct value in return for the investment in the club so this should be reviewed carefully.

2. Trends in the national and local economy. 
Clearly successful clubs are more family-orientated than in the past. The focus is no longer solely on golf, and fitness has surged in priority. Dining takes on greater importance and the desire for outside and casual dining continues to increase.

3. Community influences or issues. It is critical to understand the type of challenges and influence neighbors can have on any proposed changes to the facilities of a club. Communities are much more environmentally conscious than in the past and objections may come from a variety of sources.

4. The size, age, condition and capabilities of various capital items. In addition to evaluating the proposed renovations, clubs need to evaluate what they are not changing to determine the quality and cost of maintaining any existing facilities.

5. Communication with membership. All long-term projects, especially major renovations at a club, should be thoroughly explained to the members. While a club can never satisfy all its members, one of the worst things that can happen is to have a lot of time and energy spent on developing a plan and finding out it has no support. The earlier members’ opinions are solicited, the more likely any proposals will have the support of the membership.

FUNDING THE PROJECT

The club has established a plan and set forth its expected capital needs for the next five years. In addition it decides to go ahead and do a major renovation project. The plan integrates the direction of the club’s capital improvement projects with the club’s mission and overall member needs. As part of the planning, the board looks at a variety of methods to pay for the project. Unfortunately, while normal capital replacement may often be funded through operations, major capital expansion programs generally require additional funds. So where do they come from? In all cases, the funds come from the membership in one way or another, either through cash or opportunity costs.

In addition to the cost of the project itself, it is important that any projections include the additional operating costs associated with the new facilities. Opposition to the project also must be considered because depending on the method of financing selected, members may choose to resign rather than pay their share of the costs. In addition, care has to be used in making assumptions of increased membership or increased member usage after the project. Not all renovations generate additional revenue over the long term.

The club must evaluate the state of its membership. Does it have a waiting list? Is the number of total members increasing or decreasing? The members must be prepared to support additional cost into the future. What is the economic forecast for the community and how will that impact the demographics of future club members. In the past, many clubs did not do improvements until they had sufficient funds to pay for any improvements. That is not the case now. There are a variety of methods that clubs use to generate the needed funds. Many clubs use a combination of several.

INITIATION FEES

Initiation fees have always been the principal way that clubs have raised funds for capital improvements. Many require that initiation fees may only be used for this purpose. However, this source of funds was reduced during the recession. Clubs not only did not bring in new members but many actually lost a significant portion of their membership base. In addition, deals were cut and initiation fees in many cases were substantially reduced. While many clubs are recovering, there seems to be a much greater difference in the top clubs and the rest of the industry. As a result, initiation fees are not the source of capital funding that they were in the past.

However, this is an area to be explored. How do the club’s initiation fees compare with others in the area? Will an increase turn away potential members, or is there sufficient demand? More importantly, what happens if the projected members do not join? Where does the club make up the shortfall? 

INCOME FROM OPERATIONS

Income from operations is another method of either paying for improvements or servicing future debt. Depreciation is a noncash (but real) expense of the club. Income from operations should cover the depreciation expense on a yearly basis. A club that is financially secure usually budgets to reach better than a breakeven point before depreciation. However, the 2014 edition of Clubs in Town and Country published by PBMares, LLP shows many clubs are not able to do this. Some clubs have started to reserve funds in a Capital Improvement Fund. However, the 2014 CMAA Finance and Operations Report indicates only 63 percent of clubs currently have such a fund, and for those that do the median balance ranges from a low of $70,000 for smaller clubs to $734,162 for the larger clubs. While this may not be sufficient to do most projects, it is hopeful for the industry that clubs are becoming more financially astute.

ASSESSMENTS

In the case of a large project, most clubs have some form of assessment. This can either be on an upfront basis or over some specified period of time. The amount of the assessment can be adjusted based on membership classes or other pertinent distinctions. Some clubs provide for a monthly assessment for capital purposes only. The difficulty with this method is that members see this as additional dues.

BORROWING MONEY

Generally clubs are able to borrow money for capital projects, or at least some portion of the need. Over the last 15 years, the number of clubs borrowing money to pay for projects has skyrocketed. The era of inexpensive loans and (prior to the recession) constantly increasing membership made this step more palatable to the existing members. However, it is important to note that in dealing with a third party, lenders will expect realistic projections and assurances that the loan will be repaid. In the past, lenders were much more flexible about the terms related to any borrowing assuming that the club could assess their members if operations were not as successful as expected. Alternatively, the collateral that the banks held usually was substantially higher than the value of the loan. That has begun to change. Many banks are stuck with notes that are not being serviced. The value of the improvements is no longer worth what they cost. Banks have foreclosed and clubs have been sold to satisfy the debt. Alternatively, in some cases outside parties have taken over the debt from the bank and are operating the club. Clubs also may borrow from the members in lieu of, or in addition to, a financing institution. Generally these bonds are subordinate to outside debt and may be partially noninterest bearing.

MEMBER GIFTS

Finally, clubs should not be adverse to asking members for contributions to support capital projects. While gifts to the clubs are not tax deductible, many members would be willing to support the club in this fashion. It is important that the members making the gifts consult with their tax advisors to avoid any issues with respect to gift or estate taxes. Capital budgeting is critical to the successful operations of a club. The board should be aware of the short- and longterm needs and resources to ensure the success of the club for its members.

Kevin Reilly is a Partner at PBMares, LLP. His areas of practice include hospitality consulting including clubs, hotels and restaurants, real estate consulting, individual and business tax planning and preparation, and business advisory services. He serves as a director of NCA and as secretary/treasurer of the NCA Foundation. You can reach him at [email protected] or 703-385-8809.

SIDEBAR

Determining Renovation ROI by Laurence Hirsh

America was primarily about prestige and status. In the early years of this century, and especially post-economic downturn, we’ve seen a demonstrable shift in member behavior. Prestige and status remain relevant, but to a smaller percentage of private club members. Today, the emphasis has shifted to the perceived value members receive for their recreational dollar.

The shift in this dynamic hinges on a phrase we all recognize and understand, return on investment, or ROI. Clubs should approach it from two distinct vantage points.

First, for members, are the facilities and the programming at a club worth the investment?

That’s almost a trick question, because even if the answer is “yes,” the hyper-competitive nature of today’s private club market (in short, too many clubs fighting for the same limited number of members) obliges clubs to consistently reinvest and upgrade at all levels. That’s what it takes to achieve a productive price-value relationship over the long term.

Second, how do clubs ensure their reinvestment and upgrades yield the desired return, i.e., healthy membership rolls and appropriate dues structures?

There is no magic ROI formula due to the unique nature of individual clubs and markets. A course renovation, for example, will not necessarily increase membership, or enable a dues hike. However, if an improvement project is well conceived and implemented, and if opportunity exists in a club’s particular market, the chances of success increase exponentially.

One vital directive for any club looking to achieve ROI—from both perspectives—in this new market environment is:

Truly understand your property and your market, because that market—your club’s actual position in that market—affects every aspect of the ROI you seek, be it project planning, feasibility, financing, even implementation.

In any given region or market, there are typically three or more private clubs that compete for a finite pool of members. Unfortunately, clubs are notoriously weak at determining those areas where they compete poorly with other clubs. Why? Because membership in a private equity club for many people is an emotional, nostalgic, utterly subjective thing. Accordingly, honest self-assessment of a club’s quality—broken down into component parts: golf course, other sports facilities, clubhouse, dining room, locker-room facilities, overall programming—is supremely difficult. That’s why objective third parties, who are not saddled with these emotional attachments, are useful aids to the process.

Clubs should consider any investment in these components with a clear eye, in the context of how that upgraded component will compete in their particular market. Only then can clubs answer the other key questions related to project feasibility and, ultimately, ROI.

To continue with the golf course component as an example, will these course improvements enhance membership development and stability? Are existing members willing to pay for them? Will existing members use the course and other club facilities more frequently as a result? How will club revenues be impacted moving forward, both in the near term and long term? How will the enhanced facilities impact the club’s operating expenses? What kind of capital reserve will be required to fund replacement of new items in light of this course renovation expenditure?

Let’s get more specific in the golf course context. Many clubs today are considering state-of-the-art golf practice facilities as part of a course renovation. What’s the ROI on that additional of investment?

Well, you can’t responsibly answer that question unless and until you’ve answered the questions above—and you can’t do that until you’ve assessed what other private clubs offer in this specific component area. How many competitors have a practice facility? How good are they really? What ROI have those competitive clubs realized as a result of their practice facility investments? How many upscale daily-fee courses in your market offer this component (because here private clubs compete directly with public golf)?

The ROI of every potential investment must be set in this market context—even how your competitors financed their own investments, because, as we know, the debt clubs have incurred the last 10 years has greatly affected their ability to invest as they should.

In Blue Ocean Strategy, by W. Chan Kim and Renee Mauborgne, the authors challenge companies to break out of the “red ocean” of bloody competition by creating uncontested market space that renders the competition more or less irrelevant. In many ways private equity clubs swim in the red ocean—when it wouldn’t be that hard to find calmer, blue waters.

Clubs must undertake this sort of active market differentiation. But they can’t differentiate themselves in a market, and realize the desired ROI, without first achieving a thorough, honest understanding of that market— and their place in it.

Laurence A. Hirsh, CRE, MAI, SGA, FRICS is the president of Golf Property Analysts, a leading golf property appraisal consulting and brokerage firm based in Philadelphia. He can be reached at [email protected] or 610-397-1818.

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