Debt – How much is Right?

Among the challenges many clubs face is how much debt to take on. As most of us know, when one applies for a home mortgage loan, the lender will evaluate your application based on ability to service the debt. Typically, that means your monthly payment shouldn’t exceed, say 25% of your gross monthly income or your total debt from all sources shouldn’t exceed, say 35% of your gross monthly income. Of course, the lender will have an appraisal done on the property and the loan to value ratio will also impact the likelihood of approval.

In the golf and club world, appraisals of the property are also done, and there is often an analysis of a borrower’s ability (or potential ability) to service debt by calculating a debt coverage ratio (cash flow / debt service = DCR).

It often seems as though lenders focus more on the collateral (value of property) which may or may not be representative of a club’s ability or likelihood of adequately servicing the debt. Remember, at many clubs (especially member-owned private clubs) “zero-based” budgeting is practiced where there is no cash flow. Thus, the question of how much debt is appropriate becomes relevant.

According to Club Benchmarking Inc. (CBI), the typical club (median) carries $2,648,058 in debt while the top 25% of clubs (in terms of debt) have in excess of $5.3 million in debt. The median debt to equity ratio is 24% while the highest 25% of clubs are at 56% or above. Of particular interest to me is the debt to gross revenue ratio. The median club (according to CBI) has 34% of operating revenue as debt while the highest 25% are above 61%. In relation to dues revenue, the median club has 82% of dues revenue in debt and the highest 25% are above 139%. What does all this mean?

Clubs often like to compare themselves to each other, but when incurring debt, I’m not sure it matters much more than to simply see where other clubs stand. What’s really important, is whether the debt incurred makes sense to the club incurring it. In some cases, it’s a question of whether the costs are for “required” items (roof, HVAC, irrigation system, etc.) or if the funds will be used for club enhancements, such as a fitness center, golf course renovation, clubhouse expansion, etc. If borrowed funds are to be used for required items, the club will need to show the ability to service the debt. Each member is likely to ask how much it will cost them. If the projects being considered are “desired” and the club can show how membership, club usage and fees (revenues) will be enhanced, then the analysis of how much debt/cost can be incurred would be based on how much additional revenue can be generated. How many new members will these improvements generate? What is the risk to each existing member in dues increases and assessments if no new members or additional revenues are generated?

We like to look at this on a market basis. If dues have to be increased or assessments levied, will the club’s rates be consistent with similar clubs in the competing market? If higher, will the membership be willing to absorb the higher cost in return for the enhanced amenities?

Any analysis of a club’s capability to carry debt needs to consider not only the club’s market value, but also its present – or future – ability to service that debt which is subject to the membership’s (present & future) willingness to support the dues and fees required to service it. It’s a complex analysis with multiple ”moving parts”.