Retirement village mandatory buyback period undermines financial viability of the sector

With Government setting out proposed changes to the Retirement Villages Act, alarm bells will be well and truly ringing for many operators already struggling under a challenging business model.

Pam Newlove, Grant Thornton New Zealand's retirement village and aged care services lead says, "The move to make retirement villages pay interest after six months if a unit remains unlicensed, and full repayment of funds no later than 12 months after a unit is vacated will be a disappointing outcome for all operators, and clearly demonstrates the industry's complex business model continues to be misunderstood entirely."

"There are some huge misconceptions out there about the financial constraints that villages are already operating under, and many of these are based on the belief that building and operating a village delivers the same returns as developing and selling residential property. This is absolutely not the case."

The realities of investing and operating a retirement village in New Zealand

Earlier this year, Grant Thornton New Zealand released an industry study that dispelled this myth and demonstrated that being a retirement village operator is not for those seeking short term property development gains.

The analysis is based on a discounted cashflow model covering a 25-year period and the key stages of a retirement village development from sourcing land and construction, to project completion and revenue generation. The model then takes into account the sector-specific sensitivities that impact a village's profitability, some of which include occupancy lags, occupation right agreement (ORA) sale prices and construction costs. The findings revealed a payback period of more than two decades based on two different, but common, site scenarios.

Newlove says, "By focussing on actual cashflows, the real financial position for operators emerges. While the sites in both our scenarios experience strong early cashflows from the initial purchase of ORAs by new residents and subsequent deferred management fee (DMF) payments, this declines sharply between the seven-and-a-half to 10-year mark as ongoing operational and refurbishment costs start to eat into annual profits.

"And with the average stay of residents between seven to eight years, cashflows from the resale of ORAs quickly decrease due to reduced inflows of new residents. In addition, we know that many operators are already incurring losses on weekly fees of around 20% which puts upward pressure on ORA prices so village owners can still generate enough cashflow to cover their operating costs."

The bigger picture – disaster awaits

Newlove believes if the 12-month mandatory buy back period is passed into law, operators, residents and their families will suffer the consequences.

"Larger operators with stronger balance sheets will be better placed to weather these changes, and in fact many are already repurchasing units before they have been relicensed. However, for medium sized operators who are often located in the regions where there are fewer choices, these proposed changes will come as a blow. Compulsory buybacks would create a requirement for massive cash reserves to be held by operators. Operators will need to have additional lines of credit in place to provide ready access to cash to settle these obligations. The risk profile of villages will deteriorate in the eyes of lenders as greater financial uncertainty underpins operators should these changes be introduced. As evidenced by our model, this would decimate the financial viability of many villages.

"Not only will some villages become financially unviable, the number new market entrants may also dramatically decrease. Operators will most likely react to this by increasing the sale price of new ORAs and hiking up weekly fees, which may make retirement village living inaccessible for some retirees. Operators may also look at DMF percentages (the percentage of the ORA price that is deducted on exit). I wouldn't be surprised to see those rising as well. We only need to look across the Tasman to see the impact of the financial burden on smaller villages when mandatory buy-backs were introduced in Queensland, New South Wales and South Australia."

"The Government is heavily reliant on the private sector investing further capital into this sector to house the ballooning numbers needing retirement accommodation or care. It is well known that independent living units in villages subsidise the provision of care suites, so further investment in care suites could be the casualty of these changes. By imposing further financial pressures on the sector, many operators will be left questioning whether they want to put further capital at risk."