Like toll roads, your gut might tell you that retirement villages make an easy motza for the owner and operators.
Australia’s swelling numbers of retirees are a tantalising prospect, with an estimated two million Australians over 70, and that’s set to double in the next two decades.
But as we know from Brisbane’s Clem7 and Sydney's Cross City and Lane Cove tunnels, toll roads can spectacularly under-deliver, and this can also be true for aged care residences. Monetising aged care is in many cases proving frustratingly and unexpectedly difficult.
The fundamentals of an ageing demographic have seduced retail and institutional investors alike as they prepare for the prospect of a booming aged care and retirement industry. But aged care, retirement villages and nursing homes all have unique risks.
Exit fees, or deferred management fees (DMF), are a particular idiosyncrasy that can be problematic for investors. These fees are the controversial one-off payment made by the resident when they depart the accommodation, often representing a weighty chunk of the total cost.
Advisory firm McGrathNicol notes that the nature of the DMF model makes it difficult to determine the ability of an operator to service debt at any particular point in time, and requires funding facilities to have sufficient flexibility where forecasts are not met.
“The DMF model is inherently uncertain,” McGrathNicol says.
This is because revenue is based on the turnover of residents, with profitability maximised through shorter, more frequent turnover cycles. Cycle times are under pressure despite there being more demand for retirement dwellings because residents are living longer.
“Optimising turnover will always pose a challenge to operators, with the most successful being the ones who can provide compelling, alternate offerings to enable retirees to easily transition to a higher level of care to match their circumstances,” McGrathNicol says.
The average resident only leaves after perhaps a decade, and this lumpy and difficult to forecast nature of income can be a burdensome weight on finances and require a large corporation to sustain returns in the meantime, based on future expected exit fees. This has led to criticism that this unique and complicated fee structure, which is widely despised by residents, can struggle to outperform vanilla residential property returns – an inadequate return on investment.
“We’ve talked to offshore investors and they say if it’s deferred management fees, we won’t do it,” says one fund manager. “It’s an odd structure that’s not well understood. We don’t think it’s a good model.”
Offshore investors find the structure too unusual and uncommon, and that’s offputting. Part of the problem comes when the occupier leaves the residence, as the resale is often left to a local property manager with no vested interest, and units can sit on the market for longer.
“A major exercise undertaken is to make sure new villages are well occupied and they don’t pay enough attention to that turnover,” says the fund manager.
“The expectation is that you would realise a return similar to residential property. That sort of works in value terms until actual sale. Then there is not adequate reward for the investment,” he says, urging villages to instead work on a more regular rental model.
McGrathNicol says that given that the DMF model is based on a leasehold rather than freehold title, dwellings have a different intrinsic value than a comparable residential dwelling, meaning sale value and turnover assumptions are critical. It warns that unrealistic forecasts and expectations regarding take-up and pricing are the key reasons retirement development projects fail.
In the early stages of DMF structure, resident levies don’t meet operating expenses and cash resources can be put under strain before a critical mass of residents is achieved. So ensuring there is sufficient cash flow to fund construction of facilities and service debt along the way is essential.
Australia has around 2,000 retired living facilities catering to widely different socio-economic groups.
One operator which has eschewed the DMF model in Australia is ASX-listed Eureka Group Holdings, which caters to retirees dependent on government funding, whether via the pension or rent assistance. This is the fastest growing group of retirees in Australia, says Eureka’s executive chairman Robin Levison.
“We set out to target this particular set of customers. The rationale is to make money but we can also provide a service to the community,” Mr Levison says in an interview.
The group has received “wonderful” professional and private investor support, the majority local superannuation institutions, and also 900 individual shareholders.
“It’s the most difficult to place to make a return but if we weren’t making profits they wouldn’t be as supportive,” Levison says. The stock climbed all the way from a year-low of 26 cents to reach a high of 68.5c last month.
The group, which focuses outside the major cities where there is less competition in places such as Rockhampton, Bundaberg, Mount Gambia and Mildura, has a “buy and build” acquisitive strategy which has seen it add 17 sites over 20 months, with no plan to slow down. Levison says cost control is vital, and you need scale via multiple villages, and to cluster services.
“Economy of scale tends to really pay dividends,” he says.