Roy Davidson, 23 November 2020

COVID-19 hit the share prices of retirement village operators hard as investors fretted about the impact a weaker property sector could have on the sector’s bottom line. But why are retirement village and aged care companies so exposed to property prices?

The retirement village business model in a nutshell

When you move into a retirement village you are not buying the unit or villa itself as you would buy a house or an apartment. Nor do you simply pay rent. Rather, you buy a right to occupy - what the industry calls an ‘occupation right agreement’. This basically gives you the right to occupy a unit for life, or until you decide to move on, say to an aged care facility which are often co-located in the same village.

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When a resident leaves they are repaid the value of the occupation right agreement by the retirement village operator, minus a ‘deferred management fee’. The size of this deferred management fee varies between operators, but the country’s largest, Ryman Healthcare, charges a 20% fee after five years (or 4% annually). Fees from other operators tend to be higher than this. For example, Oceania’s is 30% over three years.

This means that if you buy an occupation right agreement for $500,000 and stay there for five years (or more), you’ll receive $400,000 back at the end. Stay three years and you’ll receive $440,000 back. In the meantime, however, the operator is able to use the money paid for the occupation right agreement, say to develop further villages.

Higher property prices result in resale gains

Ok, so that’s the basics of how the retirement village model works. But, how do rising (or falling) property prices come into this?

Well, at the end of the resident’s occupation, the retirement village is able to sell another occupation right agreement on the same unit to another prospective resident.

As people usually sell their family home to move into a retirement village, the price of an occupation rights agreement is heavily influenced by the value of surrounding properties.

Therefore, if property prices rise, the operator will likely be able to sell the occupation right agreement at a higher price than before, making a profit. This is called a resale gain.

On the flipside, if property prices fall, the retirement village operator is likely to suffer a loss. The retirement village operator is effectively taking on the market risk.

The below shows an example where an operator is able to sell an initial $500,000 occupation rights agreement for $550,000 five years later using Ryman’s pricing model. $400,000 is returned to the resident and the operator makes $100,000 as a deferred management fee and $50,000 as a resale gain.

How the retirement village model works

retirement villages making money

So, with the property market looking shaky in the early months of this year, investors worried that these resale gains would dry up. In addition, the balance sheets of some companies with significant development pipelines balance sheets were scrutinised. This is because the inability of potential residents to sell their existing home in a timely manner could impact the time taken to resell a unit, while new developments may take longer to be fully occupied, pressuring cash flows.

However, with the Reserve Bank moving swiftly to protect the economy and the property market via quantitative easing, lowering the official cash rate and reducing limits on bank lending, the share prices of operators within the retirement village sector have since recovered strongly.

Retirement villages make money in other ways

While deferred management fees and resale gains are a retirement village operator’s bread and butter, they receive revenue form a few other sources too.

Firstly, when developing a new village, the operators will earn a development margin – basically the difference in the cost to buy the land and build the village, and the amount they receive from selling occupation rights agreements. Residents will usually pay a weekly village fee. However, these typically just cover the costs of maintaining facilities, landscaping, gardening etc.

Finally, most retirement village operators also have aged care facilities from which they will receive care fees from the Government at a mandated rate. In addition, operators can charge premium fees for higher quality rooms. Some operators have also started blending the occupation rights agreement into aged care creating ‘care suites’.