Retirement villages can afford to treat customers better
Would you pay $13,500 for the opportunity to earn $1 million from a single customer? Save that thought, because it’s the crux of the battle between retirement village operators and residents. And the spoiler alert; I’m on the side of residents on this one. Operators should cough up.
Residents demand 28-day buy-back
An incredible 11,300 surveys, in 18 boxes, were hand-delivered to the Ministry of Housing and Urban Development as part of the government review into retirement villages this week. Our older generation should be proud of their turn-out. I’m told it took 3000 hours of volunteer time to collate the results.
The hottest financial topic on their list is “buy-backs”. Residents want village operators to repurchase their units within 28 days of death or exit. They see this as fair, because they don’t own their home (it’s only a licence to occupy) and operators keep all the capital gains on the property as well as a 20% to 30% deferred management fee.
A compulsory buy-back is seen as a very small way of rebalancing the financial unfairness embedded in village contracts.
28 days, six months or 12 months?
While the ministry has considered imposing buy-backs after units remain unsold for six or 12 months, residents are pushing hard for more. Personally, I agree with them.
The 12-month option appears to be a waste of time. Only 5% of units are unsold after a year. A compulsory buy-back would benefit fewer than 250 families and the status quo remains on use-of-money losses for all families. The policy only mops up a few problem cases at the tail end.
The six-month option also lacks fairness. Only 23% of units remain unsold, meaning 1100, of the 4800 units which come on the market each year would get a buy-back. Three-quarters of residents would suffer the same use-of-money loss that they do today.
28-days is affordable
The reason I support the calls for the 28-day buy-back is because operators can afford it and it’s a small legislative reset that recognises what residents have given up financially.
Over the lifespan of an average resident (eight years) with a $600,000 unit, operators can earn $1,000,000. On the cost side, looking at how unit sales are distributed, funding a buy-back will average out at $13,500.
Does that sound unfair? It really doesn’t to me, especially when I can see half of the revenue ($510,000) is made up of tax-free capital gains. This comes from an 8% a year house price inflation assumption in the ministry’s model.
The $13,500 cost is less than 3%, leaving operators with 97% of the capital gains. In any other property transaction, these would belong to a homeowner.
For all the bluster and foot stamping that villages will be brought to their knees if we have compulsory buy-backs, I simply don’t buy it. No owner of a business will ever agree to legislation that costs them money. It’s fair game to fight it all the way to the finish line.
This is a very wealthy industry and it’s almost impossible to fail. There’s so much money sloshing around the financial model, you could build one blind and still do well.
Any board of directors who feel a 28-day buy-back is going to break them, should probably pass the baton to shareholders with stronger capital structures.
What does it cost an operator to buy back a unit?
Here’s how I get to the $13,500 cost. The ministry has been using a model which takes a $600,000 unit and calculates $450,000 is paid back on death or exit (due to the 25% deferred management fee).
Operators either get a bridging loan or use their own capital for short periods, to fund this. Either way, the cost of accessing this money is said to be 10% a year.
If a unit sat on the market for a full year and didn’t sell, it would cost the operator $45,000 (10% of the buy-back price of $450,000). But that doesn’t happen. There is a sales distribution curve. We know 77% of units sell within the first six months, 91% are sold within nine months and after a year 95% of units have new owners. We can probably assume the last 5% will sell within 18 months. With an even distribution of sales within these bands, this dramatically reduces the cost of capital/debt operators use to $13,500 per unit.
With just over 40,000 units in New Zealand and a 12% death rate each year, 4800 units come up for sale.
So, here’s the big picture; across the industry, legislation would add $65 million in costs. But for that, operators maintain the social license to continue taking capital gains that traditionally belong to families; $2.5 billion worth on 4800 residents who die or exit a village each year.
We could argue the toss on the inputs into the model until we are blue in the face. But even if those gains were halved, operators would be giving residents their money back in 28-days and still taking 95% of the capital gains. The fairness dial on this matter is pretty robust.
How much money are operators making?
Over the eight-year life span of the average resident and a $600,000 unit, the numbers show $1,014,000 revenue and benefits. Some values are profits, some revenue. While that’s a slight muddle, it’s valuable perspective. More audited disclosure from operators would be welcome.
Development margin: 20% (profit) $120,000
Interest free loan: 39% (benefit) $234,000
Deferred management fee: 25% (revenue) $150,000
Capital gains: 85% (tax-free profit) $510,000
Janine Starks is the author of www.moneytips.nz and can be contacted at moneytips.nz@gmail.com. Readers should always seek specific independent financial advice appropriate to their own circumstances.