Capital Lost

Capital Cost or Capital Lost – There is a hidden issue in all the discussions around Retirement Villages.

NOTE;- THE CAPITAL VALUE LOST IS NOT BECAUSE THE STOCK MARKET CRASHED, NOT BECAUSE THE HOUSING MARKET CRASHED. THE CAPITAL VALUE LOST IS BECAUSE THE RETIREE SIMPLY SOUGHT RESIDENTIAL ACCOMMODATION IN A RETIREMENT VILLAGE AND MADE A PAYMENT COMMENSURATE WITH OWNERSHIP BUT WAS GRANTED ONLY A CONDITIONAL RIGHT TO OCCUPY.

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The issue for governments and legislators is the total $ value of capital lost as a result of the transfer of capital from Retirement Village Residents to Retirement Village Owners/Operators. There is a failure amongst consumer protection agencies, legislators, legal and financial advisors as to what the real nature of the industry is, a business model that transfers large amounts of capital away from older Australians into the hands of the owner/operator whilst the owner/operator still retains ownership of the asset.

The industry states a retirement village is not a property investment but a lifestyle but what is the cost of this lifestyle, the total cost. In the example below for a village of 100 units over 4 cycles of occupancy the total cost to residents is $161,510,000.00, yes one hundred and sixty one million five hundred and ten thousand dollars. This is the monetary value that has transferred from these 400 odd retirement village residents into the hands of the village owner/operator. Is this amount an accurate reflection of the value of the lifestyle delivered, it is more reflective of the transfer of ownership of real estate but this does not occur because an operator is able to charge a property occupancy fee commensurate with the cost of property ownership. All this supported by legislation which in some states requires that to be a retirement village one of the residents must have paid an in-going amount.

At this point some would say that without this business model investors would not construct retirement villages whereas thousands of Australians purchase investment property everyday yet do not require the retirement village business model to make satisfactory returns. In the individual private investor model the resident pays a weekly rental fee but retains 100% of their own capital base. There are only two things missing 1. security of tenure and 2. communal recreation facilities within the complex. There are proposals to have retirement village operators display an equivalent weekly rental cost based on the in-going amount, deferred fees, exit fees, refurbishment costs, earnings forgone to a enable a prospective purchaser to better examine and compare costs across the three options, retain ownership of the family home, enter a retirement village, rent privately and retain 100% of their capital.

Nobody will argue that village developers and operators are not entitled to profits earned for business risk and investment. What is argued here is the dramatic $ value of the loss of capital suffered by older Australians who enter retirement villages, a loss that should not be encouraged, supported or incentivised by governments at any level. Residents simply purchase a right or licence to occupy a residential property whereas the capital values expended are as if they are actually purchasing that residential property.

After a period of development with no doubt some commercial borrowings a village operator moves to a position where the asset is 100% owned by them and any capital costs are zero. The operator receives from the residents 100% of the village operating and maintenance costs through a monthly fee, 100% of the capital replacement and capital maintenance costs through deferred management fees and/or a capital or long term maintenance fund, 100% of the refurbishment costs of each unit, 100% of any long term capital requirements interest free and/or a large pool of investment capital interest free, 100% of the asset capital appreciation in many cases.

Beyond the establishment stage the cost of capital to the operator becomes totally free as each resident lends interest free capital as part of their in-going amount repayable on departure. This pool of free capital to the operator increases over time as the value of each unit grows to an amount initially in excess of any commercial borrowings and eventually beyond the value of the village development costs. Eventually this pool of free capital is simply a source of income to the operator through investment earnings on the funds.

Industry operators claim that their in-going sale price is generally 80% of an equivalent unit in the general community, what the never say of course is what was the cost to develop the unit in the village in the first place. The real question is are they already in profit even with a sale price at 80% of an equivalent unit in the general community. The 80% equivalent value model is left over from the very early not for profit organisation developments for residents from a lower socio-economic level. It is a technique used by the industry to both sell their units (very few prospective residents actually examine the truth of the statement) and to blind the legislators by suggesting that they are in some way giving a discount to enable older Australians the opportunity to purchase residential accommodation that they otherwise would not be able to afford.

The federal government is encouraging older Australians to sell their family homes, to downsize including moving in to retirement villages where their once growing capital base begins a journey of devaluation through deferred management fees, loss of earnings, inflation, rising property prices, rising aged care entry costs. For some retirement village residents it will reduce to the point where they will need to go to family or the federal government for financial support for an aged care placement.

In the examples below it is true to say that a seven year turnover cycle per unit is not uniform in real life although it is the industry average. Some units will be turned over two may be even three times in that 7 year cycle where some may have the same occupant for a large part of those four 7 year cycles.

The common parameters for each table below are:-

  • Deferred Fee Period – 3 years
  • Deferred Fee Rate – 30%
  • Capital Gain Rate – 20% over 7 year period (modest)
  • Capital Gain Share– 100% to operator
  • Unit Turnover Period – 7 Year Average

Let us look at some of the primary issues:-

Deferred Management Fee

Deferred management fees are claimed by developers and operators as their means to create a profit and /or provide communal facilities but what is the reality.

retirement village deferred fees

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of capital has changed hands under Deferred Fees.

  1. Units x 1 – For this one unit over the 28 year period a total of $805,200.00 has been paid by residents in Deferred Management Fees to the operator.
  2. Village of 100 – For the entire village over the 28 year period a grand total of $80.52 million dollars has been paid by the residents in Deferred Management Fees

Capital Gain

Although the capital gain share can vary operator by operator, the latest trend is to the operator retaining 100% of the capital gain in exchange for reduced costs on exit.

village units capital gains

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of capital has changed hands under Capital Gain.

  1. Units x 1 – For this one unit the total $ Capital Value lost by the residents over the period in the form of capital gain to the operator totals $364,000.00.

  2. Village of 100 – The total $ Capital Value lost by the entire village residents in the form of capital gain to the operator totals $36.4 million dollars

Value of Interest Free Loan from Residents to Retirement Village Operator

The Interest Free Loan to the Operator is part of the village entry payment, refundable on exit and is the amount left after the payment of deferred fees.

interest free loan to operator

This interest free capital from the residents allows the operator to repay commercial borrowings and/or invest the funds to increase earnings.

  1. Units x 1 – The value of the interest free loan by the resident during period 1 was $350,000.00, $420,000.00 for period 2, $504,000.00 for period 3 and $604,800.00 for period 4.

  2. Village of 100 – The total value of the interest free loan during period 1 was $35.0m, period 2 $42.0m, period 3 $50.4m and period 4 $60.48 million dollars.

Value of Lost Earnings by Residents from the Interest Free Loan to the Village Operator

The Interest Free Loan to the Operator is part of the village entry payment, refundable on exit and is the amount left after the payment of deferred fees.

village residents earnings lost

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of earnings has been lost to the residents from their Interest Free Loan to the Operator.

  1. Units x 1 – The earnings forgone on this one unit by the residents on the interest free loan component of the in-going amount paid is $445,900.00 calculated at a flat rate of 5%.

  2. Village of 100 – The total earnings forgone by the entire village over the period on the interest free loan component of the in-going amount paid is $44.95 million dollars.

Value Gained by the Operator from the Interest Free Loan from the Village Residents

The Interest Free Loan to the Operator is part of the village entry payment and is only refundable to the resident on exit and will be replaced by a new interest free loan from the incoming purchaser. This maintains a pool of free capital enabling the operator to repay any initial commercial borrowings or invest to increase earnings.

village operator earnings gained

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of savings has been made by the Operator from their Interest Free Loan by the village residents.

  1. Units x 1 – The savings made on this one unit by the operator on the interest free loan component of the in-going amount paid is $891,800.00 calculated at a flat rate of 10%.

  2. Village of 100 – The total savings made over the village by the operator on the interest free loan component of the in-going amounts paid is $89.18 million dollars calculated at a flat rate of 10%.

Total Value of Capital Lost by Retirement Village Residents

The total value of capital lost by village residents from, deferred fees, no access to capital gain and the loss of earnings on the interest free loan to the operator.

village resident capital lost total

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of savings has been made by the Operator from their Interest Free Loan by the village residents.

  1. Units x 1 – The value of capital lost by village residents from, deferred fees, no access to capital gain and the loss of earnings on the interest free loan to the operator is $1,615 million dollars.

  2. Village of 100 – The total gross value of capital lost from, deferred fees, no access to capital gain and the loss of earnings on the interest free loan to the operator is $161,51 million dollars.

Total Value of Capital Gained by Retirement Village Operator

The gross value of capital gained by the village operator from, deferred fees, capital gain and the savings made from the interest free loan from the residents.

village operator total capital gained

If you examine a retirement village unit over 28 years in a sequence of four sales the following substantial amount of savings has been made by the Operator from their Interest Free Loan by the village residents.

  1. Units x 1 – The value of capital gained on this one unit by the village operator from, deferred fees, capital gain and the savings made on the interest free loan is $2,06 million dollars.

  2. Village of 100 – The gross value of capital gained from the village by the operator in, deferred fees, capital gain and the savings made on the interest free loan is $206.1 million dollars.

Summary

The change in the capital position of these retirement village residents is as follows,

The common parameters for the calculations below are as for each table above:-

  • Deferred Fee Period – 3 years

  • Deferred Fee Rate – 30%

  • Capital Gain Rate – 20% over 7 year period (modest)

  • Capital Gain Share– 100% to operator

  • Unit Turnover Period – 7 Year Average

Retirement Village

Deferred Fees Paid = $ -80,520,000.00             

No Capital Gain to Residents =      $ -36,400.000.00              

Loss of Earnings =     $ -44,590,000.00              

TOTAL $ -161,510,000.00                                  

The total figure does not include unit and communal maintenance fees, refurbishment costs, exit costs, capital maintenance costs.

GRAND TOTAL – $ -161,510,000.00 capital lost  in 1 x 100 unit village over the period, all transferred from the hands of over 400  residents to the hands of the retirement village operator.

NOTE;- THE CAPITAL VALUE LOST IS NOT BECAUSE THE STOCK MARKET CRASHED, NOT BECAUSE THE HOUSING MARKET CRASHED. THE CAPITAL VALUE LOST IS BECAUSE THE RETIREE SIMPLY SOUGHT RESIDENTIAL ACCOMMODATION IN A RETIREMENT VILLAGE AND MADE A PAYMENT COMMENSURATE WITH OWNERSHIP BUT WAS GRANTED ONLY A CONDITIONAL RIGHT TO OCCUPY.

THESE VALUES ARE GENERATED FROM JUST ONE RETIREMENT VILLAGE (100 UNITS), WHAT ARE THE $ VALUES FOR THE ENTIRE INDUSTRY.

 

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