Capital Transferred

CAPITAL VALUE TRANSFERRED FROM OLDER AUSTRALIANS TO RETIREMENT VILLAGE OPERATORS

Capital Transferred – It is important for prospective retirement village residents to understand the impact of the current retirement village business model on the capital value of older Australians both in the short term and the long term.

The deferred fee business model drives many occupants within a retirement village toward what is referred to as the retirement village financial or poverty trap. A situation where the value of their capital base has been impacted by inflation, rising property prices, rising aged care entry costs, deferred fees etc. Residents have been reduced to the point where they have insufficient capital for another phase of their life should the need arise eg:

1. Fund an aged care placement of choice
2. Re-enter the property market

The higher the percentage of the original capital base used to enter a retirement village the higher the certainty a retirement village resident will not have the capital resources to enter this next phase. their capital base devalued to the point of reliance on family or government support.

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The federal government has announced financial incentives for older Australians to sell their family home, to downsize including a move to a retirement village where the value of their capital base will be reduced and for many to the point where they will need to go back to the federal government for increased financial support for the next phase of their life. This seems at odds with other government policies of enabling older Australians to remain longer in the family home and thereby reduce pressure on aged care funding requirements. The retirement village business model increases the demand for aged care funding as it produces citizens that no longer have the capital base necessary to either return to the property market or contribute to their own aged care placement.

capital transferred

 

entry price componentsRetirement village residents as part of their ingoing payment provide interest free capital to the operator in the form of the refundable amount, due for repayment only on departure less any outgoing expenses such as unit refurbishment costs etc.

This pool of free capital to the operator increases over time as the value of each unit grows. The new higher ingoing amount results in a higher interest free loan amount per unit. This total pool of funds is a means to reduce or remove any commercial borrowing costs and eventually grow to be a source of income through investment.

The image to the right shows a village with an entry cost of $500,000.00 and a deferred fee rate of 25% . This scenario would produce an interest free loan to the operator of $375,000.00, refundable to the resident only on departure.

 

 

There are two primary issues impacting older Australians in relation to retirement villages:-

The reduction in value of the capital base of older Australians having entered a retirement village.

The visible and the not so visible transfer of capital value from older Australians to retirement village operators.

The common parameters for each of the following tables below are:-
Deferred Fee Period – 3 years
Deferred Fee Rate – 35%
Capital Gain Rate – 42% flat over 7 year period
Capital Gain Share– 100% to operator
Unit Turnover Period – 7 Year Average

Which option has the largest negative impact on my capital base?

The following table gives an example of the potential financial impact over three different residential accommodation scenarios.

This is the view for a potential resident proposing to lease (not own) a unit in a retirement village governed by the retirement villages act, the following table compares three popular options for older Australians.

1. Sell the family home and enter a Retirement Village under a lease arrangement,
2. sell the family home, invest the capital amount received from the sale and rent a unit within the community,
3. stay in the family home.

After the first 7 year period the table shows the impact on the original Capital Value of $500,000.00:-

Column 1. Retirement Village – the impact is minus $275,000.00 capital to a lower value of $225,000.00
Column 2. Rental Unit – the impact is minus $70,000.00 capital to a lower value of $430,000.00
Column 3. Family Home – the impact is an increase of $210,000.00 capital to a higher value of $710,000.00

capital transferred

The table does contain variables such as the exact terms of the village contract, the rate of return to a rental unit landlord, the rate of return on a cash investment, the rate of return through capital gain. The table does not place a $ value on the communal/social aspect of living in a retirement village nor any $ value on the use of the communal and recreation facilities. The table does however clearly indicate the financial impact whether positive or negative and the likely financial outcome for the original capital value of $500,000.00.

The decision for a prospective retirement village resident is whether the value of the communal/social living aspect and the use of the communal/recreation facilities can justify a direct cost of $275,00.00 in the first 7 years of occupancy.

In addition to this direct cost of $275,000.00 there can be further indirect losses such as –

$113,750.00 – loss of earnings at for example 5%pa ($500,000.00 – $175,000.00 = $325,000.00) on the interest free loan (refundable amount on exit) to the operator.
$100,000.00 – loss of the increase in the value of the village unit at for example 2.85% on the initial unit value per annum.

In the retirement village example above the direct costs and indirect losses give a total reduction in capital value for a resident in a retirement village of $488,750.00 ($275,000.00 + $113,750.00 + $100,000.00) in just the first 7 years of occupancy, for a village with 100 units the total reduction in capital value would be $48.8m dollars. As the average occupancy in a retirement village is quoted at 7 years this scenario can be repeated every 7 years over the life of the village. If $48.8m dollars is the total for just 1 x 100 unit village, what is the total capital value reduction across the entire Australian retirement village sector.

It is true to say that a seven year turnover cycle per unit may not be uniform but 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 all or part of more than 1 cycle.

The transfer of capital to a retirement village operator.

It is important for legislators to understand the transfer of the capital value from older Australians to retirement village owners/operators. The following table calculates the $ value of this transfer of capital value for the various components of the retirement village deferred fee business model, there is no argument here that a village developer/operator is not entitled to a fair business/risk reward ratio. One should question however whether the risk/reward ratio is excessive when it is at the expense of a vulnerable class of Australian citizens.

This is the view from the perspective of the operator having leased out a unit in the retirement village and received the ingoing payment of $500,000.00, not providing ownership but just occupancy of the unit. The table below calculates the capital value gained by a village operator over a 7 year period from both just 1 unit and a village of 100 units. The operator never surrenders ownership of the property, the resident only has a lease despite paying an ingoing amount commensurate with the ownership cost of a similar rental unit within the general community plus costs generally associated with actual residential property ownership.

The table below shows the Capital Value gained by the operator from the lease of 1 village unit over a 7 year period.
Deferred Management Fee – +$175,000.00
Capital Gain – +$100,000.00
Interest Free Loan – +$113,750.00
Unit Refurbishment – +$50,000.00 cost paid for by the residential leaseholder
Maintenance & Administration Fees – +$50,000.00 costs paid for by the residential leaseholder
Total Capital Value Gained x 1 Unit – +$488,750.00
Total Capital Value Gained x 100 Unit Village – +$48.8m dollars

The average period of occupancy in a retirement village in Australia is quoted at 7 years, the operator has the capacity to repeat this scenario every 7 years over the life of the village.

capital value gained

The table above does contain variables such as the exact terms of the village contract, the rate of the deferred management fee, the rate of return through capital gain, the value of savings from lower or zero commercial borrowings as a result of the interest free loan provided by the resident, the value of the unit refurbishment costs, the value of administration and maintenance costs. The table does not show any village development costs as these are partially or totally funded from the very first sale of each of the 100 units. The table does however clearly indicate the positive impact and the potentially substantial increased capital value outcomes for the operator over each 7 year cycle over the life of the retirement village.

Again the decision for a prospective retirement village resident is whether as per the example above the value of the communal/social living aspect and the use of the communal/recreation facilities can justify the direct cost of $275,00.00 and the indirect losses of $213,750.00 in the first 7 years of occupancy. It seems that this reduction in overall capital value of $488,750,00 for what is likely to be on the industry average a seven year stay, that no amount of communal/recreation facilities, no amount of communal living and social interaction could possibly compensate for this reduction in the capital base from entry to departure.

In the end of course the final decision is that of each individual prospective resident, they should seek plenty of professional advice particularly from people who understand the industry. Village developers and operators are of course entitled to profits earned representative of the business risk and investment but this risk/reward ratio can become lopsided and legislators and consumer advocates have a responsibility to ensure the the playing field is reasonably level for all parties, particularly for older Australians many of whom are subject to glossy brochures and slick sales techniques at what can be an emotional and vulnerable time in their life.

Capital Transferred.

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