Retirement area earnings to slow

Chris Timms.
Chris Timms.
Rising property prices have provided a major tailwind to the New Zealand retirement sector. Craigs Investment Partners broker Chris Timms tells business editor Dene Mackenzie a cooling housing market will weigh on earnings growth, sentiment and valuations.

The listed retirement sector has a positive long-term future, driven by attractive demographics and a proven business model, Craigs Investment Partners broker Chris Timms says.

However, his view was tempered given a probable slowdown in the housing market.

"We recommend taking some profits and reducing overweight exposures to the sector."

The standard model for a retirement village operator was to sell a right to occupy a retirement villa or unit — known as an ORA, or occupation rights agreement.

That gave residents the right to occupy a unit for life or until they decided to move, such as when they needed higher levels of care, he said.

When a resident moved on, the operator on-sold the unit before repaying the resident’s ORA.

Once a village was developed, village operators earned the bulk of their profits through deferred management fees, resale gains and care fees.

The increasing value of the ORA was a key profit driver, Mr Timms said.

ORA prices were influenced by property prices in the area. It was not a linear relationship. The difference between housing prices and ORAs had expanded in recent years, providing some headroom should property prices fall.

As a result, as property prices rose, so did the prices for ORAs.

"This leads to great resale gains as units are on-sold and higher deferred management fees in future as the value of the ORA increases. Profits of retirement village operators are sensitive to property prices."

The basics of the ORA model included a deferred management fee of 20% after five years for an independent unit.

With an ORA value of $300,000, Ryman Healthcare, for example, would earn a $60,000 deferred management fee after five years and a gain on the resale — in this case $80,000 Mr Timms said.

From the sale, $240,000 was returned to the resident. The next deferred management fee would be based on an ORA of $380,000 — $76,000 on a five-year stay.

As a large share of earnings were generated through the resale of retirement units, lower, or negative, house price inflation should reduce the growth in earnings.

The inability of potential residents to sell their  homes in a timely manner might also impact the time taken to resell a unit and new developments might take longer to be fully occupied, pressuring cash flows, he said.

The sector was driven by a powerful demographic trend which was only really starting. The 75-plus population was set to more than double in the next 20 years, according to Statistics New Zealand.

"We remain attracted to the highly effective business model. But falling house prices represent a material risk to near-term earnings growth, sentiment to the sector and valuations. We temper our near-term view of the sector."

The companies with a better chance of success in current conditions included those operating a continuum of care model and having a higher share of aged care, being more distributed geographically and having high quality management teams and a strong track record, Mr Timms said.

Those conditions  made the decision to enter a village more "needs based" as a resident knew aged care facilities were available when they were needed down the track, as opposed to it being a lifestyle choice by moving into a village.

"This results in a more defensive demand for units, waiting lists and, generally, a later age of entry into a village. The clear leader of the continuum of care model is Ryman, although Summerset has also successfully executed this model recently."

Operators with a greater share of aged care were also more insulated from a property downturn as funds were largely provided by the Government on a needs-based demand, he said.

Oceania had a clear advantage although aged care was much less profitable than retirement. About half of Oceania’s present earnings were derived from the aged care business, despite it making up more than 70% of the portfolio.

Oceania’s strategy was also to increase its share of retirement units to provide a more integrated offering. Metlifecare also had a focus on increasing its aged care offering, but it was still weighted towards retirement, Mr Timms said.

A geographic spread was important and those with portfolios diversified away from Auckland were preferable, given the ramp-up in prices in that market.

Metlifecare was at most risk, given 68% of its total portfolio was in Auckland with an additional 17% in Tauranga — another hot spot.

Craigs placed more faith on management teams with superior track records to manage a property downturn, he said.

Ryman was the clear leader, managing to grow its dividend through the global financial crisis. Summerset’s performance has been strong.

It was noticeable both reported having sizeable waiting lists at several of their villages.

It was also worth noting both Ryman and Summerset operated internalised development models, providing more control over the development process and insulating the companies to a greater extent from increases in construction costs currently being seen, Mr Timms said.

 

Retirement village sector

The sector remains an excellent long-term, investment, so retain exposure.

•  Consider taking profits on large positions ahead of a period of slowing house prices.

•  Refine weightings to reflect sector preferences of Ryman and  Summerset as most preferred, Metlifecare as least preferred and Oceania as a complementary holding for larger portfolios.

Add a Comment