Tuesday, August 10, 2010

Appraisal of Retirement Villages in Australia

Included in the collateral for this mortgage loan application were two retirement villages in Western Australia.

Australian “Retirement villages” have no exact equivalent in the U.S. As multifamily properties, they physically resemble "active senior" retirement communities in the U.S., but rather than selling or leasing the residential units, the landlord trades long-term leasehold interests (20 years or more) to incoming aged residents for an interest-free loan of a substantial amount, to be repaid when the resident leaves. The developer/owner then collects: 1) reimbursements of operating expenses, 2) a deferred management fee equivalent to 4% per year up to a maximum of 20%, applied to the resale price collected by exiting residents (these numbers vary by state), and 3) a deferred charge equal to 1.5% per annum to place in a sinking fund for capital replacements, also collected when the tenant leaves.

Most of the income of these retirement villages consists of the collection of deferred management fees, which when applied to the sale of the leasehold interest to another incoming resident, allows the landlord to share in the property price appreciation.

The whole success of this property type with Australian institutional investors has been based on constant price inflation, which has been the norm for Western Australia, even until today, due to the booming mining industry in that state and Chinese demand for minerals. The ability to apply the deferred management fee to the outgoing price gives the landlord a chance to share in the capital appreciation of the individual unit.

What is less clear is how the system would work if the living units were to decrease in value (which is not currently the case). Would the landlord have to make up for resident loan shortfalls if the units are turned over at lower prices? The lease contracts I saw were not clear about this, and in asking why this problem was not dealt with in the contracts, the response suggested that such an event would never happen, that retirement village units would always go up in price, just as they have done until this day. (Remember when American investors talked like that?)

Of course, the closest equivalent to this retirement village concept in the US is the continuing care retirement community which takes large, upfront, refundable deposits. Unlike Western Australia, there are bankruptcies occurring in this industry in the U.S., the most notable one being Erickson. Such a scenario seems to be considered unthinkable in Australia. Am I being too jaded by my American experience?

Of more immediate concern to this industry, however, is a June 9th Draft Ruling from the Australian Taxation Office (equivalent to our IRS) which will require purchasers of retirement villages to pay 10% GST (Goods & Services Tax) on the interest-free loans from the village residents in addition to the tax already paid on the assets being purchased. Based on my calculations for these two properties, the additional tax would wipe out most of the owner's equity in these properties as retirement village buyers discount their purchase offers accordingly. It seems like a very unfair tax, but is consistent with ATO's aggressive new creation of taxes, such as the new 40% tax on mining profits.

Special thanks to those Australian experts who have guided me along the way, particularly Peter McMullen of Jones Lang LaSalle, John Martin of Australian Property Consultants in Perth, and once again Professor Matt Myers at the Royal Melbourne Institute of Technology.