Is 2018 The Year That Financial Backing For Retirement Communities Takes Off?

The inaugural Healthcare Investor Survey published by CBRE at the beginning of this year suggests up to £13.5 billion of equity could be invested in healthcare real estate in 2018 with asset classes once seen as being on the fringes now moving to the core.

One previously “fringe” asset class set to take advantage of this available equity is retirement communities – which, for those not in the know, offer an independent lifestyle choice for the over 55’s with purpose built apartments, restaurants, health club and other facilities as well as on site care if needed.

Two major insurers entered the market towards the end of 2017, with Legal & General Capital acquiring English Care Villages and Renaissance Villages and AXA Investment Managers – Real Assets acquiring Retirement Villages Group.

But have traditional lenders got an equal appetite to fund this growth area?  CBRE’s research suggests the answer is yes, with more than two thirds of investors deploying some form of leverage.  With Audley Group securing a £125m credit facility with HSBC and Bank Leumi to help them fund ambitious expansion plans, and other lenders including Coutts and Investec active in the market, the future seems bright for retirement living. This is a new area for lenders though and caution remains the word.

Those who are already active in the sector argue that there is a clear market for an age appropriate, aspirational product. The fundamentals seem clear. The UK is undergoing a significant change in demographics with an aging population and increased life expectancy.  JLL have estimated that almost 80% of over 65’s will be classified as having mid to high affluence by 2025.  Further, the UK market is in its infancy – it is thought that only 0.5% of the elderly population live in a retirement scheme in the UK whereas, looking overseas to the US, New Zealand and Australia, where the market is more mature, the figure is closer to 5%.  

The traditional lenders have started to get comfortable with the typical development model.  It is similar, at the outset, to many residential developments with investment required up front to fund the development of the site, including the residential units and communal areas, and which can be repaid as the residential units are sold.  At this point the models diverge.  Following sale of the units, the operator (often the same entity as the developer) will usually remain involved and oversee the continued maintenance and operation of the buildings, gardens and communal facilities.  

Whilst the on-going operation of these facilities will be largely funded by the service charge paid by the residents, operators also rely on a deferred income stream in the form of “Event Fees” to fund major works and to turn a profit.  Event fees are sums which must be paid by residents to the operator on the sale or sub-letting of a unit or on a change of occupation and so do not result in a regular income stream until the site is mature, which can be 7-10 years after initial construction.  

In the context of a typical development facility, whilst lenders might recognise the potential of this deferred income, they are not able to take it into account when looking at interest and debt service covenants on a new development facility not least because lending facilities are typically five years as against the event fee income which takes circa 7-10 years to mature.  

Lenders also remain wary of the reputational issues.  Event fees remain in the limelight.  The Law Commission published a report in March 2017 which concluded that event fees should not be abolished and made a series of recommendations centred on transparency but lenders will continue to proceed with caution until they are on a more secure legal footing.

The unproven element of the deferred income, together with the fact that this is generally a new market for lenders, means that borrowers are currently unable to achieve the same leverage levels as the house builders without, for example, the backing of a PLC guarantor.  In 5-7 years’ time however, as the current generation of retirement villages mature and assuming re-sale values continue to hold, the conversation is likely to be completely different, with event fees potentially coming to be seen as a valuable income stream in their own right. 

It would seem the level of debt available is only going to increase.

This article first appeared in CoStar