New Zealand Retirement Village Sector

Transcription

1 Research Analysts Arie Dekker arie.dekker@fnzc.co.nz This report is distributed in Australia by Credit Suisse Equities (Australia) Limited. Please see legal disclaimer and disclosure annex for further terms and information. Provided by First NZ Capital 4 October 216 Asia Pacific/New Zealand Equity Research Health Care Providers & Services (Health Care) New Zealand Retirement Village Sector SECTOR REVIEW Review of the large cap NZ village operators This report provides an updated look at Ryman, Metlifecare and Summerset, New Zealand s three large-cap retirement village operators. The model is well established, attractive and has been generating strong growth. With Group accounts dominated by development, we look at the accounts of over 7 villages over the past 1 years to help inform our analysis. Disclosure in the sector tends to accentuate the uplift from development (unobservable development margin which does not fully allocate costs is a large driver of underlying profit; reported operating cash flow includes new sales without the accompanying investment to deliver it; NTA and the growth in it is generally largely driven by development activity and the recognition of a future claim on cash flow). Executed well development is clearly a positive value driver and our detailed village analysis highlights the cash and fair value uplift that can come from good development. Over time, these villages deliver cash earnings that underpin the solid growth being achieved in core cash flow after we separate out development. The market is willing to ascribe value well in excess of NTA to operators with a landbank and development track record something we assess at a village level. With Group accounts dominated by development, we focus on the core operating cash flows of the business (separate out development cash). On a growing and maturing asset base, and with property price growth, the operators are generating strong growth in core operating cash flow, albeit at quite different scale. We use village accounts to look at the maintenance capex associated with sustaining mature villages and look at the free cash flow yield on equity and fair value growth in mature villages. This highlights more moderate growth in operating earnings at maturity with increased capex requirements, but returns across cash yield and fair value uplift that are still attractive generally low single, double digit performance is mixed. Operating at the intersection of a favourable business model, demographic trends, equity market support and positive property dynamics, it is clear why the operators are growing landbank and development. Debt is used to fund development working capital and is increasing, and will increase further (Summerset undertaking more capital-intensive development; Ryman growing in Australia having established a large operating cash flow base in NZ). We look at debt and the level of core operating cash flow that supports it. With core operating cash flow dominated by resale gains/dmf realisation, we note the importance of a broadly functioning property market to sustaining operating cash flow and supporting development selldown and consider some factors that might differentiate the operators were the market to slow down (size of operating cash flow; degree of less sensitive cash flows e.g. care/serviced apartments). The report also looks at CBRE valuation methodology, the attractive nature of the business model and covers off risks to its sustainability, and briefly reviews demographics, obsolescence and the property market. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 This report provides an in-depth profile on the large-cap operators in the New Zealand retirement village sector. There are elements of each of the operators businesses that we review in detail to help inform investors on the dynamics driving the current and future performance of the operators Report structure The sections of the report are as follows. Introducing the NZ large cap retirement village sector We start by providing a high-level snapshot of key differences between the operators with regards to size, growth trajectory, valuation and gearing. Despite operating broadly in the same sector with a geographic and operating focus that is converging, there are a number of clear differences between the operators not just in terms of the size of the portfolio, development track record and landbank, but also in valuation metrics and the level of gearing. This report is not intended as a 11 on a sector that is well understood, but in Appendix 1 we do briefly cover off on the attractive nature of the business model and do discuss key elements of Ryman s model that other operators, in particular Summerset, appear to be increasingly looking to replicate. CBRE valuation methodology CBRE completes the valuation of Investment Property and P,P&E for each of the major operators, and these valuations and movements in them are generally the single-biggest driver of reported earnings and NTA movement. This is because growth in equity is largely based on growth in future claims of cash flow, while the cash earnings of the business are largely used to service debt and pay dividends. The valuation of Investment Property is based on near-perfect information regarding key village details although it clearly requires assumptions as well. While not perfect, we take a detailed look at the CBRE valuation methodology and form a view on whether NTA is a reasonable basis on which to value the core operating assets of the retirement village operators i.e. completed villages. While CBRE may err on the side of caution, we are not convinced that the valuation is materially conservative and our analysis of overall operating cash flows and individual village cash flows at maturity, in particular, seem to support that. The low double-digit returns being generated across a mix of free cash flow yield and NTA uplift on more mature villages seem to suggest that the extent to which NTA on core operating assets is conservative comes down largely to a view on the appropriate discount rate to apply. We note that Metlifecare, which has had limited value ascribed to it for development over recent years, has tended to trade quite closely to NTA since CBRE took over valuing the assets in 212. Taking the noise associated with development out of the equation what does steady state look like? With the financials at a group level dominated by development, we use our detailed village analysis to look at what steady state looks like for a portfolio of mature or maturing retirement villages. We focus on what the uplift in NTA is for mature villages, the operating cash generation from them and the amount of capital investment required to maintain older villages this gives us some visibility on maintenance capex. This work highlights that the growth observable in Group accounts is dominated by development and that mature villages in steady state operate largely as we would expect: generally moderate growth in operating cash flows, with increasing allowance required for maintenance capex as villages age and turnover increases. Fair value movement in mature villages will be dependent on the quality of the village and the property market dynamics around it (not just broad based property market growth but local competition and the desirability of the village also clearly factors in). Overall, the free cash flow yield on equity in the village (i.e. taking into account resident funding) and the fair value growth is much as we would expect with high-single-digit to low-double-digit total returns generated, generally skewed more to the fair value movement over cash return partly reflecting the increasing value of the equity denominator over time. New Zealand Retirement Village Sector 2

3 Development is attractive but not all development is equal and the track record of the operators still appears to be different We also use the detailed village analysis to look at development outcomes in more detail. We highlight through the report (CBRE section; steady state section) the significant uplift that occurs in the Income Statement and in NTA from the first valuation of completed units as a village is delivered and then sold down for the first time. Our analysis highlights the importance of location and execution (site selection, construction and construction phasing, sales strategy) to the amount of cash generated out of development and the subsequent performance of villages. The work in this section highlights what is already observable in the landbank and development focus of the operators. There is a push towards less provincial development, towards Auckland and other higher value locations and the reasons for this are clear: the model works well in markets that have a combination of attractive demand (larger population bases) and higher property valuations. It is important to differentiate development undertaken that results in fair value uplift and development that generates a combination of fair value uplift, cash flow and a good base asset which has attractive longterm cash characteristics, although they appear to be linked. Landbank and the development pipeline Both Ryman and Summerset have been increasing the size of their landbanks quite significantly in recent years. We look at land acquisition over the past six years across the operators and look at what has been achieved in that time and the status of the current landbank. A view on landbank and the quality of it is important not just to the outlook in the next few years but beyond that as well. Regardless of the attractive funding model in place that recycles capital, the operators are long-term owners of the villages they develop and both the near-term cash flow and fair value uplift and the longer-term prospects will be influenced by the quality of site selection and construction. Establishing a track record on land acquisition is critical to confidence in the growth valuation, but consideration needs to be given to the quality of the outcomes being delivered from development and the track record on that front is equally important, in our view. As well as the largely graphical presentation comparing the three operators in the first section, we complete a more detailed review of the recent financial performance, change in financial position and valuation of the operators Financial review of the operators It has been a period of significant growth and given the incentives associated with the business model, equity market valuations, the favourable demographics and a supportive property market, it is not surprising that the retirement operators are all looking to grow their businesses. In this section: We look at the composition of cash flow distinguishing between cash flow generated from non-property related activity (care + village services less Group overhead) which is negative for two of the operators and positive for Ryman; the core operating cash flow generated from the resales engine (resale gain + deferred management fee [DMF] realisation) which both Ryman and Metlifecare have scale in; and the cash generated or invested in development where Ryman and Summerset are the most active. We consider gearing in the sector. Debt is positioned largely as a working capital facility supporting construction and the landbank. Both Summerset and Ryman s debt is expected to increase further as Ryman scales up in Australia having established a scale business in New Zealand operating in steady state from a new unit delivery perspective (core non-development operating cash flows at scale and still growing as villages mature); and Summerset begins to engage on more ambitious apartment projects which require more peak construction working capital than the villas which Summerset has tended to focus on to date. To a large extent, the cash flows of the businesses are dominated by property-related activity (new sales to pay down development debt and fund the overall development if New Zealand Retirement Village Sector 3

4 executed well and resales as the operating cash engine). As such, we consider how the operators are placed for a downturn in the property market. With limited information on headroom, we do note the advantages Ryman has with regards its greater core operating cash flow base and more diverse business, including a large portion of serviced apartments and care which is likely to be insensitive to a downturn in the property market. We do think it would be good to have more granularity on debt headroom in the sector given that the property market is cyclical. We look at valuation and discuss reasons for the different valuations applied to the operators. In the case of Summerset we look at Ryman as a guide for what Summerset needs to achieve to grow its NTA into its market capitalisation and highlight the upside associated from doing so using the Ryman experience as a guide. Appendix 1. A beautiful business model and key drivers that need to be sustainable to support growth premiums in valuation the risks With the sector being part of the listed market for some time, the business model is well understood which is why we do not cover it in detail. There is no doubt that the business model is very attractive and we highlight the characteristics that make the sector desirable from an investor perspective. We also discuss some of the likely drivers of Ryman s success given what appears to be an increasing convergence in the business models towards the continuum of care model adopted by Ryman successfully over the past 2- plus years. Given the amount of growth being priced in for some operators in the sector, we also look at risks with some observations on key drivers that are important to the sustainability of the business model and the value of the operators. Key areas of business model risk include the ability to continue to source suitable sites to fuel the development engine; demographics and obsolescence; regulatory status; and Deferred Management Fee (DMF) sustainability which may potentially be a competitive issue in the future for operators with higher levels of DMF charges or an opportunity for those with lower charges. Appendix 2. Demographics, obsolescence and the property market Demographic trends are supportive and the weight of growth in the target market for retirement villages and care facilities over the next several decades is clear. But there is a need to be careful not to generalise and differentiate between demographics that support retirement unit growth and those supporting care. In broad terms we would observe the following: The overall demographic trends that the operators tend to highlight of an aging population have a lot of relevance to the demand that is likely to drive the absolute level of demand in the future for care in facilities or in the home. The provisioning of care tends to be largely unavoidable and for a shorter period of time. It may also be supportive of serviced apartment demand. Those same demographics support increasing demand for retirement units also but needs to be overlaid by a number of factors. For a portion of the aging population, the retirement living increasingly targeted by the large-cap operators may not be affordable in particular independent retirement units. We also note that consideration needs to be given to what the changing requirements of future generations of retirees may be and how the business model may need to adapt to that. The next generation of retirees presents a significant opportunity, but their tastes and preferences may represent a challenge to some older villages this could limit their performance in the longer term or require investment not currently factored in. There is no doubt that the value of a village is very sensitive to property market considerations. A view on the rate at which the current asset base will compound into the New Zealand Retirement Village Sector 4

5 future is important, but a point we make a number of times in this report is that consideration should also be given to the amount of investment required to sustain that growth and ensure the property remains attractive to future generations of residents. While it is important and interesting, we are less focused about what the right level of house price inflation should be and how to apply it and what level of maintenance capex to assume to support it. Instead, we briefly look at the house price cycle which is important given that core operating cash flows are dominated by property market-related activity (resales) and development activity dominated by it also (new sales). We are more interested in noting the cyclical nature of the property market and the need to be cognisant of the position of the operators and the ability to deal with a slowdown in the property market should that occur particularly for operators with leverage. New Zealand Retirement Village Sector 5

6 In this section, we introduce the operators and highlight some of the issues we focus on through this research report. The operators have different balance dates: Ryman (31 March), Metlifecare (3 June) and Summerset (31 December). We compare the operators over the past five years based on their latest fullyear results i.e. year 5 is FY16 for Ryman and Metlifecare and FY15 for Summerset. Six months separate year 5 across the three operators Introducing the NZ large-cap retirement village sector Introduction The New Zealand equity market has three large scale operators: Ryman, Metlifecare and Summerset. All three have scale and have portfolios of ~2-3 villages each across a range of ages. To varying degrees, all are developers and all three have care businesses in addition to the core retirement village business, although only Ryman has a material care presence currently. The operating and financial performance of the sector on various metrics has been impressive over the past five years and we highlight that in this section which looks at the growth and compares the operators. Figure 1: Summary valuation information at last year end, NZ$s RYM MET SUM Total NTA 1,327,525 1,131,513 48,734 2,867,772 Market capitalisation 4,175, 1,177, ,613 6,236,856 Implied "extra value" 2,847,475 45, ,879 3,369,84 Net debt 545,878 74,24 241, ,647 Enterprise value 4,72,878 1,251,482 1,126,142 7,98,53 Year end share price used $ 8.35 $ 5.53 $ 4.8 Underlying profit 157,713 66,157 37,8 261,67 Core op. cash flow, ex-interest/development 97,25 5,58 13, ,283 Estimated maintenance capex 2, 12,5 6,5 39, Estimated free cash flow, ex-interest 77,25 38,8 7,25 122,283 Price/NTA Market cap/underlying profit Market cap/core op cf Market cap/estimate free cash flow Gross value IP + P,P&E 3,75,835 2,561,233 1,338,211 7,65,279 Maintenance capex %.5%.5%.5% Last four years growth in: NTA 68,36 413, ,858 1,27,148 Units 2, Care beds 947 (53) 289 Extra value/last 4 years NTA growth Development pipeline Units 3,62 1,386 2,414 Care beds 1, Current share price $ 9.63 $ 6.25 $ 5.3 Most recent NTA Price to NTA (x) Note: Metlifecare growth in NTA is over three years as 212 did not include the value associated with Vision/PLC acquisitions. Summerset most recent NTA is 1H16 NTA at 3/6/16. We note a few highlights: The combined market capitalisation of three operators is over $6 bn and enterprise value is over $7 bn. Core operating cash flow, excluding interest, was $16 mn across the three operators at their last financial year-end and we estimate maintenance capex across the three players of ~$4 mn (not particularly high on over $7.5 bn of Investment Property and P,P&E assets at gross value; closer to $6.5 bn of operating assets). NTA stood at $2.9 bn on last balance date across the sector that implies a multiple of ~2x market cap to NTA or a value gap of over $3 bn. That NTA of the three operators New Zealand Retirement Village Sector 6

7 has been established over the best part of two decades (weighted average village life of ~1 years for Ryman and Summerset; 2 years for Metlifecare) but $1.3 bn of the NTA growth occurred in just the past four years on the back of a strong property market and increasing development. The track record of the operators is quite different and the growth implied in current valuations highlights the markets differentiation between operators. We highlight the growth occurring across the operators on various measures. Certainly, the returns being generated on a combined broad based measure of cash return and growth in NTA are impressive. Particularly given that this growth can be achieved without necessarily requiring equity funding if execution and phasing are done well and development risk is well managed. In the sector, this hasn t always been the case all the time. Ryman has a flawless record in this regard, but not all the operators do The market is willing to value growth and differentiates between the operators Figure 1 highlights how the market is valuing the three operators. We think the level of absolute valuation and differences between valuation highlight dynamics and analysis required that extends beyond the high-level financial analysis of Group accounts. Clearly, there is a strong qualitative element also which must reflect confidence based on track record, and of the development pipeline and ability to keep filling it. There is a significant gap between the market capitalisation of both Ryman and Summerset and their NTA. It oversimplifies things to put that gap down to one thing and we expect it should reflect a combination of factors: Confidence in the free cash-flow growth profile of existing villages. It is important to note that confidence in this extends beyond confidence in the growth that will derive from broad-based appreciation of house pricing over time. Confidence in the viability and attractiveness of villages over the long term needs to be considered (including for different generations of retirees) with allowance made for the capital investment that might be required to support that attractiveness through time and help support unit price growth. Potentially, a view on the risk and combination of cost of capital and property price growth that is more confident than that applied in the valuations that underpin NTA. We spend some time looking at this and observe from our free cash-flow analysis at a Group and village level for the core operating asset base that yields and growth don t suggest that NTA is significantly conservative. We are not suggesting a premium is not justified simply that the size of the premium needs to be measured against the cash yield/growth being generated and an assessment of risks. A level of confidence in the discounted value that should be attributable to future development in a sector with favourable demographics and a replicable model a view informed by track record, quality of the current development pipeline and the ability to continue to replicate that. We think that the time value of money needs to be factored in here as do the timeframes associated with replicating the model. This is not easy while it has taken many years to generate the current NTA base of the operators, the NTA growth across all three has been significant in the past four years on a combination of both a supportive property market and strong development. To put the extra value attributed to future development in perspective (noting some premium to NTA for other factors is also likely justifiable), we note that developments tend to result in Investment Property outcomes of ~$1-2 mn. A development with a cash outflow of $15 mn may take anywhere from 5-1 years to complete (from the point of land acquisition to delivery of final stages). Broadly speaking, the net free cash flow from that development (following full selldown) is likely to range from a small deficit to a small surplus (which still enables the operators to declare a development margin given that some costs are not allocated, and care facilities are appropriately excluded). The completed village asset base would generate positive cash flows from that point on a mix of care profitability and resale gains/dmf realisation. Focusing on the core value driver resale/dmf the value associated with that is captured upfront on delivery of the village through the fair value movement. While it is certainly not always the case (we observe some villages with limited fair value movement), that fair value movement may be ~2-35%. A 3% uplift on a $15 mn development is $45 mn. While this dynamic underpins the attractive nature of retirement village development, it also underscores the New Zealand Retirement Village Sector 7

8 timeframes associated with driving this value growth and the timeframes associated with delivering cash flow. Market currently appearing to 'pause' on valuation for the two growth operators with recent NTA growth used to drive multiple contraction As far as momentum is concerned, Ryman has delivered the greatest growth over the past five years in year-end share price. In more recent years, there has been a period in which the market has paused on the value being attributed to Ryman (and to a lesser extent Summerset) and let the NTA catch up with share price albeit the gap still remains large. Summerset has had the most significant market value uplift compared to underlying NTA growth in the sector, over a five-year time period, as it has begun to lift its development pipeline and the confidence of the market in its ability to execute on it through a combination of: landbank acquisition (significant increase), unit build delivery (also increased quite markedly) and reported development margin. Our village analysis allows us to look beyond the reported development margin at the cash outcomes being generated at a village level. Figure 2: Financial year-end share price, NZ$ Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM Figure 3: Financial year-end price/nta, x Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM Metlifecare has tended to trade at a valuation broadly in line with its NTA over recent years. This would appear to be broadly supportive of the following: While we are not suggesting that NTA is by any means a perfect measure of the value of the existing village asset base, the market appears to be broadly comfortable that it is a reasonable proxy at least in the case of Metlifecare. Although the valuation approach adopted by CBRE is susceptible to change (there have been some significant increases in recent years; and sometimes the valuation goes down at a village level as well), the starting point is the unit prices being achieved in a village. The market appears to be quite cautious about applying a material premium to NTA on completed villages, potentially on the significant information asymmetry. More disclosure by the operators would be required before investors could better attempt to value completed assets in the way CBRE can. Operators needs to establish a track record on development with the market appearing to look for confidence in the ability to sustain a level of build (combination of development landbank and recent execution) and execute well on that development as well. We would be cautious about focusing on development margin to assess capability on development execution and would rather look at the cash flow of a village during development and thereafter. New Zealand Retirement Village Sector 8

9 An introduction to the operators using high-level financial metrics Ryman dominates on size, growth and skew to serviced apartments/care Ryman dominates across retirement units, serviced apartments and care beds and is clearly the largest operator in the sector with a skew that is more heavily weighted towards older residents through its mix of serviced apartments and care. Off a lower base, Summerset is starting to increase its rate of growth with it adding a reasonably meaningful number of units and care beds to its portfolio in recent years. Metlifecare has been the least active over this period something that reflects the requirement for a development pipeline (landbank) to be built up in advance of delivery given that lead times generally range from 2-4 years between site acquisition and the opening of a village. Figure 4: Total retirement units (independent villas, independent apartments, serviced apartments) 6, 5, 4, 3, 2, 1, Figure 5: Serviced apartments 1,8 1,6 1,4 1,2 1, Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Figure 6: Serviced apartments % of total retirement units 4% 35% 3% 25% 2% 15% 1% 5% Figure 7: Care beds 3,5 3, 2,5 2, 1,5 1, 5 % Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM New Zealand Retirement Village Sector 9

10 Figure 8: Development pipeline retirement units and care beds at last FY balance date 4,5 4, 3,5 3, 2,5 2, 1,5 1, 5 Figure 9: Current units + beds and development pipeline units + beds last FY balance date 14, 12, 1, 8, 6, 4, 2, RYM MET SUM RYM MET SUM Retirement units Care beds Current units + beds Pipeline units + beds The greater focus on care and serviced apartments has been positive for Ryman and the other operators are looking to replicate that greater diversity to some extent. We note that in a property market slowdown, the greater needs-based element of care and serviced apartment living (and the much lower entry price for serviced apartments) means there is a lower discretionary element to a decision to move into a retirement village. Ryman also has the largest development pipeline, but Summerset s is the largest in comparison to its existing portfolio size. Summerset lags on average pricing of retirement units; embedded value highlights value and relative maturity of portfolios Metlifecare has the highest average selling price for new units over the past five years although this reflects a number of factors compared to Ryman, Serviced Apartments (SA) are a smaller part of Metlifecare s unit mix and Metlifecare also has had the smallest development programme with little development outside of the Bay of Plenty/Auckland regions. Ryman and Summerset s mix of development also includes regional/provincial villages. New sales pricing is going to tend to outperform resales pricing for a number of reasons, the key one being that resales mix will be more heavily weighted to SAs due to higher rates of turnover. With its portfolio most heavily weighted to provincial New Zealand currently, Summerset s average pricing is well below that of the other two operators. Summerset s average resale price is currently ~$3k while its average new sale price is ~$4k highlighting the shift in its emphasis towards higher value areas. Figure 1: Average new retirement unit selling price, NZ$s Figure 11: Average resale retirement unit selling price, NZ$s Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM New Zealand Retirement Village Sector 1

11 Embedded value provides a snapshot of the relative maturity of a portfolio and reflects the value that would be released from accrued DMF and resale gains if all units were sold today at current list prices. The pricing is not audited and based on current list pricing being achieved in the village. We compare it to the resales gain and DMF being realised for each of the operators. Figure 12: Resales gain/unit and embedded value/unit last FY balance date, NZ$s RYM MET SUM Resales Realised gain/unit Realised DMF/unit Total Embedded value/unit Resale gain/unit DMF/unit Total Embedded value NZ$mn The higher average value of Metlifecare s portfolio and the greater maturity of the portfolio are captured in this comparison of the gains being achieved on resale and those gains embedded in the portfolio at current rates. In our detailed analysis, we highlight that the weighted average age of Metlifecare s villages is ~2 years compared to ~1 years for Ryman and Summerset. Despite having a similar average age of villages and more serviced apartments, Ryman s locations are clearly at a higher average value than that of Summerset, with Ryman s embedded resale gain/unit higher than that of Summerset. Ryman generates the highest level of resales turnover rate as a percentage of units. This reflects the higher mix of serviced apartments and what is likely to be an older skew to incoming village residents. This resale gain and DMF realisation cash flow are the key cash generating engines of all three operators at least, in what we can observe, noting the operators do not disclose care profitability, group overheads, or distinguish between development cash margin, work in progress and landbank investment or maintenance capex. Figure 13: Resales turnover rate resale units divided by total units 14% 12% 1% 8% 6% 4% 2% Figure 14: Resales gain + DMF realisation, NZ$ s 9, 8, 7, 6, 5, 4, 3, 2, 1, % Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Note: Ryman based on accrued realisation of development margin, resale gain and DMF. New Zealand Retirement Village Sector 11

12 Underlying profitability is a key industry measure of success given the limited usefulness of reported profitability and the unrealised fair value movements that often dominate it these fair value movements are heavily weighted to the initial uplift that occurs on completing a unit and applying a DCF on future cash flows for the first time Income Statement reported profit and 'underlying profit' are measures that accentuate the uplift associated with development; we focus on core operating cash flow Underlying profit includes the realised resale gains and DMF accrual (not realisation) and also includes a measure of development margin. We have an issue with underlying profitability given that the development margin is an allocated margin that excludes certain capital costs associated with delivering a village. While we recognise that the margin should not allocate costs associated with delivering care facilities, the exclusion of community facilities and amenities from the allocated cost, and the inability to observe it, makes this margin of limited value in our view. While not perfect, our village analysis highlights Ryman s ability to deliver cash surplus from development in some villages. While we have a small sample set and Summerset still has a number of villages under development, we cannot observe the same dynamic for Summerset and we think it is still too early to say with confidence that Summerset has demonstrated Ryman s capability to deliver villages with a cash surplus. We show our preferred measure of core operating cash flow (on the same scale to underlying profitability see Figures 15 and 16). This measure includes the core operating cash flow (care fees, village services and expensed Group overheads not capitalised) and both the realised resale gains and realised DMF. We exclude development cash flow and cash gains which we have no way of observing in any respect and cash interest expense (with little or no core debt, according to the operators, this is development-related interest). For Ryman, we have to use a cash proxy for cash realisation of resale gain and DMF, as Ryman provides these figures on an accrual basis. Ryman dominates the other two operators in terms of profitability, but there is a large gap between its underlying profitability and core operating cash flow proxy due to its significant development engine. Despite a lower reliance on development, Metlifecare s underlying profitability is higher than Summerset s and on a core operating cash flow basis that gap is more significant. Metlifecare is not developing at the rate Summerset is, but it has a much more mature, and higher value-embedded base that it is generating cash from. Summerset s scale may be disadvantaged (overheads on a smaller base) but we do not know what those overheads are and we note that Summerset capitalises development overheads (also not observable). Figure 15: Underlying profitability, NZ$s 18, 16, 14, 12, 1, 8, 6, 4, 2, Figure 16: Core operating cash flow proxy ex. new development sales, NZ$s 18, 16, 14, 12, 1, 8, 6, 4, 2, Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Note: Ryman based on accrued realisation of development margin, resale gain and DMF. To varying degrees, none of the three operators generate profitability outside of the core property-related income associated with development and resale turnover (see Figure 17). Despite its significant care business, Ryman s operating profitability is negative once village services, Group overheads and interest expense are taken into account and this is despite all three operators capitalising Group overhead and interest expense to varying New Zealand Retirement Village Sector 12

13 degrees. The operating losses are worse for Metlifecare and Summerset likely reflecting their smaller scale and smaller care businesses. Figure 17: Underlying profit composition last FY balance date, NZ$s 2, 15, 1, 5, Figure 18: Development cash flow excluding capitalised interest, NZ$s 2, -2, -4, -6, -8, -1, (5,) RYM MET SUM Accrued DMF Gain on resale Development margin -12, -14, Year 1 Year 2 Year 3 Year 4 Year 5 Other Total underying profit RYM MET SUM Note: Ryman based on accrued realisation of new sales. Source: Company data, FNZC estimates If we look at the receipts from new sales and the level of investment activity occurring (Figure 18), it is not possible, at a Group level, to confirm any level of cash development margin but we would not expect to see it given the growth in investment occurring which includes increasing land bank investment in recent years. We are, however, able to look at the cumulative free cash flow generated at an individual village analysis and see whether this confirms development margin or not something we do in the Development section of the report. Ryman and Metlifecare have the larger operating bases; a strong property market, among other factors, means that NTA growth has been broadly the same across the operators over the past four years despite quite different levels of development The balance sheets of the operators are large with the asset side dominated by Investment Properties which largely reflects the valuation of the operators' interest in the future cash flows associated with a retirement unit (i.e. the DCF valuation of future resale gains and DMF realisation) and the net resident loan sitting against that asset to deliver a net investment property valuation. Investment property will also include construction work in progress and in some cases the landbank assets. With its significant care facility business, Ryman has meaningful investment in P,P&E as well (for Ryman, P,P&E also includes the landbank, generally at cost; as well as care facilities). Care facilities are also valued according to their cash flows (capitalisation of assessed cash earnings into perpetuity). Ryman s approach to sales recognition means it also has a meaningful accounts receivable working capital asset. The liability side of the balance sheet is dominated by resident loans, net of accrued DMF (contractual basis). It also includes bank debt which the operators position in broad terms as development working capital facilities (funding of landbank and construction work in progress). It is worth noting that attractive funding models aside, those resident loans are repaid when residents vacate the unit (although no contractual timeframe) and the operators remain the owners of the villages. The difference between assets and liabilities is equity or the much referenced Net Tangible Assets (NTA). We look at equity over the past five years in two ways we look at NTA and NTA/share (Metlifecare and Summerset have raised equity in this period) which we rebase to $1. New Zealand Retirement Village Sector 13

14 Figure 19: Balance sheet assets, NZ$s 4,5, 4,, 3,5, 3,, 2,5, 2,, 1,5, 1,, 5, Figure 2: Balance sheet liabilities, NZ$s 4,5, 4,, 3,5, 3,, 2,5, 2,, 1,5, 1,, 5, RYM MET SUM RYM MET SUM Investment property P,P&E Accounts receivable Other assets Resident loan, net of DMF Bank debt Accounts payable Other financial liabilities Figure 21: NTA, NZ$s 1,4, Figure 22: NTA/share rebased to $1, NZ$ $2.5 1,2, 1,, 8, $2. $1.5 6, 4, 2, $1. $.5 Year 1 Year 2 Year 3 Year 4 Year 5 $. Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Ryman and Summerset have been beneficiaries of both these drivers in recent years, while Metlifecare has primarily benefited from fair value movement associated with its existing portfolio given its more limited development activity. Of course, we have no way from Group accounts to see the contribution development activity has made compared to mature villages but we look to highlight the impact using village accounts NTA growth has been very strong over the past five years. Two key things drive NTA growth and we look at different ways to explain their contribution in some detail in this report. Both have been supportive of NTA uplift over the past four years: Fair value movements associated with upwards revisions to assumptions for existing retirement village units in particular, achieved unit pricing in a strong property market. While it varies significantly depending on location of village and the performance of the village, above-trend growth (or decline) in the housing market can deliver meaningful revisions to existing investment property valuation. Development as we highlight in this report, the much bigger driver of fair value movement is generally the initial uplift associated with applying the DCF valuation to a completed unit when it is completed (before it is sold for the first time). Quite independent of the net cash development margin (which will also influence the initial fair value movement on completion) the uplift associated with the first DCF valuation is reasonably meaningful (~25-35% likely) and this can be achieved even on a development that is completed on an overall cash break-even basis. We do highlight that if site selection is poor and the sell-down less successful, development fair value movement uplift can be more modest. We note the period we are analysing for Metlifecare is based on five valuations undertaken by CBRE. Year 1 (or 212) was CBRE s first valuation of Metlifecare s villages and it is possible that some conservatism was put into the valuation that has unwound since then as CBRE increased comfort in the quality of the villages being valued. For new villages also, a combination of CBRE s initial conservatism on unit pricing (until a track record is established) and higher discount rates during the higher risk development New Zealand Retirement Village Sector 14

15 stage, as well as sales strategy that sometimes sees initial units delivered at a lower price which is raised to market pricing in the later stages, can see that initial uplift in a village generated over two to three years rather than in one upfront valuation. Our section on CBRE valuation methodology looks at this in more detail. Cash returns on NTA Ryman a stand-out; development and a strong property market has seen attractive total returns across all operators NTA is a key measure of equity value that is observable across the operators and we take much time in this note understanding the basis on which it is derived and the reasonableness of it as a measure of value in this report. In broad terms, NTA: Incorporates cash flow-based valuations of the two key income generating assets (Investment Property and P,P&E separate valuations and approach). Land held for development sits within these assets generally around cost, as does construction in progress. The assets are offset by resident funding, net of accrued contractual DMF obligations and bank debt. The principle non-cash generating assets of the operators are landbank and construction in progress. Certainly, a view on the value uplift associated with converting these assets into completed units is important for valuing the operators. As far as looking at yield on NTA is concerned though (a measure of cash return on cash generating assets), the NTA denominator is valid, in our view, as a proxy given that the non-cash producing assets are essentially funded by bank debt which offsets it in NTA. As a result, we look at cash return, pre any interest expense (expensed and capitalised) given it funds development, but including Group overhead expense (we do not have visibility into capitalised overheads) on the NTA of the operators. We use our core operating cash flow proxy to measure these returns because it excludes financing income and costs, and it excludes any development activity cash flow. We can also look at the growth being generated in NTA to look at a measure of total return proxy on the NTA value. At a group level, development uplift will clearly have a significant influence on this. However we note that this analysis does not make any allowance for maintenance capex. With significant asset bases that the operators must maintain over the long term to suitable standards to meet the requirements of incoming residents, this investment must also be taken into account. Unfortunately, the operators do not disclose maintenance capex. We highlight in our village analysis that allowance in mature villages needs to be made for this investment and it is not insignificant. As outlined upfront in this report, we have a point estimate of this capex for the most recent year and we err on the side of conservatism. We complete this analysis at a Group level, but in this report take a much more detailed look at not just the methodology underpinning NTA but also the cash flows and growth in NTA being generated at a granular village level with a focus on separating out mature villages from recently developed villages so that we can look at free cash flow yield. The analysis is not perfect but it is instructive. On a relative basis, this high-level analysis is still useful. Ryman is the clear stand-out on cash return on NTA as highlighted in Figure 23. Its large care business is a likely driver of its higher cash returns on NTA noting the higher capitalisation rates also applied in care valuation (and Ryman s current care valuation is approaching three years old). Scale will also be a contributing factor, helping spread non-capitalised overheads. We note that with some stocks trading at multiples to NTA, this cash flow yield is not necessarily the yield being generated on market equity valuations (and no maintenance capex allowance is included). New Zealand Retirement Village Sector 15

16 Figure 23: Core operating cash flow yield on NTA 9% 8% 7% 6% 5% 4% 3% 2% 1% Figure 24: Growth in NTA/share 3% 25% 2% 15% 1% 5% % Year 1 Year 2 Year 3 Year 4 Year 5 % Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Debt and commitments As development activity and the scale of it increases, the absolute quantum of debt is increasing. The operators position debt facilities as largely working capital facilities that fund the land bank and construction in progress. The approach to funding development and growth is in broad terms: The operators do not raise equity to fund development activity as they have tended to view the self-funding nature of completed villages (resident loans cover the cash required to build units, amenities and care in some cases, including at large scale for Ryman the development margin excludes the costs associated with the latter two). As a result, the preference is for debt to be used to fund development working capital including the landbank. The operators use the core cash earnings from resales activity to fund dividends. While dividend is reported as being paid in the range of 3-5% of underlying profitability (less for Metlifecare), they are a much higher portion of the core operating cash flow earnings i.e. cash earnings are not generally retained after cash interest and dividends are paid. Because of this, if an operator is not generating a cash surplus from development then they are building up core debt. The growth in equity value for the operators largely comes from the fair value uplift on completing a village and the general movement in the value of the portfolio that is, it is largely an uplift on future claims on cash generation. While this is the key gearing measure that tends to be reported in the sector, we do not think it is a very good measure to look at debt on a book gearing basis alone. With the debt being positioned as working capital, rather than core, and funding development, we are more interested in headroom, coverage and the ability to cover debt in a property market downturn. We would also like to understand the core debt holding of the operators given that it is not possible to observe the net cash flow position of development activity, just the reported development margin. We look at interest and dividend coverage and note that crystalising cash from the landbank and construction in progress to repay the bank debt relies on the same functioning property market that drives the core operating cash flows of the business resale gains and DMF realisation. Cash flow from serviced apartments and care facilities are likely to be more immune to the cycle and as we highlight in our section looking at detailed financials that Ryman was able to work through the last housing market downturn without raising equity or reducing dividends. Debt is expected to increase over the next few years. For Ryman this will be by virtue of an increasing landbank in Australia and more construction in progress in that market (debt of $8 mn+ likely) Ryman is building its position in Australia (and maintaining New Zealand Retirement Village Sector 16

17 the rate of development in New Zealand), having achieved scale and a steady state in New Zealand. For Summerset, we expect greater construction in progress as Summerset begins to move from villa delivery to greater apartment delivery in some of its sites (much greater working capital requirements in apartments). Summersets debt is likely to grow to $4-$45 mn in the next few years. As we highlight in Figure 25, Summerset has a smaller operating base and its net debt of ~$25 mn in 215 is on core operating cash earnings of $15 mn. We note that this higher than the debt Ryman had in 212 when its core operating cash earnings were $5 mn. Despite the attractiveness of development and the broader business model, we think that more disclosure may be required as the sector takes on more debt for growth. Ryman did demonstrate in the last downturn that its diverse business (higher level of serviced apartments and care) positioned it well through that period which is likely a reason why the other operators are increasingly looking to replicate elements of Ryman s model, amongst others. But we similarly note that not all operators across the sector both listed and private have demonstrated the same capability to grow without equity and for this reason we would like to see more disclosure on debt as debt levels grow again and consideration is given to how the operators are placed in a property market slowdown. We also note that with Ryman moving into Australia, it has new obligations on its balance sheet that need to be considered as the business there gets bigger. Specifically, Ryman has a statutory requirement to refund ORAs after six months in Australia which is quite different and makes the obligation to residents more real than it is in New Zealand, notwithstanding that Ryman has operated under the same pledge in New Zealand. Accommodation bonds need to be refunded almost immediately (no opportunity to wait for a new incoming patient). Ryman is looking at accommodation bonds in New Zealand for their care while this will provide a source of funding; this liability will have to be repaid within two to three weeks of turnover and needs to be treated as an on demand liability. Figure 25: Net debt, NZ$s 6, Figure 26: Cash interest expensed and capitalised, NZ$s 3, 5, 25, 4, 2, 3, 15, 2, 1, 1, 5, Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM New Zealand Retirement Village Sector 17

18 Figure 27: Core operating cash flow to cash interest coverage, NZ$s Figure 28: Shareholders equity % of total assets 5% 45% 4% 35% 3% 25% 2% 15% 1% 5%. Year 1 Year 2 Year 3 Year 4 Year 5 % Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM RYM MET SUM Figure 29: Declared dividend, NZ$s 9, 8, 7, 6, 5, 4, 3, 2, 1, Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM Figure 3: Payout ratio of core operating cash flow 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM Figure 31: Core operating cash flow coverage of interest + dividend Year 1 Year 2 Year 3 Year 4 Year 5 RYM MET SUM We are not suggesting the operators have too much debt (Ryman notes it is comfortably within its covenants. Summerset says that it is comfortable and that it does stress testing, while Metlifecare has limited debt), but we do think that as development focus increases, more information on headroom would be useful for the market. We also note again that the operators, to a varying extent, have some flexibility which includes: New Zealand Retirement Village Sector 18

19 Ability to cut or suspend dividends with its large core operating cash flow, Ryman in particular has a large dividend that it could use to help meet interest costs and reduce debt in a severe downturn. Ability to relax unit pricing to support turnover revenues not something the operators will necessarily want to do, but something they can do. Unlike other forms of property development, the retirement village operators can relax pricing for a period knowing they will have an opportunity to sell the ORA again in the future. Suspend development for a period and use the selldown on new units to reduce debt. Rely on the parts of the business less sensitive to housing market health. While there is an element of choice and discretion on the timing of moving into an independent retirement units, care and serviced apartments are less so (and serviced apartments a lot cheaper). For Ryman, this is a large part of the business that we would still expect to perform better during a downturn as it did in New Zealand Retirement Village Sector 19

20 CBRE completes valuations of the Investment Property and Care Facilities for the three large-cap operators, and a large part of the wider market, including valuations supporting market transactions which are a key consideration in their overall methodology CBRE valuation methodology Introduction The IP and care facility assets dominate the balance sheet of the operators while fair value movements in IP can dominate the reported earnings of operators during periods of strong property price growth and development (the uplift from the first valuation of future cash flows), thereby influencing the equity (through retained earnings) of the operators. Revaluations of care facilities, which do not go through the income statement but through the revaluation reserve in equity, are also large in the case of Ryman s balance sheet. The information provided by each of the operators on the key drivers in these valuations is limited. Our focus in this section is on the IP valuation methodology although we also cover care facility methodology. Our interest in understanding the methodology for Investment Property valuation in particular, is two-fold: It is a significant driver of the income statement and balance sheet of the operators and is an important valuation benchmark used by investors to monitor the value being added by the operators over periods of time. The information that CBRE utilises on a village-by-village basis is very granular (using contract-by-contract information on initial pricing, age of resident, resident density, contractual terms, unit pricing in the village, operating costs, care facility occupancy and profitability, etc). Compared to the information that analysts and the market have, our starting point is that CBRE should have a very good idea of the value of existing completed villages although we note that the valuation is completed with reference to significant assumptions also largely around growth and discount rates, and the actuarial assumptions that underpin the turnover rate output. Our conclusion is that the valuation approach used by CBRE looks like a robust and reliable starting point for thinking about existing village valuations. We understand there are some arguments about the approach being conservative with reference to house price inflation assumptions used and discount rates. We look at free cash flow and growth in free cash flow for mature villages to help inform our view on the reasonableness of the CBRE valuation (see section on steady state villages). CBRE is completing a standalone valuation of a village based on the internal rates of return (IRR) implied by market transactions and using consistent assumptions on growth and other factors in deriving these IRRs. CBRE has good visibility on the IRRs being paid in the private market although we note the market is not liquid. Our understanding is that the valuations that individual villages, and even small portfolios of villages transact, lines up with CBRE valuations we look at two recent Metlifecare village sales to highlight that this is indeed the case. In fact, rather than being conservative, these villages transacted at less than the CBRE valuation. We do note reasons which might contribute to a portfolio of villages transacting at higher values in the listed equity market (outside development which is an entirely separate issue). Those reasons include: Individual villages have lumpy cash flows because of the unpredictable nature of resident turnover a key driver of cash flow in a more mature village. That would impact the internal rate of return an owner might desire in a transaction for one village. Acquiring one village is a long process requiring reasonably significant capital. This liquidity factor would likely drive the internal rate of return higher compared to the ability to purchase equity in a listed operator. An individual village is more susceptible to risks associated with local market conditions including a deteriorating local property market or competition. Again an New Zealand Retirement Village Sector 2

21 investor in a portfolio operator has some diversification although clearly isn t immune to the negative impact should a village be negatively impacted by such factors. We do not think the premium to NTA appropriate for the listed operators is likely to be material. We base this view on a range of observations: When we look at the free cash flows and returns generated from mature villages in this report and the growth profile, it is not clear that NTA is materially conservative. At a group level, our analysis of yield on core operating cash flow (with allowance for maintenance capex) also suggests that NTA is broadly reasonable although this more high level analysis is less robust growth in NTA is dominated by development while the growth in this operating cash flow is high and includes a large number of villages that are not mature yet. By using the market generated IRR for valuation, CBRE are taking into account both attractive features of the model (resident funding and tax treatment) and constraints such as those around alternative use and inability to support a lot of bank debt. The major component of the valuation is based on a discounted cash flow valuation incorporating income generated by departures and re-sale of units (rollover income) and the daily operation and management of the village. This is valued based on the occupational right agreements (ORAs) on a unit-by-unit basis and cash flow forecasts using the contract operating in the village Metlifecare has traded close to NTA for a number of years following CBRE s appointment. While there have been large increases (as CBRE gets more comfortable; and on the back of a strong property market) the market has closely followed NTA, suggesting that in the absence of growth, the market is broadly comfortable investing at around NTA for existing operating assets. Other property-related sectors, namely listed REITs also trade with reference to NTA. In that market also, the starting reference point informing valuation are cap rates in the sector. Those cap rates may be much lower than those being applied to retirement villages by CBRE but those assets have differences. The village model is attractive but all of those attractive features regarding resident funding, DMF and resale gains are arguably captured in the market transactions. Similarly, the IRRs observed in village transactions reflect the fact that a village has more variable cash flows, limited alternative use and development potential and the operator must consult residents on a range of things (villages generally are more operationally intensive than say an office or industrial building). In addition, because of the constraints imposed by the statutory supervisor (including inability to provide first security on bank lending), bank funding against a mature village is more limited than it is for a commercial building. Retirement village valuation methodology Key assumptions underpinning the valuation include: current unit pricing; actuarial assumptions that underpin the recycle profiling output; unit growth rates; internal rate of return; non-recoverable expenses; and income & expense flows. We note CBRE s comment: While many market participants adopt a similar methodology (i.e. DCF), the treatment of certain key variables such as the term of the cash flow, treatment of refurbishments, growth rates and terminal yield vary significantly, therefore key variables discussed in the wider market place need to be treated with caution. The market may look at quoted pre-tax discount factors (~12-16%) used in these valuations, consider the attractive capital structure of a village and low interest rate environment, and consider NTA conservative. To do so in the absence of a detailed understanding of the full set of assumptions being made and the basis of valuation is potentially dangerous. There are three broad principles within CBRE s approach to retirement village valuation that we highlight: CBRE uses an actuarial approach to valuation over a standardised frequency approach. CBRE uses a market-based approach that utilises the approach investors take in transactions for individual villages or small portfolios of villages. CBRE adopts the parameters (as input variables) analysed from sales that have occurred in the market to derive the required internal rate of return for a village using a consistent approach on key assumptions for those transactions to the ones CBRE uses in valuing a village. New Zealand Retirement Village Sector 21

22 CBRE note the importance of consistency and the dangers of focusing on one parameter in informing a view on valuation When adopting a discounted cash flow methodology it is imperative that in the application one is cognisant of the explicit relationship between growth rates, the discount rate and terminal value, as all three variables are co-dependent. In other words, CBRE could apply higher house price inflation growth rates in their valuations, but if they used those same higher growth rates in observed transactions then the transaction price paid would imply a higher required internal rate of return. We can see that from an equity market perspective, the growth being achieved in unit prices (a recoverable resale gain) and the cash flows being delivered from regular DMF are very attractive, and there is an extent to which a portfolio of villages might be expected to justify a premium to the valuation derived in the CBRE valuation. However, our review of the approach similarly highlights factors that we are mindful of. Specifically, this relates to the investment required over the longer term to ensure villages remain relevant the tastes and preferences of retirees change over time and it is clear that older villages require levels of capital expenditure over time that needs to be factored in. Sometimes this is hard to do in the cash flows specifically, but can be factored in through the discount rate instead, which is why observed IRRs in market transactions may be high. Putting aside the attractive funding model, it is important to realise that residents are providing funding by way of a refundable security the village operator is still the long-term owner of the asset. Current unit pricing The starting point for valuation is to complete a review on individual unit values. The best evidence of current unit values is derived from the most recent sales within each village. CBRE considers unit sales within each village, but also gives consideration to unit sales in other retirement villages and the local real estate market for each village. List prices may also be considered, but only if they are backed up by actual recent sales for similar stock. Recycle profiling Generally, two different methods have been adopted for recycle profiling, one from an actuarial viewpoint and the other from a standardised frequency or rule of thumb viewpoint. Both approaches have their limitations and there is an inherent risk that the number of recycles and therefore cash flow will not occur in any one year. CBRE uses an approach that it notes is capable of taking into consideration all the relative factors. CBRE uses a computer simulation model, which seeks to predict the probability of unit recycles for each unit within a village. The simulation model factors in: Available actuarial reports. Death and non-death probability. Local demographics of the village this is important. The incoming age of residents is informed by the actual and recent average age of residents in the village. The individual characteristics of a unit and the village profile, including average age of entry, gender mix, resident densities (i.e. more couples is negative), occupancy periods for existing residents, age distribution of the village, etc. Unlike a standardised frequency model, adopting an actuarial approach results in stabilised occupancy periods per village that are outputs of the model rather than inputs like they are for a traditional model. Growth rates nominal house prices When it comes to unit growth rates CBRE has regard to historical price levels in the specific locations and current prices achieved in the villages in comparison with the median house prices for the surrounding location. As a broad rule, price increases are limited where particular retirement village units or apartments are priced at a level less affordable to those over the age of 65. If the median sale price within a village exceeds New Zealand Retirement Village Sector 22

23 the median in the surrounding catchment then growth is likely to be limited in the first five years of the model when CBRE forms a specific view on growth. Beyond year 5, CBRE use a long-run growth rate that is the terminal growth rate as well. This is typically %. CBRE note that anecdotal evidence suggests the growth pattern of ingoing values (selling prices) will be determined by movements in the affordability of potential residents, and will closely correlate in the long term with growth in the residential real estate market. Other factors considered when determining future growth rates include: What happened historically in an individual village and local residential real estate market, but more importantly what is expected to happen moving forward as it is the future cash flow which drives the underlying value. Quantum of vacant primary and resale secondary stock within the catchment. The intensity of existing and proposed future competition. The desirability of a particular village including its age, scale, product offering and level of community facilities in comparison to the competition. Provision for capital expenditure. The penetration rate of the target market. For the market to move away from both the discount rate (lower) used by CBRE and the house price inflation (higher) suggests an appetite to pay considerably more than observable transactions occurring for villages in the market. We believe it is very important to separate out the valuation of completed villages/units with reference to NTA and the value attributable to future growth In our detailed village analysis we observe considerable differences in how villages perform on a cash flow basis which will reflect these various factors. CBRE places a heavy reliance on the implied growth as evidenced within analysed retirement village unit transactions something that can t be achieved without the access to the information CBRE gets. Internal rates of return (discount rates) Application of internal rates of return clearly has a subjective element to them. Considerations that CBRE take into account in setting the discount rate include: Internal rates of return analysed from transactions of other villages and internal rates of return in other property investment classes. Status of the residential market at the time and investor sentiment. The expected future price growth potential of the village, scale of the village and demographic profiles. Early stage or mature at the development stage the discount rate is higher. While the 12 16% pre-tax discount rates (much higher in some cases but not in villages of the profile typically operated by listed corporates) applied seem high, we believe it is worth considering a range of factors CBRE note in relation to their selection of discount rate: In conventional investment markets, traditional yield analysis requires the assessment of value based on a stabilised income stream. In retirement villages, forecast incomes and expenses are uncertain and may actually differ from that predicted. Retirement villages require a much more intensive level of daily management in comparison to many commercial buildings which provide a passive investment option. Some of these costs are reflected in the Group overhead costs embedded in portfolio village operators. In this regard CBRE are implicitly making some allowance for the overheads required to support a village operation. Retirement village operators have to consult on decisions affecting a village with residents and the statutory supervisor in place to protect the interests of the residents. With the discount rate set off market transactions, CBRE acknowledges that the volume of transactions in the sector is low and that the process of analysing sales to solve for a New Zealand Retirement Village Sector 23

24 discount rate, growth and terminal value is somewhat dynamic CBRE uses the same terminal growth rate as the after year 5 nominal house price growth rate - ~ %. That being said though, CBRE has a strong position in the retirement village market and has access to considerable information on transactions not just of single villages but of smaller portfolios of villages which do transact. By taking the market based approach, the IRR essentially captures factors such as resident funding, tax, ability to fund with bank debt, etc. Despite contraction in cap rates in some asset classes, CBRE has observed limited contraction in the case of retirement villages. Villages are long dated assets that are not particularly liquid and use of lower spot discount rates could be problematic over the longer-term which may explain this. Non-recoverable expenses & capital expenditure allowances CBRE notes that retirement villages require continual expenditure to maintain an aesthetic appeal, structural integrity, and hence, capital value of the asset. That makes sense real estate assets in other classes also do. Our village analysis highlights this too with it clear at a village level that R&M expenditure and maintenance capex are requirements that increase with the age of the village. CBRE factors this and other costs into its valuation as follows: Operating costs such as marketing and other sundry expenses are factored in and if villages subsidise general services (village fees do not cover them) then allowance is made for this as well. A general R&M/maintenance capex allowance is made for the village at 2.5% of gross receipts per annum. At each turnover, a refurbishment capex allowance is made at a fixed dollar amount per year occupied (since the last occupancy). Care facilities are a major part of Ryman s business and care is an increasing focus for the other two large cap listed operators. To be clear, the performance of care facilities from a profitability and cash flow perspective cannot be determined by looking at the Group or village accounts of any of the operators At the first turnover to occur after 16 cumulative years for ILUs (and 12 years for serviced apartments) a broader upgrade allowance is factored in at 3.5% of Gross Investment Property value for that unit. Care facility valuation Ryman doesn t provide a breakdown of the value of its care facilities but it is an important part of the balance sheet as evidenced by the fact that Ryman has accumulated $177 mn of revaluation reserve relating to P,P&E in its balance sheet and this revaluation relates to care facilities. Using our village analysis we estimate the value of care facilities on Ryman s balance sheet to be ~$45 mn with revaluation accounting for a large amount of this. With a three year revaluation required again at FY17, Ryman is likely to have a further revaluation uplift of ~$5 - $75 mn although this will depend on how much cost has been allocated to recently added care facilities, and the success Ryman has had with growing its premium fee base. The CBRE valuation is determined by capitalising actual or proforma net cash flow/ebitdar, whichever is the lower, under the assumption a positive cash flow will be generated into perpetuity. Adjustments are made to reflect any potential upside in earnings potential (which is capitalised at a higher risk rate) and any defined trading premium (which is subject to a multiple of years purchase). Capitalisation rates are also ~12 16% with no growth in the denominator. In forming a view on value, consideration is given to recent transactions of comparable properties and a range of specific factors relating to the property are considered with key influencers being the age and quality of the asset; management expertise of the operator, government regulation and policy, and investor profile and demand for entry into the sector. New Zealand Retirement Village Sector 24

25 The performance of care facilities can be volatile vacancy rates are a key determinant of profitability and local market conditions supply in and out of the sector at a local level can impact vacancy in quite a material way. Care premiums can come and go with vacancy levels. The valuation looks to normalise out under and over performance due to the ability to take corrective action. Recent Metlifecare sales in line with CBRE valuation Metlifecare has sold two villages since FY12 Oakwoods in November 212 and Wairarapa in June 216. Relatively small losses were recorded against the book value in both cases, which is consistent with the observation that CBRE valuations are in line with observed market pricing for villages. Figure 32: Metlifecare Oakwoods, NZ$ s DMF accrual 866 1, , Village and care fees 3,516 3,463 3,527 3,85 3,765 3,98 EBITDA, ex Fair value adj. 1, ,452 1, P,P&E investment (52) (69) (41) (41) (3) (3) IP investment (5) (22) (43) (352) (488) (1,741) Invest cash flow, ex-interest (57) (91) (84) (393) (518) (1,771) Op cash flow, ex-interest 1,746 1, ,884 2,446 4,223 Free cash flow, ex-interest 1,689 1, ,491 1,928 2,452 IP 56,445 54,651 53,142 58,332 58,772 56,644 P,P&E 2,759 2,724 2,65 2,533 2,459 4,372 Refundable ORA, net of DMF 25,527 26,132 25,779 26,662 27,36 3,377 Equity in IP + P,P&E 33,677 31,243 3,13 34,23 34,195 3,639 Fair value movement (33) (1,794) (1,532) 4,792 (51) (3,868) Note: Investing cash flow and operating cash flow excludes interest. Figure 33: Metlifecare Wairarapa, NZ$ s DMF accrual Village and care fees 2,413 2,59 2,43 2,484 2,592 2,59 2,479 2,354 EBITDA, ex Fair value adj. (255) (147) (37) (54) (431) (293) (159) (526) P,P&E investment (46) (49) (38) (53) (57) (125) (184) (18) IP investment (1,415) (1,44) (39) (152) (91) (32) (587) (475) Invest cash flow, ex-interest (1,461) (1,93) (77) (25) (148) (157) (771) (583) Op cash flow, ex-interest 16 (26) (44) 44 Free cash flow, ex-interest (1,355) (1,119) 694 (95) (815) (143) IP 2,44 21,129 25,999 25,536 21,421 21,17 21,1 21,585 P,P&E 3,737 2, 1,875 1,842 3,22 2,331 2,349 2,15 Refundable ORA, net of DMF 1,182 1,178 11,22 11,14 11,956 12,849 12,912 13,621 Equity in IP + P,P&E 13,599 12,951 16,852 16,238 12,487 1,499 1,537 1,114 Fair value movement (1,96) (1,441) 4,749 (68) (4,27) (436) (53) (11) Note: Investing cash flow and operating cash flow excludes interest. We highlight the recent performance of both Oakwoods and Wairarapa and the book value of equity in IP and P,P&E which we compare to the sale price of $28.6mn (compared to 212 equity in IP + P,P&E of $3.6mn) for Oakwoods and $5.9mn for Wairarapa (compared to equity in IP + P,P&E of $1.1mn). New Zealand Retirement Village Sector 25

26 We use an illustrated example to highlight the significance of the fair value movement that occurs when a villa or apartment is delivered and sold for the first time as a retirement unit with an ORA attached to it Illustrative example of fair value uplift In property development, the developer generally looks to make a margin on the sale of a house or apartment before moving on to the next project. The retirement village operator doesn t need to focus as much on that cash development profit on first sale although it seeks one because the operator retains the ownership of the unit and sells a right to occupy which includes a DMF fee and an ability to retain gains in value over time. The delivery of the unit may or may not provide a cash development margin but it tends to drive a large fair value movement associated with the future cash flows that will come from the regular turnover of that unit into perpetuity. The absence of fair value uplifts on a new village would suggest that the costs were too high versus the price realised and outlook for those units into the future. We complete a simplified worked example of an eight-unit village to highlight a range of things with the initial valuation and its subsequent rollover and how this flows into the accounts. The example is simplified we accentuate development margin and do not make allowance for marketing costs, village services (which make a loss in the early years and may breakeven over the longer-term) or for maintenance capex allowances we want to highlight the big variables in this high level model and the cash flow profile. As such the uplift we estimate is clearly overstated. This approach is standardised and we are not replicating the CBRE methodology. Our turnover assumption timing is highlighted in Figure 34. Figure 34: Turnover timing illustrative example Year Unit 1 Unit 2 Unit 3 Unit 4 Unit 5 Unit 6 Unit 7 Unit 8 Total Turnover Y1 1 4 Y1 1 5 Y Y1 1 8 Y1 1 9 Y1 1 1 Y1 Y Y Y Y Y Y Y Y2 Y Y3 1 2 Y The key assumptions for our valuation are: Eight units completed at a unit price on first sale of $75, each. Unit price growth of 3% over years 1 to 2 and a terminal growth rate of 3%. 18 turnovers over the eight units over 2 years. This is equivalent to an average turnover period per unit in the initial 2 years of 11.3%. New Zealand Retirement Village Sector 26

27 Year 2 cash flow is reflective of the cash flow associated with turnover of one of the eight units and we assume this rate into perpetuity (i.e. one unit per annum or 12.5% stabilised turnover rate). We use a DMF rate of 2% accrued over five years. We use a pre-tax cost of capital of 12.5%. Figures 35 and 36 show the market price of a unit over the 2 year period, the DMF accrual and the cash flows for valuation resale realisation and DMF realisation. In practice, DMF accrual would be less variable than in our example as we are accruing for income and balance sheet purposes over the five year contractual term the operators accrue in the income statement over a longer period (expected occupancy) and accrual on a contractual basis on the balance sheet. Figure 35: DMF accrual and market price of a unit (RHS), NZ$ 35, 1,6, 3, 1,4, 1,2, 25, 1,, 2, 8, 15, 6, 1, 4, 5, 2, Annual DMF accrual Market value of unit Figure 36: Cash flow for valuation DMF and resale gain cash realisation, NZ$ 1,, 9, 8, 7, 6, 5, 4, 3, 2, 1, DMF cash realisation Resale gain cash realisation Using a 12.5% pre-tax discount rate and 3% terminal growth rate the valuation of these DMF and resale gain cash flows is summarised in Figure 37. The DCF uplift is equivalent to 39% of the initial price of delivering the eight units. This is clearly a simplified example and the uplift that operators observe will typically be lower (probably more in the order of 25 3% potentially lower with uplift of this quantum over two years), reflecting the costs we ignore and a more conservative initial view by the valuer on year 1 to 5 property growth rates. This initial uplift is an unrealised fair value movement. Figure 37: Valuation summary of eight units with an initial price of $75k each, NZ$ Discrete cash flows 1,846,396 Terminal cash flows 498,238 Value of Operators' interest 2,344,634 Terminal value % of total 21.25% Sale of 8 units 6,, Value uplift on starting unit prices 39.8% Rolling forward the valuation and future fair value movements realised and unrealised The initial DCF valuation uplift will be recognised when the units are completed, i.e. sometimes before they are sold. In subsequent periods, the valuation will be updated. If the assumptions did not need updating in the future (unit price growth matches the assumptions made, as does turnover), then the roll forward valuations and fair value movement outcomes can be illustrated in Figure 38. This highlights some important points: New Zealand Retirement Village Sector 27

28 Once the initial valuation uplift occurs, the future uplifts will be relatively minor in comparison and as DMF and resale cash flow is realised from a turnover there will be years in which the unrealised fair value movement can be negative, albeit the overall fair value movement will be positive if a realised resale gain is made. If unit prices move ahead or behind the assumptions in the model then subsequent periods may result in a resetting of those prices and a stepwise change in the valuation that would drive a bigger fair value movement than in ordinary rollovers. This is why we may observe local or national property market conditions impacting valuation from time to time. This has been noticeable in our detailed village analysis for the operators with Auckland villages in particular over the last two years. The fact that the initial valuation is being done on completion and the units may not yet be sold is another reason why the initial uplift may occur over several valuations as the valuer gets more comfort on the prices being achieved in the village i.e. reason to be conservative before that. Figure 38: Realised and unrealised fair value movement in investment property and Managers interest in units (RHS), NZ$ 2,5, 6,, Figure 39: Accrued DMF on balance sheet, NZ$ 1,2, 2,, 5,, 1,, 1,5, 4,, 8, 1,, 3,, 6, 5, 2,, 4, 1,, 2, (5,) Realised fair value move Unrealised fair value move Mgrs' interest in units Accrued DMF The financial statement impact We show summary financial statements for the first six years of this village in Figure 4 and 41. We assume that the cost to deliver the eight units (including land and construction of the units and amenities) of $5.7 mn a development margin of $3k for illustrative purposes. The income statement is dominated in year 1 by the unrealised fair value movement uplift associated with the first sale of eight units. We note in our example that this fair value movement is $2.14 mn ($2.344 mn initial Manager s interest less the decrease in resident loan of $24k being the DMF recognised). This initial fair value movement is recognised in the same year as the first DMF is accrued and recognised in the income statement. This highlights the fact that unrealised fair value movement is the movement is the net change in the operators (or Managers ) interest in the village i.e. the Manager s interest in Investment Property + Resident Liability, net of DMF. As the Resident Liability, net of DMF decreases by accrued DMF this is also taken into account to avoid a double count in the income statement of DMF). The gain on development of $3k also comes through the income statement if one is recorded i.e unit are sold for more than the costs of construction. This is essentially a realised gain in year 1 in our example. New Zealand Retirement Village Sector 28

29 Figure 4: Illustrative income statement and cash flow statement, NZ$ Year Income Statement DMF accrual 24, 24, 24, 241, ,69 98,374 Fair value movement breakdown Realised resale gain 45,675 69,545 94,132 Unrealised fair value movement 2,14,634 53,79 44,39 42,597 35, ,447 Total fair value movement 2,14,634 53,79 89, , , ,447 Gain on development 3, Total income 2,644, ,79 329, , ,522 39,821 Cash flow statement Operating cash flow DMF release 9, 12, 15, Resale gain release 45,675 69,545 94,132 Total cash flow 135, , ,132 Investing cash flow Cost to construct (2,,) (3,7,) First sale proceeds 6,, Net investing cash flow (2,,) 2,3, Total cash flow (2,,) 2,3, 135, , ,132 Underlying profit in year 1 would be $54k and $24k in year 2. In year 3 it would be $285k and include the first realised resale gain. Cash flows in the early years are well below the income recorded in the income statement and underlying profit. In our illustration there are no turnovers in year 6 and as a result no cash flow despite the income statement showing $4k of income, albeit just $1k of underlying profit (i.e. the DMF). With no turnovers, the unrealised fair value movement is higher, while lower DMF (initial five-year period on units that have not turned over yet ends) also influences this. In the illustrative balance sheet we highlight what drives balance sheet movements. The assets are dominated by the investment property which incorporates the value of the obligation to the resident, net of DMF plus the DCF valuation of the Manager s interest. In year 1, for the sale of these units for $6mn face value, that cash value of the sale is essentially replaced by the $2.344mn of the Manager s interest + the $5.76mn owning to residents, net of DMF after the first year. In year 2 the DCF of the manager s interest rolls over by $293k (no turnovers) but the change in fair value movement after taking into account a further reduction in the resident loan (DMF accrual is $24k) is $53k of unrealised fair value movement. When turnovers commence the fair value movement comprises a realised component (the resale gain) and the unrealised component. The attractive aspects of the development of a village are highlighted in this illustrative example. While upfront development working capital of $5.7mn is required, this is paid back from the sale of the first units with our example reflecting some development margin is realised on delivering the village ORAs. The incoming residents fund that construction and delivery of the first units through the first sale of ORA s and the balance sheet gets a major uplift, as does the equity of the village from the first fair value movement. Thereafter, DMF starts accruing, turnovers start occurring which releases both DMF and resale gains. Over time both DMF and resales gains increase on the back of the increasing value of the units that underlies it. New Zealand Retirement Village Sector 29

30 Figure 41: Illustrative balance sheet and reconciliation of fair value movement, NZ$ Year Assets Cash (2,,) 3, 3, 435, ,22 869, ,352 Land 2,, IP Value Resident Loan, net of DMF 5,76, 5,52, 5,415,675 5,363,393 5,362,916 5,264,542 DCF of Managers' interest 2,344,634 2,637,714 2,831,753 2,996,177 3,126,567 3,517,388 Total IP 8,14,634 8,157,714 8,247,428 8,359,57 8,489,483 8,781,93 Total Assets 8,44,634 8,457,714 8,683,13 8,984,79 9,358,835 9,651,282 Total Liabilities Resident Loan, net of DMF 5,76, 5,52, 5,415,675 5,363,393 5,362,916 5,264,542 Retained earnings 2,644,634 2,937,714 3,267,428 3,621,397 3,995,919 4,386,74 Total Liabilities and equity 8,44,634 8,457,714 8,683,13 8,984,79 9,358,835 9,651,282 Change in fair value movement: Change in DCF of Mgrs interest 293,79 194,39 164,424 13,39 39,821 Less change in loan, net of DMF (24,) (14,325) (52,282) (477) (98,374) Total change, comprising: 53,79 89, , , ,447 Realised fair value movement 45,675 69,545 94,132 Unrealised fair value movement 53,79 44,39 42,597 35, ,447 Sensitivity analysis: Valuation metrics and the reason why larger urban environments are preferred over the provinces; higher value IP is supported by higher property prices and drivers better valuation outcomes The illustrative example highlights key attractive components of the retirement village model. A developer that is good on execution and delivers units in a timely manner on an attractive site and with a good sales strategy can create significant equity from a working capital, rather than permanent capital, position (although, we note the resident funding is temporary). We also highlight why the operators are increasingly focused on higher value locations (outside of other factors like size of the local market in smaller provincial towns, for example). In our simplified example the base case valuation uplift is $2.3mn on units at $75k. If the units sold for $3k, then the value uplift would be $.9mn. The uplift is less sensitive to DMF. If accrual is 3%, rather than 2% then the uplift would be $2.9mn. If the village units end up outperforming the 3% growth assumption over time then the uplift will increase. If the starting assumption were 3.5% then the uplift would be $2.7 mn, highlighting the sensitivity of the model to quite small changes in property price growth assumptions. If the discount rate was 1.5% instead of 12.5% then the uplift would be $3.1 mn. New Zealand Retirement Village Sector 3

31 Investment Property Investment Property Value/Unit 4 October 216 Given the amount of noise and high level disclosure in Group accounts it is difficult to judge the performance of more mature villages in steady state What might steady state look like? Introduction Each of the village operators is relatively young on a unit and IP value weighted basis. In fact, Ryman and Summerset s unit and IP value weighted ages are less than ten years each. Considering the timeframes associated with the sell-down of a village can often be as much as five or six years (over which large fair value gains are able to be generated for good developments) and the initial turnover peak may take as much as a further six or seven years to reach (and the resale and DMF gains in cash for the first time with it), it is clear that the Group financials are not near steady state, particularly with development an ongoing feature. We use our detailed village analysis to look at how more mature villages operate in steady state. Profile of villages We provide a summary of the portfolios of each of the operators. Ryman villages are getting larger the Auckland villages stand out for their higher value Figure 42: Ryman 216 investment property, NZ$ s and number of retirement units 45, 4, 35, 3, 25, 2, 15, 1, 5, Grace Joel Evelyn Page Edmund Hillary Retirement Units Figure 43: Ryman 216 IP/unit, NZ$ s and year opened 1, Grace Joel Edmund Hillary Year Opened Evelyn Page Outside of the three mature Auckland villages completed to date, there is a reasonably close relationship between the number of units and the absolute value of investment property. Those three Auckland villages (and the recently opened Bruce McLaren village in Auckland) are the only villages that sit above the typical range of ~$4-6k IP/unit value. Ryman also has a few villages around $3k IP/unit but by and large there is a real consistency to Ryman s villages in terms of where they are targeted. While there are some exceptions (Princess Alexandra, Julia Wallace, Yvette Williams, Kiri te Kanawa) Ryman has tended to focus on villages with over $5 mn IP value since 1999 and is increasingly focused on villages with IP value around $1 mn or more. While there are some exceptions, Ryman s villages since 21 have tended to have an IP/unit value of at least $4k/unit and this is despite Ryman having a reasonable portion of serviced apartments in the mix. On villages opened through to 214, the weighted average age of a Ryman village is under ten years. Note the IP value/unit is not a gauge of the market value of that unit it includes the fair value uplift associated with the future claims on the unit. New Zealand Retirement Village Sector 31

32 Investment Property Investment Property value/unit 4 October 216 Figure 44: Ryman open villages to 214, NZ$ s Open Units Care Beds 216 IP value 216 IP/Unit Age Unit Weight Age IP Weight Age Woodcote Christchurch Essie Summers Christchurch , % 1% Margaret Stoddart Christchurch , % 1% Frances Hodgkins Dunedin , % 1% Rowena Jackson Invercargill , % 2% Malvina Major Wellington , % 4% Ngaio Marsh Christchurch , % 3% Shona McFarlane Lower Hutt , % 3% Rita Angus Wellington , % 3% Hilda Ross Hamilton , % 4% Grace Joel Auckland , % 6% Princess Alex Napier , % 2% Jane Winstone Wanganui , % 1% Anthony Wilding Christchurch , % 3% Edmund Hillary Auckland , % 16% Julia Wallace Palm. North , % 3% Ernest Rutherford Nelson , % 4% Jean Sandel New Plymouth , % 4% Jane Mander Whangarei , % 4% Evelyn Page Orewa/Akld , % 1% Yvette Williams Dunedin , % 1% Kiri te Kanawa Gisborne , % 1% Bob Owens Tauranga , % 6% Diana Isaac Christchurch , % 7% Charles Fleming Waikanae , % 4% Bruce McLaren Auckland , % 7% Total/average 4,79 2,725 2,562, Note: Village accounts unavailable for Woodcote. Metlifecare a more mature portfolio following a number of years of low development activity high value skew on geography/lack of serviced apartments Metlifecare has two villages that are worth over $25 mn and two villages that sit outside a band of ~$4-7k IP/unit The Poynton and 7 St. Vincents. There is a wider range of value in Metlifecare s portfolio of villages. Figure 45: Metlifecare investment property, NZ$ s and number of retirement units 3, 25, Poynton Pinesong 2, Figure 46: Metlifecare IP/unit, NZ$ s and year opened St Vincents 1,2 1, Poynton 8 15, 1, St Vincents 6 4 5, Retirement Units Year Opened With Metlifecare including the value of the undeveloped land for open villages in its IP value (rather than P,P&E), we note that the two villages opened in 215 have IP/unit levels that are distorted, and we leave them out of Figure 47 until the villages are complete or closer to completed. Metlifecare s average value of IP/unit is $67k IP/unit on an adjusted basis higher than Ryman s due to the greater geographic focus in Auckland and a lower serviced apartment component to the retirement unit mix. New Zealand Retirement Village Sector 32

33 Investment Property Investment Property value/unit 4 October 216 Figure 47: Metlifecare open villages to 215, NZ$ s Open Units Care Beds 216 IP value 216 IP/Unit Age Unit Weight Age IP Weight Age Greenwood Tauranga , % 6% Powley Auckland , % 1% Somervale Mt. Manganui , % 2% Crestwood Auckland , % 3% Pakuranga Auckland , % 2% Highlands Auckland , % 4% Palmerston North Palm. Nth , Kapiti Kapiti , % 4% Bayswater Mt. Manganui , % 5% Coastal Villas Kapiti , % 3% Pinesong Auckland , % 1% St Vincents Auckland ,99 1, % 5% Avenues Tauranga , % 2% Poynton Auckland , % 1% Orchards Auckland ,553 n/a 1 1% 2% Greenwich Auckland ,95 n/a 1 1% 4% Hillsborough PLC Auckland , % 5% Hibiscus PLC Auckland , % 7% Longford PLC Auckland , % 4% Waitakere VSL Auckland , % 7% Dannemora VSL Auckland , % 6% Forest Lake VSl Hamilton , % 4% Oakridge VSL Kerikeri , % 1% Papamoa VSL Papamoa , % 2% Total - ex.jv 3, ,498, Total - ex.jv/215 3, ,332, Summerset a younger overall mix to villages lowest average IP/unit, although more recent Auckland focus will clearly lift it As Summerset has shifted its focus out of the provinces where its early villages were completed it has been able to lift the overall value of its villages with larger unit footprints and higher average IP/unit values. Figure 48: Summerset investment property, NZ$ s and number of retirement units 14, Figure 49: Summerset IP/unit villages open to 213, NZ$ s and year opened 8 12, Manukau 7 1, 8, 6, Hobsonville Karaka Warkworth , 2 2, Retirement Units Retirement Units Summerset also includes the value of the undeveloped land for open villages in its IP value, so we exclude villages opened over 214/215 at this point for IP/unit. We look at average value per unit excluding these villages as well. At ~$425k/unit, this sits well below the average IP value/unit of the other two operators. New Zealand Retirement Village Sector 33

34 Summerset s weighted maturity of villages is similar to Ryman s at around ten years lower on an IP value weighted basis. The average value of units will be positively influenced by recently opened sites at Karaka, Hobsonville and Wigram. Figure 5: Summerset open villages to 215, NZ$ s Open Units Care Beds 215 IP value 215 IP/Unit Age Unit Weight Age IP Weight Age Wanganui , % 2% Paraparaumu , % 3% Palmerston North , % 3% Havelock North , % 4% Levin , % 2% Trentham , % 7% Taupo , % 4% Napier , % 5% Aotea/Wellington , % 7% Manukau , % 1% Hastings , % 5% Warkworth , % 7% Nelson , % 9% Hamilton , % 6% Dunedin , % 3% Katitaki , % 3% New Plymouth ,5 n/a 2 2% 3% Karaka ,461 n/a 2 3% 5% Hobsonville ,69 n/a 2 3% 8% Wigram ,332 n/a 1 1% 3% Total/average 2, ,145, Total/ave. ex 214/15 2, , Looking at Ryman s mature villages We separate out the performance of Ryman s villages according to: Villages opened between 1991 and 26. This gives us information on 12 villages, and excludes the small Woodcote for which financial information is not available. Villages opened since 26. This is a further 17 villages up to and including Charles Upham opened in 216. Weary Dunlop is excluded from our analysis. While we are focused on the profile of mature villages, in the case of Ryman we also look at the profile of villages developed more recently to highlight how dominant development is in the financial results. We show the unit and bed profile of these portfolios of villages over in Figure 51. We can see that over the period , mature villages are essentially stable in the number of care beds (mix change and some development still in 21 and 211) and retirement units (a very modest amount of development). New Zealand Retirement Village Sector 34

35 Figure 51: Ryman care beds and retirement units Y/e 31 March Care beds villages Hospital Rest home Total 1,59 1,63 1,141 1,141 1,112 1,197 1,197 Hospital % 31% 36% 42% 46% 48% 5% 5% 27-current villages Hospital Rest home ,15 Total ,57 1,259 1,45 1,61 1,924 Total 1,674 1,852 2,198 2,4 2,517 2,87 3,121 Retirement Units villages ILU's 1,31 1,32 1,33 1,33 1,28 1,29 1,3 SA's Total 1,62 1,63 1,65 1,65 1,64 1,631 1, current villages ILU's ,88 1,5 1,854 2,271 2,658 SA's ,97 Total 941 1,283 1,645 2,186 2,63 3,161 3,755 Total 2,543 2,886 3,25 3,791 4,27 4,792 5,387 Mature villages relatively stable in income statement contribution With a focus on mature villages, our separation and combination into a portfolio (smoothing out some of the year to year volatility) highlights some significant things: We would expect care and village services revenue to grow over time in mature villages with inflation being a factor. The reconfiguration of care facilities has clearly been positive for Ryman, although, it is equally clear that operating costs have increased over this period is well. This won t all relate to village costs and care fees. In mature villages we would expect property related costs to grow as well including R&M not all refurbishment costs are capitalised. We highlight in Figure 53 that this is indeed a contributor to growth in operating costs. The accrual of DMF has been flat to slightly down during the period. This might be influenced by some residents in villages that are younger in the overall mix staying for longer than the accrual period of ~8 years for independent living units (Note: Income Statement accrual is different to contractual accrual) and possibly a lack of unit price growth in some of these villages. EBITDA, excluding fair value adjustment is down over the last five years and flat for the last three for Ryman s mature villages. We note that the gap between the metrics we are looking at and Group reported levels. This reflects a number of things including our focus on New Zealand villages opened in 216 (Weary Dunlop in Australia is excluded as is Woodcote and a number of villages still to open). In 212 and 213 before Weary Dunlop opened the gap is relatively small. New Zealand Retirement Village Sector 35

36 Figure 52: Ryman income statement village split, NZ$ s Y/e 31 March Care and village services revenue ,67 71,853 71,758 74,84 81,33 27-current 56,134 74,385 91,338 13, ,281 Total 124, , ,96 177, ,314 Balance 2,128 2,148 2,248 4,933 11,117 Reported total 126, , , ,371 29,431 DMF revenue ,657 11,44 1,84 11,97 12, current 15,475 2,431 25,584 3,947 34,722 Total 27,132 31,835 36,424 42,44 46,895 Balance ,353 3,737 Reported total 27,253 31,986 36,55 43,397 5,632 Operating expenses (56,745) (6,623) (64,846) (71,171) (75,568) 27-current (52,854) (66,624) (82,817) (95,889) (17,278) Total (19,599) (127,247) (147,663) (167,6) (182,846) Balance (3,221) (4,819) (7,538) (15,284) (21,329) Reported total (112,82) (132,66) (155,21) (182,344) (24,175) EBITDA, ex Fair value adjustment ,575 22,753 17,869 14,18 17, current 18,776 28,252 34,648 38,673 44,835 Total 42,351 51,5 52,517 52,781 62,579 Balance (656) (2,427) (5,92) (8,657) (6,395) Reported total 41,695 48,578 47,425 44,124 56,184 Mature villages require capital investment We look at operating and investing cash flows as well. We ignore interest in the case of both operating (expensed interest) and investing (capitalised) cash flows. While capitalised interest is a real cost, it is largely a development related charge that will not influence more mature villages in any regard. Even for a relatively large portfolio of villages, operating cash flow still has some volatility in it associated with the timing of resales. Investing cash flows for these mature villages has been higher over 214, 215 and 216. While mix changes in care likely account for a reasonable amount of the P,P&E investment, it is clear from our analysis of villages that investment requirements do increase over time and they are not immaterial. This should not be surprising, while inflated by the fair value uplift in IP, the combined value of IP and P,P&E for these more mature villages is $1 bn clearly this asset base has a cost to maintain as it gets older. Ryman has had a number of villages that have required increasing levels of investment in IP in recent years. Whether that be investment associated with refurbishment of older units on turnover, remedial work at the villages or unit configuration to meet the changing needs of new residents this investment is indicative of increased investment required in mature villages. While the operators do not disclose maintenance capex we think it is important consideration is given to this when looking at the cash flow being generated by the operating village asset base. We are not suggesting that the investment in 214 to 216 on these more mature villages is all specifically maintenance capex, and our overall maintenance capex assumption for Ryman s currently operating villages takes into account one-off capex within the villages over 214 to 216 which includes cladding investment (Malvina Major and Grace Joel) and earthquake related capex (in particular Essie Summers). New Zealand Retirement Village Sector 36

37 Figure 53: Ryman property related expenses on villages opened 26 and before, NZ$ s 14, 12, 1, 8, 6, 4, 2, Figure 54: Ryman cash investment in IP and P,P&E on mature villages opened 26 and before, NZ$ s 18, 16, 14, 12, 1, 8, 6, 4, 2, Cash investment in IP Cash investment in P,P&E Figure 55: Ryman cash flow village split, NZ$ s Y/e 31 March Operating cash flow, ex-interest ,282 36,37 26,886 4,447 38,45 27-current 136, ,947 22, , ,496 Total 174, , , , ,91 Balance 2,177 (622) 1,562 54,853 67,955 Reported 176,43 231, , , ,856 Net investing cash flows, ex-interest (8,591) (6,719) (23,112) (3,648) (25,914) 27-current (126,737) (167,549) (157,827) (164,967) (211,353) Total (135,328) (174,268) (18,939) (195,615) (237,267) Balance (41,37) (11,564) (45,356) (93,627) (116,819) Reported (176,698) (185,832) (226,295) (289,242) (354,86) Free cash flow, ex-interest ,691 29,651 3,774 9,799 12, current 1,27 28,398 62,286 (17,439) 5,143 The impact of this investment is that free cash flow for Ryman s mature villages has been relatively low in recent years. For 12 villages opened by Ryman up to 26 with an asset value of ~$1 bn, the cumulative free cash flow over the last three years is just $26 mn. As noted above, there is likely an element of one off capex within this period, but even over the last five years the average annual free cash flow is $17 mn annually. The increase in the balancing figure for net investing cash flows will be reflective, both of construction activity at Weary Dunlop and other development pipeline villages but also of increasing investment in the land bank. CBRE note that retirement villages require continual expenditure to maintain an aesthetic appeal, structural integrity and hence, capital value of the asset. We think our analysis of the increasing property costs and capital expenditure at Ryman s mature villages highlights that this is indeed something that is important to factor in. While the analysis is high level in Figure 56 we specifically show the free cash flow for villages open between 1991 and 2. There has been a noticeable decline in free cash flow in some of these more mature villages over the period with some of the one-off expenditure noted above for the villages contributing here too. Specifically, Essie Summers was impacted by the Christchurch earthquake, as were other Christchurch villages to a lesser extent - Margaret Stoddart and Ngaio Marsh also required earthquake related remedial work and Malvina Major required some weather tightness related remedial work. New Zealand Retirement Village Sector 37

38 Figure 56: Free cash flow Ryman villages open 2 and before, NZ$ s 8, 6, 4, 2, (2,) (4,) (6,) (8,) (1,) Essie Summers Margaret Stoddart Frances Hodgkins Rowena Jackson Malvina Major Ngaio Marsh Shona McFarlane Growth in Investment Property and fair value movements dominated by development; more limited upwards revaluation in mature villages Growth in IP is dominated by villages in the development stage with the uplift that occurs on the first settlement of a unit being a major contributor to fair value gains. Ryman s mature villages have seen fair value uplift on IP of ~3-6% over the last five years. Figure 57: Ryman investment property and fair value movement village split, NZ$ s Y/e 31 March Investment property , ,95 74, ,23 84, current 78,671 1,11,369 1,271,717 1,566,577 1,993,427 Total 1,427,866 1,677,464 1,975,876 2,313,78 2,797,881 Balance 6,359 6,719 58,673 12, ,424 Reported 1,434,225 1,684,183 2,34,549 2,434,631 2,996,35 Ed Hillary 236,748 27,77 32,26 372,175 41,77 Fair value movement ,24 16,528 3,749 28,679 42,78 27-current 74,3 12, ,34 164, ,18 Total 11,54 118, ,89 193,33 231,888 Balance ,321 42,739 Reported 11, , ,19 217, ,627 Ed Hillary 24,819 22,397 33,83 48,898 35,874 Fair value gain on IP % 3% 5% 4% 6% 27-current 13% 13% 14% 13% 12% Broadly consistent with what one might expect given the valuation methodology used, high-single digit to low-double digit returns generated from mature villages from a mix of free cash yield and fair value uplift Our proxy of total return for the more stabilised mature villages comprises: The average free cash flow yield over the last five years (averaging for lumpiness in cash flows) divided by the equity in IP + P,P&E five years ago (the gross value of IP + New Zealand Retirement Village Sector 38

39 P,P&E less ORA, net of DMF). The denominator is essentially a proxy for village NTA with little other assets or liabilities at a village level. The growth occurring in equity in IP + P,P&E from year to year. This growth takes favourable resident funding into account, as does the cash flow yield which is on the equity in the asset base, not the gross value of the asset base. Consistent with the methodology employed, the overall return for Ryman s villages as they start to mature has been in the low double digit levels over recent years. The cash component of that return has been reducing on increasing investment. Figure 58: Ryman equity in IP + P,P&E and returns, NZ$ s Y/e 31 March Equity in IP + P,P&E ,525 46,58 44, ,18 5, current 43, , , ,281 1,96,265 Total 828, ,796 1,128,685 1,326,461 1,596, villages 5 yrs ave FCF/ equity in IP 12% 9% 8% 6% 4% Growth in Equity in IP + P,P&E 5% 2% 8% 5% 8% Similar trends at mature Metlifecare villages In the case of Metlifecare we look at the performance over the last seven years of villages Metlifecare opened between 1983 and 2. Those villages are Greenwood, Powley, Somervale, Crestwood, Pakuranga, Highland, Palmerston North, Kapiti, Bayswater, Coastal Villas, Pinesong, 7 St Vincents and the Avenues. Outside of some relatively modest development activity at Coastal Villas, these villages have been stable in terms of total retirement units and care beds over the period. We exclude villages Metlifecare acquired as part of the Vision and PLC transactions in 212. Figure 59: Metlifecare mature villages opened Y/e 3 June Retirement units ILU's 1,797 1,797 1,797 1,89 1,89 1,824 1,824 SA's Total retirement units 2,113 2,113 2,113 2,125 2,125 2,14 2,14 Coastal Villas Total - ex Coastal 1,932 1,932 1,932 1,934 1,934 1,934 1,934 Care beds + suites We highlight the Income Statement performance of these villages in Figure 6. There has been limited movement in the core earnings of the business over a seven year period with any growth in fees offset by increasing costs. R&M on IP has been variable and is not insignificant against the EBITDA, ex Fair value and Management fees paid to the parent. DMF growth is consistent with underlying growth in the resale prices being achieved. New Zealand Retirement Village Sector 39

40 Figure 6: Metlifecare mature villages summary income statement, NZ$ s Y/e 3 June Village, service fees 32,67 34,538 36,912 38,29 38,858 4,174 4,174 Membership fees 17,186 17,695 17,3 19,112 19,43 2,684 2,544 Other ,158 2,789 2,847 2,672 Revenue 5,515 52,811 54,816 6,56 61,77 63,75 63,39 Operating Expenses Employee (18,839) (19,633) (2,767) (21,532) (22,55) (22,661) (23,742) R&M on IP (3,489) (6,898) (6,643) (9,289) (6,832) (8,371) (7,859) Mgmt fees to parent (66) (1,551) (1,925) (1,921) (1,794) (1,897) (2,33) Other expenses (15,711) (13,687) (14,347) (17,752) (18,269) (18,689) (18,598) Total expenses (38,645) (41,769) (43,682) (5,494) (48,95) (51,618) (52,52) EBITDA, ex Fair value/mgmt 12,476 12,593 13,59 11,987 13,921 13,984 13,191 Metlifecare s mature villages have generated reasonable growth in operating cash flow, ex interest in recent years with an improvement in the net operating balance also reflecting increased DMF realisation since Metlifecare doesn t net this income off its refunds of ORAs. Metlifecare has been generating growing ORA cash flows (resale gains, in the absence of new sales) with 216 a strong year for resales and Metlifecare also experienced a material uplift in the fair value of IP in its more mature villages in 216. Metlifecare has also had an increase in the investment it has made at its more mature villages in recent years with it evident that Metlifecare held back on capital expenditure in 212. With a broader set of mature villages, we suspect Metlifecare s maintenance capital expenditure requirements may well be in the order of $1 $15mn annually. Figure 61: Metlifecare mature villages operating cash flow and balance sheet, NZ$ s Y/e 3 June Operating cash flow, ex-interest 22,633 24,72 26,11 31,448 41,133 Comprises: Refundable ORA receipts 84,296 11,14 89,87 98,52 11,371 Refunds of ORAs (65,95) (82,115) (7,463) (76,626) (79,627) Net ORA cash flow 18,346 19,25 19,344 21,894 3,744 Operating balance 4,287 5,695 6,667 9,554 1,389 Operating cash flow, ex-interest 22,633 24,72 26,11 31,448 41,133 Investing cash flow, ex-interest (3,984) (8,4) (9,343) (14,86) (15,893) Free cash flow, ex-interest 18,649 16,68 16,668 16,588 25,24 Investment property 983,292 1,14,239 1,49,732 1,18,925 1,227,338 P,P&E 26,94 27,14 28,31 28,225 28,545 Refundable ORA, net of DMF 536,49 548, , , ,438 Change in fair value of IP (69,893) 23,524 27,854 44,625 16,149 Fair value gain on IP % -7% 2% 3% 4% 1% Equity in IP + P,P&E 473, ,553 52, , ,445 5 yrs ave FCF/equity in IP+P,P&E 3% 3% 4% 3% 3% Growth in Equity in IP + P,P&E -12% 4% 6% 8% 17% While fair value movement has been a bit more volatile for Metlifecare it is clear that the combination of a strong property market, good resales evidence and more confidence from CBRE drove a large gain in value of Metlifecare s mature villages in 216 something accentuated at an equity in IP + P,P&E level. Like the more recent trend in Ryman s more mature villages free cash flow yield on equity in IP + P,P&E is low single digit percentage with an overall return (outside 216) of low double digit levels again consistent with Ryman. New Zealand Retirement Village Sector 4

41 Summerset has a smaller base of mature villages and we have to exclude Trentham from our analysis (it was open in 2) due to the ongoing development there. We look at villages opened between 1997 and 25, excluding Trentham. They are Wanganui, Paraparaumu, Palmerston North, Havelock North, Levin, Taupo and Napier. Summerset: Smaller mature base Our analysis of villages highlights that Summerset operates its care in a separate subsidiary (although the care assets are generally held on the balance sheet of the registered village. As a result, our analysis is more limited but we can still look at trends in mature villages which is what we do, and we also note limited care operations in Summerset s older villages. Reflecting the smaller scale of Summerset s older base of villages, the total value of Investment Property is $265 mn for these seven villages. We highlight the profile of these villages across a number of metrics in Figure 62. There is moderate growth evident in village service fees, deferred management fees and EBITDA for Summerset s portfolio of more mature villages broadly consistent with the mature villages of other operators. Fair value movement has been a bit more volatile but has also been relatively moderate in Summerset s earlier more provincial villages. Figure 62: Select income statement items for 25 and earlier Summerset villages (excluding Trentham), NZ$ s 12, 1, 8, 6, 4, 2, (2,) (4,) Care and village serrvice fees EBITDA, ex-fair value movement Property related expenses Deferred management fees Fair value movement For these smaller more provincial villages, fair value movement is quite volatile and not particularly high. We highlight fair value movements for Summerset s post 26 villages for the same period in Figures 63 and 64. This highlights quite mixed performance. Villages Summerset opened over 26 to 211 have made a contribution to more recent fair value uplift growth in particular, Manukau and Nelson. Villages open since 211 have had more mixed performance despite the uplifts that are generally expected early on in development. Of Summerset s more recent developments only Hobsonville and Karaka have contributed meaningfully in fair value movement in their first few years of development. New Zealand Retirement Village Sector 41

42 Figure 63: Fair value movement villages open , NZ$ s 15, 1, 5, (5,) (1,) Figure 64: Fair value movement villages open 212 current, NZ$ s 14, 12, 1, 8, 6, 4, 2, (15,) (2,) Aotea Manukau Hastings Warkworth Nelson Hamilton Dunedin Katitaki New Plymouth Karaka Hobsonville Wigram We show investing cash flow for these mature villages of ~$2 mn per annum in recent years on an IP asset base of $265 mn this excludes investment in P,P&E which is modest at these villages. The level of investment has been consistent over the period. The free cash flow generated from these more mature villages has been lumpy at between $5 and $1 mn per annum and averaged $8 mn. This is an attractive level of cash yield on an IP asset base of $265 mn given that the equity in IP and P,P&E is ~$1 mn on these villages. This could indicate higher discount rates applied to these villages by CBRE. The fair value movement in these villages has been lower, averaging just $4.5 mn per annum over the last five years. The total return is still consistent with low double digit levels. Figure 65: Cash flows for 25 and earlier Summerset villages (excluding Trentham), NZ$ s 14, 12, 1, 8, 6, 4, 2, (2,) (4,) (6,) Free cash flow, ex-interest Investing cash flow, ex-interest Operating cash flow, ex-interest New Zealand Retirement Village Sector 42

43 Our analysis in this section suggests that there is variation in the performance of villages from a cash and fair value movement perspective immediately around development and thereafter. Certainly this influences our view on how to approach development pipeline we do not simply see it as a matter of numbers of beds and units. A broader set of factors clearly influences the value that can be generated from development for the operators. A closer look at development and development outcomes Even in a sector that is getting reasonably large (over 7 villages across the three large cap operators) the ability to look at development outcomes is difficult because of the timeframes associated with completing developments (over many years for some operators) and the fact that developments really need to ultimately be assessed on the cash flows generated when they are operating as well. The fair value uplift generated as units are delivered is in this regard a good guide with villages that are unable to generate fair value uplift unlikely to have achieved development margin (on a full assessment of cost) and likely to struggle as well thereafter either. Certainly Ryman has been the most efficient developer and has the best set of villages to look at and analyse. We do that in this section and also look a bit further (in addition to the previous section) at how villages operate following development. We look to see what influence site selection and location, the value of the property market and other factors have on how villages operate following development. In making these observations on development we note that while there is significant fair value uplift and cash generation potential from good developments in the early years, the operators are also building these villages to own over the long-term. Despite the favourable funding model, these villages are owned by the operators into perpetuity and have to be attractive to future generations of residents. The Ryman development engine Edmund Hillary and Evelyn Page recent examples of what good development looks like Ryman announced that it had entered into a conditional agreement, subject to resource consent approval, for the purchase of the 9.2 ha site that would become Edmund Hillary retirement village in November In April 23, an announcement was made that approval had been received from the Environment Court to commence a $1 mn development consisting of 245 apartments and villas, 6 serviced apartments, 132 hospital or resthome beds and a 31 special care unit. Construction commenced in 25, the village opened in 27 and over the build phase through to 214 the village was ultimately upsized to 433 retirement units and 194 care beds. The value of investment property and P,P&E at Edmund Hillary is $45 mn. We present summary financials for Edmund Hillary in Figure 66. At an operating level (DMF accrual + profitability of care + village services), Edmund Hillary is making ~$7 - $8 mn of operating profit in steady state. This excludes the resale gains being achieved. Fair value movement on the income statement includes both realised and unrealised gains. We do observe that property related expenses are increasing as the value and scale of the property goes up but also as maintenance on the earlier parts of the village start to come through. In the operating cash flows, resident receipts are obviously dominated over much of the period by new sales activity. However, with payments to residents commencing almost immediately and peaking in 213, it is clear that Edmund Hillary has had significant turnover activity during its early years as well. 215 and 216 give an early indication of maintenance levels of capex at Edmund Hillary still quite a new village. These maintenance costs include capitalised refurbishment costs that aren t visible during development. The maintenance capex sits at around $4 mn in 216. New Zealand Retirement Village Sector 43

44 Figure 66: Edmund Hillary Auckland, NZ$ s Y/e 31 March Care beds Units Income statement Care/village fees 2,569 6,841 8,737 9,81 11,28 12,448 13,666 15,345 15,257 Management fees 854 2,251 3,273 4,52 4,714 5,636 5,979 6,716 6,327 Other income Revenue, ex-interest 3,426 9,97 12,19 13,868 15,933 18,95 19,653 22,92 21,614 Property expenses (2) (423) (1,63) (1,322) (1,467) (1,877) (2,264) (2,851) (3,22) (3,86) Operating expenses (46) (4,575) (7,33) (8,252) (8,85) (1,373) (11,385) (13,342) (14,25) (14,187) EBITDA ex Fair value (46) (1,149) 1,794 3,767 5,63 5,56 6,71 6,311 7,887 7,427 Fair value movement 3,36 12,562 16,765 8,391 14,616 24,819 22,397 33,83 48,898 35,874 Cash flow statement Resident receipts 58,675 49,949 39,577 46,511 52,223 66,36 65,86 53,266 4,779 Payments to suppliers (444) (4,27) (6,675) (7,349) (9,162) (9,1) (11,215) (13,326) (15,38) (14,66) Payments to residents (4,641) (6,226) (1,627) (11,414) (1,644) (21,88) (18,912) (19,63) (15,527) Intercompany charges (48) (48) (48) (48) (48) Op cash, ex-interest (444) 49,827 36,568 21,121 25,455 31,999 32,785 33,568 18,598 11,186 Purchase of P,P&E (28,555) (3,897) (4,363) (927) (1,37) (3,59) (1,242) (654) (1,159) (92) Purchase of IP (5,858) (41,928) (14,744) (6,65) (15,418) (17,239) (12,77) (15,321) (3,497) (2,721) Inv. cash, ex-interest (34,413) (45,825) (19,17) (7,577) (16,455) (2,829) (13,319) (15,975) (4,656) (3,641) Free cash, ex-interest (34,857) 4,2 17,461 13,544 9, 11,17 19,466 17,593 13,942 7,545 Cum. free cash flow (61,369) (57,367) (39,96) (26,362) (17,362) (6,192) 13,274 3,867 44,89 52,354 Balance sheet P,P&E 53,63 4,722 23,73 23,491 33,263 35,298 35,656 38,636 38,955 38,966 Investment Properties 19,53 93, , ,36 193, ,748 27,77 32,26 372,175 41,77 Occupancy advances 15,73 67,55 96,61 12,77 124, , ,561 29, ,33 22,887 Equity in IP + P,P&E 57,43 66,768 74,115 84,81 11, , ,82 149, ,97 228,849 Note: Investing cash flow and operating cash flow excludes interest. Because of the good resales activity Edmund Hillary has achieved, free cash flow through the period is a mix of development margin, development expenditure on amenities and P,P&E, resales gains and DMF realisation and operating profitability. 215 and 216 provide an indication that following the sell down of the village, free cash flow is starting to settle at a level below what it was when development profit was also coming through. We estimate that Ryman acquired the Edmund Hillary land for ~$1 mn around 21 and that it invested a cumulative ~$25 mn through to the end of 26. The peak working capital investment in the village (we ignore internal interest costs which are allocated but note that working capital clearly has a funding cost) is ~$6 mn in FY7. It is not until FY13, that the village s cumulative free cash flow is positive. With $3 mn of positive free cash flow to FY14 coming after the construction of care facilities that appear to be worth ~$35 mn (P,P&E) there is evidence of a pre-funding cost development margin that is not insubstantial. However, it is clear that this free cash flow also includes operating profitability and gains from DMF realisation and resale gains that are not significant during the period. We retain our view that development margin is an opaque measure in the industry that we think is overstated at 2 3% given the real costs associated with completing a village which include costs associated with amenities and community facilities. What is clear however is the dominant nature of the fair value movement that occurs during the development and sell down of a village. Edmund Hillary has accounted for $22 mn of IP fair value uplift over FY7 to FY16 an extraordinary amount on a peak working capital investment of ~$6 mn. New Zealand Retirement Village Sector 44

45 We show similar analysis for Evelyn Page in Orewa, another strong performing village for Ryman with regards $135 mn fair value uplift since it was developed and what appears to be attractive development margin. Figure 67: Evelyn Page Orewa, Auckland, NZ$ s Y/e 31 March Care beds Units Income statement Care/village fees 12 3,599 7,49 8,749 9,631 1,415 1,619 Management fees 228 1,5 2,326 3,12 4,149 4,865 4,866 Other income Revenue, ex-interest 33 4,65 9,82 11,881 13,782 15,282 15,486 Property expenses (18) (325) (744) (1,16) (1,194) (1,668) (1,644) Operating expenses (277) (1,192) (4,591) (7,132) (7,97) (8,441) (8,84) (9,162) EBITDA ex Fair value (277) (862) 59 2,688 3,974 5,341 6,478 6,324 Fair value movement 6,865 16,455 14,297 11,743 28,565 25,394 31,81 Cash flow statement Resident receipts 16,475 36,48 42,767 41,913 6,22 28,225 2,34 Payments to suppliers (276) (1,167) (3,673) (6,666) (7,168) (9,19) (9,94) (8,866) Payments to residents (436) (1,638) (4,286) (8,411) (8,881) (9,89) (6,969) Intercompany charges (48) (48) (48) Op cash, ex-interest (276) 14,872 3,617 31,335 25,854 42,32 9,322 4,199 Purchase of P,P&E (1,18) (397) (6,622) (4,52) (471) (79) (164) (261) (794) Purchase of IP (1,953) (24,72) (21,54) (12,861) (15,485) (9,547) (243) (923) Inv. cash, ex-interest (1,18) (2,35) (3,694) (26,6) (13,332) (15,564) (9,711) (54) (1,717) Free cash, ex-interest (1,18) (2,626) (15,822) 4,557 18,3 1,29 32,591 8,818 2,482 Cum. free cash flow (2,) (21,18) (23,644) (39,466) (34,99) (16,96) (6,616) 25,975 34,793 37,275 Balance sheet P,P&E 22,581 2,388 1,749 2,63 2,636 2,224 27,947 27,693 27,991 Investment Properties 24,58 58,639 99,82 125, ,614 19, , ,16 Occupancy advances 2,17 59,54 82,258 99,86 135,1 133, ,65 Equity in IP + P,P&E 22,581 26,968 49,218 6,172 64,77 74,978 83,584 11, ,42 Note: Investing cash flow and operating cash flow excludes interest. Evelyn Page moved into a positive free cash flow position in 214 the back end of development with P,P&E value of $28 mn on the balance sheet as well (cost less given revaluations). Here too it is evident that Ryman has been able to achieved positive free cash flow but it is less clear how development margin has been attributed. As the development has come to completion free cash flow has started to reduce and was only $2.5 mn in 216. Lumpiness of cash flows will be a factor but already an increase in capital expenditure is evident. While they have been developed more recently, we see similar good results from recent developments at Diana Isaac (Christchurch), Bob Owens (Tauranga) and Bruce McLaren (Auckland). Figures 68 and 69 show the free cash flow and cumulative free cash flow profile for those three villages. New Zealand Retirement Village Sector 45

46 Figure 68: Cumulative free cash flow, ex-interest, NZ$ s 4, 3, 2, 1, (1,) (2,) (3,) (4,) (5,) (6,) Bob Owens Diana Isaac Bruce McLaren Figure 69: Cumulative fair value movement, NZ$ s 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, Bob Owens Diana Isaac Bruce McLaren But even for Ryman, not all developments go as well We highlight that not all developments are equal the uplift in value and cash flow profiles of some of Ryman s developments outside of Auckland have not been as successful although only Kiri te Kanawa has been a material challenge. In Figures 7 and 71 we highlight the outcome for developments at: Julia Wallace, Palmerston North Jean Sandel, New Plymouth Kiri te Kanawa, Gisborne Figure 7: Cumulative free cash flow, ex-interest, NZ$ s 1, 5, (5,) (1,) (15,) (2,) Figure 71: Cumulative fair value movement, NZ$ s 35, 3, 25, 2, 15, 1, 5, (25,) Julia Wallace Jean Sandel Kiri Te Kanawa Julia Wallace Jean Sandel Kiri Te Kanawa In these villages, the lower values in the market and smaller catchment likely contribute to longer periods in which to generate positive free cumulative free cash flow and lower overall levels of total positive cash flow and cumulative fair value movement. We also note that in these villages, consistent with its model elsewhere, Ryman has funded scale care facilities of 8 11 beds, during the development period. New Zealand Retirement Village Sector 46

47 Summerset is still in the process of evolving its development model with it evident that it favours moving towards the approach taken by Ryman whereby it builds the community facility and care facilities in the early stages of development and increases its focus on higher value markets. Up until now Summerset has generally phased this part of the development in later stages and had more of a provincial skew to its villages. Summerset working towards achieving Ryman s development efficiency Summerset has not been as active as Ryman in development but has opened eight villages since 21 (Nelson, Hamilton, Dunedin, Katikati, New Plymouth, Karaka, Hobsonville, Wigram) and we look at the cash flow profile of those villages since they have been opened. We looked at the fair value movements in the previous section highlighting mixed performance with some villages contributing but others yet to do so meaningfully. Whereas Ryman has been able to often generate positive cumulative free cash flows quite quickly, and build and fund care facilities at scale at the same time, that is still less apparent for Summerset in this relatively early stage of its transition to a more active developer. This will reflect a number of factors including the fact that Summerset s villages are not completed and have been phased over longer periods. Of the eight villages open since 21, only Dunedin has been completed and with no disclosure on inventory generally in the sector (completed units stock with cash still to realise) it is possible they will generate positive free cash flow towards the end of the build period. We note that fair value movements are recognised on completion, rather than sale. The way in which development margin is calculated enables margin to be positive despite developments being incomplete and this margin can be achieved even for a negative free cash flow project given certain costs are not allocated to it. We do think this analysis (together with the fair value analysis) suggests Summerset still needs to consistently demonstrate its capability on the development front. Figure 72: Cumulative free cash flow (ex-interest) since 21 for recent Summerset villages opened, NZ$ s (5,) (1,) (15,) (2,) (25,) (3,) Nelson Hamilton Dunedin Katitaki New Plymouth Karaka Hobsonville Wigram We note that the cumulative free cash flows in Figure 72 exclude capitalised interest. Summerset s intention certainly is to be able to deliver completed villages, inclusive of care facilities that are positive from a free cash flow perspective. We think the key thing to point out at this point is that Summerset still needs to demonstrate this capability, including at greater scale in more urban developments that include more complex apartments and larger care facilities. New Zealand Retirement Village Sector 47

48 Location, location, location We have a strong view having looked at the villages in a lot of detail that location and the overall quality of development has a bearing on performance. The size of village is important but as we highlight in our analysis in Figures 73 and 74, there is not a straight line correlation between size and contribution to cash flow and fair value and nor should one be expected given the very diverse property markets in which villages are located. We look at the relationship between the size of village and cash generation and fair value for more mature villages opened 26 or earlier across the operators. We show: Last three years cumulative operating cash flow against number of units. We would prefer to use free cash flow, but even in mature villages, this can be skewed in periods of higher investment in remedial capex or refurbishment. Last three years cumulative fair value movement against number of units. In total we have 35 villages to look at, of which four have been excluded. We do exclude some villages opened in 26 or before that have additional Brownfield investment made in the last five years as this will skew operating cash flows through the initial receipt of resident loans. Those villages we exclude are Ryman: Essie Summers earthquake related redevelopment; Summerset: Trentham and Manukau; and Metlifecare: Coastal Villas. Figure 73: Last three years cumulative operating cash flow (y-axis, NZ$ mn) and village units and beds (x-axis) by operator 2, 18, 16, 14, 12, 1, 8, 6, 4, 2, MET SUM RYM New Zealand Retirement Village Sector 48

49 Figure 74: Last three years cumulative fair value movement (y-axis, NZ$ mn) and village units and beds (x-axis) by operator 5, 4, 3, 2, 1, (1,) MET SUM RYM Broadly speaking there is a correlation between village size and cash generation and fair value movements although there is quite significant variation within clusters of unit size which make it clear that there are factors beyond village size that have a significant influence on cash generation and fair value. As a portfolio, the size and generation of cash and fair value movement is noticeably smaller for Summerset than across the majority of the Metlifecare and Ryman portfolios Summerset s early development focus had a skew to provincial lower North Island locations. New Zealand Retirement Village Sector 49

50 Our analysis of completed villages highlights that not all developments are equal. Developments and the way in which they are executed will have different results and time value of money is important to consider with development given timeframes that can apply to consenting, construction, sell-down and subsequent cash flow harvesting. Land bank and the development pipeline It is not just site selection that will influence development success with it increasingly clear (if imitation is the best indicator of success) that Ryman s strategy of investing in community facilities and care at the early stages of a development has contributed to a more profitable development profile than those that haven t. Ryman has a track record of selecting and constructing sites and selling them down in shorter timeframes than the other two operators to date. This likely reflects a combination of factors including the demand profile that sites service and the capitalisation of the operator to complete large stages and community and care facilities up front. In this section we look at the recent development track record of the operators in acquiring land and converting it into completed villages. Ryman significant step up in land bank over the last three years Ryman s land bank at 31 March 216 is summarised in Figure 75 with two acquisitions since then also included. Figure 75: Ryman land bank at 31 March 216 Units Beds Existing sites or under construction Princess Alexandra Napier 2 Jean Sandel New Plymouth 69 Kiri te Kanawa Gisborne 52 Bob Scott Wellington 198 Possum Bourne South Auckland Bert Sutcliffe Auckland 239 Charles Upham Rangiora Greenlane Auckland New sites Devonport Auckland Tropicana Auckland Newtown Wellington River Road Hamilton Site A Australia Brandon Park Melbourne Burwood East Melbourne Total 3,62 1,19 Recent announcements Hobsonville Mt. Eliza Auckland Melbourne Outside of projects being completed on villages that opened in 29 and 211 (Jean Sandel and Kiri te Kanawa), the land bank is largely in the urban areas Ryman is increasingly targeting. The efficiency with which Ryman completes development means there is little in the way of Brownfields or ongoing development in older villages in the land bank. Ryman has a large land bank and a strong track record of efficiently converting that land bank into retirement villages and selling down over 2-3 years in most cases. We look at activity in New Zealand and Australia since 21 and suggest that timeframes for converting the land bank into constructed villages is likely to increase as more challenging and ambitious projects are undertaken with a greater urban focus. This is also a likely contributing factor in the increase in the size of the land bank as operators diversify across a greater portfolio of sites given the greater variability in getting design and consent New Zealand Retirement Village Sector 5

51 completed. An increasing land bank and greater construction of apartments (more common in urban villages) will see working capital requirements of the operators increase and with this comes a greater onus on execution and capability. Ryman has a very good track record on this front. New Zealand: Steady state achieved with ~2 sites acquired and opened each year Before we look at Ryman s current land bank in a bit more detail we highlight the consistency of Ryman s development since 21 and the timeframes between purchasing and opening of villages for villages open or about to be opened in 216. Ryman has announced the acquisition of land and then moved through to opening of the following eight villages since 21 in New Zealand: February 21: $9 mn village for Christchurch 23 rd village announced. An 11 hectare site that is Diana Isaac village. Opened two years later in 212. June 21: Announces purchase of 7.1 hectare site in Tauranga 24 th village. To be a $1 mn+ investment. Bob Owens village opened two years later in 212. March 211: 25 th village in Waikanae - $1 mn investment on 6.9 hectare site. Opened two years later as Charles Fleming village. August 211: 26 th village in Howick. 3.5 hectare site. Opened three years later as Bruce McLaren village. July 212: Site acquired in Petone a 3.3 hectare site. Opened three years later in 215 as Bob Scott village. May 213: Announce acquisition of Birkenhead site in Auckland. To open three years later in 216 as Bert Sutcliffe village. June 214: Purchase of 6.6ha site for construction of a new $1 mn village at Pukekohe. Possum Bourne village opened a year and a half later in 215. July 214: Purchase of 6.5ha site for $12 mn village in Rangiora. Opened two years later in 216 as Charles Upham village. Outside of the sites at Petone, Pukekohe, Rangiora and Birkenhead which have opened with construction stages continuing, Ryman has one other site under construction in New Zealand which is yet to open, and will open later in Greenlane: July 214: Purchase of 1.7ha site in Greenlane, Auckland for $1 mn village. Construction under way. While practical completion of the first stage will likely be achieved in early 217, the village is won t be opened until late 217 when residents can access the site. During this period since 21, Yvette Williams and Kiri Te Kanawa were also opened in 211 but the land was acquired earlier for these villages. The acquisition (eight) and opening of ten villages in New Zealand over this period has been impressive. Over this period Ryman has been able to secure land and generally have a village open within two to three years. In addition to the activity above, Ryman has secured a further six sites in New Zealand (one unidentified) and four sites in Australia (one open). We discuss these below. Increasing focus on Auckland and the need to be more creative with land acquisition looks set to see the land bank increase Ryman has a bigger portfolio of land bank opportunities currently open and the concentration of that land bank is increasingly focused on Auckland (and Australia see below). With that there is an increase in the timeframes associated with getting through consent and commencement. That is not new, and it is site specific Howick, Pukekohe and Birkenhead have all been opened within three years of site acquisition. Ryman s New Zealand Retirement Village Sector 51

52 Edmund Hillary site was purchased in 1999 and did not open to 27 due to significant delays in getting consent. Ryman has the following two sites in the consenting stage in New Zealand, both announced in 214. In both cases, the consent has been publicly notified and is still likely to take 6 9 months at best before consents are achieved and construction can commence later in 217: May 214: This acquisition was not announced as a standalone purchase but reference was made in May 214 to recently unveiled plans to build a new village on a prime site at Devonport. That site is subject to a prepaid 15 year lease. The site is now awaiting resource consent, having been publicly notified. July 214: Purchase of 8.9 ha site in Mount Roskill, Auckland Tropicana. Ryman noted on announcement that it had no firm dates for when the resource consent would be lodged but would hope to have the village opened by mid to late 216. The site is now awaiting resource consent, having been publicly notified and construction is unlikely to start until 217 at the earliest. Ryman has also announced the following four sites are in the planning stage with the formal consenting stage yet to commence: July 214: Purchase of 6 sq metre site in central Wellington for boutique village. Ryman is currently planning to lodge consent later in 217. July 215: Purchase of 8.3 ha site in River Rd, Hamilton for a second Hamilton village. The consent is with the Hamilton Council who has yet to make a decision on whether it will be publicly notified or not. July 216: Purchase of 4ha site at Hobsonville for a $2 mn development. This will be Ryman s 1 th Auckland site. Ryman are looking to lodge consent by March/April 217. Site A, New Zealand. In design stage. Ryman noted this site in their land bank in November 215 as a site being in the development phase. Ryman is still formalising its plans for this site and consent may not be lodged until 218. It is noteworthy that Ryman has three sites announced in 214, two of which it is still awaiting consent and one which it has not completed design for yet. We do expect this to be an increasing factor with the land bank likely to take longer to take through to construction phase as more challenging and ambitious sites are acquired. For the five sites in New Zealand for which we have information we would note that three are in Auckland and the other two are in cities Wellington and Hamilton. Two of the three Auckland sites are in well-established mature urban areas while one is in what we would describe a more marginal city fringe/developing area. Australia: An encouraging start means that Ryman remains ambitious about Australia. Ryman announced that it was actively seeking expansion into Australia in 21. In 215 it announced an objective to have five villages open in Melbourne by 22 following the successful sell down of its first village. Ryman has one open village and three sites. Its progress has been as follows: November 211: Announces purchase of Wheelers Hill site, the first village in Australia and 27 th for the portfolio. Opened three years later in 214. November 213: Announce that construction at Wheelers Hill going well with 48 apartments already signed up. Committing to second stage and to searching for second Melbourne site. New Zealand Retirement Village Sector 52

53 May 214: Purchase of 5.5ha site at Brandon Park, Melbourne. Currently waiting planning approval to commence construction in late 216 or early 217. February 216: Purchase of 2.5ha site in Burwood East, Melbourne for $2 mn village. In design phase - intention to apply for planning permission for the village in late 216. September 216: Purchase of 8.9ha site in Mt Eliza in the Mornington Peninsula, outside of Melbourne. Ryman s ambition is for Melbourne to be as big a part of its business as New Zealand is although no timeframe has been given. Ryman appears to be targeting the acquisition of 2-3 sites each year over the next few years. This could see the announcement of the purchase of a further 6-8 sites between now and 22. Land bank likely to get larger given Melbourne ambitions and need to incorporate longer lead times Ryman currently has nine land bank sites for which construction has not commenced. With the need to accommodate longer lead times we expect Ryman to continue to look for 2 sites a year in New Zealand (one Auckland; one outside) and for its land bank in New Zealand to remain relatively steady. In Australia we expect the land bank to get larger with Ryman need to a further four or five sites in Australia and then likely looking to acquire ~2 sites per year from then in steady state. Metlifecare development: still work in progress Metlifecare s land bank is summarised in Figure 76. Unlike Ryman, the land bank has a higher skew to brownfields opportunities at generally well established sites. Figure 76: Metlifecare land bank at 3 June 216 Units Beds Existing sites or under construction Crestwood/Pinesong Auckland 51 The Orchards Auckland 42 Greenwich Auckland The Avenues Tauranga 3 3 Papamoa Papamoa Somervale Mt. Maunganui Coastal Villas Paraparaumu 4 Oakridge Kerikeri New sites Red Beach Auckland Albany Auckland Total 1, Metlifecare has been the least active developer of the large operators over the last ten years. That is starting to change with Metlifecare opening two new villages in 215 that it commenced in 214 (and acquired the land for in 212) The Orchards in Glenfield, Auckland and Greenwich Gardens in Unsworth Heights, Auckland. Greenwich Gardens stages will continue to be delivered over the next three years through FY19 and Metlifecare also has work planned at a number of existing sites. Outside of site acquisitions in 212, Metlifecare s other land bank activities since 21 have been Auckland focused, with Metlifecare active in 215: January 215: Conditional agreement to purchase 5 ha site in Red Beach, Auckland for a proposed $15 mn development (likely upgraded to a $2 mn development). Site unconditional July 216. New Zealand Retirement Village Sector 53

54 April 215: Conditional acquisition of 5.5 ha site within the Manukau Golf Course, Manurewa, Auckland for a $175 mn development. Decision announced October 215 that Metlifecare would not follow through with the acquisition. October 215: Conditional acquisition of 3 ha site in Albany, Auckland for a $3 mn proposed development. Site unconditional in December 215. Metlifecare s decision to walk away from the Manukau opportunity reflects their assessment of the more marginal nature of the project. Further to our comments about lead times with moving to development, the following is noteworthy with regards Metlifecare s two current greenfield sites: Metlifecare is looking to deliver the first units at Red Beach in FY19, four years after the site was first announced. The Albany site is not on Metlifecare s development plans out to FY19 with a number of factors likely to see this site being a development site after FY2. Summerset: significant site acquisition in the five years since listing Summerset s land bank is summarised in Figure 77. Construction underway comprises a mix of provincial back fill and construction on sites acquired in the last three or four years which have a greater urban skew to them. Certainly the new sites have a greater focus on Auckland and in bigger regional centres. Figure 77: Summerset land bank at 3 June 216 Units Beds Existing sites or under construction Trentham Wellington 71 Levin Levin 1 1 Warkworth Auckland 79 Hamilton Hamilton 65 Katitaki Katitaki 15 2 New Plymouth New Plymouth Karaka Auckland Hobsonville Auckland Wigram Christchurch New sites Casebrook Christchurch Ellerslie Auckland Lower Hutt Wellington St Johns Auckland Parnell Auckland Richmond Nelson Rototuna Hamilton Total 2, Summerset listed at the end of 211 with in-fill and brownfield development potential of just under 75 retirement units at five existing sites and three greenfield sites at Dunedin (opened 212), Katikati (opened 213) and Karaka (opened 214) providing a further 436 units development. These sites were acquired in 29, 27 and 25, respectively. Summerset has announced the acquisition of a further ten sites over the last five years, as well as additional land adjoining Summerset s existing sites at Trentham (purchased 213), Karaka (land purchased in April 214) and Warkworth (land purchased in July 215). That is impressive. We look at the detail a little further. Of these ten acquisitions four villages have opened or are about to open: New Zealand Retirement Village Sector 54

55 April 212: Announcement of acquisition of 7.6 ha at Hobsonville, Auckland to be Summerset s 18 th site. Environment Court approval was gained in November 213 and the site opened a little over two years following acquisition in 214. November 212: Announcement of acquisition of 3.8 ha site at Ellerslie in Auckland. The site is due to open four years later in 216. Resource consent was gained two years after the initial announcement in August 214. August 213: Acquisition of a site at New Plymouth. In February 214, resource consent was gained for a $55 mn village on the 4ha site. The site opened a little over one year following acquisition in 214. December 213: Acquisition of 5.4 ha at Wigram, Christchurch. Resource consent was granted for the village in December 214. Wigram was opened two years after the site was acquired in 215. However, the other six sites, including sites acquired in 213, are yet to commence construction with four yet to have consents lodged. April 213: Acquisition of 3.3 ha site, Summerset s 2 th in Lower Hutt. The majority of this site (there is some residentially zoned land on the site) required a zone change which has been approved by the Hutt Council recently allowing Summerset to move to Resource Consent approval. It is currently Summerset s intent to commence construction of this site around 218/219. December 213: Acquisition of 9.7 ha at Casebrook, north of Christchurch. Resource consent was granted for the $1 mn village planned at Casebrook in September 215. Construction is expected to commence in early 217 with first homes available later in 217, four years after land acquisition. With Summerset already active in Christchurch and having a range of other projects underway, Summerset is likely to commence construction at some stage during 217 (looking to use some resources being deployed at Wigram currently) with the village potentially open in late 218. July 215: Acquisition of an interest in a 2.5 ha site on St John s Road in Auckland South Eastern suburbs. The site will be subject to a 125 year prepaid lease. Summerset is looking to lodge consent in late 216 which suggests that construction commencement will likely be some time away. July 215: Acquisition of a 2.3 ha site in Parnell, central Auckland. This is a more challenging site and it is unlikely that resource consents will be lodged until mid to late 217. February 216: Acquisition of 6.3 ha site for a village at Rototuna, Hamilton. Summerset is targeting to lodge resource consent application in late 217 with delivery of the first units targeted for 218. May 216: Acquisition of an 8 ha site in Richmond, outside of Nelson. Resource consent is likely to be lodged in early 217 with the delivery of the first units potentially occurring from late 218. While Summerset is yet to move into Australia it is clear that it is also pursuing a growth strategy which will see it need to hold more land bank assets as it works through consent timeframes that will not always fall within the desired one to two years. Summerset has a solid pipeline of development sites in varying stages of design and consent. While it is likely to be lumpy Summerset is currently targeting to acquire one site in Auckland and one site outside of Auckland per annum. Having secured some higher density sites in Auckland more recently (e.g. Parnell, St. Johns) its current focus is more for broadfield sites. New Zealand Retirement Village Sector 55

56 We provide a high level summary of key financials for each of Ryman, Metlifecare and Summerset. Our focus is cash flow, debt and valuation metrics. The business models of the operators are well understood and we have covered the operating base and land bank of the operators in our introduction to the operators section and in the land bank section. High level financial summary of the operators Ryman: trust earned goes a long way Ryman s growth over the last four years has been phenomenal. In the income statement, care/village fee revenues have increased from $127 mn to $29 mn over four years and DMF fees have almost doubled. The operating cost base has grown as well and at a reported EBITDA level, ex-fair value movements, growth is more modest growing from $42 mn to $56 mn over the period. We do not have visibility on how much Group overhead has grown over this period or what overhead has been capitalised to development from year to year. Similarly we do not have visibility on care profitability. The real profit driver in the Income Statement is fair value movement which has been very strong over the period with the combination of high levels of development activity and a rising property market combining to drive significant positive fair value movements. For mature villages we note that fair value movements are generally more moderate see our section looking at this specifically. Reported and underlying profit have both recorded strong growth. Reported development margin has doubled over the period to $6 mn and accounts for 4% of underlying profit. We focus more on operating cash flows and highlight that Ryman produces a positive core cash surplus from its non-property cash flows e.g. care + village services and their expenses less Group overhead expensed. There has been little growth evident in this cash flow in recent years. When we add the core operating cash earnings drivers: realised gain on resale and DMF realisation we see the strong core operating cash generated from Ryman s business. Ryman has reported steady growth in core operating cash flows as well over the period but we highlight that this, our preferred measure of core operating profitability, is ~6% of underlying profit. Ryman s cash dividend represents a ~7 8% payout ratio of this core operating cash flow. Cash interest accounts for the rest in other words, Ryman does not retain anything material by way of cash earnings its growth in equity/nta is largely on the back of fair value movements and any overall cash development margin (after accounting for all development costs something we cannot observe) rather than retained cash earnings. We group new sales and investing cash flows together which highlights that development (and the purchase of land bank and construction of care facilities) remains ahead of the sales being generated from that development. Free cash flow (before dividend) is negative in the last two years as this land banking and construction activity lifts. We also observe quite a large increase in Ryman s debtors in FY15 and a working capital difference between our cash proxies (based on accrual recognition of resales and new sales) and the actual free cash flow. New Zealand Retirement Village Sector 56

57 Figure 78: Ryman summary financials, NZ$ s Y/e 31 March Summary income statement Care/village fees 126, , , ,371 29,431 DMF fees 27,253 31,986 36,55 43,397 5,632 Operating expenses (112,82) (132,66) (155,21) (182,344) (24,175) EBITDA, ex fair value movement 41,695 48,578 47,425 44,124 56,184 Fair value movement 11, , ,19 217, ,627 Profit for the period 12, ,73 194,85 241,918 35,423 Development margin 3,574 41,332 5,324 61,597 62,396 Underlying profit 84,58 1, ,24 136, ,713 Summary cash flow Receipts from residents - care, village services 127, , , , ,817 Payments to suppliers/employees, in Group o/h (19,28) (13,615) (151,358) (184,719) (29,19) Cash surplus/(deficit) from operations 18,168 16,16 16,114 6,666 12,627 Realised gain on sale - accrual 25,188 27,553 38,612 5,312 6,613 Realised DMF - cash 11,663 15,59 16,76 22,422 24,1 Core Op. cash flow proxy, ex development 55,19 59,33 71,486 79,4 97,25 % of underlying profit 65% 59% 6% 58% 62% New sales proceeds - accrual 131, , , ,96 226,215 Investing cash flows, ex cap. interest (176,698) (185,832) (226,295) (289,242) (354,86) Development cash flow (44,77) (7,339) (52,331) (4,146) (127,871) Net cash interest - expense + capitalised (12,138) (13,442) (14,436) (19,136) (24,998) Working capital - cash timing differences (11,116) (6,644) 2,482 (86,495) (1,357) Free cash flow (13,5) 31,878 7,21 (66,377) (56,976) Cash dividend (38,5) (45,5) (55,) (62,5) (73,) Dividend % of core operating cash flow 7% 77% 77% 79% 75% Core operating cash flow coverage: Net cash interest expense Net cash interest expense + dividend Summary balance sheet Debtors 91,786 13,478 15, , ,228 P,P&E (care facilities + devel land) 382, ,62 583, ,76 754,53 Investment property 1,434,225 1,684,183 2,34,549 2,434,631 2,996,35 Payables 5,485 35, ,145 1,986 92,342 Refundable accommodation deposits 11,846 28,32 Resident's loans, net of accrued DMF 928,528 1,114,479 1,36,71 1,58,172 1,854,232 Interest bearing debt 213, , ,178 47, ,917 Shareholders' Equity = NTA 647, , ,746 1,11,321 1,327,525 Cash flow yield and NTA growth Core operating cash flow proxy 55,19 59,33 71,486 79,4 97,25 Cash yield on average NTA 8.5% 8.1% 7.7% 7.2% 7.3% NTA 647, , ,746 1,11,321 1,327,525 Growth in NTA 14% 13% 26% 19% 21% Debt and obligations Net debt 21, ,46 275,424 46, ,878 Capital commitments 15,5 22,2 27,5 26,3 88,3 Land in accounts payable 21,4 3,1 81,3 61,6 48, Annual repayment of resident loans, net of DMF 86, ,88 13, , ,319 Ryman is generating a very attractive return on NTA on a core cash operating basis. This reflects the scale and efficiency of Ryman s care operations and village services, as well as a Group overhead that is spread over the largest operator in the sector. New Zealand Retirement Village Sector 57

58 Ryman s cash yield sits well above that of the other two operators. While non-cash generating assets (land bank and construction in progress) also sit on Ryman s balance sheet we note that we do not think this creates a drag on NTA cash returns as those assets are debt funded see point below and the net equity in those assets is likely, limited. The uplift in the value of these assets will come when they are operational and units are revalued for the future claim on resale gains and DMF and care facilities are revalued and capitalised for their cash earnings. The core operating cash flow yield that we highlight excludes allowance for maintenance capex. Despite having significant asset bases that clearly require investment over time (from refurbishment on turnover through to general upkeep of the overall village and its community facilities and periodic changes in configuration for them to remain attractive), none of the operators separate out maintenance capex. Our village analysis clearly highlights that this is a feature and that the levels of investment are a drag on the free cash flow generated from mature villages. We estimate Ryman s maintenance capex currently sits at ~$2 - $25 mn per annum. Growth in NTA has been similarly impressive over the last four years with this growth essentially driven by a strong property market and the significant development activity taking place (which generates an initial uplift on the first DCF valuation of a units future cash flows). We would expect a high revaluation contribution to NTA in FY17 when Ryman puts through its three-yearly revaluation of its care facilities. Increased land banking and construction will see debt continue to increase. Ryman has a large operating cash flow base and diverse business; increased disclosure on headroom would be useful to see as debt increases Debt levels are increasing as Ryman increases its land bank and construction in progress gets larger on increasing unit delivery (Australia will be a feature here as well as Ryman gets a portfolio of development opportunities to roll out in that market). We observe that land payables and capital commitments are increasing as well. We view shareholders equity as a poor gearing measure as the growth in equity is heavily driven by fair value uplift which represents earnings associated with future delivery of cash. As such we focus more on operating cash flow coverage when looking at debt. Ryman has strong net cash flow coverage of cash interest expenses (expensed + capitalised) but we would highlight that those cash flows are heavily dominated by resales generated activity. As such some consideration needs to be given to the dual impact on both new sales (ability to repay working capital debt facilities) and resales (servicing interest costs and the dividend) from a pronounced slow-down in property market activity. In FY16 Ryman refunded $167 mn of resident loans, net of DMF. Clearly the fact that Ryman has no contractual obligation to refund in New Zealand is useful but we note its brand commitment and issues that could arise were some residents waiting longer periods for their cash to be returned in a slow down, particularly if that inability to meet refund commitments in a timely manner was associated with too much development debt. We also note that the dynamics will change as Ryman has a statutory requirement in Australia to refund resident loans after six months in that market. We accept that there is a needs based element that is also a consideration in the timing with which residents move to a retirement village this might see them accept a lower price for their existing property so that they can settle on a retirement unit. But we are cautious about an overly simplistic interpretation of this care facilities and to a lesser extent serviced apartments are needs based but independent retirement units have a less urgent element to them that could see the decision to move into a retirement unit pushed out in a severe housing market downturn. As working capital debt levels increase we would like to see Ryman (and this applies to Summerset as well) increase disclosure on their debt facilities (while covenants have never been disclosed by the operators in the sector due to commercial sensitivity, it would New Zealand Retirement Village Sector 58

59 be good to understand banking headroom) and the asset backing of debt information on headroom would be useful as a gauge of ability to deal with a slow down that impacted earnings. We note that Ryman clearly state that they operate comfortably within their covenants. We think this will be increasingly important as new liabilities come on Ryman s balance sheet and debt increases to fund the growth ambitions in Australia (debt over $8 mn likely in the next two to three years). In a functioning property market we would expect to see Ryman be able to continue to operate as it has in recent years due to its significant operating cash flows and we note that Ryman has the ability to suspend dividends (which are tied to underlying profit in any event) if it needed to weather a downturn in new and resales activity. Ryman managed through the property slowdown; it does have more debt now, but a larger and more diverse business as well We look at how Ryman performed through the last major slowdown in the housing market after 28 and compare high level metrics going into that event with how Ryman is positioned in 216. Figure 79: Ryman net debt, NZ$ s Figure 8: Ryman operating and free cash flow, NZ$ s 6, 35, 5, 3, 25, 4, 2, 3, 15, 1, 2, 5, 1, (5,) (1,) Figure 81: Ryman net investing cash flow, NZ$ s and sale of occupation rights, new and resales (RHS) 4, 1,4 Figure 82: Ryman dividend and net cash interest costs, NZ$ s 12, 35, 1,2 1, 3, 25, 2, 15, 1, 1, , 6, 4, 5, 2 2, Net investing cash flow Sales of occupation rights Cash dividend Net cash interest expense It is clear that over the period 28 to 21 there was a pause in the rise in Ryman s operating cash flow and net investing cash flow trajectory as Ryman paused on growth. Ryman was able to generate positive free cash flow as development activity slowed and was able to maintain and slightly increase dividends over the period. Ryman s new and resales activity did slow over the 28 to 21 period. New Zealand Retirement Village Sector 59

60 Growth started again in earnest in 212 across all of the metrics we highlight. While Ryman clearly has a bigger operating asset base today than it did in 28 we highlight that it has significantly higher debt and interest commitments and higher dividend expectations as well. With the core operating cash flow generated from the business also at least somewhat reliant on property market conditions the risks could be more elevated than they were in 28. There are other differences in the business also though including greater diversity (e.g. Australia). Ryman valuation track record highlights why market attributes growth to existing cash flow base; qualitative and quantitative assessment required on how much growth is reasonable. The market remains confident but is pausing on value despite strong operating and fair value growth over the last two years We summarise a range of valuation metrics for Ryman in Figure 83. Figure 83: Ryman summary valuation metrics, NZ$ s Y/e 31 March Net tangible assets 647, , ,746 1,11,321 1,327,525 NTA per share (Cps) Appreciation in NTA/share 13% 26% 19% 21% Market share price (March years) Market price/nta Shares on issue 5, 5, 5, 5, 5, Market capitalisation 1,545, 2,52, 4,375, 3,92, 4,175, Bank net debt 21, ,46 275,424 46, ,878 Enterprise value 1,755,463 2,745,46 4,65,424 4,326,766 4,72,878 Mkt cap less NTA 897,781 1,785,531 3,448,254 2,818,679 2,847,475 Reported free cash flow (13,5) 31,878 7,21 (66,377) (56,976) Core op. cash flow - ex interest & development 55,19 59,33 71,486 79,4 97,25 Core cash operating yield on NTA 8.5% 8.1% 7.7% 7.2% 7.3% Core cash op yield on Market cap 3.6% 2.4% 1.6% 2.% 2.3% Market price/nta at current price The growth in NTA has been strong but it is apparent that the market is catching up on valuation over FY14 to FY16 with Ryman de-rating on a number of valuation metrics allowing the gap to NTA to close somewhat. Certainly this de-rating isn t associated with Ryman s performance performance has been very strong over the last two years. Still at a 2.3% operating cash yield (excluding interest which we attribute to development) on market capitalisation and this coming before maintenance capex which could account for up to 2-25% of current core operating cash flow this is a premium valuation highlighting that the market retains confidence on growth potential which will be supported not just by the land bank but by the growth in cash flow being achieved. The $2.8 bn gap between market capitalisation and NTA represents a multiple of 4x the absolute value of growth in NTA achieved in the last four years a period in which development activity has been high and property market growth has been above trend. We attribute the valuation premium to a number of key factors that we have started to explore in this report. While the growth in cash flow for mature villages is reasonably moderate; the development tail (villages that have just recently been developed) will translate into growth in operating cash flows over time. As we have seen in the last four years this New Zealand Retirement Village Sector 6

61 has not been insignificant for Ryman as the operating cash flows out of significant villages like Edmund Hillary, Evelyn Page and Diana Isaac have come through the business the initial fair value uplift captures this potential at development while the cash flow comes through the first turnover period. In our view NTA is a very useful starting point for valuation of existing villages but we accept a premium is likely justified particularly given Ryman has a quality portfolio that is well positioned and that its business model operates well on a DMF of 2% (scope to go up; little chance of going down given the competition tends to be at 25%+). The quality of the development pipeline in place and the valuation uplift that can be generated from this asset base after repaying the debt that funds it. A number of things need to be considered here including the timeframes associated with competing development (time value of money), local market conditions (site specific and local competition), etc. With these assets too, an appropriate assessment needs to be made of the long-term cash generating capacity of this development pipeline. The more intangible upside associated with a favourable demographic demand outlook and the operators' track record of successfully executing on site selection and value enhancing development of those sites. Ryman clearly has a very strong track record but we would stress the importance of realistic expectations on timeframes and consideration needs to be given to applying value on assets that a business has not actually sourced yet even with favourable demographics. Ryman in Australia: still early days encouraging start and the diversification and scale that another market brings is helpful if the model translates well at scale in this market We have covered Ryman s growth ambitions in Australia in our section on land bank. Certainly Ryman has made an encouraging start and now has three sites in the development land bank. The evidence to date (sourcing of four sites since first announcing its intention in 21; potential to have five sites opened by 22) highlights that growth in Australia will take time, demographics and the size of the market aside. Certainly we would rather Ryman continue to exhibit the discipline it has shown in New Zealand and select the right sites over a more aggressive and less disciplined approach. We summarise Ryman s Australia accounts in Figure 84 for 215 and 216 the business there remains in its infancy at this point. Figure 84: Ryman Australia, A$ s Y/e 31 March Care fees 2,478 6,749 Management fees 1,92 3,228 Operating expenses (6,233) (1,477) EBIT, ex fair value movement (2,663) (5) Fair value movement in investment properties 22,862 38,659 Operating cash flow, ex-interest 58,441 69,795 Investing cash flow, ex-interest (5,4) (76,979) Free cash flow 8,41 (7,184) P,P&E 65,549 96,782 Investment properties 11,25 171,87 Accounts receivable 32,378 3,761 Core assets 28, ,63 Refundable accommodation bonds (11,594) (25,526) Occupancy advances (78,671) (133,39) Trade and other payables (48,11) (23,923) Equity in core assets 69,82 115,791 New Zealand Retirement Village Sector 61

62 The land bank provides a basis for attributing development growth but other factors that need to be considered in attributing value to the Australia opportunity include: At what point is there a basis for confidence that Ryman can generate the same operating metrics across development, care, village services and resale realisation of gains and DMF in Australia as has been achieved in New Zealand? How should Ryman accommodate differences in the treatment of ORA s in Australia (and accommodation bonds) in its capital structure? Metlifecare recently announced a strategy under a new CEO. Metlifecare has growth ambitions tied to expanding the footprint over time. A big part of this is establishing a track record of consistent development which will require a land bank and Metlifecare signalled that it is willing to look at site acquisition and development differently. This likely reflects a desire to consider the changing requirements of retirees and constraints on the access to traditional parcels of land particularly in key geographies of focus. What differences are there in the approach taken by the valuer to valuing Investment Property and Care Facilities in Australia and are we comfortable with the basis supporting what will be growing NTA attributable to the Australian assets over time in particular what is the market based approach supporting the valuation in Australia and how has it been tested given Ryman s model is unique? Metlifecare: looking to reposition the business but the journey will take time As we highlighted in the land bank section, at present Metlifecare s development pipeline is dominated by brownfield opportunities with only one genuine greenfield development in the immediate development pipeline, and that still several years away from opening. Metlifecare s transformation started in 212 with a number of things happening over 212/213 that transformed Metlifecare. This included a resetting of the investment property valuation base with the move to CBRE as valuer (effective in the 212 year end), ownership changes, recapitalisation (over 212 and 213) and a major acquisition involving the merger of Metlifecare with two Auckland/Bay of Plenty centric portfolios of villages (beginning of 213). Over 214 to 216, Metlifecare undertook some development activity but its financial performance has been dominated by a significant rerating of its investment property portfolio upwards on a strong property market (and likely CBRE getting more comfortable with the assets it has been valuing since 212). Summary financials are provided for Metlifecare in Figure 85. The combination of lack of scale in care, village services and the size of the Group overhead (do not believe much overhead is capitalised) means that Metlifecare does not generate positive cash from its non-resale and development related cash flows. Outside of fair value movements, the notable growth figure has been in core operating cash flow, ex development which has grown to $5 mn in 216. Despite the poor operating cash flow, Metlifecare s more mature asset base is generating significant cash flow from resales gains and DMF realisation these are not subject to the assumptions of the valuer but cash delivered on transactions that have occurred. Metlifecare has good coverage of cash interest expense and the dividend although the reliance on the property market needs to be noted given that Metlifecare s operating cash flows outside resales activity is negative. Core operating cash flow yield on NTA is not as high as Ryman with Metlifecare s smaller scale and lack of care business likely factors. The older nature of Metlifecare s villages also means that it may have higher non-capitalised repairs & maintenance costs influencing the cash yield. We note that this yield excludes allowance for maintenance capex which we estimate to be ~$12.5+ mn for Metlifecare. Since NTA was reset in 212, Metlifecare has recorded strong uplift in NTA which is dominated by growth in the existing portfolio as opposed to the initial uplift associated with new development. Metlifecare has a strong balance sheet and the least debt amongst the operators which reflects the limited land bank investment and development activity currently. New Zealand Retirement Village Sector 62

63 Figure 85: Metlifecare summary financials, NZ$ s Y/e 3 June Summary income statement Care/village fees 42,877 51,416 52,244 54,656 57,57 DMF fees 19,714 35,851 38,612 4,591 44,574 Operating expenses (57,962) (86,742) (79,153) (87,981) (94,424) EBITDA, ex fair value movement 5,42 4,698 15,495 11,351 11,537 Fair value movement (99,88) 58,913 65,72 121, ,241 Gain on acquisitions 63,62 Profit for the period (141,651) 12,271 68, , ,659 Development margin 2,642 8,1 7,3 8,5 1,1 Underlying profit 18,218 33,352 46,11 52,498 66,157 Summary cash flow Receipts from residents - care, village services 4,675 49,556 53,526 59,184 6,541 Payments to suppliers/employees, in Group o/h (54,917) (79,146) (73,648) (79,411) (84,33) Cash surplus/(deficit) from operations (14,242) (29,59) (2,122) (2,227) (23,492) Realised gain on sale cash 19,451 27,3 26, 31,3 46,5 Realised DMF cash 12,944 22,7 2,9 23,3 27,5 Core Op. cash flow proxy, ex development 18,153 2,41 26,778 34,373 5,58 % of underlying profit 1% 64% 58% 65% 76% New sales proceeds cash 2,372 48,9 34,4 48,8 79,5 Investing cash flows - IP, P,P&E, intangibles (1,78) (37,543) (49,192) (93,424) (14,228) Development cash flow 9,664 11,357 (14,792) (44,624) (6,728) Other investing cash flows 34 45, ,155 Net cash interest - expense + capitalised (8,38) (1,646) (4,58) (4,82) (3,364) Working capital - cash timing differences (23) 4 (4) Free cash flow 19,813 66,794 8,28 (13,656) (7,469) Equity raised 44,759 68,45 11,623 4,929 2,26 Cash dividend (1,222) (6,841) (8,456) (1,91) Dividend % of core operating cash flow % 6% 26% 25% 2% Core operating cash flow coverage: Net cash interest expense Net cash interest expense + dividend Summary balance sheet P,P&E (care facilities) 33,56 26,765 27,866 33,375 36,424 Investment property 1,168,78 1,845,138 1,96,972 2,176,556 2,524,89 Payables 15,35 16,835 18,196 26,99 31,347 Resident's loans, net of accrued DMF 618, ,441 1,5,943 1,66,141 1,154,136 Interest bearing debt 68,781 55,476 42,542 6,7 8,798 Shareholders' Equity 438, , ,83 911,44 1,132,967 NTA 438, , ,547 91,978 1,131,513 Cash flow yield and NTA growth Core operating cash flow proxy 18,153 2,41 26,778 34,373 5,58 Cash yield on NTA 4.1% 2.8% 3.4% 3.8% 4.5% NTA/share Growth in NTA 13.8% 8.3% 14.5% 23.8% Debt and obligations Net interest bearing debt 59,56 54,18 41,73 58,876 74,24 Capital commitments 21,375 54,754 75,578 21,542 Annual repayment of resident loans, net of DMF 61,154 97,343 93,388 92,89 12,926 Note: Palmerston North Joint Venture consolidated in FY12 and FY13. New Zealand Retirement Village Sector 63

64 The least challenging valuation of the three large cap operators; but the smallest land bank and recent track record on development proving itself on these levers will be a pre-requisite to re-rating We summarise a range of valuation metrics for Metlifecare in Figure 86. Figure 86: Metlifecare summary valuation metrics, NZ$ s Y/e 3 June Net tangible assets 438, , ,547 91,978 1,131,513 NTA (cps) Appreciation in NTA/share 13.8% 8.3% 14.5% 23.8% Market share price (June years) Market price/nta Shares on issue 144,115 27, ,17 212, ,883 Market capitalisation 32, , , ,687 1,177,242 Bank net debt 59,56 54,18 41,73 58,876 74,24 Enterprise value 362,22 727,697 1,,129 1,45,563 1,251,482 Mkt cap less NTA (135,885) (44,12) 166,879 75,79 45,729 Reported free cash flow 19,813 66,794 8,28 (13,656) (7,469) Core op. cash flow - ex interest & development 18,153 2,41 26,778 34,373 5,58 Core cash operating yield on NTA 4.1% 2.8% 3.4% 3.8% 4.5% Core cash op yield on Market cap 6.% 3.% 2.8% 3.5% 4.3% Market price/nta at current price Metlifecare has tended to trade at a valuation broadly in line with its NTA over recent years. This would appear to be broadly supportive of the following: While we are not suggesting that NTA is by any means a perfect measure of the value of the existing village asset base, the market is broadly comfortable that it is a reasonable proxy. Although the valuation approach adopted by CBRE is susceptible to change (there have been some significant increases in recent years; and sometimes the valuation goes down at a village level as well), the starting point is the unit prices being achieved in a village. The market is and should be quite cautious about applying a premium to NTA on completed villages given the significant information asymmetry. Operators need to establish a track record on development with the market appearing to look for confidence in the ability to sustain a level of build (combination of development land bank; and recent execution) and execute that development well. We would be cautious about focusing on development margin to assess capability on development execution and would rather look at the cash flow of a village during development and thereafter to see how well development is being delivered. Following its most recent result for 216 released in August Metlifecare has increased in share price to a multiple of NTA that is in line with as high as it has traded in recent years. While it is not a measure of free cash flow, Metlifecare s core cash operating cash flow yield has been growing in recent years. Metlifecare has also had strong growth in its NTA which will reflect the strong property market and pricing that has been achieved on resales in its village portfolio, as well as the potential that the valuer (who took over in 212) has become more comfortable with Metlifecare s portfolio of assets and lifted some conservatism from the initial valuations. Clearly the market is willing to reward operators with the right dynamics with premiums to the valuation assessed by CBRE that drives NTA. For Metlifecare we would make the following comments with regards that prospect and its current valuation: New Zealand Retirement Village Sector 64

65 The absence of much premium to NTA in our view positions Metlifecare as having the lowest valuation risk amongst the operators. That is not an absolute comment on risk but we do view the absence of premium as providing Metlifecare with a lower risk profile. We think the catalysts for a positive re-rating of Metlifecare will need to be multifaceted and consideration needs to be given to realistic timeframes as well given the risks associated with simply increasing the land bank through debt funding but choosing sites poorly. In our section on the land bank we highlighted how active Summerset has been on land acquisition and development since listing in late 211. Summerset has been rerated by the market on the back of this with land bank and perceptions on development capability likely the key drivers of market rating over and above NTA. Key things we will be looking for would be for Metlifecare to demonstrate capability in improving ex-property related operating cash generation, confidence in its ability to source attractive development sites, and development execution. Metlifecare may have the least demanding valuation in the sector, anchored around NTA with more limited downside as a result but we would view the timeframes for any re-rate as being multi-year. Summerset: High energy Summerset is at an interesting juncture it has amassed a significant land bank which should underpin its growth over the next five years but has a relatively small existing operating base both with regards asset base and the cash flows being generated off it particularly when overlaid with Summerset s overheads which have increased in scale ahead of unit scale being delivered. Summary financials are provided for Summerset in Figure 87. With a relatively small care offering and the smallest of the established asset bases, Summerset still generates relatively modest operating earnings in the Income Statement. Like the other operators fair value movement has been significant over the last two years in particular and while the strong property market has supported some of this growth coming from the existing portfolio, a substantial amount of that fair value uplift has come from development uplift in some of Summerset s new villages. Development margin has accounted for well over half of underlying profit in 214 and 215 and our core operating cash flow measure is an increasingly small percentage of underlying profit. Summerset s smaller scale and its growing overhead may be a factor here we have no visibility on growth in overheads, or how much is being capitalised to development. As Summerset ramps up its investment in land bank and construction activity it is not surprising to see investing cash flows exceed new sales proceeds the gap has increased significantly over 212 to 216. Clearly the major opportunity associated with this is to generate genuine cash development margins from that development and major fair value uplifts on sell down that translates over the medium-term to cash flow. Like Metlifecare, but less so, Summerset s operating cash flow from non-property related activities (care, village services less Group overhead) is negative. We are not sure how much overhead is capitalised. With a lower value and less mature embedded asset base, Summerset s cash flow from realised resale gains and DMF realisation remains relatively low but is, and will continue to, grow as the portfolio matures. As a result our measure of core operating cash flow has grown from $8 mn to $13.5 mn over the last four years. This is sufficient to cover cash interest but not sufficient to cover the dividend as well. That cash flow is before maintenance capex which we estimate sits around ~$6.5 mn for Summerset. Summerset s net debt has grown quite significantly to $24 mn with a further $5 mn of capital commitments at the end of 215. Annual repayment of loans to residents remains relatively modest. New Zealand Retirement Village Sector 65

66 Figure 87: Summerset summary financials, NZ$ s Y/e 31 December Summary income statement Care/village fees 24,868 27,349 3,724 37,452 46,455 DMF fees 8,643 1,612 14,275 16,526 21,779 Operating expenses (28,75) (32,62) (36,981) (44,922) (57,337) EBITDA, ex fair value movement 4,761 5,341 8,18 9,56 1,897 Fair value movement 5,841 15,128 29,722 52,481 83,458 Profit for the period 4,324 14,821 34,223 54,173 84,245 Development margin 2,3 6,864 1,45 16,699 26,138 Underlying profit 8,8 15,223 22,154 24,42 37,8 Summary cash flow Receipts from residents - care, village services 25,93 27,391 31,797 36,211 46,444 Payments to suppliers/employees, in Group o/h (28,716) (32,541) (36,91) (42,23) (54,664) Cash surplus/(deficit) from operations (3,623) (5,15) (5,113) (5,812) (8,22) Realised gain on sale settlement 7,535 9,73 9,671 8,9 12,345 Realised DMF settlement 3,932 5,215 6,199 6,165 9,4 Core Op. cash flow proxy, ex development 7,844 9,138 1,757 8,443 13,525 % of underlying profit 97% 6% 49% 35% 36% New sales proceeds - settlement 37,259 57,739 79,274 16, ,17 Investing cash flows, ex cap. interest (5,157) (75,395) (18,362) (14,163) (223,317) Development cash flow (12,898) (17,656) (29,88) (33,911) (92,3) Net cash interest - expense + capitalised (6,813) (5,943) (5,232) (8,64) (8,778) Working capital - cash timing differences (1,611) (782) (1,65) (4,569) (2,491) Free cash flow after interest (13,478) (15,243) (25,213) (38,11) (9,44) Equity raised 48,795 3,75 3,691 3,18 Cash dividend (5,342) (1,35) (8,575) Dividend % of core operating cash flow % % 5% 119% 63% Core operating cash flow coverage: Net cash interest expense Net cash interest expense + dividend Summary balance sheet P,P&E (care facilities) 36,789 42,568 51,421 63,559 77,41 Investment property 557,14 644,56 776, ,171 1,261,17 Payables 9,438 12,5 16,926 13,462 28,52 Resident's loans, net of accrued DMF 278,48 336, , , ,2 Interest bearing debt 69,121 78,162 15,268 15, ,211 Shareholders' Equity 233, , , ,27 49,786 NTA 232, , ,27 33,96 48,734 Cash flow yield and NTA growth Core operating cash flow proxy 7,844 9,138 1,757 8,443 13,525 Cash yield on NTA 3.4% 3.7% 3.8% 2.6% 3.3% NTA/share Growth in NTA/share 6.5% 12.7% 16.8% 22.9% Debt and obligations Net interest bearing debt 6,134 75,377 12, , ,529 Capital commitments 35,4 51,1 Annual repayment of resident loans, net of DMF 23,872 3,226 35,953 43,229 58,668 With such a large debt impost and the lowest level of core operating cash flow of the three large cap operators, we do view Summerset as very reliant on property markets remaining sufficiently supportive to enable orderly sell down of developments while operating cash flow builds. There is evidence that Summerset s cash flows might New Zealand Retirement Village Sector 66

67 struggle to service the funding costs on its debt if both the new sales and resales market went through a period of slowdown although it is hard to tell on the information we have how high Summerset s headroom is it would be good to have greater clarity on Summerset s banking headroom, the assets specifically backing development debt (and if there is any core debt). Summerset notes they are comfortable with their headroom and the stress testing they do. Summerset s core operating cash flow yield on NTA, before maintenance levels of capex, is low. That reflects the relative immaturity of Summerset s portfolio and smaller scale. We summarise a range of valuation metrics for Summerset in Figure 88. Figure 88: Summerset summary valuation metrics, NZ$ s Y/e 31 December Net tangible assets 232, , ,27 33,96 48,734 NTA/share (cps) Appreciation in NTA/share 6.5% 12.7% 16.8% 22.9% Market share price (December years) Market price/nta Shares on issue 212, , , , ,817 Market capitalisation 285, , , ,88 884,613 Bank debt 6,134 75,377 12, , ,529 Enterprise value 345, , , ,737 1,126,142 Mkt cap less NTA 52, , , ,92 475,879 Reported free cash flow, after interest (13,478) (15,243) (25,213) (38,11) (9,44) Core op. cash flow - ex interest & development 7,844 9,138 1,757 8,443 13,525 Core cash operating yield on NTA 3.4% 3.7% 3.8% 2.6% 3.3% Core cash op yield on Market cap 2.7% 1.9% 1.5% 1.4% 1.5% Market price/nta at current price* Note: NTA based on most recent NTA at 3 June 216. The gap between market capitalisation and NTA stood at $475 mn at 215 over two times the growth in NTA achieved over 211 to 215. Like Ryman, the market has confidence in the combined growth outlook of Summerset s existing portfolio of assets and the uplift that can come from the current and future development pipeline. The growth in NTA/share in recent years is strong but heavily weighted to the uplift associated with new development as we have already highlighted. There are some points we would make with regards Summerset s potential to justify the premium being applied to NTA: Summerset s core portfolio of its most mature villages has generated relatively modest growth in core free cash flow and fair value uplift for their size, the villages are generating attractive free cash flow yield on their NTA. We view Summerset s increasing focus on higher value property markets as likely to be supportive of greater fair value uplift on development and future cash generation vs. Summerset s pre-25 portfolio. Clearly this statement is dependent on the quality with which Summerset executes on its development and operations. We expect as these villages are delivered and mature they will help support growth in core operating cash flow. Summerset has demonstrated a strong track record since listing on site acquisition. More evidence is still required of Summerset s ability to convert that portfolio into completed villages in a timely manner (important from a time value of money New Zealand Retirement Village Sector 67

68 perspective) and of Summerset s ability to do so with attractive overall free cash margins despite what the reported margins say. An absence of the ability to do this (and continuation of high pay out of core operating cash flow after servicing interest will see core debt build up). Summerset is reporting progress on development margins but we are yet to observe a consistent track record of positive free cash flow coming out of the development phase and of consistent delivery of villages on a timely manner. This remains a core focus for Summerset. Ryman has shown the way for Summerset; if Summerset executes in the next five years then Ryman would suggest a lot more upside is possible; but there is a high hurdle to cross and there are risks With Summerset clearly looking to emulate the strategy Ryman has executed so well over a prolonged period of time we look at Ryman s growth track in NTA over 27 to 216 and overlay Summerset s profile on that where Summerset in 212 is rebased to Ryman in 27 with 27 and 212 year 1 for the two companies, respectively. We look at NTA and various other key signals of momentum in Figures 89 to 92. Figure 89: NTA (NZ$ mn), Year 1 = 27 for Ryman; 212 for Summerset. Triangle represents current Summerset market capitalisation 1,4 1,2 1, Figure 9: Sale of occupation right agreements new sales and resales, Year 1 = 27 for Ryman; 212 for Summerset 1,4 1,2 1, Net Assets - RYM Net Assets - SUM Sale of ORA's - RYM Sale of ORA's - SUM Note: Year 5 observation for Summerset is NTA at 1H16. Source: Company data, FNZC estimates Figure 91: Retirement units, Year 1 = 27 for Ryman; 212 for Summerset 6, 5, 4, 3, 2, 1, Figure 92: Growth in retirement units, Year 1 = 27 for Ryman; 212 for Summerset Retirement units - RYM Retirement units - SUM Growth in retirement units - RYM Growth in retirement units - SUM Outside of the risk and time value of money factors that need to be considered, the analysis highlights the sort of journey Summerset would need to replicate for its NTA to grow into its current market capitalisation: New Zealand Retirement Village Sector 68

69 Summerset has tracked the Ryman of 27 to 21 reasonably closely over 212 to 215. We would note over the two periods that Ryman was subject to the end of a very strong property market and two years of weaker property market conditions while Summerset has enjoyed a strong property market over the period the two companies are being compared. We also note that while the retirement unit basis of the two operators is similar over these adjusted periods, the quality of Summerset s retirement village base is lower in our view and it doesn t have the significant care component that Ryman has. Ryman s growth since 21 has been extremely strong and we note over this period that Ryman benefited from the contribution of a number of hugely successful villages in particular Evelyn Page, Edmund Hillary and Diana Isaac all made strong contributions over this period. The property market has also been very supportive. Summerset has the land bank in place to increase its retirement units in line with what Ryman has achieved. However, the timeframes associated with converting that land bank into units requires scrutiny, as do the outcomes. It is possible that Summerset could lag the development achieved by Ryman over the period. The path for Summerset to follow is laid out in front of it and the early stages of its execution over recent years has lined up with what Ryman was achieving back in 27 to 21. This is a simplified analysis and we have pointed to some of the differences above. While time and risk is not currently being factored in to the market capitalisation (when we use NTA as our focus) we note should Summerset be able to achieve this growth over the next four or five years without raising equity then, the compounding impact of delivery would likely be experienced in further market capitalisation appreciation if Ryman is an example of what is possible. Ryman s market capitalisation growth over the five years that followed 27 and 21 was significant with Ryman s share price currently pausing to catch up. As we note there are risks as well. With regards what could go wrong we would highlight: Execution with the quality of Summerset s site selection in recent years key (ability to get consent, then to effectively construct and deliver, followed by sell-down). Property market the market has been strong, a major slowdown would have some impact, particularly given Summerset s higher levels of debt (Ryman was carrying net debt of $14 mn in 21). As we have noted, Summerset has a smaller operating base and its net debt of ~$25 mn at 215 is on core operating cash earnings of $15 mn. We note that this higher than the debt Ryman had in 212 when its core operating cash earnings were $5 mn. New Zealand Retirement Village Sector 69

70 While they operate in a similar environment with converging business models and geographic focus, the execution and delivery of the model has not necessarily been uniform across the operators. Ryman has to be singled out as having the best demonstrated track record of the three large cap operators. Appendix 1: The business model, risks and tax A beautiful business model There are three large scale listed retirement village operators in the New Zealand market and a broader set of private operators of varying scale. All operate in the same market with broadly similar business models that are increasingly converging both in regards to the village mix and also geographic focus with it quite clear that the economics associated with the business model work well in higher value markets where the compounding benefits of resale gains and Deferred Management Fee (DMF) accruals work best on higher property values something that is directly linked to local market property values. Developments also appear to perform better in larger population catchments where they can be sold down more quickly and the additional early scale helps support early construction of community and care facilities, which has a synergistic impact on sell-down. While it wasn t necessarily an early focus of all operators in the sector, there appears to be an increasing appreciation of the benefits that care can bring to the overall business. The combination of favourable demographics and an attractive business model means that all three operators have an increasing development focus which would tend to be characterised as favouring urban over provincial, and increasingly focused around Auckland, Bay of Plenty, Hamilton, Wellington and Christchurch. It is not difficult to understand why a development focus is attractive. In simple terms, the operators are building into favourable demographics with a business model that is rewarding good operators that execute well: Land is acquired and the operator constructs a range of retirement village unit products (independent villas and apartments and serviced apartments) together with care facilities. With increasing urban focus, apartments are becoming an increasing part of the mix. This requires more construction working capital and has higher execution risks. The sites generally have a range of community facilities including communal areas, bowling green, swimming pool etc. The units are sold down with site selection and a good sales strategy enabling units to be sold down quickly into favourable demographics. One of several key attractive features of the business model is the funding model. Incoming residents purchase an Occupation Right Agreement (ORA) a right to occupy until they choose to vacate. This initial sale of the ORA essentially funds the retirement village units and community facilities and for a good developer appears to be able to fund the care facilities or a portion of them as well. The funding from sale of ORA s is after residents move in and as a result large working capital funding may be required during development particularly if care facilities are built upfront with community facilities and amenities. The accounting and reporting of development margin is opaque in some cases we observe positive cash flow from a development quite clearly in other cases it is harder to observe. Certainly at a group account level it cannot be observed. Notwithstanding that, if they execute well the operators have been, to varying degrees able to demonstrate the ability to grow without equity. However, we note only Ryman has demonstrated the ability to do this consistently over the long-term. The ORA provides a resident with the right to occupy for an open term and comes with the other two key value drivers of the business model (in addition to development gains and care profitability). Deferred Management Fees (DMF) of ~2 3% accrue over the first ~3-5 years of resident occupancy (can be shorter for serviced apartments) and are recovered against repayment of the ORA at the end of a residents occupancy. The gain realised on the resale of the ORA for a vacated unit is retained by the operators. While these cash flows may not be realised for some time, New Zealand Retirement Village Sector 7

71 the DMF is recognised in the Income Statement as it is accrued while an independent valuation of each unit is completed on a yearly basis that incorporates the future cash flows that will be realised off that unit essentially expectations of resale gains and DMF cash flows. That valuation generally leads to an immediate uplift in valuation on completion of a unit as would be expected and that fair value uplift is recognised in reported profitability and in the equity of the business. The balance sheet of a retirement village is dominated, on the asset side by Investment Property (the retirement village units and community facility operations which are valued using a Discounted Cash Flow (DCF) model) and Property, Plant & Equipment (essentially the care facilities which operate for profit and are also revalued upwards on operating cash flows and market transactions). The core funding of the assets are the Resident Loans although land bank and construction work in progress tends to be debt funded which is seeing increasing bank debt on the balance sheet. Because the Resident Loans come with first security over village assets (by way of a Statutory Supervisor who overseas each village), bank funding of village operators can only be supported by a second mortgage security interest. As a result bank funding tends to be of a development nature with limitations in the amount of core debt an operator should be able to take on. The operators do not distinguish between working capital and core debt in their reporting. This report has not focused on providing a 11 on a well-covered and understood sector. As such, while we have highlighted differences between the operators with regards size, earnings, trajectory etc, we have not focused too much on what the successful characteristics of the business model are and what distinguishes the most successful operators. With its valuation and largest base cash earnings as support, Ryman has certainly been the most consistent and successful operator in the sector over 2 years+ and we briefly look at the key distinguishing features of its model that we think others are increasingly looking to replicate, to varying degrees: Consistency of target market and product has likely contributed favourably to an ability to develop a recognised brand and reputation in the industry. We note for example that Ryman s average value of units and the composition of its villages are very consistent. While developers in the sector typically looked to stay clear of care for various reasons ten and more years ago, and provide it on a smaller scale, Ryman s decision to provide care across rest home, dementia and hospital and build serviced apartments at scale appears to have also been a positive contributor to both its positioning in the market and financial success including through property market downturns. Ryman has typically completed villages within a relatively short time period. There are a range of factors contributing to this but from a resident perspective Ryman s decision to typically stage community facilities and care in the early stages of construction appears to have been well received in the market. Terms and conditions are relatively standard in the sector but there are some differences, in particular Ryman s DMF is lower than the other listed operators and the broader market. This positions Ryman well from a competitive perspective. Finally, and it is certainly the case with regards the three listed operators Ryman has had the most consistency with regards tenure of management, governance and ownership in the sector. But some notes of caution also Clearly the model is attractive but we need to highlight some important elements that should not be ignored when looking at the operators and their future development plans. This includes: New Zealand Retirement Village Sector 71

72 Development is still a risky activity. The operators have significant working capital tied up in land acquisition and construction in progress more so for apartments than villas which can be staged. There are risks associated with property market conditions and site selection and the desirability of the village to potential incoming residents that influences outcomes. We review and comment on some of the key value drivers to monitor. Despite the attractiveness of the model there are some risks to be aware of. Capitalisation is important as cash generation from a village through development (despite what reported allocated margins show) and in the early years of a villages operation is not necessarily always high. Developers that are not appropriately capitalised may struggle or may make compromises in the phasing or construction of the village. It appears increasingly clear that Ryman s approach of investing in care and community facilities (and staging it at the front end of development despite the additional working capital drag) will be followed by other operators in the sector while it may not make sense from a cash perspective, it likely positively influences outcomes on sell-down and profitability of the overall development. While the funding model is attractive, consideration should be given to the fact that the operator owns the village into perpetuity. Future returns will be influenced by the quality with which the site has been developed and its ability to remain attractive for future generations of residents. Allowance needs to be made for capital expenditure on mature villages to ensure that the owners continue to be able to generate returns from them. The role of the statutory supervisor As we note in the section on the CBRE valuation methodology, retirement villages are a specialist form of real estate investment. In particular, retirement villages have an interest registered on the land which gives security of tenure to residents. This makes alternative use challenging. A statutory supervisor holds a first interest mortgage over the assets of the village which is a constraint on bank funding. The statutory supervisor also has a broader role as resident advocate and monitors the financial performance and position of the village. This oversight does not extend to giving the statutory supervisor the role of approving dividends and payments of cash up to the parent company from the operating villages. Risks: a review of key drivers that support value Fuelling the development engine with appropriate sites The operators have proven themselves adapt over recent years at continuing to source new sites although there are clearly constraints. Having reached steady state in New Zealand, Ryman has moved to Australia. The question we need to consider is how development will evolve over time and what demand dynamics will mean for the sort of sites selected, the prices paid for those sites, the lead times associated with getting consent, etc. It seems likely that competition will increase for sites in a smaller geographic area of focus. It is possible that competition will result in higher prices being paid not just due to competition between the operators, but potentially as land owners seek a greater share of the upside development of suitable sites brings with it given the complexity and risks associated with developing and then running retirement villages a healthy tension should remain. There are also risks that the operators purchase less suitable sites that could lead to suboptimal development outcomes as they look to continue to demonstrate their ability to maintain and meet the expectations of the market on annual unit delivery. DMF percentages and resales gains on rising capital values In broad terms the economics of a village are such that care facilities should generate a return in their own right (and appear to although no disclosure is provided); village services should be provisioned on a break-even basis and DMF and resale gains are the profit engine of the business (after allowing for maintenance capex on the village). DMF New Zealand Retirement Village Sector 72

73 charges range from 2 3% across the different operators. In a strong property market, resale gains are material. Done well the model is clearly attractive and profitable but it is similarly clear that significant capital needs to be deployed and that there are barriers, not just to entry, but to successful execution of the model. In addition the business model appears to be working with a high degree of market acceptance. As such we are not suggesting significant competitive factors that might adversely impact the two key value drivers of the model DMF and resale gains. Notwithstanding that we note and will monitor the following: Increasing competition, for example at a local level, could put pressure on operators to reduce DMF charges where their terms are higher than the competition. Particularly in the case where a new and more attractive village is constructed close by. Over time residents may resist paying a percentage of DMF on properties with high capital values particularly if the average age of entry and expected time of occupation drops. As we note, market acceptance appears high, but again with a focus on higher DMF fees, the assumption should not be made that the market will continue to accept that in the future. Demographics, obsolescence and property market conditions The demographics are clearly favourable for the sector. Investors need to consider how much growth to attribute to future development when looking at the operators and the favourable demographics and track record does provide a basis for assuming growth. But there are other factors to consider as well. Within mature villages we think that some consideration also needs to be given to obsolescence. Capitalisation of resale gains and DMF into perpetuity with growth on the asset value driving these cash flows clearly implies that the asset remains desirable into perpetuity and sufficiently desirable that the implied growth rates can continue. Certainly investment in the maintenance and refurbishment of the asset will aide with this but consideration should also be given to more significant investment that may be required in the asset for it to remain attractive to future generations of tenants. We can observe upgrades and changes to configuration being made in villages that are relatively young. Desirability of a village will not just be influenced by changes in what customers are looking for but also on the availability of new facilities in the area which will inform resident requirements. It is common for real estate assets to face pressure in yields or for more sizeable investment to remain relevant against newer facilities. Intuitively this is likely to be the case in retirement as well. Retirement Villages are regulated but the regulatory regime is relatively light handed. The statutory supervisor has a key regulatory role and retirement villages must be registered. This risk factor is likely a reason contributing to the application of internal rates of return for retirement village valuations that are higher than what the equity market might intuitively apply particularly given the overlay of limitations on alternative use. The need to maintain the desirability of a village means that sufficient allowance for maintenance of the village product is just as relevant as house price inflation assumptions when considering valuation in our view. A portfolio of villages does not change that need. Regulatory status The Retirement Villages Act 23 became law on 3 October 23. From 1 May 27 The Retirement Village (General) Regulations 26 came into effect with all new villages having to be registered before offers of occupation can be made. Sitting within the Act is a requirement for regulations tilted Code of Practice for retirement village operators. The regulatory regime is light handed and while there are protections in place for residents, by and large the regime is not particularly onerous and operators and residents commercially agree key terms that drive the economics associated with retirement villages i.e. the basis on which DMF and resale gains are dealt with sits outside the Act. New Zealand Retirement Village Sector 73

74 The key regulatory issue we would highlight as a risk, although there is no visibility on the potential that it might happen, is the risk that regulation requires ORA s to be refunded within a set period of time. Ryman operates under this regime in Victoria and in New Zealand its commitment to refund within six months sees it purchase ORAs from residents before resale from time to time already (more generally, if a resale fails to settle for some reason). Not all operators share this commitment and it is not a contractual feature in the New Zealand industry generally. None of the large cap operators currently pay cash tax despite reporting significant profit, underlying profit and the generation of cash profit as well. While Ryman does not believe that the Victoria treatment requires them to change the way they look at capitalisation, and we can understand that 6 months still is a reasonable period of time, we think the operators would need to consider what it meant from a capitalisation point of view if there was a move to requiring a refund within six months in New Zealand. While it would not create an on demand liability, the size of the annual repayment of ORAs on resales that are becoming a bigger part of the business would require some consideration to be given to the ability to fund more significant repurchases from time to time. Explaining favourable tax treatment and highlighting that tax does still need to be factored in The fact that gains made on the initial sale and subsequent rollover of ORA s are not a taxable activity means that the operators benefit from a significant portion of their reported accounting earnings and cash earnings being non-taxable. Notwithstanding that, the rest of the operators' activities are taxable in particular DMF, village services and care are all taxable activities. Because resale gains are non-taxable we would expect the effective tax rate to be low. We describe the broad principles of income tax for retirement village operators and look at some of the reasons why cash tax has not been payable on a Group basis to date. Income tax For most operators the income and expense situation can be described broadly as follows. At a village level: During development, capitalised interest and other upfront costs including marketing for example, are tax deductible expenses and the recognition of these costs ahead of taxable income generation will tend to contribute to the creation of a Deferred Tax Asset (a tax loss base) in the early stages of a villages operation. The increase in the value of property whether it be in development or in the uplifts in fair value movement are not taxable (but we note comments below on the Accounting Deferred Tax Liability created on the fair value uplift associated with DMF below). For tax purposes the initial sale and transfer of ORA s is a non-taxable event. Care margins and village services margins (where applicable) are taxable activity. DMF fees are taxable but the point of income tax recognition does not necessarily relate to the timing of cash receipt. Some operators recognise DMF fees for tax purposes on a contractual basis, some according to income statement accrual and some on the cash realisation. Tax depreciation on investment in Investment Property is limited to appliances while the broader fit out (e.g. carpet) is deductible for serviced apartments fit out. There is no accounting depreciation but there is tax depreciation on this limited aspect of Investment property. When refurbishment occurs, there is a full tax write-down and depreciation can start gain on new appliances and fixtures component of a fit-out. That deductibility creates a genuine tax benefit given that the uplift associated with the resale of an ORA is not taxable although the DMF is. New Zealand Retirement Village Sector 74

75 Tax depreciation on Investment in P,P&E (essentially care facilities) is broader than Investment Property with equipment able to be depreciated for tax purposes. There may be timing differences that are real here that contribute a small amount to a Deferred Tax Liability situation. Over time when all this is put into the mix, a new village will generally have a period in which it is building up tax losses (deferred tax asset), at the same time as a deferred tax liability (see below) is also being built up. The village will then move to a net tax paying position with cash tax only payable for that village once the losses are exhausted (stand alone village rather than part of a Group). For a mature village this will happen at some point. At a Group level all of the village positions are grouped together (offset of mature villages by developing village positions as well as Group overhead costs and Group interest expense). The Group will only start paying tax at the point where village deferred tax asset positions are exhausted and the overall village base is resulting in net tax obligations that are greater than any Group expenses (overheads, etc). The operators all have Deferred Tax Liabilities (DTL) on their balance sheets. For the most part, this deferred tax liability is an accounting entry of sorts that would only be practicably crystallised in the event that the assets on which they have been derived were sold in any event village sales tend to be undertaken at a Company entity level, not an asset level. Deferred tax liability For most operators, a key aspect of the increase in DTL arises from the accounting tax calculated and arising out of the DMF component that drives the fair value movement of Investment Property. The fair value movement in the financial statements relates to future claims on DMF and Resale Gain and the DMF component of this (the present value uplift arising from future DMF claims) generates DTL as it is a taxable activity this rolls forward and compounds over time. While DMF is taxable income, this DTL created from fair value movement is quite separate and is generated on the back of the DMF component of fair value movement in IP. It would only be crystallised in an asset sale resulting in a realised gain. This component of DTL will not crystallise in the normal operations. There are also some genuine timing differences that result in a Deferred Tax Liability that are real and will crystallise into tax in the future. Two key ones to note would be: Timing differences between accounting and tax depreciation of P,P&E generally relatively minor. Where an operator accrues DMF income for accounting purposes but leaves recognition of that DMF income for tax purposes until cash receipt there would be a real DTL that would unwind on a turnover event when the DMF was declared for tax income purposes. In the absence of losses and offsets this would result in cash tax. New Zealand Retirement Village Sector 75

76 Appendix 2: Demographics and the property market Favourable demographics clearly supportive of growth but we think there are limitations also Favourable demographics support the outlook for the retirement village operators. Figures 93 and 94 show the size of Ryman s opportunity in New Zealand and Victoria. While we clearly see the favourable trends, we also think the opportunities and risks associated with servicing that demographic require more nuanced consideration. We summarise some points we would make about demographics that also need to be taken into consideration. Figure 93: Population growth 75 years+, New Zealand and Victoria Figure 94: Ryman penetration of New Zealand and Victoria 75+ population Need to differentiate between care and retirement village operations We distinguish between the impact of these demographic trends on the demand that is likely to be generated for care as opposed to retirement unit demand. Certainly there is a synergy between retirement village operations and care that Ryman has clearly demonstrated with its successful model. But equally, it would be remiss to ignore the more discretionary choice associated with retirement village living. Penetration remains relatively low in large parts of New Zealand for retirement living. The current trend shows penetration increasing. It will be interesting to see how future generations of retirees approach retirement living and what their requirements will be. We would view care (whether in a care facility or in home) as a larger beneficiary of the demographic trends than retirement living. Care tends to be required for a relatively short period of time (some exceptions clearly) and is certainly less discretionary in terms of having a strong needs base. Affordability of retirement village living given increasing desire of the operators to service higher value demographics There is a noticeable shift in emphasis from lower value provincial areas to higher value locations amongst the operators currently. The value of property and the size of the local market appear to be important differentiating factors influencing development success. While we are not suggesting the business model doesn t work in a lower value property market, it is clear that the economics are better in higher value markets and that there appears to be greater development performance risk associated with small markets with lower property prices. In simple terms, if smaller centres with lower house prices are less attractive to retirement operators then this will constrain the amount of available future demand for the product and the size of the addressable market. New Zealand Retirement Village Sector 76