In focus - Markets
Uncovering value at the top of the real estate cycle: Retirement living in the UK
We look at the investment case behind retirement living communities in the UK against a backdrop of low yields in global commercial real estate.
Total returns in the UK and European commercial real estate markets are expected to weaken over the next five years, but there are segments that remain underappreciated. These offer attractive risk-adjusted returns today, the potential for future yield compression and diversification benefits. We believe one such area of the market to be UK retirement living. This sector benefits from favourable demographics as the UK population ages, rising expectations for quality of life in later years and the wealthy baby-boomer generation entering retirement.
The investment case for UK retirement living
Retirement living in the UK can be defined as the provision of permanent accommodation for over 65-year-olds, typically in a community setting. These are not care homes, but rather targeted at able-bodied, capital-rich couples or widow(er)s that are looking to downsize into a mid- to high-end community environment, where there are plenty of facilities and opportunities for keeping physically fit and mentally healthy.
Importantly, we believe the sector’s fundamental value driver – the level of latent and potential demand which far outstrips current supply – is likely to have a low correlation to the commercial real estate sector.
Relative undersupply vs. potential demand
The current penetration rate of retirement communities is very low at 0.7%, particularly when compared to other countries with similar standards of living and demographics where the figure is closer to 5-6%. This comparison suggests that there is potential demand for around 400,000 retirement community units in the UK.
Wealth and housing equity of the over 65s
The level of demand depends on two main factors: the number of older households who can afford to buy a unit in a retirement community and the attractions of retirement communities compared with other housing. People over 65 years old in the UK are relatively wealthy with a total net wealth of £4.7 trillion in 2016 (the latest year for which figures are available). We estimate that there are two million households in the UK who could afford to buy a unit in a retirement community.
Evolving tastes of over-65s favour community living
Based on a number of survey results, we estimate that 30% of older people would downsize if there were more suitable properties and that, of those downsizers, 25% would choose a retirement community as opposed to a smaller house, bungalow, etc. If we then combine that with the two million households who can afford to buy a unit in a retirement community, then we believe that currently there is potential demand for around 150,000 retirement community units in the UK, which is three times the current stock.
Significant growth in the over-65 population
The UK’s over-65 population is expected to grow by 26% between 2018 and 2030. With an existing base of only 57,000 units today, Schroders confidently expects demand for an additional 100,000 – 200,000 units by 2030 which would still only represent a fraction of the penetration levels in the more mature markets around the world.
Positive social impact
Research shows that residents in retirement communities tend to stay fitter and healthier than other people of a similar age. Community living can also help reduce chronic loneliness and lessen the burden the aged may place on their families as they get older and require more care while access to on-site care reduces the pressure on government health and social services. Such communities also free up the supply of family homes, for which there is a considerable supply shortage in the UK.
Attractive investment returns
We anticipate that retirement communities should deliver an ungeared gross internal rate of return (IRR) of c.13% over a five-year holding period. This assumes that units achieve the target price which was set at the feasibility stage. If the investment includes debt, then it might be possible to boost this IRR to c.20% assuming a loan-to-value ratio of 50%.
Understanding and accessing the sector
Retirement living is a highly specialised field and not an easy market to access as it is still in its relative infancy in the UK. Given the factors cited above, Schroders believes there has never been a better time to deploy capital in this market via a partner with sufficient experience in sourcing, developing and realising these specific assets while properly mitigating the risks.
To read our full paper on retirement living in the UK, please click on the PDF below.