A key priority for government is to build new homes, particularly social housing, but the demographics point to another major shortfall over the next 20 years. According to McCarthy & Stone (MCS), the retirement living sector leader, of the UK population of 65.6m, 11.8m are 65 or older, of which 3.4m have equity of £250k-£500k, of which 1.3m are considering downsizing. This compares to just c.157,000 owner-occupied retirement properties built in the UK. In addition, for the C2 planning use, there is in theory no obligation to build ‘affordable’ homes (although this is being challenged in London) which should help development viability.

The investment case therefore for entering the retirement living market should be compelling, and it’s very interesting to see Legal & General enter the market with its recent investment in Inspired Villages and purchase of the Helical retirement villages portfolio, following AXA’s investment in the Retirement Village Group.

So why so few listed retirement living builder/operators, especially as the homebuilder sector has been such an outperformer with stocks trading on material premiums to book? A key factor is that MCS, which listed two years ago, has materially underperformed the sector and currently trades below its IPO price. Several external factors have been at play:

• Higher rates of stamp duty continue to have a very negative impact on housing transactions, and therefore has slowed the trend of downsizing and equity release. As I have discussed before, stamp duty is a very bad tax in terms of labour mobility, but it is also causing a log-jam in terms of tied-up equity in inappropriate housing for the ageing ‘baby boomers’.
• And for many downsizing is a discretionary move, not a move of immediate necessity, and so in slower market conditions transactions tend to be deferred. It’s clear from the recent MCS results that part exchange is a growing feature of the market, but there is a cost to this.
• ‘Help to Buy’ is providing first time buyers (representing 40-50% of newbuild transactions of the major listed homebuilders) with a significant government subsidy which is not available to those looking to downsize into retirement living.
• Retirement living is also more complex than simply building new homes, as a level of service and care goes with the product, requiring additional expertise and cost, and therefore ongoing management and investment.
• Added to this we have Brexit, and the market impact of the EU referendum on housing transactions and consumer confidence. It’s clear from the MCS numbers that the business slowed materially and the company reduced its risk exposure for a few weeks (not just a few days) following the EU referendum. And the impact on MCS was exaggerated as it IPO’d as a growth rather than a yield (or return of capital) stock.
• Meanwhile, the retirement living sector has been caught up in the sale of leasehold houses debate. The government is yet to opine (or regulate) on this, but it is hoped the retirement living model (which typically includes a payment back to the developer on re-sale) will not be adversely affected.

And so external factors have heavily influenced MCS’s performance, but is this the whole story?

• MCS has three main products: Retirement Living (independence with peace of mind, minimum age 60), Retirement Living Plus (a retirement apartment you own with flexible care and support, minimum age 70), and Lifestyle Living (downsize for leisure years, minimum age 55). All three make complete sense, but I find it interesting that the company is now also exploring a rental product, and a bungalow product. Is this too many? I am still learning about this sector, but I find it interesting that some other operators are offering a highly attractive living environment where services and care can be outsourced and bought in according to need. Which is the right model?
• And can the margins be improved? MCS gross margins are c. 20%, and operating margins c. 15%, well below the major homebuilders. The company is taking action to make sales and delivery more efficient, but improving profitability is a challenge.
• Meanwhile the company is ramping back up its pipeline to try and achieve its target of 3,000 transactions pa (2,302 in FY 2017), and increasing its sales releases to 80 this year (52 in 2017). In addition the company is establishing three divisional management teams (Central, North and South) on top of its nine regional teams to manage this growth and improve efficiency.

Why does MCS’s performance matter? Retirement living is one of the few major growth markets in UK real estate and greater access to capital markets could help fund and lower the cost of this growth; and facilitating an ageing population to downsize and release equity has important wider economic benefits in terms of population mobility and funding the future cost of care in the UK. While the sector leader is underperforming it’s more difficult for smaller or new players to consider a listing – they will have to demonstrate how their business models compare to MCS and why they can perform and be well rated in capital markets; and ideally government also takes action to accelerate downsizing with stamp duty relief or abolition.