Membership Refund Liability – The Impact on Value

Among the more interesting challenges we encounter is the issue of membership refund liability.  A membership refund liability is typically derived from a club having taken a deposit for membership which is repayable to the member upon either resignation or the 30 year anniversary of the membership.  Often, there are conditions, such as the deposit only being refundable on a 4 or 5 members in to 1 out schedule or if membership is fully subscribed.  If a member endures for the 30 year (or other designated) period, they get their money back as well.

These programs were designed with the many new private clubs that were developed in the 1980’s and 1990’s and were quite popular.  Members were enticed with the promise of one day getting their money back and developers could fund the construction of the club with non-taxable dollars and limited or no need for the debt that often accompanies construction if pre-sales were brisk.  Then, the golf recession happened.  Resignation lists became long and memberships were being sold at a discount.  To make matters worse, entrance fees (including deposits) plummeted and in many cases clubs began offering non-refundable deposit memberships, typically at around half the price.

Where this becomes a significant problem is when it’s time to sell the club.  Whether member-owned or investor-owned the potential buyer of the club is likely to be a for-profit operator.  Thus, many such buyers are unlikely to have interest in assuming this financial responsibility, which often runs into the millions of dollars.  The impact on value and sale price can be significant, if a buyer can be found. and there are buyers who simply won’t consider clubs with large refund liabilities.

How does a club “clean up the mess”?

There have been some court cases on related issues (Trump National Jupiter being the most prominent) and clubs have not fared well.  Some clubs have elected to negotiate a discounted buyout of membership deposits and others have opted to declare bankruptcy, extinguishing the liability.  Some buyers have assumed this obligation while others simply avoid those clubs with a large refund liability on the balance sheet.  With some clubs having refund liabilities in the tens of millions of dollars, this can have a big impact on the value of the club, if a transfer in ownership becomes a consideration.  Other clubs have modified their membership programs to cheaper, non-refundable initiation fees that often further push the refund obligations “down the road” because none of the same type of memberships are being sold.  The changing of the deal in “mid stream” is often what leads to disputes, as per the Trump Jupiter case.

The question of impact on value from the valuation perspective is equally complex.  The first question is what value is being sought?  In mortgage financing, acquisition or disposition situations, typically the value sought is market value of the going concern, since clubs are usually sold as operating entities.  Conversely, if the value estimated is for real estate tax assessment or eminent domain, the value appraised is for the real property only.  The presence of a large refund liability can impact the value of the property, if only because there is a smaller universe of buyers willing to consider clubs with this liability for purchase.

When valuing the going concern, a net present value discounted for the time remaining until maturity of the refund obligation can be calculated.  While mathematically supportable, this method doesn’t always mirror the marketplace where buyers may utilize the refund obligation as a negotiating advantage to lower the acquisition price, often beyond a deduction for the net present value of the refund liability.

When valuing just the real property, the membership interests (depending on who you talk to) would not be included in the valuation to start with, raising the question of whether the refund liability should be considered in the value for real estate tax assessment.  The dilemma exists from a possible inconsistency.  How can membership interests not be counted as real property, but then refund liabilities deducted from the real property value?  It almost seems like a double penalty to the club already in trouble that now has to pay higher taxes when the value might certainly be impacted by a knowledgeable buyer using the refund liability as a negotiating tool.

When working to sell a club with a refund liability the problem is more complex.  The motivations of buyer and seller are critical.  Sometimes, the buyer simply plans to get rid of the liability through bankruptcy.  Other times, either seller or buyer (or both) formulate a plan to work with the members to reduce the liability and craft a buyout.  In some cases, the seller is reluctant to alienate the members and damage built up goodwill, but the elimination of the refund liability can create an income tax problem for the seller.  This can make the property difficult to sell.

For sure, the sale price of any club would be impacted by the presence of a refund liability.  However, it’s safe to say that the refund liability itself is attributable to the going concern, not the real property value.  Indirectly, however it would likely be appropriate to consider some impact on the value of the real property resulting from the limited market for the club.  Selling clubs with refund liability issues is most definitely more challenging than those without, which often impacts the time necessary to sell and the eventual selling price.

Whether buying or selling, a club with a refund liability presents unique challenges which can vary considerably.  Each club has its own specific issues and they need to be explored before developing a strategy for moving ahead.