New Zealand's aged residential care sector funding gap increased to an estimated $650 million last year, a new report from Westpac says - and a lack of profitability may be stalling further investment.

The report from Westpac looks at how service providers can tackle the sector's challenges.

Westpac industry economist Paul Clark said more people than ever were entering care, and they were doing so later in life when their care needs were more complex.

There are about 41,500 beds across New Zealand offering rest home, hospital dementia and psychogeriatric care.

"The big challenge is how to fund this care. Aged residential care is funded jointly by government and residents, with a system of add-ons and top-ups for added extras and higher needs care," Clark said.

"That funding has increased steadily over time, although not enough to keep pace with rising costs of delivery, underpinned by ongoing workforce shortages. The net result has been a structural funding gap that has widened from an estimated $170m in 2014 to $650m in 2025."

He said total sector funding had risen to just over $2.7b in 2025, of which $1.2b came from residents. He estimated the sector-wide deficit had increased about 290 percent since 2014 as funding growth diverged from the rising cost of offering care.

At $1.5b, hospital-level care accounted for the biggest share of spending last year, followed by $1.1b for rest home care and $600m for dementia care.

Clark said labour was the sector's largest cost.

There are a range of different providers offering different levels of care, and sometimes a mix of options. He said they were looking to extract efficiencies from their own operations to bring down their costs.

"The gap reflects a persistent mismatch between government funding and the actual cost of care, with labour, clinical, compliance, insurance, and capital costs generally rising faster than funding over the past decade."

He said another issue to consider was the difference in provider models. Retirement villages were a more profitable prospect than rest homes.

He estimated that retirement village operators offering units and apartments for general living, rather than just care facilities, were making about $5 billion a year from sales of occupation rights agreements.

This was calculated on the basis of about 8000 changing hands for $600,000.

"The report talks about two basic business models.

"One is the standalone model which basically refers just to care. They're more exposed to funding gap issues than some of the really big players which provide a continuum of care, that run aged residential facilities with retirement villages together.

"Those guys are a bit better off because they can use property income to offset losses. That's not to say they want to do that in the future, In fact, my understanding is they would like to see their aged residential care facilities being profitable just by themselves, standing on their own two feet.

"It's actually my understanding that it's resulting in less investment being made in aged residential care. These players are putting less investment in because it's not as profitable as it could be."