Healthcare Capital Markets Offers Long Term, Defensive Returns

Posted by Colliers on 16th February 2023 -

In respect of care home investment transactions, our H1 data showed that circa £0.5bn was transacted, the market was buoyant and returns were stable. This £0.5bn was made up of fewer transactions than 2020/21 but the total value was similar to previous years, despite the pandemic.

We had identified a further £0.5bn of transactions in the market or under offer and was therefore expecting total volumes to reach more than £1bn with transactions peaking during the last quarter of 2022. This expected volume of stock was at similar levels to the past three years but there was a stronger sentiment of demand than in previously. UK institutional investors were typically underweight and were looking to increase exposure to the sector; particularly those linked to the MSCI index and requiring long term, indexed linked income – healthcare offered that stable rental growth and longer term income where many other sectors did not.

In addition, we had seen increasing interest from European and global investors attracted by currency, the regulated
nature of the industry and the “positives” that came out of Covid – this included anticipated further government support for social care and the high percentage of rent collection levels recorded during the pandemic, principally due to government intervention and the demand for care home beds during that challenging period.

As we headed into Q4 we hit the buffers. The majority of “pre-Truss” deals agreed were put on hold or withdrawn. While we expected a significant reduction in healthcare investment transactions for Q3/Q4, albeit a number of off market transactions occurred principally in specialist care/hospitals rather than care homes by the year end.

However, we are aware of some very recent activity and transactions agreed in the past few weeks with the market showing signs of stabilisation and are hoping that this improving sentiment will result in a spike in volumes during Q2 2023.

2022 pricing

During H1, we saw the super-prime/prime categories reaching historically low yield levels. Going forward, the super-prime market has re-adjusted its pricing based on movement in the risk-free rate. This currently suggests a c50 - 75bps upwards trajectory against the historically low yields during H1 when the UK 15 year gilt rate was at least 100bps lower than today. 

We believe yields for prime assets, which we would describe as high quality, modern purpose-built stock but leased to a non-investment grade covenant, will have moved out by a lesser degree (say 0.25-0.5%) due to greater liquidity in this part of the market, i.e. continued demand from healthcare investment vehicles.  

We are concerned about Tier 2 stock as an investment opportunity. Flight to quality and future proof real estate is prevalent at present and whilst we believe there remains a relatively buoyant market for owner operator Whole Co sales, the market for leased investments of this quality has deteriorated significantly in our view.
As for forward fundings of care homes which has been very active in recent years, the market has understandably paused since September with both outward capital value movement and build cost inflation causing profit erosion and viability issues. However, with the continued supply v demand pressures, we believe the market will adjust quickly to the current dynamics and the forward funding market will be back in the new year. In the meantime, developers are exploring other avenues such as forward commitments, JVs and owner operator turnkey transactions.

Rental trends

Healthcare is somewhat of an anomaly against traditional sectors as almost all leases have rent reviews based on indexation, as opposed to open market reviews. Furthermore, when analysing rent for a new build development, we typically rely on forecast profit and loss accounts provided by the operator/tenant.

The comparable method of rent assessment is rarely used and there is a significant range of rental levels agreed but no defined metrics to confirm that this is an appropriate rent.
 
However, as our data collection improves with the development of new homes, trends are emerging – we are seeing rents being set more frequently in excess of £10,000 per bed compared with ten years ago, where rental levels typically ranged between £6-8,000. This assumes a typical new build care home of approximately 60 beds in relatively affluent locations.

Both investors and operators should be mindful of rental levels set since the collapse of Southern Cross a decade on. This was a combination of factors, but a significant influence was that rental levels were set too high from the outset, particularly in those homes which included double occupancy beds which were later reduced to single beds. Currently rent is typically the largest expense, after staff costs, (typically agreed at 50% - 65% of EBITDAR).

During the Southern Cross days rent cover was typically based on 1.5-1.75 times mature EBITDAR. Now there is a range appearing between 1.75-2 times depending on the quality of asset, size, care provision and location. With higher acuity and resultant higher average weekly fee levels, we consider 2-2.5 times more appropriate, because a reduction in occupancy can lead to rapid deterioration in EBITDAR.

With the inflationary climate we are in today, ensuring the rent is sustainable throughout the lease term should be key to any investment decision. A detailed analysis of rent and operational performance needs to be provided to enable both operators and investors to have a long term, sustainable business.

Going forward

Healthcare is essential to our daily lives. Whilst we are witnessing extreme short term turbulence in the financial markets, the demand for good quality healthcare real estate continues unabated and will remain so going forward. As an asset class, it offers long term, defensive returns and as such, we have not seen quite the same levels of volatility as we have witnessed in other real estate sectors. Our view going forward is that, whilst there will be a “new norm” in pricing, we will see confidence quickly returning to the sector. With disruption comes opportunity. 

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