Specialist investors are targeting high-quality healthcare assets, writes Daniel Cunningham.
Healthcare providers in the UK have warned that they are at crisis point. As many as 60 percent of care home residents across the country are funded by local authority fees, which have widely failed to keep pace with the rising costs of care.
In November, the UK’s five big care home operators – Four Seasons Health Care, Bupa, HC-One, Care UK and Barchester – wrote to chancellor George Osborne to warn that the introduction of a national ‘living wage’ in April will put operators who depend on public sector fees under intense pressure.
The financial situation of Four Seasons, the UK’s largest independent healthcare provider, has also been in the spotlight. The company, owned by Guy Hands’ Terra Firma, is £512 million in debt. It staved off its creditors with a £26 million interest payment in December and insists it will meet another payment due in June.
Memories of the turmoil caused by the 2011 collapse of Southern Cross, which operated 750 care homes, still haunt the sector. However, market participants argue that UK healthcare real estate remains a viable market in which to invest.
“The sector has good macro-indicators, but as with any market there can be short-term issues,” says Keith Harris, executive director in CBRE’s specialist markets division. “This is a sector that looks after very vulnerable people at the end of their lives. Any operating model needs flexibility.”
The plight of operators such as Southern Cross and Four Seasons shows that not even major care home providers are immune to the challenges of the industry. But observers argue that there is continued strong demand for healthcare assets, fuelled in part by the weight of foreign capital targeting the sector and the low cost of borrowing.
Shortage of bed stock
“The over-85 population is set to double, while the number of beds that comply with the Care Quality Commission is set to fall significantly,” says Harris. “Around 60 percent of bed stock is currently non-compliant.”
Much of that stock comprises large, converted houses run by ‘mom and pop’ operators who find it hard to meet the costs of making their stock compliant while competing for publicly funded fees. This means corporate care providers are increasing their share of a fragmented market.
“It is a polarised market,” says Colin Rees-Smith, a director in Savills’ healthcare team. “There are extremes in values from turnkey care home properties in London for £200,000 per bed, to going concerns in the North of England at £20,000 per bed.”
A wide range of real estate falls under the term ‘healthcare’. Private hospitals, specialist clinics and primary care premises such as doctors’ surgeries are all in investors’ sights, but the main focus tends to be long-term care homes.
While there are plenty of struggling providers operating out of sub-standard properties, there are also those catering for private, fee-paying residents based in lucrative, purpose-built facilities.
A total of £1.2 billion was invested in UK healthcare real estate during 2014, CBRE research shows, down from £1.7 billion in 2013, although it was the third consecutive year to top the billion pound mark.
At the big-ticket end of the UK market, US REITs such as Welltower, previously known as Health Care REIT, are dominant. Such vehicles grew rapidly in the US in the post-crisis years and later turned their attention to high-quality product in Europe.
Last May, for example, Welltower bought four Aspen Healthcare hospitals for £225 million at a 6.32 percent net initial yield, in a significant sale-and-leaseback deal.
Private equity has also been active. In November 2014, US-based Formation Capital, alongside Safanad Limited, bought 261 HC-One-operated UK nursing homes from NHP for around £477 million.
Domestic institutions have also invested in healthcare, albeit in smaller deals, with insurers keen to tap into the long leases the industry offers. A stand-out deal by a UK institution was M&G’s 2014 acquisition of six Priory Group hospitals for £233 million.
UK investor Target Healthcare REIT is focused on the care homes market. Kenneth MacKenzie, managing partner at the REIT’s fund manager Target Advisers, says the UK market is tiered. At the top are roughly 100,000 fully en-suite beds in modern homes. Below that are around 250,000 beds with en-suite toilets and washbasins, but no showers. Then there are around 100,000 beds in homes lacking adequate facilities.
Target invests £5 million to £50 million lot sizes in the top tier and occasionally the middle tier where it can raise assets’ quality.
“We are unusual in that we will invest across the country,” says MacKenzie. “We think the decision to buy a care home needs to be a local one. We are specialists in this sector. We think of ourselves as a services business that uses real estate.”
Target Healthcare REIT maintains conservative 20 percent gearing with debt provided by Royal Bank of Scotland: “The last thing this business needs is peaks and troughs,” MacKenzie adds. “It needs to be low-geared, because closing care homes can have catastrophic consequences.”
Despite the amount of investment into UK healthcare, opportunities to provide real estate-level finance are limited at the prime, big-ticket end of the market.
“US REITs tend not to finance investments at asset level,” Christopher Stephens, a director in Barclays’ real estate investment banking division, says. “They have large revolving credit facilities, often back in the US, on which they draw down. Some have been raising US and Euro bonds. We support such firms through corporate lending or acting as book-runners on bond issues.
“The property-level lending market is limited, because US investors compete so effectively for the big deals. UK institutions have also been active buyers, but they do not always add significant leverage to their deals,” Stephens adds.
When real estate owners do seek secured real estate debt, clearing banks and insurers have provided finance. As part of last year’s refinancing of Secure Income REIT, AIG provided a £315.6 million loan secured by 11 of the firm’s healthcare assets. Legal & General’s lending arm, LGIM Commercial Lending, agreed to provide £50 million to Sanctuary Group to finance a portfolio of care homes in the UK last June.
“Larger corporate operators tend to use alternative funding methods, including sale-
and-leaseback deals with REITs or individual investors, in addition to or as an alternative to bank or syndicated bank finance,” says Craig Woollam, head of healthcare at Savills. “The middle markets, comprising smaller and localised operators, remain dependent on traditional finance provided by banks.”
“Operators aiming to raise senior debt have support from banks,” adds Savills’ Rees-
Smith. “If you buy stand-alone units we are seeing 60 to 70 percent loan-to-value ratios. Lenders tend to back investors with a track record in the sector.”
France and Germany on investors’ monitors
Domestic investors largely dominate France’s established healthcare property sector. “The French market is highly regulated and there are fantastic operators,” says CBRE’s Keith Harris, “but the best real estate usually ends up in the hands of the French REITs. It is hard for overseas firms to compete.”
Domestic REITs are well invested in the sector, financed by corporate credit lines. One major French REIT, Gecina, said last October that it was considering a sale of its €1.1 billion healthcare subsidiary, Gecimed. French banks such as Crédit Lyonnais and Société Générale are reported to provide healthcare real estate finance, topping investors up with 55-60 percent loan-to-value asset-level loans.
The German market is very different, with few big domestic investors, owing partly to German open-ended funds’ inability to invest in specialist sectors. Independent ‘mom and pop’ owner-occupiers are the market’s main providers and there has been little corporate consolidation of healthcare real estate. UK and other European investors have been active in the market and US REITs such as Medical Properties Trust have also invested.
“Germany is very interesting,” says Barclays’ Christopher Stephens. “Healthcare assets are typically owned in smaller scale portfolios and there has been very little consolidation. However, French operators have become more active in the market, consequently attracting French banks that are willing to finance the operators and the real estate.”
Last October, Société Générale refinanced 70 retirement and nursing homes in Germany with a €545 million loan, replacing debt owed to 10 banks. The portfolio is known as Panacea and is understood to be owned by Swiss private equity firm Even Capital.