Sale and leaseback has been a popular investment and operating model for care homes. An investor buys the care home property and leases it to the operator for a fixed term. Guaranteeing rental income over the term of the lease, the care provider releases the equity in the building and then pays rent for the use of the site whilst operating the care business.
However, once seen as a good way of releasing equity for the care provider, sale and leaseback has faced an increasing number of hurdles over the years. Traditionally a model for larger providers, such as the now defunct care provider Southern Cross, it was reliant on ongoing demand for beds, along with consistent or increasing fee rates, to ensure income covered rent and operating costs. As local authority fees have stalled, and operational costs increased, the model can put pressure on an operator’s ability to meet rent obligations. This is most common with those providers reliant on local authority contracts, as was the case with Southern Cross.
Today, the model is mainly applied to the high quality care providers who operate from new-build properties, commanding consistent and high fees from private-pay clients. It is favoured by the relatively new care sector investors, such as Target Health Care REIT. Real estate investment trusts, like Target, use sale and leaseback as a basis for their business model. Some of Target’s recent investments look to achieve an initial yield of around 7%, over an average term of 30 to 35 years, depending on the details of the specific agreement. Over the last couple of years, Target has utilised this sale and leaseback approach to invest in properties operated by providers such as Ideal Carehomes and Priory Group.
Smaller scale sale and leaseback
Where sale and leaseback has begun to falter as a model for a wide spectrum of providers, there is now a smaller-scale model emerging. This model is based on smaller investment into individual care suites. The Care Home Group is one such organisation. New to the market, it is offering investment opportunities in care suites in homes, which it is currently acquiring across the UK.
In this instance, The Care Home Group enables people to invest in care home suites via its investment arm, Care Home Invest. The properties will then be managed by the company’s operational division, Care Home Manage, working in partnership with a leading care home management company.
Its brochure says that it offers investors unique, low-risk purchase and leaseback opportunities on individual care suites within care home businesses. Investors are able to purchase a care suite in one of the Group’s homes on a 125-year lease. They can then lease the suite back to the Group over 10 years. It says that it ‘guarantees a truly hands-off’ investment that generates a return from day one, whether the suite is occupied or not.’
Michael Kennelly, Commercial Director of The Care Home Group said, ‘We plan to be much more than an investment company; bringing smaller investors into the market through our investment model will enable us to build our portfolio of homes and refurbish them to a high standard, and by doing so bringing much needed private finance into a sector that is clearly not going to survive on public funding alone.
‘The Care Home Group will also own and manage all its homes, as well as offering its suites for retail purchase by owner/occupiers. We feel that this will give investors a higher level of confidence and enables us to use investment to build on those businesses, improve the care environment and occupancy levels and deliver the best standards of care.’
Mechanics of the process
The Care Home Invest brochure sets out the mechanics of its process. Investors are able to purchase a specialist care suite at a discounted early entry price of between ££76,950 and £111,950. Net yields on the investment are said to be 8% from day one. Returns are assured from day one, with income paid monthly in advance, whether or not the suite is occupied. At any time following the purchase, an investor can opt for The Care Home Group to market the care studio on their behalf, at its full retail price, to prospective residential customers, with a 20% return on its sale, and an opportunity to then purchase further suites for continuing returns.
The single unit, buy-to-let model discussed here has been used for student accommodation with mixed results. However, it has carried some issues. Some situations faced by investors into student accommodation include rental guarantees not being achieved and limited exit opportunities. Rooms in student accommodation are unlikely to be attractive to purchasers other than students, or other investors, making resale limited.
There have also been questions raised over whether the Chancellor’s announcement of stamp duty on buy-to-let properties will apply here. From 1st April 2016, people purchasing additional properties, such as buy-to-let and second homes will be required to pay an extra 3% in stamp duty.
OVER TO THE EXPERTS
Are these smaller scale sale and leasebacks an opportunity for providers to release equity? Is there the market from individual investors? Are providers in a position to offer the returns like those set out by Care Home Invest? Are there too many potential sticking points in, what is currently, a difficult operating climate? Will the stamp duty changes effectively close down the model altogether?
What do the experts think?
RAISES MORE QUESTIONS THAN ANSWERS
We are all acutely aware of the ageing population and the potential requirement for increasing care, however, I am not certain that this model of sale and leaseback for smaller investors is the solution to this issue.
Care homes have never been just about the property and their value has been largely dependent on the quality of care delivered. What happens if a care home gets an inadequate rating and performance suffers and requires additional equity? Care can never be truly hands-off.
In my experience, homes with absentee owners have been more prone to issues than others with fully engaged owners.
Therefore, the management of the homes would be a crucial factor to take into account and how those people would be tied into any arrangements.
I would also be concerned about the liquidity of any investments. How quickly could they be realised? What would be the demand for such assets, which, if based on the experience of student accommodation, might not be great? What happens at the end of the 10-year term?
Presumably, the care home would need to be sold to repay investors – therefore, you would be dependent on the vagaries of the market.
Clearly care home values have increased over the last 10 years. However, this isn’t guaranteed going forward; just look at what’s happened to commodity prices at the end of 2015.
Understanding the terms of the arrangements would also be needed. Are the rents upward only? What happens if the home defaulted on a payment?
To me – it raises more questions than answers at this time.
Paul Birley Head of Public Sector and Healthcare, Barclays
PROVIDES AN OPPORTUNITY TO RELEASE EQUITY
The issues that led to the demise of tenant operators of sale and leaseback are well documented. Funds have learnt from past mistakes. Perhaps too much weight was put on covenant strength without thinking about operator track record, the implications of fee freezes, wage increases and regulatory issues. Funds now seek businesses that attract private clients that provide a pressure valve on fee freezes and staff cost increases.
This model is an opportunity to release equity and develop new schemes. The sector is attractive to smaller investors. It follows similar investments in student accommodation where developers also state appealing and guaranteed initial returns. This, unfortunately, isn’t always the case.
Investors must do their homework. Do developers/operators know the local market and will the scheme meet CQC regulations and fill at a suitable rate? I would advise caution if buying off plan as a new scheme will have both development and management risks. Are proposed rents over-inflated to attract investors but too high for the local market? Once the scheme loses its ‘new’ factor, will rental levels settle?
Investors are often in the hands of the operator in terms of rent and client demand. Operator reputation and the attractiveness of the scheme are paramount. The investment market is limited to other cash investors as it is not always suitable for mainstream buy to let mortgages. Investors can be dependent upon the operator to sell their asset and this will not be a priority if there remains unsold suites from the initial development.
Although the revised stamp duty rates will have an impact for more significant investment, the level of investments here will often be beneath the threshold.
Jessamy Venables Senior Agent, Carterwood
THE SECTOR NEEDS INNOVATION BUT IT MUST BE RIGHT
The challenge for the independent sector is to get the care side right and the business side right in what should be a values-driven sector. Getting the business right is what enables the expression of those core values of service and quality. Public funding is clearly inadequate for the task, long-term underfunding has created a sector in crisis, and the Better Care Fund and Council Tax precept together will hardly lessen the gap. We need to look for answers and innovation.
Our ‘actual costs’ exercise in Lancashire, conducted by LaingBuisson in 2014, showed local authority fees at, or around, a zero return while it seems to have been NHS policy to drive down Continuing Healthcare fees. Local authority and clinical commissioning group commissioners still have, if not monopsony power, ‘super-customer’ muscle. Commissioners knowingly (they might argue unavoidably, but can’t argue unknowingly) underfund and know there are consequences.
New schemes like this need to be explored but there seems a disconnect between the high returns quoted and the levels of risk one would expect to be associated with such returns (some sources have quoted 12% pa) even in a buoyant market. It is difficult to see how public funding would attract investors.
Our advice to providers in our area (although the matter is still to be formally discussed at the Lancashire Care Association Board) would be ‘caveat emptor’ and make sure you get the right independent financial advice. If it looks too good to be true it probably is. Having said that, the care sector needs innovation in financial products to meet the needs of care providers and care users more than ever. However, anyone in the care business should be in it for the long-term and for the right reasons.
Paul Simic Chief Executive, Lancashire Care Association
Written in a personal capacity.