Business Clinic
Target Healthcare REIT, the sector’s most active investor?

In just 18 months, Target Healthcare REIT has made a real impact on the sector, reigniting the sale and leaseback model, investing all its initial funds and now raising more.

Target Healthcare REIT Ltd was launched in March 2013 with the remit to invest in UK care homes and other healthcare assets. The London Stock Exchange defines a Real Estate Investment Trust (REIT) as a single company REIT or a group REIT that owns and manages property on behalf of shareholders. Target Healthcare REIT’s concept is, ‘to bring much needed investment into the elderly care sector to improve the quality of the lives of the growing numbers of vulnerable elderly members of society, because life is precious.

‘We know from our personal experiences that care is a 24/7 vocation and that, done properly, can significantly enhance the quality of lives of those whose acuity of needs require residential care. We invest significant time in understanding the culture of healthcare providers and choose to invest in only those whose values are consistent with our own.

‘There is a sound underlying commercial benefit from this approach. Care homes with excellent care standards tend to perform much more profitably than those that don’t. Investment in maintaining the quality of the facilities and training of staff is reflected in the bottom line.

‘We are focused on behaving ethically; we always act with integrity; we place diligence at the heart of our business; we perform detailed analysis; we are genuinely passionate about what we do.’

Who is behind Target?

The team behind Target Healthcare REIT are very experienced in the sector. The board comprises six non-executive directors and an independent investment manager, Target Advisers. Chairman Malcolm Naish has over 40 years’ experience in the real estate industry. He is a chartered surveyor and has been involved in investment management for many years. One of the Non-Executive Directors is Professor June Andrews, Director of the Dementia Services Development Centre at the University of Stirling. The Centre is a world-leader for dementia care home design and Professor Andrews is a world-renowned dementia specialist.

The company’s investment manager is Target Advisers which was established in 2010 by its Managing Partner, Kenneth MacKenzie. Mr MacKenzie is an experienced care sector professional who built up and developed Scotland’s largest home care company, Independent Living Services.

Investment strategy

When it was launched, Target Healthcare REIT set out its targeted investment strategy focusing on building a portfolio of predominantly residential and nursing care home properties in the UK. The investment manager is responsible for sourcing suitable acquisition opportunities. Properties are high quality, modern purpose-built buildings, located in well-researched areas that have sufficient, sustainable demand for places and an ability to maximise private pay clients.

These high quality properties must also have equally high quality care and support too. Businesses must be run by experienced operators, offering high standards of care that meets Care Quality Commission outcomes and is, therefore, a sustainable business over the longer term.

The portfolio

Target Healthcare REIT currently owns properties which are leased back to operators, typically over a term of 35 years. Current operators are Balhousie Care, Ideal Carehomes, Orchard Care Homes, Care Concern Group, Bondcare and Priory Group. The company has also recently exchanged contracts to add an additional 80 bed, modern purpose-built care home to the portfolio located in Hastings, Kent.

The majority of the properties in the portfolio were built between 2010 and 2014, with some dating back to 2006. According to the company’s Prospectus for its new Initial Placing and Offer to raise new funds, the portfolio totals £113,206,000 with an annual running yield of 7.58 per cent. Adding on the new property in Hastings gives the company a combined portfolio total of £120,806,000.

Sale and leaseback

Target Healthcare REIT’s model is not new, it is reigniting sale and leaseback for care home owners. As a model, selling off the property assets to release equity, then leasing it back over the long-term whilst operating the business has been very common in the sector and seen as an alternative to bank financing. Care home providers have great assets in their buildings and selling the property and leasing it back over the long-term is a way to release equity to grow or develop.

However, it’s not without its controversy and most recently it was the model which saw Southern Cross struggle to meet its rent obligations in light of reduced fees from local authorities who purchased the majority of its beds, eventually leading to its demise. The model received a lot of bad press at the time. However, Southern Cross was a different company with a different business model to those Target Healthcare REIT invests in. Target Healthcare REIT is very focused on high-quality, new stock and seeks to maintain an appropriate proportion of private fee paying residents to local authority funded residents via its investment strategy. Southern Cross had a large supply of older stock, many homes competed with others in their area and were heavily reliant on local authority placements. Target Healthcare REIT, via its investment manager Target Advisers, also focuses heavily during the investment period in ensuring the rents are set at sustainable levels over the long-term.

Investing further

In the 18 months since its launch, Target Healthcare REIT has invested all of its initial funds. In early September it announced that it was planning to issue up to 100 million New Shares, including up to 50 million New Shares under an Initial Placing and Offer. It intends to have invested these net proceeds within five to eight months.

In the announcement relating to the acquisition of Hastings Court in early September, Investment Manager Kenneth MacKenzie said, ‘We have a number of other deals with both regional and national operators in advanced non-binding legal negotiations, and we expect to make further announcements soon.’

Over to the experts

With funds expected to be invested in under a year, there is clearly a market for Target Healthcare REIT to invest in and an appetite for the model it backs. The market is seeing property prices and demographics rise and private pay clients are demanding excellent care in high quality surroundings. Is this the beginning of the boom again? Is the sale and leaseback model sustainable? Does it offer a real alternative to bank financing? Will it drive up quality in the care sector or create a bigger divide between private-pay and local authority funded placements? What do our experts think?


A good time for the REITs to be investing

Paul Birley, Head of Public Sector and Healthcare, Barclays 

Sale and leaseback is a tried and tested method of funding care homes. It provides an alternative to traditional bank debt for operators who wish to expand, who perhaps don’t have the necessary capital stake that is required for securing bank finance. The obvious downside is that the operator won’t benefit from any increase in capital value of the home, however they will get additional operating profits which in turn could help them provide their stake for further expansion.

The sector has also seen a number of overseas REITs (particularly from the USA) entering the market. This will make the market more competitive which should be good for operators, although it may drive the returns down a little for Target and the other REITs. The model is relatively simple in that they attract funds and then invest in care homes to get a higher return.

The issue that could arise is operator failure and with Target only investing in homes that are well located with sustainable demand for places, even in this scenario it should be possible to find another operator who could run the home with little disruption to the rental payments. The issue with some recent operator failures was that some of the homes were over-rented and this meant that in their demise, landlords had to take rent cuts. The key will be what happens if market rentals start to fall and Target suffer an operator failure – will they be able to replace with someone that can pay the same rental? Target will also need to ensure the homes remain fit for the future and, therefore, require a minimum level of capital expenditure to ensure the homes remain in demand.

Target, therefore, offer a good alternative to bank financing. Healthcare is, and has always been, a cyclical market and now appears to be a good time for the REITs to be investing.


The model will have a short life

Erica Lockhart, Co-Chair, Care Association Alliance

Investment in the sector is welcomed, as is the choice of investment routes for providers. This route of financing is potentially a high-risk strategy, but could be the right option for some providers who would benefit from the opportunity to release money from their business but still want to continue with the operating side. It would mean the operator would be more highly-leveraged than through normal bank debt, but sometimes ‘needs must’ and in those circumstances it could, therefore, be a positive choice.

The approach described does nothing to imbue confidence in the model since it depends heavily on the self-funder market but does not address the impact on the model of the interference caused by Dilnot and the Care Act 2014. In view of this, it is not possible to draw any confident conclusions as to the sustainability of the model going forward and particularly once Dilnot begins to bite, which could take two or three years.

The model depends heavily on property values. These are beginning to rise now that confidence is building in the economy and it is inevitable that rents will increase with the strength of the economy. This is essential for the model to work.

The model concentrates on high-value youthful stock. Again, to maintain the credibility of the model, the stock will need to be turned over as it ages and could, out of necessity, be sold on at below cost prices.

Our overall view is that the model will have a short life. Timing is of the essence, get the timing right and operators could do well with this model, get it wrong and an operator by losing their freehold could risk any long-term security and future business.


A positive development which could improve quality

Clare Connell, Managing Director, Connell Consulting 

The entrance of the REITs to the care home market has been a positive development which could improve quality in the sector, particularly for private pay elderly care. However, there is currently a shortage of elderly care homes suitable for the private pay market and in the right catchment areas to interest the REITs.

Currently there are care homes for the elderly being sold for 10 times EBITDA (excluding head office costs). Valuations like these do suggest a return to the heady days of 2007 when they were commonplace.

It is difficult to see how such valuations can work long-term for investors and operators. High rents for operators are a particular burden for care homes that cater for older people who are local authority funded. The rates paid by local authorities are low, margins are tight and cost control is difficult when the Care Quality Commission has increasingly high expectations to be met, including the home environment and regular refurbishments.

Whilst private pay rates for elderly care are more generous, it is a competitive market and the opening of new homes in the local area can increase pressure on care home occupancy and increase costs as customer expectations for what a private pay care home looks like and services it offers increases.

When I have visited some high-end private pay homes recently, it is clear the standard of décor and restaurant service in the dining rooms is much more sophisticated than it was 10 years ago, which does increase costs.

A difficult scenario for a care home provider is when they experience a drop in private pay admissions and have to start accepting local authority funded clients to fill beds and their margins are really hit.

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