As we start to look to the future and consider life beyond COVID-19, it’s worth considering which of the real estate sectors presents the best long-term investment opportunities.
Naturally, there will be some winners and losers emerging from lockdown. Some sectors, such as grocers, healthcare and online-only retail should be able to demonstrate good earnings throughout this period of turbulence. By contrast, many businesses will be hoping to recover strongly once lockdown restrictions are fully lifted.
Even so, those businesses that do manage to bounce back successfully and quickly will still require more time to prove their earnings again and demonstrate their resilience. That gradual return to normality will make transactions more difficult over the short and medium term.
Care homes present an opportunity
Care home investment deserves particular scrutiny. It may seem counter-intuitive to talk about the investment opportunities within the sector at present, given its frontline status in the fight against the coronavirus. However, looking beyond the press coverage, our close experience within this sector, and our network of contacts, paints a more positive picture for care home groups than the headlines would suggest.
First, we noted an initial uptick in occupancy and bed coverage in the early days of the pandemic, with the NHS, local authorities, clinical commission groups and trusts looking to get non-coronavirus patients who didn’t require critical care out of hospitals to free up capacity. More recently, we’ve seen a stabilisation, with the NHS proving itself able to cope with the peak of the pandemic, and we haven’t seen a flood of beds being taken up. There have been isolated coronavirus cases in specific care homes, but not across the market.
Notwithstanding the COVID-19 impact, care home investment demonstrates strong fundamentals, including government-backed funding, their status as ‘real assets’ and the fact that an ageing population will only increase the demand for care homes. Also, the current fragmented market presents significant opportunities for consolidation and growth.
Growth in the sale and leaseback of care homes
The demise of care home operator Southern Cross in 2011 saw the practice of sale and leaseback fall out of favour. However, confidence in care home investment has gradually returned and we are now seeing substantial growth in sale-and-leaseback structures, as more funds with capital to invest look for defensive long-term income.
Growth has been driven by the number of care home operators willing to run other people’s care homes on leasehold terms. The good news is that there are a number of well-respected operators out there willing to take on leasehold homes, and the increased competition is helping to reduce rent cover requirements to 1.6x-1.7x, although this still depends on the quality of the fabric of the estate itself.
Sale-and-leaseback arbitrage opportunities in care home investment market
A sale and leaseback also presents good arbitrage opportunities when compared with the sale of the operating company (opco) and property company (propco). With a traditional opco and propco sale, the sale value is based on EBITDARM (earnings before interest, taxes, depreciation, amortisation, rent and management fees) times the EBITDARM multiple. With a sale and leaseback, you benefit from the additional generated rent from the new care home operators, which should produce a reasonable increase in overall value.
Other care home investment considerations
As with an investment in any sector, it’s important to be familiar with all the aspects that could affect its value. With care home investment, this means assessing:
- the operational performance of the business, particularly its rating from the Care Quality Commission and its historical trend
- the quality of the management team, which has a strong reputational bearing
- the level of capital expenditure required, particularly if the estate has been underfunded previously
- the structure of the opco and whether it is standalone or part of a wider group.
It’s also important to consider the worst-case scenario, for example with a tenant getting into financial distress, and to put a legally secure structure in place that includes step-in rights. Should the worst happen, this will let you assume control, not just of the bricks and mortar, but also of the underlying care home operator, giving you the option to find an alternative operator and ensure the care home remains a going concern.
Summary
The coronavirus has caused widespread disruption, but it hasn’t diminished appetite within this sector. Although the predicted bounce-back is likely to be fast but varied, and capital will not be deployed across all sectors, those areas of the market that were already on the radar for investors, such as care home investment, will only see increased attention.
To discuss care home investment further, contact Oliver Haunch.
