In October 2015 Fieldfisher published "The Age of Investment in UK Care Homes", a Perspective covering key areas for investors in care homes, including corporate activity, asset backed transactions, funding acquisitions and growth and regulation.
Since that time, we have seen that investment activity in the healthcare market continues to be an attractive option for domestic funds and those overseas, particularly in the US. There has been a specific focus on specialist assets where providers are operating in the care home sector and acute services. Those businesses that are breaking ground in terms of technology that allow remote monitoring and analysis to save costs have also attracted significant attention. Following the government's commitment to invest in mental health services, this has also been another area that has attracted private equity investment allowing existing providers to expand services and add specialist capabilities to their offering.
Although activity in the healthcare sector has slowed recently owing, in a large part to the upcoming Brexit election, there is still some activity and plenty of interest in the healthcare sector. In line with recent trends, this continues to come primarily from non-traditional investors, including REITS, pension funds, sovereign wealth funds and alternative asset managers.
For REITs in particular, since the RIDEA structure1 allowed REITs to change the way they accounted for healthcare real estate income, there has been more interest in the operating entity rather than the just the attraction of the traditionally longer healthcare lease (also known as a propco financing). The RIDEA allows REITs to take a share of the net operating income, as long as there is a third party manager appointed to operate the asset; a step which opened up the possibility of investing in non-stable assets and increasing potential returns beyond the standard 2-3% rent escalations. More broadly, non-traditional investors often have broad mandates and more flexible investment conditions than traditional bank investors and can therefore typically offer the kind of flexibility in their funding products to be able to tailor to the needs of the many facets in the sector.
Ultimately though, investors in the healthcare sector are looking for the right deal to fit with their investment mandate and with the breadth of opportunities available in the healthcare market there is plenty of opportunity at present. An interesting sub sector that warrants further analysis given the increasing demand is the care home space. The involvement of non-bank lenders in this area has led to a significant shift in the acquisition strategy from looking solely at net operating income and the rent payment, to more sophisticated operating underwriting proforma models, market analysis, and analysing operator pedigree and industry experience. In order to successfully identify potential targets and opportunities, investors are becoming more interested in the nature of the business and opportunities for joint ventures.
Distressed Assets and High End Product
Investors in the care home market are also looking to pick up distressed assets or invest in the hotel style high end facilities that attract the privately funded clientele. Our healthcare regulatory specialists are increasingly working as part of multidisciplinary teams helping to profile assets in terms of service delivery. This avoids the pitfalls of a purchase that may have an excellent location and premises, but is overvalued due to regulatory compliance issues that have affected the inspection rating awarded by the Care Quality Commission ("CQC"). The regulatory profile of an asset is becoming more and more significant as the CQC moves towards intelligent monitoring in relation to its registration and inspection activity. Traditionally this has been perceived by some as a pass or fail, however since the introduction of the new inspection regime in 2015, this is not the case. Interestingly, the CQC's Chief Inspector Andrea Sutcliffe recently fired a shot across the bows to luxury providers, who operate large 60 bed plus homes, stating that they need to focus more on person centred care/community with a suggestion there is an inherent difficulty in achieving an outstanding rating or a good with outstanding features when operating at this scale.
The CQC and other stakeholders
Other external relationships also matter; the reputation of the provider with the local authority (who has an interest under the Care Act), commissioners and the CQC can also impact on the ability of the business to enter into joint ventures with acute or other services to assist in meeting assessment and discharge targets. Investor clients also need to be aware of the CQC's financial oversight powers when investing in adult health and social care at an early stage to assist them in how they formulate their acquisition strategy and structure their business arrangements
From a provider perspective, It is not difficult to see why there is potential for resistance from the operators where there is too much interference from an investor. However as investors take more risks in the operating companies; they will want to avoid the situation that a number of well-known banks found themselves in with a large distressed asset portfolio on their books. There is a balance to be struck where the investor knows the key business markers that signal regulatory as well as financial distress that do not lead to disproportionate interference with the day to day service delivery. In our experience, where there is a regulatory concern, unless managed properly, financial distress is likely to follow. This can often be without any formal regulatory intervention, however the impact on the business is no less devastating.
Supply and demand
In terms of investment opportunities, there have been well publicised concerns about the financial stability of some of the larger care home providers given the anticipated impact of the national living wage and frozen local authority fees. Healthcare analysts at Laing & Buisson state that an extra 12,000 care home places are needed every year to keep pace with the numbers of people reaching 85 and over, which was the average point when the elderly and their families typically needed support. While there are currently 480,000 care home beds in the UK, nearly 80% were in ageing properties with an estimated 7,000 beds leaving the market each year. Laing & Buisson forecasts suggest that the sub-sector of modern, purpose-built homes will grow from 100,000 beds in 2015 to 160,000 by 2020. If there is a distressed asset that is a target, significant savings can be made by putting in place an effective turnaround strategy and if necessary an interim management team. The opportunities are there for savvy investors with expertise in the operation of care homes.
There is also significant potential in the development of new "alternative living" lifestyle residential care facilities, with the UK looking to models that have been operating overseas in the US and Australia to mitigate the demands of an ageing population. Smaller, "niche" care facilities with luxury facilities available to residents, assisted stay at home living arrangements and Australian-style retirement villages which combine the benefits of independent living with the care requirements necessary for the elderly are attracting increasing amounts of interest in the aged care space. In addition, technologies aimed at assisting people to live independently in their own homes for longer are proving ripe investment opportunities. What these facilities and services have in common is the private pay element, capitalising on a generation that had the benefit of capital gains on private property purchased cheaply and then experiencing exponential growth. Non-traditional, opportunistic investors are on the look out for alternative models of aged care catering to the needs of this subset of society.
With increasing pressure to make ends meet in the lower end of the care home market and growing interest from investors in the more high-end and niche options, investors in aged care have contributed to the continued polarisation of the aged care market. Following the introduction of the national living wage increase and public funding remaining within the remit of cash strapped councils, the viability of existing lower end facilities is being threatened. Those with a portfolio of less than ten homes with a local authority client base are finding themselves in distress due to economies of scale. This combined with the ever expanding options for private pay clients and the demand for places in care homes/other facilities indicates the polarisation in aged care is set to continue. Notwithstanding this, the continued volatility in the sector coupled with the obvious demand for aged care facilities and services is set to make for some exciting movement in the sector in the next few years.
1 RIDEA stands for REIT Investment Diversification and Empowerment Act enacted in 2007. The RIDEA structure allows REITs to benefit from the operating income, rather than get a fixed return irrespective of how well the business is doing.