An immature sector that is not really a property market at all: this is the picture of healthcare drawn by some observers after the collapse in July of care home provider Southern Cross. The failure of the 752-strong chain left the sector reeling. But five months on, investors, advisers and care providers say the debacle may have helped to clear the air in an area vulnerable to misunderstanding.
The landlord: Louise Issac, fund manager for Quercus, Quintain’s healthcare fund
Louise Issac was never a fan of Southern Cross. Of the eight Southern Cross homes in her £744m portfolio, six were the result of the operator taking over a rival with which Quercus had been happy to deal.
“The Southern Cross yield wasn’t right for us, and I never felt their prices were justified,” says Issac. “I could never get to the bottom of them.”
Avoiding too-good-to-be-true yields of around 5% helped Quercus to stay out of trouble. But Issac explains: “The physical asset itself is worth practically nothing. The alternative uses for a care home are minimal. It is best to knock it down and build something else.
“So when we invest we buy the goodwill of the business. I have always been careful to get to the bottom of things, to know the business, and that’s all about turnover, occupancy and wages.”
Although the number of elderly people is growing fast, demand for old-fashioned care home beds of the kind Southern Cross provided is falling.
“The days when care homes were about nice quiet old ladies doing their knitting is long gone,” says Issac. “We used to say that roughly 18% of the elderly needed care, but that’s now down to 15% and shrinking. Most elderly people will want, and be able, to stay in their own homes.”
However, demand for specialist services, including care for children and people with dementia, brain injury and learning disabilities, is set to grow.
Fees can often be much higher than for standard elderly care – by a factor of five in some cases.
“A wise investor spreads the risk around the portfolio,” says Issac.
That is one sure way to avoid another Southern Cross crash.
The alternative care provider: Nick Sanderson, chief executive of Audley Villages
Luxury provider Audley Villages has read the runes more carefully than middle-market providers like Southern Cross, says chief executive Nick Sanderson.
“There are something like 500,000 care beds for the elderly in the UK today, and most will go out of business.”
Sanderson adds. “About two-thirds do not meet modern care standards, and besides, the almost Victorian way we institutionalise old people won’t be acceptable in the future.
“Too many people have misunderstood the demographics. Having lots more elderly people, each with money to spend, does not mean that we need more care homes. That’s not what people want, and it won’t be the norm.”
Most will prefer to live in their own home, but some, he believes, will like to stay in an Audley-type retirement property, with the backing of an appropriate care package.
Others will need specialist dementia care – the number of people with dementia is expected to grow by a third in the coming years – but few, perhaps none, will want to live in a traditional old people’s home.
“Can you see the people who matured in the 1960s going quietly into an old folks’ home? I can’t,” says Sanderson.
The investor: Mike Adams, chief executive at MedicX Healthfund
The way value was created in the healthcare sector before the Southern Cross collapse was a mystery – even to many of those buying into it, but today the mechanism is much clearer, says MedicX chief executive Mike Adams.
In October, MedicX acquired two care homes let to Scotland’s largest privately-owned provider, the Balhousie Care Group, and a third in Bangor, Northern Ireland, let to Maria Mallaband Care Group. The three-property deal represented a combined investment of more than £12m.
The acquisitions were the first announced since the MedicX vehicle closed on a second fund-raising at the end of September, when £55m was secured from a number of existing investors.
The fund-raising had also attracted the involvement of Schroders.
“Southern Cross was very driven by financials – by the ability to get people to pay very high prices for things they didn’t understand,” says Adams.
“You only had to visit the properties to see that they just couldn’t sustain the prices. An old building which needs lots of money spending on it, with wages going up and fee income from local councils going down, is sure to go wrong,” he adds.
“Investors didn’t understand the asset class they were buying into, and didn’t understand how value was created in the health sector.
“It’s a dangerous place to go if you don’t have a healthcare expert working on your team,” says Adams. “But build the right building in the right location, and it’s a fantastic place to be.”
UK MAJOR CARE PROVIDERS 2007 2008 2009 2010 2011
UK average occupancy 92% 89% 89% 88% n/a
Southern Cross average occupancy 90.7% 89.5% 87.7% 84.8% c.85%
UK average fee £565 £581 £603 £704 n/a
Southern Cross average fee £499 £522 £56 £559 £559 (H1)
There are 12 major landlords that own approximately 625 Southern Cross care homes.
Three of the major landlords that are also care home operators (Four Seasons Health Care, Lifestyle and Bondcare) can step in and run the homes themselves.
Southern Cross operates approximately 70% purpose-built care homes.
The remaining circa 100 homes are owned by around 70 private landlords and small property companies.
Around 85% of Southern Cross homes are within a five-mile radius of another Southern Cross home.
Southern Cross has an overcapacity of beds in the north east of England.
Southern Cross trades with an over exposure to local authority funding and an inadequate level of private fees.
Leases are predominantly RPI-linked with annual uplifts, compounded by falling occupancy.
Source: Knight Frank
Managers must stay focused
Care home managers must ensure they keep a strong focus on their business, according to Colliers International’s Jeremy Tasker.
“At Southern Cross, management had taken their eye off the ball,” he says. “Staff were leaving and there was a lack of referrals, yet all the managerial effort was going into serving debt repayments.”
Colliers’ latest Care Homes Review, which measures occupancy rates, average weekly fees, payroll costs, non-payroll costs and profit margins (EBITDAR), reveals that while average nominal weekly fees have risen steadily over the past two years, fees in real terms weakened by 0.6% over the course of the first half of this year.
Margins are hovering at around 30%, and Colliers’ analysis of occupancy rates – both the two-year rolling average and the non-weighted data – shows that these came under pressure in the first six months of 2011.
Both nursing and residential care homes are experiencing a reduction in occupancy rates, but the greatest falls are being seen in the residential care sector.
“The climate is unlikely to improve in the short term, with operators having to constantly review their operational performance,” warns Tasker.
After their rescue of homes in the Southern Cross portfolio, agents were convinced that the neglect of property fundamentals – good location and good repair – had left the operator in a perilously vulnerable position.
Julian Evans of Knight Frank advised Methodist Homes, which took on the leases of 14 Southern Cross homes following a deal with Prestbury.
He says that 85% of Southern Cross homes were situated within five miles of another Southern Cross home, and all but a handful were within 10 miles of another in the same portfolio.
“These homes were cannibalising each other’s business,” says Evans. “The lesson here is that operators need to do proper feasibility studies.”
Vector director Richard Harris successfully re-let 58 of 60 Southern Cross homes. “Some were in a very poor state of repair,” he says.
“This is something landlords mistakenly expect to be the tenant’s responsibility and in their interests to maintain.
“The ability to monitor the homes’ condition and ensure that sufficient capital expenditure is used to maintain them in a good state of repair is now high on the agenda with landlords we advise.”
