Chief executive Kenneth MacKenzie explains specialist care home investor Target Healthcare REIT’s pivotal role in ensuring the UK’s care home stock is fit for purpose.
Kenneth spoke to CHP in the wake of the recent flurry of M&A speculation which has seen leading private equity owned providers HC-One, Care UK and Barchester go up for sale.
“We are one of the longest income funds in the London Stock Exchange, other than the ground rent funds” Kenneth said.
“We are not in this to be around for the next two years. We are in this to create a vehicle that is around for the very long term.
“Private equity is by its nature about shorter term returns. Their typical investment view is five to seven years maximum and if they can get out at three or four then all the better because returns improve faster.
“They have their own people who go in to run the businesses, and who tend to exit afterwards, so the leadership changes. While there may be resulting senior management change the people on the ground delivering the care remain and need to cope with new structures and new leadership, and sometimes new processes. People then wonder why there’s high staff turnover and why there’s endless head hunting within the sector.
“We speak about longer term lower cost capital. Private equity is trying to get 15-20% IRR’s, (Internal Rate of Return) we are trying to get 7-9%. We think we have a much more suitable model, for the healthcare sector.”
He added that Target Healthcare REIT’s modus operandi was investing in modern purpose-built homes in order to help ensure that the care home sector is fit for purpose.
The REIT has around 3,600 beds with slightly more than 100 currently without wet rooms.
“We have plans to turn most of them into wet rooms so we essentially have about 100% wet room stock which is highly unusual in the sector,” Kenneth said.
The REIT’s high quality stock contrasts starkly with the overall care sector where only 80,000 or 90,000 of the total 470,000 beds are of a future proof, market standard with wet rooms.
While acknowledging that under provision of fit for purpose stock was a major driver of private equity investment, the managing partner said he did not expect the market to expand as fast as the doubling in capacity forecast by some competitors.
Kenneth speculated that the market was likely to add around 100-150,000 beds to the current 450,000 beds over the next 20 years.
He highlighted that Target was not an initiator of the development of care homes, however, they are an active supporter and partner of existing and future tenants, as they grow their portfolio of modern homes.
“We never do speculative development or initiate development,” Kenneth explained. “We see ourselves as a long term provider of lower cost capital.
“Developers or tenants will approach us and we will work with them. We can fund the development but always on a pre-let basis where a tenant signs up for it the day we buy the ground.“
Since its foundation in 2013, the REIT has invested around £400m in the sector at a rate of around 10-12 homes a year a rate making it one of the UK’s largest modern single care home purchasers.
While having investments in some large operators such as Orchard Care and Priory Group, the staple investment for the REIT is small family providers.
“Our focus is largely on family companies,” Kenneth stressed.
“We love family businesses that are working in local regions all around the country.
“We are an active supporter of the smaller operators because every town needs a modern purpose-built care home rather than an old conversion.”
The REIT takes a more hands-on approach than the typical landlord. Its healthcare team is regularly on site to act as a sounding board to tenants.
Target also runs regular events for its tenants where they can share best practice and issues of the day.
“Our philosophy is that running a care home is a challenging, long term and very honourable profession so how can the financial services industry be a help rather than a hindrance?” Kenneth said.
“Ours is a deep commitment to the sector itself.”
While supporting providers with private fee and local authority fee payers, Target has a heavy preponderance towards the former.
“We have homes from almost all local authority fee payors to 100% private fees,” Kenneth said.
“A sustainable rent level for a home that has 10% private fees has to be a lot lower than 100%. Understanding that mix in the local market is the essence of the underwriting process.”
Size-wise, Target’s homes range from 40 to 116 beds and average between 65 and 70 beds.
“The general tendency is for the developer to want to create more bedrooms because he gets a bigger development profit for his acre of ground.” Kenneth told CHP.
“The operator probably wants a slightly smaller home so that they can regularly fill it efficiently. We would be on the operator’s side in all of that.”
With Target’s investments including four homes run in Northern Ireland run by Priory Group, CHP was interested to learn Kenneth’s views on the current operational climate in the province, given Runwood Homes’ recent problems.
“Northern Ireland is challenging,” Kenneth said.
“The thing that the Northern Ireland government has done which is very difficult for most of the operators is that the private fees are paid through the local authority to the care home so that there isn’t a separate private fee for most of the care homes and therefore the profitability of the home is constrained.
“The local authority keeps an extra amount that private fee payers are paying into a care home.”
As elsewhere, Kenneth said its Northern Ireland homes were a long term commitment but warned that local authorities would ultimately need to provide a financial structure that works so that homes can continue to operate.
The managing partner stressed that providers should have the “nous” to walk away if local authorities were failing to meet the true cost of care.
He cited the example of one provider who notified their local authority that were planning to shift their nursing homes to residential care due to a lack of funding who then received a £250-300 rise in weekly fees within days.
Target’s long-term investment ethos means sticking with an operator through the inevitable setbacks provided they display the correct commitment to the sector.
“We are an investor in a services business,” Kenneth said.
“The impact of that is that there will be upset with the regulator because people sometimes make mistakes. As a long term investor we have to back our operators to get through that.
“When you buy a new care home you are buying a start-up business and four out of five start-up fail. You need to have a bit of extra capital and real commitment to get through a couple of failures.”
The REIT is adding to its healthcare team to provide additional support for its operators.
With its long-term investment approach, Target looks set to continue to play a significant role in ensuring that the UK care home sector becomes truly fit for purpose over the coming decades.