updated on 02 July 2013
QuestionWhat opportunities will the increasing importance of private healthcare providers create for investors?
The healthcare sector is big business and, in a changing landscape, it can offer various opportunities for investors.
One of the primary drivers of this change is the fact that we are all living longer - statistics suggest that over the next 20 years the over-65 age group will increase by as much as 40%. The government is realising that the NHS (which celebrates its 75th birthday this year) needs to adapt to the changing care needs of an ageing population, which is now more prone to lifestyle-related ailments. Increasingly, private institutions are coming to the fore, not just to run in parallel with the NHS but to work in cooperation. This will only increase following the Health and Social Care Act 2012, particularly with the advent of clinical commissioning groups (CCGs) - bodies made up of local GPs authorised to outsource their community's care services to private companies. There is wide opportunity to invest in the sector, given that the spectrum of care services is evolving and increasing. It is no longer just a case of beds in hospitals; multi-purpose GP surgeries, specialist outpatient units, care homes and even retirement villages all now have an important role to play. This provides opportunities (which have already identified by private equity funds) for the companies operating these services, and also provides potentially lucrative investment opportunities from a real estate perspective.
Of course, it is possible for providers of healthcare services to purchase a freehold property to develop and operate its own facilities on this land. However, property is expensive and providers may be unwilling to tie up capital by purchasing and maintaining freehold property. This is where property investment companies have come into play, by acquiring the freehold interests in such property and granting leases to healthcare providers.
This is not a new concept. During the property boom years, some providers found themselves holding freehold properties that had rapidly increased in value. However, being asset rich and owning property that would not realise value until sold was of little use to a provider wishing to invest in and grow its business. The 'sale and leaseback' model therefore became popular, with healthcare providers finding investors willing to purchase their property and then lease it back to them. This was a win-win situation at the time; the provider was able to release capital (which was cheaper than borrowing) to reinvest into its business (which it retained full control of), while the investor benefitted from cash returns through rental income and acquired an asset that required little management and was also likely to continue to increase in value. However, this concept ran into difficulties during the recession, when operators found it increasingly difficult to keep up their rental repayments (a prime example of this being Southern Cross in 2011). Suddenly, the sale and leaseback model was not so attractive to investors.
In the changing healthcare market, some property investment companies will need to explore alternative models to profit from the increasingly important role of private healthcare providers. For some, the sale and leaseback/buy and lease model is still viable, albeit with landlords having to accept that fixed rental uplifts of the type which led to the collapse of Southern Cross are unlikely to be achieved. For others, it would seem greater operational involvement is the answer. With an ageing population and a political departure from traditional hospital care to a more community-focused approach, the building of new care facilities is a necessity. Property developers already in the business of acquiring land, sourcing a tenant and then developing the land accordingly are spotting opportunities in this sphere, often in response to the needs of local CCGs. Alternatively (or in addition), investors could look to utilise the management agreement model, which is popular in the hotel industry. Under such an agreement, an investor buys property and, rather than leasing it to a provider, enters into a contract with a manager/operator to run it. Unlike the sale and leaseback model, this gives the investor far greater input in the operational side and the ability to share in the profits. However, while managers can be incentivised with target-related fees, the downside is that there is both a financial and reputational risk to the investor (the reputational risk certainly being far greater than under a traditional lease model). Finding the right manager will be key.
The route that investors choose to take - and the legal structure they use to facilitate their investment - will ultimately vary. However, as long as the government continues to explore and pursue private involvement in the provision of healthcare, the opportunities for investment in the real estate sphere will continue to increase.
Harriet Clarke is a final-seat trainee at Irwin Mitchell.